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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, 1998
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
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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. [ ]
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1
As of March 5, 1999, the Registrant had issued and outstanding 4,403,803 shares
of the Registrant's Common Stock. In addition, it had also repurchased 193,188
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, 1999,
was $50,427,000.*
DOCUMENTS INCORPORATED BY REFERENCE
-------------------------------------------------------------------
PART III of Form 10-K--Portions of the Proxy Statement for the 1999
Annual Meeting of Stockholders.
* Based on the closing price of the Registrant's Common Stock on March 5, 1999,
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.
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2
COVEST BANCSHARES, INC.
1998 ANNUAL REPORT ON FORM 10-K
Table of Contents
Page
Number
----
PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . 34
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . 34
Item 4. Submission of Matters to a Vote of Security Holders. . . . . . 34
PART II
Item 5. Market for the Registrant's Common Stock and Related
Security Holder Matters . . . . . . . . . . . . . . . . . . 35
Item 6. Selected Financial Data. . . . . . . . . . . . . . . . . . . . 38
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . 40
Item 7A. Quantitative and Qualitative Disclosure About Market Risk. . . 52
Item 8. Consolidated Financial Statements. . . . . . . . . . . . . . . 55
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure. . . . . . . . . . . . . . . . . . 89
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . 89
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . 89
Item 12. Security Ownership of Certain Beneficial Owners and
Management. . . . . . . . . . . . . . . . . . . . . . . . . 89
Item 13. Certain Relationships and Related Transactions . . . . . . . . 89
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on 8-K. . . . . . . . . . . . . . . . . . . . . . . . . . . 90
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .91
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3
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 of 1956, as
amended (the "BHCA"). The Company's 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 subsidiary and was initially chartered as a
federal savings and loan association in 1934. 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.
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4
The Company, the Bank and CII 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 lesser 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, loan origination fees,
loan servicing fees, loan service release fees from its mortgage center
operations, 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. Its internet
address is www.covestbanc.com.
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 13 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. A second Mortgage Center was opened in Aurora, Illinois, located
approximately 35 miles southwest of Des Plaines, in July, 1998. The CoVest Banc
Mortgage Centers concentrate on mortgage loan origination and sales.
A CoVest Investment Center was opened in Berwyn, Illinois in December, 1998,
approximately 15 miles southeast of Des Plaines. The Investment Center
concentrates on annuity sales, insurance sales and securities transactions.
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
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5
characterized by single-family residences and apartment buildings. These
demographics provide the Company with diverse opportunities for commercial
lending, which became a focus of the Bank commencing 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
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 before 1996 had historically 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 in 1996, 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.
The Bank's Mortgage Center provides a full array of first mortgage products for
which it acts as a loan originator and placer. All loans are sold on a service
released basis to other financial institutions, for which the Bank receives a
fee and has no additional rights.
In November, 1998, the Company sold its $10.8 million credit card loan
portfolio. Proceeds from the sale were used to fund additional multifamily
loans.
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6
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, ---------------------------------------------
------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
Commercial loans $ 8,035 1.98% $ 5,504 1.44% $ 58 0.02% $ -% $ - -%
Real estate loans
One-to-four family 154,182 37.94 235,425 61.76 251,831 74.21 275,570 83.04 297,682 85.16
Multi-family 55,661 13.70 4,604 1.21 995 0.29 177 0.06 226 0.06
Commercial real estate 66,776 16.43 56,220 14.75 20,705 6.11 2,200 0.66 - -
Construction 40,572 9.98 8,939 2.34 1,811 0.53 - - - -
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total real estate loans 317,191 78.05 305,188 80.06 275,342 81.14 277,947 83.76 297,908 85.22
Commercial/Municipal leases 35,166 8.66 11,274 2.96 7,053 2.08 - - - -
Consumer loans
Automobile 21,036 5.18 22,781 5.98 21,802 6.42 18,618 5.61 17,192 4.93
Home equity and
improvement 22,654 5.57 21,987 5.77 18,570 5.47 16,323 4.92 14,211 4.06
Credit card - - 13,469 3.53 15,812 4.66 18,289 5.51 19,930 5.70
Other 2,290 0.56 1,008 0.26 716 0.21 677 0.20 323 0.09
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total consumer loans 45,980 11.31 59,245 15.54 56,900 16.76 53,907 16.24 51,656 14.78
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total loans 406,372 100.00% 381,211 100.00% 339,353 100.00% 331,854 100.00% 349,564 100.00%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Net deferred costs/(fees) 269 275 616 542 (1,084)
--------- --------- --------- --------- ---------
Total loans receivable $ 406,641 $ 381,486 $ 339,969 $ 332,396 $ 348,480
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
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The following table shows the composition of the Company's loan portfolio by
fixed and adjustable rate at the dates indicated:
--------------------------------------------- DECEMBER 31, ---------------------------------------------
------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
Fixed rate loans
Commercial loans $ 1,722 0.42% $ 438 0.11% $ 58 0.02% $ - -% $ - -%
Real estate loans
One-to-four family 89,390 22.00 137,314 36.02 157,430 46.39 215,556 64.96 270,536 77.39
Multi-family 391 0.10 576 0.15 995 0.29 177 0.06 226 0.06
Commercial real estate 19,735 4.85 15,863 4.16 20,304 5.98 2,200 0.66 - -
Construction 199 0.05 63 0.02 - - - - - -
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total real estate loans 109,715 27.00 153,816 40.35 178,729 52.66 217,933 65.68 270,762 77.45
Commercial leases 35,166 8.66 11,274 2.96 7,053 2.08 - - - -
Consumer loans 27,292 6.71 29,424 7.72 26,160 7.71 22,449 6.76 22,867 6.54
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total fixed loans 173,895 42.79 194,952 51.14 212,000 62.47 240,382 72.44 293,629 83.99
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Adjustable-rate loans
Commercial loans 6,313 1.56 5,066 1.32 - - - - - -
Real estate loans
One-to-four family 64,792 15.94 98,111 25.74 94,401 27.82 60,014 18.08 27,146 7.77
Multi-family 55,270 13.60 4,028 1.06 - - - - - -
Commercial real estate 47,041 11.58 40,357 10.59 2,212 0.65 - - - -
Construction 40,373 9.93 8,876 2.33 - - - - - -
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total real estate loans 207,476 51.05 151,372 39.72 96,613 28.47 60,014 18.08 27,146 7.77
Consumer loans 18,688 4.60 29,821 7.82 30,740 9.06 31,458 9.48 28,789 8.24
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total adjustable loans 232,477 57.21 186,259 48.86 127,353 37.53 91,472 27.56 55,935 16.01
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total loans 406,372 100.00% 381,211 100.00% 339,353 100.00% 331,854 100.00% 349,564 100.00%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Net deferred costs/(fees) 269 275 616 542 (1,084)
--------- --------- --------- --------- ---------
Total loans receivable $ 406,641 $ 381,486 $ 339,969 $ 332,396 $ 348,480
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
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8
The following schedule illustrates the contractual maturities of the Company's
loan portfolio at December 31, 1998. 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:
Comm. Loans,
Comm. Real Estate,
Construction,
One-to-Four Family Multi-Family Consumer
--Residential Loans-- --and Leases----- ------Loans------ ------Total------
----------------- ---------- ----- -----
(Dollars in Thousands)
Coming due during Weighted Weighted Weighted Weighted
years ending Average Average Average Average
December 31, Amount Rate Amount Rate Amount Rate Amount Rate
------------ ------ ---- ------ ---- ------ ---- ------ ----
1999* $ 6,888 6.53% $ 53,120 8.05% $ 8,922 8.68% $ 68,930 7.98%
2000 5,875 7.33 36,472 7.75 6,697 8.07 49,044 7.74
2001 5,498 7.51 7,212 7.26 4,510 8.05 17,220 7.55
2002 to 2003 12,779 7.54 26,169 8.09 8,032 8.43 46,980 8.00
2004 to 2008 35,716 7.23 70,448 7.97 17,722 8.76 123,886 7.87
2009 to 2023 69,506 7.38 12,276 8.21 97 8.58 81,879 7.51
2024 and beyond 17,920 7.29 513 8.53 - - 18,433 7.32
--------- ----- --------- ----- --------- ----- --------- -----
Total $ 154,182 7.32% $ 206,210 7.96% $ 45,980 8.52% $ 406,372 7.78%
--------- ----- --------- ----- --------- ----- --------- -----
--------- ----- --------- ----- --------- ----- --------- -----
(*) Includes demand loans, loans having no stated maturity, and overdraft
loans.
Approximately $154.7 million in fixed rate loans and $182.8 million in variable
rate loans have maturities in excess of one year.
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, 1998, the Bank's regulatory loan-to-one borrower limit was $7.0 million. On
the same date, the Bank's largest lending relationship was $6,627,000.
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 construction loans are collateralized by property within the Company's
market area. The commercial leases, which may extend beyond the Company's
market area, are primarily investment grade leases.
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9
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. These types of loans carry a
rate higher than residential mortgages, but also have a greater degree of credit
risk. Leases, of which 96 % are investment grade instruments, are not
considered a substantial risk.
At December 31, 1998, the Company had $66,776,000 in commercial real estate
loans, $40,572,000 in construction loans, $8,035,000 in commercial loans,
$35,166,000 in commercial/municipal leases, and $55,661,000 in multi-family
loans. The Allowance for Possible Loan Losses included $3,365,000 for these
types of loans at December 31, 1998.
Loan growth in multi-family loans showed the largest increase in 1998. These
loans are concentrated in the counties surrounding the Company's locations with
the major dollar volumes and numbers being situated in Cook County, Illinois.
Most of these loans are to finance or refinance apartment buildings ranging in
size from five units up to 24 units. The terms of the loans are one year
adjustable rate, three year adjustable rate, or five year adjustable rate and
have a maximum loan-to-value ratio of 80%.
Construction lending is primarily for rehabilitation projects in Cook County and
some land development projects around the Company's lending area. These
rehabilitation projects are for the conversion of old warehouse and factory
space into single family townhouses or condominiums. The typical build out time
is less than eighteen months and is priced at a margin above the prime rate.
Commercial real estate loans are primarily for mixed use properties, office
buildings that are occupied, operating strip malls and hotel/motel loans. These
loans usually reprice at least every five years based upon a margin over the
five year constant maturity treasury.
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. During 1998, the Mortgage Center
originated and sold 708 loans and 45 additional loans were originated and
retained in the Bank's portfolio. The Mortgage Center also generated $1,006,000
in non-interest income from the receipt of SRP's (service release premiums) from
the sale of the originated mortgages to secondary market investors as well as
$706,000 in other origination fees. The Mortgage Center's investor network of
approximately thirty private or institutional investors allows the Company to
offer Conventional, Jumbo, VA and B, C and D (sub-prime) loan programs for
first mortgages. The Mortgage Center also has the ability to originate and sell
125% equity loans and equity loans to borrowers with credit problems.
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 1998, the Company held as Mortgage Backed Securities ("MBS")
previously securitized with Federal Home Loan Mortgage Corporation $20 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 1999. At December 31, 1998, $149.9 million of the Company's loan
portfolio consisted of permanent loans on one-to-four family residences. The
Company also held for sale $4.3 million in loans on one-to-four family
residences originated by the Mortgage Center. At that date, the Company's
largest outstanding residential loan was $774,000. 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."
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10
The Company continues to have fewer one-to-four family residential homes in its
portfolio and has seen the total decrease from 85.16% of total loans on December
31, 1994 to 37.94% of total loans on December 31, 1998. The decrease in 1998
was due to the sale of most new loan originations to external investors by the
Company's Mortgage Center, and the acceleration of prepayment/refinancing
activity on existing loans, in response to declining interest rates.
Mortgage loans retained by the Company may have 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.
The Company currently originates substantially all of its consumer loans in its
primary market area. At December 31, 1998, the Company's consumer loans totaled
$46.0 million or 11.31% of the Company's loan portfolio. This represented a
decline of $13.3 million from December 31, 1997, primarily due to sale of the
Company's credit card loan portfolio in November, 1998.
For second mortgage and home equity loans, 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'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.
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. In 1998, 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
- -------------------------------------------------------------------------------
11
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 1998, the Company experienced $1,391,000 in loan charge-offs, 90% of which
were related to credit cards, and made provisions of $1,011,000 to the Allowance
for Possible Loan Losses related to consumer loans. During the year, the
Company was able to recover $161,000 on consumer loans previously charged off.
Management regularly conducts a review of its loan portfolio, write-off
experience and adequacy of allowance for loan losses to maintain the allowance
at a level management feels is adequate.
MORTGAGE-BACKED AND RELATED SECURITIES
The Company purchases 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
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. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Business Strategy".
The following schedule sets forth the contractual maturities of the Company's
mortgage-backed and related securities and carrying value as of December 31,
1998. All such securities are considered available-for-sale and include
approximately $20 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 securities are anticipated to be repaid in advance of their
contractual maturity as a result of projected mortgage loan prepayments, 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. $ 832 $ - $ - $ 21,362 $ 22,194
Government National Mortgage Assoc. - - - 7,325 7,325
Federal National Mortgage Assoc. - - - 5,353 5,353
--------- --------- --------- --------- ---------
$ 832 $ - $ - $ 34,040 $ 34,872
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
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
- -------------------------------------------------------------------------------
12
periodically considers the purchase of mortgage-backed and related securities
and/or residential loans from third party lenders. In 1998, the Company
purchased $40.4 million in floating rate mortgage backed securities.
In 1997, the Company purchased $700,000 in floating 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.
The Company has securitized residential real estate loans from time to time.
When loans have been securitized, the Company retains the responsibility for
servicing the loan. At December 31, 1998, and 1997, there was approximately
$118.8 million and $170.1 million, respectively, in the loan servicing
portfolio. The Company currently holds $19.8 million of these loans as
mortgage-backed securities on the balance sheet. Management does not expect to
securitize any additional loans. Also, at December 31, 1998, the Company had no
outstanding commitments to sell mortgage-backed or mortgage-related securities.
