<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 1999
Commission File Number: 0-22423
HCB BANCSHARES, INC.
---------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
<TABLE>
<S> <C>
Oklahoma 62-1670792
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(State or Other Jurisdiction of Incorporation (I.R.S. Employer
or Organization) Identification No.)
237 Jackson Street, Camden, Arkansas 71701-3941
- ---------------------------------------- -------------------
(Address of Principal Executive Offices) (Zip Code)
</TABLE>
Registrant's telephone number, including area code: (870) 836-6841
--------------
Securities registered pursuant to Section (b) of the Act: None
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) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
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, as of a
specified date within the past 60 days: $12,587,729 (1,307,816 shares at the
last sale price on August 31, 1999 ($9.625 per share); for this purpose,
directors, executive officers and 5% stockholders 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: 2,294,821 shares of common
stock as of August 31, 1999.
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DOCUMENTS INCORPORATED BY REFERENCE
The following lists the documents incorporated by reference and the Part of
the Form 10-K into which the document is incorporated:
1. Portions of Annual Report to Stockholders for the Fiscal Year Ended June 30,
1999. (Part II)
2. Portions of Proxy Statement for the 1999 Annual Meeting of Stockholders.
(Part III)
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
HCB BANCSHARES, INC. HCB Bancshares, Inc. ("Bancshares") 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, 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"). The consolidated financial statements include the accounts of
Bancshares and the Bank and are collectively referred to as the "Company". All
significant intercompany balances and transactions have been eliminated in
consolidation.
Prior to the Conversion, Bancshares did not engage in any material
operations. Since the Conversion, Bancshares has had no significant assets other
than the outstanding capital stock of the Bank, a portion of the net proceeds of
the Conversion and notes receivable, one of which is from the Employee Stock
Ownership Plan ("ESOP"). Bancshares principal business is the business of the
Bank. At June 30, 1999, the Company had consolidated total assets of $285.4
million, savings deposits of $146.3 million and stockholders' equity of $32.1
million, or 11.3% of total assets.
The holding company structure permits Bancshares to expand the financial
services currently offered through the Bank. As a holding company, Bancshares
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. Bancshares is classified as a unitary savings
institution holding company and is subject to regulation by the Office of Thrift
Supervision ("OTS"). As long as Bancshares remains a unitary savings institution
holding company, under current law it can diversify its activities in such a
manner as to include any activities allowed by law or regulation to a unitary
savings institution holding company. See "Regulation -- Regulation of Bancshares
- -- 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 at that time were 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.
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<PAGE> 3
On February 23, 1998 the Bank sold all of the shares of stock of Heritage
Banc Holding, Inc., parent of its subsidiary savings bank, HEARTLAND Community
Bank, FSB ("FSB"), pursuant to an agreement between the Bank and the Bank of the
Ozarks, Inc. ("BOO"). Upon completion of the transaction and pursuant to the
terms of the agreement, the Bank acquired the loans and certain other assets and
non-deposit liabilities of the Little Rock, Arkansas branch of FSB and all
assets and liabilities of the Monticello, Arkansas branch and the Bryant,
Arkansas loan production office of FSB and BOO acquired the savings deposits and
premises and equipment of the Little Rock, Arkansas branch of FSB, as well as
FSB's holding company charter and stock. This transaction was substantively a
branch sale. Also at such time, Bancshares became a unitary rather than a
multiple savings institution holding company.
The Bank itself currently operates through five full service banking
offices located in Camden (2), Fordyce, Sheridan, and Monticello, Arkansas and a
loan production office in Bryant, Arkansas. Historically, the principal business
strategy of the Bank, like most other savings institutions in Arkansas and
elsewhere, has been to accept savings 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.
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 installation of ATMs, the
introduction of debit cards and an 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) complementing the
Bank's internally generated growth, by 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 and Bryant areas,
management expects to find significant deposit growth and lending opportunities
throughout central and southern Arkansas.
As a federally chartered savings institution, the Bank is subject to
extensive regulation by the OTS. The Bank's lending activities and other
investments must comply with various federal regulatory requirements, and the
OTS periodically examines the Bank for compliance with various regulatory
requirements. The Federal Deposit Insurance Corporation ("FDIC") also has the
authority to conduct special examinations. The Bank 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 Regulatory Changes"
below.
3
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PROPOSED LEGISLATIVE AND REGULATORY CHANGES
Both the U.S. House of Representatives and Senate have passed legislation
which calls for the modernization of the banking system and which would
significantly affect the operations and regulatory structure of the financial
services industry, including savings institutions like the Bank. At this time,
management does not know what form the final legislation might take, or if
enacted into law, how the legislation would affect the Company's business and
competitive environment. For additional information on the provisions of this
legislation, see "Regulation of the Bank -- Proposed Legislative and Regulatory
Changes."
MARKET AREA
Management considers the Bank's primary market area to comprise the
following counties in Arkansas: Calhoun, Cleveland, Dallas, Drew, Grant, Saline
and Ouachita. To a lesser extent, the Bank accepts savings deposits and offers
loans throughout the remainder of central and southern Arkansas.
In recent years, population has experienced low to moderate growth in Drew
and Grant 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.
Household income has been well above the Arkansas average in Grant County 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 County, 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, SAU Tech and UA-Monticello.
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, and both regional and local 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 loan products, interest rates and the quality of
personal service. Competition for origination of real estate loans normally
comes from other savings institutions, commercial banks, credit unions and
mortgage companies.
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. Competing financial
institutions offer a wide 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. Management expects to
continue and to expand on these types of lending.
4
<PAGE> 5
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 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, 1999, the maximum aggregate amount
that the Bank could have lent to any one borrower under the 15% limit was $4.6
million. At such date, the largest aggregate amount of loans that the Bank had
outstanding to any one borrower was $3.8 million. However, Bancshares may
participate in loans to one borrower thereby permitting loans to one borrower to
be made by the Bank and Bancshares lending together that exceed the Bank's
regulatory loan limit. At June 30, 1999, the Bank's and Bancshares' loans to the
borrower referred to above totaled approximately $6.2 million with Bancshares
carrying $2.4 million of the loan.
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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, 1999, the Bank had no concentrations of loans
exceeding 10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
At June 30,
------------------------------------------------------------------------
1999 1998 1997
--------------------- ------------------- -----------------
Amount % Amount % Amount %
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Type of Loan
- ------------
Real estate loans:
One- to four-family residential $ 53,622,417 43.74% $ 49,267,399 44.75% $ 62,340,601 60.90%
Multi-family loans 9,226,426 7.53 12,577,034 11.43 8,873,156 8.67
Non-residential 41,907,368 34.18 35,321,040 32.08 18,814,701 18.38
Loans to facilitate sale of
foreclosed real estate -- -- 473,476 0.43 616,660 0.60
Land and other mortgage loans 3,547,514 2.89 598,860 0.54 483,236 0.47
Consumer loans:
Loans secured by savings deposits 2,021,141 1.65 2,215,441 2.01 2,434,621 2.38
Home improvement 125,990 0.10 1,291,174 1.17 1,665,244 1.63
Auto 4,269,898 3.48 4,070,750 3.70 2,399,648 2.34
Other consumer 2,517,190 2.05 1,569,076 1.43 2,629,442 2.58
Commercial 5,367,611 4.38 2,708,927 2.46 2,101,963 2.05
------------ ------- ------------ ------ ------------ ------
Total $122,605,555 100.00% $110,093,177 100.00% $102,359,272 100.00%
------------ ------- ------------ ------ ------------ ------
Less:
Loans in process $ 6,150,810 $ 3,921,787 $ 2,057,095
Deferred loan fees and discounts (37,339) 122,679 167,069
Allowance for loan losses 1,329,201 1,468,546 1,492,473
------------ ------------ -----------
Total $115,162,883 $104,580,165 $98,642,635
============ ============ ===========
<CAPTION>
At June 30,
-----------------------------------------------------
1996 1995
------------------------ ------------------------
Amount % Amount %
------ --- ------ ---
<S> <C> <C> <C> <C>
Type of Loan
- ------------
Real estate loans:
One- to four-family residential $ 61,650,286 70.79% $ 36,844,183 65.23%
Multi-family loans 6,819,212 7.83 4,928,219 8.73
Non-residential 13,746,549 15.78 11,367,097 20.12
Loans to facilitate sale of
foreclosed real estate 720,749 0.83 1,144,993 2.03
Land and other mortgage loans 36,944 0.04 53,044 0.09
Consumer loans:
Loans secured by savings deposits 1,832,180 2.10 1,623,155 2.87
Home improvement 204,776 0.24 5,340 0.01
Auto 786,656 0.90 42,070 0.07
Other consumer 418,027 0.48 344,452 0.61
Commercial 880,311 1.01 132,877 0.24
------------- ------ ------------ ------
Total $ 87,095,690 100.00% $ 56,485,430 100.00%
------------- ------ ------------ ------
Less:
Loans in process $ 1,544,097 $ 529,862
Deferred loan fees and discounts 137,335 114,097
Allowance for loan losses 1,283,234 728,491
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Total $ 84,131,024 $ 55,112,980
============= ============
</TABLE>
6
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z
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, at June 30, 1999. 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 After
Due Within One Through Due After
One Year Five Years Five Years Total
---------- ----------- ---------- -----
(In thousands)
<S> <C> <C> <C> <C>
Real estate loans:
One- to four-family mortgage loans.......... $ 4,745 $ 7,998 $ 40,879 $ 53,622
Other mortgage loans......................... 10,417 17,975 26,290 54,682
Commercial loans............................... 2,901 1,075 1,392 5,368
Consumer loans:
Loans secured by savings deposits............ 1,617 362 42 2,021
Other....................................... 932 5,070 911 6,913
------------ -------------- ------------- -----------
Total..................................... $ 20,612 $ 32,480 $ 69,514 $ 122,606
============ ============== ============= ===========
</TABLE>
The following table sets forth dollar amounts of loans due one year or more
after June 30, 1999 that had predetermined interest rates and that had
adjustable interest rates at that date.
<TABLE>
<CAPTION>
Predetermined Floating or
Rates Adjustable Rates Total
------------- ---------------- -------
(In thousands)
<S> <C> <C> <C>
Real estate loans:
One- to four-family mortgage loans................. $ 39,693 $ 9,184 $ 48,877
Other mortgage loans............................... 21,107 23,158 44,265
Commercial loans..................................... 2,432 35 2,467
Consumer loans:
Loans secured by savings deposits.................. 404 -- 404
Other consumer loans............................... 5,981 -- 5,981
------------- ------------- -----------
Total............................................ $ 69,617 $ 32,377 $ 101,994
============= ============= ===========
</TABLE>
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.
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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,
------------------------------------------------------------------
1999 1998 1997
----------- ------------ ---------
<S> <C> <C> <C>
Loans originated:
Real estate loans:
One- to four-family residential.............. $ 24,486,365 $ 9,242,608 $ 9,175,000
Other mortgage loans......................... 18,804,077 19,404,722 11,579,200
Commercial loans............................... 7,350,903 3,098,085
Consumer loans................................. 5,380,714 5,437,188 4,276,008
------------------ ---------------- ------------------
Total loans originated...................... $ 56,022,059 $ 37,182,603 $ 25,030,208
================== ================ ==================
Loans purchased:
Real estate loans.............................. $ -- $ 8,257,199 $ 1,305,000
================== ================ ==================
Loans sold....................................... $ 13,140,464 $ 4,952,961 $ 1,084,100
================== ================ ==================
</TABLE>
The Bank has increased both its scope of loan products offered and its loan
origination efforts, including the addition of new consumer and commercial
business loan offerings with 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 one large homebuilder with which the Bank has a long-standing
relationship. The Bank's experience with its purchased loans has been
successful. In light of the Bank's increased loan originations, management has
reduced the Bank's loan purchasing activities.
The Bank originates long term, fixed-rate, single-family loans and sells
them to investors in the secondary market. Management expects the Bank to
increase its origination of selected types of loans that do not meet the Bank's
loan portfolio needs, such as long-term fixed-rate residential mortgage loans
for sale to investors.
ONE- TO FOUR-FAMILY RESIDENTIAL LENDING. Historically, the Bank's principal
lending activity has been the origination of fifteen-year fixed-rate first
mortgage loans 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 $44,000. At
June 30, 1999, $53.7 million, or 43.7%, 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
approved shifting the Bank's one- to four-family residential lending emphasis in
the future away from the origination of such loans for the Bank's portfolio and
toward the origination of such loans for sale. Currently, it is the Bank's
policy to originate all 30-year term one- to four-family residential loans in
accordance with the investor's underwriting guidelines and to sell all such
originations promptly to investors, servicing released. Such loan originations
and sales have become significant. One-to-four-family residential loans
originated during the year totaled $24.5 million with $14.8 million or 60% of
originations sold or to be sold in the secondary market. The Bank will continue
to make non-conforming loans to be held in the Bank's portfolio. Management
expects to continue these policies in the future.
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<PAGE> 9
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% 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, 1999, the Bank's loan portfolio included
$3,204,704 of loans secured by one-to four-family 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 interest 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, and by requiring the involvement of qualified builders.
COMMERCIAL AND MULTI-FAMILY REAL ESTATE LENDING. The Bank offers commercial
and multi-family real estate loans in order to benefit from the higher interest
rates than could be obtained from investment securities. 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. During the year ended June 30, 1999, the Bank formed a
relationship with a Little Rock broker who referred several commercial real
estate loans to the Bank. It is anticipated that the Bank will continue to make
loans through these brokers 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.
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 emphasis on increasing this
portfolio 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 above loan officers' approved
lending authorities, generally $150,000, are reviewed and approved by the Bank's
lending committees at the headquarters in Camden prior to any funding or the
issuance of any binding commitment by the Bank.
The Bank's commercial real estate loans may be secured by offices,
warehouses, shopping centers, nursing homes, single-family subdivision
developments and other income-producing and commercial properties. Multi-family
real estate loans are collateralized by greater than one- to four- family
residential properties. At June 30, 1999, the Bank had 178 of commercial and
multi-family loans, with an average loan balance of approximately $266,000. At
that date, 53 of these loans totaling approximately $12,499,604 were secured by
properties outside Arkansas, and none of these out-of-market loans were
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.
9
<PAGE> 10
The Bank's commercial and multi-family real estate loans generally are
limited to loans not exceeding $2,500,000 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 20 years.
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. The Bank's consumer loans primarily consist of loans
secured by savings deposits at the Bank and automobiles. These loans totaled
$2,021,141 and $4,269,898, respectively, at June 30, 1999. 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
while increasing the Bank's portfolio yields and improving its asset/liability
management.
The Bank makes certificate of deposit 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. 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.
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
10
<PAGE> 11
on the Bank's loan origination and administration increase and as the Bank's
aggregate exposure to these types of loans increases.
COMMERCIAL BUSINESS LENDING. The Bank currently offers working capital
loans, floor plan loans to dealers of automobiles and recreational vehicles, and
business equipment loans. At June 30, 1999, the Bank's commercial business loans
totaled $5,367,611 and primarily consisted of recreational vehicle floor plan
loans and equipment loans. At that date, the Bank had one commercial business
loan with an outstanding balance or loan commitment exceeding $500,000. The loan
is secured by new recreational vehicles at a RV dealership in Little Rock. The
loan requires regular payments of interest monthly, and the Bank requires
principal paydowns as vehicles are sold and periodically in accordance with
specified curtailment schedules. At June 30, 1999, the Bank had committed to
lend up to $1,000,000, the outstanding balance was $970,944, 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. The
Bank's loan officers as well as branch presidents originate loans. 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. The Bank attempts to determine the impact, if any, of year 2000 computer
issues on the borrower's business.
It is the Bank's policy to record a lien on the real estate securing the
loan and to obtain a title insurance policy that insures 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.
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 committees
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
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.
11
<PAGE> 12
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 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 level yield
method. If expenses exceed fees, the excess is deferred and amortized to expense
over the loan's contractual life using the level yield method. If a loan is
prepaid, refinanced or sold, all remaining deferred fees/costs with respect to
such loan are taken into income or recognized in expense 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 re-classification, and the Board of Directors reviews
and approves all classifications. The Bank contracts with a third-party
professional to perform loan reviews generally on a semi-annual basis, including
classification of assets and an assessment of the adequacy of the loan loss
reserve. As of June 30, 1999, the Bank had no assets classified as loss or
doubtful, $2.4 million of assets classified as substandard, and $0.7 million of
assets designated as special mention. The Bank's total adversely classified or
designated assets represented approximately 1.09% of the Bank's total assets and
10.3% of the Bank's tangible regulatory capital at June 30, 1999. 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. At June 30,
1999, 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.
Management also reviews the loss factors to determine whether they are
current and relevant. Differences between estimated and actual losses have been
insignificant for several years. However, if the losses experienced change
significantly, a determination is made as to which factors utilized should be
adjusted prospectively.
Homogeneous loans are those that are considered to have common
characteristics that provide for evaluation on an aggregate or pool basis. The
Company considers the characteristics of (1) one-to four-family residential
first mortgage loans; (2) automobile loans; and (3) consumer and home
improvement loans to permit consideration of the appropriateness of the
allowance for losses of each group of loans on a pool basis. The primary
methodology used to determine the appropriateness of the allowance for losses
includes segregating certain specific, poorly performing loans based on their
performance characteristics from the pools of loans as to type and then
12
<PAGE> 13
applying a loss factor to the remaining pool balance based on several factors
including classification of the loans as to grade, past loss experience,
inherent risks, economic conditions in the primary market areas and other
factors which usually are beyond the control of the Company.
Non-homogeneous loans are those loans that can be included in a particular
loan type, such as commercial loans and multi-family and commercial first
mortgage loans, but which differ in other characteristics to the extent that
valuation on a pool basis is not valid. After segregating specific, poorly
performing loans and applying the methodology as noted in the preceding
paragraph for such specific loans, the remaining loans are evaluated based on
payment experience, known difficulties in the borrower's business or geographic
area, loss experience, inherent risks and other factors usually beyond the
control of the Company. These loans are then graded and a factor, based on
experience, is applied to estimate the probable loss.
