<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 1996
Commission file number 0-27624
RELIANCE BANCSHARES, INC.
--------------------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
WISCONSIN 39-1834823
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3140 S27TH STREET
MILWAUKEE, WISCONSIN 53215
(Address of principal executive offices) (Zip Code)
(414) 671-2222
(Registrant's telephone number, including area code)
Securities Registered Under Section 12(b) of the Exchange Act:
NONE
--------------------------------------------------------------------------
Securities Registered Under Section 12(g) of the Exchange Act:
COMMON STOCK, $1.00 PAR VALUE PER SHARE
----------------
(Title of Class)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
(1)Yes X No
----- -----
(2)Yes X No
----- -----
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will 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-KSB or any amendment to
this Form 10-KSB.[x]
State issuer's revenues for its most recent fiscal year: $2,741,000 (Total
interest and dividend income and total non-interest income.)
As of September 13, 1996, there were issued 2,562,344 shares of Common Stock of
the Registrant and 2,528,489 shares outstanding. The aggregate market value of
the voting stock held by non-affiliates of the Registrant, computed by
reference to the average of the bid and asked price of such shares of Common
Stock as of September 13, 1996 was $19.78 million. Solely for purposes of this
calculation, all executive officers and directors of the Registrant are
considered to be affiliates; also included as "affiliate shares" are certain
shares held by various employee benefit plans in which the trustees are
directors of the Registrant or are required to vote a portion of unallocated
shares at the direction of executive officers or directors of the Registrant.
The exclusion from such amount of the market value of the shares 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
Parts II and IV of Form 10-KSB: Portions of the Annual Report to Shareholders
for the fiscal year ended June 30, 1996 are incorporated by reference into
Parts II and IV hereof.
Part III of Form 10-KSB: Portions of the Proxy Statement for the 1996 Annual
Meeting of Shareholders are incorporated by reference into Part III hereof.
<PAGE> 2
PART I
ITEM I. DESCRIPTION OF BUSINESS
FORWARD-LOOKING STATEMENTS
The discussion in this Form 10-KSB includes certain forward-looking statements
based upon management expectations. Factors which could cause future results
to differ from these expectations include the following: general economic
conditions; legislative and regulatory initiatives; monetary and fiscal
policies of the federal government; deposit flows; the costs of funds; general
market rates of interest; interest rates on competing investments; demand for
loan products; demand for financial services; changes in accounting policies or
guidelines; and changes in the quality or composition of the Company's loan and
investment portfolios.
GENERAL
Reliance Bancshares, Inc., a Wisconsin corporation (the "Company" or the
"Registrant"), was formed for the purpose of owning all of the outstanding
stock of Reliance Savings Bank, a Wisconsin chartered stock savings bank (the
"Bank"), issued in the mutual to stock conversion of the Bank (the
"Conversion"). The Conversion was consummated on April 18, 1996; the Company
issued 2,562,344 shares of Common Stock in exchange for proceeds of $20.5
million, and the Company purchased all of the issued and outstanding shares of
Common Stock of the Bank for $9.5 million. The Bank is regulated by the
Wisconsin Department of Financial Institutions, Division of Savings and Loan
(the "DSL") and the Federal Deposit Insurance Corporation (the "FDIC"). The
Bank's deposits are insured up to applicable limits by the Savings Association
Insurance Fund ("SAIF") of the FDIC. The Bank also is a member of the Federal
Home Loan Bank ("FHLB") system. The Bank was organized in 1922, and has one
full service office located in Milwaukee County, Wisconsin. Because the
Company's only significant business operations are that of the Bank, the
business of the Bank is essentially the only business of the Company.
The Bank is a community oriented financial institution which emphasizes retail
financial services to individuals and consumers within its market areas. The
Bank's principal business is attracting retail deposits from the general public
and investing those deposits, together with funds generated from other
operations, primarily to originate residential mortgage loans within its
primary market areas and to invest in mortgage-backed securities and investment
securities. The principal lending is on one-to four-family owner-occupied
homes, including ARM loans, and to lesser extent, the Bank also originates,
multi-family, other consumer, commercial/non-residential and residential
construction loans. The Bank invests a significant portion of its assets in
investment securities and mortgage-backed securities, including U.S. Government
and federal agency securities, short-term liquid assets and other marketable
securities. The Bank's revenues are derived principally from interest on its
mortgage loan portfolio, interest on mortgage-backed securities and interest
and dividends on its investment securities. The Bank's principal sources of
funds are received from deposits, repayments on loans and mortgage-backed and
related securities.
MARKET AREA AND COMPETITION
The Bank offers a variety of loan and deposit products and banking services
primarily within the metropolitan Milwaukee area. The Bank's office is located
at 3140 South 27th Street, Milwaukee, Wisconsin. The City of Milwaukee is
located along the western shore of Lake Michigan, and is the largest
metropolitan statistical area ("MSA") within the State of Wisconsin. The
Milwaukee MSA includes Milwaukee, Waukesha, Ozaukee and Washington counties.
The Bank's primary market area consists of the Milwaukee MSA, which in 1994 was
the nation's 35th largest MSA. The Milwaukee MSA includes a diverse economic
base, including business, industry and agriculture, and of the nation's 35
largest MSAs, Milwaukee ranked third in the percentage of its work force in
manufacturing. Major employers include Johnson Controls, Inc., Harnischfeger
Industries, Inc., Briggs & Stratton Corp., Harley-Davidson, Inc., A.O. Smith
Corp., Allen-Bradley Co., GE Medical Systems, Miller Brewing Co., Master Lock
Co., W.H. Brady Co., Quad/Graphics, Inc., Northwestern Mutual Life Insurance
Co., and the home offices of numerous other insurance companies and financial
institutions. The Milwaukee MSA has 11 colleges and universities each with
enrollments exceeding 1,000 students, including the Milwaukee campus of the
University of Wisconsin and Marquette University.
2
<PAGE> 3
Many of the Bank's present customers and businesses are centralized within the
Bank's local market area. The Bank's local market area, generally defined as an
area within a three-mile radius of the Bank's office, has experienced limited
population growth, reduced employment and recessionary economic conditions in
recent years. The Bank's local market area has experienced modest population
declines in the last five years and decreasing median household income levels
in the last five years, and both of these trends are expected to continue. The
median household and per capita income levels of the Bank's local market area
are below the Milwaukee MSA average, and may be a reflection of the area's
primarily blue collar labor force and the migration of a large portion of the
white collar residents to outlying suburban areas. Additionally, this local
market area has experienced a general weakening of real estate values and a
slow-down of home sales and construction. These factors, along with
intensified competition from other financial institutions and mortgage brokers,
have resulted in a diminishing demand for permanent one- to four-family
mortgage loans and for deposit products in the Bank's local market area.
The Bank's local market area has a high density of financial institutions, most
of which are significantly larger and have greater financial resources than the
Bank. The Bank has significant competition in both its mortgage and consumer
lending business, as well as in attracting deposits. The Bank's competition
for loans is principally from other thrift institutions, savings banks,
mortgage banking companies, insurance companies and commercial banks. Its most
direct competition for deposits historically has come from other thrifts,
savings banks, commercial banks and credit unions. Because of the lower
interest rate environment over the past several years, the Bank has faced
additional competition for funds from a number of institutions, including the
availability of short-term money market funds and other corporate and
government securities funds offered by other financial service companies, such
as brokerage firms and insurance companies.
LENDING ACTIVITIES
General
The Bank's largest component of its gross loan portfolio, which totaled $26.6
million at June 30, 1996 was first mortgage loans secured by owner-occupied
one-to four-family residences. At June 30, 1996, one-to four-family mortgage
loans totaled $10.7 million or 40.46% of gross loans. Of the total one-to
four-family mortgage loans, $2.2 million or 20.51% were ARM loans. Of the
remaining loans held at June 30, 1996, 15.68% or $4.2 million were in
commercial real estate loans, 16.23% or $4.3 million were in residential
construction loans, 17.26% or $4.6 million were in multi-family mortgage loans,
9.00% or $2.4 million were in commercial construction and land development
loans, and the balance were in consumer loans.
The aggregate amount of loans that the Bank is permitted to make under
applicable state regulations to any one borrower, including related entities,
is generally an amount up to 15% of the Bank's capital plus an additional 10%
for loans fully secured by readily marketable collateral. At June 30, 1996,
the maximum amount which the Bank could lend under these limits to any one
borrower and the borrower's related entities was $2.9 million. At June 30,
1996, the Bank had no loans or groups of loans to related borrowers with
outstanding balances in excess of this amount. At that date, the Bank had 13
borrowers or groups of borrowers with outstanding lending relationships in
excess of $400,000, for a total of $11.5 million, all of which loans are
performing in accordance with their terms. The Bank's single largest borrowing
relationship at June 30, 1996 had multiple loans aggregating $2.9 million. All
of such loans are performing in accordance with their terms.
Composition of Loan Portfolio
The following table sets forth the composition of the Bank's loan portfolio in
dollar amounts and in percentages of the respective portfolios at the dates
indicated.
3
<PAGE> 4
<TABLE>
<CAPTION>
At June 30,
----------------------------------------------------------------------
1994 1995 1996
------------------- -------------------- --------------------
Percent Percent Percent
of of of
Amount Total Amount Total Amount Total
------ ----- ------ ----- ------ -----
MORTGAGE LOANS: (DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
One-to four-family . . . . . . $ 9,190 45.21% $10,425 47.51% $10,745 40.46%
Multi-family . . . . . . . . . 4,904 24.12 4,711 21.46 4,585 17.26
Commercial real estate . . . . 3,618 17.79 3,880 17.68 4,163 15.68
Residential construction . . . 1,641 8.07 2,226 10.14 4,311 16.23
Commercial construction/
land development . . . . . 962 4.73 694 3.16 2,390 9.00
------- ----- ------- ----- ------ -----
Total mortgage loans . . . . . . 20,315 99.92 21,936 99.95 26,194 98.63
</TABLE>
<TABLE>
<CAPTION>
At June 30,
----------------------------------------------------------------------
1994 1995 1996
-------------------- -------------------- --------------------
Percent Percent Percent
of of of
Amount Total Amount Total Amount Total
------ ----- ------ ----- ------ -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Consumer loans:
Home equity . . . . . . . . . 17 0.08 7 0.03 356 1.34
Other consumer . . . . . . . . -- -- 5 0.02 7 0.03
------ ------ ------ ------ ------ ------
Total consumer loans . 17 0.08 12 0.05 363 1.37
------ ------ ------ ------ ------ ------
Gross loans receivable . . . . 20,332 100.00% 21,948 100.00% 26,557 100.00%
====== ====== ======
Less:
Undisbursed loan proceeds . . $ 1,091 $ 701 $ 3,366
Allowance for loan losses . . 84 104 126
Deferred loan fees and
discounts . . . . . . . . . 106 109 134
------ ------ ------
Total additions/deductions . . . 1,281 914 3,626
------ ------ ------
Loans receivable, net . . . . . $19,051 $21,034 $22,931
====== ====== ======
</TABLE>
Contractual Principal Repayments
The following table sets forth the maturity or period to repricing of the
Bank's loan portfolio at June 30, 1996. Loans that have adjustable rates are
shown as being due in the period during which the interest rates are next
subject to change. The table does not include prepayments or scheduled
principal amortization. Prepayments and scheduled principal amortization on
mortgage loans totalled $2.9 million.
<TABLE>
<CAPTION>
At June 30, 1996
------------------------------------------------------------------------
One-to Multi-Family/ Consumer Total
AMOUNTS DUE(2): Four-Family(1) Non-residential(1) Loans Loans
-------------- ------------------ -------- -----
(In thousands)
<S> <C> <C> <C> <C>
Within one year . . . . . . . $ 5,913 $ 4,680 $ 25 $10,618
After one year:
One to three years . . . . . 2,786 1,386 1 4,173
Three to five years . . . . 143 745 248 1,136
Five to ten years . . . . . 530 1,230 89 1,849
Ten to twenty years . . . . 1,881 409 - 2,290
Over twenty years . . . . . 5,238 1,253 - 6,491
------ ------ ----- ------
Total due or repricing
after one year . . . . . 10,578 5,023 338 15,939
------ ------ ----- ------
Total amounts due or
repricing . . . . . . . 16,491 9,703 363 26,557
LESS:
Deferred fees and discounts . (110) (24) - (134)
Allowance for loan losses . . (73) (53) - (126)
------ ------ ----- ------
Gross loans receivable . . . $16,308 $ 9,626 $ 363 $26,297
====== ====== ===== ======
</TABLE>
4
<PAGE> 5
The following table sets forth at June 30, 1996 the dollar amount of all loans
and mortgage-backed securities due or scheduled to reprice after one year, and
whether such loans have fixed or adjustable interest rates. Loans that have
adjustable rates are shown as being due in the period during which the interest
rates are subject to change.
<TABLE>
<CAPTION>
Due or Repricing
After June 30, 1997
------------------------------
Fixed Adjustable Total
----- ---------- -----
(In thousands)
<S> <C> <C> <C>
Mortgage loans:
One-to four-family(3) . . . . . . . . . . . $ 9,706 $ 873 $10,579
Multi-family/non-residential(3) . . . . . . 4,542 480 5,022
Consumer loans . . . . . . . . . . . . . . . 338 - 338
------ ----- ------
Gross loans receivable . . . . . . . 14,586 1,353 15,939
Mortgage backed securities: . . . . . . . . . . . . 800 - 800
------ ----- ------
Gross loans receivable and mortgage-backed
securities . . . . . . . . . . . . . $15,386 $1,353 $16,739
====== ===== ======
</TABLE>
- -------------------
(1) Includes some residential construction lending.
(2) These amounts are net of loans in process.
(3) Includes some construction lending.
One-to Four-Family and Residential Construction Lending
The Bank originates first mortgage loans secured by one-to four-family
owner-occupied residences and residential construction loans within the Bank's
primary lending area. All of the Bank's first mortgage loans are originated
for the Bank's own loan portfolio. At June 30, 1996, $15.1 million, or 56.69%,
of the Bank's gross loan portfolio consisted of loans secured by one- to
four-family residential properties. Of the one- to four-family residential
mortgage loans in the Bank's gross loan portfolio, $4.3 million were in the
Bank's residential construction loan category. At June 30, 1996, $12.7
million, or 84.18%, of the Bank's one- to four-family residential mortgage
loans consisted of fixed rate loans and $2.4 million, or 15.82%, consisted of
balloon loans and ARM loans. At June 30, 1996, the average outstanding one- to
four-family loan balance was $72,800 and the largest outstanding one- to
four-family loan balance was $480,000.
Because of the highly competitive mortgage loan market in which the Bank
originates loans, a variety of mortgage products are available from the Bank,
with a variety of interest rates, fees and other origination terms. The Bank
offers conventional fixed rate mortgage loans and ARM loans with maturity dates
which typically range from 15 to 30 years. Residential mortgage loans
generally are underwritten to Federal Home Loan Mortgage Corporation ("FHLMC"),
Federal National Mortgage Association ("FNMA") and other agency guidelines.
The Bank rarely originates loans in excess of these agency limits; however, if
the Bank does originate jumbo loans, the loans are underwritten in accordance
with the Bank's underwriting guidelines and are retained in the Bank's loan
portfolio. The Bank charges origination fees ranging from zero to two points
on mortgage loans. The interest rates charged on mortgage loans at any given
date will vary, depending upon the amount of origination points to be paid.
The interest rates at which the Bank offers to grant a mortgage loan also are
determined by the secondary market pricing for comparable mortgage-backed
securities, local mortgage loan competition and the Bank's yield requirements.
Since the availability of zero point mortgage loans in recent years, most of
the Bank's borrowers accept a slightly higher interest rate and a zero point
mortgage loan.
Mortgage loan originations are solicited from real estate brokers, builders,
developers, existing or past customers and residents of the local communities
located in the Bank's primary market area. The Bank advertises its product
offerings in newspapers and other media circulating throughout its primary
market area in addition to its officers soliciting prospects. Upon receipt of
a completed mortgage application from a prospective borrower, a credit report
is ordered, income and other information is verified, and, as necessary,
additional financial information is requested. An appraisal of the real estate
that is to
5
<PAGE> 6
secure the loan is required. It is the Bank's policy to obtain title insurance
on all real estate first mortgage loans. Borrowers must present evidence of
appropriate hazard insurance and flood insurance (if applicable) prior to the
closing. The lending policy of the Bank restricts mortgage loans to 80% of the
lesser of the appraised value or purchase price of the real estate to be
mortgaged to the Bank. The Bank makes mortgage loans to 95% of the lesser of
the appraised value or purchase price subject to the availability of private
mortgage insurance insuring the amount in excess of 75% of the loan. The Bank
reviews all the pertinent information and makes a credit decision for approval
or denial within established Bank policy guidelines. Most recommendations to
deny applications based on underwriting considerations are reviewed by the
Bank's President prior to a final loan denial. All one-to four-family mortgage
loan applications are reviewed on a monthly basis by the Board of Directors.
Mortgage loans in the Bank's loan portfolio include due-on-sale clauses, which
provide the Bank with the contractual right to deem the loan immediately due
and payable in the event the borrower transfers the ownership of the property
without the Bank's consent. The Bank enforces the due-on-sale clauses of its
mortgage loans.
The Bank originates one and three year ARM loans. The Bank's one-year ARM
loans typically adjust a maximum of 200 basis points per year, with a lifetime
cap of approximately 600 basis points above the interest rate established at
the origination date of the ARM loan. Monthly payments of principal and
interest are adjusted when the interest rate adjusts, in order to maintain full
amortization of the mortgage loan within a maximum 30-year term. The Bank does
not offer ARM loans which provide for negative amortization. A conversion
option generally is available on the one-year ARM. This conversion option
provides terms under which the borrower may convert the ARM loan to a fixed
rate for a limited period of time in the early term of the ARM loan. The terms
at which the ARM loan may be converted to a fixed rate loan are established at
the date of loan origination and are set at a level allowing the Bank to
immediately sell the loan at the time of conversion. The Bank's three- year
ARM loans adjust annually after the initial three year term. The initial rate
offered on ARM loans fluctuates with general interest rate changes, and are
determined by secondary market pricing, competitive conditions and the Bank's
yield requirements. Currently, the Bank primarily utilizes the Seventh
District Cost of Funds Index, plus a margin, in order to determine the interest
rate payable upon the adjustment date of its ARM loans outstanding. In order
to minimize the risk associated with ARM loans, borrowers under ARM programs
are qualified at the higher of the initial offering rate or the fully-indexed
rate and with a specified minimum interest rate. None of the ARM loans are
granted with conversion options. As compared to fixed rate loans, ARM loans
generally pose different risks. In a rising interest rate environment, the
underlying loan payment rises, which increases the potential for default by the
borrower. At the same time, the marketability of the underlying property may
be adversely affected by higher interest rates. In a decreasing interest rate
environment, mortgagors tend to refinance into fixed rate loans.
The Bank also offers one- to four-family mortgage loans with balloon features.
Under these loans, the interest rate and monthly payment are fixed for the
initial term, which is usually one to five years, and thereafter, provided
certain conditions are met at maturity, the loan would be either paid off in
full or renewed at the then-current rate.
The Bank also offers owner-occupied one- to four-family residential
construction loans. Residential construction loans are underwritten in
conjunction with the regular first mortgage loans and terminate upon completion
of the project. At June 30, 1996, the Bank had 23 one- to four-family
construction loans in its loan portfolio, aggregating $4.3 million, and the
average outstanding residential construction loan balance was $187,000 and the
largest outstanding residential construction loan balance was $480,000.
Because most residential construction loans are ARM loans, residential
construction loans afford the Bank the opportunity to decrease the interest
rate sensitivity of its loan portfolio and to receive yields on fixed rate
loans higher than those obtainable on fixed rate loans secured by existing one-
to four-family residential properties. These higher yields, however,
correspond to the higher risks associated with residential construction loans.
Loan proceeds are disbursed in increments as construction of the residence
progresses. Title company disbursement agents are utilized to clear all lien
waivers and ensure the Bank's first lien position. These loans are structured
to allow borrowers to pay interest only on the funds advanced during the
construction period, which is generally six months. In most cases, the
6
<PAGE> 7
Bank structures residential construction loans to automatically convert to
regular first mortgage loans upon completion of the project and when
certification of occupancy has been obtained.
Upon completion of construction, residential construction loans generally
become either 30-year fixed rate loans or ARM loans with one- and three-year
interest rate adjustments. Residential construction loans made in conjunction
with the first mortgage have a loan-to-value ratio limit not to exceed 95%. As
with other one- to four-family residential mortgage loans, when the loan to
value exceeds 80%, private mortgage insurance is required. Coverage is
required to reduce the Bank's exposure to 75% of value or less.
The Bank offers one- to four-family residential construction loans to home
builders for speculation and model homes. These residential construction loans
convert to one-year ARM loans and typically are made at loan-to-value ratios of
80% or less. Payment terms are generally interest only for 12 months.
Thereafter, the borrower is required to begin principal and interest payments
to fully amortize the loan. Loan proceeds are disbursed in increments as
construction of the residence progresses.
At June 30, 1996, the largest aggregate amount of loans outstanding to any one
borrower totalled $2.9 million, and consisted of one commercial property and
four single family properties located in Waukesha County, Wisconsin. At June
30, 1996, all of these loans were current and performing in accordance with
their terms. These loans did not exceed the regulatory "loans to one borrower"
limitation at June 30, 1996. See "Regulation".
Multi-Family Lending
The Bank originates or participates in fixed rate and ARM loans secured by
multi-family properties. The Bank holds in its loan portfolio 17 multi-family
loans which at June 30, 1996 totalled $4.6 million, or 17.26% of the Bank's
gross loans. The average outstanding loan balance on each multi-family loan at
June 30, 1996 was $269,700. All payments under multi-family loans originated
by the Bank were current and performing in accordance with their terms at June
30, 1996. All of the Bank's multi-family loans are secured by properties
located in the Bank's primary market area. The rates charged on the Bank's ARM
multi-family loans are typically 25 to 50 basis points higher than on
one-to-four family residential properties. Multi-family ARM loans typically
adjust in a manner similar to that of the Bank's other ARM loans. An
origination fee of 1% to 2% is usually charged on such loans.
Multi-family loans generally are underwritten in amounts of up to 80% of the
lesser of the appraised value or purchase price of the underlying property.
The underlying properties typically are apartment buildings generally with 12
or less units. Appraisals on properties which secure multi-family loans are
performed by an independent appraiser designated by the Bank at the time the
application is submitted. All appraisals on multi-family loans are reviewed by
Bank management. In underwriting such loans, the Bank primarily considers the
net operating income generated by the real estate to support the debt service,
the financial resources and income level of the borrower and the Bank's
experience with the borrower. To assess the ability of a property to
adequately service debt, the Bank uses debt service coverage ratios. Debt
service coverage ratios are a means of estimating risk based upon the
relationship of debt service to an estimate of a property's stabilized net
operating income. Desired debt service coverage ratios will vary depending
upon the size of the loan, and the type and condition of the property. In
addition, the Bank's underwriting procedures require verification of the
borrower's credit history, and analysis of the borrower's income, personal
financial statements and banking relationships, a review of the property,
including cash flow projections and historical operating results, and an
analysis of the borrower's experience in owning or managing similar properties.
The Bank evaluates all aspects of multi-family lending in order to mitigate
risk to the extent possible. The Bank seeks to ensure that the property
securing the loans will generate sufficient cash flow to adequately cover
operating expenses and debt service payments. Typically, individuals guarantee
all of their multi-family loans.
7
<PAGE> 8
Loans secured by multi-family real estate generally involve a greater degree of
credit risk than one- to four-family mortgage loans and carry larger loan
balances. This increased credit risk is a result of several factors, including
the concentration of principal in a limited number of loans and borrowers, the
effects of general economic conditions on income producing properties and the
increased difficulty of evaluating and monitoring these types of loans.
Furthermore, the repayment of loans secured by multi-family real estate is
typically dependent upon the successful operation of the related real estate
project. If the cash flow from the project is reduced, the borrower's ability
to repay the loans may be impaired. Despite the risk inherent in multi-family
real estate lending, the Bank's delinquent multi-family loans as a percentage
of gross loans has been minimal.
The largest multi-family loan at June 30, 1996 had an outstanding balance of
$815,000 and was secured by a 16-unit apartment building located in Pewaukee,
Wisconsin. At June 30, 1996, this loan was current and performing in
accordance with its terms.
Commercial Real Estate Lending
The Bank originates or participates in commercial real estate loans secured
generally by small office buildings, apartment buildings, hotels and small
industrial/manufacturing buildings. At June 30, 1996, the Bank's commercial
real estate loan portfolio consisted of 18 loans totalling $4.2 million, or
15.68% of the Bank's gross loan portfolio. The Bank's underwriting standards
provide that commercial real estate loans generally may be made in amounts up
to 80% of the appraised value of the property, subject to the Bank's current
loans-to-one-borrower limit. These loans may be made with terms ranging from
three years to 25 years, fully amortized, and generally are offered at interest
rates which are fixed at prevailing market rates or which adjust in accordance
with the Seventh District Cost of Funds index. Some of the Bank's commercial
real estate loans are balloon loans. Balloon loan payments generally are
amortized on a 15-year to 25-year basis with a typical maturity of three to
five years. The Bank generally has required that the properties securing
commercial real estate loans have debt service coverage ratios of at least 1.0%
to 1.5%.
The average outstanding loan balance on each commercial/non-residential loan at
June 30, 1996 was $231,300. The largest commercial real estate loan at June
30, 1996 had an outstanding balance of $627,000 and was secured by a building
containing retail stores and offices located in Milwaukee, Wisconsin. The
largest concentration of commercial real estate loans to one borrower totalled
$918,000 at June 30, 1996 and consisted of five loans secured by an office and
warehouse building in Milwaukee, Wisconsin. All payments under the Bank's
commercial real estate loans were current at June 30, 1996.
The risks associated with commercial real estate lending are similar to the
risks associated with multi-family lending. To minimize these risks, the Bank
generally imposes similar underwriting standards in connection with commercial
real estate lending as it does with multi-family lending. Commercial real
estate loans generally are underwritten in amounts of up to 80% of the lesser
of the appraised value or purchase price of the underlying property.
Appraisals on properties which secure commercial real estate loans are
performed by an independent appraiser designated by the Bank at the time the
application is submitted. All appraisals on commercial real estate loans are
reviewed by Bank management. In addition, the Bank's underwriting procedures
require verification of the borrower's credit history, an analysis of the
borrower's income, financial statements and banking relationships, a review of
the borrower's property management experience and references and a review of
the property, including cash flow projections and historical operating results.
The Bank evaluates all aspects of commercial real estate lending in order to
mitigate risk to the extent possible. The Bank seeks to ensure that the
property securing the loans will generate sufficient cash flow to adequately
cover operating expenses and debt service payments. In addition, the Bank
obtains financial statements on an annual basis to monitor cash flow and
financial condition.
Commercial Construction and Land Development Lending
The Bank also provides construction loans secured by multi-family projects and
commercial real estate and land development loans. At June 30, 1996, the
Bank's commercial construction and land development loan portfolio totalled
$2.4 million, or 9.00% of the Bank's gross
8
<PAGE> 9
loans. The construction loans secured by multi-family projects usually will
involve the construction of eight-unit to 24-unit apartment complexes. The
construction loans secured by commercial real estate properties typically will
involve hotels or motels and office and warehouse buildings. The Bank will
originate land development loans to local developers for the purpose of
developing the land (i.e., roads, sewer and water). Construction loans secured
by multi-family projects and commercial real estate and land development loans
generally are made to existing customers of the Bank and developers and
contractors with whom the Bank has had previous lending experience, or will
involve the purchase of a participation interest from another financial
institution. Multi-family and commercial real estate construction loans
typically are originated as a one-year ARM loan, while land development loans
typically are originated as a three-year ARM loan or a three-year fixed rate
balloon loan. Multi-family and commercial real estate construction loans and
land development loans typically are originated with interest only payments
made during construction with amortization beginning upon completion. Balloon
loan payments, however, are amortized on a 15-year to 25-year basis with a
typical loan maturity of three years. These loans are priced at 250 to 350
basis points above the rate on U.S. Treasury securities for comparable
maturities. Typically, these loans are made in amounts not to exceed 80% of an
independent appraisal for multi-family or commercial real estate lending and
75% of appraisal on land development loans. These appraisals are made to
reflect absorption rates in the marketplace for both loan types and discounted
for carrying costs and cost of sale regarding land development lending. The
Bank monitors individual draws with funds disbursed based on actual work in
progress, a contractor's affidavit and an acceptable on-site inspection report.
All multi-family and commercial real estate construction loans and all land
development loans require a Phase I environmental audit prior to commitment.
At June 30, 1996, the Bank had no multi-family construction loans in its loan
portfolio; several commercial real estate construction loans in its loan
portfolio, the largest consisting of a loan of $496,400 secured by a hotel
construction project located in Milwaukee, Wisconsin; and one land development
loan with an outstanding balance of $32,800 in its loan portfolio, secured by
residential subdivision property located in Oak Creek, Wisconsin. At June 30,
1996, all of these loans were current and performing in accordance with its
terms.
Commercial construction and land development lending generally is considered to
involve a higher degree of risk than one- to four-family mortgage lending.
However, the Bank believes this lending activity affords the Bank the
opportunity to invest in relatively higher-yielding assets with shorter terms
to maturity and repricing than is the case with one-to four-family mortgage
lending. Therefore, the Bank is pursuing these lending opportunities to
increase its loan portfolio.
Other Consumer Lending
The Bank originates a variety of other consumer loans, generally consisting of
home improvement loans and loans secured by savings accounts. At June 30, 1995
and 1996, the total portfolio of these other types of loans totaled $12,000 and
$363,000, respectively, or .05% and 1.37%, respectively, of gross loans at
those dates. Home equity loans comprised 58.3% and 98.1% of other consumer
loans at June 30, 1995 and 1996, respectively. Consumer loans generally have
shorter terms and higher interest rates than mortgage loans but generally
involve more risk than mortgage-loans because of the type and nature of the
collateral and, in certain cases, the absence of collateral.
The underwriting standards generally employed by the Bank for other consumer
loans include a determination of the applicant's payment history on other debts
and an assessment of the borrower's ability to meet payments on the proposed
loans along with existing obligations. In addition to the creditworthiness of
the applicant, the underwriting process also includes a comparison of the value
of the security in relation to the proposed loan amount. Upon receipt of a
completed consumer loan application from a prospective borrower, a credit
report is ordered, income and other information is verified and, if necessary,
additional financial information is requested.
9
<PAGE> 10
For all consumer loans, the Bank's underwriters review all pertinent
information prior to making a credit decision. Consumer loans may entail
greater risk than residential mortgage loans, particularly in the case of
consumer loans which are unsecured or secured by rapidly depreciating assets
such as automobiles. Although the level of delinquencies in the Bank's
consumer loan portfolio has been low, there can be no assurance that
delinquencies will not increase in the future.
LOAN ORIGINATIONS, SALES AND PURCHASES
The following table sets forth the Bank's loan originations, sales, and
purchases, and principal repayments for the periods indicated. The Bank has no
mortgage loans held for sale.
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------
1994 1995 1996
---- ---- ----
MORTGAGE LOANS (GROSS): (IN THOUSANDS)
<S> <C> <C> <C>
At beginning of period . . . . . . . . . . . . . . . . $18,971 $20,315 $21,936
Mortgage loans originated:
One-to four-family . . . . . . . . . . . . . . . . 1,514 1,694 3,236
Multi-family . . . . . . . . . . . . . . . . . . . - - -
Commercial real estate . . . . . . . . . . . . . . - 179 1,965
Residential construction . . . . . . . . . . . . . 2,281 2,781 3,160
Commercial construction/land development . . . . . 1,437 620 940
------ ------ ------
Total mortgage loans originated . . . . . . . . . 5,232 5,274 9,301
Principal repayments . . . . . . . . . . . . . . . . (3,888) (3,653) (5,043)
Sale of loans . . . . . . . . . . . . . . . . . . . . - - -
Mortgage loans purchased(1) . . . . . . . . . . . . . - - -
------ ------- ------
At end of period . . . . . . . . . . . . . . . . . . . $20,315 $21,936 $26,194
====== ======= ======
CONSUMER LOANS (GROSS):
At beginning of period . . . . . . . . . . . . . . . . $ 18 $ 17 $ 12
Loans originated . . . . . . . . . . . . . . . . . . 200 48 371
Principal repayments . . . . . . . . . . . . . . . . (201) (53) (20)
------- ------ -------
At end of period . . . . . . . . . . . . . . . . . . . $ 17 $ 12 $ 363
====== ====== =======
</TABLE>
- --------------
(1) Mortgage loan purchases consist of whole loans purchased by the Bank from
various other lending institutions. Mortgage loan participations are
included in the appropriate loan category.
SALE OF MORTGAGE LOANS
The Bank has originated substantially all of the loans in its portfolio and
holds them to maturity. The Bank generally does not engage in the sale of
loans. However, from time to time, the Bank may sell participation interests
in loans which it has originated in order to spread credit risk associated with
the loan because of the size of the loan relative to the size of the Bank's
loan portfolio. Loan participations are sold on a non-recourse basis, and the
Bank retains the servicing on all loans it originates and of which it sells
participation interests. In the last five fiscal years, the Bank sold one
participation interest in a commercial real estate loan. At June 30, 1996, the
Bank's retained interest in this commercial real estate loan was $405,600 while
the sold participation interest in this loan totalled $133,900.
PURCHASE OF MORTGAGE LOANS
The Bank has purchased loans or participation interests in a variety of loans
originated by other lenders from time to time. The Bank purchases
participation interests with servicing released. As a participant, the Bank
acquires an individual, non-recourse ownership interest in the loan, and thus
does not have recourse against the selling institution, but rather, has direct
recourse against the borrower. Prior to purchase, the Bank reviews each
purchase or participation to ensure that the underlying loan complies with the
Bank's lending policy and the loans-to-one borrower limit.
