Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
------------------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [Fee Required]
For the fiscal year ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [No Fee Required]
For the transition period from _______ to _______
Commission File Number 0-20160
------------------------------
CoVest Bancshares, Inc.
(Exact name of Registrant as specified in its charter)
Delaware 36-3820609
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
749 Lee Street, Des Plaines, Illinois 60016
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (847) 294-6500
Securities Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
------------------- ---------------------
NONE NONE
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
--------------------------------------------------
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 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
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
- --------------------------------------------------------------------------------
1
As of March 5, 1998, the Registrant had issued and outstanding 4,403,803 shares
of the Registrant's Common Stock. In addition, it had also repurchased 41,765
shares which were being held as treasury stock. The aggregate market value of
the voting stock held by non-affiliates of the Registrant as of March 5, 1998,
was $68,078,370*
DOCUMENTS INCORPORATED BY REFERENCE
- -------------------------------------------------------------------------------
PART III of Form 10-K--Portions of the Proxy Statement for the 1998
Annual Meeting of Stockholders.
* Based on the closing price of the Registrant's Common Stock on March 5, 1998,
and reports of beneficial ownership filed by directors and executive officers
of Registrant and by beneficial owners of more than 5% of the outstanding shares
of Common Stock of Registrant; however, such determination of shares owned by
affiliates does not constitute an admission of affiliate status or beneficial
interest in shares of Registrant's Common Stock.
- --------------------------------------------------------------------------------
2
CoVest Bancshares, Inc.
1997 ANNUAL REPORT ON FORM 10-K
Table of Contents
Page
Number
------
PART I
Item 1. Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Item 2. Properties. . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . 32
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . 32
PART II
Item 5. Market for the Registrant's Common Stock and Related
Security Holder Matters. . . . . . . . . . . . . . . . . . . . . 33
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . . 35
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations. . . . . . . . . . . . . . . . . . . . 37
Item 7A. Quantitative and Qualitative Disclosure About Market Risk . . . . 47
Item 8. Consolidated Financial Statements . . . . . . . . . . . . . . . . 50
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure . . . . . . . . . . . . . . . . . . . . 77
PART III
Item 10. Directors and Executive Officers of the Registrant. . . . . . . . 77
Item 11. Executive Compensation. . . . . . . . . . . . . . . . . . . . . . 77
Item 12. Security Ownership of Certain Beneficial Owners and Management. . 77
- --------------------------------------------------------------------------------
3
Item 13. Certain Relationships and Related Transactions. . . . . . . . . . 77
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on 8-K . . . 78
SIGNATURES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
- --------------------------------------------------------------------------------
4
PART I
SAFE HARBOR STATEMENT
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The Company intends such forward-
looking statements to be covered by the safe harbor provisions for forward-
looking statements contained in the Private Securities Reform Act of 1995, and
is including this statement for purposes of these safe harbor provisions.
Forward-looking statements, which are based on certain assumptions and describe
future plans, strategies and expectations of the Company, are generally
identifiable by use of the words "believe," "expect," "intend," "anticipate,"
"estimate," "project" or similar expressions. The Company's ability to predict
results or the actual effect of future plans or strategies is inherently
uncertain. Factors which could have a material adverse affect on the operations
and future prospects of the Company and the subsidiaries include, but are not
limited to, changes in: interest rates, general economic conditions,
legislative/regulatory changes, monetary and fiscal policies of the U.S.
Government, including policies of the U.S. Treasury and the Federal Reserve
Board, the quality or composition of the loan or investment portfolios, demand
for loan products, deposit flows, competition, demand for financial services in
the Company's market area and accounting principles, policies and guidelines.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements. Further
information concerning the Company and its business, including additional
factors that could materially affect the Company's financial results, is
included in the Company's filings with the Securities and Exchange Commission.
Item 1. BUSINESS
THE COMPANY
GENERAL
CoVest Bancshares, Inc., a Delaware corporation (the "Company"), is a bank
holding company registered under the Bank Holding Company Act, as amended (the
"BHCA"). The Company's operating subsidiary is CoVest Banc, National
Association, a national banking association (the "Bank"). The Bank's subsidiary
service corporation, CoVest Investments, Inc., an Illinois corporation ("CII"),
engages in the business of selling annuities, insurance products and complete
brokerage services. The Company was organized in 1992, in connection with the
Bank's conversion from the mutual to the stock form of organization (the
"Conversion") which was completed on June 30, 1992. As part of the Conversion,
the Company issued 3,220,000 shares of its common stock, $.01 par value per
share (the "Common Stock"), at a price of $10.00 per share. The Company's
Common Stock is quoted on the Nasdaq National Market System under the symbol
"COVB" (neither the original number of shares nor the price per share have been
adjusted for subsequent stock splits). Prior to August, 1997 the Company was a
savings and loan holding company registered under the Home Owners Loan Act, as
amended. The Company became a bank holding company effective August 1, 1997,
when the bank completed its conversion from a federal savings association to a
national bank. The Bank is the Company's only financial institution subsidiary
and was initially chartered as a federally chartered savings and loan
association in 1934. The Bank changed its name to "First Federal Bank" in
1990. Effective August, 1997, the Bank converted from a savings association
to a national bank and changed its name to "CoVest Banc, National
Association." All references to the Company include the Bank and its
subsidiary, CII, unless otherwise indicated, except that references to the
Company at or before June 30, 1992 refer to only the Bank and CII on a
consolidated basis.
- --------------------------------------------------------------------------------
5
The Company and the Bank are subject to comprehensive regulation, examination
and supervision by the Board of Governors of the Federal Reserve System (the
"FRB"), the Office of the Comptroller of the Currency (the "OCC") and the
Federal Deposit Insurance Corporation (the "FDIC"). The Bank is a member of the
Federal Home Loan Bank System (the "FHLB") and its deposits are insured by the
Savings Association Insurance Fund ("SAIF") to the maximum extent permitted by
the FDIC. The Company engages in a general full service retail banking business
and offers a broad variety of commercial and consumer oriented products and
services to customers in its primary market area. The Company is principally
engaged in the business of attracting deposits from the general public and
originating commercial loans and to a lessor extent mortgage loans in its
primary market area. The Company also originates consumer loans and in
addition, invests in mortgage-backed and related securities, and marketable
equity securities. Finally, the Company offers, on an agency basis through CII,
annuities, insurance products and complete brokerage services to its customers.
The Company's income is derived from interest on loans, mortgage backed and
related securities and other securities, service charges and loan origination
fees, loan servicing fees and proceeds from the sale, through CII, of annuity
and insurance products. The Company's operations are materially affected by
general economic conditions, the monetary and fiscal policies of the federal
government and the policies of the various regulatory authorities, including the
OCC and the FRB. Its results of operations are largely dependent upon its net
interest income, which is the difference between the interest it receives on its
loan and securities portfolios and the interest it pays on its deposit accounts
and borrowed money.
The Company's corporate headquarters are located at 749 Lee Street, Des Plaines,
Illinois. The Company's telephone number is (847) 294-6500.
MARKET AREA
The Company's main office and a drive-up facility are located in downtown Des
Plaines, Illinois. Des Plaines is a mature suburban Chicago community which had
a population of approximately 53,200 in 1990. Des Plaines is located
approximately 20 miles from downtown Chicago and five miles north of Chicago's
O'Hare airport.
In March, 1994, the Company established its first branch office in Arlington
Heights, Illinois, through the acquisition from the Resolution Trust Corporation
of the deposits and office building of the Arlington Heights branch of the
former Irving Federal Bank, F.S.B. Arlington Heights is a suburban Chicago
community located approximately 10 miles northwest of Des Plaines. Based on the
1990 census, it had a population of approximately 75,500.
On March 2, 1995, the Company opened its third full-service office in
Schaumburg, Illinois. Schaumburg is a relatively young suburb, and has seen
rapid growth although this has slowed somewhat recently. It is located
approximately 16 miles southwest of Arlington Heights and approximately 22 miles
west of Des Plaines. Schaumburg had a population of 68,586 in 1990.
On February 11, 1998, the Company opened a Mortgage Center in McHenry, Illinois,
the county seat of McHenry County, located approximately 35 miles northwest of
Des Plaines. The CoVest Banc Mortgage Center is a full service facility that
will concentrate on mortgage loan origination and sales.
Des Plaines and parts of the surrounding contiguous communities such as Park
Ridge, Niles and Mount Prospect have historically constituted the Company's
primary market area. However, with the establishment of the two additional
offices by the Company, the market area has expanded into several other suburbs
such as Arlington Heights, Prospect Heights, Buffalo Grove, Schaumburg and
Hoffman Estates. These suburban areas are characterized by single-family
residences and apartment buildings. These demographics provide the
- --------------------------------------------------------------------------------
6
Company with diverse opportunities for commercial lending, which became a focus
of the Bank in 1996. In addition, many of the residents of the Company's
primary market area consist of professional or "white collar" workers who
commute into Chicago or engage in local retail trade, although a significant
number of residents in the farther outlying suburbs, such as Schaumburg, work in
that community at jobs in the service sector. The Company's success has been
due, in part, to its market area's growth, favorable population and income
demographics.
LENDING ACTIVITIES
General
SOURCES OF FUNDS
The Company faces strong competition both in originating loans and in attracting
deposits. Competition for commercial loans, commercial real estate,
construction and multi-family loans comes primarily from large commercial banks
and smaller community banks. Competition in originating real estate loans comes
primarily from mortgage bankers, other savings institutions and commercial
banks, all of which also make loans secured by real estate located in the
Company's primary market area. The Company competes for real estate loans
principally on the basis of the interest rates and loan fees it charges, the
types of loans it offers and the quality of services it provides to borrowers.
The competition for consumer loans comes primarily from commercial banks and
finance companies.
The principal lending activity of the Bank historically has been originating
first mortgage loans for its portfolio, secured by owner occupied one-to-four
family residential properties located in its primary market area. The Bank also
offers a wide selection of consumer loans. Beginning late in 1995, and
continuing into 1998, the Bank began a major balance sheet restructuring
project. The Bank is now a full-service commercial bank, offering commercial
loans, multi-family loans, commercial real estate loans, construction loans and
purchasing investment grade commercial leases. These types of lending will be
the major focus of the Bank going forward as it continues to function more as a
traditional commercial banking institution.
As part of the balance sheet restructuring project, in 1995 the Bank securitized
$116 million of fixed rate portfolio loans with the Federal Home Loan Mortgage
Corporation ("FHLMC.") These loans were then classified as securities
available-for-sale. In 1996, the Bank securitized $61 million of fixed rate and
balloon portfolio loans with FHLMC. These were used for liquidity needs and
management sold some of these securities in 1997, in order to originate higher
yielding commercial loans and commercial real estate loans. During 1997,
management securitized an additional $17.8 million of conforming loans of which
$10.1 million was held for securitization at December 31, 1996. Loans were
classified as securities available-for-sale at December 31, 1997. These were
used for liquidity needs and management sold some of these securities in 1997.
With the establishment of the Mortgage Center, the Bank will provide a full
array of first mortgage products for which it will act as a loan originator and
placer. It is anticipated that all loans will be sold on a serviced release
basis to mortgage buyers, for which the Bank will receive a fee and have no
additional rights.
- --------------------------------------------------------------------------------
7
LOAN PORTFOLIO COMPOSITION
The following table outlines the composition of the Company's loan portfolio in
dollar amounts and in percentages as of the dates indicated:
December 31,
------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
Commercial loans $ 5,504 1.44% $ 58 .02% $ - -% $ - -% $ - -%
Real estate loans
One-to-four family 235,425 61.76 251,831 74.21 275,570 83.04 297,682 85.16 219,836 88.49
Multi-family 4,604 1.21 995 0.29 177 0.06 226 0.06 259 0.10
Commercial real estate 56,220 14.75 20,705 6.11 2,200 0.66 - - - -
Construction 8,939 2.34 1,811 .53 - - - - - -
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 305,188 80.06 275,342 81.14 277,947 83.76 297,908 85.22 220,095 88.59
Commercial leases 11,274 2.96 7,053 2.08 - - - - - -
Consumer loans
Automobile 22,781 5.98 21,802 6.42 18,618 5.61 17,192 4.93 11,686 4.70
Home equity/improvement 21,987 5.77 18,570 5.47 16,323 4.92 14,211 4.06 9,408 3.79
Credit cards 13,469 3.53 15,812 4.66 18,289 5.51 19,930 5.70 6,940 2.80
Other loans 1,008 0.26 716 0.21 677 0.20 323 0.09 291 0.12
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans 59,245 15.54 56,900 16.76 53,907 16.24 51,656 14.78 28,325 11.41
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans 381,211 100.00% 339,353 100.00% 331,854 100.00% 349,564 100.00% 248,420 100.00%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Net deferred costs/fees 275 616 542 (1,084) (2,235)
-------- -------- -------- -------- --------
Total loans receivable $381,486 $339,969 $332,396 $348,480 $246,185
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
- -------------------------------------------------------------------------------
8
The following table shows the composition of the Company's loan portfolio by
fixed and adjustable rate at the dates indicated:
December 31,
------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
Fixed rate loans
Commercial loans $ 438 0.11% $ 58 0.02% $ - -% $ - -% $ - -%
Real estate loans
One-to-four family 137,314 36.02 157,430 46.39 215,556 64.96 270,536 77.39 207,291 83.44
Multi-family 576 0.15 995 0.29 177 0.06 226 0.06 259 0.11
Commercial real estate 15,863 4.16 20,304 5.98 2,200 0.66 - - - -
Construction 63 0.02 - - - - - - - -
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 153,816 40.35 178,729 52.66 217,933 65.68 270,762 77.45 207,550 83.55
Commercial leases 11,274 2.96 7,053 2.08 - - - - - -
Consumer loans 29,424 7.72 26,160 7.71 22,449 6.76 22,867 6.54 18,294 7.36
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total fixed loans 194,952 51.14 212,000 62.47 240,382 72.44 293,629 83.99 225,844 90.91
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Adjustable-rate loans
Commercial loans 5,066 1.32 - - - - - - - -
Real estate loans
One-to-four family 98,111 25.74 94,401 27.82 60,014 18.08 27,146 7.77 12,545 5.05
Multi-family 4,028 1.06 - - - - - - - -
Commercial real estate 40,357 10.59 2,212 0.65 - - - - - -
Construction 8,876 2.33 - - - - - - - -
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 151,372 39.72 96,613 28.47 60,014 18.08 27,146 7.77 12,545 5.05
Consumer loans 29,821 7.82 30,740 9.06 31,458 9.48 28,789 8.24 10,031 4.04
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total adjustable loans 186,259 48.86 127,353 37.53 91,472 27.56 55,935 16.01 22,576 9.09
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans 381,211 100.00% 339,353 100.00% 331,854 100.00% 349,564 100.00% 248,420 100.00%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Net deferred costs/fees 275 616 542 (1,084) (2,235)
-------- -------- -------- -------- --------
Total loans receivable $381,486 $339,969 $332,396 $348,480 $246,185
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
- -------------------------------------------------------------------------------
9
The following schedule illustrates the contractual maturities of the
Company's loan portfolio at December 31, 1997. Mortgages which have
adjustable or floating interest rates are shown as maturing in the period
during which the contract is due. The schedule does not reflect the effects
of possible prepayments or enforcement of due-on-sale clauses:
(Dollars in Thousands)
Comm. Loans,
Comm. Real Estate,
Construction,
One-to-Four Family Multi-Family Consumer
Residential Loans(1) and Leases Loans Total
-------------------- ---------- ----- -----
Coming due during Weighted Weighted Weighted Weighted
years ending Average Average Average Average
December 31, Amount Rate Amount Rate Amount Rate Amount Rate
------------ ------ ---- ------ ---- ------ ---- ------ ----
1998* $ 7,453 7.21% $16,884 8.92% $21,842 9.89% $ 46,179 9.11%
1999 8,617 7.44 6,019 7.79 6,990 8.07 21,626 7.74
2000 8,440 7.49 10,618 8.75 5,200 8.10 24,258 8.17
2001 to 2002 19,218 7.58 18,359 8.38 3,292 8.08 40,869 7.98
2003 to 2007 50,238 7.33 16,497 8.36 11,277 8.92 78,012 7.78
2008 to 2022 30,115 7.63 11,852 8.23 10,644 9.65 52,611 8.17
2023 and beyond 115,948 7.55 1,708 8.56 - - 117,656 7.56
-------- ---- ------- ---- ------- ---- -------- ----
Total $240,029 7.50% $81,937 8.47% $59,245 9.19% $381,211 7.97%
-------- ---- ------- ---- ------- ---- -------- ----
-------- ---- ------- ---- ------- ---- -------- ----
(1) Includes demand loans, loans having no stated maturity, and overdraft
loans.
The aggregate amount of loans that the Bank is permitted to make to any one
borrower is generally limited to 15% of unimpaired capital and surplus (25%
if the security for such loan has a "readily ascertainable" value,). At
December 31, 1997, based on the above, the Bank's regulatory loan-to-one
borrower limit was $7.2 million. On the same date, the Bank's largest loan
was $5,873,000.
All of the Company's lending activities are conducted in accordance with its
written underwriting standards and its loan origination procedures. The
Company is an equal opportunity lender and each year offers its Affordable
Housing Program for families with a maximum household income of 115% of the
median income as published by the Federal Housing Finance Board. Decisions
on all loan approvals or denials are made on the basis of detailed
applications and property valuations (consistent with the Company's written
appraisal policy) prepared by independent appraisers. The loan applications
are designed primarily to determine the borrower's ability to repay and the
more significant items on the application are verified through use of credit
reports, financial statements, tax returns and/or third-party confirmations.
COMMERCIAL LENDING
Management of the Company has made a commitment to become a full service
community bank. In line with this commitment, the Company has increased its
originations of commercial real estate loans, multi-family loans, commercial
leases and commercial loans. Management intends to focus on this type of
lending in the future. The commercial real estate loans, multi-family loans
and commercial loans are collateralized by property within the Company's
market area. The commercial leases, which may extend beyond the Company's
market area, are usually investment grade leases.
The underwriting standards used by the Company for these types of loans
include a determination of the applicant's payment history, cash flow, value
of collateral, and credit worthiness of the business.
- -------------------------------------------------------------------------------
10
These types of loans all carry a rate substantially higher than residential
mortgages, and also carry greater credit risk. Leases, of which 68% are
investment grade instruments, are not considered a substantial risk, and
therefore, no allowance for possible losses is being established specifically
for leases.
At December 31, 1997, the Company had $56,220,000 in commercial real estate
loans, $8,939,000 in construction loans, $5,504,000 in commercial loans, and
$4,604,000 in multi-family loans. The Allowance for Possible Loan Losses
account included $2,256,000 for these types of loans at December 31, 1997.
ONE-TO-FOUR FAMILY RESIDENTIAL REAL ESTATE LENDING
The cornerstone of the Company's lending program has historically been the
origination of one-to-four family permanent loans, to be held in its
portfolio, secured by mortgages on owner-occupied residences. In February,
1998, the Company established the CoVest Banc Mortgage Center. With the
creation of the Mortgage Center, the Company has the ability to originate
one-to-four family mortgages with competitive rates without the interest
rate exposure associated with originations for its own portfolio.
Additionally, the Mortgage Center will generate non-interest income from the
receipt of SRP's (service release premiums) from the sale of the originated
mortgages to secondary market investors. The Mortgage Center's investor
network of approximately thirty private or institutional investors will allow
the Company to offer Conventional, Jumbo, VA and B, C and D (sub-prime) loan
programs for first mortgages. The Mortgage Center will also have the ability
to originate and sell 125% equity loans and equity loans to borrowers with
credit problems, through investors.
The Company will continue to originate loans targeted at low and moderate
income home buyers through the Affordable Housing Program and the Community
Investment Program which will be retained in its portfolio.
At December 1997, the Company held as Mortgage Backed Securities ("MBS")
previously securitized with Federal Home Loan Mortgage Corporation $61
million of 15 and 30 year fixed-rate and balloon single family residential
mortgage loans. The Company, depending on liquidity needs, may sell a
portion of these securities in 1998. At December 31, 1997, $235.4 million of
the Company's loan portfolio consisted of permanent loans on one-to-four
family residences. At that date, the Company's largest outstanding
residential loan was $1,078,000. Substantially all of the residential loans
originated by the Company are secured by properties located in the Company's
primary market area. See "Origination, Purchases and Sales of Loans."
The Company continues to have fewer one-to-four family residential homes in
its portfolio and has seen the total drop from 88.49% of total loans on
December 31, 1993 to 61.76% of total loans on December 31, 1997.
The Company evaluates both the borrower's ability to make principal, interest
and escrow payments and the value of the property that will secure the loan.
The Company originates residential mortgage loans with loan-to-value ratios
of up to 95%. On any mortgage loan exceeding an 80% loan-to-value ratio at
the time of origination, the Company requires private mortgage insurance in
an amount intended to reduce the Company's exposure to 80% or less of the
appraised value of the underlying property.
The Company's residential mortgage loans customarily include due-on-sale
clauses, giving the Company the right to declare the loan immediately due and
payable in the event that, among other things, the borrower sells or
otherwise disposes of the property subject to the mortgage.
CONSUMER LENDING
Management believes that offering consumer loan products helps to expand and
create stronger ties to the Company's existing customer base. In addition,
because consumer loans generally have shorter terms to maturity and/or
adjustable rates and carry higher rates of interest than do residential
mortgage loans, they can be valuable asset/liability management tools.
Finally, management believes that consumer loans can diversify the portfolio.
Accordingly, the Company pursues consumer lending through marketing and
pricing initiatives.
- -------------------------------------------------------------------------------
11
The Company currently originates substantially all of its consumer loans in
its primary market area. At December 31, 1997, the Company's consumer loans
totaled $59.2 million or 15.54% of the Company's loan portfolio.