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 and may require adjustment. However, no
adjustment has been requested by regulators.
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.
At the date of foreclosure or other repossession, the Bank records the
property at fair value, less estimated costs to sell. 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, 1999, 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 at foreclosure is
charged-off against the allowance for loan losses. 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 differ from the net carrying value of the property, a gain or loss 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.
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 as to the appropriateness of the allowance.
13
<PAGE> 14
During the year ended June 30, 1999, in light of the Bank's loan portfolio
review, the Bank made no additional provisions for loan losses bringing the
total reserve for losses after net charged-off loans to $1.3 million, or 1.08%
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,
--------------------------------------------------------------------
1999 1998 1997 1996 1995
--------- -------- -------- -------- ------
<S> <C> <C> <C> <C> <C>
Balance at beginning of period.................... $ 1,468,546 $ 1,492,473 $ 1,283,234 $ 728,491 $ 728,491
----------- ----------- ----------- ----------- ----------
Loans charged-off:
Real estate mortgage:
One- to four-family residential............... 26,883 5,466 11,317 12,130 --
Other mortgage loans.......................... -- -- -- -- --
Commercial........................................ 37,742 -- -- -- --
Consumer.......................................... 79,632 43,100 11,668 -- --
----------- ----------- ----------- ----------- ----------
Total charge-offs................................. 144,257 48,566 22,985 12,130 --
----------- ----------- ----------- ----------- ----------
Recoveries:
Real estate mortgage:
One- to four-family residential............... 865 -- 6,333 250 --
Other mortgage loans.......................... -- -- -- -- --
Commercial...................................... -- -- -- -- --
Consumer........................................ 4,047 639 4,220 -- --
----------- ----------- ----------- ----------- ----------
Total recoveries.................................. 4,912 639 10,553 250 --
----------- ----------- ----------- ----------- ----------
Net loans charged-off............................. 139,345 47,927 12,432 11,880 --
----------- ----------- ----------- ----------- ----------
Acquisition of subsidiary......................... -- -- -- 524,140 --
Provision for loan losses......................... -- 24,000 221,671 42,483 --
----------- ----------- ----------- ----------- ----------
Balance at end of period.......................... $ 1,329,201 $ 1,468,546 $ 1,492,473 $ 1,283,234 $ 728,491
=========== =========== =========== =========== ==========
Ratio of net charge-offs to average
loans outstanding during the period............. .13% .05% .013% 0.018% --%
========== ========== ========== ========== =========
</TABLE>
The increase in consumer loans from June 30, 1996 to June 30, 1999 has
resulted in increased charge-offs during the year ended June 30, 1999. Allowance
for loan losses allocated to consumer loans has increased generally in
proportion to the level of such lending.
14
<PAGE> 15
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>
At June 30,
---------------------------------------------------------------------------
1999 1998 1997
---------------------- ----------------------- -----------------------
Percent of Percent of Percent of
Loans in Loans in Loans in
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
------ ----------- ------ ----------- ------ -----------
<S> <C> <C> <C> <C> <C> <C>
Allocated to:
Real estate loans:
One- to four-family residential..... $ 422,000 43.7% $ 504,000 45.18% $ 954,093 61.50%
Multi-family and non-residential
loans............................. 603,000 44.6 557,000 44.05 296,018 27.52
Consumer loans........................ 101,000 7.3 123,000 8.31 67,700 8.93
Commercial............................ 82,000 4.4 72,000 2.46 81,250 2.05
Unallocated........................... 121,201 212,546 -- 93,412 --
----------- ------ ------------ ------ ---------- ------
Total.......................... $ 1,329,201 100.00% $ 1,468,546 100.00% $1,492,473 100.00%
=========== ====== ============ ====== ========== ======
<CAPTION>
At June 30,
----------------------------------------------------
1996 1995
------------------------ ---------------------
Percent of Percent of
Loans in Loans in
Category to Category to
Amount Total Loans Amount Total Loans
------ ----------- ------ -----------
<S> <C> <C> <C> <C>
Allocated to:
Real estate loans:
One- to four-family residential..... $ 935,354 71.62% $ 600,856 67.26%
Multi-family and non-residential
loans............................. 278,650 23.65 125,000 28.94
Consumer loans........................ 17,635 3.72 2,635 3.56
Commercial............................ -- 1.01 -- 0.24
Unallocated........................... 51,595 -- -- --
---------- ------ --------- ------
Total.......................... $1,283,234 100.00% $ 728,491 100.00%
========== ====== ========= ======
</TABLE>
15
<PAGE> 16
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.
While management believes the Bank has established its existing loss allowances
in accordance with generally accepted accounting principles, there can be no
guarantee or assurance that such allowances are, or in the future will be,
adequate to absorb all loan losses or that regulators, in reviewing the Bank's
assets, will not require the Bank to increase its loss allowance, thereby
negatively affecting the Bank's reported financial condition and results of
operations.
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 set forth in Item 8 herein.
<TABLE>
<CAPTION>
At June 30
---------------------------------------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- ------- -------- ------
<S> <C> <C> <C> <C> <C>
Loans accounted for on a nonaccrual basis: (1)
Real estate:
One- to four-family residential.............. $ 462,205 $ 648,012 $ 133,386 $ 166,228 $ 165,009
Other mortgage loans......................... 22,139 -- -- -- --
Consumer....................................... 81,648 138,747 -- -- --
------------- ------------ -------------- ------------- -----------
Total........................................ $ 565,992 $ 786,759 $ 133,386 $ 166,228 $ 165,009
============= ============ ============== ============= ===========
Accruing loans which are contractually past due
90 days or more:
Real estate:
One- to four-family residential.............. $ -- $ 41,770 $ 323,478 $ 725,487 $ 502,064
Other mortgage loans......................... -- -- -- -- --
Consumer loans................................. -- -- 56,904 127,142 5,525
------------- ------------ -------------- ------------- -----------
Total........................................ $ -- $ 41,770 $ 380,382 $ 852,629 $ 507,589
============= ============ ============== ============= ===========
Total nonperforming loans.................... $ 565,992 $ 828,529 $ 513,768 $ 1,018,857 $ 672,598
============= ============ ============== ============= ===========
Percentage of total loans........................ 0.46% 0.75% 0.50% 1.17% 1.19%
==== ==== ==== ==== ====
Other nonperforming assets (2)................... $ 20,289 $ 17,001 $ 65,005 $ 168,206 $ 659,917
============= ============ ============== ============= ===========
Loans modified in troubled debt restructurings... $ -- $ 392,000 $ 281,441 $ 298,195 $ 313,970
============= ============ ============== ============= ===========
</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, 1999 and 1998, gross interest income of
$48,032 and $18,012, 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 $14,237 and $14,292, respectively.
At June 30, 1999, management had identified approximately $2.0 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
provide for increased monitoring of 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,
$757,555 was attributable to 19 one- to four-family residential loans, and
$904,000
16
<PAGE> 17
was attributable to 11 commercial or multi-family real estate loans. At June 30,
1999, 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, savings 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 which savings banks are
required to maintain. See "Regulation -- Regulation of the Bank -- 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 stockholders' equity. Subsequent to June 30, 1998, the Bank
adopted FAS 133. The rules for adopting this accounting standard allow a
one-time reclassification of securities designated as "held to maturity." In
order to provide greater flexibility in asset/liability and portfolio
management, the Bank reclassified all of its held to maturity securities into
the "available for sale" designation upon adoption of FAS 133.
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.
17
<PAGE> 18
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 media and by communication with the
issuer when necessary. At June 30, 1999, no privately issued securities were
rated below AA except as follows:
A Citicorp Mortgage, Inc. REMIC Pass-Through Class A Certificate was
rated "CC" by S&P. The downgrade reflected deterioration in the performance
of the mortgage pools underlying the security. At June 30, 1999, the Bank
estimated the value of the security at approximately $149,121 less than its
face value. The Bank's carrying value for this security at that date was
approximately $306,281 after recognition of impairment loss.
A Western Federal Savings and Loan Association Mortgage Pass-Through
Class 89-1 A Certificate was rated "A2" by Moody. The downgrade reflected a
deterioration of the mortgage pools underlying the security and weak
servicing. As of June 30, 1999, the deterioration affected the credit
support and not the principal or interest of the security itself. The
security's rating is still considered investment grade and management
anticipates no loss of principal or interest on this security. The Bank's
carrying value for this security as of June 30, 1999 was $252,285.
A DLJ Mortgage Acceptance Corp. Pass-Through Class A-3 Certificate was
rated "BAA3" by Moody. The downgrade reflected deterioration in the
performance of the mortgage pools underlying the security. As of June 30,
1999, the deterioration affected the credit support and not the principal
or interest of the security itself. The security's current rating is still
considered investment grade and management anticipates no loss of principal
or interest on this security. The Bank's carrying value for this security
at that date was $595,695.
The Bank's privately issued securities consist of collateralized mortgage
obligations (CMOs) and mortgage pass-through securities. At June 30, 1999, all
of the privately issued securities had adjustable interest rates with a weighted
average yield of 6.29% and a weighted average term to maturity of 22.3 years.
The carrying value of the privately issued securities was $9,685,831, or 8.5% of
the mortgage-backed securities and CMOs at that date. None of the privately
issued securities are 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 upon the interest income and the
amortization of the premium or accretion of the discount related to the
mortgage-backed security. Premiums and discounts on mortgage-backed securities
are amortized or accreted over the estimated term of the securities using a
level yield method. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed security, and these assumptions are reviewed
periodically to reflect the actual prepayment. The actual prepayments of the
underlying 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.
18
<PAGE> 19
The following table sets forth information regarding carrying values of the
Company's investment securities at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------------------
1999 1998 1997
----------- ------------ ---------
<S> <C> <C> <C>
Securities available for sale:
U.S. government and agencies............ $ 6,368,125 $ 22,491,930 $ 17,260,383
Municipal securities.................... 26,704,416 18,283,877 --
Collateralized mortgage obligations..... 12,346,191 9,673,443 6,161,779
Other mortgage-backed securities........ 101,640,582 49,023,666 12,200,208
Equity securities....................... 60,375 -- --
------------------ ------------------ ------------------
$ 147,119,689 $ 99,472,916 $ 35,622,370
================== ================== ==================
Securities held to maturity:
U.S. government and agencies............ $ -- $ -- $ --
Collateralized mortgage obligations..... -- 3,984,684 5,836,502
Other mortgage-backed securities........ -- 23,518,573 30,656,584
------------------ ------------------ ------------------
$ -- $ 27,503,257 $ 36,493,086
================== ================== ==================
Total................................ $ 147,119,689 $ 126,976,173 $ 72,115,456
================== ================== ==================
</TABLE>
19
<PAGE> 20
The following table sets forth information regarding scheduled maturities
of the Company's investment portfolio at June 30, 1999. Yields on municipal
securities are not tax-effected.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years
--------------------- --------------------- ---------------------
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
------- ------- ------- --------- ------- ---------
<S> <C> <C> <C> <C> <C> <C>
U.S. government and agencies..... $ -- -- % $3,451,875 6.25% $ 2,916,250 6.46%
Municipal securities............. -- -- -- 450,925 4.80
Collateralized mortgage
obligations................... -- -- -- --
Other mortgage-backed securities. 573,494 7.10 386,887 9.32 11,764,429 6.64
---------- ---------- -----------
Total......................... $ 573,494 7.10% $3,838,762 6.56% $15,131,604 6.55%
========== ==== ========== ==== =========== ====
Equity securities................
<CAPTION>
More than Ten Years Total Investment Portfolio
------------------------ ------------------------------------
Carrying Average Carrying Market Average
Value Yield Value Value Yield
--------- --------- --------- ------- --------
<S> <C> <C> <C> <C> <C>
U.S. government and agencies..... $ -- -- % $ 6,368,125 $ 6,368,125 6.34%
Municipal securities............. 26,253,491 4.95 26,704,416 26,704,416 4.95
Collateralized mortgage
obligations................... 12,346,191 6.29 12,346,191 12,346,191 6.29
Other mortgage-backed securities. 88,915,772 6.28 101,640,582 101,640,582 6.34
------------ ----------- -----------
Total......................... $127,515,454 6.01% 147,059,314 147,059,314 6.08%
============ ==== =====
Equity securities................ 60,375 60,375
----------- ------------
$147,119,689 $ 147,119,689
============ =============
</TABLE>
20
<PAGE> 21
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 deposit base, 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 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 to compensate for reductions in the availability of
funds, or for general operational purposes. The Bank has access to advances from
the FHLB of Dallas.
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. The Bank on a periodic
basis establishes maturities, terms, service fees and withdrawal penalties for
its deposit accounts. 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
certificates of 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.
The following table sets forth information regarding interest-bearing
average deposit balances and rates during the periods presented.
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------------------------------------------------------
1999 1998 1997
----------------------- ----------------------- --------------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
NOW accounts.................... $ 10,505,515 1.46% $ 6,101,535 2.73% $ 5,858,963 3.07%
Money market savings deposits... 20,474,110 3.57 17,937,404 4.13 18,333,058 4.23
Savings deposits - passbook..... 7,325,746 2.81 8,136,269 2.95 7,792,066 3.02
Certificates of deposit......... 103,414,235 5.35 112,427,056 5.41 116,980,504 5.42
----------- ---- ------------ ---- ------------- ----
Total....................... $141,719,606 4.67 $144,602,264 5.03 $ 148,964,591 5.06
============ ==== ============ ==== ============= ====
</TABLE>
21
<PAGE> 22
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>
Balance at Balance at
June 30, % of Increase June 30, % of Increase
1999 Deposits (Decrease) 1998 Deposits (Decrease)
------------- -------- ---------- ------------ -------- ----------
<S> <C> <C> <C> <C> <C> <C>
NOW accounts.................... $ 12,411,932 8.49% $ 1,747,386 $ 10,664,546 7.51% $ 1,274,321
Money market savings deposits... 17,619,341 12.04 (765,494) 18,384,835 12.95 577,342
Savings deposits - passbook..... 7,971,447 5.45 458,840 7,512,607 5.29 (929,238)
Certificates of deposit......... 108,293,878 74.02 2,924,536 105,369,342 74.25 (10,183,686)
------------- ------ ---------- ------------ ----- -----------
$146,296,598 100.00% $ 4,365,268 $141,931,330 100.00% $(9,261,261)
============ ====== ============ ============ ====== ===========
<CAPTION>
Balance at
June 30, % of
1997 Deposits
------------ --------
<S> <C> <C>
NOW accounts.................... $ 9,390,225 6.21%
Money market savings deposits... 17,807,493 11.78
Savings deposits - passbook..... 8,441,845 5.58
Certificates of deposit......... 115,553,028 76.43
------------ ------
$151,192,591 100.00%
============ ======
</TABLE>
22
<PAGE> 23
The following table sets forth information regarding certificates of
deposits classified by rates at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
----------------------------------------------
1999 1998 1997
-------- ------- -------
<S> <C> <C> <C>
4.00 - 5.99%......................... $ 107,158,894 $ 96,276,980 $ 99,606,159
6.00 - 7.99%......................... 1,134,984 9,092,362 15,946,869
-------------- ------------- ------------
$ 108,293,878 $ 105,369,342 $115,553,028
============== ============= ============
</TABLE>
The following table sets forth information regarding amounts and maturities
of certificates of deposits at June 30, 1999.
<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%..... $ 78,633,549 $ 22,202,622 $ 6,241,142 $ 81,581 $ 107,158,894
6.00 - 7.99%..... 906,715 200,198 20,301 7,770 1,134,984
--------------- ---------------- ---------------- -------------- ------------------
$ 79,540,264 $ 22,402,820 $ 6,261,443 $ 89,351 $ 108,293,878
=============== ================ ================ ============== ==================
</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, 1999.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------- ----------
<S> <C>
Three months or less....................................... $ 2,136,246
Over three through six months.............................. 2,225,519
Over six through 12 months................................. 4,340,324
Over 12 months............................................. 2,747,867
------------
Total.................................................. $ 11,449,956
============
</TABLE>
The following table sets forth information regarding savings activities of
the Bank for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------------------------------------
1999 1998 1997
-------- -------- -------
<S> <C> <C> <C>
Net decrease before
interest credited.................... $ (2,521,766) $ (5,923,685) $ (2,261,105)
Deposits divested...................... -- (8,541,747) --
Interest credited...................... 6,887,034 5,204,171 7,534,445
------------- -------------- -------------
Net increase (decrease) in
savings deposits................. $ 4,365,268 $ (9,261,261) $ 5,273,340
============= ============== =============
</TABLE>
BORROWINGS. 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
23
<PAGE> 24
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 with 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, first mortgage loans and mortgage-backed investment securities. During
the past year, the Bank has significantly increased its level of FHLB advances,
and used such advances to invest in investment securities. For further
information, see "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Asset/Liability Management."
The following tables set forth certain information regarding borrowings by
the Bank for the periods indicated. Averages are based on monthly balances.
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------------------------------------
1999 1998 1997
-------- -------- ------
<S> <C> <C> <C>
Amounts outstanding at end of period:
FHLB advances...................................... $ 104,523,419 $ 68,121,068 $ 10,000,000
Weighted average rate.............................. 5.63% 5.89% 6.20%
Maximum amount of borrowings outstanding
at any month end:
FHLB advances...................................... $ 104,523,419 $ 68,121,068 $ 12,500,000
Approximate average borrowings during the year
outstanding with respect to:
FHLB advances...................................... $ 95,124,165 $ 27,108,184 $ 10,208,333
Weighted average rate.............................. 5.73% 6.07% 6.23%
</TABLE>
SUBSIDIARY ACTIVITIES
As a federally chartered savings bank, the Bank is 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, 1999 on a consolidated basis
the Bank was authorized to invest up to approximately $5.7 million 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, 1999, the Bank's aggregate investment in, and loans
to, the subsidiary service corporation totaled $570,928.
