Washington, D.C.  20549

 

 

FORM 10-K

 

ý        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For the Fiscal Year Ended June 30, 2004

 

Commission File Number 0-19972

 

 

HF FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

Delaware		46-0418532
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
225 South Main Avenue, Sioux Falls, SD		57104
(Address of principal executive offices)		(Zip Code)
(605) 333-7556
(Registrant’s telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
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 12 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  ý  NO  o

 

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. ý

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act.)

YES  o  NO  ý

 

As of September 22, 2004, there were 3,550,660 issued and outstanding shares of the Registrant’s Common Stock.

 

The aggregate market value of the common equity held by non-affiliates of the registrant, computed by reference to the average of the bid and asked price of such common equity as of December 31, 2003, the last business day of the registrant’s most recently completed second fiscal quarter, was $58.3 million.  (The exclusion from such amount of the market value of the common equity owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part III of Form 10-K - Portions of the Proxy Statement for 2004 Annual Meeting of Stockholders.

 

 

Annual Report on Form 10-K

Table of Contents

 

	PART I
Item 1.	Business
Item 2.	Properties
Item 3.	Legal Proceedings
Item 4.	Submission of Matters to a Vote of Security Holders
	PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6.	Selected Financial Data
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk
Item 8.	Financial Statements and Supplementary Data
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
Item 9A.	Controls and Procedures
	PART III
Item 10.	Directors and Executive Officers of the Registrant
Item 11.	Executive Compensation
Item 12.	Security Ownership of Certain Beneficial Owners and Management
Item 13.	Certain Relationships and Related Transactions
Item 14.	Principal Accounting Fees and Services
	PART IV
Item 15.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K

 

 

Forward-Looking Statements

 

This Form 10-K and other reports issued by HF Financial Corp. (the “Company”), including reports filed with the Securities and Exchange Commission, contain “forward-looking statements” that deal with future results, expectations, plans and performance.  In addition, the Company’s management may make forward-looking statements orally to the media, securities analysts, investors or others.  These forward-looking statements might include one or more of the following:

 

•                  Projections of income, loss, revenues, earnings or losses per share, dividends, capital expenditures, capital structure, tax benefit or other financial items.

•                  Descriptions of plans or objectives of management for future operations, products or services, transactions and use of subordinated debentures payable to trusts.

•                  Forecasts of future economic performance.

•                  Descriptions of assumptions underlying or relating to such matters.

 

Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts.  They often include words such as “optimism,” “look-forward,” “bright,” “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could” or “may.”

 

Forward-looking statements about the Company’s expected financial results and other plans are subject to certain risks, uncertainties and assumptions.  These include, but are not limited to the following: possible legislative changes and adverse economic, business and competitive developments (such as shrinking interest margins); deposit outflows; reduced demand for financial services and loan products; changes in accounting policies or guidelines, or in monetary and fiscal policies of the federal government; changes in credit and other risks posed by the Company’s loan portfolios; unexpected claims against the Company’s self-insured health plan; the ability or inability of the Company to successfully enter into a definitive agreement for and close anticipated transactions; technological, computer-related or operational difficulties; adverse changes in securities markets; results of litigation; or other significant uncertainties.

 

Forward-looking statements speak only as of the date they are made.  The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.

 

PART I

 

Item 1.  Business

 

This section should be read in conjunction with Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” and Part II, Item 8, “Financial Statements and Supplementary Data”.

 

The Company

 

HF Financial Corp., a unitary thrift holding company, was formed in November 1991, for the purpose of owning all of the outstanding stock of Home Federal Bank (the “Bank”) issued in the mutual to stock conversion of the Bank.  The Company acquired all of the outstanding stock of the Bank on April 8, 1992.  The Company is incorporated under the laws of the State of Delaware and generally is authorized to engage in any activity that is permitted by the Delaware General Corporation Law.  Unless otherwise indicated, all matters discussed in this Form 10-K relate to the Company, and its direct and indirect subsidiaries, including without limitation, the Bank.  See “Subsidiary Activities” for further information on the subsidiary operations of the Company and the Bank.

 

The executive offices of the Company and its direct and indirect subsidiaries are located at 225 South Main Avenue, Sioux Falls, South Dakota, 57104.  The Company’s telephone number is (605) 333-7556.

 

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Website and Available Information

 

The website for the Company and the Bank is located at www.homefederal.com.  Information on this website does not constitute part of this Form 10-K.

 

The Company makes available, free of charge, its Annual Report on Form 10-K, its quarterly reports on Form 10-Q, its current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after such forms are filed with or furnished to the SEC.  Copies of these documents are available to stockholders upon request addressed to the Secretary of the Company at 225 South Main Avenue, Sioux Falls, SD  57104.

 

The Bank

 

The Bank was founded in 1929 and is a federally chartered stock savings bank headquartered in Sioux Falls, South Dakota.  The Bank provides full-service consumer and commercial business banking, including an array of financial products, to meet the needs of its market place.  The Bank attracts deposits from the general public and uses such deposits, together with borrowings and other funds, to originate one- to four-family residential, commercial business, consumer, multi-family, commercial real estate, construction and agricultural loans.  The Bank’s consumer loan portfolio includes, among other things, automobile loans, home equity loans, loans secured by deposit accounts and student loans.  The Bank also purchases mortgage-backed securities and invests in U.S. Government and agency obligations and other permissible investments.  The Bank does not hold any non-investment grade bonds (i.e., “junk bonds”).  The Bank receives loan servicing income on loans serviced for others and commission income from credit-life insurance on consumer loans.  The Bank, through its wholly-owned subsidiaries, offers annuities, mutual funds, life insurance and other financial products and equipment leasing services.

 

The Bank’s deposits are insured up to applicable limits by the Savings Association Insurance Fund (“SAIF”), administered by the Federal Deposit Insurance Corporation (“FDIC”), and the Bank is subject to primary regulation and examination by the Office of Thrift Supervision (“OTS”).

 

Segments

 

Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance.  The Company’s reportable segments are “banking” (including leasing activities) and “other”.  The “banking” segment is conducted through the Bank and Mid America Capital Services, Inc. (“Mid America Leasing”) and the “other” segment is composed of smaller nonreportable segments, the Company and inter-segment eliminations.  For financial information by segment see Note 1 of “Notes to Consolidated Financial Statements”.

 

Subsidiary Activities

 

In addition to the Bank, the Company had six other wholly-owned subsidiaries as of June 30, 2004:  HF Financial Group, Inc. (“HF Group”), HF Financial Capital Trust I (“Trust I”), HF Financial Capital Trust II (“Trust II”), HF Financial Capital Trust III (“Trust III”), HF Financial Capital Trust IV (“Trust IV”) and HomeFirst Mortgage Corp. (the “Mortgage Corp.”).

 

In August 2002, the Company formed HF Group, a South Dakota corporation.  HF Group has the exclusive right to market “Syben Services” for the Minneapolis-based corporation, Syben Holdings, Inc., to business customers within the seven-state territory that includes South Dakota, Minnesota, Iowa, Nebraska, Missouri, Kansas and North Dakota.  Syben Services are internet based services that utilize proprietary software developed to facilitate employee benefits administration, payroll processing and management and governmental reporting. Syben Services assists employers with the management of their employer sponsored compensation and benefit programs.  The Company anticipates that this marketing venture will provide expanded opportunities to serve the Company’s existing business customers, develop new corporate relationships and increase the Company’s fee income.

 

In November 2001, the Company formed Trust I for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company.  These subordinated debentures constitute the

 

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sole asset of Trust I.

 

In July 2002, the Company formed Trust II for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company.  These subordinated debentures constitute the sole asset of Trust II.

 

In December 2002, the Company formed Trust III for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company.  These subordinated debentures constitute the sole asset of Trust III.

 

In September 2003, the Company formed Trust IV for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company.  These subordinated debentures constitute the sole asset of Trust IV.

 

The Mortgage Corp., a South Dakota corporation, in the past was engaged in the business of originating one- to four-family residential mortgage loans, which were sold into the secondary market.  The Mortgage Corp. had no activity during fiscal year 2004.

 

As a federally chartered thrift institution, the Bank is permitted by OTS regulations to invest up to 2.00% of its assets in the stock of, or loans to, service corporation subsidiaries.  The Bank may invest an additional 1.00% of its assets in service corporations where such additional funds are used for inner-city or community development purposes.  The Bank currently has less than 1.00% of its assets in investments in its subsidiary service corporations as defined by the OTS.  In addition to investments in service corporations, the Bank is permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities in which the Bank may engage directly.

 

The Bank has five wholly-owned subsidiaries, Hometown Insurors, Inc. (“Hometown”), Mid America Leasing, Home Federal Securitization Corp. (“HFSC”), Mid-America Service Corporation (“Mid-America”) and PMD, Inc. (“PMD”).

 

Hometown, a South Dakota corporation, provides financial and insurance products to customers of the Bank and members of the general public in the Bank’s market area.  Insurance products offered by Hometown primarily include annuities and life insurance products.  On August 8, 2003, the Company sold the property and casualty insurance book of business of Hometown to a third party for total proceeds of $375,000.  The sales agreement includes a “Covenant Not to Compete” clause prohibiting Hometown from directly or indirectly selling property or casualty insurance for three years in the state of South Dakota.  The transaction was effective as of July 31, 2003 and had an immaterial impact on the Company’s financial position and results of operations.  Hometown obtains its funding via a line of credit from the Bank.  Banking regulations do not limit the amount of funding provided to an operating subsidiary.  As of June 30, 2004, the Bank had advanced no funds on an approved line of credit of $200,000.  Intercompany interest income and interest expense are eliminated in the preparation of consolidated financial statements.

 

Mid America Leasing, a South Dakota corporation, specializes in equipment finance leasing.  Mid America Leasing Co. obtains its funding via a line of credit from the Bank.  Banking regulations do not limit the amount of funding provided to an operating subsidiary.  As of June 30, 2004, the Bank had advanced $22.2 million on an approved line of credit of $35.0 million.  Intercompany interest income and interest expense are eliminated in the preparation of consolidated financial statements.

 

HFSC, a Delaware corporation, exists for the sole purpose of buying motor vehicle installment loans from the Bank to be securitized.  See Note 3 of “Notes to Consolidated Financial Statements” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion on consumer automobile loan securitization.

 

Mid-America, a South Dakota corporation, provided residential appraisal services to the Bank and other lenders in the Bank’s market area until the third quarter of fiscal 2002.  The cessation of operations of Mid-America had no material effect on the consolidated financial statements.  Mid-America had no activity during fiscal year 2004.

 

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PMD, a South Dakota corporation, in the past was engaged in the business of buying, selling and managing repossessed real estate properties.  PMD had no activity during fiscal year 2004.

 

Market Area

 

Based on total assets at June 30, 2004, the Bank is the largest thrift institution headquartered in South Dakota.  The Bank has a total of 34 banking centers in its market area and 1 internet branch located at www.homefederal.com.  The Bank’s primary market area includes communities located in eastern and central South Dakota, including the cities of Sioux Falls, Brandon, Pierre, Winner, Freeman, Dell Rapids, Hartford, Canton, Parker, Lennox, Mitchell, Aberdeen, Mobridge, Brookings, Redfield, Dakota Dunes, Colman, Crooks, Watertown and Yankton.  The Bank also has a branch in Marshall, Minnesota, which serves customers located in southwestern Minnesota, and its banking center located in Dakota Dunes, South Dakota which serves customers located in northwestern Iowa.  The Bank’s immediate market area features a variety of agri-business, banking, financial services, health care and light manufacturing firms.  The internet branch allows access to customers nationwide.