- -------------------------------------------------------------------------------
13
The following table shows the loan originations, purchases, sales, and
repayments of the Company for the periods indicated:
------------ Year Ended December 31, -------
-----------------------
1998 1997 1996
---- ---- ----
(Dollars in Thousands)
Originations of portfolio loans
Adjustable rate
Commercial loans $ 12,304 $ 5,128 $ -
Construction loans 42,845 16,170 -
One-to-four family 9,441 34,386 44,648
Commercial real estate 36,845 - -
Multi-family 45,683 - -
Consumer loans 15,049 19,986 21,146
------------ ------------- ------------
Total adjustable rate 162,167 75,670 65,794
Fixed rate
Commercial loans - - 63
One-to-four family - 3,962 14,616
Commercial real estate - 37,577 20,443
Multi-family - 2,679 -
Commercial leases 44,759 10,454 7,272
Consumer 11,548 15,096 18,978
------------ ------------- ------------
Total fixed rate 56,307 69,768 61,372
------------ ------------- ------------
Total loans originated 218,474 145,438 127,166
Purchases of mortgage-backed and related securities
Mortgage-backed securities and participation certificates 40,363 52,568 83,257
Mortgage-related securities - - 18,126
------------ ------------- ------------
Total purchased 40,363 52,568 101,383
Sales and repayments of loans and mortgage-backed and
related securities
Sales of mortgage-backed securities 87,571 46,719 222,729
Sale of credit card loans 10,805 - -
Principal repayments 219,182 101,910 87,029
------------ ------------- ------------
Total reductions 317,558 148,629 309,758
Decrease on other items (net) (1,999) (2,894) (975)
------------ ------------- ------------
Net increase (decrease) in loans and mortgage-backed securities $ (60,720) $ 46,483 $ (82,184)
------------ ------------- ------------
------------ ------------- ------------
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14
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 15 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. These loans are also
placed on non-accrual status.
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 as
deemed appropriate in the collection process.
The following table sets forth the Company's loan delinquencies by type, by
amount, and by percentage. Non performing assets are excluded from the table.
----------------------- Loans Delinquent For -------------------------
-------------------- Total
--------- 30 - 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 15 $ 851 0.55% - $ - 0.00% 15 $ 851 0.55%
Commercial real
estate - - 0.00 - - 0.00 - - 0.00
Multi-family - - 0.00 - - 0.00 - - 0.00
Construction - - 0.00 - - 0.00 - - 0.00
Commercial 3 35 0.44 - - 0.00 3 35 0.44
Commercial leases 11 213 0.61 - - 0.00 11 213 0.61
Consumer 15 80 0.17 - - 0.00 15 80 0.17
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total 44 $ 1,179 0.29% - $ - 0.00% 44 $ 1,179 0.29%
-------- -------- -------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- -------- -------- --------
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.
- -------------------------------------------------------------------------------
15
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 as 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 loans delinquent less than 90 days are
categorized as Special Mention. As a result of management's review of its
assets, at December 31, 1998, the Company had categorized $1,730,000 of its
assets as Special Mention, $1,021,000 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, 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.
- -------------------------------------------------------------------------------
16
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, -------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in Thousands)
Non-accruing loans
One-to-four family $ 996 $ - $ - $ 531 $ 176
Commercial real estate loans - - - - -
Multi-family loans - - - - -
Construction loans - - - - -
Commercial loans - - - - -
Commercial leases - - - - -
Consumer 25 - 95 - -
---------- ---------- ---------- ---------- ----------
Total 1,021 - 95 531 176
Accruing loans delinquent 90 days or more
One-to-four family - 1,137 599 - -
Commercial real estate loans - - - - -
Multi-family loans - - - - -
Construction loans - - - - -
Commercial loans - - - - -
Commercial leases - - - - -
Consumer - 167 162 150 24
---------- ---------- ---------- ---------- ----------
Total - 1,304 761 150 24
---------- ---------- ---------- ---------- ----------
Total non-performing loans $ 1,021 $ 1,304 $ 856 $ 681 $ 200
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Total non-performing loans
to net loans 0.25% 0.35% 0.25% 0.21% 0.06%
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Total non-performing loans
as percentage of assets 0.19% 0.22% 0.16% 0.11% 0.04%
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Management has considered the Company's non-performing assets in establishing
its Allowance for Possible Losses on Loans. As of December 31, 1998, there were
specific reserves of $250,000 on a commercial loan.
As of December 31, 1998, 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
On a quarterly basis, management of the bank meets to review the adequacy of the
allowance for loan losses. Each loan officer grades his individual commercial
credits and the Company's outsourced Loan Review function
- -------------------------------------------------------------------------------
17
validates the officers' grades. In the event that Loan Review downgrades the
loan, it is included in the allowance analysis at the lower grade. The grading
system is in compliance with the regulatory classifications and the allowance is
allocated to the loans based on the regulatory grading, except in instances
where there are known differences (i.e. collateral value is nominal, etc.).
Once the specific portion of the allowance is calculated, management then
calculates a historical portion for each loan category based on loan loss
history, current economic conditions and trends in the portfolio, including
delinquencies and impairments, as well as changes in the composition of the
portfolio.
During 1998, there was a significant change in the composition of the loan
portfolio. The loan portfolio has migrated from a lower risk single family
residential loan portfolio to a higher risk commercial loan portfolio. There
have been substantial increases in the multi-family, construction, lease and
commercial loan portfolio. In addition, in 1998 the credit card loan portfolio
was sold. The methodology used to determine the adequacy of the allowance for
loan losses is consistent with prior years, although there were reallocations of
the allowance based on the change in composition of the portfolio and the sale
of the credit card portfolio.
- -------------------------------------------------------------------------------
18
The following table sets forth an analysis of the Company's allowance for
possible loan losses:
---------------------------- December 31, -------------------------
Year Ended
----------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in Thousands)
Balance at beginning of period $ 3,977 $ 1,424 $ 1,379 $ 1,520 $ 1,581
Charge-offs
One-to-four family 38 - - - -
Commercial real estate loans - - - - -
Multi-family loans - - - - -
Construction loans - - - - -
Commercial loans - - - - -
Commercial leases - - - - -
Consumer 1,355 1,615 1,497 903 474
Recoveries
One-to-four family - - - - -
Commercial real estate loans - - - - -
Multi-family loans - - - - -
Construction loans - - - - -
Commercial loans - - - - -
Commercial leases - - - - -
Consumer 161 96 145 118 53
---------- ---------- ---------- ---------- ----------
Net charge-offs 1,232 1,519 1,352 785 421
---------- ---------- ---------- ---------- ----------
Additions charged to operations 1,567 4,072 1,397 644 360
---------- ---------- ---------- ---------- ----------
Balance at end of period $ 4,312 $ 3,977 $ 1,424 $ 1,379 $ 1,520
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Ratio of net charge-offs during the
period to average loans outstanding
during the period 0.37% 0.42% 0.39% 0.20% 0.15%
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Ratio of allowance to non-performing loans 4.22x 3.05x 1.66x 2.02x 7.60x
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
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.
- -------------------------------------------------------------------------------
19
The distribution of the Company's allowance for possible losses on loans at the
dates indicated is summarized as follows:
----------------------------------------- December 31, ---------------------------------------
------------
-------1998------- -------1997------- -------1996------- --------1995-------
---- ---- ---- ----
Percent Percent Percent Percent
of of of of
Allowance Loans Allowance Loans Allowance Loans Allowance Loans
for in Each for in Each for in Each for in Each
Possible Category Possible Category Possible Category Possible Category
Losses to Losses to Losses to Losses to
on Total on Total on Total on Total
Loans Loans Loans Loans Loans Loans Loans Loans
----- ----- ----- ----- ----- ----- ----- -----
(Dollars in Thousands)
One-to-four family loans $ 387 37.94% $ 100 61.76% $ 250 74.21% $ 600 83.10%
Commercial loans and leases 412 10.64 76 4.40 - 0.02 - -
Commercial real estate,
construction, and multi-family 2,953 40.11 2,180 18.30 285 6.93 44 0.66
Consumer loans 560 11.31 1,621 15.54 889 16.76 735 16.24
------- ------- ------- ------- ------- ------- ------- -------
Total $ 4,312 100.00% $ 3,977 100.00% $ 1,424 100.00% $ 1,379 100.00%
------- ------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- ------- -------
---- December 31, ----
------------
-------1994-------
----
Percent
of
Allowance Loans
for in Each
Possible Category
Losses to
on Total
Loans Loans
----- -----
(Dollars in Thousands)
One-to-four family loans $ 1,100 85.22%
Commercial loans and leases - -
Commercial real estate,
construction, and multi-family - -
Consumer loans 420 14.78
------- -------
Total $ 1,520 100.00%
------- -------
------- -------
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 during those years. In 1998, management re-allocated $837,000
from the Allowance on Consumer Loans after the sale of the credit card portfolio
in November, 1998. $551,000 of this amount was re-allocated to the Allowance
for Losses on Commercial and Commercial Real Estate Loans and $286,000 was
re-allocated to the Allowance for Losses on One-to-Four Family Loans.
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.
- -------------------------------------------------------------------------------
20
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, U.S. government and agency securities, municipal bonds, and to a
lesser extent, 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,------------------------------
----------1998---------- -----------1997---------- -----------1996----------
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%
U.S. government agency 30,041 34.13 19,991 12.18 34,674 20.06
Marketable equity securities 853 0.97 408 0.25 3,741 2.16
Municipal bonds 13,872 15.76 4,428 2.70 140 0.08
Corporate bond - - - - 198 0.11
FHLMC mortgage-backed
and related 22,194 25.22 58,000 35.33 86,761 50.19
GNMA mortgage-backed
and related 7,325 8.32 4,594 2.80 5,008 2.90
FNMA mortgage-backed
and related 5,353 6.08 57,513 35.03 17,533 10.14
CMO mortgage-related - - 646 0.39 2,633 1.52
-------- -------- -------- -------- -------- --------
Subtotal 79,638 90.48 156,593 95.39 165,686 95.84
FRB stock 469 0.53 469 0.29 - -
FHLB stock 7,910 8.99 7,110 4.32 7,190 4.16
-------- -------- -------- -------- -------- --------
Total securities and stock $ 88,017 100.00% $164,172 100.00% $172,876 100.00%
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
Average remaining life
of non-mortgage-backed
securities 3.55 years 2.45 years 6.16 years
The composition and contractual maturities of the securities portfolio at
December 31, 1998, excluding mortgage-backed securities, Federal Reserve Bank
of Chicago stock, FHLB of Chicago stock, and marketable 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 $ - $ - $ - $ - $ -
U.S. government agency - 22,594 7,447 - 30,041
Municipal bonds 2,310 10,289 1,273 - 13,872
--------- --------- --------- --------- ---------
Total securities $ 2,310 $ 32,883 $ 8,720 $ - $ 43,913
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Weighted average yield 5.82% 6.05% 5.91% -% 6.01%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
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21
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. In 1996
and 1997, an additional source of funds was the securitization of loans which
were then classified as securities. The Bank has sold some of the securities
to meet liquidity needs in the payment of deposit withdrawals or the funding
of commercial related loan growth. No additional securitizations occurred in
1998.
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, 1998, the Company had outstanding borrowings of
$120,000,000 at the FHLB of Chicago. Two additional non-deposit sources of
funds which the Company has used during 1998 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 accounts, 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%.
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. As of December 31, 1998, the
Company also had $2,686,000 in brokered deposits.
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 retain CD deposits at maturity. The Company has offered
new services to make its checking accounts more desirable, such as Telephone
Access Banking and Debit Card, both of which have been extensively utilized
by the customers. PC Banking was introduced in 1998.
- -------------------------------------------------------------------------------
22
The following table sets forth the deposit flows experienced by the Company
during the periods indicated:
----------Year Ended December 31,-------
-----------------------
(Dollars in Thousands)
1998 1997 1996
---- ---- ----
Deposit balance at January 1 $ 371,752 $ 402,090 $ 454,656
Deposits 756,327 594,060 646,685
Withdrawals (779,139) (641,008) (721,083)
Interest credited 15,595 16,610 21,832
----------- ----------- -----------
Deposit balance at December 31 $ 364,535 $ 371,752 $ 402,090
----------- ----------- -----------
----------- ----------- -----------
Net decrease $ (7,217) $ (30,338) $ (52,566)
----------- ----------- -----------
----------- ----------- -----------
Percent decrease (1.94)% (7.55)% (11.56)%
----------- ----------- -----------
----------- ----------- -----------
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23
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,----------------------------------
----------1998---------- ----------1997----------- ----------1996----------
% of % of % of
Amount Total Amount Total Amount Total
------ ----- ------ ----- ------ -----
(Dollars in Thousands)
Checking accounts $ 38,823 10.65% $ 35,265 9.49% $ 30,556 7.60%
Money market accounts 85,209 23.37 57,158 15.37 39,446 9.81
Saving accounts 52,990 14.54 59,562 16.02 66,218 16.47
-------- -------- -------- --------- -------- --------
Total non-certificates 177,022 48.56 151,985 40.88 136,220 33.88
Certificates of deposit(1)
0.00 - 2.99% 120 0.03 27 0.01 185 0.05
3.00 - 3.99% - - 18 0.01 172 0.04
4.00 - 4.99% 47,612 13.06 5,663 1.52 24,138 6.00
5.00 - 5.99% 101,385 27.81 149,140 40.12 138,641 34.48
6.00 - 6.99% 30,738 8.43 43,665 11.75 69,172 17.20
7.00 - 7.99% 7,630 2.09 14,379 3.86 27,056 6.73
8.00 - 8.99% 14 0.01 3,218 .87 5,418 1.35
9.00 - 9.99% 14 0.01 3,657 .98 1,088 .27
-------- -------- -------- --------- -------- --------
Total certificates 187,513 51.44 219,767 59.12 265,870 66.12
-------- -------- -------- --------- -------- --------
Total deposits $364,535 100.00% $371,752 100.00% $402,090 100.00%
-------- -------- -------- --------- -------- --------
-------- -------- -------- --------- -------- --------
(1) Certificates of deposit include approximately $991,000, $8,370,000, and
$15,786,000 at December 31, 1998, 1997, and 1996, 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.
- -------------------------------------------------------------------------------
24
The following table shows rate and maturity information for the Company's
certificates of deposit as of December 31, 1998. Approximately $991,000 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:
1999 2000 2001 2002 2003 Thereafter Total
---- ---- ---- ---- ---- ---------- -----
(Dollars in Thousands)
0.0 - 2.99% $ 120 $ - $ - $ - $ - $ - $ 120
3.00 - 3.99% - - - - - - -
4.00 - 4.99% 42,394 2,525 1,291 836 466 100 47,612
5.00 - 5.99% 85,675 10,888 2,774 1,357 661 30 101,385
6.00 - 6.99% 7,350 20,118 281 2,789 - 200 30,738
7.00 - 7.99% 969 3,639 3 3,019 - - 7,630
8.00 - 8.99% 14 - - - - - 14
9.00 - 9.99% - 14 - - - - 14
----------- --------- ---------- ---------- ---------- ---------- -----------
$ 136,522 $ 37,184 $ 4,349 $ 8,001 $ 1,127 $ 330 $ 187,513
----------- --------- ---------- ---------- ---------- ---------- -----------
----------- --------- ---------- ---------- ---------- ---------- -----------
The following table indicates the amount of the Company's certificates of
deposit by time remaining until maturity as of December 31, 1998.
--------------------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 $ 36,038 $ 25,019 $ 51,191 $ 41,057 $ 153,305
Certificates of deposit of $100,000 or more(1) 7,858 6,095 10,322 9,933 34,208
---------- ---------- ---------- ---------- -----------
Total certificates of deposit $ 43,896 $ 31,114 $ 61,513 $ 50,990 $ 187,513
---------- ---------- ---------- ---------- -----------
---------- ---------- ---------- ---------- -----------
(1) Includes "Jumbo" certificates of $11,047,000.
