UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _____________________ to ________________________
Commission file number 0-22103
HEMLOCK FEDERAL FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
Delaware 36-4126192
- -------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
5700 West 159th Street, Oak Forest , Illinois 60452
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (708) 687-9400
-----------------------
Securities Registered Pursuant to Section 12(b) of the Act:
None
----
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
--------------------------------------
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such requirements for the past 90 days.
YES [X] NO [ ]
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained herein, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
State issuer's revenues for its most recent fiscal year: $11.8 million
million.
The aggregate market value of the voting stock held by non-affiliates of
the registrant, computed by reference to the average of the bid and asked prices
of such stock on the Nasdaq Stock Market as of March 20, 1998, was $31.0
million. (The exclusion from such amount of the market value of the shares owned
by any person shall not be deemed an admission by the registrant that such
person is an affiliate of the registrant.)
As of March 20, 1998, there were issued and outstanding 2,006,849 shares of
the Issuer's Common Stock.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
DOCUMENTS INCORPORATED BY REFERENCE
Parts II and IV of Form 10-KSB - Annual Report to Stockholders for the
fiscal year ended December 31, 1997. Part III of Form 10-KSB - Proxy Statement
for 1998 Annual Meeting of Stockholders.
<PAGE>
PART I
Item 1. Business
General
Hemlock Federal Financial Corporation ("Hemlock" or the "Company") was
formed in 1997 by Hemlock Federal Bank for Savings ("Hemlock Federal" or the
"Bank") under the laws of Delaware for the purpose of becoming the savings and
loan holding company of the Bank. The Company's business consists primarily of
the business of Hemlock Federal.
Hemlock Federal is a federally chartered stock savings bank
headquartered in Oak Forest, Illinois. Hemlock Federal was originally chartered
in 1904. In 1959, Hemlock Federal converted to a federal mutual charter. In 1997
Hemlock Federal converted from a mutual to a federally chartered stock savings
bank. Hemlock Federal currently serves the financial needs of communities in its
market area through its main office located in Oak Forest, Illinois and its two
branch offices located in the village of Oak Lawn and Chicago. Its deposits are
insured up to applicable limits by the Federal Deposit Insurance Corporation
("FDIC"). At December 31, 1997, Hemlock Federal had total assets of $176.68
million, deposits of $130.96 million and equity of $30.43 million (or 17.22% of
total assets).
Hemlock Federal has been, and intends to continue to be, an
independent, community oriented, financial institution. Hemlock Federal's
business involves attracting deposits from the general public and using such
deposits, together with other funds, to originate primarily one- to four-family
residential mortgages and, to a much lesser extent, multi-family, consumer and
other loans primarily in its market area. At December 31, 1997, $68.28 million,
or 88.94%, of the Bank's total loan portfolio consisted of one- to four-family
residential mortgage loans. The Bank also invests in mortgage-backed and other
securities and other permissible investments.
The executive offices of the Bank are located at 5700 West 159 th
Street, Oak Forest, Illinois 60452-3198 and its telephone number is (708)
687-9400. Unless the context otherwise requires all references herein to the
Bank or the Company include the Company and the Bank on a consolidated basis.
Lending Activities
General. The principal lending activity of the Bank is originating for
its portfolio fixed and to a lesser extent, adjustable rate ("ARM") mortgage
loans secured by one- to four-family residences located primarily in the Bank's
market area. To a much lesser extent, Hemlock Federal also originates
multi-family real estate, consumer and other loans in its market area. At
December 31, 1997, the Bank's loans receivable, net totaled $76.16 million.
Under federal law, the aggregate amount of loans that the Bank is
permitted to make to any one borrower is generally limited to 15% of unimpaired
capital and surplus (25% if the security
2
<PAGE>
for such loan has a "readily ascertainable" value or 30% for certain residential
development loans). At December 31, 1997, based on the above, the Bank's
regulatory loans-to-one borrower limit was approximately $4.42 million. On the
same date, the Bank had no borrowers with outstanding balances in excess of this
amount. As of December 31, 1997, the largest dollar amount outstanding or
committed to be lent to one borrower or, group of related borrowers, related to
a multi-family loan totaling $408,000 secured by a 12-unit apartment building
located in Chicago Ridge, Illinois. At December 31, 1997, this loan was
performing in accordance with its terms. As of December 31, 1997, there were no
other loans with carrying values in excess of $300,000.
All of the Bank's lending is subject to its written underwriting
standards and to loan origination procedures. Decisions on loan applications are
made on the basis of detailed applications and property valuations (consistent
with the Bank's appraisal policy). The loan applications are designed primarily
to determine the borrower's ability to repay and the more significant items on
the application are verified through use of credit reports, financial
statements, tax returns or confirmations. All loans originated by Hemlock
Federal are approved by the loan committee currently comprised of Chairman
Partynski, President Stevens, Director Bucz and Chief Lending Officer Neil
Christenson and ratified by the full Board of Directors.
The Bank requires title insurance or other evidence of title on its
mortgage loans, as well as fire and extended coverage casualty insurance in
amounts at least equal to the principal amount of the loan or the value of
improvements on the property, depending on the type of loan. The Bank also
requires flood insurance to protect the property securing its interest when the
property is located in a flood plain.
3
<PAGE>
Loan Portfolio Composition. The following table sets forth the
composition of the Bank's loan portfolio in dollar amounts and in percentages
(before deductions (or additions) for loans in process, deferred fees (premiums)
and discounts and allowances for losses) as of the dates indicated.
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------- ------------------- ------------------ ------------------ -------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
Real Estate Loans:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family $ 68,283 88.94% $ 48,339 89.05% $ 39,089 85.08% $ 30,792 80.45% $ 28,378 75.59%
Multi-family ....... 4,951 6.45 2,783 5.13 3,386 7.37 3,742 9.78 4,035 10.75
Commercial ......... 209 .27 573 1.06 1,101 2.40 1,566 4.09 2,020 5.38
Construction or
development ....... -- -- -- -- -- -- -- -- 502 1.34
-------- ------- -------- ------ ------- ------ -------- ------ -------- -----
Total real
estate loans ..... 73,443 95.66 51,695 95.24 43,576 94.85 36,100 94.32 34,935 93.06
Consumer loans:
Deposit account .... 116 .15 169 .31 158 0.34 150 0.39 172 0.46
Automobile ......... 473 .62 301 .55 229 0.50 120 0.31 223 0.59
Home equity ........ 2,740 3.57 2,114 3.90 1,981 4.31 1,908 4.98 2,211 5.89
-------- ------- -------- ------ ------- ------ -------- ------ -------- -----
Total consumer
loans ............ 3,329 4.34 2,584 4.76 2,368 5.15 2,178 5.68 2,606 6.94
-------- ------- -------- ------ ------- ------ -------- ------ -------- -----
Total loans ...... 76,772 100.00% 54,279 100.00% 45,944 100.00% 38,278 100.00% 37,541 100.00%
======= ======= ====== ======= ======
Less:
Loans in process ... (125) -- (28) -- (82)
Deferred fees
and discounts .... 287 2 (84) (150) (184)
Allowance for losses (775) (745) (600) (469) (234)
--------- -------- ------- -------- --------
Total loans
receivable, net .. $ 76,159 $53,536 $45,232 $37,659 $37,041
======== ======== ======= ======= ========
</TABLE>
4
<PAGE>
The following table shows the composition of the Bank's loan portfolio
by fixed- and adjustable-rate at the dates indicated.
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------ ------------------ ----------------- ----------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
Fixed-Rate Loans:
Real estate:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family...........$50,671 66.00% $43,583 80.29% $36,358 79.14% $28,654 74.86% $25,480 67.87%
Multi-family.................. 4,767 6.21 2,783 5.13 3,386 7.37 3,742 9.78 4,035 10.75
Commercial.................... 209 .27 573 1.06 1,101 2.40 1,566 4.09 2,020 5.38
Construction or development... --- --- --- --- --- --- --- --- 502 1.34
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total real estate loans..... 55,647 72.48 46,939 86.48 40,845 88.91 33,962 88.73 32,037 85.34
Consumer...................... 3,329 4.34 2,584 4.76 2,368 5.15 2,178 5.68 2,606 6.94
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total fixed-rate loans...... 58,976 76.82 49,523 91.24 43,213 94.06 36,140 94.41 34,643 92.28
Adjustable-Rate Loans
Real estate:
One-to four-family............ 17,612 22.94 4,756 8.76 2,731 5.94 2,138 5.59 2,898 7.72
Multi-family.................. 184 .24 --- --- --- --- --- --- --- ---
------- ------ ------- ------ ------- ------ ------- ------ ------ ------
Total adjustable rate loans... 17,796 23.18 4,756 8.76 2,731 5.94 2,138 5.59 2,898 7.72
------ ----- ------- ------- ------- ------ ------- ------ ------ ------
Total loans................. 76,772 100.00% 54,279 100.00% 45,944 100.00% 38,278 100.00% 37,541 100.00%
====== ====== ====== ====== ======
Less:
Loans in process.............. (125) --- (28) --- (82)
Deferred fees and discounts... 287 2 (84) (150) (184)
Allowance for losses.......... (775) (745) (600) (469) (234)
------- ------- ------- ------- -------
Total loans receivable, net..$76,159 $53,536 $45,232 $37,659 $37,041
======= ======= ======= ======= =======
</TABLE>
5
<PAGE>
The following schedule illustrates the contractual maturity of the
Bank's loan portfolio at December 31, 1997. Mortgages which have adjustable or
renegotiable interest rates are shown as maturing in the period during which the
contract is due. The schedule does not reflect the effects of possible
prepayments or enforcement of due-on-sale clauses.
<TABLE>
<CAPTION>
Real Estate
---------------------------------------------
Multi-family and
Commercial Real
One- to four-family Estate Consumer Total
--------------------- -------------------- -------------------- -------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Amount Rate Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ---- ------ ----
(Dollars in Thousands)
Due During Year(s) Ended
December 31,
- -------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1998(1)........................ $ 4 7.78% $ 11 7.64% $ 157 9.99% $ 172 9.33%
1999 and 2000.................. 44 10.96 77 12.50 517 8.74 638 9.35
2001 to 2005................... 10,014 7.51 858 8.67 1,767 8.47 12,639 7.73
2006 to 2020................... 35,789 7.52 3,500 8.30 888 8.50 40,177 7.61
2021 and following............. 22,432 7.72 714 8.43 -- -- 23,146 7.74
------ ------- ------ -------
Total...................... $68,283 $5,160 $3,329 $76,772
======= ====== ====== =======
</TABLE>
- -------------
(1) Included demand loans, loans having no stated maturity and overdraft loans.
The total amount of loans due after December 31, 1998 which have
predetermined interest rates is $58.80 million while the total amount of loans
due after such dates which have floating or adjustable interest rates is $17.80
million.
6
<PAGE>
One- to Four-Family Residential Real Estate Lending. The cornerstone of
the Bank's lending program is the origination of loans secured by mortgages on
owner-occupied one- to four-family residences. Historically, the Bank focused
its residential lending activities on fixed rate loans with 30 year terms. In
the 1980s, in order to reduce the average term to repricing of its assets, the
Bank began to stress also the origination of 15 year fixed rate loans as well as
adjustable rate loans. Substantially all of the Bank's one- to four-family
residential mortgage originations are secured by properties located in its
market area. All mortgage loans currently originated by the Bank are retained
and serviced by it, although the Bank may consider selling a portion of its
residential loan originations in the future.
The Bank currently offers fixed-rate mortgage loans with maturities
from 10 to 30 years. The Bank also offers a fixed rate seven year balloon
product with a 30 year amortization schedule which is due in seven years but
which, under certain circumstances, may be converted into a fully amortizing
fixed rate loan for an additional term of up to 23 years. Interest rates and
fees charged on these fixed-rate loans are established on a regular basis
according to market conditions. As of December 31, 1997, the Bank had $8.17
million of fixed rate loans (most of which were seven year balloon loans) with
original terms of less than 10 years, $23.72 million of fixed rate loans with
original terms of 10-15 years and $18.78 million of fixed rate loans with
original terms of more than 15 years. See "--Originations, Purchases and Sales
and Loans and Mortgage-Backed Securities."
The Bank also offers ARMs which carry interest rates which adjust
annually at a margin (generally 250 basis points) over the yield on the One Year
Average Monthly U.S. Treasury Constant Maturity Index ("one year CMT"). Such
loans may carry terms to maturity of up to 30 years. The ARM loans currently
offered by the Bank provide for up to 200 basis point annual interest rate
change cap and a lifetime cap generally 600 basis points over the initial rate.
Initial interest rates offered on the Bank's ARMs may be approximately 100 basis
points below the fully indexed rate, although borrowers are qualified at the
fully indexed rate. As a result, the risk of default on these loans may increase
as interest rates increase. The Bank also originates ARMs which carry interest
rates which are fixed for an initial term of up to three years and subsequently
adjust annually to a margin over the one-year CMT. The Bank's ARMs do not permit
negative amortization of principal, do not contain prepayment penalties and may
be convertible into fixed-rate loans. At December 31, 1997, one- to four-family
ARMs totaled $17.61 million or 22.94% of the Bank's total loan portfolio.
Hemlock Federal will generally lend up to 90% of the lesser of the
sales price or appraised value of the security property on owner occupied one-
to four-family loans. The loan-to-value ratio on non-owner occupied, one- to
four-family loans is generally 80% of the lesser of the sales price or appraised
value of the security property. Non-owner occupied one- to four-family loans may
pose a greater risk to the Bank than traditional owner occupied one- to
four-family loans. In underwriting one- to four-family residential real estate
loans, the Bank currently evaluates both the borrower's ability to make
principal, interest and escrow payments, the value of the property that will
secure the loan and debt to income ratios.
7
<PAGE>
Residential loans do not currently include prepayment penalties, are
non-assumable and do not produce negative amortization. Although the Bank
currently originates mortgage loans only for its portfolio, the Bank's loans are
generally underwritten to permit their sale in the secondary market, except for
loans with loan to value ratios below 75% which are underwritten for portfolio
with a limited property evaluation rather than full appraisal.
While the Bank seeks to originate most of its one- to four-family
residential loans in amounts which are less than or equal to the applicable
Federal Home Loan Mortgage Corporation maximum (currently $214,500), the Bank
does, on an exception basis, make one- to four-family residential loans in
amounts in excess of such maximum. The Bank's delinquency experience on such
loans has been similar to its experience on its other residential loans.
The Bank's residential mortgage loans customarily include due-on-sale
clauses giving the Bank the right to declare the loan immediately due and
payable in the event that, among other things, the borrower sells or otherwise
disposes of the property subject to the mortgage and the loan is not repaid.
Multi-family and Commercial Real Estate Lending. In order to increase
the yield of its loan portfolio and to complement residential lending
opportunities, the Bank from time to time originates permanent multi-family real
estate loans secured by properties in its primary market area. The Bank made a
strategic decision in the early 1990s to eliminate its commercial real estate
lending program. At December 31, 1997, the Bank had multi-family loans totaling
$4.95 million, or 6.45% of the Bank's total loan portfolio, and $209,000 in
commercial real estate loans, representing .27% of the total loan portfolio.
The Bank's permanent multi-family real estate loans generally carry a
maximum term of 15 years and have fixed rates. These loans are generally made in
amounts of up to 80% of the lesser of the appraised value or the purchase price
of the property. Appraisals on properties securing multi-family and commercial
real estate loans are performed by an independent appraiser designated by the
Bank at the time the loan is made. All appraisals on multi-family real estate
loans are reviewed by the Bank's loan committee. In addition, the Bank's
underwriting procedures require verification of the borrower's credit history,
income and financial statements, banking relationships, references and income
projections for the property. The Bank obtains personal guarantees on these
loans.
At December 31, 1997, the Bank's largest commercial real estate or
multi-family loan outstanding totaled $408,000 and was secured by a 12-unit
apartment building in Chicago Ridge, Illinois.
Multi-family and commercial real estate loans may present a higher
level of risk than loans secured by one- to four-family residences. This greater
risk is due to several factors, including the concentration of principal in a
limited number of loans and borrowers, the effects of general economic
conditions on income producing properties and the increased difficulty of
evaluating and monitoring these types of loans. While the Bank has experienced
losses on several multi-family
8
<PAGE>
and commercial real estate loans in the past, as of December 31, 1997, there
were no multi-family loans or commercial real estate loans delinquent 90 days or
more.
Consumer Lending. Management believes that offering consumer loan
products helps to expand the Bank's customer base and to create stronger ties to
its existing customer base. In addition, because consumer loans generally have
shorter terms to maturity and carry higher rates of interest than do residential
mortgage loans, they can be valuable asset/liability management tools. The Bank
originates a variety of different types of consumer loans, including home equity
loans, automobile and deposit account loans for household and personal purposes.
Due to the tax advantages to the borrower of home equity loans, the Bank has
focused its recent consumer lending activities on home equity lending. At
December 31, 1997 consumer loans totaled $3.33 million or 4.34% of total loans
outstanding.
Consumer loan terms vary according to the type and value of collateral,
length of contract and creditworthiness of the borrower. The Bank's consumer
loans are made at fixed interest rates, with terms of up to 10 years.
The Bank's home equity loans are written so that the total commitment
amount, when combined with the balance of the first mortgage lien, may not
exceed 85% of the appraised value of the property or $50,000. These loans are
written with fixed terms of up to 10 years and carry fixed interest rates. At
December 31, 1997, the Bank's home equity loans totaled $2.74 million
outstanding, or 3.57% of the Bank's total loan portfolio.
The underwriting standards employed by the Bank for consumer loans
include a determination of the applicant's payment history on other debts and
ability to meet existing obligations and payments on the proposed loan. Although
creditworthiness of the applicant is of primary consideration, the underwriting
process also includes a comparison of the value of the security, if any, in
relation to the proposed loan amount. Consumer loans may entail greater credit
risk than do residential mortgage loans, particularly in the case of consumer
loans which are unsecured or are secured by rapidly depreciable assets, such as
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.
In addition, consumer loan collections are dependent on the borrower's
continuing financial stability, and thus are more likely to be affected by
adverse personal circumstances. Furthermore, the application of various federal
and state laws, including bankruptcy and insolvency laws, my limit the amount
which can be recovered on such loans.
Originations of Loans
Real estate loans are originated by Hemlock Federal's staff through
referrals from existing customers or real estate agents. In the early 1990s, the
Bank determined to increase its one- to four-family residential loan marketing
activities and to hire several commissioned loan underwriters. As a result, the
Bank has experienced significant loan growth in recent years.
9
<PAGE>
The Bank's ability to originate loans is dependent upon customer demand
for loans in its market and to a limited extent, various marketing efforts and
its ability to hire commissioned loan officers. Demand is affected by both the
local economy and the interest rate environment. See "- Market Area." Under
current policy, all loans originated by Hemlock Federal are retained in the
Bank's portfolio. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Asset/Liability Management" in the Annual
Report attached hereto as Exhibit 13.
In order to supplement loan originations, the Bank has acquired a
substantial amount of mortgage-backed and other securities which are held,
depending on the investment intent, in the "held-to-maturity" or
"available-for-sale" portfolios. See "Investment Activities - Mortgage- Backed
and Related Securities." In addition, depending on market conditions, the Bank
may also consider the purchase of residential loans from other lenders, although
it has not done so in the 1990s.
As a result in large part of the Bank's relatively low loans to
deposits ratios since the early 1980s, the Bank has not sold any loans in the
secondary market for many years. In view of the apparent success of the Bank's
recent loan origination efforts and the related increases in its loans to
deposits ratio, the Bank may consider the sale of a portion of its residential
loan originations in the future.
10
<PAGE>
The following table shows the loan origination and repayment activities
of the Bank for the periods indicated.
Year Ended
December 31,
--------------------------------
1997 1996 1995
---- ---- ----
(In Thousands)
Originations by type:
Adjustable rate:
Real estate - one- to four-family ......... $ 1,852 $ 2,569 $ 1,042
- multi-family ................ 185 -- --
-------- -------- --------
Total adjustable-rate ................. 2,037 2,569 1,042
Fixed rate:
Real estate - one- to four-family ......... 12,782 11,439 10,670
- multi-family ................ 2,358 404 534
Non-real estate - consumer ................ 2,158 1,308 1,363
-------- -------- --------
Total fixed-rate ...................... 17,298 13,151 12,567
-------- -------- --------
Total loans originated ................ 19,335 15,720 13,609
Purchases;
Real estate - one- to four-family ......... 12,607 -- --
Principal repayments ........................ (9,449) (7,385) (5,943)
-------- -------- --------
Total reductions ...................... (9,449) (7,385) (5,943)
Increase (decrease) in other items, net ..... 130 (31) (93)
-------- -------- --------
Net increase .......................... $ 22,623 $ 8,304 $ 7,573
======== ======== ========
Delinquencies and Non-Performing Assets
Delinquency Procedures. When a borrower fails to make a required
payment on a loan, the Bank attempts to cure the delinquency by contacting the
borrower. Generally, Bank personnel work with the delinquent borrower on a case
by case basis to solve the delinquency. Generally, a late notice is sent on all
delinquent loans followed by a phone call after the thirtieth day of
delinquency. Additional written and verbal contacts may be made with the
borrower between 30 and 60 days after the due date. If the loan is contractually
delinquent for 90 days, the Bank may institute appropriate action to foreclose
on the property. After 120 days, foreclosure procedures are initiated. If
foreclosed, the property is sold at public sale and may be purchased by the
Bank.
Real estate acquired by Hemlock Federal as a result of foreclosure or
by deed in lieu of foreclosure is classified as real estate owned until it is
sold. When property is acquired by foreclosure or deed in lieu of foreclosure,
it is recorded at the lower of cost or fair value less estimated selling costs.
After acquisition, all costs incurred in maintaining the property are expensed.
Costs relating to the development and improvement of the property, however, are
capitalized.
11
<PAGE>
Delinquent Loans. The following table sets forth information concerning
delinquent mortgage and other loans at December 31, 1997. The amounts presented
represent the total remaining principal balances of the related loans, rather
than the actual payment amounts which are overdue. Percentages are exclusive of
mortgage-backed securities.
