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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended June 30, 1997
Commission File Number: 0-22423
HCB BANCSHARES, INC.
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(Exact name of small business issuer as specified in its charter)
Oklahoma 62-1670792
- --------------------------------------------- --------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
237 Jackson Street, Camden, Arkansas 71701-3941
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (870) 836-6841
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
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(Title of Class)
Indicate by check mark whether the registrant (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 filing
requirements for the past 90 days. YES X NO .
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
State the aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of a specified date within the past 60
days: $31,942,638.75 (2,323,101 shares at the last sale price on September 23,
1997 ($13.75 per share); for this purpose, directors, executive officers and the
employee stock ownership plan have not been deemed to be non-affiliates).
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: 2,645,000 shares of common
stock as of September 23, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the registrant's Annual Report to Stockholders for the
Fiscal Year Ended June 30, 1997 (the "Annual Report"). (Part II)
2. Portions of the registrant's Proxy Statement for its 1997 Annual Meeting
of Stockholders (the "Proxy Statement"). (Part III)
<PAGE>
PART I
Item 1. Description of Business
General
HCB Bancshares, Inc. HCB Bancshares, Inc. (the "Company") was
incorporated under the laws of the State of Oklahoma in December 1996 at the
direction of the Board of Directors of HEARTLAND Community Bank (the "Bank") for
the purpose of serving as a savings institution holding company of the Bank,
including its subsidiary savings bank, Heartland Community Bank, F.S.B., upon
the acquisition of all of the capital stock issued by the Bank upon its
conversion from mutual to stock form, which was completed on April 30, 1997 (the
"Conversion"). Prior to the Conversion, the Company did not engage in any
material operations. Since the Conversion, the Company has had no significant
assets other than the outstanding capital stock of the Bank, a portion of the
net proceeds of the Conversion and a note receivable from the Employee Stock
Ownership Plan ("ESOP"). The Company's principal business is the business of the
Bank.
The holding company structure permits the Company to expand the
financial services currently offered through the Bank. As a holding company, the
Company has greater flexibility than the Bank to diversify its business
activities through existing or newly formed subsidiaries or through acquisition
or merger with other financial institutions. The Company is classified as a
multiple savings institution holding company and is subject to regulation by the
Office of Thrift Supervision ("OTS"). As long as the Company remains a multiple
savings institution holding company, the Company will be subject to regulatory
restrictions on the activities in which it and its non-savings institution
subsidiaries may engage. See "Regulation -- Regulation of the Company --
Activities Restrictions."
The Company's executive offices are located at 237 Jackson Street,
Camden, Arkansas 71701-3941, and its telephone number is (870) 836-6841.
HEARTLAND Community Bank. HEARTLAND Community Bank was organized as a
federally chartered mutual savings and loan association named "First Federal
Savings and Loan Association of Camden" ("First Federal") in 1933, and in 1934
it became a member of the FHLB system and obtained federal deposit insurance. In
May 1996, First Federal acquired the former Heritage Bank, FSB, which retained
its separate federal savings bank charter and deposit insurance as a wholly
owned subsidiary of First Federal (in order to facilitate possible future branch
expansion, in the event the Bank ever becomes subject to Arkansas branching
restrictions, which are based on the home office location of each separately
chartered banking institution), but whose business operations were fully
integrated with those of First Federal. In September 1996, First Federal and
Heritage changed their names to HEARTLAND Community Bank and HEARTLAND Community
Bank, F.S.B., respectively. The Bank itself currently operates through four full
service banking offices located in Camden (2), Fordyce and Sheridan, Arkansas,
and its subsidiary savings bank operates through two full service banking
offices located in Little Rock and Monticello, Arkansas and a loan production
office in Bryant, Arkansas. At June 30, 1997, the Bank had total assets of
$200.3 million, deposits of $151.2 million and equity of $37.7 million, or 18.8%
of total assets.
Historically, the principal business strategy of the Bank, like most
other savings institutions in Arkansas and elsewhere, has been to accept
deposits from residents of the communities served by the Bank's branch offices
and to invest those funds in single-family mortgage loans to those and other
local residents. In this manner, the Bank and countless other independent
community-oriented savings institutions operated safely and soundly for
generations. In recent years, however, as the banking business nationwide and in
the Bank's primary market area in particular has become more competitive,
smaller savings institutions like the Bank have come under increasing market
pressure either to grow and increase their profitability or to be acquired by a
larger institution. Moreover, during this period the Bank's market area
experienced only limited economic growth.
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In September 1995, the Bank's Board of Directors carefully considered
the Bank's historical results of operations, current financial condition and
future business prospects and, in consultation with the Bank's executive
officers, determined to strengthen the Bank's competitiveness and profitability
by concentrating its business strategy as an independent community bank on
expanding the Bank's products and services and growing its customer and asset
base. Since then, the Bank has actively sought to implement this strategy by
adding two new executive officers -- Cameron McKeel as Executive Vice President
and William Lyon as Senior Vice President and Chief Lending Officer -and more
than doubling the Bank's total employees, by acquiring the former Heritage Bank,
FSB, which added to the Bank's branch network additional branches in the growing
and potentially lucrative Little Rock and Monticello banking markets, by
upgrading selected branch office facilities, by expanding the types of loans and
deposit accounts offered by the Bank, by updating the Bank's name and corporate
identity from First Federal Savings and Loan Association of Camden to HEARTLAND
Community Bank and by completing the Conversion. Throughout this period, the
Bank's executive officers have worked with the Bank's directors and with the
Bank's entire staff to formulate and effectuate the Bank's current strategic
plan.
On a going forward basis, the Bank's current business strategy, as
developed and adopted by all of the Bank's directors, officers and employees,
incorporates the following key elements: (i) remaining an independent community-
oriented financial institution by continuing to provide the quality service that
only a locally based institution and its dedicated staff can deliver, including
the possible retention of additional executive officers in the future as the
Bank's growth and other needs may warrant; (ii) strengthening the Bank's core
deposit base and decreasing interest costs and increasing fee income by
expanding the Bank's deposit facilities and products, including the addition and
expansion of branch offices, the planned installation of ATMs, the introduction
of debit cards and a planned emphasis on attracting consumer demand deposits;
(iii) increasing loan yields and fee income while maintaining asset quality by
emphasizing the origination of higher yielding and shorter term loans,
especially commercial and multi-family real estate loans and consumer and
commercial business loans, for the Bank's portfolio while increasingly
originating lower yielding longer term single-family residential loans
principally for resale to investors; (iv) using the capital raised in the
Conversion to support the bank's future growth; and, (v) to complement the
Bank's internally generated growth, potentially acquiring one or more banking
institutions or other financial companies if attractive opportunities arise.
While it is expected that the Bank may experience especially high deposit and
loan growth in the relatively high income and growth segments of the Bank's
primary market area, particularly in the Sheridan, Monticello, Bryant and,
possibly, Little Rock areas, management expects to find significant deposit
growth and lending opportunities throughout central Arkansas.
As federally chartered savings institutions, each of the Bank and its
subsidiary savings bank is subject to extensive regulation by the OTS. The
lending activities and other investments of each institution must comply with
various federal regulatory requirements, and the OTS periodically examines each
institution for compliance with various regulatory requirements. The Federal
Deposit Insurance Corporation ("FDIC") also has the authority to conduct special
examinations. Each institution must file reports with OTS describing its
activities and financial condition and is also subject to certain reserve
requirements promulgated by the Board of Governors of the Federal Reserve System
("Federal Reserve Board"). See "Proposed Legislative and Regulatory Changes"
below.
Proposed Legislative and Regulatory Changes
Legislation proposed in the United States Congress could have a
profound impact on the banking and thrift industries and the operations of
commercial banks and thrift institutions, including the Bank. Such legislation
includes proposals to eliminate regulatory distinctions between institutions
chartered as banks and savings associations under federal law and would ease the
merger of the Savings Association Insurance Fund ("SAIF") and the Bank Insurance
Fund ("BIF"), the two deposit insurance funds. The legislation also could
require federally chartered savings associations to convert to federally
chartered commercial banks or to state chartered institutions, probably by a
specified date. The legislation under consideration is subject to continuing
review and major revision and might not be adopted soon or ever.
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Market Area
Management considers the Bank's primary market area to comprise the
following counties in Arkansas: Calhoun, Cleveland, Dallas, Drew, Grant,
Ouachita and Pulaski. To a lesser extent, the Bank accepts deposits and offers
loans throughout central and southern Arkansas.
In recent years, population has experienced low to moderate growth in
Drew, Grant and Pulaski Counties, while population has declined somewhat in
Calhoun, Cleveland, Dallas and Ouachita Counties. Household income has increased
substantially throughout the Bank's primary market area in recent years, and
household income has been well above the Arkansas average in Grant and Pulaski
Counties and somewhat above the Arkansas average in Ouachita County but somewhat
below the Arkansas average in Calhoun, Cleveland and Drew Counties and well
below the Arkansas average in Dallas County, though the Arkansas average is
below the national average. With respect to unemployment rates, while the
Arkansas average has tended to fall somewhat below the national average, and
unemployment rates have been well below the Arkansas average in Grant and
Pulaski Counties, unemployment rates have been well above the Arkansas and
national averages in Calhoun, Cleveland, Dallas, Drew and Ouachita Counties.
The economies in the Bank's primary market area include a variety of
industries, including manufacturing, government, services and retail trade.
Important employers include International Paper and Georgia Pacific in the
timber industry and Lockheed Martin and Atlantic Research in the defense
industry.
Competition
The Bank experiences substantial competition both in attracting and
retaining savings deposits and in the making of mortgage and other loans.
Direct competition for savings deposits comes from other savings
institutions, credit unions, regional bank holding companies and commercial
banks. Significant competition for the Bank's other deposit products and
services comes from money market mutual funds and brokerage firms. The primary
factors in competing for loans are interest rates and loan origination fees and
the quality and range of services offered by various financial institutions.
Competition for origination or real estate loans normally comes from other
savings institutions, commercial banks, credit unions, mortgage bankers and
mortgage brokers.
The Bank's primary competition comes from institutions headquartered in
the Bank's primary market area and from various non-local commercial banks that
have branch offices located in the Bank's primary market area. Many competing
financial institutions have financial resources substantially greater than the
Bank and offer a wider variety of deposit and loan products. Management's
principal competitive strategy has been to emphasize quality customer service.
Lending Activities
The Bank's principal lending activity consists of the origination of
loans secured by mortgages on existing single-family residences in the Bank's
primary market area. The Bank also makes commercial and multi-family real estate
loans and a variety of consumer and commercial business loans, and management
expects to continue and expand the Bank's increased emphasis on these types of
lending.
With certain limited exceptions, the maximum amount that a savings
institution may lend to any borrower (including certain related entities of the
borrower) at one time may not exceed 15% of the unimpaired capital and surplus
of the institution, plus an additional 10% of unimpaired capital and surplus for
loans fully secured by readily marketable collateral. Savings institutions are
additionally authorized to make loans to one borrower, for any purpose, in an
amount not to exceed $500,000 or, by order of the Director of the OTS, in an
amount not to exceed the lesser of $30,000,000 or 30% of unimpaired capital and
surplus to develop residential housing, provided: (i) the purchase price
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of each single-family dwelling in the development does not exceed $500,000; (ii)
the institution is in compliance with its fully phased-in capital requirements;
(iii) the loans comply with applicable loan-to-value requirements, and; (iv) the
aggregate amount of loans made under this authority does not exceed 150% of
unimpaired capital and surplus. At June 30, 1997, the maximum aggregate amounts
that the Bank and its subsidiary savings bank could have lent to any one
borrower under the 15% limit were $4.4 million and $500,000, respectively. At
such date, the largest aggregate amounts of loans that the Bank and its
subsidiary savings bank had outstanding to any one borrower were $1,330,000 and
$491,000, respectively.
Loan Portfolio Composition. The following table sets forth information
regarding the composition of the Bank's loan portfolio by type of loan at the
dates indicated. At June 30, 1997, the Bank had no concentrations of loans
exceeding 10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
At June 30,
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1997 1996
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Amount % Amount %
-------------- ------ ------------- ---------
<S> <C> <C> <C> <C>
Type of Loan Real estate loans:
One- to four-family residential.................... $ 62,340,601 62.27% $ 61,650,286 70.79%
Multi-family loans................................. 8,873,156 8.86 6,819,212 7.83
Non-residential.................................... 18,814,701 18.79 13,746,549 15.78
Loans to facilitate sale of
foreclosed real estate........................... 616,660 0.62 720,749 0.83
Land and other mortgage loans...................... 483,236 0.48 36,944 0.04
Consumer loans:
Loans secured by deposits.......................... 2,434,621 2.43 1,832,180 2.10
Home improvement................................... 1,665,244 1.66 204,776 0.24
Auto............................................... 2,399,648 2.40 786,656 0.90
Other consumer..................................... 2,629,442 2.63 418,027 0.48
Commercial........................................... 2,101,963 2.10 880,311 1.01
-------------- ------ ------------- -------
Total............................................ $ 102,359,272 100.00% $ 87,095,690 100.00%
------------ ====== ------------- ======
Less:
Loans in process................................... $ 2,057,095 $ 1,544,097
Deferred loan fees and discounts................... 167,069 137,335
Allowance for loan losses.......................... 1,492,473 1,283,234
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Total............................................ $ 98,642,635 $ 84,131,024
============== =============
</TABLE>
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Loan Maturity Schedules. The following table sets forth information
regarding dollar amounts of loans maturing in the Bank's portfolio based on
their contractual terms to maturity, including scheduled repayments of
principal, at June 30, 1997. Demand loans, loans having no stated schedule of
repayments and no stated maturity and overdrafts are reported as due in one year
or less. The table does not include any estimate of prepayments which
significantly shorten the average life of all mortgage loans and may cause the
Bank's repayment experience to differ from that shown below.
<TABLE>
<CAPTION>
Due During the Year Ending Due After Due After Due After
June 30, 3 Through 5 Through 10 Through
------------------------------ 5 Years After 10 Years After 15 Years After
1998 1999 2000 June 30, 1997 June 30, 1997 June 30, 1997
------ ------ ------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family mortgage
loans................... $ 2,765,998 $ 349,077 $ 3,246,769 $ 5,386,160 $ 9,452,683 $ 24,875,919
Other mortgage loans...... 1,590,551 530,544 4,046,463 3,402,878 3,627,432 2,984,246
Consumer loans:
Loans secured by deposits 1,789,446 645,175 -- -- -- --
Home improvement and
other................. 2,758,539 1,077,751 1,756,931 2,087,111 1,015,965 --
----------- ---------- ----------- ----------- ------------ ------------
Total.................. $ 8,904,534 $2,602,547 $ 9,050,163 $10,876,149 $ 14,096,080 $ 27,860,165
=========== ========== =========== =========== ============ ============
Due After 15
Years After
June 30, 1997 Total
------------- -------
Real estate loans:
One- to four-family mortgage
loans................... $ 16,880,655 $ 62,957,261
Other mortgage loans...... 11,988,979 28,171,043
Consumer loans:
Loans secured by deposits -- 2,434,621
Home improvement and
other................. -- 8,696,297
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Total.................. $ 28,869,634 $102,359,272
============ ============
</TABLE>
The following table sets forth dollar amounts of loans due one year or
more after June 30, 1997 that had predetermined interest rates and that had
adjustable interest rates at that date.
<TABLE>
<CAPTION>
Predetermined
Rate Adjustable Rate
------------- ---------------
<S> <C> <C>
Real estate loans:
One- to four-family residential.................. $ 40,266,100 $15,821,994
Multi-family residential......................... 2,693,632 11,144,039
Consumer loans:
Loans secured by deposits........................ 579,604 --
Home improvement and other....................... 7,740,680 --
------------ -----------
Total.......................................... $ 51,280,016 $26,966,033
============ ===========
</TABLE>
5
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Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets. The average life of loans is substantially less than
their contractual terms because of prepayments. In addition, due-on-sale clauses
on loans generally give the Bank the right to declare a loan immediately due and
payable in the event, among other things, that the borrower sells the real
property subject to the mortgage and the loan is not repaid. The average life of
mortgage loans tends to increase when current mortgage loan market rates are
substantially higher than rates on existing mortgage loans and, conversely,
decrease when current mortgage loan market rates are substantially lower than
rates on existing mortgage loans.
Loan Originations, Purchases and Sales. The following table sets forth
information regarding the Bank's loan originations, purchases and sales during
the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------
1997 1996
------ ------
<S> <C> <C>
Loans originated:
Real estate loans:
One- to four-family residential............... $ 9,175,000 $ 6,766,000
Other mortgage loans.......................... 11,579,200 3,928,000
Consumer loans.................................. 4,276,008 1,867,292
------------- ------------
Total loans originated....................... $ 25,030,208 $ 12,561,292
============= ============
Loans purchased:
Real estate loans............................... $ 1,305,000 $ 4,555,000
============= ============
Loans sold........................................ $ 1,804,100 $ 244,230
============= ============
</TABLE>
The Bank has increased both its range of loan products offered and its
loan origination efforts, including the addition of new consumer and commercial
business loan offerings and an increased emphasis on the origination of such
loans and commercial and multi-family real estate loans.
The Bank has purchased loans from established and reputable loan
originators from time to time to supplement the Bank's internally generated
originations. Historically, substantially all of the Bank's loan purchases have
been from large home builders, and a commercial and multi-family mortgage
banker, with which the Bank has a long-standing relationship, and the Bank's
experience with its purchased loans has been successful. In light of the
expected continuation and expansion of the Bank's increased loan originations,
management expects to reduce the Bank's loan purchasing activities in the
future.
The Bank has not sold substantial amounts of loans in the past.
However, management expects the Bank to increase its origination of selected
types of loans which do not meet the Bank's loan portfolio needs, such as
long-term fixed-rate residential mortgage loans, for sale to investors, and it
is expected that increases in such originations will result in increases in the
Bank's loan sales.
One- to Four-Family Residential Lending. Historically, the Bank's
principal lending activity has been the origination of fifteen-year fixed-rate
loans secured by first mortgages on existing single-family residences in the
Bank's primary market area. The purchase price or appraised value of most of
such residences generally has been between $50,000 and $200,000, with the Bank's
loan amounts averaging approximately $52,300. At June 30, 1997, $62.3 million,
or 60.9%, of the Bank's total loans were secured by one- to four-family
residences, substantially all of which were existing, owner-occupied,
single-family residences in the Bank's primary market area.
While the Bank offers a variety of one- to four-family residential
mortgage loans with fixed or adjustable interest rates and terms of up to 30
years, substantially all of the fixed rate loans retained in the Bank's
portfolio have terms of 15 years or less. Despite the relatively low credit
risks associated with the Bank's one- to four-family portfolio loans, due to the
unfavorable yield and interest rate risks associated with such loans, management
has shifted the Bank's
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one- to four-family residential lending emphasis away from the origination of
such loans for the Bank's portfolio and toward the origination of such loans for
sale, and management has revised the Bank's underwriting guidelines specifically
to facilitate the sale of such loans without undue delay or expense. Currently,
it is the Bank's policy to originate all one- to four-family residential loans
in accordance with the Bank's underwriting guidelines and to sell all such
originations promptly to investors, servicing released, though it is recognized
that the Bank will continue to occasionally make nonconforming loans to be held
in the Bank's portfolio. It is expected that management will continue these
policies in the future, though, in order to increase the Bank's fee income,
management may determine to retain the servicing on loans sold in the future as
the Bank's loan servicing capacity grows.
With respect to one- to four-family residential loans originated for
retention in the Bank's portfolio, the Bank's lending policies generally limit
the maximum loan-to-value ratio to 90% (with private mortgage insurance or other
collateral for the amount over 80%) for owner-occupied properties and 80% for
non-owner-occupied properties. Loans originated expressly for sale are
originated in accordance with the lending policies and underwriting guidelines
of the investor.
From time to time, the Bank makes loans to individuals for construction
of one- to four-family owner-occupied residences located in the Bank's primary
market area, with such loans usually converting to permanent financing upon
completion of construction. At June 30, 1997, the Bank's loan portfolio included
$2,102,595 of loans secured by properties under construction, some of which were
construction/permanent loans structured to become permanent loans upon the
completion of construction and some of which were interim construction loans
structured to be repaid in full upon completion of construction and receipt of
permanent financing. The Bank also offers loans to qualified builders for the
construction of one- to four-family residences located in the Bank's primary
market area. Because such homes are intended for resale, such loans are
generally not covered by permanent financing commitments by the Bank. All
construction loans are secured by a first lien on the property under
construction. Loan proceeds are disbursed in increments as construction
progresses and as inspections warrant. Construction/permanent loans are
underwritten in accordance with the same requirements as the Bank's permanent
mortgages, except the loans generally provide for disbursement in stages during
a construction period of up to nine months, during which period the borrower may
be required to make monthly payments. Borrowers must satisfy all credit
requirements that would apply to the Bank's permanent mortgage loan financing
prior to receiving construction financing for the subject property. Construction
financing generally is considered to involve a higher degree of risk of loss
than financing on existing properties. The Bank has sought to minimize this risk
by limiting construction lending to qualified borrowers in the Bank's primary
market area, by requiring the involvement of qualified builders, and by limiting
the aggregate amount of outstanding construction loans.
Commercial and Multi-Family Real Estate Lending. The Bank offers
commercial and multi-family real estate loans in order to benefit from the
higher origination fees and interest rates, as well as shorter terms to
maturity, than could be obtained from single-family mortgage loans. The Bank has
offered commercial and multi-family loans for years with many of such loans
having been indirectly originated and underwritten by the Bank through a broker
in the Memphis, Tennessee area with whom the Bank has had a long and successful
relationship. It is anticipated that the Bank will continue to make loans
through the broker in Memphis as opportunities arise, but management also has
increased the Bank's emphasis on the direct origination of commercial and
multi-family real estate loans, particularly in Central Arkansas, and has
continued to expand these activities.
Most of the Bank's commercial and multi-family real estate loans are
secured by properties located in communities within Central Arkansas that have
experienced significant growth in recent years, particularly communities in or
near the greater Little Rock area. The Bank's acquisition of the former Heritage
Bank, FSB, which was headquartered in Little Rock, resulted in the addition to
the Bank's staff of a commercial and multi-family real estate loan origination
specialist who works closely with borrowers and various members of the
commercial real estate industry throughout central Arkansas. As opportunities
for increased originations of such loans have increased, the Bank has been
expanding its loan underwriting and servicing staff. All commercial and
multi-family loans are reviewed and approved by the Bank's staff at the
headquarters office in Camden prior to any funding or the issuance of any
binding commitment by the Bank.
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The Bank's commercial and multi-family real estate loans may be secured
by apartments, offices, warehouses, shopping centers and other income-producing
multi-family and commercial properties. At June 30, 1997, the Bank had 163 of
these loans, with an average loan balance of approximately $185,150. At that
date, 65 of these loans totaling approximately $11.7 million were secured by
properties outside central Arkansas, and none of these out-of-market loans was
classified by management as substandard, doubtful or loss or designated by
management as special mention. Management expects the Bank to continue making
these out-of-market loans from time to time as opportunities arise.
The following paragraphs set forth information regarding the Bank's
commercial and multi-family real estate loans with outstanding balances
exceeding $500,000 at June 30, 1997. None of these loans was classified by
management as substandard, doubtful or loss or designated by management as
special mention at that date. For information regarding the Bank's asset
classification policies, see "Asset Classification, Allowances for Losses and
Nonperforming Assets."
Outpatient Surgery Center in Conway, Arkansas. In November
1996, the Bank made a $1,662,300 loan secured by a 6,375 square foot
medical office building and outpatient surgery center. At that time, an
appraisal indicated a loan-to-value ratio of approximately 79%. The
loan is being amortized over 20 years for the purpose of monthly
payments of principal and interest, maturing in November 2016. The
interest rate is adjustable each five years. At June 30, 1997, the
outstanding balance was $1,637,670, and the loan was fully performing
in accordance with its terms.
Shopping Center - Kiehl Plaza in Sherwood, Arkansas;
Convenience Store - 1700 Airport Road in Hot Springs, Arkansas; BP
Convenience Store in Conway, Arkansas. In November 1996, the Bank made
a $1,300,000 loan secured by a shopping center and two convenience
stores. At that time, the appraisals indicated a loan-to-value ratio of
approximately 80%. The loan is being amortized over 20 years for the
purpose of monthly payments of principal and interest, but the full
balance of the loan will be due in November 2001. Shortly after
origination, the Bank sold a 40% interest in this loan. At June 30,
1997, the outstanding balance of the Bank's 60% interest in this loan
was $770,415, and the loan was fully performing in accordance with its
terms.
Apartments in El Dorado, Arkansas. In August 1994, the Bank
made a $720,000 loan secured by a 44 unit apartment building. At that
time, an appraisal indicated a loan-to-value ratio of approximately
80%. The loan is being amortized over 15 years for the purpose of
monthly payments of principal and interest, but the full balance of the
loan will be due in August 1997. At June 30, 1997, the outstanding
balance was $638,834, and the loan was fully performing in accordance
with its terms.
Apartments in San Marcos, Texas. In February 1992, the Bank
made a $750,000 loan secured by a 69 unit apartment building. This loan
was made to facilitate the sale of the property, which had been
acquired by the Bank following a default on a prior loan. At that time,
an appraisal indicated a loan-to-value ratio of approximately 64%. The
loan currently is being amortized over 15 years for the purpose of
monthly payments of principal and interest, with the full balance of
the loan due in March 2010. At June 30, 1997, the outstanding balance
was $614,968, and the loan was fully performing in accordance with its
terms.
Retail Center in Memphis, Tennessee. In July 1996, the Bank
made a $560,000 loan secured by a 118,000 square foot retail center. At
that time, an appraisal indicated a loan-to-value ratio of
approximately 26%. The loan is being amortized over 15 years for the
purpose of monthly payments of principal and interest, and the full
balance of the loan will be due in August 2011. At June 30, 1997, the
outstanding balance was $541,949, and the loan was fully performing in
accordance with its terms.
8
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Office Building in Memphis, Tennessee. In September 1996, the
Bank made a $625,000 loan secured by a 30,000 square foot office
building. At that time, an appraisal indicated a loan-to-value ratio of
approximately 69%. The loan is being amortized over 20 years for the
purpose of monthly payments of principal and interest, and the full
balance of the loan will be due in September 2016. At June 30, 1997,
the outstanding balance was $614,276, and the loan was fully performing
in accordance with its terms.
Apartments in Conway, Arkansas. In July 1996, the Bank made a
$600,000 loan secured by a 20 unit apartment building. At that time, an
appraisal indicated a loan-to-value ratio of approximately 65%. The
loan is being amortized over 20 years for the purpose of monthly
payments of principal and interest, and the full balance of the loan
will be due in September 2002. At June 30, 1997, the loan was fully
performing in accordance with its terms.
Apartments in Conway, Arkansas. In October 1996, the Bank made
a $665,000 loan secured by another 20-unit apartment building in the
above apartment project. At that time, an appraisal indicated a
loan-to-value ratio of approximately 73%. The loan is being amortized
over 20 years for the purpose of monthly payments of principal and
interest, and the full balance of the loan will be due in September
2002. At June 30, 1997, the loan was fully performing in accordance
with its terms.
Retail Store in Fordyce, Arkansas. In January 1992, the Bank
made a $650,000 loan secured by a 32,500 square foot retail store. At
that time, an appraisal indicated a loan-to-value ratio of
approximately 73%. The loan currently is being amortized over 5 years
for the purpose of monthly payments of principal and interest, with the
full balance of the loan due in February 2000. At June 30, 1997, the
outstanding balance was $503,631, and the loan was fully performing in
accordance with its terms.
Nursing Home in Little Rock, Arkansas. In January 1997, the
Bank made a $1,000,000 loan secured by a 105-bed nursing home. At that
time, an appraisal indicated a loan-to-value ratio of approximately
50%. The loan is being amortized over 12 years for the purpose of
monthly payments of principal and interest, and the full balance of the
loan will be due in January 2000. Shortly after origination, the Bank
sold a 50% interest in this loan. At June 30, 1997, the outstanding
balance of the Bank's 50% interest in this loan was $489,856 and the
loan was fully performing in accordance with its terms.
Nursing Homes in Pine Bluff, Arkansas. In May 1997, the Bank
made a $1,900,000 loan secured by two nursing homes with 167 total
beds. At that time, an appraisal indicated a loan-to-value ratio of
approximately 75%. The loan is being amortized over 10 years for the
purpose of monthly payments of principal and interest, and the full
balance of the loan will be due in June 2000. Shortly after
origination, the Bank sold a 45% interest in this loan. At June 30,
1997, the outstanding balance of the Bank's 55% interest in this loan
was $1,045,000, and the loan was fully performing in accordance with
its terms.
In addition, at June 30, 1997 the Bank had $21.7 million in 51
commercial and multi-family real estate loans with outstanding balances
exceeding $200,000, only one of which was adversely classified or designated by
management. For additional information, see "Asset Classification, Allowances
for Losses and Nonperforming Assets" below.
The Bank's commercial and multi-family real estate loans generally are
limited to loans not exceeding $1,750,000 on properties located either in
Central Arkansas or other areas selected by management and approved by the Board
of Directors, with terms of up to 20 years and loan-to-value ratios of up to
80%. Interest rates may be fixed for up to five years, after which period the
rate may adjust or the loan may become due.