 

Mid America Leasing provides services to customers primarily in a nine-state area in the upper Midwest, but originations can and have expanded nationwide.

 

HF Group provides services to customers in the seven-state region of South Dakota, Minnesota, Iowa, Nebraska, Missouri, Kansas and North Dakota.

 

Lending Activities

 

General.  The Bank originates a variety of loans including one- to four-family residential mortgages, commercial loans, agricultural loans, consumer loans for automobile purchases, home equity and home improvement loans and student loans.

 

One- to Four-Family Residential Mortgage Lending.  One-to four-family residential mortgage loan originations are primarily generated by the Bank’s marketing efforts, its present customers, walk-in customers and referrals from real estate brokers and builders.  The Bank has focused its lending efforts primarily on the origination of loans secured by first mortgages on owner-occupied, one- to four-family residences.

 

The Bank currently makes 10-, 15- and 30-year fixed- and adjustable-rate (“ARM”) one- to four-family residential mortgage loans in amounts up to 95.00% of the appraised value of the collateral property provided that private mortgage insurance is obtained in an amount sufficient to reduce the Bank’s exposure at or below the 80.00% level.  The Bank currently offers an ARM loan which has a fixed rate for the initial three to five years and converts to a one-year ARM loan for the remainder of the life of the loan.  The Bank also offers a one-year ARM loan with a rate below the Bank’s then current fixed-rate loan for a comparable 15- or 30-year term loan.  These loans provide for an annual cap and a lifetime cap at a set percent over the fully-indexed rate.

 

The Bank also offers a 30-year balloon loan, which is sold on the secondary market and has a fixed-rate for the first five or seven years of the loan term.  At the end of the five- or seven-year period, the loan converts to a 23- or 25-year fixed-rate loan at the then current market rate provided that the borrower qualifies at the new rate.  If the borrower fails to qualify at the new rate, the loan becomes payable in full.  The Bank also offers a portfolio five- and seven-year balloon loan that is underwritten to secondary market standards but is fully payable at the end of the balloon term.

 

To meet the needs of the Bank’s borrowers and financial needs of the communities it serves, the Bank has developed two distinct types of loan programs.  The Integrity Mortgage Program is a limited documentation program that is generally available to the upper credit customer.  The Olympic Plus Program is a program for individuals that do not meet secondary market standards but are eligible for Private Mortgage Insurance.  The program underwriting guidelines match those as established by the Private Mortgage Insurance Company.  Borrowers may choose from either an ARM or balloon product as a financing option.

 

The Bank also offers fixed-rate 15- through 30-year mortgage loans that conform to secondary market standards. Interest rates charged on these fixed-rate loans are competitively priced on a daily basis according to market conditions.  Residential loans generally do not include prepayment penalties.

 

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The Bank also originates fixed-rate one- to four-family residential mortgage loans through the South Dakota Housing Development Authority (“SDHDA”) program.  These loans generally have terms not to exceed 30 years and are either insured by the Federal Housing Administration (“FHA”), Veterans Administration (“VA”) or private mortgage insuror and must have no more than a 80.00% loan to value ratio.  The Bank receives an origination fee of 1.00% of the loan amount from the borrower and a servicing fee generally 0.38% from the SDHDA for these services.  The Bank is the largest servicer of loans for the SDHDA.  At June 30, 2004, the Bank serviced $416.1 million of mortgage loans for the SDHDA.  See Note 6 of “Notes to Consolidated Financial Statements” for information on loan servicing.

 

In underwriting one- to four-family residential mortgage loans, the Bank evaluates both the borrower’s ability to make monthly payments and the value of the property securing the loan.  The property that secures the real estate loans made by the Bank is appraised by an appraiser approved under the Bank’s appraisal policy.  The Bank requires borrowers to obtain title, fire and casualty insurance in an amount not less than the amount of the loan.  Real estate loans originated by the Bank contain a “due-on-sale” clause allowing the Bank to declare the unpaid principal balance due and payable upon the sale of the collateral property.

 

Commercial Business Lending.  In order to serve the needs of the local business community and improve the interest rate sensitivity and yield of its assets, the Bank originates adjustable- and fixed-rate commercial loans.  Interest rates on commercial business loans adjust or float with a designated national index plus a specified margin.  The Bank’s commercial business lending activities encompass loans with a variety of purposes and security, including loans to finance accounts receivable, inventory and equipment and business expansion within the Bank’s market area.  The Bank originates commercial business loans directly and through programs sponsored by the Small Business Administration (“SBA”) of which a portion of such loans are also guaranteed in part by the SBA.  The Bank generally originates commercial business loans for its portfolio and retains the servicing with respect to such loans.  In the future, the Bank anticipates continued expansion and emphasis of its commercial business lending, subject to market conditions and the Home Owners’ Loan Act (“the HOLA”) restrictions.    See “Regulation–Business Activities” for HOLA restrictions.

 

Commercial business loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.  As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself (which, in turn, may be dependent upon the general economic environment).  The Bank’s commercial business loans are sometimes secured by the assets of the business, such as accounts receivable, equipment and inventory.  However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.  Whenever possible, the Bank’s commercial business loans include personal guarantees of the borrowers.  In addition, the loan officer may, on occasion, perform on-site visits, obtain financial statements and perform a financial review of the loan.

 

Multi-Family and Commercial Real Estate Lending.  The Bank engages in multi-family and commercial real estate lending primarily in South Dakota and the adjoining Midwestern states.  These lending activities may include existing property or new construction development or purchased loans.

 

Loans secured by multi-family and commercial real estate properties are generally larger and involve a greater degree of credit risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family and commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy.  If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower’s ability to repay the loan may be impaired. In addition, loans secured by property outside of the Bank’s immediate market area may contain a higher degree of risk due to the fact that the Bank may not be as familiar with market conditions where such property is located.  The Bank does not have a material concentration of multi-family or commercial real estate loans outside of South Dakota and the adjoining Midwestern states.

 

The Bank presently originates adjustable-rate, short-term balloon payment, fixed-rate multi-family and commercial real estate loans.  The Bank’s multi-family and commercial real estate loan portfolio is secured primarily by apartment buildings and owner occupied and non-owner occupied commercial real estate.  The terms of such loans are negotiated on a case by case basis.  Commercial real estate loans generally have terms that do not exceed 25 years.  The

 

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Bank has a variety of rate adjustment features, call provisions and other terms in its multi-family and commercial real estate loan portfolio.  Generally, the loans are made in amounts up to 80.00% of the appraised value of the collateral property and with debt service coverage ratios of 115.00% or higher.  The debt service coverage is the ratio of net cash from operations before payment of debt service.  However, these percentages may vary depending on the type of security and the guarantor.  Such loans provide for a negotiated margin over a designated national index.  The Bank analyzes the financial condition of the borrower, the borrower’s credit history, the borrower’s prior record for producing sufficient income from similar loans, references and the reliability and predictability of the net income generated by the property securing the loan.  The Bank generally requires personal guarantees of borrowers.  Depending on the circumstances of the security of the loan or the relationship with the borrower, the Bank may decide to sell participations in the loan.  The sale of participation interests in a loan are necessitated by the amount of the loan or the limitation of Loans to One Borrower.  See “Regulation-Loans to One Borrower” for a discussion of the Loans to One Borrower rule.  In return for servicing these loans for the participants, the Bank generally receives a fee of 0.25% to 0.38%.  Also, income is received at loan closing from loan fees and discount points.  Appraisals on properties securing multi-family and commercial real estate loans originated by the Bank are performed by appraisers approved pursuant to the Bank’s appraisal policy.

 

The HOLA includes a provision that limits the Bank’s non-residential real estate lending to no more than four times its total capital.  This maximum limitation, which at June 30, 2004 was $293.5 million, has not materially limited the Bank’s lending practices.

 

Under HOLA, the maximum amount which the Bank may lend to any one borrower is 15.00% of the Bank’s unimpaired capital and surplus or $10.8 million at June 30, 2004.  Loans in an amount equal to an additional 10.00% of unimpaired capital and surplus may be made to the same borrower if such loans are fully secured by readily marketable collateral.  The Bank may request a waiver from the OTS to exceed the 15.00% Loans to One Borrower limitation on a case by case basis.  The Bank is in compliance with the Loans to One Borrower limitation and had no borrowers in excess of the Loans to One Borrower requirements at June 30, 2004.  See “Regulation-Loans to One Borrower” for a discussion of the Loans to One Borrower rule.

 

Construction and Development Lending.  The Bank makes construction loans to individuals for the construction of their residences as well as to builders and, to a lesser extent, developers for the construction of one- to four-family residences and condominiums and the development of one- to four-family lots in the Bank’s primary market area.

 

Construction loans to individuals for their residences are structured to be converted to permanent loans at the end of the construction phase, which typically runs six to 12 months.  These construction loans have rates and terms which match the one- to four-family permanent loans offered by the Bank.  Residential construction loans are generally underwritten pursuant to the same guidelines used for originating permanent residential loans.

 

The Bank also makes loans to developers for the purpose of developing one- to four-family lots.  These loans typically have terms of one year and carry floating interest rates based on a national designated index.  Loan commitment and partial release fees are charged.  These loans generally provide for the payment of interest and loan fees from loan proceeds.  The principal balance of these loans is typically paid down as lots are sold.  Builder construction and development loans are obtained principally through continued business from developers and builders who have previously borrowed from the Bank as well as broker referrals and direct solicitations of developers and builders.  The application process includes a submission to the Bank of plans, specifications and costs of the project to be constructed or developed.  These items are used as a basis to determine the appraised value of the subject property.  Loans are based on the lesser of current appraised value and/or the cost of construction (land plus building).

 

The Bank makes loans for the construction of multi-family residential properties.  Such loans are generally made at adjustable rates, which adjust periodically based on the appropriate Treasury Note maturity.

 

Construction loans are generally originated with a maximum loan-to-value ratio of 80.00% and land development loans are generally originated with a maximum loan-to-value ratio of 60.00%, based upon an independent appraisal.  Because of the uncertainties inherent in estimating development and construction costs and the market for the project upon completion, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of ultimate success of the project.  Construction and

 

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development loans to borrowers other than owner occupants also involve many of the same risks discussed above regarding multi-family and commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans.

 

Prior to making a commitment to fund a construction loan, the Bank requires an appraisal of the property, or, for larger projects, both an appraisal and a study of the feasibility of the proposed project.  The Bank’s construction loan policy provides for the inspection of properties by independent in-house and outside inspectors at the commencement of construction and prior to disbursement of funds during the term of the construction loan.

 

Consumer Lending.  The Bank’s management considers its consumer loan products to be an important component of its lending strategy.  Specifically, consumer loans generally have shorter terms to maturity and carry higher rates of interest than do one-to four-family residential mortgage loans.  In addition, the Bank’s management believes that the offering of consumer loan products helps to expand and create stronger ties to its existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities.

 

The Bank currently purchases automobile conditional sales contracts from selected dealers within its market area as well as originating automobile loans directly.  The growth in indirect lending has provided securitization opportunities in the capital markets.  On January 31, 2003, the Bank sold approximately $40.1 million principal of indirect and $9.9 million principal of direct automobile receivables in a securitization transaction.  The proceeds were used in part to continue to service the demand of the Bank’s dealer network.  The securitization is a source of funds at a rate lower than other sources of funds, and it reduces the Bank’s capital requirements and credit risk to the Bank from the loans sold.  See Note 3 of  “Notes to Consolidated Financial Statements” for details on the consumer automobile loan securitization.