24
<PAGE> 25
REGULATION OF THE BANK
GENERAL. As a federally chartered savings institution the Bank 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 Bank for compliance with various regulatory
requirements. The FDIC also has the authority to conduct special examinations of
the Bank because its savings deposits are insured by the SAIF. The Bank must
file reports with the OTS describing its activities and financial condition and
also is 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".
PROPOSED LEGISLATIVE AND REGULATORY CHANGES. The U.S. Congress has been in
the process of drafting legislation that may have a profound effect on the
financial services industry for the past several years. In January 1999
legislation restructuring the activities and regulations oversight of the
financial services industry was reintroduced in both houses of the U.S.
Congress. The stated purposes of the legislation are to enhance consumer choice
in the financial services marketplace, level the playing field among providers
of financial services and increase competition and permit affiliations between
commercial banks, securities firms, insurance companies and, subject to certain
limitations, other commercial enterprises allowing holding companies to offer
new services and products. In particular, the legislation repeals the
Glass-Steagall Act prohibitions on banks affiliating with securities firms and
thereby allows holding companies to engage in securities underwriting and
dealing without limits and to sponsor and act as distributor for mutual funds.
The legislation also removes the Bank Holding Company Act's prohibitions on
insurance underwriting allowing holding companies to underwrite and broker any
type of insurance product, calls for a new regulatory framework for financial
institutions and their holding companies and preserves the thrift charter and
all existing thrift powers. Both the House and Senate passed separate versions
of this legislation. The Senate bill differs from the House's principally with
respect to the powers of operating subsidiaries, permissible activities of
well-managed holding companies and restrictions on nonfinancial activities of
unitary thrift holding companies. At this time, it is unknown how the
legislation will be modified, or if enacted, what form the final version of the
legislation might take and how it will affect Bancshares' and the Bank's
business and operations and competitive environment.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member 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 a member of the FHLB of Dallas,
the Bank is 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
its home mortgage loans, home purchase contracts and similar obligations at the
beginning of each year, or 1/20 of its 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 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, 1999, the Bank had $104.5 million in advances outstanding
with the FHLB of Dallas. See " -- Deposit Activity and Other Sources of Funds --
Borrowings."
LIQUIDITY REQUIREMENTS. The Bank is required to maintain average daily
balances of liquid assets (cash, savings 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 than
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 4%) of
their net withdrawable deposits plus short-term
25
<PAGE> 26
borrowings. Monetary penalties may be imposed for failure to meet liquidity
requirements. The average regulatory ratio of liquid assets for the Bank on June
30, 1999 was 33.9%.
QUALIFIED THRIFT LENDER TEST. The Bank is subject to OTS regulations that
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.
REGULATORY CAPITAL REQUIREMENTS. Under OTS capital standards, savings
institutions must maintain "tangible" capital equal to at least 1.5% of tangible
assets, "core" capital equal to at least 4% 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 savings 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.
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, 1999,
the Bank had no investments in, or extensions of credit to, non-includable
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
includable 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
includable subsidiaries, and, for purposes of the core capital requirement,
qualifying supervisory goodwill.
26
<PAGE> 27
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 savings deposits
that do not qualify as core capital, certain approved subordinated debt, certain
other capital instruments, a portion of the institution's general loan loss
allowances and up to 45% of unrealized gains on equity securities. Total core
and supplementary capital are reduced by the amount of capital instruments held
by other depository institutions pursuant to reciprocal arrangements, the
portion of the savings institution's land loans and non-residential construction
loans in excess of an 80% loan-to-value ratio and equity investments other than
those deducted from core and tangible capital. At June 30, 1999, the Bank had
three land or non-residential construction loans in excess of an 80%
loan-to-value ratio for a deduction of $107,000, 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 the Bank relative to its
various regulatory capital requirements at June 30, 1999.
<TABLE>
<CAPTION>
Percent of
Amount Assets(1)
------ ----------
(Dollars in thousands)
<S> <C> <C>
Tangible capital........................... $ 30,063 10.50%
Tangible capital requirement............... 4,293 1.50
------------- -------
Excess.................................. $ 25,770 9.00%
============= =======
Core capital............................... $ 30,063 10.50%
Core capital requirement................... 11,448 4.00
------------- -------
Excess.................................. $ 18,615 6.50%
============= =======
Total capital.............................. $ 31,285 25.44%
Risk-based capital requirement............. 9,840 8.00
------------- -------
Excess.................................. $ 21,445 17.44%
============= =======
</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.
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, 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
27
<PAGE> 28
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 Bank is required to pay assessments based on a
percentage of its insured savings deposits to the FDIC for insurance of its
savings 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 savings deposits or at a higher percentage of estimated
insured savings 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.
Historically, institutions with SAIF-assessable savings deposits, like the
Bank, paid higher deposit insurance premiums than institutions with savings
deposits insured by the Bank Insurance Fund ("BIF") administered by the FDIC. In
order to recapitalize the SAIF and rectify the premium disparity, the Deposit
Insurance Funds Act of 1996 authorized the FDIC to impose a one-time special
assessment on institutions with SAIF-assessable savings 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 savings deposits.
Institutions were assessed at the rate of 65.7 basis points based on the amount
of their SAIF-assessable savings deposits as of March 31, 1995. As a result of
the special assessment the Bank incurred a pre-tax expense totaling
approximately $889,000 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 to zero for "well
capitalized" institutions with the highest supervisory ratings and 0.31% of
insured savings deposits for institutions in 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.
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 Bank would qualify for insurance of savings 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 BIF-insured institutions a
competitive advantage over SAIF-insured institutions. The reduction of the SAIF
deposit insurance premiums effectively eliminated this disparity and could have
the effect of increasing the net income of the Bank and restoring the
competitive equality between BIF-insured and SAIF-insured institutions.
28
<PAGE> 29
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% on transaction accounts of between $4.9 million and $46.5
million plus 10% on the remainder. 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 Bank is required by OTS regulations to give the OTS 30 days'
prior notice of any proposed declaration of dividends.
OTS regulations require that savings institutions submit notice to the OTS
prior to making a capital distribution if (a) they would not be well-capitalized
after the distribution, (b) the distribution would result in the retirement of
any of the institution's common or preferred stock or debt counted as its
regulatory capital, or (c) the institution is a subsidiary of a holding company.
A savings institution must make application to the OTS to pay a capital
distribution if (x) the institution would not be adequately capitalized
following the distribution, (y) the institution's total distributions for the
calendar year exceeds the institution's net income for the calendar year to date
plus its net income (less distributions) for the preceding two years, or (z) the
distribution would otherwise violate applicable law or regulation or an
agreement with or condition imposed by the OTS. If neither the savings
institution nor the proposed capital distribution meet any of the foregoing
criteria, then no notice or application is required to be filed with the OTS
before making a capital distribution. The OTS may disapprove or deny a capital
distribution if in the view of the OTS, the capital distribution would
constitute an unsafe or unsound practice.
Under the OTS prompt corrective action regulations, the Bank 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 Tier
1 (core) capital ratio of less than 4.0%. See " -- Prompt Corrective Regulatory
Action." The OTS, after consultation with the FDIC, however, may permit an
otherwise prohibited stock repurchase if made in connection with the issuance of
additional shares in an equivalent amount and the repurchase will reduce the
institution's financial obligations or otherwise improve the institution's
financial condition.
In addition to the foregoing, earnings of the Bank appropriated to bad debt
reserves and deducted for federal income tax purposes are not available for
payment of cash dividends or other distributions to Bancshares without payment
of taxes at the then current tax rate on the amount of earnings removed from the
reserves for such
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distributions. See "Federal Income Taxation." Bancshares intends to make full
use of this favorable tax treatment afforded to the Bank, and does not
contemplate use of any post-Conversion earnings of the Bank in a manner which
would limit the 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 a savings institution is any company or
entity which controls, is controlled by or is under common control with the
institution. In a holding company context, the parent holding company of an
institution (such as Bancshares) 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 Bank, prohibits the Bank 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 Bank 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 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.
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<PAGE> 31
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 savings
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
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-
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satisfactory rating for any CAMELS rating category. As of June 30, 1999, the
Bank was 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 Bank already meets substantially all the standards adopted in
the interagency guidelines, and therefore does not believe that implementation
of these regulatory standards will materially affect the Bank's 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 Bank's operations.
The federal banking agencies have also established Year 2000 readiness
safety and soundness guidelines requiring all insured depository institutions to
implement procedures by specified key dates to ensure the institution can
continue business operations after January 1, 2000. Every institution must
identify its internal and external "mission-critical" systems (i.e., those
systems vital to the continuance of a core business activity) and develop a
written plan establishing priorities, oversight and reasonable deadlines to
complete the testing and renovation of mission-critical systems. In addition, an
institution must prepare a written business resumption contingency plan that (i)
defines scenarios where mission-critical systems might fail, (ii) evaluates
contingency options to keep business operations going, and (iii) provides for
testing of the contingency plan by an independent party. Every depository
institution must also identify among its customers those persons that represent
a material risk to the institution in the event the customer is not Year 2000
compliant and implement appropriate risks controls to manage and mitigate the
customer's Year 2000 risk to the institution. The federal banking agencies
continue to monitor the institution's overall progress in meeting the Year 2000
readiness guidelines. In the event an institution has failed to renovate its
mission-critical systems or is not on schedule with key dates, the institution
must draft a remediation contingency plan outlining alternative strategies to
comply with the guidelines and locate available third party providers. The
agencies, in their sole discretion, may take actions under the FDICIA, the
safety and soundness guidelines or any other action available to them, including
enforcement action, to ensure an institution's Year 2000 readiness. For
additional information, see "Year 2000 Readiness Disclosure" in the Annual
Report appearing in Item 7 herein.
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REGULATION OF BANCSHARES
GENERAL. Bancshares is a savings institution holding company as defined by
the Home Owners' Loan Act. As such, it is registered with the OTS and is subject
to OTS regulation, examination, supervision and reporting requirements. As a
subsidiary of a savings institution holding company, the Bank is subject to
certain restrictions in its dealings with Bancshares and affiliates thereof.
Bancshares also is required to file certain reports with, and otherwise comply
with the rules and regulations of, the Securities and Exchange Commission
("SEC") under the federal securities laws.
ACTIVITIES RESTRICTIONS. The Board of Directors of Bancshares presently
intends to continue operating as a unitary savings institution holding company.
There are generally no restrictions on the activities of a unitary savings
institution holding company. However, 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. Notwithstanding the above
rules as to permissible business activities of unitary savings institution
holding companies, if the savings institution subsidiary of such a holding
company fails to meet the QTL test, then such unitary holding company shall also
presently become subject to the activities restrictions applicable to multiple
holding companies and, unless the savings institution requalifies as a QTL
within one year thereafter, register as, and become subject to, the restrictions
applicable to a bank holding company. See "Regulation of the Bank -- Qualified
Thrift Lender Test." Legislative initiatives have been introduced in the U.S.
Congress which could result in the imposition of restrictions on the activities
of unitary savings institution holding companies in the future. See "Proposed
Legislative and Regulatory Changes."
If Bancshares were to acquire control of another savings institution, other
than through merger or other business combination with the Bank, Bancshares
would thereupon become a multiple savings institution holding company. Except
where such acquisition is pursuant to the authority to approve emergency thrift
acquisitions and where each subsidiary savings institution meets the QTL test,
the activities of Bancshares and any of its subsidiaries (other than the Bank or
other subsidiary savings institutions) would thereafter be subject to further
restrictions. Among other things, no multiple savings 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 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.
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
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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 Section 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 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. Bancshares' 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. Bancshares 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 Bank 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 Bank which met certain definitional
tests and other conditions prescribed by the Internal Revenue Code benefited
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 was 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
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debt reserve deduction for qualifying real property loans was computed as 8% of
a savings institution's taxable income, with certain adjustments. The Bank
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 Bank 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 debt reserves have already been
accrued as a deferred tax liability. The regulatory authorities have not
examined the Bank's federal income tax returns in the past five years.
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 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,
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 Bank is 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 Bank is subject to Arkansas corporation income tax which is 6.5% of all
taxable earnings when income exceeds $100,000. Bancshares is incorporated under
Oklahoma law and qualified to do business in Arkansas as a foreign corporation,
and accordingly it incurs certain franchise and other taxes, which management
believes are not material.
EMPLOYEES
As of June 30, 1999, the Bank had 82 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.
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ITEM 2. PROPERTIES
The following table sets forth information regarding the Bank's offices at
June 30, 1999.
<TABLE>
<CAPTION>
YEAR OWNED OR APPROXIMATE
OPENED LEASED BOOK VALUE SQUARE FOOTAGE
------ ------ ---------- --------------
<S> <C> <C> <C> <C>
Main Office:
237 Jackson Street, SW 1933 Owned $ 311,321 12,000
Camden, Arkansas
Branch Offices:
22461 Interstate 30, Suite 1100A 1996 Leased -- 1,800
Landers Corporate Plaza
Bryant, Arkansas
1100 Fairview Road,
Suite 208 1981 Owned 158,126 1,200
Camden, Arkansas
610 West 4th Street 1969 Owned 815,676 3,500
Fordyce, Arkansas
473 Highway 425 North 1996 Owned 1,286,038 7,400
Monticello, Arkansas
108 South Main 1996 Owned 1,114,256 5,500
Sheridan, Arkansas
</TABLE>
In addition to the offices described above, at June 30, 1999 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 $1,229,659 of which $443,189 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 $6.5 million at June 30, 1999. See Note 7 of
the Notes to Consolidated Financial Statements in the Annual Report to
Stockholders for June 30, 1999.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Bank is a party to various legal proceedings
incident to its business. At June 30, 1999, except as set forth below, there
were no legal proceedings to which the Company was a party, or to which any of
its property was subject, which were expected by management to result in a
material loss to the Company. In
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<PAGE> 37
addition, there were no pending regulatory proceedings to which the Company or
any of its properties was a party, which were expected to result in a material
loss.
During the year ended June 30, 1998, a circuit court entered a judgment
against the Bank in the amount of $78,000 for breach of contract regarding its
alleged failure to provide a party the right to purchase real estate formerly
used as a branch location. The Bank has appealed the judgment to the court of
appeals. The Bank and its counsel believe there is a reasonable likelihood that
the merits of the case will result in a reversal of the lower court's decision.
No accrual of this possible loss has been made in the Consolidated Financial
Statements as of June 30, 1999.
In May, 1999, a shareholder filed a class action complaint against the
Company and several current and former officers alleging that the defendants
defrauded the plaintiff and other shareholder class members through various
public statements and reports thereby artificially inflating the price of the
Company's common stock and causing the plaintiff and other shareholder class
members to purchase the Company's common stock at inflated prices.
The Company and its counsel have reviewed the complaint and intend to
contest the allegations vigorously. Management is unable to determine the
likelihood of an unfavorable outcome of the suit or the amount of damages that
the Company may have to pay, if any. The Company will incur costs through the
payment of legal fees and the related costs of litigation. The extent of these
costs is not determinable at this time.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on May 13, 1999.
2,258,573 shares of the Company's common stock were represented at the Annual
Meeting in person or by proxy.
Stockholders voted in favor of the election of two nominees for director.
The voting results for each nominee were as follows:
<TABLE>
<CAPTION>
VOTES IN FAVOR
NOMINEE OF ELECTION VOTES WITHHELD
<S> <C> <C>
Vida H. Lampkin 2,134,366 124,207
Clifford Steelman 2,135,266 123,307
</TABLE>
There were 63,625 broker nonvotes on the matter.
37
<PAGE> 38
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information contained under the section "Market for Common Stock
and Related Stockholder Matters" in the Annual Report is incorporated herein by
reference.
ITEM 6. SELECTED FINANCIAL DATA
The information contained in the table captioned "Selected
Consolidated Financial and Other Data" in the Annual Report is incorporated
herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in the
Annual Report is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The information contained in the section captioned "Market Risk" in
the Annual Report is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements contained in the Annual Report, which are
listed under Item 14 herein, are incorporated herein by reference.
38
<PAGE> 39
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. Effective June 18, 1998,
the Company dismissed Miller, England & Company, as the Company's independent
accountants. Effective October 1, 1998, the Company engaged Deloitte & Touche
LLP, Little Rock, Arkansas, as the Company's independent auditors. For
additional information, see the Company's Current Reports on Form 8-K dated June
25, 1997, June 25, 1998 and October 7, 1998, each of which is incorporated
herein by reference (File No. 0-22423).
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information concerning the Board of Directors and executive
officers of the Company, the information contained under the section captioned
"Proposal I -- Election of Directors" in the Company's definitive proxy
statement for the Company's 1999 Annual Meeting of Stockholders (the "Proxy
Statement") which will be filed within 120 days of the Company's fiscal year end
and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information contained under the sections captioned "Director
Compensation" and "Executive Compensation" in the Proxy Statement is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Information required by this item is incorporated herein by reference
to the section captioned "Voting Securities and Beneficial Ownership"
in the Proxy Statement.
(b) SECURITY OWNERSHIP OF MANAGEMENT
Information required by this item is incorporated herein by reference
to the sections captioned "Securities Ownership of Management" in the
Proxy Statement.
(c) CHANGES IN CONTROL
Management of the Company knows of no arrangements, including any
pledge by any person of securities of the Company, the operation of
which may at a subsequent date result in a change in control of the
registrant.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference
to the section captioned "Transactions with Management" in the Proxy Statement.