9
<PAGE>
Commercial and multi-family real estate lending entails significant
additional risks compared with one- to four-family residential lending. For
example, commercial and multi-family real estate loans typically involve large
loan balances to single borrowers or groups of related borrowers, the payment
experience on such loans typically is dependent on the successful operation of
the real estate project, and these risks can be significantly impacted by supply
and demand conditions in the market for multi-family residential units and
commercial office, retail and warehouse space. These risks may be higher with
respect to loans secured by properties outside the Bank's primary market area or
outside the Bank's most historically active lending areas. The Bank's recent and
planned increases in commercial and multi-family lending also introduce
additional risk as demands on the Bank's loan origination and administration
increase and as the Bank's aggregate exposure to these types of loans increases.
The aggregate amount of loans which federally chartered savings
institutions may make on the security of liens on commercial real estate
generally may not exceed 400% of the institution's capital.
Consumer Lending. Historically, the Bank's consumer loans have
primarily consisted of loans secured by deposits at the Bank and home
improvement loans secured by first or second mortgages on single-family
residences in the Bank's primary market area. These loans totaled approximately
$2.4 million and $4.1 million, respectively, at June 30, 1997. The Bank has
recently expanded its consumer loan offerings to include a full variety of such
loans, with a particular emphasis on loans secured by new and used automobiles
and other vehicles, including boats. These vehicle loans increased from
approximately $787,000 at June 30, 1996 to $2.4 million at June 30, 1997.
Management plans to continue the expansion of the Bank's consumer lending
activities in the future as part of management's plan to provide a wider range
of financial services to the Bank's customers while increasing the Bank's
portfolio yields and improving its asset/liability management.
The Bank makes savings account loans for up to 100% of the balance of
the account. The interest rate on these loans typically is fixed at least two
percentage points above the rate paid on a deposit at the Bank or four
percentage points above the rate paid on a deposit at another institution, with
the maturity and payment frequency matched to the terms of the deposit. The
account must be pledged as collateral to secure the loan.
The Bank makes home improvement loans secured by the borrower's
residence. These loans, combined with any higher priority mortgage loan, which
usually is from the Bank, generally are limited to 90% of the appraised value of
the residence. Home improvement loans generally have fixed interest rates and
terms of up to ten years.
The Bank's new and used automobile loans generally are underwritten in
amounts up to 90% of the purchase price, dealer cost or the loan value as
published by the National Automobile Dealers Association or the "Black Book."
The terms of such loans generally do not exceed 60 months, with loans for older
used cars underwritten for shorter terms. The Bank requires that the vehicles be
insured and that the Bank be listed as loss payee on the insurance policy.
The Bank offers floor plan loans to selected dealers on a case by case basis.
Consumer loans generally involve more risk than first mortgage loans.
Repossessed collateral for a defaulted loan may not provide an adequate source
of repayment of the outstanding loan balance as a result of damage, loss or
depreciation, and the remaining deficiency often does not warrant further
substantial collection efforts against the borrower. In addition, loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness or
personal bankruptcy. Further, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the amount
which can be recovered. These loans may also give rise to claims and defenses by
a borrower against the Bank, and a borrower may be able to assert against the
Bank claims and defenses which it has against the seller of the underlying
collateral. In underwriting consumer loans, the Bank considers the borrower's
credit history, an analysis of the borrower's income, expenses and ability to
repay the loan and the value of the collateral. The Bank's recent and planned
increases in consumer lending also introduce additional risk as demands on the
Bank's loan origination and administration increase and as the Bank's aggregate
exposure to these types of loans increases.
10
<PAGE>
Commercial Business Lending. Before the acquisition of the former
Heritage Bank, FSB, the Bank did not offer commercial business loans, except on
a limited basis in modest amounts as an accommodation to customers of the Bank.
Upon the acquisition, the Bank acquired approximately $768,000 of commercial
business loans, and since then the Bank has been expanding its commercial
business offerings and increasing its loan origination efforts. The Bank
currently offers, or plans to offer, working capital loans, accounts receivable
loans, floor plan loans to dealers of automobiles, and business equipment loans,
and the Bank has recently added to its staff an additional loan officer with
extensive experience originating and servicing indirect automobile loans. At
June 30, 1997, the Bank's commercial business loans totaled $2.1 million and
primarily consisted of automobile dealer floor plan loans and equipment loans.
At that date, the Bank had one commercial business loan with an outstanding
balance or loan commitment exceeding $300,000. The loan consisted of a floor
plan lending arrangement dating back to August 1996 and begun by the former
Heritage Bank, FSB. The loan is secured by used automobiles at a dealership in
Monticello, Arkansas. The loan requires regular payments of interest, and the
Bank requires principal paydowns as vehicles are sold and periodically in
accordance with specified repayment schedules. At June 30, 1997, the Bank had
committed to lend up to $500,000, the outstanding balance was $280,614, the loan
was fully performing in accordance with its terms, and the loan was not
adversely classified or designated by management.
Commercial business loans generally involve more risk than single
family residential loans. In underwriting commercial business loans, The Bank
considers the obligor's credit history, an analysis of the obligor's income,
expenses and ability to repay the obligation and the value of the collateral.
Loan Solicitation and Processing. The Bank's loan originations are
derived from a number of sources, including referrals by realtors, builders,
depositors, borrowers and mortgage brokers, as well as walk in customers. The
Bank's solicitation programs consist of calls by the Bank's officers, branch
managers and other responsible employees to local realtors and builders and
advertisements in local newspapers and billboards and radio broadcasts. Real
estate loans are originated by the Bank's staff loan officers as well as the
Bank's branch managers and executive officers, none of whom receives commissions
for loan originations. Loan applications are accepted at each of the Bank's
offices and, depending on the loan type and amount, may be processed and
underwritten at the originating office or forwarded to the main office.
Upon receipt of a loan application from a prospective borrower, the
Bank's staff preliminarily reviews the information provided and makes an initial
determination regarding the qualification of the borrower. If not disapproved,
the application then is placed in processing, and a credit report and
verifications are ordered to verify specific information relating to the loan
applicant's employment, income and credit standing. It is the Bank's policy to
obtain an appraisal of the real estate intended to secure a proposed mortgage
loan from independent fee appraisers. It is the Bank's policy to obtain personal
guarantees from the principals on all loans. Except when the Bank becomes aware
of a particular risk of environmental contamination, the Bank generally does not
obtain a formal environmental report on the real estate at the time a loan is
made.
It is the Bank's policy to record a lien on the real estate securing
the loan and to obtain a title insurance policy which insures that the property
is free of prior encumbrances. Borrowers must also obtain hazard insurance
policies prior to closing and, when the property is in a designated flood plain,
paid flood insurance policies. Most borrowers are also required to advance funds
on a monthly basis together with each payment of principal and interest to a
mortgage escrow account from which the Bank makes disbursements for items such
as real estate taxes.
The Board of Directors has the overall responsibility and authority for
general supervision of the Bank's loan policies. The Board has established
written lending policies for the Bank. The Bank's officers and loan committee
approve loans up to specified limits above which the approval of the Board may
be required. Loan applicants are promptly notified of the decision of the Bank.
It has been management's experience that substantially all approved loans are
funded.
Interest Rates and Loan Fees. Interest rates charged by the Bank on
mortgage loans are primarily determined by competitive loan rates offered in its
primary market area and the Bank's minimum yield requirements. Mortgage loan
11
<PAGE>
rates reflect factors such as prevailing market interest rate levels, the supply
of money available to the savings industry and the demand for such loans. These
factors are in turn affected by general economic conditions, the monetary
policies of the federal government, including the Federal Reserve Board, the
general supply of money in the economy, tax policies and governmental budget
matters.
The Bank receives fees in connection with loan commitments and
originations, loan modifications, late payments and changes of property
ownership and for miscellaneous services related to its loans. Loan origination
fees are calculated as a percentage of the loan principal. The Bank typically
receives fees of up to one point (one point being equivalent to 1% of the
principal amount of the loan) in connection with the origination of mortgage
loans. The excess, if any, of loan origination fees over direct loan origination
expenses is deferred and accreted into income over the contractual life of the
loan using the interest method. If a loan is prepaid, refinanced or sold, all
remaining deferred fees with respect to such loan are taken into income at such
time.
Collection Policies. When a borrower fails to make a payment on a loan,
the Bank generally takes prompt steps to have the delinquency cured and the loan
restored to current status. Once the payment grace period has expired (in most
instances 15 days after the due date), a late notice is mailed to the borrower,
and a late charge is imposed, if applicable. If payment is not promptly
received, a second notice is sent 15 days after the expiration of the grace
period. If the loan becomes 30 days delinquent, the borrower is contacted, and
efforts are made to formulate an affirmative plan to cure the delinquency. If a
loan becomes 60 days delinquent, the loan is reviewed by the Bank's management,
and if payment is not made, management may pursue foreclosure or other
appropriate action. If a loan remains delinquent 90 days or more, the Bank
generally initiates foreclosure proceedings.
Asset Classification, Allowances for Losses and Nonperforming Assets.
Federal regulations require savings institutions to classify their assets on the
basis of quality on a regular basis. An asset is classified as substandard if it
is determined to be inadequately protected by the current net worth and paying
capacity of the obligor or of the collateral pledged, if any. An asset is
classified as doubtful if full collection is highly questionable or improbable.
An asset is classified as loss if it is considered uncollectible, even if a
partial recovery could be expected in the future. The regulations also provide
for a special mention designation, described as assets which do not currently
expose an institution to a sufficient degree of risk to warrant classification
but do possess credit deficiencies or potential weaknesses deserving
management's close attention. Assets classified as substandard or doubtful
require an institution to establish general allowances for loan losses. If an
asset or portion thereof is classified loss, an institution must either
establish a specific allowance for loss in the amount of the portion of the
asset classified loss, or charge off such amount. Federal examiners may disagree
with an institution's classifications. If an institution does not agree with an
examiner's classification of an asset, it may appeal this determination to the
OTS Regional Director.
Management regularly reviews the Bank's assets to determine whether
assets require classification or reclassification, and the Board of Directors
reviews and approves all classifications. Following the Bank's acquisition of
the former Heritage Bank, FSB, and in light of management's intention of
increasing the Bank's emphasis on originating more commercial and multi-family
real estate loans and consumer and commercial business loans, in August 1996 the
Bank retained a consultant with extensive commercial banking experience in both
executive and advisory capacities, both to perform a detailed initial evaluation
of the Bank's loan portfolio and on an ongoing basis to assist management in
planning and implementing these changes in the Bank's lending activities. The
Bank also recently hired a staff loan analyst, whose responsibilities include
assisting with monitoring the Bank's loan portfolio quality. The Bank also
recently hired a staff loan analyst, whose responsibilities include assisting
with monitoring the Bank's loan portfolio quality. As of June 30, 1997, the Bank
had approximately $3,000 assets classified as loss, $41,000 of assets classified
as doubtful, $3.5 million of assets classified as substandard and $678,000 of
assets designated as special mention. The Bank's total adversely classified or
designated assets represented approximately 2.1% of the Bank's total assets and
14.6% of the Bank's tangible regulatory capital at June 30, 1997. At that date,
substantially all of the Bank's adversely classified or designated assets were
one- to four-family residences in the Bank's primary market area, and none of
such assets was in excess of $100,000, except for the following six loans
totaling $1,263,830:
- - Two of these loans were secured by interests in a partnership that owns
and operates a strip shopping center in Little Rock, Arkansas, and were
classified due to concerns about the borrowers' ability to repay the loan.
- - Loan secured by commercial real estate in Camden, Arkansas classified due
to insufficient cash flow and concerns about borrower's ability to repay
the debt.
- - Loan secured by a house built for speculative sale in Little Rock,
Arkansas market: classified as a result of litigtion (Litigation has since
been resolved and debt has been paid in full from sale proceeds of the
house).
- - Agriculture loan classified due to insufficient collateral and concerns
about borrower's ability to repay the debt.
- - Loan secured by a single family residence located out of market having a
extraordinarily slow payment history.
At June 30, 1997, management did not expect the Bank to incur any loss in excess
of attributable existing reserves on any of the Bank's adversely classified or
designated assets.
12
<PAGE>
In extending credit, the Bank recognizes that losses will occur and
that the risk of loss will vary with, among other things, the type of credit
being extended, the creditworthiness of the obligor over the term of the
obligation, general economic conditions and, in the case of a secured
obligation, the quality of the security. It is management's policy to maintain
adequate allowances for losses based on management's assessment of the Bank's
loan portfolio. The Bank increases its allowance for losses by charging
provisions for losses against the Bank's income. Federal examiners may disagree
with an institution's allowance for losses.
The Bank's methodology for establishing the allowance for losses takes
into consideration probable losses that have been identified in connection with
specific assets as well as losses that have not been identified but can be
expected to occur. Management conducts regular reviews of the Bank's assets and
evaluates the need to establish allowances on the basis of this review.
Allowances are established by the Board of Directors on a regular basis based on
an assessment of risk in the Bank's assets taking into consideration the
composition and quality of the portfolio, delinquency trends, current charge-off
and loss experience, the state of the real estate market, regulatory reviews
conducted in the regulatory examination process and economic conditions
generally. Allowances are provided for individual assets, or portions of assets,
when ultimate collection is considered improbable by management based on the
current payment status of the assets and the fair value or net realizable value
of the security. At the date of foreclosure or other repossession or at the date
the Bank determines a property is an "in-substance foreclosed" property, the
Bank transfers the property to real estate acquired in settlement of loans at
the lower of cost or fair value. Fair value is defined as the amount in cash or
cash-equivalent value of other consideration that a property would yield in a
current sale between a willing buyer and a willing seller. Fair value is
measured by market transactions. If a market does not exist, fair value of the
property is estimated based on selling prices of similar properties in active
markets or, if there are no active markets for similar properties, by
discounting a forecast of expected cash flows at a rate commensurate with the
risk involved. Fair value generally is determined through an appraisal at the
time of foreclosure. At June 30, 1997, the Bank held no properties acquired in
settlement of loans for which market values were unavailable. Any amount of cost
in excess of fair value is charged-off against the allowance for loan losses.
The Bank records an allowance for estimated selling costs of the property
immediately after foreclosure. Subsequent to acquisition, the property is
periodically evaluated by management and an allowance is established if the
estimated fair value of the property, less estimated costs to sell, declines.
If, upon ultimate disposition of the property, net sales proceeds exceed the net
carrying value of the property, a gain on sale of real estate is recorded.
The banking regulatory agencies, including the OTS, have adopted a
policy statement regarding maintenance of an adequate allowance for loan and
lease losses and an effective loan review system. This policy includes an
arithmetic formula for checking the reasonableness of an institution's allowance
for loan loss estimate compared to the average loss experience of the industry
as a whole. Examiners will review an institution's allowance for loan losses and
compare it against the sum of (i) 50% of the portfolio that is classified
doubtful; (ii) 15% of the portfolio that is classified as substandard; and (iii)
for the portions of the portfolio that have not been classified (including those
loans designated as special mention), estimated credit losses over the upcoming
twelve months given the facts and circumstances as of the evaluation date. This
amount is considered neither a "floor" nor a "safe harbor" of the level of
allowance for loan losses an institution should maintain, but examiners will
view a shortfall relative to the amount as an indication that they should review
management's policy on allocating these allowances to determine whether it is
reasonable based on all relevant factors.
Management actively monitors the Bank's asset quality and charges off
loans and properties acquired in settlement of loans against the allowances for
losses on such loans and such properties when appropriate and provides specific
loss allowances when necessary. Although management believes it uses the best
information available to make determinations with respect to the allowances for
losses, future adjustments may be necessary if economic conditions differ
substantially from the economic conditions in the assumptions used in making the
initial determinations.
13
<PAGE>
During the year ended June 30, 1997, in light of the Bank's
comprehensive loan portfolio review and reevaluation, the Bank made additional
provisions for loan losses totalling $221,671, bringing the total reserve for
losses on loans to $1.5 million, or 1.5% of gross loans. The following table
sets forth an analysis of the Bank's allowance for loan losses for the periods
indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------
1997 1996
------- ------
<S> <C> <C>
Balance at beginning of period..................... $ 1,283,234 $ 728,491
------------- ------------
Loans charged-off:
Real estate mortgage:
One- to four-family residential................ 11,317 12,130
Other mortgage loans........................... -- --
Consumer......................................... 11,668 --
------------- ------------
Total charge-offs.................................. 22,985 12,130
------------- ------------
Recoveries:
Real estate mortgage:
One- to four-family residential................ 6,333 250
Other mortgage loans........................... -- --
Consumer......................................... 4,220 --
------------- ------------
Total recoveries................................... 10,553 250
------------- ------------
Net loans charged-off.............................. 12,432 11,880
------------- ------------
Acquisition of subsidiary.......................... -- 524,140
Provision for loan losses.......................... 221,671 42,483
------------- ------------
Balance at end of period........................... $ 1,492,473 $ 1,283,234
============= ============
Ratio of net charge-offs to average
loans outstanding during the period.............. .024% 0.018%
============= ============
</TABLE>
14
<PAGE>
The following table allocates the allowance for loan losses by asset
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
June 30,
------------------------------------------------------
1997 1996
-------------------------- --------------------------
Percent Percent
of Loans of Loans
in Category in Category
to Total to Total
Amount Loans Amount Loans
-------- ------------ ------- -------------
<S> <C> <C> <C> <C>
Allocated to:
Real estate loans:
One- to four-family residential................ $ 954,093 60.90% $ 935,354 71.66%
Multi-family and non-residential
loans........................................ 296,018 27.05 278,650 23.61
Consumer loans:.................................. 67,700 10.00 17,635 3.72
Commercial..................................... 81,250 2.05 -- 1.01
Unallocated.................................... 93,412 -- 51,595 --
----------- ------ ----------- -------
Total..................................... $ 1,492,473 100.00% $ 1,283,234 100.00%
=========== ====== =========== ======
</TABLE>
In addition to its allowance for loan losses, the Bank maintains an
allowance for losses on real estate acquired in settlement of loans, including
in-substance foreclosures. This allowance is established to cover losses on such
properties. At June 30, 1997, the Bank had such an allowance in the amount of
approximately $28,287.
Numerous financial institutions throughout the United States have
incurred losses due to significant increases in loss provisions and charge-offs
resulting largely from higher levels of loan delinquencies and foreclosures.
Depressed real estate market conditions have adversely affected the economies of
various regions and have had a severe impact on the financial condition and
businesses of many of the financial institutions doing business in these areas.
Moreover, the Bank's increasing emphasis on the origination of commercial and
multi-family loans and consumer and commercial business loans may increase the
Bank's risk of corresponding increases in loan loss provisions and charge-offs.
Finally, as a result of declines in real estate market values and significant
losses experienced by many financial institutions, there has been a greater
level of scrutiny by regulatory authorities of the loan portfolios of financial
institutions undertaken as part of examinations of such institutions by the
FDIC, OTS or other federal or state regulators. Results of examinations indicate
that these regulators may be applying more conservative criteria in evaluating
real estate market values, requiring significantly increased provisions for
losses on loans and real estate acquired in settlement of such loans. While
management believes the Bank has established its existing loss allowances in
accordance with generally accepted accounting principles, there can be no
guaranty or assurance that such reserves are, or in the future will be, adequate
to absorb all loan losses or that regulators, in reviewing the Bank's assets,
will not make the Bank increase its loss allowance, thereby negatively affecting
the Bank's reported financial condition and results of operations.
15
<PAGE>
The following table sets forth information with respect to the Bank's
nonperforming assets at the dates indicated. For information regarding the
Bank's interest accrual practices, see the Notes to Consolidated Financial
Statements.
<TABLE>
<CAPTION>
At June 30,
------------------------------
1997 1996
----------- -----------
<S> <C> <C>
Loans accounted for on a nonaccrual basis: /1/
Real estate:
One- to four-family residential........................... $ 133,386 $ 166,228
Other mortgage loans...................................... -- --
Consumer.................................................... -- --
----------- -----------
Total..................................................... $ 133,386 $ 166,228
=========== ===========
Accruing loans which are contractually past due 90 days or more:
Real estate:
One- to four-family residential........................... $ 323,478 $ 725,487
Other mortgage loans...................................... -- --
Consumer loans.............................................. 56,904 127,142
----------- -----------
Total..................................................... $ 380,382 $ 852,629
=========== ===========
Total nonperforming loans................................. $ 513,768 $ 1,018,857
=========== ===========
Percentage of total loans..................................... .50% 1.21%
=========== ===========
Other nonperforming assets /2/................................ $ 65,005 $ 168,206
=========== ===========
Loans modified in troubled debt restructurings................ $ 281,441 $ 298,195
=========== ===========
</TABLE>
/1/ Designated nonaccrual loan payments received applied first to
contractual principal; interest income recognized when contractually
current.
/2/ Other nonperforming assets includes foreclosed real estate.
During the years ended June 30, 1997 and 1996, gross interest income of
$12,177 and $7,718, respectively, would have been recorded on loans accounted
for on a nonaccrual basis if the loans had been current throughout the
respective periods. Interest on such loans included in income during such
respective periods amounted to $17,689 and $2,604, respectively.
At June 30, 1997, management had identified approximately $4.22 million
of loans which amount is not reflected in the preceding table but as to which
known information about possible credit problems of borrowers caused management
to have doubts as to the ability of the borrowers to comply with present loan
repayment terms, all of which was included in the Bank's adversely classified or
designated asset amounts at that date. Of this aggregate amount, $2.9 million
was attributable to 126 one- to four-family residential loans, and $1.3 million
was attributable to 11 commercial or multi-family real estate loans. At June 30,
1997, management did not expect the Bank to incur any loss in excess of
attributable existing reserves on any of the Bank's assets.
Investment Activities
General. The Bank is permitted under federal law to make certain
investments, including investments in securities issued by various federal
agencies and state and municipal governments, deposits at the FHLB of Dallas,
certificates of deposit in federally insured institutions, certain bankers'
acceptances and federal funds. It may also invest, subject to certain
limitations, in commercial paper rated in one of the two highest investment
rating categories of a nationally recognized credit rating agency, and certain
other types of corporate debt securities and mutual funds. Federal regulations
require the Bank to maintain an investment in FHLB stock and a minimum amount of
liquid assets which may be invested in cash and specified securities. From time
to time, the OTS adjusts the percentage of liquid assets
16
<PAGE>
which savings banks are required to maintain. See "Regulation -- Regulation of
the Banks -- Liquidity Requirements" below.
The Bank makes investments in order to maintain the levels of liquid
assets required by regulatory authorities and manage cash flow, diversify its
assets, obtain yield and, under prior federal income tax law, satisfy certain
requirements for favorable tax treatment. The investment activities of the Bank
consist primarily of investments in mortgage-backed securities and other
investment securities, consisting primarily of securities issued or guaranteed
by the U.S. government or agencies thereof. Typical investments include
federally sponsored agency mortgage pass-through and federally sponsored agency
and mortgage-related securities. Investment and aggregate investment limitations
and credit quality parameters of each class of investment are prescribed in the
Bank's investment policy. The Bank performs analyses on mortgage-related
securities prior to purchase and on an ongoing basis to determine the impact on
earnings and market value under various interest rate and prepayment conditions.
Securities purchases are approved by the Bank's Investment Committee, and the
Board of Directors reviews all securities transactions on a monthly basis.
Securities designated as "held to maturity" are those assets which the
Bank has the ability and intent to hold to maturity. The held to maturity
investment portfolio is carried at amortized cost. Securities designated as
"available for sale" are those assets which the Bank might not hold to maturity
and thus are carried at market value with unrealized gains or losses, net of tax
effect, recognized in equity.
Mortgage-backed securities typically represent an interest in a pool of
fixed-rate or adjustable-rate mortgage loans, the principal and interest
payments on which are passed from the mortgage borrowers to investors such as
the Bank. Mortgage-backed security sponsors may be private companies or
quasi-governmental agencies such as FHLMC, FNMA and GNMA, which guarantee the
payment of principal and interest to investors. Mortgage-backed securities can
represent a proportionate participation interest in a pool of loans or,
alternatively, an obligation to repay a specified amount secured by a pool of
loans (commonly referred to as a "collateralized mortgage obligation," or
"CMO"). Mortgage-backed securities generally increase the quality of the Bank's
assets by virtue of the credit enhancements that back them, are more liquid than
individual mortgage loans and may be used to collateralize borrowings or other
obligations of the Bank. The Bank's mortgage-backed securities portfolio
primarily consists of seasoned securities either issued by a one of the
quasi-governmental agencies or rated in one of the top two categories by a
recognized rating organization.
All of the Bank's privately issued securities were rated "AA" or higher
by a nationally recognized credit rating agency at the time of purchase.
Management regularly monitors the ratings of the Bank's privately issued
holdings by reference to nationally published rating medium and by communication
with the issuer where necessary. At June 30, 1997, no privately issued
securities had been downgraded from their original rating, except during fiscal
1997 the Bank was notified of a downgrade in the rating of one of its private
issue obligations. The security is a Citicorp Mortgage, Inc. REMIC pass-thru
certificate. The downgrade reflected deterioration in the performance of the
mortgage pools underlying the security. At June 30, 1997, the Class A
Certificate holders had suffered no interest losses but had suffered $625,223 in
principle losses. The Bank's balance of this security at that date was $871,312,
which represented 1.36% of the total outstanding pool of $64,244,942. The credit
enhancement available to Class A certificate holders was $2,901,490 at June 30,
1997. As long as this amount is positive, no significant loss to the Bank, if
any, is anticipated. The Bank's privately issued securities have been primarily
collateralized mortgage obligations (CMOs). At June 30, 1997, all of these
securities had adjustable interest rates with a weighted average yield of 6.66%
and a weighted average term to maturity of 24 years. The carrying value of the
privately issued securities was $32.1 million, or 60.1% of mortgage-backed
securities at that date. None of the privately issued securities is insured or
guaranteed by FHLMC or FNMA.
The actual maturity of a mortgage-backed security varies, depending on
when the mortgagors prepay or repay the underlying mortgages. Prepayments of the
underlying mortgages may shorten the life of the investment, thereby adversely
affecting its yield to maturity and the related market value of the
mortgage-backed security. The yield is based
17
<PAGE>
upon the interest income and the amortization of the premium or accretion of the
discount related to the mortgage-backed security. Premiums and discounts on
mortgage-backed securities are amortized or accredited over the estimated term
of the securities using a level yield method. The prepayment assumptions used to
determine the amortization period for premiums and discounts can significantly
affect the yield of the mortgage-backed security, and these assumptions are
reviewed periodically to reflect the actual prepayment. The actual prepayments
of the underlying mortgages depend on many factors, including the type of
mortgage, the coupon rate, the age of the mortgages, the geographical location
of the underlying real estate collateralizing the mortgages and general levels
of market interest rates. The difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates is an important
determinant in the rate of prepayments. During periods of falling mortgage
interest rates, prepayments generally increase, and, conversely, during periods
of rising mortgage interest rates, prepayments generally decrease. If the coupon
rate of the underlying mortgage significantly exceeds the prevailing market
interest rates offered for mortgage loans, refinancing generally increases and
accelerates the prepayment of the underlying mortgages. Prepayment experience is
more difficult to estimate for adjustable-rate mortgage-backed securities.
The following table sets forth information regarding carrying values of
the Bank's investment securities at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
------------------------------
1997 1996
------------ ------------
<S> <C> <C>
Securities available for sale:
U.S. government and agencies............................... $ 16,155,955 $ 5,279,625
Collateralized mortgage obligations........................ 6,171,341 9,034,604
Other mortgage-backed securities........................... 13,919,065 3,120,595
------------ ------------
$ 36,246,161 $ 17,434,824
============ ============
Securities held to maturity:
U.S. government and agencies............................... $ -- $ --
Collateralized mortgage obligations........................ -- --
Other mortgage-backed securities........................... 35,869,295 45,212,891
------------ ------------
Total................................................... $ 72,115,456 $ 62,647,715
============ ============
</TABLE>
18
<PAGE>
The following table sets forth information in the scheduled maturities,
amortized cost, market values and average yields for the Bank's investment
portfolio at June 30, 1997.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years More than Ten Years
------------------ ------------------- ------------------- ---------------------
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
------- ------- ------- ------- ------- ------- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available for sale:
U.S. government and agencies... $ 1,503,866 6.09% $12,647,279 6.78% $2,004,610 7.05% $ -- --%
Collateralized mortgage
obligations................. -- -- -- -- -- -- 6,270,999 6.43
Other mortgage-backed securities -- -- 2,197,535 7.54 5,483,501 7.07 6,238,029 7.30
----------- ----------- ---------- -----------
1,503,866 6.09 14,844,814 6.90 7,488,111 7.06 12,509,028 6.86
Securities held to maturity:
U.S. government agencies........ -- -- -- -- -- -- -- --
Collateralized mortgage
obligations................... -- -- -- -- -- -- -- --
Mortgage-backed securities...... -- -- 703,741 9.08 1,456,595 9.29 33,708,959 6.73
----------- ----------- ---------- -----------
Total....................... $ 1,503,866 6.09 $15,548,555 7.00 $8,944,706 7.42 $46,217,987 6.77
=========== =========== ========== ===========
<CAPTION>
Total Investment Portfolio
---------------------------------
Carrying Market Average
Value Value Yield
------- ----- ------
<S> <C> <C> <C>
Securities available for sale:
U.S. government and agencies... $16,155,755 $ 16,155,755 6.45%
Collateralized mortgage
obligations................. 6,270,999 6,270,999 6.43
Other mortgage-backed securities 13,919,065 13,919,065 7.20
----------- ----------
36,345,819 36,345,819 6.86
Securities held to maturity:
U.S. government agencies........ -- -- --
Collateralized mortgage
obligations................... -- -- --
Mortgage-backed securities..... 35,869,295 36,194,350 6.81
----------- ----------
Total....................... $72,215,114 $72,540,169 6.84
=========== ===========
</TABLE>
19
<PAGE>
Deposit Activity and Other Sources of Funds
General. Deposits are the primary source of the Bank's funds for
lending, investment activities and general operational purposes. While the Bank,
like most independent savings institutions, historically has relied on
certificates of deposit for a substantial portion of its deposits, management
has recently shifted the Bank's deposit gathering emphasis away from
certificates of deposit and toward transaction accounts with more favorable
interest costs, interest rate risk characteristics and opportunities for the
Bank to perform valued customer services that generate additional fee income,
and it is expected that management will continue this trend in the future. In
addition to deposits, the Bank derives funds from loan principal and interest
repayments, maturities of investment securities and mortgage-backed securities
and interest payments thereon. Although loan repayments are a relatively stable
source of funds, deposit inflows and outflows are significantly influenced by
general interest rates and money market conditions. Borrowings may be used on a
short-term basis to compensate for reductions in the availability of funds, or
on a longer term basis for general operational purposes. The Bank has access to
borrow advances from the FHLB of Dallas, which the Bank uses from time to time.