The Company's second mortgage and home equity loans are underwritten using
the same standards as it uses for one-to-four family residential mortgage
loans. The Company's second mortgage loans and home equity lines of credit
are generally originated in amounts which, together with the amount of the
first mortgage, do not exceed 80% of the appraised value of the property
securing the loan. Home equity loans are revolving lines-of-credit, with the
interest rate floating at a stated margin over the prime rate. Second
mortgage loans are generally made for terms of up to ten years with fixed
interest rates. Other consumer loan terms vary according to the type of
collateral, length of contract and creditworthiness of the borrower. Lines
of credit extended through the Company's credit card programs are limited to
$20,000. During 1997, the average credit card line granted was $5,600.
During December 1997, the Company re-scored its credit card portfolio,
reviewed its charge-off experience and bankruptcy trends and concluded that
an additional provision was needed for the year ended December 31, 1997.
The Company offers a variety of secured consumer loans, including direct
automobile loans, second mortgage loans (including home improvement loans),
home equity loans, and loans secured by deposit accounts. In addition, the
Company offers unsecured consumer loans and credit cards. In 1997, while
limiting credit card lending, the Company continued to expand its consumer
loan portfolio by marketing automobile and home equity loans. Management
believes that these loans which carry a higher rate of interest, can enhance
the bottom line when offered in conjunction with a prudent credit risk policy
and collection program.
The underwriting standards employed by the Company for consumer loans include
a determination of the applicant's payment history on other debts and an
assessment of the borrower's ability to meet payments on the proposed loan
along with existing obligations. In addition to the creditworthiness of the
applicant, the underwriting process also includes a comparison of the value
of the security, if any, in relation to the proposed loan amount.
Consumer loans may entail greater risk than residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
depreciable assets such as automobiles. In such cases, any repossessed
collateral for defaulted consumer loans may not provide adequate sources of
repayment for the outstanding loan balances as a result of the greater
likelihood of damage, loss or depreciation. In addition, consumer loan
collections are dependent on the borrower's continuing financial stability,
and thus are more likely to be affected by adverse personal circumstances.
Furthermore, the application of various federal and state laws, including
federal and state bankruptcy and insolvency laws, may limit the amount which
can be recovered on such loans. Although the level of delinquencies in the
Company's consumer loan portfolio has been manageable, there can be no
assurance that delinquencies will not increase in the future.
In 1997, the Company incurred $1,615,000 of consumer loan charge-offs, 94%
of which were related to credit cards, and made provisions of $2,250,000 to
the Allowance for Possible Loan Losses related to consumer loans. The
additional provision related partly to credit cards after it re-scored its
portfolio and reviewed its recent loan loss experience. During the year, the
Company was able to recover $ 96,000 on consumer loans previously charged off.
Management regularly conducts a review of its loan portfolio, write-off
experience and adequacy of allowance to maintain the allowance at a level
management feels is adequate.
MORTGAGE-BACKED AND RELATED SECURITIES
The Company has long purchased mortgage-backed and mortgage-related
securities to supplement loan production. Federal agency mortgage-backed
securities generally carry a yield approximately 50 to 100 basis points below
that of the corresponding type of residential loan, and the Company's other
mortgage related
- -------------------------------------------------------------------------------
12
securities also carry lower yields; however, the Company believes they offer
greater flexibility in volatile interest rate markets. The Company has also
retained the servicing rights on all loans securitized with FHLMC. The
Company will evaluate mortgage-backed securities purchases in the future
based on its asset/liability objectives, market conditions and alternative
investment opportunities.
The Company also purchases mortgage-related securities consistent with its
asset/liability management objectives. The mortgage-related securities which
the Company owns are real estate mortgage investment conduits ("REMIC's"),
most of which carry a floating interest rate and have estimated average lives
from one to five years. Collateralized mortgage obligations are securities
derived by reallocating cash flows from mortgage pass-through securities or
from pools of mortgage loans held by a trust. No interest only, principal
only, or residual interest pools are included as part of the portfolio. At
December 31, 1997, the carrying value of other mortgage-related securities
was $646,000. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Asset/Liability Management".
The following schedule sets forth the contractual maturities of the Company's
mortgage-backed and related securities and carrying value as of December 31,
1997. All of such securities are considered available-for-sale and include
approximately $57 million that were formerly a part of the Company's loan
portfolio and were previously securitized with the FHLMC. Almost all of the
mortgage-backed and related securities are anticipated to be repaid in
advance of their contractual maturity as a result of projected mortgage loan
prepayments and are driven to a large extent by changes in the level of
interest rates.
Due In
------------------------------------------
1 to 5 5 to 10 10 to 20 Over 20 Balance
Years Years Years Years Outstanding
----- ----- ----- ----- -----------
(Dollars in Thousands)
Mortgage-backed securities
Federal Home Loan Mortgage Corp. $3,754 $ 937 $14,918 $38,391 $ 58,000
Government National Mortgage Assoc. - - - 4,594 4,594
Federal National Mortgage Assoc. - - 2,551 54,962 57,513
------ ------ ------- ------- --------
$3,754 $ 937 $17,469 $97,947 $120,107
------ ------ ------- ------- --------
------ ------ ------- ------- --------
Other mortgage-related securities
Federal Home Loan Mortgage Corp. $ 646 $ - $ - $ - $ 646
------ ------ ------- ------- --------
------ ------ ------- ------- --------
ORIGINATION, PURCHASES AND SALES OF LOANS
The Company originates real estate and other loans through internal loan
production personnel (including commissioned originators) located in the
Mortgage Center and the Company's offices. Walk-in customers and referrals
from real estate brokers, builders and commercial lenders in the area are
also important sources for loan originations.
In order to supplement loan origination during periods of unusual competition
or reduced loan demand and, in order to acquire additional adjustable rate
loans for asset/liability management purposes, the Company periodically
considers the purchase of mortgage-backed and related securities and/or
residential loans from third party lenders. In 1995, the Company purchased
$2 million of fixed rate and $21.2 million of floating rate mortgage-backed
securities, and in 1996, the Company purchased $13.9 million of fixed rate
and $87.5 million of floating rate mortgage-backed securities. In 1997, the
Company purchased $700,000 in floating
- -------------------------------------------------------------------------------
13
rate mortgage backed securities and securitized $17.8 million of mortgage
loans which had been part of its one-to-four family residential loan
portfolio. Of this total, $9.1 million were 15 and 30 year fixed rate loans,
$4.7 million were 5 and 7 year balloons, and $4 million were 5/1, 7/1, and
10/1 Adjustable Rate Mortgage ("ARM") products. This securitzation helped
improve the Company's asset/liability management position.
In November, 1997, the Company entered into an arbitrage transaction,
purchasing $50.8 million in 3/1 FNMA ARM pools and funded the transaction by
borrowing $50 million from the FHLB of Chicago. The average spread on the
transaction is anticipated to be 72 basis points and is planned to be unwound
in late 1998.
The Company has securitized residential real estate loans from time to time.
When loans have been sold, the Company retains the responsibility for
servicing the loan. At December 31, 1996, and 1997, there were approximately
$178.5 million and $170.1 million, respectively, in the loan servicing
portfolio. At December 31, 1997, all loans were securitized with the FHLMC.
The Company held these loans as mortgage-backed securities on the balance
sheet. During 1998, management believes that the trend on securitizing loans
will be eliminated. With the exception of those originated for the Affordable
Housing Program and the Community Investment Program, the Mortgage Center
will provide all new residential mortgage funding and act only as a conduit,
providing only placement of residential mortgages. Some of these previously
securitized loans will be sold in 1998 to meet liquidity needs. Furthermore,
at December 31, 1997, the Company had no outstanding commitments to sell
mortgage-backed or mortgage-related securities.
- -------------------------------------------------------------------------------
14
The following table shows the loan originations, purchases, sales, and
repayments of the Company for the periods indicated:
Year Ended December 31,
(Dollars in Thousands) ------------------------------
1997 1996 1995
---- ---- ----
Originations of portfolio loans
Adjustable rate
Commercial loans $ 5,128 $ - $ -
Construction loans 16,170 - -
One-to-four family 34,386 44,648 41,909
Consumer loans 19,986 21,146 22,451
-------- -------- --------
Total adjustable rate 75,670 65,794 64,360
Fixed rate
Commercial loans - 63 -
One-to-four family 3,962 14,616 89,655
Commercial real estate 37,577 20,443 2,200
Multi-family 2,679 - -
Commercial leases 10,454 7,272 -
Consumer 15,096 18,978 18,036
-------- -------- --------
Total fixed rate 69,768 61,372 109,891
-------- -------- --------
Total loans originated 145,438 127,166 174,251
Purchases of mortgage-backed and related securities
Mortgage-backed securities and participation certificates 52,568 83,257 21,181
Mortgage-related securities - 18,126 2,027
-------- -------- --------
Total purchased 52,568 101,383 23,208
Sales and repayments of loans and mortgage-backed and
related securities
Sales of mortgage-backed securities 46,719 222,729 -
Principal repayments 101,910 87,029 84,557
-------- -------- --------
Total reductions 148,629 309,758 84,557
Increase (decrease) on other items (net) (2,894) (975) 1,767
-------- -------- --------
Net increase (decrease) in loans and mortgage-backed securities $ 46,483 $(82,184) $114,669
-------- -------- --------
-------- -------- --------
- -------------------------------------------------------------------------------
15
DELINQUENCY PROCEDURES
When a borrower fails to make a required payment on a loan, the Company
attempts to cause the delinquency to be cured by contacting the borrower. In
the case of residential loans subject to late charges, a late notice is sent
18 days after the due date, at which time a late charge is assessed. If the
delinquency is not cured by the 30th day, contact with the borrower is made
by phone or a second notice is mailed. Additional written and oral contacts
are made with the borrower between 30 and 60 days after the due date.
In the event a real estate loan payment is past due for 90 days or more,
management performs an in-depth review of the loan status, the condition of
the property and circumstances of the borrower. Based upon the results of
its review, management will decide whether to try to negotiate a repayment
program with the borrower, or initiate foreclosure proceedings.
Delinquent consumer loans are handled in a similar manner, except that
initial contact is made when the payment is ten days past due, personal
contact is made when the loan becomes more than twenty days past due, and the
loan is classified as a delinquent loan when it is past due for 30 days or
more. Certain consumer loans are placed on non-accrual status when
delinquent more than 90 days and deemed appropriate in the collection process.
The following table sets forth the Company's loan delinquencies by type, by
amount, and by percentage:
Loans Delinquent For
------------------------------------------------------- Total
60 - 89 Days 90 Days and Over Delinquent Loans
-------------------------- -------------------------- ---------------------------
Percent Percent Percent
of of of
Loan Loan Loan
Number Amount Category Number Amount Category Number Amount Category
------ ------ -------- ------ ------ -------- ------ ------ --------
(Dollars in Thousands)
One-to-four
family 3 $111 0.05% 12 $1,137 0.48% 15 $1,248 0.53%
Consumer 52 316 0.53 44 167 0.28 96 483 0.81
--- ---- ---- --- ------ ---- --- ------ ----
Total 55 $427 0.14% 56 $1,304 0.44% 111 $1,731 0.59%
--- ---- ---- --- ------ ---- --- ------ ----
--- ---- ---- --- ------ ---- --- ------ ----
CLASSIFICATION OF ASSETS
OCC policies require that each national bank classify its own assets on a
regular basis. In addition, in connection with examinations of national
banks, OCC examiners have authority to identify problem assets and, if
appropriate, require them to be classified. There are three classifications
for problem assets: Substandard, Doubtful and Loss. The regulations also
include a Special Mention category. Substandard assets have one or more
defined weaknesses and are characterized by the distinct possibility that the
institution will sustain some loss if the deficiencies are not corrected.
Doubtful assets have the weaknesses of Substandard assets, with the
additional characteristics that the weaknesses make collection or liquidation
in full on the basis of currently existing facts, conditions and values
questionable, and there is a high possibility of loss. An asset classified
as Loss is considered un-collectable and of such little value that
continuance as an asset of the institution is not warranted.
The Special Mention category consists of assets which do not currently expose
a financial institution to a sufficient degree of risk to warrant
classification, but do possess credit deficiencies or potential weaknesses
deserving management's close attention. Assets classified as Substandard or
Doubtful require the institution to establish prudent general allowances for
possible loan losses. If an asset or portion thereof is classified as Loss,
the institution must either establish specific allowances for loan losses in
the amount of 100% of the portion of the asset classified Loss, or charge off
such amount. If an institution does not agree with an examiner's
classification of an asset, it may appeal this determination to the Regional
Director of the OCC. In the above table, all loans delinquent 90 days or more
are classified according to the above rules. Certain
- -------------------------------------------------------------------------------
16
loans delinquent less than 90 days are categorized as Special Mention. As a
result of management's review of its assets, at December 31, 1997, the
Company had categorized $1,137,000 of its assets as Special Mention,
$167,000, as Substandard, and none as Doubtful or Loss. The Company's
classified assets consist of the non-performing loans detailed below and
certain loans delinquent less than 90 days.
NON-PERFORMING ASSETS
Real estate loans are placed on non-accrual status when either principal or
interest is 90 days or more past due unless, in the judgment of management,
other factors are present to justify the accrual of interest. Interest
accrued and unpaid at the time a loan is placed on non-accrual status is
charged against interest income. Subsequent payments are either applied to
the outstanding principal balance or recorded as interest income, depending
on the assessment of the ultimate collectibility of the loan.
In accordance with Statement of Financial Accounting Standard No. 114 (SFAS
114), as amended by SFAS 118, loans which are considered to be impaired, are
reduced to the present value of expected future cash flows or to the fair
value of the related collateral, by allocating a portion of the allowance to
such loans. If these allocations cause the allowance for possible loan
losses to require an increase, such increase is reported as a provision for
possible loan losses charged to expense. Loans are evaluated for impairment
when payments are delinquent 90 days or more, or when management downgrades
the loan classification to doubtful.
The table below sets forth the amounts and categories of non-performing
assets in the Company's loan portfolio. Loans are placed on non-accrual
status when the collection of principal and/or interest becomes doubtful.
For all years presented, the Company has had no impaired loans or troubled
debt restructurings (which involve forgiving a portion of interest or
principal on any loans or making loans at a rate materially less than that of
market rates).
December 31,
----------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in Thousands)
Non-accruing loans
One-to-four family $ - $ - $ 531 $ 176 $ 381
Consumer - 95 - - 38
------ ----- ----- ----- -----
Total - 95 531 176 419
Accruing loans delinquent 90 days or more
One-to-four family 1,137 599 - - -
Consumer 167 162 150 24 -
------ ----- ----- ----- -----
Total 1,304 761 150 24 -
------ ----- ----- ----- -----
Total non-performing loans $1,304 $ 856 $ 681 $ 200 $ 419
------ ----- ----- ----- -----
------ ----- ----- ----- -----
Total non-performing loans
to net loans 0.35% 0.25% 0.21% 0.06% 0.17%
------ ----- ----- ----- -----
------ ----- ----- ----- -----
Total non-performing loans
as percentage of assets 0.22% 0.16% 0.11% 0.04% 0.11%
------ ----- ----- ----- -----
------ ----- ----- ----- -----
- -------------------------------------------------------------------------------
17
Management has considered the Company's non-performing assets in establishing
its Allowance for Possible Losses on Loans. As of December 31, 1997, there
were no specific reserves on any of these assets.
As of December 31, 1997, there were no other loans not included on the table
or discussed above where known information about the possible credit problems
of borrowers caused management to have serious doubts as to the ability of
the borrower to comply with present loan repayment terms.
LOAN LOSS RESERVE ANALYSIS
The following table sets forth an analysis of the Company's allowance for
possible loan losses:
Year Ended December 31,
------------------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
(Dollars in Thousands)
Balance at beginning of period $1,424 $1,379 $1,520 $1,581 $1,539
Charge-offs
Consumer 1,615 1,497 903 474 118
Recoveries
Consumer 96 145 118 53 40
------ ------ ------ ------ ------
Net charge-offs 1,519 1,352 785 421 78
Additions charged to operations 4,072 1,397 644 360 120
------ ------ ------ ------ ------
Balance at end of period $3,977 $1,424 $1,379 $1,520 $1,581
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Ratio of net charge-offs during the
period to average loans outstanding
during the period 0.42% 0.39% 0.20% 0.15% 0.03%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Ratio of allowance to non-performing loans 3.05x 1.66x 2.02x 7.60x 3.77x
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Because some loans may not be repaid in full, an allowance for possible loan
losses is recorded. Increases to the allowance are recorded by a provision
for possible loan losses charged to expense. Estimating the risk of the loss
and the amount of loss on any loan is necessarily subjective. Accordingly,
the allowance is maintained by management at a level considered adequate to
cover possible losses that are currently anticipated based on past loss
experience, general economic conditions, information about specific borrower
situations including their financial position and collateral values, and
other factors and estimates which are subject to change over time. While
management may periodically allocate portions of the allowance for specific
problem loan situations, the entire allowance is available for any loan
charge-offs that occur. A loan is charged off against the allowance by
management as a loss when deemed uncollectible, although collection efforts
continue and future recoveries may occur.
- -------------------------------------------------------------------------------
18
The distribution of the Company's allowance for possible losses on loans at
the dates indicated is summarized as follows:
December 31,
-----------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------- -------------------- ------------------- -------------------- -------------------
Percent Percent Percent Percent Percent
of of of of of
Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans
for in Each for in Each for in Each for in Each for in Each
Possible Category Possible Category Possible Category Possible Category Possible Category
Losses to Losses to Losses to Losses to Losses to
on Total on Total on Total on Total on Total
Loans Loans Loans Loans Loans Loans Loans Loans Loans Loans
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
One-to-four family loans $ 100 61.76% $ 250 74.21% $ 600 83.10% $1,100 85.22% $1,100 88.59%
Commercial and commercial
real estate 2,256 22.70 285 9.03 44 .66 - - - -
Consumer loans 1,621 15.54 889 16.76 735 16.24 420 14.78 481 11.41
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total $3,977 100.00% $1,424 100.00% $1,379 100.00% $1,520 100.00% $1,581 100.00%
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Note: In 1997, 1996, and 1995, management made a decision to re-allocate
$150,000, $350,000, and $500,000 respectively, to the Allowance on Consumer
Loans from the Allowance on One-to-Four Family Loans, as no losses were
realized on this portfolio
Management regularly conducts a review of its loan portfolio, write-off
experience and adequacy of allowance to maintain the allowance at a level
management feels is adequate.
- -------------------------------------------------------------------------------
19
INVESTMENT ACTIVITIES
As a part of its asset/liability management strategy, the Company invests in
high quality short- and medium-term investments, including interest-bearing
deposits and U.S. government and agency securities and, to a lesser extent,
municipal bonds and marketable equity securities.
The following table sets forth the composition of the Company's investment
portfolio at the dates indicated. All items in the table are included at fair
value:
Year Ended December 31,
--------------------------------------------------------------
1997 1996 1995
------------------ ----------------- -------------------
Fair % of Fair % of Fair % of
Value Total Value Total Value Total
-------- ------ -------- ------ -------- ------
(Dollars in Thousands)
U.S. Treasury $ 11,013 6.71% $ 14,998 8.68% $ 5,995 2.35%
U.S. government agency 19,991 12.18 34,674 20.06 36,262 14.20
Marketable equity securities 408 0.25 3,741 2.16 3,970 1.55
Municipal bonds 4,428 2.70 140 .08 186 .07
Corporate bond - - 198 0.11 - -
FHLMC mortgage-backed
and related 58,000 35.33 86,761 50.19 152,767 59.81
GNMA mortgage-backed
and related 4,594 2.80 5,008 2.90 9,733 3.81
FNMA mortgage-backed
and related 57,513 35.03 17,533 10.14 27,056 10.59
CMO mortgage-related 646 0.39 2,633 1.52 14,614 5.73
-------- ------ -------- ------ -------- ------
Subtotal 156,593 95.39 165,686 95.84 250,583 98.11
FRB stock 469 .29 - - - -
FHLB stock 7,110 4.32 7,190 4.16 4,835 1.89
-------- ------ -------- ------ -------- ------
Total securities
and stock $164,172 100.00% $172,876 100.00% $255,418 100.00%
-------- ------ -------- ------ -------- ------
-------- ------ -------- ------ -------- ------
Average remaining life
of non-mortgage-backed
securities 2.45 years 6.16 years 6.89 years
The composition and contractual maturities of the securities portfolio at
December 31, 1997, excluding Federal Reserve Bank (FRB) of Chicago, FHLB of
Chicago stock and equity securities, is indicated in the following table.
Due In
--------------------------------------------
Less than 1 to 5 5 to 10 Over 10 Total
1 Year Years Years Years Securities
--------- ------- ------- ------- ----------
(Dollars in Thousands)
U.S. Treasury $11,013 $ - $ - $ - $11,013
U.S. government agency - 19,991 - - 19,991
Municipal bonds 973 3,455 - - 4,428
------- ------- ------- ------- -------
Total securities $11,986 $23,446 $ - $ - $35,432
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Weighted average yield 6.18% 6.42% -% -% 6.33%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
- -------------------------------------------------------------------------------
20
SOURCES OF FUNDS
General
Deposit accounts have traditionally been the principal source of the Company's
funds for use in lending and for other general business purposes. In addition
to deposits, the Company derives funds from borrowings, loan repayments and cash
flows generated from operations. Scheduled loan payments are a relatively
stable source of funds, while loan prepayments and deposit flows are greatly
influenced by general interest rates, economic conditions, competition and the
restructuring occurring in the banking industry. Over the past two years, an
additional source of funds has been the securitization of loans which are then
classified as securities. The Bank has then sold some of the securities to meet
liquidity needs in the payment of deposit withdrawals or the funding of
commercial related loan growth. During 1998, additional securitizations are
not expected to occur.
The Company faces substantial competition in attracting deposits from other
savings institutions, commercial banks, securities firms, money market and
mutual funds, credit unions and other investment vehicles. The ability of the
Company to attract and retain deposits depends on its ability to provide an
investment opportunity that satisfies the requirements of investors as to rate
of return, liquidity, risk and other factors. The Company competes for these
deposits by offering a variety of deposit accounts at competitive rates,
convenient business hours and a customer oriented staff.