10
<PAGE> 11
At June 30, 1996, the Bank had no purchased loans in its loan portfolio. At
June 30, 1996, the Bank held five participation loans in its loan portfolio
totalling $2.0 million, or 7.63% of the Bank's gross loan portfolio, as
follows: a multi-family loan of $755,300 (out of an original entire loan
amount of $2.6 million) secured by a 60-unit apartment building and originated
in 1992; a commercial real estate construction loan of $500,000 (out of an
original entire loan amount of $2.9 million) secured by a hotel and originated
in 1994; a land development loan of $197,200 (out of an original entire loan
amount of $1.0 million) and originated in 1993; a multi-family loan of $425,100
(out of an original entire loan amount of $900,000) secured by a 24-unit
apartment building and originated in 1988; and a commercial real estate loan of
$149,200 (out of an original entire loan amount of $485,000) secured by a
warehouse and office building and originated in 1990.
The purchase of participation loans involves the same risks as the origination
of the same types of loans as well as additional risks related to the
purchaser's lower level of control over the origination and subsequent
administration of the loan. While the Bank intends to purchase additional
participation loans in the future, management does not anticipate such activity
will be significant.
MORTGAGE LOAN BROKERING FEES
Because of its loans-to-one borrower regulatory limit, the Bank has from time
to time received a brokering fee from other financial institutions in exchange
for the opportunity to originate various mortgage loans from borrowers with
whom the Bank already has a lending relationship. For the years ended June 30,
1995 and 1996, the Bank received real estate loan brokering fees of $9,000 and
$11,000, respectively, for loan opportunities in the aggregate amount of $1.9
and $2.2 million, respectively.
LOAN APPROVAL AND MONITORING
The President of the Bank and at least one director have the authority to
approve any consumer loan, one-to four-family mortgage loan, residential
construction loan, multi-family loan, commercial real estate loan, commercial
construction loan or land development loan, up to $150,000, provided the
loan-to-value ratio does not exceed 80%. All loans exceeding this amount and
all loans upon which the loan-to-value ratio exceeds 80% are presented to the
Board of Directors for approval. The Bank's Board of Directors reviews on a
monthly basis all loans made, and ratifies all actions taken relating to loan
approvals.
LOAN ORIGINATION, SERVICING AND OTHER FEES
In addition to interest earned on loans, the Bank receives income through fees
in connection with loan originations, loan modifications, late payments and for
miscellaneous services related to its loans. Income from these activities
varies from period to period with the volume and type of loans originated.
In connection with the origination of mortgage loans, the Bank charges points
for origination and commitment, and fees for processing and closing in addition
to requiring borrower reimbursement for out-of-pocket costs associated with
obtaining independent appraisals, credit reports, title insurance, private
mortgage insurance and other items. Because of the highly competitive mortgage
market in which the Bank originates loans, the point structure varies
considerably, depending upon the type of mortgage loan being made, its interest
rate and other competitive factors. The Bank charges origination fees ranging
from zero to two points on mortgage loan originations, and such points usually
vary inversely with the interest rate on the loan. That is, the amount of the
origination fee is typically higher with a lower interest rate and lower if a
higher interest rate is established for the loan. Since the availability of
zero point mortgage loans in recent years, most borrowers typically accept a
slightly higher interest rate and pay zero points. Fees are paid by the
applicant at the time of loan commitment, whereas the origination fees are paid
at the time of closing.
Accounting standards adopted under FASB 91 prescribe the accounting treatment
for origination and commitment fees. Loan origination and commitment fees and
certain direct loan origination costs are being deferred and the net amounts
amortized as an adjustment of the related loan's yield. These amounts are
amortized to interest income using the level yield
11
<PAGE> 12
method over the contractual life of the related loans. Deferred loan fees
totalled $106,000, $109,000 and $134,000, at June 30, 1994, 1995 and 1996,
respectively. Deferred loan origination fees and costs associated with loans
sold are recognized at the time of sale as a component for gain or loss on the
sale of loans.
DELINQUENCIES, NON-PERFORMING ASSETS AND CLASSIFIED ASSETS
At June 30, 1996, the Bank had no nonperforming assets, classified assets or
loans delinquent more than 89 days.
DELINQUENT LOANS
Management and the Bank's Board of Directors perform a monthly review of all
delinquent loans. The procedures taken by the Bank with respect to
delinquencies vary depending on the type of loan, delinquent amount and age of
delinquency. The Bank generally requires that delinquent loans be reviewed and
a written late charge notice be mailed not later than the 15th day of
delinquency. The Bank's policies provide that telephone contact will be
attempted to ascertain the reasons for delinquency and the prospects of prompt
payment. When contact is made with the borrower at any time prior to
foreclosure, the Bank will attempt to obtain full payment or work out a
repayment schedule with the borrower to avoid foreclosure. It is the Bank's
general policy to continue to accrue interest on all loans which are past due
up to 90 days. When a loan secured by a mortgage is delinquent for 90 or more
days, the Bank generally will initiate foreclosure proceedings. Property
acquired by the Bank as a result of foreclosure on a loan is classified as
"real estate owned" and is recorded at the lower of the unpaid principal
balance or fair value less costs to sell at the date of acquisition and
thereafter. Upon foreclosure, it is the Bank's policy generally to require an
appraisal of the property and, thereafter, appraisal of the property on an
annual basis and external inspections on at least a quarterly basis.
12
<PAGE> 13
At June 30, 1994, 1995, and 1996, delinquencies in the Bank's loan portfolio
were as follows:
<TABLE>
<CAPTION>
At June 30, 1994 At June 30, 1995
------------------------------------------------- ----------------------
60-89 Days 90 Days or More(1) 60-89 Days
--------------------- ------------------------- ----------------------
Principal Principal Principal
Number Balance Number Balance Number Balance
of Loans of Loans of Loans of Loans of Loans of Loans
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Mortgage loans:
One-to four-family $ 0 $ -- $ 0 $ -- $0 $ --
Multi-family 0 -- 0 -- 0 --
Commercial/real estate 0 -- 0 -- 0 --
Residential construction 0 -- 0 -- 0 --
Commercial construction/land
development 0 -- 0 -- 0 --
- ---- - ---- - ----
Total mortgage loans 0 -- 0 -- 0 --
- ---- - ---- - ----
Consumer loans:
Home equity 0 -- 0 -- 0 --
Other consumer 0 -- 0 -- 0 --
- ---- - ---- - ----
Total consumer loans 0 -- 0 -- 0 --
- ---- - ---- - ----
Total gross loans 0 $ -- 0 $ -- 0 $ --
= ==== = ==== = ====
Delinquent loans to gross loans
(including loans held for sale) 0.00% 0.00% 0.00%
<CAPTION>
At June 30, 1995 At June 30, 1996
---------------------- ----------------------------------------------------
90 Days or More(1) 60-89 Days 90 Days or More(1)
---------------------- ----------------------------------------------------
Principal Principal Principal
Number Balance Number Balance Number Balance
of Loans of Loans of Loans of Loans of Loans of Loans
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage loans:
One-to four-family $ 0 $ -- $ 0 $ -- $ 0 $ --
Multi-family 0 -- 0 -- 0 --
Commercial/real estate 0 -- 0 -- 0 --
Residential construction 0 -- 0 -- 0 --
Commercial construction/land
development 0 -- 0 -- 0 --
- ---- - ---- - ---
Total mortgage loans 0 -- 0 -- 0 --
- ---- - ---- - ---
Consumer loans:
Home equity 0 -- 0 -- 0 --
Other consumer 0 -- 0 -- 0 --
- ---- - ---- - ---
Total consumer loans 0 -- 0 -- 0 --
- ---- - ---- - ---
Total gross loans 0 $ -- 0 $ -- 0 $ --
= ===== = ===== = =====
Delinquent loans to gross loans
(including loans held for sale) 0.00% 0.00% 0.00%
</TABLE>
(1) The Bank discontinues the accrual of interest on loans when the borrower is
delinquent as to a contractually due principal or interest payment by 90
days or more.
13
<PAGE> 14
NON-PERFORMING ASSETS
Loans are placed on non-accrual status when, in the judgment of Bank
management, the probability of collection of principal or interest is deemed
insufficient to warrant further accrual of interest. The Bank discontinues the
accrual of interest on loans when the borrower is delinquent as to a
contractually due principal or interest payment by 90 days or more. When a
loan is placed on non-accrual status, all of the accrued interest on that loan
is reversed by way of a charge to interest income. Accrual of interest on a
non-accrual loan is resumed when all contractually past due payments are
current and when management believes the outstanding loan principal and
contractually due interest is no longer doubtful of collection.
Property acquired by the Bank as a result of a foreclosure, property upon which
a judgment of foreclosure has been entered but prior to foreclosure sale and
property which has been in substance foreclosed are classified as foreclosed
properties. Foreclosed properties are recorded at the lower of the unpaid
principal balance of the related loan or fair market value. The amount by
which the recorded loan balance exceeds the fair market value at the time a
property is classified as foreclosed property is charged against the allowance
for loan losses. Any subsequent reduction in the carrying value of a
foreclosed property, along with expenses incurred to maintain or dispose of a
foreclosed property, is charged against current earnings. At June 30, 1996,
the Bank had no properties in foreclosure or in substance foreclosed.
Non-performing loans include loans placed on non-accrual status and troubled
debt restructurings. Non-performing assets consist only of non- performing
loans, since there are no foreclosed properties for the periods indicated
below. The following table sets forth non-performing loans and assets:
<TABLE>
<CAPTION>
At June 30,
---------------------------
1994 1995 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Nonaccrual mortgage loans . . . . . . . . . . . . . . . . . $ -- $ -- $ --
Nonaccrual consumer loans . . . . . . . . . . . . . . . . . -- -- --
Real estate in judgment . . . . . . . . . . . . . . . . . . 78 -- --
---- ---- ----
Total non-performing assets . . . . . . . . . . . . . . . $ 78 $ -- $ --
==== ==== ====
Total non-performing assets to gross loans receivable . . . 0.38% 0.00% 0.00%
==== ==== ====
Total non-performing assets to total assets . . . . . . . . 0.24% 0.00% 0.00%
==== ==== ====
Interest on non-performing loans on the accrual basis . . . $ 9 $ -- $ --
Actual interest received on non-performing loans . . . . . . 2 -- --
---- ---- ----
Net reduction of interest income . . . . . . . . . . . . . $ 7 $ -- $ --
==== ==== ====
</TABLE>
There are no concentrations of loans exceeding 10% of loans which are not
otherwise disclosed as a category of loans.
As of June 30, 1996, there were no other loans not included in the foregoing
tables or discussed above where known information about the possible credit
problems of borrowers caused management to have serious doubts as to the
ability of the borrower to comply with present loan repayment terms and which
may result in disclosure of such loans in the future.
As of June 30, 1996, the Bank had no real estate owned ("REO"). If the Bank
were to acquire any REO, it would initially record the REO at the lower of the
recorded investment in the loan or the fair value of the assets securing the
loan at the date of foreclosure, less costs to sell. Thereafter, if there were
a further deterioration in value, the Bank would either rewrite down the REO
directly or provide a valuation allowance and charge operations for the
reduction in value. The policy for loans secured by real estate, which
comprise the bulk of the Bank's portfolio, is to establish loss reserves in
accordance
14
<PAGE> 15
with the Bank's loan classification process, based on GAAP. It is the policy
of the Bank to obtain an appraisal on all real estate acquired through
foreclosure at the time of foreclosure.
CLASSIFICATION OF ASSETS
Federal regulations require that each insured financial institution classify
its assets on a regular basis. In addition, in connection with examinations of
insured institutions by regulatory authorities, regulatory examiners have
authority to identify problem assets as Substandard, Doubtful or Loss.
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the Bank will sustain some loss if the
deficiencies are not corrected. Doubtful assets have the weaknesses of
Substandard assets with the additional characteristics that the weaknesses make
collection or liquidation in full, on the basis of currently existing facts,
conditions and values, questionable, and there is a high possibility of loss.
An asset classified as Loss is considered uncollectible and of such little
value that continuance as an asset of the Bank is not warranted. The Bank has
adopted an asset classification methodology which parallels that required by
federal regulations. Assets classified as Substandard or Doubtful require the
Bank to establish prudent general allowances for loan losses. Assets
classified as Loss must either be charged off or must have a specific allowance
established for 100% of the asset classified as a Loss.
At June 30, 1996, based upon the Bank's asset classification methodology, the
Bank had no assets classified as Substandard, Doubtful or Loss.
ALLOWANCE FOR LOAN LOSSES
Under federal regulations, when an insured institution classifies problem
assets as either Substandard or Doubtful, it is required to establish general
allowances for loans losses in an amount deemed prudent by management. In
addition to general valuation allowances, the Bank may establish specific loss
reserves against specific assets in which a loss may be realized. General
allowances represent loss allowances which have been established to recognize
the inherent risks associated with lending activities, but which, unlike
specific allowances, have not been allocated to recognize probable losses on
particular problem assets. The Bank's determination as to its classification
of assets and the amount of its specific and general valuation allowances are
subject to review by the DSL and the FDIC, either of which can order the
establishment of additional general or specific loss allowances.
The FDIC, in conjunction with the other federal banking agencies, has adopted
an interagency policy statement on the allowance for loan and lease losses.
The policy statement provides guidance for financial institutions on both the
responsibilities of management for the assessment and establishment of adequate
allowances and guidance for banking agency examiners to use in determining the
adequacy of general valuation guidelines. Generally, the policy statement
recommends that institutions have effective systems and controls to identify,
monitor and address asset quality problems; management has analyzed all
significant factors that affect the collectibility of the portfolio in a
reasonable manner; and management has established acceptable allowance
evaluation processes that meet the objectives set forth in the policy
statement. While the Bank believes that it has established an adequate
allowance for loan losses, there can be no assurance that regulators, in
reviewing the Bank's loan portfolio, will not request the Bank to materially
increase at that time its allowance for loan losses, thereby negatively
affecting the Bank's financial condition and earnings at that time. Although
management believes that adequate specific and general loan loss allowances
have been established, actual losses are dependent upon future events and, as
such, further additions to the level of specific and general loan loss
allowances may become necessary.
15
<PAGE> 16
The allowance for loan losses is established through a provision for loan
losses based on management's evaluation of the risk inherent in its portfolio
and the general economy. Such evaluation, which includes a review of all loans
on which full collectibility may not be reasonably assured, considers, among
other matters, the estimated value of the underlying collateral, the nature and
type of collateral, economic conditions, recent loan loss experience, industry
standards, regulatory considerations and other factors that warrant recognition
in providing for an adequate loss allowance. There can be no assurance that
the allowance for loan losses will be adequate to cover losses which may in
fact be realized in the future and that additional provisions for loan losses
will not be required. The amount of the provision for loan losses for the
years ended June 30, 1994, 1995 and 1996 reflected management's intention to
continue to make annual additions to the Bank's allowance for loan losses until
it is equal to approximately 1.0% of the Bank's gross loan portfolio. However,
the Bank will continue to monitor its loan loss experience, the condition and
composition of its loan portfolio and general economic conditions, and may make
further additions to its allowance for loan losses to a greater or lesser
extent than it has done historically, depending upon changes in the
aforementioned conditons.
The following table sets forth the Bank's allowance for loan losses at the
dates indicated.
<TABLE>
<CAPTION>
At June 30,
-------------------------------------
1994 1995 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of period . . . . . . . . . . . . . . . $ 62 $ 84 $ 104
Provision for loan losses . . . . . . . . . . . . . . . . . 22 22 22
Charge-offs net of recoveries:
Mortgage loans . . . . . . . . . . . . . . . . . . . . -- 2 --
Consumer loans . . . . . . . . . . . . . . . . . . . . -- -- --
---- ---- ----
Total charge-offs (net) . . . . . . . . . . . . . . . . . . -- 2 --
---- ---- ----
Balance at end of period . . . . . . . . . . . . . . . . . . $ 84 $ 104 $ 126
==== ==== ====
Ratio of allowance for loan losses to gross loans receivable
at the end of period . . . . . . . . . . . . . . . . . 0.41% 0.47% 0.47%
Ratio of allowance for loan losses to non-performing loans
at the end for period . . . . . . . . . . . . . . . . 0.00% 0.00% 0.00%
Ratio of allowance for loan losses to total non-performing
assets at the end of period . . . . . . . . . . . . . 107.69% 0.00% 0.00%
Ratio of net charge-offs to average gross loans during
period . . . . . . . . . . . . . . . . . . . . . . . . 0.00% 0.01% 0.00%
</TABLE>
The following table shows the Bank's total allowance for loan losses and the
allocation to the various categories of loans held for investment at the dates
indicated. It is not anticipated that charge-offs during the year ending June
30, 1997 will exceed the amount allocated to any individual category of loans.
16
<PAGE> 17
<TABLE>
<CAPTION>
At June 30,
----------------------------------------------------------------------------------------------
1994 1995 1996
---------------------- ----------------- --------------------
% of Total
Loans in Loans in Loans in
Category Category Category
% of Total To Total % of Total To Total % of Total To Total
Loans by Outstanding Loans by Outstanding Loans by Outstanding
Amount Category Loans Amount Category Loans Amount Category Loans
------ -------- ----- ------ -------- ----- ------ -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Breakdown of Allowance:
Mortgage Loans
One-to-four family 38 0.41% 45.21% 50 0.47% 47.51% 51 0.47% 40.46%
Commercial real estate 15 0.41% 17.79% 18 0.47% 17.68% 20 0.47% 15.68%
Multi-family 20 0.41% 24.12% 22 0.47% 21.46% 22 0.47% 17.26%
Commercial construction 4 0.41% 4.73% 3 0.47% 3.16% 11 0.47% 9.00%
Residential construction 7 0.41% 8.07% 11 0.47% 10.14% 20 0.47% 16.23%
-- ----- ------- --- ----- ------- --- ----- -------
Total mortgage loans 84 0.00% 99.92% 104 0.00% 99.95% 124 0.00% 98.63%
Consumer loans 0 0.08% 0 0.05% 2 1.37%
-- ------- --- ------- --- -------
Total allowance for loan losses 84 100.00% 104 100.00% 126 100.00%
== ======= === ======= === =======
</TABLE>
(1) The Bank expects to maintain at a minimum an allowance of .40% of its loan
portfolio.
17
<PAGE> 18
INVESTMENT ACTIVITIES
GENERAL
The investment policy of the Bank, which is established by the Board of
Directors and implemented by the Bank's management, is designed primarily to
provide and maintain required liquidity, generate a favorable return on
investments without incurring undue interest rate and credit risk and
complement the Bank's lending activities. The Bank primarily invests in
mortgage-backed and related securities. United States treasury obligations and
mutual funds (the assets of which are comprised primarily of government
guaranteed mortgage-backed and related securities).
The Bank's investment policy permits investment in various types of liquid
assets authorized under FDIC and state regulations, which include U.S. Treasury
obligations, securities of various federal agencies, certain certificates of
deposit of insured banks and savings institutions, certain banker's acceptances
and deposits at the FHLB-Chicago. The Bank also is permitted to invest in
commercial paper, mutual funds, investment grade corporate debt securities and
mortgage-backed and related securities. Investment and aggregate investment
limitations and credit quality parameters of each class of investment are
prescribed in the Bank's investment policy. The Bank performs analyses on
mortgage related securities prior to purchase and on an ongoing basis to
determine the impact on earnings and market value under various interest rate
and prepayment conditions. The Bank's investment policy prohibits the Bank
from engaging in hedging activities which involve the use of options, futures,
interest rate swaps or forward commitments, and from purchasing non-investment
grade corporate debt securities. During the years ended June 30, 1994, 1995
and 1996, the Bank did not hold any derivative financial instruments in its
investment portfolio to which the provisions of SFAS No. 119 would apply.
The Bank categorizes the securities it purchases into a "Held to Maturity" or
"Available for Sale" portfolio as follows:
1. Securities Held to Maturity. The Bank has the ability and intent to hold
these assets to maturity. Upon acquisition, securities are classified as
to the Bank's intent and a sale would only be effected due to
deteriorating investment quality. The investment portfolio is not used
for speculative purposes and is carried at amortized cost. In the event
the Bank sells securities from this portfolio for other than credit
quality reasons, all securities within the investment portfolio with
matching characteristics may be reclassified as assets held for sale.
2. Securities Available for Sale. The Bank does not intend to hold these
assets to maturity and thus are carried at an amount which is the lower
of aggregate cost or market value with unrealized losses recognized as a
component of stockholders' equity. This portion of the securities
portfolio is designed to meet anticipated loan demand and deposit runoff
or to take advantage of market opportunities.
MORTGAGE-BACKED SECURITIES
At June 30, 1996, the Bank's mortgage-backed securities portfolio totalled
$700,000, and consisted of $679,000 of GNMA participation certificates and
$21,000 of FHLMC participation certificates.
Mortgage-backed securities represent a participation interest in a pool of
single-family or multi-family mortgage loans, the principal and interest
payments on which are passed from the mortgage loan originators through
intermediaries (generally federal government-sponsored enterprises) that pool
and repackage the participation interest in the form of securities to investors
such as the Bank. Such federal government-sponsored enterprises, which
guarantee the payment of principal and interest to investors include FHLMC,
FNMA and GNMA. Mortgage- backed securities generally increase the quality of
the Bank's assets by virtue of the guarantees that back them, are more liquid
than individual mortgage loans and may be used to collateralize borrowings or
other obligations of the Bank.
18
<PAGE> 19
Mortgage-backed securities typically are issued with stated principal amounts
and the securities are backed by pools of mortgage loans with interest rates
within a range and have varying maturities. The underlying pool of mortgage
loans can be composed of either fixed rate mortgage or ARM loans.
Mortgage-backed securities commonly are referred to as mortgage participation
certificates or pass-through certificates. As a result, the interest rate risk
characteristics of the underlying pool of mortgage loans (i.e., fixed rate or
adjustable rate), as well as prepayment risk, are passed on to the certificate
holder. The life of a mortgage-backed pass-through security is equal to the
life of the underlying mortgage loans.
The actual maturity of a mortgage-backed security varies, however, depending on
when the mortgagors prepay or repay the underlying mortgage loans. Prepayments
of the underlying mortgage loans may shorten the life of the investment,
thereby adversely affecting its yield to maturity and the related market value
of the mortgage-backed security. The yield is based upon the interest income
and the amortization of the premium or accretion of the discount, related to
the mortgage-backed security. Premiums and discounts on mortgage-backed
securities are amortized or accreted over the estimated term of the securities
using a level yield method. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed security and these assumptions are reviewed
periodically to reflect the actual prepayment. The actual prepayments of the
underlying mortgage loans depend on many factors, including type of mortgage
loans and general levels of market interest rates. The difference between the
interest rates on the underlying mortgage loans and the prevailing mortgage
interest rates is an important determinant in the rate of prepayments. During
periods of falling mortgage interest rates, prepayments generally increase. If
the coupon rate of the underlying mortgage loans significantly exceeds the
prevailing market interest rates offered for mortgage loans, refinancing
generally increases and accelerates the prepayment of the underlying mortgage
loans. Prepayment experience is more difficult to estimate for adjustable rate
mortgage-backed securities. While mortgage-backed securities carry a reduced
credit risk as compared to whole loans (and generally yield less than the loans
that underlie such securities because of the cost payment guarantees or credit
enhancements that result in nominal credit risk), such securities remain
subject to the risk that a fluctuating interest rate environment, along with
other factors such as the geographic distribution of the underlying mortgage
loans, may alter the prepayment rate of such mortgage loans and so affect both
the prepayment speed and value of such securities.
MORTGAGE-RELATED SECURITIES
At June 30, 1996, the Bank's mortgage-related securities portfolio totalled
$100,000, consisting entirely of CMOs which were issued by the FHLMC. CMOs are
typically issued by a special purpose entity, which may be organized in a
variety of legal forms, such as a trust, a corporation or a partnership. The
entity aggregates pools of pass-through securities, which are used to
collateralize the mortgage-related securities. Once combined, the cash flows
can be divided into "tranches" or "classes" of individual securities, thereby
creating more predictable average lives for each security than the underlying
pass-through pools. Accordingly, under this security structure all principal
paydowns from the various mortgage pools are allocated to a mortgage-related
securities class or classes, structured to have priority until it has been paid
off. Thus, these securities are intended to address the reinvestment concerns
associated with mortgage-backed security pass- throughs, namely that they tend
to pay off when interest rates fall. Bank management believes these securities
represent attractive alternatives relative to other investments due to the wide
variety of maturity and repayment options available through such investments
and due to the limited prepayment risk associated with such investments. The
Bank has not purchased and does not intend to purchase higher risk CMO
residuals or stripped mortgage securities for its investment securities
portfolio. The Bank's investment in CMOs are primarily in short- and
intermediate-term (1-5 years) fixed rate tranche securities.
19
<PAGE> 20
COMPOSITION OF THE BANK'S MORTGAGE-BACKED AND RELATED SECURITIES PORTFOLIO
The table below sets forth certain information regarding the carrying value,
weighted average yields and maturities of the Bank's mortgage- backed and
related securities held for investment at June 30, 1996. At June 30, 1996, the
Bank did not have any mortgage-backed and related securities held for sale.
<TABLE>
<CAPTION>
At June 30, 1996
--------------------------------------------------------------------
One Year or Less Over One to Five Years Over Five to Ten Years
----------------- ---------------------- ----------------------
Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities:
GNMA $ -- --% $ -- --% $ 242 8.57%
FHLMC -- -- 21 9.00 -- --
Mortgage-related securities:
CMOs -- -- -- -- -- --
---- --- ---- ----- ----- ----
Total mortgage-backed and related
securities $ -- --% $ 21 9.00% $ 242 8.57%
==== ==== ==== ===== ===== ====
<CAPTION>
At June 30, 1996
---------------------------------------------------------------------------
Mortgage-Backed and Related Securities
Over Ten Years Totals
------------------ ---------------------------------------
Average
Weighted Remaining Approximate Weighted
Carrying Average Years To Carrying Average Market
Value Yield Maturity Value Value Yield
----- ------- -------- ----- ----- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities:
GNMA $ 437 10.20% 15.18 $ 679 $ 735 9.90%
FHLMC -- -- 4.92 21 22 9.00
Mortgage-related securities:
CMOs 100 6.00 22.96 100 95 6.00
----- ----- ----- ----- ----- ----
Total mortgage-backed and related
securities $ 537 9.78% 15.58 $ 800 $ 852 9.51%
===== ==== ===== ===== ===== ====
</TABLE>
The following table sets forth certain information regarding carrying and
market values and percentage of total carrying values of the Bank's
mortgage-backed and related securities portfolio held for investment.
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------------------------------
1994 1995
------------------ ---------------------
(Dollars in thousands)
Carrying Market Carrying Market
Value % of Total Value Value % of Total Value
------ ---------- ----- ------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities:
GNMA $ 1,151 89.15% $ 1,278 $ 896 87.84% $ 966
FHLMC 40 3.10 41 24 2.35 26
Mortgage-related securities:
CMOs 100 7.75 91 100 9.81 95
------- ------ ------- ------- ------ -----
Total mortgage-backed and related securities $ 1,291 100.00% $ 1,410 $ 1,020 100.00% $ 1,087
======= ====== ======= ====== ====== =======
<CAPTION>
At June 30,
---------------------------------------
1996
----------
(Dollars in thousands)
Carrying Market
Value % of Total Value
------- ---------- ------
<S> <C>
Mortgage-backed securities:
GNMA $ 679 84.88% $ 735
FHLMC 21 2.62 22
Mortgage-related securities:
CMOs 100 12.50 95
----- ------ -----
Total mortgage-backed and related securities $ 800 100.00% $ 852
===== ======= =====
</TABLE>
20
<PAGE> 21
The following table sets forth the activity in the Bank's mortgage-backed and
related securities portfolio during the periods indicated.
<TABLE>
<CAPTION>
Years Ended June 30,
------------------------------
1994 1995 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
MORTGAGE-BACKED AND RELATED SECURITIES HELD FOR INVESTMENT
At beginning of period . . . . . . . . . . . . . . . . $1,984 $1,291 $1,020
Purchases . . . . . . . . . . . . . . . . . . . . . 100 -- --
Sales . . . . . . . . . . . . . . . . . . . . . . . -- -- --
Repayments . . . . . . . . . . . . . . . . . . . . . (803) (273) (221)
Premium/discount amortization . . . . . . . . . . . 10 2 1
----- ----- -----
End of period . . . . . . . . . . . . . . . . . . . . $1,291 $1,020 $ 800
===== ===== =====
</TABLE>
The Bank may, in future periods, leverage its capital base by using the
proceeds of borrowings from the FHLB-Chicago to purchase mortgage- backed and
related securities or investment securities. Therefore, if the leveraging
strategy is implemented, the size of the Bank's mortgage- backed and related
securities portfolio may increase in future periods.
INVESTMENT SECURITIES
The Bank invests in various types of liquid assets that are permissible
investments for state chartered savings banks, including United States Treasury
obligations, securities of various federal agencies, certain certificates of
deposit of federally insured banks and savings institutions and federal funds.
Subject to various restrictions, the Bank also may invest its assets in
commercial paper, mutual funds, and investment grade corporate debt securities.
The Bank's current investment policy permits purchase only of investments rated
investment grade (i.e., rated in one of the top four rating categories) by a
nationally recognized statistical rating organization ("NRSRO") and does not
permit purchases of securities of non-investment grade quality. Investment
securities generally are carried at cost, as adjusted for amortization of
premiums and accretion of discounts, because it is management's intention to
hold such securities to maturity.
A significant portion of the Bank's investment securities portfolio consists of
U.S. government and other agency obligations and mutual fund investments. At
June 30, 1996, U.S. government and other agency obligations investments
totalled $11.2 million or 57.29% of the Bank's total investment securities
portfolio. The amount of these securities increased significantly during the
year ended June 30, 1996 as proceeds from the Conversion were invested. At
June 30, 1996, mutual fund investments totalled $5.4 million, or 27.42%, of the
Bank's total investment securities portfolio. All of the Bank's mutual fund
investments are permissible investments under the Bank's investment policy and
all other applicable regulations. Mutual fund investments are carried at
market value. Management anticipates that the Bank's investment portfolio may
decrease in fiscal 1997 if the Bank is successful in diversifying and expanding
its mortgage loans originations, and expanding its deposit funding through the
building or acquisition of branch facilities or the acquisition of other
financial institutions.
21
<PAGE> 22
The following table sets forth investment securities issued by a single entity
with a total carrying value in excess of 10% of the Bank's retained earnings at
June 30, 1996 and all mutual fund investments contained in the Bank's
investment securities portfolio at June 30, 1996.
<TABLE>
<CAPTION>
Carrying Market
Value at Value at
Name of Issuer June 30, 1995 June 30, 1996
-------------- ------------- -------------
(In thousands)
<S> <C> <C>
Federated ARMS Fund, Institutional Shares,
251,004.016 shares . . . . . . . . . . . . . . . . . $2,500 $2,420
Asset Management Fund, Inc., Adjustable Rate Mortgage
(ARM) Portfolio, 122,517.732 shares . . . . . . . . 1,225 1,215
Federated Short-Term Income Fund (A Portfolio of
Federate Income Securities Trust), Institutional
Shares, 109,409.19 shares . . . . . . . . . . 1,000 947
FHLB Bond, due 11/21/97 . . . . . . . . . . . . . . . 2,000 1,996
Strong Government Securities Fund, 74,976.57
shares . . . . . . . . . . . . . . . . . . . . . . 800 768
FHLMC Bond, due 11/20/98 . . . . . . . . . . . . . . . 1,986 1,980
</TABLE>
22
<PAGE> 23
COMPOSITION OF THE BANK'S INVESTMENT SECURITIES PORTFOLIO
The following table sets forth certain information regarding the fair market
values and the amortized cost or market value of the Bank's investment
securities.
<TABLE>
<CAPTION>
At June 30,
---------------------------------------------------------------------------------------
1994 1995
--------------------------------------- -----------------------------------------
Amortized Amortized
Cost or Cost or
Carrying Market Carrying Market
Value % of Total Value Value % of Total Value
----- ---------- ----- ----- ---------- -----
<S> <C> <C> <C> <C> <C> <C>
(Dollars in thousands)
Securities available for sale:
Equity securities-mutual funds $ 6,564 96.02% $ 6,789 $ 5,884 95.01% $ 6,028
Corporate debt securities -- -- -- -- -- --
Equity securities-FHLMC stock 272 3.98 27 309 4.99 27
------- ------ ------- ------- ------ -------
Total investment securities available for
sale $ 6,836 100.00% $ 6,816 $ 6,193 100.00% $ 6,055
======= ====== ======= ======= ====== =======
Securities held to maturity:
U.S. Government and other agency
obligations $ 2,182 52.15% $ 2,175 $ 2,196 77.68% $ 2,203
Certificates of deposit 1,864 44.55 1,864 479 16.94 479
FHLB stock 138 3.30 138 152 5.38 152
------ ------ ------ ------ ------ ------
Total securities held to maturity $ 4,184 100.00% $ 4,177 $ 2,827 100.00% $ 2,834
======= ====== ======= ======= ====== =======
<CAPTION>
At June 30,
---------------------------------------
1996
---------------------------------------
Amortized
Cost or
Carrying Market
Value % of Total Value
----- ---------- -----
<S> <C> <C> <C>
(Dollars in thousands)
Securities available for sale:
Equity securities-mutual funds $ 5,350 67.88% $ 5,525
Corporate debt securities 1,955 24.80 1,955
Equity securities-FHLMC stock 577 7.32 28
------ ------ -------
Total investment securities available for
sale $ 7,882 100.00 $ 7,508
======= ====== =======
Securities held to maturity:
U.S. Government and other agency
obligations $11,178 96.12% $11,161
Certificates of deposit 294 2.53 294
FHLB stock 157 1.35 157
------ ------ -------
Total securities held to maturity $11,629 100.00% $11,813
======= ====== =======
</TABLE>
23
<PAGE> 24
The table below sets forth certain information regarding the carrying value or
amortized cost, weighted average yields and maturities of the Bank's investment
securities at June 30, 1996.