Deposits. The Bank attracts deposits principally from within its
primary market area by offering competitive rates on its deposit instruments,
including money market accounts, passbook savings accounts, Individual
Retirement Accounts and certificates of deposit which range in maturity from 90
days to three years. Deposit terms vary according to the minimum balance
required, the length of time the funds must remain on deposit and the interest
rate. Maturities, terms, service fees and withdrawal penalties for its deposit
accounts are established by the Bank on a periodic basis. In determining the
characteristics of its deposit accounts, the Bank considers the rates offered by
competing institutions, lending and liquidity requirements, growth goals and
federal regulations. The Bank does not accept brokered deposits or pay
negotiated rates for jumbo deposits.
The Bank attempts to compete for deposits with other institutions in
its market area by offering competitively priced deposit instruments that are
tailored to the needs of its customers. Additionally, the Bank seeks to meet
customers' needs by providing convenient customer service to the community,
efficient staff and convenient hours of service. Substantially all of the Bank's
depositors are Arkansas residents who reside in the Bank's primary market area.
Savings deposits in the Bank at June 30, 1997 were represented by the
various types of savings programs listed below.
<TABLE>
<CAPTION>
Interest Minimum Minimum Percentage of
Rate /1/ Term Category Amount Balances Total Deposits
- -------- -------- -------- -------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Demand Deposits
2.76% None NOW accounts $ 500 $ 9,406,397 6.22%
4.09 None Money market deposits 2,500 17,807,493 11.78
------------ -------
Total Demand Deposits $ 27,213,890 18.00
3.04 None Savings deposits-passbook 8,441,845 5.50
Certificates of Deposit
4.13 3 months or less Fixed-term, fixed-rate 1,000 1,558,705 1.03
5.27 6 months Fixed-term, fixed-rate 1,000 33,602,568 22.22
5.39 12 months Fixed-term, fixed-rate 1,000 42,381,305 28.04
5.77 15-72 months Fixed-term, fixed-rate 1,000 38,010,450 25.13
------------ -------
5.63 Total certificates of deposit 115,553,028 76.42
------------ -------
5.12 Total deposits $151,208,763 100.00%
============ ======
</TABLE>
- -------------
/1/ Represents weighted average interest rate.
20
<PAGE>
The following table sets forth information regarding average deposit
balances and rates during the periods presented.
<TABLE>
<CAPTION>
June 30,
----------------------------------------------------
1997 1996
------------------------ ------------------------
Average Average Average Average
Balance Rate Balance Rate
------------ --------- ------------- ---------
<S> <C> <C> <C> <C>
NOW accounts...................................... $ 5,858,963 3.07% $ 4,387,731 2.92%
Money market deposits............................. 18,333,058 4.23 13,777,197 3.94
Savings deposits - passbook....................... 7,792,066 3.02 6,632,913 3.71
Certificates of deposit........................... 116,980,504 5.42 95,231,454 5.66
------------ -------------
Total......................................... $148,964,591 5.05 $ 120,029,295 5.26
============ =============
</TABLE>
The following table sets forth information regarding changes in dollar
amounts of deposits in various types of accounts offered by the Bank between the
dates indicated.
<TABLE>
<CAPTION>
Increase
Balance at (Decrease) Balance at
June 30, % of from June 30, June 30, % of
1997 Deposits 1996 1996 Deposits
---------- -------- -------------- ---------- --------
<S> <C> <C> <C> <C> <C>
NOW accounts........................ $ 9,406,397 6.22% $ 2,737,862 $ 6,668,535 4.57%
Money market deposits............... 17,807,493 11.78 2,315,902 15,491,591 10.62
Savings deposits - passbook 8,441,845 5.58 413,690 8,028,155 5.50
Certificates of deposits............ 115,553,028 76.42 (177,942) 115,730,970 79.31
------------ ------ ----------- ------------- ------
$151,208,763 100.00% $ 5,289,512 $ 145,919,251 100.00%
============ ====== =========== ============= ======
</TABLE>
The following table sets forth information regarding time deposits
classified by rates at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
-------------------------------
1997 1996
------------- -------------
<S> <C> <C>
2.00 - 3.99%............................................... $ -- $ --
4.00 - 5.99%............................................... 99,606,159 75,847,271
6.00 - 7.99%............................................... 15,946,869 39,883,699
8.00 - 9.99%............................................... -- --
------------- -------------
$ 115,553,028 $ 115,730,970
============= =============
</TABLE>
21
<PAGE>
The following table sets forth information regarding amounts and
maturities of time deposits at June 30, 1997.
<TABLE>
<CAPTION>
Amount Due
--------------------------------------------------------
Less Than After
Rate One Year 1-2 Years 2-3 Years 3 Years Total
- ---- -------- --------- --------- ------- -----
<S> <C> <C> <C> <C> <C>
4.00 - 5.99%................. $ 4,923,824 $48,797,581 $ 1,570,754 $ -- $ 99,606,519
6.00 - 7.99%................. 4,419,330 11,521,177 6,632 -- 15,947,139
----------- ----------- ----------- ---------- -------------
$53,657,154 $60,318,758 $ 1,577,116 $ -- $ 115,553,658
=========== =========== =========== ========== =============
</TABLE>
The following table sets forth information regarding amounts of
certificates of deposit of $100,000 or more by time remaining until maturity at
June 30, 1997.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------- ------------
<S> <C>
Three months or less....................... $ --
Over three through six months.............. 2,957,579
Over six through 12 months................. 3,929,943
Over 12 months............................. 2,486,229
------------
Total.................................. $ 9,373,751
============
</TABLE>
The following table sets forth information regarding savings activities
of the Bank for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------------
1997 1996
-------------- -------------
<S> <C> <C>
Deposits.................................................... $ 142,004,936 $ 93,529,413
Withdrawals................................................. (144,249,869) (91,037,454)
Net increase (decrease) before
interest credited......................................... -- 2,491,959
Subsidiary acquisition...................................... -- 25,101,788
Interest credited........................................... 7,534,445 6,314,641
-------------- -------------
Net increase (decrease) in savings
deposits.............................................. $ 5,289,512 $ 33,908,388
============== =============
</TABLE>
Borrowings. Savings deposits historically have been the primary source
of funds for the Bank's lending, investments and general operating activities.
The Bank is authorized, however, to use advances from the FHLB of Dallas to
supplement its supply of lendable funds and to meet deposit withdrawal
requirements. The FHLB of Dallas functions as a central reserve bank providing
credit for savings institutions and certain other member financial institutions.
As a member of the FHLB System, the Bank is required to own stock in the FHLB of
Dallas and is authorized to apply for advances. Advances are pursuant to several
different programs, each of which has its own interest rate and range of
maturities. Advances from the FHLB of Dallas are secured by the Bank's stock in
the FHLB of Dallas and first mortgage loans.
22
<PAGE>
The following tables set forth certain information regarding short-term
borrowings by the Bank for the periods indicated. Averages are based on monthly
balances.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------
1997 1996
------------- ------------
<S> <C> <C>
Amounts outstanding at end of period:
FHLB advances............................................... $ 10,000,000 $ 10,000,000
Maximum amount of borrowings outstanding at any month end:
FHLB advances............................................... $ 12,500,000 $ 10,000,000
Approximate average short-term borrowings outstanding with respect to:
FHLB advances............................................... $ 10,208,333 $ 7,500,000
</TABLE>
Subsidiary Activities
As federally chartered savings banks, the Bank and its separate
subsidiary savings bank, are each permitted to invest an amount equal to 2% of
its assets in non-savings institution service corporation subsidiaries, with an
additional investment of 1% of assets where such investment serves primarily
community, inner-city and community development purposes. Under such
limitations, as of June 30, 1997 on a consolidated basis the Bank was authorized
to invest up to approximately $6,010,973 in the stock of or loans to such
subsidiaries, including the additional 1% investment for community inner-city
and community development purposes. The Bank has one subsidiary service
corporation, HCB Properties, Inc., which was formed in August 1996 to hold
certain properties acquired by the Bank for possible future expansion, because
the properties are larger than the Bank's anticipated expansion needs, and it is
expected that portions of the properties eventually will be sold. At June 30,
1997, the Bank's aggregate investment in, and loans to, the subsidiary service
corporation totalled $1,307,000, all of which was subject to exclusion from the
Bank's regulatory capital under applicable legal requirements (see "Regulation
of the Banks -- Regulatory Capital Requirements").
Regulation of the Banks
General. As federally chartered savings institutions, each of the Bank
and its savings bank subsidiary (collectively, the "Banks") is subject to
extensive regulation by the OTS and the FDIC and to OTS regulations governing
such matters as capital standards, mergers, establishment of branch offices,
subsidiary investments and activities and general investment authority. The OTS
periodically examines the Banks for compliance with various regulatory
requirements. The FDIC also has the authority to conduct special examinations of
the Banks because their deposits are insured by the SAIF. The Banks must file
reports with the OTS describing their activities and financial condition and
also are subject to certain reserve requirements promulgated by the Federal
Reserve Board. This supervision and regulation is intended primarily for the
protection of depositors. See also "Proposed Legislative and Regulatory
Changes."
Federal Home Loan Bank System. The Banks are members of the FHLB
System, which consists of 12 district FHLBs subject to supervision and
regulation by the Federal Housing Finance Board ("FHFB"). The FHLBs provide a
central credit facility primarily for member institutions. As members of the
FHLB of Dallas, the Banks are required to acquire and hold shares of capital
stock in the FHLB of Dallas in an amount at least equal to 1% of the aggregate
unpaid principal of their home mortgage loans, home purchase contracts and
similar obligations at the beginning of each year, or 1/20 of their advances
(borrowings) from the FHLB of Dallas, whichever is greater.
The FHLB of Dallas serves as a reserve or central bank for its member
institutions within its assigned district. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System. It makes
advances to members in accordance with policies and procedures established by
the FHLB and the Board of Directors
23
<PAGE>
of the FHLB of Dallas. Long-term advances may only be made for the purpose of
providing funds for residential housing finance. At June 30, 1997, the Banks had
$10 million in advances outstanding with the FHLB of Dallas. See " -- Deposit
Activity and Other Sources of Funds -- Borrowings."
Liquidity Requirements. The Banks are required to maintain average
daily balances of liquid assets (cash, deposits maintained pursuant to Federal
Reserve Board requirements, time and savings deposits in certain institutions,
obligations of the United States and states and political subdivisions thereof,
shares in mutual funds with certain restricted investment policies, highly rated
corporate debt and mortgage loans and mortgage-related securities with less that
one year to maturity or subject to pre-arranged sale within one year) equal to
the monthly average of not less than a specified percentage (currently 5%) of
their net withdrawable savings deposits plus short-term borrowings. The Banks
are also required to maintain average daily balances of short-term liquid assets
at a specified percentage (currently 1%) of the total of their net withdrawable
savings accounts and borrowings payable in one year or less. Monetary penalties
may be imposed for failure to meet liquidity requirements. The average ratios of
liquid assets and short-term liquid assets of the Banks for June 1997 were
68.11% and 26.23%, respectively.
Qualified Thrift Lender Test. The Banks are subject to OTS regulations
which use the concept of a Qualified Thrift Lender to determine eligibility for
Federal Home Loan Bank advances and for certain other purposes. To qualify as a
Qualified Thrift Lender, a savings institution must either qualify as a
"domestic building and loan association" under the Internal Revenue Code or
maintain at least 65% of its "portfolio" assets in Qualified Thrift Investments.
Portfolio assets are defined to include total assets less intangibles, property
used by a savings institution in its business and liquidity investments in an
amount not exceeding 20% of assets. Qualified Thrift Investments consist of (i)
loans, equity positions or securities related to domestic, residential real
estate or manufactured housing, and educational, small business and credit card
loans, (ii) 50% of the dollar amount of residential mortgage loans subject to
sale under certain conditions, and (iii) stock issued by a Federal Home Loan
Bank. Subject to a 20% of portfolio assets limit, savings institutions are able
to treat as Qualified Thrift Investments 200% of their investments in loans to
finance "starter homes" and loans for construction, development or improvement
of housing and community service facilities or for financing small businesses in
"credit-needy" areas. To be qualified as a Qualified Thrift Lender, a savings
institution must maintain its status as a Qualified Thrift Lender for nine out
of every 12 months. Failure to qualify as a Qualified Thrift Lender results in a
number of sanctions, including the imposition of certain operating restrictions
imposed on national banks and a restriction on obtaining additional advances
from the Federal Home Loan Bank System. Upon failure to qualify as a Qualified
Thrift Lender for two years, a savings institution must convert to a commercial
bank in excess of the required percentage.
At June 30, 1997, approximately 68.11% and 83.18% of the Banks'
respective portfolio assets were invested in Qualified Thrift Investments.
Regulatory Capital Requirements. Under OTS capital standards, savings
institutions must maintain "tangible" capital equal to at least 1.5% of adjusted
total assets, "core" capital equal to at least 3% of adjusted total assets and
"total" capital (a combination of core and "supplementary" capital) equal to at
least 8% of "risk-weighted" assets. In addition, the OTS has adopted regulations
which impose certain restrictions on institutions that have a total risk-based
capital ratio that is less than 8.0%, a ratio of Tier 1 capital to risk-weighted
assets of less than 4.0% or a ratio of Tier 1 capital to adjusted total assets
of less than 4.0% (or 3.0% if the institution is rated CAMELS 1 under the OTS
examination rating system). For purposes of these regulations, Tier 1 capital
has the same definition as core capital. See " -- Prompt Corrective Regulatory
Action." Core capital is defined as common stockholders' equity (including
retained earnings), noncumulative perpetual preferred stock and related surplus,
minority interests in the equity accounts of fully consolidated subsidiaries,
certain nonwithdrawable accounts and pledged deposits and "qualifying
supervisory goodwill." Core capital is generally reduced by the amount of an
institution's intangible assets for which no market exists. Limited exceptions
to the deduction of intangible assets are provided for purchased mortgage
servicing rights and qualifying supervisory goodwill. Tangible capital is given
the same definition as core capital but does not include an exception for
qualifying supervisory goodwill and is reduced by the amount of all the savings
institution's intangible assets with only a limited exception for purchased
mortgage servicing rights.
24
<PAGE>
Both core and tangible capital are further reduced by an amount equal
to a savings institution's debt and equity investments in subsidiaries engaged
in activities not permissible to national banks (other than subsidiaries engaged
in activities undertaken as agent for customers or in mortgage banking
activities and depository institutions or their holding companies). As of June
30, 1997, the Banks had approximately $1,307,000 and zero, respectively, of
investments in, or extensions of credit to, non-includible subsidiaries.
Adjusted total assets are a savings institution's total assets as
determined under generally accepted accounting principles, increased by certain
goodwill amounts and by a pro rated portion of the assets of unconsolidated
includible subsidiaries in which the institution holds a minority interest.
Adjusted total assets are reduced by the amount of assets that have been
deducted from capital, the savings institution's investments in unconsolidated
includible subsidiaries, and, for purposes of the core capital requirement,
qualifying supervisory goodwill.
In determining compliance with the risk-based capital requirement, a
savings institution is allowed to use both core capital and supplementary
capital provided the amount of supplementary capital used does not exceed the
institution's core capital. Supplementary capital is defined to include certain
preferred stock issues, nonwithdrawable accounts and pledged deposits that do
not qualify as core capital, certain approved subordinated debt, certain other
capital instruments and a portion of the institution's general loan loss
allowances. Total core and supplementary capital are reduced by the amount of
capital instruments held by other depository institutions pursuant to reciprocal
arrangements and, by the amount of the savings institution's high loan-to-value
ratio land loans, non-residential construction loans and equity investments
other than those deducted from core and tangible capital. At June 30, 1997, the
Banks had no high ratio land or non-residential construction loans and no equity
investments for which OTS regulations require a deduction from total capital.
The risk-based capital requirement is measured against risk-weighted
assets which equal the sum of each asset and the credit-equivalent amount of
each off-balance sheet item after being multiplied by an assigned risk weight.
Under the OTS risk-weighting system, one- to four-family first mortgages not
more than 90 days past due with loan-to-value ratios under 80% and average
annual occupancy rates of at least 80% and certain qualifying loans for the
construction of one- to four-family residences pre-sold to home purchasers are
assigned a risk weight of 50%. Consumer and residential construction loans are
assigned a risk weight of 100%. Mortgage-backed securities issued, or fully
guaranteed as to principal and interest, by the FNMA or FHLMC are assigned a 20%
risk weight. Cash and U.S. Government securities backed by the full faith and
credit of the U.S. Government (such as mortgage-backed securities issued by
GNMA) are given a 0% risk weight.
The table below presents the capital position of HEARTLAND Community
Bank relative to its various regulatory capital requirements at June 30, 1997.
<TABLE>
<CAPTION>
Percent of
Amount Assets(1)
--------- ------
(Dollars in thousands)
<S> <C> <C>
Tangible capital............................... $ 29,058 16.92%
Tangible capital requirement................... 2,576 1.50
--------- ------
Excess...................................... $ 26,482 15.42%
========= =====
Core capital................................... $ 29,058 16.92%
Core capital requirement....................... 5,152 3.00
--------- ------
Excess...................................... $ 23,906 13.92%
========= =====
Total capital.................................. $ 29,819 41.31%
Risk-based capital requirement................. 5,274 8.00
--------- -------
Excess..................................... $ 24,045 33.31%
========= =====
</TABLE>
- -----------------
(1) Based on adjusted total assets for purposes of the tangible
capital and core capital requirements and risk-weighted assets
for purpose of the risk-based capital requirement.
25
<PAGE>
The table below presents the capital position of HEARTLAND Community
Bank, F.S.B., relative to its various regulatory capital requirements at June
30, 1997.
<TABLE>
<CAPTION>
Percent of
Amount Assets(1)
--------- ------
(Dollars in thousands)
<S> <C> <C>
Tangible capital............................... $ 1,822 6.03%
Tangible capital requirement................... 454 1.50
--------- ------
Excess...................................... $ 1,368 4.53%
========= ======
Core capital................................... $ 1,822 6.03%
Core capital requirement....................... 907 3.00
--------- ------
Excess...................................... $ 915 3.03%
========= ======
Total capital.................................. $ 2,071 10.85%
Risk-based capital requirement................. 1,526 8.00
--------- -------
Excess..................................... $ 545 2.85%
========= =======
</TABLE>
- ---------------------
(1) Based on adjusted total assets for purposes of the tangible
capital and core capital requirements and risk-weighted assets
for purpose of the risk-based capital requirement.
The OTS' risk-based capital requirements require savings institutions
with more than a "normal" level of interest rate risk to maintain additional
total capital. An institution's interest rate risk will be measured in terms of
the sensitivity of its "net portfolio value" to changes in interest rates. Net
portfolio value is defined, generally, as the present value of expected cash
inflows from existing assets and off-balance sheet contracts less the present
value of expected cash outflows from existing liabilities. A savings institution
is considered to have a "normal" level of interest rate risk exposure if the
decline in its net portfolio value after an immediate 200 basis point increase
or decrease in market interest rates (whichever results in the greater decline)
is less than two percent of the current estimated economic value of its assets.
A savings institution with a greater than normal interest rate risk will be
required to deduct from total capital, for purposes of calculating its
risk-based capital requirement, an amount (the "interest rate risk component")
equal to one-half the difference between the institution's measured interest
rate risk and the normal level of interest rate risk, multiplied by the economic
value of its total assets. Management does not believe the implementation of the
interest rate risk requirement will have a material effect on the Banks.
The OTS calculates the sensitivity of an institution's net portfolio
value based on data submitted by the institution in a schedule to its quarterly
Thrift Financial Report and using the interest rate risk measurement model
adopted by the OTS. The amount of the interest rate risk component, if any, to
be deducted from an institution's total capital will be based on the
institution's Thrift Financial Report filed two quarters earlier. Savings
institutions with less than $300 million in assets and a risk-based capital
ratio above 12% are generally exempt from filing the interest rate risk schedule
with their Thrift Financial Reports. However, the OTS will require any exempt
institution that it determines may have a high level of interest rate risk
exposure to file such schedule on a quarterly basis and may be subject to an
additional capital requirement based upon its level of interest rate risk as
compared to its peers. Due to their size and capital level, the Banks are exempt
from the interest rate risk component.
In addition to requiring generally applicable capital standards for
savings institutions, the Director of the OTS is authorized to establish the
minimum level of capital for a savings institution at such amount or at such
ratio of capital-to-assets as the Director determines to be necessary or
appropriate for such institution in light of the particular circumstances of the
institution. Such circumstances would include a high degree of exposure of
interest rate risk,
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prepayment risk, credit risk and concentration of credit risk and certain risks
arising from non-traditional activities. The Director may treat the failure of
any savings institution to maintain capital at or above such level as an unsafe
or unsound practice and may issue a directive requiring any savings institution
which fails to maintain capital at or above the minimum level required by the
Director to submit and adhere to a plan for increasing capital. Such an order
may be enforced in the same manner as an order issued by the FDIC.
Deposit Insurance. The Banks are required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the SAIF. Under the Federal Deposit Insurance Act, the FDIC is required to set
semi-annual assessments for SAIF-insured institutions at a level necessary to
maintain the designated reserve ratio of the SAIF at 1.25% of estimated insured
deposits or at a higher percentage of estimated insured deposits that the FDIC
determines to be justified for that year by circumstances indicating a
significant risk of substantial future losses to the SAIF. Under the FDIC's
risk-based deposit insurance assessment system, the assessment rate for an
insured depository institution depends on the assessment risk classification
assigned to the institution by the FDIC, which is determined by the
institution's capital level and supervisory evaluations. Based on the data
reported to regulators for the date closest to the last day of the seventh month
preceding the semi-annual assessment period, institutions are assigned to one of
three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as in the prompt
corrective action regulations. See "-- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken.
In recent years, institutions with SAIF-assessable deposits, like the
Banks, were required to pay higher deposit insurance premiums than institutions
with deposits insured by the Bank Insurance Fund ("BIF") administered by the
FDIC. In order to recapitalize the SAIF and address the premium disparity, in
November 1996 the FDIC imposed a one-time special assessment on institutions
with SAIF-assessable deposits based on the amount determined by the FDIC to be
necessary to increase the reserve levels of the SAIF to the designated reserve
ratio of 1.25% of insured deposits. Institutions were assessed at the rate of
65.7 basis points based on the amount of their SAIF-assessable deposits as of
March 31, 1995. As a result of the special assessment the Banks incurred a
pre-tax expense totalling approximately $889,011 during the quarter ended
September 30, 1996.
The special assessment recapitalized the SAIF, and as a result the FDIC
lowered the SAIF deposit insurance assessment rates through the end of 1997 to
zero for well capitalized institutions with the highest supervisory ratings and
0.31% of insured deposits for institutions in the highest risk-based premium
category. Since the BIF is above its designated reserve ratio of 1.25% of
insured deposits, "well-capitalized" institutions in Subgroup A, numbering 95%
of BIF-insured institutions, pay no federal deposit insurance premiums, with the
remaining 5% of institutions paying a graduated range of rates up to 0.27% of
insured deposits for the highest risk-based premium category. Until December 31,
1999, SAIF-insured institutions will be required to pay assessments to the FDIC
at the rate of 6.5 basis points to help fund interest payments on certain bonds
issued by the Financing Corporation ("FICO") an agency of the federal government
established to finance takeovers of insolvent thrifts. During this period, BIF
members will be assessed for these obligations at the rate of 1.3 basis points.
After December 31, 1999, both BIF and SAIF members will be assessed at the same
rate for FICO payments, or sooner if the two funds are merged.
Since the SAIF now meets its designated reserve ratio as a result of
the special assessment, SAIF members are now permitted to convert to the status
of members of the BIF and may merge with or transfer assets to a BIF member.
Although the Banks would qualify for insurance of deposits of the BIF,
substantial entrance and exit fees apply to conversions from SAIF to BIF
insurance and such fees may make a SAIF to BIF conversion prohibitively
expensive. In the past, the substantial disparity existing between deposit
insurance premiums paid by BIF and SAIF members gave
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BIF-insured institutions a competitive advantage over SAIF-insured institutions
like the Banks. The reduction of the SAIF deposit insurance premiums effectively
eliminated this disparity and could have the effect of increasing the net income
of the Banks and restoring the competitive equality between BIF-insured and
SAIF-insured institutions. See also "Proposed Legislation and Regulatory
Changes."
The FDIC has adopted a regulation which provides that any insured
depository institution with a ratio of Tier 1 capital to total assets of less
than 2% will be deemed to be operating in an unsafe or unsound condition, which
would constitute grounds for the initiation of termination of deposit insurance
proceedings. The FDIC, however, would not initiate termination of insurance
proceedings if the depository institution has entered into and is in compliance
with a written agreement with its primary regulator, and the FDIC is a party to
the agreement, to increase its Tier 1 capital to such level as the FDIC deems
appropriate. Tier 1 capital is defined as the sum of common stockholders'
equity, noncumulative perpetual preferred stock (including any related surplus)
and minority interests in consolidated subsidiaries, minus all intangible assets
other than mortgage servicing rights and qualifying supervisory goodwill
eligible for inclusion in core capital under OTS regulations and minus
identified losses and investments in certain securities subsidiaries. Insured
depository institutions with Tier 1 capital equal to or greater than 2% of total
assets may also be deemed to be operating in an unsafe or unsound condition
notwithstanding such capital level. The regulation further provides that in
considering applications that must be submitted to it by savings institutions,
the FDIC will take into account whether the institution is meeting with the Tier
1 capital requirement for state non-member banks of 4% of total assets for all
but the most highly rated state non-member banks.
Federal Reserve System. Pursuant to regulations of the Federal Reserve
Board, all FDIC-insured depository institutions must maintain average daily
reserves equal to 3% must be maintained on the first $49.3 million of
transaction accounts, and a reserve of 10% must be maintained against all
remaining transaction accounts. This percentage is subject to adjustment by the
Federal Reserve Board. Because required reserves must be maintained in the form
of vault cash or in a noninterest-bearing account at a Federal Reserve Bank, the
effect of the reserve requirement is to reduce the amount of the institution's
interest-earning assets.
Dividend Restrictions. Under OTS regulations, the Bank is not permitted
to pay dividends on its capital stock if its regulatory capital would thereby be
reduced below the amount then required for the liquidation account established
for the benefit of certain depositors of the Bank at the time of the Conversion.
In addition, the Banks are required by OTS regulations to give the OTS 30 days'
prior notice of any proposed declaration of dividends.
OTS regulations impose additional limitations on the payment of
dividends and other capital distributions (including stock repurchases and cash
mergers) by the Banks. Under these regulations, an institution that, immediately
prior to, and on a pro forma basis after giving effect to, a proposed capital
distribution, has total capital (as defined by OTS regulations) that is equal to
or greater than the amount of its fully phased-in capital requirements (a "Tier
1 Association") is generally permitted, after notice, to make capital
distributions during a calendar year in the amount equal to the greater of: (i)
75% of its net income for the previous four quarters; or (ii) 100% of its net
income to date during the calendar year plus an amount that would reduce by
one-half the amount by which its ratio of total capital to assets exceeded
regulatory requirements at the beginning of the calendar year. An institution
with total capital in excess of current minimum capital ratio requirements but
not in excess of the fully phased-in requirements (a "Tier 2 Association") is
permitted, after notice, to make capital distributions without OTS approval of
up to 75% of its net income for the previous four quarters, less dividends
already paid for such period. An institution that fails to meet current minimum
capital requirements (a "Tier 3 Association") is prohibited from making any
capital distributions without the prior approval of the OTS. A Tier 1
Association that has been notified by the OTS that it is in need of more than
normal supervision will be treated as either a Tier 2 or Tier 3 Association. The
Banks are Tier 1 Associations. Despite the above authority, the OTS may prohibit
any institution from making a capital distribution that would otherwise be
permitted by the regulation, if the OTS were to determine that the distribution
constituted an unsafe or unsound practice.