 

Loans secured by second mortgages, together with loans secured by all prior liens, are limited to 100.00% or less of the appraised value of the property securing the loan and generally have maximum terms that do not exceed 10 to 15 years.

 

The student loans originated by the Bank are guaranteed as to principal and interest by the South Dakota Education Assistance Corporation.  The Bank sells such student loans with servicing rights released approximately 120 days after funds have been disbursed to the student.

 

Consumer loan terms vary according to the type of collateral, length of contract and creditworthiness of the borrower.  The Bank offers both open- and closed-end credit.  Overdraft lending is extended through lines of credit that are tied to a checking account.  The credit lines generally bear interest at 18.00% and are generally limited to no more than $2,000.  Loans secured by deposit accounts at the Bank are currently originated for up to 90.00% of the account balance (although historically the Bank has loaned up to 100.00% of the account balance), with a hold placed on the account restricting the withdrawal of the account balance.  The interest rate on such loans is typically equal to 2.00% above the contract rate.

 

The underwriting standards employed by the Bank for consumer loans, including mobile home loans, include an application, a determination of the applicant’s payment history on other debts, and an assessment of the ability to meet existing obligations and payments on the proposed loan.  Although creditworthiness of the applicant is a primary consideration, 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 credit risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as mobile homes, automobiles or boats.  In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.  In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

 

Agricultural Loans.  In order to serve the needs of the local business community and improve the interest rate sensitivity and yield of its assets, the Bank originates agricultural loans through its agricultural division.  The

 

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agricultural division offers loans to its customers such as: (1) operating loans which are used to fund operating expenses which typically have a one year term and are indexed to the national prime rate; (2) term loans on machinery, equipment and breeding stock that may have a term up to seven years and require annual payments; (3) agricultural farmland term loans which are used to fund land purchases or refinances; (4) specialized livestock loans to fund facilities and equipment for confinement enterprises; and (5) loans to fund ethanol plant development.  Agriculture real estate loans typically will have personal guarantees of the borrowers, a first lien on the real estate, interest rates adjustable to the national prime rate or Treasury Note rates, and annual, quarterly or monthly payments.  Operating and term loans are secured by farm chattels (crops, livestock, machinery, etc.), which are the operating assets of the borrower.  The Bank also originates agricultural loans directly and through programs sponsored by the Farmers Service Agency (“FSA”) of which a portion of such loans are also guaranteed in part by the FSA.

 

Loan customers are required to supply current financial statements, tax returns for the past three to five years, and cash flow projections which are updated on an annual basis.  In addition, on major loans, the loan officer will perform an annual farm visit, obtain financial statements and perform a financial review of the loan.

 

Leasing Activities

 

General. Through its wholly-owned subsidiary, Mid America Leasing, the Bank originates commercial and municipal leases.  These products have a fixed interest rate for the duration of the lease with terms typically ranging from 24 – 60 months.  The leases generally are 100.00% financed with usually only the first or first and last months’ payments due at lease inception.  As a result of the 100.00% financing and fixed interest rate, the yield on leases is higher than similar type lending products.

 

Leases are originated generally in a nine-state area in the upper Midwest.  All leases are secured by the equipment leased, with personal guarantees of the borrowers normally obtained on commercial leases.

 

Commercial Leases.   In order to support the Bank and its customers and to improve the yield of its assets,  Mid America Leasing originates commercial leases to customers primarily in the upper Midwest.  The Bank offers three types of commercial leases: capital, tax and Terminal Rental Adjustment Clause leases (“TRAC”).  TRAC leases are generally for medium- to heavy-duty titled equipment, such as semi-tractors and trailers and medium- to heavy-duty trucks.  Leases may be structured with a contracted residual of as little as $1.00 up to 20.00-25.00% of the equipment cost.  Leases encompass a wide variety of equipment for a variety of commercial uses.   The customer base tends to be small- to medium-sized businesses that view leasing as another financing option that augments their overall operation.  Repayment terms tend to be monthly in nature.

 

As with commercial loans, commercial leases typically are made on the basis of the borrower’s ability to make repayment from the cash flow of their business.  As a result, the availability of funds for the repayment of commercial leases may be substantially dependent on the success of the business itself.  The collateral securing the leases will generally depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

 

Municipal Leases.   The Bank also originates leases to municipal entities such as cities, counties, and public schools.  The lessee must be a political subdivision of the state in order to qualify as a municipal lease.   Because the interest income earned on this type of lease is exempt from federal income taxes, the rate offered to the municipality is usually substantially lower than a comparable commercial lease.  Repayment terms generally are on a monthly, semi-annual or annual basis.  Residuals are $1.00 for municipal leases.

 

Repayment is based on the municipality’s ability to levy and collect taxes.  Assuming the municipality has a bond rating, that bond rating, together with audited financial statements are the basis for the lease.  On larger leases, bond ratings and financial statements will be reviewed annually.

 

8

 

Loan and Lease Portfolio Composition.  The following table sets forth information concerning the composition of the Company’s loan and lease portfolio from continuing operations in dollar amounts and in percentages (before deductions for the undisbursed portion of loans in process, deferred fees and discounts and allowance for losses) as of the dates indicated.  Balances related to discontinued credit card loan operations have been eliminated for all periods presented.

 

		At June 30,
		2004					2003					2002					2001					2000
		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total
		(Dollars In Thousands)
Real Estate Loans:
One- to four-family (1)		$	104,492		15.80	%	$	100,065		16.18	%	$	79,074		13.78	%	$	124,951		21.71	%	$	134,014		23.62	%
Multi-family		42,721			6.46		49,364			7.98		56,952			9.92		44,378			7.71		44,793			7.89
Commercial		89,538			13.54		93,405			15.10		89,111			15.53		73,720			12.81		68,556			12.08
Agricultural		20,449			3.09		18,002			2.91		12,722			2.22		12,753			2.21		11,669			2.06
Construction and development		15,044			2.28		9,083			1.47		12,738			2.22		28,419			4.94		35,511			6.26
Total real estate loans		272,244			41.17		269,919			43.64		250,597			43.67		284,221			49.38		294,543			51.91
Other Loans and Leases:
Consumer Loans:
Mobile home		848			0.13		1,468			0.24		2,365			0.41		3,920			0.68		5,676			1.00
Automobiles		101,669			15.38		74,066			11.98		84,782			14.77		78,082			13.57		81,092			14.29
Deposit account		1,489			0.22		1,463			0.24		1,597			0.28		1,917			0.33		2,360			0.42
Student (2)		324			0.05		7,745			1.25		7,340			1.28		6,831			1.19		7,146			1.26
Junior liens on mortgages		85,684			12.96		81,064			13.11		73,680			12.84		61,397			10.67		56,243			9.91
Other		4,900			0.74		6,035			0.98		8,529			1.49		10,939			1.90		11,570			2.04
Total consumer loans		194,914			29.48		171,841			27.80		178,293			31.07		163,086			28.34		164,087			28.92
Commercial business		124,158			18.78		113,570			18.36		95,462			16.63		97,362			16.92		87,137			15.36
Equipment finance leases		26,942			4.07		23,016			3.72		22,834			3.98		10,509			1.82		—			0.00
Agricultural		42,953			6.50		40,109			6.48		26,707			4.65		20,370			3.54		21,597			3.81
Total other loans and leases		388,967			58.83		348,536			56.36		323,296			56.33		291,327			50.62		272,821			48.09
Total gross loans and leases		$	661,211		100.00	%	$	618,455		100.00	%	$	573,893		100.00	%	$	575,548		100.00	%	$	567,364		100.00	%
Less:
Undisbursed portion of loans in process		(7,338		)			(3,576		)			(4,678		)			(3,853		)			(17,374		)
Deferred fees and discounts		1,029					364					504					(133		)			(356		)
Allowance for losses		(3,605		)			(3,842		)			(4,461		)			(5,509		)			(5,499		)
Total loans and leases receivable, net		$	651,297				$	611,401				$	565,258				$	566,053				$	544,135

 

(1)          Includes one- to four-family loans held for sale.

(2)          Includes student loans held for sale.

 

9

 

The following table sets forth the composition of the Company’s loan and lease portfolio from continuing operations by fixed- and adjustable-rate in dollar amounts and in percentages (before deductions for the undisbursed portion of loans in process, deferred fees and discounts and allowance for losses) as of the dates indicated.  Balances related to discontinued credit card loan operations have been eliminated for all periods presented.

 

		At June 30,
		2004					2003					2002					2001					2000
		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total
		(Dollars In Thousands)
Fixed-Rate Loans and Leases:
Real Estate:
One- to four-family (1)		$	70,895		10.72	%	$	72,472		11.72	%	$	45,804		7.98	%	$	78,350		13.61	%	$	84,478		14.89	%
Multi-family, commercial & construction		44,065			6.66		41,231			6.67		44,842			7.81		39,752			6.91		36,552			6.44
Agricultural		2,609			0.39		4,760			0.77		1,305			0.23		3,433			0.60		2,843			0.50
Total real estate loans		117,569			17.77		118,463			19.16		91,951			16.02		121,535			21.12		123,873			21.83
Consumer (2)		133,012			20.12		110,037			17.79		127,488			22.21		125,955			21.88		130,770			23.05
Agricultural		3,905			0.59		5,285			0.85		5,596			0.98		6,007			1.04		7,632			1.35
Equipment finance leases		26,942			4.07		23,016			3.72		22,834			3.98		10,509			1.82		—			0.00
Commercial business		26,631			4.03		23,839			3.85		21,463			3.74		25,983			4.52		25,474			4.49
Total fixed-rate loans and leases		308,059			46.58		280,640			45.37		269,332			46.93		289,989			50.38		287,749			50.72
Adjustable-Rate Loans:
Real estate:
One- to four-family(1)		33,597			5.08		27,593			4.46		33,270			5.80		46,601			8.10		49,536			8.73
Multi-family, commercial & construction		103,238			15.61		110,621			17.89		113,959			19.86		106,765			18.55		112,308			19.80
Agricultural		17,840			2.70		13,242			2.14		11,417			1.99		9,320			1.62		9,558			1.68
Total real estate loans		154,675			23.39		151,456			24.49		158,646			27.65		162,686			28.27		171,402			30.21
Consumer (2) (3)		61,902			9.37		61,804			10.00		50,805			8.85		37,131			6.45		33,317			5.87
Agricultural		39,048			5.91		34,824			5.63		21,111			3.68		14,363			2.50		13,233			2.33
Commercial business		97,527			14.75		89,731			14.51		73,999			12.89		71,379			12.40		61,663			10.87
Total adjustable-rate loans		353,152			53.42		337,815			54.63		304,561			53.07		285,559			49.62		279,615			49.28
Total loans and leases		$	661,211		100.00	%	$	618,455		100.00	%	$	573,893		100.00	%	$	575,548		100.00	%	$	567,364		100.00	%
Less:
Undisbursed portion of loans in process		(7,338		)			(3,576		)			(4,678		)			(3,853		)			(17,374		)
Deferred fees and discounts		1,029					364					504					(133		)			(356		)
Allowance for loan losses		(3,605		)			(3,842		)			(4,461		)			(5,509		)			(5,499		)
Total loans and leases receivable, net		$	651,297				$	611,401				$	565,258				$	566,053				$	544,135

 

(1)          Includes one- to four-family loans held for sale.