39
<PAGE> 40
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,
1999 and 1998
Consolidated Statements of Operations for the years ended June
30, 1999, 1998 and 1997
Consolidated Statements of Stockholders' Equity for the years
ended June 30, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the years ended June
30, 1999, 1998 and 1997
Notes to Consolidated Financial Statements for the years ended
June 30, 1999, 1998 and 1997
(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.
(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 *+
</TABLE>
40
<PAGE> 41
<TABLE>
<S> <C>
10.5 Heartland Community Bank Directors' Retirement Plan, as amended*+
21 Subsidiaries
23.1 Consent of Deloitte & Touche, LLP
23.2 Consent of Miller, England & Company
27 Financial Data Schedule
</TABLE>
- ----------
* Incorporated by reference to the Company's Registration Statement on Form
SB-2 (File No. 333-19093).
+ Management contract or compensatory plan or arrangement.
(b) REPORTS ON FORM 8-K. During the last quarter of the period covered by
this report, the Registrant filed two Current Reports on Form 8-K. On May 14,
1999, the Company reported under Item 5 that a class action complaint had been
filed against it in the United States Court for the Eastern District of Texas.
On June 2, 1999, the Company reported under Item 5 that it had received
regulatory approval to acquire up to an additional 10% of its outstanding common
stock.
(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.
41
<PAGE> 42
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 23, 1999 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.
<TABLE>
<S> <C>
By: /s/ Vida H. Lampkin September 23, 1999
---------------------------------------------------
Vida H. Lampkin
Chairman of the Board, President and Chief
Executive Officer
(Principal Executive Officer)
By: /s/ Scott A. Swain September 23, 1999
---------------------------------------------------
Scott A. Swain
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
By: /s/ Cameron D. McKeel September 23, 1999
---------------------------------------------------
Cameron D. McKeel
Director and Vice President
By: /s/ Roy Wayne Moseley September 23, 1999
---------------------------------------------------
Roy Wayne Moseley
Director
By: /s/ Bruce D. Murry September 23, 1999
---------------------------------------------------
Bruce D. Murry
Director
By: /s/ Carl E. Parker, Jr. September 23, 1999
---------------------------------------------------
Carl E. Parker, Jr.
Director
By: /s/ Lula Sue Silliman September 23, 1999
---------------------------------------------------
Lula Sue Silliman
Director
By: /s/ Clifford Steelman September 23, 1999
---------------------------------------------------
Clifford Steelman
Director
</TABLE>
<PAGE> 1
EXHIBIT 13
HCB BANCSHARES, INC.
ANNUAL REPORT
1999
<PAGE> 2
[LETTERHEAD]
To Our Stockholders:
The past year has included a number of significant achievements for HCB
Bancshares, Inc., making our Company stronger, safer, and better equipped to
pursue our goals of excellent customer service, growth, expansion, and growing
profitability.
In November, 1998, after more than two years of planning and preparation, we
converted our data processing from a service bureau's 1970s model to an
ultra-modern client-server system. Our new system will carry us into the highly
competitive years ahead with the ability to offer virtually any product or
service. Since that November conversion, we have introduced imaged statements,
combined statements, Optional Overdraft Protection Service, customer-selected
PIN numbers, and our new Privileges checking accounts for customers age 50 or
better, with several more products currently in development.
Several key additions to our staff have enhanced our ability to succeed.
Experienced and productive lending personnel, both residential and commercial,
have brought an explosion of new business to our Bryant office. The combination
of a new chief financial officer, a new financial accounting manager, and a new
controller, all with years of experience in those roles with other institutions,
have added considerable strength to our financial accounting systems. The
addition of a new officer to our loan administration staff has been a key factor
in the installation of new systems for loan document preparation and document
exception tracking. All of these additions make us faster, stronger, and more
profitable.
In the aftermath of a decline in the price of our stock, we completed a buyback
of 132,250 shares, which was 5% of our outstanding stock. We subsequently
received regulatory approval of another buyback, this time for 10%, and it is
still in progress, further increasing shareholder value.
After an intensive review of our internal controls, we have developed an
aggressive program of continuing audit of internal controls, bank operations,
and financial accounting. Augmented by outside professionals in the fields of
compliance, accounting, and audit, our internal audit program includes quarterly
reports to our Directors Audit Committee, with emphasis on early detection of
exceptions to established policies and procedures.
With these changes -- new information technology, new but experienced people,
and new, stronger systems of internal controls and audit -- we foresee our
increasing ability to provide customer service unmatched by our competitors,
internal growth due to a broader array of products and excellent customer
service, the opportunity and ability to open new branches and to acquire other
institutions, and increasing profitability. May the current year continue to
show progress toward those goals.
Vida H. Lampkin
Chairman of the Board, President and Chief Executive Officer
<PAGE> 3
HCB BANCSHARES, INC.
HCB Bancshares, Inc. ("Bancshares") 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, upon the conversion of the
Bank from mutual to stock form, which was completed on April 30, 1997 (the
"Conversion"). The accompanying consolidated financial statements include the
accounts of Bancshares and the Bank and are collectively referred to as the
"Company". All significant intercompany balances and transactions have been
eliminated in consolidation.
Prior to the Conversion, Bancshares did not engage in any material
operations. Bancshares has no significant assets other than the outstanding
capital stock of the Bank, a portion of the net proceeds of the Conversion and
notes receivable, one of which is from the Employee Stock Ownership Plan
("ESOP"). Bancshares' principal business is the business of the Bank. At June
30, 1999, the Company had total assets of $285.4 million, deposits of $146.3
million and stockholders' equity of $32.1 million, or 11.3% of total assets.
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
Federal Home Loan Bank ("FHLB") system and obtained federal deposit insurance.
In May 1996, First Federal acquired the former Heritage Bank, FSB ("Heritage"),
which retained its separate federal savings bank charter and deposit insurance
as a wholly owned subsidiary of First Federal 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.
On February 23, 1998 the Bank sold all of the shares of stock of
Heritage Banc Holding, Inc., parent of its subsidiary savings bank, HEARTLAND
Community Bank, FSB ("FSB"), pursuant to an agreement between the Bank and the
Bank of the Ozarks, Inc. ("BOO"). Upon completion of the transaction and
pursuant to the terms of the agreement, the Bank acquired the loans and certain
other assets and non-deposit liabilities of the Little Rock, Arkansas branch of
FSB and all assets and liabilities of the Monticello, Arkansas branch and the
Bryant, Arkansas loan production office of FSB and BOO acquired the savings
deposits and premises and equipment of the Little Rock, Arkansas branch of FSB,
as well as FSB's holding company charter and stock. This transaction was
substantively a branch sale. Also at such time, Bancshares became a unitary
rather than a multiple savings institution holding company.
The Bank currently operates through five full service-banking offices
located in Camden (2), Fordyce, Sheridan, and Monticello, Arkansas and a loan
production office in Bryant, Arkansas.
As a federally chartered savings institution, the Bank is subject to
extensive regulation by the OTS. The Bank's lending activities and other
investments must comply with various federal regulatory requirements, and the
OTS periodically examines the Bank for compliance. The Bank's deposits are
insured up to the maximum limits by the Savings Association Insurance Fund
("SAIF") administered by the Federal Deposit Insurance Corporation ("FDIC").
The FDIC also has the authority to conduct special examinations. The Bank must
file reports with OTS describing its activities and financial condition and is
also subject to certain reserve requirements promulgated by the Federal Reserve
Board.
3
<PAGE> 4
MARKET FOR COMMON STOCK
AND RELATED STOCKHOLDER MATTERS
Bancshares common stock began trading on the Nasdaq National Market on
May 7, 1997, under the symbol "HCBB." Effective February 2, 1999, the Bancshares
common stock was delisted and ceased trading on the Nasdaq National Market. At
June 30, 1999, there were 2,329,544 shares of the common stock outstanding and
approximately 831 stockholders of record. Bancshares common stock began
trading on the OTC Bulletin Board effective September 16, 1999. Following are
the high and low bid prices, by fiscal quarter, as reported on the Nasdaq
National Market from July 1, 1997 to February 2, 1999 and through the initial
underwriting brokerage firm of Trident Securities (McDonald Investments) from
February 3 to June 30, 1999, as well as the dividends paid during such quarters.
<TABLE>
<CAPTION>
High Low Dividends Per Share
---- --- -------------------
<S> <C> <C> <C>
Fiscal 1999:
First Quarter $ 15.25 $ 10.50 $ 0.06
Second Quarter 13.00 6.00 0.06
Third Quarter 10.75 9.00 0.06
Fourth Quarter 9.44 8.00 0.06
Fiscal 1998:
First Quarter $ 14.125 $ 12.875 $ 0.05
Second Quarter 14.500 13.125 0.05
Third Quarter 15.750 14.000 0.05
Fourth Quarter 16.250 14.625 0.05
</TABLE>
The stated high and low bid prices reflect inter-dealer prices, without
retail mark-up, markdown or commission, and may not represent actual
transactions.
The payment of dividends on common stock is subject to determination
and declaration by the Board of Directors of Bancshares. The payment of future
dividends will be subject to the requirements of applicable law and the
determination by the Board of Directors of Bancshares that the net income,
capital and financial condition of Bancshares and the Bank, thrift industry
trends and general economic conditions justify the payment of dividends, and
there can be no assurance that dividends will continue to be paid in the future.
Since Bancshares has no significant source of income other than
dividends from the Bank, the payment of dividends by Bancshares can be dependent
upon receipt of dividends from the Bank. Payment of cash dividends by the Bank
is limited by certain federal regulations under which the Bank may not declare
or pay a cash dividend on or repurchase any of its common stock if the effect
thereof would cause its regulatory capital to be reduced below (1) the amount
required for the liquidation account established in connection with the Bank's
conversion to stock form or (2) the regulatory capital requirements imposed by
the OTS. In certain circumstances earnings appropriated to bad debt reserves and
deducted for federal income tax purposes may not be available to pay cash
dividends without the payment of federal income taxes by the Bank on the amount
of such earnings removed from the reserves for such purposes at the then current
income tax rate.
Federal regulations impose certain additional limitations on the
payment of dividends and other capital distributions (including stock
repurchases and cash mergers) by the Bank. Under OTS regulations, savings
institutions must submit notice to the OTS prior to making a capital
distribution if (a) they would not be well capitalized after the distribution,
(b) the distribution would result in the retirement of any of the institution's
common or preferred stock or debt counted as its regulatory capital, or (c) the
institution is a subsidiary of a holding company. A savings institution must
make application to the OTS to pay a capital distribution if (x) the institution
would not be adequately capitalized following the distribution, (y) the
institution's total distributions for the calendar year exceeds the
institution's net income for the calendar year to date plus its net income (less
distributions) for the preceding two years, or (z) the distribution would
otherwise violate applicable law or regulation or an agreement with or condition
imposed by the OTS.
4
<PAGE> 5
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
<TABLE>
<CAPTION>
AT JUNE 30,
----------------------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Total assets.............................. $285,396,885 $250,953,770 $200,498,516 $171,235,322 $126,987,168
Loans receivable, net..................... 115,162,883 104,580,165 98,642,635 84,131,024 55,112,980
Allowance for loan losses................. 1,329,201 1,468,546 1,492,473 1,283,234 728,491
Cash and due from banks................... 3,560,884 1,531,363 1,057,943 422,509 195,703
Interest-earning savings deposits......... 1,693,330 5,073,035 18,273,882 16,869,373 2,929,896
Investment securities:
Available for sale..................... 33,132,916 40,775,807 -- 5,279,625 957,500
Held to maturity....................... -- -- 17,260,383 -- 2,000,000
Mortgage-backed securities:
Available for sale.................... 113,986,773 58,697,109 18,361,987 12,155,199 6,088,450
Held to maturity...................... -- 27,503,257 36,493,086 45,212,891 57,144,915
Deposits.................................. 146,296,598 141,931,330 151,192,591 145,919,251 112,005,588
FHLB advances............................. 104,523,419 68,121,068 10,000,000 10,000,000 --
Note payable.............................. 240,000 320,000 400,000 -- --
Stockholders' equity...................... 32,117,560 37,678,924 37,430,852 14,228,436 14,270,972
Number of:
Real estate loans outstanding.......... 2,425 3,037 2,093 1,993 1,507
Savings accounts....................... 18,526 17,158 15,380 14,163 10,993
Offices open........................... 6 6 7 6 3
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------- ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C>
Interest income........................... $ 18,274,647 $ 15,027,677 $ 12,987,848 $ 10,333,181 $ 8,844,782
Interest expense.......................... 12,093,603 8,942,149 8,195,782 6,766,598 5,112,481
------------- ------------ ------------ ------------ -----------
Net interest income....................... 6,181,044 6,085,528 4,792,066 3,566,583 3,732,301
Provision for loan losses................. -- 24,000 221,671 42,483 --
------------- ------------ ------------ ------------ -----------
Net interest income after provision
for loan losses......................... 6,181,044 6,061,528 4,570,395 3,524,100 3,732,301
Noninterest income (loss)................. 1,018,654 710,856 305,067 (773,652) 196,023
Noninterest expense....................... 6,847,715 6,407,976 5,765,870 2,350,658 1,609,691
------------- ------------ ------------ ------------ -----------
Income (loss) before income taxes and
cumulative effect of change in method
of accounting for income taxes and
investment securities................... 351,983 364,408 (890,408) 399,790 2,318,633
Provision (benefit) for income taxes...... (63,658) (20,705) (280,935) 174,801 966,763
-------------- ------------- ------------ ------------ -----------
Income (loss) before cumulative effect of
change in method of accounting for
investment securities.................. 415,641 385,113 (609,473) 224,989 1,351,870
Cumulative effect of change in method of
accounting for investment securities.... -- -- -- -- 77,567
------------- ------------ ------------ ------------ -----------
Net income (loss)......................... $ 415,641 $ 385,113 $(609,473)(1) $ 224,989 $ 1,429,437
============ =========== ============ =========== ==========
Earnings per share:
Basic................................... $ 0.18 $ 0.16 $ (.25) $ -- $ --
Diluted................................. 0.18 0.16 (.25) -- --
Cash dividends declared................... 0.24 0.20 -- -- --
</TABLE>
- ---------------
(1) Noninterest expense and, therefore, net 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, management estimates that
noninterest expense would have been approximately $4,876,859 and that net loss
would have been approximately $58,286.
5
<PAGE> 6
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-------------------------------------------------------------
1999 1998 1997 1996 1995
-------- ------- -------- -------- ------
<S> <C> <C> <C> <C> <C>
PERFORMANCE RATIOS:
Return on assets (net income (loss) divided
by average total assets) (1)................ 0.15% 0.18% (0.34)% 0.16% 1.06%
Return on average equity (net income (loss)
divided by average equity) (1).............. 1.14 1.02 (3.38) 1.53 9.82
Interest rate spread (combined weighted
average interest rate earned less combined
weighted average interest rate cost)........ 1.81 2.11 2.35 2.16 2.51
Net interest margin (net interest income
divided by average interest-earning assets). 2.34 2.96 2.76 2.58 2.96
Ratio of average interest-earning assets
to average interest-bearing liabilities..... 111.55 119.51 108.76 108.47 111.22
Ratio of noninterest expense to average
total assets................................ 2.48 3.00 3.18 1.64 1.26
ASSET QUALITY RATIOS:
Nonperforming assets to total assets
at end of period............................ 0.21 0.34 0.29 0.14 0.23
Nonperforming loans to total loans
at end of period............................ 0.46 0.75 0.50 1.17 1.19
Allowance for loan losses to total
loans at end of period...................... 1.08 1.33 1.46 1.47 1.29
Allowance for loan losses to nonperforming
loans at end of period...................... 234.84 177.25 290.50 125.95 108.31
Provision for loan losses to total loans
at end of period ........................... -- .02 0.22 0.05 --
Net charge-offs to average loans outstanding... 0.13 .05 .01 0.02 --
CAPITAL RATIOS:
Equity to total assets at end of period........ 11.25 15.01 18.92 8.31 11.24
Average equity to average assets............... 13.19 17.71 9.95 10.25 10.76
Dividend payout ratio(2)....................... 142.58 137.36 -- -- --
</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 .70%. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" under Item
7.
(2) The fiscal year ended June 30, 1998, was the first full year that
Bancshares was publicly traded. Dividend payout ratio is the total
dividends declared divided by net income.
6
<PAGE> 7
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
When used in this Annual Report, the words or phrases "will likely
result," "are expected to," "will continue," "is anticipated," "estimate,"
"project" or similar expressions are intended to identify "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Such statements are subject to certain risks and uncertainties
including changes in economic conditions in the Company's market area, changes
in policies by regulatory agencies, fluctuations in interest rates, demand for
loans in the Company's market area, and competition that could cause actual
results to differ materially from historical earnings and those presently
anticipated or projected. The Company wishes to caution readers not to place
undue reliance on any such forward-looking statements, which speak only as of
the date made. The Company wishes to advise readers that the factors listed
above could affect the Company's financial performance and could cause the
Company's actual results for future periods to differ materially from any
opinions or statements expressed with respect to future periods in any current
statements.
The Company does not undertake, and specifically disclaims any
obligation, to publicly release the result of any revisions which may be made to
any forward-looking statements to reflect events or circumstances after the date
of such statements or to reflect the occurrence of anticipated or unanticipated
events.
GENERAL
The Bank's principal business consists of attracting savings 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' savings deposits and other borrowings. 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 loans and
securities and other fees. In addition, net income is affected by the level of
noninterest expense, which primarily consists of employee compensation expenses,
occupancy expenses, 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.
YEAR 2000 READINESS DISCLOSURE
The Company realizes the challenges of the year 2000 issue. In
compliance with regulatory guidelines, a committee was assembled to review the
effects the century change would have on the Company's systems and to assess the
potential risks that it presents. A formal plan of action was developed to
address this issue. This plan was approved by the Board of Directors and has the
full support of senior management. An inventory of internal systems, both
computer and non-computer related, was completed in this process. Relationships
with third party vendors were also analyzed. Potential weaknesses were then
documented and prioritized as to their effect on critical business functions.