<TABLE>
<CAPTION>
Real Estate
---------------------------------------------------------
One- to four-family Commercial/Multi-Family Consumer and Other
--------------------------- --------------------------- --------------------------
Number Amount Percent Number Amount Percent Number Amount Percent
------ ------ ------- ------ ------ ------- ------ ------ -------
(Dollars in Thousands)
Loans delinquent for:
December 31, 1997:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
30-59 days................. -- $ -- --% -- $ -- --% -- $ -- --%
60-89 days................. 3 132 .19 -- --
90 days and over........... 3 256 .38 -- -- -- -- -- --
---- ----- ---- ---- ------ ---- ---- ----- ----
Total.................. 6 $ 388 .57% -- $ -- --% -- $ -- --%
==== ===== ==== ==== ====== ===== ==== ===== ====
</TABLE>
Total
-------------------------------
Number Amount Percent
------ ------ -------
Loans delinquent for:
December 31, 1997:
30-59 days................. -- $ -- --%
60-89 days................. 3 132 .19
90 days and over........... 3 256 .38
----- ----- ----
Total.................. 6 $ 388 .57%
===== ===== ====
12
<PAGE>
Classification of Assets. Federal regulations require that each savings
institution classify its own assets on a regular basis. In addition, in
connection with examinations of savings institutions, OTS and FDIC examiners
have authority to identify problem assets and, if appropriate, require them to
be classified. There are three classifications for problem assets: Substandard,
Doubtful and Loss. Substandard assets have one or more defined weaknesses and
are characterized by the distinct possibility that the Bank will sustain some
loss if the deficiencies are not corrected. Doubtful assets have the weaknesses
of Substandard assets, with the additional characteristics that the weaknesses
make collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified Loss is considered uncollectible and of such little value that
continuance as an asset on the balance sheet of the institution is not
warranted. Assets classified as Substandard or Doubtful require the institution
to establish prudent general allowances for loan losses. If an asset or portion
thereof is classified as a loss, the institution charges off such amount against
the loan loss allowance. If an institution does not agree with an examiner's
classification of an asset, it may appeal this determination to the District
Director of the OTS.
On the basis of management's review of its assets, at December 31,
1997, the Bank had classified a total of $284,000 of its loans and other assets
as follows:
December 31, 1997
-----------------
(In Thousands)
Special Mention...................... $ 208
Substandard.......................... 76
Doubtful............................. --
Loss................................. --
--------
Total........................... 284
========
General loss allowance............... 775
========
Specific loss allowance.............. --
========
Charge-offs.......................... --
========
13
<PAGE>
Non-Performing Assets. The table below sets forth the amounts and
categories of non-performing assets in the Bank's loan portfolio. Foreclosed
assets include assets acquired in settlement of loans.
December 31,
--------------------------------
1997 1996 1995
---- ---- ----
(Dollars in Thousands)
Non-accruing loans:
One- to four-family ............... $256 $ -- $110
Multi-family ...................... -- -- --
Commercial real estate ............ -- -- --
Construction or development ....... -- -- --
Consumer .......................... -- -- --
---- -------- ----
Total ........................ 256 -- 110
Accruing loans delinquent
more than 90 days:
One- to four-family ............... -- -- --
Multi-family ...................... -- -- --
Commercial real estate ............ -- -- --
Construction or development ....... -- -- --
Consumer .......................... -- -- --
---- -------- ----
Total ........................ -- -- --
Foreclosed assets:
One- to four-family ............... -- -- --
Multi-family ...................... -- -- --
Commercial real estate ............ -- -- --
Construction or development ....... -- -- --
Consumer .......................... -- -- --
---- -------- ----
Total ........................ -- -- --
Renegotiated loans .................. -- -- 469(1)
---- -------- ----
Total non-performing assets ......... $256 $ -- $579
==== ======== ====
Total as a percentage of
total assets ..................... .15% --% 0.40%
==== ======== ====
- ----------
(1) Consisted of a 24% interest in a loan on a Comfort Inn located in Downers
Grove, Illinois. The loan terms were renegotiated in 1994. The loan has
been current since the renegotiation date.
For the years ended December 31, 1997 and 1996, gross interest income
which would have been recorded had the non-accruing loans been current in
accordance with their original terms amounted to $19,713 and $0, respectively.
The amounts that were included in interest income on such loans were $13,165 and
$0 for the years ended December 31, 1997 and 1996, respectively.
14
<PAGE>
Management considers the Bank's non-performing and "of concern" assets
in establishing its allowance for loan losses.
The following table sets forth an analysis of the Bank's allowance for
loan losses.
Year Ended December 31,
----------------------------
1997 1996 1995
---- ---- ----
(Dollars in Thousands)
Balance at beginning of period ............. $745 $ 600 $ 469
Charge-offs:
One- to four-family ...................... -- 5 --
Multi-family ............................. -- -- --
Commercial real estate ................... -- -- --
Consumer ................................. -- -- 3
---- ----- -----
-- 5 3
---- ----- -----
Recoveries:
One- to four-family ...................... -- -- --
Multi-family ............................. -- -- --
Commercial real estate ................... -- -- --
Consumer ................................. -- -- --
---- ----- -----
-- -- --
---- ----- -----
Net charge-offs ............................ -- (5) (3)
Additions charged to operations ............ 30 150 134
---- ----- -----
Balance at end of period ................... $775 $ 745 $ 600
==== ===== =====
Ratio of net charge-offs
(recoveries) during the
period to average loans
outstanding during the
period .................................... --% 0.01% 0.01%
==== ===== =====
Ratio of net charge-offs
(recoveries) during the
period to average
non-performing assets ..................... --% 3.52% 2.70%
==== ===== ====
15
<PAGE>
The distribution of the Bank's allowance for losses on loans at the
dates indicated is summarized as follows:
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------- ------------------------------ ------------------------------
Percent Percent Percent
of loans of loans of loans
Amount Loan in Each Amount Loan in Each Amount Loan in Each
of loan Amounts Category of loan Amounts Category of loan Amounts Category
loss by of Total loss by of Total loss by of Total
Allowance Category Loans Allowance Category Loans Allowance Category Loans
--------- -------- ----- --------- -------- ----- --------- -------- -----
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family..... $341 $68,283 88.94% $242 $48,339 89.05% $195 $39,089 85.08%
Multi-family............ 149 4,951 6.45 83 2,783 5.13 102 3,386 7.37
Commercial real estate.. 11 209 .27 29 573 1.06 55 1,101 2.40
Construction or -- -- -- -- -- -- -- --- --
development............
Consumer................ 18 3,329 4.34 13 2,584 4.76 12 2,368 5.15
Unallocated............. 256 -- -- 378 -- -- 236 --- --
----- ------- ------ ---- ------- ------- ---- ------- ------
Total.............. $775 $76,772 100.00% $745 $54,279 100.00% $600 $45,944 100.00%
==== ======= ====== ==== ======= ====== ==== ======= ======
</TABLE>
December 31,
-------------------------------
Percent
of loans
Amount Loan in Each
of loan Amounts Category
loss by of Total
Allowance Category Loans
--------- -------- -----
(In Thousands)
One- to four-family..... $ 62 $30,792 80.45%
Multi-family............ 37 3,742 9.78
Commercial real estate.. 47 1,566 4.09
Construction or -- -- --
development............
Consumer................ 5 2,178 5.68
Unallocated............. 318 -- --
---- ------- ------
Total.............. $469 $38,278 100.00%
==== ======= ======
16
<PAGE>
The allowance for loan losses is established through a provision for
loan losses charged to earnings based on management's evaluation of the risk
inherent in its entire loan portfolio. Such evaluation, which includes a review
of all loans of which full collectibility may not be reasonably assured,
considers the market value of the underlying collateral, growth and composition
of the loan portfolio, delinquency trends, adverse situations that may affect
the borrower's ability to repay, prevailing and projected economic conditions
and other factors that warrant recognition in providing for an adequate
allowance for loan losses. In determining the general reserves under these
policies, historical charge-offs and recoveries, changes in the mix and levels
of the various types of loans, net realizable values, the current and
prospective loan portfolio and current economic conditions are considered.
While management believes that it uses the best information available
to determine the allowance for loan losses, unforeseen economic and market
conditions could result in adjustments to the allowance for loan losses, and net
earnings could be significantly affected, if circumstances differ substantially
from the assumptions used in making the final determination.
Investment Activities
General. Hemlock Federal must maintain minimum levels of investments
and other assets that qualify as liquid assets under OTS regulations. Liquidity
may increase or decrease depending upon the availability of funds and
comparative yields on investments in relation to the return on loans.
Historically, Hemlock Federal has maintained liquid assets at levels
significantly above the minimum requirements imposed by the OTS regulations and
above levels believed adequate to meet the requirements of normal operations,
including potential deposit outflows. At December 31, 1997, Hemlock Federal's
liquidity ratio for regulatory purposes was 18.86%.
Generally, the investment policy of Hemlock Federal is to invest funds
among categories of investments and maturities based upon the Bank's
asset/liability management policies, investment quality, loan and deposit
volume, liquidity needs and performance objectives. Prior to December 31, 1993,
the Bank recorded its investments in its investment securities portfolio at the
lower of cost or current market value if held for sale or at amortized cost if
held for investment. Unrealized declines in the market value of securities held
to maturity were not reflected in the financial statements; however, unrealized
losses in the market value of securities held for sale were recorded as a charge
to current earnings. Effective December 31, 1993, Hemlock Federal adopted SFAS
115. As required by SFAS 115, securities are classified into three categories:
trading, held-to-maturity and available-for-sale. Securities that are bought and
held principally for the purpose of selling them in the near term are classified
as trading securities and are reported at fair value with unrealized gains and
losses included in trading account activities in the statement of operations.
Securities that Hemlock Federal has the positive intent and ability to hold to
maturity are classified as held-to-maturity and reported at amortized cost. All
other securities not classified as trading or held-to-maturity are classified as
available-for-sale. At December 31, 1997, Hemlock Federal had no securities
which were classified as trading and $31.68 million of mortgage-backed and
related securities and $14.74 million of other securities classified as
held-to-maturity. Available-for-sale securities are reported at fair value with
unrealized gains and losses included, on an after-tax basis, in a separate
component of retained
17
<PAGE>
earnings. At December 31, 1997, $29.98 million of mortgage-backed and related
securities and $4.7 million of other securities were classified as
available-for-sale.
Mortgage-Backed and Related Securities. In order to supplement its
lending activities and achieve its asset liability management goals, the Bank
invests in mortgage-backed and related securities. As of December 31, 1997, all
of the mortgage-backed and related securities owned by the Bank are issued,
insured or guaranteed either directly or indirectly by a federal agency or are
rated "AAA" by a nationally recognized credit rating agency. However, it should
be noted that, while a (direct or indirect) federal guarantee or a high credit
rating may indicate a high degree of protection against default, they do not
indicate that the securities will be protected from declines in value based on
changes in interest rates or prepayment speeds.
Consistent with its asset/liability management strategy, at December
31, 1997, $42.71 million, or 69.89% of Hemlock Federal's mortgage-backed and
related securities had adjustable or floating interest rates. In addition, as
discussed below, as of the same date, the Bank had $8.78 million of fixed rate
collateralized mortgage obligations ("CMOs") and real estate mortgage investment
conduits ("REMICs") with anticipated average lives of five years or less.
The Bank's CMOs and REMICs are securities derived by reallocating the
cash flows from mortgage-backed securities or pools of mortgage loans in order
to create multiple classes, or tranches, of securities with coupon rates and
average lives that differ from the underlying collateral as a whole. The terms
to maturity of any particular tranche is dependent upon the prepayment speed of
the underlying collateral as well as the structure of the particular CMO or
REMIC. Although a significant proportion of the Bank's CMOs and REMICs are
interests in tranches which have been structured (through the use of cash flow
priority and "support" tranches) to give somewhat more predictable cash flows,
the cash flow and hence the value of CMOs and REMICs is subject to change.
The Bank invests in CMOs and REMICs as an alternative to mortgage loans
and conventional mortgage-backed securities as part of its asset/liability
management strategy. Management believes that CMOs and REMICs represent
attractive investment alternatives relative to other investments due to the wide
variety of maturity and repayment options available through such investments. In
particular, the Bank has from time to time concluded that short and intermediate
duration CMOs and REMICs (five year or less average life) often represent a
better combination of rate and duration than adjustable rate mortgage-backed
securities.
To assess price volatility, the Federal Financial Institutions
Examination Council ("FFIEC") adopted a policy in 1992 which requires an annual
"stress" test of mortgage derivative securities. This policy, which has been
adopted by the OTS, requires the Bank to annually test its CMOs and other
mortgage-related securities to determine whether they are high-risk or
nonhigh-risk securities. Mortgage derivative products with an average life or
price volatility in excess of a benchmark 30-year, mortgage-backed, pass-through
security are considered high-risk mortgage securities. Under the policy, savings
institutions may generally only invest in low-risk mortgage securities in order
to reduce interest rate risk. In addition, all high-risk mortgage securities
acquired after February 9, 1992 which are classified as high risk at the time of
purchase
18
<PAGE>
must be carried in the institution's trading account or as assets
available-for-sale. At December 31, 1997, none of the Bank's mortgage-backed
securities were classified as "high-risk."
The following table sets forth the composition of the Bank's
mortgage-backed securities at the dates indicated.
<TABLE>
<CAPTION>
December 31,
------------------------------------------------------------------------------------
1997 1996 1995
------------------------- ------------------------ --------------------------
Carrying % of Carrying % of Carrying % of
Value Total Value Total Value Total
----- ----- ----- ----- ----- -----
(Dollars in Thousands)
Mortgage-backed securities
held-to- maturity:
<S> <C> <C> <C> <C> <C> <C>
GNMA............................ $ 4,328 7.02% $ 3,058 4.81% $ 3,810 5.54%
FNMA............................ 11,977 19.42 13,916 21.89 17,592 25.60
FHLMC........................... 7,773 12.61 10,094 15.88 12,954 18.85
CMOs............................ 7,605 12.33 2,469 3.88 8,750 12.73
-------- ------ -------- ----- -------- ------
31,683 51.38 29,537 46.46 43,106 62.72
Mortgage-backed securities
available-for- sale:
GNMA............................ -- -- -- -- -- --
FNMA............................ 7,777 12.61 12,821 20.17 6,050 8.80
FHLMC........................... 5,347 8.67 7,742 12.17 7,415 10.79
CMOs............................ 16,859 27.34 13,478 21.20 12,155 17.69
-------- ------ ------- ------ -------- ------
29,983 48.62 34,041 53.54 25,620 37.28
-------- ------ ------- ------ -------- ------
Total mortgage-backed
securities....................... $ 61,666 100.00% $ 63,578 100.00% $ 68,726 100.00%
======== ====== ======== ====== ======== ======
</TABLE>
19
<PAGE>
The following table sets forth the contractual maturities of the Bank's
mortgage-backed securities at December 31, 1997.
<TABLE>
<CAPTION>
December 31,
Due in 1997
------------------------------------------------------------------- ------------------
6 Months 6 Months 1 to 3 to 5 5 to 10 10 to 20 Over 20 Amortized Carrying
or Less to 1 Year 3 Years Years Years Years Years Cost Value
------- --------- ------- ----- ----- ----- ----- ---- -----
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Federal Home Loan
Mortgage Corporation .................... $ -- $ -- $ 84 $ 81 $ 2,495 $ 6,439 $ 3,838 $12,937 $13,120
Federal National Mortgage
Association ............................. 150 -- 194 448 157 7,999 10,517 19,465 19,754
Government National
Mortgage Association .................... -- -- 23 97 248 1,161 2,799 4,328 4,328
CMOs ..................................... -- -- 149 127 3,992 3,289 16,828 24,385 24,464
------- ------- ------- ------- ------- ------- ------- ------- -------
Total ............................... $ 150 $ -- $ 450 $ 753 $ 6,892 $18,888 $33,982 $61,115 $61,666
======= ======= ======= ======= ======= ======= ======= ======= =======
Weighted average yield ................... 9.00 -- 8.65 8.89 7.03 7.82 6.62 7.09 7.02
</TABLE>
20
<PAGE>
As of December 31, 1997, the Bank did not have any mortgage-backed
securities in excess of 10% of retained earnings except for FNMA, FHLMC and GNMA
issues, amounting to $19.75 million, $13.12 million and $4.33 million,
respectively.
The market values of a portion of the Bank's mortgage-backed securities
held-to-maturity have been from time to time lower than their carrying values.
However, for financial reporting purposes, such declines in value are considered
to be temporary in nature since they have been due to changes in interest rates
rather than credit concerns.
The following table shows mortgage-backed securities purchase, sale and
repayment activities of the Bank for the periods indicated.
Year Ended
December 31,
---------------------------------
1997 1996 1995
---- ---- ----
(In Thousands)
Purchases:
Adjustable-rate ....................... $ 3,561 $ 11,960 $ 9,103
Fixed-rate ............................ -- -- --
CMOs .................................. 14,179 10,075 11,350
-------- -------- --------
Total purchases ................ 17,740 22,035 20,453
Sales:
Adjustable-rate ....................... -- 979 --
Fixed-rate ............................ -- -- 575
CMOs .................................. -- 3,754 3,071
-------- -------- --------
Total sales ................... -- 4,733 3,646
Principal repayments .................. (19,865) (22,112) (22,440)
Discount/premium net change ........... (91) (230) (564)
Fair value net change ................. 304 (108) 639
-------- -------- --------
Net increase (decrease) ........ $ (1,912) $ (5,148) $ (5,558)
======== ======== ========
As a result in part of competitive factors, the Bank's holdings of
mortgage-backed securities are larger than its loans receivable. Since
pass-through mortgage-backed securities generally carry a yield approximately 50
to 100 basis points below that of the corresponding type of residential loan
(due to the implied federal agency guarantee fee and the retention of a
servicing spread by the loan servicer), and the Bank's CMOs and REMICs also
carry lower yields (due to the implied federal agency guarantee and because such
securities tend to have shorter actual durations than 30 year loans), in the
event that the proportion of the Bank's assets consisting of mortgage-backed and
related securities increases, the Bank's asset yields could be somewhat
adversely affected. The Bank will evaluate mortgage-backed and related
securities purchases in the future based on its asset/liability objectives,
market conditions and alternative investment opportunities.
21
<PAGE>
Securities. Federally chartered savings institutions have the authority
to invest in various types of liquid assets, including United States Treasury
obligations, securities of various federal agencies, certain certificates of
deposit of insured banks and savings institutions, certain bankers' acceptances,
repurchase agreements and federal funds. Subject to various restrictions,
federally chartered savings institutions may also invest their assets in
commercial paper, investment grade corporate debt securities and mutual funds
whose assets conform to the investments that a federally chartered savings
institution is otherwise authorized to make directly.
In order to complement its lending and mortgage-backed securities
investment activities and to increase its holding of short and medium term
assets, the Bank invests in liquidity investments and in high-quality
investments, such as U.S. Treasury and agency obligations. At December 31, 1997,
the Bank's securities portfolio totaled $18.35 million. At December 31, 1997,
the Bank did not own any securities of a single issuer which exceeded 10% of the
Bank's retained earnings, other than federal agency obligations.
22
<PAGE>
The following table sets forth the composition of the Bank's securities
and other earning assets at the dates indicated.
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------------
1997 1996 1995
--------------------- ------------------- ------------------------
Carrying % of Carrying % of Carrying % of
Value Total Value Total Value Total
----- ----- ----- ----- ----- -----
(Dollars in Thousands)
Securities held-to-maturity:
<S> <C> <C> <C> <C> <C> <C>
Federal agency obligations .................. $14,735 80.29% $ -- -- 1,500 10.26%
Securities available-for sale:
Federal agency obligations .................. 3,617 19.71 7,827 100.00 13,125 89.74
------- ------ ------ ------ ------- ------
Total securities ....................... $18,352 100.00% $7,827 100.00% $14,625 100.00%
======= ====== ====== ====== ======= ======
Average remaining life of securities: ......... 4 years 1 year 3 years
Other earning assets:
Interest-earning deposits with banks ........ $12,169 85.34% $15,639 90.45% $10,158 87.90%
FHLB stock .................................. 987 6.92 901 5.21 849 7.35
FHLMC stock ................................. 1,103 7.74 751 4.34 549 4.75
Federal funds sold .......................... -- -- -- -- -- --
------- ------ ------- ------ ------- ------
Total ................................. $14,259 100.00% $17,291 100.00% $11,556 100.00%
======= ====== ======= ====== ======= ======
</TABLE>
The composition and maturities of the securities portfolio, excluding
FHLB stock, are indicated in the following table.
<TABLE>
<CAPTION>
December 31, 1997
---------------------------------------------------------------------------------------------------
Less Than 1 to 5 5 to 10 Over
1 Year Years Years 10 years Total Securities
---------- ---------- ---------- ---------- ------------------------------
Book Value Book Value Book Value Book Value Book Value Carrying Value
---------- ---------- ---------- ---------- ---------- --------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Federal agency obligations.....$1,000 $10,516 $6,866 $ --- $18,382 $18,352
------ ------- ------ ------ ------- -------
Total investment securities....$1,000 $10,516 $6,866 $ --- $18,382 $18,352
------ ------- ------ ------ ------- -------
Weighted average yield......... 6.01% 5.32% 6.06% ---% 5.64% 5.65%
===== ===== ===== ===== ===== =====
</TABLE>
Sources of Funds
General. The Bank's primary sources of funds are deposits, payments
(including prepayments) of loan principal, interest earned on loans and
securities, repayments of securities, borrowings and funds provided from
operations.
Deposits. Hemlock Federal offers deposit accounts having a wide range
of interest rates and terms. The Bank's deposits consist of passbook, NOW, money
market and various certificate accounts. The Bank relies primarily on
competitive pricing and customer service to attract and retain these deposits.
The Bank's customers may access their accounts through any of the Bank's three
offices and two automated teller machines. In addition, the Bank's customers may
access their accounts through CIRRUS, a nationwide ATM network. The Bank only
solicits deposits in its market area and does not currently use brokers to
obtain deposits.