(2)          Includes mobile home loans

(3)          Includes student loans held for sale

 

10

 

The following schedule illustrates the scheduled principal contractual repayments of the Company’s loan and lease portfolio from continuing operations at June 30, 2004.  Mortgages which have adjustable or renegotiable interest rates are shown as maturing at the contractual maturity date.  The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.

 

		Real Estate															Non-Real Estate
		One- to Four- Family (1)			Multi- Family			Commercial			Agricultural			Construction & Development			Consumer (2)			Commercial Business (3)			Agricultural			Total
		(Dollars in Thousands)
Due in 1 year or less		$	3,721		$	2,675		$	7,534		$	1,151		$	7,349		$	51,147		$	81,213		$	29,018		$	183,808
After 1 to 5 years		16,961			12,403			34,589			5,379			7,695			143,767			61,366			12,452			294,612
Greater than 5 years		83,810			27,643			47,415			13,919			—			—			8,521			1,483			182,791
Total		$	104,492		$	42,721		$	89,538		$	20,449		$	15,044		$	194,914		$	151,100		$	42,953		$	661,211

 

(1) Includes one- to four-family loans held for sale.

(2) Includes demand loans, loans having no stated maturity, student loans held for sale and overdraft loans.

(3) Includes equipment finance leases.

 

The total amount of loans due after June 30, 2005 which have predetermined interest rates is $249.3 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $228.1 million.

 

Scheduled contractual principal repayments of loans do not reflect the actual life of such assets.  The average life of loans is substantially less than their average contractual terms because of prepayments.  In addition, due-on-sale clauses on loans generally give the Bank the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid.  The average life of mortgage loans tends to increase when current mortgage loan rates are substantially higher than rates on existing mortgage loans and decrease when rates on existing mortgages are substantially higher than current mortgage loan rates.  One- to four-family residential mortgage loans have prepaid significantly and refinanced at lower rates due to the effect of lower mortgage rates during the last year.

 

11

 

Potential Problem Loans

 

Nonperforming Assets.  See “Asset Quality” under Management’s Discussion and Analysis for discussion.

 

Classified Assets.  Federal regulations provide for the classification of loans, leases and other assets, such as debt and equity securities considered by the OTS to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  “Substandard” assets include those characterized by the “distinct possibility” that the Company will sustain “some loss” if the deficiencies are not corrected.  Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.”  Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.  Assets which do not currently expose the Company to sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses, are required to be designated “criticized” or “special mention” by management.

 

When the Company classifies problem assets as “loss, “ it is required either to establish a specific allowance for losses equal to 100.00% of that portion of the asset so classified or to charge-off such amount.  The Company’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the Bank’s Regional Director at the regional OTS office, who may order the establishment of additional general or specific loss allowances.

 

In connection with the filing of its periodic reports with the OTS and in accordance with its classification of assets policy, the Company regularly reviews problem loans and leases in its portfolio to determine whether any loans or leases require classification in accordance with applicable regulations.  On the basis of management’s monthly review of its assets, at June 30, 2004, the Company had designated $15.2 million of its assets as special mention and $3.9 million of its assets as classified.  Other potential problem loans are included in criticized and classified assets.  See “Asset Quality” under Management’s Discussion and Analysis for further discussion.

 

Allowance for Loan and Lease Losses. See “Application of Critical Accounting Policies” and “Asset Quality” under Management’s Discussion and Analysis for discussion.

 

12

 

Investment Activities

 

The Bank is required under OTS regulation to maintain a sufficient amount of liquid assets.  Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans.  Historically, the Bank has maintained its liquid assets above the minimum requirements imposed by the OTS regulations and at a level believed by management adequate to meet requirements of normal daily activities, repayment of maturing debt and potential deposit outflows.  As of June 30, 2004, the Bank’s liquidity ratio (liquid assets as a percentage of net withdrawable savings deposits and current borrowings) was 4.28%. See “Regulation-Liquidity.”

 

Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds.  Subject to various restrictions, federally chartered savings institutions may also invest their assets in commercial paper, investment grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly.

 

Generally, the investment policy of the Bank is to invest funds among various categories of investments and maturities based upon the Bank’s asset/liability management policies, investment quality and marketability, liquidity needs and performance objectives.

 

At June 30, 2004, the Company’s investments in mortgage-backed securities totaled $105.0 million, or 12.4% of its total assets. As of such date, the Bank also had a $5.5 million investment in the stock of the Federal Home Loan Bank of Des Moines (“FHLB” or “FHLB of Des Moines”) in order to satisfy the FHLB of Des Moines’ requirement for membership.

 

The composition and maturities of the investment securities portfolio, excluding equity securities, are indicated in the following table.

 

		At June 30, 2004
		Less Than 1 Year					1 to 5 Years					5 to 10 Years					Over 10 Years					Total Investment Securities
		Amortized Cost			Weighted Average Yield		Amortized Cost			Weighted Average Yield		Amortized Cost			Weighted Average Yield		Amortized Cost			Weighted Average Yield		Amortized Cost			Fair Value
		(Dollars in Thousands)
U.S. government agencies & corporations		$	—		—		$	2,999		2.76	%	$	—		—		$	—		—		$	2,999		$	2,985
Federal Home Loan Bank		1,000			7.00	%	—			—		—			—		—			—		1,000			1,030
Municipal bonds		2,049			2.41	%	2,569			2.21	%	—			—		—			—		4,618			4,613
Preferred term securities		—			—		—			—		—			—		9,000			2.91	%	9,000			9,034
Mortgage-backed securities		113			6.14	%	49			7.03	%	9,818			4.62	%	97,287			4.05	%	107,267			105,015
Total investment securities		$	3,162				$	5,617				$	9,818				$	106,287				$	124,884		$	122,677

 

The Company’s investment securities portfolio did not contain non-investment grade bonds (i.e., “junk bonds”) or other corporate debt securities.

 

The Bank’s investment security portfolio is managed in accordance with a written investment policy adopted by the Board of Directors.  Investments may be made by the Bank’s officers within specified limits and approved in advance by the Board of Directors for transactions over these limits.  At the present time, the Bank does not have any investments that are held for trading purposes.  At June 30, 2004, the Company had $122.7 million of securities available for sale, including mortgage-backed securities of $105.0 million.  See Note 4 of “Notes to Consolidated Financial Statements” for further information on the Company’s investment portfolio.

 

13

 

Sources of Funds

 

General.  The Company’s primary sources of funds are earnings, in-market deposits, FHLB advances and other borrowings, amortization and repayments of loan principal, mortgage-backed securities and callable agency securities.  Secondary sources include sales of mortgage loans, sales and/or maturities of securities, mortgage-backed securities, out-of-market deposits and short-term investments.

 

Borrowings of the Bank are primarily from the FHLB of Des Moines, and may be used on a short-term basis to compensate for seasonal reductions in deposits or deposit inflows at less than projected levels, and may be used on a longer-term basis to support expanded lending activities.  The Bank has established collateral at the Federal Reserve Bank as a contingent source of funding.  The availability of funds from loan sales is influenced by general interest rates.  See Note 9 of the “Notes to Consolidated Financial Statements” for further detail of the Company’s borrowings.

 

Deposits.  The Bank offers a variety of deposit accounts having a wide range of interest rates and terms.  The Bank’s deposits consist of statement savings accounts, checking accounts, money market and certificate accounts ranging in terms from 30 days to five years.  The Bank primarily solicits deposits from its market area.  The Bank relies primarily on customer service, competitive pricing policies and advertising to attract and retain these deposits.  Based on liquidity needs, the Bank may, from time to time, acquire out-of-market deposits.

 

The flow of deposits is influenced by general economic conditions, changes in money market and prevailing interest rates and competition.

 

The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand.  In recent years, the Bank has become more susceptible to short-term fluctuations in deposit flows as customers have become more interest rate conscious.  The Bank manages the pricing of its deposits in keeping with its asset/liability management and profitability objectives.  Based on its experience, the Bank believes that its statement savings, money market, and checking accounts are stable sources of deposits.  However, the ability of the Bank to attract and maintain certificates of deposit, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions.

 

14

 

The following table sets forth the dollar amount of deposits in the various types of deposit accounts offered by the Bank as of the dates indicated.

 

		At June 30,
		2004					2003					2002
		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total
		(Dollars in Thousands)
Transaction Accounts:
Noninterest bearing accounts		$	75,251		11.42	%	$	77,004		12.39	%	$	61,355		10.91	%
Interest bearing accounts weighted average rates of 0.18%, 0.16%, and 0.39% at June 30, 2004, 2003 and 2002		45,738			6.95		43,699			7.03		41,669			7.41
Savings accounts weighted average rates of 0.72%, 0.68% and  1.13% at June 30, 2004, 2003 and 2002		63,670			9.67		54,462			8.77		50,387			8.95
Money market accounts(1) weighted average rates of 1.40%, 1.41% and 1.80% at June 30, 2004, 2003 and 2002		211,928			32.17		178,113			28.66		157,770			28.04
Total transaction accounts		396,587			60.21		353,278			56.85		311,181			55.31
In-Market Certificates of Deposit:
0.00 - 3.99%		206,552			31.36		174,662			28.11		136,062			24.96
4.00 - 4.99%		16,102			2.44		21,112			3.40		29,089			5.17
5.00 - 5.99%		10,312			1.57		17,711			2.85		29,752			5.29
6.00 - 6.99%		12,335			1.87		18,040			2.90		34,167			6.07
7.00 - 7.99%		1,006			0.15		985			0.16		17,979			3.20
Total in-market certificates of deposit		246,307			37.39		232,510			37.42		247,049			44.69
Out-of-market certificates of deposit weighted average rate of 2.23%, 2.11% and 2.90% at June 30, 2004, 2003 and 2002		15,825			2.40		35,593			5.73		4,366			—
Total certificates of deposit		262,132			39.79		268,103			43.15		251,415			44.69
Total deposits		$	658,719		100.00	%	$	621,381		100.00	%	$	562,596		100.00	%

 

(1) Includes out-of-market money market accounts in the amount of $18.4 million, $14.1 million and $0 for 2004, 2003 and 2002, respectively.

 

15

 

The following table sets forth the amount of the Company’s certificates of deposit and other deposits by time remaining until maturity as of June 30, 2004.

 

		Maturity
		3 Months or Less			3 to 6 Months			6 to 12 Months			Over 12 Months			Total
		(Dollars in Thousands)
Certificates of deposit less than $100,000		$	28,350		$	29,134		$	45,780		$	77,327		$	180,591
Certificates of deposit of $100,000 or more		5,763			6,415			12,794			13,751			38,723
Out-of-market certificates of deposit (1) (2)		1,677			2,640			5,127			6,381			15,825
Public funds (3) (4)		5,190			12,491			7,358			1,954			26,993
Total certificates of deposit		$	40,980		$	50,680		$	71,059		$	99,413		$	262,132

 

(1)          Includes funds from the Certificate of Deposit Account Registry Service (“CDARS”) certificate of deposit program of $3,668.

(2)          Includes certificates of deposit of $100,000 or greater of $1,352.

(3)          Includes certificates of deposit from governmental and other public entities, excluding out-of-market certificates of deposit.

(4)          Includes certificates of deposit of $100,000 or greater of $25,260.

 

The Bank solicits certificates of deposit of $100,000 or greater from various state, county and local government units which carry rates which are negotiated at the time of deposit.  See Note 8 of “Notes to Consolidated Financial Statements.”  Deposits at June 30, 2004 and 2003 included $53.0 million and $42.4 million, respectively, of deposits from one local governmental entity, the majority of which are savings accounts.