The primary source of borrowing has been the FHLB of Chicago. The Company has
regularly used this as an alternative source of funding. These funds usually
provide a cheaper source of borrowing on both a fixed rate and floating rate
basis. At December 31, 1997, the Company had outstanding borrowings of
$135,000,000 at the FHLB of Chicago. Two additional non-deposit sources of
funds which the Company has used during 1997 are the Treasury Tax and Loan
("T T & L") Option Account and the Retail Repurchase Agreement. The T T & L
Account enables the U. S. Treasury to keep tax dollars with the Company at a
floating interest rate, and the Retail Repurchase Agreement allows customers
to lend the Company money which is collateralized by a security that the Bank
owns.
DEPOSITS
The Company attracts both short-term and long-term deposits from the Company's
primary market area by offering a wide assortment of accounts and rates. The
Company offers checking accounts (both interest bearing and non-interest
bearing), Preferred and regular money market, savings accounts, fixed interest
rate certificates of deposits with varying maturities, and individual retirement
accounts.
Deposit account terms vary, according to the minimum balance required, the time
period the funds must remain on deposit and the interest rate, among other
factors. In March 1995, the Company offered for one day, a certificate
promotion in conjunction with the grand opening of its new Schaumburg location.
Approximately $69 million was deposited, at a rate of 7.80%. These certificates
matured in September 1996, and concurrently, the Company offered a new Preferred
Money Market product. The product has been successful, with a rate that is
competitive, but significantly lower than 7.80%, which helped the Company's net
interest margin to improve during the last quarter of 1996 and throughout 1997.
In setting rates, the Company regularly evaluates (i) its investment and lending
opportunities, (ii) its internal costs of funds, (iii) the rates offered by
competing institutions and (iv) its liquidity position. In order to decrease
the volatility of its deposits, the Company imposes penalties on early
withdrawal on its certificates of deposit. The Company does not have any
brokered deposits and has no present intention to accept or solicit such
deposits.
- -------------------------------------------------------------------------------
21
The Company believes that non-certificate accounts can provide relatively low
cost funds and accordingly, the Company introduces promotions to attract new
checking accounts, and has begun offering new services to make these accounts
more desirable such as Telephone Access Banking and Debit Card, both of which
have been extensively utilized by the customers.
The following table sets forth the deposit flows experienced by the Company
during the periods indicated:
Year Ended December 31,
-----------------------------------
1997 1996 1995
--------- --------- ---------
Deposit balance at January 1 $ 402,090 $ 454,656 $ 409,640
Deposits 594,060 646,685 651,760
Withdrawals (641,008) (721,083) (627,748)
Interest credited 16,610 21,832 21,004
--------- --------- ---------
Deposit balance at December 31 $ 371,752 $ 402,090 $ 454,656
--------- --------- ---------
--------- --------- ---------
Net increase (decrease) $ (30,338) $ (52,566) $ 45,016
--------- --------- ---------
--------- --------- ---------
Percent increase (decrease) (7.55)% (11.56)% 10.99%
--------- --------- ---------
--------- --------- ---------
- -------------------------------------------------------------------------------
22
The following table sets forth the dollar amount of deposits in the various
types of deposit programs offered by the Company for the periods indicated:
Year Ended December 31,
-----------------------------------------------------------
1997 1996 1995
----------------- ----------------- -----------------
% of % of % of
Amount Total Amount Total Amount Total
-------- ------ -------- ------ -------- ------
(Dollars in Thousands)
Checking accounts $ 35,265 9.49% $ 30,556 7.60% $ 28,845 6.34%
Money market accounts 57,158 15.37 39,446 9.81 11,302 2.49
Saving accounts 59,562 16.02 66,218 16.47 69,202 15.22
-------- ------ -------- ------ -------- ------
Total non-certificates 151,985 40.88 136,220 33.88 109,349 24.05
Certificates of deposit(1)
0.00 - 2.99% 27 .01 185 .05 902 .20
3.00 - 3.99% 18 .01 172 .04 676 .15
4.00 - 4.99% 5,663 1.52 24,138 6.00 20,403 4.49
5.00 - 5.99% 149,140 40.12 138,641 34.48 97,816 21.51
6.00 - 6.99% 43,665 11.75 69,172 17.20 112,094 24.65
7.00 - 7.99% 14,379 3.86 27,056 6.73 111,782 24.59
8.00 - 8.99% 3,218 .87 5,418 1.35 1,586 .35
9.00 - 9.99% 3,657 .98 1,088 .27 48 .01
-------- ------ -------- ------ -------- ------
Total certificates 219,767 59.12 265,870 66.12 345,307 75.95
-------- ------ -------- ------ -------- ------
Total deposits $371,752 100.00% $402,090 100.00% $454,656 100.00%
-------- ------ -------- ------ -------- ------
-------- ------ -------- ------ -------- ------
(1) Certificates of deposit include approximately $8,370,000, $15,786,000,
and $17,262,000 at December 31, 1997, 1996, and 1995, respectively, which
bear interest at increasing rates over the life of the deposit term. These
certificates are included in the table at their current rate, while the
Company records interest expense on these certificates on a level-yield
basis over the contractual deposit term.
- -------------------------------------------------------------------------------
23
The following table shows rate and maturity information for the Company's
certificates of deposit as of December 31, 1997. Approximately $8.4 million of
the Company's certificates of deposit bear interest at increasing rates over the
life of their contractual maturity term. The Company records interest expense
on these certificates on a level-yield basis over their contractual maturity
term. The table below details the scheduled maturities of certificates of
deposit as follows:
1998 1999 2000 2001 2002 Thereafter Total
-------- ------- ------- ------ ------ ---------- --------
(Dollars in Thousands)
0.00 - 2.99% $ 27 $ - $ - $ - $ - $ - $ 27
3.00 - 3.99% 18 - - - - - 18
4.00 - 4.99% 3,080 2,090 71 315 103 4 5,663
5.00 - 5.99% 130,380 9,984 6,889 1,244 599 44 149,140
6.00 - 6.99% 13,739 6,867 19,384 942 2,733 - 43,665
7.00 - 7.99% 6,852 687 3,862 2 2,976 - 14,379
8.00 - 8.99% 3,218 - - - - - 3,218
9.00 - 9.99% 3,536 108 13 - - - 3,657
-------- ------- ------- ------ ------ --- --------
$160,850 $19,736 $30,219 $2,503 $6,411 $48 $219,767
-------- ------- ------- ------ ------ --- --------
-------- ------- ------- ------ ------ --- --------
The following table indicates the amount of the Company's certificates of
deposit by time remaining until maturity as of December 31, 1997.
Maturity
--------------------------------------
3 Months 3 to 6 6 to 12 Over 12
or Less Months Months Months Total
-------- ------- ------- ------- --------
(Dollars in Thousands)
Certificates of deposit less than $100,000 $63,074 $33,727 $41,701 $46,228 $184,730
Certificates of deposit of $100,000 or more(1) 9,873 6,456 6,019 12,689 35,037
------- ------- ------- ------- --------
Total certificates of deposit $72,947 $40,183 $47,720 $58,917 $219,767
------- ------- ------- ------- --------
------- ------- ------- ------- --------
(1) Includes "Jumbo" certificates of $9,860,000.
"Jumbo" certificates are a deposit product for deposits of over $100,000 which
carry a rate and term negotiated between the Bank and the depositor at the time
of issuance. Not all certificates of deposit with balances in excess of
$100,000 are "Jumbos".
For additional information regarding the composition of the Company's deposits,
see Note 7 of the "Notes to the Consolidated Financial Statements".
- -------------------------------------------------------------------------------
24
BORROWINGS
The Company's other available sources of funds include advances from the FHLB of
Chicago and collateralized borrowings. As a member of the FHLB of Chicago, the
Company is required to own capital stock in the FHLB of Chicago and is
authorized to apply for advances from the FHLB of Chicago. Each FHLB credit
program has its own interest rate, which may be fixed or variable, and range of
maturities. The FHLB of Chicago may prescribe the acceptable uses for these
advances, as well as limitations on the size of the advances and repayment
provisions. The Company had $135 million of FHLB advances outstanding at
December 31, 1997, secured by residential mortgage loans and a $25 million FNMA
mortgage backed security. Additional information regarding borrowings can be
obtained in Note 8 of the "Notes to the Consolidated Financial Statements".
The following table sets forth the maximum month-end balance, average balance,
and weighted average rates of borrowings for the periods indicated:
1997 1996 1995
---- ---- ----
(Dollars in Thousands)
Maximum month-end balances
FHLB advances $ 135,000 $ 135,600 $ 89,500
Securities sold under repurchase agreement 14,292 16,162 462
Other 10,000 11,187 10,358
Average balances
FHLB advances 71,956 89,630 46,033
Securities sold under repurchase agreement 12,781 11,683 142
Other 3,497 6,630 1,612
Weighted average rates
FHLB advances 5.99% 5.89% 6.25%
Securities sold under repurchase agreement 5.22 5.25 5.70
Other 5.30 5.40 5.83
- -------------------------------------------------------------------------------
25
SUPERVISION AND REGULATION
GENERAL
Financial institutions and their holding companies are extensively regulated
under federal and state law. As a result, the growth and earnings performance
of the Company can be affected not only by management decisions and general
economic conditions, but also by the requirements of applicable state and
federal statutes and regulations and policies of the OCC, the FRB, the FDIC, the
Internal Revenue Service and state taxing authorities, and the Securities and
Exchange Commission (the "SEC"). The effect of such statutes, regulations and
policies can be significant, and cannot be predicted with a high degree of
certainty.
Federal and state laws and regulations generally applicable to financial
institutions, such as the Company and its subsidiaries, regulate, among other
things, the scope of business, investments, reserves against deposits, capital
levels relative to operations, the nature and amount of collateral for loans,
the establishment of branches, mergers, consolidations and dividends. The system
of supervision and regulation applicable to the Company and its subsidiaries
establishes a comprehensive framework for their respective operations and is
intended primarily for the protection of the FDIC's deposit insurance funds and
the depositors, rather than the shareholders, of financial institutions.
The following references to material statutes and regulations affecting the
Company and its subsidiaries are brief summaries thereof and do not purport to
be complete, and are qualified in their entirety by reference to such statutes
and regulations. Any change in applicable law or regulations may have a
material effect on the business of the Company and its subsidiaries.
RECENT REGULATORY DEVELOPMENTS
PENDING LEGISLATION
Legislation is pending in the Congress that would allow bank holding companies
to engage in a wider range of non-banking activities, including greater
authority to engage in securities and insurance activities. The expanded powers
generally would be available to a bank holding company only if the bank holding
company and its bank subsidiaries remain well-capitalized and well-managed.
Additionally, the pending legislation would eliminate the federal thrift charter
and merge the FDIC's Bank Insurance Fund ("BIF") and Savings Association
Insurance Fund ("SAIF"). At this time, the Company is unable to predict whether
the proposed legislation will be enacted and, therefore, is unable to predict
the impact such legislation may have on the operations of the Company and the
Bank.
THE COMPANY
GENERAL
The Company, as the sole shareholder of the Bank, is a bank holding company. As
a bank holding company, the Company is registered with, and is subject to
regulation by, the FRB under the BHCA. In accordance with FRB policy, the
Company is expected to act as a source of financial strength to the Bank and to
commit resources to support the Bank in circumstances where the Company might
not do so absent such policy. Under the BHCA, the Company is subject to
periodic examination by the FRB and is required to file the FRB periodic reports
of its operations and such additional information as the FRB may require.
INVESTMENTS AND ACTIVITIES
Under the BHCA, a bank holding company must obtain FRB approval before: (i)
acquiring, directly or indirectly, ownership or control of any voting shares of
another bank or bank holding company if, after such acquisition, it would own or
control more than 5% of such shares (unless it already owns or controls the
- -------------------------------------------------------------------------------
26
majority or such shares); (ii) acquiring all or substantially all of the assets
of another bank; or (iii) merging or consolidating with another bank holding
company. Subject to certain conditions (including certain deposit concentration
limits established by the BHCA), the FRB may allow a bank holding company to
acquire banks located in any state of the United States without regard to
whether the acquisition is prohibited by the law of the state in which the
target bank is located. In approving interstate acquisitions, however, the FRB
is required to give effect to applicable state law limitations on the aggregate
amount of deposits that may be held by the acquiring bank holding company and
its insured depository institution affiliates in the state in which the target
bank is located (provided that those limits do not discriminate against
out-of-state depository institutions or their holding companies) or which
require that the target bank have been in existence for a minimum period of
time (not to exceed five years) before being acquired by an out-of-state bank
holding company.
The BHCA also prohibits, with certain exceptions, the Company from acquiring
direct or indirect ownership or control of more than 5% of the voting shares of
any company which is not a bank and from engaging in any business other than
that of banking, managing and controlling banks or furnishing services to banks
and their subsidiaries. The principal exception to this prohibition allows bank
holding companies to engage in, and to own shares of companies engaged in,
certain businesses found by the FRB to be "so closely related to banking... as
to be a proper incident thereto." Under current regulations of the FRB, the
Company and its non-bank subsidiaries are permitted to engage in, among other
activities, such banking-related businesses as the operation of a thrift, sales
and consumer finance, equipment leasing, the operation of a computer service
bureau, including software development, and mortgage banking and brokerage. The
BHCA generally does not place territorial restrictions on the domestic
activities of non-bank subsidiaries of bank holding companies.
Federal law also prohibits acquisition of "control" of a bank, such as the Bank,
or bank holding company, such as the Company, without prior notice to certain
federal bank regulators. "Control" is defined in certain cases as acquisition
of 10% of the outstanding shares of a bank or bank holding company.
CAPITAL REQUIREMENTS
Bank holding companies are required to maintain minimum levels of capital in
accordance with FRB capital adequacy guidelines. If capital falls below minimum
guideline levels, a bank holding company, among other things, may be denied
approval to acquire or establish additional banks or non-bank businesses.
The FRB's capital guidelines establish the following minimum regulatory capital
requirements for bank holding companies: a risk-based requirement expressed as a
percentage of total risk weighted assets, and a leverage requirement expressed
as percentage of total assets. The risk-based requirement consists of a minimum
ratio of total capital to total risk-weighted assets of 8%, at least one-half of
which must be Tier 1 capital. The leverage requirement consists of a minimum
ratio of Tier 1 capital to total assets of 3% for the most highly rated
companies, with minimum requirements of 4% to 5% for all others. For purposes
of these capital standards, Tier 1 capital consists primarily of permanent
stockholders' equity less intangible assets (other than certain mortgage
servicing rights and purchased credit card relationships) and total capital
means Tier 1 capital plus certain other debt and equity instruments which do not
qualify as Tier 1 capital and a portion of the company's allowance for loan and
lease losses.
The risk-based and leverage standards described above are minimum requirements,
and higher capital levels will be required if warranted by the particular
circumstances or risk profiles of individual banking organizations. For
example, the FRB's capital guidelines contemplate that additional capital may be
required to take adequate account of, among other things, interest rate risk, or
the risks posed by concentrations of credit, nontraditional activities or
securities trading activities. Further, any banking organization experiencing
or anticipating significant growth would be expected to maintain capital ratios,
including tangible capital positions (i.e., Tier 1 capital less all intangible
assets), well above the minimum levels.
- -------------------------------------------------------------------------------
27
As of December 31, 1997, the Company had regulatory capital, calculated on a
consolidated basis, in excess of the FRB's minimum requirements, with a
risk-based capital ratio of 15.42% and a leverage ratio of 7.7%.
DIVIDENDS
The FRB has issued a policy statement with regard to the payment of cash
dividends by bank holding companies. In the policy statement, the FRB expressed
its view that a bank holding company should not pay cash dividends which exceed
its net income or which can only be funded in ways that weaken the bank holding
company's financial health, such as by borrowing. Additionally, the FRB
possesses enforcement powers over bank holding companies and their non-bank
subsidiaries to prevent or remedy actions that represent unsafe or unsound
practices or violations of applicable statutes and regulations. Among these
powers is the ability to proscribe the payment of dividends by banks and bank
holding companies. In addition to the restrictions on dividends that may be
imposed by the FRB, the General Corporation Law (the "DGCL") allows the Company
to pay dividends only out of its surplus (as defined and computed in accordance
with the provisions of the DGCL), or if the Company has no such surplus, out of
its net profits for the fiscal year in which the dividend is declared and/or the
preceding fiscal year.
FEDERAL SECURITIES REGULATION
The Company's common stock is registered with the SEC under the Securities Act
of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). Consequently, the Company is subject to the information, proxy
solicitation, insider trading and other restrictions and requirements of the SEC
under the Exchange Act.
THE BANK
GENERAL
The Bank is a national bank, chartered by the OCC under the National Bank Act.
The deposit accounts of the Bank are insured by the SAIF of the FDIC, and the
Bank is a member of the Federal Reserve System. As a SAIF-insured national
bank, the Bank is subject to the examination, supervision, reporting and
enforcement requirements of the OCC, as the chartering authority for national
banks, and the FDIC, as administrator of the SAIF. The Bank is also a member of
the Federal Home Loan Bank System, which provides a central credit facility
primarily for member institutions.
DEPOSIT INSURANCE
As an FDIC-insured institution, the Bank is required to pay deposit insurance
premium assessments to the FDIC. The FDIC has adopted a risk-based assessment
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their respective
levels of capital and results of supervisory evaluations. Institutions
classified as well-capitalized (as defined by the FDIC) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (as defined by the FDIC) and considered of substantial supervisory
concern pay the highest premium. Risk classification of all insured
institutions is made by the FDIC for each semi-annual assessment period.
During the year ended December 31, 1997, SAIF assessments ranged from 0% of
deposits to 0.27% of deposits. For the semi-annual assessment period beginning
January 1, 1998, SAIF assessment rates will continue to range from 0% of
deposits to 0.27% of deposits.
The FDIC may terminate the deposit insurance of any insured depository
institution if the FDIC determines, after a hearing, that the institution has
engaged or is engaging in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, order, or any condition imposed in writing by, or written agreement
with, the FDIC. The FDIC may also suspend deposit insurance temporarily during
the hearing process for a permanent termination of insurance of the institution
if
- -------------------------------------------------------------------------------
28
the institution has no tangible capital. Management of the Company is not
aware of any activity, or condition that could result in termination of the
deposit insurance of the Bank.
FICO ASSESSMENTS
Since 1987, a portion of the deposit insurance assessments paid by SAIF members
has been used to cover interest payments due on the outstanding obligations of
the FICO, the entity created to finance the recapitalization of the Federal
Savings and Loan Insurance Corporation, the SAIF's predecessor insurance
fund. Pursuant to federal legislation enacted September 30, 1996, commencing
January 1, 1997 both SAIF members and BIF members became subject to
assessments to cover the interest payments on outstanding FICO obligations.
Such FICO assessments are in addition to amounts assessed by the FDIC for
deposit insurance. Until January 1, 2000, the FICO assessments made against
BIF members may not exceed 20% of the amount of the FICO assessments made
against SAIF members. Between January 1, 2000 and the maturity of the
outstanding FICO obligations in 2019, BIF members and SAIF members will share
the cost of the interest on the FICO bonds on a pro rata basis. During the
year ended December 31, 1997, the FICO assessment rate for SAIF members was
approximately 0.063% of deposits while the FICO assessment rate for BIF members
was approximately 0.013% of deposits. During the year ended December 31, 1997,
the Bank paid FICO assessments totaling $202,608.
OCC ASSESSMENTS
All national banks are required to pay supervisory fees to the OCC to fund the
operations of the OCC. The amount of such supervisory fees is based upon each
institution's total assets, including consolidated subsidiaries as reported to
the OCC.
CAPITAL REQUIREMENTS
The OCC has established the following minimum capital standards for national
banks, such as the Bank: a leverage requirement consisting of a minimum ratio of
Tier 1 capital to total assets of 3% for the most highly-rated banks with
minimum requirements of 4% to 5% for all others, and a risk-based capital
requirement consisting of a minimum ratio of total capital to total
risk-weighted assets of 8%, at least one-half of which must be Tier 1
capital. For purposes of these capital standards, Tier 1 capital and total
capital consist of substantially the same components as Tier 1 capital and
total capital under the FRB's capital guidelines for bank holding companies
(see "--The Company--Capital Requirements").
The capital requirements described above are minimum requirements. Higher
capital levels will be required if warranted by the particular circumstances or
risk profiles of individual institutions. For example, the regulations of the
OCC provide that additional capital may be required to take adequate account of,
among other things, interest rate risk or the risks posed by concentrations of
credit, nontraditional activities or securities trading activities.
During the year ended December 31, 1997, the Bank was not required by the OCC to
increase its capital to an amount in excess of the minimum regulatory
requirements. As of December 31, 1997, the Bank exceeded its minimum regulatory
capital requirements with a leverage ratio of 7.6% and a risk-based capital
ratio of 14.0%.
Federal law provides the federal banking regulators, with broad power to take
prompt corrective action to resolve the problems of undercapitalized
institutions. The extent of the regulators' powers depends on whether the
institution in question is "well-capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" or "critically
undercapitalized." Depending upon the capital category to which an institution
is assigned, the regulators' corrective powers include: requiring the
submission of a capital restoration plan; placing limits on asset growth and
restrictions on activities; requiring the submission of a capital restoration
plan; placing limits on asset growth and restrictions on activities; requiring
the institution to issue additional capital stock (including additional voting
stock) or to be acquired; restricting transactions with affiliates; restricting
the interest rate the institution may pay on deposits; ordering a new
- -------------------------------------------------------------------------------
29
election of directors of the institution; requiring that senior executive
officers or directors be dismissed; prohibiting the institution from
accepting deposits from correspondent banks; requiring the institution to
divest certain subsidiaries; prohibiting the payment of principal or interest
on subordinated debt; and ultimately, appointing a receiver for the
institution.
DIVIDENDS
The National Bank Act imposes limitations on the amount of dividends that may be
paid by a national bank, such as the Bank. Generally, a national bank may pay
dividends out of its undivided profits, in such amounts and at such times as the
bank's board of directors deems prudent. Without prior OCC approval, however, a
national bank may not pay dividends in any calendar year which, in the
aggregate, exceed the bank's year-to-date net income plus the bank's adjusted
retained net income for the two preceding years.