<TABLE>
<CAPTION>
At June 30, 1996
-----------------------------------------------------------------------------
One Year or Less Over One to Five Years Over Five to Ten Years
---------------------- ----------------------- ------------------------
Carrying Carrying Carrying
Value or Weighted Value or Weighted Value or Weighted
Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield
---- ----- ---- ----- ---- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Securities held to maturity:
U.S. Government and other
agency obligations $ 498 5.75% $ 8,479 6.16% $ 1,000 8.00%
Certificates of deposit 100 5.25 194 5.40 -- --
FHLB stock -- -- -- -- -- --
---- ---- ----- ----- ----- ----
Total securities held to
maturity $ 598 5.67% $ 8,673 6.15 $ 1,000 8.00%
==== ==== ====== ==== ====== ====
Securities available for sale:
Equity securities-mutual funds $ -- --% $ -- --% --% --%
Corporate debt securities -- -- -- -- -- --
Equity securities-FHLMC stock -- -- -- -- -- --
---- ---- ----- ----- ----- ----
Total securities available for
sale $ -- --% $ -- --% --% --%
==== ==== ====== ==== ====== ====
<CAPTION>
At June 30, 1996
------------------------------------------------------------------------------------------------
No
Contractual
Over Ten Years Maturity Investment Securities Totals
------------------- ------------- ----------------------------
Carrying Carrying Average Carrying
Value or Weighted Value or Remaining Value or Approximate Weighted
Amortized Average Amortized Years to Amortized Market Average
Cost Yield Cost Maturity Cost Value Yield
---- ----- ---- -------- ---- ----- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Securities held to maturity:
U.S. Government and other
agency obligations $ 1,200 7.00% $ -- 5.56% $11,178 $ 11,161 6.40%
Certificates of deposit -- -- -- 2.05 294 294 5.35
FHLB stock -- -- 157 -- 157 157 6.68
------ ---- ----- ------- ------- -----
Total securities held to
maturity $ 1,200 7.00% $ 157 $11,629 $ 11,612 6.38%
====== ==== ===== ====== ====== ====
Securities available for sale:
Equity securities-mutual funds $ -- -- 5,350 $ 5,525 $ 5,350 6.17%
Corporate debt securities 1,955 5.47 -- 27.29 1,955 1,955 5.47
Equity securities-FHLMC stock -- -- 576 -- 28 577 31.49
------ ---- ----- ------ ------ -----
Total securities available for
sale $ 1,955 5.47% $ 5,926 $ 7,508 $ 7,882 6.08%
====== ==== ===== ====== ===== =====
</TABLE>
24
<PAGE> 25
SOURCES OF FUNDS
GENERAL
The Bank's primary sources of funds for use in lending, investing and for other
general purposes are deposits, proceeds from principal and interest payments on
loans, mortgage-backed and related securities and investment securities.
Contractual loan payments are a relatively stable source of funds, while
deposit inflows and outflows and loan prepayments are significantly influenced
by general market interest rates and economic conditions. Borrowings may be
used on a short-term basis to compensate for seasonal or other reductions in
normal sources of funds or for deposit inflows at less than projected levels.
The Bank is a member of the FHLB-Chicago and may borrow from the FHLB-Chicago.
The Bank also has other lines of credit available for borrowing purposes with
other local financial institutions.
DEPOSITS
The Bank offers a variety of deposit accounts having a range of interest rates
and terms. The Bank's deposits principally consist of demand accounts
(non-interest bearing checking, NOW, MMDA and passbook) and certificates of
deposit. The flow of deposits is influenced significantly by general economic
conditions, changes in prevailing interest rates and competition. The Bank's
deposits are obtained primarily from the area in which its office is located,
and the Bank relies principally on customer service, marketing programs and
long-standing relationships with customers to attract and retain these
deposits. Various types and limited amounts of advertising and promotion to
attract and retain deposit accounts also are used. The Bank does not currently
solicit or currently accept brokered deposits. Management monitors the Bank's
certificate accounts and based on historical experience, management believes it
will retain a large portion of such accounts upon maturity. Management
considers Bank profitability, the matching of term lengths with assets, the
attractiveness to customers and rates offered by competitors in deposit
offerings and promotions. The Bank has been competitive in the types of
accounts and interest rates it has offered on its deposit products. The Bank
intends to continue its efforts to attract deposits as a primary source of
funds for supporting its lending and investing activities.
The Bank sets interest rates on its deposits on a weekly basis, based upon a
number of factors, including: (i) the previous week's deposit flow; (ii) a
current survey of selected group of competitors' rates for similar products;
(iii) external data which may influence interest rates; (iv) investment
opportunities and loan demand; and (v) scheduled maturities.
The following table presents the deposit activity of the Bank for the periods
indicated. During the low interest rate environment over the past three years,
the Bank's deposits have declined, with depositors shifting funds from lower
interest certificates of deposit to mutual funds and other investment
alternatives offering higher yields. In addition, although the Bank has been
competitively pricing its deposit products over the past two years, its core
deposits have continued to decline. The Bank believes its office location and
the characteristics of its local market area are primary contributors to this
continued decline. See "--Market Area and Competition". One of the goals of
the Conversion was to enhance the Bank's ability to build or acquire at least
one additional branch facility to be located with the Bank's primary market
area of the Milwaukee MSA; management believes that the Bank needs to grow and
expand if it is to remain competitive and to counteract limited loan demand and
deposit funds in its local market area. Management believes that an additional
branch facility will enable the Bank to attract deposits form the local areas
surrounding such facilities. In addition, the Bank's deposit account balance
has declined by the amount authorized to be withdrawn by depositors for payment
for shares of Common Stock in connection with the Conversion.
25
<PAGE> 26
<TABLE>
<CAPTION>
Years Ended June 30,
------------------------------------
1994 1995 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Deposits $ 6,104 $ 4,977 $ 2,289
Withdrawals 7,359 6,808 7,334
------ ------ ------
Net deposits (withdrawals) (1,255) (1,831) (5,045)
Interest credited on deposits 851 876 933
------ ------ ------
Total increase (decrease) in deposits $ (404) $ (955) $(4,112)
====== ====== ======
</TABLE>
At June 30, 1995 and 1996, the Bank had outstanding $2.41 million and $1.38
million, respectively, in certificates of deposit in amounts of $100,000 or
more maturing as follows:
<TABLE>
<CAPTION>
At At
June 30, 1995 June 30, 1996
------------- -------------
<S> <C> <C>
Three months or less $ 329 $ 100
Over three through six months 219 318
Over six through twelve months 1,043 521
Over twelve months 822 439
----- -----
Total $2,413 $1,378
====== ======
</TABLE>
26
<PAGE> 27
The following table sets forth the distribution of the Bank's deposit accounts
at the dates indicated and the weighted average nominal rates on each category
of deposits presented.
<TABLE>
<CAPTION>
At June 30,
-------------------------------------------------------------------------------
1994 1995
-------------------------- -------------------
Weighted
Percent of Average Percent of
Amount Total Deposits Nominal Rate Amount Total Deposits
------ -------------- ------------ ------ --------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Demand accounts:
Non-interest bearing $ 4 0.02% -- $ 16 0.07%
Interest-bearing (NOW) 39 0.17% 2.50% 66 0.30%
Money market 2,012 8.65% 3.45% 1,499 6.72%
Passbook 3,626 15.58% 3.01% 3,096 13.88%
------- ------ ------ -------- --------
Total demand accounts 5,681 24.42% 3.16% 4,677 20.96%
Certificate of deposit accounts:
Six months and less 8,162 35.08% 4.27% 6,711 30.08%
6 to 12 months 4,735 0.35% 4.56% 5,701 25.55%
12 to 36 months 3,283 14.11% 5.41% 4,493 20.14%
36 to 60 months 1,387 5.96% 5.82% 682 3.06%
60 to 90 months 19 .08% 7.75% -- 0.00%
Jumbo (over 90 months) - 0.00% 0.00% 48 0.22%
------- ------ ------ -------- --------
Total certificates of deposits 17,586 75.58% 4.65% 17,635 79.04%
------- ------ ------ -------- --------
Total deposit accounts $23,267 100.00% 4.28% $22,312 100.00%
======= ====== ====== ======== ========
<CAPTION>
At June 30,
--------------------------------------------------------------
1995 1996
---------------------------- --------------------------------
Weighted Weighted
Average Percent of Average
Nominal Rate Amount Total Deposits Nominal Rate
------------ ------ -------------- ------------
<S> <C> <C> <C> <C>
(Dollars in thousands)
Demand accounts:
Non-interest bearing -- $ 89 0.49% --
Interest-bearing (NOW) 2.50% 126 0.69% 2.50%
Money market 3.45% 952 5.23% 3.45%
Passbook 3.01% 2,775 15.25% 2.78%
------- ------ ------ --------
Total demand accounts 3.14% 3,942 21.66% 2.87%
Certificate of deposit accounts:
Six months and less 5.28% 7,230 39.73% 5.59%
6 to 12 months 6.04% 3,533 19.41% 5.49%
12 to 36 months 5.97% 2,813 15.46% 5.84%
36 to 60 months 6.21% 632 3.47% 6.01%
60 to 90 months 0.00% 50 0.27% 8.00%
Jumbo (over 90 months) 8.00% -- 0.00% 0.00%
------- ------ ------ --------
Total certificates of deposits 5.74% 14,258 78.34% 5.64%
------- ------ ------ --------
Total deposit accounts 5.20% $18,200 100.00% 5.04%
======= ======= ====== ========
</TABLE>
27
<PAGE> 28
The following table presents, by various rate categories, the amount of
certificate accounts outstanding at June 30, 1994, 1995 and 1996 and the
periods to maturity of the certificate accounts outstanding at June 30, 1996.
<TABLE>
<CAPTION>
At June 30, Period to Maturity from June 30, 1996
- ------------------------------------------------------------------------------------------------------------------------
1994 1995 1996 Within One Year One to Three Years Thereafter Totals
----- ---- ---- --------------- ------------------ ---------- ------
(In Thousands)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Certificate of deposit
accounts:
3.99% and less $ 3,596 $ 21 $ 10 $ 10 $ -- $ -- $ 10
4.00% to 4.99% 7,445 2,504 95 95 -- -- 95
5.00% to 5.99% 4,531 7,721 11,180 9,085 1,764 331 11,180
6.00% to 6.99% 1,148 6,626 2,402 1,278 880 244 2,402
7.00% to 7.99% 814 710 521 295 168 58 521
8.00% to 8.99% 52 53 50 -- -- 50 50
9.00% to 9.99% -- -- -- -- -- -- --
------- ------- ------- ------- ------ ----- -------
Total $17,586 $17,635 $14,258 $10,763 $2,812 $ 683 $14,258
======= ======= ======= ======= ====== ===== =======
</TABLE>
28
<PAGE> 29
Borrowings and Other Financing Transactions
The Bank's other available sources of funds include notes payable to the
FHLB-Chicago and collateralized borrowings. As a member of FHLB- Chicago, the
Bank is required to own capital stock in and is authorized to apply for
borrowings from the FHLB-Chicago. Each FHLB credit program has its own
interest rate, which may be fixed or variable, and a range of maturities. The
FHLB-Chicago may prescribe the acceptable uses for these borrowings, as well as
limitations on the amount and repayment provisions. The Bank has borrowed
funds in the past, and will continue to monitor use of this source in the
future. At June 30, 1995 and 1996, the Bank had no outstanding borrowings from
the FHLB-Chicago. Other sources of funding are from correspondent banks on a
short-term basis.
The Bank's borrowings from time to time include reverse repurchase agreements
and repurchase agreements. The form of reverse repurchase agreements used by
the Bank involves the sale of securities owned by the Bank with a commitment to
repurchase the same or substantially the same securities at a predetermined
price at a future date, typically within 30 days to 12 months. The form of
repurchase agreements used by the Bank generally are entered into with local
businesses and institutions seeking to deposit funds in excess of insurable
limits. Both of these transactions are treated as borrowings collateralized by
the securities sold and therefore are included as other borrowings on the
Bank's financial statements. These transactions are authorized by the Bank's
Investment Policy and are governed by agreements with primary government
dealers under PSA Master Repurchase Agreements. At June 30, 1995 and 1996,
there were no outstanding reverse repurchase agreements or repurchase
agreements.
The following table sets forth certain information regarding the Bank's
FHLB-Chicago advances, reverse repurchase agreements and repurchase agreements
at or for the periods ended on the dates indicated.
<TABLE>
<CAPTION>
At or for Years Ended June 30,
-----------------------------
1994 1995 1996
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
FHLB-CHICAGO ADVANCES:
Average balance outstanding $ -- $ -- $ 134
Maximum amount outstanding at any month-end during the
period -- -- 650
Balance outstanding at end of period -- -- --
Weighted average interest rate during the period(1) -- -- 5.82%
Weighted average interest rate at end of period -- -- --
REVERSE REPURCHASE AGREEMENTS:
No activity $ -- $ 280 $ --
REPURCHASE AGREEMENTS:
Average balance outstanding -- 880 --
Maximum amount outstanding at any month-end during the
period -- -- --
Balance outstanding at end of period -- -- --
Weighted average interest rate during the period -- 6.43% --
Weighted average interest rate at end of period -- -- --
</TABLE>
- --------------
(1) Computed on the basis of average monthly balances.
29
<PAGE> 30
FEDERAL TAXATION
General
The following discussion of tax matters is intended to be a summary of the
material tax rules applicable to the Bank and does not purport to be a
comprehensive description of all applicable tax rules.
The Bank and the Holding Company report their income on a fiscal year basis
using the cash method of accounting and are subject to federal income taxation
in the same manner as other corporations with some exceptions, including
particularly the Bank's reserve for bad debts discussed below. For its taxable
year ended June 30, 1996, the Bank was subject to a blended federal income tax
rate of approximately 34.0%.
Bad Debt Reserves
Savings institutions, such as the Bank, which meet certain definitional tests
primarily relating to their assets and the nature of their business
("qualifying thrifts"), are permitted to establish a reserve for bad debts and
to make annual additions, thereto, which additions may, within specified
formula limits, be deducted in arriving at their taxable income. For its
taxable year ended June 30, 1993, the Bank adopted the Book/Tax Conformity
method for bad debt deductions under IRC 166. This method allows the Bank to
take bad debt deductions for specific loss reserves that it establishes. Each
year the Bank will review the most favorable way to calculate the deduction.
Earnings that have been appropriated for bad debt reserves and deducted for
federal income tax purposes cannot be used by the Bank to pay cash dividends to
the Holding Company without the payment of income taxes by the Bank at the then
current income tax rate on the amount deemed distributed, which would include
the amount of any federal income taxes attributable to the distribution. Thus,
any dividends to the Holding Company that would reduce amounts appropriated to
the Bank's bad debt reserves and deducted for federal income tax purposes could
create a tax liability for the Bank. The Bank does not intend to pay dividends
that would result in a recapture of its bad debt reserves. See "Regulation."
Distributions
To the extent that (i) the Bank's reserve for losses on qualifying real
property loans exceeds the amount that would have been allowed under an
experience method, and (ii) the Bank makes "non-dividend distributions" to
stockholders that are considered to result in distributions from the excess bad
debt reserve or the supplemental reserve for losses on loans ("Excess
Distribution"), then an amount based on the amount distributed will be included
in the Bank's taxable income. Non-dividend distributions include distributions
in excess of the Bank's current and accumulated earnings and profits,
distributions in redemption of stock and distributions in partial or complete
liquidation. However, dividends paid out of the Bank's current or accumulated
earnings and profits, as calculated for federal income tax purposes, will not
be considered to result in a distribution from the Banks' bad debt reserves.
The amount of additional taxable income created from an Excess Distribution is
an amount that when reduced by the tax attributable to the income is equal to
the amount of the distribution. Thus, if after the Conversion, certain
portions of the Bank's accumulated tax bad debt reserve are used for any
purpose other than to absorb qualified bad debt losses, such as for the payment
of dividends or other distributions with respect to the Bank's capital stock
(including distributions upon redemption or liquidation), approximately one and
one-half times the amount so used would be includable to gross income for
federal income tax purposes, assuming a 34% corporate income tax rate
(exclusive of state taxes). See "Dividend Policy" and "Regulations" for limits
on the payment of dividends by the Bank.
30
<PAGE> 31
Corporate Alternative Minimum Tax
For taxable years beginning after December 31, 1986, the Internal Revenue Code
imposes an alternative minimum tax ("AMT") on a corporation's alternative
minimum taxable income ("AMTI") which is imposed at a rate of 20%. The excess
of the bad debt reserve deduction using the percentage of taxable income
method, over the deduction that would have been allowable under an experience
method, is treated as a preference item for purposes of computing the AMTI.
Only 90% of AMTI can be offset by net operating losses. For taxable years
beginning after December 31, 1989, the adjustment to AMTI based on book income
will be an amount equal to 75% of the amount by which a corporation's adjusted
current earnings exceeds its AMTI (determined without regard to this preference
and prior to reduction for net operating losses). In addition, for taxable
years beginning after December 31, 1986, and before January 1, 1996, an
environmental tax of 0.12% of the excess of AMTI (with certain modifications)
over $2.0 million is imposed on corporations, including the Bank, whether or
not an AMT is due. The Bank is not subject to the environmental tax and does
not expect to be subject to the AMT.
STATE TAXATION
The Bank is subject to franchise taxes at a rate of 7.9% imposed by the State
of Wisconsin. Wisconsin taxable income is generally similar to federal taxable
income except that interest from state and municipal obligations is taxable, no
deduction is allowed for state income taxes, and net operating losses may be
carried forward but not back. Wisconsin law does not provide for filing of
consolidated income tax returns.
REGULATION
The Bank consummated its conversion from a mutual to a stock savings bank on
April 18, 1996. Therefore, the ensuing discussion involves regulations as they
apply to stock savings banks.
The Bank is a Wisconsin-chartered stock savings bank and its deposit accounts
are insured up to applicable limits by the FDIC under the Savings Association
Insurance Fund ("SAIF"). The Bank is subject to extensive regulation by the
Director, as its chartering agency, and by the FDIC, as its deposit insurer and
principal federal regulator. The lending and investment authority of the Bank
is prescribed by Wisconsin law and regulations, as well as applicable federal
law and regulations, and the Bank is prohibited from engaging in any activities
not permitted by such law and regulations. The Company is a one-bank holding
company subject to regulatory oversight by the Federal Reserve Board ("FRB"),
the Director and the Securities and Exchange Commission ("SEC").
WISCONSIN SAVINGS BANK REGULATION
Regulations administered by the Director govern various aspects of the
activities and operations of Wisconsin-chartered savings banks.
Examinations and Assessments
The Bank is required to file periodic reports with and is subject to periodic
examinations at least once every 18-month period by the Director. Savings
banks are required to pay examination fees and annual assessments to fund the
supervisory operations of the Director. Based on the assessment rates
published by the Director and the Bank's total assets of $32.0 million at
December 31, 1995, the Bank paid $1,501 in assessments for the period ended
June 30, 1996.
Loans and Investments
Under Wisconsin law, the Bank is authorized to make, invest in, sell, purchase,
participate or otherwise deal in mortgage loans or interests in mortgage loans
without geographic restriction, including loans made on the security of
residential and commercial property. Savings banks may lend funds, on a
secured or unsecured basis, for commercial or consumer purposes, provided that
aggregate commercial loans do not exceed 10% of the savings bank's
31
<PAGE> 32
total assets and aggregate consumer loans do not exceed 10% of the savings
bank's total assets. Subject to certain limited exceptions, savings banks may
not make a loan secured by a first lien mortgage in an amount in excess of 90%
of the fair market value of the real estate security.
Savings banks also may invest funds in certain types of debt and equity
securities, including obligations of federal, state and local governments and
agencies. Investment in debt securities of local governmental units may not
exceed 50% of capital and temporary borrowings of any local government unit
maturing within one year from the date of issue may not exceed 60% of capital.
Investment in short-term commercial paper issued by a financial institution,
corporation or other borrower must have a maturity of two to 270 days and be
rated in one of the four highest categories by a nationally recognized rating
service.
Subject to the prior approval of the Director, savings banks may invest in
residential housing development projects or in the stock of a corporation that
owns one or more of such projects and is a wholly owned subsidiary of a
financial institution, provided that investment in any one project does not
exceed 15% of capital and the aggregate investment in such projects does not
exceed 50% of capital.
Savings banks may invest in service corporations or subsidiaries with the prior
approval of the Director, provided that the service corporation or subsidiary
engages in only those activities pre-approved by the Director, agrees to be
audited annually by a certified public accountant, agrees to bear the expense
of all examinations and audits conducted by the Commissioner, and agrees not to
enter into a business venture, directly or indirectly, with an officer,
director or employee of the savings bank. The Bank does not have any
subsidiary operations.
The lending and investment powers of Wisconsin savings banks also are limited
by FDIC regulation and other federal law and regulations. See "Federal Deposit
Insurance Corporation Improvement Act of 1991".
Loans to One Borrower
Wisconsin-chartered savings banks may make loans and extensions of credit, both
direct and indirect, to one borrower in amounts up to 15% of capital plus an
additional 10% for loans fully secured by readily marketable collateral. In
addition, savings banks may make loans to one borrower for any purpose in an
amount not to exceed $500,000, or to develop domestic residential housing units
in an amount not to exceed the lesser of $30 million or 30% of capital,
provided certain conditions are satisfied. If the collateral securing an
outstanding loan falls below 100% of the total amount of the loan or extension
of credit or otherwise does not conform to the foregoing loans-to-one borrower
limitations, a savings bank must bring such loan into conformance within 15
business days unless a judicial proceeding or other extraordinary occurrence
prevents the savings bank from taking action. At June 30, 1996, the Bank did
not have any loans which exceeded the loans-to-one borrower limitations.
Qualified Thrift Requirement
As a Wisconsin-chartered savings bank, the Bank must qualify for and maintain a
level of qualified thrift investments equal to 60% of its assets as prescribed
in Section 7701(a)(19) of the Internal Revenue Code of 1986, as amended
("Internal Revenue Code"). At June 30, 1996, the Bank maintained over 75% of
its assets in qualified thrift investments and therefore met the qualified
thrift-requirement.
Dividend Limitations
A savings bank which meets its regulatory capital requirement may declare
dividends on capital stock based upon net profits, provided that its paid-in
surplus equals its capital stock. If the paid-in surplus of the savings bank
does not equal its capital stock, the board of directors may not declare a
dividend unless at least 10% of the net profits of the preceding half year in
the case of quarterly or semi-annual dividends, or 10% of the net profits of
the preceding year in case of annual dividends, has been transferred to paid-in
surplus. In addition, prior approval of the Director is required before
dividends exceeding
32
<PAGE> 33
50% of profits for any calendar year may be declared and before a dividend may
be declared out of retained earnings. Under the Director's regulations, a
savings bank which has converted from mutual to stock form also is prohibited
from paying a dividend on its capital stock if the effect thereof would cause
the regulatory capital of the savings bank to be reduced below the amount
required for its liquidation account.
Liquidity
Savings banks are required to maintain an average daily balance of liquid
assets (including cash, certain time deposits, certain banker's acceptances,
certain corporate debt securities and highly rated commercial paper, securities
of certain mutual funds and specified United States government, state or
federal agency obligations) of not less than 8% of its average daily balance
during the preceding calendar month of its net withdrawable accounts plus its
short-term borrowings. Also required is a "primary liquid assets" ratio of at
least 4% of average daily withdrawable accounts and short-term borrowings.
"Primary liquid assets" is defined as primarily short-term liquid assets and
U.S. government and government agency securities. On June 30, 1996, the Bank's
liquidity ratio was 39.69%.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA"), enacted
in December 1991, addresses the safety and soundness of deposit insurance
funds, and supervision and other regulatory actions relating to the banking
industry. The goal of FDICIA is to reduce the overall risks within the thrift
and banking system and financial markets. FDICIA addressed the following
issues: (i) development of a system of risk- based deposits insurance
assessments; (ii) supervisory and accounting reforms; (iii) prompt corrective
regulatory action; (iv) brokered deposits and interest rate limitations
thereon; (v) establishment of uniform lending standards; and (vi) general
standards for safety and soundness of insured financial institutions.
Risk-Based Insurance Assessments
FDICIA require the FDIC to develop a system of risk-based insurance
assessments. Under a system implemented in 1994 higher insurance assessment
rates we charged to those banks and thrifts deemed to pose greater risk to the
deposit insurance funds. Under this system, which was implemented beginning
with the assessment period commencing January 1, 1994, the FDIC places each
insured depository in one of nine risk categories based on its level of capital
and other relevant information (such as supervisory evaluations). Each
institutions's insurance assessment rate is then determined by the risk
category in which it has been classified by the FDIC. Under the current
schedule, applicable to SAIF institutions, there is an eight basis point spread
between the highest and lowest assessment rates, so that institutions
classified as strongest by the FDIC are subject to an annual rate of $0.23 per
one hundred dollars of deposits, and institutions classified as weakest by the
FDIC are subject to an annual rate of $0.31 per one hundred dollars of deposits
(with intermediate annual rates of $0.26, $0.29, and $0.30 per $100 of
deposits).
The Bank has been classified in a risk category which will result in annual
assessments of $0.23 per one hundred dollars of deposits as discussed above.
The Bank's expense related to federal deposit insurance premiums to the SAIF
was $55,000 for the fiscal year ended June 30, 1996. Placement of the Bank in
any risk category other than the category having the lowest assessment rate
will result in increased SAIF insurance assessments, with a corresponding
decrease in net earnings and capital. The Bank does not presently expect that
any reasonably foreseeable increased insurance assessments would significantly
impair the Bank's overall financial condition or results of operations.
Improved Examinations and Audits
FDICIA revised examination and audit procedures to require: (i) annual on-site
examinations for all depository institutions except those well- capitalized
institutions with assets of less than $100 million; (ii) annual audits by
independent public accountants for all insured institutions with assets in
excess of $500 million; (iii) the formation of independent audit committees of
the boards of directors of insured depository institutions for institutions
33
<PAGE> 34
with assets equal to or in excess of $500 million; (iv) management of
depository institutions to prepare certain financial reports annually and to
establish internal compliance procedures; (v) implementation of accounting
objectives, standards and requirements through regulations; and, (vi)
restrictions on the receipt of "brokered deposits" and the rates of interest
which may be paid on any deposits by institutions which are not "well
capitalized" (even if they meet minimum regulatory capital requirements).
Prompt Corrective Regulatory Action
FDICIA established a system of prompt corrective action to resolve the problems
of undercapitalized institutions. Under this system, federal bank regulators
are required to take certain supervisory actions with respect to
undercapitalized institutions, the severity of which depends upon the
institution's degree of capitalization. Generally, FDICIA requires federal
bank regulators to appoint a receiver or conservator for an institution that is
critically undercapitalized. FDICIA authorizes federal bank regulators to
specify the ratio of tangible capital to assets at which an institution becomes
critically undercapitalized and requires that the ratio be no less than 2% of
total assets.
Under the regulations, an institution shall be deemed to be: (i) "well
capitalized" if it has a total risk-based capital ratio of 10.0% or more, has a
Tier 1 risk-based capital ratio of 6.0% or more, has a Tier 1 leverage capital
ratio of 5.0% or more and is not subject to specified requirements to meet and
maintain a specific capital level for any capital measure; (ii) "adequately
capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier
1 risk-based capital ratio of 4.0% or more and a Tier 1 leverage capital ratio
of 4.0% or more (3.0% under certain circumstances) and does not meet the
definition of "well capitalized"; (iii) "undercapitalized" if it has a total
risk- based capital ratio less than 8.0%, a Tier 1 risk-based capital ratio
less than 4.0% or a Tier 1 leverage capital ratio less than 4.0% (or less than
3.0% under certain circumstances); (iv) "significantly undercapitalized" if it
has a total risk-based capital ratio less than 6.0%, a Tier 1 risk-based
capital ratio less than 3.0% or a Tier 1 leverage capital ratio less than 3.0%;
and (v) "critically undercapitalized" if it has a ratio of tangible equity to
total assets equal to or less than 2.0%.
Subject to limited exceptions, insured institutions in any of the
undercapitalized categories are prohibited from declaring dividends, making any
other capital distribution or paying a management fee to a controlling person.
Undercapitalized institutions are subject to certain mandatory supervisory
actions, including increased monitoring, required capital restoration planning
and growth and acquisition restrictions. The filing of a capital restoration
plan, which must be guaranteed by any parent holding company, also is required.
Significantly undercapitalized institutions face even more severe restrictions,
requiring the institution to raise additional capital; restricting transactions
between the institution and its affiliates; restricting interest rates paid on
deposits; requiring the institution to accept an offer to be acquired by
another institution or company; and requiring the institution to terminate,
reduce or alter any activity posing excessive risk to the institution. The
Bank currently exceeds all applicable regulatory capital requirements and
therefore is not subject to prompt corrective action.
At June 30, 1996, the Bank was a "well capitalized" institution under the
prompt corrective action regulations.
Brokered Deposits; Interest Rate Limitations
FDIC regulations promulgated under FDICIA govern the acceptance of brokered
deposits by insured depository institutions. The capital position of an
institution determines whether and with what limitations an institution may
accept brokered deposits. A "well-capitalized" institution (one that
significantly exceeds specified capital ratios) may accept brokered deposits
without restriction. "Undercapitalized" institutions (those that fail to meet
minimum regulatory capital requirements) may not accept brokered deposits and
"adequately capitalized" institutions (those that are not "well-capitalized" or
undercapitalized") may only accept such deposits with the consent of the FDIC.
"Adequately capitalized" institutions may apply for a waiver by letter to the
FDIC. An institution that is not "well-capitalized", even if meeting minimum
capital requirements, may not solicit brokered or other
34
<PAGE> 35
deposits by offering interest rates that are significantly higher than the
relevant local or national rate as determined under the regulations. As a
"well-capitalized" institution, the Bank may accept brokered deposits without
restrictions.
Uniform Lending Standards
Under FDICIA, federal bank regulators are required to adopt uniform regulations
prescribing standards for extensions of credit that are secured by liens on
interests in real estate or made for the purpose of financing the construction
of a building or other improvements to real estate. Savings institutions and
savings banks must adopt and maintain written policies that establish
appropriate limits and standards for extensions of credit secured by liens or
interests in real estate or made for the purpose of financing permanent
improvements to real estate. These policies must establish loan portfolio
diversification standards, prudent underwriting standards (including
loan-to-value limits) that are clear and measurable, loan administration
procedures and documentation, approval and reporting requirements. The real
estate lending polices must reflect consideration of the Interagency Guidelines
for Real Estate Lending Policies adopted by federal bank regulators. The Bank
has adopted and maintains such policies.
Standards for Safety and Soundness
FDICIA required federal bank regulators to prescribe operational and managerial
standards for all insured depository institutions and depository institution
holding companies relating to internal controls, information systems and audit
systems, loan documentation, credit underwriting, interest rate risk exposure,
asset growth, and compensation, fees and benefits. The compensation standards
would prohibit employment contracts, compensation or benefit arrangements,
stock option plans, fee arrangements or other compensatory arrangements that
would provide excessive compensation, fees or benefit or could lead to material
financial loss. In addition, federal bank regulators were required to
prescribe standards relating to asset quality, earnings and stock valuation
that the regulators determined to be appropriate.
On September 23, 1994, the Riegle Act (the "Riegle Act") was enacted. The
Riegle Act amended Section 39 of the FDI Act: (1) To authorize the federal
bank regulators to establish safety and soundness standards by regulation or by
guideline for all insured depository institutions; (2) to give the regulators
greater flexibility in prescribing asset quality and earnings standards; and
(3) to eliminate the requirement that standards prescribed under Section 39
apply to depository institution holding companies.
On July 10, 1995, federal bank regulators adopted Interagency Guidelines
Establishing Standards for Safety and Soundness (the "Guidelines") and also
adopted a final rule establishing deadlines for submission and review of safety
and soundness compliance plans. Federal bank regulators are authorized, but
not required, to request a compliance plan for failure to satisfy the safety
and soundness standards set out in the Guidelines. An institution must file a
compliance plan within 30 days of a request to do so from the institution's
primary federal regulators. Regulators expect to request a compliance plan
from an institution whose failure to meet one or more of the standards is of
such severity that it could threaten the safe and sound operation of the
institution.
With respect to internal controls, information systems and internal audit
systems of institutions, the Guidelines prescribe the functions that adequate
internal controls and information systems must be able to perform rather than
providing the types of controls or systems that must be present in every case.
Each institution is required to have an internal audit system that provides for
adequate testing and review of internal controls and information systems.
The Guidelines do not specify in detail what loan documentation must contain.
Documentation practices would be evaluated based upon each institution's
ability to: (i) make informed decisions and assess risk on an ongoing basis;
(ii) identify the purpose of the loan and assess the ability of the borrower to
repay the indebtedness in a timely manner; (iii) insure that any claim against
a borrower is legally enforceable; (iv) demonstrate appropriate administration
and monitoring of the loan; and, (v) take account of the size and complexity of
the loan. The Guidelines establish general parameters of safe and sound credit
35
<PAGE> 36
underwriting practices, and require each institution to establish and maintain
prudent credit underwriting practices commensurate with the size of the
institution and the nature and scope of its lending activities.
With respect to interest rate risk management, the Guidelines require
institutions to manage interest rate risk in a manner appropriate to the size
of the institution and the complexity of its assets and liabilities. Larger
institutions that are exposed to significant interest rate risk would be
expected to maintain a more formal system for the measurement and management of
such risk. Further, an institution is required to base its asset growth on a
plan that reflects consideration of: (i) the source, volatility and use of the
funds that support asset growth; (ii) any increase in credit risk or interest
rate as a result of growth; and (iii) the effect of growth on the institution's
capital.
The Guidelines also require an institution to base its asset growth on a plan
that fully considers the source of an institution's growth, the risks presented
by such growth, and the effect of growth on the institution's capital.
Regulators will evaluate asset growth against an institution's overall
strategic plan for growth.
