<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to _______________
Commission File No.: 0-28312
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
TEXAS 71-0785261
--------------------------------- -----------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
200 WEST STEPHENSON
HARRISON, ARKANSAS 72601
--------------------------------- -----------------------
(Address) (Zip Code)
Registrant's telephone number, including area code: (870) 741-7641
Securities registered pursuant to Section 12(b) of the Act:
NOT APPLICABLE
Securities registered pursuant to Section 12(g) of the Act
COMMON STOCK (PAR VALUE $.01 PER SHARE)
---------------------------------------
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / X /
As of March 22, 1999, the aggregate value of the 4,036,685 shares of Common
Stock of the Registrant issued and outstanding on such date, which excludes
382,012 shares held by all directors and officers of the Registrant as a group,
was approximately $66.6 million. This figure is based on the last sales price of
$16.50 per share of the Registrant's Common Stock on March 22, 1999.
Number of shares of Common Stock outstanding as of March 22, 1999: 4,418,697
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents incorporated by reference and the
Part of the Form 10-K into which the document is incorporated.
(1) Portions of the Annual Report to Stockholders for the year ended December
31, 1998 are incorporated into Part II, Items 5 through 8 of this Form 10-K.
(2) Portions of the definitive proxy statement for the 1999 Annual Meeting of
Stockholders are incorporated into Part III, Items 10 through 13 of this Form
10-K.
<PAGE>
PART I.
ITEM 1. BUSINESS
GENERAL
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC. First Federal Bancshares of
Arkansas, Inc. (the "Company") is a Texas corporation organized in January 1996
by First Federal Bank of Arkansas, FA ("First Federal" or the "Bank") for the
purpose of becoming a unitary holding company of the Bank. The only significant
assets of the Company are the capital stock of the Bank, the Company's loan to
the Employee Stock Ownership Plan ("ESOP"), and the portion of the net proceeds
retained by the Company in connection with the Bank's conversion to stock form
and the concurrent offering of the Company's common stock (the "Conversion").
The business and management of the Company consists of the business and
management of the Bank. The Company does not presently own or lease any
property, but instead uses the premises, equipment and furniture of the Bank. At
the present time, the Company does not employ any persons other than officers of
the Bank, and the Company utilizes the support staff of the Bank from time to
time. Additional employees will be hired as appropriate to the extent the
Company expands or changes its business in the future. At December 31, 1998, the
Company had $615.1 million in total assets, $481.1 million in total deposits and
$81.0 million in stockholders' equity.
The Company's executive office is located at the home office of the Bank at
200 West Stephenson Avenue, Harrison, Arkansas 72601, and its telephone number
is (870) 741-7641.
FIRST FEDERAL BANK OF ARKANSAS, FA. The Bank is a federally chartered stock
savings and loan association which was formed in 1934. First Federal conducts
business from its main office and twelve full service branch offices, all of
which are located in a six county area in Northcentral and Northwest Arkansas
comprised of Benton, Marion, Washington, Carroll, Baxter and Boone counties.
First Federal's deposits are insured by the Savings Association Insurance Fund
("SAIF"), which is administered by the Federal Deposit Insurance Corporation
("FDIC"), to the maximum extent permitted by law.
The Bank is a community oriented savings institution which has traditionally
offered a wide variety of savings products to its retail customers while
concentrating its lending activities on the origination of loans collateralized
by one- to four-family residential dwellings. To a significantly lesser extent,
the Bank's activities have also included origination of multi-family residential
loans, commercial real estate loans, construction loans, commercial loans and
consumer loans. In addition, the Bank maintains a significant portfolio of
investment securities. In addition to interest and dividend income on loans and
investments, the Bank receives other income from loan fees and various service
charges. The Bank's goal is to continue to serve its market area as an
independent community oriented financial institution dedicated primarily to
financing home ownership while providing financial services to its customers in
an efficient manner.
The Bank is subject to examination and comprehensive regulation by the
Office of Thrift Supervision ("OTS"), which is the Bank's chartering authority
and primary regulator. The Bank is also regulated by the FDIC, the administrator
of the SAIF. The Bank is also subject to certain reserve requirements
established by the Board of Governors of the Federal Reserve System ("FRB") and
is a member of the Federal Home Loan Bank ("FHLB") of Dallas, which is one of
the 12 regional banks comprising the FHLB System.
1
<PAGE>
This Form 10-K and the Company's Annual Report to Stockholders contain
certain forward-looking statements and information relating to the Company that
are based on the beliefs of management as well as assumptions made by and
information currently available to management. In addition, in those and other
portions of this document and the Company's Annual Report to Stockholders, the
words "anticipate", "believe," "estimate," "expect," "intend," "should" and
similar expressions, or the negative thereof, as they relate to the Company or
the Company's management, are intended to identify forward-looking statements.
Such statements reflect the current views of the Company with respect to future
looking events and are subject to certain risks, uncertainties and assumptions.
Should one or more of these risks or uncertainties materialize or should
underlying assumptions prove incorrect, actual results may vary materially from
those described herein as anticipated, believed, estimated, expected or
intended. The Company does not intend to update these forward-looking
statements.
LENDING ACTIVITIES
GENERAL. At December 31, 1998, the Bank's total portfolio of loans
receivable ("total loan portfolio"), amounted to $453.3 million or 73.7% of the
Company's $615.1 million of total assets at such time. The Bank has
traditionally concentrated its lending activities on conventional first mortgage
loans collateralized by single-family (one- to four-family) residential
property. Consistent with such approach, $370.2 million or 81.66% of the Bank's
total loan portfolio consisted of one- to four-family residential loans at
December 31, 1998. To a significantly lesser extent, the Bank also originates
multi-family residential loans, commercial real estate loans, construction
loans, commercial loans and consumer loans. At December 31, 1998, such loan
categories amounted to $1.5 million, $23.2 million, $18.2 million, $8.4 million
and $31.7 million, respectively, or .34%, 5.12%, 4.02%, 1.86% and 7.00% of the
total loan portfolio, respectively. The Bank currently does not offer loans
which are insured by the Federal Housing Administration ("FHA") nor partially
guaranteed by the Office of Veterans Affairs ("VA").
2
<PAGE>
LOAN COMPOSITION. The following table sets forth certain data relating to the
composition of the Bank's loan portfolio by type of loan at the dates indicated.
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------------------------
1998 1997 1996
------------------------- ------------------------- ------------------------
Percentage of Percentage Percentage
Amount Loans Amount of Loans Amount of Loans
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands)
Real estate loans:
Single-family residential $370,211 81.66% $370,955 83.18% $338,349 82.36%
Multi-family residential 1,540 .34 1,303 .29 1,555 .38
Commercial real estate 23,196 5.12 18,593 4.17 19,136 4.66
Construction 18,226 4.02 20,753 4.66 20,053 4.88
----------- ----------- ----------- ----------- ----------- -----------
Total real estate loans 413,173 91.14 411,604 92.30 379,093 92.28
----------- ----------- ----------- ----------- ----------- -----------
Commercial loans 8,437 1.86 5,649 1.27 4,348 1.06
----------- ----------- ----------- ----------- ----------- -----------
Consumer loans:
Home equity and second
mortgage loans 13,308 2.94 13,023 2.92 12,549 3.06
Automobile 10,693 2.36 8,307 1.86 7,556 1.84
Other 7,712 1.70 7,372 1.65 7,244 1.76
----------- ----------- ----------- ----------- ----------- -----------
Total consumer loans 31,713 7.00 28,702 6.43 27,349 6.66
----------- ----------- ----------- ----------- ----------- -----------
Total loans receivable 453,323 100.00% 445,955 100.00% 410,790 100.00%
----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- -----------
Less:
Undisbursed loan funds (6,770) (7,305) (8,670)
Unearned discounts and net
deferred loan fees (3,296) (3,512) (4,361)
Allowance for loan losses (771) (1,196) (1,251)
----------- ----------- -----------
Total loans receivable, net $442,486 $433,942 $396,508
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------
1995 1994
------------------------- -----------------------
Percentage Percentage of
Amount of Loans Amount Loans
----------- ---------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Real estate loans:
Single-family residential $287,872 82.54% $237,724 82.96%
Multi-family residential 1,060 .30 800 0.28
Commercial real estate 19,723 5.66 17,529 6.12
Construction 11,603 3.33 7,468 2.61
----------- ---------- ---------- ----------
Total real estate loans 320,258 91.83 263,521 91.97
----------- ---------- ---------- ----------
Commercial loans 4,014 1.15 3,192 1.11
----------- ---------- ---------- ----------
Consumer loans:
Home equity and second
mortgage loans 10,466 3.00 8,752 3.05
Automobile 6,993 2.01 5,154 1.80
Other 7,021 2.01 5,938 2.07
----------- ---------- ---------- ----------
Total consumer loans 24,480 7.02 19,844 6.92
----------- ---------- ---------- ----------
Total loans receivable 348,752 100.00% 286,557 100.00%
----------- ---------- ---------- ----------
---------- ----------
Less:
Undisbursed loan funds (4,298) (3,318)
Unearned discounts and net
deferred loan fees (3,721) (2,322)
Allowance for loan losses (1,228) (1,134)
----------- ----------
Total loans receivable, net $339,505 $279,783
----------- ----------
----------- ----------
</TABLE>
3
<PAGE>
LOAN MATURITY AND INTEREST RATES. The following table sets forth certain
information at December 31, 1998 regarding the dollar amount of loans maturing
in the Bank's loan portfolio based on their contractual terms to maturity.
Demand loans and loans having no stated schedule of repayments and no stated
maturity are reported as due in one year or less. All other loans are included
in the period in which the final contractual repayment is due.
<TABLE>
<CAPTION>
After Three After Five After Ten
One Year Years Years Years Beyond
Within Through Three Through Five Through Ten Through Twenty
One Year Years Years Years Twenty Years Years Total
----------- ------------- ------------- ------------ ------------- ----------- -----------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
Single-family residential $ 420 $ 1,095 $ 3,818 $43,219 $144,257 $177,402 $370,211
Multi-family residential 172 -- -- 485 883 -- 1,540
Commercial real estate 2,235 1,662 6,070 6,973 6,256 -- 23,196
Construction 1,928 -- -- 510 4,911 10,877 18,226
Commercial loans 4,227 1,087 1,689 897 537 -- 8,437
Consumer loans 9,307 7,080 14,031 1,208 87 -- 31,713
----------- ------------- ------------- ------------ ------------- ----------- -----------
Total(1) $18,289 $10,924 $25,608 $53,292 $156,931 $188,279 $453,323
----------- ------------- ------------- ------------ ------------- ----------- -----------
----------- ------------- ------------- ------------ ------------- ----------- -----------
</TABLE>
(1) Gross of undisbursed loan funds, unearned discounts and net deferred loan
fees and the allowance for loan losses.
The following table sets forth the dollar amount of the Bank's loans at
December 31, 1998 due after one year from such date which have fixed interest
rates or which have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Floating or
Fixed-Rates Adjustable-Rates Total
------------------- ------------------- ---------------
(In Thousands)
<S> <C> <C> <C>
Real estate loans:
Single-family residential $135,286 $234,505 $369,791
Multi-family residential 940 428 1,368
Commercial real estate 20,961 -- 20,961
Construction 5,321 10,977 16,298
Commercial loans 4,210 -- 4,210
Consumer loans 22,406 -- 22,406
------------------- ------------------- ---------------
Total $189,124 $245,910 $435,034
------------------- ------------------- ---------------
------------------- ------------------- ---------------
</TABLE>
Scheduled contractual maturities of loans do not necessarily reflect the
actual term of the Bank's portfolio. The average life of mortgage loans is
substantially less than their average contractual terms because of loan
prepayments and refinancing. The average life of mortgage loans tends to
increase, however, when current mortgage loan rates substantially exceed rates
on existing mortgage loans and, conversely, decrease when rates on existing
mortgage loans substantially exceed current mortgage loan rates.
ORIGINATION, PURCHASE AND SALE OF LOANS. The lending activities of the Bank
are subject to the written, non-discriminatory, underwriting standards and loan
origination procedures established by the Bank's Board of Directors and
management. Loan originations are obtained by a variety of sources, including
realtors, walk-in customers, branch managers and radio, television and newspaper
advertising. In its marketing, the Bank emphasizes its community ties and an
efficient underwriting and approval process. The Bank believes it can provide
its personalized service to its customers in a more efficient manner due in part
to the use of in-house appraisal and underwriting staff. The Bank requires
hazard, title and, to the extent applicable, flood insurance on all security
property.
4
<PAGE>
Loan applications are initially processed by branch managers or loan
officers and all real estate loans up to $500,000 must be approved by two
members of the Bank's Loan Committee, one of which must be a member of senior
management. Loans in excess of $500,000 up to $750,000 must be approved by three
members of the Bank's Loan Committee, two of which must be members of senior
management. Real estate loans in excess of $750,000 must be approved by the
Bank's Board of Directors. Consumer loans are initially processed by consumer
loan officers and are required to be approved by designated officers of the Bank
depending on the amount of the loan. All loans are ratified by the Board of
Directors.
Historically, the Bank has not been an active purchaser of loans due to
consistent loan demand. No loans were purchased during the last three years.
The Bank originates and sells loans with fixed terms of fifteen years or
greater to specific investors in the secondary mortgage loan market. This allows
the Bank to provide to its' customers competitive long-term fixed-rate loan
products without assuming additional interest rate risk. These loans are
originated subject to underwriting by a third party with the purchase price
confirmed by the respective investor prior to loan closing. Due to these loans
being underwritten by a third party, the repurchase risk typically associated
with such contracts is being assumed by the underwriter. The Bank is not
involved in loan hedging or other speculative mortgage origination activities.
In 1998, 1997, and 1996, the Bank's loan sales were $20.5 million, $2.2 million,
and $73,000, respectively.
Set forth below is a table showing the Bank's originations, purchases, sales
and repayments of loans during the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------
1998 1997 1996
-------- --------- -------
(In Thousands)
<S> <C> <C> <C>
Loans receivable at beginning
of period $445,955 $410,790 $348,752
-------- --------- --------
Loan originations:
Real estate:
Single-family residential 114,518 92,684 102,214
Multi-family residential 590 -- 556
Commercial real estate 13,776 3,633 4,866
Construction 24,033 20,587 25,537
Commercial loans 7,159 5,257 3,060
Consumer:
Home equity and second
mortgage loans 9,652 8,807 10,400
Automobile 10,273 7,311 7,235
Other 8,830 6,798 7,225
-------- --------- --------
Total loan originations 188,831 145,077 161,093
Purchases -- -- --
-------- --------- --------
Total loan originations and
purchases 188,831 145,077 161,093
Repayments (156,426) (106,408) (98,540)
Loan sales (20,494) (2,244) (73)
Other (4,543) (1,260) (442)
-------- --------- --------
Net loan activity 7,368 35,165 62,038
-------- --------- --------
Loans receivable
at end of period $453,323 $445,955 $410,790
-------- --------- --------
-------- --------- --------
</TABLE>
5
<PAGE>
LOANS-TO-ONE BORROWER. A savings institution generally may not make
loans-to-one borrower and related entities in an amount which exceeds 15% of its
unimpaired capital and surplus, although loans in an amount equal to an
additional 10% of unimpaired capital and surplus may be made to a borrower if
the loans are fully secured by readily marketable securities. At December 31,
1998, the Bank's limit on loans-to-one borrower was approximately $10.9 million.
At December 31, 1998, the Bank's largest loans or groups of loans-to-one
borrower, including persons or entities related to the borrower, amounted to
$5.7 million. Such amount consists of 22 loans, primarily commercial real estate
loans, all of which were current at December 31, 1998. The Bank's ten largest
loans or groups of loans-to-one borrower, including persons or entities related
to the borrower, amounted to $22.3 million at December 31, 1998. All of such
loans are current.
ONE-TO FOUR-FAMILY RESIDENTIAL REAL ESTATE LOANS. The Bank has historically
concentrated its lending activities on the origination of loans collateralized
by first mortgage liens on existing one- to four-family residences. At December
31, 1998, $370.2 million or 81.7% of the Bank's total loan portfolio consisted
of one- to four-family residential real estate loans. The Bank originated $114.5
million, $92.7 million and $102.2 million of one- to four-family residential
loans in 1998, 1997, and 1996, respectively, and intends to continue to
emphasize the origination of permanent loans collateralized by first mortgage
liens on one- to four-family residential properties in the future. Of the $370.2
million of such loans at December 31, 1998, $234.5 million or 63.3% had
adjustable-rates of interest (including $190.3 million in seven-year adjustable
rates) and $136.0 million or 36.7% had fixed-rates of interest.
The Bank currently originates both fixed-rate and adjustable-rate one- to
four-family residential mortgage loans. The Bank's fixed-rate loans for
portfolio are presently originated with maximum terms of 15 years and are fully
amortizing with monthly payments sufficient to repay the total amount of the
loan with interest by the end of the loan term. The Bank does offer fixed-rate
loans with terms exceeding fifteen years although such loans are typically sold
in the secondary market. The Bank's one- to four-family loans are typically
originated under terms, conditions and documentation which permit them to be
sold to U.S. Government sponsored agencies such as the Federal Home Loan
Mortgage Corporation ("FHLMC") and the Federal National Mortgage Association
("FNMA"). However, as stated above, such loans with terms of 15 years or less
are generally originated for portfolio while substantially all of such loans
over 15 years are sold in the secondary market. The Bank's fixed-rate loans
typically include "due on sale" clauses.
The Bank's adjustable-rate mortgage loans typically provide for an interest
rate which adjusts every one-, three-, five- or seven-years in accordance with a
designated index plus a margin. Such loans are typically based on a 25- or
30-year amortization schedule. The Bank generally does not offer below market
rates, and the amount of any increase or decrease in the interest rate per one
or three year period is generally limited to 2%, with a limit of 6% over the
life of the loan. The Bank's five-year adjustable rate loans provide that any
increase or decrease in the interest rate per period is limited to 3%, with a
limit of 6% over the life of the loan. The Bank's seven-year adjustable rate
loans provide that any increase or decrease in the interest rate per period is
limited to 5% with a limit of 5% over the life of the loan. The Bank's
adjustable-rate loans are assumable (generally without release of the initial
borrower), do not contain prepayment penalties and do not provide for negative
amortization. The Bank's adjustable-rate mortgage loans typically include "due
on sale" clauses. Such loans may be converted to a fixed-rate loan at the
discretion of the Bank. The Bank generally underwrites its one- and three-year
adjustable-rate loans on the basis of the borrowers' ability to pay at the rate
after the first adjustment. Adjustable-rate loans decrease the risks associated
with changes in interest rates but involve other risks, primarily because as
interest rates rise, the payment by the borrower rises to the extent permitted
by the terms of the loan, thereby increasing the potential for default. At the
same time, the marketability of the underlying property may be adversely
affected by higher interest rates.
The Bank's residential mortgage loans typically do not exceed 90% of the
appraised value of the security property. However, pursuant to underwriting
guidelines adopted by the Board of Directors, the Bank can lend up to 97% of the
appraised value of the property securing a one- to four-family residential loan,
and requires borrowers to obtain private mortgage insurance on the portion of
the principal amount of the loan that exceeds 90% of the appraised value of the
security property. At December 31, 1998, the Bank had $1.3 million of
nonperforming single-family residential loans. See "- Asset Quality."
MULTI-FAMILY RESIDENTIAL REAL ESTATE LOANS. Although the Bank does not
emphasize multi-family residential loans and has not been active in this area,
the Bank offers mortgage loans for the acquisition and refinancing of existing
multi-family residential properties. At December 31, 1998, $1.5 million or .3%
of the Bank's total loan portfolio consisted of loans collateralized by existing
multi-family residential real estate properties.
6
<PAGE>
Multi-family loans are generally made on terms up to ten years with fixed
rates although the Bank will originate such loans with call provisions up to
five years. Loan to value ratios on the Bank's multi-family real estate loans
are currently limited to 80%. It is also the Bank's general policy to obtain
corporate or personal guarantees, as applicable, on its multi-family residential
real estate loans from the principals of the borrower.
Multi-family real estate lending entails significant additional risks as
compared with one- to four-family residential property lending. Such loans
typically involve large loan balances to single borrowers or groups of related
borrowers. The payment experience on such loans is typically dependent on the
successful operation of the real estate project. The success of such projects is
sensitive to changes in supply and demand conditions in the market for
multi-family real estate as well as economic conditions generally. At December
31, 1998, the Bank did not have any nonperforming multi-family real estate
loans. See "- Asset Quality."
COMMERCIAL REAL ESTATE LOANS. The Bank originates mortgage loans for the
acquisition and refinancing of commercial real estate properties. At December
31, 1998, $23.2 million or 5.1% of the Bank's total loan portfolio consisted of
loans collateralized by existing commercial real estate properties. The Bank
does not actively market its commercial real estate loan products and offers
such loans primarily as an accommodation to its present customers. Management
does not expect the Bank's portfolio of commercial real estate loans to
significantly increase in the future.
The majority of the Bank's commercial real estate loans are collateralized
by office buildings, convenience stores, service stations, mini-storage
facilities, hotels, churches and small shopping malls. The majority of the
Bank's commercial real estate loans are collateralized by property located in
the Bank's market area.
At December 31, 1998, the Bank had approximately $8.7 million of loans which
are either for the construction of service station and convenience store
facilities or are collateralized by such facilities. The Bank requires that
construction loans for such facilities meet present standards established by the
Environmental Protection Agency. With respect to existing facilities, the Bank
requires an environmental study of the property. To date, the Bank has not
experienced any material credit or environmental problems with such loans.
The Bank requires appraisals of all properties securing commercial real
estate loans. The Bank considers the quality and location of the real estate,
the credit of the borrower, cash flow of the project and the quality of
management involved with the property. The Bank's commercial real estate loans
are originated with fixed interest rates based on a ten or fifteen year
amortization schedule and loan to value ratios on such loans are generally
limited to 80%. As part of the criteria for underwriting multi-family and
commercial real estate loans, the Bank generally imposes a debt coverage ratio
(the ratio of net cash from operations before payment of debt service to debt
service) of not less than 1.2. It is also the Bank's policy to typically obtain
corporate or personal guarantees, as applicable, on its commercial real estate
loans from the principals of the borrower.
Commercial real estate lending entails significant additional risks as
compared with single-family residential property lending. Such loans typically
involve large loan balances to single borrowers or groups of related borrowers.
The payment experience on such loans is typically dependent on the successful
operation of the real estate project. The success of such projects is sensitive
to changes in supply and demand conditions in the market for commercial real
estate as well as regional and economic conditions generally. At December 31,
1998, the Bank did not have any nonperforming commercial real estate loans.
See"-Asset Quality."
CONSTRUCTION LOANS. The Bank also originates primarily residential
construction loans, although the Bank has originated commercial real estate and
multi-family residential construction loans to a limited degree. The Bank's
construction lending activities are limited to the Bank's primary market area.
At December 31, 1998, construction loans amounted to $18.2 million or 4.0% of
the Bank's total loan portfolio, of which $16.4 million consisted of
single-family residential construction loans and $1.8 million consisted of
commercial real estate and multi-family residential construction loans. The
Bank's construction loans generally have fixed interest rates for a term of six
months to nine months. However, the Bank is permitted to originate construction
loans with terms of up to two years under its loan policy. Commercial real
estate and multi-family residential
7
<PAGE>
construction loans are made with a maximum loan to value ratio of 80%.
Construction loans to individuals are typically made with a loan to value ratio
of up to 90% and non-owner occupied construction loans are limited to 80%.
With limited exceptions, the Bank's construction loans are made to
individual homeowners and a limited number of local real estate builders and
developers for the purpose of constructing one- to four-family residential
homes. Construction loans to individuals are typically made in connection with
the granting of the permanent financing on the property. Such loans convert to a
fully amortizing adjustable or fixed-rate loan at the end of the construction
term. The Bank typically requires that permanent financing with the Bank or some
other lender be in place prior to closing any construction loan to an
individual. Interest on construction/permanent loans is due upon completion of
the construction phase of the loan. At such time, the loan automatically
converts to a permanent loan with an interest rate which is determined upon the
closing of the construction/permanent loan.
Upon application, credit review and analysis of personal and, if applicable,
corporate financial statements, the Bank makes construction loans to local
builders for the purpose of construction of speculative (or unsold) residential
properties and for the construction of pre-sold single-family homes. Prior to
making a commitment to fund a construction loan, the Bank requires an appraisal
of the property by the Bank's appraisal staff. The Bank's appraisal staff also
reviews and inspects each project at the commencement of construction and
typically before each disbursement of funds during the term of the construction
loan. Loan proceeds are disbursed after inspections of the project based on a
percentage of completion or presentation of substantiated costs incurred.
Interest on construction loans is due upon maturity.