The payment of dividends by any financial institution or its holding company is
affected by the requirement to maintain adequate capital pursuant to applicable
capital adequacy guidelines and regulations, and a financial institution
generally is prohibited from paying any dividends if, following payment thereof,
the institution would be undercapitalized. As described above, the Bank
exceeded its minimum capital requirements under applicable guidelines as of
December 31, 1997. Further, the Bank may not pay dividends in an amount which
would reduce its capital below the amount required for the liquidation account
established in connection with the Bank's conversion from the mutual to the
stock form of ownership in 1992. As of December 31, 1997 approximately $20
million was available to be paid as dividends to the Company by the Bank.
Notwithstanding the availability of funds for dividends, however, the OCC may
prohibit the payment of any dividends by the Bank if the OCC determines such
payment would constitute an unsafe or unsound practice.
INSIDER TRANSACTIONS
The Bank is subject to certain restrictions imposed by the Federal Reserve Act
on extensions of credit to the Company and its subsidiaries, on investments in
the stock or other securities of the Company and its subsidiaries and the
acceptance of the stock or other securities of the Company or its subsidiaries
as collateral for loans. Certain limitations and reporting requirements are
also placed on extensions of credit by the Bank to its directors and officers,
to directors and officers of the Company and its subsidiaries, to principal
stockholders of the Company, and to "related interests" of such directors,
officers and principal stockholders. In addition, federal law and regulations
may affect the terms upon which any person becoming a director or officer of the
Company or one of its subsidiaries or a principal stockholder of the Company may
obtain credit from banks with which the Bank maintains a correspondent
relationship.
SAFETY AND SOUNDNESS STANDARDS
The federal banking agencies have adopted guidelines which establish operational
and managerial standards to promote the safety and soundness of federally
insured depository institutions. The guidelines set forth standards for
internal controls, information systems, internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth,
compensation, fees and benefits, asset quality and earnings. In general, the
guidelines prescribe the goals to be achieved in each area, and each institution
will be responsible for establishing its own procedures to achieve those goals.
If an institution fails to comply with any of the standards set forth in the
guidelines, the institution's primary federal regulator may require the
institution to submit a plan for achieving and maintaining compliance. The
preamble to the guidelines states that the agencies expect to require a
compliance plan from an institution whose failure to meet one or more of the
guidelines is of such severity that it could threaten the safety and soundness
of the institution. Failure to submit an acceptable plan, or failure to comply
with a plan that has been accepted by the appropriate federal regulator, would
constitute grounds for further enforcement action.
- -------------------------------------------------------------------------------
30
BRANCHING AUTHORITY
National banks headquarters in Illinois, such as the Bank, have the same
branching rights in Illinois as banks chartered under Illinois law. Illinois
law grants Illinois-chartered banks the authority to establish branches anywhere
in the State of Illinois, subject to receipt of all required regulatory
approvals.
Effective June 1, 1997 (or earlier if expressly authorized by applicable state
law), the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Riegle-Neal Act") allows banks to establish interstate branch networks
through acquisitions of other banks, subject to certain conditions, including
certain limitations on the aggregate amount of deposits that may be held by the
surviving bank and all of its insured depository institution affiliates. The
establishment of de novo interstate branches or the acquisition of individual
branches of a bank in another state (rather than the acquisition of an
out-of-state bank in its entirety) is allowed by the Riegle-Neal Act only if
specifically authorized by state law. The legislation allows individual
states to "opt-out" of certain provisions of the Riegle-Neal Act by enacting
appropriate legislation prior to June 1, 1997. Illinois has enacted
legislation permitting interstate mergers beginning on June 1, 1997, subject
to certain conditions, including a prohibition against interstate mergers
unless any Illinois bank involved has been in existence and continuous
operation for more than five years.
FEDERAL RESERVE SYSTEM
FRB regulations, as presently in effect, require depository institutions to
maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts), as follows: for transaction
accounts aggregating $47.8 million or less, the reserve requirement in 3% of
total transaction accounts; and for transactions accounts aggregating in excess
of $47.8 million, the reserve requirement is $1,434,000 plus 10% of the
aggregate amount of total transaction accounts in excess of $47.8 million. The
first $4.7 million of otherwise reservable balances are exempted from the
reserve requirements. These reserve requirements are subject to annual
adjustment by the FRB. The Bank is in compliance with the foregoing
requirements.
EMPLOYEES
At December 31, 1997, the Company had a total of 119 full-time employees and 39
part-time employees. None of the Company's employees are represented by any
collective bargaining group.
- -------------------------------------------------------------------------------
31
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company, each of whom is currently an executive
officer of the Bank, are identified below. The executive officers of the
Company are elected annually by the Company's Board of Directors. The Bank has
entered into change of control agreements with the executive officers named
below.
Position With
Name Holding Company Position with Bank
- -------------------------------------------------------------------------------------------------------
Larry G. Gillie President and Chief Executive President and Chief
Officer Executive Officer
R. Kennedy Alger Executive Vice-President Executive Vice President and
Senior Lending Officer
Paul A. Larsen Senior Vice-President, Treasurer Senior Vice President,
Chief Financial Officer, and Treasurer, Chief Financial
Corporate Secretary Officer and Corporate Sec'y
Allen J. Bishop Senior Vice-President Senior Vice President, Marketing
Lawrence J. Schmidt Senior Vice-President Senior Vice President, Administrative
Joseph H. Tillotson Senior Vice-President Senior Vice President, Retail Banking
Vernon J. Wiggenhauser Senior Vice-President Senior Vice President, Operations
Larry G. Gillie, age 57, became the Company's President and Chief Executive
Officer on March 1, 1994. Until that time, he had been the Company's
Executive Vice President since its formation. He also became the President
and Chief Executive Officer of the Bank on March 1, 1994, after having served
as the Executive Vice President of the Bank since January 17, 1990. Mr.
Gillie joined the Bank in 1987. Prior to joining the Bank, Mr. Gillie was the
President of Northbrook Bank, Northbrook, Illinois, from 1979 to 1986.
R. Kennedy Alger, age 51, joined the Company and the Bank in August 1997, as
Executive Vice-President and Senior Loan Officer. Mr. Alger has over 28
years of Commercial Banking experience, serving as either a Senior Loan
Officer or Community Bank President for the last 20 years.
Paul A. Larsen, age 48, joined the Company in March 1995 as Senior
Vice-President, Chief Financial Officer and Treasurer, and serves in a
similar capacity for the Bank. Mr. Larsen has over 25 years of financial
management and treasury operations experience within the Commercial Banking
environment.
Allen J. Bishop, age 50, was named Senior Vice-President of the Company and
the Bank in March 1995. He joined the Bank in August 1992 as Marketing
Manager. Mr. Bishop has over 23 years experience in bank marketing and
advertising.
Lawrence J. Schmidt, age 45, joined the Company and the Bank in November 1995
as Senior Vice-President, Administrative Manager. Mr. Schmidt has 20 years
experience in a commercial bank environment, with emphasis on commercial
lending, loan review and strategic planning.
Joseph H. Tillotson, age 53, was named a Senior Vice-President of the Company
and the Bank in March 1995. He joined the Bank in March 1993 as Lending
Manager. Since June 1997, Mr. Tillotson has been
- -------------------------------------------------------------------------------
32
managing all of Retail Banking. Mr. Tillotson has over 27 years of lending
and operations experience in banking.
Vernon J. Wiggenhauser, age 54, joined the Company and the Bank in June 1997
as Senior Vice-President of Bank Operations. Mr. Wiggenhauser has 26 years
experience in Commercial Banking operations and financial control
administration.
ITEM 2. PROPERTIES
The Company owns the building and land for its headquarters which is located
at 749 Lee Street, Des Plaines, Illinois, and which opened in 1954. At
December 31, 1997, this property had 19,575 square feet and a net book value
of approximately $2.8 million. The Company also owns the land for its
employee parking lot located at 761 Graceland Street, Des Plaines, Illinois.
In March, 1994, the Company acquired the Arlington Heights branch of the
former Irving Federal Bank, F.S.B. from the Resolution Trust Corporation.
The building contains approximately 14,260 square feet. At December 31,
1997, the net book value of the land and the building was approximately $2.6
million.
In March of 1995, the Company opened its new branch office in Schaumburg,
Illinois. The office has approximately 9,800 square feet of space and is
situated on a 1.6 acre parcel. At December 31, 1997 the net book value of
the land and the building was approximately $2.8 million.
On February 12, 1998, the Company entered into a lease arrangement for 2,100
square feet at 1771 North Richmond Road, McHenry, Illinois. The term of the
lease is five years with two additional five year options. The location
houses the Mortgage Center.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved as plaintiff or defendant in various legal actions
arising in the normal course of its business. While the ultimate outcome of
these various legal proceedings cannot be predicted with certainty, it is the
opinion of management that the resolution of these legal actions should not
have a material effect on the Company's consolidated financial position or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders, through the solicitation
of proxies or otherwise, during the quarter ended December 31, 1997.
- -------------------------------------------------------------------------------
33
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
SECURITY HOLDER MATTERS
As of March 6, 1998, there were approximately 640 holders of record of CoVest
Bancshares, Inc. Common Stock, and an estimated 1,700 holders of its stock in
"street name."
The Common Stock of CoVest Bancshares, Inc. is traded on the National
Association of Securities Dealers Automated Quotation (Nasdaq) National
Market System under the symbol COVB.
The table below shows the reported high and low sales prices and dividends
(split adjusted) during the periods indicated. The Common Stock began
trading on June 30, 1992.
1997 Dividend High Low 1996 Dividend High Low
1st Qtr. $.0667 $12.17 $11.17 1st Qtr. $.0444 $ 9.78 $ 9.33
2nd Qtr. $.0667 $12.67 $11.33 2nd Qtr. $.0667 $11.75 $ 9.61
3rd Qtr. $.0667 $16.17 $12.25 3rd Qtr. $.0667 $11.67 $10.83
4th Qtr. $.08 $18.00 $16.00 4th Qtr. $.0667 $11.67 $11.00
Year end closing price = $16.50 Year end closing price = $11.50
The Annual Meeting of Stockholders of CoVest Bancshares, Inc. will be held at
10:00 a.m. on Tuesday, April 28, 1998 at the following location:
Casa Royale
783 Lee Street
Des Plaines, Illinois 60016
Stockholders are welcome to attend.
Investor information is available without charge by writing to Larry G.
Gillie, President, or Paul A. Larsen, Senior Vice President and Treasurer, at
the corporate office:
CoVest Bancshares, Inc.
749 Lee Street
Des Plaines, Illinois 60016
(847) 294-6500
- -------------------------------------------------------------------------------
34
The following companies make a market in COVB Common Stock:
Stifel Nicolaus & Co., Inc Howe Barnes Investments, Inc.
ABN AMRO Chicago Corporation Herzog, Heine, Geduld, Inc.
Chicago Capital, Inc.
The dividend reinvestment and stock purchase plan offers stockholders an
opportunity to automatically make full or partial dividend reinvestments and
make optional cash purchases between $25 and $5,000 each quarter, with no
commission charges.
Inquiries regarding stock transfer, registration, lost certificates or
changes in name and address should be directed to the stock transfer agent
and registrar by writing:
Harris Trust and Savings Bank
Shareholder Communications Team
P.O. Box A 3504
Chicago, Illinois 60690-3504
(312) 360-5201
Corporate Office: CoVest Bancshares, Inc.
749 Lee Street
Des Plaines, Illinois 60016
(847) 294-6500
Corporate Counsel: Barack, Ferrazzano, Kirschbaum, Perlman & Nagelberg
333 W. Wacker Drive Suite 2700
Chicago, Illinois 60606
Independent Auditor: Crowe, Chizek and Company LLP
One Mid America Plaza Suite 800
Oak Brook, Illinois 60522
Internet address: http://www.covestbanc.com
CoVest Banc Offices:
749 Lee Street
Des Plaines, Illinois 60016
(847) 294-6500
770 W. Dundee Road
Arlington Heights, Illinois 60004
(847) 577-8100
2601 W. Schaumburg Road
Schaumburg, Illinois 60194
(847) 798-2800
1771 N. Richmond Rd.
McHenry, Illinois 60050
(800) 995-6750
- -------------------------------------------------------------------------------
35
Item 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL INFORMATION
December 31, 1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(Dollars in Thousands)
Selected financial condition data
Total assets $582,722 $541,169 $622,500 $523,213 $394,122
Loans receivable (net) 377,509 338,545 331,017 346,960 244,604
Total investments 164,172 172,876 255,418 152,471 138,235
Non-earning assets 17,571 16,911 18,716 17,006 8,479
Deposits 371,752 402,090 454,656 409,640 327,127
Other borrowings 151,956 78,690 97,835 47,000 -
Non-interest bearing liabilities 10,720 10,445 12,332 9,726 6,836
Stockholders' equity(1) 48,294 49,944 57,678 56,847 60,159
Selected operations data
Total interest income 39,364 42,377 40,854 30,749 28,739
Total interest expense 23,914 29,241 26,727 16,314 13,754
Net interest income 15,450 13,136 14,127 14,435 14,985
Provision for possible loan losses 4,072 1,397 644 360 120
-------- -------- -------- -------- --------
Net interest income after provision 11,378 11,739 13,483 14,075 14,865
Total non-interest income 3,672 4,241 1,217 1,020 569
Special SAIF assessment - 3,033 - - -
Total non-interest expense 11,305 10,818 10,722 9,490 7,928
-------- -------- -------- -------- --------
Income before income tax expense 3,745 2,129 3,978 5,605 7,506
Income tax expense 1,135 540 1,367 1,985 2,514
-------- -------- -------- -------- --------
Net income $ 2,610 $ 1,589 $ 2,611 $ 3,620 $ 4,992
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
(1) Under applicable provision of the Internal Revenue Code, the Company
deducted for tax purposes loan loss provisions which exceeded its financial
statement loan loss provisions. Accordingly, retained earnings at December
31, 1997 included approximately $9.3 million for which no liability for
federal taxes has been recorded.
- -------------------------------------------------------------------------------
36
SELECTED FINANCIAL RATIOS AND OTHER DATA
Year Ended December 31; 1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(Dollars in Thousands)
Performance ratios:
Return on assets (ratio of net income to
average total assets) 0.48% 0.26% 0.46% 0.80% 1.29%
Interest rate spread information
Average during year 2.42 1.72 2.08 2.78 3.25
End of year 2.52 2.41 1.86 2.63 2.33
Interest margin 2.94 2.22 2.59 3.28 3.98
Ratio of operating expenses to average
total assets 2.08 2.29 1.90 2.10 2.05
Ratio of net interest income to non-interest
expenses 1.37x 0.95x 1.32x 1.52x 1.89x
Basic earnings per share $0.61 $0.34 $0.51 $0.67 $0.83
Diluted earnings per share 0.58 0.32 0.50 0.65 0.80
Return on stockholders' equity (ratio of
net income to average equity) 5.40% 2.94% 4.67% 6.13% 8.12%
Dividend payout ratio 47.70 82.22 40.30 37.93 91.74
Asset quality ratios:
Non-performing assets to total assets at
end of year 0.22 0.16 0.11 0.04 0.11
Allowance for possible loan losses to
non-performing loans 3.05x 1.66x 2.02x 7.60x 3.77x
Capital ratios:
Stockholders' equity to total assets at
end of year 8.29% 9.23% 9.27% 10.86% 15.26%
Average stockholders' equity to
average assets 8.88 8.92 9.92 13.05 15.95
Ratio of average interest-earning assets to
average interest-bearing liabilities 1.12x 1.10x 1.11x 1.14x 1.20x
Other data
Facilities
Number of full-service offices 3 3 3 2 1
Number of mortgage centers 1 0 0 0 0
- -------------------------------------------------------------------------------
37
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FINANCIAL OVERVIEW
The Company's assets increased 8% to $582.7 million as of December 31, 1997,
from $ 541.2 million at December 31, 1996. Management of the Company has
undertaken a restructuring of the balance sheet from that of a traditional
thrift to that of a full service commercial bank. Commercial type lending
increased by $55.6 million during 1997. Commercial real estate loans
increased by $35.5 million, followed by increases of $7.1 million in
construction lending, $5.4 million in commercial lending, $4.2 million in
commercial leases and $3.6 million in multi-family lending.
For the year ended December 31, 1997, the Company earned $2.6 million, an
increase from 1996. This increase occurred even after the Company recorded a
$2.4 million provision for loan losses in the fourth quarter of 1997. In
keeping with the restructuring of the balance sheet and the recent conversion
of CoVest Banc from a thrift to a commercial bank, the Company reevaluated
its methodology in providing for possible loan losses. Changes in loan
portfolio mix, rescoring of the credit card loan portfolio, and the recent
levels of loan loss experience were the driving considerations behind the
decision.
STOCK REPURCHASE PROGRAM AND DIVIDENDS
On December 1, 1997, the Company effected a three-for-two stock split. This
is the second stock split declared in the last two years. The regular
dividend rate of $.08 per share post-split was paid to stockholders during
the fourth quarter of 1997. The Company paid regular quarterly dividends
during 1997, with the first three quarters being $.0667 post-split. The
Company has also announced an $.08 per share dividend payable March 31, 1998,
to shareholders of record on March 16, 1998.
The Company announced its 10th stock repurchase plan on January 27, 1997 for
100,000 shares pre-split. This was completed on June 12, 1997. On June 24,
1997, the Company announced its 11th stock repurchase plan, which enabled the
Company to repurchase up to 100,000 pre-split shares in the open market or
through privately negotiated transactions. That repurchase plan was also
completed. The 12th stock repurchase plan was announced on October 28, 1997,
and enables the Company to repurchase up to 150,000 post-split shares in the
open market or through privately negotiated transactions. As of December 31,
1997, 42,075 post-split shares had been repurchased.
GENERAL
On June 30, 1992, the Bank converted from a federally chartered mutual
savings bank to a federally chartered stock savings bank. The Bank issued
all of its common stock to the Company, and concurrently, the Company issued
3,220,000 shares of Common Stock at $10 per share, pre-split, all pursuant to
a plan of conversion (the 'Conversion'). As part of the Conversion, proceeds
were used to purchase the stock of the Bank. In August, 1997 the Bank was
converted to a national bank.
The Company's business activities currently consists of ownership of the
Bank, and investments in other debt and equity securities. The Bank's
principal business activities consist of attracting deposits from the public
and investing these deposits, together with funds generated from operations
and borrowings, primarily in loans secured by mortgages on one-to-four family
residences, consumer loans, commercial real estate and commercial loans,
securities and mortgage-backed securities. The Bank's deposit accounts are
insured to the maximum allowable by the Federal Deposit Insurance Corporation
(the 'FDIC').
The Bank's results of operations are dependent primarily on net interest
income, which is the difference between the interest earned on its loans and
mortgage-backed securities and other securities portfolios, and the interest
paid on deposits and borrowed funds. The Bank's operating results are also
affected, to a lesser
- -------------------------------------------------------------------------------
38
extent, by loan commitment fees, deposit related charges and other income.
Operating expenses of the Bank include employee compensation and benefits,
equipment and occupancy costs, federal deposit insurance premiums and other
administrative expenses.
The Bank's results of operations are further affected by economic and
competitive conditions, particularly changes in market interest rates.
Results are also affected by monetary and fiscal policies of federal
agencies, and actions of regulatory authorities.
The Company's basic mission is to continue to serve its local communities by
offering profitable financial services. In seeking to accomplish this
mission, management is committed to (i) maintaining tangible capital in
excess of regulatory requirements, (ii) maintaining high asset quality, (iii)
maximizing interest rate spread, and (iv) managing exposure to interest rate
risk.
The following information for the Company is presented on a consolidated
basis. Except as the context otherwise requires, references to the "company"
refer to the Company, the Bank, and the Bank's subsidiary, CoVest
Investments, Inc. The discussion and analysis that follows should be read in
conjunction with the financial statements, notes, and tables presented
herein. The information provided below has been rounded in order to simplify
presentation. However, ratios and percentages are calculated using the
detailed financial information.
BUSINESS STRATEGY
The key components of management's strategy are as follows:
BALANCE SHEET STRUCTURE AND INTEREST RATE RISK MANAGEMENT
Management of the Company has undertaken a restructuring of the balance sheet
from that of a traditional thrift to that of a full service commercial bank.
As part of this effort, in December 1995, management securitized with FHLMC,
the conforming portfolio of 15 and 30 year fixed rate single family
residential mortgage loans totaling approximately $116 million. This was
completed at a time when the slope of the yield curve was relatively flat.
The addition of long term fixed rate loans at this time would add to the risk
associated with rising rates. The Company had 73% of its balance sheet
invested in fixed rate assets, many of which had long term maturities.
In 1996, the Company sold over $93 million of these securitized 15 and 30
year fixed rate mortgage-backed securities and replaced most of those fixed
rate assets with shorter term floating rate instruments. In the process of
completing this restructuring, the Company generated net gains of over $2.6
million, or approximately $1.5 million after related taxes. In December of
1996, the Company securitized another $61 million in fixed rate long-term
mortgages and seven to ten year balloon mortgages, again with the FHLMC.
These securities were classified as available-for-sale mortgage backed
securities. Some of these were sold in 1997 to reduce interest rate risk and
provide additional funding for commercial related loans. Finally, in 1997,
the Company securitized $17.8 million, the residential fixed rate mortgages
that were not scheduled to reprice in the next five years. In 1998, the
Company opened its first mortgage center. This mortgage center is located in
McHenry, Illinois, and will house mortgage loan sales and production
function. This group will concentrate on mortgage loan originations and
sales. It is anticipated that all loans will be sold on a service release
basis to mortgage buyers for which the Company will receive a fee and have no
additional rights.
These changes will allow the Company to concentrate on filling the void left
by the consolidation of competing financial institutions in its marketplace
and to serve, "on a timely basis", those commercial lending customers who may
need a commercial loan, a commercial real estate loan, a construction loan or
multi-family loan. The Company's ability to serve this market helped to
expand the commercial related portfolio by $55.6 million during 1997. Most
of this increase came in commercial real estate loans which increased by
$35.5 million, followed by increases of $7.1 million in construction lending,
$5.4 million in commercial lending, $4.2 million in commercial leases and
$3.6 million in multi-family lending.