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Under the OTS prompt corrective action regulations, the Banks would be
prohibited from making any capital distributions if, after making the
distribution, it would have: (i) a total risk-based capital ratio of less than
8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a
leverage ratio of less than 4.0%. See " -- Prompt Corrective Regulatory Action."
Furthermore, during the first year following completion of the Conversion, the
Bank will not pay dividends to the Company if, as a result of any such dividend,
the Bank's tangible capital would be reduced below 10% of its adjusted total
assets.
In addition to the foregoing, earnings of the Banks appropriated to bad
debt reserves and deducted for federal income tax purposes are not available for
payment of cash dividends or other distributions to the Company without payment
of taxes at the then current tax rate on the amount of earnings removed from the
reserves for such distributions. See "Taxation." The Company intends to make
full use of this favorable tax treatment afforded to the Banks, and the Company
and does not contemplate use of any post-Conversion earnings of the Banks in a
manner which would limit either Bank's bad debt deduction or create federal tax
liabilities.
Transactions with Related Parties. Transactions between savings
institutions and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of an institution is any company or entity
which controls, is controlled by or is under common control with the savings
institution. In a holding company context, the parent holding company of an
institution (such as the Company) and any companies which are controlled by such
parent holding company are affiliates of the savings institution. Generally,
Sections 23A and 23B (i) limit the extent to which the savings institution or
its subsidiaries may engage in "covered transactions" with any one affiliate to
an amount equal to 10% of such institution's capital stock and surplus, and
contain an aggregate limit on all such transactions with all affiliates to an
amount equal to 20% of such capital stock and surplus and (ii) require that all
such transactions be on terms substantially the same, or at least as favorable,
to the institution or subsidiary as those provided to a non-affiliate. The term
"covered transaction" includes the making of loans, purchase of assets, issuance
of a guarantee and similar other types of transactions. In addition to the
restrictions imposed by Sections 23A and 23B, no savings institution may (i)
loan or otherwise extend credit to an affiliate, except for any affiliate which
engages only in activities which are permissible for bank holding companies, or
(ii) purchase or invest in any stocks, bonds, debentures, notes or similar
obligations of any affiliate, except for affiliates which are subsidiaries of
the savings institution. Section 106 of the Bank Holding Company Act which
applies to the Banks, prohibits the Banks from extending credit to or offering
any other services, or fixing or varying the consideration for such extension of
credit or service, on the condition that the customer obtain some additional
service from the institution or certain of its affiliates or not obtain services
of a competitor of the institution, subject to certain exceptions.
Loans to Directors, Executive Officers and Principal Stockholders.
Depository institutions like the Banks are also subject to the restrictions
contained in Section 22(h) and Section 22(g) of the Federal Reserve Act on loans
to executive officers, directors and principal stockholders. Under Section
22(h), loans to a director, executive officer and to a greater than 10%
stockholder of a depository institution and certain affiliated interests of such
persons, may not exceed, together with all other outstanding loans to such
person and affiliated interests, the institution's loans-to-one- borrower limit
(generally equal to 15% of the institution's unimpaired capital and surplus plus
an additional 10% of such capital and surplus for loans fully secured by certain
readily marketable capital). Section 22(h) also prohibits the making of loans
above amounts prescribed by the appropriate federal banking agency, to
directors, executive officers and greater than 10% stockholders of an
institution, and their respective affiliates, unless such loan is approved in
advance by a majority of the board of directors of the institution with any
"interested" director not participating in the voting. The Federal Reserve Board
has prescribed the loan amount (which includes all other outstanding loans to
such person) as to which such prior board of director approval is required as
being the greater of $25,000 or 5% of capital and surplus (up to $500,000).
Further, Section 22(h) requires that loans to directors, executive officers and
principal stockholders be made on terms substantially the same as offered in
comparable transactions to other persons. Section 22(h) also generally prohibits
a depository institution from paying the overdrafts of any of its executive
officers or directors.
Section 22(g) of the Federal Reserve Act requires that loans to
executive officers of depository institutions not be made on terms more
favorable than those afforded to other borrowers, requires approval for such
extensions of credit
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by the board of directors of a the institution, and imposes reporting
requirements for and additional restrictions on the type, amount and terms of
credits to such officers. In addition, Section 106 of the Bank Holding Company
Act prohibits extensions of credit to executive officers, directors, and greater
than 10% stockholders of a depository institution by any other institution which
has a correspondent banking relationship with the institution, unless such
extension of credit is on substantially the same terms as those prevailing at
the time for comparable transactions with other persons and does not involve
more than the normal risk of repayment or present other unfavorable features.
Prompt Corrective Regulatory Action. Under the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA"), the federal banking
regulators are required to take prompt corrective action if an institution fails
to satisfy certain minimum capital requirements. All institutions, regardless of
their capital levels, are restricted from making any capital distribution or
paying any management fees that would cause the institution to become
undercapitalized. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") generally is: (i)
subject to increased monitoring by the appropriate federal banking regulator;
(ii) required to submit an acceptable capital restoration plan within 45 days;
(iii) subject to asset growth limits; and (iv) required to obtain prior
regulatory approval for acquisitions, branching and new lines of businesses. The
capital restoration plan must include a guarantee by the institution's holding
company that the institution will comply with the plan until it has been
adequately capitalized on average for four consecutive quarters, under which the
holding company would be liable up to the lesser of 5% of the institution's
total assets or the amount necessary to bring the institution into capital
compliance as of the date it failed to comply with its capital restoration plan.
A "significantly undercapitalized" institution, as well as any undercapitalized
institution that does not submit an acceptable capital restoration plan, may be
subject to regulatory demands for recapitalization, broader application of
restrictions on transactions with affiliates, limitations on interest rates paid
on deposits, asset growth and other activities, possible replacement of
directors and officers, and restrictions on capital distributions by any bank
holding company controlling the institution. Any company controlling the
institution may also be required to divest the institution or the institution
could be required to divest subsidiaries. The senior executive officers of a
significantly undercapitalized institution may not receive bonuses or increases
in compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
action provisions. If an institution's ratio of tangible capital to total assets
falls below the "critical capital level," the institution will be subject to
conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund. Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized.
Under the OTS regulation implementing the prompt corrective action
provisions of FDICIA, the OTS measures an institution's capital adequacy for
purposes of the prompt corrective action rules on the basis of its total
risk-based capital ratio (the ratio of its total capital to risk-weighted
assets), Tier 1 risk-based capital ratio (the ratio of its core capital to
risk-weighted assets) and leverage ratio (the ratio of its core capital to
adjusted total assets). An institution that is not subject to an order or
written directive to meet or maintain a specific capital level is deemed "well
capitalized" if it also has: (i) a total risk-based capital ratio of 10% or
greater; (ii) a Tier 1 risk-based capital ratio of 6% or greater; and (iii) a
leverage ratio of 5% or greater. An "adequately capitalized" savings institution
is an institution that does not meet the definition of well capitalized and has:
(i) a total risk-based capital ratio of 8% or greater; (ii) a Tier 1 capital
risk-based ratio of 4% or greater; and (iii) a leverage ratio of 4% or greater
(or 3% or greater if the savings institution has a composite 1 CAMELS rating).
An "undercapitalized institution" is an institution that has (i) a total
risk-based capital ratio less than 8%; or (ii) a Tier 1 risk-based capital ratio
of less than 4%; or (iii) a leverage ratio of less than 4% (or 3% if the
institution has a composite 1 CAMELS rating). A "significantly undercapitalized"
institution is defined as an institution that has: (i) a total risk-based
capital ratio of less than 6%; or (ii) a Tier 1 risk-based capital ratio of less
than 3%; or (iii) a leverage ratio of less than 3%. A "critically
undercapitalized" savings institution is defined as an institution that has
"tangible equity" of less than 2%. Tangible equity is defined as core capital
plus cumulative perpetual preferred stock (and related surplus) less all
intangibles other than qualifying supervisory goodwill and certain purchased
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mortgage servicing rights. The OTS may reclassify a well capitalized savings
institution as adequately capitalized and may require an adequately capitalized
or undercapitalized institution to comply with the supervisory actions
applicable to institutions in the next lower capital category (but may not
reclassify a significantly undercapitalized institution as
critically-undercapitalized) if the OTS determines, after notice and an
opportunity for a hearing, that the savings institution is in an unsafe or
unsound condition or that the institution has received and not corrected a
less-than- satisfactory rating for any CAMELS rating category. As of June 30,
1997, the Banks were classified as "well capitalized" under the prompt
corrective action regulations.
Safety and Soundness Guidelines. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each Federal banking agency is required to establish safety and soundness
standards for institutions under its authority. On July 10, 1995, the federal
banking agencies, including the OTS and Federal Reserve Board, released
Interagency Guidelines Establishing Standards for Safety and Soundness and
published a final rule establishing deadlines for submission and review of
safety and soundness compliance plans. The final rule and the guidelines went
into effect on August 9, 1995. The guidelines require depository institutions to
maintain internal controls and information systems and internal audit systems
that are appropriate for the size, nature and scope of the institution's
business. The guidelines also establish certain basic standards for loan
documentation, credit underwriting, interest rate risk exposure, and asset
growth. The guidelines further provide that depository institutions should
maintain safeguards to prevent the payment of compensation, fees and benefits
that are excessive or that could lead to material financial loss, and should
take into account factors such as comparable compensation practices at
comparable institutions. If the appropriate federal banking agency determines
that a depository institution is not in compliance with the safety and soundness
guidelines, it may require the institution to submit an acceptable plan to
achieve compliance with the guidelines. A depository institution must submit an
acceptable compliance plan to its primary federal regulator within 30 days of
receipt of a request for such a plan. Failure to submit or implement a
compliance plan may subject the institution to regulatory sanctions. Management
believes that the Banks already meet substantially all the standards adopted in
the interagency guidelines, and therefore does not believe that implementation
of these regulatory standards will materially affect the Banks' operations.
Additionally under FDICIA, as amended by the CDRI Act, the federal
banking agencies are required to establish standards relating to the asset
quality and earnings that the agencies determine to be appropriate. On July 10,
1995, the federal banking agencies, including the OTS and Federal Reserve Board,
issued proposed guidelines relating to asset quality and earnings. Under the
proposed guidelines, an FDIC insured depository institution should maintain
systems, commensurate with its size and the nature and scope of its operations,
to identify problem assets and prevent deterioration in those assets as well as
to evaluate and monitor earnings and ensure that earnings are sufficient to
maintain adequate capital and reserves. Management believes that the asset
quality and earnings standards, in the form proposed by the banking agencies,
would not have a material effect on the Banks' operations.
Regulation of the Company
General. The Company is a savings institution holding company as
defined by the Home Owners' Loan Act. As such, the Company is registered with
the OTS and is subject to OTS regulation, examination, supervision and reporting
requirements. As subsidiaries of a savings institution holding company, the
Banks are subject to certain restrictions in their dealings with the Company and
affiliates thereof. The Company also is required to file certain reports with,
and otherwise comply with the rules and regulations of, the SEC under the
federal securities laws.
Activities Restrictions. The Board of Directors of the Company
presently intends to continue operating the Company as a multiple savings
institution holding company, in order to facilitate possible future branch
expansion, in the event the Bank ever becomes subject to Arkansas branching
restrictions, which are based on the home office location of each separately
chartered banking institution. As a result, the activities of the Company and
any of its subsidiaries (other than the Banks or other subsidiary savings
institutions) will be subject to various restrictions. Among other things, no
multiple savings institution holding company or subsidiary thereof which is not
an institution shall commence or continue for a limited period of time after
becoming a multiple savings institution holding company or subsidiary
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thereof, any business activity, upon prior notice to, and no objection by, the
OTS, other than: (i) furnishing or performing management services for a
subsidiary savings institution; (ii) conducting an insurance agency or escrow
business; (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary savings institution; (iv) holding or managing properties used
or occupied by a subsidiary savings institution; (v) acting as trustee under
deeds of trust; (vi) those activities authorized by regulation as of March 5,
1987 to be engaged in by multiple holding companies; or (vii) unless the
Director of the OTS by regulation prohibits or limits such activities for
savings institution holding companies, those activities authorized by the
Federal Reserve Board as permissible for bank holding companies. A multiple
savings institution holding company must obtain the approval of the OTS prior to
engaging in the activities described in (vii) above. In addition, if the
Director of the OTS determines that there is reasonable cause to believe that
the continuation by an institution holding company of an activity constitutes a
serious risk to the financial safety, soundness or stability of its subsidiary
savings institution, the Director of the OTS may impose such restrictions as
deemed necessary to address such risk including limiting: (i) payment of
dividends by the savings institution; (ii) transactions between the savings
institution and its affiliates; and (iii) any activities of the savings
institution that might create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the savings institution.
Restrictions on Acquisitions. Savings institution holding companies may
not acquire, without prior approval of the Director of the OTS, (i) control of
any other savings institution or savings institution holding company or
substantially all the assets thereof or (ii) more than 5% of the voting shares
of an institution or holding company thereof which is not a subsidiary. Under
certain circumstances, a registered savings institution holding company is
permitted to acquire, with the approval of the Director of the OTS, up to 15% of
the voting shares of an under-capitalized savings institution pursuant to a
"qualified stock issuance" without that savings institution being deemed
controlled by the holding company. In order for the shares acquired to
constitute a "qualified stock issuance," the shares must consist of previously
unissued stock or treasury shares, the shares must be acquired for cash, the
savings institution holding company's other subsidiaries must have tangible
capital of at least 6 1/2% of total assets, there must not be more than one
common director or officer between the savings institution holding company and
the issuing savings institution, and transactions between the savings
institution and the savings institution holding company and any of its
affiliates must conform to Sections 23A and 23B of the Federal Reserve Act.
Except with the prior approval of the Director of the OTS, no director or
officer of an institution holding company or person owning or controlling by
proxy or otherwise more than 25% of such company's stock, may also acquire
control of any savings institution, other than a subsidiary savings institution,
or of any other savings institution holding company.
The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings institution holding company which controls
savings institutions in more than one state if: (i) the multiple savings
institution holding company involved controls an institution which operated a
home or branch office in the state of the institution to be acquired as of March
5, 1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the FDIC Act; or
(iii) the statutes of the state in which the institution to be acquired is
located specifically permit institutions to be acquired by state-chartered
institutions or savings institution holding companies located in the state where
the acquiring entity is located (or by a holding company that controls such
state-chartered savings institutions).
OTS regulations permit federal savings institutions to branch in any
state or states of the United States and its territories. Except in supervisory
cases or when interstate branching is otherwise permitted by state law or other
statutory provision, a federal institution may not establish an out-of-state
branch unless (i) the federal institution qualifies as a QTL or as a "domestic
building and loan association" under ss.7701(a)(19) of the Internal Revenue Code
and the total assets attributable to all branches of the institution in the
state would qualify such branches taken as a whole for treatment as a QTL or as
a domestic building and loan association and (ii) such branch would not result
in (a) formation of a prohibited multi-state multiple savings holding company or
(b) a violation of certain statutory restrictions on branching by savings
institution subsidiaries of banking holding companies. Federal savings
institutions generally may not establish new branches unless the institution
meets or exceeds minimum regulatory capital requirements. The OTS
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will also consider the institution's record of compliance with the Community
Reinvestment Act of 1977 in connection with any branch application.
Federal Securities Law. The Common Stock is registered with the SEC
under the Securities Exchange Act of 1934, as amended ("Securities Exchange
Act"), and, under OTS regulations, generally may not be deregistered for at
least three years after the Conversion. The Company is subject to the
information, proxy solicitation, insider trading restrictions and other
requirements of the Securities Exchange Act.
Federal Income Taxation
Savings institutions such as the Banks are subject to the provisions of
the Internal Revenue Code of 1986, as amended (the "Internal Revenue Code") in
the same general manner as other corporations. Through tax years beginning
before December 31, 1995, institutions such as the Banks which met certain
definitional tests and other conditions prescribed by the Internal Revenue Code
benefitted from certain favorable provisions regarding their deductions from
taxable income for annual additions to their bad debt reserve. For purposes of
the bad debt reserve deduction, loans are separated into "qualifying real
property loans," which generally are loans secured by interests in certain real
property, and "nonqualifying loans," which are all other loans. The bad debt
reserve deduction with respect to nonqualifying loans must be based on actual
loss experience. The amount of the bad debt reserve deduction with respect to
qualifying real property loans may be based upon actual loss experience (the
"experience method") or a percentage of taxable income determined without regard
to such deduction (the "percentage of taxable income method"). Under the
experience method, the bad debt deduction for an addition to the reserve for
qualifying real property loans was an amount determined under a formula based
generally on the bad debts actually sustained by a savings institution over a
period of years. Under the percentage of taxable income method, the bad debt
reserve deduction for qualifying real property loans was computed as 8% of a
savings institution's taxable income, with certain adjustments. The Banks
generally elected to use the method which has resulted in the greatest
deductions for federal income tax purposes in any given year.
Legislation that is effective for tax years beginning after December
31, 1995 requires institutions to recapture into taxable income over a six
taxable year period the portion of the tax loan reserve that exceeds the
pre-1988 tax loan loss reserve. The Banks will no longer be allowed to use the
reserve method for tax loan loss provisions, but would be allowed to use the
experience method of accounting for bad debts. There will be no future effect on
net income from the recapture because the taxes on these bad debts reserves has
already been accrued as a deferred tax liability.
The Banks' federal income tax returns have not been examined by the
regulatory authorities in the past five years. For additional information, see
Note 12 of the Notes to Consolidated Financial Statements contained elsewhere
herein.
For taxable years beginning after June 30, 1986, the Internal Revenue
Code imposes an alternative minimum tax at a rate of 20%. The alternative
minimum tax generally applies to a base of regular taxable income plus certain
tax preferences ("alternative minimum taxable income" or "AMTI") and is payable
to the extent such AMTI exceeds an exemption amount. The Internal Revenue Code
provides that an item of tax preference is the excess of the bad debt deduction
allowable for a taxable year pursuant to the percentage of taxable income method
over the amount allowable under the experience method. The other items of tax
preference that constitute AMTI include (a) tax-exempt interest on newly-issued
(generally, issued on or after August 8, 1986) private activity bonds other than
certain qualified bonds and (b) for taxable years including 1987 through 1989,
50% of the excess of (i) the taxpayer's pre-tax adjusted net book income over
(ii) AMTI (determined without regard to this latter preference and prior to
reduction by net operating losses). For taxable years beginning after 1989, this
latter preference has been replaced by 75% of the excess (if any) of (i)
adjusted current earnings as defined in the Internal Revenue Code, over (ii)
AMTI (determined without regard to this preference and prior to reduction by net
operating losses). For any taxable year beginning after 1986, net operating
losses can offset no more than 90% of AMTI. Certain payments of alternative
minimum taxes may be used as credits against regular tax liabilities in future
years. In addition, for taxable years after 1986 and before 1992, corporations,
33
<PAGE>
including savings institutions, are also subject to an environmental tax equal
to 0.12% of the excess of AMTI for the taxable year (determined without regard
to net operating losses and the deduction for the environmental tax) over $2.0
million. The Banks are not currently paying any amount of alternative minimum
tax but may, depending on future results of operations, become subject to this
tax.
State Income Taxation
The Banks are subject to Arkansas corporation income tax which is 6.5%
of all taxable earnings when income exceeds $100,000. The Company is
incorporated under Oklahoma law and qualified to do business in Arkansas as a
foreign corporation, and accordingly the Company incurs certain franchise and
other taxes, which management does not expect to be material to the Company as a
whole.
Employees
As of June 30, 1997, the Bank had 63 full-time and 4 part-time
employees, none of whom was represented by a collective bargaining agreement.
Management considers the Bank's relationships with its employees to be good.
Executive Officers Who Are Not Directors
The following table sets forth information regarding the executive
officer of the Company who does not serve on the Board of Directors.
<TABLE>
<CAPTION>
Age at
June 30,
Name 1997 Title
---- ------- -----
<S> <C> <C>
William C. Lyon 56 Vice President of the Company; Senior Vice
President and Chief Lending Officer of the
Bank
</TABLE>
The following paragraph sets forth information regarding the principal
occupation of the executive officer designated above.
William C. Lyon has served as Vice President of the Company since
December 1996 and has been Senior Vice President and Chief Lending Officer of
the Bank since May 1996. Mr. Lyon also serves as a director and the Chief
Lending Officer of the Bank's subsidiary savings bank. From January 1994 to May
1996, Mr. Lyon was a self-employed banking consultant and from 1991 to 1994 he
served as Senior Vice President of American National Bank and Trust Co. in
Shawnee, Oklahoma. Mr. Lyon is a member of the Lions Club and serves on various
Chamber of Commerce committees.
34
<PAGE>
Item 2. Properties
The following table sets forth information regarding the Bank's offices
at June 30, 1997.
<TABLE>
<CAPTION>
Year Owned or Approximate
Opened Leased Book Value Square Footage
------ -------- ---------- --------------
<S> <C> <C> <C> <C>
Main Office:
237 Jackson Street, S.W 1933 Owned $720,900 12,000
Camden, Arkansas
Branch Offices:
23233 Interstate 30, No. 201 1996 Leased 18,300 1,000
Bryant, Arkansas
208 Cardinal Shopping Center 1981 Owned 156,000 1,200
Camden, Arkansas
610 West 4th Street 1969 Owned 724,000 3,500
Fordyce, Arkansas
109 North Chester 1993 Owned 610,000 1,800
Little Rock, Arkansas
207 North Church2 1993 Leased 26,000 2,200
Monticello, Arkansas
108 East Pine3 1996 Leased 120,900 900
Sheridan, Arkansas
</TABLE>
- --------------
1 Limited service loan production office opened in November 1996.
2 The Bank built a 7,400 square foot replacement branch at 473 Highway
425 North in Monticello, which opened in July 1997 at an aggregate
building cost of approximately $1,250,000.
3 The Bank built a 5,500 square foot replacement branch at 108 South
Main Street in Sheridan, which opened in August 1997 at an aggregate
building cost of approximately $975,000.
In addition to the offices described above, at June 30, 1997 the Bank
held five other properties located in various communities within the Bank's
primary market area. These properties were acquired for possible future
construction of additional offices and related facilities, though certain of the
properties are larger than the Bank's foreseeable needs, and therefore portions
of those properties may be sold by the Bank. At that date, the aggregate net
book value of these properties totaled $1.1 million, of which $480,000 was
classified as held for resale. It is anticipated that in the future management
may determine to expand the Bank's network of banking facilities by installing
ATMs in existing or new banking facilities, by building branches or other
facilities on the properties held by the Bank, by acquiring other facilities or
sites and/or by acquiring banks or other financial companies with their own
facilities.
The book value of the Bank's aggregate investment in properties,
premises and equipment totaled approximately $4.6 million at June 30, 1997. See
Note 7 of the Notes to Consolidated Financial Statements.
35
<PAGE>
Item 3. Legal Proceedings
From time to time, the Bank is a party to various legal proceedings
incident to its business. At June 30, 1997, there were no legal proceedings to
which the Company or the Bank was a party, or to which any of their property was
subject, which were expected by management to result in a material loss to the
Company or the Bank, and there were no pending regulatory proceedings to which
the Company, the Bank or its subsidiaries was a party, or to which any of their
properties was subject, which were expected to result in a material loss.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the
fourth quarter of fiscal 1997.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The information required by this item is incorporated by reference to
"Item 1. Business -- Regulation of the Banks -- Dividend Restrictions" herein
and "Market Information," "Market Price of Common Stock and Dividend
Information" and Note 21 of the Notes to Consolidated Financial Statements in
the portions of the Annual Report filed as Exhibit 13 to this report.
Item 6. Selected Financial Data
The information required by this item is incorporated by reference to
"Selected Consolidated Financial and Other Data" in the portions of the Annual
Report filed as Exhibit 13 to this report.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The information required by this item is incorporated by reference to
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the portions of the Annual Report filed as Exhibit 13 to this
report.
Item 8. Financial Statements and Supplementary Data
The financial statements required by this item are incorporated by
reference to the Consolidated Financial Statements, Notes to Consolidated
Financial Statements and Independent Auditors' Reports in the portions of the
Annual Report filed as Exhibit 13 to this report.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Effective June 25, 1997, the Company dismissed Gaunt & Co., Little
Rock, Arkansas, and engaged Miller, England & Company, Little Rock, Arkansas, as
the Company's independent certified public accountants. For additional
information, see the Company's Current Report on Form 8-K dated June 25, 1997,
which is incorporated herein by reference (File No. 0-22423).
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this item is incorporated by reference to
"Election of Directors" in the Proxy Statement and "Item 1. Description of
Business -- Executive Officers Who Are Not Directors" herein.
36
<PAGE>
Item 11. Executive Compensation
The information required by this item is incorporated by reference to
"Executive Compensation" in the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is incorporated by reference to
"Voting Securities and Security Ownership" and "Election of Directors" in the
Proxy Statement.
Item 13. Certain Relationships and Related Transactions
The information required by this item is incorporated by reference to
"Transactions with Management" in the Proxy Statement.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) List of Documents Filed as Part of this Report
(1) Financial Statements. The following consolidated financial
statements are incorporated by reference from Item 8 hereof:
Independent Auditors' Reports
Consolidated Statements of Financial Condition as of
June 30, 1997 and 1996
Consolidated Statements of Income for the years ended
June 30, 1997, 1996, and 1995
Consolidated Statements of Stockholders' Equity for
the years ended June 30, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the years
ended June 30, 1997, 1996 and 1995
Notes to Consolidated Financial Statements for the
years ended June 30, 1997, 1996 and 1995
Consolidated Statements of Income of subsidiary for
the period from July 1, 1994 to May 3, 1996 (uanudited)
Consolidated Statements of Stockholders' Equity of subsidiary
for the period from July 1, 1994 to May 3, 1996 (unaudited)
Consolidated Statements of Cash Flows of subsidiary for the
period from July 1, 1994 to May 3, 1996 (unaudited)
Notes to Financial Statements of subsidiary (unaudited)
(2) Financial Statement Schedules. All schedules for which provision is
made in the applicable accounting regulations of the Securities and Exchange
Commission are omitted because of the absence of conditions under which they are
required or because the required information is included in the consolidated
financial statements and related notes thereto.
37
<PAGE>
(3) Exhibits. The following is a list of exhibits filed as part of this
Annual Report on Form 10-K and is also the Exhibit Index.
<TABLE>
<CAPTION>
No. Description
--- -----------
<S> <C>
3.1 Articles of Incorporation of HCB Bancshares, Inc. *
3.2 Bylaws of HCB Bancshares, Inc. *
4 Form of Common Stock Certificate of HCB Bancshares, Inc. *
10.1 Form of HCB Bancshares, Inc. 1997 Stock Option and Incentive Plan *+
10.2 Form of HCB Bancshares, Inc. Management Recognition Plan and Trust Agreement *+
10.3(a) Employment Agreements by and between Heartland Community Bank and Vida H.
Lampkin and Cameron D. McKeel *+
10.3(b) Employment Agreements by and between HCB Bancshares, Inc. and Vida H. Lampkin
and Cameron D. McKeel *+
10.4(a) Change-in-Control Protective Agreement between Heartland Community Bank and
William C. Lyon *+
10.4(b) Change-in-Control Protective Agreement between HCB Bancshares, Inc. and William C.
Lyon *+
10.5 Heartland Community Bank Directors' Retirement Plan, as amended*+
13 Portions of Annual Report to Stockholders for the Fiscal Year Ended June 30, 1997
21 Subsidiaries**
27 Financial Data Schedule
</TABLE>
* Incorporated by reference to the Company's Registration Statement on
Form SB-2 (File No. 333-19093).
** Incorporated by reference to Item 1 herein.
+ Management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K. The Company filed a Current Report on Form 8-K
dated June 25, 1997 reporting under Item 4 thereof a change of the Company's
independent certified public accountants. See Item 9 herein.
(c) Exhibits. The exhibits required by Item 601 of Regulation S-K are
either filed as part of this Annual Report on Form 10-K or incorporated by
reference herein.
(d) Financial Statements and Schedules Excluded from Annual Report.
There are no other financial statements and financial statement schedules which
were excluded from the Annual Report to Stockholders pursuant to Rule 14a-3(b)
which are required to be included herein.
38
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HCB BANCSHARES, INC.
Date: September 29, 1997 By: /s/ Vida H. Lampkin
-------------------
Vida H. Lampkin
Chairman of the Board, President 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 on behalf of the
registrant in the capacities and on the dates indicated.
By: /s/ Vida H. Lampkin
-----------------------------------------------
Vida H. Lampkin
Chairman of the Board, President and Chief
Executive Officer
(Principal Executive, Financial and
Accounting Officer)
By: /s/ Cameron D. McKeel
-----------------------------------------------
Cameron D. McKeel
Director and Vice President
By: /s/ Roy Wayne Moseley
-----------------------------------------------
Roy Wayne Moseley
Director
By: /s/ Bruce D. Murry
-----------------------------------------------
Bruce D. Murry
Director
By: /s/ Carl E. Parker, Jr.
-----------------------------------------------
Carl E. Parker, Jr.
Director
By: /s/ Lula Sue Silliman
-----------------------------------------------
Lula Sue Silliman
Director
By: /s/ Clifford Steelman
-----------------------------------------------
Clifford Steelman
Director
39
<PAGE>
Exhibit 13
Portions of 1997 Annual Report to Stockholders
<PAGE>
MARKET FOR COMMON STOCK
AND RELATED STOCKHOLDER MATTERS
The Company's common stock began trading on the Nasdaq National Market
on May 7, 1997, under the symbol "HCBB." At August 31, 1997, there were
2,645,000 shares of the common stock outstanding and approximately 871
stockholders of record. Between May 7, 1997 and June 30, 1997, the low and high
reported prices of the common stock on the Nasdaq National Market were between
$12.50 and $14.12 per share, respectively.