23
<PAGE>
The variety of deposit accounts offered by the Bank has allowed it to
be competitive in obtaining funds and to respond with flexibility to changes in
consumer demand. As a result, as customers have become more interest rate
conscious, the Bank has become more susceptible to short-term fluctuations in
deposit flows.
The Bank manages the pricing of its deposits in keeping with its
asset/liability management, profitability and growth objectives. However, the
Bank has found it difficult to increase its deposits on a cost effective basis
as a result of intense competition in the communities in which it operates. In
order to improve its deposit growth, the Bank has purchased land in Lemont,
Illinois, a southwest suburb of Chicago. Construction of a full service branch
office on this site commenced in November, 1997, and is expected to be completed
in the second half of 1998.
Management believes that the "core" portion of the Bank's regular
savings, NOW and money market accounts can have a lower cost and be more
resistant to interest rate changes than certificate accounts. These accounts
decreased $5.39 million since December 31, 1993. The Bank intends to utilize
customer service and marketing initiatives in an effort to maintain the volume
of such deposits. However, there can be no assurance as to whether the Bank will
be able to maintain or increase its core deposits in the future.
The following table sets forth the savings flows at the Bank during the
periods indicated.
Year Ended
December 31,
----------------------------------------
1997 1996 1995
---- ---- ----
(Dollars In Thousands)
Opening balance ................... $ 131,243 $ 130,741 $ 130,771
Deposits .......................... 271,622 207,748 210,667
Withdrawals ....................... (277,503) (212,752) (215,972)
Interest credited ................. 5,596 5,506 5,275
--------- --------- ---------
Ending balance .................... $ 130,958 $ 131,243 $ 130,741
========= ========= =========
Net increase (decrease) ........... $ (285) $ 502 $ (30)
========= ========= =========
Percent increase (decrease) ....... (0.22)% 0.38% (0.02)%
========= ========= =========
24
<PAGE>
The following table sets forth the dollar amount of savings deposits in
the various types of deposit programs offered by the Bank as of the dates
indicated.
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------
1997 1996 1995
------------------- ------------------ -------------------
Percent Percent Percent
Amount of Total Amount of Total Amount of Total
------ -------- ------ -------- ------ --------
(Dollars in Thousands)
Transactions and Savings Deposits
<S> <C> <C> <C> <C> <C> <C>
Passbook Accounts 2.94%................ $44,891 34.28% $47,174 35.94% $46,053 35.23%
NOW Accounts 2.22%..................... 14,950 11.41 13,711 10.45 14,021 10.72
Money Market Accounts 3.20%............ 5,091 3.89 5,463 4.16 5,999 4.59
---------- ------ --------- ------ --------- ------
Total Non-Certificates................. 64,932 49.58 66,348 50.55 66,073 50.54
Certificates:
0.00 - 3.99%........................... -- -- -- -- -- --
4.00 - 5.99%........................... 57,588 43.98 56,735 43.23 54,033 41.33
6.00 - 7.99%........................... 8,438 6.44 8,160 6.22 10,635 8.13
---------- ------ --------- ------- --------- -------
Total Certificates..................... 66,026 50.42 64,895 49.45 64,668 49.46
--------- ------ --------- ------ --------- ------
Total Deposits......................... $130,958 100.00% $131,243 100.00% $130,741 100.00%
======== ====== ======== ====== ======== ======
</TABLE>
The following table indicates the amount of the Bank's certificates of
deposit and other deposits by time remaining until maturity as of December 31,
1997.
<TABLE>
<CAPTION>
Maturity
-------------------------------------------------
Over Over
3 Months 3 to 6 6 to 12 Over
or Less Months Months 12 months Total
------- ------ ------ --------- -----
(In Thousands)
<S> <C> <C> <C> <C> <C>
Certificates of deposit less
than $100,000......................... $13,563 $13,873 $17,218 $16,240 $60,894
Certificates of deposit of
$100,000 or more...................... 1,718 1,131 1,249 1,034 5,132
-------- -------- -------- -------- --------
Total certificates of deposit.......... $15,281 $15,004 $18,467 $17,274 $66,026
======= ======= ======= ======= =======
</TABLE>
Borrowings. Hemlock Federal's other available sources of funds include
advances from the FHLB of Chicago and other borrowings. As a member of the FHLB
of Chicago, the Bank is required to own capital stock in the FHLB of Chicago and
is authorized to apply for advances from the FHLB of Chicago. Each FHLB credit
program has its own interest rate, which may be fixed or variable, and range of
maturities. The FHLB of Chicago may prescribe the acceptable uses for these
advances, as well as limitations on the size of the advances and repayment
provisions.
25
<PAGE>
The following table sets forth the maximum month-end balance and
average balance of FHLB advances for the periods indicated. The Bank had no
other outstanding borrowings during the periods shown
Year Ended
December 31,
-------------------------------------
1997 1996 1995
---- ---- ----
(Dollars In Thousands)
Maximum Balance:
FHLB Advances ................... $11,000 $ 1,500 $ 1,500
Average Balance:
FHLB Advances ................... $ 3,462 $ 1,500 $ 1,500
The following table sets forth certain information as to the Bank's
FHLBank advances at the dates indicated.
December 31,
---------------------------------------
1997 1996 1995
---- ---- ----
(Dollars in Thousands)
FHLB advances .................... $ 11,000 $ 1,500 $ 1,500
---------- --------- ---------
Total borrowings ............... $ 11,000 $ 1,500 $ 1,500
========== ========= =========
Weighted average interest
rate during the period of
FHLB advances ................... 5.86% 9.72% 9.72%
Weighted average interest
rate at end of period of
FHLB advances ................... 5.86% 9.72% 9.72%
Subsidiary and Other Activities
As a federally chartered savings bank, Hemlock Federal is permitted by
OTS regulations to invest up to 2% of its assets in the stock of, or loans to,
service corporation subsidiaries, and may invest an additional 1% of its assets
in service corporations where such additional funds are used for inner-city or
community development purposes. In addition to investments in service
corporations, federal institutions are permitted to invest an unlimited amount
in operating subsidiaries engaged solely in activities which a federal savings
association may engage in directly. At December 31, 1997, Hemlock Federal did
not have any subsidiaries.
26
<PAGE>
REGULATION
General
Hemlock Federal is a federally chartered savings bank, the deposits of
which are federally insured and backed by the full faith and credit of the
United States Government. Accordingly, Hemlock Federal is subject to broad
federal regulation and oversight extending to all its operations. Hemlock
Federal is a member of the FHLB of Chicago and is subject to certain limited
regulation by the Board of Governors of the Federal Reserve System ("Federal
Reserve Board"). As the savings and loan holding company of Hemlock Federal, the
Holding Company also is subject to federal regulation and oversight. The purpose
of the regulation of the Holding Company and other holding companies is to
protect subsidiary savings associations. Hemlock Federal is a member of the
Savings Association Insurance Fund ("SAIF"), which together with the Bank
Insurance Fund (the "BIF") are the two deposit insurance funds administered by
the FDIC, and the deposits of Hemlock Federal are insured by the FDIC. As a
result, the FDIC has certain regulatory and examination authority over Hemlock
Federal.
Certain of these regulatory requirements and restrictions are discussed
below or elsewhere in this document.
Federal Regulation of Savings Associations
The OTS has extensive authority over the operations of savings
associations. As part of this authority, Hemlock Federal is required to file
periodic reports with the OTS and is subject to periodic examinations by the OTS
and the FDIC. The last regular OTS and FDIC examinations of Hemlock Federal were
as of September 1997 and February 1995, respectively. Under agency scheduling
guidelines, it is likely that another examination will be initiated in the near
future. When these examinations are conducted by the OTS and the FDIC, the
examiners may require Hemlock Federal to provide for higher general or specific
loan loss reserves. All savings associations are subject to a semi-annual
assessment, based upon the savings association's total assets, to fund the
operations of the OTS. Hemlock Federal's OTS assessment for the fiscal year
ended December 31, 1997 was $50,124.
The OTS also has extensive enforcement authority over all savings
institutions and their holding companies, including Hemlock Federal and the
Holding Company. This enforcement authority 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. Except
under certain circumstances, public disclosure of final enforcement actions by
the OTS is required.
In addition, the investment, lending and branching authority of Hemlock
Federal is prescribed by federal laws and it is prohibited from engaging in any
activities not permitted by such laws. For instance, no savings institution may
invest in non-investment grade corporate debt
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securities. In addition, the permissible level of investment by federal
associations in loans secured by non-residential real property may not exceed
400% of total capital, except with approval of the OTS. Federal savings
associations are also generally authorized to branch nationwide. Hemlock Federal
is in compliance with the noted restrictions.
Hemlock Federal's general permissible lending limit for
loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired
capital and surplus (except for loans fully secured by certain readily
marketable collateral, in which case this limit is increased to 25% of
unimpaired capital and surplus). At December 31, 1997, Hemlock Federal's lending
limit under this restriction was $4.42 million. Hemlock Federal is in compliance
with the loans-to-one-borrower limitation.
The OTS, as well as the other federal banking agencies, has adopted
guidelines establishing safety and soundness standards on such matters as loan
underwriting and documentation, asset quality, earnings standards, internal
controls and audit systems, interest rate risk exposure and compensation and
other employee benefits. Any institution which fails to comply with these
standards must submit a compliance plan. A failure to submit a plan or to comply
with an approved plan will subject the institution to further enforcement
action.
Insurance of Accounts and Regulation by the FDIC
Hemlock Federal is a member of the SAIF, which is administered by the
FDIC. Deposits are insured up to applicable limits by the FDIC and such
insurance is backed by the full faith and credit of the United States
Government. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious risk
to the SAIF or the BIF. The FDIC also has the authority to initiate enforcement
actions against savings associations, after giving the OTS an opportunity to
take such action, and may terminate the deposit insurance if it determines that
the institution has engaged in unsafe or unsound practices or is in an unsafe or
unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified as
well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1
or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at
least 6% and a risk-based capital ratio of at least 10%) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a
risk-based capital ratio of less than 8%) and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
institutions is made by the FDIC for each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semiannual
basis, if it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of
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1.25% of SAIF-insured deposits. In setting these increased assessments, the FDIC
must seek to restore the reserve ratio to that designated reserve level, or such
higher reserve ratio as established by the FDIC. The FDIC may also impose
special assessments on SAIF members to repay amounts borrowed from the United
States Treasury or for any other reason deemed necessary by the FDIC.
For the first six months of 1995, the assessment schedule for BIF
members and SAIF members ranged from .23% to .31% of deposits. As is the case
with the SAIF, the FDIC is authorized to adjust the insurance premium rates for
banks that are insured by the BIF of the FDIC in order to maintain the reserve
ratio of the BIF at 1.25% of BIF insured deposits. As a result of the BIF
reaching its statutory reserve ratio the FDIC revised the premium schedule for
BIF insured institutions to provide a range of .04% to .31% of deposits. The
revisions became effective in the third quarter of 1995. In addition, the BIF
rates were further revised, effective January 1996, to provide a range of 0% to
.27%. The SAIF rates, however, were not adjusted. At the time the FDIC revised
the BIF premium schedule, it noted that, absent legislative action (as discussed
below), the SAIF would not attain its designated reserve ratio until the year
2002. As a result, SAIF insured members would continue to be generally subject
to higher deposit insurance premiums than BIF insured institutions until, all
things being equal, the SAIF attains its required reserve ratio.
In order to eliminate this disparity and any competitive disadvantage
between BIF and SAIF member institutions with respect to deposit insurance
premiums, legislation to recapitalize the SAIF was enacted in September 1996.
The legislation provided for a one-time assessment to be imposed on all deposits
assessed at the SAIF rates, as of March 31, 1995, in order to recapitalize the
SAIF. It also provides for the merger of the BIF and the SAIF on January 1, 1999
if no savings associations then exist. The special assessment rate has been
established at .657% of deposits by the FDIC and the resulting assessment of
$840,000 was paid in November 1996. This special assessment significantly
increased noninterest expense and adversely affected the Bank's results of
operations for the year ended December 31, 1996. As a result of the special
assessment, the Bank's deposit insurance premiums were reduced to $71,000 based
upon its current risk classification and the new assessment schedule for SAIF
insured institutions. These premiums are subject to change in future periods.
Prior to the enactment of the legislation, a portion of the SAIF
assessment imposed on savings associations was used to repay obligations issued
by a federally chartered corporation to provide financing ("FICO") for resolving
the thrift crisis in the 1980s. Although the FDIC has proposed that the SAIF
assessment be equalized with the BIF assessment schedule, effective October 1,
1996, SAIF-insured institutions will continue to be subject to a FICO assessment
as a result of this continuing obligation. Although the legislation also now
requires assessments to be made on BIF-assessable deposits for this purpose,
effective January 1, 1997, that assessment will be limited to 20% of the rate
imposed on SAIF assessable deposits until the earlier of December 31, 1999 or
when no savings association continues to exist, thereby imposing a greater
burden on SAIF member institutions such as Hemlock Federal. Thereafter, however,
assessments on BIF-member institutions will be made on the same basis as
SAIF-member institutions. The rates to be established by the FDIC to implement
this requirement for all FDIC-insured institutions are uncertain at this time,
but are expected to be about a 6.5 basis points assessment on SAIF
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deposits and 1.5 basis points on BIF deposits until BIF insured institutions
participate fully in the assessment.
Regulatory Capital Requirements
Federally insured savings associations, such as Hemlock Federal, are
required to maintain a minimum level of regulatory capital. The OTS has
established capital standards, including a tangible capital requirement, a
leverage ratio (or core capital) requirement and a risk-based capital
requirement applicable to such savings associations. These capital requirements
must be generally as stringent as the comparable capital requirements for
national banks. The OTS is also authorized to impose capital requirements in
excess of these standards on individual associations on a case-by-case basis.
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity and retained income, and certain
noncumulative perpetual Hemlock Federal stock and related income. In addition,
all intangible assets, other than a limited amount of purchased mortgage
servicing rights, must be deducted from tangible capital for calculating
compliance with the requirement. At December 31, 1997, Hemlock Federal did not
have any intangible assets recorded as assets on its financial statements.
The OTS regulations establish special capitalization requirements for
savings associations that own subsidiaries. In determining compliance with the
capital requirements, all subsidiaries engaged solely in activities permissible
for national banks or engaged in certain other activities solely as agent for
its customers are "includable" subsidiaries that are consolidated for capital
purposes in proportion to the association's level of ownership. For excludable
subsidiaries the debt and equity investments in such subsidiaries are deducted
from assets and capital. All subsidiaries of Hemlock Federal are includable
subsidiaries.
At December 31, 1997, Hemlock Federal had tangible capital of $20.70
million, or 12.3% of adjusted total assets, which is approximately $18.19
million above the minimum requirement of 1.5% of adjusted total assets in effect
on that date.
The capital standards also require core capital equal to at least 3% of
adjusted total assets. Core capital generally consists of tangible capital plus
certain intangible assets, including a limited amount of purchased credit card
relationships. As a result of the prompt corrective action provisions discussed
below, however, a savings association must maintain a core capital ratio of at
least 4% to be considered adequately capitalized unless its supervisory
condition is such to allow it to maintain a 3% ratio. At December 31, 1997,
Hemlock Federal had no intangibles which were subject to these tests.
At December 31, 1997, Hemlock Federal had core capital equal to $20.70
million, or 12.3% of adjusted total assets, which is $15.68 million above the
minimum leverage ratio requirement of 3% as in effect on that date.
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The OTS risk-based requirement requires savings associations to have
total capital of at least 8% of risk-weighted assets. Total capital consists of
core capital, as defined above, and supplementary capital. Supplementary capital
consists of certain permanent and maturing capital instruments that do not
qualify as core capital and general valuation loan and lease loss allowances up
to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used
to satisfy the risk-based requirement only to the extent of core capital. The
OTS is also authorized to require a savings association to maintain an
additional amount of total capital to account for concentration of credit risk
and the risk of non-traditional activities. At December 31, 1997, Hemlock
Federal had $770,000 of general loss reserves and $0 of capital instruments that
qualify as supplementary capital, which was less than 1.25% of risk-weighted
assets.
Certain exclusions from capital and assets are required to be made for
the purpose of calculating total capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
nonresidential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments. Hemlock Federal had no
such exclusions from capital and assets at December 31, 1997.
In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet items, will be multiplied by a risk weight,
ranging from 0% to 100%, based on the risk inherent in the type of asset. For
example, the OTS has assigned a risk weight of 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 FHLMC.
OTS regulations also require that every savings association with more
than normal interest rate risk exposure to deduct from its total capital, for
purposes of determining compliance with such requirement, an amount equal to 50%
of its interest-rate risk exposure multiplied by the present value of its
assets. This exposure is a measure of the potential decline in the net portfolio
value of a savings association, greater than 2% of the present value of its
assets, based upon a hypothetical 200 basis point increase or decrease in
interest rates (whichever results in a greater decline). Net portfolio value is
the present value of expected cash flows from assets, liabilities and
off-balance sheet contracts. The rule will not become effective until the OTS
evaluates the process by which savings associations may appeal an interest rate
risk deduction determination. It is uncertain as to when this evaluation may be
completed. Any savings association with less than $300 million in assets and a
total capital ratio in excess of 12% is exempt from this requirement unless the
OTS determines otherwise.
On December 31, 1997, Hemlock Federal had total capital of $21.47
million (including $20.70 million in core capital and $770,000 in qualifying
supplementary capital) and risk-weighted assets of $61.59 million; or total
capital of 34.85% of risk-weighted assets. This amount was $16.54 million above
the 8% requirement in effect on that date.
The OTS and the FDIC are authorized and, under certain circumstances
required, to take certain actions against savings associations that fail to meet
their capital requirements. The OTS is generally required to take action to
restrict the activities of an "undercapitalized association"
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(generally defined to be one with less than either a 4% core capital ratio, a 4%
Tier 1 risked-based capital ratio or an 8% risk-based capital ratio). Any such
association must submit a capital restoration plan and until such plan is
approved by the OTS may not increase its assets, acquire another institution,
establish a branch or engage in any new activities, and generally may not make
capital distributions. The OTS is authorized to impose the additional
restrictions that are applicable to significantly undercapitalized associations.
As a condition to the approval of the capital restoration plan, any
company controlling an undercapitalized association must agree that it will
enter into a limited capital maintenance guarantee with respect to the
institution's achievement of its capital requirements.
Any savings association that fails to comply with its capital plan or
is "significantly undercapitalized" (i.e., Tier 1 risk-based or core capital
ratios of less than 3% or a risk-based capital ratio of less than 6%) must be
made subject to one or more of additional specified actions and operating
restrictions which may cover all aspects of its operations and include a forced
merger or acquisition of the association. An association that becomes
"critically undercapitalized" (i.e., a tangible capital ratio of 2% or less) is
subject to further mandatory restrictions on its activities in addition to those
applicable to significantly undercapitalized associations. In addition, the OTS
must appoint a receiver (or conservator with the concurrence of the FDIC) for a
savings association, with certain limited exceptions, within 90 days after it
becomes critically undercapitalized. Any undercapitalized association is also
subject to the general enforcement authority of the OTS and the FDIC, including
the appointment of a conservator or a receiver.
The OTS is also generally authorized to reclassify an association into
a lower capital category and impose the restrictions applicable to such category
if the institution is engaged in unsafe or unsound practices or is in an unsafe
or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on
Hemlock Federal may have a substantial adverse effect on Hemlock Federal's
operations and profitability. Company shareholders do not have preemptive
rights, and therefore, if the Company is directed by the OTS or the FDIC to
issue additional shares of Common Stock, such issuance may result in the
dilution in the percentage of ownership of the Company.
Limitations on Dividends and Other Capital Distributions
OTS regulations impose various restrictions on savings associations
with respect to their ability to make distributions of capital, which include
dividends, stock redemptions or repurchases, cash-out mergers and other
transactions charged to the capital account. OTS regulations also prohibit a
savings association from declaring or paying any dividends or from repurchasing
any of its stock if, as a result, the regulatory capital of the association
would be reduced below the amount required to be maintained for the liquidation
account established in connection with its mutual to stock conversion.
Generally, savings associations, such as Hemlock Federal, that before
and after the proposed distribution meet their capital requirements, may make
capital distributions during any
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calendar year equal to the greater of 100% of net income for the year-to-date
plus 50% of the amount by which the lesser of the association's tangible, core
or risk-based capital exceeds its capital requirement for such capital
component, as measured at the beginning of the calendar year, or 75% of their
net income for the most recent four quarter period. However, an association
deemed to be in need of more than normal supervision by the OTS may have its
dividend authority restricted by the OTS. Hemlock Federal may pay dividends in
accordance with this general authority.
Savings associations proposing to make any capital distribution need
only submit written notice to the OTS 30 days prior to such distribution.
Savings associations that do not, or would not meet their current minimum
capital requirements following a proposed capital distribution, however, must
obtain OTS approval prior to making such distribution. The OTS may object to the
distribution during that 30-day period notice based on safety and soundness
concerns. See "Regulatory Capital Requirements."
The OTS has proposed regulations that would revise the current capital
distribution restrictions. Under the proposal a savings association that is a
subsidiary of a holding company may make a capital distribution without notice
to the OTS (unless it is a subsidiary of a holding company) provided that it has
a CAMEL 1 or 2 rating, is not of supervisory concern, and would remain
adequately capitalized (as defined in the OTS prompt corrective action
regulations) following the proposed distribution. Savings associations that
would remain adequately capitalized following the proposed distribution but do
not meet the other noted requirements must notify the OTS 30 days prior to
declaring a capital distribution. The OTS stated it will generally regard as
permissible that amount of capital distributions that do not exceed 50% of the
institution's excess regulatory capital plus net income to date during the
calendar year. A savings association may not make a capital distribution without
prior approval of the OTS and the FDIC if it is undercapitalized before, or as a
result of, such a distribution. As under the current rule, the OTS may object to
a capital distribution if it would constitute an unsafe or unsound practice. No
assurance may be given as to whether or in what form the regulations may be
adopted.
Liquidity
All savings associations, including Hemlock Federal, 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. For a discussion of what Hemlock Federal
includes in liquid assets, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources." This liquid asset ratio requirement may vary from time to time
(between 4% and 10%) depending upon economic conditions and savings flows of all
savings associations. At the present time, the minimum liquid asset ratio is 5%.