- -------------------------------------------------------------------------------
39
Changing the Bank's name in June, 1997 from First Federal Bank to CoVest
Banc and changing the Bank's charter affiliation in August, 1997 from a
thrift to a national bank helped attract customers who may not have
previously associated with First Federal Bank because of the perception that
we were a savings and loan whose core business revolved around first
mortgages to the retail sector.
Total deposits decreased 8% to $371.8 million from $ 402.1 million at
December 31, 1996. The deposit base of the organization is also undergoing a
transformation. In 1996, the Company offered a Preferred Money Market
account with a competitive rate tied to the weekly 91-day treasury bill
auction. The marketplace responded positively as the growth in this deposit
type alone increased by 57% over the ending balance in 1996.
The Company continues to strive to build the volume of non-interest bearing
checking accounts coupled with a "direct deposit" function. This transaction
account is another core account of a community bank. From the Company's
perspective it also helps improve non-interest income and will help to
improve the net interest margin. The Company offers promotions to attract
new checking accounts and provides additional services to make these accounts
more desirable. These services include telephone banking and a Debit Card
that can be used as a credit card or at automated teller machines for the
withdrawal or deposit of money.
Certificates of deposit have declined from $265.9 million at December 31,
1996 to $219.8 on December 31, 1997. This decline may be attributed, in
part, to the transfer of funds to more attractive Preferred Money Market
Accounts.
In setting rates, the Company regularly evaluates (i) its investment and
lending opportunities, (ii) its internal cost of funds, (iii) the rates being
offered by competing institutions and (iv) its liquidity position. In order
to decrease the volatility of its deposits, the Company imposes penalties on
early withdrawal on its certificates of deposit. The Company does not have
any brokered deposits and does not intend to accept or solicit such deposits
at the current time. The decline in overall deposits has been augmented by
additional borrowings at the Federal Home Loan Bank of Chicago ("FHLB") where
funds can be competitively purchased in the wholesale market in large dollar
amounts. Fifty million of these additional borrowings are for an arbitrage.
The arbitrage was begun in late November 1997, using the FHLB borrowings that
mature in late 1998 to fund two large mortgage backed security pools and is
projected to have an average spread of 72 basis points.
At December 31, 1997, total non-performing assets amounted to $ 1.3 million,
or 0.35% of net loans receivable compared to $ 856,000, or 0.25% of net loans
receivable at December 31, 1996.
At December 31, 1997, the allowance for loan losses amounted to almost $4
million, or 305% of non-performing loans as compared to a 166% coverage at
December 31, 1996.
Stockholders' equity in CoVest Bancshares, Inc. totaled $48 million at
December 31, 1997. The number of common shares outstanding was 4,365,761 and
the book value per common share outstanding was $11.06 as of December 31,
1997. Approximately 108,000 shares remained to be repurchased under the
current stock repurchase program.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1997 AND
DECEMBER 31, 1996
GENERAL
Net income for the year ended December 31, 1997 was $2,610,000 compared to
$1,589,000 for the year ended December 31, 1996, an increase of 64%. During
1996, the one-time special assessment of $3,033,000, pre-tax, was incurred
to recapitalize SAIF. This non-recurring charge was offset by net gains on
the sales of securities of approximately $2.6 million, or $1.5 million, after
related taxes. Without the effect of these non-recurring items, net income
for 1996 would have been $3,465,000.
- -------------------------------------------------------------------------------
40
In the fourth quarter of 1997, the Company reevaluated its methodology in
providing for possible loan losses. The Company evaluated its loan mix,
rescored its credit card portfolio, assessed its recent loan loss experience,
and decided to provide an extra $2.4 million in loan loss provision during
the quarter. This resulted in a net loss for the three months ended December
31, 1997 of $735,000, compared to net income of $605,000 for the comparable
period in 1996.
Returns on average assets and average equity during 1997 were 0.48% and
5.40%, respectively, compared to 0.26% and 2.94% in 1996.
CoVest Bancshares, Inc. had earnings of 61 cents per share (basic) for the
full year of 1997. This compares with 34 cents per share (basic) for the
comparable period in 1996.
INTEREST INCOME
Interest income for 1997 decreased by over $3 million from 1996. The balance
sheet averaged $67 million less in average earning assets when compared to
1996. Mortgage backed securities showed the largest decrease in interest
income as the volume declined by $66.3 million. The volume of securities
also decreased by over $10 million. Some of this decrease was offset by the
average increase in volume for loans of $7.7 million. The overall yield on
earning assets increased 34 basis points, from 7.15% in 1996 to 7.49% in 1997.
INTEREST EXPENSE
The interest expense for the same periods declined from $29.2 million in 1996
to $23.9 million in 1997. This $5.3 million decline in funding costs
resulted from a decrease in volume of over $67 million and reduced interest
costs of 36 basis points.
Overall this resulted in net interest income increasing by over 17% or $2.3
million. The interest rate spread and margin averaged 2.42% and 2.94%,
respectively, during 1997, a 70 and 72 basis point increase from 1.72% and
2.22%, respectively, during 1996. This represented increases of 41% in
interest rate spread and 32% in net interest margin growth. In the current
interest rate environment, management expects margins to increase from the
1997 levels as the loan composition of commercial and commercial real estate
loans become a larger percentage of the overall loan portfolio and asset mix.
PROVISION FOR POSSIBLE LOAN LOSSES
The provision for possible loan losses increased from $1,397,000 for 1996 to
$4,072,000 in 1997. This increase of almost $2.7 million was the result of
the Company's decision to provide an extra $2.4 million in loan loss
provision during the fourth quarter of 1997, after evaluating its loan mix,
rescoring its credit card portfolio, and reviewing its recent loan loss
experience. Nationally, as well as in the Bank's portfolio, credit losses
from bankruptcy continue to increase, many having no prior evidence of
delinquency. In 1997, bankruptcies accounted for over $624,000 in losses
alone. Current bankruptcy laws continue to hurt providers of credit cards.
The commercial related loan portfolio that represents commercial, commercial
real estate, construction and multi-family lending increased in total volume
by almost $52 million during 1997, or almost 220% in one year.
NON-INTEREST INCOME
Non-interest income, excluding gains from sales of securities and a
non-recurring death benefit of $187,000, increased 32%, or almost $548,000
from 1996. An increase in loan charges and servicing fees of $311,000 and
deposit related charges and fees of $257,000 led the way. With the addition
of the mortgage center it is anticipated that all loans will be sold on a
service released basis to mortgage buyers for which the Bank will receive a
commission.
- -------------------------------------------------------------------------------
41
NON-INTEREST EXPENSE
Other operating expenses increased by only 4.5% or $487,000, excluding the
special 1996 FDIC assessment. The largest increase came in salaries and
benefits that jumped $563,000 or 11.6%. Additional staff has been added to
serve both the commercial and retail customer in providing prompt loan and
deposit related request responses. Advertising expenses increased by over
92% during 1997, as the Company heralded the new name of CoVest and its
entrance into commercial banking. Finally, data processing expenses
increased as the Company converted its main frame operations during the
third and fourth quarters of 1997, in order to offer new deposit and loan
related products and serve more transaction deposit accounts. These expenses
were offset by a decrease in federal deposit insurance premium expenses of
$859,000. In 1998, operating expenses related to the new mortgage center
operation will be incurred, and sales commission expenses will increase as
production volume grows.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1996 AND
DECEMBER 31, 1995
GENERAL
Net income for the year ended December 31, 1996, was $1,589,000 compared to
$2,611,000 for the year ended December 31, 1995, a decrease of $1,022,000
or 39.1 %. This decrease included the one-time special assessment to
re-capitalize the SAIF, in the amount of $3,033,000, pre-tax. This
non-recurring charge was offset by net gains on the sales of securities of
approximately $2.5 million, or $1.5 million, after related taxes.
During 1995, two non-recurring items were recorded. They were $271,000 for
the estimated unfunded liability of the Defined Benefit Plan, and $124,000
for compensation to former officers, less related taxes.
Without the effect of these non-recurring items, net income for 1996 would
have been $3,465,000, compared to $2,852,000 for 1995, an increase of
$615,000 or 21.6%. This increase can be attributed to gains on sales of
securities and increases in other non-interest income of $3,025,000, offset
by a decrease in net interest income of $990,000, an increase in the
provision for possible loan losses of $753,000, an increase in non-interest
expense of $464,000, and increase in taxes of $206,000, (prior to the tax
effect on the non-recurring items.)
INTEREST INCOME
Interest income increased by $1,523,000 or 3.7% to $42,377,000 for the year
ended December 31, 1996 as compared to $40,854,000 for the year ended
December 31, 1995, even though the yield on average earning assets decreased
34 basis points to 7.15% for 1996, as compared to a 7.49% yield for 1995.
Contributing to the decrease in yield was the restructuring of the balance
sheet, which resulted in a greater amount of adjustable rate mortgage-backed
securities as compared to last year. Management began to convert those
securities to higher yielding loans. During 1996, the Company started
operating a new Commercial Lending Department in an attempt to have those
types of loans become an increasing portion of the total loan portfolio.
INTEREST EXPENSE
Interest expense increased by $2,514,000 or 9.4 % to $29,241,000 for the
year ended December 31, 1996 as compared to $26,727,000 for the year ended
December 31, 1995. This increase was attributed primarily to an increase in
the average amount of borrowed money, from $47,800,000 for 1995, to
$107,900,000 for 1996. The cost of total interest-bearing liabilities
remained constant, at 5.43% for 1996 and 1995.
- -------------------------------------------------------------------------------
42
The following table illustrates the decrease in costs of average
interest-bearing liabilities the Company experienced for each quarter of
1996. During September 1996, the maturity of $69 million in certificates of
deposit took place.
FOR THE INDICATED
QUARTER OF 1996
1st 2nd 3rd 4th
----- ----- ----- -----
Cost of Average Interest-Bearing
Liabilities 5.56% 5.50% 5.45% 5.11%
PROVISION FOR POSSIBLE LOAN LOSSES
The provision for possible loan losses totaled $1,397,000 for the year ended
December 31, 1996, compared to $644,000 for the year ended December 31, 1995.
Of this $753,000, or 116.9% increase, $242,000 was related to new commercial
real estate loans, for which the Company established a provision for possible
losses at the time the loans are recorded. The balance of this increase
resulted from a decision by management to increase the loan loss allowance in
light of higher write-off experience on credit cards. The Company, and the
banking industry as a whole, began to see more credit card charge-offs
resulting from personal bankruptcies. For the year ended December 31, 1996,
42% of all of the charge-offs experienced by the Company were related to
personal bankruptcies. Management regularly conducts a review of its loan
portfolio, write-off experience and adequacy of allowance.
NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN LOSSES
Net interest income after provision for possible loan losses decreased by
$1,743,000 or 12.9% to $11,739,000 for the year ended December 31, 1996 as
compared to $13,483,000 for the year ended December 31, 1995. The average
net interest rate spread for 1996 was 1.72%, compared to 2.06% for 1995.
NON-INTEREST INCOME
Non-interest income increased by $474,000 or 38.9% to $1,690,000 for the year
ended December 31, 1996 as compared to $1,217,000 for the year ended December
31, 1995, prior to net gains on the sale of securities in 1996 of $2,551,000.
The year ended December 31, 1995 produced a net loss on the sale of
securities of $53,000. Most of the balance of the increase in non-interest
income was attributable to recognition of loan servicing fees, which
increased $335,000 or 76.3%. Deposit related fees and charges also increased
$96,000 or 19.5%, as there has been a general increase in fees charged for
various Bank services.
NON-INTEREST EXPENSE
Non-interest expense was $13,852,000 for 1996, compared to $10,722,000 for
1995, an increase of $3,131,000 or 29.2%. In 1995, there were two
non-recurring items recorded. They were $271,000 for the estimated unfunded
liability of the Defined Benefit Plan, and $124,000 for compensation to
former officers, less related taxes. During 1996, a non-recurring expense was
recorded for $30,000, representing the final unfunded liability as a result
of the termination of the Defined Benefit Plan. The final determination was
higher than anticipated due to a decrease in interest rates between the
termination announcement date of January 5, 1995, and the date the final
distribution was made on May 29, 1996. Also recorded in 1996, was $3,033,000
for the one-time assessment to re-capitalize the SAIF insurance fund, at 65.7
basis points. Without giving consideration to these items, non-interest
expense increased $344,000 or 3.3%, from $10,327,000 for 1995, to $10,671,000
for 1996. Most of this increase was attributed to the operation of the
Schaumburg location, opened in March of 1995.
- -------------------------------------------------------------------------------
43
NET INTEREST INCOME ANALYSIS
The following table presents, for the periods indicated, the total dollar
amount of interest income from average interest-earning assets and the
resultant yields, as well as interest expense on average interest-bearing
liabilities, expressed both in dollars and rates.
Year Ended December 31,
------------------------------------------------------------------------------------------------
1997 1996 1995
----------------------------- ----------------------------- ------------------------------
Average Interest Average Interest Average Interest
Annual Earned/ Yield/ Annual Earned/ Yield/ Annual Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
------- ---- ---- ------- ---- ---- ------- ---- ----
(Dollars in Thousands)
Interest-earning assets
Loans receivable $357,467 $28,186 7.89% $349,790 $27,238 7.79% $395,159 $31,145 7.88%
Mortgage-backed
and related securities 99,891 7,018 7.03 166,106 10,135 6.10 74,252 4,827 6.50
Securities 58,150 3,723 6.40 68,163 4,443 6.52 67,311 4,305 6.40
Other investments 10,321 437 4.23 8,806 561 6.37 8,582 577 6.73
-------- ------- ----- -------- ------- ----- -------- -------- ----
Total interest-
earning assets 525,829 39,364 7.49 592,865 42,377 7.15 545,304 40,854 7.49
Non-interest
earning assets 18,713 12,241 18,293
-------- -------- --------
Total assets $544,542 $605,106 $563,597
-------- -------- --------
-------- -------- --------
Interest-bearing liabilities
Savings account $ 62,297 $ 1,574 2.53% $ 68,666 $ 1,717 2.50% $ 70,795 $ 1,771 2.50%
NOW account 21,798 390 1.79 21,889 391 1.79 23,897 414 1.73
Money Market 50,372 2,439 4.84 19,515 804 4.12 11,188 332 2.97
Certificates 248,676 14,347 5.77 320,735 19,990 6.23 338,728 21,193 6.26
FHLB advances 71,956 4,308 5.99 89,630 5,368 5.99 46,033 2,915 6.33
Other borrowed money 16,278 856 5.26 18,313 971 5.30 1,754 102 5.82
-------- ------- ----- -------- ------- ----- -------- -------- ----
Total interest-bearing
liabilities 471,377 23,914 5.07 538,748 29,241 5.43 492,395 26,727 5.43
Other liabilities 24,824 12,367 15,302
-------- -------- --------
Total liabilities 496,201 551,115 507,697
Stockholders' equity 48,341 53,991 55,900
-------- -------- --------
Total liabilities and
stockholders' equity $544,542 $605,106 $563,597
-------- -------- --------
-------- -------- --------
Net interest income $ 15,450 $ 13,136 $ 14,127
Net interest rate spread 2.42% 1.72% 2.06%
Net earning assets $ 54,452 $ 54,117 $ 52,909
Net yield on average
interest-earning assets 2.94% 2.22% 2.59%
Average interest-earning
assets to average
interest-bearing
liabilities 1.12x 1.10x 1.11x
- -------------------------------------------------------------------------------
44
WEIGHTED AVERAGE YIELD ANALYSIS
The following table sets forth the weighted average yields on the Company's
interest-earning assets, the weighted average interest rates on
interest-bearing liabilities, and the interest rate spread between the
weighted average yields and rates at the dates indicated:
December 31, 1997 1996 1995
---- ---- ----
Weighted average yield on
Loans receivable 8.03% 7.68% 7.65%
Mortgage-backed and mortgage-related securities 6.90 6.98 6.95
Securities 6.42 6.62 6.29
Other investments and FHLB stock 5.93 6.50 4.92
Combined weighted average yield on interest-earning assets 7.59 7.46 7.33
Weighted average rates paid on
Savings accounts 2.51 2.50 2.50
NOW accounts 1.80 1.79 1.79
Money market accounts 4.97 4.57 2.70
Certificates 5.73 5.83 6.41
FHLB advances 5.72 5.91 5.95
Other borrowed money 5.28 5.28 5.52
Combined weighted average rate paid on interest-bear liabilities 5.07 5.05 5.47
Net interest rate spread 2.52 2.41 1.86
- -------------------------------------------------------------------------------
45
VOLUME/RATE ANALYSIS
The following schedule presents the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets
and interest-bearing liabilities. It distinguishes between the increase
related to higher outstanding balances and that due to changes in interest
rates. For each category of interest-earning assets and interest-bearing
liabilities, information is provided on changes attributable to: (1) changes
in volume (i.e., changes in volume multiplied by old rate) and (2) changes in
rate (i.e., changes in rate multiplied by old volume). For purposes of this
table, changes attributable to both rate and volume which cannot be
segregated have been allocated proportionately to both changes.
1997 vs. 1996 1996 vs. 1995
Increase (Decrease) Due To: Increase (Decrease) Due To:
----------------------------------- -----------------------------------
Total Total
Increase Increase
Volume Rate (Decrease) Volume Rate (Decrease)
------ ---- ---------- ------ ---- ----------
(Dollars in Thousands)
Interest-earning assets
Loans receivable $ 865 $ 83 $ 948 $(3,542) $(365) $(3,907)
Mortgage-backed and
related securities (4,039) 922 (3,117) 5,587 (278) 5,309
Securities and other
investments (788) (56) (844) 98 23 121
------- ------- ------- ------- ----- -------
Total interest-earning
assets (3,962) 949 (3,013) 2,143 (620) 1,523
------- ------- ------- ------- ----- -------
Interest-bearing liabilities
NOW accounts (1) - (1) (38) 15 (23)
Savings accounts (143) - (143) (54) - (54)
Money markets 1,271 364 1,635 310 162 472
Certificates (4,530) (1,113) (5,643) (1,111) (92) (1,203)
FHLB advances (1,032) (28) (1,060) 2,648 (195) 2,453
Other borrowed money (100) (15) (115) 877 (8) 869
------- ------- ------- ------- ----- -------
Total interest-bearing
liabilities (4,535) (792) (5,327) 2,632 (118) 2,514
------- ------- ------- ------- ----- -------
Net change in interest
income $ 573 $ 1,741 $ 2,314 $ (489) $(502) $ (991)
------- ------- ------- ------- ----- -------
------- ------- ------- ------- ----- -------
- -------------------------------------------------------------------------------
46
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
The Company's primary sources of funds are deposits, principal and interest
payments on loans and mortgage-backed securities, and funds provided by other
operations. While scheduled loan and mortgage-backed securities repayments
and maturities of short-term investments are a relatively predictable source
of funds, deposit flows and loan prepayments are greatly influenced by
general interest rates, economic conditions, competition and the
restructuring occurring in the banking industry.
The Company's cash flows are a result of three principal activities:
operating activities, investing activities and financing activities. Net
cash received in operating activities, primarily interest on loans and
investments, less interest paid on deposits and borrowed funds, was $7.6
million for the year ended December 31, 1997. Net cash used in investing
activities was $33.4 million for the year ended December 31, 1997. Security
sales and maturities generated $21.3 million while principal payments on
mortgage-backed and related securities amounted to $37.7 million. Purchases
of investment securities and mortgage-backed securities were $99.7 million,
and loan origination's, net of principal payments, were $60.5 million for the
year. Net cash provided by financial activities amounted to $36.5 million
for the year ended December 31, 1997, and was accounted for mostly by the net
increase in borrowings.
The Company uses its liquidity to meet its ongoing commitments to fund
maturing certificates of deposit and deposit withdrawals, repay borrowings,
fund existing and continuing loan commitments, and pay operating expenses.
At December 31, 1997, the Company had commitments to originate loans totaling
$11.5 million, and its customers had approved but unused lines of credit
totaling $78.3 million. The Company considers its liquidity and capital
resources to be adequate to meet its foreseeable short and long-term needs.
The Company expects to be able to fund or refinance, on a timely basis, its
material commitments and long-term liabilities.
CAPITAL RESOURCES
At December 31, 1997, the Bank had total capital to risk-weighted assets of
$46.4 million. This is approximately $15.9 million above the amount required
to be "well capitalized." Tier 1 capital to risk-weighted assets was $42.6
million. This is approximately $24.3 million or 8% above the required
ratio of 6%. Tier 1 capital to average assets was $42.6 million. This is
approximately $14.7 million or 2.6% above the required ratio of 5%. For
additional information, see Note 11 of the "Notes to the Consolidated
Financial Statements".
IMPACT OF NEW ACCOUNTING STANDARDS
Statement of Financial Accounting Standards No. 130 (SFAS No. 130), REPORTING
COMPREHENSIVE INCOME, will become effective during 1998 and requires that all
components of comprehensive income be presented in a separate statement.
Management does not anticipate that SFAS No. 130 will have a significant impact
on the Company's results of operations or capital.
Statement of Financial Accounting Standards No. 131 (SFAS No. 131), DISCLOSURES
ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, will also become
effective during 1998. SFAS No. 131 establishes standards for the way public
companies report information about its operating segments and requires that
these standards be adhered to for interim reporting as well. SFAS No. 131
requires companies to provide more descriptive disclosures about its
operating segments including the way in which the segment was determined, the
products and services provided by the segment, and the profit or loss
generated by the segment. Management does not anticipate that SFAS No. 131
will have a significant impact on the Company's results of operations or
capital.
- -------------------------------------------------------------------------------
47
YEAR 2000 COMPLIANCE
A critical issue facing the financial institution industry is concerns over
computer systems' ability to process year-date data beyond the year 1999.
Except in recently developed year 2000 compliant programs, computer
programmers consistently have abbreviated dates by eliminating the first two
digits of a year, with the assumption that these two digits would always be
"19". Unless corrected, this situation is expected to cause widespread
problems on January 1, 2000, when computer systems may recognize this date as
January 1, 1900, and process data incorrectly or stop processing altogether.