In addition, the Guidelines would require that each institution maintain
safeguards to prevent the payment of compensation, fees, or benefits that are
excessive or could lead to material financial loss. Compensation that is
unreasonable or disproportionate to the service actually performed by the
institution being compensated would be considered excessive. In making such a
determination, the federal regulators would consider all relevant factors,
including the compensation history of the individual and other individuals with
comparable expertise at the institution, the financial condition of the
institution, comparable compensation packages at comparable institutions, and
any connection between an individual and any wrongdoing at the institution.
Federal regulators concluded that establishing stock valuation standards for
publicly traded institutions is not appropriate. Regulators intend to continue
the existing practice of augmenting overall examinations and ongoing monitoring
of publicly-traded institutions through the review of stock price changes,
market price to book value ratios, bond ratings and other indicators of the
market's assessment of an institution's performance.
The Bank believes that its operational and managerial standards substantially
comply with the standards set forth in the Guidelines and that compliance with
the Guidelines will therefore not impose a significant burden on Bank
operations.
Restrictions Upon State-Chartered Banks
The FDICIA added a new Section 24 to the Federal Deposit Insurance Act of 1950
("FDI Act") which generally limits the activities and equity investments of
FDIC-insured state-chartered banks and their subsidiaries to those permissible
for federally chartered national banks and their subsidiaries, unless such
activities and investments are specifically exempted by Section 24 or consented
to by the FDIC.
Regulations governing equity investments of banks generally prohibit certain
equity investments and require divestiture of such investments by December 19,
1996. Section 24 provides an exception for investments in common and preferred
stocks listed on a national securities exchange or the shares of registered
investment companies by a bank if: (1) the bank held such types of investments
during the 14-month period from September 30, 1990 through November 26, 1991;
(2) the state in which the bank is chartered permitted such investments as of
September 30, 1991; and (3) the bank notifies the FDIC and obtains approval
from the FDIC to make or retain such investments. Upon receiving such FDIC
approval, an institution's investment in such equity securities will be subject
to an aggregate limit up to its core capital. Section 24 also contains an
exception for certain majority-owned subsidiaries. Banks holding impermissible
equity investments that do not receive FDIC approval must submit to the FDIC a
plan for divesting such investments as quickly and as prudently as possible.
The Bank does not hold any impermissible equity investments.
36
<PAGE> 37
Insured savings banks must obtain the FDIC's prior approval before directly, or
indirectly through a majority-owned subsidiary, engaging "as principal" in any
activity that is not permissible for a national bank unless certain exceptions
apply. An "activity permissible for a national bank" includes any activity
that is authorized for a national bank under the National Bank Act (12 U.S.C.
21 et seq.) or any other statute, as well as activities recognized as
permissible in regulations issued by the Office of Comptroller of Currency (the
"OCC"), official circulars or bulletins issued by the OCC, or any order or
written interpretation issued by the OCC. However, in order for a state bank
to conduct an activity as principal without the FDIC's consent, the activity
must be conducted in the same manner in which a national bank is authorized to
conduct the activity. Under the activity regulations, FDIC-supervised state
banks will not be permitted to directly engage in commercial ventures or any
insurance underwriting activity other than to the extent such activities are
permissible for a national bank or a national bank subsidiary or except for
certain limited insurance underwriting activities. In addition, the activity
regulations provide that state banks which meet all regulatory capital
requirements may engage in certain activities that are not permissible for
national banks which are deemed not to present a significant risk to the
insurance fund, including guaranteeing certain obligations of others,
activities which the FRB has found to be closely related to banking and certain
securities activities conducted through subsidiaries. The FDIC will not
approve an activity it determines would present a significant risk to the FDIC
insurance funds. Bank activities are of a type permissible under FDICIA.
Effect of FDICIA on Operations and Financial Condition of the Bank
While management of the Bank cannot predict the final impact of FDICIA upon the
future financial condition and operations of the Bank, management believes that
FDIC regulations enacted pursuant to FDICIA have subjected the Bank to
increased operational costs through higher deposit insurance premiums and
compliance costs. Further, if the capital ratios of the Bank should decline
significantly, the Bank may become subject to more severe regulatory action
than was possible under prior law and regulation.
CAPITAL MAINTENANCE
FDIC Regulation
FDIC-insured institutions are required to follow certain capital adequacy
guidelines which prescribe minimum levels of capital and require that
institutions meet certain risk-based and leverage capital requirements. Under
the FDIC capital regulations, the Bank is required to meet the following
capital standards: (i) "Tier 1 capital" in an amount not less than 3% of
total assets; (ii) "Tier 1 capital" in an amount not less than 4% of
risk-weighted assets; and (iii) "total capital" in an amount not less than 8%
of risk-weighted assets.
FDIC-insured institutions in the strongest financial and managerial condition
(with a composite rating of "1" under the Uniform Financial Institutions Rating
System established by the Federal Financial Institutions Examination Council)
are required to maintain "Tier 1 capital" equal to at least 3% of total assets
(the "leverage limit" requirement). For all other FDIC-insured institutions,
the minimum leverage limit requirement is 3% of total assets plus at least an
additional 100 to 200 basis points. Tier 1 capital is defined to include the
sum of common stockholders' equity, noncumulative perpetual preferred stock
(including any related surplus), and minority interests in consolidated
subsidiaries, minus all intangible assets (with certain exceptions), identified
losses and qualifying investments in securities subsidiaries. An institution
that fails to meet the minimum leverage limit requirement must file a capital
restoration plan with the appropriate FDIC regional director that details the
steps it will take to reach capital compliance. At June 30, 1996, the Bank's
ratio of Tier 1 capital to total assets was 49.31% or 46.31% in excess of the
minimum leverage limit requirement.
FDIC-insured institutions also are required to adhere to certain risk-based
capital guidelines which are designed to provide a measure of capital more
sensitive to the risk profiles of individual banks. Under the risk-based
capital guidelines, capital is divided into two tiers: core (Tier 1) capital,
as defined above, and supplementary capital (Tier 2). Tier 2 capital is
limited to 100% of core capital and includes cumulative perpetual preferred
37
<PAGE> 38
stock, perpetual preferred stock, mandatory convertible securities,
subordinated debt, intermediate preferred stock and allowance for possible loan
and lease losses. Allowance for possible loan and lease losses includable in
supplementary capital is limited to a maximum of 1.25% of risk-weighted assets.
Total capital is the sum of Tier 1 and Tier 2 capital. The risk-based capital
framework assigns balance sheet assets to one of four broad risk categories
which are assigned risk-weights ranging from 0% to 100% based primarily on the
degree of credit risk associated with the obligor. Off-balance sheet items are
converted to an on-balance sheet "credit equivalent" amount utilizing certain
conversion factors. The weighted sum of the four risk-weighted categories
equals risk-weighted assets. At June 30, 1996, the Bank's Tier 1 capital to
risk-weighted assets was 91.80%, or 87.80% in excess of the FDIC requirement
and the Bank's total capital to risk-weighted assets was 49.64%, or 41.64% in
excess of the FDIC requirement.
Wisconsin Regulation
Wisconsin-chartered savings banks are required to maintain a minimum capital to
assets ratio of 6% and must maintain total capital necessary to ensure the
continuation of insurance of deposit accounts by the FDIC. If the Director
determines that the financial condition, history, management or earning
prospects of a savings bank are not adequate, the Commissioner may require a
higher minimum capital level for the savings bank. If a savings bank's capital
ratio falls below the required level, the Director may direct the savings bank
to adhere to a specific written plan established by the Director to correct the
savings bank's capital deficiency, as well as a number of other restrictions on
the savings bank's operations, including a prohibition on the declaration of
dividends by the savings bank's board of directors. At June 30, 1996, the
Bank's total capital, as calculated under Wisconsin law, was $19.2 million or
50.24% of total assets, which was 44.24% in excess of the required amount.
INSURANCE OF DEPOSITS
The Bank's deposits are insured to applicable limits under the Savings
Association Insurance Fund ("SAIF") of the FDIC. The FDIC regulations assign
institutions to a particular capital group based on the level of an
institution's capital -- "well capitalized", "adequately capitalized", and
"undercapitalized". These three groups are then divided into three subgroups
which reflect varying levels of supervisory concern from those which are
considered to be healthy to those which are considered to be of substantial
supervisory concern. The matrix so created results in nine assessments risk
classifications, with reduced insurance rates paid by well capitalized,
financially sound institutions and higher rates paid by undercapitalized
institutions that pose a substantial risk of loss to the insurance fund unless
effective corrective action is taken.
Deposit insurance premiums for the Bank, which is classified as a well
capitalized savings bank, are currently assessed at the rate of 23 cents per
$100 of deposits. The Bank's expense related to FDIC premiums was $55,000 for
the fiscal year ended June 30, 1996. Deposit premium levels are set in order
to permit the SAIF to achieve a ratio of reserves to insured deposits of 1.25%,
and the FDIC may adjust assessment rates in order to maintain the target ratio.
In addition, the FDIC may impose special assessments on SAIF members to repay
amounts borrowed from the United States Treasury or for any other reason deemed
necessary by the FDIC. While an increase in premiums for the Bank could have
an adverse effect on earnings, a decrease in premiums could have a positive
impact on earnings. The Bank does not expect that any reasonably foreseeable
increased insurance assessments would significantly impair the Bank's overall
financial condition or results of operations.
The FDIC insures commercial bank deposits through a separate fund, the Bank
Insurance Fund ("BIF"). During 1995, BIF assessment rates were reduced and as
a result BIF member institutions are paying lower deposit insurance premiums
then SAIF-member institutions. Congress has been considering legislative
alternatives to mitigate the effect of the BIF/SAIF premium disparity. See,
"Effect of the Recapitalization of SAIF and SAIF and BIF Premium Differential
on the Bank's Future Operations and Prospects".
38
<PAGE> 39
The FDIC may terminate the deposit insurance of any insured depository
institution if it determines after a hearing that the institution has engaged
or is engaging in unsafe or unsound practices, is in an unsafe or unsound
condition to continue operations, or has violated any applicable law,
regulation, order or any condition imposed by an agreement with the FDIC. It
also may suspend deposit insurance temporarily during the hearing process for
the permanent termination of insurance, if the institution has no tangible
capital. If insurance of accounts is terminated, the accounts at the
institution at the time of termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined
by the FDIC. Management is aware of no existing circumstances which could
result in termination of the deposit insurance of the Bank.
EFFECT OF THE RECAPITALIZATION OF SAIF AND THE SAIF AND BIF PREMIUM
DIFFERENTIAL ON THE BANK'S FUTURE OPERATIONS AND PROSPECTS
Deposits of the Bank are currently insured by the FDIC under the SAIF. The
FDIC also maintains another insurance fund, the Bank Insurance Fund ("BIF"),
which primarily insures commercial bank and some state savings bank deposits.
Applicable law requires that the SAIF and BIF funds each achieve and maintain a
ratio of insurance reserves to total insured deposits equal to 1.25%. The BIF
reached this required reserve ratio in May 1995, while the SAIF is not expected
to do so until 2002 under the current rate of assessment. The SAIF has not
grown as quickly as the BIF due to a number of factors, including the fact that
a significant portion of SAIF premiums have been and are currently being used
to make payments on bonds issued by the Financing Corporation ("FICO Bonds") in
the late 1980s to recapitalize the now defunct Federal Savings and Loan
Insurance Corporation ("FSLIC"). In addition to the SAIF's underfunding, the
SAIF also has assumed the responsibility for resolving savings association
failures since June 30, 1995. The FDIC reports that, because the SAIF is
significantly underfunded, significant insurance losses in the near-term could
render the SAIF insolvent.
The BIF and SAIF assessment rate schedules had been identical. However,
pursuant to a final rule dated August 8, 1995, the FDIC modified the premium
rate schedule for BIF member institutions and lowered premium rates for most
BIF-insured institutions. On November 14, 1995, the FDIC reduced assessment
rates by $0.04 per $100 of deposits and again modified the assessment rate
schedule for BIF member institutions, approving a schedule ranging from 0% to
0.27% of deposits. Based on the latest assessment rate modifications, which
were effective beginning January, 1996, the majority of BIF members will pay
only the $2,000 minimum annual premium. Currently, the average SAIF member
pays $0.23 per $100 of deposits. As a result of the new assessment rate
provisions, BIF member institutions will benefit from reduced deposit insurance
premiums and SAIF member institutions will be placed at a competitive
disadvantage based on higher deposit insurance premium obligations. It is
expected the BIF-insured banks, which constitute some of the Bank's primary
competitors, will be able to offer higher yields on their deposit products than
the SAIF-insured counterparts because of the cost savings resulting from the
premium differential.
To address the BIF/SAIF disparity and the competitive disadvantage it creates
for savings associations, several large stock-based savings associations have
recently announced plans to charter BIF-insured banks as separate wholly-owned
subsidiaries of their holding company. Because the BIF insurance premiums for
the newly chartered commercial banks will be lower than the SAIF insurance
premiums for the existing savings association, the new banks will be able to
offer rates on savings deposits that are higher than the rates offered by its
sister savings association. Accordingly, savings deposits will be drawn away
from the SAIF-insured savings association to the BIF-insured commercial banks.
If these savings associations are successful in transferring deposits away from
the SAIF, the assessment base for the SAIF will be reduced. This could mean
higher deposit insurance premiums for the remaining SAIF-insured savings
associations, or a delay in the eventual reduction of insurance premiums beyond
the year 2002, or both.
Congress is currently evaluating various proposals and bills concerning the
premium differential between the FDIC's BIF and SAIF funds and related matters.
One element present in these proposals is a one-time assessment of
approximately 85 to 90 basis points per $100 of SAIF deposits as of March 31,
1995. If the special assessment were imposed at 85 basis points per $100 of
insurable deposits, the amount of the assessment to the Bank would be
39
<PAGE> 40
approximately $155,000. The special assessment would have the effect of
reducing the Bank's earnings and capital by the after-tax amount of the
assessment as of the date of enactment. It is anticipated that, with the
recapitalization of the SAIF, BIF and SAIF premiums would be comparable and
FDIC premium expense would be reduced in future periods. Proposals under
consideration also address related issues, including (i) providing that the
FICO bond obligations be borne by all insured depository institutions (rather
than solely by the SAIF); and (ii) the merger of the SAIF and BIF by January 1,
1998 (provided no FDIC - insured depository institution is a savings
association on that date). One of the additional proposals, involving
repealing the bad debt reserve accounting method currently available to thrift
savings associations such as the Bank, with certain provisions for deferred
recapture, has recently been passed as part of the Small Business Job
Protection Act of 1996. The Bank is unable to predict when or whether any of
the foregoing legislation will be enacted, the amount or applicable retroactive
date of any one-time assessment, or the rates that might subsequently apply to
assessable SAIF deposits; however, management anticipates that the Bank, after
consideration of the one-time assessment, would continue to exceed all
regulatory minimum capital levels. Further, management does not anticipate
that any of the current legislative proposals, if enacted, would have a
material impact on the Company's financial condition in future periods.
RESTRICTIONS ON LOANS TO AND TRANSACTIONS WITH INSIDERS AND AFFILIATES
In accordance with Section 22(h) of the Federal Reserve Act of 1913, as amended
("Federal Reserve Act"), FRB regulations limited the total amount a savings
bank may lend to its executive officers, directors, principal shareholders and
their related interests (collectively referred to herein as "affiliated
persons"). Generally, an affiliated person may borrow an aggregate amount not
exceeding 15% of a savings bank's unimpaired capital and unimpaired surplus on
an unsecured basis and an additional 10% on a secured basis. FDICIA also set a
limit on the aggregate amount a depository institution may lend to affiliated
persons as a class to an amount not exceeding the institution's unimpaired
capital and unimpaired surplus.
In addition, the Director's regulations establish restrictions on loans and
other transactions with the Bank's affiliated persons. All loans to affiliated
persons must be made in the "ordinary course of business" involving not more
than the "normal risks of collectibility" and not exceeding the loan amount
which would be available to members of the general public of similar credit
status, must be secured by the principal residence of the affiliated person or
deposit accounts maintained at the Bank and must be approved by a majority of
the Bank's disinterested directors. Interest rates on loans to affiliated
persons must be equal to or greater than the Bank's current cost of funds,
except that the interest rate of a loan secured by a deposit account must be at
least 1% above the rate of return on the deposit account. Extensions of credit
to affiliated persons for commercial purposes, in the aggregate, may not exceed
$100,000.
FDIC-insured state-chartered savings banks must comply with Sections 23A and
23B of the Federal Reserve Act ("Sections 23A and 23B") relating to
transactions with affiliates in the same manner and to the same extent as if
the savings bank were a Federal Reserve member bank. Generally, Sections 23A
and 23B limit the extent to which an insured institution or its subsidiaries
may engage in certain covered transactions with an affiliate to an amount equal
to 10% of such institution's capital and surplus, plus an aggregate limit on
all such transactions with affiliates to an amount equal to 20% of such capital
and surplus, and require that all transactions be on terms substantially the
same, or at lest as favorable to the institution or subsidiary, as those
provided to a non-affiliate. The term "covered transaction" includes the
making of loans, the purchase of assets, issuance of a guaranty and similar
other types of transactions. The Director, for safety and soundness reasons,
may impose more stringent restrictions on savings banks but may not exempt
transactions from or otherwise abridge Sections 23A and 23B. Exemptions from
23A and 23B may be granted only by the FRB.
Unless prior approval of the Director is obtained, a savings bank may not
purchase, lease or acquire a site for an office building or an interest in real
estate from an affiliated person, including a stockholder owning more than 10%
of its capital stock, or from any firm, corporation, entity or family in which
an affiliated person or 10% stockholder has a direct or indirect interest. The
Bank has not been significantly affected by such restrictions on loans to and
transactions with affiliates.
40
<PAGE> 41
COMMUNITY REINVESTMENT ACT
Under the Community Reinvestment Act of 1977, as amended (the "CRA"), as
implemented by FDIC regulations, the Bank 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 it believes are best suited to its
particular community. The CRA requires the FDIC, in connection with its
examination of a bank, to assess the institution'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 institution. The Financial Institutions
Reform, Recovery and Enforcement Act of 1989 ("FIRREA") amended the CRA to
require, effective July 1, 1990, public disclosure of an institution's CRA
rating and require the primary regulator to provide a written evaluation of an
institution's performance. The Bank's latest CRA rating, received on December
7, 1993 was "satisfactory".
On May 4, 1995, the federal banking regulators adopted a final rule ("Final CRA
Rule") governing compliance with the CRA. The Final CRA Rule eliminates the
previous CRA regulation's 12 assessment factors and substitutes a performance
based evaluation system. The Final CRA Rule will be phased in over a period of
time and become fully effective by July 1, 1997. Under the Final CRA Rule, an
institution's performance in meeting the credit needs of its entire community,
including low- and moderate-income areas, as required by the CRA, will
generally be evaluated under three assessment tests relating to lending,
investment and service.
The lending test analyzes lending performance using five criteria: (i) the
number and amount of loans in the institution's assessment area; (ii) the
geographic distribution of lending, including the proportion of lending in the
assessment area, the dispersion of lending in the assessment area, and the
number of amount of loans in low-, moderate-, middle-, and upper-income areas
in the assessment area; (iii) borrower characteristics, such as the income
level of individual borrowers and the size of businesses or farms; (iv) the
number and amount, as well as the complexity and innovativeness of an
institution's community development lending; and (v) the use of innovative or
flexible lending practices in a safe and sound manner to address the credit
needs of low- or moderate-income individuals or areas.
The investment test analyzes investment performance using four criteria: (i)
the dollar amount of qualified investments; (ii) the innovativeness or
complexity of qualified investments; (iii) the responsiveness of qualified
investments to credit and community development needs; and (iv) the degree to
which the qualified investments made by the institution are not routinely
provided by private investors.
The service test analyzes service performance using six criteria: (i) the
institution's branch distribution among low-, moderate-, middle- and
upper-income areas; (ii) its record of opening and closing branches,
particularly in low- and moderate-income areas; (iii) the availability and
effectiveness of alternative systems for delivering retail banking services;
(iv) the rate of services provided in low-, moderate-, middle-, and
upper-income areas and the extent to which those services are tailored to meet
the needs of those areas; (v) the extent to which the institution provides
community development services; and (vi) the innovativeness and responsiveness
of community development services provided.
Financial institutions with assets of less than $250 million, or a financial
institution with assets of less than $250 million that is a subsidiary of a
holding company with assets of less than $1 billion, will be evaluated under a
streamlined assessment method based primarily on its lending record. The
streamlined test considers an institution's loan-to-deposit ratio adjusted for
seasonal variation and special lending activities, its percentage of loans and
other lending related businesses and farms of different sizes, the geographic
distribution of its loans, and its record of taking action, if warranted, in
response to written complaints. In lieu of being evaluated under the three
assessment tests or the streamlined test, a financial institution can adopt a
"strategic plan" and elect to be evaluated on the basis of achieving the goals
and benchmarks outlined in the strategic plan. Based upon a review of the
Final CRA Rule, management of the holding Company does not anticipate that the
new CRA regulations will adversely affect the Bank.
41
<PAGE> 42
FEDERAL RESERVE SYSTEM
Regulation D, promulgated by the FRB, imposes reserve requirements on all
depository institutions, including savings banks and savings institutions,
which maintain transaction accounts or non-personal time deposits. Checking
accounts, NOW accounts and certain other types of accounts that permit payments
or transfers to third parties fall within the definition of transaction
accounts and are subject to Regulation D reserve requirements, as are any
non-personal time deposits (including certain money market deposit accounts) at
a savings institution. A depository institution must maintain average daily
reserves equal to 3% of the first $52.0 million of net transaction accounts and
an initial reserve of $1.6 million, plus 10% of that portion of total
transaction accounts in excess of $52.0 million. The first $4.3 million of
otherwise reservable balances (subject to adjustment by the FRB) are exempt
from the reserve requirements. These percentages and threshold limits are
subject to adjustment by the FRB. As of June 30, 1996, the Bank met its
Regulation D reserve requirements.
Thrift institutions also have authority to borrow from the Federal Reserve Bank
"discount window", but FRB policy generally requires thrift institutions to
exhaust all sources before borrowing from the Federal Reserve System. The Bank
had no discount window borrowings as of June 30, 1996.
FEDERAL HOME LOAN BANK SYSTEM
The Federal Home Loan Bank System, consisting of 12 FHLBs, is under the
jurisdiction of the Federal Housing Finance Board ("FHFB"). The designated
duties of the FHFB are to supervise the FHLBs; ensure that the FHLBs carry out
their housing finance mission; ensure that the FHLBs remain adequately
capitalized and able to raise funds in the capital market; and ensure that the
FHLBs operate in a safe and sound manner.
The Bank, as a member of the FHLB-Chicago, is required to acquire and hold
shares of capital stock in the FHLB-Chicago in an amount equal to the greater
of: (i) 1% of the aggregate outstanding principal amount of residential
mortgage loans, home purchase contracts and similar obligations at the
beginning of each year, or (ii) 1% of 30% of total assets. The Bank is in
compliance with this requirement with an investment in FHLB-Chicago stock of
$157,000 at June 30, 1996.
Among other benefits, the FHLBs provide a central credit facility primarily for
member institutions. It is funded primarily from proceeds derived from the
sale of consolidated obligations of the FHLB System. It makes advances to
members in accordance with policies and procedures established by the FHFB and
the Board of Directors of the FHLB-Chicago. At June 30, 1996, the Bank had no
advances from the FHLB-Chicago. See "Business of the Bank".
HOLDING COMPANY REGULATION
Federal Regulation
The Company applied for the prior approval of the FRB to become a registered
bank holding company pursuant to the Bank Holding Company Act of 1956, as
amended (the "BHCA"), by acquiring all of the common stock of the Bank to be
issued in connection with the Conversion. The FRB approved the Holding
Company's application on February 16, 1996.
The Company is subject to examination, regulation and periodic reporting under
the BHCA, as administered by the FRB. The FRB has adopted capital adequacy
guidelines for bank holding companies (on a consolidated basis) substantially
similar to those of the FDIC for the Bank. The Company's total and Tier 1
capital significantly exceeded such capital adequacy requirements.
The Company is required to obtain the prior approval of the FRB to acquire all,
or substantially all, of the assets of any bank or bank holding company. Prior
FRB approval will be required for the Company to acquire direct or indirect
ownership or control of any voting securities of any bank or bank holding
company if, after giving effect to such acquisition, it would, directly or
indirectly, own or control more than 5% of any class of
42
<PAGE> 43
voting shares of such bank or bank holding company. The BHCA also prohibits
the acquisition by the Company of more than 5% of the voting shares or
substantially all the assets of a bank located outside the State of Wisconsin
unless such an acquisition is specifically authorized by the laws of the state
in which such bank is located. In addition to the approval of the FRB, before
any bank acquisition can be completed, prior approval thereof also may be
required to be obtained from other agencies having supervisory jurisdiction
over the bank to be acquired, including the Commissioner.
The Company is required to give the FRB prior written notice of any purchase or
redemption of its outstanding equity securities if the gross consideration for
the purchase or redemption, when combined with the net consideration paid for
all such purchases or redemptions during the preceding 12 months, is equal to
10% or more of the Company's consolidated net worth. The FRB may disapprove
such a purchase or redemption if it determines that the proposal would
constitute an unsafe and unsound practice, or would violate any law,
regulation, FRB order or directive, or any condition imposed by, or written
agreement with, the FRB.
The status of the Company as a registered bank holding company under the BHCA
does not exempt it from certain federal and state laws and regulations
applicable to corporations generally, including without limitation, certain
provisions of the federal securities laws.
In addition, a bank holding company generally is prohibited from engaging in,
or acquiring direct or indirect control of any company engaged in, non-banking
activities. One of the principal exceptions to this prohibition is for
activities found by the FRB to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto. Some of the principal
activities the FRB has determined by regulation to be so closely related to
banking are: (i) making or servicing loans; (ii) performing certain data
processing services; (iii) providing discount brokerage services; (iv) acting
as fiduciary, investment or financial advisor; (v) leasing personal or real
property; (vi) making investments in corporations or projects designed
primarily to promote community welfare; and (vii) acquiring and/or operating a
savings and loan association.
Under FIRREA, depository institutions are liable to the FDIC for losses
suffered or anticipated by the FDIC in connection with the default of a
commonly controlled depository institution or any assistance provided by the
FDIC to such an institution in danger of default. This law would have
potential applicability if the Company ever acquired as a separate subsidiary a
depository institution in addition to the Bank. The Company currently does not
have any arrangements, plans or arrangements, written or oral, with respect to
such an acquisition.
The FRB's "Policy Statement on Cash Dividends Not Fully Covered by Earnings"
sets forth guidelines a bank holding company should follow when establishing
its dividend policy. In general, the policy statement provides that dividends
should be paid only out of current earnings and only if the prospective rate of
earnings retention by the bank holding company appears consistent with its
capital needs, asset quality and overall financial condition. The FRB policy
also requires that a bank holding company serve as a source of financial
strength to its subsidiary banks by standing ready to use available resources
to provide adequate capital funds to those banks during periods of financial
stress or adversity. These policies could affect the ability of the Company to
pay cash dividends.
Subsidiary banks of a bank holding company are subject to certain quantitative
and qualitative restrictions imposed by the Federal Reserve Act on any
extension of credit to, or purchase of assets from, or letter of credit on
behalf of, the bank holding company or its subsidiaries, and on the investment
in or acceptance of stocks or securities of such holding company or its
subsidiaries as collateral for loans. In addition, provisions of the Federal
Reserve Act and FRB regulations limit the amounts of, and establish required
procedures and credit standards with respect to, loans and other extensions of
credit to officers, directors and principal shareholders of the Bank, the
Company, any subsidiary of the Company and related interests of such persons.
See "Restrictions on Loans to and Transactions with Insiders and Affiliates".
Moreover, subsidiaries of bank holding companies are prohibited from engaging
in certain tie-in arrangements (with the Company or any of its subsidiaries)
43
<PAGE> 44
in connection with any extension of credit, lease or sale of property or
furnishing of services.
The Company and its subsidiary, the Bank, will be affected by the monetary and
fiscal policies of various agencies of the United States government, including
the Federal Reserve System. In view of changing conditions in the national
economy and in the money markets, it is impossible for management of the
Company to accurately predict future changes in monetary policy or the effect
of such changes on the business or financial condition of the Company.
State Savings Bank Holding Company Regulation
In addition to the FRB bank holding company regulations, a bank holding company
that owns or controls, directly or indirectly, more than 25% of the voting
securities of a state savings bank also is subject to regulation as a savings
bank holding company by the Commissioner. The Commissioner has not yet issued
regulations governing savings bank holding companies.
ACQUISITION OF THE HOLDING COMPANY
Under the federal Change in Bank Control Act of 1978, as amended ("CBCA"), a
notice must be submitted to the FRB if any person (including a company), or
group acting in concert, seeks to acquire 10% or more of the Company's shares
of Common Stock outstanding, unless the FRB has found that the acquisition will
not result in a change in control of the Company. Under the CBCA, the FRB has
60 days within which to act on such notices, taking into consideration certain
factors, including the financial and managerial resources of the acquiror, the
convenience and needs of the communities served by the Company and the Bank,
and the anti-trust effects of the acquisition. Under the BHCA, any company
would be required to obtain prior approval from the FRB before it may obtain
"control" of the Company within the meaning of the BHCA. Control generally is
defined to mean the ownership or power to vote 25% or more of any class of
voting securities of the Company or the ability to control in any manner the
election of a majority of the Company's directors. In addition, the BHCA
prohibits the acquisition of the Company by a bank holding company located
outside the State of Wisconsin, unless such acquisition is specifically
authorized by Wisconsin law.
REGULATORY AND CRIMINAL ENFORCEMENT PROVISIONS
FIRREA contains several changes to existing regulatory and criminal enforcement
provisions. The major applicable provisions: (i) expand the reach of the
depository institution regulatory agencies' civil enforcement authority to
include, in addition to directors, officers, employees and agents, any
"institution-affiliated party" of a depository institution; (ii) clarify and
enhance the authority of the agencies to order restitution or reimbursement in
a cease-and-desist order; (iii) unify removal provisions by the regulators and
allow the agencies to proceed with a removal or prohibition action when an
institution has been harmed without requiring the agencies to quantify the harm
or prejudice; (iv) authorize the agencies to take enforcement actions against
culpable institution-affiliated parties who depart from an institution, within
six years of the departure date; (v) increase the maximum amount for civil
money penalties from an institution, within six years of the departure date;
(vi) increase the maximum amount for civil money penalties ("CMPs") and expand
the grounds for imposing them; (vii) increase the criminal penalty up to $1
million and five years' imprisonment for violations of a removal order; (viii)
impose a three-tier level of CMPs for both failure to file or the late filing
of call reports and other information and filing any false or misleading report
or information; (ix) permit the FDIC to take particular enforcement actions
against savings banks; (x) require publication of formal enforcement orders
issued by the agencies; (xi) shorten the period from 120 days to 30 days for
agency notice for termination of deposit insurance; and, (xii) increase to 20
years the maximum prison term for the banking-related offenses in the Federal
Criminal Code.
FEDERAL SECURITIES LAWS
The Company filed with the SEC a registration statement under the Securities
Act of 1933, as amended (the "Securities Act"), for the registration of the
Common Stock issued pursuant to the Conversion. Upon completion of the
Conversion, the Company's Common Stock was registered with the SEC under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). The
44
<PAGE> 45
Company is subject to the information, proxy solicitation, insider trading
restrictions and other requirements under the Exchange Act.
The registration under the Securities Act of the shares of the Common Stock
does not cover the resale of such shares. Shares of Common Stock purchased by
persons who are not affiliates of the Company may be resold without
registration. Shares purchased by an affiliate of the Company will be subject
to the resale restrictions of Rule 144 under the Securities Act. If the
Company meets the current public information requirements of Rule 144 under the
Securities Act, each affiliate of the Company who complies with the other
conditions of Rule 144 (including those that require the affiliate's sale to be
aggregated with those of certain other persons) would be able to sell in the
public market, without registration, a number of shares not to exceed, in any
three-month period, the greater of (i) 1% of the outstanding shares Common
Stock of the Company, or (ii) the average weekly volume of trading in such
shares during the preceding four calendar weeks.
ITEM 2. DESCRIPTION OF PROPERTY
The Bank conducts its operations through its full-service office listed below.
<TABLE>
<CAPTION> Net Book Value
Year of Property at
Location Opened Owned or Leased June 30, 1996
- -------- ------ --------------- -------------
<S> <C> <C> <C>
3140 South 27th Street 1953 Owned $49,000
Milwaukee, WI 53215
</TABLE>
In order to expand and diversify its operations, the Bank intends to build or
purchase a branch facility in its primary market area of the Milwaukee MSA, or
purchase a financial institution that has one or more of such branch
facilities.
ITEM 3. LEGAL PROCEEDINGS
The Bank is not involved in any pending legal proceedings other than routine
legal proceedings occurring in the ordinary course of business, which in the
aggregate involve amounts that are believed by management to be immaterial to
the financial condition of the Bank.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders of the Company during the
three months ended June 30, 1996.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Information required by this item is included under the heading "Notes to
Financial Statements of Reliance Bancshares, Inc." and "Shareholder
Information" in the Registrant's Annual Report to Shareholders for the fiscal
year ended June 30, 1996, which has been filed separately pursuant to Rule
14a-3 under the Securities Exchange Act of 1934 and in accordance with General
Instruction E(2) to Form 10-KSB, and which sections are hereby incorporated
herein by reference.
The Board of Directors of the Registrant intends to consider a policy of paying
regular or special cash dividends on the shares of Common Stock in the future.
However, no decision has been made as to the amount or timing of such
dividends, if any. Declarations of dividends by the Board of Directors will
depend upon a number of factors, including investment opportunities available
to the Company and the Bank, the extent of the effectiveness of the deployment
of the net proceeds from the Conversion, capital requirements, regulatory
limitations and the Bank's and the Company's financial condition and results of
operations, tax considerations and general economic conditions. The payment of
cash dividends by the
45
<PAGE> 46
Company may be dependent upon dividend payments to the Company by the Bank.