 

Borrowings.  Although deposits are the Bank’s primary source of funds, the Bank’s policy has been to utilize borrowings when they are a less costly source of funds or can be invested at a positive rate of return.

 

The Bank’s borrowings consist primarily of advances from the FHLB of Des Moines upon the security of its capital stock of the FHLB of Des Moines and certain pledgable loans, including but not limited to, its mortgage related loans, mortgage-backed securities and U.S. Government and other agency securities.  Such advances can be made pursuant to several different credit programs, each of which has its own interest rate and range of maturities.  At June 30, 2004, the Bank’s FHLB advances totaled $93.0 million, representing 11.69% of total Company liabilities.  See Note 9 of  “Notes to Consolidated Financial Statements” for further detail of the Company’s borrowings.

 

16

 

The following table sets forth the maximum month-end balances and average balances of FHLB and FRB advances and other borrowings at the dates indicated.

 

 

The following table sets forth certain information as to the Bank’s FHLB and FRB advances and other borrowings of the Company at the dates indicated.

 

 

Trust Preferred Securities.  Through an unconsolidated trust subsidiary, the Company issued trust preferred securities during fiscal 2004 in order to provide funding to purchase treasury stock and repay other borrowings.  See Note 10 of  “Notes to Consolidated Financial Statements”.

 

Consumer Automobile Loan Securitization.  The growth in indirect lending is providing securitization opportunities in the capital markets.  On January 31, 2003, the Bank sold approximately $40.1 million principal of indirect and $9.9 million principal of direct automobile receivables in a securitization transaction.  See Note 3 of  “Notes to Consolidated Financial Statements” for details on the consumer automobile loan securitization.

 

Competition

 

The Bank faces strong competition, both in originating real estate, commercial and consumer loans and in attracting deposits. Competition in originating real estate loans comes primarily from other commercial banks, credit unions and mortgage bankers making loans secured by real estate located in the Bank’s market areas. Commercial banks and finance companies provide vigorous competition in consumer lending.  The Bank competes for real estate and other loans principally on the basis of the quality of services it provides to borrowers, interest rates and loan fees it charges and the types of loans it originates.

 

The Bank attracts the majority of its deposits through its retail banking offices, primarily from the communities in which those retail banking offices are located; As such, competition for those deposits is principally from other commercial banks and credit unions located in the same communities.  The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours, and convenient branch locations with interbranch deposit and withdrawal privileges at each.

 

Employees

 

At June 30, 2004, the Bank had a total of 306 full-time equivalent employees (“FTEs”) including nine FTEs of the Bank’s service corporations.  The Bank’s employees are not represented by any collective bargaining group.  Management considers its relations with its employees to be good.

 

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Regulation

 

General.  The Bank is a federally chartered thrift institution, the deposits of which are federally insured by the SAIF of the FDIC.  Accordingly, the Bank is subject to broad federal regulation and oversight extending to all its operations, by its primary federal regulator, the OTS.  The Bank is a member of the FHLB of Des Moines and is subject to certain limited regulation by the Federal Reserve Board (the “FRB”).  As the unitary thrift holding company of the Bank, the Company also is subject to federal regulation and oversight by the OTS.  The purpose of the regulation of the Company and other holding companies is to protect subsidiary savings associations where deposits are federally insured.

 

Certain of these regulatory requirements and restrictions are discussed below or elsewhere in this document.  The following discussion is intended to be a summary of the material statutes, regulations and policies applicable to savings associations and their holding companies, and it does not purport to be a complete discussion of all such statutes, regulations and policies.

 

Regulation of Federal Savings Associations.  The OTS has extensive authority over the operations of federal savings associations, such as the Bank.  Pursuant to this authority, the Bank is required to file periodic reports with the OTS and is subject to periodic examinations primarily by the OTS and to a lesser extent by the FDIC.  The last examination of the Bank by the OTS concluded on February 16, 2004.  Examiners may require a federal savings association to provide for higher general or specific loan loss-reserves.

 

Assessments.  The OTS has established a schedule for the assessment of fees upon all savings associations to fund the operations of the OTS.  The general assessment, paid on a semiannual basis, is computed by totaling three components: the size of the association on which the basic assessment is based; the association’s supervisory condition, which would result in an additional assessment based on a percentage of the basic assessment for any savings institution with a composite rating of 3, 4 or 5 in its most recent safety and soundness examination; and the complexity of the association’s operations, which would result in an additional assessment based on a percentage of the basic assessment for any savings association that managed over $1.0 billion in trust assets, serviced for others loans aggregating more than $1.0 billion, or had certain off-balance sheet assets aggregating more than $1.0 billion.  The Bank’s OTS assessment (standard assessment) for the fiscal year ended June 30, 2004 was approximately $164,000.

 

Enforcement.  Under the Federal Deposit Insurance Act (the “FDI Act”), the OTS has primary enforcement responsibility over savings associations and has the authority to bring enforcement action against all “institution-affiliated parties,” including any controlling stockholder or any stockholder, attorney, appraiser or accountant who knowingly or recklessly participates in any violation of applicable law or regulation or breach of fiduciary duty or certain other wrongful actions that causes or is likely to cause more than a minimal loss or other significant adverse effect on an insured savings association.  Civil penalties cover a wide range of violations and actions and range from $5,000 for each day during which violations of law, regulations, orders and certain written agreements and conditions continue, to up to $1.0 million per day for such violations if the person obtained a substantial pecuniary gain as a result of such violation or knowingly or recklessly caused a substantial loss to the institution.  Criminal penalties for certain financial institution crimes include fines of up to $1.0 million and imprisonment for up to 30 years.  In addition, regulators have substantial discretion to take enforcement action against an institution that fails to comply with its regulatory requirements, particularly with respect to its capital requirements.  Possible enforcement actions range from the imposition of a capital plan and capital directive to receivership, conservatorship or the termination of deposit insurance.  Under the FDI Act, the FDIC has the authority to recommend to the Director of the OTS that enforcement action be taken with respect to a particular savings association.  If action is not taken by the Director of the OTS, the FDIC has authority to take such action under certain circumstances.

 

Safety and Soundness Standards.  Pursuant to the FDI Act, as amended by the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), and the Riegle Community Development and Regulatory Improvement Act of 1994, the OTS and the federal bank regulatory agencies adopted a set of guidelines prescribing safety and soundness standards pursuant to FDICIA, as amended.  The guidelines establish general standards relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings and compensation, fees and benefits.  In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the

 

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guidelines.  The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal stockholder.  In addition, the OTS adopted regulations that authorize, but do not require, the OTS to order an institution that has been given notice by the OTS that it is not satisfying any of such safety and soundness standards to submit a compliance plan.  If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the OTS must issue an order directing action to correct the deficiency and may issue an order directing corrective actions and other actions of the types to which an undercapitalized association is subject under the “prompt corrective action” provisions of FDICIA.  If an institution fails to comply with such an order, the OTS may seek to enforce such order in judicial proceedings and to impose civil money penalties.

 

Prompt Corrective Action Standards.  The OTS and the FDIC are authorized and, under certain circumstances, required to take certain actions against any association that fails to meet its capital requirements.  For this purpose, a savings bank is placed in one of the following four categories based on the associations capital:  (a) well-capitalized, (b) adequately capitalized, (c) undercapitalized or (d) critically undercapitalized.  The OTS is generally required to take action to restrict the activities of an “undercapitalized association” (generally defined to be one with less than a 4.00% core ratio or Tier 1 risked-based capital ratio or less than an 8.00% risk-based capital ratio).  Any such association must submit a capital restoration plan and until such plan is approved by the OTS may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions.  The OTS is authorized to impose the additional restrictions discussed below that are applicable to significantly undercapitalized associations.

 

As a condition to the approval of the capital restoration plan, any company controlling an undercapitalized association must agree that it will enter into a limited capital maintenance guarantee with respect to the institution’s achievement of its capital requirements.

 

Any savings association that fails to comply with its capital plan or is “significantly undercapitalized” (i.e., Tier 1 risk-based or core capital ratios of less than 3.00% or a risk-based capital ratio of less than 6.00%) must be subject to one or more of the additional specified actions and operating restrictions mandated by FDICIA.  These actions and restrictions include requiring the issuance of additional voting securities, limitations on asset growth, mandated asset reduction, changes in senior management, divestiture, merger or acquisition of the association, restrictions on executive compensation and any other action the OTS deems appropriate.

 

An association that becomes “critically undercapitalized” (i.e., a tangible capital ratio of 2.00% or less) is subject to further restrictions on its activities in addition to those applicable to significantly undercapitalized associations.  The FDIC must restrict the activities of a critically undercapitalized association and, among other things, prohibit any material transaction outside the ordinary course of business or engaging in certain transactions with affiliates, without the approval of the FDIC.  The OTS must appoint a receiver (or conservator with the concurrence of the FDIC) for a savings association, with certain limited exceptions, within 90 days after it becomes critically undercapitalized.

 

Any undercapitalized association is also subject to other possible enforcement actions by the OTS or the FDIC.  Such actions could include a capital directive, a cease-and-desist order, civil money penalties, the establishment of restrictions on all aspects of the association’s operations or the appointment of a receiver or conservator or a forced merger into another institution.  The grounds for appointment of a conservator or receiver include substantially insufficient capital and losses or likely losses that will deplete substantially all capital with no reasonable prospect for replenishment of capital without federal assistance.

 

If the OTS determines that an association is in an unsafe or unsound condition or is engaged in an unsafe or unsound practice it is authorized to reclassify a well-capitalized association as an adequately capitalized association and if the association is adequately capitalized, to impose the restrictions applicable to an undercapitalized association.

 

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The imposition by the OTS or the FDIC of any of these measures on the Bank may have a substantial adverse effect on the Bank’s and the Company’s operations and profitability and the value of the Company’s Common Stock.  The Company’s stockholders do not have preemptive rights, and therefore, if the Company is directed by the OTS or the FDIC to issue additional shares of Common Stock, such issuance may result in the dilution in the percentage of ownership of the Company of those persons owning shares of the Company’s Common Stock.

 

At June 30, 2004, the Bank met the criteria for being well-capitalized.

 

Business Activities.  The Bank derives its lending and investment powers from the HOLA, and the regulations of the OTS thereunder.  Under these laws and regulations, the Bank may invest in mortgage loans secured by residential and commercial real estate, commercial and consumer loans, certain types of debt securities and certain other assets.  The Bank may also establish service corporations that may engage in activities not otherwise permissible for the Bank, including certain real estate equity investments and securities and insurance brokerage.  These investment powers are subject to various limitations, including (a) a prohibition against the acquisition of any corporate debt security that is not rated in one of the four highest rating categories; (b) a limit of 400.00% of an association’s capital on the aggregate amount of loans secured by non-residential real estate property; (c) a limit of 20.00% of an association’s assets on the aggregate amount of commercial and agricultural loans and leases with the amount of commercial loans in excess of 10.00% of assets being limited to small business loans; (d) a limit of 35.00% of an association’s assets on the aggregate amount of consumer loans and acquisitions of certain debt securities; (e) a limit of 5.00% of assets on non-conforming loans (loans in excess of the specific limitations of the HOLA); and (f) a limit of the greater of 5.00% of assets or an association’s capital on certain construction loans made for the purpose of financing what is or is expected to become residential property.  In addition, the HOLA and the OTS regulations provide that a federal savings association may invest up to 10.00% of its assets in tangible personal property for leasing purposes.  Such general leases, however, do not have to be aggregated with the institution’s loans for purposes of the HOLA’s investment and lending limitations.  During the fiscal year ended June 30, 2004, the Bank reclassified certain loans into other HOLA categories allowed by the regulations.  The result of the reclassification allowed the Bank to meet the 20.00% limitation with 16.39% of total Bank assets at June 30, 2004.