This issue could affect a variety of the Company's systems from its data
processing system which records loan and deposit information to other
ancillary systems such as alarms and locking devices. Management has
considered this issue internally and receives periodic correspondence from
its data processor regarding their plans to be year 2000 compliant. Management
does not anticipate that the Company will incur material operating expenses
to be required to invest heavily in computer system improvements to be year
2000 compliant. Nevertheless, if not properly addressed, these issues could
result in interruptions in the Company's business and have a material adverse
effect on the Company's results of operations.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
In an attempt to manage the Bank's exposure to changes in interest rates,
management closely monitors the Bank's interest rate risk. Management has an
Asset/Liability Committee, consisting of senior officers, which meets monthly to
review the Bank's interest rate risk position and make recommendations for
adjusting such position. In addition, the Board reviews the Bank's position
on a monthly basis, including simulations of the effect on the Bank's capital
of various interest rate scenarios.
In managing its asset/liability mix, the Bank may place greater or less emphasis
on maximizing net interest margin than on better matching the interest rate
sensitivity of its assets and liabilities in an effort to improve its capital,
depending on the relationship between long and short-term interest rates, market
conditions, and consumer preferences. Management believes that the increased
net income resulting from a mismatch in the maturity of its assets and
liability portfolios can, during periods of declining or stable interest
rates, provide high enough returns to justify the increased exposure to
sudden and unexpected increases in interest rates which can result from such
a mismatch. As a result, the Bank may be somewhat more exposed to rapid
increases in interest rates than some other institutions which concentrate
principally on matching the duration of their assets and liabilities.
The business of the Company and the composition of its balance sheet consists
of investments in interest-earning assets (primarily loans and
mortgage-backed securities) which are primarily funded by interest-bearing
liabilities (deposits and borrowings). Such financial instruments have
varying levels of sensitivity to changes in market interest rates resulting
in market risk. Other than loans which are originated and held for sale, all
of the financial instruments of the Company are for other than trading purposes.
Interest rate risk results when the maturity or repricing intervals and
interest rate indices of the interest-earning assets, interest-bearing
liabilities, and off-balance sheet financial instruments are different,
creating a risk that changes in the level of market interest rates will
result in disproportionate changes in the value of, and the net earnings
generated from, the Company's interest-earning assets, interest-bearing
liabilities, and off-balance sheet financial instruments. The Company's
exposure to interest rate risk is managed primarily through the Company's
strategy of selecting the types and terms of interest-earning assets and
interest-bearing liabilities which generate favorable earnings, while
limiting the potential negative effects of changes in market interest rates.
Since the Company's primary source of interest-bearing liabilities is
customer deposits, the Company's ability to manage the types and terms of
such deposits may be somewhat limited by customer preferences in the market
areas in which the Company operates. Borrowings, which include FHLB Advances,
short-term borrowings, and long-term borrowings, are generally structured
with specific terms which in management's judgment, when aggregated with the
terms for outstanding deposits and matched with interest-earning assets,
mitigate the Company's exposure to interest rate risk. The rates, terms and
interest rate indices of the Company's interest-earning assets result
primarily from the Company's strategy of investing in
- -------------------------------------------------------------------------------
48
loans and securities (a substantial portion of which have adjustable-rate
terms) which permit the Company to limit its exposure to interest rate risk,
together with credit risk, while at the same time achieving a positive
interest rate spread from the difference between the income earned on
interest-earning assets and the cost of interest-bearing liabilities (see
"Business--Factors Affecting Earnings--Asset and Liability Management" for a
further discussion of rate sensitive assets, rate sensitive liabilities and
net interest spread).
SIGNIFICANT ASSUMPTIONS UTILIZED IN MANAGING INTEREST RATE RISK
Managing the Company's exposure to interest rate risk involves significant
assumptions about the prepayments of loans or early withdrawal of deposits
and the relationship of various interest rate indices of certain financial
instruments.
A substantial portion of the Company's loans and mortgage-backed securities
are residential mortgage loans which permit the borrower to prepay the
principal balance of the loan prior to maturity ("prepayments") without
penalty. A loans propensity for prepayment is dependent upon a number of
factors, including, the current interest rate and interest rate index (if
any) on the loan, the financial ability of the borrower to refinance, the
economic benefit to be obtained from refinancing, availability of refinancing
at attractive terms, as well as economic and other factors in specific
geographic areas which affect the sales and price levels of residential
property. In a changing interest rate environment, prepayments may increase
or decrease on fixed-and adjustable-rate loans depending on the current
relative levels and expectations of future short- and long-term interest
rates. Prepayments on ARM loans generally increase when long-term interest
rates fall or are at historically low levels relative to short-term interest
rates making Fixed-rate loans more desirable.
Securities, other than those with early call provisions, generally repay
pursuant to specific terms until maturity. While savings and checking
deposits generally may be withdrawn upon the customer's request without prior
notice, a continuing relationship with customers resulting in future deposits
and withdrawals is generally predictable resulting in a dependable and
uninterruptible source of funds. Time deposits generally have early
withdrawal penalties, while term FHLB Advances have prepayment penalties,
which discourage customer withdrawal of time deposits and prepayment of FHLB
Advances prior to maturity.
The Company's ARM loans are primarily indexed to the One Year Constant
Maturity Treasury Index. When such loans and mortgage-backed securities are
funded by interest-bearing liabilities which are determined by other indices,
primarily deposits and FHLB Advances, a changing interest rate environment
may result in different levels of change in the different indices leading to
disproportionate changes in the value of, and the net earnings generated
from, the Company's financial instruments. Each index is unique and is
influenced by different external factors, therefore, the historical
relationships in various indices may not necessarily be indicative of the
actual change which may result in a changing interest rate environment.
INTEREST RATE RISK MEASUREMENT
In addition to periodic gap reports comparing the sensitivity of
interest-earning assets and interest-bearing liabilities to changes in
interest rates, management utilizes a monthly report ("model") prepared by
the Bank which measures the Bank's exposure to interest rate risk. The model
calculates the present value of assets, liabilities, off-balance sheet
financial instruments, and equity at current interest rates, and at
hypothetical higher and lower interest rates at one percent intervals. The
present value of each major category of financial instrument is calculated by
the model using estimated cash flows based on weighted average contractual
rates and terms at discount rates representing the estimated current market
interest rate for similar financial instruments. The resulting present value
of longer term fixed-rate financial instruments are more sensitive to change
in a higher or lower market interest rate scenario, while adjustable-rate
financial instruments largely reflect only a change in present value
representing the difference between the contractual and discounted rates
until the next interest rate repricing date.
- -------------------------------------------------------------------------------
49
The following table presents the Bank's current exposure to hypothetical changes
in interest rates as of December 31, 1997
Percent Change in
Change in Interest Rates Percent Change in MV of Portfolio
(basis points) Net Interest Income Equity
------------------------ ------------------- -----------------
+200 (9%) (16%)
100 (4) (8)
0 0 0
(100) 4 10
(200) 7 (20)
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. For example, although certain assets and liabilities may
have similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest rates on
certain types of assets and liabilities may fluctuate in advance of changes
in market interest rates, while interest rates on other types may lag behind
changes in market rates. Additionally, certain assets, such as adjustable-rate
mortgage loans, have features that restrict changes in interest rates on a
short-term basis and over the life of the loan. Further, in the event of a
change in interest rates, prepayment and early withdrawal levels could
deviate significantly from those assumed in calculating the tables. Finally,
the ability of many borrowers to service their debt may decrease in the event
of a significant interest rate increase.
In addition, the previous table does not necessarily indicate the impact of
general interest rate movements on the Company's net interest income because
the repricing of certain categories of assets and liabilities are subject to
competitive and other pressures beyond the Company's control. As a result,
certain assets and liabilities indicated as maturing or otherwise repricing
within a stated period may in fact mature or reprice at different times and
at different volumes.
- -------------------------------------------------------------------------------
50
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
CoVest Bancshares, Inc.
Des Plaines, Illinois
We have audited the accompanying consolidated statements of financial
condition of CoVest Bancshares, Inc. (formerly FirstFed Bancshares, Inc.) as
of December 31, 1997 and 1996, and the related consolidated statements of
income, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of CoVest
Bancshares, Inc. as of December 31, 1997 and 1996, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting
principles.
Crowe, Chizek and Company LLP
Oak Brook, Illinois
February 27, 1998
COVEST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 1997 and 1996
(In thousands, except share data)
1997 1996
-------- --------
ASSETS
Cash and cash equivalents
Cash on hand and in banks $ 5,670 $ 1,616
Interest-bearing deposits in other financial institutions 17,800 11,221
-------- --------
23,470 12,837
Securities
Securities available-for-sale 35,840 53,751
Mortgage-backed and related securities available-for-sale 120,753 111,935
Federal Home Loan Bank stock and Federal Reserve stock 7,579 7,190
-------- --------
164,172 172,876
Loans receivable, net
Loans receivable 381,486 339,969
Less allowance for possible loan losses 3,977 1,424
-------- --------
377,509 338,545
Accrued interest receivable 3,487 3,608
Premises and equipment 10,767 9,859
Other assets 3,317 3,444
-------- --------
$582,722 $541,169
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits
Non-interest-bearing $ 14,112 $ 8,834
NOW and money market accounts 78,311 61,168
Savings accounts 59,562 66,218
Certificates of deposit 219,767 265,870
-------- --------
371,752 402,090
Short-term borrowings 76,956 53,690
Long-term borrowings from Federal Home Loan Bank 75,000 25,000
Advances from borrowers for taxes and insurance 2,914 3,724
Accrued expenses and other liabilities 7,806 6,721
-------- --------
534,428 491,225
Stockholders' equity
Preferred stock - par value $.01 per share; 100,000 authorized shares;
no shares outstanding at December 31, 1997 and 1996 - -
Common stock - par value $.01 per share; 7,500,000 authorized shares;
4,365,761 and 5,109,924 shares issued at December 31, 1997 and 1996,
respectively 44 34
Additional paid-in capital 19,365 22,155
Retained earnings 28,410 33,990
Treasury stock, 1997 - 0 shares; 1996 - 686,600 shares, at cost - (5,838)
Unearned stock awards (73) (73)
Unearned ESOP shares (511) (858)
Unrealized gain on securities available-for-sale 1,059 534
-------- --------
48,294 49,944
-------- --------
$582,722 $541,169
-------- --------
-------- --------
- -------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
51
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 1997, 1996, and 1995
(In thousands, except share and per share data)
1997 1996 1995
------- ------- -------
Interest income
Loans receivable $28,186 $27,237 $31,145
Mortgage-backed and related securities 7,018 10,135 4,827
Securities 3,207 4,148 4,026
Other interest and dividend income 953 857 856
------- ------- -------
39,364 42,377 40,854
Interest expense
Deposits 18,750 22,902 23,710
Advances from Federal Home Loan Bank 4,308 5,368 2,915
Other borrowed funds 856 971 102
------- ------- -------
23,914 29,241 26,727
------- ------- -------
NET INTEREST INCOME 15,450 13,136 14,127
Provision for possible loan losses 4,072 1,397 644
------- ------- -------
NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN LOSSES 11,378 11,739 13,483
Noninterest income
Loan charges and servicing fees 1,085 774 439
Deposit related charges and fees 842 585 490
Gain (loss) on sale of securities 1,247 2,551 (53)
Other 498 331 341
------- ------- -------
Total noninterest income 3,672 4,241 1,217
Noninterest expense
Compensation and benefits 5,410 4,847 5,189
Occupancy and equipment 1,740 1,468 1,402
Federal deposit insurance premium 203 1,062 1,003
Special SAIF assessment - 3,033 -
Data processing 1,000 798 714
Advertising 640 334 452
Other 2,312 2,309 1,962
------- ------- -------
Total noninterest expense 11,305 13,851 10,722
------- ------- -------
INCOME BEFORE INCOME TAXES 3,745 2,129 3,978
Income tax provision 1,135 540 1,367
------- ------- -------
NET INCOME $ 2,610 $ 1,589 $ 2,611
------- ------- -------
Earnings per common share
Basic $ .61 $ .34 $ .51
------- ------- -------
------- ------- -------
Diluted $ .58 $ .32 $ .50
------- ------- -------
------- ------- -------
- -------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
52
COVEST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended December 31, 1997, 1996, and 1995
(In thousands, except share and per share data)
Unrealized
Gain
(Loss) on Total
Additional Unearned Unearned Securities Stock-
Common Paid-In Retained Treasury ESOP Stock Available- holders'
Stock Capital Earnings Stock Shares Awards for-Sale Equity
------ ---------- -------- -------- -------- -------- ----------- --------
Balance at January 1, 1995 $28 $26,851 $38,051 $(5,197) $(1,630) $(129) $(1,127) $56,847
Net income - - 2,611 - - - - 2,611
Cash dividend ($.18 per share) - - (975) - - - - (975)
Issuance of stock in
connection with DRIP - 3 - 73 - - - 76
Exercise of stock options - 161 - - - - - 161
Issuance of stock in connection
with exercise of stock options - (3) (314) 696 - - - 379
Purchase of stock - - - (4,969) - - - (4,969)
Release of unearned ESOP shares - - - - 432 - - 432
Stock award earned - - - - - 32 - 32
Tax benefits related to
employee stock plans - 217 - - - - - 217
Effect of transfer of securities
from held-to-maturity to
available-for-sale on December 19,
1995, net of income taxes of $147 - - - - - - 232 232
Increase in fair value of
securities available-for-sale,
net of income taxes of $1,534 - - - - - - 2,634 2,634
--- ------- ------- ------- ------- ----- ------- -------
Balance at December 31, 1995 28 27,229 39,373 (9,397) (1,198) (97) 1,739 57,677
Net income - - 1,589 - - - - 1,589
Cash dividend ($.25 per share) - - (1,221) - - - - (1,221)
Issuance of stock in connection
with exercise of stock options - - (542) 1,030 - - - 488
Purchase of stock - - - (8,053) - - - (8,053)
Issuance of stock in connection
with three-for-two stock split 6 (5,379) (5,209) 10,582 - - - -
- -------------------------------------------------------------------------------
(CONTINUED)
54
COVEST BANCSHARES, INC.
Release of unearned ESOP shares - - - - 340 - - 340
Stock award earned - - - - - 24 - 24
Tax benefits related to
employee stock plans - 305 - - - - - 305
Decrease in fair value
of securities available-
for-sale, net of income
taxes of $734 - - - - - - (1,205) (1,205)
--- ------- ------- ------- ------- ----- ------- -------
Balance at December 31, 1996 34 22,155 33,990 (5,838) (858) (73) 534 49,944
- -------------------------------------------------------------------------------
(CONTINUED)
55
COVEST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years ended December 31, 1997, 1996, and 1995
(In thousands, except share and per share data)
Unrealized
Gain
(Loss) on Total
Additional Unearned Unearned Securities Stock-
Common Paid-In Retained Treasury ESOP Stock Available- holders'
Stock Capital Earnings Stock Shares Awards for-Sale Equity
------ ---------- -------- -------- -------- -------- ----------- --------
Balance at December 31, 1996 $34 $22,155 $33,990 $(5,838) $(858) $(73) $ 534 $49,944
Net income - - 2,610 - - - - 2,610
Cash dividend ($.28 per share) - - (1,245) - - - - (1,245)
Issuance of stock in connection
with exercise of stock options - - (882) 1,783 - - - 901
Purchase of stock - - - (5,302) - - - (5,302)
Issuance of stock in connection
with three-for-two stock split 10 (3,304) (6,063) 9,357 - - - -
Release of unearned ESOP shares - - - - 347 - - 347
Tax benefits related to
employee stock plans - 514 - - - - - 514
Increase in fair value of
securities available-for-sale,
net of income taxes of $332 - - - - - - 525 525
--- ------- ------- ------- ----- ---- ------ -------
Balance at December 31, 1997 $44 $19,365 $28,410 $ - $(511) $(73) $1,059 $48,294
--- ------- ------- ------- ----- ---- ------ -------
--- ------- ------- ------- ----- ---- ------ -------
- -------------------------------------------------------------------------------
(CONTINUED)
56
COVEST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996, and 1995
(In thousands)
1997 1996 1995
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,610 $ 1,589 $ 2,611
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation 864 683 603
Amortization of intangible assets 206 206 206
Deferred income taxes 927 343 703
Deferred loan origination fees (341) 74 (911)
Provision for possible loan losses 4,072 1,397 644
Net (gain) loss on sales of securities (1,247) (2,551) 53
ESOP expense 347 340 432
Stock award earned - 24 32
Change in
Prepaid expenses and other assets 127 (503) 452
Accrued interest receivable 120 (147) (141)
Accrued expenses and other liabilities (102) 503 (46)
-------- --------- --------
Net cash provided by operating activities 7,583 1,958 4,638
CASH FLOWS FROM INVESTING ACTIVITIES
Net loan principal originations (60,477) (70,074) (99,082)
Purchase of securities and securities held-to-maturity - - (18,389)
Purchase of securities available-for-sale (99,662) (171,309) (53,163)
Proceeds from sales of securities available-for-sale 69,897 242,622 4,217
Proceeds from maturities of securities held-to-maturity - - 42,980
Proceeds from maturities of securities available-for-sale 21,258 38,537 32,500
Proceeds from repayment of securities available-for-sale 37,673 36,822 11,085
Purchase of Federal Home Loan Bank stock and Federal
Reserve Bank stock (389) (2,355) (2,047)
Purchase of office properties and equipment (1,722) (282) (1,588)
-------- --------- --------
Net cash provided by (used in) investing activities (33,422) 73,961 (83,487)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits (30,338) (52,566) 45,016
Net increase (decrease) in mortgage escrow funds (810) (1,771) 748
Short-term borrowings, net 23,266 (16,745) 30,635
Proceeds from long-term borrowings 50,000 - 25,000
Repayments of long-term borrowings - (2,400) (4,800)
Proceeds from exercise of stock options, net of treasury
shares issued 901 488 540
Purchase of treasury stock (5,302) (8,053) (4,969)
Cash dividends paid, net of dividend reinvestments (1,245) (1,233) (898)
-------- --------- --------
Net cash provided by (used in) financing activities 36,472 (82,280) 91,272
-------- --------- --------
-------- --------- --------
- -------------------------------------------------------------------------------
(Continued)
57
COVEST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996, and 1995
(In thousands)
1997 1996 1995
------- -------- --------
Net increase (decrease) in cash and cash equivalents $10,633 $(6,361) $ 12,423
Cash and cash equivalents at beginning of year 12,837 19,198 6,775
------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR $23,470 $12,837 $ 19,198
------- ------- --------
------- ------- --------
Supplemental disclosures of cash flow information
Cash paid for
Interest $23,900 $29,364 $ 26,269
Income taxes 1,100 641 865
Transfer of investment securities to securities
available-for-sale $ - $ - $ 64,640
------- ------- --------
Securitization of portfolio loans 17,782 61,030 115,635
------- ------- --------
------- ------- --------
- -------------------------------------------------------------------------------
(Continued)
58
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
(Table amounts in thousands of dollars)
- -------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS: CoVest Bancshares, Inc. formerly known as FirstFed
Bancshares, Inc. (the "Company") is a bank holding company organized under the
laws of the state of Delaware. During 1997, the Company converted its bank,
First Federal Bank to a National Bank Charter and concurrently changed the name
to CoVest Banc, National Association (the "Bank"). The Company provides a full
line of financial services to customers within nine counties in northeast
Illinois from its three locations.
BASIS OF PRESENTATION: The accompanying consolidated financial statements for
the years ended December 31, 1997, 1996, and 1995 include the accounts of CoVest
Bancshares, Inc., CoVest Banc, and the Bank's wholly-owned subsidiary, CoVest
Investments, Inc. On July 31, 1997, the Bank converted from a federal stock
savings bank to a national bank. Since the transaction is an internal
reorganization, the historical cost basis of accounting is continued for the
Bank. All significant intercompany transactions and balances are eliminated in
consolidation.
The preparation of financial statements in conformity with generally accepted
accounting principles and with general practices within the banking industry
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of
income and expenses during the reporting period. Actual results could differ
from these estimates.
SECURITIES: Securities are classified as available-for-sale since the Company
may decide to sell those securities in response to changes in market interest
rates, liquidity needs, changes in yields or alternative investments, and for
other reasons. These securities are carried at fair value with unrealized gains
and losses charged or credited, net of income taxes, to a valuation allowance
included as a separate component of stockholders' equity. Realized gains and
losses on disposition are based on the net proceeds and the adjusted carrying
amounts of the securities sold, using the specific identification method.
Interest income, adjusted for amortization of premium and accretion of
discounts, is included in earnings.
LOANS AND LOAN INCOME: Loans are stated at the principal amount outstanding,
net of unearned income and the allowance for possible loan losses.
Interest on loans is accrued over the term of the loans based upon the principal
balance outstanding. Where serious doubt exists as to the collectibility of a
loan, the accrual of interest is discontinued.
The Company defers loan fees, net of certain direct loan origination costs. The
net amount deferred is reported in the statements of financial condition as part
of loans and is recognized as interest income over the term of the loan or its
repricing period using the level-yield method.
The accrual of interest income is discontinued on a loan when principal or
interest is ninety days or more past due, unless the loan is well secured and in
the process of collection. When a loan is placed on nonaccrual status, interest
previously accrued but not collected in the current period is reversed against
current period interest income. Interest accrued in prior years but not
collected is charged against the allowance for possible loan losses.
- -------------------------------------------------------------------------------
(Continued)
59
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
(Table amounts in thousands of dollars)
- -------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
When a loan is sold or securitized, a separate asset is recognized for the
mortgage servicing rights. This asset is amortized over the life of the
underlying loans. Loans held for securitization are carried at the lower of
cost or estimated market value in the aggregate.
ALLOWANCE FOR POSSIBLE LOAN LOSSES: Because some loans may not be repaid in
full, an allowance for possible loan losses is recorded. Increases to the
allowance are recorded by a provision for possible loan losses charged to
expense. Estimating the risk of the loss and the amount of loss on any loan is
necessarily subjective. Accordingly, the allowance is maintained by management
at a level considered adequate to cover possible losses that are currently
anticipated based on past loss experience, general economic conditions,
information about specific borrower situations including their financial
position and collateral values, and other factors and estimates which are
subject to change over time. While management may periodically allocate
portions of the allowance for specific problem loan situations, the entire
allowance is available for any loan charge-offs that occur. A loan is
charged-off against the allowance by management as a loss when deemed
uncollectible, although collection efforts continue and future recoveries may
occur.