The Company was already in the process of selecting a new data-processing system
to facilitate its business plan. Year 2000 compliance became an important issue
in the selection process. A vendor with a year 2000 compliant system was
selected and conversion was completed in the quarter ended December 1998. This
system had undergone thorough testing prior to its installation. All the user
departments were involved in review of the test results and in additional onsite
testing. This testing process revealed no year 2000 related problems. Testing
7
<PAGE> 8
also took place for external parties with which the Bank exchanges significant
information. In addition, testing was performed on all other mission critical
information systems. It is believed that this thorough process has increased the
likelihood of uninterrupted operation of the Bank.
Seven vendors have been identified as "mission critical". All seven
have indicated that they are presently year 2000 compliant. The Company's
internal operating systems have been tested, and those which failed have been
replaced. Replacement systems have been tested and passed. As a result of this
process, all of the internal operating systems have been determined to be year
2000 compliant.
In addressing the year 2000 issue, the Bank has used its current internal
staffing with little reliance on outside resources. Major vendors have provided
compliant software at no additional expense to the Bank. Replacement of the main
data-processing system has cost approximately $650,000.
Rapid and accurate data processing is essential to Company operations.
System failures could have an adverse impact on the Company. In the unlikely
event that some year 2000 issues remain undetected, management, through its
ongoing year 2000 process, will mobilize all internal and external resources
available to correct any systems which are critical to the Bank's operations.
Contingency plans have been developed to address potential problem areas.
Management expects as a result of its efforts that any impact of the year 2000
upon its operations will be minimal.
Because the Company has not historically engaged in typical commercial
lending, less than 40 non-real estate commercial borrowers are deemed to be
potentially vulnerable to year 2000 problems. The Company has contacted these
customers by mail, and by telephone requesting information as to their
preparedness. They have responded, but the overall level of planning was not
high.
The Company's most reasonably likely worst-case year 2000 scenario
foreseeable at this time would involve failures by suppliers of electricity and
telephone service. Those suppliers have provided increased assurance of
continuity of service and the United States Senate Special Committee on the Year
2000 Technology Problem has stated its belief that there is currently less than
a 10 percent chance that the power grid will fail. The Committee indicated that
while isolated outages may occur, they will not be widespread or long lived.
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 savings deposits by
maintaining substantial liquidity and capital levels to withstand 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 its 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.
The Bank has continued a growth program using Federal Home Loan Bank
borrowings. Two primary considerations which prompted this program's creation
were the development of asset/liability management tools and the Bank's
relatively high capital level. In general, the Bank's growth in borrowed funds
has been largely accompanied by growth in the investment portfolio. Rather than
being match-funding transactions, however, particular borrowings and particular
investments are selected based on their own individual effects on the total
balance sheet. Management's purpose in the borrowing and investment selection
processes is to manage the entire
8
<PAGE> 9
balance sheet for safety and soundness coupled with optimal income and stability
of earnings. The growth of the investment portfolio also provides the bank with
additional liquidity. Should additional funds be needed, investments may be
pledged as collateral for additional borrowings or they may be sold to raise
funds.
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.
At June 30, 1999, the Bank's total interest-bearing liabilities
maturing or repricing within one year exceeded its total interest-earning assets
maturing or repricing in the same period, and the Bank's cumulative one-year gap
ratio totaled negative 17.41%. In addition, the Bank's total interest-earning
assets maturing or repricing within five years were slightly less than its total
interest-bearing liabilities maturing or repricing in the same period, and the
Bank's cumulative five-year gap ratio totaled a negative 2.05%. The Bank's gap
measures indicate that net interest income would be exposed to increases in
interest rates in the short term, but would be much less exposed to increases in
interest rates over the longer term.
9
<PAGE> 10
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS AND RATES
The following table sets forth information regarding the Company'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 indicated. Average balances are
derived from monthly balances. The table also presents information for the
periods indicated 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. The yield on non-taxable securities has not
been adjusted to a tax equivalent basis. Yield on available for sale securities
is based on amortized cost. Loans on a nonaccrual basis are included in the
computation of the average balance of loans receivable. Loan fees deferred and
accreted into income are included in interest earned. 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,
--------------------------------------------------------------------------------
1999 1998
--------------------------------------- --------------------------------------
Average Average
Average Interest Yield/ Average Interest Yield/
Balance Earned/Paid Rate Balance Earned/Paid Rate
------------- ----------- ------- ------------ ----------- -------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable......................... $ 108,211,367 $ 8,984,708 8.30% $105,237,178 $ 8,766,232 8.33%
Investment and mortgage-backed securities
Taxable................................ 127,823,503 7,879,802 6.16 77,987,004 5,017,211 6.43
Nontaxable............................. 18,542,595 906,755 4.89 9,010,567 445,122 4.94
Other interest-earning assets............ 9,895,390 503,382 5.09 13,402,789 799,112 5.96
------------- ----------- ------------ -----------
Total interest-earning assets ......... $ 264,472,855 18,274,647 6.91 $205,637,538 15,027,677 7.31
-----------
Non-interest-earning assets................ 11,984,411 7,874,964
------------- ------------
Total assets........................... $ 276,457,266 $213,512,502
============ ===========
Interest-bearing liabilities:
Deposits................................. $ 141,719,606 6,620,808 4.67 $144,602,264 7,272,554 5.03
FHLB advances............................ 95,124,165 5,453,795 5.73 27,108,184 1,644,595 6.07
Notes payable............................ 253,333 19,000 7.50 352,142 25,000 7.10
------------- ----------- ------------ -----------
Total interest-bearing liabilities..... 237,097,104 12,093,603 5.10 172,062,590 8,942,149 5.20
----------- ---- ----------- ----
Non-interest-bearing liabilities........... 2,903,969 3,645,847
------------- ------------
Total liabilities...................... 240,001,073 175,708,437
Equity..................................... 36,456,193 37,804,065
------------- ------------
Total liabilities and equity........... $ 276,457,266 $213,512,502
============ ===========
Net interest income........................ $ 6,181,044 $ 6,085,528
========== ==========
Net interest rate spread................... 1.81% 2.11%
===== =====
Net yield on interest-earning assets....... 2.34% 2.96%
===== ======
Ratio of average interest-earning assets
to average interest-bearing liabilities.. 111.55% 119.51%
======= ======
<CAPTION>
Year Ended June 30,
----------------------------------------
1997
----------------------------------------
Average
Average Interest Yield/
Balance Earned/Paid Rate
------------- ----------- -------
<S> <C> <C> <C>
Interest-earning assets:
Loans receivable......................... $ 95,084,828 $ 7,958,458 8.37%
Investment and mortgage-backed securities
Taxable................................ 67,125,006 4,436,436 6.61
Nontaxable............................. -- -- --
Other interest-earning assets............ 11,297,355 592,954 5.25
------------ ------------
Total interest-earning assets ......... $173,507,189 12,987,848 7.49
------------
Non-interest-earning assets................ 7,914,134
------------
Total assets........................... $181,421,323
===========
Interest-bearing liabilities:
Deposits................................. $148,964,591 7,534,445 5.06
FHLB advances............................ 10,208,333 636,337 6.23
Notes payable............................ 357,142 25,000 7.00
------------ ------------
Total interest-bearing liabilities..... 159,530,066 8,195,782 5.14
------------ ----
Non-interest-bearing liabilities........... 3,833,363
------------
Total liabilities...................... 163,363,429
Equity..................................... 18,057,894
------------
Total liabilities and equity........... $181,421,323
===========
Net interest income........................ $ 4,792,066
===========
Net interest rate spread................... 2.35%
=======
Net yield on interest-earning assets....... 2.76%
========
Ratio of average interest-earning assets
to average interest-bearing liabilities.. 108.76%
======
</TABLE>
10
<PAGE> 11
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) changes in rate/volume (changes in rate
multiplied by changes in volume).
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------------------------------------------------------------------------
1999 vs. 1998 1998 vs. 1997
------------------------------------------- ----------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------------------------- ----------------------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------ ---- ------ ----- ------ ---- ------ -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest income:
Loans receivable $ 248 $ (28) $ (1) $ 219 $ 850 $ (38) $ (4) $ 808
Investment securities and
mortgage- backed
securities 3,677 (214) (139) 3,324 1,314 (222) (66) 1,026
Other interest-earning
assets (210) (117) 31 (296) 110 81 15 206
-----------------------------------------------------------------------------------------
Total interest-earning
assets 3,715 (359) (109) 3,247 2,274 (179) (55) 2,040
----- -------- ------- ----- ----- ------- ------ ------
Interest expense:
Deposits (145) (517) 10 (652) $ (221) $ (42) $ (1) $ (262)
FHLB advances 4,126 (90) (227) 3,809 1,053 (17) (28) 1,008
Note payable (7) 1 -- (6) -- -- -- --
----------------------------------------------------------------------------------------
Total interest-bearing
liabilities 3,974 (606) (217) 3,151 832 (59) (27) 746
----- ------- ------- ----- ----- ------- ------- ------
Change in net interest
income $ (259) $ 247 $ 108 $ 96 $ 1,442 $ (120) $ (28) $1,294
======== ======= ====== ======= ====== ======= ======= =====
</TABLE>
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 1999 AND 1998
The Company had consolidated total assets of $285.4 million and $251.0
million at June 30, 1999 and 1998, respectively. During the twelve-month period
ended June 30, 1999 the Company experienced an increase in its consolidated loan
portfolio from $104.6 million at June 30, 1998, to $115.2 million. The Bank's
ability to expand its lending base and the size of its loan portfolio continues
to be constrained by the lack of strong loan demand and competition. During this
same period, investments and mortgage-backed securities and other short-term
interest-earning assets increased from $132.0 million at June 30, 1998 to $148.8
million at June 30, 1999. Due to the lack of strong loan demand, investment
securities were purchased, primarily with the proceeds of FHLB advances, in
order to increase net income and to facilitate improvements in the Bank's
interest rate risk management program.
Deposits increased slightly from $141.9 million at June 30,1998 to
$146.3 million at June 30, 1999. This represents a 3.0 percent increase in
deposits. Although the Bank's level of deposits has been sufficient to fund its
loan demand and provide for adequate liquidity, the deposit market is also
competitive. Additionally, the Bank borrowed from the FHLB to fund increases in
its investment portfolio. The outstanding balances of FHLB borrowings were
$104.5 million and $68.1 million at June 30, 1999 and June 30, 1998,
respectively. The result of the borrowings was to reduce interest rate risk by
better matching rate indexes and maturities of interest-earning assets to
interest-bearing liabilities, and maximize potential interest income while
maintaining capital ratios well in excess of required minimums.
11
<PAGE> 12
Stockholders' equity amounted to $32.1 million at June 30, 1999, and
$37.7 million at June 30, 1998. The changes in equity were primarily due to the
purchase of treasury stock, the changes to unrealized gain (loss) on investment
securities available for sale, and the Company's net income earned for the
fiscal year ended June 30, 1999. The Company also fulfilled its obligation to
purchase stock for the management recognition plan. At June 30, 1999, the Bank's
regulatory capital exceeded all applicable regulatory capital requirements.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 1999 AND 1998
Net Income. Net income for the year ended June 30, 1999 was $416,000
compared to net income of $385,000 for the year ended June 30, 1998. The changes
resulted primarily from an increase in net interest income of $96,000, an
increase in non-interest income of $308,000, an increase in non-interest expense
of $440,000, and an increase in the tax benefit of $43,000.
Net Interest Income. Net interest income for the year ended June 30,
1999 was $6.2 million, or $96,000 more than net interest income for the year
ended June 30, 1998. The total average interest earning assets increased $58.8
million, but the yield decreased from 7.31% to 6.91% primarily due to a 28 basis
point decrease in the average yield on investments while total average
investments increased $59.4 million. Also, of the $59.4 million increase in
average investments, $9.5 million was in nontaxable securities at an average
rate of 4.89%.
Provision for Loan Losses. During the year ended June 30, 1999, the
Bank's management continued its review of loan files. Based on these reviews,
management did not make any provisions for loan losses in the year ended June
30, 1999, compared to $24,000 in the year ended June 30, 1998. The allowance for
loan losses of $1.3 million at June 30, 1999 represented 1.08% of outstanding
loans. Nonperforming loans as of June 30, 1999 as a percent of total loans
decreased to .46% from .75% as of June 30, 1998.
Management evaluates the carrying value of the loan portfolio
periodically and the provision is adjusted if necessary. While management uses
the best information available to make evaluations, future adjustments to the
provision may be necessary if conditions differ substantially from the
assumptions used in making the evaluations. 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.
During the year ended June 30, 1999, management continued to emphasize
growth in land, multi-family, non-residential real estate loans and commercial
loans. These loans generally are considered to have a greater inherent risk of
loss due to the concentration with one or few borrowers and the dependence of
the collateral's performance on a broad array of economic factors. As a result
of these efforts, these types of loans increased from $51.2 million to $60.0
million, or 17.2%. As a result of this increased emphasis in areas of generally
higher risk, the amount of the allowance allocated to these lending types has
increased.
There were no significant changes in concentrations or loan terms
during the year, other than that mentioned in the preceding paragraph, nor were
there significant changes in the estimation methodologies employed or
assumptions utilized. Nonperforming loan and loss trends did not indicate a
need to modify loss experience factors during the year.
Noninterest Income. Noninterest income is comprised primarily of gains
on the sales of investment securities, and service charges on deposit accounts.
Noninterest income for the year ended June 30, 1999 was approximately $1,019,000
compared to approximately $711,000 for the year ended June 30, 1998. This
increase of approximately $308,000 is the result of gains on sales of loans and
investment securities and the growth of the Bank's checking and savings
accounts, both in dollars and in numbers of accounts, resulting in increased
service charges.
12
<PAGE> 13
Noninterest Expense. The major components of noninterest expense are
salaries and employee benefits paid to or on behalf of the Company's employees
and directors, occupancy expense for ownership and maintenance of the Company's
buildings, furniture, and equipment, data processing expenses, and professional
fees paid to consultants, attorneys, and accountants. Total noninterest expense
for the year ended June 30, 1999 was $6.85 million compared to $6.41 million for
the year ended June 30, 1998. Significant components of the increase in
non-interest expense are the increase of $234,000 in salaries and benefits
resulting from increased staff and the implementation of the Management
Recognition Plan, an increase of $583,000 in professional fees, an increase of
$176,000 in net occupancy expense, and increase of $101,000 in data processing
expense, while all other non-interest expenses decreased $654,000. It is
anticipated by management that future professional fees will be significantly
less than the year ended June 30, 1999.
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,
and introducing new deposit and loan products and services, it is expected that
the Bank's noninterest expense levels may remain 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
continued increased loan originations in the areas of multi-family residential,
commercial business, and consumer loans.
Income Taxes. The effective income tax rates for the Company for the fiscal
years ended June 30, 1999 and 1998 were (18.1)% and (5.7)%, respectively. The
variance in the effective rate from the expected statutory rate is due primarily
to tax exempt interest.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED JUNE 30, 1998 AND 1997
Net Income (Loss). Net income for the year ended June 30, 1998 was
$385,000 compared to a net loss of $609,000 for the year ended June 30, 1997.
The changes resulted from an increase in net interest income of $1,293,000 and
an increase in non-interest income of $406,000, partially offset by an increase
in non-interest expense of $642,000. Significant components of the increase in
non-interest expense are the increase of $883,000 in salaries and benefits
resulting from increased staff and the implementation of the Management
Recognition Plan, and an increase of $238,000 in net occupancy expense due to
the completion and occupancy of new office buildings housing the Sheridan and
Monticello branch offices. Federal insurance premiums decreased mainly because
of the one-time assessment of $889,000 during the year ended June 30, 1997.
Net Interest Income. Net interest income for the year ended June 30,
1998 was $6.1 million, an increase of $1.3 million when compared to net interest
income of $4.8 million for the year ended June 30, 1997. This increase was the
result of an increase in total interest income of $2.0 million and an increase
in total interest expense of $0.7 million. The increases are attributable to the
Bank's program of borrowing from the Federal Home Loan Bank and investing the
proceeds in investment securities, resulting in improved interest rate risk.
FHLB borrowings increased by $58.1 million and total investment securities
increased by $54.9 million, contributing to the increase in net interest income.
Provision for Loan Losses. During the year ended June 30, 1997, the
Bank's management initiated an internal loan review of all loan files. An
increase in the allowance was considered appropriate given the emphasis in
certain lending areas, such as commercial real estate, and business and consumer
loans, which inherently have more risk. Management made provisions for loan
losses in the year ended June 30, 1997 of $222,000 compared to $24,000 in the
year ended June 30, 1998. The allowance for loan losses of $1.5 million at June
30, 1998 represented 1.33% of outstanding loans. Nonperforming loans as of June
30, 1998 as a percent of total loans increased to .75% from .50% as of June 30,
1997.
Management evaluates the carrying value of the loan portfolio
periodically and the provision is adjusted accordingly. While management uses
the best information available to make evaluations, future adjustments to the
provision may be necessary if conditions differ substantially from the
assumptions used in making the evaluations.
13
<PAGE> 14
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.
During the year ended June 30, 1998, management emphasized growth in
multi-family and non-residential real estate loans. These loans generally are
considered to have a greater inherent risk of loss due to the concentration with
one or few borrowers and the dependence of the collateral's performance on a
broad array of economic factors. During this year, management also increased, to
a lesser degree, the Bank's consumer lending. This type of lending carries a
greater degree of inherent risk than single family residential lending because
of several factors including the generally depreciable nature of the collateral.
As a result of this increased emphasis in areas of generally higher risk, the
amount of the allowance allocated to these lending types has increased.
There were no significant changes in concentrations or loan terms
during the year, nor were there significant changes in the estimation
methodologies employed or assumptions utilized. Nonperforming loan and loss
trends did not indicate a need to modify loss experience factors during the
year.