Construction lending is generally considered to involve a higher level of
risk as compared to one- to four-family residential lending, due to the
concentration of principal in a limited number of loans and borrowers and the
effects of general economic conditions on developers and builders. Moreover, a
construction loan can involve additional risks because of the inherent
difficulty in estimating both a property's value at completion of the project
and the estimated cost (including interest) of the project. The nature of these
loans is such that they are generally more difficult to evaluate and monitor. In
addition, speculative construction loans to a builder are not pre-sold and thus
pose a greater potential risk to the Bank than construction loans to individuals
on their personal residences.
The Bank has attempted to minimize the foregoing risks by, among other
things, limiting the extent of its construction lending generally and by
limiting its construction lending to primarily residential properties. In
addition, the Bank has adopted underwriting guidelines which impose stringent
loan to value, debt service and other requirements for loans which are believed
to involve higher elements of credit risk, by limiting the geographic area in
which the Bank will do business and by working with builders with whom it has
established relationships. At December 31, 1998, the Bank did not have any
nonperforming construction loans. See "- Asset Quality."
COMMERCIAL LOANS. To a limited extent, the Bank offers commercial loans
which primarily consist of equipment and inventory loans which are typically
cross-collateralized by commercial real estate. The Bank does not actively
market such loans and offers such loans primarily as an accommodation to its
present customers. At December 31, 1998, such loans amounted to $8.4 million or
1.9% of the total loan portfolio. At December 31, 1998, the Bank had three
nonperforming commercial loans totaling $30,000. See "- Asset Quality."
The Bank's commercial loans are originated with fixed interest rates with
call provisions between one and five years. Such loans are typically based on a
ten year amortization schedule.
CONSUMER LOANS. The Bank offers consumer loans in order to provide a full
range of financial services to its customers. The consumer loans offered by the
Bank include primarily home equity and second mortgage loans, automobile loans,
deposit account secured loans and unsecured loans. Consumer loans amounted to
$31.7 million or 7.0% of the total loan portfolio at December 31, 1998, of which
$13.3 million, $10.7 million and $7.7 million consisted of home equity and
second mortgage loans, automobile loans and other consumer loans, respectively.
The Bank intends to continue its emphasis on consumer loans in furtherance of
its role as a community oriented financial institution. Consumer loans are
subject to Arkansas usury law
8
<PAGE>
which limits the interest rate that may be charged to 5% over the Federal
Reserve discount rate, which was 4.50% at December 31, 1998. A change in the
usury rate does not affect loans already in portfolio.
The Bank's home equity and second mortgage loans are typically fixed-rate
loans with terms of up to 15 years. Although the Bank does not require that it
hold the first mortgage on the secured property, the Bank does hold the first
mortgage on a significant majority of its home equity and second mortgage loans.
The Bank limits the mortgages on the secured property to 85% of the value of the
secured property.
The Bank's automobile loans are typically originated for the purchase of new
and used cars and trucks. Such loans are generally originated with a maximum
term of five years.
Other consumer loans consist primarily of deposit account loans and
unsecured loans. Loans secured by deposit accounts are originated for up to 90%
of the account balance, with a hold placed on the account restricting the
withdrawal of the account balance.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
rapidly depreciating assets such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant
further substantial collection efforts against the borrower beyond obtaining a
deficiency judgment. In addition, consumer loan collections are dependent on the
borrower's continuing financial stability, and thus are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Furthermore, the application of various federal and state laws, including
federal and state bankruptcy and insolvency laws, may limit the amount which can
be recovered on such loans. At December 31, 1998, the Bank had $159,000 of
nonperforming consumer loans. See "-Asset Quality."
ASSET QUALITY
When a borrower fails to make a required payment on a loan, the Bank
attempts to cure the deficiency by contacting the borrower and seeking the
payment. Depending upon the type of loan, late notices are sent and/or personal
contacts are made. In most cases, deficiencies are cured promptly. While the
Bank generally prefers to work with borrowers to resolve such problems, when a
mortgage loan becomes 90 days delinquent, the Bank generally institutes
foreclosure or other proceedings, as necessary, to minimize any potential loss.
Loans are placed on non-accrual status when, in the judgment of management,
the probability of collection of interest is deemed to be insufficient to
warrant further accrual. When a loan is placed on non-accrual status, previously
accrued but unpaid interest is deducted from interest income. The Bank does not
accrue interest on loans past due 90 days or more. Loans may be reinstated to
accrual status when payments are made to bring the loan under 90 days past due
and, in the opinion of management, collection of the remaining balance can be
reasonably expected.
Real estate properties acquired through, or in lieu of, loan foreclosure are
initially recorded at fair value at the date of foreclosure. After foreclosure,
valuations are periodically performed by management and the real estate is
carried at the lower of carrying amount or fair value less cost to sell. Revenue
and expenses from operations are included in the current period income.
Additions to the valuation allowance are included in the provision for real
estate losses.
9
<PAGE>
DELINQUENT LOANS. The following table sets forth information concerning
delinquent loans at December 31, 1998, in dollar amounts and as a percentage of
the Bank's total loan portfolio. The amounts presented represent the total
outstanding principal balances of the related loans, rather than the actual
payment amounts which are past due.
<TABLE>
<CAPTION>
Single-family Commercial
Residential Real Estate Commercial Consumer
------------------- ------------------- ---------------- ---------------
Percentage Percentage Percentage Percentage
of Total of Total of Total of Total
Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans
delinquent:
30-59 days $1,682 .37% $ 35 .01% $ -- --% $ 257 .06%
60-89 days 612 .14 80 .02 34 .01 38 .01
90 days and
over 1,275 .28 -- -- 30 .01 159 .04
------ ----- ---- -----
Total $3,569 $ 115 $ 64 $ 454
------ ----- ---- -----
------ ----- ---- -----
</TABLE>
Interest income that would have been recorded under the original terms of
the Bank's non-accruing loans for the year ended December 31, 1998 amounted to
$114,000, and the interest recognized during this period amounted to $64,000.
The following table sets forth the amounts and categories of the Bank's
nonperforming assets at the dates indicated.
<TABLE>
<CAPTION>
December-31,
----------------------------------------------------------
1998 1997 1996 1995 1994
------ ------ ------ ------ ------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Nonperforming loans:
Single-family residential $1,275 $1,001 $ 493 $ 223 $ 159
Multi-family residential -- 109 -- -- --
Commercial real estate -- 3,365(1) -- -- --
Construction loans -- -- -- -- 78
Commercial loans 30 48 -- -- --
Consumer loans 159 434 228 127 33
------ ------ ------ ------ ------
Total nonperforming loans 1,464 4,957 721 350 270
------ ------ ------ ------ ------
Real estate owned 4,270(1) 195 154 234 250
------ ------ ------ ------ ------
Total nonperforming assets $5,734 $5,152 $ 875 $ 584 $ 520
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Total nonperforming loans as a
percentage of total loans
receivable 0.32% 1.11% 0.18% 0.10% 0.09%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Total nonperforming assets as a
percentage of total assets 0.93% 0.94% 0.17% 0.13% 0.12%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
</TABLE>
- --------------
(1) The Bank reclassified a previously reported non-accrual commercial real
estate loan secured by a 202 room hotel in Oklahoma to real estate owned in
1998. Real estate owned primarily consists of the Bank's 75% ownership of this
property. As a result of such 75% ownership interest, the Bank is required to
include the 25% minority interest ownership in the real estate owned amount
shown above.
10
<PAGE>
CLASSIFIED ASSETS. Federal regulations require that each insured savings
association classify its assets on a regular basis. In addition, in connection
with examinations of insured institutions, federal examiners have authority to
identify problem assets and, if appropriate, classify them. There are three
classifications for problem assets: "substandard," "doubtful" and "loss."
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the insured institution will sustain some loss if
the deficiencies are not corrected. Doubtful assets have the weaknesses of
substandard assets with the additional characteristic 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 loss is considered uncollectible and of such little value that
continuance as an asset of the institution is not warranted. At December 31,
1998, the Bank had $4.8 million of classified assets, $4.7 million of which were
classified as substandard and $91,000 of which were classified as loss. In
addition, at such date, the Bank had $16,000 of assets designated as special
mention.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is a valuation
allowance to provide for incurred but not yet realized losses. The Bank reviews
its non-homogeneous loans for impairment on a quarterly basis. Impairment is
determined by assessing the probability that the borrower will not be able to
fulfill the contractual terms of the agreement. If a loan is determined to be
impaired, the amount of the impairment is measured based on the present value of
expected future cash flows discounted at the loan's effective interest rate or
by use of the observable market price of the loan or fair value of collateral if
the loan is collateral dependent. Throughout the year management estimates the
level of probable losses to determine whether the allowance for loan losses is
appropriate considering the estimated losses existing in the portfolio. Based on
these estimates, an amount is charged to the provision for loan losses and
credited to the allowance for loan losses in order to adjust the allowance to a
level determined by management to be appropriate relative to losses. The
allowance for loan losses is increased by charges to income (provisions) and
decreased by charge-offs, net of recoveries.
Management's periodic evaluation of the appropriateness of the allowance is
based on the Company's past loan loss experience, known and inherent risks in
the portfolio, adverse situations that may affect the borrower's ability to
repay, the estimated value of any underlying collateral and current economic
conditions.
Homogeneous loans are those that are considered to have common
characteristics that provide for evaluation on an aggregate or pool basis. The
Bank considers the characteristics of (1) one-to-four family residential first
mortgage loans; (2) unsecured consumer loans and; (3) secured consumer loans to
permit consideration of the appropriateness of the allowance for losses of each
group of loans on a pool basis. The primary methodology used to determine the
appropriateness of the allowance for losses includes segregating certain
specific, poorly performing loans based on their performance characteristics
from the pools of loans as to type, grading these loans, and then applying a
loss factor to the remaining pool balance based on several factors including
past loss experience, inherent risks, economic conditions in the primary market
areas, and other factors which usually are beyond the control of the Bank.
Non-homogeneous loans are those loans that can be included in a particular
loan type, such as commercial loans, construction loans, multi-family, and
commercial first mortgage loans, but which differ in other characteristics to
the extent that valuation on a pool basis is not valid. Those segregated
specific loans are evaluated using the present value of future cash flows,
usually determined by estimating the fair value of the loan's collateral reduced
by any cost of selling and discounted at the loan's effective interest rate if
the estimated time to receipt of monies is more that three months or by use of
the observable market price of the loan or fair value of collateral if the loan
is collateral dependent. After segregating specific, poorly performing loans,
the remaining loans are evaluated based on payment experience, known
difficulties in the borrower's business or geographic area, loss experience,
inherent risks and other factors usually beyond the control of the Bank. A
factor, based on experience, is applied to these loans to estimate the probable
loss.
11
<PAGE>
Estimates of the probability of loan losses involve an exercise of
judgement. While it is possible that in the near term the Bank may sustain
losses which are substantial in relation to the allowance for loan losses, it is
the judgement of management that the allowance for loan losses reflected in the
consolidated statements of financial condition is appropriate considering the
estimated probable losses in the portfolio.
The following table summarizes changes in the allowance for loan losses and
other selected statistics for the periods presented.
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Total loans outstanding at
end of period $ 453,323 $ 445,955 $ 410,790 $ 348,752 $ 286,557
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Average loans outstanding $ 441,702 $ 415,075 $ 369,185 $ 306,175 $ 257,261
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Allowance at beginning of period $ 1,196 $ 1,251 $ 1,228 $ 1,134 $ 1,447
--------- --------- --------- --------- ---------
Charge-offs:
Single-family residential (17) -- -- (2) (24)
Commercial real estate (369) -- -- (8) (335)
Consumer loans (103) (67) (40) (30) (9)
--------- --------- --------- --------- ---------
Total charge-offs (489) (67) (40) (40) (368)
--------- --------- --------- --------- ---------
Recoveries:
Commercial real estate -- -- 1 -- --
Consumer loans 9 12 2 1 1
--------- --------- --------- --------- ---------
Total recoveries 9 12 3 1 1
--------- --------- --------- --------- ---------
Net charge-offs (480) (55) (37) (39) (367)
--------- --------- --------- --------- ---------
Total provisions for losses 55 -- 60 133 54
--------- --------- --------- --------- ---------
Allowance at end of period $ 771 $ 1,196 $ 1,251 $ 1,228 $ 1,134
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Allowance for loan losses as a
percentage of total loans
outstanding at end of period 0.17% 0.27% 0.30% 0.35% 0.40%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net loans charged-off as a
percentage of average loans
outstanding 0.11% 0.01% 0.01% 0.01% 0.14%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
12
<PAGE>
The following table presents the allocation of the Bank's allowance for loan
losses by the type of loan at each of the dates indicated. The significant
portion of the allowance which is unallocated is due to historically low levels
of nonperforming single-family residential loans, multi-family residential
loans, commercial real estate loans, construction loans, commercial loans and
consumer loans, which would otherwise require a larger allocation of the
allowance, balanced with management's desire to provide for an adequate
allowance in light of the size of the Bank's loan portfolio.
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------------------------------------------
1998 1997 1996 1995
----------------------- -------------------- -------------------- ---------------------
Percent of Percent of Percent of Percent of
Total Loans by Total Loans Total Loans Total Loans
Amount Category Amount by Category Amount by Category Amount by Category
------ -------------- ------ ----------- ------ ----------- ------ -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Single-family residential $ 46 81.66% $ 49 83.18% $ 11 82.36% $ 11 82.54%
Multi-family residential -- .34 -- .29 -- .38 -- .30
Commercial real estate 147 5.12 125 4.17 117 4.66 124 5.66
Construction loans - 4.02 -- 4.66 -- 4.88 -- 3.33
Commercial loans 60 1.86 13 1.27 19 1.06 27 1.15
Consumer loans 135 7.00 221 6.43 270 6.66 241 7.02
Unallocated 383 -- 788 -- 834 -- 825 --
------ ------ ------ ------ ------ ------ ------ ------
Total $ 771 100.00% $1,196 100.00% $1,251 100.00% $1,228 100.00%
------ ------ ------ ------ ------ ------ ------ ------
------ ------ ------ ------ ------ ------ ------ ------
</TABLE>
<TABLE>
<CAPTION>
December 31,
-------------------------
1994
-------------------------
Percent of
Total Loans by
Amount Category
------ --------------
(Dollars in Thousands)
<S> <C> <C>
Single-family residential $ 16 82.96%
Multi-family residential -- 0.28
Commercial real estate 117 6.12
Construction loans -- 2.61
Commercial loans 21 1.11
Consumer loans 143 6.92
Unallocated 837 --
------ ------
Total $1,134 100.00%
------ ------
------ ------
</TABLE>
13
<PAGE>
INVESTMENT ACTIVITIES
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities (which also are known
as mortgage participation certificates or pass-through certificates) typically
represent a participation interest in a pool of single-family or multi-family
mortgages, the principal and interest payments on which are passed from the
mortgage originators, through intermediaries (generally U.S. Government agencies
and government sponsored enterprises) that pool and repackage the participation
interests in the form of securities, to investors such as the Bank. Such U.S.
Government agencies and government sponsored enterprises, which guarantee the
payment of principal and interest to investors, primarily include the FHLMC, the
FNMA and the Government National Mortgage Association ("GNMA").
The FHLMC is a public corporation chartered by the U.S. Government and
guarantees the timely payment of interest and the ultimate return of principal
within one year. The FHLMC mortgage-backed securities are not backed by the full
faith and credit of the United States, but because the FHLMC is a U.S.
Government sponsored enterprise, these securities are considered high quality
investments with minimal credit risks. The GNMA is a government agency within
the Department of Housing and Urban Development which is intended to help
finance government assisted housing programs. The GNMA guarantees the timely
payment of principal and interest, and GNMA securities are backed by the full
faith and credit of the U.S. Government. The FNMA guarantees the timely payment
of principal and interest, and FNMA securities are indirect obligations of the
U.S. Government.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
underlying pool of mortgages, i.e., fixed rate or adjustable rate, as well as
the prepayment risk, are passed on to the certificate holder. Accordingly, the
life of a mortgage-backed pass-through security approximates the life of the
underlying mortgages. It has been the Bank's practice to invest only in
fixed-rate mortgage-backed securities. Mortgage-backed securities that
management has the positive intent and ability to hold to maturity are
classified as held to maturity and are reported at amortized cost.
The following table sets forth certain information relating to the
composition of the Bank's mortgage-backed securities at the dates indicated.
<TABLE>
<CAPTION>
December 31,
-------------------------------------
1998 1997 1996
---- ---- ----
(In Thousands)
<S> <C> <C> <C>
Mortgage-backed securities
held to maturity:
FHLMC $ 25 $ 157 $ 227
---- ---- ----
Total mortgage-backed
securities $ 25 $ 157 $ 227
---- ---- ----
---- ---- ----
</TABLE>
Mortgage-backed securities are generally backed by insurance or
guarantees, are more liquid than individual mortgage loans and may be used to
collateralize borrowings or other obligations of the Bank. At December 31, 1998,
no mortgage-backed securities were pledged to secure obligations of the Bank.
14
<PAGE>
Of the $25,000 of mortgage-backed securities at December 31, 1998,
$5,000 was scheduled to mature between one and five years and $20,000 between
five and ten years. The $5,000 and $20,000 of mortgage-backed securities had
weighted average yields of 7.13% and 8.50%, respectively. At such date, all of
the Bank's mortgage-backed securities were fixed-rate and are disclosed above in
the periods in which they are scheduled to mature. The actual maturity of a
mortgage-backed security may be less than its stated maturity due to prepayments
of the underlying mortgages. Prepayments that are faster than anticipated will
shorten the life of the security and adversely affect its yield to maturity. The
yield is based upon the interest income and the amortization of any premium or
discount related to the mortgage-backed security. In accordance with generally
accepted accounting principles, premiums and discounts are amortized over the
estimated lives of the securities, which decrease and increase interest income,
respectively. 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 actual prepayments. Although prepayments of underlying mortgages depend
on many factors, including the type of mortgages, the coupon rate, the age of
mortgages, the geographical location of the underlying real estate
collateralizing the mortgages and general levels of market interest rates, the
difference between the interest rates on the underlying mortgages and the
prevailing mortgage interest rates generally is the most significant determinant
of the rate of prepayments. During periods of falling mortgage interest rates,
if the coupon rate of the underlying mortgages exceeds the prevailing market
interest rates offered for mortgage loans, refinancing generally increases and
accelerates the prepayment of the underlying mortgages and the related security.
Under such circumstances, the Bank may be subject to reinvestment risk because
to the extent that the Bank's mortgage-backed securities amortize or prepay
faster than anticipated, the Bank may not be able to reinvest the proceeds of
such repayments and prepayments at a comparable interest rate.
INVESTMENT SECURITIES. The investment policy of the Bank, as
established by the Board of Directors, is designed primarily to provide and
maintain liquidity and to generate a favorable return on investments without
incurring undue interest rate risk, credit risk, and investment portfolio asset
concentrations. The Bank's investment policy is currently implemented by the
Bank's President within the parameters set by the Board of Directors. The Bank
is authorized to invest in obligations issued or fully guaranteed by the U.S.
Government, certain federal agency obligations, certain time deposits,
negotiable certificates of deposit issued by commercial banks and other insured
financial institutions, investment grade corporate debt securities and other
specified investments.
Investment securities that management has the positive intent and
ability to hold to maturity are classified as held to maturity and are reported
at amortized cost. Investment securities classified as available for sale are
reported at fair value, with unrealized gains and losses excluded from earnings,
net of taxes, and reported as a separate component of equity. At December 31,
1998, the Bank held no investment securities classified as available for sale.
At December 31, 1998, approximately $16 million of the Bank's investment
securities were pledged to secure obligations of the Bank. At December 31, 1998,
investments in the debt and/or equity securities of any one issuer, other than
those issued by U.S. Government agencies, did not exceed more than 10% of the
Company's stockholders' equity.
At December 31, 1998, the Bank's investment securities included
structured notes of $2.1 million, of which $2.0 million were adjustable-rate
FHLB notes and $126,000 were FHLB zero coupon bonds with a face value of
$550,000. The adjustable-rate FHLB notes adjust semi-annually based on a
multiple of the ten-year CMT index plus 160 basis points with a floor of 4.50%
and a cap of 24.0%. The adjustable-rate FHLB notes are non-callable with a
stated maturity of March 2000. The CMT index could result in the interest rate
on these notes being less than market rates of interest. At December 31, 1998,
the FHLB zero coupon bond had a remaining maturity of nineteen years with a call
date within one year.
The maturity terms of the investment securities purchased in 1998
totaling $111.4 million generally have been longer term, up to twenty years with
three month to two year call protection.
15
<PAGE>
The following table sets forth the amount of investment securities
which contractually mature during each of the periods indicated and the weighted
average yields for each range of maturities at December 31, 1998. Expected
maturities may differ from contractual maturities because issuers may have the
right to call or prepay the obligation without prepayment penalties.
<TABLE>
<CAPTION>
Less Than One to Five Five to Ten After Ten
One Year Years Years Years Total
--------------- ---------------- --------------- -------------- --------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
-------- ----- -------- ------ ------- ------ ------- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(Dollars in Thousands)
Bonds and other debt
securities held to maturity:
U.S. Government and
agency obligations $10,008 6.12% $8,188 5.70% $14,100 6.76% $94,854 6.74% $127,150 6.63%
------ ----- ------ ------ -------
Total investment securities $10,008 $8,188 $14,100 $94,854 $127,150
------ ----- ------ ------ -------
------ ----- ------ ------ -------
</TABLE>
As of December 31, 1998, there were approximately $113 million of
investments with issuer call options, of which approximately $97 million are
callable within one year.
The following table sets forth the carrying value of the Company's
investment securities classified as held to maturity and available for sale at
the dates indicated.
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------
1998 1997 1996
--------- ------- -------
(In Thousands)
<S> <C> <C> <C>
Investment securities held
to maturity:
U.S. Government and agency
obligations $127,150 $95,376 $90,755
Equity securities available
for sale:
FHLMC preferred stock(1) -- -- 340
--------- ------- -------
Total investment securities $ 127,150 $95,376 $91,095
--------- ------- -------
--------- ------- -------
</TABLE>
- ----------------
(1) Reflects carrying value at fair market value. At December 31, 1998 and
1997 the Company held no securities as available for sale.
As a member of the FHLB of Dallas, the Bank is required to maintain an
investment in FHLB stock. At December 31, 1998, the Bank's investment in FHLB
stock amounted to $3.9 million. No ready market exists for such stock and it has
no quoted market value.
16
<PAGE>
SOURCES OF FUNDS
GENERAL. Deposits are the primary source of the Bank's funds for
lending and other investment purposes. In addition to deposits, the Bank derives
funds from loan principal repayments and prepayments and interest payments,
maturities of investment securities and advances from the FHLB of Dallas. Loan
repayments are a relatively stable source of funds, while deposit inflows and
outflows are significantly influenced by general interest rates and money market
conditions. Borrowings may be used on a short-term basis to compensate for
reductions in the availability of funds from other sources. They may also be
used on a longer term basis for general business purposes. The Bank began
utilizing FHLB of Dallas advances as an additional source of funds during 1997.
DEPOSITS. The Bank's deposit products include a broad selection of
deposit instruments, including negotiable order of withdrawal ("NOW") accounts,
demand deposit accounts ("DDA"), money market accounts, regular savings accounts
and term certificate accounts. Deposit account terms vary, with the principal
differences being the minimum balance required, the time period the funds must
remain on deposit, early withdrawal penalties and the interest rate.
The Bank considers its primary market area to be Northcentral and
Northwest Arkansas. The Bank utilizes traditional marketing methods to attract
new customers and savings deposits. The Bank does not advertise for deposits
outside of its primary market area or utilize the services of deposit brokers,
and management believes that an insignificant number of deposit accounts were
held by non-residents of Arkansas at December 31, 1998.
The Bank has been competitive in the types of accounts and in interest
rates it has offered on its deposit products but does not necessarily seek to
match the highest rates paid by competing institutions. Although market demand
generally dictates which deposit maturities and rates will be accepted by the
public, the Bank intends to continue to promote longer term deposits to the
extent possible and consistent with its asset and liability management goals.
The following table shows the distribution of, and certain other
information relating to, the Bank's deposits by type of deposit, as of the dates
indicated.