"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".
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25
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 $120 million of FHLB advances
outstanding at December 31, 1998, secured by residential mortgage loans and
$39 million in mortgage backed securities. 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:
1998 1997 1996
---- ---- ----
(Dollars in Thousands)
Maximum month-end balances
FHLB advances $ 120,000 $ 135,000 $ 135,600
Securities sold under repurchase agreement 3,774 14,292 16,162
Other 2,981 10,000 11,187
Average balances
FHLB advances 154,644 71,956 89,630
Securities sold under repurchase agreement 3,365 12,781 11,683
Other 6,993 3,497 6,630
Weighted average rates
FHLB advances 5.48% 5.99% 5.99%
Securities sold under repurchase agreement 5.14 5.22 5.25
Other 5.16 5.30 5.40
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26
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 the policies of various governmental
regulatory authorities, including the OCC, the FRB, the Federal Deposit
Insurance Corporation (the "FDIC"), the Internal Revenue Service and state
taxing authorities and the Securities and Exchange Commission (the "SEC").
The effect of applicable statutes, regulations and regulatory 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 is a summary of the material elements of the regulatory
framework that applies to the Company and its subsidiaries. It does not
describe all of the statutes, regulations and regulatory policies that apply
to the Company and its subsidiaries, nor does it restate all of the
requirements of the statutes, regulations and regulatory policies that are
described. As such, the following is qualified in its entirety by reference
to the applicable statutes, regulations and regulatory policies. Any change
in applicable law, regulations or regulatory policies may have a material
effect on the business of the Company and its subsidiaries.
RECENT REGULATORY DEVELOPMENTS
PENDING LEGISLATION
Legislation has been introduced in the Congress that would allow bank holding
companies to engage in a wider range of nonbanking 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. 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 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 Federal Reserve under the Bank Holding Company Act of
1956, as amended (the "BHCA"). In accordance with Federal Reserve 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 otherwise do so. Under the BHCA, the Company is subject to periodic
examination by the Federal Reserve. The Company is also required to file with
the Federal Reserve periodic reports of the Company's operations and such
additional information regarding the Company and its subsidiaries as the
Federal Reserve may require.
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27
INVESTMENTS AND ACTIVITIES
Under the BHCA, a bank holding company must obtain Federal Reserve approval
before: (i) acquiring, directly or indirectly, ownership or control of any
voting shares of another bank or bank holding company if, after the
acquisition, it would own or control more than 5% of the shares of the other
bank or bank holding company (unless it already owns or controls the majority
of 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 Federal Reserve 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 Federal Reserve 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) and state laws 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 generally prohibits 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. This general prohibition is subject to a number of
exceptions. The principal exception allows bank holding companies to engage
in, and to own shares of companies engaged in, certain businesses found by
the Federal Reserve to be "so closely related to banking ... as to be a
proper incident thereto." Under current regulations of the Federal Reserve,
the Company and its non-bank subsidiaries are permitted to engage in a
variety of banking-related businesses, including 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 any person or company from acquiring "control" of
a bank or a bank holding company without prior notice to the appropriate
federal bank regulator. "Control" is defined in certain cases as the
acquisition of at least 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 Federal Reserve 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 Federal Reserve'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 a 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 a
minimum requirement of 4% 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). Total capital consists primarily of
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
possible loan and lease losses.
The risk-based and leverage standards described above are minimum
requirements. Higher capital levels will be required if warranted by the
particular circumstances or risk profiles of individual banking
organizations. For example, the Federal Reserve'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.
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28
As of December 31, 1998, the Company had regulatory capital in excess of the
Federal Reserve's minimum requirements, with a risk-based capital ratio of
13.72% and a leverage ratio of 8.14%.
DIVIDENDS
The Delaware 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. Additionally, the Federal Reserve has issued a policy
statement with regard to the payment of cash dividends by bank holding
companies. The policy statement provides 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. The Federal Reserve also 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.
FEDERAL SECURITIES REGULATION
The Company's common stock is registered with the SEC under 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 FDIC's Savings
Association Insurance Fund ("SAIF"), 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, 1998, SAIF assessments ranged from 0% of
deposits to 0.27% of deposits. For the semi-annual assessment period
beginning January 1, 1999, 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 (i)
has engaged or is engaging in unsafe or unsound practices, (ii) is in an
unsafe or unsound condition to continue operations or (iii) 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 if 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.
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29
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 Financing Corporation ("FICO"). FICO was created in 1987
to finance the recapitalization of the Federal Savings and Loan Insurance
Corporation, the SAIF's predecessor insurance fund. As a result of federal
legislation enacted in 1996, beginning as of January 1, 1997, both SAIF
members and members of the FDIC's Bank Insurance Fund ("BIF") became subject
to assessments to cover the interest payments on outstanding FICO
obligations. These 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 final
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, 1998, the FICO assessment rate for
SAIF members ranged between approximately 0.061% of deposits and
approximately 0.063% of deposits, while the FICO assessment rate for BIF
members ranged between approximately 0.012% of deposits and approximately
0.013% of deposits. During the year ended December 31, 1998, the Bank paid
FICO assessments totaling $222,284.
SUPERVISORY ASSESSMENTS
All national banks are required to pay supervisory assessments to the OCC to
fund the operations of the OCC. The amount of the assessment is calculated
using a formula which takes into account the bank's size and its supervisory
condition (as determined by the composite rating assigned to the bank as a
result of its most recent OCC examination). During the year ended December
31, 1998, the Bank paid supervisory assessments to the OCC totaling $125,810.
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
a minimum requirement of at least 4% 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 Federal Reserve'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, 1998, the Bank was not required by the OCC
to increase its capital to an amount in excess of the minimum regulatory
requirement. As of December 31, 1998, the Bank exceeded its minimum
regulatory capital requirements with a leverage ratio of 7.84% and a
risk-based capital ratio of 13.29%.
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," in each case as defined by regulation. Depending upon the
capital category to which an institution is assigned, the regulators'
corrective powers include: requiring the institution to submit a capital
restoration plan; limiting the institution's asset growth and restricting its
activities; requiring the institution to issue additional capital stock
(including additional voting stock) or to be acquired; restricting
transactions between the institution and its affiliates; restricting the
interest rate the institution may pay on deposits; ordering a new 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.
As of December 31, 1998, the Bank was "well capitalized," as defined by OCC
regulations.
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30
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
retained net income for the two preceding years. In 1997 and 1998 the Bank
made dividend payments to the Company of $2 million and $4 million
respectively, $205,000 and $1,000 less than net earnings in each year.
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, 1998. 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, 1998,
approximately $19 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 federal law 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 addition, in
October 1998, the federal banking regulators issued safety and soundness
standards for achieving Year 2000 compliance, including standards for
developing and managing Year 2000 project plans, testing remediation efforts
and planning for contingencies.
In general, the safety and soundness guidelines prescribe the goals to be
achieved in each area, and each institution is 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. If an institution fails to submit an
acceptable compliance plan, or fails in any material respect to implement a
compliance plan that has been accepted by its primary federal regulator, the
regulator is required to issue an order directing the institution to cure the
deficiency. Until the deficiency cited in the regulator's order is cured, the
regulator may restrict the institution's rate of growth, require the
institution to increase its capital, restrict the rates the institution pays
on deposits or require the institution to take any other action the regulator
deems appropriate under the circumstances. Noncompliance with the standards
established by the safety and soundness guidelines may also constitute
grounds for other enforcement action by the federal banking regulators,
including cease and desist orders and civil money penalty assessments.
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31
BRANCHING AUTHORITY
National banks headquartered 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.
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the "Riegle-Neal Act"), both state and national banks are allowed 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 new
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 allowed individual states to "opt-out" of
certain provisions of the Riegle-Neal Act by enacting appropriate legislation
prior to June 1, 1997. Illinois enacted legislation permitting interstate
mergers beginning on June 1, 1997, subject to certain conditions, including a
prohibition against interstate mergers involving an Illinois bank that has
been in existence and continuous operation for fewer than five years.
FEDERAL RESERVE SYSTEM
Federal Reserve 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 $46.5 million or less, the
reserve requirement is 3% of total transaction accounts; and for transaction
accounts aggregating in excess of $46.5 million, the reserve requirement is
$1.395 million plus 10% of the aggregate amount of total transaction accounts
in excess of $46.5 million. The first $4.9 million of otherwise reservable
balances are exempted from the reserve requirements. These reserve
requirements are subject to annual adjustment by the Federal Reserve. The
Bank is in compliance with these reserve requirements.
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32
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company, each of whom is also 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.
Name Position With
Holding Company Position with Bank
- ----------------------------------------------------------------------------------------------------------------
James L. Roberts President and Chief Executive President and Chief
Officer Executive Officer
Paul A. Larsen Senior Vice President, Treasurer, Senior Vice President,
Chief Financial Officer, and Treasurer, Chief Financial
Corporate Secretary Officer and Corporate Secretary
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
James L. Roberts, age 56, was elected as the Company's President and Chief
Executive Officer on January 21, 1999. Prior to joining the Bank, Mr. Roberts
was President and CEO of Perpetual Midwest Financial, Inc. of Cedar Rapids,
Iowa from 1993 through 1998. He has over 30 years of experience in the
financial services industry. He succeeds Larry G. Gillie, who left the
Company and the Bank in August 1998.
Paul A. Larsen, age 49, 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 51, 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 25 years experience in bank marketing and
advertising.
Lawrence J. Schmidt, age 46, joined the Company and the Bank in November 1995
as Senior Vice President, Administrative Manager. Mr. Schmidt has over 20
years experience in a commercial bank environment, with emphasis on
commercial lending, loan review and strategic planning.
Joseph H. Tillotson, age 54, 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 managing Retail Banking. He
also manages the Mortgage Center. Mr. Tillotson has over 25 years of lending
and operations experience in banking.
Vernon J. Wiggenhauser, age 55, joined the Company and the Bank in June 1997
as Senior Vice President of Operations. Mr. Wiggenhauser has over 25 years
experience in Commercial Banking operations.
R. Kennedy Alger, age 52, joined the Company and the Bank in August 1997, as
Executive Vice President and Senior Loan Officer. Mr. Alger served as interim
President following the departure of the former President in August 1998,
until his resignation and departure from the Company and the Bank in February
1999.
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33
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. Extensive
remodeling was completed in 1998. At December 31, 1998, this property had
19,575 square feet and a net book value of approximately $3.5 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, 1998, the
net book value of the land and the building was approximately $2.6 million.
In March of 1995, the Company opened a 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, 1998 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. This location
houses the Mortgage Center. Building improvements at this facility had a book
value of approximately $ 0.1 million as of December 31, 1998.
CoVest Banc has a 3 year profit sharing arrangement based on the individual
office's performance with Institutional Financial Services of Aurora,
Illinois, for the following locations. No occupancy expenses are incurred for
these locations.
CoVest Banc Mortgage Center CoVest Investment Center
1187 North Farnsworth Road 6447 West Cermak Road
Aurora, Illinois 60505 Berwyn, Illinois 60402
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,
1998.
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34
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
SECURITY HOLDER MATTERS
As of March 5, 1999, there were approximately 670 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 Nasdaq Stock
Market 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.
1998 Dividend High Low 1997 Dividend High Low
1st Qtr. $.08 $19.75 $14.50 1st Qtr. $.0667 $12.17 $11.17
2nd Qtr. $.08 $20.75 $17.38 2nd Qtr. $.0667 $12.67 $11.33
3rd Qtr. $.08 $18.75 $12.75 3rd Qtr. $.0667 $16.17 $12.25
4th Qtr. $.08 $15.13 $11.38 4th Qtr. $.08 $18.00 $16.00
Year end closing price = $12.25 Year end closing price = $16.50
The Annual Meeting of Stockholders of CoVest Bancshares, Inc. will be held at
10:00 a.m. on Tuesday, April 27, 1999 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 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
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35
The following companies make a market in COVB Common Stock:
Stifel Nicolaus & Co., Inc Howe Barnes Investments, Inc.
ABN AMRO Corporation Herzog, Heine, Geduld, 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) 360-5106
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 Branch
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
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36
CoVest Banc
Mortgage Centers:
1771 N. Richmond Rd.
McHenry, Illinois 60050
(800) 995-6750
1187 N. Farnsworth Rd.
Aurora, Illinois 60505
(888) 520-9255
CoVest Investment
Center: 6447 W. Cermak Rd.
Berwyn, Illinois 60402
(708) 484-8403
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37
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL INFORMATION
December 31, 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in Thousands)
Selected financial condition data
Total assets $ 548,697 $ 582,722 $ 541,169 $ 622,500 $ 523,213
Loans receivable (net) 402,329 377,509 338,545 331,017 346,960
Total investments 88,017 164,172 172,876 255,418 152,471
Non-earning assets 18,674 17,571 16,911 18,716 17,006
Deposits 364,535 371,752 402,090 454,656 409,640
Other borrowings 126,755 151,956 78,690 97,835 47,000
Non-interest bearing liabilities 10,456 10,720 10,445 12,332 9,726
Stockholders' equity 46,951 48,294 49,944 57,678 56,847
Selected operations data
Total interest income 40,943 39,364 42,377 40,854 30,749
Total interest expense 24,739 23,914 29,241 26,727 16,314
----------- ----------- ----------- ----------- -----------
Net interest income 16,204 15,450 13,136 14,127 14,435
Provision for possible loan losses 1,567 4,072 1,397 644 36
----------- ----------- ----------- ----------- -----------
Net interest income after provision 14,637 11,378 11,739 13,483 14,075
Total non-interest income 5,579 3,672 4,241 1,217 1,020
Special SAIF assessment - - 3,033 - -
Total non-interest expense 14,245 11,305 10,818 10,722 9,490
----------- ----------- ----------- ----------- -----------
Income before income tax expense 5,971 3,745 2,129 3,978 5,605
Income tax expense 2,100 1,135 540 1,367 1,985
----------- ----------- ----------- ----------- -----------
Net income $ 3,871 $ 2,610 $ 1,589 $ 2,611 $ 3,620
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
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38
SELECTED FINANCIAL RATIOS AND OTHER DATA
Year Ended December 31; 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Performance ratios:
Return on assets (ratio of net income to
average total assets) 0.67% 0.48% 0.26% 0.46% 0.80%
Interest rate spread information
Average during year 2.53% 2.42% 1.72% 2.08% 2.78%
End of year 2.67% 2.52% 2.41% 1.86% 2.63%
Interest margin 2.96% 2.94% 2.22% 2.59% 3.28%
Ratio of operating expenses to average
total assets 2.47% 2.08% 2.29% 1.90% 2.10%
Ratio of net interest income to non-interest
expenses 1.14x 1.37x 0.95x 1.32x 1.52x
Basic earnings per share $0.92 $0.61 $0.34 $0.51 $0.67
Diluted earnings per share $0.87 $0.58 $0.32 $0.50 $0.65
Return on stockholders' equity (ratio of
net income to average total equity) 8.15% 5.40% 2.94% 4.67% 6.13%
Dividend payout ratio 35.55% 47.70% 82.22% 40.30% 37.93%
Asset quality ratios:
Non-performing assets to total assets at
end of year 0.19% 0.22% 0.16% 0.11% 0.04%
Allowance for possible loan losses to
non-performing loans 4.22x 3.05x 1.66x 2.02x 7.60x
Capital ratios:
Stockholders' equity to total assets at
end of year 8.56% 8.29% 9.23% 9.27% 10.86%
Average stockholders' equity to
average assets 8.25% 8.88% 8.92% 9.92% 13.05%
Ratio of average interest-earning assets to
average interest-bearing liabilities 1.10x 1.12x 1.10x 1.11x 1.14x
Other data
Facilities
Number of full-service offices 3 3 3 3 2
Number of mortgage centers 2 - - - -
Number of investment centers 1 - - - -
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39
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FINANCIAL OVERVIEW
The Company's assets decreased 5.8% to $548.7 million as of December 31,
1998, from $582.7 million at December 31, 1997. This decrease was primarily
the result of the liquidation of a $50 million arbitrage transaction entered
into in November, 1997 that matured in November, 1998. Management of the
Company is continuing its restructuring of the balance sheet to that of a
full service commercial bank. Commercial type lending increased by $119.7
million during 1998. This increase was comprised of the following:
Multi-family lending increased by $51.1 million, followed by increases of
$31.6 million in construction lending, $23.9 million in commercial/municipal
leases, $10.6 million in commercial real estate loans and $2.5 million in
commercial lending.