The payment of dividends on the Common Stock is subject to
determination and declaration by the Board of Directors of the Company.
Following fiscal 1997, the Board of Directors adopted a policy of paying regular
quarterly cash dividends on the Common Stock. In addition, from time to time,
the Board of Directors may determine to pay special cash dividends in addition
to, or in lieu of, regular cash dividends. The payment of future dividends will
be subject to the requirements of applicable law and the determination by the
Board of Directors of the Company that the net income, capital and financial
condition of the Company and the Association, thrift industry trends and general
economic conditions justify the payment of dividends, and there can be no
assurance that dividends will be paid or, if paid, will continue to be paid in
the future. The Company did not pay dividends in fiscal 1997. Following fiscal
1997, the Company declared a cash dividend of $.05 per share payable on or about
October 10, 1997 to stockholders of record as of September 30, 1997.
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
<TABLE>
<CAPTION>
At June 30,
------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ------------ ------------ ------------ ------------
(In thousands)
<S> <C> <C> <C> <C> <C>
Total assets ............................. $200,365,778 $171,235,322 $126,987,168 $126,722,704 $123,748,431
Loans receivable, net .................... 98,642,635 84,131,024 55,112,980 53,247,142 50,000,592
Cash and cash equivalents ................ 19,456,092 17,291,882 3,125,599 3,054,978 3,527,284
Investment securities:
Available for sale .................... 16,155,755 5,279,625 957,500 3,386,625 --
Held to maturity ...................... -- -- 2,000,000 -- 909,600
Mortgage-backed securities:
Available for sale ................... 20,090,406 12,155,199 6,088,450 -- --
Held to maturity ..................... 35,869,295 45,212,891 57,144,915 64,084,120 66,773,893
Deposits ................................. 151,208,763 145,919,251 112,005,588 113,350,670 111,771,582
FHLB advances ............................ 10,000,000 10,000,000 -- -- --
Notes payable ............................ 400,000 -- -- -- --
Equity - substantially restricted ........ 37,739,513 14,228,436 14,270,972 12,860,593 11,472,231
Number of:
Real estate loans outstanding ......... 2,093 1,993 1,507 1,537 1,602
Savings accounts ...................... 15,380 14,163 10,993 11,057 11,006
Offices open .......................... 7 6 3 3 3
<CAPTION>
Year Ended June 30,
---------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------ ------------ ---------- ----------- -----------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Interest income .................................... $ 13,101,676 $ 10,333,181 $8,844,782 $ 8,416,735 $ 8,492,889
Interest expense ................................... 8,195,782 6,766,598 5,112,481 4,645,404 4,920,251
------------ ------------ ---------- ----------- -----------
Net interest income ................................ 4,905,894 3,566,583 3,732,301 3,771,331 3,572,638
Provision for loan losses .......................... (221,671) (42,483) -- (7,500) (120,000)
------------ ------------ ---------- ----------- -----------
Net interest income after provision
for loan losses .................................. 4,684,223 3,524,100 3,732,301 3,763,831 3,452,638
Noninterest income ................................. 305,067 (733,652) 196,023 102,212 173,986
Noninterest expense ................................ 5,578,934 2,350,658 1,609,691 1,585,401 1,444,384
------------ ------------ ---------- ----------- -----------
Income (loss) before income taxes and
cumulative effect of change in method of
accounting for income taxes and investment
securities ....................................... (589,644) 399,790 2,318,363 2,280,642 2,182,240
Provision for income taxes (benefits) .............. (166,645) 174,801 966,763 869,756 847,869
------------ ------------ ---------- ----------- -----------
Income (loss) before cumulative effect of
change in method of accounting for
income taxes and investment
securities ....................................... (422,999) 224,989 1,351,600 1,410,886 1,334,371
Cumulative effect of change in method of
accounting for income taxes ...................... -- -- -- (22,523) --
Cumulative effect of change in method of
accounting for investment securities ............. -- -- 77,567 -- --
------------ ------------ ---------- ----------- -----------
Net income (loss) .................................. $ (422,999) $ 224,989 $1,429,167 $ 1,388,363 $ 1,334,371
============ ============ ========== =========== ===========
</TABLE>
- ---------------
1 Noninterest expense and, therefore, net income (loss), for the year ended June
30, 1997 were adversely affected by the imposition of a special deposit
insurance assessment in the second quarter of fiscal 1997 in connection with
the recapitalization of the SAIF. Absent such assessment,
<PAGE>
management estimates that noninterest expense would have been approximately
$4,689,923 and that net income would have been approximately $125,610. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" below.
<TABLE>
<CAPTION>
Year Ended June 30,
1997 1996 1995 1994 1993
-------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C>
Performance Ratios:
Return on assets (net income (loss) divided
by average total assets)(1)............... (0.23)% 0.16% 1.06% 1.11% 1.10%
Return on average equity (net income (loss)
divided by average equity)(1)............. (3.00) 1.53 9.82 11.52 12.24
Interest rate spread (combined weighted
average interest rate earned less combined
weighted average interest rate cost) 2.43 2.16 2.51 2.66 2.74
Net interest margin (net interest income
divided by average interest-earning assets) 2.84 2.58 2.96 3.03 3.08
Ratio of average interest-earning assets
to average interest-bearing liabilities 116.48 108.47 111.22 110.06 108.09
Ratio of noninterest expense to average
total assets.............................. 3.08 1.64 1.26 1.25 1.19
Asset Quality Ratios:
Nonperforming assets to total assets
at end of period.......................... 0.24 0.14 0.23 0.37 0.35
Nonperforming loans to total loans
at end of period.......................... 0.14 0.20 0.29 0.27 0.62
Allowance for loan losses to total
loans at end of period.................... 1.51 1.53 1.33 1.37 1.45
Allowance for loan losses to nonperforming
loans at end of period.................... 11.19x 7.69x 4.41x 5.08x 2.36x
Provision for loan losses to total loans
at end of period(2)....................... 0.22% 0.05% --% --% 0.24%
Net charge-offs to average loans
outstanding(2)............................ 0.01 0.02 -- 0.04 0.04
Capital Ratios:
Equity to total assets at end of period...... 7.03 8.31 11.25 10.15 9.27
Average equity to average assets............. 7.78 10.25 10.76 9.66 9.02
</TABLE>
- --------------
(1) Before cumulative effect adjustment. Returns on assets and equity for the
year ended June 30, 1997 were adversely affected by the imposition of a
special deposit insurance assessment in the second quarter of fiscal 1997 in
connection with the recapitalization of the SAIF. Absent such assessment,
management estimates that return on assets would have been approximately
.07% and that return on average equity would have been approximately .89%.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations" below.
(2) Annualized.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The Bank's principal business consists of attracting deposits from the
general public and investing those funds in loans secured by first mortgages on
existing owner-occupied single-family residences in the Bank's primary market
area and, to a lesser but growing extent, commercial and multi-family real
estate loans and consumer and commercial business loans. The Bank also maintains
a substantial investment portfolio of mortgage-related securities and U.S.
government and agency securities.
The Bank's net income is dependent primarily on its net interest
income, which is the difference between interest income earned on its loans,
mortgage-backed securities and securities portfolio and interest paid on
customers' deposits. The Bank's net income is also affected by the level of
noninterest income, such as service charges on customers' deposit accounts, net
gains or losses on the sale of securities and other fees. In addition, net
income is affected by the level of noninterest expense, which primarily consists
of employee compensation expenses, deposit insurance premiums and other
expenses.
The financial condition and results of operations of the Bank and the
thrift and banking industries as a whole are significantly affected by
prevailing economic conditions, competition and the monetary and fiscal policies
of governmental agencies. Lending activities are influenced by demand for and
supply of credit, competition among lenders and the level of interest rates in
the Bank's market area. The Bank's deposit flows and costs of funds are
influenced by prevailing market rates of interest, primarily on competing
investments, as well as account maturities and the levels of personal income and
savings in the Bank's market area.
Asset/Liability Management
Net interest income, the primary component of the Bank's net income, is
determined by the difference or "spread" between the yield earned on the Bank's
interest-earning assets and the rates paid on its interest-bearing liabilities
and the relative amounts of such assets and liabilities. Key components of a
successful asset/liability strategy are the monitoring and managing of interest
rate sensitivity on both the interest-earning assets and interest-bearing
liabilities. It has been the Bank's historical policy to mitigate the interest
rate risk inherent in the historical savings institution business of originating
long term single-family mortgage loans funded by short term deposits by
maintaining substantial liquidity and capital levels to sustain unfavorable
movements in market interest rates, by purchasing investment securities with
adjustable-rates and/or short terms to maturity and by originating limited
amounts of relatively shorter term consumer loans. In the future, however, it is
anticipated that as the Bank sells more of its long term loan originations and
originates for portfolio more commercial and multi-family real estate loans and
consumer and commercial business loans with relatively shorter terms to maturity
or repricing, the Bank's interest rate risk exposure may decline somewhat. The
matching of the Bank's assets and liabilities may be analyzed by examining the
extent to which its assets and liabilities are interest rate sensitive and by
monitoring both its interest rate sensitivity "gap" and the expected effects of
interest rate changes on its net portfolio value.
Interest Rate Sensitivity Gap. An asset or liability is interest rate
sensitive within a specific time period if it will mature or reprice within that
time period. The interest rate sensitivity gap is defined as the difference
between the amount of interest-earning assets maturing or repricing within a
specific time period and the amount of interest-bearing liabilities maturing or
repricing within that time period. A gap is considered positive when the amount
of interest rate sensitive assets exceeds the amount of interest rate
liabilities. A gap is considered negative when the amount of interest rate
sensitive liabilities exceeds the amount of interest rate sensitive assets.
During a period of rising interest rates, a negative gap would tend to adversely
affect net interest income while a positive gap would tend to positively affect
net interest income. Similarly, during a period of falling interest rates, a
negative gap would tend to positively affect net interest income while a
positive gap would tend to adversely affect net interest income.
<PAGE>
At June 30, 1997, the Bank's total interest-bearing liabilities
maturing or repricing within one and five years exceeded its total
interest-earning assets maturing or repricing in the same periods, and the
Bank's cumulative one- and five-year gap ratios totaled negative 11.29% and
19.65%, respectively. The Bank's gap measures indicate that net interest income
could be significantly exposed to increases in interest rates. In a rising
interest rate environment, the Bank's net interest income could be adversely
affected as liabilities would reprice to higher market rates more quickly than
assets. This effect would be compounded, because the prepayment speeds of the
Bank's long-term fixed-rate assets would decrease in a rising interest rate
environment.
The following table sets forth information regarding projected
maturities and repricing of interest-earning assets and interest-bearing
liabilities of the Bank at June 30, 1997. The computations were made without
using assumptions for loan repayments or deposit decays. Except as stated below,
the amounts of assets and liabilities shown to reprice or mature within a given
period were determined in accordance with contractual terms of the assets or
liabilities. In making the computations, all adjustable rate loans were
considered to be due at the end of the next upcoming adjustment period. Fixed
rate loans were considered to reprice at their contractual maturities with no
consideration given to prepayments or scheduled payments. Liquid
interest-earning investments with no contractual maturities are assumed to be
subject to immediate repricing. Statement savings and money market accounts are
subject to immediate availability and repricing and have been placed in the
earliest gap category. In addition, fixed maturity deposits were assumed to
reprice at their contractual maturities without consideration for early
withdrawals. The interest rate sensitivity of the Bank's assets and liabilities
illustrated in the following table could vary substantially if different
assumptions were used or if actual experience differs from that indicated by
such assumptions.
<TABLE>
<CAPTION>
Over One Over Five Over Ten Over
One Year Through Through Through Twenty
or Less Five Years Ten Years Twenty Years Years Total
------------ ------------ ------------ ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
One- to four-family mortgage loans $ 14,801,331 $ 5,741,541 $ 13,206,278 $27,233,929 $ -- $60,983,079
Other mortgage loans.............. 688,317 12,238,050 7,616,522 5,985,749 -- 26,528,638
Consumer loans.................... 4,600,080 3,448,296 2,557,057 525,485 -- 11,130,918
Investment securities............. 1,503,910 12,651,845 2,000,000 -- -- 16,155,755
Mortgage-backed securities 38,044,501 1,316,850 4,868,741 3,584,991 6,898,118 54,713,201
FHLB of Dallas stock.............. 1,246,500 -- -- -- -- 1,246,500
Other interest-earning assets 18,273,882 -- -- -- -- 18,273,882
------------ ------------ ------------ ----------- ----------- ------------
Total.......................... $ 79,465,379 $ 35,396,582 $ 30,248,598 $37,330,154 $ 6,898,118 $189,031,973
------------ ------------ ------------ ----------- ----------- ------------
Interest-bearing liabilities:
Deposits.......................... $101,698,450 $ 46,820,549 $ -- $ -- $ -- $148,518,999
FHLB advances..................... -- 5,000,000 5,000,000 -- -- 10,000,000
Notes payable..................... 80,000 320,000 -- -- -- 400,000
------------ ------------ ------------ ----------- ----------- ------------
Total.......................... 101,778,450 52,140,549 5,000,000 -- -- 158,918,999
------------ ------------ ------------ ----------- ----------- ------------
Interest sensitivity gap............. $(22,619,929) $(16,743,967) $ 25,248,598 $37,330,154 $ 6,898,118 $ 30,112,974
============ ============ ============ =========== =========== ============
Cumulative interest
sensitivity gap.................... $(22,619,929) $(39,363,896) $(14,115,298) $23,214,856 $30,112,974 $ 30,112,974
============ ============ ============ =========== =========== ============
Ratio of interest-earning assets
to interest-bearing liabilities... 77.78% 67.89% 604.97% --% --% 118.95%
============ ============ ============ =========== =========== ============
Ratio of cumulative gap to
total assets....................... (11.29)% (19.65)% (7.04)% 11.59% 15.03% 15.03%
============ ============ ============ =========== =========== ============
</TABLE>
<PAGE>
Certain shortcomings are inherent in the method of analysis presented
in the preceding table. Although certain assets and liabilities may have similar
maturity or periods of repricing they may react in different degrees to changes
in the market interest rates. The interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
rates on other types of assets and liabilities may lag behind changes in market
interest rates. Certain assets, such as adjustable-rate mortgages, generally
have features which restrict changes in interest rates on a short-term basis and
over the life of the asset. In the event of a change in interest rates,
prepayments and early withdrawal levels would likely deviate significantly from
those assumed in calculating the table. Additionally, an increased credit risk
may result as the ability of many borrowers to service their debt may decrease
in the event of an interest rate increase. Virtually all of the adjustable-rate
loans in the Bank's portfolio contain conditions which restrict the periodic
change in interest rate.
Net Portfolio Value. While the Bank historically has measured its
interest rate sensitivity by computing the "gap" between the assets and
liabilities which were expected to mature or reprice within certain periods, the
OTS requires the Bank to measure its interest rate risk by computing estimated
changes in the net present value of its cash flows from assets, liabilities and
off-balance sheet items ("NPV") in the event of a range of assumed changes in
market interest rates. These computations estimate the effect on the Bank's NPV
of sudden and sustained 1% to 4% increases and decreases in market interest
rates. The Bank's Board of Directors has adopted an interest rate risk policy
which establishes maximum decreases in the Bank's estimated NPV of 30%, 50%, 75%
and 100% in the event of assumed immediate and sustained 1%, 2%, 3% and 4%
increases or decreases in market interest rates, respectively. At June 30, 1997,
based on information provided by the OTS as of March 31, 1997, it was estimated
that the Bank's consolidated NPV could decrease 15%, 33%, 52% and 71% in the
event of 1%, 2%, 3% and 4% respective increases in market interest rates, and no
decreases were estimated in the event of equivalent decreases in market interest
rates. Like the "gap" calculations above, these calculations indicate that the
Bank's net portfolio value could be adversely affected by increases in interest
rates. Changes in interest rates also may affect the Bank's net interest income,
with increases in rates expected to decrease income and decreases in rates
expected to increase income, as the Bank's interest-bearing liabilities would be
expected to mature or reprice more quickly than the Bank's interest-earning
assets.
The Bank's Board of Directors is responsible for reviewing the Bank's
asset and liability policies. On at least a quarterly basis, the Board reviews
interest rate risk and trends, as well as liquidity and capital ratios and
requirements. The Bank's management is responsible for administering the
policies and determinations of the Board of Directors with respect to the Bank's
asset and liability goals and strategies.
<PAGE>
Average Balances, Interest and Average Yields and Rates
The following table sets forth information regarding the Bank's average
interest-earning assets and interest-bearing liabilities and reflects the
average yield of interest-earning assets and the average cost of
interest-bearing liabilities for the periods and at the date indicated. Average
balances are derived from monthly balances, and loans receivable include
nonaccrual loans. The table also presents information for the periods indicated
and at June 30, 1997 with respect to the difference between the weighted average
yield earned on interest-earning assets and the weighted average rate paid on
interest-bearing liabilities, or "interest rate spread," which savings
institutions have traditionally used as an indicator of profitability. Another
indicator of an institution's net interest income is its "net yield on
interest-earning assets," which is its net interest income divided by the
average balance of interest-earning assets. Net interest income is affected by
the interest rate spread and by the relative amounts of interest-earning assets
and interest-bearing liabilities. Whenever interest-earning assets equal or
exceed interest-bearing liabilities, any positive interest rate spread will
generate net interest income.
<TABLE>
<CAPTION>
Year Ended June 30, 1997
At June 30, 1997 ---------------------------------
--------------------- Average
Yield/ Average Yield/
Balance Cost Balance Interest Cost
------- ------ ------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable......................... $ 98,642,635 8.15% $ 95,084,828 $ 8,038,783 8.45%
Investment and mortgage-backed securities 72,115,456 6.15 67,125,006 4,436,436 6.61
Other interest-earning assets............ 18,273,882 3.43 11,297,355 626,457 5.55
------------ ------------ -----------
Total interest-earning assets.......... $189,031,973 6.93 $173,507,189 13,101,676 7.55
-----------
Non-interest-earning assets................ 11,333,805 7,914,134
------------ ------------
Total assets........................... $200,365,778 $181,421,323
============ ============
Interest-bearing liabilities:
Deposits................................. $148,518,999 4.67% $148,964,591 7,534,445 5.06%
FHLB advances............................ 10,000,000 6.21 10,208,333 636,637 6.24
Notes payable............................ 400,000 7.50 357,142 25,000 7.00
------------ ------------ -----------
Total interest-bearing liabilities..... 158,918,999 5.12 159,530,066 8,196,082 5.12
-----------
Non-interest-bearing liabilities........... 3,707,266 7,780,215
------------ ------------
Total liabilities...................... 162,626,265 167,310,281
Equity..................................... 37,739,513 14,111,042
------------ ------------
Total liabilities and equity........... $200,365,778 $181,421,323
============ ============
Net interest income........................ $ 4,905,594
===========
Interest rate spread....................... 2.43%
======
Net yield on interest-earning assets....... 2.84%
======
Ratio of average interest-earning assets
to average interest-bearing liabilities.. 108.76%
======
<CAPTION>
Year Ended June 30, 1996
------------------------------------
Average
Average Yield/
Balance Interest Cost
------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Interest-earning assets:
Loans receivable......................... $ 65,360,871 $ 5,352,338 8.19%
Investment and mortgage-backed securities 66,253,218 4,467,685 6.74
Other interest-earning assets............ 6,719,134 513,217 7.64
------------ -----------
Total interest-earning assets......... $138,333,223 10,333,240 7.47
-----------
Non-interest-earning assets................ 5,115,105
------------
Total assets........................... $143,448,328
============
Interest-bearing liabilities:
Deposits................................. $120,029,295 $ 6,314,641 5.26
FHLB advances............................ 7,508,000 451,957 6.03
Notes payable............................ -- -- --
------------ -----------
Total interest-bearing liabilities..... 127,529,295 6,766,598 5.31
-----------
Non-interest-bearing liabilities........... 1,216,329
------------
Total liabilities...................... 128,745,149
Equity..................................... 14,702,704
------------
Total liabilities and equity........... $143,448,328
============
Net interest income........................ $ 3,566,642
===========
Interest rate spread....................... 2.16%
======
Net yield on interest-earning assets....... 2.58%
======
Ratio of average interest-earning assets
to average interest-bearing liabilities.. 108.47%
======
</TABLE>
<PAGE>
Rate/Volume Analysis
The following table analyzes dollar amounts of changes in interest
income expense for major components of interest-earning assets and
interest-bearing liabilities. The table distinguishes between (i) changes
attributable to volume (changes in volume multiplied by the prior period's
rate), (ii) changes attributable to rate (changes in rate multiplied by the
prior period's volume) and (iii) net change (the sum of the previous columns).
The change attributable to both rate and volume (changes in rate multiplied by
changes in volume) has been allocated equally to both the changes attributable
to volume and the changes attributable to rate.
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------
1997 vs. 1996
-----------------------------------------------
Increase (Decrease) Due to
-----------------------------------------------
Rate/
Volume Rate Volume Total
------- ------- -------- -------
(In thousands)
<S> <C> <C> <C> <C>
Interest income:
Loans receivable................................... $ 2,434 $ 169 $ 83 $ 2,686
Investment securities and mortgage-
backed securities.............................. 59 (86) (4) (31)
Other interest-earning assets..................... 254 (140) (7) 113
------- ------- -------- -------
Total interest-earning assets................... 2,747 (57) 78 2,768
------- ------- -------- -------
Interest expense:
Deposits.......................................... 1,523 (240) (63) 1,220
FHLB advances..................................... 162 16 6 184
Note payable...................................... 25 -- -- 25
------- ------- -------- -------
Total interest-bearing
liabilities.................................. 1,710 (224) (57) 1,429
------- ------- -------- -------
Change in net interest income....................... $ 1,037 $ 167 $ 135 $ 1,339
======= ======= ======== =======
</TABLE>
Comparison of Financial Condition at June 30, 1997 and 1996
The Bank had total assets of $200.3 million and $171.2 million at June
30, 1997 and 1996, respectively. The Bank's ability to expand its lending base
and the size of its loan portfolio has been constrained by the lack of strong
loan demand in its primary lending market based on its prior product offerings.
The economic base in the Bank's primary lending area has not grown significantly
over the last several years. Investments in loans totalled $98.6 million and
$89.6 million at June 30, 1997 and 1996, respectively. During this same period,
investment and mortgage-backed securities and other short-term interest-earning
deposits fluctuated between$62.6 million at June 30, 1996 and $72.1 million at
June 30, 1997. Due to the lack of strong loan demand, investment securities and
other short-term interest-earning deposits tend to vary in conjunction with
variations in savings activity. Additionally, the Bank expended $3.1 million to
purchase land and construct and/or improve facilities during the year ended June
30, 1997 to consummate management's planned growth projections.
Deposits increased from $145.9 million at June 30, 1996 to $151.2
million at June 30, 1997. The outstanding balances of FHLB advances at June 30,
1996 and 1997 were $10 million. These advances were utilized to reduce interest
rate risk by better matching rates and maturities of existing interest-earning
assets and interest-bearing liabilities.
Equity amounted to $37.7 million at June 30, 1997, and to $14.2 million
at June 30, 1996, respectively. The changes in equity were due primarily to the
Bank's stock conversion during the fourth quarter. At June 30, 1997, the Bank's
regulatory capital substantially exceeded all applicable regulatory capital
requirements.
<PAGE>
Comparison of Results of Operations for the Years Ended June 30, 1997 and 1996
Net Income (Loss). Net loss for the year ended June 30, 1997 was
$422,999 compared to net income of $224,889 for the year ended June 30, 1996.
The changes were attributable to a special deposit insurance assessment of
$889,011 and a provision for loan losses of $221,671, which were partially
offset by an increase in net interest income of $1,339,311 and an increase in
noninterest income of $1,079,719 for the year ended June 30, 1997, as compared
to the year ended June 30, 1996. Income tax expense for the year ended June 30,
1997 compared to 1996 was a tax benefit of $166,645 compared to a tax expense of
$174,801.
Net Interest Income. Net interest income for the year ended June 30,
1997 was $4,905,894, an increase of 37.5% when compared to net interest income
of $3,566,583 for the year ended June 30, 1996. This increase was attributable
to an increase in total interest income of $2,768,495 and an increase in total
interest expense of $1,429,184. The net interest margin for the year ended June
30, 1997 was 2.84% compared to 2.58% for the year ended June 30, 1996. This
increase in net interest income and net interest margin is due to an increase in
the average volume of interest-earning assets, combined with a decrease in the
average rate paid on interest-bearing liabilities. One cause for the increase in
average interest-earning assets when comparing the year ended June 30, 1997 to
the year ended June 30, 1996 was the acquisition of the subsidiary, Heritage
Bank, FSB in May of 1996. The average volume of interest-earning assets
increased from $138.3 million for the year ended June 30, 1996 to $173.5 million
for the year ended June 30, 1997 which had the effect of increasing total
interest income by $2,843,000. The average rate paid on interest-bearing
liabilities decreased during the year ended June 30, 1997 to 5.12% from 5.31%
for the year ended June 30, 1996. The decrease in the average rate on
interest-bearing liabilities had the effect of decreasing total interest expense
between the year ended June 30, 1996 and the year ended June 30, 1997 by
$224,000.
The average yield on interest-earning assets remained relatively
unchanged between the two periods, which is indicative of the fact that the
Bank's interest-earning assets are not highly sensitive to the increases in
market interest rates which occurred between the two periods. For the year ended
June 30, 1997, the average yield on interest-earning assets was 7.55%, compared
to 7.47% for the year ended June 30, 1996, which had the effect of increasing
total interest income by $21,000. In addition, the average volume of
interest-bearing liabilities increased by 24.1%, reflecting the acquisition of
the Bank's subsidiary savings bank, when comparing June 30, 1997 to June 30,
1996. This volume increase attributed to an increase in total interest expense
of $1,710,000.
Provision for Loan Losses. During the year ended June 30, 1997, the
Bank's management initiated an extensive internal loan review of all loan files
both of the parent and subsidiary. The review resulted in the adoption of more
conservative loan loss allowance standards than had been used in the past. This
new policy on allowance for loan losses was deemed prudent in establishing
credit underwriting standards for future expected lending areas, such as
commercial real estate, business and consumer loans, which inherently have more
risk. Management made provisions for loan losses in the year ended June 30, 1997
of $221,671. There was a provision of $42,483 made in the year ended June 30,
1996. The fiscal 1997 provisions were the result of the aforementioned extensive
review of the allowance for loan losses of the Bank and management's estimates
of conditions and circumstances that materialized in the year ended June 30,
1997 (See also Note 23 in Notes to Consolidated Financial Statements). The
allowance for loan losses, after this provision, of $1,492,473, represented
1.49% of outstanding loans at June 30, 1997. Nonperforming loans as of June 30,
1997 and 1996, as a percent of total loans, remained below .20%.
Management evaluates the carrying value of the loan portfolio
periodically and the allowance is adjusted accordingly. While management uses
the best information available to make evaluations, future adjustments to the
allowance may be necessary if conditions differ substantially from the
assumptions used in making the evaluations. In particular, management recognizes
that recent and planned changes in the amounts and types of lending by the Bank
will result in further growth of the Bank's loan loss allowance and may justify
further changes in the Bank's loan loss allowance policy in the future. In
addition, various regulatory agencies, as an integral part of their examination
process, periodically review the Bank's allowance for loan losses. Such agencies
may require the Bank to recognize changes to the allowance based upon their
judgments and the information available to them at the time of their
examination.
<PAGE>
Noninterest Income. Noninterest income is comprised primarily of
insurance commissions from sales of credit life insurance, fees for banking
service charges and sales of investment and mortgage-backed securities.
Noninterest income (loss) for the year ended June 30, 1997, was $305,067,
compared to ($773,651) for the year ended June 30, 1996. This represents an
increase of $1,078,718. This is partially due to losses of $926,947, that were
realized on sales of investment securities which were classified as
available-for-sale during the year ended June 30, 1996. The remaining increase
of $151,771, is due to fluctuations in sales of credit life insurance policies
and to an increase in new fee earning banking services offered by the Bank to
its deposit customers.
In light of the increasingly competitive markets for deposits and
loans, management has recently shifted the Bank's deposit taking and loan
origination activities to reflect, among other things, the importance of
offering valued customer services that generate additional fee income, and it is
expected that management will continue this trend after the Conversion.
Noninterest Expense. The major components of noninterest expense are
compensation and benefits paid to the Bank's employees and directors, occupancy
expense for ownership and maintenance of the Bank's building and furniture and
equipment, and insurance premiums paid to the FDIC for insurance of deposits.