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------------
1998 1997 1996
------------------ ------------------ ------------------
Amount % Amount % Amount %
-------- ----- -------- ----- -------- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Certificate accounts:
3.00% - 3.99% $ 453 .1 % $ 362 .1% $ 607 .2%
4.00% - 5.99% 278,335 57.9 241,660 53.6 205,912 48.7
6.00% - 7.99% 91,156 18.9 97,885 21.7 90,568 21.4
8.00% and over 8,821 1.8 20,236 4.5 36,408 8.6
-------- ----- -------- ----- -------- -----
Total certificate accounts 378,765 78.7 360,143 79.9 333,495 78.9
-------- ----- -------- ----- -------- -----
Transaction accounts:
Passbook and statement savings 25,916 5.4 25,330 5.6 26,451 6.2
Money market accounts 16,164 3.4 15,438 3.4 17,214 4.1
NOW accounts/DDA 60,248 12.5 49,963 11.1 45,698 10.8
----- -------- ----- -------- -----
Total transaction accounts 102,328 21.3 90,731 20.1 89,363 21.1
-------- ----- -------- ----- -------- -----
Total deposits $481,093 100.0% $450,874 100.0% $422,858 100.0%
-------- ----- -------- ----- -------- -----
-------- ----- -------- ----- -------- -----
</TABLE>
17
<PAGE>
The following table presents the average balance of each type of
deposit and the average rate paid on each type of deposit and/or total deposits
for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------------------
1998 1997 1996
----------------------- ----------------------------- ---------------------
Average Average Average
Average Rate Average Rate Average Rate
Balance Paid Balance Paid Balance Paid
---------- ---------- ------------- ------------ ---------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Passbook and statement savings
accounts $ 26,128 2.72% $ 26,092 2.72% $ 27,149 2.72%
Money market accounts and
NOW accounts 58,226 2.33 55,486 2.34 54,748 2.42
Demand deposit accounts 11,758 -- 9,624 -- 9,244 --
Certificates of deposit 366,484 5.99 348,945 6.11 328,921 6.19
------- ---- ------- ---- ------- ----
Total deposits $462,596 5.19% $440,147 5.30% $420,062 5.33%
------- ---- ------- ---- ------- ----
------- ---- ------- ---- ------- ----
</TABLE>
The following table presents, by various interest rate categories, the
amount of certificates of deposit at December 31, 1998 and 1997 and the amounts
at December 31, 1998 which mature during the periods indicated.
<TABLE>
<CAPTION>
Balance at December 31, 1998
December 31, Maturing in the 12 Months Ending December 31,
-------------------------- --------------------------------------------------
1998 1997 1999 2000 2001 Thereafter
----------- ----------- ---------- --------- -------- -----------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Certificates of Deposit
3.00% - 3.99% $ 453 $ 362 $ 453 $ -- $ -- $ --
4.00% - 5.99% 278,335 241,660 212,808 49,238 10,578 5,711
6.00% - 7.99% 91,156 97,885 20,602 13,328 12,404 44,822
8.00% and over 8,821 20,236 3,167 -- -- 5,654
-------- -------- -------- ------- ------- -------
Total certificate accounts $378,765 $360,143 $237,030 $62,566 $22,982 $56,187
-------- -------- -------- ------- ------- -------
-------- -------- -------- ------- ------- -------
</TABLE>
The following table sets forth the savings flows of the Bank during the
periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------
1998 1997 1996
------- ------- --------
(In Thousands)
<S> <C> <C> <C>
Increase (decrease) before interest credited $11,895 $10,786 $(10,731)
Interest credited 18,324 17,230 16,360
------- ------- --------
Net increase in deposits $30,219 $28,016 $ 5,629
------- ------- --------
------- ------- --------
</TABLE>
The decrease in deposits before interest credited in 1996 was primarily
due to the use of such funds by customers to purchase shares of the Company's
common stock in the Conversion.
The following table sets forth maturities of the Bank's certificates of
deposit of $100,000 or more at December 31, 1998 by time remaining to maturity.
<TABLE>
<CAPTION>
Amounts
----------
Period Ending: (In Thousands)
<S> <C>
March 31, 1999 $20,364
June 30, 1999 20,509
December 31, 1999 10,814
After December 31, 1999 22,757
-------
Total certificates of deposit with
balances of $100,000 or more $74,444
-------
-------
</TABLE>
18
<PAGE>
BORROWED FUNDS. The Bank has utilized FHLB advances in its normal
operating and investing activities during 1998 and 1997. There were no advances
outstanding at previous year ends. The Bank pledges as collateral for FHLB
advances their FHLB stock and has entered into blanket collateral agreements
with the FHLB whereby the Bank agrees to maintain, free of other encumbrances,
qualifying single family first mortgage loans with unpaid principal balances,
when discounted at 75% of the such balances, of at least 100% of total
outstanding advances.
Advances at December 31, 1998, have maturity dates and weighted average
rates as follows:
<TABLE>
<CAPTION>
WEIGHTED
YEAR ENDING AVERAGE
DECEMBER 31 RATE AMOUNT
- ----------------- ------------ -------------
<S> <C> <C>
1999 5.71% $19,000
2000 5.31 14,000
2001 4.85 7,000
2002 6.60 3,985
2003 5.56 1,000
THEREAFTER 6.01 4,000
-------
TOTAL 5.57% $48,985
-------
-------
</TABLE>
THE FOLLOWING TABLE SETS FORTH INFORMATION WITH RESPECT TO THE
COMPANY'S FHLB ADVANCES AT AND DURING THE PERIODS INDICATED.
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------
1998 1997 1996
------- ------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
MAXIMUM BALANCE $50,687 $12,997 $2,600
AVERAGE BALANCE 30,452 6,493 916
YEAR END BALANCE 48,985 11,997 --
WEIGHTED AVERAGE
INTEREST RATE:
AT END OF YEAR 5.57% 6.31% --
DURING THE YEAR 5.81 6.42 5.45%
</TABLE>
EMPLOYEES
The Bank had 168 full-time employees and 22 part-time employees at
December 31, 1998. None of these employees is represented by a collective
bargaining agent, and the Bank believes that it enjoys good relations with its
personnel.
19
<PAGE>
SUBSIDIARIES
The Bank is permitted to invest up to 2% of its assets in the capital
stock of, or secured or unsecured loans to, subsidiary corporations, with an
additional investment of 1% of assets when such additional investment is
utilized primarily for community development purposes. The Bank's only
subsidiary, First Harrison Service Corporation (the "Service Corporation"), was
formed in 1971. At December 31, 1998, the Service Corporation's only significant
asset was a $4.0 million repossessed commercial loan collateralized by a hotel
in Oklahoma City, Oklahoma. The property has been listed and is being operated
by a management company until disposition. The Service Corporation generated net
income of approximately $9,000 during 1998.
COMPETITION
The Bank faces strong competition both in attracting deposits and
making real estate loans. Its most direct competition for deposits has
historically come from other savings associations, credit unions and commercial
banks, including many large financial institutions which have greater financial
and marketing resources available to them. In addition, during times of high
interest rates, the Bank has faced additional significant competition for
investors' funds from short-term money market securities, mutual funds and other
corporate and government securities. The ability of the Bank to attract and
retain savings deposits depends on its ability to generally provide a rate of
return, liquidity and risk comparable to that offered by competing investment
opportunities.
The Bank experiences strong competition for real estate loans
principally from savings associations, commercial banks and mortgage companies.
The Bank competes for loans principally through the interest rates and loan fees
it charges and the efficiency and quality of services it provides borrowers.
Competition has increased as a result of the continuing reduction of
restrictions on the interstate operations of financial institutions.
20
<PAGE>
REGULATION
SET FORTH BELOW IS A BRIEF DESCRIPTION OF THOSE LAWS AND REGULATIONS
WHICH, TOGETHER WITH THE DESCRIPTIONS OF LAWS AND REGULATIONS CONTAINED
ELSEWHERE HEREIN, ARE DEEMED MATERIAL TO AN INVESTOR'S UNDERSTANDING OF THE
EXTENT TO WHICH THE COMPANY AND THE BANK ARE REGULATED. THE DESCRIPTION OF THE
LAWS AND REGULATIONS HEREUNDER, AS WELL AS DESCRIPTIONS OF LAWS AND REGULATIONS
CONTAINED ELSEWHERE HEREIN, DOES NOT PURPORT TO BE COMPLETE AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO APPLICABLE LAWS AND REGULATIONS.
THE COMPANY
GENERAL. The Company, as a savings and loan holding company within the
meaning of the Home Owners Loan Act ("HOLA"), has registered with the OTS and is
subject to OTS regulations, examinations, supervision and reporting
requirements. As a subsidiary of a savings and loan holding company, the Bank is
subject to certain restrictions in its dealings with the Company and affiliates
thereof.
ACTIVITIES RESTRICTIONS. There are generally no restrictions on the
activities of a savings and loan holding company which holds only one subsidiary
savings institution. However, if the Director of the OTS determines that there
is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings institution, the
Director may impose such restrictions as deemed necessary to address such risk,
including limiting (i) payment of dividends by the savings institution; (ii)
transactions between the savings institution and its affiliates; and (iii) any
activities of the savings institution that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings institution. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
institution subsidiary of such a holding company fails to meet the qualified
thrift lender ("QTL") test, as discussed under "- The Bank - Qualified Thrift
Lender Test," then such unitary holding company also shall become subject to the
activities restrictions applicable to multiple savings and loan holding
companies and, unless the savings institution requalifies as a QTL within one
year thereafter, shall register as, and become subject to the restrictions
applicable to, a bank holding company. See "- The Bank - Qualified Thrift Lender
Test."
If the Company were to acquire control of another savings institution,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
test, as set forth below, the activities of the Company and any of its
subsidiaries (other than the Bank or other subsidiary savings institutions)
would thereafter be subject to further restrictions. Among other things, no
multiple savings and loan holding company or subsidiary thereof which is not a
savings institution shall commence or continue for a limited period of time
after becoming a multiple savings and loan holding company or subsidiary thereof
any business activity, upon prior notice to, and no objection by the OTS, other
than: (i) furnishing or performing management services for a subsidiary savings
institution; (ii) conducting an insurance agency or escrow business; (iii)
holding, managing, or liquidating assets owned by or acquired from a subsidiary
savings institution; (iv) holding or managing properties used or occupied by a
subsidiary savings institution; (v) acting as trustee under deeds of trust; (vi)
those activities authorized by regulation as of March 5, 1987 to be engaged in
by multiple savings and loan holding companies; or (vii) unless the Director of
the OTS by regulation prohibits or limits such activities for savings and loan
holding companies, those activities authorized by the Federal Reserve Board
("FRB") as permissible for bank holding companies. Those activities described in
(vii) above also must be approved by the Director of the OTS prior to being
engaged in by a multiple savings and loan holding company.
LIMITATIONS ON TRANSACTIONS WITH AFFILIATES. Transactions between
savings institutions and any affiliate are governed by Sections 23A and 23B of
the Federal Reserve Act. An affiliate of a savings institution is any company or
entity which controls, is controlled by or is under common control with the
savings institution. In a holding
21
<PAGE>
company context, the parent holding company of a savings institution (such as
the Company) and any companies which are controlled by such parent holding
company are affiliates of the savings institution. Generally, Sections 23A and
23B (i) limit the extent to which the savings institution or its subsidiaries
may engage in "covered transactions" with any one affiliate to an amount equal
to 10% of such institution's capital stock and surplus, and contain an aggregate
limit on all such transactions with all affiliates to an amount equal to 20% of
such capital stock and surplus and (ii) require that all such transactions be on
terms substantially the same, or at least as favorable, to the institution or
subsidiary as those provided to a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
other similar transactions. In addition to the restrictions imposed by Sections
23A and 23B, no savings institution may (i) loan or otherwise extend credit to
an affiliate, except for any affiliate which engages only in activities which
are permissible for bank holding companies, or (ii) purchase or invest in any
stocks, bonds, debentures, notes or similar obligations of any affiliate, except
for affiliates which are subsidiaries of the savings institution.
RESTRICTIONS ON ACQUISITIONS. Except under limited circumstances,
savings and loan holding companies are prohibited from acquiring, without prior
approval of the Director of the OTS, (i) control of any other savings
institution or savings and loan holding company or substantially all the assets
thereof or (ii) more than 5% of the voting shares of a savings institution or
holding company thereof which is not a subsidiary. Except with the prior
approval of the Director of the OTS, no director or officer of a savings and
loan holding company or person owning or controlling by proxy or otherwise more
than 25% of such company's stock, may acquire control of any savings
institution, other than a subsidiary savings institution, or of any other
savings and loan holding company.
The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state if (i) the multiple savings and loan holding
company involved controls a savings institution which operated a home or branch
office located in the state of the institution to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act ("FDIA"); or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by the state-chartered institutions or savings and loan holding
companies located in the state where the acquiring entity is located (or by a
holding company that controls such state-chartered savings institutions).
Under the Bank Holding Company Act of 1956, the FRB is authorized to
approve an application by a bank holding company to acquire control of a savings
institution. In addition, a bank holding company that controls a savings
institution may merge or consolidate the assets and liabilities of the savings
institution with, or transfer assets and liabilities to, any subsidiary bank
which is a member of the BIF with the approval of the appropriate federal
banking agency and the FRB. As a result of these provisions, there have been a
number of acquisitions of savings institutions by bank holding companies in
recent years.
22
<PAGE>
THE BANK
GENERAL. The OTS has extensive authority over the operations of
federally chartered savings institutions. As part of this authority, savings
institutions are required to file periodic reports with the OTS and are subject
to periodic examinations by the OTS and the FDIC. The last regulatory
examination of the Bank by the OTS was completed in January, 1999. The Bank was
not required to make any material changes to its operations as a result of such
examination. The investment and lending authority of savings institutions are
prescribed by federal laws and regulations, and such institutions are prohibited
from engaging in any activities not permitted by such laws and regulations.
Those laws and regulations generally are applicable to all federally chartered
savings institutions and may also apply to state-chartered savings institutions.
Such regulation and supervision is primarily intended for the protection of
depositors.
The OTS' enforcement authority over all savings institutions and their
holding companies includes, among other things, the ability to assess civil
money penalties, to issue cease and desist or removal orders and to initiate
injunctive actions. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with the OTS.
INSURANCE OF ACCOUNTS. The deposits of the Bank are insured to the
maximum extent permitted by the SAIF, which is administered by the FDIC, and are
backed by the full faith and credit of the U.S. Government. As insurer, the FDIC
is authorized to conduct examinations of, and to require reporting by,
FDIC-insured institutions. It also may prohibit any FDIC-insured institution
from engaging in any activity the FDIC determines by regulation or order to pose
a serious threat to the FDIC. The FDIC also has the authority to initiate
enforcement actions against savings institutions, after giving the OTS an
opportunity to take such action.
The deposits of the Bank are currently insured by the SAIF. Both the
SAIF and the BIF, the federal deposit insurance fund that covers commercial bank
deposits, are required by law to attain and thereafter maintain a reserve ratio
of 1.25% of insured deposits. The BIF had achieved a fully funded status in
contrast to the SAIF and, therefore, the FDIC substantially reduced the average
deposit insurance premium paid by commercial banks to a level approximately 75%
below the average premium paid by savings institutions.
The FDIC is authorized to establish separate annual assessment rates
for deposit insurance for members of the BIF and the SAIF. The FDIC may increase
assessment rates for either fund if necessary to restore the fund's ratio of
reserves to insured deposits to its target level within a reasonable time and
may decrease such assessment rates if such target level is met. The FDIC has
established a risk-based assessment system for both SAIF and BIF members. Under
this system, assessments are set within a range, based on the risk the
institution poses to its deposit insurance fund. This risk level is determined
based on the institution's capital level and the FDIC's level of supervisory
concern about the institution.
The premium schedule for BIF and SAIF insured institutions ranges from
0 to 27 basis points. However, SAIF insured institutions are required to pay a
Financing Corporation assessment, in order to fund the interest on bonds issued
to resolve thrift failures in the 1980s, equal to approximately 6 basis points
for each $100 in domestic deposits, while BIF insured institutions pay an
assessment equal to approximately 1 basis point for each $100 in domestic
deposits. The SAIF assessment is expected to be reduced to about 2 basis points
no later than January 1, 2000, when BIF insured institutions fully participate
in the assessment. These assessments, which may be revised based upon the level
of BIF and SAIF deposits will continue until the bonds mature in the year 2017.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, 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
23
<PAGE>
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 the 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
would result in termination of the Bank's deposit insurance.
REGULATORY CAPITAL REQUIREMENTS. Federally insured savings institutions
are required to maintain minimum levels of regulatory capital. The OTS has
established capital standards applicable to all savings institutions. These
standards generally must be as stringent as the comparable capital requirements
imposed on national banks. The OTS also is authorized to impose capital
requirements in excess of these standards on individual institutions on a
case-by-case basis.
Current OTS capital standards require savings institutions to satisfy
three different capital requirements. Under these standards, savings
institutions must maintain "tangible" capital equal to at least 1.5% of adjusted
total assets, "core" capital equal to at least 3.0% of adjusted total assets and
"total" capital (a combination of core and "supplementary" capital) equal to at
least 8.0% of "risk-weighted" assets. For purposes of the regulation, core
capital generally consists of common stockholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Tangible capital is given the same definition as core capital but
does not include qualifying supervisory goodwill and is reduced by the amount of
all the savings institution's intangible assets, with only a limited exception
for purchased mortgage servicing rights. The Bank had no goodwill or other
intangible assets at December 31, 1998. Both core and tangible capital are
further reduced by an amount equal to a savings institution's debt and equity
investments in subsidiaries engaged in activities not permissible to national
banks (other than subsidiaries engaged in activities undertaken as agent for
customers or in mortgage banking activities and subsidiary depository
institutions or their holding companies). These adjustments do not materially
affect the Bank's regulatory capital. At December 31, 1998, the Bank exceeded
its tangible, core and risk-based capital requirements.
In determining compliance with the risk-based capital requirement, a
savings institution is allowed to include both core capital and supplementary
capital in its total capital, provided that the amount of supplementary capital
included does not exceed the savings institution's core capital. Supplementary
capital generally consists of hybrid capital instruments; perpetual preferred
stock which is not eligible to be included as core capital; subordinated debt
and intermediate-term preferred stock; and general allowances for loan losses up
to a maximum of 1.25% of risk-weighted assets. In determining the required
amount of risk-based capital, total assets, including certain off-balance sheet
items, are multiplied by a risk weight based on the risks inherent in the type
of assets. The risk weights assigned by the OTS for principal categories of
assets are (i) 0% for cash and securities issued by the U.S. Government or
unconditionally backed by the full faith and credit of the U.S. Government; (ii)
20% for securities (other than equity securities) issued by U.S.
Government-sponsored agencies and mortgage-backed securities issued by, or fully
guaranteed as to principal and interest by, the FNMA or the FHLMC, except for
those classes with residual characteristics or stripped mortgage-related
securities; (iii) 50% for prudently underwritten permanent one- to four-family
first lien mortgage loans not more than 90 days delinquent and having a
loan-to-value ratio of not more than 80% at origination unless insured to such
ratio by an insurer approved by the FNMA or the FHLMC, qualifying residential
bridge loans made directly for the construction of one- to four-family
residences and qualifying multi-family residential loans; and (iv) 100% for all
other loans and investments, including consumer loans, commercial loans, and
one- to four-family residential real estate loans more than 90 days delinquent,
and for repossessed assets.
LIQUIDITY REQUIREMENTS. All savings institutions are required to
maintain an average daily balance of liquid assets equal to a certain percentage
of the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings institutions. At the present time, the required minimum
liquid asset ratio is 4%. At December 31, 1998, the Bank's liquidity ratio was
28.0%.
24
<PAGE>
QUALIFIED THRIFT LENDER TEST. All savings institutions are required to
meet a QTL test to avoid certain restrictions on their operations. A savings
institution that does not meet the QTL test must either convert to a bank
charter or comply with the following restrictions on its operations: (i) the
institution may not engage in any new activity or make any new investment,
directly or indirectly, unless such activity or investment is permissible for a
national bank; (ii) the branching powers of the institution shall be restricted
to those of a national bank; (iii) the institution shall not be eligible to
obtain any advances from its FHLB; and (iv) payment of dividends by the
institution shall be subject to the rules regarding payment of dividends by a
national bank. Upon the expiration of three years from the date the savings
institution ceases to be a QTL, it must cease any activity and not retain any
investment not permissible for a national bank and immediately repay any
outstanding FHLB advances (subject to safety and soundness considerations).
Currently, the QTL test requires that 65% of an institution's
"portfolio assets" (as defined) consist of certain housing and consumer-related
assets on a monthly average basis in nine out of every 12 months. Assets that
qualify without limit for inclusion as part of the 65% requirement are loans
made to purchase, refinance, construct, improve or repair domestic residential
housing and manufactured housing; home equity loans; mortgage-backed securities
(where the mortgages are secured by domestic residential housing or manufactured
housing); stock issued by the FHLB of Dallas; and direct or indirect obligations
of the FDIC. In addition, the following assets, among others, may be included in
meeting the test subject to an overall limit of 20% of the savings institution's
portfolio assets: 50% of residential mortgage loans originated and sold within
90 days of origination; 100% of consumer and educational loans (limited to 10%
of total portfolio assets); and stock issued by the FHLMC or the FNMA. Portfolio
assets consist of total assets minus the sum of (i) goodwill and other
intangible assets, (ii) property used by the savings institution to conduct its
business, and (iii) liquid assets up to 20% of the institution's total assets.
At December 31, 1998, the qualified thrift investments of the Bank were
approximately 87.0% of its portfolio assets.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB of
Dallas, which is one of 12 regional FHLBs that administers the home financing
credit function of savings institutions. Each FHLB serves as a reserve or
central bank for its members within its assigned region. It is funded primarily
from proceeds derived from the sale of consolidated obligations of the FHLB
System. It makes loans to members (i.e., advances) in accordance with policies
and procedures established by the Board of Directors of the FHLB. At December
31, 1998, the Bank had $49.0 million of outstanding FHLB advances.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Dallas in an amount equal to at least 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year. At December 31, 1998, the Bank had $3.9 million in
FHLB stock, which was in compliance with this requirement. No ready market
exists for such stock and it has no quoted market value.
The FHLBs are required to provide funds for the resolution of troubled
savings institutions and to contribute to affordable housing programs through
direct loans or interest subsidies on advances targeted for community investment
and low- and moderate-income housing projects. These contributions have
adversely affected the level of FHLB dividends paid in the past and could
continue to do so in the future. These contributions also could have an adverse
effect on the value of FHLB stock in the future.
FEDERAL RESERVE SYSTEM. The FRB requires all depository institutions to
maintain reserves against their transaction accounts and non-personal time
deposits. As of December 31, 1998, no reserves were required to be maintained on
the first $4.9 million of transaction accounts, reserves of 3% were required to
be maintained against the next $46.5 million of net transaction accounts (with
such dollar amounts subject to adjustment by the FRB), and a reserve of 10%
(which is subject to adjustment by the FRB to a level between 8% and 14%)
against all remaining net transaction accounts. Because required reserves must
be maintained in the form of vault cash or a noninterest-bearing account at a
Federal Reserve Bank, the effect of this reserve requirement is to reduce an
institution's earning assets.
25
<PAGE>
TAXATION
FEDERAL TAXATION
GENERAL. The Company and Bank are subject to the generally applicable
corporate tax provisions of the Internal Revenue Code of 1986, as amended
("Code"), and Bank is subject to certain additional provisions of the Code which
apply to thrift and other types of financial institutions. The following
discussion of federal taxation is intended only to summarize certain pertinent
federal income tax matters material to the taxation of the Company and the Bank
and is not a comprehensive discussion of the tax rules applicable to the Company
and Bank.
YEAR. The Bank files a federal income tax return on the basis of a
fiscal year ending on December 31. The Company filed a consolidated federal
income tax return with both the Bank and the Service Corporation.
BAD DEBT RESERVES. Prior to the enactment of the Small Business Jobs
Protection Act (the "Act"), which was signed into law on August 21, 1996,
certain thrift institutions, such as the Bank, were allowed deductions for bad
debts under methods more favorable than those granted to other taxpayers.
Qualified thrift institutions could compute deductions for bad debts using
either the specific charge off method of Section 166 of the Code or the reserve
method of Section 593 of the Code.
Under Section 593, a thrift institution annually could elect to deduct
bad debts under either (i) the "percentage of taxable income" method applicable
only to thrift institutions, or (ii) the "experience" method that also was
available to small banks. Under the "percentage of taxable income" method, a
thrift institution generally was allowed a deduction for an addition to its bad
debt reserve equal to 8% of its taxable income (determined without regard to
this deduction and with additional adjustments). Under the experience method, a
thrift institution was generally allowed a deduction for an addition to its bad
debt reserve equal to the greater of (i) and amount based on its actual average
experience for losses in the current and five preceding taxable years, or (ii)
an amount necessary to restore the reserve to its balance as of the close of the
base year. A thrift institution could elect annually to compute its allowable
addition to bad debt reserves for qualifying loans either under the experience
method or the percentage of taxable income method. For tax years 1995 and 1994,
the Bank used the percentage of taxable income method because such method
provided a higher bad debt deduction than the experience method.