For the year ended December 31, 1998, the Company earned $3.9 million, an
increase of $1.3 million from 1997.
STOCK REPURCHASE PROGRAM AND DIVIDENDS
The Company paid regular quarterly dividends during 1998 of $.08 per share.
The Company has also announced an $.08 per share dividend payable March 31,
1999, to shareholders of record on March 15, 1999.
The Company completed its 13th stock repurchase plan for 100,000 shares on
August 7, 1998. On August 25, 1998, the Company announced its 14th stock
repurchase plan, which enabled the Company to repurchase up to 100,000 shares
in the open market or through privately negotiated transactions. That
repurchase plan was completed on December 29, 1998.
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 commercial real estate and commercial loans,
consumer loans, securities and mortgage-backed securities. In addition, the
Bank has a subsidiary which provides insurance and brokerage services. The
Bank's deposit accounts are insured to the maximum allowable by 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 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
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40
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
Management of the Company has accomplished much of the restructuring
necessary to fully transform the balance sheet to that of a full service
commercial bank.
In 1996, the Company sold over $93 million of 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,
1996, the Company securitized $61 million in fixed rate long-term mortgages
and seven to ten year balloon mortgages 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. In 1997, the Company securitized $17.8 million
of residential fixed rate mortgages that were not scheduled to reprice in the
next five years. Additional securitized loans were sold in 1998 to provide
liquidity and fund commercial, multi-family, construction, and commercial
real estate loan originations. In 1998, the Company opened mortgage centers
in McHenry and Aurora, Illinois. The Mortgage Centers concentrate on mortgage
loan originations and sales. The loans are sold on a service released basis
to mortgage buyers for which the Company receives a fee and has no additional
rights.
These changes 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 $119.7 million during 1998. Most
of this increase came in multi-family loans which increased by $51.1 million,
followed by increases of $31.6 million in construction lending, $23.9 million
in commercial leases, $10.6 million in commercial real estate lending and
$2.5 million in commercial loans.
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 the Bank
was a savings and loan whose core business revolved around first mortgages to
the retail sector.
Total deposits decreased 2% to $364.5 million from $371.8 million at December
31, 1997. 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 increased
by 50% over the ending balance in 1997.
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. PC Banking was introduced in 1998.
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41
Certificates of deposit have declined from $219.8 million at December 31,
1997 to $187.5 on December 31, 1998. This decline may be attributed, in part,
to the transfer of funds to the market rate driven Preferred Money Market
Accounts during times of volatile interest rates and stock market
fluctuations.
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 currently has
brokered deposits; however, no commissions are paid. The decline in overall
deposits has been augmented by additional borrowings at the FHLB where funds
can be competitively purchased in the wholesale market in large dollar
amounts.
At December 31, 1998, total non-performing assets amounted to $ 1.0 million,
or 0.25% of net loans receivable compared to $1.3 million, or 0.35% of net
loans receivable at December 31, 1997.
At December 31, 1998, the allowance for possible loan losses amounted to
almost $4.3 million, or 422% of non-performing loans as compared to a 305%
coverage at December 31, 1997.
Stockholders' equity in CoVest Bancshares, Inc. totaled $47 million at
December 31, 1998. The number of common shares outstanding was 4,210,615 and
the book value per common share outstanding was $11.15 as of December 31,
1998. At March 5, 1999, approximately 91,000 shares remained to be
repurchased under the 15th stock repurchase program.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1998 AND
DECEMBER 31, 1997
GENERAL
Net income for the year ended December 31, 1998 was $3,871,000 compared to
$2,610,000 for the year ended December 31, 1997, an increase of 48%.
In the fourth quarter of 1997, the Company reevaluated 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. Without this
additional provision, net income for 1997 would have been $4,080,000.
Returns on average assets and average stockholders' equity during 1998 were
0.67% and 8.15%, respectively, compared to 0.48% and 5.40% in 1997.
CoVest Bancshares, Inc. had earnings of 92 cents per share (basic) for the
full year of 1998. This compares with 61 cents per share (basic) for the
comparable period in 1997. Fully diluted earnings per share was 87 cents per
share in 1998 versus 58 cents per share in 1997.
INTEREST INCOME
Interest income for 1998 increased by $1.6 million from 1997. The balance
sheet averaged $28 million more in average earning assets when compared to
1997, resulting in an additional $3.8 million in income in 1998. Some of this
increase was offset by a decrease of $21.1 million in investment volume,
resulting in a reduction of $2.2 million in 1998 income. In addition, the
overall yield on earning assets decreased 9 basis points, from 7.49% in 1997
to 7.40% in 1998.
INTEREST EXPENSE
The interest expense for the same periods increased from $23.9 million in
1997 to $24.7 million in 1998. This $.8 million increase in funding cost
resulted from an increase in funding liability volume of over $33.4 million
offset in part by reduced interest costs of 20 basis points.
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42
NET INTEREST INCOME
Net interest income increased by nearly 5% or $.8 million. The interest rate
spread and margin averaged 2.53% and 2.96%, respectively, during 1998, an 11
basis point increase and 2 basis point increase from 2.42% and 2.94%,
respectively, during 1997. During 1998, commercial, construction, and
commercial real estate loans became a larger percentage of the overall loan
portfolio and asset mix. However, since many of these loans were adjustable
rate, yields dropped in conjunction with an overall drop in rates experienced
by the economy during 1998.
PROVISION FOR POSSIBLE LOAN LOSSES
The provision for possible loan losses decreased from $4,072,000 for 1997 to
$1,567,000 in 1998. During the fourth quarter of 1997, the Company provided
an extra $2.4 million in loan loss provision after evaluating its loan mix,
rescoring its credit card portfolio, and reviewing its recent loan loss
experience. The credit card loan portfolio experienced continuing losses from
bankruptcy and was sold in November, 1998. The commercial related loan
portfolio that represents commercial, commercial real estate, construction
and multi-family lending increased in total volume by almost $120 million
during 1998, or almost 140% in one year.
NON-INTEREST INCOME
Non-interest income, excluding gains from sales of securities and a
non-recurring gain from the sale of the credit card loan portfolio of
$672,000, increased 93%, or $2,257,000 from 1997. Mortgage Center service
release and other fees contributed $1,712,000 in non-interest income. Loan
charges and servicing fees increased $459,000, primarily due to collection of
loan prepayment penalties. Deposit related fees increased by $126,000.
Net gains from the sale of securities were $225,000. This included a net loss
of $560,000 recognized in November, 1998 to unwind an arbitrage transaction.
During the fourth quarter of 1997, the Bank entered into an arbitrage
transaction. Using FHLB borrowings of $50 million that matured in late 1998,
the Bank purchased two large mortgage-backed security pools that were
structured as 3/1 adjustable rate mortgages ("ARMs"). A 3/1 ARM is an
adjustable rate mortgage that is fixed for the first three year period and
then reprices at a spread over the one year constant maturity term treasury.
The transaction was projected to have an average spread of 72 basis points
and employ excess capital, thus improving the return on average equity for
the period of the transaction. However, interest rates dropped dramatically,
with the 30 year treasury rate falling from 6.04% at the end of November 1997
to a historic low of 4.72% on October 5, 1998. Borrowers who had previously
financed their mortgage loans using this type of lending structure refinanced
their outstanding balances in record numbers and prepayment speeds reached
record levels, which was detrimental to this transaction.
Since the two mortgage-backed securities were purchased at a premium,
amortization of the premium accelerated, which caused an overall reduction in
the projected spread from 72 basis points down to a negative 34 basis points.
Additionally, a liquidity crisis reportedly caused by instability in Russia
and Brazil caused spreads between all financial instruments and treasury
securities to widen to historic levels in November, 1998 when the borrowings
with the FHLB matured and the securities were sold to repay the borrowings.
In November 1998, the Bank sold its credit card portfolio and recognized a
gain of $672,000 before termination expenses of $137,000. The size of the
credit card portfolio had decreased one-third over the last several years to
approximately $11 million, at the time of the sale. The portfolio was not
attracting new customers and was declining in size as current customers took
advantage of "teaser" rates, "rebates" and "rewards" programs offered by the
industry giants.
The level of losses related to the credit card portfolio also entered into
the decision to sell the portfolio. Losses from both bankruptcy and credit
losses over the last three years topped at least $1.1 million annually, while
operating costs continued to increase.
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43
NON-INTEREST EXPENSE
Other operating expenses increased 26% or $2,940,000. The largest increase
came in salaries and benefits that jumped $1,876,000 or 34.7%. Additional
staff have been added to serve both commercial and retail customers in
providing prompt loan and deposit related request responses. Additionally, in
1998 the Bank paid $699,000 in commission and incentive payments, primarily
to Mortgage Center personnel. Occupancy and equipment expenses increased by
17.6% or $307,000 due to extensive remodeling of the three branches and
purchase of new furniture. Expenses were also incurred to provide facilities
and equipment for Mortgage Center employees.
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.
In the fourth quarter of 1997, the Company reevaluated 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. 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.
The Company had earnings of 61 cents per share (basic) for the full year of
1997. This compared with 34 cents per share (basic) for 1996. Fully diluted
earnings per share was 58 cents per share in 1997 versus 32 cents per share
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 cost resulted
from a decrease in volume of over $67 million and reduced interest cost of 36
basis points.
NET INTEREST INCOME
Net interest income increased 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.
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44
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 Company's portfolio, credit losses
from bankruptcy continued to increase, many having no prior evidence of
delinquency. In 1997, bankruptcies accounted for over $624,000 in losses
alone. The commercial related loan portfolio that represented 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.
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 were 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.
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45
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,
-----------------------
1998 1997 1996
---- ---- ----
(Dollars in Thousands)
Average Interest Average Interest Average Interest
Annual Earned/ Yield/ Annual Earned/ Yield/ Annual Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
------- ---- ---- ------- ---- ---- ------- ---- ----
Interest-earning assets
Commercial loans $ 7,055 $ 642 9.11% $ 1,607 $ 179 11.13% $ 11 $ 1 7.93%
Commercial real estate loans 62,174 5,182 8.22% 31,540 2,698 8.44% 6,108 521 8.53%
Multi-family loans 27,059 2,120 7.73% 754 62 8.15%
Construction loans 23,463 2,208 9.28% 7,187 603 8.28%
Commercial/municipal leases 31,877 2,093 6.56% 9,169 630 6.87% 481 30 6.29%
Mortgage 193,552 14,335 7.41% 247,945 18,412 7.43% 283,375 21,244 7.50%
Consumer loans 61,314 5,418 8.84% 59,265 5,602 9.46% 59,815 5,442 9.09%
Mortgage-backed securities 90,136 5,725 6.35% 99,891 7,018 7.03% 166,106 10,135 6.10%
Securities 46,676 2,874 6.16% 58,150 3,740 6.40% 68,163 4,443 6.52%
Other investments 10,423 538 5.09% 10,321 437 4.23% 8,806 561 6.37%
--------- --------- ------- --------- --------- ------- --------- --------- -------
Total interest-earning assets 553,729 41,135 7.40% 525,829 39,381 7.49% 592,865 42,377 7.15%
Non-interest earning assets 22,291 18,713 12,241
--------- --------- ---------
TOTAL ASSETS $ 576,020 $ 544,542 $ 605,106
--------- --------- ---------
--------- --------- ---------
Interest-bearing liabilities
Savings accounts $ 55,525 $ 1,389 2.50% $ 62,297 $ 1,574 2.53% $ 68,666 $ 1,717 2.50%
NOW accounts 21,907 266 1.21% 21,798 390 1.79% 21,889 391 1.79%
Money Market accounts 74,576 3,494 4.69% 50,372 2,439 4.84% 19,515 804 4.12%
Certificates 187,810 10,446 5.56% 248,676 14,347 5.77% 320,735 19,990 6.23%
FHLB advances 154,644 8,595 5.48% 71,956 4,233 5.99% 89,630 5,368 5.99%
Other borrowed money 10,358 549 5.15% 16,278 931 5.26% 18,313 971 5.30%
--------- --------- ------- --------- --------- ------- --------- --------- -------
Total interest-bearing 504,820 24,739 4.87% 471,377 23,914 5.07% 538,748 29,241 5.43%
liabilities
Other Liabilities 23,682 24,824 12,367
--------- --------- ---------
TOTAL LIABILITIES 528,502 496,201 551,115
Stockholders' equity 47,518 48,341 53,991
--------- --------- ---------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 576,020 $ 544,542 $ 605,106
--------- --------- ---------
--------- --------- ---------
Net interest income $ 16,396 $ 15,467 $ 13,136
--------- --------- ---------
--------- --------- ---------
Net interest spread 2.53% 2.42% 1.72%
Net earning assets $ 48,909 $ 54,452 $ 54,117
Net yield on average interest- 2.96% 2.94% 2.22%
earning assets
Average interest-earning assets to
average interest-bearing liabilities 1.10X 1.12X 1.10X
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46
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:
At December 31,
-------------------------------
1998 1997 1996
---- ---- ----
Weighted average yield on
Commercial loans 8.67% 9.39% 8.06%
Commercial real estate loans 8.01 8.78 7.37
Multi-family loans 7.76 8.41 --
Construction loans 8.75 9.06 --
Commercial/municipal leases 6.44 7.32 6.22
Mortgage 7.33 7.48 7.46
Consumer loans 8.16 9.39 9.10
Mortgage-backed and mortgage-related securities 6.44 6.90 6.98
Securities 6.07 6.42 6.62
Other investments 5.09 5.93 6.50
Combined weighted average yield on interest-earning assets 7.33 7.59 7.46
Weighted average rates paid on
Savings accounts 2.50 2.50 2.50
NOW accounts 1.06 1.80 1.79
Money market accounts 4.33 4.97 4.57
Certificates 5.39 5.73 5.83
FHLB advances 5.34 5.72 5.91
Other borrowed money 4.64 5.28 5.28
Combined weighted average rate paid on interest-bearing liabilities 4.66 5.07 5.05
Net interest rate spread 2.67 2.52 2.41
- -------------------------------------------------------------------------------
47
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.