In addition, short-term liquid assets (e.g., cash, certain time
deposits, certain bankers acceptances and short-term United States Treasury
obligations) currently must constitute at least 1% of the association's average
daily balance of net withdrawable deposit accounts and current borrowings.
Penalties may be imposed upon associations for violations of either liquid asset
ratio
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requirement. At December 31, 1997, Hemlock Federal was in compliance with both
requirements, with an overall liquid asset ratio of 18.86% and a short-term
liquid assets ratio of 18.15%.
Accounting
An OTS policy statement applicable to all savings associations
clarifies and re-emphasizes that the investment activities of a savings
association must be in compliance with approved and documented investment
policies and strategies, and must be accounted for in accordance with GAAP.
Under the policy statement, management must support its classification of and
accounting for loans and securities (i.e., whether investment, sale or trading)
with appropriate documentation.
Hemlock Federal is in compliance with these amended rules.
OTS accounting regulations, which may be made more stringent than GAAP
require that transactions be reported in a manner that best reflects their
underlying economic substance and inherent risk and that financial reports must
incorporate any other accounting regulations or orders prescribed by the OTS.
Qualified Thrift Lender Test
All savings associations, including Hemlock Federal, are required to
meet a qualified thrift lender ("QTL") test to avoid certain restrictions on
their operations. This test requires a savings association to have at least 65%
of its portfolio assets (as defined by regulation) in qualified thrift
investments on a monthly average for nine out of every 12 months on a rolling
basis. As an alternative, the savings association may maintain 60% of its assets
in those assets specified in Section 7701(a)(19) of the Internal Revenue Code.
Under either such test such assets primarily consist of residential housing
related loans and investments. At December 31, 1997, Hemlock Federal met the
test and has always met the test since its effectiveness.
Any savings association that fails to meet the QTL test must convert to
a national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If such an association has not yet requalified or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such association
has not requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
association that fails the QTL test is controlled by a holding company, then
within one year after the failure, the holding company must register as a bank
holding company and become subject to all restrictions on bank holding
companies. See "- Holding Company Regulation."
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Community Reinvestment Act
Under the Community Reinvestment Act ("CRA"), every FDIC insured
institution has a continuing and affirmative obligation consistent with safe and
sound banking practices to help meet the credit needs of its entire community,
including low and moderate income neighborhoods. The CRA does not establish
specific lending requirements or programs for financial institutions nor does it
limit an institution's discretion to develop the types of products and services
that it believes are best suited to its particular community, consistent with
the CRA. The CRA requires the OTS, in connection with the examination of Hemlock
Federal, to assess the institution's record of meeting the credit needs of its
community and to take such record into account in its evaluation of certain
applications, such as a merger or the establishment of a branch, by Hemlock
Federal. An unsatisfactory rating may be used as the basis for the denial of an
application by the OTS.
The federal banking agencies, including the OTS, have recently revised
the CRA regulations and the methodology for determining an institution's
compliance with the CRA. Due to the heightened attention being given to the CRA
in the past few years, Hemlock Federal may be required to devote additional
funds for investment and lending in its local community. Hemlock Federal was
examined for CRA compliance in March 1997 and received a rating of satisfactory.
Transactions with Affiliates
Generally, transactions between a savings association or its
subsidiaries and its affiliates are required to be on terms as favorable to the
association as transactions with non-affiliates. In addition, certain of these
transactions, such as loans to an affiliate, are restricted to a percentage of
the association's capital. Affiliates of Hemlock Federal include the Holding
Company and any company which is under common control with Hemlock Federal. In
addition, a savings association may not lend to any affiliate engaged in
activities not permissible for a bank holding company or acquire the securities
of most affiliates. Hemlock Federal's subsidiaries are not deemed affiliates;
however, the OTS has the discretion to treat subsidiaries of savings
associations as affiliates on a case-by-case basis.
Certain transactions with directors, officers or controlling persons
are also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such
loans must be made on terms substantially the same as for loans to unaffiliated
individuals.
Holding Company Regulation
The Company is a unitary savings and loan holding company subject to
regulatory oversight by the OTS. As such, the Company is required to register
and file reports with the OTS and is subject to regulation and examination by
the OTS. In addition, the OTS has enforcement authority over the Company and its
non-savings association subsidiaries which also permits the
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OTS to restrict or prohibit activities that are determined to be a serious risk
to the subsidiary savings association.
As a unitary savings and loan holding company, the Company generally is
not subject to activity restrictions. If the Company acquires control of another
savings association as a separate subsidiary, it would become a multiple savings
and loan holding company, and the activities of the Company and any of its
subsidiaries (other than Hemlock Federal or any other SAIF-insured savings
association) would become subject to such restrictions unless such other
associations each qualify as a QTL and were acquired in a supervisory
acquisition.
If Hemlock Federal fails the QTL test, the Company must obtain the
approval of the OTS prior to continuing after such failure, directly or through
its other subsidiaries, any business activity other than those approved for
multiple savings and loan holding companies or their subsidiaries. In addition,
within one year of such failure the Company must register as, and will become
subject to, the restrictions applicable to bank holding companies. The
activities authorized for a bank holding company are more limited than are the
activities authorized for a unitary or multiple savings and loan holding
company. See "- Qualified Thrift Lender Test."
The Company must obtain approval from the OTS before acquiring control
of any other SAIF-insured association. Such acquisitions are generally
prohibited if they result in a multiple savings and loan holding company
controlling savings associations in more than one state. However, such
interstate acquisitions are permitted based on specific state authorization or
in a supervisory acquisition of a failing savings association.
Federal Securities Law
The stock of the Company is registered with the SEC under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Company is
subject to the information, proxy solicitation, insider trading restrictions and
other requirements of the SEC under the Exchange Act.
Company stock held by persons who are affiliates (generally officers,
directors and principal stockholders) of the Company may not be resold without
registration or unless sold in accordance with certain resale restrictions. If
the Company meets specified current public information requirements, each
affiliate of the Company is able to sell in the public market, without
registration, a limited number of shares in any three-month period.
Federal Reserve System
The Federal Reserve Board requires all depository institutions to
maintain non-interest bearing reserves at specified levels against their
transaction accounts (primarily checking, NOW and Super NOW checking accounts).
At December 31, 1997, Hemlock Federal was in compliance with these reserve
requirements. The balances maintained to meet the reserve requirements imposed
by the Federal Reserve Board may be used to satisfy liquidity requirements that
may be imposed by the OTS. See "-Liquidity."
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Savings associations are authorized to borrow from the Federal Reserve
Bank "discount window," but Federal Reserve Board regulations require
associations to exhaust other reasonable alternative sources of funds, including
FHLB borrowings, before borrowing from the Federal Reserve Bank.
Federal Home Loan Bank System
Hemlock Federal is a member of the FHLB of Chicago, which is one of 12
regional FHLBs, that administers the home financing credit function of savings
associations. Each FHLB serves as a reserve or central bank for its members
within its assigned region. It is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB System. It makes loans to
members (i.e., advances) in accordance with policies and procedures, established
by the board of directors of the FHLB, which are subject to the oversight of the
Federal Housing Finance Board. All advances from the FHLB are required to be
fully secured by sufficient collateral as determined by the FHLB. In addition,
all long-term advances are required to provide funds for residential home
financing.
As a member, Hemlock Federal is required to purchase and maintain stock
in the FHLB of Chicago. At December 31, 1997, Hemlock Federal had $987,000 in
FHLB stock, which was in compliance with this requirement. In past years,
Hemlock Federal has received substantial dividends on its FHLB stock. Over the
past five calendar years such dividends have averaged 6.75% and were 6.81% for
calendar year 1997.
Under federal law the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to low- and
moderately priced housing programs through direct loans or interest subsidies on
advances targeted for community investment and low- and moderate-income housing
projects. These contributions have affected adversely the level of FHLB
dividends paid and could continue to do so in the future. These contributions
could also have an adverse effect on the value of FHLB stock in the future. A
reduction in value of Hemlock Federal's FHLB stock may result in a corresponding
reduction in Hemlock Federal's capital.
For the year ended December 31, 1997, dividends paid by the FHLB of
Chicago to Hemlock Federal totaled $64,000, which constitute a $5,000 increase
from the amount of dividends received in calendar year 1996. The $48,000
dividend received for the year ended December 31, 1997, reflects an annualized
rate of 6.83%.
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Federal and State Taxation
Savings associations such as Hemlock Federal, are permitted to
establish reserves using an experience method for bad debts and to make annual
additions thereto which may, within specified formula limits, be taken as a
deduction in computing taxable income for federal income tax purposes. Under the
experience method, the bad debt reserve deduction is an amount determined under
a formula based generally upon the bad debts actually sustained by the savings
association over a period of years.
In August 1996, legislation was enacted that repeals the reserve method
of accounting (including the percentage of taxable income method) used by many
thrifts, including the Bank, to calculate their bad debt reserve for federal
income tax purposes. As a result, thrifts must recapture that portion of the
reserve that exceeds the amount that could have been taken under the specific
charge-off method for post-1987 tax years. The legislation also requires thrifts
to account for bad debts for federal income tax purposes on the same basis as
commercial banks for tax years beginning after December 31, 1995. The recapture
will occur over a six-year period, the commencement of which will be delayed
until the first taxable year beginning after December 31, 1997, provided the
institution meets certain residential lending requirements. The management of
the Company does not believe that the legislation will have a material impact on
the Company or the Bank.
In addition to the regular income tax, corporations, including savings
associations such as Hemlock Federal, generally are subject to a minimum tax. An
alternative minimum tax is imposed at a minimum tax rate of 20% on alternative
minimum taxable income, which is the sum of a corporation's regular taxable
income (with certain adjustments) and tax preference items, less any available
exemption. The alternative minimum tax is imposed to the extent it exceeds the
corporation's regular income tax and net operating losses can offset no more
than 90% of alternative minimum taxable income. The Bank does not expect to be
subject to the alternative minimum tax.
To the extent earnings appropriated to a savings association's bad debt
reserves exceed the allowable amount of such reserves computed under the
experience method ("Excess"), such Excess may not, without adverse tax
consequences, be utilized for the payment of cash dividends or other
distributions to a shareholder (including distributions on redemption,
dissolution or liquidation) or for any other purpose (except to absorb bad debt
losses). As of December 31, 1997, Hemlock Federal's Excess for tax purposes
totaled approximately $3.1 million.
The Company and Hemlock Federal file separate federal and state income
tax returns on a calendar basis, using the accrual method of accounting.
The Company and Hemlock Federal have not been audited by the IRS with
respect to federal income tax returns in the past five years. With respect to
years examined by the IRS, either all deficiencies have been satisfied or
sufficient reserves have been established to satisfy asserted deficiencies. In
the opinion of management, any examination of still open returns (including
returns of subsidiaries and predecessors of, or entities merged into, the
Company) would not result in a deficiency which could have a material adverse
effect on the financial condition of the Company and its subsidiaries.
38
<PAGE>
Illinois Taxation. For Illinois income tax purposes, the Company and
Hemlock Federal are taxed at an effective rate equal to 7.18% of Illinois
taxable income. For these purposes, "Illinois Taxable Income" generally means
federal taxable income, subject to certain adjustments (including the addition
of interest income on state and municipal obligations and the exclusion of
interest income on United States Treasury obligations).
Delaware Taxation. As a Delaware holding company, the Company is
exempted from Delaware corporate income tax but is required to file an annual
report with and pay an annual fee to the State of Delaware. The Company is also
subject to an annual franchise tax imposed by the State of Delaware.
Competition
Hemlock Federal faces strong competition both in originating real
estate loans and in attracting deposits. Competition in originating loans comes
primarily from commercial banks, credit unions, mortgage bankers and other
savings institutions, which also make loans secured by real estate located in
the Bank's market area. Hemlock Federal competes for loans principally on the
basis of the interest rates and loan fees it charges, the types of loans it
originates and the quality of services it provides to borrowers.
Competition for those deposits is principally from commercial banks,
credit unions, mutual funds, securities firms and other savings institutions
located in the same communities. The ability of the Bank to attract and retain
deposits depends on its ability to provide an investment opportunity that
satisfies the requirements of investors as to rate of return, liquidity, risk,
convenient locations and other factors. The Bank competes for these deposits by
offering competitive rates, convenient business hours and a customer oriented
staff.
Executive Officers Of the Registrant Who Are Not Directors
The following information as to the business experience during the last
five years is supplied with respect to executive officers of the Bank who do not
serve on the Company's or the Bank's Board of Directors.
Jean M. Thornton. Ms. Thornton, age 37, is currently serving as
Vice-President, Controller/Treasurer. She has worked at the Bank since 1991 as
Chief Accountant, and as Treasurer since 1994.
Employees
At December 31, 1997, the Bank had a total of 47 employees including 3
part-time employees. None of the Bank's employees are represented by any
collective bargaining agreement. Management considers its employee relations to
be good.
39
<PAGE>
Item 2. Properties
The following table sets forth information concerning the main office
and each branch office of the Bank at December 31, 1997. At December 31, 1997,
the Bank's premises had an aggregate net book value of approximately $2.51
million.
Year Owned or Net Book Value at
Location Acquired Leased December 31, 1997
- --------------------------- -------- ---------- -----------------
(In Thousands)
Main Office:
- ------------
5700 West 159th Street 1974 Owned $537
Oak Forest, Illinois 60452
Full Service Branches:
- ----------------------
8855 South Ridgeland Ave. 1975 Leased(1) 178
Oak Lawn, Illinois 60453
4646 South Damen Avenue 1990 Leased(2) --
Chicago, Illinois 60609
15730 West 127th Street 1997 Owned(3) 969
Lemont, Illinois 60439
- ------------
(1) The land on which the Oak Lawn branch is built is leased. Under the terms
of the lease, upon the expiration of the lease in 2005, title to the
building housing the branch which is currently held by the Bank, will pass
to the landlord.
(2) The lease is currently in the process of renegotiation.
(3) Consists of purchase of land. Building to be constructed in 1998.
The Bank believes that its current facilities are adequate to meet the
present and foreseeable future needs of the Bank and the Company.
The Bank's depositor and borrower customer files are maintained by an
independent data processing company. The net book value of the data processing
and computer equipment utilized by the Bank at December 31, 1997 was
approximately $15,000.
Item 3. Legal Proceedings
From time to time, Hemlock Federal is involved as plaintiff or
defendant in various legal proceedings arising in the normal course of its
business. While the ultimate outcome of these various legal proceedings cannot
be predicted with certainty, it is the opinion of management that the resolution
of these legal actions should not have a material effect on the Company's and
Hemlock Federal's financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the quarter ended December 31,
1997.
40
<PAGE>
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
Page 48 of the Annual Report is herein incorporated by reference.
Item 6. Management's Discussion and Analysis or Plan of Operation
Pages 5 through 16 of the Annual Report is herein incorporated by
reference.
Item 7. Financial Statements
(a) Financial Statements
The following information appearing in the Company's Annual Report to
Stockholders for the year ended December 31, 1997, is incorporated by reference
in this Annual Report on Form 10-KSB as Exhibit 13.
Annual Report Section Pages in Annual Report
- --------------------- ----------------------
Common Stock and Related Information 48
Selected Financial and Other Data 3
Management's Discussion and Analysis 5
of Financial Condition and Results
of Operations
Independent Auditors' Report 21
Consolidated Statements of Financial 22
Condition as of December 31, 1997 and 1996
Consolidated Statements of Income 23
Consolidated Statements of Changes 24
in Stockholders' Equity for Years Ended
December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows 25
Notes to Consolidated Financial 27
Statements
41
<PAGE>
With the exception of the aforementioned information, the Corporation's
Annual Report to Stockholders for the year ended December 31, 1997 is not deemed
filed as part of this Annual Report on Form 10-KSB.
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
There has been no Current Report on Form 8-K filed within 24 months
prior to the date of the most recent financial statements reporting a change of
accountants and/or reporting disagreements on any matter of accounting principle
or financial statement disclosure.
PART III
Item 9. Directors, Executive Officers Promoters and Control
Persons; Compliance with Section 16(a) of the Exchange Act
Information concerning Directors of the Registrant is incorporated
herein by reference from the Company's definitive Proxy Statement for the Annual
Meeting of Stockholders to be held in 1998, a copy of which will be filed not
later than 120 days after the close of the fiscal year.
Item 10. Executive Compensation
Information concerning executive compensation is incorporated herein by
reference from the definitive Proxy Statement for the Annual Meeting of
Stockholders to be held in 1998, a copy of which will be filed not later than
120 days after the close of the fiscal year.
Item 11. Security Ownership of Certain Beneficial Owners and
Management
Information concerning security ownership of certain beneficial owners
and management is incorporated herein by reference from the definitive Proxy
Statement for the Annual Meeting of Stockholders to be held in 1998, a copy of
which will be filed not later than 120 days after the close of the fiscal year.
Item 12. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions
is incorporated herein by reference from the definitive Proxy Statement for the
Annual Meeting of Stockholders to be held in 1998, a copy of which will be filed
not later than 120 days after the close of the fiscal year.
42
<PAGE>
PART IV
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Reference to
Regulation Prior filing or
S-K Exhibit Exhibit Number
Number Document Attached Hereto
------ -------- ---------------
<S> <C> <C>
2 Plan of acquisition, reorganization, arrangement, liquidation or
succession ............................................................ None
3(i) Articles of Incorporation .............................................. *
3(ii) By-Laws ................................................................ *
4 Instruments defining the rights of security holders, including
debentures ............................................................ *
9 Voting Trust Agreement ................................................. None
10 Material contracts:
(i) Stock Option and Incentive Plan ............................ *
(ii) Recognition and Retention Plan ............................. *
(iii) Employment Agreement with Executive Officers ............... *
11 Statement re: computation of per share earnings ........................ None
13 Annual Report .......................................................... 13
16 Letter re: change in certifying accountants ............................ None
21 Subsidiaries of Registrant ............................................. 21
22 Published report regarding matters submitted to vote of
security holders ...................................................... None
23 Consent of Experts and Counsel ......................................... Not required
24 Power of attorney ...................................................... Not required
27 Financial Data Schedule ................................................ 27
28 Information from reports furnished to state insurance
regulatory authorities ................................................ None
99 Additional Exhibits .................................................... None
</TABLE>
- ----------------
* Filed as exhibit to the Company's Form S-1 registration statement filed on
December 27, 1996 (File No. 333-18895) pursuant to Section 5 of the
Securities Act of 1933. All of such previously filed documents are hereby
incorporated herein by reference in accordance with Item 601 of Regulation
S-B.
The Company did not file any reports on Form 8-K during the quarter
ended December 31, 1997.
43
<PAGE>
Exhibit Index
Exhibit
No. Document
--- --------
13 Annual Report
21 Subsidiaries of Registrant
27 Financial Data Schedule
- --------------------------------------------------------------------------------
1997 ANNUAL REPORT
- --------------------------------------------------------------------------------
[LOGO]
HEMLOCK FEDERAL FINANCIAL CORPORATION
<PAGE>
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Chairman's Message........................................ 1
Selected Consolidated Financial Information............... 3
Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 5
Consolidated Financial Statements......................... 11
Stockholder Information................................... 48
Corporate Information..................................... 48
<PAGE>
- --------------------------------------------------------------------------------
FROM YOUR CHAIRMAN & PRESIDENT
- --------------------------------------------------------------------------------
April 10, 1998
We would like to welcome you as a stockholder of Hemlock Federal
Financial Corporation. On March 31, 1997, we completed the conversion of Hemlock
Federal from a mutual to stock institution, successfully raising $20.1 million
in capital. This additional capital was the primary factor in our asset growth
of 21% from $146.4 million at December 31, 1996 to $176.7 million at December
31, 1997. Stockholders' equity rose from $12.1 million to $30.4 million. Net
income for the year ended December 31, 1997 was $944,000, as compared to
$162,000 for the previous year.
Upon completion of the Conversion, we promptly began implementing a
strategic plan with the goal of maximizing stockholder value over the long term.
Our first step, which began in the third quarter of 1997, was to begin
construction of a new branch facility in Lemont, Illinois, a Southwest suburb of
Chicago. This facility, which we expect to open in mid 1998, will complement our
existing branch locations in Oak Forest, Oak Lawn and the Back of the Yards area
of Chicago. The new branch will initially cause operating expenses to increase.
However, we believe that the future growth prospects for Lemont, particularly in
the area of loan originations, provide us with the opportunity to effectively
leverage our capital and increase profitability over the long term.
Our next step in enhancing stockholder value involves increasing loan
production and loans held in portfolio. Loan originations in 1997 increased 34%
over 1996 totals to $18.5 million. We are looking forward to the possibility
that 1998 loan volume will exceed 1997 levels. While the interest rate
environment has undoubtedly been conducive to loan originations, we believe our
strategy of expanding the staff of commissioned loan officers, effectively
marketing multi-family and jumbo loans, while maintaining the superior level of
service and personal contact customers have come to expect from Hemlock Federal,
has been the key to our success. In 1998 we will introduce a home equity line of
credit product designed to match the needs of our loan and deposit customers. We
will also implement a formalized cross-sales program, along with relationship
banking products and services as a means of further increasing profitability.
Despite the $22.6 million increase in loans held in portfolio over the
past year, loan quality remains high, with a ratio of non-performing assets to
total assets of .15%, as of December 31, 1997, as compared to .05% at the end of
1996. We believe that reserves for losses in the loan portfolio remain fully
adequate, with our allowance for loan losses at 1.01% of total loans at year
end.
In addition to the above strategies, the Board of Directors authorized
dividend payments totaling $.12 per share in 1997. We have also received
permission from the Office of Thrift Supervision to repurchase shares, up to 5%
of our outstanding shares, which will begin in the first quarter of 1998.
1
<PAGE>
Our stock price has steadily increased since our initial offering. On
December 31, 1997, our stock price closed at $17.125, compared to our initial
offering price of $10.00. While we do not believe continued gains of this
magnitude are realistically sustainable, we believe the strategies we have in
place will continue to enhance stockholder value.