 

Loans to One Borrower.  Under the HOLA, savings associations are generally subject to the same limits on Loans to One Borrower as are imposed on national banks.  Generally, under these limits, a savings association may not make a loan or extend credit to a single or related group of borrowers in excess of 15.00% of the association’s unimpaired capital and surplus.  Additional amounts may be loaned, not in excess of 10.00% of unimpaired capital and surplus, if such loans or extensions of credit are fully secured by readily-marketable collateral.  Such collateral is defined to include certain debt and equity securities and bullion, but generally does not include real estate.  The Bank may request a waiver from the OTS to exceed the 15.00% Loans to One Borrower limitation on a case by case basis.  At June 30, 2004, the Bank’s lending limit under this restriction was $10.8 million.  The Bank is in compliance with the Loans to One Borrower limitation and had no borrowers in excess of the Loans to One Borrower requirements at June 30, 2004.

 

Insurance of Accounts and Regulation by the FDIC.  The Bank is a member of the SAIF, which is administered by the FDIC.  Savings deposits are insured up to $100,000 per insured member (as defined by law and regulation) by the FDIC and such insurance is backed by the full faith and credit of the United States Government.  As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions.  It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the FDIC.  The FDIC also has the authority to initiate enforcement actions against savings associations, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged or is engaging in unsafe or unsound practices, or is in an unsafe or unsound condition.

 

Pursuant to FDICIA, the FDIC established a risk based assessment system for determining the deposit insurance assessments to be paid by insured depositary institutions.  Under the assessment system, the FDIC assigns an institution to one of three capital categories based on the institution’s financial information as of its most recent quarterly financial report filed with the applicable bank regulatory agency prior to commencement of the assessment period.  The three capital categories consist of (a) well-capitalized, (b) adequately capitalized, or (c) undercapitalized.  The FDIC also assigns an institution to one of three supervisory subcategories within each capital

 

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group.  The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the institution’s primary federal regulator and information that the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the deposit insurance funds.  An institution’s assessment rate depends on the capital category and supervisory subcategory to which it is assigned.  Under the regulation, there are nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied.  Assessment rates currently range from 0.00% of deposits for an institution in the highest category (i.e., well capitalized and financially sound, with no more than a few minor weaknesses) to 0.27% of deposits for an institution in the lowest category (i.e., undercapitalized and substantial supervisory concern).  The FDIC is authorized to raise the assessment rates as necessary to maintain the required reserve ratio of 1.25%.  As a result of the Deposit Insurance Funds Act of 1996 (the “1996 Act”), both the BIF and the SAIF currently satisfy the reserve ratio requirement at June 30, 2004.

 

The 1996 Act also provides that the FDIC cannot assess regular insurance assessments for an insurance fund unless required to maintain or to achieve the designated reserve ratio of 1.25%, except on those of its member institutions that are not classified as “well capitalized” or that have been found to have “moderately severe” or “unsatisfactory” financial, operational or compliance weaknesses.  The Bank has not been so classified by the FDIC or the OTS.

 

In addition, the 1996 Act expanded the assessment base for the payments on the bonds issued in the late 1980s by the Financing Corporation to recapitalize the now defunct FSLIC to include the deposits of both BIF- and SAIF-insured institutions beginning January 1, 1997.  Both BIF and SAIF-insured deposits are assessed the same FICO rates.

 

Under the FDI Act, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS.  The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.

 

Regulatory Capital Requirements.  Federally insured savings associations, such as the Bank, are required to maintain a minimum level of regulatory capital.  The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings associations.  These capital requirements must be generally as stringent as the comparable capital requirements for national banks.  The OTS is also authorized to impose capital requirements in excess of these standards on individual associations on a case-by-case basis.

 

The capital regulations require tangible capital not less than 1.50% of adjusted total assets (as defined by regulation).  Tangible capital generally includes common stockholders’ equity and retained earnings, and certain noncumulative perpetual preferred stock and related earnings on withdrawable accounts and deposits that qualify as core capital.  In addition, all intangible assets, other than a limited amount of mortgage servicing rights and other categories must be deducted from tangible capital.  At June 30, 2004, the Bank had $4.6 million of unamortized loan servicing rights.  Included in total unamortized loan servicing was $64,000 of nonmortgage servicing rights which was required to be deducted from tangible capital.

 

The OTS regulations establish special capitalization requirements for savings associations that own subsidiaries.  Under these regulations certain subsidiaries are consolidated for capital purposes and others are excluded from assets and capital.  In determining compliance with the capital requirements, all subsidiaries engaged solely in activities permissible for national banks or engaged in certain other activities solely as agent for its customers such as mortgage banking activities are “includable” subsidiaries that are consolidated for capital purposes in proportion to the association’s level of ownership, including the assets of includable subsidiaries in which the association has a minority interest that is not consolidated for GAAP purposes.  All subsidiaries of the Bank are includable subsidiaries.

 

The capital standards also require core capital equal to at least 4.00% of adjusted total assets (as defined by regulation).  Core capital generally consists of tangible capital plus certain intangible assets, and up to 25.00% of other intangibles which meet certain separate salability and market valuation tests.  At June 30, 2004, the Bank had $5.0 million in intangible assets which were subject to these tests.  The amount of servicing rights includable as core capital is limited to 50.00% of such capital.  At June 30, 2004, the Bank had Tier I (core) capital equal to $69.8 million, or

 

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8.28% of adjusted total assets, which is $36.1 million above the minimum leverage ratio requirement of 4.00% as in effect on that date.

 

The OTS risk-based capital requirement requires savings associations to have total capital of at least 8.00% of risk-weighted assets.  Total capital consists of core capital, as defined above, and supplementary capital.  Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets.  Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital up to 100.00% of core capital.  At June 30, 2004, the Bank had no capital instruments that qualified as supplementary capital and $3.0 million of general loss reserves, which was not in excess of 1.25% of risk-weighted assets.

 

Certain exclusions from capital and assets are required to be made for the purpose of calculating total capital, in addition to the adjustments required for calculating core capital.  Such exclusions consist of equity investments (as defined by regulation) and that portion of land loans and nonresidential construction loans in excess of an 80.00% loan-to-value ratio, retained interest on securitizations and reciprocal holdings of qualifying capital instruments.  The Bank had $1.9 million in dollar for dollar exclusions from capital and assets at June 30, 2004 for the retained interest from securitized automobile loans.

 

In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by the appropriate risk weight based on the risks inherent in the type of assets.  The risk weights assigned by the OTS for principal categories of assets are: (a) 0.00% for cash and securities issued by the United States Government or unconditionally backed by the full faith and credit of the United States Government, (b) 20.00% for securities (other than equity securities) issued by United States Government sponsored agencies, high quality mortgage-backed securities  and mortgage-backed securities issued by, or fully guaranteed as to principal and interest by, the FNMA or the FHLMC except for those classes with residual characteristics or stripped mortgaged-related securities, (c) 50.00% for prudently underwritten permanent one- to four-family first lien mortgage loans not more than 90 days delinquent and having a loan-to-value ratio of not more than 80.00% at origination unless insured to such ratio by an insurer approved by FNMA or FHLMC and (d) 100.00% for all other loans and investments, including consumer loans, commercial loans, repossessed and loans more than 90 days past due and all other assets.

 

On June 30, 2004, the Bank had total risk-based capital of $71.5 million (including $69.8 million in core capital, $3.6 million in qualifying supplementary capital and dollar for dollar exclusions for the retained interest from securitized automobile loans of $1.9 million) and risk-weighted assets of $678.4 million (including $24.9 million in converted off-balance sheet assets), or total capital of 10.54% of risk-weighted assets.  This amount was $17.2 million above the 8.00% requirement in effect on that date.

 

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The following table sets forth the Bank’s compliance with its capital requirements at June 30, 2004.

 

		Amount(2)			Percent of Applicable Assets(1)
		(Dollars in Thousands)
GAAP capital		$	73,386		8.68	%
Tier I (core) capital		$	69,762		8.28	%
Required		33,689			4.00
Excess over requirement		$	36,073		4.28	%
Risk-based capital(3)		$	71,502		10.54	%
Required		54,270			8.00
Excess over requirement		$	17,232		2.54	%

 

(1)                                  Tier I (core) capital figures are determined as a percentage of total adjusted assets; risk-based capital figures are determined as a percentage of risk-weighted assets.

(2)                                  The Bank’s investment in its subsidiaries is included for purposes of calculating regulatory capital.

(3)                                  Includes qualifying supplementary capital of $3.6 million and dollar for dollar exclusion for the retained interest from securitized automobile loans of $1.9 million.

 

Under FDICIA all the Federal banking agencies, including the OTS, must revise their risk-based capital requirements to ensure that such requirements account for interest rate risk, concentration of credit risk and the risks of non-traditional activities, and to further endure that they reflect the actual performance of and expected loss on multi-family loans.  On May 10, 2002, the OTS adopted an amendment to its capital regulations that eliminated the interest rate risk component of the risk-based capital requirement.

 

Limitations on Dividends and Other Capital Distributions.  The OTS regulations impose various restrictions or requirements on associations with respect to their ability to pay dividends or make other distributions of capital.  The OTS regulations prohibit an association from declaring or paying any dividends or from repurchasing any of its stock if, as a result, the regulatory capital of the association would be reduced below the amount required to be maintained for the liquidation account established in connection with its mutual to stock conversion.

 

The OTS imposes various restrictions or requirements on the Bank’s ability to make capital distributions, including cash dividends.  A savings institution that is the subsidiary of a savings and loan holding company must file a notice with the OTS at least 30 days before making a capital distribution.  The Bank must file an application for prior approval if the total amount of its capital distributions, including the proposed distribution, for the applicable calendar year would exceed an amount equal to the Bank’s net income for that year plus retained net income for the previous two years.

 

The OTS may disapprove of a notice or application if:

 

•                  the Bank would be undercapitalized following the distribution;

•                  the proposed capital distribution raises safety and soundness concerns; or

•                  the capital distribution would violate a prohibition contained in any statute, regulation or agreement.

 

Liquidity.  All savings associations, including the Bank, are required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation.  For a discussion of what the Bank includes in liquid assets, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”  At June 30, 2004, the Bank’s overall liquid asset ratio was 4.28%.

 

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Branching.  Subject to certain limitations, the HOLA and the OTS regulations permit federally chartered savings associations to establish branches in any state of the United States.  The authority to establish such branches is available (a) in states that expressly authorize branches of savings associations located in another state or (b) to an association that qualifies as a “domestic building and loan association” under the Internal Revenue Code of 1986, as amended, which imposes qualification requirements similar to those for a “qualified thrift lender” under the HOLA.  See the section below entitled “Qualified Thrift Lender Test.”  The authority for a federal savings association to establish an interstate branch network would facilitate a geographic diversification of the association’s activities.  This authority under the HOLA and the OTS regulations preempts any state law purporting to regulate branching by federal savings associations.

 

Community Reinvestment.  Under the Community Reinvestment Act (the “CRA”), as implemented by the OTS regulations, a savings association has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods.  The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA.  The CRA requires the OTS, in connection with its examination of a savings association, to assess the association’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such association.  The CRA also requires all institutions to make public disclosure of their CRA ratings.  The Association received an  “Outstanding” CRA rating in its most recent examination.