Section 1616(a) of the Act repealed the Section 593 reserve method of
accounting for bad debts by thrift institutions, effective for taxable years
beginning after 1995. Thrift institutions that are treated as small banks are
allowed to utilize the experience method applicable to such institutions, while
thrift institutions that are treated as large banks are required to use only the
specific charge off method. The percentage of taxable income method of
accounting for bad debts is no longer available for any financial institution.
A thrift institution required to change its method of computing
reserves for bad debts will treat such change as a change in the method of
accounting, initiated by the taxpayer and having been made with the consent of
the Secretary of the Treasury. Section 481(a) of the Code requires certain
amounts to be recaptured with respect to such change. Generally, the amounts to
be recaptured will be determined solely with respect to the "applicable excess
reserves" of the taxpayer. The amount of the applicable excess reserves will be
taken into account ratably over a six-taxable year period, beginning with the
first taxable year beginning after 1995, subject to the residential loan
requirement described below. In the case of a thrift institution that is treated
as a large bank, the amount of the institution's applicable excess reserves
generally is the excess of (i) the balances of its reserve for losses on
qualifying real property loans (generally loans secured by improved real estate)
and its reserve for losses on nonqualifying loans (all other types of loans) as
of the close of its last taxable year beginning before January 1, 1996, over
(ii) the balances of such reserves as of the close of its last taxable year
beginning before January 1, 1988 (i.e., the "pre-1988 reserves"). In the case of
a thrift institution that is treated as a small bank, like the Bank, the amount
of the institution's applicable excess reserves generally is the excess of (i)
the balances of its reserve for losses on qualifying real property loans and its
reserve for losses on nonqualifying loans as of the close of its last taxable
year beginning before January 1, 1996,
26
<PAGE>
over (ii) the greater of the balance of (a) its pre-1988 reserves or, (b) what
the thrift's reserves would have been at the close of its last year beginning
before January 1, 1996, had the thrift always used the experience method.
For taxable years that begin after December 31, 1995, and before
January 1, 1998, if a thrift meets the residential loan requirement for a tax
year, the recapture of the applicable excess reserves otherwise required to be
taken into account as a Code Section 481(a) adjustment for the year will be
suspended. A thrift meets the residential loan requirement if, for the tax year,
the principal amount of residential loans made by the thrift during the year is
not less than its base amount. The "base amount" generally is the average of the
principal amounts of the residential loans made by the thrift during the six
most recent tax years beginning before January 1, 1996.
A residential loan is a loan as described in Section 7701(a)(19)(C)(v)
(generally a loan secured by residential or church property and certain mobile
homes), but only to the extent that the loan is made to the owner of the
property.
The balance of the pre-1988 reserves is subject to the provisions of
Section 593(e), as modified by the Act, which requires recapture in the case of
certain excessive distributions to shareholders. The pre-1988 reserves may not
be utilized for payment of cash dividends or other distributions to a
shareholder (including distributions in dissolution or liquidation) or for any
other purpose (except to absorb bad debt losses). Distribution of a cash
dividend by a thrift institution to a shareholder is treated as made: first, out
of the institution's post-1951 accumulated earnings and profits; second, out of
the pre-1988 reserves; and third, out of such other accounts as may be proper.
To the extent a distribution by the Bank to the Company is deemed paid out of
its pre-1988 reserves under these rules, the pre-1988 reserves would be reduced
and the Bank's gross income for tax purposes would be increased by the amount
which, when reduced by the income tax, if any, attributable to the inclusion of
such amount in its gross income, equals the amount deemed paid out of the
pre-1988 reserves. As of December 31, 1998, the Bank's pre-1988 reserves for tax
purposes totaled approximately $4.2 million.
MINIMUM TAX. The Code imposes an alternative minimum tax at a rate of
20%. The alternative minimum tax generally applies to a base of regular taxable
income plus certain tax preferences ("alternative minimum taxable income" or
"AMTI") and is payable to the extent such AMTI is in excess of an exemption
amount. The Code provides that an item of tax preference is the excess of the
bad debt deduction allowable for a taxable year pursuant to the percentage of
taxable income method over the amount allowable under the experience method.
Other items of tax preference that constitute AMTI include (a) tax-exempt
interest on newly issued (generally, issued on or after August 8, 1986) private
activity bonds other than certain qualified bonds and (b) 75% of the excess (if
any) of (i) adjusted current earnings as defined in the Code, over (ii) AMTI
(determined without regard to this preference and prior to reduction by net
operating losses).
NET OPERATING LOSS CARRYOVERS. A financial institution may, for federal
income tax purposes, carry back net operating losses ("NOLs") to the preceding
three taxable years and forward to the succeeding 15 taxable years. This
provision applies to losses incurred in taxable years beginning after 1986. At
December 31, 1998, the Bank had no NOL carryforwards for federal income tax
purposes.
CAPITAL GAINS AND CORPORATE DIVIDENDS-RECEIVED DEDUCTION. Corporate net
capital gains are taxed at a maximum rate of 35%. The corporate
dividends-received deduction is 80% in the case of dividends received from
corporations with which a corporate recipient does not file a consolidated tax
return, and corporations which own less than 20% of the stock of a corporation
distributing a dividend may deduct only 70% of dividends received or accrued on
their behalf. However, a corporation may deduct 100% of dividends from a member
of the same affiliated group of corporations.
OTHER MATTERS. Federal legislation is introduced from time to time that
would limit the ability of individuals to deduct interest paid on mortgage
loans. Individuals are currently not permitted to deduct interest on consumer
loans. Significant increases in tax rates or further restrictions on the
deductibility of mortgage interest could adversely affect the Bank.
27
<PAGE>
The Bank's federal income tax returns for the tax years ended December
31, 1995 forward are open under the statute of limitations and are subject to
review by the IRS.
STATE TAXATION
The Bank will continue to be subject to Arkansas corporation income tax
which is a progressive rate up to a maximum of 6.5% of all taxable earnings.
The Company is incorporated under Texas law and, accordingly, is
subject to Texas franchise tax in an amount equal to 4.5% of net income
allocated to Texas pursuant to apportionments of gross receipts based upon where
the Company conducts business.
28
<PAGE>
ITEM 2. PROPERTIES.
At December 31, 1998, the Bank conducted its business from its
executive office in Harrison, Arkansas, and eleven full service offices, all of
which are located in Northcentral and Northwest Arkansas.
The following table sets forth the net book value (including leasehold
improvements and equipment) and certain other information with respect to the
offices and other properties of the Bank at December 31, 1998.
<TABLE>
<CAPTION>
Leased/ Net Book Value
Description/Address Owned of Property Amount of Deposits
(In Thousands)
<S> <C> <C> <C>
200 West Stephenson
Harrison, AR 72601 Owned $ 1,819(1) $145,424
128 West Stephenson Owned 105 (2)
Harrison, AR 72601
Corner Central & Willow Owned 256 (2)
Harrison, AR 72601
Ozark Mall - Hwy. 62-65 North Leased(3) 24 25,361
Harrison, AR 72601
324 Hwy. 62-65 Bypass Owned 287 40,139
Harrison, AR 72601
210 South Main Owned 271 25,682
Berryville, AR 72616
668 Highway 62 East Owned 681 159,623
Mountain Home, AR 72653
1337 Highway 62 SW Owned(5) 320 (5)
Mountain Home, AR 72653
301 Highway 62 West Owned 114 20,184
Yellville, AR 72687
307 North Walton Blvd. Owned 290 23,457
Bentonville, AR 72712
3460 North College Owned 436 27,325
Fayetteville, AR 72703
1303 West Hudson Owned 230 2,062
Rogers, AR 72756
201 East Henri De Tonti Blvd. Owned 241 3,889
Tontitown, AR 72762
2025 North Crossover Road Owned 800 4,611
Fayetteville, AR 72703
249 West Main Street Leased(4) 181 3,336
Farmington, AR 72730
</TABLE>
- ---------------
(1) Includes property acquisition for expansion in North Harrison.
(2) Such offices do not open deposit accounts.
(3) Such property is subject to a month-to-month lease.
(4) Such property is subject to a five year lease expiring November 1, 2002.
(5) Such property was under construction at December 31, 1998 and opened in
February 1999.
29
<PAGE>
ITEM 3. LEGAL PROCEEDINGS.
Neither the Company nor the Bank is involved in any pending legal
proceedings other than nonmaterial legal proceedings occurring in the ordinary
course of business.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
None.
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The information required herein, to the extent applicable, is
incorporated by reference from page 44 of the Company's 1998 Annual Report to
Stockholders ("1998 Annual Report").
ITEM 6. SELECTED FINANCIAL DATA.
The information required herein is incorporated by reference from pages
3 and 4 of the 1998 Annual Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The information required herein is incorporated by reference from pages
6 to 16 of the 1998 Annual Report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
The information required herein is incorporated by reference from pages
6 and 7 of the 1998 Annual Report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required herein is incorporated by reference from page
5 and pages 18 to 42 of the 1998 Annual Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not Applicable.
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required herein is incorporated by reference from pages
3 to 5 of the definitive proxy statement of the Company for the Annual Meeting
of Stockholders to be held on April 21, 1999 ("Definitive Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION.
The information required herein is incorporated by reference from pages
8 to 11 of the Definitive Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required herein is incorporated by reference from pages
6 and 7 of the Definitive Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required herein is incorporated by reference from page
12 of the Definitive Proxy Statement.
30
<PAGE>
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A) DOCUMENTS FILED AS PART OF THIS REPORT
(1) The following financial statements are incorporated by reference
from Item 8 hereof (see Exhibit 13):
Independent Auditors' Report
Consolidated Statements of Financial Condition at December 31,
1998 and 1997
Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Changes in Stockholders' Equity for
the years ended December 31, 1998, 1997 and 1996.
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996.
Notes to Consolidated Financial Statements.
(2) All schedules for which provision is made in the applicable
accounting regulation of the SEC are omitted because of the absence of
conditions under which they are required or because the required information is
included in the financial statements and related notes thereto.
(3) The following exhibits are filed as part of this Form 10-K and this
list includes the Exhibit Index.
31
<PAGE>
EXHIBIT INDEX
2.1* Plan of Conversion
3.1* Articles of Incorporation of First Federal Bancshares of Arkansas, Inc.
3.2* Bylaws of First Federal Bancshares of Arkansas, Inc.
4.0** Stock Certificate of First Federal Bancshares of Arkansas, Inc.
10.5* Employment Agreement between the Company, the Bank and Frank L.
Coffman, Jr.
10.6* Employment Agreement between the Company, the Bank and Larry J. Brandt
10.7* Employment Agreement between the Company, the Bank and Carolyn M.
Thomason
13.0 1998 Annual Report to Stockholders
22.0 Subsidiaries of the Registrant - Reference is made to
"Item 1 Business - Subsidiaries" for the required information
27.0 Financial Data Schedule
- ----------
(*) Incorporated herein by reference from the Company's Registration Statement
on Form S-1 (File No. 333-612) filed with the SEC.
(**) Incorporated herein by reference from the Company's Registration Statement
on Form 8-A filed with the SEC.
32
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
By: /S/ LARRY J. BRANDT
-------------------------------------
Larry J. Brandt
President and Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/S/ FRANK L. COFFMAN, JR. March 24, 1999
- ---------------------------------------
Frank L. Coffman, Jr.
Chairman of the Board and Chief
Executive Officer
/S/ LARRY J. BRANDT March 24, 1999
- ----------------------------------------
Larry J. Brandt
President and Chief
Operating Officer
/S/ JOHN P. HAMMERSCHMIDT March 24, 1999
- ---------------------------------------
John P. Hammerschmidt
Director
/S/ JAMES D. HEUER March 24, 1999
- ---------------------------------------
James D. Heuer
Director
/S/ WILLIAM F. SMITH March 24, 1999
- ---------------------------------------
William F. Smith
Director
March 24, 1999
/S/ TOMMY W. RICHARDSON
- ---------------------------------------
Tommy W. Richardson
Senior Vice President and Chief
Financial Officer
<PAGE>
Exhibit 13
FIRST FEDERAL BANCSHARES
OF ARKANSAS, INC.
------------------------------------------
1998
------------------------------------------
ANNUAL REPORT
------------------------------------------
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
President's Letter to Stockholders.................................................................... 1
Corporate Profile..................................................................................... 2
Selected Consolidated Financial and Other Data........................................................ 3
Selected Quarterly Operating Results.................................................................. 5
Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................................................... 6
Independent Auditors' Report.......................................................................... 18
Consolidated Financial Statements..................................................................... 19
Directors and Executive Officers...................................................................... 43
Banking Locations..................................................................................... 43
Stockholder Information............................................................................... 44
</TABLE>
<PAGE>
[GRAPHIC OMITTED]
- --------------------------------------------------------------------------------
FIRST FEDERAL
- --------------------------------------------------------------------------------
BANCSHARES
- --------------------------------------------------------------------------------
OF ARKANSAS, INC.
Dear Stockholder:
First Federal Bancshares of Arkansas continued to have another great year in
1998. We again had record profits with over $6 million in net income. Our
earnings per share exceeded analysts' expectations with a 10.7% increase to
$1.35 per share. In addition, in 1998 we increased our quarterly dividend by
16.7% to 7 cents per share.
In 1998 we completed a second repurchase program of 5% of our stock totaling
244,803 shares. Immediately after completion of our second repurchase, we were
approved for a third repurchase of 5% of our stock. We subsequently completed
that repurchase of 232,563 shares on February 8, 1999. The shares acquired
through both repurchase programs will be held as treasury stock and further
reflect the board's commitment to enhance shareholder value.
We continued to excel in both mortgage and installment lending with
approximately $189 million in new loans originated in 1998 in Northwest and
Northcentral Arkansas. The secondary mortgage division exceeded all their goals
and projections to add to the banner year in lending.
In 1998 we also signed two major contracts for financial services. The first
was with Primevest Financial Services, a broker/dealer. Our Primevest
affiliation will enable the bank to offer full-service stock brokerage,
mutual funds, annuities, bonds and other financial services in all our
locations. Our second contract was with nFront for Internet banking services
through our computer service bureau, BISYS. Internet banking will become a
reality for our customers in 1999.
We recently opened our fifteenth office and second location in the excellent
market area of Mountain Home, Arkansas. The state-of-the-art facility features a
full service lobby, four drive-thru lanes and an ATM. We are committed to
readily meeting the family banking needs of this major retirement area in
Arkansas.
Our Year 2000 Project plan continues to make progress toward Year 2000
preparedness. We anticipate completion of our testing during the second quarter
of 1999. We do not anticipate any major problems with the century rollover but
we do have a business resumption contingency plan in place.
As we enter our 65th year of banking services to Northwest and Northcentral
Arkansas, the board, management, and all "First Team" members remain committed
to our mission of "being the best provider of family banking services in our
market areas and maximizing our shareholders' value". Our vision of "being the
premier family bank in Arkansas" is only possible through the loyalty and
support of our customers and stockholders. We appreciate you and pledge to do
our best to continue to merit your confidence in 1999 and future years.
Sincerely,
/s/ Larry J. Brandt
--------------------------
Larry J. Brandt
President
1
<PAGE>
CORPORATE PROFILE
First Federal Bancshares of Arkansas, Inc. (the "Company") was
incorporated in January 1996 under Texas law for the purpose of acquiring all of
the capital stock issued by First Federal Bank of Arkansas, FA ("First Federal"
or the "Bank") in connection with its conversion from a federally chartered
mutual savings and loan association to a federally chartered stock savings and
loan association (the "Conversion"). The Conversion was consummated on May 3,
1996 and, as a result, the Company became a unitary savings and loan holding
company of the Bank. The Company has no significant assets other than the shares
of the Bank's common stock acquired in the Conversion, the Company's loan to the
Employee Stock Ownership Plan ("ESOP") and the portion of the net Conversion
proceeds retained and invested by the Company. The Company has no significant
liabilities.
The Bank is a federally chartered stock savings and loan association
which was formed in 1934. First Federal conducts business from its main office
and eleven full service branch offices, all of which are located in a six county
area in Northcentral and Northwest Arkansas comprised of Benton, Marion,
Washington, Carroll, Baxter and Boone counties. First Federal's deposits are
insured by the Savings Association Insurance Fund ("SAIF"), which is
administered by the Federal Deposit Insurance Corporation ("FDIC"), to the
maximum extent permitted by law. The Bank is a community oriented savings
institution which has traditionally offered a wide variety of savings products
to its retail customers while concentrating its lending activities on the
origination of loans secured by one- to four-family residential dwellings. To a
significantly lesser extent, the Bank's activities have also included
origination of multi-family residential loans, commercial real estate loans,
construction loans, commercial loans and consumer loans. In addition, the Bank
maintains a significant portfolio of investment securities.
At December 31, 1998, the Company had total assets of $615.1 million,
total deposits of $481.1 million and stockholders' equity of $81.0 million. The
Company's and the Bank's principal executive offices are located at 200 West
Stephenson, Harrison, Arkansas 72601, and their telephone number is
(870)741-7641.
2
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The selected consolidated financial and other data of the Company set
forth below and on the following page does not purport to be complete and should
be read in conjunction with, and is qualified in its entirety by, the more
detailed information, including the Consolidated Financial Statements and
related Notes, appearing elsewhere herein.
<TABLE>
<CAPTION>
At or For the
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------------- ------------ ------------ ------------ ---------------
(In Thousands)
<S> <C> <C> <C> <C> <C>
SELECTED FINANCIAL CONDITION DATA:
Total assets $615,055 $549,607 $505,739 $454,479 $428,312
Cash and cash equivalents 26,163 6,627 6,819 8,845 8,280
Investment securities 127,175 95,533 91,322 96,312 130,527
Loans receivable, net 442,486 433,942 396,508 339,505 279,783
Allowance for loan losses 771 1,196 1,251 1,228 1,134
Deposits 481,093 450,874 422,858 417,229 395,483
Federal Home Loan Bank advances 48,985 11,997 - - -
Stockholders' equity 81,023 82,884 80,758 35,308 31,242
SELECTED OPERATING DATA:
Interest income $ 43,814 $ 40,445 $ 37,192 $ 32,964 $ 29,790
Interest expense 25,774 23,748 22,449 21,538 17,700
--------------- ------------ ------------ ------------ ---------------
Net interest income 18,040 16,697 14,743 11,426 12,090
Provision for loan losses 55 - 60 133 54
--------------- ------------ ------------ ------------ ---------------
Net interest income after provision
for loan losses 17,985 16,697 14,683 11,293 12,036
Gain on sale of mortgage-backed
and investment securities -- 394 - 311 446
Noninterest income 1,836 1,526 1,222 1,107 1,137
Noninterest expense(1) 10,482 10,016 10,749 6,836 6,667
--------------- ------------ ------------ ------------ ---------------
Income before income taxes 9,339 8,601 5,156 5,875 6,952
Provision for income taxes 3,309 3,099 1,756 1,871 2,250
--------------- ------------ ------------ ------------ ---------------
Net income(1) $ 6,030 $ 5,502 $ 3,400 $ 4,004 $ 4,702
--------------- ------------ ------------ ------------ ---------------
--------------- ------------ ------------ ------------ ---------------
EARNINGS PER SHARE:
Basic $1.35 $1.22 $0.72 NA NA
Diluted 1.33 1.21 0.72 NA NA
CASH DIVIDENDS DECLARED $0.28 $0.22 -- NA NA
</TABLE>
- ------------------------------------
(1) The year ended December 31, 1996 includes a nonrecurring SAIF special
assessment of approximately $2.6 million or approximately $1.7 million
net of the income tax benefit.
3
<PAGE>
<TABLE>
<CAPTION>
AT OR FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
SELECTED OPERATING RATIOS(1):
Return on average assets(2) 1.04% 1.03% .69% .91% 1.12%
Return on average equity(2) 7.22 6.76 5.22 12.03 16.22
Average equity to average assets 14.36 15.26 13.23 7.55 6.91
Interest rate spread(3) 2.55 2.47 2.48 2.37 2.74
Net interest margin(3) 3.20 3.22 3.08 2.66 2.96
Net interest income after provision for
loan losses to noninterest expense 171.58 166.70 136.60 165.20 180.53
Noninterest expense to average assets 1.80 1.88 2.18 1.55 1.59
Average interest-earning assets to
average interest-bearing liabilities 114.20 116.21 112.96 105.92 105.23
Operating efficiency(4) 52.74 53.80 67.33 53.22 48.76
ASSET QUALITY RATIOS(5):
Nonperforming loans to total loans(6) 0.32 1.11 0.18 0.10 0.09
Nonperforming assets to total assets(6) 0.93 0.94 0.17 0.13 0.12
Allowance for loan losses to non-
performing loans(6) 52.65 24.12 173.51 350.86 420.00
Allowance for loan losses to total loans 0.17 0.27 0.30 0.35 0.40
CAPITAL RATIOS(5):
Tangible capital to adjusted total assets 11.67 11.98 12.30 7.74 7.29
Core capital to adjusted total assets 11.67 11.98 12.30 7.74 7.29
Risk-based capital to risk-weighted
assets 22.44 22.52 23.24 15.57 16.62
OTHER DATA:
Dividend payout ratio(7) 22.11 19.58 - - --
Full service offices at end of period 12 12 10 8 8
</TABLE>
- ------------------------------------
(1) Ratios for 1998 and 1997 are based on average daily balances. Ratios
prior to 1997 are based on average month end balances.
(2) The year ended December 31, 1996 includes a nonrecurring SAIF special
assessment of approximately $2.6 million or approximately $1.7 million
net of the income tax benefit. For the year ended December 31, 1996,
return on average assets, without the SAIF special assessment, would
have been 1.04% and return on average equity for the same period would
have been 7.83%.
(3) Interest rate spread represents the difference between the weighted
average yield on average interest-earning assets and the weighted
average cost of average interest-bearing liabilities, and net interest
margin represents net interest income as a percent of average
interest-earning assets.
(4) Noninterest expense to net interest income plus noninterest income.
(5) Asset quality ratios and capital ratios are end of period ratios.
(6) Nonperforming assets consist of nonperforming loans and real estate
owned ("REO"). Nonperforming loans consist of non-accrual loans while
REO consists of real estate acquired in settlement of loans.
(7) The calendar year ended December 31, 1997 was the first full year the
Company was publicly traded. Dividend payout ratio is the total
dividends declared divided by net income.
4
<PAGE>
SELECTED QUARTERLY OPERATING RESULTS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
FOURTH THIRD SECOND FIRST
YEAR ENDED DECEMBER 31, 1998 QUARTER QUARTER QUARTER QUARTER
-------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
Interest income $11,270 $11,052 $10,864 $10,628
Interest expense 6,676 6,545 6,375 6,178
-------------- -------------- -------------- ---------------
Net interest income 4,594 4,507 4,489 4,450
Provision for loan losses 30 -- 10 15
-------------- -------------- -------------- ---------------
Net interest income after provision
for loan losses 4,564 4,507 4,479 4,435
Noninterest income 426 514 438 458
Noninterest expense 2,565 2,583 2,671 2,663
-------------- -------------- -------------- ---------------
Income before income taxes 2,425 2,438 2,246 2,230
Provision for income taxes 854 861 784 810
-------------- -------------- -------------- ---------------
Net income $ 1,571 $ 1,577 $ 1,462 $ 1,420
-------------- -------------- -------------- ---------------
-------------- -------------- -------------- ---------------
Earnings per share(1):
Basic $0.37 $0.35 $0.32 $0.31
Diluted $0.37 $0.35 $0.31 $0.30
Selected Ratios (Annualized):
Net interest margin 3.15% 3.18% 3.23% 3.26%
Return on average assets 1.04 1.08 1.02 1.01
Return on average equity 7.71 7.52 6.89 6.77
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997 FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
-------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
Interest income $10,456 $10,226 $10,048 $9,715
Interest expense 6,191 6,153 5,831 5,573
-------------- -------------- -------------- ---------------
Net interest income 4,265 4,073 4,217 4,142
Provision for loan losses -- -- -- --
-------------- -------------- -------------- ---------------
Net interest income after provision
for loan losses 4,265 4,073 4,217 4,142
Noninterest income 370 360 872 318
Noninterest expense 2,501 2,374 3,029 2,112
-------------- -------------- -------------- ---------------
Income before income taxes 2,134 2,059 2,060 2,348
Provision for income taxes 774 748 739 838
-------------- -------------- -------------- ---------------
Net income $ 1,360 $ 1,311 $ 1,321 $ 1,510
-------------- -------------- -------------- ---------------
-------------- -------------- -------------- ---------------
Earnings per share(1):
Basic $0.30 $0.29 $0.29 $0.33
Diluted $0.30 $0.29 $0.29 $0.33
Selected Ratios (Annualized):
Net interest margin 3.19% 3.07% 3.29% 3.33%
Return on average assets 0.99 0.96 1.00 1.18
Return on average equity 6.62 6.50 6.50 7.41
</TABLE>
- ----------------------------------------
(1) Basic and Diluted Shares Outstanding
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998 FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
-------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
Basic weighted - average shares 4,262,883 4,465,271 4,560,765 4,552,948
Effect of dilutive securities 3,790 62,085 152,851 114,397
-------------- -------------- -------------- ---------------
Diluted weighted - average shares 4,266,673 4,527,356 4,713,616 4,667,345
-------------- -------------- -------------- ---------------
-------------- -------------- -------------- ---------------
YEAR ENDED DECEMBER 31, 1997
Basic weighted - average shares 4,542,544 4,532,143 4,521,744 4,511,344
Effect of dilutive securities 59,015 45,714 1,964 0
-------------- -------------- -------------- ---------------
Diluted weighted - average shares 4,601,559 4,577,857 4,523,708 4,511,344
-------------- -------------- -------------- ---------------
-------------- -------------- -------------- ---------------
</TABLE>
5
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Management's discussion and analysis of financial condition and results
of operations is intended to assist in understanding the consolidated financial
condition and results of operations of the Company. The information contained in
this section should be read in conjunction with the Consolidated Financial
Statements and the accompanying Notes to Consolidated Financial Statements and
the other sections contained in this Annual Report.