Total noninterest expense for the year ended June 30, 1997 was $5,578,934,
compared to $2,350,658 for the year ended June 30, 1996. The increase was
largely due to an increase in expense related to a one time assessment by the
FDIC to the Bank to replenish the SAIF depleted by prior years losses in the
thrift industry. During the years in which thrifts as an industry, suffered many
publicized and non-publicized "bailouts" by the SAIF, and its predecessor, the
Federal Savings and Loan Insurance Corporation, the deposit insurance fund for
the thrift industry was severely depleted. After several years of debate
Congress with the assistance of the FDIC, which administers the SAIF,
consummated a plan of action to replenish the SAIF to a level of coverage
required by statute (the designated reserve ratio of 1.25% of insured deposits)
for the remaining covered deposits. The plan of remedy included a one time
assessment to each thrift institution based on capital levels, and deposits
among other factors. This one time assessment was recognized by the Bank in the
year ended June 30, 1997, in the amount of $889,011 and was expensed in the same
period. This assessment was paid November 27, 1996. The effective deposit
insurance rate prior to the assessment was .23% compared to a rate of .065%
after the assessment. The second largest component of noninterest expense for
1997 and 1996 was compensation expense, which totaled $2,029,428 in 1997
compared to $919,772 in 1996. This increase was attributable to increases in
salary expense due to an increase in personnel for future growth, the
acquisition of the subsidiary savings bank and increased directors fees due to
additional time incurred by the Board in evaluating and working on various
strategic plans for the Bank. Other noninterest expense incurred during the year
ended June 30, 1997, included amounts incurred to facilitate the name change of
the Bank to HEARTLAND Community Bank in September 1996. In addition, fees were
incurred for personnel placement services to attract key personnel for hire, a
computer consultant was engaged to evaluate operating systems and further growth
needs, and marketing consultants were approached for market strategies and
implementation. These expense categories increased $721,554 during the year
ended June 30, 1997 compared with the same period in 1996. Noninterest expense
increased for the year ended June 30, 1997, compared to the year ended
June 30, 1996, by approximately $1,382,000 as a direct result of the acquisition
of the subsidiary savings bank, exclusive of the FDIC one-time assessment.
Included in noninterest expenses for the year ended June 30, 1997 was a
charge for the amortization of goodwill of $160,073, which resulted from the
acquisition of the subsidiary bank during the year ended June 30, 1996. The
amortization will be $160,073 per year over a ten year period, subsequent to
June 30, 1996, and is not expected to have a material effect on the future
earnings of the Bank.
In light of the substantial costs associated with the recent, pending
and planned expansions of the Bank's activities, facilities and staff, including
additional costs associated with adding staff, building or renovating branches,
introducing new deposit and loan products and services and implementing planned
stock benefit plans, it is expected that the Bank's noninterest expense levels
may remain somewhat high relative to the historical levels for the Bank, as well
as the prevailing levels for institutions that are not undertaking such
expansions, for an indefinite period of time, as management implements the
Bank's business strategy. Among the activities planned are increased loan
originations in the areas of multi-family residential, commercial real estate,
commercial business and consumer loans. Customer
<PAGE>
products being introduced include ATM and debit cards and an expanded deposit
account mix. In addition, two new branch facilities were constructed, which were
completed in July and August 1997. Other existing facilities are being renovated
to attract and serve an increased customer base.
Income Taxes. The effective income tax rates for the Bank for the years
ended June 30, 1997 and 1996 were (28.26)% and 43.7%, respectively, which
included federal and Arkansas tax components. A tax benefit of $166,645 for 1997
and an expense of $174,801 for 1996 was recognized.
Sources of Capital and Liquidity
The Company has no business other than that of the Bank. The Company's
primary sources of liquidity are dividends paid by the Bank and repayment of the
ESOP loan. The Bank is subject to regulatory limitations with respect to the
payment of dividends to the Company.
The Bank has historically maintained substantial levels of capital. The
assessment of capital adequacy is dependent on several factors including assets
quality, earnings trends, liquidity and economic conditions. Maintenance of
adequate capital levels is integral to provide stability to the Bank. The Bank
seeks to maintain substantial levels of regulatory capital to give it maximum
flexibility in the changing regulatory environment and to respond to changes in
the market and economic conditions. These levels of capital have been achieved
through consistent earnings enhanced by low levels of noninterest expense and
have been maintained at those high levels as a result of its historical policy
of moderate growth.
The Bank is required to maintain minimum levels of liquid assets as
defined by the OTS regulations. This requirement which may be varied at the
discretion of the OTS depending on economic conditions and deposit outflows, is
based upon a percentage of deposits and short term borrowings. Current OTS
regulations require that a savings institution maintain liquid assets of not
less than 5% of its average daily balance of net withdrawal deposit accounts and
borrowings payable in one year or less, of which short-term liquid assets must
consist of not less than 1%. At June 30, 1997, the Bank's liquidity was in
excess of the minimum OTS liquidity requirements. Management of the Bank seeks
to maintain a relatively high level of liquidity in order to retain flexibility
in terms of investment opportunities and deposit pricing and in order to meet
funding needs of deposit outflows and loan commitments. Historically, the Bank
has been able to meet its liquidity demands through internal sources of funding
supplemented from time to time by advances from the FHLB of Dallas.
The Bank's primary source of funds are deposits, proceeds from
principal and interest payments on loans and mortgage-backed securities,
interest payments and maturities of investment securities, and earnings. While
scheduled principal repayments on loans and mortgage-backed securities and
interest payments on investment securities are a relatively predictable source
of funds, deposit flows and loan and mortgage-backed prepayments are greatly
influenced by general interest rates, economic conditions, competition and other
factors. The Bank does not solicit deposits outside of its market area through
brokers or other financial institutions.
The Bank has also designated certain securities as available for sale
in order to meet liquidity demands. At June 30, 1997, the Bank had designated
securities with a fair value of approximately $36.3 million as available for
sale. In addition to internal sources of funding, the Bank as a member of the
FHLB has substantial borrowing authority with the FHLB. The Bank's use of a
particular source of funds is based on need, comparative total costs and
availability.
Another source of liquidity is the net proceeds of the Conversion. The
Bank has received over half of the net proceeds of the Conversion. These funds
have been used by the Bank for its business activities, including investment in
interest-earning assets.
<PAGE>
At June 30, 1997, the Bank had outstanding $4,027,495 in commitments to
originate loans (including unfunded portions of construction loans) and $78,000
in unused lines of credit. At the same date, the total amount of certificates of
deposit which were scheduled to mature in one year or less was $53.7 million.
Management anticipates that the Bank will have adequate resources to meet its
current commitments through internal funding sources described above.
Historically, the Bank has been able to retain a significant amount of its
deposits as they mature.
Management is not aware of any current recommendations by its
regulatory authorities, legislation, competition, trends in interest rate
sensitivity, new accounting guidance or other material events and uncertainties
that would have a material effect on the Bank's ability to meet its liquidity
demands.
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
HCB Bancshares, Inc. and Subsidiaries
Camden, Arkansas
We have audited the accompanying consolidated statements of financial condition
of HCB Bancshares, Inc. and its subsidiaries as of June 30, 1997 and the related
consolidated statements of income, stockholders' equity and cash flows for the
year then ended. These financial statements are the responsibility of the Bank's
management. Our responsibility is to express an opinion on these financial
statements based on our audit. The consolidated financial statements for the
years ended June 30, 1996 and 1995 were audited by another auditor and their
report is attached hereto.
We conducted our audit 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
misstatements. 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 in significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of HCB Bancshares,
Inc. and its subsidiaries as of June 30, 1997 and the results of their
consolidated operations and cash flows for the years ended in conformity with
generally accepted accounting principles.
/s/ Miller, England & Co.
Little Rock, Arkansas
September 5, 1997
<PAGE>
[LETTERHEAD OF GAUNT & COMPANY, LTD. APPEARS HERE]
INDEPENDENT AUDITORS' REPORT
Board of Directors
Heartland Community Bank and Subsidiaries
(formerly First Federal Savings and Loan Association of Camden)
Camden, Arkansas
We have audited the accompanying consolidated statements of financial
condition of Heartland Community Bank (formerly First Federal Savings and Loan
Association of Camden) and its subsidiary as of June 30, 1996 and 1995 and the
related consolidated statements of income, equity and cash flows for the years
then ended. These financial statements are the responsibility of the Bank'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 audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatements. 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 in significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Heartland Community Bank (formerly First Federal Savings and Loan Association of
Camden) and its subsidiary as of June 30, 1996 and 1995 and the results of their
consolidated operations and cash flows for the years ended in conformity with
generally accepted accounting principles.
As discussed in note 18, the financial statements for the year ended
June 30, 1996, are consolidated as a result of the acquisition of the wholly
owned-subsidiary on May 3, 1996. Also discussed in note 1c, as of July 1, 1994
the Bank changed its method of accounting for certain investments in debt and
equity securities.
/s/ Gaunt & Company, Ltd.*
Little Rock, Arkansas
August 28, 1996
(Except for Note [23], as to
which the date is February 4, 1997)
- ----------------
*This auditors' report was provided for use in the registrant's Registration
Statement on Form SB-2 (No. 333-19093) declared effective March 21, 1997. The
auditors did not provide this report for use in this Annual Report on Form
10-K. Changes to conform with the current financial statements and notes are in
brackets. The changed reference to Note [23] was to Note 27 in the original
auditors' report.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Consolidated Statements of Financial Condition
June 30, 1997 and 1996
<TABLE>
<CAPTION>
ASSETS
------
June 30,
------------------------------
1997 1996
------------- ---------------
<S> <C> <C>
Cash and cash equivalents $ 1,182,210 $ 422,509
Interest-bearing deposits in other financial institutions 18,273,882 16,869,373
Investment Securities (Note 2)
Securities available for sale 16,155,755 5,279,625
Mortgage-backed securities (Note 2)
Securities available for sale 20,090,406 12,155,199
Securities held-to-maturity (estimated market value of
$36,194,353, and $44,934,075 respectively) 35,869,295 45,212,891
Loans, (net of allowance of $1,492,473 $1,283,234
respectively) (Note 3) 98,642,635 84,131,024
Accrued interest receivable 1,339,455 977,004
Foreclosed real estate, net 36,179 168,206
Premises and equipment (Note 7) 4,613,006 2,124,293
Land held for resale 480,000 --
Stock in Federal Home Loan Bank (at cost) 1,246,500 1,199,000
Income taxes receivable 648,398 556,959
Deferred tax asset 95,928 134,210
Goodwill, net of amortization (Note 16) 1,415,223 1,575,296
Other assets 276,906 429,733
------------- -------------
TOTAL ASSETS $ 200,365,778 $ 171,235,322
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Consolidated Statements of Financial Condition
June 30, 1997 and 1996
LIABILITIES and EQUITY
----------------------
<TABLE>
<CAPTION>
June 30,
---------------------------------
LIABILITIES 1996 1996
--------------- ---------------
<S> <C> <C>
Deposits (Note 8) $ 151,208,763 $ 145,919,251
Advances - Federal Home Loan Bank (Note 9) 10,000,000 10,000,000
Note payable (Note 10) 400,000 - -
Accrued interest payable 410,477 395,939
Advances from borrowers for taxes and insurance 209,140 114,004
Accrued income taxes payable - - - -
Other liabilities 397,885 577,692
--------------- ---------------
Total Liabilities $ 162,626,265 $ 157,006,886
--------------- ---------------
Commitments and Contingencies Note (6 and 14)
<CAPTION>
STOCKHOLDERS' EQUITY
<S> <C> <C>
Common stock, .01 par value, authorized 10,000,000 shares $ $
issued and outstanding 2,625,000 shares 2,645 - -
Additional paid-in capital 25,794,471 - -
Notes receivable, ESOP (Note 25) (2,116,000) - -
Retained earnings, substantially restricted (Note 13 and 21) 14,091,750 14,514,749
Unrealized loss on securities available-for-sale,
net of applicable deferred taxes (33,353) (286,313)
--------------- ---------------
Total Stockholders' Equity $ 37,739,513 $ 14,228,436
--------------- ---------------
TOTAL LIABILITIES and STOCKHOLDERS' EQUITY $ 200,365,778 $ 171,235,322
=============== ===============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Consolidated Statements of Income
For the years ended June 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
INTEREST INCOME 1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
Interest and fees on loans $ 8,038,783 $ 5,352,338 $ 4,526,621
Investment securities 849,541 252,560 202,942
Mortgage-backed and related securities 3,586,895 4,215,125 3,927,181
Other interest income 626,457 513,158 188,038
------------- ------------- -------------
Total interest income $ 13,101,676 $ 10,333,181 $ 8,844,782
------------- ------------- -------------
INTEREST EXPENSE
Deposits (Note 8) $ 7,534,445 $ 6,314,641 $ 4,979,125
Borrowed funds 636,337 451,957 133,356
Notes payable 25,000 - - - -
------------- ------------- -------------
Total interest expense $ 8,195,782 $ 6,766,598 $ 5,112,481
------------- ------------- -------------
Net interest income $ 4,905,894 $ 3,566,583 $ 3,732,301
Provision for loan losses (Note 3) $ 221,671 $ 42,483 $ - -
------------- ------------- -------------
Net interest income after provision for loan losses $ 4,684,223 $ 3,524,100 $ 3,732,301
------------- ------------- -------------
NONINTEREST INCOME
Net realized gain (loss) on sales of available
for sale securities (Note 2) $ (21,215)$ (926,947) $ 101,994
Gain on sale of foreclosed real estate 18,911 - - - -
Gain on sale of loans 3,261
Banking service charges 203,023 79,245 62,093
Other income 101,087 74,050 31,936
------------- ------------- -------------
Total noninterest income (loss) $ 305,067 $ (773,652) $ 196,023
------------- ------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Consolidated Statements of Income
For the years ended June 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
NONINTEREST EXPENSE 1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
Salaries and compensation $ 2,029,428 $ 919,772 $ 789,685
Retirement and ESOP plan cost (Note 17 and 24) 427,617 319,997 45,569
Occupancy and equipment 366,596 172,278 117,467
Federal deposit insurance premiums (Note 22) 1,084,547 268,370 257,126
Loss on foreclosed real estate 32,857 43,439 19,127
Data processing expenses 269,067 114,171 97,984
Professional fees 411,984 109,986 47,376
Amortization of goodwill 160,073 25,436 - -
Other expenses 796,765 377,209 235,627
------------- ------------- -------------
Total noninterest expense $ 5,578,934 $ 2,350,658 $ 1,609,961
------------- ------------- -------------
Income (loss) before income taxes and cumulative
effect of change in accounting principle $ (589,644) $ 399,790 $ 2,318,363
Provision for income taxes (benefits) (166,645) 174,801 966,763
------------- ------------- -------------
Income (loss) before cumulative effect of change
in accounting principle $ (422,999) $ 224,989 $ 1,351,600
Change in accounting principle - cumulative
effect of application of Statement on Financial
Accounting Standards No. 115 "Accounting for
Certain Investments in Debt Equity Securities" - - - - 77,567
------------- ------------- -------------
Net income (loss) $ (422,999) $ 224,989 $ 1,429,167
============= ============= =============
Earnings per share (Note 1 and 21) $ (0.17) $ - - $ - -
============= ============= =============
Cash dividends per share (Note 1 and 21) $ - - $ - - $ - -
============= ============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
For the years ended June 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
Unrealized
Common Additional Note Holding
Stock Paid-in Receivable Retained Gain (Loss)
(par) Capital ESOP Earnings Adjustment Total
--------- ------------ ------------ ------------ ------------- ---------------
<S> <C> <C> <C> <C> <C>
Balance at June 30, 1994 $ -- -- $ -- $ 12,860,593 $ -- $ 12,860,593
Net income 1,429,167 1,429,167
Unrealized gain (loss) on securities
available for sale, net of deferred taxes -- -- -- -- (18,788) (18,788)
--------- ------------ ------------ ------------ ------------- ---------------
Balance at June 30, 1995 14,289,760 (18,788) 14,270,972
Net income 224,989 224,989
Unrealized gain (loss) on securities
available for sale, net of deferred taxes -- -- -- -- (267,525) (267,525)
--------- ------------ ------------ ------------ ------------- ---------------
Balance at June 30, 1996 -- -- -- 14,514,749 (286,313) 14,228,436
Net (loss) (422,999) (422,999)
Net proceeds from issuance of
common stock (Note 21) 2,645 23,642,341 23,644,986
Purchase of common stock by the ESOP 2,116,000 (2,116,000) --
ESOP contribution (Note 25) 36,130 36,130
Unrealized gain (loss) on securities
available for sale, net of deferred taxes 252,960 252,960
--------- ------------ ------------ ------------ ------------- ---------------
Balance at June 30, 1996 $ 2,645 25,794,471 $ (2,116,000) $ 14,091,750 $ (33,353) $ 37,739,513
========= ============ ============ ============ ============= ===============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flow
For the years ended June 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
June 30,
--------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES 1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
Net Income (Loss) $ (422,999) $ 224,989 $ 1,429,167
------------- ------------- -------------
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation $ 159,725 $ 66,005 $ 51,234
Amortization of:
Deferred loan origination fees (26,698) 6,258 55,349
Goodwill 160,073 25,436 - -
Premiums and discounts on loans (27,627) 309 (119)
Premiums and discounts on investment securities (24,428) 125,952 106,296
Provision for loan loss 220,671 42,483 - -
Provision for loss on foreclosed real estate 13,528 30,000 - -
Deferred income taxes (110,574) (57,986) 147,239
Cumulative effect of FASB #115 adoption - - - - (77,567)
Net (gain) loss on sale of investments:
Available for sale 21,215 926,946 (99,093)
Held-to-maturity - - - - (2,902)
(Gain) loss on disposal of other assets 2,558 (5,732) 12,468
ESOP contribution credited to capital 36,130 - - - -
Decrease (increase) in accrued interest receivable (363,939) 4,743 (60,723)
Increase in accrued interest payable 14,538 29,818 35,718
(Increase) decrease in other assets 5,909 (174,649) (93,218)
Increase (decrease) in other liabilities (127,957) 442,156 5,691
(Increase) in prepaid / payable income taxes (56,271) (567,831) 37,729
------------- ------------- -------------
Total adjustments $ (103,147) $ 893,908 $ 118,102
------------- ------------- -------------
Net cash flows provided (used) by
operating activities $ (526,146) $ 1,118,897 $ 1,547,269
------------- ------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flow
For the years ended June 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
June 30,
--------------------------------------------------------
1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES
Loan originations and principal payments on loans $ (16,575,647) $ (5,283,509) $ 1,401,183
Proceeds from sale of loans 1,804,100 244,230
Purchase of loans (1,305,000) (4,555,000) (2,628,000)
Proceeds from sale of investment securities:
Available for sale 7,754,176 18,151,851 7,023,989
Held-to-maturity - - - - 406,779
Purchase of investment securities available for sale (28,986,589) (1,995,000) (9,780,348)
Purchase of investment securities held-to-maturity - - (20,475,412) (5,094,695)
Principal payments on investment securities 11,627,182 10,506,353 8,641,932
Investment in subsidiary - - (1,492,782) - -
Investment in foreclosed real estate - - - - (2,378)
Proceeds from sale of other assets 62,550 19,723 55,514
Purchases of premises and equipment (3,118,319) (762,178) (167,526)
------------- ------------- ------------
Net cash flows used by investing activities $ (28,737,547) $ (5,641,724) $ (143,550)
------------- ------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in demand deposits,
NOW accounts, passbook savings accounts and
certificates of deposit $ 5,289,512 $ 8,806,600 $ (1,345,081)
Net (decrease) increase in mortgage escrow funds (22,594) (117,491) 11,983
Proceeds from note payable 400,000 - - - -
Net proceeds from issuance of common stock 25,760,985 - - - -
Advances from FHLB - - 10,000,000 - -
------------- ------------- -------------
Net cash flows provided (used) by
financing activities $ 31,427,903 $ 18,689,109 4 (1,333,098)
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents $ 2,164,210 $ 14,166,283 $ 70,621
Cash and cash equivalents, beginning of year $ 17,291,882 $ 3,125,599 $ 3,054,978
------------- ------------- -------------
Cash and cash equivalents, end of year $ 19,456,092 $ 17,291,882 $ 3,125,599
============= ============= =============
Suplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 3,162,551 $ 6,775,124 $ 4,961,607
Income taxes $ 419,961 $ 786,845 $ 782,602
Loans transferred to foreclosed real estate $ 51,000 $ 126,307 $ 122,165
Suplemental disclosure of noncash investing and
financing activities:
Stock issued in exchange for note receivable from ESOP $ 2,116,000 $ - - $ - -
============= ============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 1 - Summary of Significant Accounting Policies
- ---------------------------------------------------
Conversion and Organization of Holding Corporation
- --------------------------------------------------
On April 30, 1997, pursuant to a Plan of Conversion which was approved by its
members and regulators, Heartland Community Bank ("Bank") converted from a
federally chartered mutual savings and loan association to a federally chartered
stock savings and loan association, and became a wholly-owned subsidiary of HCB
Bancshares, Inc. (the "Corporation"). The Corporation was formed under Oklahoma
Law in December 1996 to acquire all of the common stock of the Bank upon its
conversion to stock form. The Corporation has no other operations and conducts
no business of its own other than owning the Bank, investing its portion of the
net proceeds received in the Conversion, and lending funds to the Employee Stock
Ownership Plan (the "ESOP") which was formed in connection with the Conversion.
Nature of Business
- ------------------
The Bank and its subsidiary bank, are a federally chartered operating savings
and loan association primarily engaged in the business of obtaining deposits and
providing mortgage credit to the general public. The Association's primary
regulator is the Office of Thrift Supervision (OTS) and its deposits are insured
by the Savings Association Insurance Fund ("SAIF") of the FDIC.
Basis of Financial Statement Presentation
- -----------------------------------------
The accounting and reporting policies of the Corporation conform to generally
accepted accounting principles and general practices within the financial
services industry. In preparing the consolidated financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance sheet
and revenues and expenses for the period. Actual results could differ from those
estimates.
Outlined below are the accounting and reporting policies considered significant
by the Corporation.
Basis of Consolidation
- ----------------------
The consolidated financial statements as of June 30, 1997 and 1996, include the
accounts of HCB Bancshares, Inc., Heartland Community Bank (formerly First
Federal Savings and Loan Association of Camden), (see also Note 18), and its
wholly-owned subsidiaries, (Heartland Community Bank, FSB (formerly Heritage
Banc Holding, Inc. and its wholly-owned subsidiary) and HCB Properties, Inc.
(see also Note 16 and 20). All material intercompany balances and transactions
have been eliminated in the consolidation.
Cash Equivalents
- ----------------
For purposes of the statements of cash flows, the Bank considers all highly
liquid debt instruments with original maturities when purchased of three months
or less to be cash equivalents.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 1 - Summary of Significant Accounting Policies - Continued
- ---------------------------------------------------------------
Investment Securities and Mortgage-Backed Securities
- ----------------------------------------------------
In May 1993, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." The Bank adopted the provisions of the new standard
for investments held as of July 1, 1994. Under the new rules, securities that
the Bank has both the positive intent and ability to hold to maturity are
carried at amortized cost. Securities that the Bank does not have the positive
intent and ability to hold to maturity are classified as available-for-sale or
trading and are carried at fair value. Unrealized holding gains and losses, net
of tax, on securities classified as available - for-sale are carried as a
separate component of equity. The Bank does not carry any trading securities.
The cumulative effect as of July 1, 1994, of adopting Statement No. 115 included
the reversal of $77,567 previously included in earnings that is to be excluded
from earnings under this statement.
Mortgage-backed securities represent participating interests in pools of
long-term first mortgage loans originated and serviced by issuers of the
securities. Mortgage-backed securities that are classified held-to-maturity are
carried at unpaid principal balances, adjusted for unamortized premiums and
unearned discounts. Premiums and discounts are amortized using the interest
method over the remaining period to contractual maturity, adjusted for
anticipated prepayments.
Gains and losses on the sale of securities are determined using the specific
identification method.
If the fair value of an investment security declines for reasons other than
temporary market conditions, the carrying value of such security is written down
to current value by a charge to operations.
Securities Held to Maturity: Securities classified as held to maturity are those
- ---------------------------
debt securities the Corporation has both the intent and the ability to hold to
maturity regardless of changes in market conditions, liquidity needs or changes
in general economic conditions. These securities are carried at cost adjusted
for amortization of premiums or accretion of discounts, computed by a method
which approximates the interest method over their contractual lives. In the
event of a permanent decline in market value, these securities may be adjusted
to fair market value. The unrealized loss on write down of securities held to
maturity is charged to current operations.
Securities Available for Sale: Securities classified as available for sale are
- -----------------------------
those debt securities that the Corporation intends to hold for an indefinite
period of time but not necessarily to maturity and marketable equity securities
not classified as held for trading. Any decision to sell a security classified
as available for sale would be based on various factors, including significant
movements in interest rates, changes in the maturity mix of its securities,
liquidity needs and other similar factors. Securities available for sale are
carried at fair value. Unrealized gains and losses are reported as a separate
component of equity, net of related tax effects. Realized gains and losses are
included in earnings.
Securities Held for Trading: Trading securities are held in anticipation of
- ---------------------------
short-term market gains. Such securities are carried at fair value with realized
and unrealized gains and losses included in earnings. The Corporation currently
has no securities which are classified as trading.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 1 - Summary of Significant Accounting Policies - Continued
- ---------------------------------------------------------------
Loans Receivable
- ----------------
Loans receivable are stated at unpaid principal balances, less the allowance for
loan losses, and net of deferred loan-origination fees and discounts.
Discounts on first mortgage loans are amortized to income using the interest
method over the remaining period to contractual maturity, adjusted for
anticipated prepayments. Discounts on consumer loans are recognized over the
lives of the loans using the interest method.
The allowance for loan losses is increased by charges to income and decreased by
charge-offs (net of recoveries.) Management's periodic evaluation of the
adequacy of the allowance is based on the Bank's past loan loss experience,
known and inherent risks in the portfolio, adverse situations that may affect
the borrower's ability to repay, the estimated value of any underlying
collateral, and current economic conditions.
The Bank has adopted SFAS No. 114 "Accounting by Creditors for Impairment of a
Loan" which was amended by SFAS No. 118 "Accounting by Creditors for Impairment
of a Loan - Income Recognition and Disclosures" on October 1, 1995. These
statements prescribed the recognition criterion for loan impairment and the
measurement methods for certain impaired loans and loans whose terms are
modified in troubled debt restructuring. These measurement methods apply to all
creditors and all loans, uncollateralized as well as collateralized, except for
larger groups smaller-balanced homogeneous loans that are collectively evaluated
for impairment, loans measured at fair market or lower of cost or fair value,
leases and debt securities. The Bank considers all one-to-four family
residential loans, construction loans, auto loans and other consumer loans, (as
presented in Note 4), to be smaller homogenous loans. These statements apply to
all restructured loans that involve a modification of terms. Loans within the
scope of these statements are considered impaired when, based on current
information and events, it is probable that all principal and interest will not
be collected in accordance with the contractual terms of the loans. Management
determines impairment of the loans based on knowledge of the borrower's
repayment history. Pursuant to SFAS No. 114, paragraph 8, management has
determined that a delay less than 90 days will be considered an insignificant
delay and that an amount less than $25,000 will be considered an insignificant
shortfall. The Bank does not apply SFAS No. 114 using major risk
classifications, but applies SFAS No.114 on a loan by loan basis. All nonaccrual
loans are considered to be impaired. Nonaccrual loans are specifically
designated and segregated within the loan portfolio by management. Loans are
charged off when management determines that principal and interest are not
collectible. At June 30, 1997 and 1996, only nonaccrual loans were considered to
be impaired. (See Note 4)
Uncollectible interest on loans, all categories, that are contractually past due
over ninety (90) days is charged off, or an allowance is established based on
management's periodic evaluation. The allowance is established by a charge to
interest income equal to all interest previously accrued, and income is
subsequently recognized only to the extent that cash payments are received
until, in management's judgment, the borrower's ability to make periodic
interest and principal payments is back to normal, in which case the loan is
returned to accrual status.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 1 - Summary of Significant Accounting Policies - Continued
- ---------------------------------------------------------------
Loan-Origination Fees, Commitment Fees, and Related Costs
- ---------------------------------------------------------
Loan fees and certain direct loan origination costs are deferred, and the net
fee or cost is recognized as an adjustment to interest income using the interest
method over the contractual life of the loans, adjusted for estimated
prepayments based on the Bank's historical prepayment experience. Commitment
fees and costs relating to commitments, the likelihood of exercise of which is
remote, are recognized over the commitment period on a straight-line basis. If
the commitment is subsequently exercised during the commitment period, the
remaining unamortized commitment fee at the time of exercise is recognized over
the life of the loan as an adjustment to yield.
Foreclosed Real Estate
- ----------------------
Real estate properties acquired through, or in lieu of, loan foreclosure are
initially recorded at the lower of the related loan balance, less any specific
allowance for loss, or fair value (less selling costs) at the date of
foreclosure. Costs relating to development and improvement of property are
capitalized, whereas costs relating to the holding of property are expensed.
Valuations are periodically performed by management, and an allowance for losses
is established by a charge to operations if the carrying value of a property
exceeds its estimated net realizable value.
Income Taxes
- ------------
The Bank records income tax expense based on the amount of taxes currently due
on its tax return plus deferred taxes computed based on the expected future tax
consequences of temporary differences between the financial statement amounts
and tax basis of assets and liabilities, using existing tax rates.
Premises and Equipment
- ----------------------
Land is carried at cost. Buildings and furniture, fixtures, and equipment are
carried at cost, less accumulated depreciation and amortization. Buildings and
furniture, fixtures and equipment are depreciated using the straight-line method
over the estimated useful lives of the assets which range from 15 to 40 years
for buildings and improvements and 3 to 10 years for equipment.