Noninterest Income. Noninterest income is comprised primarily of
service charges on deposit accounts, gains on the sales of investment
securities, rental of safe deposit boxes, and sales of credit life insurance.
Noninterest income for the year ended June 30, 1998 was $711,000 compared to
$305,000 for the year ended June 30, 1997. This increase of $406,000 is the
result of the gain on sales of investment securities and the growth of the
Bank's loans, checking, and savings accounts both in dollars and in numbers of
accounts, resulting in increased service charges and fee income.
Noninterest Expense. The major components of noninterest expense are
salaries and employee benefits paid to or on behalf of the Company's employees
and directors, occupancy expense for ownership and maintenance of the Company's
buildings, furniture, and equipment, data processing expenses, and professional
fees paid to consultants, attorneys, and accountants. Total noninterest expense
for the year ended June 30, 1998 was $6.4 million compared to $5.8 million for
the year ended June 30, 1997. The increase of $883,000 in salaries and benefits
was due to increased salaries for an increased staff, the addition of the
Management Recognition Plan as approved by the stockholders, and an increased
contribution to the ESOP plan to allow it to properly service its debt. The
increase of $238,000 in occupancy expense is a result of moving the Monticello
and Sheridan branches into new, larger and more modern office buildings during
the year ended June 30, 1998. Another significant component of the change in
noninterest expense is the decrease in Federal insurance premiums to $91,000 for
the year ended June 30, 1998 from $1,085,000 for the year ended June 30, 1997,
resulting primarily from the one-time SAIF assessment of $889,000.
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,
and introducing new deposit and loan products and services, it is expected that
the Bank's noninterest expense levels may remain 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
business, and consumer loans.
Income Taxes. There was a decrease in tax benefit to $21,000 in 1998
from $281,000 for 1997 due to earnings in 1998 net of non-taxable interest
income.
SOURCES OF CAPITAL AND LIQUIDITY
The Company has no business other than that of the Bank. Bancshares'
primary sources of liquidity are cash, dividends paid by the Bank and earnings
on investments and loans. In addition, the Bank is subject to regulatory
limitations with respect to the payment of dividends to Bancshares.
14
<PAGE> 15
The Bank has historically maintained substantial levels of capital. The
assessment of capital adequacy is dependent on several factors including asset
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.
The Bank's primary source of funds are savings 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 savings deposits outside of its market area
through brokers or other financial institutions.
The Bank has also designated all of its securities as available for
sale in order to meet liquidity demands. At June 30, 1999, the Bank had
designated securities with a fair value of approximately $147.1 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.
At June 30, 1999, the Bank had outstanding approximately $7.1 million
in commitments to originate loans (including unfunded portions of construction
loans) and $219,000 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 $79.5 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 savings 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.
MARKET RISK
Market risk reflects the risk of economic loss resulting from adverse
changes in market prices and interest rates. The risk of loss can be reflected
in diminished current market values and/or reduced potential net interest income
in future periods. The Company's market risk arises primarily from interest rate
risk inherent in lending and deposit-taking activities. The Company does not
maintain a trading account for any class of financial instrument nor does it
engage in hedging activities or purchase derivative instruments. Furthermore,
the Company is not subject to foreign currency exchange rate risk or commodity
price risk.
The OTS currently requires savings institutions to measure and evaluate
interest rate risk on a quarterly basis. A savings institution's interest rate
risk is measured in terms of the sensitivity of its net portfolio value (NPV) 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 and off-balance sheet contracts. The Bank presently monitors and
evaluates the potential impact of interest rate changes upon the market value of
the Bank's NPV on a quarterly basis. These computations estimate the effect on
the Bank's NPV of sudden and sustained 100 Basis Points (BP) to 300 BP 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 20%, 35%, and 55% in the event of assumed immediate and
sustained 100 BP to 300 BP, increases or decreases in market interest rates,
respectively.
15
<PAGE> 16
The following tables present the Bank's projected change in NPV as of
June 30, 1999 and 1998, as calculated by OTS, based on information provided to
the OTS by the Bank. Based on such information, from June 30, 1998 to June 30,
1999, the Bank's interest rate risk has shifted from being primarily exposed to
decreasing interest rates to being moderately exposed to increasing rates. This
is consistent with the Bank's investment strategy to reduce overall interest
rate risk over the period, and well within the Bank's policy limits.
<TABLE>
<CAPTION>
1999
- ---------------------------------------------------------------------------------------------------------------
BP CHANGE IN NPV
CHANGE IN NPV AS A PERCENTAGE OF ESTIMATED
INTEREST RATES NET PORTFOLIO VALUE RATIO MARKET VALUE OF ASSETS
IN BP ---------------------------------- ----- ----------------------
(RATE SHOCK) AMOUNT $ CHANGE % CHANGE
------------ ------ -------- --------
<S> <C> <C> <C> <C> <C>
+300 $23,862 $(7,923) (25)% 9.27 % (207)
+200 26,884 (4,901) (15) 10.15 (120)
+100 29,710 (2,075) (7) 10.89 (45)
+0 31,785 11.35
-100 32,126 341 1 11.23 (12)
-200 31,055 (730) (2) 10.67 (68)
-300 30,435 (1,350) (4) 10.25 (110)
</TABLE>
<TABLE>
<CAPTION>
1998
- ---------------------------------------------------------------------------------------------------------------
CHANGE IN NPV
CHANGE IN NPV AS A PERCENTAGE OF ESTIMATED
INTEREST RATES NET PORTFOLIO VALUE RATIO MARKET VALUE OF ASSETS
IN BP ---------------------------------- ----- ----------------------
(RATE SHOCK) AMOUNT $ CHANGE % CHANGE
------------ ------ -------- --------
<S> <C> <C> <C> <C> <C>
+400 $24,390 $(1,932) (7)% 10.91 % .26%
+300 26,156 (166) (1) 11.39 .74
+200 27,098 776 3 11.50 .85
+100 27,272 950 4 11.30 .65
+0 26,322 -- -- 10.65 --
-100 23,653 (2,669) (10) 9.38 (1.27)
-200 19,497 (6,825) (26) 7.59 (3.06)
-300 14,482 (11,841) (45) 5.52 (5.13)
-400 8,517 (17,805) (68) 3.17 (7.48)
</TABLE>
At June 30, 1999, it was estimated that the Bank's NPV could decrease
7%, 15%, and 25% in the event of 100 BP, 200 BP, and 300 BP respective increases
in market interest rates, and could increase 1%, or decrease 2%, and 4% in the
event of equivalent decreases in market interest rates. These calculations
indicate that the Bank's NPV could be adversely affected by decreases or to a
greater degree by significant increases in interest rates. Changes in interest
rates also may affect the Bank's net interest income. In a declining rate
environment, more borrowers would be expected to refinance fixed rate loans at
lower rates. This would have the effect of cutting the Bank's yield on fixed
rate assets at a time when its liability costs would decline more slowly. In a
rising rate environment fewer borrowers would be expected to refinance while
more depositors would be expected to liquidate their certificates of deposit and
reinvest them in higher rate certificates of deposit. Depositors would tend to
exhibit this behavior once rates had increased sufficiently to offset early
withdrawal penalties. This would have the effect of maintaining the asset yield
at a time when liability costs would tend to rise.
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. At June 30, 1999, the Bank's estimated
changes in net interest income and NPV were within the targets established by
the Board of Directors.
Computations of prospective effects of hypothetical interest rate
changes, such as the above computations, are based on numerous assumptions,
including relative levels of market interest rates, loan prepayments and deposit
decay, and should not be relied upon as indicative of actual results. Further,
the computations do not contemplate any actions the Bank may undertake in
response to changes in interest rates.
16
<PAGE> 17
INDEPENDENT AUDITORS' REPORT
The Board of Directors
HCB Bancshares, Inc.
Camden, Arkansas
We have audited the consolidated statements of financial condition of HCB
Bancshares, Inc. and subsidiary (the "Company") as of June 30, 1999 and 1998,
and the related consolidated statements of income and comprehensive income,
stockholders' equity and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of HCB Bancshares, Inc. and its
subsidiary at June 30, 1999 and 1998, and the results of their operations and
their cash flows for the years then ended in conformity with generally accepted
accounting principles.
/s/ Deloitte & Touche, LLP
Little Rock, Arkansas
September 10, 1999
17
<PAGE> 18
[MILLER ENGLAND & COMPANY LETTERHEAD]
INDEPENDENT AUDITORS' REPORT
Board of Directors
HCB Bancshares, Inc. and Subsidiaries
Camden, Arkansas
We have audited the statements of income and comprehensive income, stockholders'
equity, and cash flows of HCB Bancshares, Inc. (the "Company") for the year
ended June 30, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
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
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the results of operations and cash flows of the Company for the year
ended June 30, 1997 in conformity with generally accepted accounting principles.
/s/ Miller England & Company
Little Rock, Arkansas
September 5, 1997
February 3, 1999, as to the effect of the restatement (no longer presented
herein)
<PAGE> 19
HCB BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 1999 AND 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 1999 1998
<S> <C> <C>
Cash and due from banks $ 3,560,884 $ 1,531,363
Interest bearing deposits with banks 975,330 2,291,035
------- ---------
Cash and cash equivalents 4,536,214 3,822,398
Other interest bearing deposits with banks 718,000 2,782,000
Investment securities:
Available for sale, at fair value (amortized cost at June 30, 1999
and 1998, of $151,505,753 and $99,385,263, respectively) 147,119,689 99,472,916
Held to maturity, at amortized cost (fair value, $27,476,304) -- 27,503,257
Loans receivable, net of allowance at June 30, 1999 and 1998,
of $1,329,201 and $1,468,546, respectively 115,162,883 104,580,165
Accrued interest receivable 1,717,823 1,839,326
Federal Home Loan Bank stock 5,379,100 3,448,900
Premises and equipment, net 6,500,704 5,601,767
Goodwill, net 356,250 431,250
Real estate held for sale 463,478 461,190
Other assets 3,442,744 1,010,601
--------- ---------
TOTAL $ 285,396,885 $ 250,953,770
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Deposits $ 146,296,598 $ 141,931,330
Federal Home Loan Bank advances 104,523,419 68,121,068
Liability to purchase shares for management retention plan -- 846,400
Advance payments by borrowers for
taxes and insurance 128,442 209,242
Accrued interest payable 815,197 643,887
Note payable 240,000 320,000
Other liabilities 1,275,669 1,202,919
--------- ---------
Total liabilities 253,279,325 213,274,846
----------- -----------
COMMITMENTS AND CONTINGENCIES (Notes 12 and 14)
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value, 10,000,000 shares authorized, 2,645,000 shares
issued, 2,329,544 and 2,645,000 shares
outstanding at June 30, 1999 and 1998, respectively 26,450 26,450
Additional paid-in capital 25,993,872 25,861,230
Unearned ESOP shares (1,481,200) (1,692,800)
Unearned MRP shares (390,056) (578,528)
Accumulated other comprehensive income (loss) (2,620,673) 53,907
Retained earnings 13,831,694 14,008,665
---------- ----------
35,360,087 37,678,924
---------- ----------
Treasury stock, at cost, 315,456 shares (3,242,527) --
----------- -----------
Total stockholders' equity 32,117,560 37,678,924
---------- ----------
TOTAL $ 285,396,885 $ 250,953,770
=========== ===========
</TABLE>
See notes to consolidated financial statements.
19
<PAGE> 20
HCB BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
YEARS ENDED JUNE 30, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
INTEREST INCOME:
Interest and fees on loans $ 8,984,708 $ 8,766,232 $ 7,958,458
Investment securities:
Taxable 7,879,802 5,017,211 4,436,436
Nontaxable 906,755 445,122 --
Other 503,382 799,112 592,954
------------- ------------- -------------
Total interest income 18,274,647 15,027,677 12,987,848
INTEREST EXPENSE:
Deposits 6,620,808 7,272,554 7,534,445
Federal Home Loan Bank advances 5,453,795 1,644,595 636,337
Note payable 19,000 25,000 25,000
------------- ------------ --------------
Total interest expense 12,093,603 8,942,149 8,195,782
---------- ----------- ------------
NET INTEREST INCOME 6,181,044 6,085,528 4,792,066
PROVISION FOR LOAN LOSSES -- 24,000 221,671
------------- ------------ -------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 6,181,044 6,061,528 4,570,395
NONINTEREST INCOME:
Service charges on deposit accounts 328,958 291,684 203,023
Gain (loss) on sales of investment securities
available for sale 261,996 22,257 (21,215)
Other 427,700 396,915 123,259
----------- ----------- -----------
Net noninterest income 1,018,654 710,856 305,067
--------- ----------- -----------
NONINTEREST EXPENSES:
Salaries and employee benefits 3,574,562 3,340,936 2,458,403
Net occupancy expense 808,255 632,190 393,969
Federal insurance premiums 88,035 91,448 1,084,547
Real estate related costs 6,245 2,135 32,857
Data processing 397,585 297,077 269,067
Professional fees 1,080,916 497,519 487,492
Loss on impaired investment security 9,000 150,356 --
Amortization of goodwill 75,000 123,133 160,073
Other 808,117 1,273,182 879,462
---------- --------- ----------
Total noninterest expenses 6,847,715 6,407,976 5,765,870
--------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES 351,983 364,408 (890,408)
INCOME TAX BENEFIT (63,658) (20,705) (280,935)
------------ ------------ ----------
NET INCOME (LOSS) $ 415,641 $ 385,113 $ (609,473)
---------- ---------- ----------
(Continued)
</TABLE>
20
<PAGE> 21
HCB BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
YEARS ENDED JUNE 30, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
OTHER COMPREHENSIVE INCOME (LOSS),
NET OF TAX
Unrealized holding gain (loss) on securities
arising during period $ (2,501,663) $101,950 $ 238,958
Reclassification adjustment for
(gains) losses included in net income (172,917) (14,690) 14,002
------------- ----------- -----------
Other comprehensive income (loss) (2,674,580) 87,260 252,960
------------ --------- ----------
COMPREHENSIVE INCOME (LOSS) $ (2,258,939) $ 472,373 $ (356,513)
============ ======== ==========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING 2,348,737 2,462,084 2,434,971
=========== ========= =========
EARNINGS (LOSS) PER SHARE:
Basic $ 0.18 $ 0.16 $ (0.25)
==== ==== ======
Diluted $ 0.18 $ 0.16 $ (0.25)
==== ==== ======
DIVIDENDS PER SHARE $ 0.24 $ 0.20 $ --
(Concluded)
</TABLE>
See notes to consolidated financial statements.
21
<PAGE> 22
HCB BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED JUNE 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ISSUED ADDITIONAL UNEARNED UNEARNED
COMMON STOCK PAID-IN ESOP MRP
SHARES AMOUNT CAPITAL SHARES SHARES
<S> <C> <C> <C> <C> <C>
BALANCE, JULY 1, 1996
Net loss
Issuance of common stock, net of
costs 2,645,000 $ 26,450 $ 23,623,393
Purchase of common stock
by ESOP 2,116,000 $ (2,116,000)
Common stock committed to be
released for ESOP 36,130 125,680
Net change in unrealized gain (loss) on
securities available for sale, net of tax
----------- ------- ---------- ------------ --------
BALANCE, JUNE 30, 1997 2,645,000 26,450 25,775,523 (1,990,320) --
Net income
Common stock committed to be
released for ESOP 85,707 297,520
Liability to purchase MRP shares (846,400)
MRP shares earned 267,872
Net change in unrealized gain (loss) on
securities available for sale, net of tax
Dividends paid
----------- ------- ---------- ------------ --------
BALANCE, JUNE 30, 1998 2,645,000 26,450 25,861,230 (1,692,800) (578,528)
Net income
Common stock committed to be
released for ESOP 8,570 211,600
MRP shares earned 124,072 188,472
Net change in unrealized gain (loss) on
securities available for sale, net of tax
Treasury stock purchased
Dividends paid
----------- ------- ---------- ------------ --------
BALANCE, JUNE 30, 1999 2,645,000 $ 26,450 $ 25,993,872 $(1,481,200) $(390,056)
=========== ====== ========== =========== =========
<CAPTION>
ACCUMULATED
OTHER TREASURY TREASURY TOTAL
COMPREHENSIVE RETAINED STOCK STOCK STOCKHOLDERS'
INCOME (LOSS) EARNINGS SHARES AMOUNT EQUITY
<S> <C> <C> <C> <C> <C>
BALANCE, JULY 1, 1996 $ (286,313) $14,762,025 $ 14,475,712
Net loss (609,473) (609,473)
Issuance of common stock, net of
costs 23,649,843
Purchase of common stock
by ESOP
Common stock committed to be
released for ESOP 161,810
Net change in unrealized gain (loss) on
securities available for sale, net of tax 252,960 252,960
------------ ----------- ----------- -------- -------------
BALANCE, JUNE 30, 1997 (33,353) 14,152,552 -- -- 37,930,852
Net income 385,113 385,113
Common stock committed to be
released for ESOP 383,227
Liability to purchase MRP shares (846,400)
MRP shares earned 267,872
Net change in unrealized gain (loss) on
securities available for sale, net of tax 87,260 87,260
Dividends paid (529,000) (529,000)
------------ ----------- ----------- -------- -------------
BALANCE, JUNE 30, 1998 53,907 14,008,665 -- -- 37,678,924
Net income 415,641 415,641
Common stock committed to be
released for ESOP 220,170
MRP shares earned 312,544
Net change in unrealized gain (loss) on
securities available for sale, net of tax (2,674,580) (3,242,527) (2,674,580)
Treasury stock purchased 315,346 (3,242,527)
Dividends paid (592,612) (592,612)
------------ ----------- ----------- ----------- -------------
BALANCE, JUNE 30, 1999 $(2,620,673) $13,831,694 315,346 $(3,242,527) $ 32,117,560
=========== =========== =========== =========== ==========
</TABLE>
See notes to consolidated financial statements.