The Company's results of operations depend primarily on its net interest
income, which is the difference between interest income on interest-earning
assets and interest expense on interest-bearing liabilities. The Company's
results of operations also are affected by the provision for loan losses, the
level of its noninterest income and expenses, and income tax expense.
ASSET AND LIABILITY MANAGEMENT
The ability to maximize net interest income is largely dependent upon
the achievement of a positive interest rate spread that can be sustained during
fluctuations in prevailing interest rates. Interest rate sensitivity is a
measure of the difference between amounts of interest-earning assets and
interest-bearing liabilities which either reprice or mature within a given
period of time. The difference, or the interest rate repricing "gap", provides
an indication of the extent to which an institution's interest rate spread will
be affected by changes in interest rates. A gap is considered positive when the
amount of interest-rate sensitive assets exceeds the amount of interest-rate
sensitive liabilities, and is considered negative when the amount of
interest-rate sensitive liabilities exceeds the amount of interest-rate
sensitive assets. Generally, during a period of rising interest rates, a
negative gap within shorter maturities would adversely affect net interest
income, while a positive gap within shorter maturities would result in an
increase in net interest income, and during a period of falling interest rates,
a negative gap within shorter maturities would result in an increase in net
interest income while a positive gap within shorter maturities would have the
opposite effect. As of December 31, 1998, the Bank estimates that the ratio of
its one-year gap to total assets was a negative 9.8% and its ratio of
interest-earning assets to interest-bearing liabilities maturing or repricing
within one year was 78.7%.
In order to minimize the potential for adverse effects of material and
prolonged increases in interest rates on the Company's results of operations,
the Company's management has implemented and continues to monitor asset and
liability management policies to better match the maturities and repricing terms
of the Bank's interest-earning assets and interest-bearing liabilities. Such
policies have consisted primarily of: (i) emphasizing the origination of
adjustable-rate mortgage loans ("ARMs"); (ii) lengthening the maturity on
deposits by offering longer term certificates of deposit; and (iii) utilizing
Federal Home Loan Bank ("FHLB") of Dallas advances. Presently, deposits into
longer term certificates of deposit are minimal due to the prevailing low
interest rate environment.
The Bank focuses its lending activities on the origination of one-,
three-, five- and seven-year adjustable-rate residential mortgage loans.
Although adjustable-rate loans involve certain risks, including increased
payments and the potential for default in an increasing interest rate
environment, such loans decrease the risks associated with changes in interest
rates. As a result of the Bank's efforts, as of December 31, 1998, $234.5
million or 63.3% of the Bank's portfolio of one- to four-family residential
mortgage loans consisted of ARMs, including $190.3 million in seven-year ARMs.
The Company's investment securities portfolio amounted to $127.2 million
or 20.7% of the Company's total assets at December 31, 1998. Of such amount,
$10.0 million or 7.9% is contractually due within one year and $8.2 million or
6.4% is contractually due after one year to five years. However, actual
maturities are normally shorter than contractual maturities due to the ability
of borrowers to call or prepay such obligations without call or prepayment
6
<PAGE>
penalties. As of December 31, 1998, there was approximately $113 million of
investment securities with call options held by the issuer, of which
approximately $97 million are callable within one year.
Deposits are the Bank's primary funding source and the Bank prices its
deposit accounts based upon competitive factors and the availability of prudent
lending and investment opportunities. The Bank seeks to lengthen the maturities
of its deposits by soliciting longer term certificates of deposit when market
conditions have created opportunities to attract such deposits. However, the
Bank does not solicit high-rate jumbo certificates of deposit and does not
pursue an aggressive growth strategy which would force the Bank to focus
exclusively on competitors' rates rather than deposit affordability. In 1998,
the Bank utilized FHLB of Dallas advances as an additional funding source.
At December 31, 1998, the Bank had $49.0 million of FHLB advances.
NET PORTFOLIO VALUE
Management also presently monitors and evaluates the potential impact of
interest rate changes upon the market value of the Bank's portfolio equity and
the level of net interest income on a quarterly basis. The Office of Thrift
Supervision ("OTS") adopted a final rule in August 1993 incorporating an
interest rate risk component into the risk- based capital rules. Under the rule,
an institution with a greater than "normal" level of interest rate risk will be
subject to a deduction of its interest rate component from total capital for
purposes of calculating the risk-based capital requirement. An institution with
a greater than "normal" interest rate risk is defined as an institution that
would incur a loss of net portfolio value ("NPV") exceeding 2% of the estimated
market value of its assets in the event of a 200 basis point increase or
decrease in interest rates. NPV is the difference between incoming and outgoing
discounted cash flows from assets, liabilities, and off-balance sheet contracts.
A resulting change in NPV of more than 2% of the estimated market value of an
institution's assets will require the institution to deduct from its capital 50%
of that excess change. The rule provides that the OTS will calculate the
interest rate risk component quarterly for each institution. The OTS has
indicated that no institution will be required to deduct capital for interest
rate risk until further notice. However, utilizing this measurement concept, at
December 31, 1998, there would be a decrease of approximately 296 basis points
in the Bank's NPV as a percentage of present value of assets, assuming a 200
basis point increase in interest rates.
The following table presents the Bank's NPV as of December 31, 1998, as
calculated by the OTS, based on information provided to the OTS by the Bank.
<TABLE>
<CAPTION>
NET PORTFOLIO VALUE
- ----------------------------------------------------------------------------------------------------------------
Estimated NPV as
a Percentage of
Change in Interest Present Value Amount Percent
Rates (basis points) Estimated NPV of Assets of Change of Change
- -------------------- -------------------- -------------------- -------------------- --------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
+400 $47,226 8.17% $(48,644) (51)%
+300 59,870 10.06 (36,000) (38)
+200 72,793 11.88 (23,077) (24)
+100 85,269 13.53 (10,061) (11)
-- 95,870 14.84 -- --
-100 104,300 15.80 8,430 9
-200 113,775 16.84 17,905 19
-300 125,218 18.07 29,348 31
-400 136,098 19.16 40,228 42
</TABLE>
7
<PAGE>
CHANGES IN FINANCIAL CONDITION
GENERAL. At December 31, 1998, the Company's total assets amounted to
$615.1 million as compared to $549.6 million at December 31, 1997. The $65.5
million or 11.9% increase was primarily due to an increase of $19.5 million or
249.8% in cash and cash equivalents, a $8.5 million or 2.0% increase in loans
receivable, net, a $31.6 million or 33.1% increase in investment securities held
to maturity, and a $4.1 million increase in real estate acquired in settlement
of loans, net.
The loans receivable increase resulted from the continued origination of
loans during the year ended December 31, 1998. Originations for the year ended
December 31, 1998 consisted of $114.5 million in one- to four-family residential
loans, $600,000 in multi-family residential, $20.9 million in commercial loans,
$24.0 million in construction loans and $28.8 million in consumer installment
loans, of which $10.3 million consisted of automobile loans and $9.7 million
consisted of home equity loans. At December 31, 1998, the Bank had outstanding
loan commitments of $3.6 million, unused lines of credit of $4.0 million, and
the undisbursed portion of construction loans of $6.8 million. Real estate
acquired in settlement of loans increased $4.1 million primarily due to the Bank
accepting a deed in lieu of foreclosure on a commercial real estate loan, as
discussed below. Liabilities increased $66.4 million or 14.2% to $533.1 million
at December 31, 1998 compared to $466.7 million at December 31, 1997. The
increase in liabilities was primarily due to an increase of $30.2 million or
6.7% in deposits, and a $36.7 million increase in advances from the FHLB of
Dallas. The increases in deposits and advances from the FHLB of Dallas were used
to fund the net loan increase, to increase cash and cash equivalents, and to
purchase additional investment securities. Stockholders' equity amounted to
$81.0 million or 13.17% of total assets at December 31, 1998 compared to $82.9
million or 15.08% of total assets at December 31, 1997.
Nonperforming assets, consisting of nonperforming loans and repossessed
assets, amounted to $5.7 million or .93% of total assets at December 31, 1998,
compared to $5.2 million, or .94% of total assets at December 31, 1997. The Bank
reclassified a previously reported non-accrual commercial real estate loan to
real estate acquired in settlement of loans in the first quarter of 1998. The
majority ownership of a partnership, which owns and operates this commercial
real estate property, was consolidated with the Bank's financial position and
results of operations during the quarter ended September 30, 1998. Such property
has a carrying value at December 31, 1998 of $4.0 million. As a result of such
consolidation, the Bank's real estate acquired in settlement of loans increased
$1.0 million reflecting the minority interest ownership. The property is
currently operated by a management company and is being marketed for
disposition.
LOANS RECEIVABLE. Net loans receivable increased by $8.5 million, or
2.0%, to $442.5 million at December 31, 1998 from $433.9 million at December 31,
1997. Loan originations for 1998 totaled $188.8 million. The net loans
receivable increase was composed of increases in commercial loans of $7.4
million or 30.5%, and consumer loans of $3.0 million or 10.5%, and decreases in
single-family residential loans of $700,000 or .2% and construction loans, net
of undisbursed funds of $2.5 million or 1.2%. Loans were originated using the
Bank's normal underwriting standards, rates, and terms.
Unearned loan fee income at December 31, 1998 amounted to $3.3 million,
down from $3.5 million at December 31, 1997. These unearned fees are recognized
as an adjustment to yield over the contractual lives of the related loans.
Undisbursed amounts of loans in process related to construction loans at
December 31, 1998 were $6.8 million, compared to $7.3 million at December 31,
1997.
ALLOWANCE FOR LOAN LOSSES. The reduction in the allowance for loan
losses from $1.2 million at December 31, 1997, to $800,000 at December 31, 1998
resulted primarily from two changes. First, nonperforming commercial real estate
loans decreased from $3.4 million at December 31, 1997 to $0 at December 31,
1998. Additionally, nonperforming consumer loans decreased from $434,000 at
December 31, 1997 to $159,000 at December 31, 1998. Otherwise, the composition
of the allowance remained relatively unchanged. There were no changes in
concentrations, terms, methods or assumptions that occurred or significantly
affected the allowance during
8
<PAGE>
the year ended December 31, 1998. Management compared the loan portfolio's loss
experience ratios from year to year and adjusted the ratios to reflect current
loss experience. Management also considered whether there were any other matters
that might affect the adequacy of the allowance and identified no such matters.
INVESTMENT SECURITIES. Investment securities all of which were
classified as held to maturity amounted to $127.2 million as of December 31,
1998 compared to $95.5 million as of December 31, 1997. In 1998, approximately
$110.2 million of government agency obligations and $900,000 of municipal bonds
were purchased. Securities which matured or were called during 1998 amounted to
$79.5 million, which resulted in an increase of $31.6 million or 33.1% in
investment securities at December 31, 1998 compared to December 31, 1997.
DEPOSITS. Deposits at December 31, 1998 amounted to $481.1 million, an
increase of $30.2 million or 6.7% from the December 31, 1997 balance of $450.9
million. The Bank does not advertise for deposits outside of its primary market
area, Northcentral and Northwest Arkansas, or utilize the services of deposit
brokers. In 1997, the Bank began offering special promotion certificate of
deposits which continued throughout 1998.
BORROWED FUNDS. Borrowed funds, which consist entirely of FHLB of Dallas
advances, increased by $37.0 million to $49.0 million at December 31, 1998 from
$12.0 million at December 31, 1997. The weighted average rate on such borrowings
was 5.57% at December 31, 1998. These borrowings were used to fund loan growth,
to purchase additional investment securities and to increase cash and cash
equivalents.
STOCKHOLDERS' EQUITY. Stockholders' equity decreased $1.9 million to
$81.0 million at December 31, 1998 from $82.9 million at December 31, 1997. The
decrease in stockholders' equity was primarily due to the purchase of treasury
stock totaling $8.0 million. In addition, during the twelve months ended
December 31, 1998 cash dividends aggregating $1.3 million were paid. Such
decreases in stockholders' equity were partially offset by net income in the
amount of $6.0 million for the year ended December 31, 1998.
9
<PAGE>
AVERAGE BALANCE SHEETS
The following table sets forth certain information relating to the
Company's average balance sheets and reflects the average yield on assets and
average cost of liabilities for the periods indicated and the yields earned and
rates paid at December 31, 1998. Such yields and costs are derived by dividing
income or expense by the average balance of assets or liabilities, respectively,
for the periods presented and outstanding balances at December 31, 1998. For the
years ended December 31, 1998 and 1997, average balances are based on daily
balances during the period. For the year ended December 31, 1996, average
balances are based on month end balances during the period.
<TABLE>
<CAPTION>
Year Ended December 31,
December 31, ----------------------------------------------------------------
1998 1998 1997
------------- --------------------------------------------- ------------------
Average
Yield/ Average Yield/ Average
Cost Balance Interest Cost Balance
------------- ------------ ------------- ------------- -------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable(1) 8.05% $441,702 $35,762 8.10% $415,075
Investment securities(2) 6.61 116,504 7,802 6.70 96,170
Mortgage-backed securities 8.24 86 6 7.02 202
Other interest-earning assets 4.65 4,777 244 5.09 7,615
------------ ------------- -------------
Total interest-earning assets 7.63 563,069 43,814 7.78 519,062
------------- -------------
Noninterest-earning assets 18,502 14,550
------------ -------------
Total assets $581,571 $533,612
------------ -------------
------------ -------------
Interest-bearing liabilities:
Deposits 5.01 $462,596 24,004 5.19 $440,147
Other borrowings 5.57 30,452 1,770 5.81 6,493
------------ ------------- -------------
Total interest-bearing liabilities 5.07 493,048 25,774 5.23 446,640
Noninterest-bearing liabilities 5,019 5,561
------------ -------------
Total liabilities 498,067 452,201
Stockholders' equity 83,504 81,411
------------ -------------
Total liabilities and
stockholders' equity $581,571 $533,612
------------ -------------
------------ -------------
-------------
Net interest income $ 18,040
-------------
-------------
Net earning assets $ 70,021 $ 72,422
------------ -------------
------------ -------------
Interest rate spread 2.56% 2.55%
------------- -------------
------------- -------------
Net interest margin 3.20%
-------------
-------------
Ratio of interest-earning assets to
interest-bearing liabilities 114.20%
-------------
-------------
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------------------------------
1997 1996
----------------------------- ----------------------------------------------
Average Average
Yield/ Average Yield/
Interest Cost Balance Interest Cost
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable(1) $33,804 8.14% $369,185 $30,498 8.26%
Investment securities(2) 6,207 6.45 102,398 6,258 6.11
Mortgage-backed securities 17 8.46 264 22 8.33
Other interest-earning assets 417 5.48 6,335 414 6.54
------------- ------------- -------------
Total interest-earning assets 40,445 7.79 478,182 37,192 7.78
------------- -------------
Noninterest-earning assets 13,821
-------
Total assets $492,003
-------------
-------------
Interest-bearing liabilities:
Deposits 23,331 5.30 $420,062 22,409 5.33
Other borrowings 417 6.42 3,264 40 1.23
------------- ------------- -------------
Total interest-bearing liabilities 23,748 5.32 423,326 22,449 5.30
Noninterest-bearing liabilities 3,564
-------------
Total liabilities 426,890
Stockholders' equity 65,113
-------------
Total liabilities and
stockholders' equity $492,003
-------------
-------------
------------ -------------
Net interest income $ 16,697 $ 14,743
------------- -------------
------------- -------------
Net earning assets $ 54,856
-------------
-------------
Interest rate spread 2.47% 2.48%
------------- -------------
------------- -------------
Net interest margin 3.22% 3.08%
------------- -------------
------------- -------------
Ratio of interest-earning assets to
interest-bearing liabilities 116.21% 112.96%
------------- -------------
------------- -------------
</TABLE>
- ----------------
(1) Includes non-accrual loans.
(2) Includes FHLB of Dallas stock and for the year 1996 Federal Home Loan
Mortgage Corporation ("FHLMC") preferred stock at cost.
10
<PAGE>
RATE/VOLUME ANALYSIS
The table below sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(changes in average volume multiplied by prior rate); (ii) changes in rate
(change in rate multiplied by prior average volume); (iii) changes in
rate-volume (changes in rate multiplied by the change in average volume); and
(iv) the net change.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------
1998 vs. 1997
----------------------------------------------
Increase (Decrease)
Due to
---------------------------------
Total
Rate/ Increase
Volume Rate Volume (Decrease)
---------- --------- ---------- -----------
(In Thousands)
<S> <C> <C> <C> <C>
Interest income:
Loans receivable............. $2,169 $ (198) $ (13) $1,958
Investment securities........ 1,312 234 49 1,595
Mortgage-backed securities (10) (3) 2 (11)
Other interest-earning assets (155) (29) 11 (173)
---------- --------- ---------- -----------
Total interest-earning
assets................. 3,316 4 49 3,369
---------- --------- ---------- -----------
Interest expense:
Deposits..................... 1,190 (492) (25) 673
Other borrowings............. 1,538 (40) (145) 1,353
---------- --------- ---------- -----------
Total interest-bearing
liabilities.............. 2,728 (532) (170) 2,026
---------- --------- ---------- -----------
Net change in interest income.. $ 588 $ 536 $ 219 $ 1,343
---------- --------- ---------- -----------
---------- --------- ---------- -----------
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------
1997 vs. 1996
-----------------------------------------------------
Increase (Decrease)
Due to
--------------------------------------
Total
Rate/ Increase
Volume Rate Volume (Decrease)
------------ ---------- ---------- ----------
(In Thousands)
<S> <C> <C> <C> <C>
Interest income:
Loans receivable............. $3,791 $(431) $(54) $3,306
Investment securities........ (381) 351 (21) (51)
Mortgage-backed securities (5) - - (5)
Other interest-earning assets 84 (67) (14) 3
------------ ---------- ---------- ----------
Total interest-earning
assets................. 3,489 (147) (89) 3,253
------------ ---------- ---------- ----------
Interest expense:
Deposits..................... 1,072 (143) (7) 922
Other borrowings............. 39 170 168 377
------------ ---------- ---------- ----------
Total interest-bearing
liabilities.............. 1,111 27 161 1,299
------------ ---------- ---------- ----------
Net change in interest income.. $2,378 $(174) $(250) $1,954
------------ ---------- ---------- ----------
------------ ---------- ---------- ----------
</TABLE>
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998 AND
1997.
GENERAL. The Company reported net income of $6.0 million for the year
ended December 31, 1998 compared to $5.5 million for the same period in 1997.
The increase of $528,000 or 9.6% in net income in the 1998 period compared to
the same period in 1997 was due to an increase in net interest income which was
partially offset by an increase in noninterest expenses and income taxes and a
reduction in noninterest income. Net interest income increased by $1.3 million
or 8.0% from $16.7 million to $18.0 million for the years ended December 31,
1997 and 1998, respectively. The Company's net interest margin remained
relatively unchanged at 3.20% and the interest rate spread increased to 2.55%
for 1998 compared to 3.22% and 2.47%, respectively, for 1997.
NET INTEREST INCOME. Net interest income is determined by the Company's
interest rate spread (i.e., the difference between the yields earned on its
interest-earning assets and the rates paid on its interest-bearing liabilities)
and the relative amounts of interest-earning assets and interest-bearing
liabilities. The Company's net interest income amounted to $18.0 million in
1998, an increase of $1.3 million or 8.0% compared to $16.7 million for 1997.
The Company's interest rate spread increased to 2.55% for 1998 from 2.47% for
1997. The Company's net interest margin remained stable at 3.20% for 1998
compared to 3.22% for 1997.
INTEREST INCOME. Interest income amounted to $43.8 million for the year
ended December 31, 1998 compared to $40.4 million for the same period in 1997.
The increase of $3.4 million or 8.3% was primarily due to an increase in the
average balance of loans receivable and investment securities. The average
balance of loans receivable increased as a result of continued loan demand and
portfolio growth. Such increase was partially offset by a decline in the average
yield earned on such assets due primarily to the origination or modification of
loans at market interest rates which are
11
<PAGE>
currently lower than the average yield of the Bank's loan portfolio. The average
balance of investment securities increased due to additional purchases of
investment securities. The average balance and rate earned on investment
securities increased due to the purchase of longer-term investments at rates
higher than the average yield earned on such assets in portfolio. Such increases
were partially offset by a decline in the average balance of other
interest-earning assets, primarily overnight interest-bearing cash accounts.
INTEREST EXPENSE. Interest expense increased $2.0 million or 8.5% to
$25.8 million for the year ended December 31, 1998 compared to $23.8 million for
the same period in 1997. Such increase was primarily due to an increase in the
average balance of FHLB of Dallas advances as well as an increase in the average
balance of deposits. Such increases were offset by a decrease in the average
yield paid on both deposit accounts and FHLB of Dallas advances.
PROVISION FOR LOAN LOSSES. Provisions for loan losses amounted to
$55,000 for 1998. No provisions for loan losses were provided for in 1997.
Provisions for loan losses include charges to reduce the recorded balance of
mortgage loans to their estimated fair value. Such provision and the adequacy of
the allowance for loan losses is evaluated for adequacy quarterly by management
of the Bank based on the Bank's past loan loss experience, known and inherent
risks in the portfolio, adverse situations that may affect the borrower's
ability to repay, the estimated value of any underlying collateral and current
economic conditions. The increase in the provision for loan losses in 1998
compared to 1997 was due to management's evaluation of the adequacy of the
allowance for loan losses.
NONINTEREST INCOME. Noninterest income amounted to $1.8 million for the
year ended December 31, 1998 compared to $1.9 million for the same period in
1997. The decrease of $84,000 or 4.4% was due primarily to a gain of $394,000
recognized in 1997 on the sale of FHLMC stock and to the recognition in 1997 of
$145,000 on previously deferred profit on the sale of real estate owned. There
were no similar gains in 1998. The decrease in noninterest income for the year
ended December 31, 1998 compared to the year ended December 31, 1997 was
partially offset by an increase of $240,000 from $30,000 to $270,000 in gain on
the sale of mortgage loans in the secondary mortgage market. In addition,
deposit fee income increased $82,000 or 10.1% to $896,000 compared to $814,000
for the year ended December 31, 1998 and 1997, respectively.
NONINTEREST EXPENSE. Noninterest expenses increased $466,000 or 4.7% to
$10.5 million compared to $10.0 million for the year ended December 31, 1998 and
December 31, 1997, respectively. This increase was primarily due to increased
costs associated with the Company's ESOP as a result of an increase in the
Company's daily average stock price, occupancy costs due to branch expansions,
salaries and benefits due to increased personnel and normal salary and merit
increases, and a loss on disposition of real estate held for investment. Such
increases were partially offset by a decrease in costs related to the Management
Recognition and Retention Plan ("MRR Plan"). Such costs amounted to $754,000
compared to $1.2 million for the year ended December 31, 1998 and 1997,
respectively, resulting in a $440,000 decrease. This decrease was due to the
cost recognition, in the second quarter of 1997, of an immediate 20% vesting
after the plan was approved by the Company's shareholders.
INCOME TAXES. Income taxes amounted to $3.3 million and $3.1 million for
the year ended December 31, 1998 and December 31, 1997, respectively, resulting
in effective tax rates of 35.4% and 36.0%, respectively.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997 AND
1996.
GENERAL. Net income amounted to $5.5 million for 1997 compared to $3.4
million for 1996. The increase in net income of $2.1 million was due primarily
to an increase in net interest income and noninterest income offset by an
increase in noninterest expenses, excluding the one-time SAIF special
assessment.