Hemlock Federal was established in 1904 to help residents of the south
side of Chicago achieve the American Dream. We have built on our original
mission to provide personalized banking with a high level of service and support
for our customers and our communities.
On behalf of the Directors, Management and employees of Hemlock
Federal, we thank you for your confidence and support. Together, we will work
diligently for the long term profitability of Hemlock Federal Financial
Corporation.
Maureen G. Partynski
Chairman and
Chief Executive Officer
Michael R. Stevens
President
2
<PAGE>
SELECTED CONSOLIDATED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
At December 31,
------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Selected Financial Condition Data:
<S> <C> <C> <C> <C> <C>
Total assets.................................... $176,683 $146,405 $145,626 $143,877 $146,679
Cash and cash equivalents....................... 14,883 17,410 13,301 16,827 18,131
Loans receivable, net(3)........................ 76,159 53,536 45,232 37,659 37,041
Mortgage-backed securities(2):
Held-to-maturity.............................. 31,683 29,537 43,106 66,040 81,439
Available-for-sale............................ 29,983 34,041 25,620 8,244 --
Investment securities:(2)
Held-to-maturity.............................. 14,735 -- 1,500 3,500 6,003
Available-for-sale............................ 3,617 7,827 13,125 7,934 --
FHLB stock...................................... 987 901 849 837 991
Deposits........................................ 130,958 131,243 130,741 130,771 132,583
Total borrowings................................ 11,000 1,300 1,500 1,500 3,000
Stockholders' Equity............................ 30,427 12,115 11,877 10,379 9,855
</TABLE>
<TABLE>
<CAPTION>
Year Ended
December 31,
--------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Selected Operations Data:
<S> <C> <C> <C> <C> <C>
Total interest income ................. $ 11,293 $ 10,137 $ 9,934 $ 8,501 $ 8,815
Total interest expense ................ 5,723 5,643 5,416 4,672 4,948
-------- -------- -------- -------- --------
Net interest income ................. 5,570 4,494 4,518 3,829 3,867
Provision for loan losses ............. 30 150 133 150 149
-------- -------- -------- -------- --------
Net interest income after provision for
loan losses ........................... 5,540 4,344 4,385 3,679 3,718
Fees and service charges .............. 417 379 352 308 345
Gain (loss) on sales of mortgage-backed
securities and investment securities (3) (124) (161) (89) 270
Other non-interest income ............. 125 132 146 164 112
-------- -------- -------- -------- --------
Total non-interest income ............. 539 387 337 383 727
Total non-interest expense ............ 4,509 4,487 3,211 3,180 3,313
-------- -------- -------- -------- --------
Income (loss) before taxes and
cumulative effect ..................... 1,570 244 1,511 882 1,132
Income tax provision .................. 626 82 559 343 411
Cumulative effect ..................... -- -- -- -- 256
-------- -------- -------- -------- --------
Net income ............................ $ 944 $ 162 $ 952 $ 539 $ 977
======== ======== ======== ======== ========
</TABLE>
- ------------
(1) The allowance for loan losses at December 31, 1997, 1996, 1995, 1994, and
1993, was $775,000, $745,000, $600,000, $469,000, and $234,000,
respectively.
(2) The Bank adopted Statement of Financial Accounting Standards ("SFAS") No.
115, "Accounting for Certain Investments in Debt and Equity Securities,"
effective as of January 1, 1994. Prior to the adoption of SFAS No. 115,
investment securities and mortgage-backed securities held for sale were
carried at the lower of amortized cost or market value, as adjusted for
amortization of premiums and accretion of discounts over the remaining
terms of the securities from the dates of purchase.
3
<PAGE>
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Selected Financial Ratios and Other Data:
Performance Ratios:
Return on assets (ratio of net income
to average total assets) ................. .58% .11% 0.66% 0.37% 0.68%
Return on equity (ratio of net income
to average equity)(3) .................... 3.52 1.38 8.73 5.27 10.40
Interest rate spread information:
Average during period ..................... 2.85 2.93 3.01 2.49 2.54
End of period ............................. 2.92 3.07 3.11 2.93 3.58
Net interest margin(1) .................... 3.53 3.20 3.25 2.69 2.74
Ratio of operating expense to average
total assets .............................. 2.76 3.07 2.23 2.18 2.30
Ratio of average interest-earning assets
to average interest-bearing liabilities ... 118.59 106.67 106.31 106.27 105.58
Quality Ratios:
Non-performing assets to total assets at
end of period ............................ 0.15 0.05 0.40 0.43 0.80
Allowance for loan losses to non-performing
loans .................................... 302.73 116.51 103.63 76.01 30.91
Allowance for loan losses to gross loans
receivable ............................... 1.01 1.37 1.31 1.23 0.62
Capital Ratios:(2)
Stockholders' equity to total assets at
end of period ............................ 17.22 7.86 8.16 7.22 6.72
Average stockholders' equity to
average assets ........................... 16.45 7.93 7.59 7.01 6.51
Other data:
Number of full service offices ............ 3 3 3 3 3
</TABLE>
- -------------
(1) Net interest income divided by average interest-earning assets.
(2) Ratios are exclusive of SFAS 115 valuation.
4
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Hemlock Federal Financial Corporation (the "Company") is a Delaware
Corporation. The Company is a savings and loan holding company which has as its
wholly owned subsidiary, Hemlock Federal Bank for Savings (the "Bank").
Financial and other information presented herein after March 31, 1997, relates
to consolidated information of the Company and the Bank. Financial and other
information prior to March 31, 1997, relates only to Hemlock Federal Bank for
Savings. The Company is a financial intermediary engaged primarily in attracting
deposits from the general public and using such deposits to acquire
mortgage-backed and other securities and to originate one-to-four family
residential mortgage and, to a significantly lesser extent, multi-family,
consumer and other loans primarily in its market area. The Company's revenues
are derived principally from interest earned on mortgage-backed and other
securities and loans. The operations of the Company are influenced significantly
by general economic conditions and by policies of financial institution
regulatory agencies, including the OTS and FDIC. The Company's cost of funds is
influenced by interest rates on competing investments and general market
interest rates. Lending activities are affected by the demand for financing of
real estate and other types of loans, which in turn is affected by the interest
rates at which such financings may be offered.
The Company's net interest income is dependent primarily upon the
difference or spread between the average yield earned on securities and loans
receivable, net and the average rate paid on deposits, as well as the relative
amounts of such assets and liabilities. The Company, like other savings and loan
holding companies, is subject to interest rate risk to the degree that its
interest-bearing liabilities mature or reprice at different times, or on a
different basis, than its interest-earning assets.
Financial Condition
Consolidated total assets aggregated $176.7 million and $146.4 million
at December 31, 1997 and December 31, 1996, respectively. The increase in total
assets is primarily attributable to the proceeds raised in the Company's initial
public offering. The net proceeds were invested in securities held-to-maturity
and mortgage loans as of December 31, 1997, resulting in an increase in
securities held-to-maturity of $16.9 million and an increase in loans receivable
of $22.7 million. This was partially offset by a decrease in cash and cash
equivalents of $2.5 million and a decrease in securities available for sale of
$7.9 million.
Total liabilities at December 31, 1997 were $146.3 million compared to
$134.3 million at December 31, 1996. Total deposits decreased by $285,000, from
$131.2 million at December 31, 1996 to $131.0 million at December 31, 1997, due
principally to the purchase of common stock in the initial public offering by
Bank depositors. In addition, FHLB advances increased by $9.5 million, from $1.5
million at December 31, 1996 to $11.0 million at December 31, 1997.
5
<PAGE>
Stockholders' equity at December 31, 1997 was $30.4 million compared to
$12.1 million at December 31, 1996, an increase of $18.3 million, due primarily
to net proceeds of the initial public offering that was completed on March 31,
1997.
Results of Operations
The Company's results of operations depend primarily upon the level of
net interest income, which is the difference between the interest income earned
on its interest-earning assets such as securities and loans, and the costs of
the Company's interest-bearing liabilities, primarily deposits and borrowings.
Results of operations are also dependent upon the level of the Company's
noninterest income, including fee income and service charges, and affected by
the level of its noninterest expenses, including its general administrative
expenses. Net interest income depends upon the volume of interest-earnings
assets and interest-bearing liabilities and the interest rate earned or paid on
them, respectively.
COMPARISON OF OPERATING RESULTS FOR
THE YEARS ENDED DECEMBER 31, 1997 AND 1996
General
Consolidated net income of the Company for the year ending December 31,
1997 was $944,000, as compared to $162,000 for the year ending December 31,
1996. The $782,000 increase in net income was primarily attributable to the
reinvestment of proceeds from the stock offering, as well as the $514,000 after
tax one time payment to recapitalize the Savings Association Insurance Fund,
which occurred in 1996. These items were partially offset by the $650,000 after
tax accrual to establish the Hemlock Federal Charitable Foundation, which took
place in March, 1997.
Net Interest Income
Net interest income after provisions for loan losses increased by $1.1
million, to $5.6 million for the year ending December 31, 1997, as compared to
$4.5 million for the year ending 1996. The net interest margin increased to
3.53% for the year ended December 31, 1997 from 3.20% for the year ended
December 31, 1996, primarily as a result of the increase in the ratio of
interest earning assets to interest-bearing liabilities to 118.59% for the year
ended December 31, 1997 from 106.67% for the year ended December 31, 1996. This
was partially offset by a decrease in the net interest spread from 2.93% for the
year ended December 31, 1996 to 2.85% for the year ended December 31, 1997.
Interest Income
Interest income for the year ended December 31, 1997 was $11.3 million
compared to $10.1 million for the year ended December 31, 1996. The increase in
interest income was primarily a result of an increase of $17.3 million in the
average balance of interest-earning assets as a result of the Company investing
net proceeds from the initial public offering, which occurred in March 1997.
6
<PAGE>
The average balance of loans receivable increased $10.0 million and the average
balance of securities increased $8.8 million. This was partially offset by a
decrease in the average yield on interest-earning assets from 7.21% for the year
ended December 31, 1996 to 7.15% for the year ended December 31, 1997. The yield
on loans and mortgage-backed securities decreased as a result of declining
market rates.
Interest Expense
Interest expense for the year ended December 31, 1997 was $5.7 million
compared to $5.6 million for the year ended December 31, 1996. The increase was
primarily the result of a $1.4 million increase in the average balance of
interest-bearing liabilities resulting from increased advances from the Federal
Home Loan Bank of Chicago.
Provision for Loan Losses
The Company recorded a provision for loan losses of $30,000 for the
year ended December 31, 1997, increasing the total allowance for loan losses to
$775,000 as of December 31, 1997. The allowance was equal to 1.01% of total
loans and 302.73% of non-performing loans as of December 31, 1997. The Company
had non-performing assets totaling $256,000 as of December 31, 1997. The amount
of the provision and allowance for estimated losses on loans is influenced by
current economic conditions, actual loss experience, industry trends and other
factors, such as adverse economic conditions, including declining real estate
values, in the Company's market area. In addition, various regulatory agencies,
as an integral part of the examination process, periodically review the
Company's allowance for estimated losses on loans. While management believes the
existing level of reserves is adequate, future adjustments to the allowance may
be necessary due to economic, operating, regulatory, and other conditions that
may be beyond the Company's control.
Non-Interest Income
Non-interest income increased $152,000 to $539,000 for the year ended
December 31, 1997. The increase was primarily attributable to a loss on the sale
of securities of $124,000 in the year ended December 31, 1996, as compared to a
loss of $3,000 for the year ended December 31, 1997. In addition, fees and
service charges increased $38,000 for the year ended December 31, 1997,
resulting from an increase in fees associated with lending.
Non-Interest Expense
Non-interest expense was $4.5 million for both the years ended December
31, 1997, and 1996. Non-interest expense for 1997 included a $1.0 million
accrual to establish the Hemlock Federal Charitable Foundation, as well as an
increase in compensation expense of $183,000, due primarily to costs associated
with the ESOP and RRP benefit plans. This increase was offset by a decrease of
$231,000 in federal insurance premiums for the year ended December 31, 1997.
Non-interest expense for 1996 also included the payment of $840,000 to
recapitalize the Savings Association Insurance Fund.
7
<PAGE>
Provision for Income Taxes
The Company's federal and state income tax expense increased from
$82,000 for the year ended December 31, 1996 to $626,000 for the year ended
December 31, 1997. The $544,000 increase in income tax was the result of the
increase in net income before income taxes of $1.3 million.
COMPARISON OF OPERATING RESULTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
General
Net income for the year ended December 31, 1996 was $161,000 compared
to net income of $952,000 for the year ended December 31, 1995, a decrease of
$791,000, or 83.1%. The decrease was primarily a result of an $840,000 FDIC
special assessment on SAIF insured deposits effective September 30, 1996. In
addition, the Bank realized a $223,000 gain on sale of real estate owned in
1995; there was no such gain in 1996.
Interest Income
Interest income for the year ended December 31, 1996 was $10.1 million
compared to $9.9 million for the year ended December 31, 1995, an increase of
$202,000, or 2.0%. The contributing factor in the increase in interest income
was the 6 basis point increase in the yield on average interest-earning assets
from 7.15% for the year ended December 31, 1995 to 7.21% for the year ended
December 31, 1996. The average yield on mortgage-backed securities increased
from 6.80% for the year ended December 31, 1995 to 7.02% for the year ended
December 31, 1996 due to the upward repricing of adjustable rate securities
coupled with the reduced amortization of premiums as a result of a slowdown in
prepayments from the prior year as anticipated by management. Although the yield
on average loans receivable decreased from 8.21% for the year ended December 31,
1995 to 8.05% for the year ended December 31, 1996, the average balance of loans
receivable increased by $9.4 million due to the shift from lower yielding
securities and mortgage-backed securities to higher yielding loans receivable.
The increase in the average balance of loans receivable was the result of
management's concerted effort through the addition of lending personnel and
increased emphasis on loan marketing.
Interest Expense
Interest expense for the year ended December 31, 1996 was $5.6 million
compared to $5.4 million for the year ended December 31, 1995, an increase of
$227,000, or 4.2%. The increase in interest expense reflects a higher interest
rate environment, as the average cost of interest-bearing liabilities increased
by 14 basis points from 4.14% for the year ended December 31, 1995 to 4.28% for
the year ended December 31, 1996. The increase in the average cost of funds was
also attributable to a shift of deposits from money market accounts to higher
yielding certificates of deposit. The average cost of certificates of deposit
increased from 5.23% for the year ended
8
<PAGE>
December 31, 1995 to 5.45% for the year ended December 31, 1996. In addition,
the average balance of interest-bearing liabilities increased $1.1 million from
$130.7 million for the year ended December 31, 1995 to $131.8 million for the
year ended December 31, 1996 as a result of market demand.
Net Interest Income
Net interest income of $4.5 million for the year ended December 31,
1996 represented no increase from the amount reported for the year ended
December 31, 1995. There was a decrease in the net interest spread from 3.01%
for the year ended December 31, 1995 to 2.93% for the year ended December 31,
1996. The decrease in the net interest rate spread was a result of the average
cost of interest-bearing deposits increasing at a more rapid rate than the
average yield on interest-earning assets.
Provision for Loan Losses
The Bank's provision for loan losses for the year ended December 31,
1996 was $150,000 compared to $134,000 for the year ended December 31, 1995. The
allowance for loan losses represented 1.4% and 1.3% of gross loans receivable at
December 31, 1996 and 1995, respectively. The amount of the provision and
allowance for estimated losses on loans is influenced by current economic
conditions, actual loss experience, industry trends and other factors, such as
adverse economic conditions, including declining real estate values, in the
Bank's market area. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review the Bank's allowance for
estimated losses on loans. Such agencies may require the Bank to provide
additions to the allowance based upon judgments which differ from those of
management. Although management uses the best information available and
maintains the Bank's allowance for losses at a level it believes adequate to
provide for losses, future adjustments to the allowance may be necessary due to
economic, operating, regulatory and other conditions that may be beyond the
Bank's control.
Noninterest Income
Noninterest income for the year ended December 31, 1996, was $387,000
compared to $337,000 for the year ended December 31, 1995, an increase of
$50,000, or 14.8%. The increase was the result of a decrease in the loss on sale
of securities of $37,000 combined with the $27,000 increase in fees and service
charges. This was partially offset by a decrease of $18,000 in other income
primarily related to FHA and VA loans on which the applications were taken for
other lenders.
Noninterest Expense
Noninterest expense was $4.5 million for the year ended December 31,
1996 compared to $3.2 million for the year ended December 31, 1995, an increase
of $1.3 million, or 40.6%. The increase was primarily due to an $840,000
one-time special assessment on SAIF insured deposits resulting from federal
legislation enacted on September 30, 1996. The Bank also recognized a gain
9
<PAGE>
on the sale of other real estate owned of $223,000 in 1995 compared to zero in
1996 and experienced an increase in occupancy expense of $82,000 due primarily
to increased real estate tax assessments in 1996.
Income Taxes
The provision for income taxes was $83,000 for the year ended December
31, 1996 compared to $559,000 for the year ended December 31, 1995. The decrease
was primarily due to a decrease in pretax income of $1.3 million.
10
<PAGE>
The following table presents, for the periods indicated, the total
dollar amount of interest income from average interest-earning assets and the
resultant yields, as well as the interest expense on average interest-bearing
liabilities, expressed both in dollars and rates. No tax equivalent adjustments
were made. All average balances are monthly average balances. Non-accruing loans
have been included in the table as loans carrying a zero yield.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------------------
1997 1996 1995
--------------------------- -------------------------- ------------------------------
Average Interest Average Interest Average Inteerest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
------- ---- ---- ------- ---- ---- ------- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans receivable(1)........... $60,541 $4,829 7.98% $50,555 $4,069 8.05% $41,189 $3,383 8.21%
Mortgage-backed securities.... 63,597 4,295 6.75 65,739 4,617 7.02 72,126 4,904 6.80
Securities(2)................. 18,759 1,210 6.45 9,992 599 5.99 14,780 898 6.08
Interest-bearing deposits..... 14,082 884 6.28 13,428 782 5.82 10,028 687 6.85
Other earning assets(3)....... 986 75 7.61 915 70 7.65 872 63 7.22
-------- ------ -------- ------ ------- -----
Total earning assets(1)...... 157,965 11,293 7.15 140,629 10,137 7.21 138,991 9,935 7.15
Non-interest earning assets... 5,151 5,354 4,697
----- ----- -----
Total assets.................. $163,196 $195,983 $143,688
======== ======== ========
Interest-Earning Liabilities:
Savings deposits.............. 45,741 1,467 3.21 46,369 1,445 3.12 $46,425 1,441 3.10
Demand and NOW................ 14,211 337 2.37 13,330 323 2.42 13,237 321 2.43
MMDA.......................... 5,024 159 3.16 5,516 174 3.15 6,297 198 3.14
Certificates of Deposit....... 64,765 3,541 5.47 65,125 3,552 5.45 63,283 3,308 5.23
Borrowings.................... 3,462 219 6.32 1,500 149 9.93 1,500 148 9.87
-------- ------ -------- ----- ------- -----
Total interest-bearing
liabilities............... 133,203 5,723 4.30 131,840 5,643 4.28 130,742 5,416 4.14
------ ----- -----
Non-interest-bearing
liabilities.................. 3,091 2,531 2,040
----- ----- -----
Total liabilities........... 136,312 134,371 132,782
Equity......................... 26,834 11,612 10,906
------ ------ ------
Total liabilities and
equity.................... $163,146 $145,983 $143,688
======== ======== ========
Net interest/spread............ $5,570 2.85% $4,494 2.93% $4,519 3.01%
====== ==== ====== ==== ====== ====
Margin......................... 3.53% 3.20% 3.25%
==== ==== ====
Assets to liabilities....... 118.59% 106.67% 106.31%
====== ====== ======
</TABLE>
(1) Calculated net of deferred loan fees, loan discounts, loans in process and
loss reserves.
(2) Calculated based on amortized cost.
(3) Includes FHLMC and FHLB stock at cost.
11
<PAGE>
The following table presents the weighted average yields earned on
loans, securities and other interest-earning assets, and the weighted average
rates paid on savings deposits and the resultant interest rate spreads at the
date indicated. Weighted average balances are based on monthly balances.
<TABLE>
<CAPTION>
At December 31,
------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Weighted average yield on:
<S> <C> <C> <C> <C> <C>
Loans receivable(1) ................................. 7.63% 7.81% 8.06% 8.20% 9.78%
Mortgage-backed securities(2) ....................... 6.99 7.28 8.22 6.42 7.77
Securities(2) ....................................... 5.22 7.60 5.10 6.71 9.71
Other interest-earning assets ....................... 5.77 6.16 4.26 5.38 5.16
Combined weighted average yield on interest-earning
assets ........................................ 7.27 7.36 7.45 6.78 8.21
Weighted average rate paid on:
Passbook Savings .................................... 2.94 3.14 3.15 3.14 5.12
NOW ................................................. 2.22 2.52 3.14 3.14 5.13
MMDA ................................................ 3.20 3.20 2.52 2.52 4.58
Certificate accounts ................................ 5.62 5.47 5.57 4.65 6.49
Borrowings .......................................... 5.86 9.72 9.72 9.72 9.59
Other interest-bearing liabilities .................. -- -- -- -- --
Combined weighted average rate paid on
interest-bearing liabilities ......................... 4.35 4.29 4.34 3.85 5.92
Spread ............................................... 2.92% 3.07% 3.11% 2.93% 2.29%
</TABLE>
(1) Excluding amortization of deferred loan fees.
(2) Excluding premium amortization and discount accretion.
12
<PAGE>
The following schedule presents the dollar amount of changes in
interest income and interest expense for major components of interest-earning
assets and interest-bearing liabilities. It distinguishes between the changes
related to outstanding balances and that due to the changes in interest rates.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume (i.e.,
changes in volume multiplied by old rate) and (ii) changes in rate (i.e.,
changes in rate multiplied by old volume). For purposes of this table, changes
attributable to both rate and volume, which cannot be segregated, have been
allocated proportionately to the change due to volume and the change due to
rate.