22
<PAGE> 23
HCB BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 415,641 $ 385,113 $ (609,473)
Adjustments to reconcile net income (loss) to net
cash provided (used) by operating activities:
Depreciation 544,142 407,850 187,098
Amortization (accretion) of:
Deferred loan origination fees (2,729) (26,757) (26,698)
Goodwill 75,000 123,133 160,073
Premiums and discounts on loans, net (510) (5,454) (27,627)
Premiums and discounts on investment securities, net 323,110 213,806 (24,428)
Provision for loan loss -- 24,000 221,671
Provision for loss on foreclosed real estate -- -- 13,528
Deferred income taxes (311,921) 27,027 (110,374)
Net (gain) loss on sale of investment securities
available for sale (261,996) (22,257) 21,215
Loss on impaired investment security 9,000 150,356 --
Loss on disposal of assets, net 5,464 20,395 2,558
Originations of loans held for sale (14,751,445) -- --
Proceeds from sales of loans 13,140,464 4,952,961 1,084,100
Stock compensation expense 400,072 695,271 161,810
Change in accrued interest receivable 121,503 (533,374) (363,939)
Change in accrued interest payable 171,310 233,410 14,538
Change in other assets (321,083) 245,682 (121,167)
Change in other liabilities 72,750 503,764 (12,203)
------------- ------------ ------------
Net cash provided (used) by operating activities (371,228) 7,394,926 570,682
INVESTING ACTIVITIES:
Purchases of investment securities available for sale (94,991,103) (88,941,413) (28,986,589)
Purchases of other interest bearing deposits -- (2,782,000) --
Purchases of loans -- (8,257,199) (1,305,000)
Purchases of Federal Home Loan Bank stock (1,930,200) (2,202,400) --
Proceeds from sales of investment securities - available
for sale 48,024,577 20,794,327 7,754,176
Loan originations, net of repayments (8,968,498) (2,667,081) (15,855,647)
Principal payments on investment securities 22,279,177 13,087,527 11,627,182
Proceeds from maturities of other interest bearing deposits 2,064,000 -- --
Proceeds from sale of subsidiary -- 3,100,000 --
Investment in subsidiary sold -- (3,100,000) --
Proceeds from sales of real estate (2,288) 71,132 --
Proceeds from sales of premises and equipment 14,426 605,641 --
Proceeds from sales of other assets -- -- 62,550
Purchases of premises and equipment (1,462,969) (1,680,464) (3,118,319)
------------ ------------- -------------
Net cash used by investing activities (34,972,878) (71,971,930) (29,821,647)
(Continued)
</TABLE>
23
<PAGE> 24
HCB BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
FINANCING ACTIVITIES:
Net increase in deposits $ 4,365,268 $ 141,326 $ 5,273,340
Deposits assumed by others, net -- (8,541,747) --
Advances from Federal Home Loan Bank 124,128,000 76,607,000 --
Repayment of Federal Home Loan Bank advances (87,725,649) (18,485,932) --
Net increase (decrease) in advance payments by
borrowers for taxes and insurance (80,800) 102 (22,594)
Issuance of common stock, net of related expenses -- -- 25,640,162
Proceeds from note payable -- -- 400,000
Purchase of treasury stock (3,242,527) -- --
Purchase of shares for the management retention plan (722,328) -- --
Repayment of note payable (80,000) (80,000) --
Dividends paid (592,612) (529,000) --
Common stock committed to be released for ESOP 8,570 -- --
Other -- (44,172) --
------------ ------------ -----------
Net cash provided by financing activities 36,057,922 49,067,577 31,290,908
------------ ------------ -----------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS 713,816 (15,509,427) 2,039,943
CASH AND CASH EQUIVALENTS:
Beginning of year 3,822,398 19,331,825 17,291,882
------------ ------------ -----------
End of year $ 4,536,214 $ 3,822,398 $19,331,825
============ ============ ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid for:
Interest $ 11,922,293 $ 8,708,739 $ 8,181,244
============ ============ ===========
Income taxes $ 95,000 $ 220,000 $ 419,961
============ ============ ===========
SUPPLEMENTAL SCHEDULE OF NONCASH
INVESTING ACTIVITIES:
Stock issued in exchange for note
receivable from ESOP $ -- $ -- $ 2,116,000
============ ============ ===========
(Concluded)
</TABLE>
See notes to consolidated financial statements.
24
<PAGE> 25
HCB BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 1999, 1998 AND 1997
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS AND PRINCIPLES OF CONSOLIDATION - HCB Bancshares,
Inc. ("Bancshares") was incorporated under the laws of the state of Oklahoma
for the purpose of becoming the bank holding company of Heartland Community
Bank and its subsidiary (the "Bank") in connection with the Bank's conversion
from a federally chartered mutual savings bank to a federally chartered stock
savings bank, pursuant to its Plan of Conversion ("Conversion"). On April 30,
1997, the Bank completed the Conversion and became a wholly owned subsidiary of
Bancshares. Bancshares' business is primarily that of owning the Bank and
participating in the Bank's activities.
The Bank provides a broad line of financial products to individuals and
small to medium-sized businesses through full service banking offices located
in Camden, Fordyce, Sheridan, and Monticello, Arkansas, as well as a loan
production office in Bryant, Arkansas.
The accompanying consolidated financial statements include the accounts of
Bancshares and the Bank and are collectively referred to as the "Company". All
significant intercompany balances and transactions have been eliminated in
consolidation.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS - For purposes of presentation in the
consolidated statements of cash flows, "cash and cash equivalents" includes
cash on hand and amounts due from depository institutions, which includes
interest-bearing amounts available upon demand.
OTHER INTEREST BEARING DEPOSITS WITH BANKS - Other interest bearing
deposits with banks represents certificates of deposit in other banks held by
the Company not meeting the definition of a cash equivalent.
INVESTMENT SECURITIES - The Company classifies investment securities into
one of two categories: held to maturity or available for sale. The Company does
not engage in trading activities. Debt securities that the Company has the
positive intent and ability to hold to maturity are classified as held to
maturity and recorded at cost, adjusted for the amortization of premiums and
the accretion of discounts.
Investment securities that the Company intends to hold for indefinite
periods of time are classified as available for sale and are recorded at fair
value. Unrealized holding gains and losses are excluded from earnings and
reported net of tax as a separate component of stockholders' equity until
realized. Investment securities in the available for sale portfolio may be used
as part of the Company's asset and liability management practices and may be
sold in response to changes in interest rate risk, prepayment risk or other
economic factors.
Premiums are amortized into interest income using the interest method to
the earlier of maturity or call date. Discounts are accreted into interest
income using the interest method over the period to maturity. The specific
identification method of accounting is used to compute gains or losses on the
sales of investment securities.
25
<PAGE> 26
If the fair value of an investment security declines for reasons other
than temporary market conditions, the carrying value of such a security is
written down to fair value by a charge to operations.
LOANS RECEIVABLE - Loans receivable that management has the intent and
ability to hold for the foreseeable future or until maturity or pay-off are
stated at unpaid principal balances adjusted for any charge-offs, the allowance
for loan losses, deferred loan fees or costs, and unamortized premiums or
discounts. Deferred loan fees or costs and premiums and discounts on loans are
amortized or accreted to income using the level-yield method over the remaining
period to contractual maturity.
The accrual of interest on impaired loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they
become due or when the loan becomes ninety days past due, whichever occurs
first. When interest accrual is discontinued, all unpaid accrued interest is
reversed. Interest income is subsequently recognized only to the extent cash
payments in excess of principal due are received, until such time that in
management's opinion, the borrower will be able to meet payments as they become
due.
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses is a valuation
allowance to provide for incurred but not yet realized losses. The Bank reviews
its loans for impairment on a quarterly basis. Impairment is determined by
assessing the probability that the borrower will not be able to fulfill the
contractual terms of the agreement. If a loan is determined to be impaired, the
amount of the impairment is measured based on the present value of expected
future cash flows discounted at the loan's effective interest rate or by use of
the observable market price of the loan or fair value of collateral if the loan
is collateral dependent. Throughout the year management estimates the level of
probable losses to determine whether the allowance for loan losses is
appropriate considering the estimated losses existing in the portfolio. Based
on these estimates, an amount is charged or credited to the provision for loan
losses and credited or charged to the allowance for loan losses in order to
adjust the allowance to a level determined by management to be appropriate
relative to losses. The allowance for loan losses is increased by charges to
income (provisions) and decreased by credits to income and by charge-offs, net
of recoveries.
Management's periodic evaluation of the appropriateness of the allowance
is based on the Company's past loan loss experience, known and inherent risks
in the portfolio, adverse situations that may affect the borrower's ability to
repay, the estimated value of any underlying collateral and current economic
conditions.
Homogeneous loans are those that are considered to have common
characteristics that provide for evaluation on an aggregate or pool basis. The
Company considers the characteristics of (1) one-to-four family residential
first mortgage loans; (2) automobile loans and; (3) consumer and home
improvement loans to permit consideration of the appropriateness of the
allowance for losses of each group of loans on a pool basis. The primary
methodology used to determine the appropriateness of the allowance for losses
includes segregating certain specific, poorly performing loans based on their
performance characteristics from the pools of loans as to type and then
applying a loss factor to the remaining pool balance based on several factors
including classification of the loans as to grade, past loss experience,
inherent risks, economic conditions in the primary market areas and other
factors which usually are beyond the control of the Company. Those segregated
specific loans are evaluated using the present value of future cash flows,
usually determined by estimating the fair value of the loan's collateral
reduced by any cost of selling and discounted at the loan's effective interest
rate if the estimated time to receipt of monies is more than three months.
Non-homogeneous loans are those loans that can be included in a particular
loan type, such as commercial loans and multi-family and commercial first
mortgage loans, but which differ in other characteristics to the extent that
valuation on a pool basis is not valid. After segregating specific, poorly
performing loans and applying the methodology as noted in the preceding
paragraph for such specific loans, the remaining loans are evaluated based on
payment experience, known difficulties in the borrowers business or geographic
area, loss experience, inherent risks and other factors usually beyond the
control of the Company. These loans are then graded and a factor, based on
experience, is applied to estimate the probable loss.
Estimates of the probability of loan losses involve an exercise of
judgment. While it is possible that in the near term the Company may sustain
losses which are substantial in relation to the allowance for loan losses, it
is the judgment of management that the allowance for loan losses reflected in
the consolidated statements of financial condition is appropriate considering
the estimated probable losses in the portfolio.
REAL ESTATE HELD FOR SALE - Real estate acquired in settlement of loans is
initially recorded at estimated fair value less estimated costs to sell and is
subsequently carried at the lower of carrying amount or fair value less
estimated disposal costs. Management periodically performs valuations, and an
allowance for losses is established
26
<PAGE> 27
by a charge to operations to the extent that the carrying value of a
property exceeds its estimated fair value. Costs relating to the development
and improvement of the property are capitalized, whereas those relating to
holding the property are expensed. Real estate acquired for sale is carried of
the lower of cost or fair value less costs to sell.
PREMISES AND EQUIPMENT - Office premises and equipment are stated at cost
less accumulated depreciation and amortization. The Company computes
depreciation of premises and equipment using the straight-line method over the
estimated useful lives of the individual assets which range from 5 to 50 years
for buildings and improvements and from 3 to 10 years for furniture and
equipment.
GOODWILL AND LONG LIVED ASSETS - Goodwill is being amortized over six
years using the straight-line method. Goodwill and other long lived assets are
reviewed for recoverability whenever events or changes in circumstances
indicate that the carrying amount may not be recoverable.
LOAN ORIGINATION FEES - Loan origination fees and certain direct loan
origination costs are deferred and the net fee or cost is recognized as an
adjustment to interest income using the level-yield method over the contractual
life of the loans. When a loan is fully repaid or sold, the amount of
unamortized fee or cost is recorded in income.
INCOME TAXES - The Company recognizes deferred tax liabilities and assets
for the expected future tax consequences of temporary differences between the
carrying amounts and the tax bases of assets and liabilities. Deferred tax
assets and liabilities are reflected at currently enacted income tax rates
applicable to the period in which the deferred tax assets or liabilities are
expected to be realized or settled. As changes in tax laws or rates are
enacted, deferred tax assets and liabilities are adjusted through the provision
for income taxes. The Company considers the need for a valuation allowance if,
based on available evidence, deferred tax assets are not expected to be
realized.
INTEREST RATE RISK - The Bank's asset base is exposed to risk including the
risk resulting from changes in interest rates and changes in the timing of cash
flows. The Bank monitors the effect of such risks by considering the mismatch
of the maturities of its assets and liabilities in the current interest rate
environment and the sensitivity of assets and liabilities to changes in
interest rates. The Bank's management has considered the effect of significant
increases and decreases in interest rates and believes such changes, if they
occurred, would be manageable and would not affect the ability of the Bank to
hold its assets as planned. However, the Bank is exposed to significant market
risk in the event of significant and prolonged interest rate changes.
RECENTLY ISSUED ACCOUNTING STANDARDS - During the year ended June 30,
1999, the Company adopted Financial Accounting Standards Board ("FASB")
Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income. SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components. The Company classifies
items of other comprehensive income by their nature in a financial statement
and displays the accumulated balance of other comprehensive income separately
from retained earnings and additional paid-in capital in the equity section of
the statements of financial condition. Also during the year ended June 30,
1999, the Company adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, which establishes standards for the way
public enterprises report information about operating segments in annual
financial statements and interim financial reports issued to shareholders. It
also establishes standards for related disclosures about products and services,
geographic areas, and major customers. Because the adoption of SFAS Nos. 130
and 131 require only additional disclosures, they have not had a material
effect on the Company's consolidated financial statements.
The Company early-adopted SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities as of October 1, 1998. This statement
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for
27
<PAGE> 28
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. Concurrent with adoption, the Company
transferred all of its investment securities classified as held to maturity to
available for sale resulting in an immaterial decrease in the carrying value of
investment securities and stockholders' equity.
EMPLOYEE STOCK OWNERSHIP PLAN - Compensation expense for the Employee Stock
Ownership Plan ("ESOP") is determined based on the average fair value of shares
committed to be released during the period and is recognized as the shares are
committed to be released. For the purposes of earnings per share, ESOP shares
are included in weighted-average common shares outstanding as the shares are
committed to be released.
MANAGEMENT RECOGNITION PLAN - Compensation for Management Recognition Plan
shares granted is based on the fair value of the shares at the date of grant and
is recognized ratably over the vesting period.
EARNINGS PER SHARE - Earnings per share ("EPS") of common stock has been
computed on the basis of the weighted-average number of shares of common stock
outstanding, assuming the Company was a public company since July 1, 1996. Basic
and diluted earnings per share were both calculated with 2,348,737, 2,462,084,
2,434,971 and weighted-average common shares outstanding for the years ended
June 30, 1999, 1998, and 1997, respectively. Weighted-average common shares
outstanding was the same for basic and diluted in those years. Potential
dilutive common shares include the Stock Option Plan shares and the Management
Recognition Plan shares, all of which were granted May 1, 1998. These potential
common shares had no dilutive effect for the years ended June 30, 1999 or 1998.
RECLASSIFICATIONS - Certain amounts in the 1998 and 1997 consolidated
financial statements have been reclassified to conform to the classifications
adopted for reporting in 1999 or 1998.
28
<PAGE> 29
2. INVESTMENT SECURITIES
Investment securities consisted of the following at June 30:
<TABLE>
<CAPTION>
1999
-------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE FOR SALE COST GAINS LOSSES VALUE
<S> <C> <C> <C> <C>
U.S. Government and agencies $ 6,481,345 $ 113,220 $ 6,368,125
Municipal securities 27,617,353 $ 7,522 920,459 26,704,416
Equity securities 63,100 2,725 60,375
Mortgage-backed securities 104,464,913 81,356 2,905,687 101,640,582
Collateralized mortgage obligations 12,879,042 4,990 537,841 12,346,191
---------- ----- ------- ----------
Total $ 151,505,753 $ 93,868 $ 4,479,932 $ 147,119,689
=========== ====== ========= ===========
<CAPTION>
1998
-------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
AVAILABLE FOR SALE COST GAINS LOSSES VALUE
<S> <C> <C> <C> <C>
U.S. Government and agencies $ 22,466,239 $ 42,964 $ 17,273 $ 22,491,930
Municipal securities 18,404,701 83,793 204,617 18,283,877
Mortgage-backed securities 48,804,919 258,101 39,354 49,023,666
Collateralized mortgage obligations 9,709,404 7,462 43,423 9,673,443
--------- ----- ------ ---------
Total $ 99,385,263 $ 392,320 $ 304,667 $ 99,472,916
========== ======= ======= ==========
<CAPTION>
1998
-------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
HELD TO MATURITY COST GAINS LOSSES VALUE
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 23,518,573 $ 76,295 $ 97,374 $ 23,497,494
Collateralized mortgage obligations 3,984,684 1,220 7,094 3,978,810
--------- ----- ----- ---------
Total $ 27,503,257 $ 77,515 $ 104,468 $ 27,476,304
========== ====== ======= ==========
</TABLE>
Effective October 1, 1998, the Company adopted SFAS No. 133. Concurrent
with this adoption, investment securities with an amortized cost of $25,424,636
and a market value of $25,428,154 at September 30, 1998, categorized in the
statement of financial condition as held to maturity were transferred to
available for sale. This transfer from the held to maturity category at the
date of the initial adoption of SFAS No. 133 does not call into question the
Company's intent to hold other debt securities to maturity in the future.
29
<PAGE> 30
Such investment securities were categorized as held to maturity as of June
30, 1998, because it was management's intent at that date to hold such
securities until maturity and the subsequent change in that intent and the
recategorization of such securities to available for sale occurred only upon
the adoption of SFAS No. 133. SFAS No. 133 prohibits the presentation of any
change due to its adoption in any period prior to the period of adoption.