Fair Values of Financial Instruments
- ------------------------------------
During the year ended June 30, 1996, the Bank adopted Statement of Financial
Accounting Standards No. 107, "Disclosures About Fair Value of Financial
Instruments", requires disclosure of fair value information about financial
instruments, whether or not recognized in the statement of financial condition.
In cases where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those techniques
are significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows.
In that regard, the derived fair value estimates cannot be substantiated by
comparison to independent markets and, in many cases, could not be realized in
immediate settlement of the instruments. Statement No. 107 excludes certain
financial instruments and all nonfinancial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts presented do not
represent the underlying value of the Bank.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 1 - Summary of Significant Accounting Policies - Continued
- ---------------------------------------------------------------
Fair Values of Financial Instruments - Continued
- ------------------------------------------------
The following methods and assumptions were used by the Bank in estimating its
fair value disclosures for consolidated financial instruments at June 30, 1997:
Cash and cash equivalents: The carrying amounts reported in the statement of
- -------------------------
financial condition for cash and cash equivalents approximate those assets' fair
values.
Time deposits: Fair values for time deposits are estimated using a discounted
- -------------
cash flow analysis that applies interest rates currently being offered on
certificates to a schedule of aggregated contractual maturities on such time
deposits.
Investment securities: Fair values for investment securities are based on quoted
- ---------------------
market prices, where available. If quoted market prices are not available, fair
values are based on quoted market prices of comparable instruments.
Loans: For variable-rate loans that reprice frequently and with no significant
- -----
change in credit risk, fair values are based on carrying amounts. The fair
values for other loans are estimated using discounted cash flow analysis, based
on interest rates currently being offered for loans with similar terms to
borrowers of similar credit quality. Loan fair value estimates include judgments
regarding future expected loss experience and risk characteristics. The carrying
amount of accrued interest receivable approximates its fair value.
Deposits: The fair values disclosed for demand deposits (for example,
- --------
interest-bearing checking accounts and passbook accounts) are, by definition,
equal to the amount payable on demand at the reporting date (that is, their
carrying amounts.) The fair values for certificates of deposit are estimated
using a discounted cash flow calculation that applies interest rates currently
being offered on certificates to a schedule of aggregated contractual maturities
on such time deposits. The carrying amount of accrued interest payable
approximates fair value.
Short-term borrowings and notes payable: The carrying amounts of short-term
- ---------------------------------------
borrowings and notes payable approximate their fair values.
Other liabilities: Commitments to extend credit were evaluated and fair value
- -----------------
was estimated using the fees currently charged to enter into similar agreements,
taking into account the remaining terms of the agreements and the present credit
worthiness of the counter-parties. For fixed-rate loan commitments, fair value
also considers the difference between current levels of interest rates and the
committed rates.
NOTE 2 - Investment and Mortgage-Backed Securities
- --------------------------------------------------
Investment Securities: The amortized cost and estimated market values of
- ---------------------
investment securities at June 30, 1997, are summarized as follows:
<TABLE>
<CAPTION>
Available for Sale
------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Gains Unrealized Market Values
Cost Losses
----------------- ----------------- ---------------- -----------------
<S> <C> <C> <C> <C>
U.S. Government and
Federal Agencies $16,178,740 $ 9,646 $ 32,631 $ 16,155,755
========== ====== ======= ===========
</TABLE>
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 2 - Investment and Mortgage-Backed Securities - Continued
- --------------------------------------------------------------
The amortized cost and estimated market values of investment securities at June
30, 1996, are summarized as follows:
<TABLE>
<CAPTION>
Available for Sale
------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Market Values
----------------- ----------------- ---------------- -----------------
<S> <C> <C> <C> <C>
U.S. Government and
Federal Agencies $ 5,306,383 $ -- $ 26,758 $ 5,279,625
========== ===== ======= ==========
</TABLE>
The scheduled maturities of investment securities were as follows:
<TABLE>
<CAPTION>
June 30, 1997 June 30, 1996
----------------------------------- ---------------------------------
Amortized Amortized
Available for Sale Cost Market Value Cost Market Value
- ------------------ ---------------- --------------- --------------- --------------
<S> <C> <C> <C> <C>
Due in one year or less $ 1,499,413 $ 1,503,866 $ 1,398,728 $ 3,387,887
Due after one year through five years 12,769,327 12,647,279 3,353,836 3,340,631
Due after five through ten years 2,000,000 2,004,610 554,819 551,107
----------- ----------- ---------- ----------
$ 16,178,740 $ 16,155,755 $ 5,306,383 $ 5,279,625
=========== =========== ========== ==========
</TABLE>
Proceeds from sales of securities available-for-sale during the year ended June
30, 1997 and 1996 were $7,571,924 and $1,006,875, respectfully. Gross losses of
$21,215 were realized on those sales for the year ended June 30, 1997 and gross
gains of $10,358 were realized on those sales recorded in the year ended June
30, 1996.
Mortgage-Backed Securities: Mortgage-backed securities consist of the following
- --------------------------
at June 30, 1997:
<TABLE>
<CAPTION>
Available-for-Sale
-----------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Market Values
----------------- ----------------- ----------------- ----------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 13,854,553 $ 111,663 $ 33,399 $ 13,919,065
Collateralized Mortgage
Obligations 6,270,999 15,723 114,173 6,171,341
----------- -------- -------- -----------
$ 20,125,552 $ 127,286 $ 147,572 $ 20,090,406
=========== ======== ======== ===========
<CAPTION>
Held-to-Maturity
----------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Market Values
----------------- ----------------- ----------------- ----------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 35,869,295 $ 584,890 $ 259,832 $ 36,194,353
=========== ======== ======== ===========
</TABLE>
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 2 - Investment and Mortgage-Backed Securities - Continued
- --------------------------------------------------------------
Mortgage-Backed Securities - Continued
- --------------------------------------
Mortgage-backed securities consist of the following at June 30, 1996:
<TABLE>
<CAPTION>
Available-for-Sale
-----------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Market Values
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 3,135,911 $ 8,612 $ 23,928 $ 3,120,595
Collateralized Mortgage
Obligations 9,455,472 1,043 421,911 9,034,604
----------- ------ -------- -----------
$ 12,591,383 $ 9,655 $ 445,839 $ 12,155,199
=========== ====== ======== ===========
<CAPTION>
Held-to-Maturity
-----------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Market Values
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 45,212,891 $ 470,641 $ 749,458 $ 44,934,074
=========== ======== ======== ===========
</TABLE>
The amortized cost and fair value of mortgage-backed securities by contractual
maturity, are shown below. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
<TABLE>
<CAPTION>
June 30, 1997 June 30, 1996
---------------------------------- -----------------------------------
Amortized Market Amortized Market Value
Available-For-Sale Cost Value Cost
------------------ --------------- -------------- --------------- ----------------
<S> <C> <C> <C> <C>
Due in one year or less $ $ $ 995,571 $ 991,951
- - - -
Due after one through five years 2,194,753 2,197,535 771,337 777,371
Due after five through ten years 5,431,474 5,483,501 2,578,400 2,341,674
Due after ten years 12,499,325 12,409,370 8,246,075 8,044,202
----------- ----------- ----------- -----------
$ 20,125,552 $ 20,090,406 $ 12,591,383 $ 12,155,198
=========== =========== =========== ===========
<CAPTION>
June 30, 1997 June 30, 1996
----------------------------------- ----------------------------------
Amortized Market Amortized Market
Held-To-Maturity Cost Value Cost Value
---------------- ---------------- --------------- ---------------- --------------
<S> <C> <C> <C> <C>
Due after one through five years $ 703,741 $ 700,000 $ 285,348 $ 297,587
Due after five through ten years 1,456,595 1,500,000 2,485,383 2,597,545
Due after ten years 33,708,959 33,994,350 42,445,160 42,038,942
----------- ----------- ----------- -----------
$ 33,869,295 $ 36,194,350 $ 45,212,891 $ 44,934,074
=========== =========== =========== ===========
</TABLE>
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 2 - Investment and Mortgage-Backed Securities - Continued
- --------------------------------------------------------------
Mortgage-Backed Securities - Continued
- --------------------------------------
All mortgage-backed securities were issued by either U.S. government agencies
(Government National Mortgage Association, Federal National Mortgage
Association), government-sponsored enterprises (Federal Home Mortgage
Corporation or Resolution Trust Corporation) or private issuer mortgage-backed
securities.
As of June 30, 1997 and 1996, the carrying value of privately issued
mortgage-backed securities included in the above schedules are presented below:
<TABLE>
<CAPTION>
June 30, 1997 June 30, 1996
------------- -------------
<S> <C> <C>
Available-for-sale $ 6,271,822 $ 8,637,067
Held-to-maturity 5,794,156 32,896,294
----------- -----------
$ 32,065,978 $ 41,533,361
=========== ===========
</TABLE>
During the year ended June 30, 1996, the Bank sold mortgage-backed securities
available-for-sale for total proceeds of $17,144,976 and realized gross gains of
$3,839 and gross losses of $941,324. In the year ended June 30, 1996, proceeds
from sale of mortgage-backed securities held-to-maturity, of which greater than
85% of he principal had already been collected, were $406,779. Gross gains of
$4,512 and gross losses of $1,610 were realized on those sales.
On December 11, 1995, securities with an amortized cost of $26,270,667 were
transferred from held-to-maturity to available-for-sale because of a one time
reassessment in accordance with the implementation guidance of Statement No 115
on "Accounting for Certain Investments in Debt and Equity Securities". The
securities had an unrealized loss of approximately $898,756.
During the fiscal year 1997, the Bank was notified of a downgrade in the rating
of one of its private issue obligations. The security is Citicorp Mortgage,
Inc. - REMIC pass-thru certificates. The downgrade reflected deterioration in
the performance of the mortgage pools underlying the certificates. Though the
Class A Certificate holders have suffered no interest losses and suffered
$625,223 in principle losses to date. The Bank's par balance of this security as
of June 30, 1997 was $871,312 which represented 1.36% of the total outstanding
pool of $64,244,942. The Class A credit enhancement available to certificate
holders was $2,901,490 at June 30, 1997. As long as this amount is positive no
significant loss to the bank, if any, is anticipated.
Gains are summarized as follows for the years ended June 30, 1996 and 1995:
<TABLE>
<CAPTION>
June 30,
-----------------------------------
Realized gain on sales of: 1997 1996
--------------- ----------------
<S> <C> <C>
Mortgage-backed securities $ - - $ 3,839
Investment securities - - 10,538
-----------
- - 14,377
Realized losses on sales of - -
Mortgaged-back securities - - (941,324)
Investment Securities $ (21,215) - -
-------- ----------
Net income (loss) $ (21,215) $ (926,947)
======== ==========
</TABLE>
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 3 - Loans Receivable
- -------------------------
Loans receivable at June 30, 1997 and 1996 are summarized as follows:
<TABLE>
<CAPTION>
Loans secured by first mortgages on real estate:
June 30, 1997 June 30, 1996
------------- -------------
<S> <C> <C>
Conventional 1-4 family residences $ 76,327,453 $ 61,650,286
Conventional Other 14,184,241 20,602,705
Loans to facilitate sales of foreclosed real estate 616,660 720,749
------------ -----------
Total first mortgage loans 91,128,354 82,973,740
------------ -----------
Loans secured by deposits 2,434,621 1,832,180
Auto 2,399,648 786,656
Home improvement and consumer loans 4,194,686 622,803
------------ -----------
Total installment loans 9,028,955 3,241,639
------------ -----------
Commercial loans 2,101,963 880,311
------------ -----------
102,359,272 87,095,690
------------ -----------
Less:
Allowance for loan losses 1,492,473 1,283,234
Net deferred loan fees, premiums and discounts 167,069 135,335
Loans in process 2,057,095 1,544,097
------------ -----------
$ 98,642,635 $ 84,131,024
============ ===========
</TABLE>
Activity in the allowance for loan losses is summarized as follows for the years
ended June 30, 1997 and 1996:
<TABLE>
<CAPTION>
June 30, 1997 June 30, 1996
------------- -------------
<S> <C> <C>
Balance at beginning of period $ 1,283,234 $ 728,491
Acquisition of subsidiary - - 524,140
Provision charged to income 221,671 42,483
Charge-offs (22,985) (12,130)
Recoveries 10,553 250
---------- ----------
Balance at end of period $ 1,492,473 $ 1,283,234
========== ==========
</TABLE>
At June 30, 1997 and 1996, the Bank had loans totaling $133,386 and $166,228
respectively on which interest had ceased to be recognized. The interest income
not recorded on these loans totaled $12,177 and $7,718 respectively.
At June 30, 1997 and 1996, the Bank had the following loans recognized as
impaired loans under the criteria established by SFAS No.114 and SFAS No. 118:
<TABLE>
<CAPTION>
June 30, 1997 June 30, 1996
------------- -------------
<S> <C> <C>
Investment in loans - nonaccruals $ 133,386 $ 166,228
Related allowance for loan loss $ 33,346 $ 41,557
</TABLE>
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 3 - Loans Receivable - Continued
- -------------------------------------
Renegotiated loans for which interest has been reduced totaled $281,441 and
$298,195 at June 30, 1997 and 1996. Interest income that would have been
recorded under the original terms of such loans and the interest income actually
recognized for the years ended June 30, 1997 and 1996 are summarized below:
<TABLE>
<CAPTION>
June 30, 1997 June 30, 1996
------------- -------------
<S> <C> <C>
Interest income that would have been recorded $ 29,729 $ 35,311
Interest income recognized 20,343 21,383
------ ------
Interest income foregone $ 9,386 $ 13,927
======= =======
</TABLE>
The Bank is not committed to lend additional funds to debtors whose loans have
been modified.
NOTE 4 - Accrued Interest Receivable
- ------------------------------------
Accrued interest receivable at June 30, 1997 and 1996 is summarized below:
<TABLE>
<CAPTION>
June 30, 1997 June 30, 1996
------------- -------------
<S> <C> <C>
Investment securities $ 348,044 $ 51,842
Mortgage-backed securities 309,440 332,064
Loans receivable 648,467 593,098
ESOP Plan 33,503 - -
---------- --------
$ 1,339,454 $ 772,620
========== ========
</TABLE>
NOTE 5 - Foreclosed Real Estate
- -------------------------------
Activity in the allowance for losses for real estate foreclosed for the years
ended June 30, 1997 and 1996 are presented below:
<TABLE>
<CAPTION>
June 30, 1997 June 30, 1996
------------- -------------
<S> <C> <C>
Balance at beginning of year $ 58,587 $ 28,587
Provision charged to income 13,527 30,000
Recoveries through sales (43,289) --
-------- --------
Balance at end of year $ 28,287 $ 58,587
======== ========
</TABLE>
NOTE 6 - Commitments and Contingencies
- --------------------------------------
In the ordinary course of business, the Bank has various outstanding commitments
and contingent liabilities that are not reflected in the accompanying financial
statements. In addition, the Bank is a defendant in certain claims and legal
actions arising in the ordinary course of business. In the opinion of
management, after consultation with legal counsel, the ultimate disposition of
these matters is not expected to have a material adverse effect on the financial
position of the Bank.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 6 - Commitments and Contingencies - Continued
- --------------------------------------------------
The principal commitments of the Bank and its subsidiary are as follows:
<TABLE>
<CAPTION>
June 30,
-----------------------------------
1997 1996
----------------- --------------
<S> <C> <C>
Fixed Rate
- ----------
First mortgage loans $ 4,027,495 $ 1,127,500
Consumer loan - - 23,800
---------- ----------
4,027,495 1,151,300
Adjustable Rate
- ---------------
First mortgage loans - - 2,000,000
---------- ----------
$ 4,027,495 $ 3,151,000
========== ==========
</TABLE>
In addition, the Bank had outstanding letter of credit to customers in the
amount of $78,000 which were unfunded at year end June 30, 1997.
NOTE 7 - Premises and Equipment
- -------------------------------
Premises and equipment at June 30, 1997 and 1996 are summarized as follows:
<TABLE>
<CAPTION>
Cost: June 30, 1997 June 30, 1996
- ----- ------------- -------------
<S> <C> <C>
Land and buildings $ 4,252,598 $ 2,207,867
Leasehold improvements 32,548 34,549
Equipment 1,074,130 545,293
---------- ----------
5,359,276 2,785,709
Accumulated depreciation (746,270) (661,416)
---------- ----------
$ 4,613,006 $ 2,124,293
========== ==========
</TABLE>
Depreciation expense amounted to $159,725 and $66,005 for the years ended June
30, 1997 and 1996 respectively.
NOTE 8 - Deposits
- -----------------
Deposits at June 30, 1997 and 1996 are presented below:
<TABLE>
<CAPTION>
June 30, 1997 June 30, 1996
--------------------------------------------- ------------------------------------------
Weighted Weighted
Demand and NOW Average Average
Accounts: Rate Amount % Rate Amount %
----------- ---------------- ---------- ----------- ---------------- -------
<S> <C> <C> <C> <C> <C> <C>
Non-interest bearing $ 2,689,637 1.78 $ 215,162 .14
Interest bearing 2.76% 6,716,760 4.44 2.65% 6,453,373 4.42
Money market 4.09% 17,807,493 11.78 4.14% 15,491,591 10.62
Passbook savings 3.04% 8,441,845 5.58 3.06% 8,028.15 5.50
---------- ----- ---------- -----
35,655,735 23.58 30,188,281 20.68
---------- ----- ---------- -----
</TABLE>
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 8 - Deposits - Continued
- -----------------------------
<TABLE>
<CAPTION>
Certificates of Deposit
- -------------------------
<S> <C> <C> <C> <C> <C> <C>
4.00% to 4.99% 4.84% 17,784,816 11.76 4.83% 13,614,170 9.26
5.00% to 5.99% 5.44% 81,821,344 54.11 5.39% 62,333,102 42.71
6.00% to 6.99% 6.30% 15,730,506 10.40 6.17% 39,600,698 27.16
7.00% to 7.99% 7.15% 216,362 .14 7.73% 283,000 .19
8.00% to 8.99% -- -- 8.00% 63,352 .06
------------ ------ ------------ ------
115,553,028 76.42 115,730,970 79.32
------------ ------ ------------ ------
$151,208,763 100.00 $145,919,251 100.00
============ ====== ============ ======
</TABLE>
The aggregate amount of short-term jumbo certificates of deposit with a minimum
denomination of $100,000 was approximately $49,373,751 and $8,924,677 at June
30, 1997 and 1996 respectively.
Deposit accounts with balances in excess of $100,000 are not federally insured.
At June 30, 1997 the scheduled maturities of consolidated certificates of
deposit are as follows:
<TABLE>
<CAPTION>
1998 1999 2000 2001 TOTAL
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
4.00% to 4.99% $17,784,816 $ 17,784,816
5.00% to 5.99% 31,453,008 $40,399,490 $ 8,398,091 $ 1,570,754 81,821,343
6.00% to 6.99% 4,319,330 9,810,321 1,600,856 -- 15,730,507
7.00% to 7.99% 100,000 10,000 100,000 6,632 216,362
---------- ---------- ---------- ---------- -----------
$53,657,154 $50,309,811 $10,008,947 $ 1,577,116 $115,553,028
========== ========== ========== ========== ===========
</TABLE>
Interest expense on deposits for the years ended June 30, 1997 and 1996, is
summarized as follows:
<TABLE>
<CAPTION>
June 30,
---------------------------------
1997 1996
-------------- --------------
<S> <C> <C>
Money Market $ 775,882 $ 562,528
Passbook savings 235,320 194,014
NOW 179,721 128,322
Certificate of Deposit 6,343,522 5,429,775
--------- ---------
$7,534,445 $6,314,641
========= =========
</TABLE>
NOTE 9 - Federal Home Loan Bank Advances
- ----------------------------------------
Pursuant to collateral agreements with the Federal Home Loan Bank (FHLB),
advances are secured by qualifying single family first mortgage loans. Advances
at June 30, 1997 and 1996 have the following maturities:
<TABLE>
<CAPTION>
Fixed
Maturity Interest Rate
-------- -------------
<S> <C> <C>
2001 6.407% $ 5,000,000
2003 6.000% 5,000,000
----------
$10,000,000
==========
</TABLE>
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 10 - Note Payable
- ----------------------
As of June 30, 1997, the Bank had a note payable outstanding to an unrelated
Trust entity for the purchase of a banking facility site in the amount of
$400,000. The note is payable in five annual installments of $80,000, plus
interest at, seven and one-half percent (71/2%) per anum.
NOTE 11 - Pension and Profit-Sharing Plans
- ------------------------------------------
The Bank had a qualified, noncontributory defined benefit retirement plan
covering all of its eligible employees. Employees are eligible when they have
attained at least twenty-one years of age and six months of service with the
Bank. The Bank adopted a resolution on July 1, 1996 to terminate the
defined-benefit pension plan as of September 16, 1996 and to freeze benefit
accruals under the plan as of July 31, 1996. The anticipates settlement of the
related pension obligation within the next plan year.
It is expected that the plan will qualify for a standard termination under the
Internal Revenue Code for plans deemed "not in distress", meaning that plan
assets are sufficient to provide all plan liabilities under the plan.
All active participants will become fully vested in their accrued benefits.
The following table sets forth the plan's funded status and amounts recognized
in the Bank's consolidated statements of financial condition at June 30,1997 and
1996:
<TABLE>
<CAPTION>
June 30
-----------------------------
1997 1996
------------- ------------
<S> <C> <C>
Actuarial present value of benefit obligations:
Accumulated benefit obligation:
Vested ($441,321) ($297,024)
Nonvested - - (5,159)
---------- ----------
(441,321) (302,183)
Effect of projected compensation - - (108,348)
---------- ----------
Projected benefit obligation for service rendered to date (441,321) (410,531)
Plan assets at fair value 483,583 422,572
---------- ----------
Funded Status 42,262 12,041
Unrecognized net (gain) or loss from past experience
different from that assumed and effects of changes
in assumptions 15,555 15,555
Unrecognized gain on curtailment of benefit obligation 108,348 - -
Unrecognized net transition obligation (from adoption of
FASB statement No. 87) being amortized over 26.35 years 14,968 14,968
---------- ----------
Prepaid (accrued) pension cost $ 181,133 $ 42,564
========== ==========
</TABLE>
The components of net pension expense for the year ended June 30, 1997 and 1996
is as follows:
<TABLE>
<CAPTION>
June 30
-----------------------
1997 1996
----------- ----------
<S> <C> <C>
Service cost-benefits earned during the period $ -- $ 23,874
Interest cost on projected benefit obligation 30,790 27,179
Actual return on plan assets (60,011) (54,544)
Net amortization and deferral 30,221 29,059
-------- ---------
Net pension expense $ -- $ 25,568
======== =========
</TABLE>
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 11 - Pension and Profit-Sharing Plans - Continued
- ------------------------------------------------------
Assumptions used to develop the net periodic pension cost were:
<TABLE>
<S> <C> <C>
Discount rate 7.5% 7.5%
Expected long-term rate of return on assets 7.5% 7.5%
Rate of increase in compensation levels 3.5% 3.5%
</TABLE>
The actuarial values and tables were not available for the years ended June 30,
1997.
The Bank had a profit-sharing (cash bonus) program. The year end of the plan
coincides with the Bank's year end. Contributions to the profit-sharing (cash
bonus) plan are based on five percent (5%) of the net profit after taxes for the
period July 1 to May 31, of each year as the figures are available. All
employees share equally in dollar amount based on employment for the entire plan
year. Employees hired after July 1 and before June 30 of each year will
participate on a pro-rated basis. Since contributions are not guaranteed from
year to year and the computation is not determined by the board until the
calculation period of July 1 to May 31 each year, no contribution is recorded
for the profit-sharing plan for the year end June 30, 1997. Contributions for
the plan years ended June 30, 1997 and June 30, 1996 were $ 6,818 and $37,512
respectively.
Effective July 1, 1993, employees of the Bank may participate in a 401(k)
savings plan, whereby the employees may elect to make contributions pursuant to
a salary reduction agreement upon meeting the age requirement of twenty-one and
the length-of-service to the Bank requirement of one year. The Bank makes a
matching contribution of twenty percent (20%) of the first eight percent (8%) of
employee contributions. Matching contributions to the plan were $ 25,997 and
$1,188 for the year ended June 30, 1997 and 1996, respectively.
NOTE 12 - Income Taxes
- ----------------------
The Bank filed consolidated federal income tax returns on a fiscal year basis
for the years ended June 30, 1997 and 1996. If certain conditions are met in
determining taxable income, the Bank is allowed a special bad-debt deduction
based on a Percentage of taxable income (presently eight (8) percent) or on
specific experience formulas. The Bank used the percentage-of -taxable income
method in the years June 30, 1997 and 1996.
During the year end June 30, 1997 the Small Business Job Protection Act of 1996
(the 1996 Act) became effective for tax years beginning after December 31, 1995
and effected tax related deductions pertaining to reserves for bad debt. The
1996 Act repealed the internal revenue code section which in prior years allowed
using a percentage of taxable income or actual loss. In addition to the repeal
of the Code, the Bank is subject to a recapture of previously deducted
provisions to bad debt reserves for tax purposes, since 1988, which exceed the
calculations which would have been applicable using the historical "experience
method", compared to a base reserve at the end of 1988.
The estimated amount to be recaptured is approximately $738,887 with an
applicable tax component of $251,222. The 1996 Act provided for a delay in the
recapture tax payment for up to two years, if certain real estate lending
conditions are met and at the point of recapture allows the tax to be repaid
over a six year period. This potential recapture has been considered in recent
years in calculating the deferred tax liability components by a valuation
allowance of the bad debt reserves. The future calculation of the recapture tax
due to the 1996 Act, as it relates to bad debt reserves, is not expected to have
a significant effect on any future earnings.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 12 - Income Taxes - Continued
- ----------------------------------
Effective July 1, 1993 the Bank adopted Statement No. 109 of the Financial
Accounting Standards Board in accounting for income taxes. Deferred tax
components include timing differences related to depreciation, allowance for
loan loss reserves and premium and discounts on loans and investments. These are
highlighted below:
Retained earnings at June 30, 1997 and 1996, include approximately $3,462,860
for which no deferred federal income tax liability has been recognized. This
amount represents an allocation of income to bad-debt deductions for tax
purposes only. Reduction of amounts so allocated for purposes other than tax
bad-debt losses or adjustments arising from carryback of net operating losses
would create income for tax purposes only, which would be subject to the then
current corporate income tax rate. The unrecorded deferred income tax liability
in the above amounts was approximately $1,326,200 at June 30, 1997 and 1996.
The components of the deferred tax assets and liabilities at year end June 30,
1997, 1996 and 1995 are presented below:
<TABLE>
<CAPTION>
June 30,
------------------------------------------------------------
1997 1996 1995
----------------- --------------- ----------------
<S> <C> <C> <C>
Deferred Tax Assets
- -------------------
Unrealized losses on securities available for sale $ 22,259 $ 184,332 $ 11,718
Deferred compensation 181,808 93,342 --
Deferred loan origination fees 45,475 41,696 43,915
Investment securities -- 13,153 1,191
Other 14,803 -- --
------- ------- -------
Total 264,345 332,523 $ 56,824
------- ------- -------
Deferred Tax Liabilities
- ------------------------
Property and equipment 88,134 71,897 70,382
Allowance for loan losses, net of valuation
adjustment 2,653 101,359 161,104
Discounts on loans purchased 38,783 23,351 --
Investments 36,769 -- --
Other 2,078 -- --
--------- -------- -------
Total 168,417 198,313 231,486
--------- -------- -------
Net deferred tax assets $ 95,928 $ 134,210 $ 174,662
========= ======== -------
</TABLE>
Total income tax expense (benefits) for the years ended June 30, 1997, 1996 and
1995 differed from the amounts computed by applying the federal income tax rate
of 34% and the Arkansas income tax rates of 6.5% to pretax income as a result of
the following:
<TABLE>
<CAPTION>
June 30,
------------------------------------------------------
Income Tax Expense (Benefit) 1997 1996 1995
---------------------------- --------------- ------------ ---------------
<S> <C> <C> <C>
Current $ (56,271) $ 230,791 $ 819,524
Deferred (110,374) (55,990) 147,239
--------- -------- ---------
Income tax expense (benefit) $ (166,645) $ 174,801 $ 966,763
========= ======== =========
</TABLE>
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 12 - Income Taxes - Continued
- ----------------------------------
<TABLE>
<CAPTION>
June 30,
---------------------------------------------------------
1997 1996 1995
------------------ ----------------- ---------------
<S> <C> <C> <C>
Expected income tax expense (benefits) $(225,774) $ 153,879 $892,537
Goodwill amortization 61,291 9,790 --
Tax bad-debt deduction, 2,662 5,681 55,231
Other, net (4,824) 5,451 18,995
--------- -------- -------
Total income tax expense (benefits) $(166,645) $ 174,801 $966,763
========= ======== =======
Effective tax expense (benefit) rate (28,26)% 43.7% 41.7%
====== ==== =====
</TABLE>
The difference between federal and state taxable income is generally
attributable to interest income on U.S. Obligations that is tax exempt for state
taxation purposes.
NOTE 13 - Capital Requirements
- ------------------------------
FIRREA was signed into law on August 9, 1989; regulations for savings
institutions' minimum-capital requirements went into effect on December 7, 1989.