The payment of cash dividends by the Bank to the Company will be subject to
significant regulatory restrictions. There can be no assurance that dividends
will in fact be paid on the shares of Common Stock or that, if paid, such
dividends will not be reduced or eliminated in future periods.
ITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
The Item 6 information for the Registrant has been provided, and is included
under the heading "Management's Discussion and Analysis of Financial Condition
and Results of Operations of Reliance Bancshares, Inc." in the Registrant's
Annual Report to Shareholders for the fiscal year ended June 30, 1996, which
has been filed with the Securities and Exchange Commission separately pursuant
to Rule 14a-3 under the Securities Exchange Act of 1934 and in accordance with
General Instruction E(2) to Form 10-KSB, and which section is hereby
incorporated herein by reference.
ITEM 7. FINANCIAL STATEMENTS
Form 10-KSB equivalent financial information for the Registrant for the fiscal
year ended June 30, 1996, has been provided, and is included under the headings
"Financial Statements of Reliance Bancshares, Inc." and "Notes to Financial
Statements of Reliance Bancshares, Inc." in the Registrant's Annual Report to
Shareholders for the fiscal year ended June 30, 1996, which has been filed with
the Securities and Exchange Commission separately pursuant to Rule 14a-3 under
the Securities Exchange Act of 1934 and in accordance with General Instruction
E(2) to Form 10-KSB, and which sections are hereby incorporated herein by
reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, AND CONTROL PERSONS: COMPLIANCE WITH
SECTION 16(A) OF THE EXCHANGE ACT.
Information required by this item with respect to directors is included under
the heading "Election of Directors" in the Registrant's definitive Proxy
Statement dated September 24, 1996, relating to the 1996 Annual Meeting of the
Shareholders scheduled for October 28, 1996, which has been filed separately
with the Securities and Exchange Commission pursuant to Rule 14a-6 under the
Securities Exchange Act of 1934 and in accordance with General Instruction E(3)
to Form 10-KSB, not later than 120 days after the end of the Registrant's
fiscal year, and which section is hereby incorporated herein by reference.
There are no arrangements or understandings between the persons named and any
other person pursuant to which such officers were selected, nor are there any
family relationships among them.
Information required by this item with respect to Item 405, Compliance with
Section 16(a) of the Exchange Act, is included under the heading "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Registrant's definitive Proxy
Statement dated September 24, 1996, relating to the 1996 Annual Meeting of
Shareholders scheduled for October 28, 1996, which has been filed separately
with the Securities and Exchange Commission pursuant to Rule 14a-6 under the
Securities Exchange Act of 1934 and in accordance with General Instruction E(3)
to Form 10-KSB, not later than 120 days after the end of the Registrant's
fiscal year, and which section is hereby incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION
Information required by this item is included under the heading "Compensation
of Executive Officers and Directors" in the Registrant's definitive Proxy
Statement dated September 24, 1996, relating to the 1996 Annual Meeting of
Shareholders scheduled for October 28, 1996,
46
<PAGE> 47
which has been filed separately with the Securities and Exchange Commission
pursuant to Rule 14a-6 under the Securities Exchange Act of 1934 and in
accordance with General Instruction E(3) to Form 10-KSB, not later than 120
days after the end of the Registrant's fiscal year, and which section is hereby
incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is included under the heading "Stock
Ownership of Certain Beneficial Owners" in the Registrant's definitive Proxy
Statement dated September 24, 1996, relating to the 1996 Annual Meeting of
Shareholders Scheduled for October 28, 1996, which has been filed separately
with the Securities and Exchange Commission pursuant to Rule 14a-6 under the
Securities Exchange Act of 1934 and in accordance with General Instruction E(3)
to Form 10-KSB, not later than 120 days after the end of the Registrant's
fiscal year, and which section is hereby incorporated herein by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is included under the heading "Indebtedness
of Management and Certain Transactions" in the Registrant's definitive Proxy
Statement dated September 24, 1996, relating to the 1996 Annual Meeting of
Shareholders scheduled for October 28, 1996, which has been filed separately
with the Securities and Exchange Commission pursuant to Rule 14a-6 under the
Securities Exchange Act of 1934 and in accordance with General Instruction E(3)
to Form 10-KSB, not later than 120 days after the end of the Registrant's
fiscal year, and which section is hereby incorporated herein by reference.
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits Required by Item 601:
2.1 Plan of Conversion of Reliance Savings Bank(1)
3.1 Articles of Incorporation of Registrant(1)
3.2 By-laws of Registrant(1)
3.3 Stock Articles of Incorporation of Reliance Savings Bank(1)
3.4 By-laws of Reliance Savings Bank(1)
4.1 Specimen Stock Certificate of Registrant(1)
4.2 Specimen Stock Certificate of Reliance Savings Bank(1)
10.1 Reliance Savings Bank Employee Stock Ownership Plan(1)
10.2 Credit Agreement by and Between Reliance Savings Bank
Employee Stock Ownership Trust and Registrant(1)
10.3 Employment Agreement - Mr. Allan T. Bach(1)
10.4 Employment Agreement - Ms. Carol A. Barnharst(1)
13.1 1996 Annual Report to Shareholders(2)
23.1 Consent of Meier, Clancy, George & Co. LLP(2)
24.1 Powers of Attorney for Certain Officers and Directors(1)
27.1 Financial Data Schedule(2)
99.1 Financial Statements of Reliance Bancshares, Inc.(2)
Independent Auditors' Report
Financial Statements:
Consolidated Statements of Financial Condition at June 30, 1995 and
1996
47
<PAGE> 48
Consolidated Statements of Income for the Years
Ended June 30, 1995 and 1996
Consolidated Statements of Stockholders' Equity for the
Years Ended June 30, 1995 and 1996
Consolidated Statements of Cash Flow for the Years Ended
June 30, 1995 and 1996
Notes to Consolidated Financial Statements
(1) Incorporated by reference to exhibits filed with Registrant's Form
SB-2 declared effective on February 29, 1996 (Registration Number
53-99706).
(2) Filed herewith.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by the Registrant during the three
months ended June 30, 1996.
48
<PAGE> 49
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, herewith duly authorized.
RELIANCE BANCSHARES, INC.
Dated: September 13, 1996 By: /s/
------------------------------------
Allan T. Bach, Chairman of the
Board, President and Chief Executive
Officer (Principal Executive
Officer)
By: /s/
------------------------------------
Carol A. Barnharst, Vice-President
and Chief Financial Officer
(Principal Financial and Accounting
Officer)
In accordance with the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Chairman of the Board, September 13, 1996
- ------------------------- President, Chief Executive Officer, and Director
Allan T. Bach
/s/ Vice-President, Chief Financial Officer, Secretary, September 13, 1996
- ------------------------- Treasurer and Director
Carol A. Barnharst
/s/ September 13, 1996
- ------------------------- Director
O. William Held
/s/ September 13, 1996
- ------------------------- Director
John T. Lynch
/s/ September 13, 1996
- ------------------------- Director
Marjorie A. Spicuzza
</TABLE>
49
<PAGE> 50
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
13.1 1996 Annual Report to Shareholders
23.1 Consent of Meier, Clancy, George & Co. LLP
27.1 Financial Data Schedule
99.1 Financial Statements of Reliance Bancshares, Inc.
50
<PAGE> 1
EXHIBIT 13.1
1996 ANNUAL REPORT
TO SHAREHOLDERS
<PAGE> 2
[RELIANCE BANCSHARES, INC. LOGO]
ANNUAL REPORT 1996
<PAGE> 3
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Company Profile 1
Financial Highlights of Reliance Bancshares, Inc. 2
Letter to Shareholders 3
Financial Table of Contents 5
Selected Financial and Other Data of Reliance Bancshares, Inc. 6
Management's Discussion and Analysis of Financial Condition and Results of
Operations of Reliance Bancshares, Inc. 8
Independent Auditor's Report 29
Financial Statements of Reliance Bancshares, Inc.
Consolidated Statements of Financial Condition of the Company at June 30,
1996 and 1995 30
Consolidated Statements of Income of the Company for the Years Ended
June 30, 1996, 1995 and 1994 31
Consolidated Statements of Stockholders' Equity of the Company for the Years
Ended June 30, 1996, 1995 and 1994 33
Consolidated Statements of Cash Flows of the Company for the Years Ended
June 30, 1996, 1995 and 1994 34
Notes to Consolidated Financial Statements of Reliance Bancshares, Inc. 36
Shareholder Information 56
</TABLE>
COMPANY PROFILE
Reliance Bancshares, Inc. is the holding company for Reliance Savings Bank.
The Bank converted from a Wisconsin-chartered mutual savings bank to a
Wisconsin-chartered stock savings bank on April 18, 1996. In connection with
the Conversion, Reliance Bancshares, Inc. sold 2,562,344 shares of its Common
Stock at $8.00 per share and used a portion of the net proceeds to purchase all
of the issued and outstanding capital stock of the Bank.
Reliance Savings Bank was established in 1922, and is regulated by the
Wisconsin Department of Financial Institutions, Division of Savings and Loan
and the Federal Deposit Insurance Corporation. The Bank is a
community-oriented, full-service financial institution offering a variety of
retail financial services to meet the needs of the communities it serves. The
Bank's principal business consists of attracting funds in the form of deposits
and investing such funds in loans secured by real estate, varying from
residential to one- to four-family to commercial, various types of consumer
loans, mortgage-backed securities and investment securities. The Bank has a
full-service office located in Milwaukee County, Wisconsin. At June 30, 1996,
the Company had total assets of $47.8 million, total deposits of $18.2 million
and stockholders' equity of $29.3 million.
The shares of Common Stock of Reliance Bancshares, Inc. are publicly traded on
the National Association of Securities Dealers Automated Quotation (NASDAQ)
"Small-Cap" Market under the symbol "RELI".
1
<PAGE> 4
FINANCIAL HIGHLIGHTS OF RELIANCE BANCSHARES, INC.
<TABLE>
<CAPTION>
At or For the Years Ended June 30,
----------------------------------
1996 1995 1994
---- ---- ----
(Dollars in thousands
except per share data)
<S> <C> <C> <C>
Total Assets $ 47,752 $ 32,260 $ 32,880
Loans Receivable, net 22,931 21,034 19,051
Investment Securities 19,354 8,868 10,882
Mortgage-Backed Securities 800 1,020 1,291
Deposits 18,200 22,312 23,267
Stockholders' Equity, Substantially Restricted 29,348 9,616 9,140
Net Interest Income After Provision for Loan Losses 1,549 1,348 1,258
Total Non-Interest Income 17 8 8
Total Non-Interest Expenses 721 680 674
Net Income 514 405 357
Earnings Per Share(1) .21 N/A N/A
Return on Average Assets 1.40% 1.23% 1.07%
Return on Average Equity 3.45 4.32 3.96
Interest Rate Spread 2.25 2.96 2.76
Net Interest Margin 4.42 4.24 3.91
Non-Performing Assets to Total Assets 0.00 0.00 0.24
Stockholders' Equity to Total Assets 61.46 29.81 27.80
</TABLE>
- -----------------------
(1) Reliance Savings Bank converted from mutual to stock form on April 18,
1996; therefore, earnings per share data for prior periods is not
applicable.
2
<PAGE> 5
LETTER TO SHAREHOLDERS
We are pleased to present Reliance Bancshares, Inc.'s first annual report. As
you know, 1996 was a historic year for Reliance Savings Bank and its parent
holding company, Reliance Bancshares, Inc. During the year, the Bank completed
a successful subscription offering to facilitate the mutual to stock conversion
of the Bank and its acquisition by Reliance Bancshares, Inc. Since the
Conversion was completed in April, 1996, this year's Annual Report reflects the
first year of operations of Reliance Bancshares, Inc. as a state-chartered
stock savings bank holding company.
In August, 1995, following careful study and deliberation, the Board of
Directors of Reliance Savings Bank voted unanimously to convert the Bank to a
state-chartered stock savings bank and to form a parent holding company. The
Conversion was completed in April, 1996 with the sale of 2,562,344 shares of
common stock at $8.00 per share. The Company appreciates the support of the
Bank's existing customers and members of our community as evidenced by their
interest in the offering and the successful completion of the Conversion.
At June 30, 1996, our total assets were $47.8 million, compared to $32.3
million for the previous year end. The Bank's loan portfolio increased to
$22.9 million from $21.0 million for the previous year end. Deposits decreased
to $18.2 million from $22.3 million for the year ended June 30, 1995. Our net
interest income increased from $1,370,000 for the year ended June 30, 1995 to
$1,571,000 for the year ended June 30, 1996. Operating expenses also increased
to $721,000 from $680,000. Finally, the Bank's net income increased to
$514,000 from $405,000 for the previous year end.
The Company's management has followed a consistent strategy of focusing on
strengthening the Bank's capital position through controlled growth and
emphasizing quality customer service. The Company hopes to strengthen its
franchise in its community by increasing its visibility within the community
and by remaining competitive in its primary business of attracting deposits and
originating real estate mortgage loans. We hope you will review the
information that follows in this Annual Report discussing our business in
fiscal 1996. We think the following are particularly noteworthy.
ASSET QUALITY. The Bank continues its focus on high asset quality in both its
lending activities and investment portfolio. There were no nonperforming
assets at June 30, 1996. The Bank has experienced only $2,000 of charge-offs
during the past three years and none of the Bank's investment securities or
mortgage-backed securities have been categorized as nonperforming assets during
the past three years.
LENDING. During both the years ended June 30, 1995 and 1996, the Bank has seen
a decrease in one-to-four family mortgage loans due to increased competition
for mortgage loan originations and the lack of quality one- to four-family
lending opportunities in the Bank's local market area. While market interest
rates on mortgage loans remained fairly steady during the year ended June 30,
1996, even if this trend were to continue, the Bank does not anticipate an
increase in one-to-four family mortgage loans in its portfolio in the near
future, particularly in light of an anticipated lessening of demand for
mortgage loan products and the increased competition for mortgage loan
originations that exists in the current market. In addition, the Bank believes
its non one- to four-family lending activities afford the Bank the opportunity
to invest in relatively high-yielding assets with shorter terms to maturity and
repricing than is the case with one- to four-family mortgage lending.
Therefore, the Bank is pursuing other lending opportunities, including
commercial construction and land development loans, to increase its loan
portfolio.
3
<PAGE> 6
INVESTMENTS. The amount invested in U.S. government and other agency
obligations investments increased significantly during the year ended June 30,
1996, by utilizing proceeds from the Conversion. The Bank may, in future
periods, leverage its capital base by using the proceeds of borrowings from the
FHLB-Chicago to purchase mortgage-backed and related securities or investment
securities. The amount of investments may decrease during fiscal 1997 if the
Bank is successful in increasing lending activity in commercial construction
and land development loans.
CAPITAL POSITION. Prior to and after the Conversion, the Bank met all of its
regulatory capital requirements and has been profitable in all recent years.
At June 30, 1996, the Bank had $18.8 million of capital, or 49.31% of total
assets, with GAAP Capital of 39.85% of adjusted total assets and Tier 1 capital
of 91.80% of total risk weighted assets. The additional capital acquired in
the Conversion provides the Company with opportunities to further expand its
operations within its community.
INTEREST RATE RISK MANAGEMENT. The Bank continues to actively manage its
interest rate risk. At June 30, 1996, the Bank's interest-earning assets with
maturities of one year or less exceeded its interest-bearing liabilities with
comparable maturities by $6.7 million, or 14.13% of total assets. The Bank
anticipates the magnitude of its positive gap position at June 30, 1996 will
increase steadily during fiscal 1997.
DEPOSITS. While the Bank's deposits decreased $4.1 million to $18.2 million at
the fiscal year end, some of the decline in deposits was due to the conversion
of deposit account monies to stock proceeds as a result of the Conversion,
along with a decreasing deposit base during 1996. The Bank intends to continue
to focus on increasing its core deposits as a more stable deposit base, and
will continue to aggressively price its deposit products in an effort to at
least maintain its deposit position.
We appreciate the confidence you have shown by becoming shareholders in our
Company. We intend to work hard to meet the challenges and opportunities
presented to the financial services industry during the second half of the
1990's. Explicit in our business plan is an intention to increase the value of
the Company by improving its position in its community marketplace. We intend
to control our growth and constantly monitor credit quality and financial
soundness. We do not intend to grow for growth's sake alone, but rather to
realize improved earnings and to maximize shareholder value. We are happy you
are a shareholder and will strive to justify your confidence in 1997.
Sincerely,
Mr. Allan T. Bach
President, CEO and Chairman of the Board
4
<PAGE> 7
FINANCIAL TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
SELECTED FINANCIAL AND OTHER DATA OF RELIANCE BANCSHARES, INC. 6
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OF RELIANCE BANCSHARES, INC.
General 8
Management Strategy 9
Comparison of Operating Results for the Years Ended June 30, 1996
and 1995 10
Comparison of Operating Results for the Years Ended June 30, 1995
and 1994 13
Financial Condition 16
Liquidity, Capital Resources and Regulatory Capital 18
Impact of Inflation and Changing Prices 21
Current Accounting Developments 21
Asset/Liability Management 23
Average Balance Sheet 26
Rate/Volume Analysis 28
INDEPENDENT AUDITOR'S REPORT 29
FINANCIAL STATEMENTS OF RELIANCE BANCSHARES, INC.
Consolidated Statements of Financial Condition at June 30, 1996 and 1995 30
Consolidated Statements of Income for the Years Ended June 30, 1996, 1995 and 1994 31
Consolidated Statements of Stockholders' Equity for the Years Ended June 30, 1996, 1995 and 1994 33
Consolidated Statements of Cash Flows for the Years Ended June 30, 1996, 1995 and 1994 34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS OF RELIANCE BANCSHARES, INC. 36
</TABLE>
5
<PAGE> 8
SELECTED FINANCIAL AND OTHER DATA OF
RELIANCE BANCSHARES, INC.
Set forth below are selected financial and other data of the Company. The
financial data is derived in part from, and should be read in conjunction with,
the Financial Statements of the Company and notes thereto presented elsewhere
in this Annual Report.
<TABLE>
<CAPTION>
AT JUNE 30,
---------------------------------------
1996 1995 1994
---- ---- ----
SELECTED FINANCIAL DATA: (DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Total assets $47,752 $32,260 $32,880
Cash and cash equivalents 4,055 777 1,221
Loans receivable, net 22,931 21,034 19,051
Investment securities 19,354 8,868 10,882
Mortgage-backed securities 800 1,020 1,291
FHLB stock 157 152 138
Deposits 18,200 22,312 23,267
FHLB advances and other borrowings -- -- --
Stockholders' equity, substantially restricted 29,348 9,616 9,140
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
---------------------------------------
1996 1995 1994
---- ---- ----
SELECTED OPERATING DATA:(1) (DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Total interest and dividend income $ 2,724 $ 2,453 $ 2,334
Total interest expense 1,153 1,083 1,054
Net interest income before provision for loan losses 1,571 1,370 1,280
Provision for loan losses 22 22 22
Net interest income after provision for loan losses 1,549 1,348 1,258
Non-interest income:
Loan fees and service charges 11 9 8
Deposit fees and service charges -- -- --
Gain (loss) on sales of investments (3) (11) (10)
Other income, net 9 10 10
------ ------ ------
Total non-interest income 17 8 8
------ ------ ------
Non-interest expenses:
Compensation and benefits 358 313 303
Data processing 70 67 60
Deposit insurance premiums 50 54 55
Other expenses 243 246 256
------ ------ ------
Total non-interest expenses 721 680 674
------ ------ ------
Income before income tax expense 845 676 592
Income tax expense 331 271 235
------ ------ ------
Net income $ 514 $ 405 $ 357
====== ====== ======
</TABLE>
- -------------------
(1) Fiscal year ended June 30, 1996 is based on the audited consolidated
financial statements of the Holding Company and its wholly owned Bank.
Fiscal years ended June 30, 1995 and 1994 are based on the Bank only
audited financial statements.
6
<PAGE> 9
SELECTED FINANCIAL AND OTHER DATA OF
RELIANCE BANCSHARES, INC. (CONTINUED)
<TABLE>
<CAPTION>
AT JUNE 30,
---------------------------------------
1996 1995 1994
---- ---- ----
SELECTED FINANCIAL RATIOS AND OTHER DATA: (DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
PERFORMANCE RATIOS
Return on average assets 1.40% 1.23% 1.07%
Return on average equity 3.45 4.32 3.96
Interest rate spread during period(1) 2.25 2.96 2.76
Net interest margin(1) 4.42 4.24 3.91
Non-interest expenses to average assets 1.97 2.06 2.03
Non-interest income to average assets 0.05 0.02 0.02
Average interest-earning assets to average interest-
bearing liabilities 166.94 138.02 135.78
ASSET QUALITY RATIOS
Nonperforming loans to gross loans(2) 0.00% 0.00% 0.00%
Nonperforming assets to total assets(2) 0.00 0.00 0.24
Allowance for loan losses to nonperforming loans(2) 0.00 0.00 0.00
Net charge-offs to average gross loans 0.00 0.01 0.00
REGULATORY CAPITAL AND CAPITAL RATIOS(3)
Tier 1 risk-based capital ratio 91.80% 52.63% 53.93%
Tier 2 risk-based capital ratio 49.64 53.20 54.43
Leverage ratio 49.31 29.55 27.76
Wisconsin capital to assets ratio 50.24 30.13 28.05
Average stockholders' equity to average assets 40.71 28.49 27.10
Stockholders' equity to total average assets 61.46 29.81 27.80
OTHER DATA
Number of deposit accounts 1,757 1,872 1,793
Number of real estate loans outstanding 238 231 226
Number of consumer loans outstanding 9 4 3
Real estate loan originations (in thousands) $ 9,301 $ 5,274 $ 5,232
Full-service facilities 1 1 1
</TABLE>
- -------------------
(1) Interest rate spread represents the difference between the weighted
average yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities. Net interest margin represents net
interest income as a percentage of average interest-earning assets.
(2) Nonperforming loans consist of non-accrual loans. Nonperforming assets
consist only of nonperforming loans because the Bank has no foreclosed
properties.
(3) For a discussion of the Bank's regulatory capital ratios, see "Notes to
Consolidated Financial Statements."
7
<PAGE> 10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF
RELIANCE BANCSHARES, INC.
FORWARD-LOOKING STATEMENTS
The discussion in this Annual Report includes certain forward-looking
statements based upon management expectations. Factors which could cause
future results to differ from these expectations include the following:
general economic conditions; legislative and regulatory initiatives; monetary
and fiscal policies of the federal government; deposit flows; the costs of
funds; general market rates of interest; interest rates on competing
investments; demand for loan products; demand for financial services; changes
in accounting policies or guidelines; and changes in the quality or composition
of the Company's loan and investment portfolios.
GENERAL
Reliance Bancshares, Inc. (the "Company") is the holding company for Reliance
Savings Bank (the "Bank"). On April 18, 1996, the Bank completed its
conversion from a Wisconsin-chartered mutual savings bank to a
Wisconsin-chartered stock savings bank (the "Conversion"). On that date, the
Company issued 2,562,344 shares of common stock at $8.00 per share to complete
the Conversion. The gross proceeds from the sale of the shares of common stock
were $20.5 million. Net proceeds to the Company were $19.1 million, after
deduction of Conversion expenses of approximately $720,000 and after lending
$713,000 to the Bank's Employee Stock Ownership Plan. The Company utilized
approximately $9.5 million of the net proceeds to purchase all of the issued
and outstanding common stock of the Bank.
The Company's business currently consists of the business of the Bank. The
Bank is headquartered in Milwaukee, Wisconsin and is a community- oriented,
full-service financial institution offering a variety of retail financial
services to meet the needs of the communities it serves. The Bank's principal
business consists of attracting funds in the form of deposits and investing
such funds in loans secured by real estate, investment securities (including
United States government and other agency obligations and mutual funds) and
mortgage-backed and related securities.
The earnings of the Bank depend primarily on its level of net interest income,
which is the difference between interest earned on interest- earning assets,
consisting primarily of mortgage loans, mortgage-backed and related securities
and other investment securities, and the interest paid on interest-bearing
liabilities, consisting primarily of deposits. Net interest income is a
function of the Bank's interest rate spread, which is the difference between
the average yield earned on interest-earning assets and the average rate paid
on interest-bearing liabilities as well as a function of the average balance of
interest-earning assets as compared to interest-bearing liabilities. Many of
the Bank's assets, including mortgage loans and mortgage-backed and related
securities, are subject to reinvestment risk. During periods of falling
interest rates, higher yielding loans and mortgage-backed and related
securities are more likely to prepay and the Bank may not be able to reinvest
the proceeds from such prepayment in loans or securities with yields similar to
those prepaying. The Bank's earnings also are affected by the level of its
other income, including loan servicing, commitment and origination fees and
gains on sale of loans and investments as well as its level of noninterest
expenses, including employee compensation and benefits, directors' fees,
occupancy and equipment costs and federal deposit insurance premiums. The
Bank's operating results are significantly affected by general economic
conditions, and the monetary, fiscal and regulatory policies of governmental
agencies. Lending activities are influenced by the demand for and supply of
housing, competition among lenders, the level of interest rates and the
availability of funds. Deposit flow and costs of funds likewise are heavily
influenced by prevailing market rates of interest on competing investment
alternatives, account maturities and the levels of personal income and savings
in the Bank's primary market area.
8
<PAGE> 11
MANAGEMENT'S DISCUSSION (CONT.)
MANAGEMENT STRATEGY
For many years, the Bank's financial condition has been characterized by high
capital and liquidity levels. While the Bank has in recent years had funds to
lend, the Bank believes there has been a diminishing demand for one-to
four-family mortgage loans in its local market area (generally defined as an
area within a three-mile radius of the Bank's office). The Bank intends to
continue to emphasize one- to four-family mortgage lending in its local market
area, but also has been, and intends to continue to, originate one- to
four-family, residential construction, commercial real estate, commercial
construction and land development and multi-family loans both within and
outside its local market area in suburbs surrounding the City of Milwaukee,
which encompass the Wisconsin counties of Milwaukee, Waukesha, Ozaukee and
Washington, in order to generate earnings, adequately leverage its capital and
make effective use of its liquid assets.
The Bank's strategic business plan is to utilize its well-capitalized position
to take advantage of future expansion and growth opportunities, while
controlling expenses, controlling exposure to credit and interest rate risk and
continuing to operate a profitable and independent community-oriented savings
institution dedicated to providing quality customer service. The Bank seeks to
accomplish these goals by: (i) expanding its lending activities beyond its
local market area and originating loans throughout its primary market area of
the Milwaukee MSA; (ii) continuing to diversify its lending activities beyond
one- to four-family mortgage lending; and (iii) meeting the financial needs of
customers. Financial highlights and operating strategies of the Bank include
the following:
- PROFITABILITY AND CAPITAL STRENGTH; POSSIBLE USE OF STRONG CAPITAL
POSITION. The Bank has been profitable and has met all of its regulatory
capital requirements over at least the past 20 years. For the years
ended June 30, 1995 and 1996, the Company's net income was $405,000 and
$514,000, respectively. The Company's return on average assets for the
years ended June 30, 1995 and 1996 was 1.23% and 1.40%, respectively.
The Bank's return on average equity for the years ended June 30, 1995 and
1996 was 4.32% and 3.45%, respectively.
At June 30, 1996, the Bank had $18.9 million of stockholders' equity, or
61.46% of total assets, and met all of its regulatory capital
requirements, in each case on a fully phased-in basis, with GAAP capital
of 61.46% of total assets and Tier 1 capital of 49.31% of total
risk-weighted assets.
The Bank may, in future periods, leverage its capital base by using the
proceeds of borrowings from the FHLB-Chicago to purchase mortgage-backed
and related securities and investment securities. The Bank may implement
this strategy and continue such a strategy, until other earning asset
growth fully utilizes its capital. In addition, the Bank intends to
utilize its well-capitalized position to expand and diversify its lending
activities as discussed herein.
- EXPANSION AND DIVERSIFICATION OF LENDING ACTIVITIES. The largest portion
of the Bank's loan portfolio is one- to four-family residential mortgage
loans, which amounted to $10.7 million, or 40.46% of total gross loans,
at June 30, 1996. The remaining $15.9 million, or 59.54% of total gross
loans, at June 30, 1996 consisted of $4.6 million of multi-family loans,
$4.2 million of commercial real estate loans, $4.3 million of residential
construction loans, $2.4 million of commercial construction and land
development loans, and $363,000 of consumer loans. The Bank intends to
continue to emphasize one- to four-family mortgage lending, but intends
to continue to expand its focus for such lending beyond its local market
area (generally defined as an area within a three-mile radius of the
Bank's office) throughout its primary market area of the Milwaukee MSA.
The Bank anticipates that its efforts to continue to build its one- to
four- family mortgage lending portfolio will be enhanced through the
hiring of at least one mortgage lending officer, and through its efforts
to build or acquire at least one branch facility to be located within the
Bank's primary market area of the Milwaukee MSA. Bank management
believes that a key factor in the Bank's inability to consistently
penetrate the one- to four-family mortgage lending market is the limited
staffing and resources currently
9
<PAGE> 12
MANAGEMENT'S DISCUSSION (CONT.)
available to it; therefore, the Bank believes that the employment of at
least one additional loan officer will increase the ability of the Bank
to maintain a presence in the residential loan market. Bank management
also believes that growth trends and demographic characteristics of the
local area surrounding its main office have not been favorable for
originating residential mortgage loans. The Bank believes that the
addition of a branch facility within its primary market area of the
Milwaukee MSA may enhance the Bank's ability to attract deposit funds and
originate residential mortgage loans.
Due to the Bank's belief that there has been diminishing demand for
permanent one- to four-family mortgage loans in the Banks' local market
area since the early 1990's and the increased competition relating to
one- to four-family mortgage lending opportunities, the Bank has
developed a niche lending strategy involving the origination of
comparatively large balance construction and land development loans and
commercial and multi-family loans. The Bank intends to continue to
expand these portfolios, as these types of loans afford the Bank the
opportunity to invest in relatively higher-yielding assets with shorter
terms to maturity or repricing than is the case with one- to four-family
mortgage lending. In addition, one of the purposes of the Conversion was
to increase the Bank's capital so that the Bank's loans-to-one borrower
limit would increase. This increased limit will allow the Bank to
originate and retain in its portfolio additional non-one- to four-family
mortgage loans for borrowers with whom it has a preexisting relationship.
The Bank has sought to address the risks associated with these types of
loans, and loan concentrations by developing and adhering to underwriting
policies, disbursement procedures and monitoring practices.
- ASSET QUALITY. The Bank focuses on high asset quality in its lending
activities. At June 30, 1996, the Bank had no non-performing assets, and
the Bank's non-performing assets have ranged between 0% to 0.24% as a
percent of total assets during the last three fiscal years. Moreover,
the Bank had only $2,000 in charge-offs during the last three fiscal
years. During the years ended June 30, 1995 and 1996, respectively, the
Bank added $22,000 to its allowance for loan losses and there were $2,000
and $0 in charge-offs. Absent any significant change in the
collectibility of the Bank's loan portfolio, future additions to the
allowance for loan losses will be made at a rate per year so that the
Bank's allowance for loan losses is equal to approximately 1.0% of the
Bank's gross loan portfolio.
- CUSTOMER SERVICE. The Bank is committed to meeting the financial needs
of its customers. Management believes that the Bank is large enough to
provide a range of personal and business financial services, and yet is
small enough to be able to provide such services on a personalized and
efficient basis. Management believes that the Bank can be more effective
in servicing its customers than many of its nonlocal competitors because
of the Bank's ability to quickly and effectively provide senior
management responses to customer needs and inquiries. The Bank also
intends to build or acquire at least one branch facility to offer, in
addition to the products and services currently available at the Bank's
main office, drive-up facilities, an automated teller machine and safe
deposit boxes to meet the needs of its customers. In addition to
enhancing the delivery of retail services to customers, a new branch
facility should improve the Bank's office facilities and better position
the Bank for future growth.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED JUNE 30, 1996 AND 1995
General
Net income for the year ended June 30, 1996 increased 26.9% to $514,000
compared to $405,000 for the year ended June 30, 1995. The increase in the net
income was primarily attributable to an increase in net interest income. Net
interest income increased 14.7% to $1.57 million for the year ended June 30,
1996 compared to $1.37 million for the year ended June 30, 1995, due primarily
to a decrease in average interest-bearing liabilities and an increase in
10
<PAGE> 13
MANAGEMENT'S DISCUSSION (CONT.)
interest-earning assets, partially offset by a reduction in the interest rate
spread. Non-interest income increased 112.5% to $17,000 for the year ended
June 30, 1996 compared to $8,000 for the year ended June 30, 1995.
Non-interest expense increased 6.0% to $721,000 for the year ended June 30,
1996 compared to $680,000 for the year ended June 30, 1995, primarily due to a
$45,000 increase in compensation and benefits. Income taxes increased 22.1% to
$331,000 for the year ended June 30, 1996 compared to $271,000 for the year
ended June 30, 1995. The return on average assets increased to 1.40% for the
year ended June 30, 1996 compared to 1.23% for the year ended June 30, 1995,
while the return on average equity declined to 3.45% for the year ended June
30, 1996 compared to 4.32% for the year ended June 30, 1995.
Net Interest Income
Net interest income is determined by an institution's interest rate spread, the
relative dollar amount or mix of interest-earning assets and interest-bearing
liabilities and the degree of match in the maturity and repricing of its
interest-earning assets and interest-bearing liabilities.
Net interest income increased $201,000 to $1.57 million for the year ended June
30, 1996 compared to $1.37 million for the year ended June 30, 1995. The
increase was due to a $271,000 increase in total interest income which was
partially offset by an increase in total interest expense of $70,000. The
increase in net interest income was the result of a 9.0% decline in average
interest bearing liabilities, and a 10.0% increase in average interest- earning
assets, partially offset by a 71 basis point decrease in the interest rate
spread. The decline in interest rate spread between June 30, 1996 and 1995 was
due primarily to the increase in the average cost of deposit accounts by 74
basis points, while the average yield on interest-earning assets increased by
only seven basis points for the same period.