NET INTEREST INCOME. The Company's net interest income amounted to $16.7
million in 1997, an increase of $2.0 million or 13.3% compared to $14.7 million
for 1996. The Company's interest rate spread remained virtually unchanged at
2.47% for 1997 compared to 2.48% for 1996. The Company's net interest margin
increased to 3.22%
12
<PAGE>
for 1997 compared to 3.08% for 1996. Such increase in the Bank's net interest
margin was due to the increased investment in loans receivable, and an increase
in the ratio of interest-earning assets to interest-bearing liabilities to
116.21% for 1997 compared to 112.96% for 1996, which was partially offset by an
increase in interest expense due to deposit growth and borrowings of FHLB
advances.
INTEREST INCOME. Interest income increased $3.3 million or 8.7% to $40.4
million for 1997 compared to $37.2 million for 1996. The interest income
increase resulted from an increase of $3.3 million in interest income on loans
receivable which was partially offset by a decrease of $51,000 in interest
income from investment securities. The increase in interest income on loans
receivable was due to an increase of $45.9 million or 12.4% in the average
balance of loans receivable as a result of continued loan originations. The
positive impact of the increase on the average balance of loans receivable was
partially offset by a decrease in the average yield earned on such assets to
8.14% for 1997 from 8.26% in 1996. Such decrease in the average yield was due to
originations of loans at lower interest rates and refinancing of higher rate
loans. Interest income on investment securities declined primarily as a result
of a decrease in the average balance of such assets due to maturities and calls
of such investments. The decline was substantially offset by an increase in the
average yield earned on investment securities from 6.11% in 1996 to 6.45% in
1997 due to purchasing investment securities with higher yields and longer
maturity terms. Such bonds typically contain call features.
INTEREST EXPENSE. Interest expense increased $1.3 million or 5.8% to
$23.7 million in 1997 compared to $22.4 million in 1996. The increase was due
primarily to an increase of $20.1 million or 4.8% in the average balance of
deposits resulting from the Bank offering special promotion certificates of
deposit and from interest credited on existing accounts.
PROVISION FOR LOAN LOSSES. Provisions for loan losses amounted to
$60,000 for 1996. No provisions for loan losses were provided for in 1997.
Provisions for loan losses include charges to reduce the recorded balance of
mortgage loans to their estimated fair value. Such provision and the adequacy of
the allowance for loan losses is evaluated for adequacy quarterly by management
of the Bank based on the Bank's past loan loss experience, known and inherent
risks in the portfolio, adverse situations that may affect the borrower's
ability to repay, the estimated value of any underlying collateral and current
economic conditions. The decrease in the provision for loan losses in 1997
compared to 1996 was due to management's evaluation of the adequacy of the
allowance for loan losses.
NONINTEREST INCOME. Noninterest income increased $698,000 or 57.1% to
$1.9 million compared to $1.2 million for 1997 and 1996, respectively. The
increase was due primarily to a gain of $394,000 on the sale of Federal Home
Loan Mortgage Corporation stock, which was previously classified as an available
for sale investment security, and to the current recognition of $145,000 on
previously deferred profit on the sale of real estate owned.
NONINTEREST EXPENSE. Noninterest expenses, excluding the SAIF special
assessment of $2.6 million in 1996, increased $1.9 million or 23.1% to $10.0
million in 1997 compared to $8.1 million in 1996. The increase was primarily due
to an increase in salaries and employee benefits, including costs associated
with the implementation of the Company's ESOP and the Company's MRR Plan,
additional costs attributable to being a public company, advertising costs
related to targeting special promotions and branch openings and occupancy costs
due to branch expansions. Such increases were partially offset by a decline in
the quarterly FDIC premiums from $902,000 in 1996 to $272,000 in 1997.
The salaries and employee benefits increased $2.1 million or 47.6% to
$6.4 million compared to $4.3 million for 1997 and 1996, respectively. Such
increase included the $754,000 fair market value of 39,170 vested shares of
stock granted to key officers as well as to non-employee directors during the
second quarter ended June 30, 1997 pursuant to the MRR Plan adopted by the
Company's shareholders on May 7, 1997. An additional cost of $440,000 was
accrued during the year for shares awarded under the plan that will vest in May
1998. The costs related to the Company's ESOP amounted to $745,000 for 1997
compared to $402,000 for 1996. This $343,000 or 85.3% increase resulted, in
part, from the recognition of compensation expense for ESOP shares committed to
be released at the fair
13
<PAGE>
market value which increased during 1997. In addition, the ESOP expense for 1996
represented a partial year commencing upon conversion on May 3, 1996. Other
increases in salaries and employee benefits are attributable to an increase in
the number of employees due to expansion and growth.
Net occupancy expense amounted to $804,000 in 1997 compared to $672,000
in 1996, an increase of $132,000 or 19.7%. Such increase was primarily due to
branch expansion as previously discussed. Advertising costs increased $81,000 or
41.6% to $275,000 for 1997 compared to $194,000 for 1996. The increase was
related to targeting special promotions for product offerings and advertising
branch openings. Noninterest expenses also increased as a result of additional
costs attributable to being a public company. Noninterest expense increases were
partially offset by a reduction in the FDIC premiums which amounted to $272,000
in 1997 compared to $902,000 in 1996. Such reduction in the premium was mandated
by the legislation requiring the payment, in the third quarter of 1996, of the
one-time special assessment used to recapitalize the SAIF.
INCOME TAXES. Income taxes amounted to $3.1 million and $1.8 million for
1997 and 1996, respectively, resulting in effective tax rates of 36.0% and
34.1%, respectively. Such increase was primarily due to an increase in pre-tax
income and additional state income tax in 1997 attributable to tax exempt
investment security interest income not sufficient to reduce state taxable
income to the 1996 level of zero.
LIQUIDITY AND CAPITAL RESOURCES
The Bank's liquidity, represented by cash and cash equivalents and
eligible investment securities, is a product of its operating, investing and
financing activities. The Bank's primary sources of funds are deposits,
collections on outstanding loans, maturities and calls of investment securities
and other short-term investments and funds provided from operations. While
scheduled loan amortization and maturing investment securities and short-term
investments are relatively predictable sources of funds, deposit flows and loan
prepayments are greatly influenced by general interest rates, economic
conditions and competition. The Bank manages the pricing of its deposits to
maintain a steady deposit balance. In addition, the Bank invests excess funds in
overnight deposits and other short-term interest-earning assets which provide
liquidity to meet lending requirements. The Bank has generally been able to
generate enough cash through the retail deposit market, its traditional funding
source, to offset the cash utilized in investing activities. As an additional
source of funds, the Bank has borrowed from the FHLB of Dallas. At December 31,
1998, the Bank had outstanding advances from the FHLB of Dallas of $49.0
million. Such advances were used in the Bank's normal operating and investing
activities.
All savings institutions are required to maintain an average daily
balance of liquid assets equal to a certain percentage of the sum of its average
daily balance of net withdrawable deposit accounts and borrowings payable in one
year or less. The liquidity requirement may vary from time to time (between 4%
and 10%) depending upon economic conditions and savings flows of all savings
institutions. At the present time, the required minimum liquid asset ratio is
4%. At December 31, 1998, the Bank's liquidity ratio was 28.0%.
Liquidity management is both a daily and long-term function of business
management. Excess liquidity is generally invested in short-term investments
such as overnight deposits. On a longer-term basis, the Bank maintains a
strategy of investing in various lending products. The Bank uses its sources of
funds primarily to meet its ongoing commitments, to pay maturing savings
certificates and savings withdrawals, to repay maturing FHLB of Dallas advances,
and to fund loan commitments. At December 31, 1998, the total approved mortgage
loan origination commitments outstanding, excluding the undisbursed portion of
construction loans, amounted to $3.6 million. At the same date, the undisbursed
portion of construction loans approximated $6.8 million. The Bank's unused lines
of credit at December 31, 1998 were approximately $4.0 million. Certificates of
deposit scheduled to mature in one year or less at December 31, 1998 totaled
$237.0 million. Management believes that a significant portion of maturing
deposits will remain with the Bank. FHLB of Dallas advances scheduled to mature
within one year at December 31, 1998 totaled $19.0 million. Investment
securities scheduled to mature in one year or less at December 31, 1998 totaled
$10.0 million. However, actual maturities are normally shorter than contractual
14
<PAGE>
maturities due to the ability of borrowers to call or prepay such obligations
without call or prepayment penalties. As of December 31, 1998, there was
approximately $97.4 million of investment securities with call options held by
the issuer exercisable within one year.
As of December 31, 1998, the Bank's regulatory capital was well in
excess of all applicable regulatory requirements. At December 31, 1998, the
Bank's tangible, core and risk-based capital ratios amounted to 11.67%, 11.67%
and 22.44%, respectively.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related financial data presented herein
have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and operating results in
terms of historical dollars, without considering changes in relative purchasing
power over time due to inflation.
Unlike most industrial companies, virtually all of the Bank's assets and
liabilities are monetary in nature. As a result, interest rates generally have a
more significant impact on a financial institution's performance than does the
effect of inflation.
THE YEAR 2000 ISSUE
The Year 2000 issue is the result of computer programs being written
using two digits rather than four digits to define the applicable year. Computer
programs that have time-sensitive coding may recognize a date using "00" as the
year 1900 rather than the Year 2000. Systems that do not properly recognize such
information could result in a system failure or generation of erroneous data.
The Federal Financial Institutions Examination Council ("FFIEC"),
through bank regulatory agencies including the OTS and the FDIC, has issued
mandatory guidelines requiring all financial institutions to develop and
implement plans for addressing Year 2000 issues as they relate to the operations
of financial institutions. The Bank has developed a Year 2000 Project plan,
required by these guidelines, that is intended to ensure that its computer
systems and software will function properly with respect to dates in the Year
2000 and thereafter. The Year 2000 Project consists of various phases including
an awareness phase, assessment phase, renovation phase, testing phase and
implementation phase. The awareness and assessment phases are substantially
complete. In the assessment phase, hardware, software, third-party vendors,
customers, and non-technological systems that could be affected by the century
rollover were identified. In this assessment, various systems were identified as
mission-critical. The primary focus of the renovation and testing phases is on
these mission-critical systems. The testing phase for mission-critical systems
is well underway and the Bank expects that such testing will be completed in the
second quarter of 1999.
The majority of the Bank's data processing is performed by a third party
service bureau. Processing by the servicer includes account processing for all
deposit and loan accounts. The servicer has completed the remediation of its
host deposit and loan systems. The Bank is substantially complete with testing
of the servicer's system. Dates tested on the servicer's system included the
century date rollover from December 31, 1999 through January 3, 2000, leap year
2000, year-end 2000 and 2001 rollover. This testing was performed by Bank
personnel.
The Bank utilizes various third party software systems that interface
with the servicer's system that are deemed to be mission-critical. Approximately
50% of these software packages currently utilized by the Bank are not Year 2000
compliant, but upgrades or replacement systems are currently available and will
be installed by the Bank. These upgrades or replacements for Year 2000 will also
upgrade the systems to a Windows operating system. The majority of the other
third party software systems will be converted to a Windows operating
environment as well. These upgrades or replacements are scheduled to be
installed by the end of the second quarter of 1999. The testing of these systems
is scheduled to be conducted as the software is replaced and should also be
completed in the second quarter of 1999.
15
<PAGE>
Approximately 85% of the computers within the Bank were identified as
not being Year 2000 compliant. These computers are currently being replaced with
completion scheduled in the second quarter of 1999. Installation of a wide area
network and conversion to a Windows operating environment will be implemented
along with the replacement of the computers. Testing of the computers and the
network is scheduled to be conducted as the hardware and the network are
installed and should be completed in the second quarter of 1999.
The majority of the software and hardware being replaced are or will be
fully depreciated and are a part of a scheduled plan to upgrade the Bank's
systems to a Windows operating environment. Therefore, the Bank is not
accelerating the replacement due to Year 2000 issues and all costs associated
with the replacement of systems are considered costs incurred in the ordinary
course of business. To date the Bank has spent approximately $5,000 in costs
directly related to Year 2000. These costs were primarily related to customer
communications regarding the century date rollover. Any additional costs related
to Year 2000 are not expected to be material to the on-going operating costs of
the Company.
The failure to correct a Year 2000 problem of a mission-critical system
could result in an interruption in, or a failure of, certain normal business
activities or operations. Such failures could materially and adversely affect
the Company's results of operations, liquidity, and financial condition. Due to
the general uncertainty inherent in the Year 2000 problem, resulting in part
from the uncertainty of third-party suppliers, including power companies and
telephone companies, the Company is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the Company's
result of operations, liquidity or financial condition. The Bank's Year 2000
Project is anticipated to significantly reduce the uncertainty about the Year
2000 problem and, in particular, about the Year 2000 readiness of the Bank's
data processing servicer. The Company believes that, based on the data
processing servicer's Year 2000 efforts, the Bank's testing of the servicer's
system, and the completion of the Year 2000 Project by the Bank, the likelihood
of significant interruptions of normal operations should be reduced. However, a
"worst case scenario" would be one in which the servicer's system was not
available for an extended period of time. Non-availability of the servicer's
system would most likely be the result of a power or telecommunications failure.
In this "worst case scenario" the Bank could experience material disruptions in
its ability to process customer accounts and otherwise conduct its business.
Contingency plans for Year 2000 issues relating to mission-critical
systems are being addressed by the Bank. The Bank currently has a business
resumption recovery plan that addresses various contingencies within the Bank
including the servicer's computer system being inoperable as well as other
mission-critical systems. Contingency planning for a "worst case scenario", such
as a power failure, is being addressed as well. Due to the possibility of a
power outage occurring at any given time, even outages unrelated to Year 2000,
the Bank is installing a generator powered by natural gas at the corporate
office of the Bank to provide power to mission critical equipment. Contingency
planning for Year 2000 is ongoing as systems are replaced and additional
information becomes available regarding Year 2000 issues. The updating and
validation of the business resumption recovery plan, including contingency plans
for Year 2000 related issues, is expected to be completed by June 30, 1999.
16
<PAGE>
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17
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors of
First Federal Bancshares of Arkansas, Inc.:
We have audited the consolidated statements of financial condition of First
Federal Bancshares of Arkansas, Inc. and its subsidiary (the "Company") as of
December 31, 1998 and 1997, and the related consolidated statements of income
and comprehensive income, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1998. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of First Federal Bancshares of
Arkansas, Inc. and its subsidiary at December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
[GRAPHIC OMITTED]
/s/ Deloitte & Touche LLP
Little Rock, Arkansas
February 26, 1999
18
<PAGE>
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1998 AND 1997 (IN THOUSANDS, EXCEPT SHARE DATA)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 1998 1997
------ ------
<S> <C> <C>
Cash and cash equivalents:
Cash and collection items $ 8,842 $ 6,548
Interest-bearing deposits with banks 17,321 79
--------- ----------
Total cash and cash equivalents 26,163 6,627
Investment securities:
Held to maturity, at amortized cost (fair value at December 31, 1998
and 1997, of $127,013 and $95,614, respectively) 127,175 95,533
Federal Home Loan Bank stock 3,912 3,603
Loans receivable, net of allowance at December 31, 1998 and 1997,
of $771 and $1,196, respectively 442,486 433,942
Accrued interest receivable 4,755 4,134
Real estate acquired in settlement of loans, net 4,270 195
Office properties and equipment, net 6,055 5,218
Prepaid expenses and other assets 239 355
--------- ----------
TOTAL $ 615,055 $ 549,607
--------- ----------
--------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits $ 481,093 $ 450,874
Federal Home Loan Bank advances 48,985 11,997
Advance payments by borrowers for
taxes and insurance 1,006 900
Other liabilities 1,990 2,952
--------- ----------
Total liabilities 533,074 466,723
--------- ----------
MINORITY INTEREST 958 --
--------- ----------
STOCKHOLDERS' EQUITY:
Preferred stock, no par value, 5,000,000 shares authorized, none issued
Common stock, $.01 par value, 20,000,000 shares authorized, 5,153,751
shares issued, 4,512,760 and 4,896,063 shares outstanding at 52 52
December 31, 1998 and 1997, respectively
Additional paid-in capital 50,487 50,237
Employee stock benefit plans (5,037) (6,207)
Retained earnings - substantially restricted 47,678 42,982
--------- ----------
93,180 87,064
Treasury stock, at cost, 640,991 and 257,688 shares at
December 31, 1998 and 1997, respectively (12,157) (4,180)
--------- ----------
Total stockholders' equity 81,023 82,884
--------- ----------
TOTAL $ 615,055 $ 549,607
--------- ----------
--------- ----------
</TABLE>
See notes to consolidated financial statements.
19
<PAGE>
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
INTEREST INCOME:
Loans receivable $ 35,762 $ 33,804 $ 30,498
Investment securities 7,802 6,207 6,258
Mortgage-backed securities 6 17 22
Other 244 417 414
-------- -------- -------
Total interest income 43,814 40,445 37,192
INTEREST EXPENSE:
Deposits 24,004 23,331 22,409
Federal Home Loan Bank advances 1,770 417 40
-------- -------- -------
Total interest expense 25,774 23,748 22,449
-------- -------- -------
NET INTEREST INCOME 18,040 16,697 14,743
PROVISION FOR LOAN LOSSES 55 -- 60
-------- -------- -------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 17,985 16,697 14,683
NONINTEREST INCOME:
Gain on sales of available for sale investment securities -- 394 --
Deposit fee income 896 814 764
Other 940 712 458
-------- -------- -------
Total noninterest income 1,836 1,920 1,222
-------- -------- -------
NONINTEREST EXPENSES:
Salaries and employee benefits 6,525 6,384 4,325
Net occupancy expense 874 804 672
Federal insurance premiums 276 272 902
SAIF special assessment -- -- 2,611
Provision for real estate losses 15 37 38
Data processing 804 810 745
Postage and supplies 393 369 309
Other 1,595 1,340 1,147
-------- -------- -------
Total noninterest expenses 10,482 10,016 10,749
-------- -------- -------
INCOME BEFORE INCOME TAXES 9,339 8,601 5,156
INCOME TAX PROVISION 3,309 3,099 1,756
-------- -------- -------
NET INCOME 6,030 5,502 3,400
OTHER COMPREHENSIVE INCOME, Net of tax:
Unrealized holding gain on securities arising during period -- 58 51
Less: reclassification adjustment for gains included
in net income -- (260) --
-------- -------- -------
COMPREHENSIVE INCOME $ 6,030 $ 5,300 $ 3,451
-------- -------- -------
-------- -------- -------
EARNINGS PER SHARE:
Basic $ 1.35 $ 1.22 $ 0.72
-------- -------- -------
-------- -------- -------
Diluted $ 1.33 $ 1.21 $ 0.72
-------- -------- -------
-------- -------- -------
</TABLE>
See notes to consolidated financial statements.
20
<PAGE>
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (IN THOUSANDS, EXCEPT SHARE DATA)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ACCUMULATED
ISSUED ADDITIONAL EMPLOYEE OTHER
COMMON STOCK PAID-IN STOCK COMPREHENSIVE RETAINED
----------------------- -
SHARES AMOUNT CAPITAL BENEFIT PLANS INCOME EARNINGS
<S> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1996 $ 151 $ 35,157
Net income 3,400
Issuance of common stock $ 5,153,751 $ 52 $ 49,848
Loan to Employee Stock
Ownership Plan ("ESOP") $ (4,123)
Release of ESOP shares 127 275
Net change in unrealized gain
on securities available for sale 51
Purchase of treasury stock, at cost
------------ ------- -------- --------- ------ --------
BALANCE, DECEMBER 31, 1996 5,153,751 52 49,975 (3,848) 202 38,557
Net income 5,502
Release of ESOP shares 414 416
Common stock acquired or committed to be
acquired for employee stock benefit plan (152) (3,968)
Stock compensation expense 1,193
Net change in unrealized gain on
securities available for sale (202)
Dividends paid (1,077)
------------ ------- -------- --------- ------ --------
BALANCE, DECEMBER 31, 1997 5,153,751 52 50,237 (6,207) -- 42,982
Net income 6,030
Release of ESOP shares 564 416
Common stock acquired for employee
stock benefit plan (434)
Stock compensation expense 754
Shares released from restricted stock trust 120
Purchase of treasury stock, at cost
Dividends paid (1,334)
------------ ------- -------- --------- ------ --------
BALANCE, DECEMBER 31, 1998 5,153,751 $ 52 $ 50,487 $ (5,037) $ -- $ 47,678
------------ ------- -------- --------- ------ --------
------------ ------- -------- --------- ------ --------
</TABLE>
<TABLE>
<CAPTION>
TOTAL
TREASURY STOCK STOCKHOLDERS'
--------------------------
SHARES AMOUNT EQUITY
<S> <C>
BALANCE, JANUARY 1, 1996 $ 35,308
Net income 3,400
Issuance of common stock 49,900
Loan to Employee Stock
Ownership Plan ("ESOP") (4,123)
Release of ESOP shares 402
Net change in unrealized gain
on securities available for sale 51
Purchase of treasury stock, at cost 257,688 (4,180) (4,180)
--------- -------- -------
BALANCE, DECEMBER 31, 1996 257,688 (4,180) 80,758
Net income 5,502
Release of ESOP shares 830
Common stock acquired or committed to be
acquired for employee stock benefit plan (4,120)
Stock compensation expense 1,193
Net change in unrealized gain on
securities available for sale (202)
Dividends paid (1,077)
--------- -------- -------
BALANCE, DECEMBER 31, 1997 257,688 (4,180) 82,884
Net income 6,030
Release of ESOP shares 980
Common stock acquired for employee
stock benefit plan (434)
Stock compensation expense 754
Shares released from restricted stock trust 120
Purchase of treasury stock, at cost 383,303 (7,977) (7,977)
Dividends paid (1,334)
--------- -------- -------
BALANCE, DECEMBER 31, 1998 640,991 $(12,157) $ 81,023
--------- -------- -------
--------- -------- -------
</TABLE>
See notes to consolidated financial statements.
21
<PAGE>
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income $ 6,030 $ 5,502 $ 3,400
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 55 -- 60
Provision for real estate losses 15 37 38
Deferred tax provision 227 27 111
Gain on sale of investment securities - available for sale -- (394) --
Gain (loss) on sale of real estate owned, net 47 (158) (10)
Gain on sale of mortgage loans originated to sell (270) (30) --
Depreciation 508 465 403
Real estate owned depreciation 115 -- --
Accretion of deferred loan fees, net (855) (621) (640)
Release of ESOP shares 980 830 402
Stock compensation expense 754 1,193 --
Other (42) -- --
Changes in operating assets and liabilities:
Accrued interest receivable (621) (514) (143)
Prepaid expenses and other assets 116 370 (433)
Other liabilities 314 299 (21)
-------- -------- --------
Net cash provided by operating activities 7,373 7,006 3,167
-------- -------- --------
INVESTING ACTIVITIES:
Purchases of investment securities - held to maturity (111,418) (51,678) (41,172)
Proceeds from sales of investment securities - available
for sale -- 406 --
Proceeds from maturities of investment securities -
held to maturity 79,467 46,550 46,040
Loan originations, net of repayments (31,688) (39,305) (56,518)
Proceeds from sales of mortgage loans originated to sell 20,709 2,251 --
Proceeds from sales of real estate owned 253 205 146
Purchases of office properties and equipment (1,345) (2,118) (975)
-------- -------- --------
Net cash used by investing activities (44,022) (43,689) (52,479)
-------- -------- --------
FINANCING ACTIVITIES:
Net increase in deposits 30,219 28,016 5,629
Advances from Federal Home Loan Bank 36,988 11,997 --
Net increase in advance payments by borrowers for taxes
and insurance 106 94 60
Issuance of common stock, net of related expenses -- -- 45,777
Purchase of treasury stock (7,977) -- (4,180)
Common stock acquired for employee stock benefit plan (1,817) (2,539) --
Dividends paid (1,334) (1,077) --
-------- -------- --------
Net cash provided by financing activities 56,185 36,491 47,286
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 19,536 (192) (2,026)
CASH AND CASH EQUIVALENTS:
Beginning of year 6,627 6,819 8,845
-------- -------- --------
End of year $ 26,163 $ 6,627 $ 6,819
-------- -------- --------
-------- -------- --------
</TABLE>
(Continued)
22
<PAGE>
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION -
Cash paid for:
Interest $ 25,635 $ 23,656 $ 22,451
-------- -------- --------
-------- -------- --------
Income taxes $ 3,125 $ 2,908 $ 1,899
-------- -------- --------
-------- -------- --------
SUPPLEMENTAL SCHEDULE OF NONCASH
INVESTING ACTIVITIES:
Real estate acquired in settlement of loans $ 3,888 $ 272 $ 95
-------- -------- --------
-------- -------- --------
Loans to facilitate sales of real estate owned $ 341 $ -- $ 110
-------- -------- --------
-------- -------- --------
</TABLE>
(Concluded)
See notes to consolidated financial statements.