 

The CRA regulations rate an institution based on its actual performance in meeting community needs.  In particular, the rating system focuses on three tests:  (a) a lending test, to evaluate the institution’s record of making loans in its assessment areas; (b) an investment test, to evaluate the institution’s record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses; and (c) a service test, to evaluate the institution’s delivery of services through its branches, ATMs and other offices.  The amended CRA regulations also clarify how an institution’s CRA performance would be considered in the application process.

 

Qualified Thrift Lender Test.  All savings associations, including the Bank, are required to meet a qualified thrift lender (“QTL”) test to avoid certain restrictions on their operations.  This test requires a savings association to have at least 65.00% of its portfolio assets (which consists of total assets less the sum of goodwill and other intangible assets, properties used to conduct the savings association’s business and specified liquid assets not exceeding 20.00% of total assets) in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis.  At June 30, 2004 the Bank maintained 78.95% of its portfolio assets in qualified thrift investments, and thus met the test.  The Bank has met the QTL test since its inception.

 

Loans and mortgage-backed securities secured by domestic residential housing, FHLB stock, credit card loans, educational loans and certain small business loans as well as certain obligations of the Federal Savings and Loan Insurance Corporation (“FSLIC”), the FDIC and certain other related entities may be included in qualifying thrift investments without limit.  FHLMC and FNMA stock and certain other housing-related and non-residential real estate loans and investments, including loans to develop churches, nursing homes, hospitals and schools, and consumer loans and investments in subsidiaries engaged in housing-related activities may also be included, in varying amounts, not to exceed 20.00% of portfolio assets.

 

Any savings association that fails to meet the QTL test must either convert to a national bank charter or operate under certain restrictions on its activities, unless it requalifies as a QTL and thereafter remains a QTL.  If any association that fails the QTL test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies.  See the section below entitled “Holding Company Regulation.”

 

Transactions with Affiliates.  The Bank’s authority to engage in transactions with its “affiliates” is limited by the OTS regulations and by Sections 23A and 23B of the Federal Reserve Act (the “FRA”).  In general, an affiliate of the Bank is any company that controls the Bank or any other company that is controlled by a company that controls the Bank, excluding the Bank’s subsidiaries other than those that are insured depository institutions.  The OTS regulations prohibit a savings association (a) from lending to any of its affiliates that is engaged in activities that are not

 

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permissible for bank holding companies under Section 4(c) of the BHC Act and (b) from purchasing the securities of any affiliate other than a subsidiary.  Section 23A of the FRA limits the aggregate amount of transactions with any individual affiliate to 10.00% of the capital and surplus of the savings association and also limits the aggregate amount of transactions with all affiliates to 20.00% of the savings association’s capital and surplus.  Extensions of credit to affiliates are required to be secured by collateral in an amount and of a type described in Section 23A of the FRA, and the purchase of low quality assets from affiliates is generally prohibited.  Section 23B of the FRA provides that certain transactions with affiliates, including loans and asset purchases, must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the association as those prevailing at the time for comparable transactions with non-affiliated companies.  In the absence of comparable transactions, such transactions may only occur under terms and circumstances, including credit standards, that in good faith would be offered to or would apply to non-affiliated companies.

 

Effective April 1, 2003, the FRB rescinded its interpretations of Sections 23A and 23B of the FRA and replaced these interpretations with Regulation W.  In addition, Regulation W makes various changes to existing law regarding Sections 23A and 23B of the FRA, including expanding the definition of what constitutes an affiliate subject to Sections 23A and 23B of the FRA and exempting certain subsidiaries of state-chartered banks from the restrictions of Sections 23A and 23B of the FRA.

 

Under Regulation W, all transactions entered into on or before December 12, 2002, which either became subject to Sections 23A and 23B of the FRA solely because of Regulation W, and all transactions covered by Sections 23A and 23B of the FRA, the treatment of which will change solely because of Regulation W, became subject to Regulation W on July 1, 2003.  All other covered affiliate transactions became subject to Regulation W on April 1, 2003.  The FRB expects each depository institution that is subject to Sections 23A and 23B of the FRA to implement policies and procedures to ensure compliance with Regulation W.  Changes made by Regulation W did not have a material adverse effect on the Company’s business.

 

The Bank’s authority to extend credit to its directors, executive officers and 10.00% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the FRB thereunder.  Among other things, these provisions require that extensions of credit to insiders (a) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features and (b) not exceed certain limitations on the amount of the association’s capital.  In addition, extensions of credit in excess of certain limits must be approved by the association’s board of directors.  Section 402 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) prohibits the extension of personal loans to directors and executive officers of issuers (as defined in the Sarbanes-Oxley Act).  The prohibition, however, does not apply to mortgages advanced by an insured depository institution, such as the Bank, that are subject to the insider lending restrictions of Section 22(h) of the FRA.

 

Certain transactions with directors, officers or controlling persons are also subject to conflict of interest regulations enforced by the OTS.  These conflict of interest regulations and other statutes also impose restrictions on loans to such persons and their related interests.  Among other things, such loans must be made on terms substantially the same as those for loans to unaffiliated individuals.

 

Real Estate Lending Standards.  The OTS and the other federal banking agencies adopted regulations to prescribe standards for extensions of credit that (a) are secured by real estate or (b) are made for the purpose of financing the construction of improvements on real estate.  The OTS regulations require each savings association to establish and maintain written internal real estate lending standards that are consistent with safe and sound banking practices and appropriate to the size of the association and the nature and scope of its real estate lending activities.  The standards also must be consistent with accompanying OTS guidelines, which include loan-to-value ratios for the different types of real estate loans.  Associations are also permitted to make a limited amount of loans that do not conform to the proposed loan-to-value limitations so long as such exceptions are reviewed and justified appropriately.  The guidelines also list a number of lending situations in which exceptions to the loan-to-value standards are justified.

 

Privacy Regulations.  Under the OTS regulations adopted pursuant to the Gramm-Leach-Bliley Act of 1999 (“GLB Act”), the Bank is required to adopt procedures to protect customers’ “nonpublic personal information.”  The new regulations generally require that the Bank disclose its privacy policy, including identifying with whom it

 

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shares a customer’s “nonpublic personal information,” to customers at the time of establishing the customer relationship and annually thereafter.  In addition, the Bank is required to provide its customers with the ability to “opt-out” of having it share their personal information with unaffiliated third parties and not to disclose account numbers or access codes to nonaffiliated third parties for marketing purposes.  The Bank currently has a privacy protection policy in place, which has been reviewed, for compliance with the regulations.

 

Federal Reserve System.  Under FRB regulations, the Bank is required to maintain noninterest-earning reserves against its transaction accounts.  FRB regulations generally require that (a) reserves of 3.00% must be maintained against aggregate transaction accounts of $45.4 million or less, subject to adjustment by the FRB, and (b) a reserve of $1.2 million plus 10.00% (subject to adjustment by the FRB between 8.00% and 14.00%) must be maintained against that portion of total transaction accounts in excess of $45.4 million.  The first $6.6 million of otherwise reservable balances are exempted from the reserve requirements.  The Bank is in compliance with these reserve requirements at June 30, 2004.  Because required reserves must be maintained in the form of either vault cash, a noninterest bearing account at a FRB, or a passthrough account as defined by the FRB, the effect of this reserve requirement is to reduce the Bank’s interest-earning assets to the extent that the requirement exceeds vault cash.

 

Federal Home Loan Bank System.  The Bank is a member of the FHLB of Des Moines, which is one of 12 regional FHLBs that administers the home financing credit function of savings associations.  Each FHLB serves as a reserve or central bank for its members within its assigned region.  It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System.  It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB.  These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board.  All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB.  On July 1, 2003 the FHLB of Des Moines implemented a new capital plan converting from a subscription capital structure to a new permanent capital structure mandated by the GLB Act.  Under this new capital plan, the Bank, as a member of the FHLB of Des Moines, is required to acquire and hold shares of capital stock in the FHLB of Des Moines equal to 0.12% of the total assets of the Bank at December 31 annually.  The Bank is also required to own activity-based stock, which is based on 4.45% of the Bank’s outstanding advances.  These percentages are subject to change at the discretion of the FHLB Board of Directors.

 

At June 30, 2004, the Bank had $5.5 million in FHLB stock, which was in compliance with this requirement.  The Bank receives dividends on its FHLB stock, subject to approval by the FHLB.  For the fiscal year ended June 30, 2004, dividends paid by the FHLB of Des Moines to the Bank totaled approximately $107,000, which constitutes a $97,000 decrease in the amount of dividends received in fiscal year 2003.  This decrease was primarily due to a decrease in the dividend rate approved by the FHLB Board of Directors.

 

Trust Activities Regulation.  The Bank derives its trust powers from Section 5(n) of the HOLA and the regulations and policies of the OTS.  Under these laws, regulations and policies, the trust activities of federal savings banks are governed by both federal and state laws.  Generally, the scope of trust activities that the Bank can provide will be governed by the laws of the states in which the Bank is “located” (as such term is defined under the regulations of the OTS), while other aspects of the trust operations of the Bank are governed by federal laws and regulations.  If the trust activities of a federal savings bank are located in more than one state, however, then the scope of fiduciary services the federal savings bank can provide will vary depending on the laws of each state.

 

The Bank, through its trust department, acts as trustee, executor, administrator, guardian, custodian, record keeper, agent, registrar, advisor and manager for various accounts.  As of June 30, 2004, the trust department of the Bank maintained approximately $83.0 million in assets under management.

 

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USA Patriot Act.  In response to the events of September 11, 2001, President George W. Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”) on October 26, 2001.  The USA PATRIOT Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements.  By way of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act takes measures intended to encourage information-sharing among bank regulatory agencies and law enforcement bodies.  Further, certain provisions of Title III of the USA PATRIOT Act impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act.

 

Among other requirements, Title III of the USA PATRIOT Act imposes the following requirements with respect to financial institutions:

 

•                  Pursuant to Section 352, all financial institutions must establish anti-money laundering programs that include, at minimum: (a) internal policies, procedures, and controls, (b) specific designation of an anti-money laundering compliance officer, (c) ongoing employee training programs, and (d) an independent audit function to test the anti-money laundering program.  Interim final rules implementing Section 352 were issued by the Treasury Department on April 29, 2002, and were subsequently amended on November 6, 2002, and November 14, 2002.  Such rules state that a financial institution is in compliance with Section 352 if it implements and maintains an anti-money laundering program that complies with the anti-money laundering regulations of its federal functional regulator.  The Bank is in compliance with the OTS’s anti-money laundering regulations.

 

•                  Pursuant to Section 326, on May 9, 2003, the OTS, in conjunction with other bank regulators, issued a Joint Final Rule that provides for minimum standards with respect to customer identification and verification.  This rule became effective October 1, 2003.

 

•                  Section 312 requires financial institutions that establish, maintain, administer or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) to establish appropriate, specific and, where necessary, enhanced due diligence policies, procedures and controls designed to detect and report money laundering.

 

•                  Effective December 25, 2001, financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and are be subject to certain recordkeeping obligations with respect to correspondent accounts of foreign banks.

 

•                  Bank regulators are directed to consider a holding company’s effectiveness in combating money laundering when ruling on FRA and Bank Merger Act applications.