The increase in average interest-earning assets over interest-bearing
liabilities between June 30, 1996 and 1995 was due to the decrease in the
average balances of deposit accounts between periods of $1.53 million and the
decrease in the average balances of escrow accounts between periods of
$441,000, while the average balances of loans and investments increased by
$3.24 million for the same period. Management believes deposits declined due
to general demographic changes in the Bank's local market area and due to
competition from alternative investments that were more attractive to
depositors during the period. A portion of the decline in deposit accounts was
due to the conversion of deposit account monies to stock proceeds at the
Conversion. Escrows declined as a result of the Bank's decision to return all
escrow balances to customers in July and August of 1995, and have the borrowers
be responsible for their own insurance and real estate taxes.
Interest Income
Total interest income increased $271,000, or 11.0% to $2.72 million for the
year ended June 30, 1996 compared to $2.45 million for the year ended June 30,
1995, as a result of an increase in the average yield on interest-earning
assets and the average balance of interest-earning assets. The average yield
on interest-earning assets increased seven basis points to 7.66% for the year
ended June 30, 1996 compared to 7.59% for the year ended June 30, 1995. For
the year ended June 30, 1996, the Bank's average yield on loans was 8.55%
compared to 8.52% for the year ended June 30, 1995. In fiscal 1996,
lower-yielding interest-earning deposit funds and lower-yielding maturing
certificates of deposit were reinvested by the Bank primarily in permanent and
construction mortgage loans secured by one- to four-family residences and in
higher-yielding investment securities. Total interest-earning assets increased
10.0% to $35.6 million for the year ended June 30, 1996 from $32.3 million for
the year ended June 30, 1995, primarily due to the reinvestment of Conversion
proceeds into investment securities and loans.
11
<PAGE> 14
MANAGEMENT'S DISCUSSION (CONT.)
Interest income on loans increased to $1.89 million for the year ended June 30,
1996 compared to $1.72 million for the year ended June 30, 1995. The increase
was primarily due to an increase in average loan balances of $1.9 million, and
an increase in the average yield of three basis points. Interest income on
investments increased to $743,000 for the year ended June 30, 1996 from
$618,000 for the year ended June 30, 1995, due primarily to the reinvestment of
proceeds from the Conversion into investment securities.
Interest income on mortgage-backed and related securities declined to $84,000
for the year ended June 30, 1996 compared to $106,000 for the year ended June
30, 1995. The decline was due to a reduction in the balance of mortgage-backed
and related securities due to increased prepayments on mortgage-backed pools
yielding over 10%.
Interest Expense
Total interest expense, which consisted almost entirely of interest expense on
deposits, increased $70,000, or 6.5%, to $1.15 million for the year ended June
30, 1996 from $1.08 million for the year ended June 30, 1995. The general
increase in market rates of interest during the year ended June 30, 1996
resulted in increases in average rates paid on all of the Bank's major
categories of deposits to 5.41% for the year ended June 30, 1996 from 4.67% for
the year ended June 30, 1995. This increase was partially offset by a $1.5
million decrease in deposits to $21.2 million for the year ended June 30, 1996
from $22.7 million for the year ended June 30, 1995. A portion of the decline
in deposit accounts was due to the conversion of deposit account monies to
stock proceeds at the Conversion. The level of deposit inflows during any
given period is heavily influenced by factors such as the general level of
interest rates in the economy, as well as alternative yields that investors may
obtain on competing investment instruments. Management believes the higher
returns on equity investments over the past few years has made alternative
financial products, such as mutual funds, more competitive with the Bank's
traditional deposit base. In addition, the Bank's deposit base has been
decreasing as competition for funds has increased and as the Bank's local
market area has experienced demographic changes and recessionary conditions.
Provision for Loan Losses
The provision for loan losses was $22,000 for both the year ended June 30, 1996
and 1995. The Bank determines the desired level of allowance for loan losses
based on the Bank's historical loan loss experience, the condition and
composition of the Bank's loan portfolio and general economic conditions. The
amount of the provision for loan losses for both the years ended June 30, 1996
and 1995 reflects management's intention to continue to make annual additions
to the Bank's allowance for loan losses until it is equal to approximately 1.0%
of the Bank's gross loan portfolio. However, the Bank will continue to monitor
its loan loss experience, the condition and composition of its loan portfolio
and general economic conditions, and may make further additions to its
allowance for loan losses to a greater or lesser extent than it has done
historically, depending upon changes in the aforementioned factors. The
allowance for loan losses totalled $126,000 and $104,000 at June 30, 1996 and
1995, respectively. The allowance for loan losses was 0.47% of gross loans at
June 30, 1996 and 1995, and there were no nonperforming loans at June 30, 1996.
While the Bank recorded no charge-offs for the year ended June 30, 1996,
charge-offs in the amount of $2,000 were recorded for the year ended June 30,
1995.
Non-Interest Income
Non-interest income increased to $17,000 for the year ended June 30, 1996
compared to $8,000 for the year ended June 30, 1995. The change was due in
part to an $11,000 investment loss during the year ended June 30, 1995 compared
to a $3,000 investment loss during the year ended June 30, 1996. The remainder
of the change was due to real estate loan brokerage fee income of $11,000 for
the year ended June 30, 1996 compared to $9,000 for the year ended June 30,
1995.
12
<PAGE> 15
MANAGEMENT'S DISCUSSION (CONT.)
Non-Interest Expense
Non-interest expense increased $41,000, or 6.03%, to $721,000 for the year
ended June 30, 1996 from $680,000 for the year ended June 30, 1995. The
increase was primarily due to an increase of $45,000 in compensation and
benefits, and an increase of $3,000 in fees and expenses for directors,
officers, and employees, which expenses were partially offset by cost
reductions in other areas. The Bank anticipates a continued increase in
non-interest expense as a result of the Conversion due to anticipated increased
legal and accounting fees and the hiring of additional personnel for accounting
and loan origination purposes. Non-interest expense as a percentage of average
assets (on an annualized basis) was 2.06% and 1.97%, respectively, for the
years ended June 30, 1996 and 1995.
Income Tax Expense
Income tax expense increased $60,000, or 22.1%, to $331,00 for the year ended
June 30, 1996 from $271,000 for the year ended June 30, 1995, primarily due to
increased income before income taxes. The increase reflects the increase in
income before taxes from $676,000 for the year ended June 30, 1995, to $845,000
for the year ended June 30, 1996. The Company's effective tax rates were 39.2%
and 40.1%, respectively, for the years ended June 30, 1996 and 1995.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED JUNE 30, 1995 AND 1994
General
Net income increased $48,000, or 13.45%, to $405,000 for the year ended June
30, 1995 from $357,000 for the year ended June 30, 1994. Net interest income
increased $90,000, or 7.03%, to $1.37 million for the year ended June 30, 1995
compared to $1.28 million for the year ended June 30, 1994. The increase in
net interest income was the result of an increase in the excess of average
interest-earning assets over interest-bearing liabilities by approximately
$276,000, along with an increase in the interest rate spread of 20 basis
points. The Bank's provision for loan losses and non-interest income remained
unchanged between the periods, while total non-interest expense increased
$6,000 and the provision for income taxes decreased $36,000 between the
periods. The return on average assets and return on average equity was 1.23%
and 4.32%, respectively, for the year ended June 30, 1995, compared to 1.07%
and 3.96%, respectively, for the year ended June 30, 1994.
Net Interest Income
Net interest income increased $90,000, or 7.0%, to $1.37 million for the year
ended June 30, 1995 from $1.28 million for the year ended June 30, 1994. The
increase was due to an increase in total interest income of $119,000, which was
partially offset by an increase in total interest expense of $29,000. The
improvement in net interest income primarily reflects a 3.2% increase in the
excess of the Bank's average interest-earning assets over average
interest-bearing liabilities to $8.91 million for the year ended June 30, 1995
compared to $8.63 million for the year ended June 30, 1994, and an increase in
the Bank's interest rate spread to 2.96% for the year ended June 30, 1995
compared to 2.76% for the year ended June 30, 1994. The increase in average
interest-earning assets over interest-bearing liabilities between June 30, 1995
and 1994 was due to the decrease in the average balances of deposit accounts
between periods of $968,000, partially offset by an increase in the average
balances of borrowings between periods of $280,000, while the average balances
of loans and investments decreased by $420,000 for the same period. Deposits
declined due to general demographic changes in the Bank's local market area and
due to competition from alternative investments that were more attractive to
depositors during the period. Borrowings increased due to the increased
liquidity needs created by the deposit outflows cited above. The increase in
interest rate spreads between June 30, 1995 and 1994 was due primarily from the
increase in the average yield on interest-earning assets by 46 basis points
while the average cost on deposit accounts increased by 25 basis points for the
same period.
13
<PAGE> 16
MANAGEMENT'S DISCUSSION (CONT.)
Interest Income
Total interest income increased $119,000, or 5.1%, to $2.45 million for the
year ended June 30, 1995 from $2.33 million for the year ended June 30, 1994,
primarily as a result of an increase in the average yield on interest-earning
assets, which was partially offset by a reduction in the average balance of
interest-earning assets. The average yield on interest-earning assets was
7.59% for the year ended June 30, 1995 compared to 7.13% for the year ended
June 30, 1994, an increase of 46 basis points. The average balance of
interest-earning assets decreased $420,000 between the periods. Changes in the
average yield and average balance of the Bank's loan portfolio and portfolio of
investment and other securities between the periods had the most significant
effect on the Bank's interest income. Interest income on loans increased
$101,000 between the periods as a result of a $2.0 million increase in the
average balance of the loan portfolio which more than offset a decrease in the
average yield on loans from 8.87% for the year ended June 30, 1994 to 8.52% for
the year ended June 30, 1995. Interest income on investments and other
securities increased $73,000 between the periods as a result of an increase in
the average yield on such securities from 4.27% for the year ended June 30,
1994 to 5.62% for the year ended June 30, 1995, which more than offset a $1.9
million decrease in the average balance of such securities between the periods.
Interest rates gradually fell during the last six months of 1994 and then
reversed and increased each month over the first six months of 1995. For the
year ended June 30, 1995, the Bank's loan interest rate yield ranged from a
8.37% low in December, 1994 to an 8.53% high in June, 1995. During this
period, lower-yielding interest-bearing deposit funds and lower- yielding
maturing certificates of deposit were reinvested by the Bank primarily in
construction mortgage loans on one- to four-family residences. Total average
interest-earning assets decreased 1.3%, or $420,000 to $32.3 million for the
year ended June 30, 1995 from $32.7 million for the year ended June 30, 1994.
Interest income on loans increased to $1.7 million for the year ended June 30,
1995 from $1.6 million for the year ended June 30, 1994. The increase was due
primarily to an increase in average loan balances of $2.0 million from $18.2
million in fiscal 1994 to $20.2 million in fiscal 1995, partially offset by a
35 basis point decrease in the average yield from 8.87% in fiscal 1994 to 8.52%
in fiscal 1995.
Interest income on investments increased to $618,000 for the year ended June
30, 1995 from $549,000 for the year ended June 30, 1994. The increase was
primarily the result of the reinvestment of maturing lower-yielding investments
and certificates of deposit into higher yielding U.S. agency bonds and mutual
funds. The average investment balance and average yield was $11.0 million and
5.62%, respectively, for the year ended June 30, 1995 compared to $12.9 million
and 4.27%, respectively, for the year ended June 30, 1994.
Interest income on mortgage-backed and related securities declined to $106,000
for the year ended June 30, 1995 from $155,000 for the year ended June 30,
1994. The decline was due primarily to a reduction in the balance of
mortgage-backed and related securities from $1.3 million at June 30, 1994, to
$1.0 million at June 30, 1995, and due to increased prepayments during fiscal
1995 on higher yielding mortgage-backed and related securities. The average
yield on mortgage-backed and related securities was 10.04% for the year ended
June 30, 1995 compared to 10.60% for the year ended June 30, 1994.
Interest Expense
Total interest expense increased $29,000, or 2.8%, to $1.08 million for the
year ended June 30, 1995 from $1.05 million for the year ended June 30, 1994.
The general increase in market rates of interest during fiscal 1995 resulted in
increases in average rates paid on all of the Bank's major categories of
deposits to 4.67% for the year ended June 30, 1995 from 4.42% for the year June
30, 1994, partially offset by a decrease in the average amount of
interest-bearing liabilities from $24.1 million for the year ended June 30,
1994 to $23.4 million for the year ended June 30, 1995. Interest expense on
deposits increased $11,00, or 1.0%, to $1.07 million for the year ended June
30, 1995 from $1.05 million for the year ended
14
<PAGE> 17
MANAGEMENT'S DISCUSSION (CONT.)
June 30, 1994. The increase in interest expense on deposits was due to the
general increase in market rates, which resulted in increases in average rates
paid on deposits to 4.67% for the year ended June 30, 1995 compared to 4.42%
for the year ended June 30, 1994, partially offset by a decrease in deposits of
$1.0 million to $22.3 million at June 30, 1995 from $23.3 million at June 30,
1994. Interest on borrowings was $18,000 for the year ended June 30, 1995 and
$0 for the year ended June 30, 1994. The increase reflected the need for
short-term borrowings to fund the decline in savings deposits during fiscal
1995.
Provision for Loan Losses
The provision for loan losses are charged to operations to bring the total
allowance for loan losses to a level considered appropriate by management based
on historical experience, volume and type of lending conducted by the Bank,
industry standards, the levels and status of past due and nonperforming loans,
the general economic conditions of the Bank's lending area and other factors
affecting collectibility of the Bank's loan portfolio.
The provision for loan losses was $22,000 for both the year ended June 30, 1995
and June 30, 1994. The Bank determines the desired level of allowance for loan
losses based on the Bank's historical loan loss experience, the condition and
composition of the Bank's loan portfolio and general economic conditions. The
amount of the provision for loan losses for both the years ended June 30, 1995
and June 30, 1994 reflects management's intention to continue to make annual
additions to the Bank's allowance for loan losses until it is equal to
approximately 1.0% of the Bank's gross loan portfolio. However, the Bank will
continue to monitor its loan loss experience, the condition and composition of
its loan portfolio and general economic conditions, and may make further
additions to its allowance for loan losses to a greater or lesser extent than
it has done historically, depending upon changes in the aforementioned factors.
The allowance for loan losses totalled $104,000 and $84,000 at June 30, 1995
and 1994, respectively, and represented 0.47% and 0.41% of gross loans. The
Bank did not have any non-performing loans or assets at June 30, 1995. For the
year ended June 30, 1994, the Bank had $78,000 of non-performing assets. Net
charge-offs were $2,000 during the year ended June 30, 1995 and none during the
year ended June 30, 1994.
Non-Interest Income
Non-interest income was $8,000 for both the years ended June 30, 1995 and 1994,
and there were no material changes in the line items comprising non-interest
income.
Non-Interest Expense
Non-interest expense increased $6,000, or 0.9%, to $680,000 for the year ended
June 30, 1995 from $674,000 for the year ended June 30, 1994. The increase was
primarily the result of an increase of $10,000 in compensation and other
employee benefits, an increase of $5,000 in advertising expenses, a decrease of
$20,000 in professional fee expense (due to prior year costs for conversion
which was abandoned), and increase of $7,000 in data processing expenses, and
an increase of $4,000 in fees and expenses for directors, officers, and
employees. Non- interest expense as a percentage of average assets (on an
annualized basis) was 2.09% and 2.05%, respectively, for the years ended June
30, 1995 and 1994. The Bank anticipates an increase in non-interest expense as
a result of the Conversion due to anticipated increased legal and accounting
fees and the hiring of additional personnel for accounting and loan origination
purposes.
Income Tax Expense
Income tax expense increased $36,000, or 15.3%, to $271,000 for the year ended
June 30, 1995 from $235,000 for the year ended June 30, 1994. The increase was
due to a 14.2% increase in income before income taxes to $676,000 for the year
ended June 30, 1995, compared to $592,000 for the year ended June 30, 1994.
The Bank's effective tax rates were 40.0% and 39.7% for the years ended June
30, 1995 and 1994, respectively.
15
<PAGE> 18
MANAGEMENT'S DISCUSSION (CONT.)
FINANCIAL CONDITION
The following table summarizes certain information relating to the Company's
statement of financial condition at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
---------------------------------------
1996 1995 1994
---- ---- ----
(Dollars in thousands)
<S> <C> <C> <C>
ASSETS:
Cash and cash equivalents $ 4,055 $ 777 $ 1,221
Investment securities 19,354 8,868 10,882
Mortgage-backed securities 800 1,020 1,291
Loans receivable, net 22,931 21,034 19,051
LIABILITIES:
Deposits 18,200 22,312 23,267
Stockholders' equity, substantially restricted 29,348 9,616 9,140
</TABLE>
The statement of financial condition at June 30, 1996 is consolidated (see
"Principles of Consolidation" in the Notes to Consolidated Financial
Statements), whereas June 30, 1995 and 1994, represent the Bank only.
Cash and Cash Equivalents
Cash and cash equivalents increased to $4.1 million at June 30, 1996 from
$777,000 at June 30, 1995. The increase was attributable to the proceeds
received from the Conversion.
Investment Securities
Investment securities increased to $19.4 million at June 30, 1996 from $8.9
million at June 30, 1995. The change was primarily the result of management's
decision to use Conversion proceeds and prepayments of mortgage-backed
securities to purchase additional investment securities.
The Bank may, in future periods, leverage its capital base by using the
proceeds of borrowings from the FHLB-Chicago to purchase mortgage- backed and
related securities and investment securities. Therefore, if the leveraging
strategy is implemented, the size of the Bank's investment securities portfolio
may further increase in future periods.
Mortgage-Backed and Related Securities
Mortgage-backed and related securities declined to $800,000 at June 30, 1996
from $1.0 million at June 30, 1995. The decrease was the result of normal
principal repayments and escalated prepayments on mortgage-backed pools
yielding over 10% since market rates were significantly lower during this
period. Management decided to reinvest the repayment and prepayment proceeds
into higher yielding mortgage loans and other investment securities. The Bank
may, in future periods, leverage its capital base by using the proceeds of
borrowings from the FHLB-Chicago to purchase mortgage-backed and related
securities and investment securities. Therefore, if the leveraging strategy is
implemented, the size of the Bank's mortgage-backed and related securities
portfolio may increase in future periods.
Loans Receivable
Net loans receivable increased to $22.9 million at June 30, 1996 from $21.0
million at June 30, 1995. The net change in loans arising from originations
and principal repayments for the years ended June 30, 1996 and 1995 was
$320,000 and $1.2 million for one-to-four family loans, respectively;
($126,000) and ($193,000) for multi-family loans, respectively; $3.8 million
and $317,000 for construction and land development loans, respectively; and
$283,000 and $262,000 for commercial real estate loans, respectively. There
were no loans
16
<PAGE> 19
MANAGEMENT'S DISCUSSION (CONT.)
sold during these periods. As a result of the originations and repayments
during these periods, mortgage loans increased or decreased as follows:
one-to-four family mortgage loans were $10.7 million at June 30, 1996 compared
to $10.4 million at June 30, 1995; commercial construction and land development
loans were $6.7 million at June 30, 1996 compared to $2.9 million at June 30,
1995; multi-family loans were $4.6 million at June 30, 1996 compared to $4.7
million at June 30, 1995; and commercial real estate loans were $4.2 million at
June 30, 1996 compared to $3.9 million at June 30, 1995. The large increase in
commercial and land development loans is due to a strategic decision to pursue
these higher-yielding, shorter maturity loans.
Deposits and Borrowings
Deposits were $18.2 million and $22.3 million at June 30, 1996 and 1995,
respectively. Deposits are the Bank's primary source of externally generated
funds. The level of deposits is heavily influenced by factors such as the
general level of short and long-term interest rates, as well as alternative
yields that investors may obtain on competing investment instruments such as
mutual funds. In recent years, the lower yields on bank deposit products have
made alternative financial products more competitive with the Bank's
traditional deposit products. During the year ended June 30, 1996, this
competition caused the Bank's certificate of deposit accounts to decline by
$3.4 million and non-certificate accounts to decline by $735,000. At June 30,
1996 and 1995, demand accounts, which consist of interest-bearing and
noninterest-bearing NOW accounts, money market accounts and passbook accounts,
were $3.9 million and $4.7 million, respectively. The general decrease in
these accounts was primarily due to the general decline in the average rates
paid on demand accounts from 3.14% for the year ended June 30, 1995 to 2.87%
for the year ended June 30, 1996. The Bank intends to focus on increasing its
core deposits in order to maintain a more stable deposit base. However,
although the Bank has been competitively pricing its deposit products over the
past two years, its core deposits have continued to decline. Upon consummation
of the Conversion, the Bank's liability balance has also decreased by the
amount of stock proceeds received (in escrow) in connection with the Conversion
by the amount authorized to be withdrawn by depositors for payment for shares
of common stock in connection with the Conversion.
The Bank had no outstanding advances or other borrowings at June 30, 1996 or
1995. However, during the period December, 1994 through May, 1995, the Bank
did make use of repurchase agreements to fund short-term liquidity needs. The
maximum outstanding on repurchase agreements during this period was $880,000.
The Bank, on an ongoing basis, considers the use of these other borrowings and
FHLB-Chicago advances in the management of its asset/liability portfolio.
During the year ended June 30, 1996, the Bank borrowed $650,000 on FHLB-Chicago
advances which was repaid prior to June 30, 1996. The Bank may, in future
periods, leverage its capital base by using the proceeds of borrowings from the
FHLB-Chicago to purchase mortgage-backed and related securities and investment
securities. The Bank may continue such a strategy, until other earning asset
growth fully utilizes its capital.
Stockholders' Equity
The Company's stockholders' equity increased to $29.3 million at June 30, 1996
from $9.6 million at June 30, 1995. The increase was primarily attributable to
the Conversion and the $19.1 million of net proceeds from the sale of shares of
the Company's common stock. Stockholders' equity also increased as a result of
the Company's net income of $514,000 for the year ended June 30, 1996. In
addition, stockholders' equity also was increased by unrealized gains, net of
taxes, for the Bank's securities which were held as available for sale. For
the year ended June 30, 1996, the unrealized gain was $144,000, which was net
of assumed taxes of $92,000, and for the year ended June 30, 1995, the
unrealized gain was $71,000, which was net of assumed taxes of $46,000.
17
<PAGE> 20
MANAGEMENT'S DISCUSSION (CONT.)
LIQUIDITY, CAPITAL RESOURCES AND REGULATORY CAPITAL
The Bank's primary sources of funds are deposits, proceeds of principal and
interest payments on loans, and principal and interest payments on
mortgage-backed and related securities and investment securities. Although
maturity and scheduled amortization of loans and investments are predictable
sources of funds, deposit flows, mortgage loan prepayments and prepayments on
mortgage-backed and related securities are influenced significantly by general
interest rates, economic conditons and competition. During the years ended
June 30, 1996 and 1995, rates in general declined only moderately and mortgage
loan prepayments thus were fairly stable. Prepayments on mortgage-backed and
related securities, however, were considerably higher during these years
because the yield on many of those securities was over 10%. For the years
ended June 30, 1996 and 1995, the Bank reinvested loan and mortgage-backed and
related securities repayments into new mortgage loan originations, primarily
commercial and land development loans, and investment securities. In a period
of rising interest rates, it is anticipated that mortgage loan prepayments will
decrease, and any proceeds from such prepayments would be invested in higher
yielding loans or investments which would have the effect of increasing
interest income.
The Bank is required to maintain minimum levels of liquid assets under the
Wisconsin Director of Savings and Loan's (the "Director") regulations for
state-chartered savings banks. Savings banks are required to maintain an
average daily balance of liquid assets (including cash, certain time deposits,
certain banker's acceptances, certain corporate debt securities and highly
rated commercial paper, securities of certain mutual funds and specified United
States government, state or federal agency obligations) of not less than 8% of
its average daily balance of net withdrawable accounts plus short-term
borrowings. The Bank's liquidity ratios were 39.69% and 43.62%, at June 30,
1996 and 1995, respectively.
The Company's most liquid assets are cash and cash equivalents, which include
investments in highly liquid, short-term investments. The levels of these
assets are dependent on the Bank's operating, financing, lending and investing
activities during any given period. At June 30, 1996 and 1995, cash and cash
equivalents were $4.1 million and $800,000, respectively. The increase in cash
and cash equivalents resulted primarily from proceeds from the Conversion.
Until the net proceeds from the Conversion are permanently invested, management
anticipates continuing to maintain somewhat higher levels of liquid assets.
Liquidity management for the Bank is both a daily and long-term component of
the Bank's management strategy. The Bank maintains liquidity levels sufficient
to accommodate normal deposit fluctuations and various funding needs, and to
meet its assets and liability management objectives. Excess funds generally
are invested in short-term investments. At June 30, 1996, the Bank had $0
borrowings outstanding under an approved borrowing resolution with the FHLB,
but may use FHLB advances if liquidity conditions or investment strategies
warrant their use.
The primary investing activity of the Bank is the origination of loans. For
the years ended June 30, 1996 and 1995, respectively, the Bank originated $9.3
million and $5.3 million in mortgage loans. There were no sales or purchases
of mortgage loans during these periods. The Bank also did not originate or
purchase any mortgage-backed and related securities during these periods.
During the years ended June 30, 1996 and 1995, respectively, the Bank received
principal repayments on loans totalling $5.0 million and $3.7 million, and
principal repayments on mortgage-backed and related securities of $221,000 and
$273,000.
At June 30, 1996, the Bank had $1.4 million in outstanding loan commitments.
The Bank had no commitments to purchase mortgage-backed and related securities
at that date. The Bank anticipates it will have sufficient funds available to
meet its current loan commitments, including loan applications received and in
process prior to the issuance of firm commitments. Certificates of deposit
which are scheduled to mature in one year or less at June 30, 1996 were $10.8
million. Based on its historical experience, management believes that a
significant portion of such deposits will remain with the Bank.
18
<PAGE> 21
MANAGEMENT'S DISCUSSION (CONT.)
Effective June 7, 1993, the Bank converted from a state-chartered mutual
savings and loan regulated by the OTS to a state-chartered mutual savings bank
subject to regulation by the FDIC and the Wisconsin Department of Financial
Institutions, Division of Savings and Loan. Applicable FDIC regulations
require institutions to meet three capital standards: (i) "Tier 1 capital" in
an amount not less than 3% of total assets; (ii) "Tier 1 capital" in an amount
not less than 4% of risk-weighted assets; and (iii) "Total Capital" in an
amount not less than 8% of risk-weighted assets. Wisconsin-chartered savings
banks also are required to maintain a minimum capital to assets ratio of 6%.
The percent of assets for Wisconsin regulatory capital purposes is based on
total unconsolidated assets. See "Regulation" for a discussion of the Bank's
regulatory capital requirements.
Cash flows are categorized as to whether they relate to the operating,
investing or financing activities of the Bank. Cash flow from operating
activities includes net income plus or minus non-cash income statement items
and cash flow related to the origination and sale of mortgage loans held for
sale. Cash flow from investing activities includes proceeds from the sale of
maturity of investment securities, principal payments collected on loans and
mortgage-backed and related securities, loan originations and purchases of
investments and mortgage-backed and related securities. Cash flow from
financing activities includes the increase or decrease in deposits, borrowings
and escrows and common stock transactions. The amount of principal repayments
on loans and mortgage-backed and related securities are heavily influenced by
the general level of interest rates in the economy. During periods in which
the Bank is unable to originate a sufficient amount of loans that it intends to
retain, such as ARM loans and other loans with shorter terms, and during
periods of high principal repayments, the Bank will increase liquid assets,
with remaining amounts invested in mortgage-backed and related securities.
Deposits were $18.2 million and $22.3 million at June 30, 1996 and 1995,
respectively. The Bank's certificates of deposit accounts at June 30, 1996 and
1995 were $14.3 million and $17.6 million, respectively, and demand accounts,
which consist of NOW accounts, money market accounts and passbook accounts,
were $3.9 million and $4.7 million, respectively, at June 30, 1996 and 1995.
The decreases were due to the general decline in the average rate on deposit
accounts from 5.20% from the year ended June 30, 1995 to 5.04% for the year
ended June 30, 1996.
In addition, the Bank's deposit account balance has declined by the amount
authorized to be withdrawn by depositors for payment for shares of Common Stock
in connection with the Conversion.
19
<PAGE> 22
A summary of the Bank's regulatory capital amounts follows:
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------------------------
1995 1996
--------------------------------- -----------------------------
Amount Percent of Assets Amount Percent of Assets
------ ----------------- ------ -----------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Total capital under generally accepted
accounting principles $9,616 29.81% $19,030 49.91%
===== ====== ====== ======
Tier 1 capital leverage $9,533 29.55% 18,803 49.31%
Tier 1 capital leverage requirement 968 3.00 1,144 3.00
----- ------ ------ ------
Excess $8,565 26.55% $17,659 46.31%
===== ====== ====== ======
Tier 1 risk-based capital $9,533 52.63% $18,803 91.80%
Tier 1 risk-based capital requirement 725 4.00 819 4.00
----- ------ ------ ------
Excess $8,808 48.63% $17,984 87.80%
===== ====== ====== ======
Total risk-based capital $9,637 53.20% $18,929 49.64%
Total risk-based capital requirement 1,449 8.00 1,639 8.00
----- ------ ------ ------
Excess $8,188 45.20% $17,290 41.64%
===== ====== ====== ======
Wisconsin regulatory capital $9,720 30.13% $19,156 50.24%
Wisconsin regulatory capital requirement 1,936 6.00 2,288 6.00
----- ------ ------ ------
Excess $7,784 24.13% $16,868 44.24%
===== ====== ====== ======
</TABLE>
20
<PAGE> 23
MANAGEMENT'S DISCUSSION (CONT.)
DIVIDENDS
The Board of Directors of the Company intends to consider a policy of paying
regular or special cash dividends on the shares of Common Stock in the future.
However, no decision has been made as to the amount or timing of such
dividends, if any. Declaration of dividends by the Board of Directors will
depend upon a number of factors, including investment opportunities available
to the Company and the Bank, the extent of the effectiveness of the deployment
of the net proceeds from the Conversion, capital requirements, regulatory
limitations and the Bank's and the Company's financial condition and results of
operations, tax considerations and general economic conditions. The payment of
cash dividends by the Company may be dependent upon dividend payments to the
Company by the Bank. The payment of cash dividends by the Bank to the Company
will be subject to significant regulatory restrictions. No assurances can be
given that any dividends will be paid or, if commenced, will continue to be
paid.
COMMON STOCK SHARE REPURCHASE PROGRAM
The Company adopted a share repurchase program for its common stock on August
29, 1996. The repurchase program was adopted to improve earnings per share and
return on equity, and represents an attractive investment alternative compared
to other available investments. The repurchased shares will become treasury
shares and will be used for general corporate purposes. The Company has
notified the Wisconsin Department of Financial Institutions, Division of
Savings and Loan and the FDIC of the repurchase program and has obtained
regulatory approvals for the program consistent with applicable regulations.
The Company plans to purchase up to 5% of the outstanding shares of common
stock, or approximately 128,117 shares, at prevailing market prices over a
six-month period of time. Approximately 34,000 shares have been repurchased at
an approximate cost of $283,000 as of September 13, 1996.
IMPACT OF INFLATION AND CHANGING PRICES
The Company's Consolidated Financial Statements and Notes thereto have been
prepared in accordance with GAAP, which requires the measurement of financial
position and operating results in terms of historical dollars without
considering the changes in the relative purchasing power of money over time due
to inflation. The impact of inflation is reflected in the increased cost of
the Company's operations. Unlike most industrial companies, nearly all of the
assets and liabilities of the Company are monetary in nature. As a result,
interest rates have a greater impact on the Company's performance than do the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or to the same extent as the price of goods and services.
CURRENT ACCOUNTING DEVELOPMENTS
In December 1991, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("FAS") No. 107, "Disclosures about
Fair Value of Financial Instruments". This statement requires disclosure of
the fair value of financial instruments, both assets and liabilities, whether
or not such instruments are recognized in the balance sheet. Financial
instruments involve either a right or an obligation to receive or deliver cash
or an equivalent to another entity. Such disclosures could be on the face of
the financial statements or in footnotes thereto to the extent that such fair
value is reasonably attainable, and would not necessarily result in any
adjustment to the carrying amounts of such instruments on the Bank's statement
of financial condition. As it relates to the Bank's financial instruments,
including cash equivalents, investment securities, mortgage-backed and related
securities, loans receivable and deposits, FAS No. 107 has been adopted by the
Bank for its year ending June 30, 1996.
21
<PAGE> 24
MANAGEMENT'S DISCUSSION (CONT.)
During 1993, the Accounting Standards Executive Committee of the AICPA issued
SOP 93-6, "Employers' Accounting for Stock Ownership Plans". Under SOP 93-6,
employers are required to recognize compensation cost equal to the fair value
for ESOP shares committed to be released to compensate employees directly. For
ESOP shares committed to be released to settle or fund liabilities for other
employee benefits, such as an employer's match of employees' 401(k)
contributions, employers would be required to report satisfaction of the
liabilities when the shares are committed to be released to settle the
liabilities. Compensation cost and liabilities associated with providing such
benefits would be recognized the way they would be if any ESOP had not been
used to fund the benefit. Under SOP 93-6, employers must charge dividends on
allocated ESOP shares to retained earnings. They must report dividends on
unallocated shares as a reduction of debt or accrued interest or as
compensation cost (depending on whether the dividends are used for debt service
or paid to participants). For earnings per share computations, ESOP shares
that have been committed to be released should be considered outstanding. SOP
93-6 is effective for fiscal years beginning after December 15, 1993. The Bank
has followed the requirements of SOP 93-6 upon the establishment of its ESOP.