<TABLE>
<CAPTION>
Year Ended December 31, Year Ended December 31,
1996 vs. 1997 1995 vs. 1996
------------------------------------ ------------------------------------
Increase Increase
(Decrease) (Decrease)
Due to Total Due to Total
---------------------- Increase -------------------- Increase
Volume Rate (Decrease) Volume Rate (Decrease)
------ ---- ---------- ------ ---- ----------
Interest-earning assets:
<S> <C> <C> <C> <C> <C> <C>
Loans receivable .............................. $ 797 $ (37) $ 760 $ 335 $ (16) $ 319
Mortgage-backed securities .................... (148) (174) (322) (663) 1,059 396
Securities .................................... 562 49 611 326 172 498
------- ------- ------- ------- ------- -------
Interest-bearing deposits ...................... 39 63 102 (79) 300 221
Other earning assets ........................... 5 -- 5 (2) 2 --
Total interest-earning assets ............... $ 1,255 $ (99) $ 1,156 $ (83) $ 1,517 $ 1,434
------- ------- ------- ------- ------- -------
Interest-bearing liabilities:
Passbook savings .............................. (20) 42 22 (73) 142 69
NOW ........................................... 21 (7) 14 5 29 34
MMDA .......................................... (16) 1 (15) (43) 31 (12)
Certificate of Deposit ........................ (20) 9 (11) 73 669 742
Borrowings .................................... 139 (69) 70 (91) 2 (89)
------- ------- ------- ------- ------- -------
Total interest-bearing liabilities .......... 104 (24) 80 (129) 873 744
------- ------- ------- ------- ------- -------
Net interest/spread ............................ $ 1,151 $ (75) $ 1,076 $ 46 $ 644 $ 690
======= ======= ======= ======= ======= =======
</TABLE>
13
<PAGE>
Asset/Liability Management
In an attempt to manage its exposure to changes in interest rates,
management monitors the Company's interest rate risk. The Board of Directors
reviews at least quarterly the Company's interest rate risk position and
profitability. The Board of Directors also reviews the Company's portfolio,
formulates investment strategies and oversees the timing and implementation of
transactions to assure attainment of the Company's objectives in the most
effective manner. In addition, the Board anticipates reviewing on a quarterly
basis the Company's asset/liability position, including simulations of the
effect on the Company's capital of various interest rate scenarios.
In managing its asset/liability mix, the Company, depending on the
relationship between long- and short-term interest rates, market conditions and
consumer preference, at times places more emphasis on managing net interest
margin than on better matching the interest rate sensitivity of its assets and
liabilities in an effort to enhance net interest income. Management believes
that the increased net interest income resulting from a mismatch in the maturity
of its asset and liability portfolios can, during periods of declining or stable
interest rates, provide high enough returns to justify the increased exposure to
sudden and unexpected increases in interest rates.
The Company has taken a variety of steps to manage its interest rate
risk level. First, the Company maintains a significant portfolio of
mortgage-backed securities having adjustable rates and/or short or intermediate
terms to maturity. At December 31, 1997, $43,130 million or 24.4% of the
Company's assets consisted of mortgage-backed and related securities having
adjustable or floating interest rates or anticipated average lives of five years
or less. Second, the Company focuses its lending activities on the origination
of adjustable rate mortgage loans ("ARMs"), seven year balloon loans and fixed
rate loans with terms to maturity of 15 years or less. Third, the Company
maintains a portfolio of securities and liquid assets with weighted average
lives of four years or less. At December 31, 1997, the Company had $18.4 million
of securities with a remaining average life of four years. Finally, a
substantial proportion of the Company's liabilities consists of NOW and passbook
savings accounts which are believed by management to be somewhat less sensitive
to interest rate changes than certificate accounts.
Net Portfolio Value
Management utilizes the net portfolio value ("NPV") analysis to
quantify interest rate risk. In essence, this approach calculates the difference
between the present value of liabilities, expected cash flows from assets and
cash flows from off balance sheet contracts. Under OTS regulations, an
institution's "normal" level of interest rate risk in the event of an immediate
and sustained 200 basis point change in interest rates is a decrease in the
institution's NPV in an amount not exceeding 2% of the present value of its
assets. Pursuant to this regulation, thrift institutions with greater than
"normal" interest rate exposure must take a deduction from their total capital
available to meet their risk-based capital requirement. The amount of that
deduction is one-half of the difference between (a) the institution's actual
calculated exposure to the 200 basis point interest rate increase or decrease
(whichever results in the greater pro forma decrease in NPV) and (b) its
"normal" level of exposure which is 2% of the present value of its assets.
Savings institutions, however, with less than $300 million in assets and a total
capital ratio in excess of 12%, will be
14
<PAGE>
exempt from this requirement unless the OTS determines otherwise. The OTS has
postponed the implementation of the rule until further notice. Based upon its
asset size and capital level at December 31, 1997, the Bank would qualify for an
exemption from this rule; however, management believes that the Bank would not
be required to make a deduction from capital if it were subject to this rule.
The following table sets forth, at December 31, 1997, an analysis of
the Bank's interest rate risk as measured by the estimated changes in NPV
resulting from instantaneous and sustained parallel shifts in the yield curve
("400 basis points, measured in 100 basis point increments) as compared to
tolerance limits under the Bank's current policy.
Change in Interest Estimated Ratio of NPV Estimated Increase
Rates NPV to (Decrease) in NPV
(Basis Points) Amount Total Assets Amount Percent
-------------- ------ ------------ ------ -------
(Dollars in Thousands)
+400 $19,037 11.68% $(7,061) (27)%
+300 21,926 12.90 (4,674) (18)
+200 23,633 13.99 (2,467) (9)
+100 25,267 14.75 (833) (3)
-- 26,100 15.10 --
B100 25,986 14.98 (114) 0
B200 26,010 14.92 (90) 0
B300 26,390 15.04 290 41
B400 27,260 15.38 1160 54
Certain assumptions utilized in assessing the interest rate risk of
thrift institutions were employed in preparing the preceding table. These
assumptions relate to interest rates, loan prepayment rates, deposit decay
rates, and the market values of certain assets under the various interest rate
scenarios. It was also assumed that delinquency rates will not change as a
result of changes in interest rates although there can be no assurance that this
will be the case. Even if interest rates change in the designated amounts, there
can be no assurance that the Bank's assets and liabilities would perform as set
forth above. In addition, a change in U.S. Treasury rates in the designated
amounts accompanied by a change in the shape of the Treasury yield curve would
cause significantly different changes to the NPV than indicated above.
Liquidity and Capital Resources
The Company's primary sources of funds are deposits and proceeds from
principal and interest payments on loans and mortgage-backed securities. While
maturities and scheduled amortization of loans and securities are predictable
sources of funds, deposit flows and mortgage prepayments are greatly influenced
by general interest rates, economic conditions and competition. Hemlock Federal
generally manages the pricing of its deposits to be competitive and increase
core deposit relationships.
Federal regulations require Hemlock Federal to maintain minimum levels
of liquid assets. The required percentage has varied from time to time based
upon economic conditions and savings
15
<PAGE>
flows and is currently 5% of net withdrawable savings deposits and borrowings
payable on demand or in one year or less during the preceding calendar month.
Liquid assets for purposes of this ratio include cash, certain time deposits,
U.S. Government, government agency and corporate securities and other
obligations generally having remaining maturities of less than five years.
Hemlock Federal has historically maintained its liquidity ratio for regulatory
purposes at levels in excess of those required. At December 31, 1997, Hemlock
Federal's liquidity ratio for regulatory purposes was 18.86%.
The Company's cash flows are comprised of three primary
classifications: cash flows from operating activities, investing activities and
financing activities. Cash flows provided by operating activities were $2.5
million and $574,000 for the years ended December 31, 1997 and December 31,
1996, respectively. Net cash from investing activities consisted primarily of
disbursements for loan originations and the purchase of investments and
mortgage-backed securities, offset by principal collections on loans, proceeds
from maturation and sales of securities and paydowns on mortgage-backed
securities. Net cash from financing activities consisted primarily of activity
in proceeds from the issuance of stock and proceeds from borrowings.
The Company's most liquid assets are cash and short-term investments.
The levels of these assets are dependent on the Company's operating, financing,
lending and investing activities during any given period. At December 31, 1997,
cash and short-term investments totaled $14.9 million. The Company has other
sources of liquidity if a need for additional funds arises, including securities
maturing within one year and the repayment of loans. The Company may also
utilize the sale of securities available-for-sale and Federal Home Loan Bank
advances as a source of funds.
At December 31, 1997, the Bank had outstanding commitments to originate
loans of $652,000, of which $352,000 had fixed interest rates. These loans are
to be secured by properties located in its market area. The Bank anticipates
that it will have sufficient funds available to meet its current loan
commitments. Certificates of deposit which are scheduled to mature in one year
or less from December 31, 1997 totaled $48.8 million. Management believes that a
significant portion of such deposits will remain with the Bank.
Liquidity management is both a daily and long-term responsibility of
management. Hemlock Federal adjusts its investments in liquid assets based upon
management's assessment of (i) expected loan demand, (ii) expected deposit
flows, (iii) yields available on interest-earning deposits and investment
securities, and (iv) the objectives of its asset/liability management program.
Excess liquidity is invested generally in interest-earning overnight deposits
and short- and intermediate-term U.S. Government and agency obligations and
mortgage-backed securities of short duration. If Hemlock Federal requires funds
beyond its ability to generate them internally, it has additional borrowing
capacity with the FHLB of Chicago.
Hemlock Federal is subject to various regulatory capital requirements
imposed by the OTS. At December 31, 1997, Hemlock Federal was in compliance with
all applicable capital requirements on a fully phased-in basis. See "Regulation
- - Regulatory Capital Requirements" and Note 11 of the Notes to the Financial
Statements.
16
<PAGE>
Regulatory Capital
Federally insured savings institutions are required to maintain a
minimum level of regulatory capital. OTS regulations established capital
requirements, including a tangible capital requirement, a leverage (or core
capital) requirement and a risk-based capital requirement applicable to savings
institutions. These capital requirements must be generally as stringent as the
comparable capital requirements for national banks. The OTS is also authorized
to impose capital requirements in excess of these standards on individual
institutions on a case-by-case basis.
At December 31, 1997, the Bank continued to exceed all regulatory
capital requirements with tangible and core capital of $20.7 million and $20.7
million, or 12.3% and 12.3% of adjusted total assets, respectively, which were
approximately $18.2 million and $15.7 million above the minimum requirements of
3.0% and 1.5%, respectively, of the adjusted total assets in effect on that
date. On December 31, 1997 the Bank had risk-based capital of $21.5 million, or
34.9% of risk-weighted assets of $61.6 million. This amount was $16.5 million
above the 8.0% requirement in effect on that date. Under regulatory guidelines,
the Bank was considered well-capitalized at December 31, 1997.
Impact of Inflation
The financial statements and related data presented herein have been
prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operating results in
historical dollars without considering changes in the relative purchasing power
of money over time due to inflation. The primary impact of inflation on the
operations of the Company is reflected in increased operating costs. Unlike most
industrial companies, virtually all of the assets and liabilities of a financial
institution are monetary in nature. As a result, change in interest rates
generally have a more significant impact on a financial institution's
performance than does inflation. Interest rates do not necessarily move in the
same direction or to the same extent as the prices of goods and services. In the
current interest rate environment, liquidity and maturity structure of the
Company's assets and liabilities are critical to the maintenance of acceptable
performance levels.
Impact of New Accounting Standards
In 1996, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 125 ("SFAS No. 125"),
"Accounting for Transfers and Extinguishments of Liabilities." SFAS No. 125
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. SFAS No. 125 requires a
consistent application of a financial-components approach that focuses on
control. Under that approach, after a transfer of financial assets, an entity
recognizes the financial and servicing assets it controls and the liabilities it
has incurred, and derecognizes liabilities when extinguished. SFAS No. 125 is
effective for some transactions in 1997 and other in 1998. The effect of SFAS
No. 125 on the results of operation and the financial condition of the Company
is not expected to be material.
On March 3, 1997, the Financial Accounting Standards Board ("FASB")
issued Statement 128, "Earnings Per Share," which is effective for financial
statements beginning with year end 1997.
17
<PAGE>
Statement 128 simplifies the calculation of earnings per share ("EPS") by
replacing primary EPS with basic EPS. It also requires dual presentation of
basic EPS and diluted EPS for entities with complex capital structures. Basic
EPS includes no dilution and is computed by dividing income available to common
stockholders by the weighted-average common shares outstanding for the period.
Diluted EPS reflects the potential dilution of securities that could share in
earnings, such as stock options, warrants or other common stock equivalents. The
Company expects Statement 128 to have little impact on its earnings per share
calculations in future years, other than changing terminology from primary EPS
to basic EPS.
The Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income," was issued by the FASB in 1997. This statement
established standards for reporting and display of comprehensive income and its
components in a full set of general purpose financial statements. It does not
address issues of recognition or measurement for comprehensive income and its
components. Statement 130 is effective for fiscal years beginning after December
15, 1997. Since the provisions of this Statement are disclosure oriented, it
will have no impact on the operations or financial condition of the Company.
The Statement of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related Information," was issued in 1997 by
the FASB. The Statement established standards for the way that public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports issued to stockholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. Statement 131 is effective for periods
beginning after December 15, 1997. Management does not believe that the
provisions of this Statement are applicable to the Company, since substantially
all of the Company's operations are banking activities.
Year 2000
The Company has conducted a review of its computer systems to review
the systems that could be affected by the "Year 2000" issue and is developing an
implementation plan to resolve the issue. The Year 2000 problem is the result of
computer programs being written using two digits rather than four to define the
applicable year. For example, programs that have time-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a major system failure or miscalculations. The Company presently
believes that, with modifications to existing software and by converting to new
software, the Year 2000 problem will not pose significant operational problems
for the Company's computer systems as so modified and converted. However, if
such modifications and conversions are not complete in a timely manner, the Year
2000 problem may have a material impact on the operations of the Company.
18
<PAGE>
Safe Harbor Statement
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended and Section 21E of the
Securities Exchange Act of 1934, as amended. The Company intends such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Reform Act of
1995, and is including this statement for purposes of these safe harbor
provisions. Forward-looking statements, which are based on certain assumptions
and describe future plans, strategies and expectations of the Company, are
generally identifiable by use of the words "believe", "expect", "intend",
"anticipate", "estimate", "project" or similar expressions. The Company's
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Factors which could have a material adverse affect on the
operations and future prospects of the Company and the subsidiaries include, but
are not limited to, changes in: interest rates, general economic conditions,
legislative/regulatory changes, monetary and fiscal policies of the U.S.
Government, including policies of the U.S. Treasury and the Federal Reserve
Board, the quality or composition of the loan or investment portfolios, demand
for loan products, deposit flows, competition, demand for financial services in
the Company's market area and accounting principles, policies and guidelines.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements. Further
information concerning the Company and its business, including additional
factors that could materially affect the Company's financial results, is
included in the Company's filings with the Securities and Exchange Commission.
19
<PAGE>
HEMLOCK FEDERAL FINANCIAL CORPORATION
STOCKHOLDER INFORMATION
ANNUAL MEETING
The Annual Meeting of Stockholders will be held at 10:30 a.m., Oak
Forest, Illinois time on May 6, 1998 at the main office of Hemlock Federal
Financial Corporation, 5700 West 159th Street, Oak Forest, Illinois 60452.
STOCK LISTING
Hemlock Federal Financial Corporation common stock is traded on the
National Association of Securities Dealers, Inc. National Market under the
symbol "HMLK."
PRICE RANGE OF COMMON STOCK
The per share price range of the common stock for each quarter since
the common stock began trading on March 31, 1997 was as follows:
FISCAL 1997 HIGH LOW DIVIDENDS
----------- ---- --- ---------
Second Quarter................. $13.875 $12.500 $.00
Third Quarter.................. $15.625 $13.875 $.06
Fourth Quarter................. $17.500 $15.375 $.06
The stock price information set forth in the table above was provided by the
National Association of Securities Dealers, Inc. Automated Quotation System. The
average of the bid and asked prices of Hemlock Federal Financial Corporation's
common stock on April 3, 1998 was $12.563.
At April 3, 1998, there were 2,006,849 shares of Hemlock Federal Financial
Corporation common stock outstanding (including unallocated ESOP shares) and
there were ____ holders of record.
20
<PAGE>
HEMLOCK FEDERAL FINANCIAL CORPORATION AND SUBSIDIARY
Oak Forest, Illinois
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
CONTENTS
REPORT OF INDEPENDENT AUDITORS...................................... 21
FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION.................... 22
CONSOLIDATED STATEMENTS OF INCOME................................. 23
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY........ 24
CONSOLIDATED STATEMENTS OF CASH FLOWS............................. 25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS........................ 27
20
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Hemlock Federal Financial
Corporation
Oak Forest, Illinois
We have audited the accompanying consolidated statements of financial condition
of Hemlock Federal Financial Corporation and Subsidiary, as of December 31, 1997
and 1996, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Corporation's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Hemlock Federal
Financial Corporation and Subsidiary as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles.
Crowe, Chizek and Company LLP
Oak Brook, Illinois
January 23, 1998
21
<PAGE>
HEMLOCK FEDERAL FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 1997 and 1996
(Dollars in thousands)
- --------------------------------------------------------------------------------
1997 1996
---- ----
ASSETS
Cash and due from banks ................................ $ 2,714 $ 1,771
Interest-bearing deposits in
financial institutions ............................... 12,169 15,639
--------- ---------
Cash and cash equivalents ......................... 14,883 17,410
Securities available-for-sale .......................... 34,703 42,619
Securities held-to-maturity (fair
value: 1997 - $47,418; 1996 - $30,322) ............... 46,418 29,537
Loans receivable, net .................................. 76,159 53,536
Federal Home Loan Bank stock, at cost .................. 987 901
Accrued interest receivable ............................ 904 788
Premises and equipment, net ............................ 2,099 1,043
Prepaid expenses and other assets ...................... 530 571
--------- ---------
Total assets ...................................... $ 176,683 $ 146,405
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits ............................................... $ 130,958 $ 131,243
Advance from Federal Home Loan Bank .................... 11,000 1,500
Advance payments by borrowers for taxes
and insurance ........................................ 804 681
Accrued interest payable and other liabilities ......... 3,494 866
--------- ---------
Total liabilities ................................. 146,256 134,290
Stockholders' equity
Common stock, $.01 par value; 2,500,000 shares
authorized; 2,076,325 shares issued ............... 21 --
Additional paid-in capital .......................... 20,105 --
Unearned ESOP shares ................................ (1,495) --
Unearned stock awards ............................... (1,382) --
Retained earnings, substantially restricted ......... 12,203 11,508
Net unrealized gain on securities
available-for-sale, net of income taxes ........... 975 607
--------- ---------
Total equity .................................... 30,427 12,115
--------- ---------
Total liabilities and stockholders' equity .... $ 176,683 $ 146,405
========= =========
See accompanying notes to consolidated financial statements
22
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 1997, 1996, and 1995
(Dollars in thousands)
- --------------------------------------------------------------------------------
1997 1996 1995
---- ---- ----
Interest income
Loans .................................. $ 4,829 $ 4,068 $ 3,383
Mortgage-backed and other
securities ........................... 4,295 4,617 4,904
Securities ............................. 1,210 599 897
Other interest-earning assets .......... 959 853 750
-------- -------- --------
Total interest income ............... 11,293 10,137 9,934
Interest expense
Deposits ............................... 5,504 5,494 5,268
Other borrowings ....................... 219 149 148
-------- -------- --------
Total interest expense .............. 5,723 5,643 5,416
-------- -------- --------
Net interest income ........................ 5,570 4,494 4,518
Provision for loan losses .................. 30 150 133
-------- -------- --------
Net interest income after provision
for loan losses ......................... 5,540 4,344 4,385
Noninterest income
Fees and service charges ............... 417 379 352
Rental income .......................... 40 43 39
Loss on sale of securities ............. (3) (124) (161)
Miscellaneous income ................... 85 89 107
-------- -------- --------
Total noninterest income ............ 539 387 337
Noninterest expense
Compensation and employee benefits ..... 1,864 1,681 1,635
Occupancy and equipment expenses ....... 625 720 637
Data processing ........................ 235 226 201
Federal insurance premiums ............. 71 302 298
SAIF special assessment ................ -- 840 --
Gain on sale of real estate owned ...... -- -- (223)
Advertising and promotion .............. 80 129 124
Contributions .......................... 1,007 40 25
Other .................................. 627 549 514
-------- -------- --------
Total noninterest expense ........... 4,509 4,487 3,211
-------- -------- --------
Income before provision for
income taxes ............................ 1,570 244 1,511
Provision for income taxes ................. 626 82 559
-------- -------- --------
Net income ................................. $ 944 $ 162 $ 952
======== ======== ========
Earnings per share
Basic and diluted ...................... $ .40
========
See accompanying notes to consolidated financial statements
23
<PAGE>
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years ended December 31, 1997, 1996, and 1995
(Dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Unrealized
Retained Gains (Losses)
Additional Unearned Unearned Earnings, on Securities
Common Paid-In ESOP Stock Substantially Available-
Stock Capital Shares Awards Restricted for-Sale Total
----- ------- ------ ------ ---------- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1995 ....................... $ -- $ -- $ -- $ -- $ 10,394 $ (15) $ 10,379
Net income ....................................... -- -- -- -- 952 -- 952
Reclassification of securities from
held-to-maturity to available-for-
sale, net of tax of $55 (Note 2) ............... -- -- -- -- -- 86 86
Change in unrealized loss on
securities available-for-sale,
net of income tax of $291 ...................... -- -- -- -- -- 460 460
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1995 ..................... -- -- -- -- 11,346 531 11,877
Net income ....................................... -- -- -- -- 162 -- 162
Change in unrealized gain on
securities available-for-sale,
net of income tax of $49 ....................... -- -- -- -- -- 76 76
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1996 ..................... -- -- -- -- 11,508 607 12,115
Issuance of stock and restricted
stock awards in connection
with conversion ................................ 21 20,016 (1,661) (1,433) -- -- 16,943
ESOP shares earned ............................... -- 89 166 -- -- -- 255
Stock awards earned .............................. -- -- -- 51 -- -- 51
Net income ....................................... -- -- -- -- 944 -- 944
Cash dividends ($.12 per share) .................. -- -- -- -- (249) -- (249)
Change in unrealized gain on
securities available-for-sale,
net of income tax of $235 ...................... -- -- -- -- -- 368 368
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 1997 ..................... $ 21 $ 20,105 $ (1,495) $ (1,382) $ 12,203 $ 975 $ 30,427
======== ======== ======== ======== ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements
24
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996, and 1995
(Dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
Cash flows from operating activities
<S> <C> <C> <C>
Net income .......................................... $ 944 $ 162 $ 952
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation ..................................... 117 141 134
Amortization of premiums and discounts on
investment and mortgage-backed securities, net . 268 181 746
Net loss on sale of securities ................... 3 124 161
Provision for loan losses ........................ 30 150 133
FHLB stock dividends ............................. -- -- (13)
Change in deferred income taxes .................. (320) (10) 112
Gain on sale of REO .............................. -- -- (223)
ESOP compensation expense ........................ 255 -- --
Stock awards expense ............................. 51 -- --
(Increase) decrease in accrued interest receivable (116) 318 (222)
Increase (decrease) in accrued interest payable
and other liabilities .......................... 960 (39) 18
Increase in net deferred loan costs .............. (101) (86) (66)
(Increase) decrease in other assets .............. 361 (367) 233
-------- -------- --------
Net cash provided by operating activities ..... 2,452 574 1,965
Cash flows from investing activities
Purchase of securities available-for-sale ........... (12,051) (30,474) (39,683)
Proceeds from sales of securities available-for-sale 596 7,621 4,914
Proceeds from sales of securities held-to-maturity .. -- -- 575
Principal payments on mortgage-backed
securities and collateralized mortgage obligations 21,030 22,136 22,440
Purchase of securities held-to-maturity ............ (39,258) (325) (5,110)
Proceeds from maturities and calls of securities .... 21,050 12,605 19,000
Purchase of FHLB stock .............................. (86) (51) --
Purchase of loans ................................... (12,865) -- --
Net increase in loans ............................... (9,687) (8,368) (7,640)
Property and equipment expenditures ................. (1,173) (140) (96)
Proceeds from sale of real estate owned ............. -- -- 223
-------- -------- --------
Net cash provided by (used in) investing
activities ..................................... (32,444) 3,004 (5,377)
Cash flows from financing activities
Net increase (decrease) in deposits ................. (285) 502 (30)
Increase (decrease) in advance payments by
borrowers for taxes and insurance ................. 123 29 (83)
Borrowings of FHLB advances ......................... 9,500 -- --
Issuance of stock ................................... 18,376 -- --
Dividends paid ...................................... (249) -- --
-------- -------- --------
Net cash provided by (used in) financing
activities ..................................... 27,465 531 (113)
-------- -------- --------
</TABLE>
(Continued)
25
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996, and 1995
(Dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net increase (decrease) in cash and cash equivalents $ (2,527) $ 4,109 $ (3,525)
Cash and cash equivalents at beginning of year ...... 17,410 13,301 16,826
-------- -------- --------
Cash and cash equivalents at end of year ............ $ 14,883 $ 17,410 $ 13,301
======== ======== ========
Supplemental disclosures of cash flow information
Cash paid during the year for
Interest ....................................... $ 5,683 $ 5,631 $ 5,396
Income taxes ................................... 690 316 371
Supplemental schedule of noncash investing activities
Transfer of debt securities to available-for-sale
from held-to-maturity on December 31, 1995 ...... -- -- 9,311
</TABLE>
See accompanying notes to consolidated financial statements
26
<PAGE>
HEMLOCK FEDERAL FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996, and 1995
(Table amounts in thousands of dollars)
- --------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The accompanying consolidated financial statements
include the accounts of Hemlock Federal Financial Corporation (the Corporation)
and its wholly-owned subsidiary, Hemlock Federal Bank for Savings (the Bank).