23
<PAGE>
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS AND PRINCIPLES OF CONSOLIDATION - First Federal
Bancshares of Arkansas, Inc. (the "Company") was incorporated in January
1996 by First Federal Bank of Arkansas, FA (the "Bank") in connection with
the conversion of the Bank from a federally chartered mutual savings and
loan association to a federally chartered stock savings and loan
association, the issuance of the Bank's common stock to the Company, and
the offer and sale of the Company's common stock by the Company (the
"Conversion"). Upon consummation of the Conversion on May 3, 1996, the
Company became a unitary holding company for the Bank. Approximately 50%
of the net proceeds from the Conversion were used to acquire 100% of the
common stock of the Bank. The remaining net proceeds from the Conversion
were retained by the Company. The Conversion was accounted for at
historical cost in a manner similar to that in pooling of interests
accounting.
The Bank provides a broad line of financial products to individuals and
small to medium-sized businesses. The consolidated financial statements
also include the accounts of the Bank's wholly-owned subsidiary, First
Harrison Service Corporation ("FHSC"), whose activities are limited to
owning an interest in a repossessed commercial property. During the first
quarter of 1998, in settlement of a loan, FHSC obtained 75% ownership of a
partnership that owned and operated a 202 room hotel in Oklahoma. The
financial position and results of operations of this hotel property have
been consolidated in the 1998 financial statements. The 25% ownership is
reflected in the consolidated statement of financial condition at December
31, 1998, as minority interest. All material intercompany transactions
have been eliminated in consolidation. Results of operations and cash
flows of the Bank for the period from January 1, 1996 to May 3, 1996, are
included in the consolidated financial statements of the Company for the
year ended December 31, 1996.
USE OF 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 revenues and
expenses during the reporting period. Actual results could differ from
those estimates and such differences could be significant.
LIQUIDITY REQUIREMENT - Regulations require the Bank to maintain an amount
equal to 4% of deposits (net of loans on deposits) plus short-term
borrowings in cash and U.S. Government and other approved securities.
CASH AND CASH EQUIVALENTS - For purposes of reporting cash flows, cash and
cash equivalents includes cash on hand and amounts due from depository
institutions, which includes interest-bearing amounts available upon
demand.
INVESTMENT SECURITIES - The Company classifies investment securities into
one of two categories: held to maturity or available for sale. The Company
does not engage in trading activities. Debt securities that the Company
has the positive intent and ability to hold to maturity are classified as
held to maturity and recorded at cost, adjusted for the amortization of
premiums and the accretion of discounts.
24
<PAGE>
Investment securities that the Company intends to hold for indefinite
periods of time are classified as available for sale and are recorded at
fair value. Unrealized holding gains and losses are excluded from earnings
and reported net of tax as a separate component of stockholders' equity
until realized. Investment securities in the available for sale portfolio
may be used as part of the Company's asset and liability management
practices and may be sold in response to changes in interest rate risk,
prepayment risk, or other economic factors.
Premiums are amortized into interest income using the interest method to
the earlier of maturity or call date. Discounts are accreted into interest
income using the interest method over the period to maturity. The specific
identification method of accounting is used to compute gains or losses on
the sales of investment securities.
The overall return or yield earned on mortgage-backed securities depends
on the amount of interest collected over the life of the security and the
amortization of any premium or accretion of any discount. Premiums and
discounts are recognized in income using a method that approximates the
level-yield method over the assets' remaining lives adjusted for actual
and anticipated prepayments. Although the Company receives the full amount
of principal if prepaid, the interest income that would have been
collected during the remaining period to maturity, net of any discount
accretion or premium amortization is lost. Accordingly, the actual yields
and maturities of mortgage-backed securities depend on when the underlying
mortgage principal and interest are prepaid. Prepayments generally result
when market interest rates fall below a mortgage's contractual interest
rate and it is to the borrower's advantage to prepay the existing loan and
obtain new, lower rate financing. In addition to changes in interest
rates, mortgage prepayments depend on other factors such as loan types and
geographic location of the related properties.
If the fair value of an investment security declines for reasons other
than temporary market conditions, the carrying value of such a security is
written down to fair value by a charge to operations.
LOANS RECEIVABLE - Loans receivable that management has the intent and
ability to hold until maturity or pay-off are stated at unpaid principal
balances adjusted for any charge-offs, the allowance for loan losses and
deferred loan fees or costs and discounts. Deferred loan fees or costs and
discounts on first mortgage loans are amortized or accreted to income
using the level-yield method over the remaining period to contractual
maturity.
Mortgage loans originated and committed for sale in the secondary market
are carried at the lower of cost or estimated market value in the
aggregate. At December 31, 1998 and 1997, the balances of such loans are
not material, and are carried at cost due to the short period of time
between funding and sale, generally one to two weeks.
The accrual of interest on impaired loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they
become due or when the loan becomes 90 days past due, whichever occurs
first. When interest accrual is discontinued, all unpaid accrued interest
is reversed. Interest income is subsequently recognized only to the extent
cash payments in excess of principal due are received, until such time
that in management's opinion, the borrower will be able to meet payments
as they become due.
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses is a valuation
allowance to provide for incurred but not yet realized losses. The Bank
reviews its non-homogeneous loans for impairment on a quarterly basis.
Impairment is determined by assessing the probability that the borrower
will not be able to fulfill the contractual terms of the agreement. If a
loan is determined to be impaired, the amount of the impairment is
measured based on the present value of expected future cash flows
discounted at
25
<PAGE>
the loan's effective interest rate or by use of the observable market
price of the loan or fair value of collateral if the loan is collateral
dependent. Throughout the year management estimates the level of probable
losses to determine whether the allowance for loan losses is appropriate
considering the estimated losses existing in the portfolio. Based on these
estimates, an amount is charged to the provision for loan losses and
credited to the allowance for loan losses in order to adjust the allowance
to a level determined by management to be appropriate relative to losses.
The allowance for loan losses is increased by charges to income
(provisions) and decreased by charges-offs, net of recoveries.
Management's periodic evaluation of the appropriateness of the allowance
is based on the Company's past loan loss experience, known and inherent
risks in the portfolio, adverse situations that may affect the borrower's
ability to repay, the estimated value of any underlying collateral and
current economic conditions.
Homogeneous loans are those that are considered to have common
characteristics that provide for evaluation on an aggregate or pool basis.
The Bank considers the characteristics of (1) one- to- four family
residential first mortgage loans; (2) unsecured consumer loans and; (3)
secured consumer loans to permit consideration of the appropriateness of
the allowance for losses of each group of loans on a pool basis. The
primary methodology used to determine the appropriateness of the allowance
for losses includes segregating certain specific, poorly performing loans
based on their performance characteristics from the pools of loans as to
type, grading these loans, and then applying a loss factor to the
remaining pool balance based on several factors including past loss
experience, inherent risks, economic conditions in the primary market
areas, and other factors which usually are beyond the control of the Bank.
Non-homogeneous loans are those loans that can be included in a particular
loan type, such as commercial loans, construction loans, multi-family, and
commercial first mortgage loans, but which differ in other characteristics
to the extent that valuation on a pool basis is not valid. Those
segregated specific loans are evaluated using the present value of future
cash flows, usually determined by estimating the fair value of the loan's
collateral reduced by any cost of selling and discounted at the loan's
effective interest rate if the estimated time to receipt of monies is more
than three months or by use of the observable market price of the loan or
fair value of collateral if the loan is collateral dependent. After
segregating specific, poorly performing loans, the remaining loans are
evaluated based on payment experience, known difficulties in the borrowers
business or geographic area, loss experience, inherent risks, and other
factors usually beyond the control of the Bank. A factor, based on
experience, is applied to these loans to estimate the probable loss.
Estimates of the probability of loan losses involve judgment. While it is
possible that in the near term the Bank may sustain losses which are
substantial in relation to the allowance for loan losses, it is the
judgment of management that the allowance for loan losses reflected in the
consolidated statements of financial condition is appropriate considering
the estimated probable losses in the portfolio.
FORECLOSED REAL ESTATE - Real estate acquired in settlement of loans is
initially recorded at estimated fair value less estimated costs to sell
and is subsequently carried at the lower of carrying amount or fair value
less estimated disposal costs. Valuations are periodically performed by
management, and an allowance for losses is established by a charge to
operations or the balance is written off if the carrying value of a
property exceeds its estimated fair value. Costs relating to the
development and improvement of the property are capitalized, whereas those
relating to holding the property are expensed.
26
<PAGE>
OFFICE PROPERTIES AND EQUIPMENT - Office properties and equipment are
stated at cost less accumulated depreciation and amortization. The Company
computes depreciation of office properties and equipment using the
straight-line method over the estimated useful lives of the individual
assets which range from 3 to 30 years.
LOAN ORIGINATION FEES - Loan origination fees and certain direct loan
origination costs are deferred and the net fee or cost is recognized as an
adjustment to interest income using the level-yield method over the
contractual life of the loans. When a loan is fully repaid or sold, the
amount of unamortized fee or cost is recorded in income.
INCOME TAXES - The Company recognizes deferred tax liabilities and assets
for the expected future tax consequences of temporary differences between
the carrying amounts and the tax bases of assets and liabilities.
INTEREST RATE RISK - The Bank's asset base is exposed to risk including
the risk resulting from changes in interest rates and changes in the
timing of cash flows. The Bank monitors the effect of such risks by
considering the mismatch of the maturities of its assets and liabilities
in the current interest rate environment and the sensitivity of assets and
liabilities to changes in interest rates. The Bank's management has
considered the effect of significant increases and decreases in interest
rates and believes such changes, if they occurred, would be manageable and
would not affect the ability of the Bank to hold its assets as planned.
However, the Bank is exposed to significant market risk in the event of
significant and prolonged interest rate changes.
EMPLOYEE STOCK OWNERSHIP PLAN - Compensation expense for the Employee
Stock Ownership Plan ("ESOP") is determined based on the average fair
value of shares committed to be released during the period and is
recognized as the shares are committed to be released. For the purpose of
earnings per share, ESOP shares are included in weighted-average common
shares outstanding as the shares are committed to be released.
EARNINGS PER SHARE - Earnings per share of common stock has been computed
on the basis of the weighted-average number of shares of common stock
outstanding, assuming the Company was a public company since January 1,
1996.
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 128, EARNINGS PER SHARE ("SFAS 128") for the year ended December 31,
1997, and prior periods were restated. As required by SFAS 128, dual
presentation of basic and diluted earnings per share ("EPS") is included
on the face of the income statement and a reconciliation of the numerator
and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation is presented in the notes to
the consolidated financial statements. Basic EPS excludes dilution and is
computed by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period.
RECENTLY ISSUED ACCOUNTING STANDARDS - In June 1998, the Financial
Accounting Standards Board ("FASB") issued Statement No. 133, ACCOUNTING
FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS 133"). SFAS 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as "derivatives"), and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial condition and measure those
instruments at fair value. SFAS 133 is effective for fiscal years
beginning after June 15, 1999. Management has not yet made a determination
as to the effect, if any, the adoption of SFAS 133 will have on the
Company's financial position or results of operations.
27
<PAGE>
In October 1998, the FASB issued Statement No. 134, ACCOUNTING FOR
MORTGAGE-BACKED SECURITIES RETAINED AFTER THE SECURITIZATION OF MORTGAGE
LOANS HELD FOR SALE BY A MORTGAGE BANKING ENTERPRISE ("SFAS 134"). This
statement amends SFAS 65 to require that after the securitization of
mortgage loans held for sale, an entity engaged in mortgage banking
activities classify the resulting mortgage-backed securities or other
retained interests based on its ability and intent to sell or hold those
investments. This statement conforms the subsequent accounting for
securities retained after the securitization of mortgage loans by a
mortgage banking enterprise with the subsequent accounting for securities
retained after the securitization of other types of assets by a
nonmortgage banking enterprise. The adoption of SFAS No. 134 is not
expected to have a material effect on the Company's consolidated financial
statements.
RECENTLY ADOPTED ACCOUNTING STANDARDS - In 1998, the Company adopted
Statement of Financial Accounting Standards No. 130, REPORTING
COMPREHENSIVE INCOME ("SFAS 130"). SFAS 130 establishes standards for
reporting and displaying comprehensive income and its components in the
financial statements. In addition, SFAS 130 requires the Company to
classify items of other comprehensive income by their nature in a
financial statement and display the accumulated balance of other
comprehensive income separately in the stockholders' equity section of the
statement of financial condition.
The Company also adopted Statement of Financial Accounting Standards
No. 132, EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT
BENEFITS, an amendment of FASB Statement Nos. 87, 88, and 106
("SFAS 132"). The statement revises employers' disclosure about pension
and other postretirement benefit plans. It does not change the
measurement or recognition of those plans. It standardizes the
disclosure requirements for pension and other postretirement benefits
to the extent practicable, requires additional information on changes
in the benefit obligations and fair values of plan assets that will
facilitate financial analysis, and eliminates certain disclosures that
are no longer as useful as they were when FASB Statement Nos. 87, 88,
and 106 were issued.
RECLASSIFICATIONS - Certain amounts in the 1997 and 1996 consolidated
financial statements have been reclassified to conform to the
classifications adopted for reporting in 1998.
2. INVESTMENT SECURITIES
Investment securities consisted of the following at December 31 (in
thousands):
<TABLE>
<CAPTION>
1998
---------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
HELD TO MATURITY COST GAINS LOSSES VALUE
<S> <C> <C> <C> <C>
U.S. Government and Agency obligations $ 127,150 $ 397 $ 560 $ 126,987
Mortgage-backed securities - FHLMC 25 1 26
--------- ---------- ---------- -----------
Total $ 127,175 $ 398 $ 560 $ 127,013
--------- ---------- ---------- -----------
--------- ---------- ---------- -----------
</TABLE>
<TABLE>
<CAPTION>
1997
---------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
HELD TO MATURITY COST GAINS LOSSES VALUE
<S> <C> <C> <C> <C>
U.S. Government and Agency obligations $ 95,376 $ 428 $ 351 $ 95,453
Mortgage-backed securities - FHLMC 157 4 161
--------- ---------- ---------- -----------
Total $ 95,533 $ 432 $ 351 $ 95,614
--------- ---------- ---------- -----------
--------- ---------- ---------- -----------
</TABLE>
28
<PAGE>
The Company has pledged investment securities held to maturity with
carrying values of approximately $16 million and $15 million at December
31, 1998 and 1997, respectively, as collateral for certain deposits in
excess of $100,000.
Gross realized gains on sales of available for sale securities were
approximately $394,000 in 1997. There were no significant gross losses.
The scheduled maturities of debt securities at December 31, 1998, by
contractual maturity are shown below (in thousands). Expected maturities
may differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
1998
--------------------------------
AMORTIZED FAIR
COST VALUE
<S> <C> <C>
Due in one year or less $ 10,008 $ 10,063
Due from one year to five years 8,188 8,236
Due from five years to ten years 14,100 14,245
Due after ten years 94,854 94,443
Mortgage-backed securities 25 26
-------------- ------------
Total $ 127,175 $ 127,013
-------------- ------------
-------------- ------------
</TABLE>
As of December 31, 1998 and December 31, 1997, there were approximately
$113 million and $71 million, respectively, of investments with call
options held by the issuer, of which approximately $97 million and $60
million, respectively, are callable within one year.
3. LOANS RECEIVABLE
Loans receivable consisted of the following at December 31 (in thousands):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
First mortgage loans:
One- to- four family residences $ 370,211 $ 370,955
Other properties 24,736 19,896
Construction 18,226 20,753
Less:
Unearned discounts (287) (331)
Undisbursed loan funds (6,770) (7,305)
Deferred loan fees, net (3,174) (3,320)
--------------- -------------
Total first mortgage loans 402,942 400,648
--------------- -------------
Consumer and other loans:
Commercial loans 8,437 5,649
Automobile 10,693 8,307
Consumer loans 3,977 4,065
Home equity and second mortgage 13,308 13,023
Savings loans 1,537 1,339
Other 2,199 1,968
Deferred loan costs 164 139
--------------- -------------
Total consumer and other loans 40,315 34,490
--------------- -------------
Allowance for loan losses (771) (1,196)
--------------- -------------
Loans receivable, net $ 442,486 $ 433,942
--------------- -------------
--------------- -------------
</TABLE>
29
<PAGE>
The Company originates and maintains loans receivable which are
substantially concentrated in its lending territory (primarily Northwest
and Northcentral Arkansas). The majority of the Company's loans are
residential mortgage loans and construction loans for residential
property. The Company's policy calls for collateral or other forms of
repayment assurance to be received from the borrower at the time of loan
origination. Such collateral or other form of repayment assurance is
subject to changes in economic value due to various factors beyond the
control of the Company.
In the normal course of business, the Company has made loans to its
directors, officers, and their related business interests. In the opinion
of management, related party loans are made on substantially the same
terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with unrelated persons and do not involve
more than the normal risk of collectibility. The aggregate dollar amount
of loans outstanding to directors, officers, and their related business
interests totaled approximately $2.6 million and $2.9 million at December
31, 1998 and 1997, respectively.
Loans identified by management as impaired at December 31, 1998 and 1997,
were not significant. The Company is not committed to lend additional
funds to debtors whose loans have been modified.
4. LOAN SERVICING
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid principal
balances of these loans at December 31 are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Mortgage loans underlying FHLMC
pass-through securities $ - $ 297
Mortgage loan portfolios serviced
for other investors 849 1,037
-------- ---------
Total $ 849 $ 1,334
-------- ---------
-------- ---------
</TABLE>
Servicing loans for others generally consists of collecting mortgage
payments, maintaining escrow accounts, disbursing payments to investors,
and foreclosure processing. Loan servicing income is recorded on the
accrual basis and includes servicing fees from investors and certain
charges collected from borrowers, such as late payment fees.
5. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable consisted of the following at December 31 (in
thousands):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Loans $ 2,482 $ 2,645
Investment securities 2,273 1,489
---------- ----------
Total $ 4,755 $ 4,134
---------- ----------
---------- ----------
</TABLE>
30
<PAGE>
6. ALLOWANCE FOR LOAN LOSSES
A summary of the activity in the allowance for loan losses is as follows
for the years ended December 31 (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Balance, beginning of year $ 1,196 $ 1,251 $ 1,228
Provisions for estimated losses 55 60
Recoveries 9 12 3
Losses charged off (489) (67) (40)
-------- -------- ---------
Balance, end of year $ 771 $ 1,196 $ 1,251
-------- -------- ---------
-------- -------- ---------
</TABLE>
7. FEDERAL HOME LOAN BANK STOCK
The Bank is a member of the Federal Home Loan Bank System. As a member of
this system, it is required to maintain an investment in capital stock of
the Federal Home Loan Bank ("FHLB") in an amount equal to the greater of
1% of its outstanding home loans or .3% of its total assets. No ready
market exists for such stock and it has no quoted market value. The
carrying value of the stock is its cost.
8. OFFICE PROPERTIES AND EQUIPMENT
Office properties and equipment consisted of the following at December 31
(in thousands):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Land $ 2,226 $ 2,014
Buildings and improvements 3,600 3,276
Furniture and equipment 3,956 3,237
Automobiles 443 410
-------- --------
Total 10,225 8,937
Accumulated depreciation (4,170) (3,719)
-------- --------
Office properties and equipment, net $ 6,055 $ 5,218
-------- --------
-------- --------
</TABLE>
9. DEPOSITS
Deposits are summarized as follows at December 31 (in thousands):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Demand and NOW accounts, including noninterest-bearing
deposits of $14,133 and $10,539 in 1998 and 1997, respectively $ 60,248 $ 49,963
Money market 16,164 15,438
Regular savings 25,916 25,330
Certificates of deposit 378,765 360,143
-------- ----------
Total $481,093 $450,874
-------- ----------
-------- ----------
</TABLE>
31
<PAGE>
The aggregate amount of short-term jumbo certificates of deposit with a
minimum denomination of $100 thousand was approximately $31 million and
$27 million at December 31, 1998 and 1997, respectively.
At December 31, 1998, scheduled maturities of certificates of deposit are
as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Years ending December 31:
1999 $237,029
2000 62,567
2001 22,982
2002 18,759
2003 and thereafter 37,428
---------
Total $378,765
---------
---------
</TABLE>
Interest expense on deposits consisted of the following (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------------------------
1998 1997 1996
<S> <C> <C> <C>
NOW and money market $ 1,358 $ 1,299 $ 1,324
Regular savings and certificate accounts 22,745 22,145 21,178
Early withdrawal penalties (99) (113) (93)
-------- -------- --------
Total $ 24,004 $ 23,331 $ 22,409
-------- -------- --------
-------- -------- --------
</TABLE>
Eligible deposits of the Bank are insured up to $100 thousand by the
Savings Association Insurance Fund ("SAIF") of the Federal Deposit
Insurance Corporation ("FDIC").
Legislation, passed by the U.S. House of Representatives and the Senate,
was signed into law by the President on September 30, 1996, to
recapitalize the SAIF. As a result of such legislation, the Bank was
required to pay a one-time special assessment of $2.6 million which had an
approximate $1.7 million after-tax effect. The legislation also mandated
that the deposit insurance premiums charged SAIF-insured institutions
(such as the Bank) decline to approximately 6.5 basis points effective
January 1, 1997. Effective July 1, 1998, the deposit insurance premium
declined to 6.10 basis points.
10. FEDERAL HOME LOAN BANK ADVANCES
The Bank pledges as collateral for FHLB advances their FHLB stock and has
entered into blanket collateral agreements with the FHLB whereby the Bank
agrees to maintain, free of other encumbrances, qualifying single family
first mortgage loans with unpaid principal balances, when discounted at
75% of such balances, of at least 100% of total outstanding advances.
Advances at December 31, 1998 and 1997, consisted of the following:
<TABLE>
<CAPTION>
1998 1997
--------------------- ---------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
RATE AMOUNT RATE AMOUNT
<S> <C> <C> <C> <C>
Amounts maturing in years ending
December 31:
1999 5.71 % $19,000 6.19 % $ 4,000
2000 5.31 % 14,000 6.04 % 2,000
2001 4.85 % 7,000
2002 6.60 % 3,985 6.59 % 3,997
2003 5.56 % 1,000
Thereafter 6.01 % 4,000 6.26 % 2,000
-------- ----------
Total 5.57 % $48,985 6.31 % $11,997
-------- ----------
-------- ----------
</TABLE>
32
<PAGE>
11. INCOME TAXES
The provisions for income taxes are summarized as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
----------------------------------------
1998 1997 1996
<S> <C> <C> <C>
Income tax provision:
Current $ 3,082 $ 3,072 $ 1,645
Deferred 227 27 111
------------ ---------- -----------
Total $ 3,309 $ 3,099 $ 1,756
------------ ---------- -----------
------------ ---------- -----------
</TABLE>
The reasons for the differences between the statutory federal income tax
rates and the effective tax rates are summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
------------------------------------------------------------------------
1998 1997 1996
<S> <C> <C> <C> <C> <C> <C>
Taxes at statutory rate $ 3,175 34.0 % $ 2,924 34.0 % $ 1,753 34.0 %
Increase resulting from:
State income tax, net 48 0.5 % 119 1.4 % - -
Other, net 86 0.9 % 56 0.6 % 3 0.1 %
------------- --------- --------- -------- --------- -------
Total $ 3,309 35.4 % $ 3,099 36.0 % $ 1,756 34.1 %
------------- --------- --------- -------- --------- -------
------------- --------- --------- -------- --------- -------
</TABLE>
During the year ended December 31, 1996, new legislation was enacted which
provides for the recapture into taxable income of certain amounts
previously deducted as additions to the bad debt reserves for income tax
purposes. The Bank began changing its method of determining bad debt
reserves for tax purposes following the year ended December 31, 1995. The
amounts to be recaptured for income tax reporting purposes are considered
by the Bank in the determination of the net deferred tax liability.
The Company's net deferred tax liability account was comprised of the
following at December 31 (in thousands):
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Deferred tax assets:
Loan fees deferred $ 79 $ 158
Stock based compensation 168 168
Loan loss reserves 4 --
Other -- 72
--------- --------
Total deferred tax assets 251 398
Deferred tax liabilities:
Office properties (159) (168)
Federal Home Loan Bank stock (629) (544)
Loan loss reserves -- (61)
Other (65) --
--------- --------
Total deferred tax liabilities (853) (773)
--------- --------
Net deferred tax liability $(602) $(375)
--------- --------
--------- --------
</TABLE>
33
<PAGE>
Specifically exempted from deferred tax recognition requirements are bad
debt reserves for tax purposes of U.S. savings and loans in the
institution's base year, as defined. Base year reserves totaled
approximately $4.2 million. Consequently, a deferred tax liability of
approximately $1.6 million related to such reserves was not provided for
in the consolidated statements of financial condition at December 31, 1998
and 1997. Payment of dividends to shareholders out of retained earnings
deemed to have been made out of earnings previously set aside as bad debt
reserves may create taxable income to the Bank. No provision has been made
for income tax on such a distribution as the Bank does not anticipate
making such distributions.