1998 vs. 1997 1997 vs. 1996
-----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 $ 4,198 $ (385) $ 3,813 $ 865 $ 84 $ 949
Mortgage-backed and
related securities (659) (634) (1,293) (4,039) 922 (3,117)
Securities and other
investments (633) (307) (940) (788) (57) (845)
-------- -------- -------- -------- -------- --------
Total interest-earning
assets 2,906 (1,326) 1,580 (3,962) 949 (3,013)
-------- -------- -------- -------- -------- --------
Interest-bearing liabilities
NOW accounts (2) 126 124 (1) -- (1)
Savings accounts 185 -- 185 (143) -- (143)
Money markets (1,172) 117 (1,055) 1,271 364 1,635
Certificates 3,515 386 3,901 (4,530) (1,113) (5,643)
FHLB advances (4,917) 555 (4,362) (1,032) (28) (1,060)
Other borrowed money 50 332 382 (100) (15) (115)
-------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities (2,341) 1,516 (825) (4,535) (792) (5,327)
-------- -------- -------- -------- -------- --------
Net change in interest
income $ 565 $ 189 $ 754 $ 573 $ 1,741 $ 2,314
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
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48
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 $1.0 million for the year ended
December 31, 1998. Net cash used in investing activities was $51.9 million for
the year ended December 31, 1998. Securities sales and maturities generated
$133.4 million while principal payments on mortgage-backed and related
securities amounted to $36.7 million. Purchases of investment securities and
mortgage-backed securities were $94.4 million, and loan originations, net of
principal payments, were $32.9 million for the year. Net cash provided by
financial activities amounted to ($36.7) million for the year ended December 31,
1998, and was accounted for mostly by the reduction 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,
1998, the Company had approved and accepted commitments to originate loans
totaling $18.8 million, and its customers had approved but unused lines of
credit totaling $72.4 million. Additionally, the Company has $10.6 million in
letters of credit and credit enhancements outstanding. 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, 1998, the Bank had total risk based capital of $47.2 million.
This was approximately $11.7 million above the 10% ratio required to be "well
capitalized." Tier 1 risk based capital was $42.9 million. This is approximately
$21.6 million or 6% above the required ratio of 6%. The Tier 1 capital leverage
ratio is 7.84%. This is approximately $15.5 million or 2.8% above the required
ratio of 5%. For additional information, see Note 11 of the "Notes to the
Consolidated Financial Statements."
YEAR 2000 COMPLIANCE
GENERAL
The Company is devoting significant resources through its operations to minimize
the risk of potential disruption from the Y2K problem. This problem is a result
of computer programs having been written using two digits (rather than four) to
define the year. Any time-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000, which could result in miscalculations
and system failures. The problem could affect non-information technology systems
such as operating and control systems that have embedded chip systems. The
Company is also at risk from Y2K failures on the part of business relationships
with vendors, suppliers, and public utility providers such as electricity,
water, gas and communications.
System failures resulting from the Y2K problem could adversely affect operations
and financial results by incorrectly calculating accrued interest receivable and
payable. Failures could also affect the ability of customers to perform normal
business activities, thereby causing an interruption of their deposits and loan
payments.
- -------------------------------------------------------------------------------
49
ADDRESSING THE PROBLEM
The Company has developed a six-phase plan to resolve Y2K issues that are
reasonably within its control. The plan is implemented and coordinated through a
senior level task force. As of December 31, 1998, ten officer level staff
members were a part of the committee and devoted a minimum of 25% of their time
to the Y2K effort. The Y2K committee chairman reports to the Bank's senior
management committee on a weekly basis and at least quarterly to the Board of
Directors. The Company's Y2K efforts are also reviewed during external and
internal audits and examined by the Office of the Comptroller of the Currency.
The plan and anticipated timing of each phase are described as follows:
PHASE I - AWARENESS
The first phase entailed conducting awareness briefings with all levels of staff
and management, including the Board of Directors, by sharing all pertinent Y2K
related articles, documents and regulatory bulletins. It was necessary to
identify the scope of the Y2K problem and determine the resources available to
minimize the risk. The awareness phase was primarily completed by March 31,
1998, although new information is received, reviewed and shared throughout the
Company on a continuous basis.
PHASE II - ASSESSMENT AND INVENTORY
The second phase required developing a comprehensive list of all information
processing systems (IPS) to include hardware, software, and infrastructure
systems that may be at risk. Once each at-risk system has been identified, the
Y2K task force assessed how critical the system is to business operations and
the potential impact of failure. Systems were classified as "mission critical",
"mission necessary", or "mission desirable". A "mission critical" system is one
that, if not operational, would hinder the Company's operation on the first
business day after the new century. A "mission necessary" system would reflect a
negative impact to the Company's business processes by the 2nd or 3rd business
day. A "mission desirable" system would impact operations within five to ten
business days. The inventory/assessment process was completed by May 31, 1998,
resulting in cataloging nearly 200 systems.
PHASE III - RENOVATION
The third phase assigned a Y2K committee member to each inventory item. It was
that person's responsibility to establish communication relationships with the
vendors for the purpose of obtaining letters of systems certification for Y2K
compliance and the level at which the systems were tested. If the system was not
certified, it would be assigned a reasonable time frame to correct
non-compliance issues and determine a plan of action to replace non-conforming
systems. This phase was completed by July 31, 1998.
PHASE IV - TESTING AND VALIDATION
This phase includes establishing a test environment, performing systems testing,
and certifying and documenting the results. The certification process requires
having functional experts run system tests and review results against
pre-established criteria to ensure compliance. Documentation should be
maintained in the form of data reports and computer print screens. The "mission
critical" systems, other than those associated with the Company's third party
data processor ( M&I Data ) for which the Company will participate in proxy
testing, were completed by December 31, 1998. The Company expects the proxy
tested system and the remainder of the initial "mission necessary" and "mission
desirable" systems to be certified by March 31, 1999. Testing for
non-information technology systems, such as utilities and other infrastructure
systems, has been initiated; however, due to the Company's reliance on their
system test schedule, it is not possible to estimate exactly when this phase
will be completed. These companies have indicated that it is anticipated that
the majority of their testing will be completed in the third quarter of 1999.
PHASE V - CUSTOMER AWARENESS PROGRAM
In this phase, the Company will outline its strategy to develop a proactive
customer awareness program. The plan is to furnish customers and the community
with enough Y2K related information for them to make intelligent, educated
decisions regarding the Company's Y2K readiness and its ability to serve their
banking needs in the next century. Banking customers and members of the
community, where applicable, will receive informational lobby brochures,
statement stuffers, and have questions answered by personal banking
- -------------------------------------------------------------------------------
50
representatives. Other methods of disseminating Y2K information in 1999 will be
through seminars, news releases, web-site and direct mail letters.
PHASE VI - BUSINESS RESUMPTION CONTINGENCY PLANS
This phase involves addressing any remaining open issues and points of critical
system failures at year end, 1999. As a precautionary measure, the Company will
develop detailed contingency plans for all systems that are not expected to be
Y2K compliant or have a remote possibility for failure. Contingency plans
consist of alternative automated systems, internal stand alone computer
spreadsheets, and various manual fallback procedures.
COSTS
As of December 31, 1998, costs had been incurred of approximately $32,000
related to the Y2K project, of which $24,000 has been capitalized. The estimated
additional costs to complete the project are expected to be approximately
$110,000, of which $50,000 is expected to be capitalized. The remaining costs
are allocated to training, education, marketing and contingency plans. The
Company is using current staff and other internal resources to manage the Y2K
project. The Company does not expect these redeployments of resources to have a
material adverse effect on other ongoing business operations. All the costs of
the Y2K project are incurred from operating cash flows.
At the present time, management believes that the majority of all mission
critical and mission necessary date-related software and systems will remain
operating properly after January 1, 2000. The Company does not anticipate that
internal systems failures will result in any material adverse effect to its
operational or financial condition. During 1999, the Company will continue its
efforts to insure that providers of infrastructure services, such as utilities
and communication companies, will be compliant by the Year 2000. At this time,
management believes that the most likely "worst-case" scenario involves
potential disruption of service from third party vendors whose systems may not
work after January 1, 2000, and the Company must rely on their testing results.
While such failures could affect Bank operations in a significant manner, the
Company cannot estimate the likelihood or the potential cost of the failures.
The Company's year 2000 plan is revised periodically as some goals are completed
and new issues are identified. It is important to note that the description of
the plan involves estimates and projections with respect to some activities
required in the future which are subject to possible substantial changes or
corrections.
ACCOUNTING MATTERS
NEW ACCOUNTING STANDARDS
Statement of Financial Accounting Standards (Statement) No. 133 on derivatives
will, in 2000, require all derivatives to be recorded at fair value in the
balance sheet, with changes in fair value charged or credited to income. If
derivatives are documented and effective as hedges, the change in the derivative
fair value will be offset by an equal change in the fair value of the hedged
item. Under the new standard, securities held-to-maturity can no longer be
hedged, except for changes in the issuer's creditworthiness. Therefore, upon
adoption of Statement No. 133, companies will have another one-time window of
opportunity to reclassify held-to-maturity securities to either trading or
available-for-sale, provided certain criteria are met. This Statement may be
adopted early at the start of a calendar quarter. Since the Company has no
significant derivative instruments or hedging activities, adoption of Statement
No. 133 is not expected to have a material impact on the Company's financial
statements. Management has not decided whether to adopt Statement No. 133 early.
Statement No. 134 on mortgage banking will, in 1999, allow mortgage loans that
are securitized to be classified as trading; available-for-sale; or, in certain
circumstances, held-to-maturity. Currently, these must be classified as trading.
Since the Company does not intend to securitize mortgage loans, Statement No.
134 is not expected to affect the Company.
- -------------------------------------------------------------------------------
51
American Institute of Certified Public Accountant Statement of Position 98-1,
effective in 1999, sets the accounting requirement to capitalize costs incurred
to develop or obtain software that is to be used solely to meet internal needs.
Costs to capitalize are those direct costs incurred after the preliminary
project stage, up to the date when all testing has been completed and the
software is substantially ready for use. All training costs, research and
development costs, costs incurred to convert data, and all other general and
administrative costs are to be expensed as incurred. The capitalized cost of
internal-use software is amortized over its useful life and reviewed for
impairment using the criteria in Statement No. 121. Statement of Position 98-1
is not expected to have material impact on the Company.
American Institute of Certified Public Accountants Statement of Position 98-5,
also effective in 1999, requires all start-up, pre-opening, and organization
costs to be expensed as incurred. Any such costs previously capitalized for
financial reporting purposes must be written off to income at the start of the
year. Statement of Position 98-5 is not expected to have a material impact on
the Company.
The Financial Accounting Standards Board continues to study several issues,
including recording all financial instruments at fair value and abolishing
pooling-of-interests accounting. Also, it is likely that APB25's measurement for
stock option plans will be limited to employees and not to non-employees such as
directors, thereby causing compensation expense to be required for 1999 awards
of stock options to outside directors.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
In an attempt to manage the Company's exposure to changes in interest rates,
management closely monitors interest rate risk. Management has an
Asset/Liability Committee, consisting of senior officers, which meets monthly to
review the interest rate risk position and make recommendations for adjusting
such position. In addition, the Board reviews the position on a monthly basis,
including simulations of the effect on the Company'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 Company 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
- -------------------------------------------------------------------------------
52
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 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.
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
dependent on residential mortgage loans which permit the borrower to prepay the
principal balance of the loan prior to maturity ("prepayments") without penalty.
A loan's 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") which measures the
Company'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.
- -------------------------------------------------------------------------------
53
The following table presents the Company's current exposure to hypothetical
changes in interest rates as of December 31,
1998 1997
------------------------------------------- ------------------------------------------
Changes in Percent Change Percent Change in Percent Change Percent Change in
Interest Rates in Net Interest MV of Portfolio in Net Interest MV of Portfolio
(basis points) Income Equity Income Equity
- ------------------- ------------------ --------------------- ------------------ --------------------
+200 -11% -23% -9% -16%
+100 -5 -12 -4 -8
0 0 0 0 0
-100 +5 +13 +4 +10
-200 +11 +27 +7 +20
The percentage change in net interest income and the market value of portfolio
equity as of December 31, 1998 demonstrate larger percentage changes than the
Company's exposure at December 31, 1997 due to a larger increase in the
Company's floating rate liabilities and a lesser increase in floating rate
assets during 1998.
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.