All significant intercompany transactions and balances are eliminated in
consolidation.
Nature of Operations: The only business of the Corporation is the ownership of
the Bank. The Bank is a federally-chartered stock savings bank and member of the
Federal Home Loan Bank (FHLB) system which maintains insurance on deposit
accounts with the Savings Association Insurance Fund (SAIF) of the Federal
Deposit Insurance Corporation. The Bank is engaged in the business of retail
banking, with operations conducted through its main office and two branches
located in the Chicago metropolitan area.
Use of Estimates in the Preparation of Financial Statements: 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
income and expenses during the reporting period. Actual results could differ
from those estimates. The collectibility of loans, fair value of financial
instruments, and status of contingencies are particularly subject to change.
Securities: Securities are classified as held-to-maturity when the Corporation
has the positive intent and ability to hold those securities to maturity.
Accordingly, they are stated at cost, adjusted for amortization of premiums and
accretion of discounts. All other securities are classified as
available-for-sale since the Corporation may decide to sell those securities in
response to changes in market interest rates, liquidity needs, changes in yields
or alternative investments, and for other reasons. These securities are carried
at fair value with unrealized gains and losses charged or credited, net of
income taxes, to a valuation allowance included as a separate component of
equity. Realized gains and losses on disposition are based on the net proceeds
and the adjusted carrying amounts of the securities sold, using the specific
identification method.
Loans Receivable: Loans receivable are stated at unpaid principal balances, less
the allowance for loan losses and deferred loan origination fees and discounts.
Allowance for Loan Losses: Because some loans may not be repaid in full, an
allowance for loan losses is maintained. Increases to the allowance are recorded
by a provision for loan losses charged to expense. Estimating the risk of the
loss and the amount of loss on any loan is necessarily subjective. Accordingly,
the allowance is maintained by management at a level considered adequate to
cover losses that are currently anticipated based on past loss experience,
general economic conditions, information about specific borrower situations
27
<PAGE>
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
including their financial position and collateral values, and other factors and
estimates which are subject to change over time. While management may
periodically allocate portions of the allowance for specific problem loan
situations, including impaired loans discussed below, the whole allowance is
available for any charge-offs that occur. Loans are charged off in whole or in
part when management's estimate of the undiscounted cash flows from the loan are
less than the recorded investment in the loan, although collection efforts
continue and future recoveries may occur.
The Corporation measures impaired loans based on the present value of expected
cash flows discounted at the loan's effective interest rate or, as a practical
expedient, at the loan's observable market price or the fair value of collateral
if the loan is collateral dependent. Loans considered to be impaired are reduced
to the present value of expected future cash flows or to the fair value of
collateral, by allocating a portion of the allowance for loan losses to such
loans. If these allocations cause the allowance for loan losses to require
increase, such increase is reported as a provision for loan losses.
Smaller balance homogenous loans are defined as residential first mortgage loans
secured by one-to-four-family residences, residential construction loans, and
share loans and are evaluated collectively for impairment. Commercial real
estate loans are evaluated individually for impairment. Normal loan evaluation
procedures, as described in the second preceding paragraph, are used to identify
loans which must be evaluated for impairment. In general, loans classified as
doubtful or loss are considered impaired while loans classified as substandard
are individually evaluated for impairment. Depending on the relative size of the
credit relationship, late or insufficient payments of 30 to 90 days will cause
management to reevaluate the credit under its normal loan evaluation procedures.
While the factors which identify a credit for consideration for measurement of
impairment, or nonaccrual, are similar, the measurement considerations differ. A
loan is impaired when the economic value estimated to be received is less than
the value implied in the original credit agreement. A loan is placed in
nonaccrual when payments are more than 90 days past due unless the loan is
adequately collateralized and in the process of collection.
Recognition of Income on Loans: Interest on real estate and certain consumer
loans is accrued over the term of the loans based upon the principal balance
outstanding. Where serious doubt exists as to the collectibility of a loan, the
accrual of interest is discontinued. The carrying values of impaired loans are
periodically adjusted to reflect cash payments, revised estimates of future cash
flows, and increases in the present value of expected cash flows due to the
passage of time. Cash payments representing interest income are reported as
such. Other cash payments are reported as reductions in carrying value, while
increases or decreases due to changes in estimates of future payments and due to
the passage of time are reported as adjustments to the provision for loan
losses.
28
<PAGE>
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loan fees, net of direct loan origination costs, are deferred and amortized over
the contractual life of the loan as a yield adjustment.
Premises and Equipment: Premises and equipment are stated at cost less
accumulated depreciation. Depreciation is computed using the straight-line
method over the estimated useful lives of the respective premises and equipment.
Maintenance and repairs are charged to expense as incurred and improvements
which extend the useful lives of assets are capitalized.
Income Taxes: The Corporation records income tax expense based on the amount of
taxes due on its tax return, plus deferred taxes computed on the expected future
tax consequences of temporary differences between the carrying amounts and the
tax bases of assets and liabilities, using enacted tax rates.
Employee Stock Ownership Plan: The cost of shares issued to the ESOP but not yet
allocated to participants is presented in the consolidated balance sheet as a
reduction of stockholders' equity. Compensation expense is recorded based on the
market price of the shares as they are committed to be released for allocation
to participant accounts. The difference between the market price and the cost of
shares committed to be released is recorded as an adjustment to paid-in capital.
Dividends on unallocated ESOP shares are reflected as a reduction of debt.
Shares are considered outstanding for earnings per share calculations as they
are committed to be released; unallocated shares are not considered outstanding.
Earnings per Share: Earnings per share is computed under the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings Per Share", which
was adopted retroactively by the Corporation at the beginning of the fourth
quarter of 1997. Amounts reported as earnings per share for the year ended
December 31, 1997 reflect earnings since March 31, 1997 (date of the conversion)
available to common stockholders divided by the weighted average number of
common shares outstanding since March 31, 1997.
Statement of Cash Flows: Cash and cash equivalents include cash on hand, amounts
due from banks, and daily federal funds sold. The Corporation reports net cash
flows for customer loan transactions and deposit transactions.
29
<PAGE>
NOTE 2 - SECURITIES
Securities consist of the following at:
<TABLE>
<CAPTION>
December 31, 1997
-------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
---- ----- -------- -----
Securities available-for-sale
<S> <C> <C> <C> <C>
U.S. government agencies .......... $ 3,647 $ -- $ (30) $ 3,617
FHLMC stock ....................... 26 1,077 -- 1,103
FHLMC certificates ................ 5,164 183 -- 5,347
FNMA certificates ................. 7,488 289 -- 7,777
Collateralized mortgage obligations 16,780 106 (27) 16,859
-------- -------- -------- --------
$ 33,105 $ 1,655 $ (57) $ 34,703
======== ======== ======== ========
Securities held-to-maturity
U.S. government agencies .......... $ 14,735 $ 8 $ (25) $ 14,718
GNMA certificates ................. 4,328 133 -- 4,461
FHLMC certificates ................ 7,773 444 -- 8,217
FNMA certificates ................. 11,977 368 (25) 12,320
Collateralized mortgage obligations 7,605 97 -- 7,702
-------- -------- -------- --------
$ 46,418 $ 1,050 $ (50) $ 47,418
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1996
-------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
---- ----- -------- -----
Securities available-for-sale
<S> <C> <C> <C> <C>
U.S. government agencies .......... $ 7,804 $ 30 $ (7) $ 7,827
FHLMC stock ....................... 26 725 -- 751
FHLMC certificates ................ 7,602 150 (10) 7,742
FNMA certificates ................. 12,731 115 (25) 12,821
Collateralized mortgage obligations 13,461 45 (28) 13,478
-------- -------- -------- --------
$ 41,624 $ 1,065 $ (70) $ 42,619
======== ======== ======== ========
Securities held-to-maturity
GNMA certificates ................. $ 3,058 $ 106 $ -- $ 3,164
FHLMC certificates ................ 10,094 413 (9) 10,498
FNMA certificates ................. 13,916 253 (6) 14,163
Collateralized mortgage obligations 2,469 30 (2) 2,497
-------- -------- -------- --------
$ 29,537 $ 802 $ (17) $ 30,322
======== ======== ======== ========
</TABLE>
30
<PAGE>
NOTE 2 - SECURITIES (Continued)
On December 31, 1995, the Corporation reclassified a portion of its securities
held-to-maturity to available-for-sale in accordance with "A Guide to
Implementation of Statement 115 on Accounting for Certain Investments in Debt
and Equity Securities", in order to improve the Bank's flexibility in meeting
liquidity needs. The amortized cost and unrealized gain on securities
transferred to available-for-sale were $9,311,000 and $141,000, respectively.
The amortized cost and estimated market value of debt securities at December 31,
1997 by contractual maturity are shown below. 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.
Held-to-Maturity Available-for-Sale
------------------ ---------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---- ----- ---- -----
Due in one year or less ........ $ 999 $ 995 $ -- $ --
Due after one year
through five years ............ 6,852 6,838 2,664 2,625
Due after five years
through ten years ............. 6,884 6,885 983 992
------- ------- ------- -------
14,735 14,718 3,647 3,617
FHLMC stock .................... -- -- 26 1,103
Mortgage-backed securities
and collateralized
mortgage obligations .......... 31,683 32,700 29,432 29,983
------- ------- ------- -------
$46,418 $47,418 $33,105 $34,703
======= ======= ======= =======
At December 31, 1997 and 1996, all of the Corporation's mortgage-backed and
related securities were guaranteed or insured by quasi-governmental agencies
(e.g., GNMA, FNMA, FHLMC).
Sales of securities available-for-sale are summarized as follows:
For the Year Ended
December 31,
--------------------------------------
1997 1996 1995
---- ---- ----
Proceeds ....................... $ 596 $7,621 $4,914
Gross losses ................... 3 124 157
On February 13, 1995, the Corporation sold six securities classified as
held-to-maturity. These sales were permissible under the provisions of SFAS No.
115 since the securities had been paid down to less than 15% of the original par
value. Gross proceeds totaled $575,000, with gross gains of $2,000 and gross
losses of $6,000.
31
<PAGE>
NOTE 3 - LOANS RECEIVABLE
Loans receivable consist of the following at:
December 31,
-----------------------
1997 1996
---- ----
First mortgage loans
Principal balances:
Secured by one-to-four-family residences ......... $ 68,283 $ 48,339
Secured by multi-family .......................... 4,951 2,783
Secured by commercial real estate ................ 209 573
-------- --------
73,443 51,695
Less:
Loans in process ................................. 125 --
Net deferred loan origination costs .............. (287) (2)
-------- --------
Total first mortgage loans .................. 73,605 51,697
Consumer and other loans Principal balances:
Home equity loans ................................ 2,740 2,114
Loans on deposits ................................ 116 169
Automobile loans ................................. 473 301
-------- --------
Total consumer and other loans .............. 3,329 2,584
Less allowance for loan losses ..................... 775 745
-------- --------
$ 76,159 $ 53,536
======== ========
There were no impaired loans at December 31, 1997 or December 31, 1996.
Nonaccrual and renegotiated loans totaled approximately $256,000 and $0 at
December 31, 1997 and 1996, respectively. The approximate amounts of interest
income that would have been recorded under the original terms of such loans and
the interest income actually recognized were not material.
The Corporation is not committed to lend additional funds to debtors whose loans
have been modified.
Loans serviced for others consisted of approximately $1,527,000, $1,931,000, and
$2,539,000 at December 31, 1997, 1996, and 1995, respectively. These loans were
sold to the Federal Home Loan Mortgage Corporation.
32
<PAGE>
NOTE 3 - LOANS RECEIVABLE (Continued)
The Corporation's lending activities have been concentrated primarily in Cook
County, Illinois, where its main office is located. The largest portion of the
Corporation's loans are originated for the purpose of enabling borrowers to
purchase residential real estate property secured by first liens on such
property. At December 31, 1997, approximately 89% of the Corporation's loans
were secured by owner-occupied, one-to-four-family residential property. The
Corporation requires collateral on all loans and generally maintains
loan-to-value ratios of 80% or less.
Activity in the allowance for loan losses is summarized as follows:
For the Year Ended
December 31,
-------------------------------
1997 1996 1995
---- ---- ----
Balance at beginning of year ............. $ 745 $ 600 $ 469
Provision charged to income .............. 30 150 133
Charge-offs .............................. -- (5) (2)
----- ----- -----
$ 775 $ 745 $ 600
===== ===== =====
NOTE 4 - PREMISES AND EQUIPMENT
Premises and equipment consists of the following at:
December 31,
------------------------
1997 1996
---- ----
Land ........................................... $ 1,045 $ 77
Building and landscaping ....................... 1,461 1,465
Leasehold improvements ......................... 102 --
Furniture, fixtures, and equipment ............. 477 473
------- -------
Total cost ................................. 3,085 2,015
Accumulated depreciation ....................... (986) (972)
------- -------
$ 2,099 $ 1,043
======= =======
33
<PAGE>
NOTE 5 - DEPOSITS
Savings and certificate of deposit accounts with balances greater than $100,000
totaled $5,459,000 and $6,421,000 at December 31, 1997 and 1996, respectively.
Deposits greater than $100,000 are not insured.
At December 31, 1997, scheduled maturities of certificates of deposit are as
follows:
1998 ............................ $ 48,752
1999 ............................ 11,362
2000 ............................ 3,543
2001 ............................ 1,550
2002 and thereafter ............. 819
--------
$ 66,026
========
NOTE 6 - ADVANCES FROM FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank of Chicago were as follows:
Interest
Maturity Date Rate 1997 1996
------------- ---- ---- ----
August 19, 1997 ............... 9.72% $ -- $ 1,500
October 23, 1998 .............. 5.86 11,000 --
------- -------
$11,000 $ 1,500
======= =======
The Corporation maintains a collateral pledge agreement covering secured
advances whereby the Corporation has agreed to at all times keep on hand, free
of all other pledges, liens, and encumbrances, whole first mortgage loans on
improved residential property not more than 90-days delinquent aggregating no
less than 167% of the outstanding secured advances from the Federal Home Loan
Bank of Chicago.
34
<PAGE>
NOTE 7 - INCOME TAXES
An analysis of the provision for income taxes consists of the following:
For the Year Ended
December 31,
----------------------------------------
1997 1996 1995
---- ---- ----
Current
Federal .................... $ 842 $ 107 $ 414
State ...................... 104 (15) 33
Deferred ..................... (320) (10) 112
----- ----- -----
$ 626 $ 82 $ 559
===== ===== =====
The provision for income taxes differs from that computed at the statutory
corporate tax rate as follows:
For the Year Ended
December 31,
-----------------------------------------------
1997 1996 1995
------------ ------------- ---------------
Provision for federal
income taxes computed
at statutory rate of 34% ... $534 34.0% $ 83 34.0% $514 34.0%
State income taxes, net
of federal tax effect and
other ...................... 92 5.9 (1) (.2) 45 3.0
---- ---- ---- ---- ---- ----
$626 39.9% $ 82 33.8% $559 37.0%
==== ==== ==== ==== ==== ====
Deferred tax assets (liabilities) are comprised of the following:
December 31,
--------------------
1997 1996
---- ----
Contributions ...................................... $ 372 $ --
Loans, principally due to allowance
for loan losses .................................. 175 163
----- -----
Total deferred tax assets ...................... 547 163
Unrealized gain on securities
available-for-sale ............................... (623) (388)
Depreciation ....................................... (44) (40)
Federal Home Loan Bank stock dividends ............. (42) (42)
Deferred loan fees ................................. (60) (19)
Contributions ...................................... -- (2)
Other .............................................. (38) (17)
----- -----
Total deferred tax liabilities ................. (807) (508)
----- -----
Net deferred tax liabilities .............. $(260) $(345)
===== =====
35
<PAGE>
NOTE 7 - INCOME TAXES (Continued)
The Bank has qualified under provisions of the Internal Revenue Code which
permit it to deduct from taxable income a provision for bad debts which differs
from the provision charged to income on the financial statements. Retained
earnings at December 31, 1997 and 1996 include approximately $3,114,000 for
which no deferred federal income tax liability has been recorded.
NOTE 8 - EARNINGS PER SHARE
A reconciliation of the numerators and denominators for earnings per share
computations for the period April 1, 1997 to December 31, 1997 is presented
below.
Basic earnings per share
Net income ................................................. $ 944
Less: net income of Bank prior to conversion .............. (171)
-------
Net income available to common stockholders ............ $ 773
=======
Weighted average common shares outstanding ................. 1,918
Basic earnings per share ............................... $ .40
=======
The Corporation's outstanding stock options were not considered in the
computations of diluted earnings per share because the effects of assumed
exercise would have been antidilutive. In addition, the Corporation's
outstanding performance-based stock awards granted during 1997 were not
considered in the computations of diluted earnings per share because the
performance conditions for such awards had not been attained as of December 31,
1997. In future years, outstanding stock options may be exercised which would
increase the weighted average common shares outstanding and, thereby, dilute
earnings per share. In addition, if the average common stock price were to
exceed the exercise price of outstanding options in a future year or if the
performance conditions specified under the performance-based stock award plan
were to be met by the end of a future year, the assumed exercise of the options
and/or the assumed issuance of the performance awards would have a dilutive
effect on earnings per share for that future year. However, previously reported
earnings per share and diluted earnings per share are not restated to reflect
changes in the status of performance conditions or changes in the relationship
between exercise prices and average stock prices.
36
<PAGE>
NOTE 9 - EMPLOYEE BENEFIT PLANS
An employee profit sharing plan was approved by the Board of Directors effective
January 1, 1985. The plan covers employees having over one year of service (one
thousand working hours) and who are at least 21 years of age. Contributions to
the profit sharing plan are determined and approved annually by the
Corporation's Board of Directors. Contributions of $42,000, $108,000, and
$132,000 were approved and funded for the years ended December 31, 1997, 1996,
and 1995, respectively.
A money purchase plan was approved by the Board of Directors effective January
1, 1993. The plan covers employees having over one year of service (one thousand
working hours) and who are at least 21 years of age. The Corporation contributes
an amount equal to ten percent of participants' salaries. Contributions of
$82,000, and $91,000 were funded for the years ended December 31, 1996, and
1995, respectively. During 1996, the Board of Directors authorized the
termination of the Corporation's money purchase plan.
As part of the conversion transaction, the Corporation established an employee
stock ownership plan (ESOP) for the benefit of substantially all employees. The
ESOP borrowed $1,661,060 from the Corporation and used those funds to acquire
166,106 shares of the Corporation's stock at $10 per share.