12. OTHER COMPREHENSIVE INCOME
The amount of income tax expense or benefit allocated to each component of
comprehensive income, including reclassification adjustments, are shown
below. There were no other comprehensive income components for the year
ended December 31, 1998.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
---------------------------------------
TAX
BEFORE-TAX (EXPENSE) NET-OF-TAX
AMOUNT OF BENEFIT AMOUNT
<S> <C> <C> <C>
Unrealized gains on securities:
Unrealized holding gains arising during period $ 66 $ (8) $ 58
Less: reclassification of adjustment for gains
realized in net income (394) 134 (260)
-------- -------- -----------
-------- -------- -----------
Other comprehensive income $(328) $ 126 $(202)
-------- -------- -----------
-------- -------- -----------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
-----------------------------------------
TAX
BEFORE-TAX (EXPENSE) NET-OF-TAX
AMOUNT OF BENEFIT AMOUNT
<S> <C> <C> <C>
Unrealized gains on securities:
Unrealized holding gains arising during period $ 83 $ (32) $ 51
Less: reclassification of adjustment for gains
realized in net income - - -
-------- -------- -----------
Other comprehensive income $ 83 $ (32) $ 51
-------- -------- -----------
-------- -------- -----------
</TABLE>
13. BENEFIT PLANS
In 1997, the Company's shareholders approved the Stock Option Plan ("SOP")
and Management Recognition and Retention Plan ("MRR Plan").
STOCK OPTION PLAN - The SOP provides for a committee of the Company's
Board of Directors to award incentive stock options, non-qualified or
compensatory stock options and stock appreciation rights representing up
to 515,375 shares of Company stock. One-fifth of the options granted
vested immediately upon grant, with the balance vesting in equal amounts
on the four subsequent anniversary dates of the grant. Two-fifths of the
options granted during 1997 have vested as of December 31, 1998. Options
granted vest immediately in the event of retirement, disability, or death.
Stock options granted expire in ten years.
Under the SOP, options have been granted to directors and key employees to
purchase common stock of the Company. The exercise price in each case
equals the fair market value of the Company's stock at the date of grant.
Options granted in 1997 have exercise prices ranging from $19.25 to
$20.38, and a weighted average remaining contract life of 8.4 years at
December 31, 1998. Options granted in 1998 have exercise prices ranging
from $23.25 to $24.00 and a weighted average remaining contract life of
9.1 years at December 31, 1998.
34
<PAGE>
A summary of the status of the Company's SOP as of December 31, 1998 and
1997, and changes during the years ending on those dates are presented
below:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
OPTIONS SHARES PRICE
<S> <C> <C>
Outstanding at January 1, 1997 -- $ --
Granted 496,073 19.27
Exercised -- --
Forfeited (1,600) 19.25
------- ---------
Outstanding at December 31, 1997 494,473 19.27
Granted 13,000 23.31
Exercised -- --
Forfeited (3,600) 20.00
------- ---------
Outstanding at December 31, 1998 503,873 $ 19.37
------- ---------
------- ---------
Options exercisable at December 31, 1998 200,630 $ 19.33
------- ---------
------- ---------
</TABLE>
The Company applies the provisions of APB Opinion No. 25 in accounting
for its stock option plan, as allowed under SFAS No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION ("SFAS 123"). Accordingly, no compensation cost
has been recognized for options granted to employees. Had compensation
cost for these plans been determined based on the fair value at the
grant dates for awards under those plans consistent with the methods of
SFAS 123, the Company's pro forma net income and pro forma earnings per
share would have been as follows:
<TABLE>
<CAPTION>
1998 1997
------------------------- ------------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA
<S> <C> <C> <C> <C>
Net income (in thousands) $ 6,030 $ 5,505 $ 5,502 $ 4,987
Earnings per share:
Basic $ 1.35 $ 1.23 $ 1.22 $ 1.10
Diluted $ 1.33 $ 1.21 $ 1.21 $ 1.10
</TABLE>
In determining the above pro forma disclosure, the fair value of options
granted during 1997 was estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions: expected volatility - 22%, expected life of options - 6.5
years, risk-free interest rate - 5.7%, and expected dividend rate -
1.05%. The weighted average fair value of options granted during the
fiscal year ended December 31, 1997, was $7.85 per share.
The fair value of options granted during 1998 was estimated on the date of
grant using the Black-Scholes option-pricing model with the following
assumptions: expected volatility - 20.28% to 21.09%, expected life of
options - 7.0 years, risk-free interest rate - 5.59% and expected dividend
rate - 1.04% to 1.17%. The weighted average fair value of options granted
during the fiscal year ended December 31, 1998, was $9.02 per share.
MANAGEMENT RECOGNITION AND RETENTION PLAN - The MRR Plan provides for a
committee of the Company's Board of Directors to award restricted stock to
key officers as well as non-employee directors. The MRR Plan authorizes
the Company to grant up to 206,150 shares of the Company stock, of which
195,844 shares were granted during 1997. Compensation expense will be
recognized based on
35
<PAGE>
the fair market value of the shares on the grant date of $19.25 over the
vesting period. One-fifth of the shares granted to date (39,170 shares)
vested immediately on the date of grant. The remainder will vest at a rate
of 25% per year over the next four anniversary dates of the grants.
Two-fifths of the shares granted to date have vested as of December 31,
1998. Shares granted will be deemed vested in the event of disability or
death. All shares granted under the plan have been purchased in the open
market at a total cost of $4.4 million. A liability has been established,
based on the grant price, for the remainder of the shares to be purchased.
Differences between the price at the date of grant and the actual purchase
price will be recorded as an adjustment to stockholders' equity.
Approximately $754,000 and $1.2 million in compensation expense was
recognized during the years ended December 31, 1998 and 1997,
respectively.
EMPLOYEE STOCK OWNERSHIP PLAN - The Company established an Employee Stock
Ownership Plan on May 3, 1996. During 1996, the ESOP borrowed $4.1 million
from the Company to purchase shares of Company stock. The loan is
collateralized by the shares that were purchased with the proceeds of the
loan. As the loan is repaid, ESOP shares will be allocated to participants
of the ESOP and are available for release to the participants subject to
the vesting provisions of the ESOP.
Forfeitures of nonvested benefits will be reallocated among remaining
participating employees in the same proportion as contributions. During
each of the years ended December 31, 1998, 1997, and 1996, 41,604, 41,604,
and 27,465 shares, respectively, were released by the ESOP to participant
accounts. At December 31, 1998, there were 109,061 shares allocated to
participant accounts and 301,627 unallocated shares. The fair value of the
unallocated shares amounted to approximately $5,618,000 at December 31,
1998.
During the years ended December 31, 1998, 1997, and 1996, ESOP expense was
approximately $884,000, $745,000, and $402,000, respectively.
OTHER POSTRETIREMENT BENEFITS - The Bank is a participant in a
multi-employer retirement plan and therefore separate information is not
available. The plan is noncontributory and covers substantially all
employees. The plan provides a retirement benefit and a death benefit.
Retirement benefits are payable in monthly installments for life and must
begin not later than the first day of the month coincident with or next
following the seventieth birthday or the participant may elect a lump-sum
distribution. Death benefits are paid in a lump-sum distribution, the
amount of which depends on years of service. For the years ended December
31, 1997 and 1996, there was a net pension cost of approximately $56,000,
and $100,000, respectively. There was no net pension cost for the year
ended December 31, 1998.
36
<PAGE>
14. EARNINGS PER SHARE
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
-------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
<S> <C> <C> <C>
Basic EPS -
Income available to common stockholders $ 6,029,505 4,459,685 $ 1.35
Effect of dilutive securities -
Stock options -- 89,506
-------------- ----------
Diluted EPS -
Income available to common stockholders
and assumed conversions $ 6,029,505 4,549,191 $ 1.33
-------------- ----------
-------------- ----------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
-------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
<S> <C> <C> <C>
Basic EPS -
Income available to common stockholders $ 5,501,617 4,527,043 $ 1.22
Effect of dilutive securities -
Stock options -- 22,365
------------ ----------
Diluted EPS -
Income available to common stockholders
and assumed conversions $ 5,501,617 4,549,408 $ 1.21
------------- ----------
------------- ----------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
-------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
<S> <C> <C> <C>
Basic and Diluted EPS -
Income available to common stockholders $ 3,400,036 4,730,010 $ 0.72
</TABLE>
During the year ended December 31, 1996, there were no potential
dilutive securities.
15. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend
credit and standby letters of credit. Those instruments involve, to
varying degrees, elements of credit risk in excess of the amount
recognized in the consolidated statements of financial condition. The Bank
does not use financial instruments with off-balance sheet risk as part of
its asset/liability management program or for trading purposes. The Bank's
exposure to credit loss in the event of nonperformance by the other party
to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amounts of those
instruments. The Bank uses the same credit policies in making commitments
and conditional obligations as it does for on-balance sheet instruments.
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. The Bank evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary
by the Bank upon extension of credit, is based
37
<PAGE>
on management's credit evaluation of the counterparty. Such collateral
consists primarily of residential properties. Standby letters of credit
are conditional commitments issued by the Bank to guarantee the
performance of a customer to a third party. The credit risk involved in
issuing letters of credit is essentially the same as that involved in
extending loan facilities to customers.
The Bank had the following outstanding commitments at December 31, 1998
(in thousands):
<TABLE>
<S> <C>
Undisbursed construction loans $ 6,770
Commitments to originate mortgage loans 3,581
Letters of credit 53
Unused lines of credit 3,967
--------
Total $ 14,371
--------
--------
</TABLE>
The funding period for construction loans is generally less than nine
months and commitments to originate mortgage loans are generally
outstanding for 60 days or less. At December 31, 1998, interest rates on
commitments ranged from 5.75% to 10.00%.
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies.
However, considerable judgment is required to interpret market data to
develop the estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amounts the Company could
realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on
the estimated fair value amounts. The estimated fair values of financial
instruments are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
-------------------------------------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
<S> <C> <C> <C> <C>
ASSETS:
Cash and cash equivalents $ 26,163 $ 26,163 $ 6,627 $ 6,627
Investment securities -
Held to maturity 127,175 127,013 95,533 95,614
Federal Home Loan Bank stock 3,912 3,912 3,603 3,603
Loans receivable, net 442,486 448,755 433,942 438,775
Accrued interest receivable 4,755 4,755 4,134 4,134
LIABILITIES:
Deposits:
Demand, NOW, money
market and regular savings 102,328 102,328 90,731 90,731
Certificates of deposit 378,765 385,084 360,143 363,640
Federal Home Loan Bank advances 48,985 49,872 11,997 12,147
Accrued interest payable 665 665 526 526
Advance payments by borrowers
for taxes and insurance 1,006 1,006 900 900
Commitments -- -- -- --
</TABLE>
For cash and cash equivalents, Federal Home Loan Bank stock and accrued
interest receivable, the carrying value is a reasonable estimate of fair
value, primarily because of the short-term nature of the instruments or,
as to Federal Home Loan Bank stock, the ability to sell the stock back to
the Federal Home Loan Bank at cost. The fair value of investment
securities is based on quoted market prices, dealer quotes and prices
obtained from independent pricing services. The fair value of variable
rate loans are based on repricing dates. Fixed rate commercial loans and
installment loans were valued using discounted cash flows. The discount
rates used to determine the present value of these loans were based on
interest rates currently being charged by the Bank on comparable loans as
to credit risk and term.
38
<PAGE>
The fair value of demand deposit accounts, NOW accounts, savings accounts
and money market deposits is the amount payable on demand at the reporting
date. The fair value of fixed-maturity certificates of deposit and Federal
Home Loan Bank advances is estimated using the rates currently offered for
deposits and advances of similar remaining maturities at the reporting
date. For advance payments by borrowers for taxes and insurance and
accrued interest payable the carrying value is a reasonable estimate of
fair value, primarily because of the short-term nature of the instruments.
Commitments are generally made at prevailing interest rates at the time of
funding and, therefore, there is no difference between the contract amount
and fair value.
The fair value estimates presented herein are based on pertinent
information available to management as of December 31, 1998 and 1997.
Although management is not aware of any factors that would significantly
affect the estimated fair value amounts, such amounts have not been
comprehensively revalued for purposes of these financial statements since
the reporting date and, therefore, current estimates of fair value may
differ significantly from the amounts presented herein.
17. COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Company has various outstanding
commitments and contingent liabilities that are not reflected in the
accompanying consolidated financial statements (see Note 15). In addition,
the Company is a defendant in certain claims and legal actions arising in
the ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these matters
is not expected to have a material adverse effect on the consolidated
financial statements of the Company.
18. RETAINED EARNINGS - SUBSTANTIALLY RESTRICTED
Upon conversion, the Company established a special liquidation account for
the benefit of eligible account holders and the supplemental eligible
account holders in an amount equal to the net worth of the Bank as of the
date of its latest statement of financial condition contained in the final
offering circular used in connection with the conversion. The liquidation
account will be maintained for the benefit of eligible account holders and
supplemental eligible account holders who continue to maintain their
accounts in the Bank after conversion. In the event of a complete
liquidation (and only in such event), each eligible and supplemental
eligible account holder will be entitled to receive a liquidation
distribution from the liquidation account in an amount proportionate to
the current adjusted qualifying balances for accounts then held.
The Company may not declare or pay cash dividends on its shares of common
stock if the effect thereof would cause the Company's stockholders' equity
to be reduced below applicable regulatory capital maintenance requirements
for insured institutions or below the special liquidation account referred
to above.
19. REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements
administered by the Office of Thrift Supervision ("OTS"). Failure to meet
minimum capital requirements can initiate certain mandatory--and possible
additional discretionary--actions by regulators that, if undertaken, could
have a direct material effect on the Bank's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of the Bank's assets, liabilities, and
certain off-balance sheet items as
39
<PAGE>
calculated under regulatory accounting practices. The Bank's capital
amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
table below) of tangible capital (as defined in the regulations) to
tangible assets (as defined) and core capital (as defined) to adjusted
tangible assets (as defined), and of total risk-based capital (as defined)
to risk-weighted assets (as defined).
At December 31, 1998 and 1997, the most recent notification from the OTS
categorized the Bank as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well capitalized the
Bank must maintain minimum core (Tier I leverage), Tier I risk-based, and
total risk-based ratios as set forth in the table. There are no conditions
or events since that notification that management believes have changed
the Bank's category.
The Bank's actual capital amounts (in thousands) and ratios are also
presented in the table:
<TABLE>
<CAPTION>
TO BE CATEGORIZED
AS WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
--------------------- -------------------- ---------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998:
Tangible Capital to Tangible Assets $71,654 11.67 % $ 9,211 1.50 % N/A N/A
Core Capital to Adjusted Tangible Assets 71,654 11.67 % 18,423 3.00 % $30,705 5.00 %
Total Capital to Risk-Weighted Assets 72,334 22.44 % 25,786 8.00 % 32,233 10.00 %
Tier I Capital to Risk-Weighted Assets 71,654 22.23 % N/A N/A 19,340 6.00 %
As of December 31, 1997:
Tangible Capital to Tangible Assets $65,852 11.98 % $ 8,244 1.50 % N/A N/A
Core Capital to Adjusted Tangible Assets 65,852 11.98 % 16,488 3.00 % $27,480 5.00 %
Total Capital to Risk-Weighted Assets 66,619 22.52 % 23,661 8.00 % 29,576 10.00 %
Tier I Capital to Risk-Weighted Assets 65,852 22.27 % N/A N/A 17,746 6.00 %
</TABLE>
20. PARENT COMPANY ONLY FINANCIAL INFORMATION
The following condensed statements of financial condition, as of December
31, 1998 and 1997, and condensed statements of income and of cash flows
for the years ended December 31, 1998 and 1997, for First Federal
Bancshares of Arkansas, Inc. should be read in conjunction with the
consolidated financial statements and the notes herein.
40
<PAGE>
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF FINANCIAL CONDITION (IN THOUSANDS)
DECEMBER 31, 1998 AND 1997
- ----------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 1998 1997
<S> <C> <C>
Cash and cash equivalents (deposits in Bank) $ 85 $ 72
Loan to Bank subsidiary 8,573 17,793
Accrued interest receivable 35 82
Investment in Bank 71,654 65,852
Other assets 893 866
------- -------
TOTAL ASSETS $81,240 $84,665
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses and other liabilities $ 217 $ 1,781
Stockholders' equity 81,023 82,884
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $81,240 $84,665
------- -------
------- -------
</TABLE>
CONDENSED STATEMENTS OF INCOME (IN THOUSANDS)
YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
1998 1997
<S> <C> <C>
INCOME:
Interest income - investment securities $ -- $ 418
Interest income - loan to Bank 771 714
------- -------
Total income 771 1,132
EXPENSES:
Management fees 66 66
Other operating expenses 143 142
------- -------
Total expenses 209 208
------- -------
INCOME BEFORE INCOME TAX PROVISION AND EQUITY
IN UNDISTRIBUTED EARNINGS OF BANK SUBSIDIARY 562 924
INCOME TAX PROVISION 215 343
------- -------
INCOME BEFORE EQUITY IN UNDISTRIBUTED
EARNINGS OF BANK SUBSIDARY 347 581
EQUITY OF UNDISTRIBUTED EARNINGS OF
BANK SUBSIDIARY 5,683 4,921
------- -------
NET INCOME $6,030 $5,502
------- -------
------- -------
</TABLE>
41
<PAGE>
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
1998 1997
OPERATING ACTIVITIES:
<S> <C> <C>
Net income $ 6,030 $ 5,502
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed net income of Bank (5,683) (4,921)
Repayment of ESOP loan 980 830
Stock compensation expense 754 1,193
Changes in operating assets and liabilities:
Accrued interest receivable 47 128
Other assets (26) (688)
Accrued expenses and other liabilities (181) 133
-------- --------
Net cash provided by operating activities 1,921 2,177
-------- --------
INVESTING ACTIVITIES:
Loan to Bank, net of repayments 9,220 (8,525)
Proceeds from maturities of investment securities - held to maturity -- 9,987
-------- --------
Net cash provided by investing activities
9,220 1,462
-------- --------
FINANCING ACTIVITIES:
Purchase of treasury stock (7,977) --
Common stock acquired for employee stock benefit plan (1,817) (2,539)
Dividends paid (1,334) (1,077)
-------- --------
Net cash used in financing activities (11,128) (3,616)
-------- --------
NET INCREASE IN CASH AND CASH EQUIVALENTS 13 23
CASH AND CASH EQUIVALENTS:
Beginning of period 72 49
-------- --------
End of period $ 85 $ 72
-------- --------
-------- --------
</TABLE>
* * * * * *
42
<PAGE>
FIRST FEDERAL BANCSHARES OF ARKANSAS, INC.
FIRST FEDERAL BANK OF ARKANSAS, FA
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DIRECTORS EXECUTIVE OFFICERS
<S> <C>
FRANK L. COFFMAN, JR. FRANK L. COFFMAN, JR.
Chairman of the Board and Chairman of the Board and
Chief Executive Officer Chief Executive Officer
LARRY J. BRANDT LARRY J. BRANDT
President and Chief Operating President and Chief Operating
Officer Officer
JOHN P. HAMMERSCHMIDT CAROLYN M. THOMASON
U. S. Congressman, Retired Executive Vice President and Secretary
JAMES D. HEUER TOMMY W. RICHARDSON
Farming and Investments Senior Vice President and Chief Financial Officer
WILLIAM F. SMITH SHERRI R. BILLINGS
Retired Pharmacist and Investments Senior Vice President and Treasurer
</TABLE>
BANKING LOCATIONS
- --------------------------------------------------------------------------------
MAIN OFFICE
200 West Stephenson
Harrison, Arkansas 72601
BRANCH OFFICES
<TABLE>
<CAPTION>
<S> <C> <C>
128 West Stephenson Ozark Mall - Highway 62-65 North 301 Highway 62 West
Harrison, Arkansas 72601 Harrison, Arkansas 72601 Yellville, Arkansas 72687
Corner Central & Willow 324 Highway 62-65 Bypass 307 North Walton Blvd.
Harrison, Arkansas 72601 Harrison, Arkansas 72601 Bentonville, Arkansas 72712
210 South Main 1303 West Hudson 3460 North College
Berryville, Arkansas 72616 Rogers, Arkansas 72756 Fayetteville, Arkansas 72703
668 Highway 62 East 201 East Henri De Tonti Blvd. 2025 North Crossover Road
Mountain Home, Arkansas 72653 Tontitown, Arkansas 72762 Fayetteville, AR 72703
1337 Hwy 62 SW 249 West Main Street
Mountain Home, Arkansas 72653 Farmington, AR 72730
</TABLE>
43
<PAGE>
STOCKHOLDER INFORMATION
- --------------------------------------------------------------------------------
First Federal Bancshares of Arkansas, Inc. is a unitary savings and loan
holding company conducting business through its wholly-owned subsidiary, First
Federal Bank of Arkansas, FA. The Bank is a federally-chartered, SAIF- insured
savings institution operating through its main office and eleven full service
branch offices. The Company's and the Bank's principal executive office is
located at 200 West Stephenson, Harrison, Arkansas 72601.
TRANSFER AGENT/REGISTRAR
Registrar and Transfer Company
10 Commerce Drive
Cranford, New Jersey 07016
Phone: (800) 368-5948
- --------------------------------------------------------------------------------
STOCKHOLDER REQUESTS
Request for annual reports, quarterly reports and related stockholder literature
should be directed to Investor Relations, First Federal Bancshares of Arkansas,
Inc., P. O. Box 550, Harrison, Arkansas 72602.
Stockholders needing assistance with stock records, transfers or lost
certificates, should contact the Company's transfer agent, Registrar and
Transfer Company, at the telephone number listed above.
- --------------------------------------------------------------------------------
COMMON STOCK INFORMATION
Shares of the Company's common stock are traded under the symbol "FFBH"
on the Nasdaq National Market System. At March 15, 1999, the Company had
4,418,697 shares of common stock outstanding and had approximately 1,291
stockholders of record. Such holdings do not reflect the number of beneficial
owners of common stock.
The following table sets forth the reported high and low sale prices of
a share of the Company's common stock as reported by Nasdaq for the periods
indicated.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
QUARTER YEAR ENDED YEAR ENDED
ENDED DECEMBER 31, 1998 DECEMBER 31, 1997
- -----------------------------------------------------------------------------------------------------------
High Low Dividend High Low Dividend
--------------- ------------ ------------- ----------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
MARCH 31 $30.25 $22.75 $0.07 $20.38 $15.88 $0.05
JUNE 30 30.13 26.31 0.07 20.63 17.38 0.05
SEPTEMBER 30 26.31 18.50 0.07 21.75 20.13 0.06
DECEMBER 31 21.00 16.00 0.07 24.38 20.00 0.06
- -----------------------------------------------------------------------------------------------------------
</TABLE>
44
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 8,842
<INT-BEARING-DEPOSITS> 17,321
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 127,175
<INVESTMENTS-MARKET> 127,013
<LOANS> 443,257
<ALLOWANCE> 771
<TOTAL-ASSETS> 615,055
<DEPOSITS> 481,093
<SHORT-TERM> 19,000
<LIABILITIES-OTHER> 2,996
<LONG-TERM> 29,985
0
0
<COMMON> 33,345
<OTHER-SE> 47,678
<TOTAL-LIABILITIES-AND-EQUITY> 615,055
<INTEREST-LOAN> 35,762
<INTEREST-INVEST> 7,802
<INTEREST-OTHER> 250
<INTEREST-TOTAL> 43,814
<INTEREST-DEPOSIT> 24,004
<INTEREST-EXPENSE> 25,774
<INTEREST-INCOME-NET> 18,040
<LOAN-LOSSES> 55
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 10,482
<INCOME-PRETAX> 9,339
<INCOME-PRE-EXTRAORDINARY> 6,030
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,030
<EPS-PRIMARY> 1.35
<EPS-DILUTED> 1.33
<YIELD-ACTUAL> 7.78
<LOANS-NON> 1,464
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 1,373
<ALLOWANCE-OPEN> 1,196
<CHARGE-OFFS> 489
<RECOVERIES> 9
<ALLOWANCE-CLOSE> 771
<ALLOWANCE-DOMESTIC> 388
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 383
</TABLE>