- -------------------------------------------------------------------------------
54
`
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. as of December 31, 1998 and 1997, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 1998. These financial
statements are the responsibility of the 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, 1998 and 1997, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
Crowe, Chizek and Company LLP
Oak Brook, Illinois
January 29, 1999
- --------------------------------------------------------------------------------
55
COVEST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1998 AND 1997
(IN THOUSANDS, EXCEPT SHARE DATA)
- --------------------------------------------------------------------------------
1998 1997
--------- ---------
ASSETS
Cash and cash equivalents
Cash on hand and in banks $ 18,395 $ 5,670
Interest-bearing deposits in other financial institutions 21,282 17,800
--------- ---------
39,677 23,470
Securities
Securities available-for-sale 44,766 35,840
Mortgage-backed and related securities available-for-sale 34,872 120,753
Federal Home Loan Bank stock and Federal Reserve Bank stock 8,379 7,579
--------- ---------
88,017 164,172
Loans and leases receivable, net
Loans receivable 406,641 381,486
Less allowance for possible loan and lease losses 4,312 3,977
--------- ---------
402,329 377,509
Accrued interest receivable 3,280 3,487
Premises and equipment 11,372 10,767
Other assets 4,022 3,317
--------- ---------
$ 548,697 $ 582,722
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits
Non-interest-bearing $ 14,998 $ 14,112
Interest-bearing checking 23,825 21,153
Money Market accounts 85,209 57,158
Savings accounts 52,990 59,562
Certificates of deposit 187,513 219,767
--------- ---------
364,535 371,752
Short-term borrowings 6,755 76,956
Long-term borrowing from Federal Home Loan Bank 120,000 75,000
Advances from borrowers for taxes and insurance 3,637 2,914
Accrued expenses and other liabilities 6,819 7,806
--------- ---------
501,746 534,428
Stockholders' equity
Preferred stock - par value $.01 per share; 100,000 authorized shares;
no shares outstanding at December 31, 1998 and 1997 - --
Common stock - par value $.01 per share; 7,500,000 authorized shares;
4,403,803 and 4,365,761 shares issued at December 31, 1998 and 1997,
respectively 44 44
Additional paid-in capital 18,967 19,365
Retained earnings 30,905 28,410
Treasury stock, 1998 - 193,188 shares; 1997 - 0 shares, at cost (3,017) --
Unearned stock awards (73) (73)
ESOP loan (161) (511)
Accumulated other comprehensive income 286 1,059
--------- ---------
46,951 48,294
--------- ---------
$ 548,697 $ 582,722
--------- ---------
--------- ---------
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
56
COVEST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
- --------------------------------------------------------------------------------
1998 1997 1996
--------- --------- ---------
Interest income
Loans and leases receivable $ 31,998 $ 28,186 $ 27,237
Mortgage-backed and related securities 5,725 7,018 10,135
Securities 2,082 3,207 4,148
Other interest and dividend income 1,138 953 857
--------- --------- ---------
40,943 39,364 42,377
Interest expense
Deposits 15,595 18,750 22,902
Advances from Federal Home Loan Bank 8,595 4,308 5,368
Other borrowed funds 549 856 971
--------- --------- ---------
24,739 23,914 29,241
--------- --------- ---------
NET INTEREST INCOME 16,204 15,450 13,136
Provision for possible loan losses 1,567 4,072 1,397
--------- --------- ---------
NET INTEREST INCOME AFTER PROVISION FOR POSSIBLE LOAN LOSSES 14,637 11,378 11,739
Noninterest income
Loan charges and servicing fees 1,544 1,085 774
Mortgage center fees 1,712 - -
Deposit related charges and fees 968 842 585
Gain on sale of securities 225 1,247 2,551
Gain on sale of credit card loans 672 - -
Other 458 498 331
--------- --------- ---------
Total noninterest income 5,579 3,672 4,241
Noninterest expense
Compensation and benefits 7,286 5,410 4,847
Commissions and incentives 699 - -
Occupancy and equipment 2,047 1,740 1,468
Federal deposit insurance premium 222 203 1,062
Special SAIF assessment - - 3,033
Data processing 1,047 1,000 798
Advertising 384 640 334
Other 2,560 2,312 2,309
--------- --------- ---------
Total noninterest expense 14,245 11,305 13,851
--------- --------- ---------
INCOME BEFORE INCOME TAXES 5,971 3,745 2,129
Income tax provision 2,100 1,135 540
--------- --------- ---------
NET INCOME $ 3,871 $ 2,610 $ 1,589
--------- --------- ---------
--------- --------- ---------
Earnings per common share
Basic $ .92 $ .61 $ .34
--------- --------- ---------
--------- --------- ---------
Diluted $ .87 $ .58 $ .32
--------- --------- ---------
--------- --------- ---------
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
57
COVEST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
- --------------------------------------------------------------------------------
Additional
Common Paid-In Retained Treasury
Stock Capital Earnings Stock
----------- ----------- ----------- -----------
Balance at
January 1, 1996 $ 28 $ 27,229 $39,373 $ (9,397)
Cash dividend ($.25 per share) - - (1,221) -
Issuance of stock in connection
with exercise of stock options - - (542) 1,030
Purchase of stock - - - (8,053)
Issuance of stock in connection
with three-for-two stock split
with cash paid on fractional
shares 6 (5,379) (5,209) 10,582
Payment on ESOP loan - - - -
Stock award earned - - - -
Tax benefits related to
employee stock plans - 305 - -
Comprehensive income
Net income - - 1,589 -
Net decrease in fair value
of securities classified as
available-for-sale, net of
income taxes and
reclassification adjustments - - - -
Total comprehensive
income
----------- ----------- ----------- -----------
Balance at
December 31, 1996 34 22,155 33,990 (5,838)
Cash dividend ($.28 per share) - - (1,245) -
Issuance of stock in connection
with exercise of stock options - - (882) 1,783
Purchase of stock - - - (5,302)
Issuance of stock in connection
with three-for-two stock
split with cash paid on
fractional shares 10 (3,304) (6,063) 9,357
Payment on ESOP loan - - - -
Tax benefits related to
employee stock plans - 514 - -
Comprehensive income
Net income - - 2,610 -
Net increase in fair value of
securities classified as
available-for-sale, net of
income taxes and
reclassification adjustments - - - -
Total comprehensive
income
----------- ----------- ----------- -----------
Balance at
December 31, 1997 44 19,365 28,410 -
Accumulated
Other Total
Unearned Compre- Stock-
Stock ESOP hensive holders'
Awards Loan Income Equity
----------- ----------- ----------- -----------
Balance at
January 1, 1996 $ (97) $ (1,198) $ 1,739 $ 57,677
Cash dividend ($.25 per share) - - - (1,221)
Issuance of stock in connection
with exercise of stock options - - - 488
Purchase of stock - - - (8,053)
Issuance of stock in connection
with three-for-two stock split
with cash paid on fractional
shares - - - -
Payment on ESOP loan - 340 - 340
Stock award earned 24 - - 24
Tax benefits related to
employee stock plans - - - 305
Comprehensive income
Net income - - - 1,589
Net decrease in fair value
of securities classified as
available-for-sale, net of
income taxes and
reclassification adjustments - - (1,205) (1,205)
-----------
Total comprehensive
income 384
----------- ----------- ----------- -----------
Balance at
December 31, 1996 (73) (858) 534 49,944
Cash dividend ($.28 per share) - - - (1,245)
Issuance of stock in connection
with exercise of stock options - - - 901
Purchase of stock - - - (5,302)
Issuance of stock in connection
with three-for-two stock
split with cash paid on
fractional shares - - - -
Payment on ESOP loan - 347 - 347
Tax benefits related to
employee stock plans - - - 514
Comprehensive income
Net income - - - 2,610
Net increase in fair value of
securities classified as
available-for-sale, net of
income taxes and
reclassification adjustments - - 525 525
-----------
Total comprehensive
income 3,135
----------- ----------- ----------- -----------
Balance at
December 31, 1997 (73) (511) 1,059 48,294
- --------------------------------------------------------------------------------
(Continued)
58
COVEST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
- --------------------------------------------------------------------------------
Additional
Common Paid-In Retained Treasury
Stock Capital Earnings Stock
----------- ----------- ----------- -----------
Balance at
December 31, 1997 $ 44 $ 19,365 $ 28,410 $ -
Cash dividend ($.32 per share) - - (1,376) -
Issuance of stock in connection
with exercise of stock options - (914) - 2,062
Purchase of stock - - - (5,079)
Payment on ESOP loan - - - -
Tax benefits related to
employee stock plans - 516 - -
Comprehensive income
Net income - - 3,871 -
Net decrease in fair value of
securities classified as
available-for-sale,
net of income taxes
and reclassification
adjustments - - - -
Total comprehensive
income
----------- ----------- ----------- -----------
Balance at
December 31, 1998 $ 44 $ 18,967 $ 30,905 $ (3,017)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Accumulated
Other Total
Unearned Compre- Stock-
Stock ESOP hensive holders'
Awards Loan Income Equity
----------- ----------- ----------- -----------
Balance at
December 31, 1997 $ (73) $ (511) $ 1,059 $ 48,294
Cash dividend ($.32 per share) - - - (1,376)
Issuance of stock in connection
with exercise of stock options - - - 1,148
Purchase of stock - - - (5,079)
Payment on ESOP loan - 350 - 350
Tax benefits related to
employee stock plans - - - 516
Comprehensive income
Net income - - - 3,871
Net decrease in fair value of
securities classified as
available-for-sale,
net of income taxes
and reclassification
adjustments - - (773) (773)
-----------
Total comprehensive
income 3,098
----------- ----------- ----------- -----------
Balance at
December 31, 1998 $ (73) $ (161) $ 286 $ 46,951
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
59
COVEST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
(IN THOUSANDS)
- --------------------------------------------------------------------------------
1998 1997 1996
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 3,871 $ 2,610 $ 1,589
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation 993 864 683
Amortization of intangible assets 206 206 206
Deferred income taxes 557 927 343
Net real estate loans originated for sale (4,294) - -
Deferred loan origination fees (6) (341) 74
Provision for possible loan losses 1,567 4,072 1,397
Net gain on sales of securities (225) (1,247) (2,551)
Gain on sale of credit card loans (672) - -
Stock award earned - - 24
Change in
Other assets (911) 127 (503)
Accrued interest receivable 207 120 (147)
Accrued expenses and other liabilities (316) (102) 503
-------- -------- --------
Net cash provided by operating
activities 977 7,236 1,618
CASH FLOWS FROM INVESTING ACTIVITIES
Net loan principal originations (32,892) (60,477) (70,074)
Proceeds from sale of credit card loans 11,477 - -
Purchase of securities available-for-sale (94,416) (99,662) (171,309)
Proceeds from sales of securities available-
for-sale 119,434 69,897 242,622
Proceeds from maturities of securities
available-for-sale 13,970 21,258 38,537
Proceeds from repayment of securities
available-for-sale 36,707 37,673 36,822
Purchase of Federal Home Loan Bank stock
and Federal Reserve Bank stock (800) (389) (2,355)
Purchase of office properties and equipment (1,598) (1,722) (282)
-------- -------- --------
Net cash provided by (used in)
investing activities 51,882 (33,422) 73,961
- --------------------------------------------------------------------------------
(Continued)
60
COVEST BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
(IN THOUSANDS)
- --------------------------------------------------------------------------------
1998 1997 1996
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net decrease in deposits $ (7,217) $(30,338) $(52,566)
Net increase (decrease) in mortgage escrow
funds 723 (810) (1,771)
Short-term borrowings, net (70,201) 23,266 (16,745)
Proceeds from long-term borrowings 45,000 50,000 -
Repayments of long-term borrowings - - (2,400)
Proceeds from exercise of stock options,
net of treasury shares issued 1,148 901 488
Payment received on loan to ESOP 350 347 340
Purchase of treasury stock (5,079) (5,302) (8,053)
Cash dividends paid (1,376) (1,245) (1,233)
-------- -------- --------
Net cash provided by (used in)
financing activities (36,652) 36,819 81,910
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents 16,207 10,633 (6,361)
Cash and cash equivalents at beginning of year 23,470 12,837 19,198
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 39,677 $ 23,470 $ 12,837
-------- -------- --------
-------- -------- --------
Supplemental disclosures of cash flow information
Cash paid for
Interest $24,959 $23,900 $29,364
Income taxes 1,760 1,100 641
Securitization of portfolio loans - 17,782 61,030
- --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
61
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS: CoVest Bancshares, Inc. (the "Company") is a bank holding
company organized under the laws of the state of Delaware. Through its bank and
nonbank subsidiary, the Company provides a full line of financial services to
corporate and individual customers in northern Illinois from its five locations.
These services include demand, time, and savings deposits; lending; mortgage
banking; and insurance products.
BASIS OF PRESENTATION: The accompanying consolidated financial statements for
the years ended December 31, 1998, 1997, and 1996 include the accounts of CoVest
Bancshares, Inc., CoVest Banc (the Bank), 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 amount of
revenues 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.
- --------------------------------------------------------------------------------
(Continued)
62
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 loan losses.
MORTGAGE LOANS HELD FOR SALE: The Company, through its mortgage centers in
McHenry and Aurora, originates fixed rate and variable rate residential mortgage
loans for sale into the secondary market. Servicing rights are not retained on
the sold loans. The loans held for sale are carried at the lower of aggregate
cost or market value. The servicing release premiums, application fees and
documentation preparation fees are classified as mortgage center fees in the
"consolidated statements of income." When a loan is sold or securitized and
servicing retained, a separate asset is recognized for the mortgage servicing
rights. This asset is amortized over the life of the underlying loans.
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."
- --------------------------------------------------------------------------------
(Continued)
63
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Smaller balance homogeneous loans are defined as residential first mortgage
loans secured by one-to-four-family residences, residential construction loans,
and deposit loans and are evaluated collectively for impairment. Commercial
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.
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 $1,954,000 and $2,160,000 are included in other
assets in the December 31, 1998 and 1997 statements of financial condition,
respectively.
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.
COMPREHENSIVE INCOME: Effective January 1, 1998, the Company retroactively
adopted the provisions of Statement of Financial Accounting Standards No. 130
which requires comprehensive income to be reported for all periods.
Comprehensive income includes both net income and other comprehensive income
elements, including the change in unrealized gains and losses on securities
available-for-sale, net of tax.
- --------------------------------------------------------------------------------
(Continued)
64
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
NEW ACCOUNTING PRONOUNCEMENTS: Beginning January 1, 2000, a new accounting
standard will require all derivatives to be recorded at fair value. Unless
designated as hedges, changes in these fair values will be recorded in the
income statement. Fair value changes involving hedges will generally be
recorded by offsetting gains and losses on the hedge and on the hedged item,
even if the fair value of the hedged item is not otherwise recorded. This is
not expected to have a material effect but will depend on derivative holdings
when this standard is first adopted.
A new accounting standard for 1999 will allow mortgage loans originated in
mortgage banking which are converted into securities to be classified as
available-for-sale, trading, or held-to-maturity, instead of the current
requirement to classify as trading. This is not expected to have a material
effect but the effect will vary depending on the level and designation of
securitizations as well as on market price movements.
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.
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 stockholders.
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 and deposit transactions.
RECLASSIFICATIONS: Certain items in the financial statements as of and for the
years ended December 31, 1997 and 1996 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.
- --------------------------------------------------------------------------------
(Continued)
65
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
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, 1998, 1997, and
1996 is presented below.