Shares issued to the ESOP are allocated to ESOP participants based on principal
repayments made by the ESOP on the loan from the Corporation. The loan is
secured by shares purchased with the loan proceeds and will be repaid by the
ESOP with funds from the Corporation's discretionary contributions to the ESOP
and earnings on ESOP assets. Principal payments are scheduled to occur in even
quarterly amounts over a ten-year period. However, in the event the
Corporation's contributions exceed the minimum debt service requirements,
additional principal payments will be made.
During 1997, 16,610 shares of stock with an average fair value of $15.35 per
share were committed to be released, resulting in ESOP compensation expense of
$255,000. Shares held by the ESOP at December 31, 1997 are as follows:
Allocated shares ................................. 17
Unallocated shares ............................... 149
------
Total ESOP shares ............................. 166
======
Fair value of unallocated shares .............. $2,552
======
37
<PAGE>
NOTE 9 - EMPLOYEE BENEFIT PLANS (Continued)
The Corporation has a stock option plan under the terms of which 207,633 shares
of the Corporation's common stock were reserved for issuance. The options become
exercisable on a cumulative basis in equal installments over a five-year period
from the date of grant. The options expire ten years from the date of grant.
A summary of the status of the Corporation's stock option plan and changes
during the year are presented below:
Weighted-
December 31, Average
1997 Exercise
Shares Price
------ -----
Outstanding at beginning of year ............ -- $ --
Granted ..................................... 182,716 17.24
Exercised ................................... -- --
Forfeited ................................... -- --
------- ------
Outstanding at end of year ............. 182,716 $17.24
======= ======
Options exercisable at end of year .......... --
Weighted-average fair value of options
granted during year ....................... $ 5.63
Average remaining option term ............... 9.8 years
The Corporation applies APB Opinion 25 and related Interpretations in accounting
for its stock option plan. Accordingly, no compensation cost has been recognized
at the date of grant. Had compensation cost been determined based on the fair
value at the grant dates for awards under the plan in 1997 consistent with the
method of SFAS No. 123, "Accounting for Stock-Based Compensation", the
Corporation's net income and earnings per share would have been reduced to the
pro forma amounts in the table below. For purposes of pro forma disclosure, the
estimated fair value of the options is amortized to expense over the options'
vesting period.
Pro forma net income ............... $ 742
Pro forma earnings per share
Basic and diluted .............. .39
38
<PAGE>
NOTE 9 - EMPLOYEE BENEFIT PLANS (Continued)
The Black-Scholes option pricing valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its stock
options.
Date of grant ..................................... 10/22/97 12/9/97
Options granted ................................... 172,334 10,382
Estimated fair value stock of options granted: .... $ 5.64 $ 5.44
Assumptions used:
Risk-free interest rate .................... 6.12% 5.95%
Expected option life ....................... 10 years 10 years
Expected stock price volatility ............ .05 .05
Expected dividend yield .................... 1.40% 1.40%
In connection with the conversion to stock ownership, the Corporation adopted a
Management Recognition and Retention Plan (MRP). In 1997, the Corporation
contributed $1.4 million allowing the MRP to acquire 83,053 shares of common
stock of the Corporation, at an average cost of $17.25 per share, to be awarded
to directors and key employees. These shares vest over a five-year period. The
unamortized cost of shares not yet earned (vested) is reported as a reduction of
stockholders' equity. MRP compensation expense totaled $50,817 for the year
ended December 31, 1997.
NOTE 10 - REGULATORY MATTERS
The Bank is subject to regulatory capital requirements administered by federal
regulatory agencies. Capital adequacy guidelines and prompt corrective action
regulations involve quantitative measures of assets, liabilities, and certain
off-balance-sheet items calculated under regulatory accounting practices.
Capital amounts and classifications are also subject to qualitative judgments by
regulators about components, risk weightings, and other factors, and the
regulators can lower classifications in certain cases. Failure to meet various
capital requirements can initiate regulatory action that could have a direct
material effect on the financial statements.
39
<PAGE>
NOTE 10 - REGULATORY MATTERS (Continued)
The prompt corrective action regulations provide five classifications, including
well capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized, although these terms are not
used to represent overall financial condition. If adequately capitalized,
regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required.
At year end, actual capital levels of the Bank and minimum required levels were:
<TABLE>
<CAPTION>
Minimum Required
to Be Well
Minimum Required Capitalized
for Capital Under Prompt Corrective
Actual Adequacy Purposes Action Regulations
--------------------- ------------------- -----------------------
1997 Amount Ratio Amount Ratio Amount Ratio
- ---- ------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Total capital (to risk-weighted assets) .............. $21,468 34.9% $ 4,928 8.0% $ 6,159 10.0%
Tier 1 (core) capital (to risk-weighted
assets) ............................................ 20,698 33.6 2,464 4.0 3,696 6.0
Tier 1 (core) capital (to adjusted total
assets) ............................................ 20,698 12.3 5,019 3.0 N/A N/A
Tangible capital (to adjusted total
assets) ............................................ 20,698 12.3 2,510 1.5 N/A N/A
Tier 1 (leverage) capital (to average
total assets) ...................................... 20,698 12.6 4,920 3.0 8,200 5.0
1996
- ----
Total capital (to risk-weighted assets) .............. $12,124 24.6% $ 3,936 8.0% $ 4,920 10.0%
Tier 1 (core) capital (to risk-weighted
assets) ............................................ 11,508 23.4 1,968 4.0 2,952 6.0
Tier 1 (core) capital (to adjusted total
assets) ............................................ 11,508 7.9 4,390 3.0 N/A N/A
Tangible capital (to adjusted total
assets) ............................................ 11,508 7.9 2,195 1.5 N/A N/A
Tier 1 (leverage) capital (to average
total assets) ...................................... 11,508 7.9 4,395 3.0 7,325 5.0
</TABLE>
At December 31, 1997, the most recent notification from the Office of Thrift
Supervision categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. There are no conditions or events since
that notification that management believes have changed the institution's
category.
40
<PAGE>
NOTE 10 - REGULATORY MATTERS (Continued)
Federal regulations require the Bank to comply with a Qualified Thrift Lender
(QTL) test which requires that 65% of assets be maintained in housing-related
finance and other specified assets. If the QTL test is not met, limits are
placed on growth, branching, new investments, FHLB advances, and dividends or
the institution must convert to a commercial bank charter. Management considers
the QTL test to have been met.
NOTE 11 - OFF-BALANCE-SHEET RISK AND CONCENTRATIONS OF CREDIT RISK
The Corporation is party to financial instruments with off-balance-sheet risk in
the normal course of business of meeting the financing needs of its customers.
These financial instruments include commitments to fund loans and previously
approved unused lines of credit. The Corporation's exposure to credit loss in
the event of nonperformance by the parties to these financial instruments is
represented by the contractual amount of the instruments. The Corporation uses
the same credit policy for commitments as it uses for on-balance-sheet items.
These financial instruments are summarized as follows:
Contract Amount
December 31,
-------------------
1997 1996
---- ----
Financial instruments whose contract
amounts represent credit risk
Commitments to extend credit, including
loans in process ................................ $ 652 $1,223
At December 31, 1997 and 1996, commitments to extend credit, including loans in
process, consisted of $352,000 and $858,000, respectively, in fixed rate
commitments. The commitments at December 31, 1997 are due to expire within 30 to
60 days of issuance and have rates ranging from 7.125% to 7.5%.
Financial instruments which potentially subject the Corporation to
concentrations of credit risk include interest-bearing deposit accounts in other
financial institutions and loans. At December 31, 1997 and 1996, the Corporation
had deposit accounts with balances totaling approximately $13,686,000 and
$15,514,000, respectively, at the Federal Home Loan Bank of Chicago.
Concentrations of loans are described in Note 3.
41
<PAGE>
NOTE 12 - COMMITMENTS AND CONTINGENCIES
The Corporation is, from time to time, a party to certain lawsuits arising in
the ordinary course of its business. The Corporation believes that none of these
lawsuits would, if adversely determined, have a material adverse effect on its
financial condition, results of operations, or capital.
At December 31, 1997 and 1996, the Corporation was obligated under noncancelable
operating leases for office space. Net rent expenses under operating leases,
including the proportionate share of taxes, insurance, and maintenance costs,
were approximately $95,000, $89,000, and $93,000 for the years ended December
31, 1997, 1996, and 1995, respectively. The lease for the Oak Lawn branch
expires April 1, 2002. The lease for the Chicago branch expires on July 1, 2002.
Projected minimum rental payments under the terms of the leases, not including
taxes, insurance, and maintenance, are as follows at December 31, 1997:
1998 .................................. $ 78
1999 .................................. 78
2000 .................................. 78
2001 .................................. 78
2002 and thereafter ................... 27
------
Total ............................. $ 339
======
NOTE 13 - FAIR VALUES OF FINANCIAL INSTRUMENTS
The approximate carrying amount and estimated fair value of financial
instruments consist of the following:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
------------------------- --------------------------
Approximate Approximate
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
Financial Assets
<S> <C> <C> <C> <C>
Cash and cash equivalents..................... $ 14,883 $ 14,883 $ 17,410 $ 17,410
Securities.................................... 81,121 82,121 72,156 72,941
Loans receivable, net......................... 76,159 77,293 53,536 53,873
Federal Home Loan Bank stock.................. 987 987 901 901
Accrued interest receivable................... 904 904 788 788
</TABLE>
42
<PAGE>
NOTE 13 - FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
------------------------- --------------------------
Approximate Approximate
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
Financial Liabilities
<S> <C> <C> <C> <C>
Interest-bearing demand deposits.......... $ (20,041) $ (20,041) $ (19,175) $ (19,175)
Savings deposits.......................... (44,891) (44,891) (47,173) (47,173)
Time deposits............................. (66,026) (66,306) (64,895) (65,047)
Advance from Federal Home Loan Bank....... (11,000) (11,013) (1,500) (1,515)
Advance payments by borrowers for
taxes and insurance..................... (804) (804) (681) (681)
Accrued interest payable.................. (168) (168) (128) (128)
</TABLE>
For purposes of the above, the following assumptions were used:
Cash and Cash Equivalents: The estimated fair values for cash and cash
equivalents are based on their carrying values due to the short-term nature of
these assets.
Securities: The fair values of investment and mortgage-backed securities are
based on the quoted market value for the individual security or its equivalent.
Loans Receivable: The estimated fair value for loans has been determined by
calculating the present value of future cash flows based on the current rate the
Bank would charge for similar loans with similar maturities, applied for an
estimated time period until the loan is assumed to be repriced or repaid.
Deposits: The estimated fair value for time deposits has been determined by
calculating the present value of future cash flows based on estimates of rates
the Corporation would pay on such deposits, applied for the time period until
maturity. The estimated fair values of interest-bearing demand and savings
deposits are assumed to approximate their carrying values as management
establishes rates on these deposits at a level that approximates the local
market area. Additionally, these deposits can be withdrawn on demand.
Advances from Federal Home Loan Bank: The fair value of the Federal Home Loan
Bank advance was determined by calculating the present value of future cash
flows using the current rate for an advance with a similar length to maturity.
Accrued Interest: The fair values of accrued interest receivable and payable are
assumed to equal their carrying values.
43
<PAGE>
NOTE 13 - FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
Off-Balance-Sheet Instruments: Off-balance-sheet items consist principally of
unfunded loan commitments. The fair value of these commitments is not material.
Other assets and liabilities of the Corporation not defined as financial
instruments, such as property and equipment, are not included in the above
disclosures. Also not included are nonfinancial instruments typically not
recognized in financial statements such as the value of core deposits, loan
servicing rights, customer goodwill, and similar items.
While the above estimates are based on management's judgment of the most
appropriate factors, there is no assurance that if the Corporation disposed of
these items on December 31, 1997 or 1996, the fair value would have been
achieved, because the market value may differ depending on the circumstances.
The estimated fair values at December 31, 1997 and 1996 should not necessarily
be considered to apply at subsequent dates.
NOTE 14 - PLAN OF CONVERSION
On September 10, 1996, the Board of Directors of the Bank adopted a Plan of
Conversion to convert from a federal mutual savings bank to a federal stock
savings bank with the concurrent formation of a holding company and the adoption
of a federal thrift charter. On March 31, 1997, the Corporation sold 2,076,325
shares of common stock at $10 per share and received proceeds of $18,376,279 net
of conversion expenses of $725,910 and ESOP shares. Approximately 50% of the net
proceeds were used by the Corporation to acquire all of the capital stock of the
Bank.
Simultaneous with the conversion, the Board of Directors of the holding company
established The Hemlock Federal Charitable Foundation. The foundation is a
not-for-profit entity. In 1997, the Board approved a $1,000,000 unconditional
contribution to the Foundation, of which $280,000 was paid in 1997. The
remaining $720,000 is included in other liabilities in the consolidated
statements of financial condition at December 31, 1997.
At the time of conversion, the Bank established a liquidation account in an
amount equal to its total net worth as of the latest statement of financial
condition appearing in the final prospectus. The balance at that date was
$11,680,000. The liquidation account will be maintained for the benefit of
eligible depositors who continue to maintain their accounts at the Bank after
the conversion. The liquidation account will be reduced annually to the extent
that eligible depositors have reduced their qualifying deposits. Subsequent
increases will not restore an eligible account holder's interest in the
liquidation account. In the event of a complete liquidation, each eligible
depositor will be entitled to receive a distribution from the liquidation
account in an amount proportionate to the current adjusted qualifying balances
for accounts then held. The liquidation account balance is not available for
payment of dividends.
44
<PAGE>
NOTE 15 - PARENT COMPANY FINANCIAL STATEMENTS
Presented below are the condensed statement of financial condition, statement of
income, and statement of cash flows for Hemlock Federal Financial Corporation.
The Corporation was formed on March 31, 1997. Accordingly, the statements of
income and cash flows reflect the period April 1, 1997 through December 31,
1997.
CONDENSED STATEMENT OF FINANCIAL CONDITION
December 31, 1997
ASSETS
Cash and cash equivalents .................................... $ 5,448
Securities held-to-maturity .................................. 3,619
ESOP loan .................................................... 1,495
Investment in bank subsidiary ................................ 21,673
Accrued interest receivable and other assets ................. 364
--------
$ 32,599
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses and other liabilities ....................... $ 2,172
Stockholders' equity
Common stock ............................................ 21
Additional paid-in capital .............................. 20,105
Unearned ESOP shares .................................... (1,495)
Unearned stock awards ................................... (1,382)
Retained earnings ....................................... 12,203
Net unrealized gain on subsidiary
securities available-for-sale ......................... 975
--------
$ 32,599
========
45
<PAGE>
NOTE 15 - PARENT COMPANY FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENT OF INCOME
For the period April 1, 1997 to December 31, 1997
Income
Securities ................................................. $ 205
ESOP loan .................................................. 87
Interest-bearing deposits with other
financial institutions ................................... 184
-------
Total income ........................................... 476
Other expenses .................................................. 1,074
-------
Loss before income taxes and equity in undistributed
earnings of bank subsidiary ................................... (598)
Income tax benefit .............................................. (202)
-------
Loss before equity in undistributed earnings of
bank subsidiary ............................................... (396)
Equity in undistributed earnings of bank subsidiary ............. 1,169
-------
Net income ...................................................... $ 773
=======
46
<PAGE>
NOTE 15 - PARENT COMPANY FINANCIAL STATEMENTS (Continued)
CONDENSED STATEMENT OF CASH FLOWS
For the period April 1, 1997 to December 31, 1997
Operating activities
Net income .................................................... $ 773
Adjustments to reconcile net income to net cash
provided by operating activities
Amortization of discounts and premiums on securities, net . (6)
Equity in undistributed earnings of bank subsidiary ....... (1,169)
Change in
Other assets ......................................... (364)
Other liabilities .................................... 739
--------
Net cash used in operating activities ............ (27)
Investing activities
Purchase of securities held-to-maturity ....................... (7,485)
Principal payments on securities .............................. 122
Proceeds from maturities and calls of securities .............. 3,750
Purchase of bank subsidiary stock ............................. (9,205)
--------
Net cash used in investing activities ..................... (12,818)
Financing activities
Net proceeds from sale of common stock ........................ 18,376
Payment received on loan to ESOP .............................. 166
Dividends paid ................................................ (249)
--------
Net cash provided by financing activities ................. 18,293
--------
Net change in cash and cash equivalents ............................ 5,448
Cash and cash equivalents at beginning of period ................... --
--------
Cash and cash equivalents at end of period ......................... $ 5,448
========
47
<PAGE>
STOCKHOLDERS AND GENERAL INQUIRIES TRANSFER AGENT
Rosanne M. Belczak Registrar and Transfer Co.
Hemlock Federal Financial Corporation 10 Commerce Drive
5700 West 159th Street Cranford, NJ 07016
Oak Forest, Illinois 60452 1-(800) 368-5948
(708) 687-9400
ANNUAL AND OTHER REPORTS
A copy of Hemlock Federal Financial Corporation's Annual Report on Form
10-KSB for the year ended December 31, 1997, as filed with the Securities and
Exchange Commission, may be obtained without charge by contacting Rosanne M.
Belczak, Hemlock Federal Financial Corporation, 5700 West 159th Street, Oak
Forest, Illinois 60452.
HEMLOCK FEDERAL FINANCIAL CORPORATION
CORPORATE INFORMATION
Hemlock Federal Financial Corporation Hemlock Federal Bank
Board of Directors Officers
Maureen G. Partynski, Chairman Maureen G. Partynski
Michael R. Stevens Chairman and CEO
Rosanne M. Belczak, Secretary Michael R. Stevens
Kenneth J. Bazarnik President
Frank A. Bucz Jean Thornton
Charles Gjondla Vice-President, Controller
G. Gerald Schiera Neil Christensen
Vice-President, Lending
Rosanne M. Belczak
Vice-President, Secretary
Hemlock Federal Bank for Savings Locations:
Main Office:
5700 W. 159th St.
Oak Forest, Illinois 60452 708-687-9400
8855 S. Ridgeland Ave.
Oak Lawn, Illinois 60453
4636 S. Damen Ave.
Chicago, Illinois 60609
Opening August, 1998:
15730 W. 127th St.
Lemont, Illinois 60439
48
<PAGE>
Independent Auditors Special Counsel
Crowe Chizek & Co. Silver, Freedman & Taff, L.L.P.
One Mid America Plaza, Suite 700 1100 New York Avenue, N.W.
Oak Brook Terrace, Illinois 60181 7th Floor
Washington, D.C. 20005
Stock Trading Information:
Hemlock Federal Financial Corporation Common Stock is traded on the NASDQ stock
market under the trading symbol "HMLK."
Stockholder Services:
Stockholders should direct inquiries concerning their stock, change of name,
address or ownership; report lost certificates or consolidate accounts to the
Company's transfer agent at 1-800-368-5948 or write:
Registrar and Transfer
P.O. Box 1010
Cranford, New Jersey 07016
Investor Relations
Hemlock Federal Financial Corporation files an annual report to the
Securities and Exchange Commission on Form 10K and three quarterly reports on
Form 10Q. Copies of these forms are available by request. Requests, as well as
inquiries from stockholders, analysts and others seeking information about
Hemlock Financial Corporation should be directed to Michael R. Stevens,
President, at 5700 W. 159th St., Oak Forest, Illinois 60452, phone 708-687-9400.
49
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 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.
HEMLOCK FEDERAL FINANCIAL CORPORATION
Date: March 31, 1998 By: /s/ Maureen G. Partynski
-------------------------
Maureen G. Partynski, Chairman of
the Board and Chief Executive
Officer
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities and on
the dates indicated.
/s/ Michael R. Stevens /s/ Kenneth J. Bazarnik
- ------------------------------------ -----------------------------------
Michael R. Stevens, President, Chief Kenneth J. Bazarnik, Director
Financial and Accounting Officer
and Director
Date: March 31, 1998 Date: March 31, 1998
/s/ Rosanne Pastrek-Belczak /s/ Charles Gjondla
- ------------------------------------ -----------------------------------
Rosanne Pastrek-Belczak, Charles Gjondla, Director
Vice-President/Secretary and
Director
Date: March 31, 1998 Date: March 31, 1998
/s/ Frank A. Bucz /s/ G. Gerald Schiera
- ------------------------------------ -----------------------------------
Frank A. Bucz, Auditor/Consultant G. Gerald Schiera, Director
and Director
Date: March 31, 1998 Date: March 31, 1998
Subsidiaries of Registrant
================================================================================
Registrant Subsidiary State of Incorporation
- --------------------------------------------------------------------------------
Hemlock Federal Financial Hemlock Federal Bank for United States
Corporation Savings
================================================================================
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ANNUAL
REPORT ON FORM 10-KSB FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-Mos
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 2,714
<INT-BEARING-DEPOSITS> 12,169
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 34,703
<INVESTMENTS-CARRYING> 46,418
<INVESTMENTS-MARKET> 47,418
<LOANS> 76,159
<ALLOWANCE> 775
<TOTAL-ASSETS> 176,683
<DEPOSITS> 103,958
<SHORT-TERM> 11,000
<LIABILITIES-OTHER> 4,298
<LONG-TERM> 0
0
0
<COMMON> 21
<OTHER-SE> 30,406
<TOTAL-LIABILITIES-AND-EQUITY> 176,683
<INTEREST-LOAN> 4,829
<INTEREST-INVEST> 5,505
<INTEREST-OTHER> 959
<INTEREST-TOTAL> 11,293
<INTEREST-DEPOSIT> 5,504
<INTEREST-EXPENSE> 5,723
<INTEREST-INCOME-NET> 5,570
<LOAN-LOSSES> 30
<SECURITIES-GAINS> (3)
<EXPENSE-OTHER> 4,509
<INCOME-PRETAX> 1,570
<INCOME-PRE-EXTRAORDINARY> 944
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 944
<EPS-PRIMARY> .40
<EPS-DILUTED> .40
<YIELD-ACTUAL> 3.53
<LOANS-NON> 256
<LOANS-PAST> 388
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 745
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 775
<ALLOWANCE-DOMESTIC> 519
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 256
</TABLE>