In addition to the capital requirements, FIRREA includes provisions for changes
in the federal regulatory structure for institutions, including a new deposit
insurance system, increased deposit insurance premiums, and restricted
investment activities with respect to non-investment grade corporate debt and
certain other investments. FIRREA also increases the required ratio of
housing-related assets needed to qualify as a savings institution. Regulations
require institutions to have minimum regulatory tangible capital equal to 1.5
percent of total assets a core capital ratio of 3% of adjusted assets, and a
risk-based capital ratio equal to 8% of risk adjusted assets as defined by
regulation.
FIRREA also includes restrictions on loans to one borrower, certain types of
investment and loans, loans to officers, directors' and principal stockholders,
brokered deposits, and transactions with affiliates.
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 Bank must convert to a commercial bank charter. Management considers the QTL
test to have been met.
Regulations of the Office of Thrift Supervision limit the amount of dividends
and other capital distributions that may be paid by a savings institution
without prior approval of the Office of Thrift Supervision. This regulatory
restriction is based on a three-tiered system with the greatest flexibility
being afforded to well-capitalized institutions which maintain minimum total
risk-based, Tier I risk-based, and Tier I leverage ratios. The Bank currently
meets the requirements of a Tier I institution and has not been informed by the
OTS of the need for more than normal supervision. Accordingly, the Bank can
make, without prior regulatory approval, distributions during a fiscal year up
to 100% of its net income to date during a fiscal year, plus an amount that
would reduce by one-half its "surplus capital ratio" (the excess over its Fully
Phased-in Capital Requirements) at the beginning of the fiscal year.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 13 - Capital Requirements - Continued
- ------------------------------------------
The following is a reconciliation of the Bank's equity under generally accepted
accounting principles ("GAAP") to the Bank's tangible, leveraged and risk-based
capital available to meet regulatory requirements:
<TABLE>
<CAPTION>
June 30,
-----------------------------------
1997 1996
---------------- ----------------
<S> <C> <C>
Total equity, per financial statements $ 29,061,493 $ 14,228,436
Add:
Unrealized losses on available-for-sale
securities 33,353 286,313
Less:
Intangible assets, required to be deducted (1,415,223) (1,575,296)
Advances to nonincludable subsidiaries (1,306,807) --
----------- -----------
Tangible capital 26,372,816 12,939,453
Required deductions -- --
Core capital 26,372,643 12,939,453
General allowance for loan losses 1,492,473 1,283,234
----------- -----------
Risk-based capital $ 27,865,116 $ 14,222,687
=========== ===========
</TABLE>
At June 30, 1997 and 1996, the Heartland Community Bank's actual capital amounts
and ratios are presented below:
<TABLE>
<CAPTION>
For capital Adequacy
Purposes and to Be
Adequately Capitalized
under the Prompt Corrective
Action Provisions
------------------------------------------
Actual Provisions
------------------------ ------------------------------------------
Amount Ratio Amount Ratio
----------- ---------- ---------------------- -----------------
<S> <C> <C> <C> <C>
As of June 30, 1997
- ---------------------
Total risk-based capital
(to risk weighted assets) $27,865,116 30.07% Greater-than 7,414,535 Greater-than 8.0%
Tier I capital
(to risk-weighted assets) $26,372,643 28.46% Greater-than 3,707,218 Greater-than 4.0%
Tier I capital
(to adjusted total assets) $26,372,643 13.16% Greater-than 8,017,562 Greater-than 4.0%
As of June 30, 1996
- ---------------------
Total risk-based capital
(to risk-weighted assets) $14,222,687 18.42% Greater-than 5,942,160 Greater-than 8.0%
Tier I capital
(to risk-weighted assets) 12,939,453 17.42% Greater-than 2,971,080 Greater-than 4.0%
Tier I capital
(to adjusted total assets) 12,939,453 7.43% Greater-than 6,786,401 Greater-than 4.0%
</TABLE>
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 14 - Significant Group Concentrations of Credit Risk
- ---------------------------------------------------------
The Bank grants real estate loans for 1-4 family residential housing and
consumer loans primarily in the designated trade areas within and adjacent to
Camden, Arkansas and Central Arkansas. In addition, real estate mortgage loans
for multi-family residential and commercial real estate, which meet
pre-established "loan to value" ratios and other financial criteria are also
granted in specific areas outside this trade area under the Bank's loan
diversification policies.
As of June 30, 1997 and 1996, loans secured by real estate mortgages amounted to
89% and 95% respectively, of the Bank's total consolidated loan portfolio. Real
estate mortgage loans in areas outside the Camden, Arkansas and Central Arkansas
trade areas and identified as preferred markets by the loan diversification
policy equaled 12% and 15% of the Bank's real estate loan portfolio at June 30,
1997 and 1996.
The Bank is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit (Note 6 and 19).
The Bank exposure to credit loss in the event of non-performance by the other
party to the financial instrument for commitments to extend credit is
represented by the contractual amount of these instruments. The Bank and its
subsidiary use the same credit policies in making commitments and conditional
obligations as it does for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since some of the commitments will expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. The Bank evaluates each customer's credit worthiness
on a case-by-case basis. The amount of collateral obtained, if it is deemed
necessary by the Bank upon extension of credit, is based on management's credit
evaluation of the counterpart.
NOTE 15 - Related Party Transactions
- ------------------------------------
In the normal course of business, the Bank has made loans to its directors,
officers and their related business interests. Related party loans are made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with unrelated persons and do
not involve more than the normal risk of collectability. The aggregate dollar
amount of loans outstanding to directors, officers and their related business
interests total approximately $207,805 and $435,200 as of June 30, 1997 and 1996
respectively. Activity for the year ended June 30, 1997 included loan
originations of $124,000 and repayments of $351,395.
NOTE 16 - Purchase of Subsidiary
- --------------------------------
On May 3, 1996 the Bank purchased 100% of the outstanding stock of Heartland
Community Bank, FSB (formerly Heritage Banc Holding, Inc.), a federal savings
bank, in Little Rock, Arkansas, ("FSB").
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 16 - Purchase of Subsidiary - Continued
- --------------------------------------------
The investment in FSB was $3,500,451 and was accounted for using the purchase
method. As a result of the investment, cost in excess of the fair value of net
assets of $1,600,732, was recognized and recorded as "pushed down goodwill" on
the accounts of the subsidiary. (See also Note 23)
The accompanying consolidated statement of income and cash flows for the year
ended June 30, 1996, includes the operations of the subsidiary for the year
ended June 30, 1997 and the period May 4, 1996 through June 30, 1996. The
aforementioned "goodwill" is to be amortized over a period of ten years. For the
period May 4, 1996 to June 30, 1996, $160,073 and $25,436 of amortization
expense was recorded. The following supplemental information gives proforma
effect for the subsidiary purchase, annualized for the fiscal year ended June
30, 1996.
<TABLE>
<CAPTION>
Supplemental Disclosure 1996 1995
----------------------- ---------------- --------------
<S> <C> <C>
Interest Income $ 12,145,063 $ 10,952,927
Interest Expense 7,896,737 6,341,253
----------- ----------
Net interest income 4,248,326 4,611,674
----------- ----------
Provision for loan losses 500,824 -0-
----------- ----------
3,747,502 4,611,674
Noninterest income ( 563,780) 120,577
Goodwill amortization (160,073) (160,073)
Noninterest expense (2,806,670) (2,523,182)
----------- ----------
Net income before income taxes and
cumulative effect of accounting change 216,979 2,048,996
Provision for income taxes (benefits) ( 90,046) (784,561)
Cumulative effect of accounting change (Note 1c) 77,767
----------
Net income (proforma) $ 126,933 $ 1,342,202
=========== ==========
</TABLE>
NOTE 17 - Officers' and Directors' Retirement Plan
- --------------------------------------------------
During the year ended June 30, 1996, the Bank adopted a "non-qualified"
retirement plan for its officers and directors in recognition of their years of
service to the Bank. The plan is an annuity contract plan whereas funds are to
be set aside annually in a grantor trust, with the Bank acting as trustee of the
Trust. Distributions are scheduled to be paid upon completion of six to ten
years of service to the Bank. No tax deduction for the Plan is claimed until
funds are paid to the beneficiaries.
For the years ended June 30, 1997 and 1996, the plan was funded with $232,308
and $242,511.
NOTE 18 - Change of Name to Heartland Community Bank
- -----------------------------------------------------
Subsequent to year end June 30, 1996, the Bank (formerly known as First Federal
Savings & Loan Association of Camden), applied for and obtained approval from
the proper regulatory authorities to change its name along with its
<PAGE>
wholly-owned subsidiary, Heritage Bank, FSB to "Heartland Community Bank". The
effective date of the change was effective as of September 9, 1996.
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 19 - Fair Values of Financial Instruments
- ----------------------------------------------
The estimated fair values of the Bank's consolidated financial instruments are
as follows:
<TABLE>
<CAPTION>
June 30, 1997 June 30, 1996
----------------------------------- ----------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
---------------- --------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $19,456,092 $19,456,092 $17,291,882 $17,291,882
Investment securities:
Available-for-sale 16,155,755 16,155,755 5,279,625 5,279,625
Mortgage-backed securities:
Available-for-sale 20,090,406 20,090,406 12,155,199 12,155,199
Held-to-maturity 35,869,295 36,194,353 45,212,891 44,934,074
Loans, net of allowances 98,642,635 99,131,271 84,131,024 85,344,161
Financial Liabilities
Deposits, savings and NOW
accounts 35,655,735 35,655,735 30,188,282 30,188,282
Deposits, time certificates 115,553,028 114,856,342 115,730,969 116,540,019
Advances FHLB 10,000,000 10,000,000 10,000,000 10,000,000
Unrecognized Financial
Instruments:
Commitment to extend credit $ 4,027,495 $ 4,027,495 $ 3,151,300 $ 3,151,300
========== ========== ========== ==========
</TABLE>
NOTE 20 - Incorporation of HCB Properties, Inc.
- -----------------------------------------------
In September, 1996, the Bank formed a wholly-owned subsidiary named HCB
Properties, Inc. The Bank is the sole stockholder of the Company. HCB
Properties, Inc. was formed to hold, as necessary, property acquired by the Bank
for future expansion and that in part, is expected to be sold by the Bank when
and if the original purchase does not fully meet with the future business plan
of the Bank. As of June 30, 1997, HCB Properties, Inc. held two parcels of land
and improvements due to new construction with a book value of $1,705,000. All
intercompany transactions have been eliminated in the financial statements for
the year ended June 30, 1997 respectively.
NOTE 21 - Stockholders' Equity/Stock Conversion
- -----------------------------------------------
On April 30, 1996, HCB Bancshares, Inc. completed and closed its stock offering.
Gross proceeds from the sale of 2,645,000 shares (excluding the 211,600 shares
purchased by the ESOP) amounted to $26,450,000 and were reduced by conversion
costs of $689,014. The Corporation paid $15,000,000 for all common stock of the
Bank and retained the remaining net proceeds.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 21 - Stockholders' Equity/Stock Conversion - Continued
- -----------------------------------------------------------
Concurrent with the conversion, the Bank established a liquidation account in an
amount equal to its net worth as reflected in its latest statement of financial
condition used in its final offering circular. The liquidation account will be
maintained for the benefit of eligible deposit account holders and supplemental
eligible deposit account holders who continue to maintain their deposit accounts
in the Bank after the Conversion. Only in the event of a complete liquidation
will eligible deposit account holders and supplemental eligible deposit account
holders be entitled to receive a liquidation distribution from the liquidation
account in the amount of the then current adjusted sub-account balance for
deposit accounts then held before any liquidation distribution may be made with
respect to common stockholders.
Subject to applicable law, the Board of Directors of Heartland Community Bank
and HCB Bancshares, Inc. may each provide for the payment of dividends. Future
declaration of cash dividends, if any, by the Corporation may depend upon
dividend payments by the Bank to the Corporation. Subject to regulations
promulgated by the OTS, the Bank will not be permitted to pay dividends on its
common stock if its stockholders' equity would be reduced below the amount
required for the liquidation account or its capital requirement.
In addition, as a Tier I institution, or an institution that meets all of its
fully phased-in capital requirements, the Bank may pay a cash dividend to HCB
Bancshares, Inc. With notification but without prior OTS approval, during a
calendar year an amount not to exceed the greater of (i) 100% of the Bank's net
income to date during the calendar year plus the amount that would reduce by
one-half its surplus capital ratio at the beginning of the calendar year or (ii)
75% of its net income over the most recent four quarter period. No dividend was
declared or paid during the period April 30, 1997 to June 30, 1997.
NOTE 22 - SAIF Assessment
- -------------------------
In September, 1996, the Bank and its subsidiary was assessed a one time charge
of $ 889,011. The special assessment, is to be used to replenish the SAIF
reserves depleted by prior years savings & loan industry losses. The assessment
has been charged to current operations as a current period expense in the year
ended June 30, 1997. The assessment was paid on November 27, 1996. Prior to the
"SAIF assessment", the Bank's deposit insurance rate was .23 percent.
Subsequent to the assessment, the rate of insurance on deposits decreased to
.065 percent.
NOTE 23 -Event(s) Subsequent to June 30, 1996 - Review of Allowance for Loan
- ----------------------------------------------------------------------------
Losses
- ------
During the year ended June 30, 1997, and subsequent to the issuance of the
auditors' report on the June 30, 1996 financial statements, dated August 28,
1998, the Bank's management initiated an extensive review of all existing loan
files at all locations and its subsidiary savings bank. The objectives of this
in depth detailed review was to evaluate the standardization of loan origination
and credit review practices at all Bank branches and subsidiary and update
existing loan policies for the planned growth of the Bank's loan portfolio in
the commercial, nonresidential real estate and consumer markets.
At the conclusion of the review, which was performed by selected Bank personnel
as well as a third party consultant, it was determined that a substantial
shortfall existed in the allowance for loan losses at the subsidiary savings
bank due to a combination of loan file documentation weaknesses and an increase
in past due loans. After further review of the loan review procedures performed
and resulting findings, it was determined that an addition to the allowance was
required and that the circumstances that gave rise to the needed increase were
in two categories.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 23 -Event(s) Subsequent to June 30, 1996 - Review of Allowance for Loan
- ----------------------------------------------------------------------------
Losses - Continued
- ------------------
Those categories were for conditions existing as of the date of acquisition of
the subsidiary savings bank, which was May 3, 1996, and in part to circumstances
and events that had occurred or materialized subsequent to June 30, 1996.
Therefore, the consolidated financial statements as of June 30, 1996 and for the
year then ended, were restated to give effect for the resulting revision to the
acquired allowance for loan losses of the subsidiary savings bank and the
related accrued and deferred income taxes. In addition, as referenced above, a
determination was made by management that a provision to the allowance for loan
losses of the subsidiary savings bank was necessary for the year ended June 30,
1997. A summary of the amounts and net effects on the statements for the year
ended June 30, 1996, herein included, are presented below:
<TABLE>
<CAPTION>
1996
--------------
<S> <C>
Increase provision to allowance to loan losses None
Increase in amortization of goodwill (expense) 4,998
Increase in cost in excess of fair value (goodwill) 344,498
Net change in accrued and deferred income tax (benefits) (1,803)
</TABLE>
NOTE 24 - Employment Agreements
- -------------------------------
During 1996, the Association entered into employment agreements with three key
executive officers to ensure a stable and competent management base. The
agreements provide for three-year term, but upon each anniversary, the
agreements will automatically extend so that the remaining term shall always be
three years unless the Board of Directors expressly acts to limit the extension.
The agreements provide for benefits as spelled out in the contract and cannot be
terminated by the Board of Directors, except for cause, without prejudicing the
officer's right to receive vested rights, including compensation, for the
remaining term of the agreements. In the event of a change in control of the
Association and termination of the officers, as defined in the agreement, the
officers will receive a lump sum equal to 2.99 times their average salary paid
during the prior five years.
NOTE 25 - Employee Stock Ownership Plan
- ---------------------------------------
The Association has established an employee stock ownership plan (ESOP) to
benefit substantially all employees. The ESOP originally purchased 211,600
shares of common stock in the Conversion with proceeds received from a loan from
the Corporation.
The Corporation's note receivable is to be repaid based upon one principal
installment of $125,675 on June 30, 1997, one principal installment of $297,525
on June 30, 1998 and eight installments of $211,600 on June 30th each year
through 2006. Interest is based upon prime, which will be adjusted and paid
quarterly. The note may be prepaid without penalty. The unallocated shares of
stock held by the ESOP are pledged as collateral for the debt. The ESOP is
funded by contributions made by the Bank in amounts sufficient to retire the
debt. At June 30, 1997, the outstanding balance of the note receivable is
$1,990,325 and is presented as a reduction of stockholders' equity.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 25 - Employee Stock Ownership Plan - Continued
- ---------------------------------------------------
Shares released as the debt is repaid and earnings from the common stock held by
the ESOP are allocated among participants on the basis of compensation in the
year of allocation. Benefits become 100% vested after five years of credited
service. Forfeitures of nonvested benefits will be reallocated among remaining
participating employees in the same proportion as contributions.
Dividends on unallocated shares may be used by the ESOP to repay the debt to the
Corporation and are not reported as dividends in the financial statements.
Dividends on allocated or committed to be allocated shares are credited to the
accounts of the participants and reported as dividends in the financial
statements.
Expense of $195,308 during 1997 has been incurred in connection with the ESOP.
The expense includes, in addition to the cash contribution necessary to fund the
ESOP, $36,130, which represents the difference between the fair market value of
the shares which have been released or committed to be released to participants,
and the cost of these shares to the ESOP. The Association has credited this
amount to paid-in capital in accordance with the provisions of AICPA Statement
of Position 93-6.
At June 30, 1997, 12,568 shares held by the ESOP have been released or committed
to be released to the plan's participants. The fair value of the unallocated
shares amounted to approximately $2,562,537 at June 30, 1997.
NOTE 26 - Future Reporting Requirements
- ---------------------------------------
The Financial Accounting Standards Board has issued SFAS No. 123, Accounting for
Stock-Based Compensation which the Corporation has not been required to adopted
as of June 30, 1997. The Statement, which will be in effect for the
Corporation's fiscal year ending June 30, 1998, will require that the
Corporation account for stock based compensation plans using a fair value based
method which measures compensation cost at the grant date based upon the value
of the award, which is then recognized over the service period, usually the
vesting period. The accounting requirements of the Statement apply to grants or
awards entered into in fiscal years that begin after December 15, 1995. The
Statement allows entities to continue to use APB Opinion No. 25 to measure
compensation cost, but requires that the proforma effects on net income and
earnings per share be disclosed to reflect the difference between the
compensation cost, if any, from applying APB Opinion No. 25 and the related cost
measured by the air value method defined in the Statement. The Statement is not
expected to have a material impact on the Corporation's accounting for stock
compensation plans because (I) the Statement does not apply to the ESOP plan nor
will it change the accounting requirements of the proposed restricted stock
plan, and (ii) the Corporation expects to account for proposed stock option
plans using the accounting treatment permitted under APB Opinion No. 25.
In June 1996, the Financial Accounting and Standards Board (the"FASB") issued
SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." SFAS No. 125 provides accounting and reporting
standards for transfers and servicing of financial assets and extinguishments of
liabilities based on 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, derecognizes financial assets when control has
been surrendered and derecognizes liabilities when extinguished. This statement
is effective for transfers and servicing of financial assets and extinguishments
of liabilities occurring after December 31, 1996, and is to be applied
prospectively. Related to SFAS No. 125 the FASB has issued SFAS No. 127 which
delays the effective date for certain transactions until after December 31,
1997. Earlier or retroactive application is not permitted.
<PAGE>
HCB BANCSHARES, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 26 - Future Reporting Requirements - Continued
- ---------------------------------------------------
Effective for accounting periods ending after December 15, 1997, SFAS No. 128,
"Earnings per Share," replaces the presentation of primary EPS with a
presentation of basic EPS. It also requires dual presentation of basic and
diluted EPS on the face of the income statement of all publicly held companies
with complex capital structure.
The FASB has issued SFAS No. 129, "Disclosure of Information about Capital
Structure," effective for periods ending after December 15, 1997. This statement
presents standards for disclosing information about an entity's capital
structure. It applies to all entities and continues previous requirements to
disclose certain information about an entity's capital structure. Examples of
the information required to be disclosed include dividend and liquidation
preferences, participation rights, call features, conversion or exercise prices
and pertinent dates, sinking fund requirements and unusual voting rights.
NOTE 27 - Events and Purchase Commitments subsequent to June 30, 1997
- ----------------------------------------------------------------------
In July, 1997 the Bank completed the construction of one of two new branch
facilities which were under construction at June 30, 1997. The second branch
facilty was opened by the end of August, 1997. The expected capital outlay to
complete both of these projects was not to exceed $1,156,000.
In addition to the above, the Bank entered into a contract during the year ended
June 30, 1997 to upgrade its computer and communications network. The contract
was for $400,000 and the project was partially complete as of year end June 30,
1997. The balance remaining on the contract, subject to completion of
installation and training, was $142,000.
<PAGE>
HEARTLAND COMMUNITY BANK, FSB
(formerly Heritage Banc Holding, Inc.)
AND SUBSIDIARY
Consolidated Statements of Income
For the year ended June 30, 1995 and the period July 1, 1995 to May 3, 1996
<TABLE>
<CAPTION>
July 1, 1995 to June 30,
Interest Income May 3, 1996 1995
- --------------- --------------- -------------
<S> <C> <C>
Interest and fees on loans $ 1,515,653 $ 1,589,616
Investment securities 119,514 249,658
Mortgage-backed and related securities 123,933 109,715
Other interest income 56,846 159,156
------------- -------------
Total interest income $ 1,815,946 $ 2,108,145
------------- -------------
Interest Expense
- ----------------
Deposits (Note 8) $ 1,052,448 $ 1,123,359
Borrowed funds 559 15,025
Notes payable 77,133 90,388
------------- -------------
Total interest expense $ 1,130,140 $ 1,228,772
------------- -------------
Net interest income $ 685,806 $ 879,373
Provision for loan losses (Note 4) $ 458,341 $ - -
------------- -------------
Net interest income after provision for loan losses $ 227,465 $ 879,373
------------- -------------
Noninterest Income
- ------------------
Net realized gain (loss) on sales of available
for sale securities (Note 14) $ - - $ (245,223)
Amortization of negative goodwill 63,040 75,648
Other income 133,319 94,129
------------- -------------
Total noninterest income (loss) $ 196,359 $ (75,446)
------------- -------------
Noninterest Expense 1996 1995
- ------------------- ------------- -------------
Salaries and compensation $ 330,563 $ 442,801
Occupancy and equipment 81,968 87,277
Federal deposit insurance premiums 48,787 55,821
Data processing expenses 62,866 72,029
Professional fees 6,025 19,741
Other expenses 175,395 235,552
------------- -------------
Total noninterest expense $ 705,604 $ 913,221
------------- -------------
Income (loss) before income tax expense (benefit) $ (281,780) $ (109,294)
Provision for income tax (benefit) (88,873) (57,877)
------------- -------------
Net income (loss) $ (192,907) $ (51,417)
============= =============
</TABLE>
See notes to unaudited consolidated financial statements.
<PAGE>
HEARTLAND COMMUNITY BANK, FSB
(formerly Heritage Banc Holding, Inc.)
AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity
For the year ended June 30, 1995 and the period July 1, 1995 to May 3, 1996
<TABLE>
<CAPTION>
July 1, 1995 to June 30,
Common Stock May 3, 1996 1995
- ------------ ----------------- -------------
<S> <C> <C>
Common stock; $20 par value; 1,000 shares $ 20,000 $ 20,000
issued and outstanding
Additional Paid-in Capital
- --------------------------
Balance beginning of period $ 601,300 $ 601,300
Additional contributed capital 1,470,800 1,470,800
------------- -------------
Balance end of period $ 2,072,100 $ 2,072,100
------------- -------------
Retained Earnings
- -----------------
Balance beginning of period $ 343,667 $ 436,584
Net income (loss) (192,907) (51,417)
Dividends paid (57,000) (41,500)
------------- -------------
Balance end of period $ 93,760 $ 343,667
------------- -------------
Unrealized Depreciation on Securities
- -------------------------------------
Available for Sale
------------------
Balance beginning of period $ (51,359) $ (218,690)
Net increase (decrease), net
of applicable deferred income taxes 19,247 167,331
------------- -------------
Balance end of period $ (32,112) $ (51,359)
------------- -------------
Total equity at period end $ 2,185,860 $ 2,384,408
============= =============
</TABLE>
See notes to unaudited consolidated financial statements.
<PAGE>
HEARTLAND COMMUNITY BANK, FSB
(formerly Heritage Holding, Inc.)
AND SUBSIDIARY
Consolidated Statements of Cash Flow
For the year ended June 30, 1995 and the period July 1, 1995 to May 3, 1996
<TABLE>
<CAPTION>
July 1, 1995 to June 30,
Cash Flows from Operating Activities May 3, 1996 1995
- ------------------------------------ ------------- -------------
<S> <C> <C>
Net Income (Loss) $ (192,907)$ (51,417)
------------- -------------
Adjustments to reconcile net income to cash provided by operating
activities:
Depreciation $ 26,052 $ 25,012
Amortization Deferred loan origination fees 5,791 (7,990)
Amortization Negative goodwill (63,040) (75,648)
Amortization Premiums and discounts on investment securities, loans (10,240) 24,755
Provision for loan loss 458,341 - -
Net (gain) loss on sale of investments: - - 245,223
Decrease (increase) in accrued interest receivable (15,761) 28,452
Increase in accrued interest payable (40,469) 75,142
(Increase) decrease in other assets 88,343 (36,857)
Increase in other liabilities (43,967) 39,698
(Increase) decrease in prepaid / payable income taxes (87,220) (44,334)
------------- -------------
Total adjustments $ 317,830 $ 273,453
------------- -------------
Net cash flows provided (used) by operating activities $ 124,923 $ 222,036
------------- -------------
Cash Flows from Investing Activities:
- ------------------------------------
Loan originations and principal payments on loans $ (2,479,546)$ (1,299,129)
Proceeds from sale of investment securities: - - 4,198,178
Purchase of investment securities available for sale (463,000) (2,100,000)
Principal payments on investment securities 1,372,720 1,575,984
Purchases of premises and equipment (144,935) (488,096)
------------- -------------
Net cash flows used by investing activities $ (1,714,761)$ 1,886,937
------------- -------------
Cash Flows from Financing Activities:
- ------------------------------------
Net increase (decrease) in demand deposits, NOW accounts, passbook
savings accounts and certificates of deposits $ (790,839)$ 1,498,938
Net (decrease) increase in mortgage escrow funds (82,037) 40,860
Dividends paid (57,000) (41,500)
Payment of FHLB advances - - (650,000)
------------- -------------
Net cash flows provided (used) by financing activities $ (929,876)$ 848,298
------------- -------------
Net increase (decrease) in cash and cash equivalents $ (2,519,714)$ 2,957,271
Cash and cash equivalents, beginning of year $ 4,582,661 $ 1,625,390
------------- -------------
Cash and cash equivalents, end of year $ 2,062,947 $ 4,582,661
============= =============
Supplemental disclosures of cash flow information:
- -------------------------------------------------
Cash paid during the period for:
Interest $ 1,093,322 $ 1,048,289
Income taxes $ 17,500 $ 26,500
</TABLE>
See notes to unaudited consolidated financial statements.
---------
<PAGE>
HEARTLAND COMMUNITY BANK, FSB
(formerly Heritage Banc Holding, Inc.)
AND SUBSIDIARY
Notes to Consolidated Financial Statements
For the year ended June 30, 1995 and the period July 1, 1995 to May 3, 1996
(UNAUDITED)
NOTE 1 - Summary of Significant Accounting Policies
- ---------------------------------------------------
Basis of Consolidation
- ----------------------
The consolidated financial statements as of the year ended June 30, 1995 and the
period July 1, 1995 to May 3, 1996 include the accounts of Heritage Banc
Holding, Inc. and its wholly-owned subsidiary, Heritage Bank, FSB. All material
intercompany balances and transactions have been eliminated in the
consolidation. The unaudited statements reflect all adjustments, consisting of
normal recurring accruals, which are in the opinion of management, necessary for
fair presentation of the results of operations, changes in stockholders' equity
and cash flows for the period July 1, 1994 to May 3, 1996.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-END> JUN-30-1997
<CASH> 1,182,210
<INT-BEARING-DEPOSITS> 18,273,882
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 36,246,161
<INVESTMENTS-CARRYING> 35,869,295
<INVESTMENTS-MARKET> 36,194,353
<LOANS> 98,642,635
<ALLOWANCE> 1,492,473
<TOTAL-ASSETS> 200,365,778
<DEPOSITS> 151,208,763
<SHORT-TERM> 10,000,000
<LIABILITIES-OTHER> 1,417,502
<LONG-TERM> 0
0
0
<COMMON> 2,645
<OTHER-SE> 37,736,868
<TOTAL-LIABILITIES-AND-EQUITY> 200,365,778
<INTEREST-LOAN> 8,038,783
<INTEREST-INVEST> 4,436,436
<INTEREST-OTHER> 626,457
<INTEREST-TOTAL> 13,101,676
<INTEREST-DEPOSIT> 7,534,445
<INTEREST-EXPENSE> 8,195,782
<INTEREST-INCOME-NET> 4,905,894
<LOAN-LOSSES> 221,671
<SECURITIES-GAINS> (21,215)
<EXPENSE-OTHER> 5,578,934
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