In October 1994, the FASB issued Statement of Financial Accounting Standards
No. 119, "Disclosure About Derivative Financial Instruments and Fair Value of
Financial Instruments" ("SFAS 119"). This statement amends Statement of
Financial Accounting Standards No. 105, "Disclosure of Information About
Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments
with Concentrations of Credit Risk", and Statement of Financial Accounting
Standards No. 107, "Disclosures about Fair Value of Financial Instruments", and
provides specific disclosure requirements for derivative financial instruments.
SFAS 119 is effective for financial statements issued for fiscal years ending
after December 15, 1994. The Company does not utilize derivative financial
instruments.
In March 1995, the FASB issued Statement of Financial Accounting Standards No.
121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of". SFAS 121 requires that long-lived assets
and certain identifiable intangibles be reviewed for impairment whenever events
or circumstances indicate that the carrying amount of an asset may not be
recoverable. However, SFAS 121 does not apply to financial instruments,
mortgage and other servicing rights or deferred tax assets. SFAS 121 is
effective for fiscal years beginning after December 15, 1995. The adoption of
SFAS 121 will have no material impact on the Company's financial statements.
In May, 1995, the FASB issued Statement of Financial Accounting Standards No.
122 ("SFAS 122"), "Accounting for Mortgage Servicing Rights, an amendment to
Statement of Financial Accounting Standards No. 65". SFAS 122 requires an
institution that purchases or originates mortgage loans and sells or
securitizes those loans with servicing rights retained to allocate the total
cost of the mortgage loans to the mortgage servicing rights and the loans
(without the mortgage servicing rights) based on their relative fair values.
In addition, institutions are required to assess impairment of the capitalized
mortgage servicing portfolio based on the fair value of those rights on a
stratum-by-stratum basis with any impairment recognized through a valuation
allowance for each impaired stratum. Capitalized mortgage servicing rights
should be stratified based upon one or more of the predominant risk
characteristics of the underlying loans such as loan type, size, note rate,
date of origination, term and/or geographic location. SFAS 122 is effective
for fiscal years beginning after December 15, 1995. The adoption of SFAS 122
will have no material impact on the Company's financial statements.
On December 30, 1994, the AICPA issued SOP 94-6, "Disclosure of Certain
Significant Risks and Uncertainties". SOP 94-6 requires financial statement
disclosures concerning: (i) the nature of operations; (ii) use of estimates in
the preparation of financial statements; (iii) certain significant estimates;
and (iv) current vulnerability due to certain concentrations. The provisions
of SOP 94-6 are effective for financial statements issued for years ending
after December 15, 1995, and for financial statements for interim periods in
years subsequent to the year for which the SOP is first applied. The Bank
implemented SOP 94-6 in 1996.
22
<PAGE> 25
MANAGEMENT'S DISCUSSION (CONT.)
In October, 1995, the FASB issued FAS 123, "Accounting for Stock Compensation".
The statement encourages companies to account for stock compensation awards
based on their fair value at the date the awards are granted. The resulting
compensation cost would be shown as an expense on the income statement. FAS
123 is effective for calendar year 1996. However, companies will be required
to include in that year's financial statements information about options
granted in 1995. Companies can choose not to apply the new accounting method
and continue to apply current accounting requirements, which generally result
in no compensation cost for most fixed stock options plans. Those that do so,
however, will be required to disclose in the notes to the financial statements
what net income and earnings per share would have been if they had followed the
new accounting method. The Bank plans to implement FAS 123 in 1996, upon
approval and establishment of its stock compensation plans.
ASSET/LIABILITY MANAGEMENT
The Bank's profitability, like that of most financial institutions, depends to
a large extent upon its net interest income, which is the difference between
the interest it earns on interest-earning assets, such as loans and
investments, and the interest expense it pays on interest-bearing liabilities,
such as deposits and borrowings. The matching of assets and liabilities may be
analyzed by examining the extent to which such assets and liabilities are
"interest rate sensitive" and by monitoring an institutions' interest rate
sensitivity "gap". An asset or liability is said to be interest rate sensitive
within a specific time period if it matures or re-prices within that time
period. The interest rate sensitivity gap is defined as the difference between
the amount of interest-earning assets anticipated, based upon certain
assumptions, to mature or re-price within a specific time period and the amount
of interest-bearing liabilities anticipated, based upon certain assumptions, to
mature or re-price within that time period. A gap is considered positive when
the amount of interest rate sensitive assets exceeds the amount of interest
rate sensitive liabilities that mature or re-price within a specified time
period. A gap is considered negative when the amount of interest rate
sensitive liabilities exceeds the amount of interest rate sensitive assets that
mature or re-price within a specified time period. During a period of rising
interest rates, therefore, a negative gap theoretically would tend to adversely
affect net interest income, while a positive gap would tend to result in an
increase in net interest income. Conversely, during a period of falling
interest rates, a negative gap position would theoretically tend to result in
an increase in net interest income while a positive gap would tend to affect
net interest income adversely.
In an attempt to manage vulnerability to interest rate changes, management
monitors the Bank's interest rate risk. The principal objective of the Bank's
interest rate risk management function is to evaluate the interest rate risk
included in certain balance sheet accounts, determine the level of risk for the
Bank given its operating environment, capital and liquidity requirements and
performance objectives, and manage the risk consistent with board approved
guidelines. Through such management, the Bank seeks to reduce the
vulnerability of its operations to changes in interest rates. The Bank
monitors its interest rate risk as such risk relates to its operating
strategies. The Bank's Board of Directors has established an Asset/Liability
Committee, responsible for reviewing its asset/liability policies and interest
rate risk position, which meets monthly and reports trends to the Board of
Directors on a monthly basis and the Bank's interest rate risk position on a
quarterly basis.
Generally, the Bank utilizes the following strategies to manage interest rate
risk: (i) emphasizing the origination of adjustable rate one- to four-family
mortgage loans and non-one- to four-family mortgage loans (which typically are
either adjustable rate or short-term) for its loan portfolio; (ii) holding
primarily short-term mortgage-backed and related securities and investment
securities,; and (iii) attempting to reduce the overall interest rate
sensitivity of liabilities by emphasizing core and longer-term deposits.
23
<PAGE> 26
MANAGEMENT'S DISCUSSION (CONT.)
By originating ARM loans and other mortgage loans with short to medium terms
and by investing in relatively short to medium term mortgage- backed and
related securities and investment securities, the Bank has been able to reduce
interest rate risk by more closely matching the terms and repricing
characteristics of its assets and liabilities. Although the Bank has
significantly increased its emphasis upon originating ARM loans and has been
developing other types of mortgage loans with shorter average lives or terms
and invests in mortgage-backed and related securities with shorter average
lives, the level of the Bank's portfolio of fixed rate mortgage loans and
investments with longer average lives continues to affect its gap position.
The Bank's ARM loans also typically have annual and lifetime caps on interest
rate increases, which reduces the extent to which they protect the Bank against
interest rate risk. Further, mortgage-backed securities are subject to
reinvestment risk. For example, during periods of falling interest rates,
mortgage-backed securities are more likely to prepay, and the Bank may not be
able to reinvest the proceeds from prepayments in securities or other assets
with yields similar to those of the prepaying mortgage-backed securities.
Mortgage-backed and related securities also are subject to extension risk,
which is the risk that the effective maturity of the security may increase in a
rising interest rate environment. The market value of a security with a longer
maturity typically is more sensitive to changes in market rates of interest,
and rising interest rates may have a more pronounced adverse effect on the
market value of mortgage- backed and related securities than on other types of
investment securities.
The Bank continues to closely monitor its interest rate risk as that risk
relates to its strategies. At June 30, 1996, total interest-earnings assets
maturing or repricing within one year exceeded total interest-bearing
liabilities maturing or re-pricing in the same period by $6.7 million,
representing a positive cumulative one year gap ratio of 14.13%. With a
positive gap position, during periods of rising interest rates, it is projected
that the cost of the Bank's interest-bearing liabilities would rise slower than
the yield on its interest-earning assets, which would have a positive effect
upon net interest income. The opposite effect on net interest income would
occur in periods of falling interest rates. The Bank also could experience
substantial prepayments of its fixed rate mortgage loans in periods of falling
interest rates, which would likely result in the reinvestment of such proceeds
at market rates which are lower than current rates.
ASSET/LIABILITY MANAGEMENT SCHEDULE
The following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at June 30, 1996, which are
anticipated by the Company to mature or reprice in each of the periods shown,
based on the information and assumptions set forth in the notes thereto.
Except as stated below, the amount of assets and liabilities shown which
reprice or mature during a particular period were determined in accordance with
the earlier of term to repricing or the contractual maturity of the asset or
liability. It is intended to provide an approximation of the projected
repricing of assets and liabilities at June 30, 1996 on the basis of
contractual maturities, anticipated prepayments, and scheduled rate adjustments
within a three month period and subsequent selected time intervals. The loan
amounts in the table reflect principal balances expected to be redeployed
and/or repriced as a result of contractual amortization and anticipated
prepayments of adjustable rate loans and fixed rate loans, and as a result of
contractual rate adjustments on adjustable rate loans. For loans on
residential properties, adjustable rate loans and fixed rate loans are
projected to prepay at rates between 15% and 30% annually. Prepayment
assumptions are based on OTS prepayment assumptions of 10% - 30% based on loan
type. Mortgage-backed and related securities are projected to prepay at rates
between 23% and 29% annually. Money market savings accounts, passbook accounts
and negotiable order of withdrawal ("NOW") accounts are assumed to have decay
rates between 40% and 79% annually.
24
<PAGE> 27
<TABLE>
<CAPTION>
At June 30, 1996
-------------------------------------------------------------------------------
More
More Than
Than One Three
Within Four to Year to Years to Over
Three Twelve Three Five Five
Months Months Years Years Years Total
------ ------ ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS(1)
Mortgage loans(2)
Fixed $ 1,060 $ 2,900 $ 1,781 $ 1,132 $ 8,271 $15,144
Variable 1,077 5,017 1,337 -- -- 7,431
Consumer loans(2) 21 61 144 94 36 356
Mortgage-backed
securities 9 28 87 97 579 800
Investment securities
and other assets 9,405 498 8,575 99 4,188 23,465
------ ------ ------ ------ ------ ------
Total interest-earning
assets $11,572 $ 8,504 $11,924 $ 1,422 $13,774 $47,196
====== ====== ====== ====== ====== ======
INTEREST-BEARING
LIABILITIES
Deposits(3):
NOW accounts $ 13 $ 39 $ 49 $ 18 $ 7 $ 126
Money market accounts 188 564 128 46 26 952
Passbook accounts 278 833 1,066 384 215 2,776
Certificates of deposit 4,422 6,993 2,172 622 49 14,258
------ ------ ------ ------ ------ ------
Total interest-bearing
liabilities $ 4,901 $ 8,429 $ 3,415 $ 1,070 $ 297 $18,112
====== ====== ====== ====== ====== ======
Excess (deficiency) of
interest-earning assets
over interest-bearing
liabilities $ 6,671 $ 75 $ 8,509 $ 352 $13,477 $29,084
====== ====== ====== ====== ====== ======
Cumulative excess
(deficiency) of
interest-earning assets
over interest-bearing
liabilities $ 6,671 $ 6,746 $15,255 $15,607 $29,084 $29,084
====== ====== ====== ====== ====== ======
Cumulative excess
(deficiency) of
interest-earning assets
over interest-bearing
liabilities as a percent
of total assets 13.97% 14.13% 31.95% 32.68% 60.91% 60.91%
</TABLE>
- -------------------
(1) Adjustable and floating rate assets are included in the period in which
interest rates are next scheduled to adjust rather than in the period in
which they are due, and fixed rate assets are included in the periods in
which they are scheduled to be repaid based on scheduled amortization, in
each case adjusted to take into account estimated prepayments utilizing OTS
prepayment assumptions of 10% - 30% based on loan type.
(2) Balances have been reduced for undisbursed loan proceeds, unearned
interest, deferred loan fees and allowances for loan losses, which
aggregated $3,626,000 at June 30, 1996. Consumer loans include home equity
loans.
25
<PAGE> 28
MANAGEMENT'S DISCUSSION (CONT.)
(3) Although the Bank's negotiable order of withdrawal ("NOW") accounts, money
market accounts and passbook accounts generally are subject to immediate
withdrawal, management considers a certain amount of such accounts to be
core deposits having significantly longer effective maturities and times to
repricing based on the Bank's historical retention of such deposits in
changing interest rate environments. NOW accounts, passbook savings
accounts and money market deposit accounts have been assumed to be
withdrawn at annual rates of 40%, 40% and 79%, respectively, of the
declining balance of such accounts during the period shown. The withdrawal
rates are higher than the Bank's historical rates but are considered by
management to be more indicative of expected withdrawal rates currently.
If all of the Bank's NOW accounts, passbook savings accounts and money
market deposit accounts had been assumed to be subject to repricing within
one year, the one- year cumulative excess of interest-earning assets over
interest-bearing liabilities would have been $4.8 million or 10.07% of
total assets.
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different degrees
to changes in market interest rates. The interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types may lag behind changes in market
rates. Additionally, certain assets, such as ARM loans and mortgage-backed
securities, have features which restrict changes in interest rates on a
short-term basis and over the life of the asset. In addition, the proportion
of ARM loans and mortgage-backed securities in the Bank's portfolios could
decrease in future periods if market interest rates remain at or decrease below
current levels due to the exercise of conversion options and refinancing
activity. Further, in the event of a change in interest rates, prepayment and
early withdrawal levels would likely deviate significantly from those assumed
in the table. Finally, the ability of many borrowers to service their debt may
decrease in the event of an interest rate increase.
AVERAGE BALANCE SHEET
The following table sets forth certain information relating to the Company's
average statements of financial condition and the statements of income for the
years ended June 30, 1996, 1995, and 1994, and reflects the average yield on
assets and average cost of liabilities for the periods indicated. Such yields
and costs are derived by dividing income or expense by the average balance of
assets or liabilities, respectively, for the periods shown. Average balances
are derived principally from average daily balances and include non-accruing
loans. The yields and costs include fees which are considered adjustments to
yields. The amount of interest income resulting from the recognition of loan
fees was $22,000, $34,000 and $52,000 for the years ended June 30, 1996, 1995
and 1994, respectively. Interest income on nonaccruing loans is reflected in
the period it is collected and not in the periods it is earned. Such amounts
are not material to net interest income or net change in net interest income in
any period. Nonaccrual loans are included in the average balances and do not
have a material effect on the average yield.
26
<PAGE> 29
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------------------------------------------
1994 1995
---------------------------------------- --------------------------
Average
Average Balance Interest Yield/Cost Average Balance Interest
- ------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Loans $18,247 $1,619 8.87% $20,199 $1,720
Mortgage-backed and related securities 1,444 155 10.73 996 106
Investment and other securities 12,866 549 4.27 10,996 618
Federal Home Loan Bank stock 192 11 5.73 138 9
------- ------ ------- ------
Total interest-earning assets(1) 32,749 2,334 7.13 32,329 2,453
Noninterest earning assets 526 -- -- 604 --
------- ------ ------- ------
Total assets $33,275 $2,334 $32,933 $2,453
======= ====== ======= ======
Liabilities and Retained Earnings:
Interest-bearing liabilities:
Total deposits $23,664 $1,045 4.42 $22,696 $1,059
Advances from borrowers for taxes and
insurance 456 9 1.97 448 6
Borrowings -- -- -- 280 18
------- ------ ------ ------- ------
Total interest-bearing liabilities 24,120 1,054 4.37 23,424 1,083
Noninterest-bearing liabilities 138 -- -- 126 --
Retained earnings 9,017 -- -- 9,383 --
------- ------ ------- ------
Total liabilities and retained earnings $33,275 $1,054 $32,933 $1,083
======= ====== ======= ======
Net interest income/interest rate spread(2) $1,280 2.76% $1,370
====== ===== ======
Net interest-earning assets/net interest
margin(3) $ 8,629 3.91% $ 8,905
======= ===== =======
Average interest-earning assets to
average interest-bearing liabilities 135.78% 138.02%
====== ======
<CAPTION>
Year Ended June 30,
--------------------------------------------------------------------
1995 1996
---------- ------------------------------------------------------
Average Average
Yield/Cost Average Balance Interest Yield/Cost
- ------------------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Assets:
Interest-earning assets:
Loans 8.52% $22,079 $1,887 8.55%
Mortgage-backed and related securities 10.64 895 84 9.39
Investment and other securities 5.62 12,444 743 5.97
Federal Home Loan Bank stock 6.52 153 10 6.54
------- ------
Total interest-earning assets(1) 7.59 35,571 2,724 7.66
Noninterest earning assets -- 1,021 -- --
------- ------
Total assets $36,592 $2,724
======= ======
Liabilities and Retained Earnings:
Interest-bearing liabilities:
Total deposits 4.67 $21,167 $1,146 5.41
Advances from borrowers for taxes and
insurance 1.34 7 -- --
-------
Borrowings 6.43 134 7 5.22
------- ------
Total interest-bearing liabilities 4.62 21,308 1,153 5.41
Noninterest-bearing liabilities -- 387 -- --
Retained earnings -- 14,897 -- --
------- ------
Total liabilities and retained earnings $36,592 $1,153
======= ======
Net interest income/interest rate spread(2) 2.96% $1,571 2.25%
==== ======
Net interest-earning assets/net interest
margin(3) 4.24% $14,263 166.94% 4.42%
==== ======= ====== ====
Average interest-earning assets to
average interest-bearing liabilities
</TABLE>
(1) Calculated net of deferred loan fees, loan discounts, loans in process and
allowance for loan losses.
(2) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average rate paid on interest- bearing
liabilities.
(3) Net interest margin represents net interest income divided by average
interest-earning assets.
27
<PAGE> 30
MANAGEMENT'S DISCUSSION (CONT.)
RATE/VOLUME ANALYSIS
The following table presents the extent to which changes in interest rates and
changes in the volume of interest-earning assets and interest- bearing
liabilities have affected the Company's interest income and interest expense
during the periods indicated. Information is provided in each category with
respect to: (i) changes attributable to changes in volume (changes in volume
multiplied by prior rate), (ii) changes attributable to changes in rate (change
in rate multiplied by prior volume), and (iii) the net change. The changes
attributable to the combined impact of volume and rate have been allocated
proportionately to the changes due to volume and the changes due to rate.
<TABLE>
<CAPTION>
Year Ended June 30, 1995 Year Ended June 30, 1994
Compared to Compared to
Year Ended June 30, 1996 Year Ended June 30, 1995
--------------------------- ---------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
--------------------------- ---------------------------
(In thousands)
Rate Volume Net Rate Volume Net
---- ------ --- ---- ------ ---
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Loans $ 6 $ 161 $ 167 $ (66) $ 167 $ 101
Mortgage-backed and related
securities (11) (11) (22) (8) (45) (53)
Investment and other
securities 40 85 125 161 (88) 73
Federal Home Loan
Bank stock -- 1 1 (1) (1) (2)
---- ---- ---- ---- ---- ----
Total interest-earning assets 35 236 271 86 33 119
INTEREST-BEARING LIABILITIES:
Total deposits 164 (77) 87 58 (44) 14
Advances from
borrowers for taxes
and insurance (3) (3) (6) (3) -- (3)
Borrowings (3) (8) (11) -- 18 18
---- ---- ---- ---- ---- ----
Total interest-bearing
liabilities 158 (88) 70 55 (26) 29
---- ---- ---- ---- ---- ----
Net change in net
interest income $(123) $ 324 $ 201 $ 31 $ 59 $ 90
==== ==== ==== ==== ==== ====
</TABLE>
28
<PAGE> 31
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Reliance Bancshares, Inc.
Milwaukee, Wisconsin
We have audited the accompanying consolidated statements of financial condition
of RELIANCE BANCSHARES, INC. as of June 30, 1996 and 1995, and the related
statements of income, stockholders' equity, and cash flows for the three years
in the period ended June 30, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of RELIANCE BANCSHARES, INC. as
of June 30, 1996 and 1995, and the results of its operations and its cash flows
for each of the three years in the period ended June 30, 1996 in conformity
with generally accepted accounting principles.
Certified Public Accountants
July 19, 1996
Brookfield, Wisconsin
29
<PAGE> 32
RELIANCE BANCSHARES, INC.
================================================================================
Consolidated Statements of Financial Condition
<TABLE>
<CAPTION>
June 30,
----------------------
1996 1995
---- ----
(In thousands)
<S> <C> <C>
ASSETS
Cash $ 98 $ 293
Cash equivalent interest-bearing deposits 3,957 484
----- ------
Total cash and cash equivalents 4,055 777
Investments
Certificates of deposit - at cost 294 479
Investment securities available-for-sale, at fair value 7,882 6,193
Investment securities held-to-maturity (estimated market
value of $11,161 in 1996 and $2,203 in 1995) 11,178 2,196
Mortgage-backed and related securities (estimated market
value of $852 in 1996 and $1,087 in 1995) 800 1,020
Federal Home Loan Bank stock - at cost 157 152
Loans receivable - net 22,931 21,034
Accrued interest receivable 173 95
Office properties and equipment 84 107
Prepaid expenses and other assets 198 207
------ ------
Total assets $47,752 $32,260
====== ======
LIABILITIES AND EQUITY
Deposit accounts $18,200 $22,312
Advance payment by borrowers for taxes - 172
Income taxes
Current 5 64
Deferred 94 6
Accrued and other liabilities
Interest 33 33
Other 72 57
------ ------
Total liabilities 18,404 22,644
------ ------
Commitments and contingencies - -
Stockholders' equity
Common stock of $1 par value; 6,000,000 shares
authorized; 2,562,344 shares issued and outstanding 2,562 -
Additional paid-in capital 17,225 -
Unearned ESOP compensation (713) -
Unrealized gain on securities available-for-sale,
net of applicable deferred income taxes 227 83
Retained earnings, substantially restricted 10,047 9,533
------ ------
Total stockholders' equity 29,348 9,616
------ ------
Total liabilities and stockholders' equity $47,752 $32,260
====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
30
<PAGE> 33
RELIANCE BANCSHARES, INC.
================================================================================
Consolidated Statements of Income
<TABLE>
<CAPTION>
Years Ended June 30,
----------------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
INTEREST AND DIVIDEND INCOME: (In thousands, except per share data)
Mortgage loans $1,886 $1,719 $1,618
Investment securities 743 618 549
Mortgage-backed and related securities 84 106 155
Other loans 1 1 1
Dividends on stock in Federal Home Loan Bank 10 9 11
----- ----- -----
Total interest and dividend income 2,724 2,453 2,334
----- ----- -----
INTEREST EXPENSE:
Deposits and escrows 1,146 1,065 1,054
Notes payable and other borrowings 7 18 -
----- ----- -----
Total interest expense 1,153 1,083 1,054
----- ----- -----
Net interest income 1,571 1,370 1,280
Provision for loan losses 22 22 22
----- ----- -----
Net interest income after provision for loan
losses 1,549 1,348 1,258
----- ----- -----
NONINTEREST INCOME:
Gain (loss) on sale of investment (3) (11) (10)
Other income 9 10 10
Loan fees and service charges 11 9 8
----- ----- -----
Total noninterest income 17 8 8
----- ----- -----
Operating income 1,566 1,356 1,266
----- ----- -----
</TABLE>
See accompanying notes to consolidated financial statements.
31
<PAGE> 34
RELIANCE BANCSHARES, INC.
================================================================================
Consolidated Statements of Income
<TABLE>
<CAPTION>
Years Ended June 30,
---------------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
NONINTEREST EXPENSE: (In thousands, except per share data)
Compensation and benefits $ 358 $ 313 $ 303
Occupancy 30 31 34
Advertising 7 18 13
Furniture and equipment 22 20 19
Federal insurance premiums 50 54 55
Professional services 31 28 48
Data processing 70 67 60
Stationery, communications and other operating
expenses 60 59 56
Directors' fees and expenses of directors,
officers and employees 93 90 86
---- ---- ----
Total noninterest expense 721 680 674
---- ---- ----
Income before income taxes 845 676 592
---- ---- ----
INCOME TAXES:
Current 336 298 230
Deferred (5) (27) 5
---- ---- ----
Total income taxes 331 271 235
---- ---- ----
Net income $ 514 $ 405 $ 357
==== ==== ====
Earnings per share $0.21 $ N/A $ N/A
==== ==== ====
</TABLE>
See accompanying notes to consolidated financial statements.
32
<PAGE> 35
RELIANCE BANCSHARES, INC.
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Additional Unearned ESOP
Common Stock Paid-In Capital Compensation
------------ --------------- ------------
(In thousands)
<S> <C> <C> <C>
Balances at June 30, 1993 $ - $ - $ -
Net income - - -
Change in unrealized gain (loss) on securities
available-for-sale, net of applicable deferred
income taxes of $8 - - -
---------- ------------ ----------
Balances at June 30, 1994 - - -
Net income - - -
Change in unrealized gain (loss) on securities
available-for-sale, net of applicable deferred
income taxes of $46 - - -
---------- ------------ ----------
Balances at June 30, 1995 - - -
Sale of 2,562,344 shares of common stock at $8
per share, net of related expenses 2,562 17,225 (713)
Net income - - -
Change in unrealized gain (loss) on securities
available-for-sale, net of applicable deferred
income taxes of $92 - - -
---------- ------------ ----------
Balances at June 30, 1996 $ 2,562 $ 17,225 $ (713)
========== ============ ==========
<CAPTION>
Unrealized Gain (Loss)
on Securities Available
for Sale, Net of
Applicable Deferred Retained
Income Taxes Earnings Total
------------ ---------- ---------
(In thousands)
<S> <C> <C> <C>
Balances at June 30, 1993 $ - $ 8,771 $ 8,771
Net income - 357 357
Change in unrealized gain (loss) on securities
available-for-sale, net of applicable deferred
income taxes of $8 12 - 12
------------ ---------- ----------
Balances at June 30, 1994 12 9,128 9,140
Net income - 405 405
Change in unrealized gain (loss) on securities
available-for-sale, net of applicable deferred
income taxes of $46 71 - 71
------------ ---------- ----------
Balances at June 30, 1995 83 9,533 9,616
Sale of 2,562,344 shares of common stock at $8
per share, net of related expenses - - 19,074
Net income - 514 514
Change in unrealized gain (loss) on securities
available-for-sale, net of applicable deferred
income taxes of $92 144 - 144
----------- ---------- ----------
Balances at June 30, 1996 $ 227 $ 10,047 $ 29,348
=========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
33
<PAGE> 36
RELIANCE BANCSHARES, INC.
================================================================================
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years Ended June 30,
---------------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES: (In thousands)
Net income
Adjustments to reconcile net income to net $ 514 $ 405 $ 357
cash provided by operating activities:
Provision for depreciation 23 25 23
Provision for loan losses 22 20 22
Amortization of premiums, discounts, and
fees - net (33) (52) (13)
Increase (decrease) in income taxes payable (59) 131 (68)
Provision for (reduction of) deferred income
taxes (4) (27) 5
(Increase) decrease in interest receivable (78) (7) 13
Net increase (decrease) in accrued/other
liabilities 15 14 11
Net (increase) decrease in prepaid expenses
and other assets 9 (188) (11)
Loss (gain) on investments 3 11 10
------- ------- -------
Net cash provided by operating
activities 412 332 349
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Federal Home Loan Bank stock (5) (14) -
Proceeds from sale of Federal Home Loan Bank
stock - - 66
Proceeds from sales/maturities of investment
securities 6,939 3,135 6,180
Purchase of investment securities (17,182) (1,000) (5,850)
Net (increase) decrease in loans (1,896) (1,967) (2,353)
Principal payments collected on mortgage-backed
securities 220 273 803
Purchase of fixed assets - (20) (32)
Investment in real estate in judgement - - (78)
Proceeds from real estate in judgement - 78 -
------- ------- -------
Net cash provided (used) by investing activities (11,924) 485 (1,264)
------- ------- -------
</TABLE>
See accompanying notes to consolidated financial statements.
34
<PAGE> 37
RELIANCE BANCSHARES, INC.
================================================================================
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years Ended June 30,
----------------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES: (In thousands)
Net proceeds from issuance of common stock $19,074 $ - $ -
Repayments of short-term borrowing (650) (8,190) -
Proceeds from short-term borrowing 650 8,190 -
Increase (decrease) in advance payments by
borrowers (172) (306) (4)
Increase (decrease) in deposit accounts (4,112) (955) (404)
------ ------ ------
Net cash provided (used) by financing
activities 14,790 (1,261) (408)
------ ------ ------
Increase (decrease) in cash and cash
equivalents 3,278 (444) (1,323)
CASH AND CASH EQUIVALENTS:
Beginning of year 777 1,221 2,544
------ ------ ------
End of year $ 4,055 $ 777 $ 1,221
====== ====== ======
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for:
Interest on deposit accounts $ 183 $ 184 $ 197
Income taxes 395 233 298
Interest on borrowings 7 18 -
Noncash investing activities:
Loans transferred to foreclosed
properties and real estate
in judgement - - 78
Total increase in unrealized gain
on securities available-for-sale 236 118 20
</TABLE>
Accounting polices note: Cash equivalents include demand deposits at other
financial institutions and the Federal Home Loan Bank.
See accompanying notes to consolidated financial statements.
35
<PAGE> 38
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Note 1 - Summary of significant accounting policies
The accounting policies of Reliance Bancshares, Inc. and Subsidiary (the
Company) conform to generally accepted accounting principles and prevailing
practices within the thrift industry. A summary of the more significant
accounting policies follows:
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Reliance Bancshares, Inc. and its wholly-owned subsidiary, Reliance Savings
Bank (the Bank). All significant intercompany accounts and transactions have
been eliminated in consolidation.
Business
Reliance Bancshares, Inc. provides a full range of financial services to
individual customers in southeastern Wisconsin through its wholly- owned
insured banking subsidiary, Reliance Savings Bank. The Bank is a state
chartered stock savings bank which conducts its business through one facility.
The Bank emphasizes permanent and construction loans secured by real estate.
The Bank's primary deposit products are savings accounts and certificates of
deposit.
Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period.
Actual results could differ from those estimates.
Investments in Securities
The Company's investments in securities are classified in two categories and
accounted for as follows:
SECURITIES HELD TO MATURITY - Debt and mortgage-backed securities for which
the Company has the positive intent and ability to hold to maturity are
reported at cost, adjusted for amortization of premiums and accretion of
discounts, which are recognized in interest income using the interest method
over the period to maturity.
SECURITIES AVAILABLE FOR SALE - Securities available for sale consist of
equity securities and certain debt and mortgage-backed securities not
classified as securities held to maturity. Unrealized holding gains and
losses, net of tax, on securities available for sale are reported as a net
amount in a separate component of stockholders' equity until realized, if
judged to be temporary.
The Company does not hold any trading securities at June 30, 1996.
Gains and losses on the sale of securities available for sale are determined
using the specific identification method.
36
<PAGE> 39
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Note 1 - Summary of significant accounting policies, continued
Mortgaged-Backed Securities
The Company has a portfolio of mortgage-backed certificates which bear interest
at stated rates ranging from 8.5% to 15% and which mature between 2005 and
2020. Most of the pools were acquired at a discount; a few were acquired at a
nominal premium. Mortgage-backed certificates acquired at a discount after
July 1, 1982 are being amortized and included in the Company's gross income
using the interest method. Prior year discounts are being amortized on a
straight-line basis over eleven to twelve years. The difference in prior year
discount amortization on a straight-line basis versus the interest method is
not material. The Company will continue to amortize discounts on
mortgage-backed certificates purchased prior to July 1, 1982 on a straight-line
basis. Premium amortizations are not material in amount. The Company has
adequate liquidity and capital, and it is generally management's intention to
hold such assets to maturity. Should any be sold, gains and losses will be
recognized based on the specific identification method.
At June 30, 1996 and 1995, the Company had no outstanding commitments to sell
loans or securities.
Loans Receivable
Loans receivable are stated at unpaid principal balances, less the allowance
for loan losses, and net deferred loan-origination fees and discounts.
The allowance for loan losses is increased by charges to income and decreased
by charge-offs (net of recoveries). Management's periodic evaluation of the
adequacy of the allowance is based on the Bank's past loan loss experience,
known and inherent risks in the portfolio, adverse situations that may effect
the borrower's ability to repay, the estimated value of any underlying
collateral, and current economic conditions.
Interest on Loans
Interest on loans is recorded as income as the borrowers' payments become due.
Interest collected in advance of the payment due date is deferred until the
payment is due. Uncollected interest on loans in excess of 90 days delinquent
is fully reserved (June 30, 1996 - $0, June 30, 1995 - $0).
Loan-Origination Fees and Related Costs
Prior to July 1, 1988, the Bank recognized loan origination fees as income over
a period of ten years at ten percent a year, the related costs associated with
these loans were expensed as incurred.
Loan fees received on or after July 1, 1988, are accounted for in accordance
with FASB Statement No. 91, "Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial Direct Costs of
Leases."
Accordingly, loan origination fees and certain direct loan origination costs
are being deferred and the net amount amortized as an adjustment of the related
loan's yield. The Bank is generally amortizing these amounts over the
contractual life of the related loans.
37
<PAGE> 40
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Note 1 - Summary of significant accounting policies, continued
Office Properties and Equipment
Office properties and equipment are stated at cost less accumulated
depreciation and include expenditures for new facilities and items which
substantially increase the useful lives of existing buildings and equipment.
Building and equipment are depreciated on the straight-line method over the
estimated lives of the assets. Expenditures for normal repairs and maintenance
are charged to operations as incurred. When properties are retired or
otherwise disposed of, the related costs and accumulated depreciation are
removed from the respective accounts and the resulting gain or loss is recorded
in income. The estimated useful lives used to compute depreciation for
financial reporting purposes are as follows:
Office, buildings and improvements 10 - 42 years
Furniture, fixtures and equipment 5 - 10 years
Automobile 6 years
Income Taxes
Deferred income taxes have been provided under the liability method. Deferred
tax assets and liabilities result primarily from the Company and the Bank
reporting taxable income using the cash basis method of accounting which
differs from the accrual method used in reporting income on the financial
statements, as measured by the enacted tax rates which will be in effect when
these differences are expected to reverse.