 

The Sarbanes-Oxley Act.  On July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley Act.  The Sarbanes-Oxley Act implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in corporate America and to better protect investors from the type of corporate wrongdoing that occurred in Enron, WorldCom and similar companies.  The Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission (the “SEC”), under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

 

The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and the securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of specified issues by the SEC and the Comptroller General.  The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.

 

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The Sarbanes-Oxley Act’s principal legislation includes:

 

•                                    the creation of an independent accounting oversight board;

 

•                                    auditor independence provisions which restrict non-audit services that accountants may provide to their audit clients;

 

•                                    additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer certify financial statements;

 

•                                    the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;

 

•                                    an increase in the oversight of, and enhancement of certain requirements relating to audit committees of public companies and how they interact with the Company’s independent auditors;

 

•                                    the requirement that audit committee members must be independent and are absolutely barred from accepting consulting, advisory or other compensatory fees from the issuer;

 

•                                    the requirement that companies disclose whether at least one member of the committee is an “audit committee financial expert” (as such term is defined by the SEC) and if not, why not;

 

•                                    expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition  on insider  trading during pension blackout periods;

 

•                                    a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions;

 

•                                    the disclosure of a code of ethics and filing a Current Report on Form 8-K for a change or waiver of such code;

 

•                                    the mandatory disclosure by analysts of potential conflicts of interest; and

 

•                                    a range of enhanced penalties for fraud and other violations.

 

The SEC was delegated the task of enacting rules to implement various provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act.  Although the SEC has implemented most of the provisions of the Sarbanes-Oxley Act, it does continue to issue final rules, reports and press releases.  As the SEC issues new rules, reports and press releases, the Company reviews such requirements and complies as required.

 

Furthermore, the NASDAQ Stock Market (the “NASDAQ”) has also implemented corporate governance rules which implement the mandates of the Sarbanes-Oxley Act.  The material NASDAQ rules include, among other things, ensuring that a majority of the board of directors are independent of management, establishing and publishing a code of conduct for directors, officers and employees, and requiring stockholder approval of all new stock option plans and all material modifications.  These rules affect the Company because its common stock is listed on the NASDAQ under the symbol “HFFC.”

 

Although the Company anticipates that it will incur additional expense in complying with the provisions of the Sarbanes-Oxley Act and the resulting regulations, management does not expect that such compliance will have a material impact on the Company’s results of operations or financial condition.

 

Holding Company Regulation.  The Company is a unitary thrift holding company subject to regulatory oversight by the OTS.  As such, the Company is registered with and files reports with the OTS and is subject to regulation and examination by the OTS.  Under the GLB Act, any company which becomes a unitary savings and

 

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loan holding company pursuant to a charter application filed with the OTS after May 4, 1999, is prohibited from engaging in non-financial activities or affiliating with non-financial companies.  All unitary savings and loan holding companies in existence prior to May 4, 1999, such as the Company, are “grandfathered” under the GLB Act and may continue to operate as a unitary savings and loan holding company without any limitations in the types of business activities in which it can engage at the holding company level, provided the Bank continues to satisfy the QTL Test.  In addition, the OTS has enforcement authority over the Company and its non-savings association subsidiaries which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association.

 

As a “grandfathered” unitary thrift holding company, the Company generally is not subject to activity restrictions.  If the Company acquires control of another savings association as a separate subsidiary, it would become a multiple savings and loan holding company, and the activities of the Company and any of its subsidiaries (other than the Bank or any other SAIF-insured savings association) would become subject to such restrictions unless such other associations each qualify as a QTL and were acquired in a supervisory acquisition.

 

If the Bank fails the QTL test, the Company must obtain the approval of the OTS prior to continuing after such failure, directly or through its other subsidiaries, any business activity other than those approved for multiple savings and loan holding companies or their subsidiaries.  In addition, within one year of such failure the Company must register as, and will become subject to, the restrictions applicable to bank holding companies.  The activities authorized for a bank holding company are more limited than are the activities authorized for a unitary or multiple savings and loan holding company.  See the section above entitled “Qualified Thrift Lender Test.”

 

In addition, for grandfathered savings and loan holding companies, such as the Company, the GLB Act also prohibits the sale of such entities to nonfinancial companies.  This prohibition is intended to restrict the transfer of grandfathered rights to other entities and, thereby, prevent evasion of the limitation on the creation of new unitary savings and loan holding companies.

 

Federal Securities Law.  The common stock of the Company is registered with the SEC under the Exchange Act.  The Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act.

 

Company stock held by persons who are affiliates (generally officers, directors and principal stockholders) of the Company may not be resold without registration or unless sold in accordance with certain resale restrictions.  If the Company meets specified current public information requirements, each affiliate of the Company is able to sell in the public market, without registration, a limited number of shares in any three-month period.

 

Federal and State Taxation

 

The Company and its direct and indirect subsidiaries file a consolidated federal income tax return on a fiscal year basis.  In addition, each of Trust I, Trust II, Trust III, Trust IV and Home Federal Automobile Securitization Trust 2003-A are required to file individual trust returns on a calendar year basis.

 

In addition to the regular income tax, corporations, including savings associations such as the Bank, generally are subject to a minimum tax.  An alternative minimum tax is imposed at a minimum tax rate of 20.00% on alternative minimum taxable income, which is the sum of a corporation’s regular taxable income (with certain adjustments) and tax preference items, less any available exemption.  The alternative minimum tax is imposed to the extent it exceeds the corporation’s regular income tax and net operating losses can offset no more than 90.00% of alternative minimum taxable income.

 

To the extent earnings appropriated to a savings association’s bad debt reserves for “qualifying real property loans” and deducted for federal income tax purposes exceed the allowable amount of such reserves computed under the experience method and to the extent of the association’s supplemental reserves for losses on loans (“Excess”), such Excess may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a shareholder (including distributions on redemption, dissolution or liquidation) or for any other purpose (except to absorb bad debt losses).  As of June 30, 2004, the Bank’s Excess for tax purposes totaled approximately $4.8 million.

 

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South Dakota Taxation.  The Bank is subject to the South Dakota Franchise tax to the extent that such corporations are engaged in business in the state of South Dakota. South Dakota does not have a corporate income tax.  The franchise tax will be imposed at a rate of 6.00% on franchise taxable income which is computed in the same manner as federal taxable income with some minor variations to comply with South Dakota law, other than the carryover of net operating losses which is not permitted under South Dakota law.  A South Dakota return of franchise tax must be filed annually.

 

Minnesota Taxation.  The Bank is subject to the Minnesota Corporate Income tax to the extent that such corporations are engaged in business in the state of Minnesota.  The Corporate Income tax is imposed at a rate of 9.8% on corporate taxable income, which is computed in the same manner as federal taxable income with some minor variations to comply with Minnesota law.  A Minnesota return of Corporate Income tax must be filed annually.

 

Delaware Taxation.  As a Delaware holding company, the Company is exempted from Delaware corporate income tax but is required to file an annual report with and pay an annual fee to the State of Delaware.  The Company is also subject to an annual franchise tax imposed by the State of Delaware.

 

Taxation in Other States.  Mid America Leasing may be required to file state income tax returns in those states which lessees have operations.  The total taxes paid in the year ended June 30, 2004 were not material to the operation of Company.

 

Executive Officers of the Company

 

The following information as to the business experience during the past five years is supplied with respect to executive officers of the Company and the Bank.

 

Curtis L. Hage - - Mr. Hage, age 58, is Chairman, President and Chief Executive Officer of the Company.  He was elected Chairman of the Board of Directors of the Company in September 1996 and has held the position of President and Chief Executive Officer since February 1991.  Prior to such time, Mr. Hage served as Executive Vice President of the Bank since 1986.  Since joining the Bank in 1968, he served in various capacities prior to being elected Executive Vice President.  Mr. Hage received his M.B.A. from the University of South Dakota and attended the Graduate School of Savings Institution Management at the University of Texas.

 

Darrel L. Posegate – Mr. Posegate, age 46, is Executive Vice President/Chief Financial Officer and Treasurer of the Company and the Bank, a position he has held since January 2002.  He was employed as Chief Financial Officer for West Des Moines State Bank, Des Moines, IA, a state banking institution, from 1998 until joining the Bank.  Prior to that time he was employed as President of Liberty Services, Inc., a bank services company, from 1994 to 1998.  Mr. Posegate received his B.A. degree from Luther College, Decorah, IA, and is a Certified Public Accountant.

 

David A. Brown – Mr. Brown, age 42, is Senior Vice President/Business Banking, a position he has held since November 1999.  Prior to joining the Bank, Mr. Brown served as Vice President/Manager Commercial Banking at Firstar Bank, Sioux City, Iowa, a national banking institution, a position he held since December 1998.  Mr. Brown received his Masters of Business Administration and a B.S. in Business Administration from University of South Dakota.

 

Mary F. Hitzemann - - Ms. Hitzemann, age 51, is Senior Vice President/Human Resources, a position she has held since October 1993.  Ms. Hitzemann joined the Bank in January 1993.  Prior to that time, she was employed as Vice President of Human Resources for Rapid City Regional Hospital from May 1989 to May 1992.  Ms. Hitzemann received her B.A. degree from Augustana College.

 

Mark S. Sivertson - Mr. Sivertson, age 46, is Senior Vice President/Trust Officer, a position he has held since July 1996.  He joined the Bank in February 1995 as Vice President/Trust Officer.  Prior to joining the Bank, Mr. Sivertson was Vice President and Trust Officer in charge of the Investment Management and Trust Department at Western Bank.  He holds a law degree from the University of North Dakota and the Certified Trust Financial Advisor designation from the American Bankers Association.

 

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Natalie A. Solberg – Ms. Solberg, age 41, is Senior Vice President/Service and Support.  Since joining the Bank in February 1994, she has been responsible for managing automated telephone banking, deposit operations and retail support functions.  She was promoted to Vice President/In-Touch Banking in October 1995, and subsequently, held the position of Vice President/Retail Support.  Prior to joining the Bank, she was employed by the Bank of New York from October 1989 to October 1993.  Ms. Solberg received her B.S. from Northern State University.

 

Raymond C. Wilson – Mr. Wilson, age 46, is Vice President/Senior Controller for the Bank.  Mr. Wilson joined the Bank in September 2003.  Prior to joining the Bank, he held senior financial and accounting management positions with two community banks in Ohio.  Mr. Wilson received his BBA and MAFIS from Cleveland State University, Cleveland, Ohio.

 

Item 2.  Properties

 

The Company and its direct and indirect subsidiaries conduct their business at the main office located at 225 South Main Avenue, Sioux Falls, South Dakota, 57104.  Currently, the Bank also conducts business from 33 other offices located in its primary market area.  Of such 34 total business offices, the Company owns 20 and leases 14 others.

 

The total net book value of the Company’s premises and equipment (including land, building, leasehold improvements and furniture, fixtures and equipment) at June 30, 2004 was $12.6 million.  Management believes that the Company’s existing properties are adequate for its current needs.

 

Item 3.  Legal Proceedings

 

The Company, the Bank and their subsidiaries are, from time to time, involved as plaintiff or defendant in various legal actions arising in the normal course of their businesses.  While the ultimate outcome of any such proceedings cannot be predicted with certainty, it is generally the opinion of management, after consultation with counsel representing the Bank and the Company in any such proceedings, that the resolution of any such proceedings should not have a material effect on the Company’s consolidated financial position or results of operations.  The Company, the Bank and their direct and indirect subsidiaries are not aware of any legal actions or other proceedings contemplated by governmental authorities outside of the normal course of business.

 

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 quarterly period ended June 30, 2004.

 

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