Year Ended December 31,
--------------------------------------
1998 1997 1996
-------- -------- --------
Earnings per share
Net income $ 3,871 $ 2,610 $ 1,589
Weighted average common shares
outstanding 4,192 4,285 4,738
-------- -------- --------
Earnings per share $.92 $.61 $.34
-------- -------- --------
-------- -------- --------
Earnings per share assuming dilution
Net income $ 3,871 $ 2,610 $ 1,589
Weighted average common shares
outstanding 4,192 4,285 4,738
Add: dilutive effect of assumed exercises of
incentive stock options and management
retention plan 277 199 197
-------- -------- --------
Weighted average common and dilutive
potential common shares outstanding 4,469 4,484 4,935
-------- -------- --------
Diluted earnings per share $ .87 $ .58 $ .32
-------- -------- --------
-------- -------- --------
- --------------------------------------------------------------------------------
(Continued)
66
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 4 - SECURITIES
The amortized cost and fair value of securities available-for-sale are as
follows:
December 31, 1998
-------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
Securities available-for-sale
U.S. government agencies $ 29,987 $ 97 $ (43) $ 30,041
Marketable equity securities 994 9 (150) 853
States and political subdivisions 13,743 129 - 13,872
---------- ---------- ---------- ----------
44,724 235 (193) 44,766
Mortgage-backed securities
Federal Home Loan Mortgage Corporation 21,695 499 - 22,194
Government National Mortgage Association 7,383 - (58) 7,325
Federal National Mortgage Association 5,368 - (15) 5,353
---------- ---------- ---------- ----------
34,446 499 (73) 34,872
Federal Home Loan Bank stock 7,910 - - 7,910
Federal Reserve Bank stock 469 - - 469
---------- ---------- ---------- ----------
$ 87,549 $ 734 $ (266) $ 88,017
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
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)
67
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 4 - SECURITIES (Continued)
Proceeds from sales of securities available-for-sale in 1998, 1997, and 1996 and
gross realized gains and losses are as follows:
1998 1997 1996
-------- ------- --------
Proceeds from sales $119,434 $69,897 $242,622
Gross realized gains 882 1,422 3,285
Gross realized losses (657) (175) (734)
The carrying value of mortgage-backed and related securities are net of
unamortized premiums of $163,000 and $1,079,000 and unaccreted discounts of
$74,000 and $233,000 at December 31, 1998 and 1997, respectively.
At December 31, 1998 and 1997, respectively, $59,297,000 and $53,366,000 of
securities were pledged to secure deposits, short-term borrowings, and Federal
Home Loan Bank advances.
The amortized cost and fair value of securities available-for-sale at
December 31, 1998, 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.
Amortized Fair
Cost Value
--------- ---------
SECURITIES AVAILABLE-FOR-SALE
Due in one year or less $ 2,297 $ 2,310
Due after one year through five years 32,674 32,883
Due after five years through ten years 8,759 8,720
Mortgage-backed securities 34,446 34,872
Federal Home Loan Bank stock 7,910 7,910
Federal Reserve Bank stock 469 469
Marketable equity securities 994 853
--------- ---------
$ 87,549 $ 88,017
--------- ---------
--------- ---------
- --------------------------------------------------------------------------------
(Continued)
68
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 5 - LOANS RECEIVABLE
Loans receivable at December 31 are summarized as follows:
1998 1997
--------- ---------
Mortgage loans
Secured by one-to-four-family residences $ 154,182 $ 235,425
Net deferred loan origination costs 297 652
--------- ---------
Total mortgage loans 154,479 236,077
Commercial loans and leases
Commercial real estate 66,776 56,220
Multi-family loans 55,661 4,604
Construction 40,572 8,939
Commercial loans 8,035 5,504
Commercial and municipal leases 35,166 11,274
--------- ---------
206,210 86,541
Net deferred loan origination fees (28) (377)
--------- ---------
Total commercial loans and leases 206,182 86,164
Consumer and other loans
Automobile 21,036 22,781
Credit card - 13,469
Home equity and improvement 22,654 21,987
Other 2,290 1,008
--------- ---------
45,980 59,245
--------- ---------
$ 406,641 $ 381,486
--------- ---------
--------- ---------
Loans serviced for the Federal Home Loan Mortgage Corporation (the "FHLMC")
approximated $118,800,000, $170,113,000, and $178,548,000 at December 31, 1998,
1997, and 1996, respectively.
The Bank had lending transactions with directors and executive officers of the
Company and the Bank and their associates which totaled approximately $360,000
and $840,000 at December 31, 1998 and 1997, respectively.
Included in secured one-to-four-family residences are $4,294,000 of loans held
for sale at December 31, 1998.
- --------------------------------------------------------------------------------
(Continued)
69
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 5 - LOANS RECEIVABLE (Continued)
The Company did not have any loans which were impaired either at or during the
year ended December 31, 1998 and 1997.
Activity in the allowance for possible loan losses is summarized as follows for
the years ended December 31:
1998 1997 1996
-------- -------- --------
Balance at beginning of year $ 3,977 $ 1,424 $ 1,379
Provision 1,567 4,072 1,397
Recoveries 161 96 145
Loans charged-off (1,393) (1,615) (1,497)
-------- -------- --------
Net charge-offs (1,232) (1,519) (1,352)
-------- -------- --------
Balance at end of year $ 4,312 $ 3,977 $ 1,424
-------- -------- --------
-------- -------- --------
NOTE 6 - PREMISES AND EQUIPMENT
Premises and equipment at December 31 are summarized as follows:
1998 1997
-------- --------
Cost
Land $ 1,656 $ 1,656
Buildings 9,992 9,071
Furniture, fixtures, and equipment 4,811 4,256
-------- --------
16,459 14,983
Less accumulated depreciation and amortization 5,087 4,216
-------- --------
$ 11,372 $ 10,767
-------- --------
-------- --------
- --------------------------------------------------------------------------------
(Continued)
70
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 7 - DEPOSITS
Certificates of deposit accounts of $100,000 and over totaled $34,208,000 and
$35,037,000 at December 31, 1998 and 1997, respectively. At December 31,
1998, stated maturities of all certificates of deposit were:
1999 $ 136,522
2000 37,184
2001 4,349
2002 8,001
2003 and thereafter 1,457
------------
$ 187,513
------------
------------
Certificates of deposit included approximately $991,000 and $8,370,000 at
December 31, 1998 and 1997, 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:
1 9 9 8 1 9 9 7
------------------------------- ------------------------------
Weighted Weighted
Average Average
Rate Amount Rate Amount
---- ------ ---- ------
Short-term borrowings
- ---------------------
Advances from the Federal Home
Loan Bank due
1998 -% $ - 5.74% $ 60,000
Securities sold under
repurchase agreement 5.14 3,774 5.28 12,947
Other borrowings 5.06 2,981 5.27 4,009
------------ -----------
$ 6,755 $ 76,956
------------ -----------
------------ -----------
- --------------------------------------------------------------------------------
(Continued)
71
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 8 - BORROWINGS (Continued)
1 9 9 8 1 9 9 7
------------------------------- ------------------------------
Weighted Weighted
Average Average
Rate Amount Rate Amount
---- ------ ---- ------
Long-term borrowings
- --------------------
Advances from Federal Home
Loan Bank due
2000 6.19% $ 25,000 6.19% $ 25,000
2002 5.35 50,000 5.35 50,000
2008 4.87 45,000 - -
------------ -----------
$ 120,000 $ 75,000
------------ -----------
------------ -----------
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 delinquent) aggregating no less than
167% of the outstanding secured advances from the Federal Home Loan Bank. In
1998, various securities were also pledged as collateral.
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.
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. This borrowing has an interest rate which adjusts weekly. This
borrowing is collateralized by a pledge of various securities, with an amortized
cost of $9,130,000 and $4,994,000 and a fair value of $9,252,000 and $4,988,000
at December 31, 1998 and 1997, respectively.
- --------------------------------------------------------------------------------
(Continued)
72
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 9 - INCOME TAXES
The income tax provision for the years ended December 31 is summarized as
follows:
1998 1997 1996
---- ---- ----
Current
Federal $ 2,268 $ 1,875 $ 338
State 389 187 (141)
Deferred (557) (927) 343
----------- ----------- -----------
$ 2,100 $ 1,135 $ 540
----------- ----------- -----------
----------- ----------- -----------
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:
1998 1997 1996
---- ---- ----
Expected income tax expense at federal
tax rate $ 2,030 $ 1,273 $ 724
State income tax, net of federal tax benefit 198 (12) (114)
Tax exempt interest income on securities
and loans (96) (10) -
Increase in cash surrender value of director
life insurance (1) (82) (56)
Other (31) (34) (14)
----------- ----------- -----------
$ 2,100 $ 1,135 $ 540
----------- ----------- -----------
----------- ----------- -----------
The net deferred tax assets and liabilities, included in other assets and other
liabilities in the accompanying statement of financial condition, consisted of
the following at December 31, 1998 and 1997:
1998 1997
---- ----
Gross deferred tax assets
Bad debt deduction $ 667 $ 337
Deferred compensation and employee benefits 828 776
Other 111 -
----------- -----------
1,606 1,113
- --------------------------------------------------------------------------------
(Continued)
73
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 9 - INCOME TAXES (Continued)
1998 1997
---- ----
Gross deferred tax liabilities
Unrealized gain on securities available-for-sale $ (182) $ (669)
Depreciation (449) (453)
FHLB stock dividends (176) (176)
Deferred loan fees (511) (595)
Mortgage servicing rights (78) (54)
----------- -----------
(1,396) (1,947)
----------- -----------
Net deferred tax asset (liability) $ 210 $ (834)
----------- -----------
----------- -----------
The deferred tax asset for the unrealized loss on marketable equity securities
is offset by a valuation allowance of an equal amount.
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. 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.
- --------------------------------------------------------------------------------
(Continued)
74
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 10 - COMMITMENTS, CONTINGENT LIABILITIES, AND CONCENTRATIONS
(Continued)
At December 31, 1998 and 1997, these financial instruments are summarized as
follows:
Amount
-------------------------
1998 1997
---- ----
Off-balance-sheet financial instruments whose contract
amounts represent credit risk
Commitments to extend credit
Fixed rate $ 5,475 $ 3,734
Variable rate 13,323 7,732
Letters of credit 3,619 8,625
Unused lines of credit 72,365 78,340
Credit enhancements 6,978 6,500
The fixed rate commitments have rates ranging from 7.00% to 9.25% and 8.25% to
9.50% at December 31, 1998 and 1997, 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 northern Illinois and most
loans are secured by specific collateral including residential and commercial
real estate.
During 1997, the Company entered into a credit enhancement agreement with a
local municipality to guarantee the repayment of an amount not exceeding $7.2
million of municipal revenue bonds which are secured by a first mortgage on a
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.
- --------------------------------------------------------------------------------
(Continued)
75
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 11 - CAPITAL REQUIREMENTS (Continued)
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.
At December 31, 1998 and 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
------ ---------------- -----------------
1998 Amount Ratio Amount Ratio Amount Ratio
- ---- ------ ----- ------ ----- ------ -----
Total capital
(to risk-weighted assets)
Company $ 49.0 13.7% $ 28.6 8.0% $ 35.7 10.0%
Bank 47.2 13.3 28.4 8.0 35.5 10.0
Tier 1 capital
(to risk-weighted assets)
Company 44.7 12.5 14.3 4.0 21.4 6.0
Bank 42.9 12.1 14.2 4.0 21.3 6.0
Tier 1 capital
(to average assets)
Company 44.7 8.0 22.4 4.0 27.9 5.0
Bank 42.9 7.7 22.3 4.0 27.8 5.0
1997
- ----
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
- --------------------------------------------------------------------------------
(Continued)
76
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 11 - CAPITAL REQUIREMENTS (Continued)
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
Companies 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 and cash equivalents; interest-bearing
deposits with financial institutions; Federal Home Loan Bank stock; accrued
interest receivable; NOW, money market, and savings deposits; short-term
borrowings; 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, 1998 and 1997,
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, 1998 and 1997, 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 borrowings at December 31, 1998 and 1997 for a time period until maturity.
Loan commitments are not included in the table below as their estimated fair
value is immaterial.
- --------------------------------------------------------------------------------
(Continued)
77
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 12 - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)
At December 31, 1998 At December 31, 1997
-------------------- --------------------
(In thousands) (In thousands)
Approximate Estimated Approximate Estimated
Carrying Fair Carrying Fair
Value Value Value Value
----- ----- ----- -----
FINANCIAL INSTRUMENT ASSETS
Cash on hand and in banks $ 18,395 $ 18,395 $ 5,670 $ 5,670
Interest-bearing deposits in other
financial institutions 21,282 21,282 17,800 17,800
Securities available-for-sale 88,017 88,017 164,172 164,172
Loans receivable, net 402,329 403,362 377,509 377,862
Accrued interest receivable 3,280 3,280 3,487 3,487
FINANCIAL INSTRUMENT LIABILITIES
NOW, money market, and
passbook savings 177,022 177,022 151,985 151,985
Certificates of deposits 187,513 189,109 219,767 220,336
Short-term borrowings 6,755 6,755 76,956 76,956
Long-term borrowings 120,000 120,000 75,000 75,000
Advances from borrowers for
taxes and insurance 3,637 3,637 2,914 2,914
Accrued interest payable 737 737 957 957
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, 1998 and 1997, the fair values would
have been achieved, because the market value may differ depending on the
circumstances. The estimated fair values at December 31, 1998 and 1997 should
not necessarily be considered to apply at subsequent dates.
- --------------------------------------------------------------------------------
(Continued)
78
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 13 - EMPLOYEE BENEFIT PLANS
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
are eligible to enter the plan the beginning of the month following employment.
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 1998, 1997, and 1996 was
$85,000, $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. The options have an exercise period of ten
years from the date of grant. 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 1998, options for 99,000 shares were granted at $12.72 to $18.30 per
share and are fully vested after six years. During 1997, options for 409,500
shares were granted at $11.21 to $17.67 per share and are fully vested after six
years. During 1996, options for 241,500 shares were granted at $9.45 to $11.33
per share and are fully vested after six years.
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 1998, 1997, and 1996.
1998 1997 1996
---- ---- ----
Net income as reported $ 3,871 $ 2,610 $ 1,589
Pro forma net income 3,660 2,243 1,363
Basic earnings per share as reported $ .92 $ .61 $ .34
Pro forma basic earnings per share .87 .52 .29
Diluted earnings per share as reported $ .87 $ .58 .32
Diluted earnings per share .82 .50 .28
- --------------------------------------------------------------------------------
(Continued)
79
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 13 - EMPLOYEE BENEFIT PLANS (Continued)
The activity in the stock option plans for 1998, 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
Granted 99,000 16.25
Exercised (158,017) (6.42)
Forfeited (192,931) (9.82)
-------------- ----------
Outstanding at December 31, 1998 1,012,170 $ 11.09
-------------- ----------
-------------- ----------
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
December 31, 1998 268,170 7.79
- --------------------------------------------------------------------------------
(Continued)
80
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 13 - EMPLOYEE BENEFIT PLANS (Continued)
For options granted during the year, the weighted average fair values at grant
date are as follows:
Weighted
Average
Number of Exercise Fair
Options Price Value
------- ----- -----
1996 211,500 $ 10.71 $ 2.41
1997 409,500 14.52 4.89
1998 99,000 16.25 2.11
The fair value of options granted during 1998, 1997, and 1996 is estimated using
the following weighted average information:
1998 1997 1996
---- ---- ----
Risk free interest rate 4.5% 6.5% 6.5%
Expected life 6 years 6 years 6 years
Expected volatility of stock price 5.893% 16.624% 14.72%
Expected dividend 2.5% 2.5% 2.5%
At year end, options outstanding were as follows:
Outstanding Exercisable
----------- -----------
Weighted Average Weighted
Range of Remaining Average
Exercise Contractual Exercise
Prices Number Life Number Price
------ ------ ---- ------ -----
$ 4.44 - $ 6.66 118,920 4 years 118,920 $ 4.44
6.67 - 10.00 301,500 7 years 93,000 8.95
10.01 - 15.00 371,250 8 years 38,250 11.21
15.00 - 18.75 220,500 9 years 18,000 16.66
-------------- ----------- ------------ ---------
Outstanding at year end 1,012,170 7.5 years 268,170 $ 7.79
-------------- ----------- ------------ ---------
-------------- ----------- ------------ ---------
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 is restricted as to certain rights at the time of
issuance. These restrictions are removed over a period of five years. During
1998 and 1997, no shares were granted or vested. During 1996, 17,757 shares
vested. The market value of the shares, determined at the date of grant, are
charged to expense over the vesting period.