Real Estate Owned/Real Estate in Judgment
Property acquired in settlement of loans is recorded at the lower of the
related principal balance upon foreclosure or its fair value. Costs of
developing and improving such properties are to be capitalized. Expenses
related to holding such real estate, net of rental and other income, are
charged against income as incurred. A provision for estimated losses is
recorded when it is known that the net realizable value is less than the
carrying value.
Profit on the sale of real estate is recognized as income in the year sold only
to the extent that cash is received. Excess profit, if any, is deferred and
recognized as income as principal payments are made on the loan or contract.
Earnings per Share
On April 18, 1996, Reliance Savings Bank converted from a state-chartered
mutual savings bank to a state-chartered stock savings bank with the concurrent
formation of a holding company. As part of this conversion, Reliance
Bancshares, Inc. sold 2,562,344 shares of stock.
Earnings per share of common stock for the year ended June 30, 1996, were
computed based on consolidated net income and weighted average outstanding
shares of common stock computed as if Reliance Bancshares, Inc. initial public
offering had taken place on July 1, 1995. In this computation, net income was
not adjusted for the additional income which could have been earned had the net
proceeds from the offering been available for investment as of July 1, 1995.
Uncommitted ESOP shares (89,125) were not included in the weighted average
outstanding shares per SOP 93-6. The resulting weighted average number of
shares of common stock is 2,473,219.
38
<PAGE> 41
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Note 1 - Summary of significant accounting policies, continued
Earnings per share are not presented for years ended June 30, 1995 and 1994, as
Reliance Bancshares, Inc. first issued stock on April 18, 1996.
Pending Accounting Change
The FASB issued SFAS No. 123 ("Accounting for Stock-Based Compensation") in
October 1995 relative to financial accounting and reporting standards for
stock-based employee compensation plans. SFAS No. 123 is effective for fiscal
years beginning after December 15, 1995. The Statement defines a fair-value
based method of accounting for employee stock options or similar equity
instruments and encourages all entities to adopt that method of accounting for
all employee stock compensation plans. However, the Statement also allows an
entity to continue to measure compensation cost for these plans using an
intrinsic value-based method of accounting prescribed by Accounting Principles
Board Opinion No. 25 ("APB No. 25"). Entities electing to retain the
accounting treatment under APB No. 25 must make pro forma footnote disclosures
of net income and earnings per share as if the fair value-based-method of
accounting defined in this statement has been applied. Management has not
decided which method it will elect.
Reclassifications
Certain prior year items have been reclassified to conform to current year
presentation.
Note 2 - Investment securities available for sale
The carrying value (amortized cost) and estimated market values of investment
securities available-for-sale are as follows:
<TABLE>
<CAPTION>
June 30, 1996
-------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
(In thousands)
<S> <C> <C> <C> <C>
Equity securities - common stock $ 28 $ 549 $ - $ 577
Corporate debt securities 1,955 - - 1,955
Equity securities - mutual funds 5,525 - 175 5,350
------- ------- ------- -------
Total $ 7,508 $ 549 $ 175 $ 7,882
======= ======= ======= =======
<CAPTION>
June 30, 1995
-------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
(In thousands)
<S> <C> <C> <C> <C>
Equity securities - common stock $ 27 $ 282 $ - $ 309
Equity securities - mutual funds 6,028 - 144 5,884
------ ------ ------- ------
Total $ 6,055 $ 282 $ 144 $ 6,193
====== ====== ======= ======
</TABLE>
39
<PAGE> 42
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Detail of sales of investment securities available-for-sale are as follows:
<TABLE>
<CAPTION>
Proceeds
from Gross Gross
Sales Gains Losses
-------- ----- ------
<S> <C> <C> <C>
Year Ended (In Thousands)
June 30, 1996 $ 500 $ - $ 3
June 30, 1995 750 - 11
June 30, 1994 1,000 - 11
</TABLE>
Note 3 - Investment securities held-to-maturity
The amortized cost and estimated market values of investment securities
held-to-maturity are as follows:
<TABLE>
<CAPTION>
June 30, 1996
----------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
(In thousands)
<S> <C> <C> <C> <C>
U.S. Treasury obligations and obligations
of U.S. agencies $ 11,178 $ 5 $ 22 $ 11,161
======= ======= ======== =======
<CAPTION>
June 30, 1995
----------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
(In thousands)
<S> <C> <C> <C> <C>
U.S. Treasury obligations and obligations
of U.S. agencies $ 2,196 $ 9 $ 2 $ 2,203
======= ======= ======= ======
</TABLE>
The amortized cost and estimated market value of investment securities by
contractual maturity are shown below. Expected maturities will differ from
contractual maturities on those securities where the borrowers may have the
right to call or prepay obligation with or without call or prepayment
penalties.
40
<PAGE> 43
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Contractual maturities are as follows:
<TABLE>
<CAPTION>
June 30,
-----------------------------------------------------------------
1996 1995
------------------------------- -----------------------------
Estimated Estimated
Amortized Market Amortized
Cost Value Cost Value
---- ----- ---- -----
(In thousands)
<S> <C> <C> <C> <C>
Within one year or no maturity $ 498 $ 499 $ - $ -
Greater than one year but less
than five years 8,480 8,459 996 995
Greater than five years but
less than ten years 1,000 1,000 - -
Greater than ten years $ 1,200 $ 1,204 $ 1,200 $ 1,208
------- ------- ------- -------
Total $ 11,178 $ 11,162 $ 2,196 $ 2,203
======= ======= ======= =======
</TABLE>
There were no sales of investment securities held-to-maturity during the years
ended June 30, 1996 and 1995.
Note 4 - Mortgage-backed securities and related securities
The amortized cost and estimated market value of mortgage-backed and related
securities are summarized as follows:
<TABLE>
<CAPTION>
June 30, 1996
---------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
(In thousands)
<S> <C> <C> <C> <C>
Participation certificates:
Government National Mortgage Association $ 679 $ 56 $ - $ 735
Collateralized Mortgage Obligation 100 - 5 95
Federal Home Loan Mortgage Corp. 21 1 - 22
------- ------- ------- -------
Total mortgage-backed securities $ 800 $ 57 $ 5 $ 852
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
June 30, 1995
--------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
(In thousands)
<S> <C> <C> <C> <C>
Participation certificates:
Government National Mortgage Association $ 896 $ 70 $ - $ 966
Collateralized Mortgage Obligation 100 - 5 95
Federal Home Loan Mortgage Corp. 24 2 - 26
------- ------- ------- -------
Total mortgage-backed securities $ 1,020 $ 72 $ 5 $ 1,087
======= ======= ======= =======
</TABLE>
There were no sales of mortgage-backed securities during the years ended June
30, 1996 and 1995.
41
<PAGE> 44
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Note 5 - Loans receivable
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
June 30,
---------------------------
1996 1995
---- ----
<S> <C> <C>
(In thousands)
First mortgage loans:
One-to-four family residential $ 10,745 $ 10,425
Multi-family residential 4,585 4,711
Commercial 4,163 3,880
Construction 6,701 2,920
Consumer and other loans:
Savings account 7 5
Second mortgages 356 7
------- -------
Total loans 26,557 21,948
------- -------
Less:
Undisbursed loan proceeds 3,366 701
Deferred loan fees 134 109
Allowance for loan losses 126 104
------- -------
3,626 914
------- -------
Loans receivable - net $ 22,931 $ 21,034
======= =======
</TABLE>
Activity in the allowance for loan losses is summarized as follows:
<TABLE>
<CAPTION>
Years Ended June 30,
---------------------------------------------
1996 1995 1994
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 104 $ 84 $ 62
Provisions charged against income 22 22 22
Charge-offs and recoveries - net - (2) -
------- ------- -------
Balance at end of year $ 126 $ 104 $ 84
======= ======= =======
</TABLE>
The existing allowance for loan losses is considered neither inadequate nor
excessive relative to credit risk.
Loans receivable from officers and directors aggregated $158,620, and $161,735
at June 30, 1996 and 1995.
The Bank did not have any specific allowance for loan loses at June 30, 1996
and 1995. The Bank's policy is to set up a specific loss allowance when it
becomes evident that a specific loan would be disposed of at a loss.
The majority of the Bank's lending activity is with borrowers located in
metropolitan Milwaukee, Wisconsin. Although the Bank has a diversified
portfolio, a substantial portion of its debtors' ability to honor their
contracts is dependent upon the general economic conditions of the area.
42
<PAGE> 45
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Note 6 - Accrued interest receivable
Accrued interest receivable is summarized as follows:
<TABLE>
<CAPTION>
June 30,
---------------------------
1996 1995
---- ----
(In thousands)
<S> <C> <C>
Investment securities $ 146 $ 76
Mortgage-backed securities 6 8
Loans receivable 21 11
------- -------
$ 173 $ 95
======= =======
</TABLE>
Note 7 - Office properties and equipment
Office properties and equipment are summarized by major classifications as
follows:
<TABLE>
<CAPTION>
June 30,
---------------------------
1996 1995
---- ----
(In thousands)
<S> <C> <C>
Land $ 7 $ 7
Office building 147 147
Furniture, fixtures and equipment 106 106
Automobile 27 27
------- -------
287 287
Less accumulated depreciation 203 180
------- -------
$ 84 $ 107
======= =======
</TABLE>
Depreciation charged to operations totaled $23,000, $25,000, and $23,000 for
the years ended June 30, 1996, 1995 and 1994.
43
<PAGE> 46
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Note 8 - Deposit accounts
Deposits are summarized as follows:
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------------------------------
1996 1995
------------------------------------- ------------------------------------
Weighted Weighted
Percent Average Percent Average
of Total Nominal of Total Nominal
Amount Deposits Rate Amount Deposits Rate
------ -------- ---- ------ -------- ----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Demand accounts:
Non-interest-bearing $ 88 0.48% -% $ 16 0.07% -%
NOW 126 0.69 2.50 66 0.30 2.50
Passbook 2,776 15.26 2.78 3,096 13.88 3.01
Money market 952 5.23 3.45 1,499 6.72 3.45
------- ------ ------- ------
Total demand accounts 3,942 21.66 2.87 4,677 20.97 3.14
------- ------ ------- ------
Certificate accounts:
3.00% to 3.99% 10 0.05 3.40 21 0.09 3.40
4.00% to 4.99% 95 0.53 4.80 2,504 11.22 4.59
5.00% to 5.99% 11,180 61.43 5.41 7,721 34.60 5.36
6.00% to 6.99% 2,402 13.20 6.38 6,626 29.70 6.46
7.00% to 7.99% 521 2.86 7.17 710 3.18 7.19
8.00% to 8.99% 50 0.27 8.00 53 0.24 8.00
------- ------ ------- ------
Total certificates 14,258 78.34 5.64 17,635 79.03 5.74
------- ------ ------- ------
Total deposit accounts $ 18,200 100.00% 5.04 $ 22,312 100.00% 5.20
======= ====== ======= ======
</TABLE>
Deposit accounts with individual balances of $100,000 or more totaled
$1,378,000, and $2,413,000 at June 30, 1996 and 1995, respectively.
44
<PAGE> 47
RELIANCE BANCSHARES, INC.
Notes to Consolidated Financial Statements
Note 8 - Deposit accounts, continued
On June 30, 1996, certificate accounts have scheduled maturity dates as
follows:
<TABLE>
<CAPTION>
Year Ending June 30,
---------------------------------------------------------------------------------------------------
1997 1998 1999 2000 2001 Thereafter Totals
-------- -------- -------- -------- -------- ---------- ---------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
3.00% to 3.99% $ 10 $ - $ - $ - $ - $ - $ 10
4.00% to 4.99% 95 - - - - - 95
5.00% to 5.99% 9,085 1,114 650 320 11 - 11,180
6.00% to 6.99% 1,278 737 143 22 222 - 2,402
7.00% to 7.99% 295 94 74 58 - - 521
8.00% to 8.99% - - - - - 50 50
------- ------ ----- --- --- ---- ---------
$ 10,763 $ 1,945 $ 867 $ 400 $ 233 $ 50 $14,258
======= ====== ===== ==== ==== === ======
</TABLE>
45
<PAGE> 48
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Interest expense on deposit accounts consist of the following:
<TABLE>
<CAPTION>
Years Ended June 30,
-----------------------------------------------------
1996 1995 1994
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Passbook, money market, and
certificate accounts $ 1,144 $ 1,058 $ 1,045
Escrows - 6 9
NOW accounts 2 1 -
------- ------- -------
$ 1,146 $ 1,065 $ 1,054
======= ======= =======
</TABLE>
Note 9 - Notes payable and other borrowings
The Bank had no notes payable or other borrowings at June 30, 1996 or 1995.
If the Bank does opt to take advances from the Federal Home Loan Bank, it will
be required to maintain unencumbered mortgage loans in its portfolio
aggregating at least 170% of the amount of outstanding advances from the
Federal Home Loan Bank as collateral. In addition, advances would be
collateralized by all Federal Home Loan Bank stock.
In addition, the Bank has an open line of credit with Bank One, Milwaukee. Any
advances bear interest based on the Bank One internal daily cost of funds.
Note 10 - Stockholders' equity
At the time of its stock conversion, the Bank established a liquidation account
in an amount equal to its total net worth as of the date of the latest
statement of financial condition. The amount of the liquidation account was
determined to be $10,049,000. The liquidation account will be maintained for
the benefit of eligible account holders who continue to maintain their accounts
at the Bank after the conversion. The liquidation account will be reduced
annually to the extent that eligible account holders have reduced their
qualifying deposits. Subsequent increases will not restore an eligible account
holder's interest in the liquidation account. In the event of a complete
liquidation, each account holder will be entitled to receive a distribution
from the liquidation account in an amount proportionate to the current adjusted
qualifying balances for accounts then held. Except for the purchase of stock
and payment of dividends by the Bank, the existence of the liquidation account
will not restrict use or application of stockholders' equity.
46
<PAGE> 49
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
In connection with the insurance of its deposits by the Federal Deposit
Insurance Corporation, the Bank is required to maintain a minimum level of
capital. Also, Wisconsin charted savings banks are required to meet minimum
capital levels of 6%. The following table summarizes the Bank's capital
requirements and ratios:
<TABLE>
<CAPTION>
At June 30, 1996
--------------------------------------------------------------------------
Amount Ratios
Actual Required Excess Actual Required Excess
------ -------- ------ ------ -------- ------
<S> <C> <C> <C> <C> <C> <C>
Tier 1 risk-based capital $18,803 $ 819 $17,984 91.80% 4.00% 87.80%
Tier 2 risk-based capital 18,929 1,639 17,290 49.64 8.00 41.64
Leverage ratio 18,803 1,144 17,659 49.31 3.00 46.31
State of Wisconsin 19,156 2,288 16,868 50.24 6.00 44.24
</TABLE>
The Bank's capital exceeds all of the fully phased-in capital requirements
imposed by federal and Wisconsin law and regulation.
The following table summarizes the differences between the Company's
stockholders' equity and the Bank's regulatory capital at June 30, 1996:
<TABLE>
<CAPTION>
Tier 1 Tier 2
Risk-Based Risk-Based Leverage State of
Capital Capital Ratio Wisconsin
------- ------- ----- ---------
(In Thousands)
<S> <C> <C> <C> <C>
Total consolidated stockholders'
equity $ 29,348 $ 29,348 $ 29,348 $ 29,348
Holding Company stockholders'
equity not available for
regulatory purposes (10,318) (10,318) (10,318) (10,318)
General loss allowances - 126 - 126
Unrealized gain on securities
available
for sale (227) (227) (227) -
------- ------- ------- -------
$ 18,803 $ 18,929 $ 18,803 $ 19,156
======= ======= ======= =======
</TABLE>
47
<PAGE> 50
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Note 11 - Income taxes
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
Years Ended June 30,
--------------------------------------------
1996 1995 1994
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Current tax provision:
Federal $ 264 $ 236 $ 180
State 72 62 50
------- ------- -------
Total current 336 298 230
------- ------- -------
Deferred tax provision (credit):
Federal (4) (23) 6
State (1) (4) (1)
------- ------- -------
Total deferred (5) (27) 5
------- ------- -------
Total provision for income taxes $ 331 $ 271 $ 235
======= ======= =======
</TABLE>
At June 30, 1996, the Bank has a net capital loss carryforward for tax
return purposes of $18,530 which, if unused, $4,340 expires in 1999,
$11,172 expires in 2000, and $3,018 expires in 2001.
Actual income tax expense differs from the "expected" income tax expense,
computed by applying the statutory federal corporate tax rate to income
before income taxes as follows:
<TABLE>
<CAPTION>
Years Ended June 30,
--------------------------------------------------
1996 1995 1994
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Federal taxes at statutory rates $ 287 $ 230 $ 201
Increase (decrease) resulting from:
State income taxes - net of
federal income tax benefit 44 35 31
Other - net - 6 3
------- ------- -------
Provision for income taxes $ 331 $ 271 $ 235
======= ======= =======
</TABLE>
48
<PAGE> 51
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at June 30, 1996 and
1995 are presented below:
<TABLE>
<CAPTION>
June 30,
-------------------------
1996 1995
---- ----
(In thousands)
<S> <C> <C>
Deferred tax assets:
Deferred loan fees $ 53 $ 44
Allowance for loan losses 41 33
Accrued expenses 7 9
Deferred compensation 22 11
Other 12 9
------- -------
Gross deferred tax assets 135 106
------- -------
Deferred tax liabilities:
Accrued income 71 43
FHLB stock dividends 6 6
Depreciation 5 9
Unrealized gain on securities 147 54
------- -------
Gross deferred tax liabilities 229 112
------- -------
Net deferred tax asset (liability) $ (94) $ (6)
======= =======
</TABLE>
Previously, the Bank qualified under provisions of the Internal Revenue Code
which permitted as a deduction from taxable income allowable bad debt
deductions which significantly exceeded actual experience and the financial
statement loan loss provisions. A deferred tax liability was not required on
these excess tax bad debt reserves. At June 30, 1996, the Bank's tax bad debt
reserves were approximately $1,401,000. The Bank is now required to establish
a deferred tax liability for the excess of its tax bad debt reserves over the
balance at the close of the base year. The amount of the base year reserves is
considered to meet the indefinite reversal criteria of Accounting Principles
Board Opinion No. 12, "Accounting for income Taxes - Special Areas," and
accordingly, is not subject to deferred taxes. The Bank's base year tax bad
debt reserves were approximately $1,401,000. Income taxes would be imposed at
the then-applicable rates if the Bank were to use these reserves for any other
purpose other than to absorb bad debts.
49
<PAGE> 52
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Note 12 - Foreclosed properties and real estate in judgment
Foreclosed properties and real estate in judgment is summarized as follows:
<TABLE>
<CAPTION>
June 30,
---------------------
1996 1995
---- ----
(In thousands)
<S> <C> <C>
Real estate in judgment subject to redemption $ - $ -
Foreclosed properties - -
Allowance for losses - -
---- ----
$ - $ -
==== ====
</TABLE>
Note 13 - Officer, Director and Employee Benefit Plans
The Bank has a non-contributory pension plan covering substantially all of its
employees. The Bank's employees are covered under the Financial Institution's
Retirement Fund, which is a multi-employer comprehensive plan. Separate
actuarial assumptions include an 8% rate of return on plan investments. Normal
current costs are funded annually. The book value of the assets of the
multi-employer fund exceed the liability for vested benefits. Pension costs
aggregated $29,000, $27,000 and $22,000, the years ended June 30, 1996, 1995
and 1994, respectively. The Bank's policy is to fund pension costs accrued.
Concurrent with the conversion from a mutual savings bank to a stock savings
bank, the Bank borrowed funds from the holding company to purchase 89,125
shares of Reliance Bancshares, Inc. common stock to establish an Employee Stock
Ownership Plan (ESOP) for substantially all of its employees. The loan is to
be repaid over fifteen years and bears interest at 7.0%. Unallocated ESOP
shares are reflected as a reduction from stockholders' equity in the Company's
consolidated statements of financial condition. No shares were allocated to
participants for the year ended June 30, 1996.
The Bank has a nonqualified deferred retirement plan for directors. The Plan
was approved by the Commissioner of Savings and Loan of the State of Wisconsin
on June 20, 1994. The Plan provides for each director to receive additional
benefits at retirement. In the event of death during service, the same amounts
are payable to a director designated beneficiary. The Bank has acquired
permanent life insurance policies on the individuals to fund the Plans. The
cash value of the policies totaled $193,000 at June 30, 1996. The directors
have no rights, title or interest in the insurance policies. The deferred
compensation liabilities are being accrued ratably from July 1994 to the
respective normal retirement dates. As of June 30, 1996 and 1995, $57,000 and
$28,000 had been accrued for the Plan.
Note 14 - Financial instruments with off-balance sheet risk and other
commitments
The Bank is party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. The
financial instrument consists of commitments to extend credit. This instrument
involves, to varying degrees, elements of credit and interest rate risk in
excess of the amount recognized in the statement of financial condition. The
contract amounts reflect the extent of involvement the Bank has in the
particular class of financial instrument. The Bank's maximum exposure to
credit loss for commitments to extend credit is represented by the contract
amount of those instruments.
50
<PAGE> 53
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Financial instruments whose contract amounts represent credit risk are as
follows:
<TABLE>
<CAPTION>
June 30,
------------------------
1996 1995
---- ----
(In thousands)
<S> <C> <C>
Commitments to extend credit
Fixed rate $1,350 $ 668
</TABLE>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and
generally require payment of a fee. As some commitments expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. The Bank evaluates the credit worthiness of each customer
on a case by case basis. The Bank generally extends credit only on a secured
basis. Collateral obtained varies, but consists primarily of one-to-four
family residences.
Commitments to extend credit on a fixed-rate basis expose the Bank to a certain
amount of interest rate risk if market rates of interest substantially increase
during the commitment period.
The Bank is a party to various legal actions normally associated with financial
institutions, the aggregate effect of which, in management's and legal
counsel's opinion, would not be material to the financial condition of Reliance
Bancshares, Inc.
Note 15 - Disclosure about fair value of financial instruments
Statement No. 107, ("Disclosures about Fair Value of Financial Instruments"),
requires disclosure of fair value information about financial instruments,
whether or not recognized in the balance sheet, for which it is practicable to
estimate that value. In cases where quoted market prices are not available,
fair values are based on estimates using present value or other valuation
techniques. Those techniques are significantly affected by the assumptions
used, including the discount rate and estimates of future cash flows. In that
regard, the derived fair value estimates cannot be substantiated by comparison
to independent markets and, in many cases, could not be realized in immediate
settlement of the instrument. Statement No. 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure requirements.
Accordingly, the aggregate fair value amounts presented do not necessarily
represent the underlying value of Reliance Bancshares, Inc. Reliance
Bancshares, Inc. does not routinely measure the market value of financial
instruments because such measurements represent point-in-time estimates of
value. It is generally not the intent of Reliance Bancshares, Inc. to
liquidate and therefore realize the difference between market value and
carrying value and even if it were, there is no assurance that the estimated
market values could be realized. Thus, the information presented is not
particularly relevant to predicting Reliance Bancshares, Inc.'s future earnings
or cash flows.
The following methods and assumptions were used by Reliance Bancshares, Inc. in
estimating its fair value disclosures for financial instruments:
Cash and Short-Term Investments
The carrying values approximate the fair values for these assets.
51
<PAGE> 54
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Securities Available for Sale, Investments, and Mortgage-Backed Securities
Fair values are based on quoted market prices, where available. If a quoted
market price is not available, fair value is estimated using quoted market
prices for similar securities.
Loans
Fair values are based on quoted market prices for loans with similar financial
characteristics.
Deposits
The fair value of deposits with no stated maturity, such as noninterest-bearing
demand deposits, savings, NOW accounts, money market, and checking accounts, is
the amount payable on demand at the reporting date. The fair value of fixed
rate time deposits is calculated using discounted cash flows applying interest
rates currently being offered on similar certificates.
Off-Balance Sheet Instruments
The fair value of commitments is estimated using the fees currently charged to
enter into similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counter parties. The fair
value of these off-balance-sheet items approximates the recorded amounts of the
related fees and is not material.
The carrying amounts and estimated fair value of financial instruments at June
30, 1996 were as follows:
<TABLE>
<CAPTION>
Carrying Estimated
Amount Fair Value
------ ----------
(In thousands)
<S> <C> <C>
Financial Assets
Cash and cash equivalents $ 4,055 $ 4,055
Certificates of deposit 294 294
Securities available for sale 7,882 7,882
Securities held to maturity 11,178 11,162
Mortgage-backed securities 800 852
Loans receivable 22,931 23,702
Financial Liabilities
Deposits:
Demand accounts 3,942 3,942
Certificates 14,258 14,383
</TABLE>
Note 16 - Condensed parent company only financial statements
The following condensed statements of financial condition as of June 30, 1996
and condensed statements of income and cash flows for the period then ended for
Reliance Bancshares, Inc. should be read in conjunction with the consolidated
financial statements and the notes thereto.
52
<PAGE> 55
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
STATEMENT OF FINANCIAL CONDITION
June 30, 1996
(In thousands)
<TABLE>
<S> <C>
ASSETS
Cash $ 2,126
Investment securities 7,446
Investment in Bank 19,030
Loan to ESOP 697
Other assets 63
------
Total Assets $29,362
======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities $ 14
Total stockholders' equity 29,348
------
Total liabilities and stockholders' equity $29,362
======
STATEMENT OF INCOME
For the Period Starting April 18, 1996
and Ending June 30, 1996
(In thousands)
Interest on investments $ 110
Interest on loan to ESOP 10
Equity on undistributed net income of Bank 157
------
Total income 277
Other expense 5
------
Total income before provision for income taxes 272
Provision for income taxes 46
------
Net income $ 226
======
</TABLE>
53
<PAGE> 56
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Note 16 - Condensed parent company only financial statements, continued
STATEMENT OF CASH FLOWS
For the Period Starting April 18, 1996
and Ending June 30, 1996
(In thousands)
<TABLE>
<S> <C>
Cash flows from operating activities:
Net income $ 226
Adjustments to reconcile net income to
net cash provided by operating activities:
Equity in net income of Bank (157)
Net amortization (7)
Increase in other assets (63)
Increase in other liabilities 14
-------
Net cash provided by operating activities 13
-------
Cash flows from investing activities:
Purchase stock of subsidiary (9,537)
Purchase of investment securities (11,989)
Proceeds from sales/maturities of
investment securities 4,549
Loan to ESOP (713)
Payment received on loan to ESOP 16
-------
Net cash used by investing activities (17,674)
-------
Cash flows from financing activities:
Net proceeds from issuance of common
stock upon conversion 19,787
-------
Net cash provided by financing activities 19,787
-------
Net increase in cash 2,126
Cash at beginning -
-------
Cash at end $ 2,126
=======
</TABLE>
54
<PAGE> 57
RELIANCE BANCSHARES, INC.
================================================================================
Notes to Consolidated Financial Statements
Note 17 - Quarterly consolidated financial information (unaudited)
<TABLE>
<CAPTION>
Three Months Ended
----------------------------------------------------------------------
Sept. 30, Dec. 31, March 31, June 30,
1995 1995 1996 1996
---- ---- ---- ----
(In thousands except per share amounts)
<S> <C> <C> <C> <C>
Interest and dividend income $ 622 $ 620 $ 623 $ 859
Interest expense 294 291 289 279
Net interest income 328 329 334 580
Provision for loan losses 5 6 5 6
---- ---- ---- ----
Net interest income after provision for loan losses 323 323 329 574
Non-interest income 8 2 2 5
Non-interest expense 165 185 183 188
Income before income taxes 166 140 148 391
Income taxes 65 55 59 152
---- ---- ---- ----
Net income $ 101 $ 85 $ 89 $ 239
==== ==== ==== ====
</TABLE>
The following schedule is a summary of earnings per share and market
information since the conversion on April 18, 1996. No dividends were declared
on the shares of common stock during the year ended June 30, 1996.
<TABLE>
<CAPTION>
Sept. 30, Dec. 31, March 31, June 30,
1995 1995 1996 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Earnings per share $ -- $ -- $ -- $ 0.10
Market information:
Trading range
Ask -- -- -- 8.75
Bid -- -- -- 7.50
Close -- -- -- 8.00
</TABLE>
55
<PAGE> 58
SHAREHOLDER INFORMAITON
<TABLE>
<S> <C> <C>
BOARD OF DIRECTORS OF RELIANCE HEADQUARTERS AUDITORS
BANCSHARES, INC. AND Meier, Clancy, George & Co.
RELIANCE SAVINGS BANK RELIANCE BANCSHARES, INC. LLP
ALLAN T. BACH 3140 South 27th St 3245 North 124th Street
Chairman of the Board, Milwaukee, WI 53215 Brookfield, Wisconsin 53005
Director,President and Chief (414)671-2222
Executive Officer of the LEGAL COUNSEL
Company; Director, President RELIANCE SAVINGS BANK Michael Best & Friedrich
and Chief Executive Officer 3140 South 27th St. 100 East Wisconsin Avenue
of the Bank since 1991 Milwaukee, WI 53215 Milwaukee, Wisconsin 53202
(414)671-2222
TRANSFER AGENT
RELIANCE SAVINGS BANK - BANK OFFICE Firstar Trust Company
CAROL A. BARNHARST LOCATIONS 615 E. Michigan Street
Director, Vice President, Secretary, MAIN OFFICE Fourth Floor
Treasurer and Chief Financial Officer of 3140 South 27th St. Milwaukee, WI 53202
the Company; Director, Chief Financial Milwaukee, WI 53215 Telephone: (414) 276-3737
Officer and Vice President of the Bank
since 1981. SHAREHOLDER/MEDIA RELATIONS STOCK LISTING INFORMATION
Shareholders, investors, analysts, the Reliance Savings Bank converted from a
O. WILLIAM HELD news media and others interested in mutual to a stock company, effective
Director of the Company; Chairman of the additional information may contact Allan April 18, 1996, at which time Reliance
Board and Director of the Bank since T. Bach, Chairman of the Board, President Bancshares, Inc. consummated the sale of
1985; President and Chief Executive and Chief Executive Officer of the 2,562,344 shares of its Common Stock to
Officer of the Bank prior to his Company, at the Company's headquarters. the public. The shares of Common Stock
retirement in 1991 of Reliance Bancshares, Inc. are publicly
ANNUAL REPORT ON FORM 10-KSB traded on the NASDAQ "Small Cap" Market
A copy of Reliance Bancshares, Inc.'s under the symbol "RELI".
JOHN T. LYNCH Form 10-KSB filed with the Securities and
Director of the Company; Director of the Exchange Commission is available without STOCK PRICE INFORMATION
Bank since 1988, practices law as a sole charge by writing: Shares of Common Stock of Reliance
practitioner, owns and manages Bancshares, Inc. were made available to
residential rental properties Carol A. Barnharst, Secretary qualified subscribers at $8.00 per share
Reliance Bancshares, Inc. during the initial public offering, which
3140 South 27th St. was consummated on April 18, 1996. At
MARJORIE A. SPICUZZA Milwaukee, WI 53215 September 13, 1996, the closing bid price
Director of the Company; Director of the of the Common Stock was $8.625 per share.
Bank since 1980; prior to her retirement ANNUAL MEETING
in 1985, President and Chief Executive SHAREHOLDERS AND SHARES
Officer of the Bank. The annual meeting of shareholders of OUTSTANDING
Reliance Bancshares, Inc. will be held at As of September 13, 1996 there were 376
EXECUTIVE OFFICERS OF RELIANCE 2:00 p.m., Milwaukee time, October 28, registered shareholders of record and
BANCSHARES, INC. AND RELIANCE SAVINGS 1996 at the Quality Inn (Airport), 5311 1,100 estimated additional beneficial
BANK South Howell Avenue, Milwaukee, Wisconsin shareholders for an approximate total of
ALLAN T. BACH 1,476. Shares outstanding at September
Chief Executive Officer of the Company; 13, 1996 were 2,528,489.
President, Chief Executive Officer of the
Bank
CAROL A. BARNHARST
Vice-President, Chief Financial Officer
and Secretary/Treasurer of the Company
and Vice President and Chief Financial
Officer of the Bank
</TABLE>
56
<PAGE> 1
EXHIBIT 23.1
[MEIER, CLANCY, GEORGE, & CO. LLP LETTERHEAD]
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and
to the use of our report dated July 19, 1996, with respect to the consolidated
financial statements of Reliance Bancshares, Inc. in the Form 10-KSB for the
fiscal year ended June 30, 1996 of Reliance Bancshares, Inc.
Meier, Clancy, George & Co. LLP
Certified Public Accountants
Brookfield, Wisconsin
September 12, 1996
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1996
<PERIOD-START> JUL-01-1995
<PERIOD-END> JUN-30-1996
<CASH> 98
<INT-BEARING-DEPOSITS> 3,957
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 7,882
<INVESTMENTS-CARRYING> 12,429
<INVESTMENTS-MARKET> 12,465
<LOANS> 22,931
<ALLOWANCE> 126
<TOTAL-ASSETS> 47,752
<DEPOSITS> 18,200
<SHORT-TERM> 0
<LIABILITIES-OTHER> 204
<LONG-TERM> 0
0
0
<COMMON> 2,562
<OTHER-SE> 26,786
<TOTAL-LIABILITIES-AND-EQUITY> 47,752
<INTEREST-LOAN> 1,887
<INTEREST-INVEST> 837
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 2,724
<INTEREST-DEPOSIT> 1,146
<INTEREST-EXPENSE> 1,153
<INTEREST-INCOME-NET> 1,571
<LOAN-LOSSES> 22
<SECURITIES-GAINS> (3)
<EXPENSE-OTHER> 721
<INCOME-PRETAX> 845
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 514
<EPS-PRIMARY> .21
<EPS-DILUTED> 0
<YIELD-ACTUAL> 7.66
<LOANS-NON> 0
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 104
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 126
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 126
</TABLE>