Loans which are considered to be impaired are reduced to the present value of
expected future cash flows or to the fair value of the related collateral by
allocating a portion of the allowance to such loans. If these allocations cause
the allowance for possible loan losses to require an increase, such increase is
reported as a provision for possible loan losses charged to expense. Loans are
evaluated for impairment when payments are delinquent 90 days or more or when
management downgrades the loan classification to doubtful.
Smaller balance homogeneous loans are defined as residential first mortgage
loans secured by one-to-four-family residences, residential construction loans,
and consumer loans and are evaluated collectively for impairment. Commercial
loans, commercial real estate loans, construction loans, and multi-family loans
are evaluated individually for impairment. Normal loan evaluation procedures,
as described in the second preceding paragraph, are used to identify loans which
must be evaluated for impairment. In general, loans classified as doubtful or
loss are considered impaired while loans classified as substandard are
individually evaluated for impairment.
Depending on the relative size of the credit relationship, late or insufficient
payments of 30 to 90 days will cause management to reevaluate the credit under
its normal loan evaluation procedures. While the factors which identify a
credit for consideration for measurement of impairment, or nonaccrual, are
similar, the measurement considerations differ. A loan is impaired when the
economic value estimated to be received is less than the value implied in the
original credit agreement. A loan is placed in nonaccrual when payments are
more than 90 days past due unless the loan is adequately collateralized and in
the process of collection.
PREMISES AND EQUIPMENT: Bank premises and equipment are stated at cost, less
accumulated depreciation and amortization. Provisions for depreciation and
amortization, included in operating expenses, are computed on the straight-line
method over the estimated useful lives of the assets. The cost of maintenance
and repairs is charged to income as incurred while significant repairs are
capitalized.
- -------------------------------------------------------------------------------
(Continued)
60
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
(Table amounts in thousands of dollars)
- -------------------------------------------------------------------------------
INTANGIBLE ASSETS: Goodwill and core deposit intangibles of $3,040,000 are being
amortized over 10-15 years, using the straight-line method. The unamortized
premium balances of $2,160,000 and $2,366,000 are included in other assets in
the December 31, 1997 and 1996 statements of financial condition, respectively.
- -------------------------------------------------------------------------------
(Continued)
61
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- -------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
INCOME TAXES: The provision for income taxes is based on an asset and
liability approach. The asset and liability approach requires the
recognition of deferred tax liabilities and assets for the expected future
tax consequences of temporary differences between the carrying amounts and
the tax bases of assets and liabilities.
EARNINGS PER SHARE: Basic earnings per share is based on weighted average
common shares outstanding. Diluted earnings per share further assumes the
issuance of any potentially dilutive common shares. The accounting standard
for computing earnings per share was revised for 1997, and all earnings per
share previously reported are restated to follow the new standard. Earnings
per share are restated for all subsequent stock dividends and splits.
STATEMENT OF CASH FLOWS: For the purpose of this statement, cash and cash
equivalents is defined to include cash on hand, demand balances, and
interest-bearing deposits with financial institutions with original
maturities of three months or less. The Company reports net cash flows for
customer loan transactions, deposit transactions, and short-term borrowings.
DIVIDEND RESTRICTION: Banking regulations require the maintenance of certain
capital levels and may limit the amount of dividends which may be paid by the
Bank to the holding company or by the holding company to shareholders.
RECLASSIFICATIONS: Certain items in the financial statements as of and for
the years ended December 31, 1996 and 1995 have been reclassified, with no
effect on net income, to conform with the current year presentation.
NOTE 2 - STOCK SPLIT
On December 1, 1997, the Company's Board of Directors authorized a
three-for-two stock split effected in the form of a one-for-two stock
dividend. All share and per share amounts included in the financial
statements have been restated to reflect the stock split.
NOTE 3 - EARNINGS PER SHARE
A reconciliation of the numerators and denominators for earnings per common
share dilution computations for the years ended December 31, 1997, 1996, and
1995 is presented below.
Year Ended December 31,
--------------------------
1997 1996 1995
---- ---- ----
Earnings per share
Net income $2,610 $1,589 $2,611
Weighted average common shares outstanding 4,285 4,738 5,096
------ ------ ------
Earnings per share $ .61 $ .34 $ .51
------ ------ ------
------ ------ ------
- -------------------------------------------------------------------------------
(Continued)
62
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- -------------------------------------------------------------------------------
NOTE 3 - EARNINGS PER SHARE (Continued)
Year Ended December 31,
--------------------------
1997 1996 1995
---- ---- ----
Earnings per share assuming dilution
Net income $2,610 $1,589 $2,611
------ ------ ------
------ ------ ------
Weighted average common shares outstanding 4,285 4,738 5,096
Add: dilutive effect of assumed exercises
Incentive stock options and management
retention plan 199 197 152
------ ------ ------
Weighted average common and dilutive
potential common shares outstanding 4,484 4,935 5,248
------ ------ ------
------ ------ ------
Diluted earnings per share $ .58 $ .32 $ .50
------ ------ ------
------ ------ ------
NOTE 4 - SECURITIES
The amortized cost and fair value of securities available-for-sale are as
follows:
December 31, 1997
--------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
Securities available-for-sale
U.S. Treasury $ 10,976 $ 37 $ - $ 11,013
U.S. government agencies 19,994 28 (31) 19,991
Marketable equity securities 327 81 - 408
States and political subdivisions 4,428 4 (4) 4,428
-------- ------ ---- --------
35,725 150 (35) 35,840
Mortgage-backed securities
Federal Home Loan Mortgage Corporation 56,756 1,244 - 58,000
Government National Mortgage Association 4,405 189 - 4,594
Federal National Mortgage Association 57,335 178 - 57,513
Collateralized mortgage obligations 644 2 - 646
-------- ------ ---- --------
119,140 1,613 - 120,753
Federal Home Loan Bank stock 7,110 - - 7,110
Federal Reserve Bank stock 469 - - 469
-------- ------ ---- --------
$162,444 $1,763 $(35) $164,172
-------- ------ ---- --------
-------- ------ ---- --------
- -------------------------------------------------------------------------------
(Continued)
63
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- -------------------------------------------------------------------------------
NOTE 4 - SECURITIES (Continued)
December 31, 1996
---------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
Securities available-for-sale
- -----------------------------
U.S. Treasury $ 14,903 $ 95 $ - $ 14,998
U.S. government agencies 34,772 42 (140) 34,674
Marketable equity securities 3,181 560 - 3,741
States and political subdivisions 139 1 - 140
Other 198 - - 198
-------- ------ ----- --------
53,193 698 (140) 53,751
Mortgage-backed securities
Federal Home Loan Mortgage Corporation 86,634 331 (204) 86,761
Government National Mortgage Association 4,909 99 - 5,008
Federal National Mortgage Association 17,439 137 (43) 17,533
Collateralized mortgage obligations 2,639 - (6) 2,633
-------- ------ ----- --------
111,621 567 (253) 111,935
Federal Home Loan Bank stock 7,190 - - 7,190
-------- ------ ----- --------
$172,004 $1,265 $(393) $172,876
-------- ------ ----- --------
-------- ------ ----- --------
Proceeds from sales of securities available-for-sale in 1997, 1996, and 1995
and gross realized gains and losses are as follows:
1997 1996 1995
---- ---- ----
Proceeds from sales $69,897 $242,622 $4,217
Gross realized gains 1,422 3,285 17
Gross realized losses (175) (734) (70)
The carrying value of mortgage-backed and related securities are net of
unamortized premiums of $1,079,000 and $130,000 and unaccreted discounts of
$233,000 and $122,000 at December 31, 1997 and 1996, respectively.
At December 31, 1997 and 1996, respectively, $53,366,000 and $36,494,000 of
securities were pledged to secure deposits and borrowings.
The amortized cost and fair value of securities available-for-sale at
December 31, 1997, by contractual maturity, are shown below. Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
- -------------------------------------------------------------------------------
(Continued)
64
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- -------------------------------------------------------------------------------
NOTE 4 - SECURITIES (Continued)
Amortized Fair
Cost Value
---- -----
Securities available-for-sale
- -----------------------------
Due in one year or less $ 11,950 $ 11,986
Due after one year through five years 23,448 23,446
Mortgage-backed securities 118,496 120,107
Collateralized mortgage obligations 644 646
Federal Home Loan Bank stock 7,110 7,110
Federal Reserve Bank stock 469 469
Marketable equity securities 327 408
-------- --------
$162,444 $164,172
-------- --------
-------- --------
NOTE 5 - LOANS RECEIVABLE
Loans receivable at December 31 are summarized as follows:
1997 1996
-------- --------
Mortgage loans
Secured by one-to-four-family residences $235,425 $251,831
Net deferred loan origination costs 652 647
-------- --------
Total mortgage loans 236,077 252,478
Commercial loans
Commercial real estate 56,220 20,705
Multi-family loans 4,604 995
Construction 8,939 1,811
Commercial loans 5,504 58
Commercial leases 11,274 7,053
-------- --------
86,541 30,622
Net deferred loan origination fees (377) (31)
-------- --------
Total commercial loans 86,164 30,591
Consumer and other loans
Automobile 22,781 21,802
Credit card 13,469 15,812
Home equity and improvement 21,987 18,570
Other 1,008 716
-------- --------
59,245 56,900
-------- --------
$381,486 $339,969
-------- --------
-------- --------
Included in first mortgage loans secured by one-to-four-family residences at
December 31, 1996 are $10,100,000 of loans held for securitization.
- -------------------------------------------------------------------------------
(Continued)
65
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 5 - LOANS RECEIVABLE (Continued)
Loans serviced for the Federal Home Loan Mortgage Corporation (the "FHLMC")
approximated $170,113,000, $178,548,000, and $133,433,000 at December 31, 1997,
1996, and 1995, respectively.
The Bank had lending transactions with directors and executive officers of the
Company which totaled approximately $840,000 and $821,000 at December 31, 1997
and 1996, respectively.
The Company did not have any loans which were impaired either at or during the
years ended December 31, 1997 and 1996.
Activity in the allowance for possible loan losses is summarized as follows for
the years ended December 31:
1997 1996 1995
-------- ------- ------
Balance at beginning of year $ 1,424 $ 1,379 $1,520
Provision 4,072 1,397 644
Recoveries 96 145 118
Loans charged-off (1,615) (1,497) (903)
------- ------- ------
Net charge-offs (1,519) (1,352) (785)
------- ------- ------
Balance at end of year $ 3,977 $ 1,424 $1,379
------- ------- ------
------- ------- ------
NOTE 6 - PREMISES AND EQUIPMENT
Premises and equipment at December 31 are summarized as follows:
1997 1996
------- -------
Cost
Land $ 1,656 $ 1,656
Buildings 8,805 8,776
Furniture, fixtures, and equipment 4,256 2,799
Construction in progress 266 -
------- -------
14,983 13,231
Less accumulated depreciation and amortization 4,216 3,372
------- -------
$10,767 $ 9,859
------- -------
------- -------
- --------------------------------------------------------------------------------
(Continued)
66
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 7 - DEPOSITS
Certificates of deposit accounts individually exceeding $100,000 totaled
$35,037,000 and $28,741,000 at December 31, 1997 and 1996, respectively. At
December 31, 1997, stated maturities of all certificates of deposit were:
1998 $160,850
1999 19,736
2000 30,219
2001 2,503
2002 and after 6,459
--------
$219,767
--------
--------
Certificates of deposit included approximately $8,370,000 and $15,786,000 at
December 31, 1997 and 1996, respectively, which bear interest at increasing
rates over the life of the deposit term. The Bank records interest expense on
these deposits on a level-yield basis over the contractual deposit term.
NOTE 8 - BORROWINGS
Borrowings at December 31 are summarized as follows:
1997 1996
------------------ -------------------
Weighted Weighted
Average Average
Rate Amount Rate Amount
-------- ------- -------- --------
SHORT-TERM BORROWINGS
Advances from the Federal Home Loan Bank due
1997 $ - 5.72% $37,400
1998 5.74% 60,000 - -
Securities sold under repurchase agreements 5.28 12,947 5.26 12,792
Other borrowings 5.27 4,009 5.15 3,498
------- -------
$76,956 $53,690
------- -------
------- -------
LONG-TERM BORROWINGS
Advances from Federal Home Loan Bank due
2000 6.19% $25,000 6.19% $25,000
2002 5.35 50,000 - -
------- -------
$75,000 $25,000
------- -------
------- -------
The Bank maintains a collateral pledge agreement dated February 1, 1993 covering
secured advances whereby the Bank has agreed to at all times keep on hand, free
of all other pledges, liens, and encumbrances, first mortgages on improved
residential property (not more than 90 days
- --------------------------------------------------------------------------------
(Continued)
67
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
delinquent) aggregating no less than 167% of the outstanding secured advances
from the Federal Home Loan Bank.
- --------------------------------------------------------------------------------
(Continued)
68
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 8 - BORROWINGS (Continued)
Securities sold under repurchase agreements either carry a fixed rate for the
term of the agreement, and generally mature within 90 to 180 days from the
transaction date, or reprice weekly. Physical control is maintained over the
collateral pledged in the agreements. One repurchase agreement is with the
state of Illinois, in the amount of $10,000,000. This agreement matures on
January 20, 1998, and the total amount at risk would be $1,178,000 at
December 31, 1997.
Other borrowings consisted of a Treasury tax and loan option which allows the
Company to accept U.S. Treasury deposits of excess funds along with deposits of
customer taxes. The other borrowing has an interest rate which adjusts weekly.
This borrowing is collateralized by a pledge of various securities, with an
amortized cost of $4,994,000 and $12,408,000 and a fair value of $4,988,000 and
$12,506,000 at December 31, 1997 and 1996, respectively.
NOTE 9 - INCOME TAXES
The income tax provision for the years ended December 31 is summarized as
follows:
1997 1996 1995
------ ------ --------
Current
Federal $1,875 $ 338 $ 807
State 187 (141) (143)
Deferred (927) 343 703
------ ----- ------
$1,135 $ 540 $1,367
------ ----- ------
------ ----- ------
Total income tax expense differed from the amounts computed by applying the
U.S. federal income tax rate of 34% to income before income taxes as a result
of the following:
1997 1996 1995
------- ------ -------
Expected income tax expense at federal tax rate $1,273 $ 724 $1,352
State income tax, net of federal tax benefit (12) (114) 21
Increase in cash surrender value of director life insurance (82) (56) -
Other (44) (14) (6)
------ ----- ------
$1,135 $ 540 $1,367
------ ----- ------
------ ----- ------
- --------------------------------------------------------------------------------
(Continued)
69
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 9 - INCOME TAXES (Continued)
The deferred tax liabilities, included in other liabilities in the accompanying
statement of financial condition, consisted of the following at December 31,
1997 and 1996:
1997 1996
-------- --------
Gross deferred tax assets
Bad debt deduction $ 337 $ -
Deferred compensation and employee benefits 776 748
Other - 14
------- -------
1,113 762
Gross deferred tax liabilities
Unrealized gain on securities available-for-sale (669) (338)
Depreciation (453) (417)
FHLB stock dividends (176) (176)
Bad debt deduction - (652)
Deferred loan fees (595) (609)
Other (54) -
------- -------
(1,947) (2,192)
------- -------
Net deferred tax liability $ (834) $(1,430)
------- -------
------- -------
The deferred tax asset for the unrealized loss on marketable equity securities
is offset by a valuation allowance of an equal amount.
Prior to 1996, the Bank qualified under provisions of the Internal Revenue Code
which permitted it to deduct from taxable income a provision for bad debts which
differs from the provision charged to income in the financial statements.
Retained earnings at December 31, 1997 and 1996 include approximately $9,264,000
representing the bad debt deduction accumulated prior to 1987, for which no
deferred income tax liability has been recorded.
NOTE 10 - COMMITMENTS, CONTINGENT LIABILITIES, AND CONCENTRATIONS
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 and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit and previously approved unused
lines of credit. Those instruments involve, to varying degrees, elements of
credit and interest-rate risk in excess of the amount recognized in the
statement of financial condition.
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 and
previously approved unused lines of credit is represented by the contractual
amount of those instruments.
- --------------------------------------------------------------------------------
(Continued)
70
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Table amounts in thousands of dollars)
- -------------------------------------------------------------------------------
NOTE 10 - COMMITMENTS, CONTINGENT LIABILITIES, AND CONCENTRATIONS (Continued)
The Company uses the same credit policies in making commitments and
conditional obligations as it does for loans recorded in the statement of
financial condition.
At December 31, 1997 and 1996, these financial instruments are summarized as
follows:
Amount
------
1997 1996
---- ----
Off-balance-sheet financial instruments whose contract amounts
represent credit risk
Commitments to extend credit
Fixed rate $ 3,734 $ 16,476
Variable rate 7,732 2,174
Unused lines of credit 78,340 64,528
Credit enhancements 6,500 -
The fixed rate commitments have rates ranging from 8.25% to 9.50% and 6.25%
to 8.125% at December 31, 1997 and 1996, respectively. Since certain
commitments to make loans and fund lines of credit and loans in process
expire without being used, the above amounts do not necessarily represent
future cash commitments. No losses are anticipated as a result of these
transactions.
The Company's principal loan customers are located in northeast Illinois and
most loans are secured by specific collateral including residential and
commercial real estate.
During 1997, the Company has entered into a credit enhancement agreement with
a local municipality to guarantee the repayment of an aggregate of $6.5
million of municipal revenue bonds which are secured by a first mortgage on
real estate. In the event of default on the bonds, the Company's maximum
liability is the amount of the credit guaranty.
NOTE 11 - CAPITAL REQUIREMENTS
The Company is subject to regulatory capital requirements administered by
federal banking agencies. Capital adequacy guidelines and prompt corrective
action regulations involve quantitative measures of assets, liabilities, and
certain off-balance-sheet items calculated under regulatory accounting
practices. Capital amounts and classifications are also subject to
qualitative judgments by regulators about components, risk weightings, and
other factors, and the regulators can lower classifications in certain cases.
Failure to meet various capital requirements can initiate regulatory action
that could have a direct material effect on the financial statements.
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although
these terms are not used to represent overall financial condition. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans of capital restoration are required.
- -------------------------------------------------------------------------------
(Continued)
71
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Table amounts in thousands of dollars)
- -------------------------------------------------------------------------------
NOTE 11 - CAPITAL REQUIREMENTS (Continued)
At December 31, 1997, the Bank's regulators categorized the Bank as well
capitalized. Actual capital levels (in millions) and minimum required levels
were:
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purpose Action Provisions
------ ---------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total capital
(to risk-weighted assets)
Company $47.1 15.4% $24.5 8.0% $30.6 10.0%
Bank 46.4 15.2 24.4 8.0 30.5 10.0
Tier 1 capital
(to risk-weighted assets)
Company 43.3 14.2 12.2 4.0 18.4 6.0
Bank 42.6 14.0 12.2 4.0 18.3 6.0
Tier 1 capital
(to average assets)
Company 43.3 7.7 22.5 4.0 28.1 5.0
Bank 42.6 7.6 22.3 4.0 27.9 5.0
On June 30, 1992, the Bank converted from a federal mutual savings and loan
association to a federal stock savings bank with the concurrent formation of
a holding company. At the time of conversion, the Bank established a
liquidation account for the benefit of eligible account holders as of March
31, 1991 who continue to maintain their accounts at the Bank after the
conversion. The liquidation account will be reduced annually to the extent
that eligible account holders have reduced their qualifying deposits.
Subsequent increases will not restore an eligible account holder's interest
in the liquidation account. In the event of a complete liquidation, each
eligible account holder will be entitled to receive a distribution from the
liquidation account in an amount proportionate to the current adjusted
qualifying balances for accounts then held before any distribution may be
made with respect to the Bank's capital stock.
NOTE 12 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Corporations are required to disclose fair value information about their
financial instruments. The fair value of financial instruments is defined as
the amount at which the instruments could be exchanged in a current
transaction between willing parties, other than in a forced or liquidation
sale. The methods and assumptions used to determine fair values for each
class of financial instruments are presented below.
The estimated fair value for cash on hand and in banks; interest-bearing
deposits in other financial institutions; Federal Home Loan Bank stock; Federal
Reserve stock; accrued interest receivable; NOW, money market, and passbook
savings deposits; short-term borrowings; advances by borrowers for taxes and
insurance; and accrued interest payable are considered to approximate their
carrying values. The estimated fair value for securities available-for-sale is
based on quoted market values for the individual securities or for equivalent
securities. The estimated fair value for loans is based on estimates of the
rate the Company would charge for similar loans at December 31, 1997
- -------------------------------------------------------------------------------
(Continued)
72
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Table amounts in thousands of dollars)
- -------------------------------------------------------------------------------
NOTE 12 - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
and 1996, applied for the time period until estimated repayment. The
estimated fair value of certificates of deposit is based on estimates of the
rate the Company would pay on such deposits at December 31, 1997 and 1996,
applied for the time period until maturity. The estimated fair value of
Federal Home Loan Bank advances and other borrowings is based on the estimate
of the rate the Company would pay for such
- -------------------------------------------------------------------------------
(Continued)
73
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Table amounts in thousands of dollars)
- -------------------------------------------------------------------------------
NOTE 12 - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
borrowings at December 31, 1997 and 1996 for a time period until maturity.
Loan commitments are not included in the table below as their estimated fair
value is immaterial.