- --------------------------------------------------------------------------------
(Continued)
81
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 13 - EMPLOYEE BENEFIT PLANS (Continued)
In 1993, the Company began to provide certain postretirement health care
benefits for employees, as well as a Director's deferred compensation plan.
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 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, 1998, 1997, and 1996, respectively, the APBO for all of the
plans was $867,000, $973,000, and $706,000 and the postretirement benefit cost
for each of the years ended December 31, 1998, 1997, and 1996 was $116,000,
$106,000, and $108,000, respectively. The annual rate of increase in the per
capita cost of covered health care is assumed to be 11.5% for three 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 $150,000, $11,000
and $62,000 has been included in compensation and benefits in the accompanying
consolidated statements of income for the years ended December 31, 1998, 1997,
and 1996, respectively. During 1997, the Company received insurance proceeds of
$187,000 due to the death of a director. The Company is the beneficiary of life
insurance policies on the directors with an aggregate face value of
approximately $2,618,000 and $2,700,000 at December 31, 1998 and 1997,
respectively. In addition, the policies had aggregate cash surrender values of
approximately $551,000 and $476,000 at December 31, 1998 and 1997, respectively.
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
$161,000 and $511,000 at December 31, 1998 and 1997, 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 $236,000,
$267,000, and $290,000 for 1998, 1997, and 1996, respectively. The ESOP shares
as of December 31 were as follows:
1998 1997
---- ----
Allocated shares 276,489 281,712
Committed to be released 51,782 51,782
Suspense shares 58,811 110,593
------------ ------------
Total ESOP shares 387,082 444,087
------------ ------------
------------ ------------
- --------------------------------------------------------------------------------
(Continued)
82
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
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, 1998 and 1997
1998 1997
---- ----
ASSETS
Cash in banks $ 208 $ 1,930
Securities 853 408
Investment in Bank 45,242 45,842
Other assets 738 552
----------- -----------
$ 47,041 $ 48,732
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 90 $ 438
Stockholders' equity
Common stock 44 44
Additional paid in capital 18,967 19,365
Retained earnings 30,905 28,410
Treasury stock, at cost (3,017) -
Unearned stock awards (73) (73)
ESOP loan (161) (511)
Other comprehensive income 286 1,059
----------- -----------
46,951 48,294
----------- -----------
$ 47,041 $ 48,732
----------- -----------
----------- -----------
- --------------------------------------------------------------------------------
(Continued)
83
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 14 - PARENT COMPANY ONLY FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENTS OF INCOME
Years ended December 31, 1998, 1997, and 1996
1998 1997 1996
---- ---- ----
Operating income
Interest on investments $ 7 $ 33 $ 44
Dividends received from subsidiary 4,000 2,000 10,000
Gain on sale of investments 55 1,148 5
Other 31 53 95
----------- ----------- -----------
Total operating income 4,093 3,234 10,144
Operating expenses 223 829 245
----------- ----------- -----------
INCOME BEFORE EQUITY IN UNDISTRIBUTED EARNINGS
OF SUBSIDIARY 3,870 2,405 9,899
Equity (excess) in undistributed earnings of
subsidiary 1 205 (8,310)
----------- ----------- -----------
NET INCOME $ 3,871 $ 2,610 $ 1,589
----------- ----------- -----------
----------- ----------- -----------
- --------------------------------------------------------------------------------
(Continued)
84
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
(TABLE AMOUNTS IN THOUSANDS OF DOLLARS)
- --------------------------------------------------------------------------------
NOTE 14 - PARENT COMPANY ONLY FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31, 1998, 1997, and 1996
1998 1997 1996
---- ---- ----
OPERATING ACTIVITIES
Net income $ 3,871 $ 2,610 $ 1,589
Adjustments to reconcile net income to
net cash provided by operating activities
Equity (excess) in undistributed
earnings of subsidiary (1) (205) 8,310
Net gain on sales of securities (55) (1,148) (5)
Change in
Other assets 379 (20) (1)
Other liabilities (347) 1,098 (40)
----------- ----------- -----------
Net cash provided by
operations 3,847 2,335 9,853
INVESTING ACTIVITIES
Purchase of securities (779) (100) (2,853)
Proceeds from sales of securities 167 4,103 134
----------- ----------- -----------
Net cash provided by (used in)
investing activities (612) 4,003 (2,719)
FINANCING ACTIVITIES
Proceeds from exercise of stock options,
net of treasury shares issued 1,148 901 488
Payment received on loan to ESOP 350 347 340
Purchase of treasury stock (5,079) (5,302) (8,053)
Cash dividend paid, net of dividend
reinvestments (1,376) (1,245) (1,233)
----------- ----------- -----------
Net cash used in financing activities (4,957) (5,299) (8,458)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents (1,722) 1,039 (1,324)
Cash and cash equivalents at beginning of year 1,930 891 2,215
----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 208 $ 1,930 $ 891
----------- ----------- -----------
----------- ----------- -----------
- --------------------------------------------------------------------------------
(Continued)
85
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
- --------------------------------------------------------------------------------
NOTE 15 - OTHER COMPREHENSIVE INCOME
Changes in other comprehensive income components and related taxes are as
follows:
Years Ended December 31,
---------------------------------------
1998 1997 1996
---- ---- ----
Change in unrealized gains (losses)
on securities available-for-sale $ (1,035) $ 2,103 $ 612
Less reclassification adjustment for gains
recognized in income 225 1,247 2,551
---------- ---------- ----------
Net unrealized gains (losses) (1,260) 856 (1,939)
Tax expense (benefit) (487) 331 (734)
---------- ---------- ----------
Other comprehensive income $ (773) $ 525 $ (1,205)
---------- ---------- ----------
---------- ---------- ----------
NOTE 16 - COMMON STOCK AND TREASURY STOCK
On May 15, 1996 and December 1, 1997, the Company's Board of Directors declared
a three-for-two split of its common stock, to be effected by means of a 100%
stock distribution. All share and per share amounts have been restated to
reflect the stock split.
An analysis of changes in the number of shares of common stock and treasury
stock outstanding follows:
1998 1997 1996
---- ---- ----
Common Stock
------------
Balance at January 1 4,365,761 3,406,616 4,214,427
Distribution of three-for-two stock split - 959,145 895,497
Shares issued for stock options 38,042 - -
------------- ------------- -------------
Balance at December 31 4,403,803 4,365,761 5,109,924
------------- ------------- -------------
------------- ------------- -------------
Treasury Stock
--------------
Balance at January 1 - 514,950 1,094,228
Distribution of three-for-two stock split - (744,059) (807,755)
Stock options exercised (119,978) (158,242) (109,845)
Treasury stock purchases 313,166 387,351 338,322
------------- ------------- -------------
Balance at December 31 193,188 - 514,950
------------- ------------- -------------
------------- ------------- -------------
- --------------------------------------------------------------------------------
(Continued)
86
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
- --------------------------------------------------------------------------------
NOTE 17 - SEGMENT INFORMATION
During 1998 the Company opened two mortgage centers to originate and sell
mortgage loans with servicing released into the secondary market. The mortgage
center operations and the banking operations are considered to be reportable
segments during 1998. Loans, investments, and deposits provide the revenues in
the banking operation, and servicing release fees and loan sales provide the
revenues in mortgage banking. All operations are domestic.
The accounting policies used are the same as those described in the summary of
significant accounting policies except that income taxes are not allocated to
the mortgage banking operations. Information reported internally for performance
assessment as of December 31, 1998 follows.
Mortgage Consolidated
Banking Banking Total
------- ------- -----
Net interest income $ 15,826 $ 378 $ 16,204
Other revenue 3,867 1,712 5,579
Other expense 11,708 1,544 13,252
Noncash items:
Depreciation 977 16 993
Provision for loan loss 1,567 - 1,567
Segment profit, before income taxes 5,441 530 5,971
Segment assets 543,793 4,904 548,697
NOTE 18 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
Three Months Ended
---------------------------------------------------------
1998 March 31 June 30 September 30 December 31
---- -------- ------- ------------ -----------
Interest income $ 10,447 $ 10,151 $ 10,524 $ 9,821
Interest expense 6,403 6,179 6,349 5,808
----------- ----------- ----------- -----------
NET INTEREST INCOME 4,044 3,972 4,175 4,013
Provision for possible loan losses 399 769 399 -
Other income 1,186 1,578 1,322 1,493
Other expense 3,292 3,304 3,739 3,910
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 1,539 1,477 1,359 1,596
Income taxes 530 505 460 605
----------- ----------- ----------- -----------
NET INCOME $ 1,009 $ 972 $ 899 $ 991
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
EARNINGS PER COMMON SHARE
Basic $ .24 $ .23 $ .22 $ .24
Diluted .22 .21 .20 .23
- --------------------------------------------------------------------------------
(Continued)
87
COVEST BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997, AND 1996
- --------------------------------------------------------------------------------
NOTE 18 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (Continued)
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)
- --------------------------------------------------------------------------------
88
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 Company is incorporated herein by
reference from the Company's definitive Proxy Statement for the 1998 Annual
Meeting of Stockholders. Information concerning the executive officers of the
Company 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 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, 1998 through December 31, 1998.
Item 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by
reference from the Company's definitive Proxy Statement for the 1998 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 1998 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
1998 Annual Meeting of Stockholders.
- --------------------------------------------------------------------------------
89
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K
A report on Form 8-K was filed on November 12, 1998 to report under Item 5,
Other Events, that the Company issued a press release announcing that its
subsidiary, CoVest Banc, had entered into an agreement to sell its credit
card portfolio.
A report on Form 8-K was filed on November 24, 1998 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 29, 1998 to report under Item 5,
Other Events, that the Company issued a press release announcing the
completion of the Stock Repurchase Program dated August 25, 1998.
- --------------------------------------------------------------------------------
90
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/ James L. Roberts By: /s/ Paul A. Larsen
------------------------------ -----------------------------------
James L. Roberts, Paul A. Larsen,
President and Senior Vice President,
Chief Executive Officer Treasurer and Chief Financial
Officer
Date: March 5, 1999 Date: March 5, 1999
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/ Frank A. Svoboda By: /s/ James L. Roberts
------------------------------ --------------------------------------
Frank A. Svoboda, Jr., James L. Roberts, President,
Chairman of the Board Chief Executive Officer and
Director
Date: March 5, 1999 Date: March 5, 1999
By: /s/ George T. Drost By: /s/ John A. Flink
------------------------------ --------------------------------------
George T. Drost, Director John A. Flink, Director
Date: March 5, 1999 Date: March 5, 1999
By: /s/ David M. Miller By: /s/ Gerald T. Niedert
------------------------------ --------------------------------------
David M. Miller, Director Gerald T. Niedert, Director
Date: March 5, 1999 Date: March 5, 1999
By: /s/ David B. Speer By: /s/ Thomas TenHoeve
-------------------------------- --------------------------------------
David B. Speer, Director Thomas TenHoeve, Director
Date: March 5, 1999 Date: March 5, 1999
- --------------------------------------------------------------------------------
91
COVEST BANCSHARES, INC.
Exhibit Index
To
Annual Report of Form 10-K
EXHIBIT DESCRIPTION INCORPORATED HEREIN BY FILED SEQUENTIAL
NO. REFERENCE 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 Exhibit 3.2 to the 1997
of Incorporation of CoVest 10-K filed with the Commission
Bancshares, Inc. by CoVest Bancshares, Inc. on
March 24, 1998
(Commission File No. 000-20160)
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 Exhibit 4.1 to the 1997
of CoVest Bancshares, 10-K filed with the Commission
Inc. by CoVest Bancshares, Inc. on
March 24, 1998
(Commission File No. 000-20160)
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 Form of Change of Exhibit 10.3 to the 1997
Control Agreement for 10-K filed with the Commission
Paul A. Larsen by CoVest Bancshares, Inc. on
Allen J. Bishop March 24, 1998
Joseph H. Tillotson (Commission File No. 000-20160)
Lawrence J. Schmidt
Vernon J. Wiggenhauser
10.3 Form of Change of Exhibit 10.4 to the 1997
Control Agreement for 10-K filed with the Commission
R. Kennedy Alger by CoVest Bancshares, Inc. on
March 24, 1998
(Commission File No. 000-20160)
10.4 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)
10.5 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)
10.6 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)
10.7 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)
10.8 Amendment 1997-1 to Exhibit 10.9 to the 1997
CoVest Bancshares, Inc. 10-K filed with the Commission
1992 Stock Option and by CoVest Bancshares, Inc. on
Incentive Plan March 24, 1998
(Commission File No. 000-20160)
10.9 1996 Stock Option and Exhibit 10.10 to the 1997
Incentive Plan 10-K filed with the Commission
by CoVest Bancshares, Inc. on
March 24, 1998
(Commission File No. 000-20160)
10.10 Amendment 1997-1 to Exhibit 10.11 to the 1997
1996 Stock Option and 10-K filed with the Commission
Incentive Plan by CoVest Bancshares, Inc. on
March 24, 1998
(Commission File No. 000-20160)
10.11 Employment Agreement X
between CoVest
Bancshares, Inc.
and James L. Roberts,
dated January 20, 1999
10.12 Non-Qualified Stock X
Option Agreement between
CoVest Bancshares, Inc.
and James L. Roberts,
dated January 20, 1999
10.13 Agreement Regarding X
Post Employment
Restrictive Covenants
between CoVest Bancshares,
Inc., CoVest Banc,
National Association,
and James L. Roberts,
dated January 20, 1999.
21.1 Subsidiaries of the Exhibit 21.1 to the 1997
Registrant 10-K filed with the Commission
by CoVest Bancshares, Inc. on
March 24, 1998
(Commission File No. 000-20160)
23.1 Consent of Crowe Chizek X
99.1 Proxy Statement and proxy Schedule 14A filed with the
(except such portions Commission on March 22,
incorporated by reference 1999.
into this Form 10-K, such
materials shall not be
deemed to be "filed" with
the Commission)
3