At December 31,
---------------
1 9 9 7 1 9 9 6
------- -------
Approximate Estimated Approximate Estimated
Carrying Fair Carrying Fair
Value Value Value Value
----- ----- ----- -----
Financial instrument assets
- ---------------------------
Cash on hand and in banks $ 5,670 $ 5,670 $ 1,616 $ 1,616
Interest-bearing deposits in other
financial institutions 17,800 17,800 11,221 11,221
Securities available-for-sale 164,172 164,172 172,876 172,876
Loans receivable, net 377,509 377,862 338,545 335,948
Accrued interest receivable 3,487 3,487 3,608 3,608
Financial instrument liabilities
- --------------------------------
NOW, money market, and passbook savings (151,985) (151,985) (136,220) (136,220)
Certificates of deposits (219,767) (220,336) (265,870) (268,565)
Short-term borrowings (76,956) (76,956) (53,690) (53,690)
Long-term borrowings (75,000) (75,000) (25,000) (25,000)
Advances by borrowers for taxes and insurance (2,914) (2,914) (3,724) (3,724)
Accrued interest payable (957) (957) (943) (943)
Other assets and liabilities of the Company that are not defined as financial
instruments, such as property and equipment, are not included in the above
disclosures. Also not included are nonfinancial instruments typically not
recognized in financial statements such as loan servicing rights, customer
goodwill, and similar items.
While the above estimates are based on management's judgment of the most
appropriate factors, there is no assurance that were the Company to have
disposed of these items on December 31, 1997 and 1996, the fair values would
have been achieved, because the market value may differ depending on the
circumstances. The estimated fair values at December 31, 1997 and 1996
should not necessarily be considered to apply at subsequent dates.
NOTE 13 - EMPLOYEE BENEFIT PLANS
In 1996, the Company terminated its defined benefit pension plan which
covered substantially all employees and distributed all proceeds to the
participants. In 1995, an estimated curtailment expense for the termination
was recorded in the amount of $271,000, and in 1996, an additional expense of
$30,000 was recorded when the final determination was made.
- -------------------------------------------------------------------------------
(Continued)
74
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Table amounts in thousands of dollars)
- -------------------------------------------------------------------------------
NOTE 13 - EMPLOYEE BENEFIT PLANS (Continued)
The Bank has a defined contribution plan covering all of its eligible
employees. Employees are eligible to participate in the plan after attainment
of age 21 and completion of one year of service. The Company provides
matching funds under the Company's 401(k) plan. The Company matches an
amount equal to the employee's contribution, up to a maximum of 2.5% of
annual compensation. The expense recorded in 1997 and 1996 was $65,000 and
$61,000, respectively.
The Company's Board of Directors has adopted a stock option and incentive
plan that was ratified by the stockholders. Under the stock option plan,
stock options, stock appreciation rights, and restricted stock awards, up to
an aggregate of 724,500 shares at the market price of the Company's common
stock on the date of grant, were available to be granted to the directors,
officers, and employees of the Company or the Bank. During 1995, the stock
option plan was amended to increase to 1,287,000 the aggregate shares
available.
In 1996, the Board of Directors adopted the 1996 Stock Option and Incentive
Plan, whereby an additional 246,000 stock options could be granted. In 1997,
this plan was amended to increase the aggregate shares available to 621,000.
During 1997, options for 409,500 shares had been granted at $11.21 to $17.67
per share and are fully vested after six years. During 1996, options for
211,500 shares had been granted at $9.45 to $11.33 per share and are fully
vested after completing six years of service.
Statement of Financial Accounting Standards No. 123 requires pro forma
disclosures for companies that do not adopt its fair value accounting method
for stock-based employee compensation. Accordingly, the following pro forma
information presents net income and earnings per share had the fair value
method been used to measure compensation cost for stock option plans.
Compensation cost actually recognized for stock options was $0 for 1997 and
1996.
1997 1996
---- ----
Net income as reported $2,610 $1,589
Pro forma net income 2,243 1,363
Basic earnings per share as reported .61 .34
Pro forma basic earnings per share .52 .29
Diluted earnings per share as reported .58 .32
Pro forma diluted earnings per share .50 .28
- -------------------------------------------------------------------------------
(Continued)
75
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
(Table amounts in thousands of dollars)
- -------------------------------------------------------------------------------
NOTE 13 - EMPLOYEE BENEFIT PLANS (Continued)
The activity in the stock option plans for 1997 and 1996 is summarized as
follows:
Weighted
Number Average
of Exercise
Options Price
------- -----
Outstanding at January 1, 1996 1,007,955 $ 6.68
Granted 211,500 10.71
Exercised (109,845) (4.45)
Forfeited (36,000) (8.55)
---------
Outstanding at December 31, 1996 1,073,610 7.65
Granted 409,500 14.52
Exercised (158,242) (5.70)
Forfeited (60,750) (8.86)
---------
Outstanding at December 31, 1997 1,264,118 9.91
---------
---------
Options exercisable at year end are as follows:
Weighted
Number Average
of Exercise
Options Price
------- -----
December 31, 1996 373,860 $ 4.67
December 31, 1997 431,618 6.47
For options granted during the year, the weighted average fair values at
grant date are as follows:
Number of Exercise Fair
Options Price Value
------- ----- -----
1996 211,500 $10.71 $2.41
1997 409,500 14.52 4.89
The fair value of options granted during 1997 and 1996 is estimated using the
following weighted average information: risk-free interest rate of 6.5%,
expected life of 6 years, expected volatility of stock price of 11.624% and
14.72%, and expected dividends of 2.5% per year.
- -------------------------------------------------------------------------------
(Continued)
76
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- -------------------------------------------------------------------------------
NOTE 13 - EMPLOYEE BENEFIT PLANS (Continued)
At year end, options outstanding were as follows:
Number of options 1,264,118
Range of exercise price $4.45 - $17.67
Weighted average exercise price $9.91
Weighted average remaining option life 6 years
For options now exercisable
Number 431,618
Weighted average exercise price $6.47
The Bank has established a Bank Incentive Plan ("BIP") in order to provide
persons in key management positions with an ownership interest in the Company.
Under the BIP, 182,176 shares have been awarded to key personnel. The stock
granted under the BIP was restricted as to certain rights at the time of
issuance. These restrictions were removed over a period of five years. During
1997 and 1996, 0 and 17,757 shares vested. The market value of the shares,
determined at the date of grant, are charged to expense over the vesting period.
In 1993, the Company began to provide certain postretirement health care
benefits for eligible employees. Employees may become eligible based on the
number of years of service and if they reach normal retirement age while working
for the Company. In addition, the Company maintains a retirement plan for
directors which provides retirement benefits based upon the total number of
years of service and average monthly fees received during the last three years
of service as a director. Retirement benefits are payable upon retirement, as
defined under the Plan, and are payable for ten years. In addition to the
monthly retirement benefit, upon attainment of age 65, each director and their
spouse is provided lifetime medical and dental coverage as a supplement to
Medicare.
In accordance with Statement of Financial Accounting Standards No. 106,
"Employers Accounting for Postretirement Benefits Other Than Pensions", the
Company has elected to amortize the accumulated postretirement benefit
obligation (APBO) over 20 years. At December 31, 1997 and 1996, respectively,
the APBO was $973,000 and $706,000, and the postretirement benefit costs for
each of the years ended December 31, 1997, 1996, and 1995 was $106,000,
$124,000, $108,000, respectively. The annual rate of increase in the per capita
cost of covered health care is assumed to be 11.5% for five years and 5.5%
thereafter. The other related disclosures are not considered significant to the
financial statements.
The Company and most of its outside directors have entered into various deferred
compensation agreements. These agreements provide for guaranteed payments for a
specified period (ranging from 60 to 180 months) after a specified age is
attained (ranging from age 60 to age 72). The liability for each covered
director is being accrued over the vesting period. Expense of $11,000, $62,000,
and $152,000 has been included in compensation and benefits in the accompanying
consolidated statements of income for the years ended December 31, 1997, 1996,
and 1995, respectively.
The Company is the beneficiary of life insurance policies on the directors with
an aggregate face value of approximately $2,700,000 and $2,800,000 at
December 31, 1997 and 1996,
- -------------------------------------------------------------------------------
(CONTINUED)
77
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- -------------------------------------------------------------------------------
respectively. In addition, the policies had aggregate cash surrender values
of approximately $548,000 and $308,000 at December 31, 1997 and 1996,
respectively. During 1997, the Company received net insurance proceeds of
$187,000 due to the death of a director.
- -------------------------------------------------------------------------------
(CONTINUED)
78
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- -------------------------------------------------------------------------------
NOTE 13 - EMPLOYEE BENEFIT PLANS (Continued)
The Company's Board of Directors adopted an ESOP for the benefit of all
employees of the Bank. On June 30, 1992, in conjunction with the Bank's mutual
to stock conversion, the ESOP acquired 579,600 shares of Company stock, at $4.45
per share for a total of $2,576,000. To fund the acquisition of Company stock,
the ESOP borrowed $2,576,000 from the Company. The balance of this loan was
$511,000 and $858,000 at December 31, 1997 and 1996, respectively, and is
reflected as a reduction of stockholders' equity. The Company makes annual
contributions to the ESOP equal to the ESOP's debt service. All dividends
received by the ESOP are used to pay debt service. The ESOP shares are pledged
as collateral for its debt. As the debt is repaid, shares are released from
collateral and allocated to active employees, based on the proportion of debt
service paid in the year. Debt of the ESOP is recorded as debt and the shares
pledged as collateral are reported as unearned ESOP shares in the statement of
financial condition. The Company recognizes compensation expense equal to the
amount of cash contributed to the ESOP. ESOP contributions were $267,000,
$290,000, and $303,000 for 1997, 1996, and 1995, respectively. The ESOP shares
as of December 31 were as follows:
1997 1996
------- -------
Allocated shares 281,712 243,192
Committed to be released 51,782 69,537
Suspense shares 110,593 194,129
------- -------
Total ESOP shares 444,087 506,858
------- -------
------- -------
NOTE 14 - PARENT COMPANY ONLY FINANCIAL STATEMENTS
Presented below are the condensed balance sheets, condensed statements of
income, and condensed statements of cash flows for CoVest Bancshares, Inc.
CONDENSED BALANCE SHEETS
December 31, 1997 and 1996
1997 1996
------- -------
ASSETS
Cash in banks $ 1,930 $ 891
Securities 408 3,939
Investment in Bank 45,842 44,638
Other assets 552 532
------- -------
$48,732 $50,000
------- -------
------- -------
- -------------------------------------------------------------------------------
(CONTINUED)
79
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- -------------------------------------------------------------------------------
NOTE 14 - PARENT COMPANY ONLY FINANCIAL STATEMENTS (Continued)
1997 1996
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 438 $ 56
Stockholders' equity
Common stock 44 34
Additional paid in capital 19,365 22,155
Retained earnings 28,410 33,990
Treasury stock, at cost - (5,838)
Unearned stock awards (73) (73)
Unearned ESOP shares (511) (858)
Unrealized gain on securities available-for-sale 50 343
Unrealized gain on securities available-for-sale
of subsidiary Bank 1,009 191
------- -------
48,294 49,944
------- -------
$48,732 $50,000
------- -------
------- -------
CONDENSED STATEMENTS OF INCOME
Years ended December 31, 1997, 1996, and 1995
1997 1996 1995
------ ------- -------
Operating income
Interest on investments $ 33 $ 44 $ 44
Dividends received from subsidiary 2,000 10,000 5,000
Gain on sale of securities 1,148 5 11
Other 53 95 98
------ ------- -------
Total operating income 3,234 10,144 5,153
Operating expenses 829 245 270
------ ------- -------
INCOME BEFORE EQUITY IN UNDISTRIBUTED EARNINGS
OF SUBSIDIARY 2,405 9,899 4,883
EQUITY (EXCESS) IN UNDISTRIBUTED EARNINGS OF SUBSIDIARY 205 (8,310) (2,272)
------ ------- -------
NET INCOME $2,610 $ 1,589 $ 2,611
------ ------- -------
------ ------- -------
- -------------------------------------------------------------------------------
(CONTINUED)
80
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- -------------------------------------------------------------------------------
NOTE 14 - PARENT COMPANY ONLY FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996, and 1995
1997 1996 1995
------- ------- -------
OPERATING ACTIVITIES
Net income $ 2,610 $ 1,589 $ 2,611
Adjustments to reconcile net income to net cash
provided by operating activities
Equity (excess) in undistributed earnings of subsidiary (205) 8,310 2,271
Net gain on sales of securities (1,148) (5) (11)
Change in
Other assets (20) (1) 177
Other liabilities 1,098 (40) 129
------- ------- -------
Net cash provided by operating activities 2,335 9,853 5,177
INVESTING ACTIVITIES
Purchase of securities (100) (2,853) (2,299)
Proceeds from sale of securities 4,103 134 489
Proceeds from maturity of securities - - 2,000
------- ------- -------
Net cash provided by (used in) investing activities 4,003 (2,719) 190
FINANCING ACTIVITIES
Proceeds from exercise of stock options,
net of treasury shares issued 901 488 540
Payment received on loan to ESOP 347 340 432
Purchase of treasury stock (5,302) (8,053) (4,969)
Cash dividend paid, net of dividend reinvestments (1,245) (1,233) (898)
------- ------- -------
Net cash used in financing activities (5,299) (8,458) (4,895)
------- ------- -------
Net increase (decrease) in cash and cash equivalents 1,039 (1,324) 472
Cash and cash equivalents at beginning of year 891 2,215 1,743
------- ------- -------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 1,930 $ 891 $ 2,215
------- ------- -------
------- ------- -------
- -------------------------------------------------------------------------------
(CONTINUED)
81
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
- -------------------------------------------------------------------------------
NOTE 15 - QUARTERLY RESULTS OF OPERATIONS (Unaudited)
(In thousands, except per share data)
Three Months Ended 1997
-------------------------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
Interest income $ 9,678 $ 9,922 $ 9,605 $ 10,159
Interest expense 5,856 6,067 5,733 6,258
-------- -------- -------- --------
NET INTEREST INCOME 3,822 3,855 3,872 3,901
Provision for possible loan losses 351 402 430 2,889
Other income 1,071 832 909 860
Other expense 2,513 2,796 2,748 3,248
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES 2,029 1,489 1,603 (1,376)
Income taxes 712 502 562 (641)
-------- -------- -------- --------
NET INCOME $ 1,317 $ 987 $ 1,041 $ (735)
-------- -------- -------- --------
-------- -------- -------- --------
EARNINGS PER COMMON SHARE
Basic $ .30 $ .23 $ .24 $ (.17)
Diluted .29 .22 .23 (.17)
Three Months Ended 1996
-------------------------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
Interest income $ 10,683 $ 10,502 $ 11,034 $ 10,158
Interest expense 7,584 7,500 7,697 6,460
-------- -------- -------- --------
NET INTEREST INCOME 3,099 3,002 3,337 3,698
Provision for possible loan losses 190 342 300 565
Other income 2,886 379 526 450
Special SAIF assessment - - 3,033 -
Other expense 2,716 2,691 2,540 2,872
-------- -------- -------- --------
- -------------------------------------------------------------------------------
(Continued)
82
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
INCOME BEFORE INCOME TAXES 3,079 348 (2,010) 711
Income taxes 1,121 65 (753) 106
-------- -------- -------- --------
NET INCOME $ 1,958 $ 283 $ (1,257) $ 605
-------- -------- -------- --------
-------- -------- -------- --------
EARNINGS PER COMMON SHARE
Basic $ .40 $ .06 $ (.27) $ .13
Diluted .39 .06 (.27) .12
- -------------------------------------------------------------------------------
(Continued)
83
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning directors of the Registrant is incorporated herein by
reference from the Company's definitive Proxy Statement for the 1997 Annual
Meeting of Stockholders. Information concerning the executive officers of the
Registrant is discussed in Item 1 of this Report, "Business--Executive
Officers of the Company."
Section 16(a) of the Securities Exchange Act of 1934 requires that the
Company's executive officers and directors and persons who own more than 10%
of the Company Common Stock file reports of ownership and changes in
ownership with the Securities and Exchange Commission and with the exchange
on which the Company's shares of Company Common Stock are traded. Such
persons are also required to furnish the Company with copies of all Section
16(a) forms they file. Based solely on the Company's review of the copies of
such forms furnished to the Company and, if appropriate, representations made
to the Company by any such reporting person concerning whether a Form 5 was
required to be filed for the 1995 fiscal year, the Company is not aware that
any of its directors and executive officers or 10% stockholders failed to
comply with the filing requirements of Section 16(a) during the period
commencing January 1, 1997 through December 31, 1997.
Item 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by
reference from the Company's definitive Proxy Statement for the 1997 Annual
Meeting of Stockholders, except for information contained under the heading
"Compensation Committee Report on Executive Compensation" and "Performance
Graph."
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Information concerning security ownership of certain beneficial owners and
management is incorporated herein by reference from the Company's definitive
Proxy Statement for the 1997 Annual Meeting of Stockholders.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and transactions is incorporated
herein by reference from the Company's definitive Proxy Statement for the
1997 Annual Meeting of Stockholders.
- -------------------------------------------------------------------------------
84
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
A report on Form 8-K was filed on October 16, 1997 to report under Item 5,
Other Events, that the Company issued a press release pertaining to net
income for the quarter ended September 30, 1997.
A report on Form 8-K was filed on October 28, 1997 to report under Item 5,
Other Events, that the Company announced a three-for-two stock split.
A report on Form 8-K was filed on November 25, 1997 to report under Item 5,
Other Events, that the Company announced a regular quarterly dividend.
A report on Form 8-K was filed on December 31, 1997 to report under Item 5,
Other Events, that its subsidiary, CoVest Banc would increase its Provision
For Possible Loan Losses during the fourth quarter of 1997 to a total of
approximately $4,100,000 which would result in a loss for the fourth
quarter, 1997.
- -------------------------------------------------------------------------------
85
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.
COVEST BANCSHARES, INC.
By: /s/ Larry G. Gillie By: /s/ Paul A. Larsen
---------------------------- -------------------------------
Larry G. Gillie, Paul A. Larsen,
President and Senior Vice-President,
Chief Executive Officer Treasurer and Chief Financial
Officer
Date: March 6, 1998 Date: March 6, 1998
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/ Donald J. Cameron By: /s/ Larry G. Gillie
---------------------------------- -------------------------------
Donald J. Cameron, Larry G. Gillie, President,
Chairman of the Board Chief Executive Officer
and Director
Date: March 6, 1998 Date: March 6, 1998
By: /s/ George T. Drost By: /s/ John A. Flink
------------------------------- ---------------------------------
George T. Drost, Director John A. Flink, Director
Date: March 6, 1998 Date: March 6, 1998
By: /s/ David M. Miller By: /s/ Gerald T. Niedert
----------------------------- ---------------------------------
David M. Miller, Director Gerald T. Niedert, Director
Date: March 6, 1998 Date: March 6, 1998
By: /s/ David B. Speer By: /s/ Frank A. Svoboda
------------------------------- ----------------------------------
David B. Speer, Director Frank A. Svoboda, Jr., Director
Date: March 6, 1998 Date: March 6, 1998
By: /s/ Thomas TenHoeve
----------------------------------
Thomas TenHoeve, Director
Date: March 6, 1998
- -------------------------------------------------------------------------------
86
COVEST BANCSHARES, INC.
Exhibit Index
To
Annual Report of Form 10-K
EXHIBIT DESCRIPTION INCORPORATED HEREIN BY FILED SEQUENTIAL
NO. REFERENCE TO HEREWITH PAGE NO.
3.1 Certificate of Exhibit 3.1 to the
Incorporation of CoVest Registration Statement on
Bancshares, Inc. Form S-1 filed with the
Commission by CoVest
Bancshares, Inc. on April 1,
1992, as amended (SEC File
No. 33-46909)
3.2 Amendment to Certificate X
of Incorporation of CoVest
Bancshares, Inc.
3.3 Bylaws of CoVest Exhibit 3.2 to the
Bancshares, Inc. Registration Statement of
Form S-1 filed with the
Commission by CoVest
Bancshares, Inc. on April 1,
1992, as amended (SEC File
No. 33-46909)
4.1 Specimen Stock Certificate X
of CoVest Bancshares,
Inc.
10.1 Stock Option and Incentive Exhibit 10.1 to the
Plan Registration Statement of
Form S-1 filed with the
Commission by CoVest
Bancshares, Inc. on April 1,
1992, as amended (SEC File
No. 33-46909)
10.2 Employment Agreement Exhibit 10.2 to the 1995 10-K
for Larry G. Gillie dated filed with the Commission
February 26, 1996 by CoVest Bancshares, Inc.
on March 28, 1996
(Commission File No. 0-20160)
10.3 Form of Change of X
Control Agreement for
Paul A. Larsen
Allen J. Bishop
Joseph H. Tillotson
Lawrence J. Schmidt
Vernon J. Wiggenhauser
10.4 Form of Change of X
Control Agreement for
R. Kennedy Alger
10.5 Bank Incentive Plan and Exhibit 10.4 to the
Trusts Registration Statement of
Form S-1 filed with the
Commission by CoVest
Bancshares, Inc. on April 1,
1992, as amended (SEC File
No. 33-46909)
10.6 Employee Stock Exhibit 10.5 to the
Ownership Plan Registration Statement of
Form S-1 filed with the
Commission by CoVest
Bancshares, Inc. on April 1,
1992, as amended (SEC File
No. 33-46909)
10.7 Profit Sharing/401(k) Plan Exhibit 10.1 and 10.2 to the
and Trust Agreement March 31, 1995 10-Q, filed
with the Commisssion by
CoVest Bancshares, Inc. on
May 11, 1995 (Commission
File No. 0-20160)
10.8 Amendment 1995-1 to Exhibit 10.1 to the June 30,
CoVest Bancshares, Inc. 1995 10-Q, filed with the
1992 Stock Option and Commission by CoVest
Incentive Plan Bancshares, Inc. on August 8,
1995 (Commission File
2
No. 0-20160)
10.9 Amendment 1997-1 to X
CoVest Bancshares, Inc.
1992 Stock Option and
Incentive Plan
10.10 1996 Stock Option and X
Incentive Plan
10.11 Amendment 1997-1 to X
1996 Stock Option and
Incentive Plan
10.12 Data Processing Contract X
with M & I
21.1 Subsidiaries of the X
Registrant
23.1 Consent of Crowe Chizek X
99.1 Proxy Statement and proxy Schedule 14A filed with the
(except such portions Commission on March 24,
incorporated by reference 1998.
into this Form 10-K, such
materials shall not be
deemed to be "filed" with
the Commission)
3