Gross realized gains on sales of available for sale securities were
approximately $262,000 in the year ended June 30, 1999. There were no
significant gross realized losses in the year ended June 30, 1999. Gross
realized gains (losses) on sales of available for sale securities were
approximately $22,000 and ($21,000) in the years ended June 30, 1998 and 1997,
respectively.
The scheduled maturities of available for sale debt securities at June 30,
1999 by contractual maturity are shown below. Expected maturities may differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
<S> <C> <C>
Due in one year or less $ -- $ --
Due from one year to five years 3,497,398 3,451,875
Due from five years to ten years 3,467,730 3,367,175
Due after ten years 27,133,570 26,253,491
---------- ----------
34,098,698 33,072,541
Equity securities 63,100 60,375
Mortgage-backed securities 104,464,913 101,640,582
Collateralized mortgage obligations 12,879,042 12,346,191
---------- ----------
Total $ 151,505,753 $ 147,119,689
=========== ===========
</TABLE>
3. LOANS RECEIVABLE
Loans receivable consisted of the following at June 30:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
First mortgage loans:
One- to four- family residences $ 50,417,714 $ 48,400,399
Multi-family and commercial 42,922,554 39,235,934
Real estate construction loans 14,963,457 10,128,000
Loans to facilitate sales of foreclosed real estate -- 473,476
Less undisbursed loan funds (6,150,810) (3,921,787)
---------------- ------------
Total first mortgage loans 102,152,915 94,316,022
-------------- ----------
Consumer and other loans:
Commercial loans 5,367,611 2,708,927
Automobile 4,269,898 4,070,750
Consumer and home improvement loans 2,643,180 2,860,250
Loans collateralized by deposits 2,021,141 2,215,441
------------ -----------
Total consumer and other loans 14,301,830 11,855,368
---------- ----------
Allowance for loan losses (1,329,201) (1,468,546)
Deferred loan costs (fees) 37,339 (122,679)
------------ ------------
Loans receivable, net $ 115,162,883 $ 104,580,165
=========== ===========
</TABLE>
The Company originates and maintains loans receivable which are
substantially concentrated in its lending territory (primarily Southern
Arkansas) but also originates commercial real estate loans in other areas of
Arkansas and in contiguous states. The Company's policy calls for collateral or
other forms of repayment assurance to be
30
<PAGE> 31
received from the borrower at the time of loan origination. Such
collateral or other form of repayment assurance is subject to changes in
economic value due to various factors beyond the control of the Company.
The Company has made loans to its directors, officers, and their related
business interests. The aggregate dollar amount of loans outstanding to
directors, officers and their related business interests totaled approximately
$631,000 and $436,000 at June 30, 1999 and 1998, respectively.
Loans identified by management as impaired at June 30, 1999 and 1998, were
not significant. The Company is not committed to lend additional funds to
debtors whose loans have been modified.
Certain loans are originated for sale. These loans are typically held for
sale only a short time, and do not represent a material amount in the aggregate
prior to their sale. Normally the short time between origination and sale does
not provide for significant differences between cost and market values.
4. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable consisted of the following at June 30:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Investment securities $ 1,059,051 $ 1,220,964
Loans 658,772 618,362
---------- ----------
Total $ 1,717,823 $ 1,839,326
========= =========
</TABLE>
5. ALLOWANCES FOR LOAN AND REAL ESTATE LOSSES
A summary of the activity in the allowances for loan and real estate
losses is as follows for the years ended June 30:
<TABLE>
<CAPTION>
1999 1998 1997
REAL REAL REAL
LOANS ESTATE LOANS ESTATE LOANS ESTATE
------------------- ------------------------ ----------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, beginning of year $ 1,468,546 -- $ 1,492,473 $ 28,825 $ 1,283,234 $ 58,587
Provision -- -- 24,000 221,671 13,527
Charge-offs, net of recoveries (139,345) -- (47,927) (28,825) (12,432) (43,289)
--------- ---- --------- -------- --------- --------
Balance, end of year $ 1,329,201 -- $ 1,468,546 $ -- $ 1,492,473 $ 28,825
========= ===== ========= ======== ========= ========
</TABLE>
6. FEDERAL HOME LOAN BANK STOCK
The Bank is a member of the Federal Home Loan Bank System. As a member of
this system, it is required to maintain an investment in capital stock of the
Federal Home Loan Bank ("FHLB") in an amount equal to the greater of 1% of its
outstanding home loans or .3% of its total assets. No ready market exists for
such stock and it has no quoted market value but may be redeemed at par. The
carrying value of the stock is its cost.
7. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following at June 30:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Land and buildings $ 5,433,038 $ 4,641,036
Furniture and equipment 2,682,725 2,037,876
--------- ---------
Total 8,115,763 6,678,912
Accumulated depreciation (1,615,059) (1,077,145)
----------- -----------
Premises and equipment, net $ 6,500,704 $ 5,601,767
========== ==========
</TABLE>
31
<PAGE> 32
8. DEPOSITS
Deposits are summarized as follows at June 30:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Demand and NOW accounts, including noninterest-bearing
deposits of $5,384,227 and $4,332,481 in 1999 and
1998, respectively $ 12,411,932 $ 10,664,546
Money market 17,619,341 18,384,835
Passbook savings 7,971,447 7,512,607
Certificates of deposit 108,293,878 105,369,342
----------- -----------
Total $ 146,296,598 $ 141,931,330
============ ============
</TABLE>
The aggregate amount of short-term jumbo certificates of deposit with a
minimum denomination of $100,000 was approximately $11.4 million and $10.0
million at June 30, 1999 and 1998, respectively.
At June 30, 1999, scheduled maturities of certificates of deposit are as
follows:
<TABLE>
<CAPTION>
Years ending June 30:
<S> <C>
2000 $ 79,540,264
2001 22,402,820
2002 6,261,443
2003 89,351
------------
Total $ 108,293,878
===========
</TABLE>
Eligible deposits of the Bank are insured up to $100,000 by the Savings
Association Insurance Fund ("SAIF") of the Federal Deposit Insurance
Corporation ("FDIC").
Legislation was signed into law by the President on September 30, 1996, to
recapitalize the SAIF. As a result of such legislation, the Bank was required
to pay a one-time special assessment of $889,011 which had an approximate
$551,000 after-tax effect on the results of operations for the year ended June
30, 1997. The legislation also mandated that the deposit insurance premiums
charged SAIF-insured institutions (such as the Bank) decline effective January
1, 1997.
9. FEDERAL HOME LOAN BANK ADVANCES AND NOTE PAYABLE
The Bank pledges as collateral for FHLB advances its FHLB stock and has
entered into blanket collateral agreements with the FHLB whereby the Bank
agrees to maintain, free of other encumbrances, qualifying single family first
mortgage loans with unpaid principal balances, when discounted to 75% of such
balances, of at least 100% of total outstanding advances. Additionally the Bank
has pledged mortgage-backed securities with a carrying value of approximately
$66.6 million at June 30, 1999, as additional collateral. Advances at June 30,
1999 and 1998, have maturity dates as follows:
<TABLE>
<CAPTION>
1999 1998
WEIGHTED WEIGHTED
AVERAGE AVERAGE
RATE AMOUNT RATE AMOUNT
Years ending June 30:
<S> <C> <C> <C> <C>
1999 -- -- 5.65 % $ 5,289,500
2000 5.09 % $ 24,425,000 5.81 3,000,000
2001 6.00 7,625,000 6.31 6,125,000
2002 5.50 7,550,000 5.86 4,500,000
2003 5.66 11,555,000 5.88 9,055,000
2004 5.66 4,875,000 5.94 2,625,000
Thereafter 5.85 48,493,419 5.90 37,526,568
---- ---------- ---- ----------
Total 5.63 % $ 104,523,419 5.91 % $ 68,121,068
==== =========== ===== ==========
</TABLE>
32
<PAGE> 33
The note payable is due in annual installments of $80,000 plus interest
through September 2001. The note bears interest at 7.50% and is collateralized
by real estate held for sale and office premises with a combined carrying value
at June 30, 1999, of approximately $500,000.
10. INCOME TAXES
Income tax provisions (benefits) are summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
------------------------------------------
1999 1998 1997
<S> <C> <C> <C>
Income tax provision (benefit):
Current $ 248,263 $ (47,732) $ (170,561)
Deferred (311,921) 27,027 (110,374)
--------- ------ ---------
Total $ (63,658) $ (20,705) $ (280,935)
========== ======== =========
</TABLE>
The reasons for the differences between the statutory federal income
tax rates and the effective tax rates are summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
------------------------------------------------------------------------------
1999 1998 1997
<S> <C> <C> <C> <C> <C> <C>
Taxes at statutory rate $ 119,674 34.00 % $ 123,899 34.0 % $ (302,739) (34.0)%
Increase (decrease)
resulting from:
Tax exempt income (304,193) (86.42) (135,853) (37.3)
Disallowed interest expense 44,561 12.66
Change in estimate 64,915 18.44
Goodwill 41,865 11.5 54,425 6.1
Compensation (14,389) (4.09) (68,347) (18.8)
Other, net 25,774 7.32 17,731 4.9 (32,621) (3.7)
------ ---- ------ --- -------- -----
Total $ (63,658) (18.09)% $ (20,705) (5.7)% $ (280,935) (31.6)%
======== ======= ======== ===== ========= ======
</TABLE>
During the year ended December 31, 1996, new legislation was enacted which
provides for the recapture into taxable income of certain amounts previously
deducted as additions to the bad debt reserves for income tax purposes. The
Bank changed its method of determining bad debt reserves for tax purposes
following the year ended June 30, 1997. The amounts to be recaptured for income
tax reporting purposes are considered by the Bank in the determination of the
net deferred tax liability.
The Company's deferred tax asset account was comprised of the following at
June 30:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses $ 225,376 $ 225,376
Unrealized loss on investments 1,764,294 --
Deferred compensation 269,052 213,828
Net operating losses 231,320 --
AMT credit carryover 142,658 --
Other 28,213 --
Loan fees -- 31,283
------------- ----------
Total deferred tax assets 2,660,913 470,487
Deferred tax liabilities:
Premises and equipment 120,617 94,677
Investment premiums and discount 8,162 16,325
Loan fees 23,111 --
FHLB dividends 140,522 --
Loan discounts 8,610 17,219
Unrealized gain on investments -- 33,746
Other -- 58,590
-------------- ------
Total deferred tax liabilities 301,022 220,557
-------- -------
Net deferred tax asset $ 2,359,891 $ 249,930
========= =======
</TABLE>
33
<PAGE> 34
A deferred tax liability has not been recognized for the bad debt reserves
of the Bank created in the tax years which began prior to December 31, 1987
(the base year). At June 30, 1999, the amount of these reserves totaled
approximately $3,459,119 with an unrecognized deferred tax liability of
$1,177,372. Such unrecognized deferred tax liability could be recognized in the
future, in whole or in part, if (i) there is a change in federal tax law, (ii)
the Bank fails to meet certain definitional tests and other conditions in the
federal tax law, (iii) certain distributions are made with respect to the stock
of the Bank, or (iv) the bad debt reserves are used for any purpose other than
absorbing bad debt losses.
The Company has a net operating loss carryforward of $695,394 expiring in
2019. The Company's AMT credit carryforward of $142,658 does not expire.
11. BENEFIT PLANS
EMPLOYEE STOCK OWNERSHIP PLAN - The Company 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 Bancshares.
Bancshares' note receivable, presented in the statements of stockholders'
equity as unearned ESOP shares, is to be repaid in installments of $211,600 on
June 30th each year through 2006. Interest is based upon the prime rate, which
is to be adjusted and paid quarterly. The note may be prepaid without penalty.
The ESOP is funded by contributions made by the Bank in amounts sufficient to
retire the debt. Compensation expense of $220,171, $427,399, and $161,813 was
recognized during the years ended June 30, 1999, 1998, and 1997, respectively.
Shares no longer required to be held to collateralize the debt 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 three years of credited service. Forfeitures of
nonvested benefits will be reallocated among remaining participating employees
in the same proportion as contributions. At June 30, 1999 and 1998, 21,160 and
29,752 shares, respectively, were committed to be released by the ESOP to
participant accounts. At June 30, 1999, there were 63,480 shares allocated to
participant accounts and 148,120 unallocated shares. The fair value of the
unallocated shares amounted to approximately $1,397,882 at June 30, 1999.
Participants with vested account balances leaving employment, generally,
may elect to have their allocated shares distributed. In the case of a
distribution of shares which at the time of distribution are not readily
tradeable on an established securities market, the Company is required to issue
a put option to the participant. Any excess of the total purchase price at
which the participant may put the shares to the Company over the fair value of
the shares at the date of the issuance of the option is recognized as expense
to the Company with the fair value of the shares recorded as treasury stock.
During the year ended June 30, 1999, put options were issued to two employees
resulting in an expense to the Company totaling approximately $20,000.
STOCK OPTION PLAN - The Stock Option Plan ("SOP"), approved by the
Company's stockholders during the year ended June 30, 1998, provides for a
committee of the Company's Board of Directors to award incentive or
non-incentive stock options, representing up to 317,400 shares of Company
stock. Options granted to executive officers and directors vest 25% immediately
and 25% on each of the three subsequent anniversary dates on the grant. Options
granted to employees vest 20% immediately upon grant, with the balance vesting
in equal amounts on the four subsequent anniversary dates of the grant. Options
granted vest immediately in the event of retirement, disability, or death.
Outstanding stock options can be exercised over a ten year period from the date
of grant.
Under the SOP, options have been granted to directors and key employees to
purchase common stock of the Company. The exercise price in each case equals
the fair market value of the Company's stock at the date of grant. On October
29, 1998, the options committee of the Board of Directors lowered the option
grant price on the existing 304,140 options outstanding to current employees and
directors at that date to $9.125 per share, which was market value on that day.
New options granted in the current year have an average exercise price of
$9.35, and a weighted average remaining contract life of 9.7 years at June 30,
1999.
34
<PAGE> 35
A summary of the status of the Company's stock option plan as of June 30,
1999, and changes during the years ending June 30, 1999 and 1998, is presented
below:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
OPTIONS SHARES PRICE
<S> <C> <C>
Outstanding at July 1, 1997 -- $ --
Granted 304,300 16.00
Exercised -- --
Forfeited (128) 16.00
----- -----
Outstanding at June 30, 1998 304,172 16.00
Granted 20,100 9.35
Exercised -- --
Forfeited 9,104 9.31
----- ----
Outstanding at June 30, 1999 315,168 9.14
------- ----
Options exercisable at June 30, 1999 (vested) 146,106 $ 9.14
======= ====
</TABLE>
Exercise prices for options outstanding at June 30, 1999, range from $9.125
to $9.375 per share. The weighted average remaining contractual life of such
shares was 8.8 years at June 30, 1999.
The Company applies the provisions of Accounting Principles Board Opinion
No. 25 in accounting for its stock option plan, as allowed under SFAS No. 123,
Accounting for Stock-Based Compensation. Accordingly, no compensation cost has
been recognized for options granted to employees. Had compensation cost for
these plans been determined based on the fair value at the grant dates or
repricing date for awards under those plans consistent with the methods of SFAS
No. 123, the Company's pro forma net income and pro forma earnings per share
would have been as follows:
<TABLE>
<CAPTION>
1999
AS REPORTED PRO FORMA
<S> <C> <C>
Net income (in thousands) $ 416 $311
Earnings per share:
Basic $0.18 $0.13
Diluted $0.18 $0.13
</TABLE>
<TABLE>
<CAPTION>
1998
AS REPORTED PRO FORMA
<S> <C> <C>
Net income (in thousands) $ 385 $ 157
Earnings per share:
Basic $0.18 $0.06
Diluted $0.18 $0.06
</TABLE>
In determining the above pro forma disclosure, the fair value of options
granted was estimated on the date of grant using the binomial option-pricing
model with the following weighted average assumptions:
<TABLE>
<CAPTION>
1999 1998
GRANTS GRANTS
<S> <C> <C>
Volatility 54% 15%
Life of options 7.5 years 7.5 years
Risk-free interest rate 5.3% 5.7%
Dividend rate 2.56% 2.63%
</TABLE>
The weighted average fair value of options granted during the fiscal year
ended June 30, 1999, was $2.25 per share.
35
<PAGE> 36
MANAGEMENT RECOGNITION PLAN - The Management Recognition Plan ("MRP"),
approved by the Company's stockholders during the year ended June 30, 1998,
provides for a committee of the Company's Board of Directors to award restricted
stock to key officers as well as non-employee directors. The MRP authorizes the
Company to grant up to 52,900 shares of Company stock, all of which were granted
during 1998. Compensation expense will be recognized based on the fair market
value of the shares on the grant date of $16.00 over the vesting period. Shares
granted to directors (37,024) vest 25% at the grant date and 25% each May 1
afterward. Shares granted to non-directors (15,876, of which 1,271 were
forfeited as of June 30, 1999) vest 20% at the grant date and 20% each May 1
afterward. Shares granted will be deemed vested in the event of retirement,
disability, or death. At June 30, 1999, all shares have been acquired that are
necessary to meet the Plan's award requirements. The difference between the
price at the date of grant and the actual purchase price was recorded as an
adjustment to stockholders' equity. Approximately $188,000 and $268,000 in
compensation expense was recognized during the years ended June 30, 1999, and
1998, respectively.
DEFINED BENEFIT PLAN - The Bank had a qualified, noncontributory defined
benefit retirement plan (the "Plan") covering all of its eligible employees.
Employees were eligible when they had attained at least twenty-one years of age
and six months of service with the Bank. The Board of Directors initially
adopted a resolution on July 1, 1996, to terminate the Plan as of September 16,
1996, and to freeze benefit accruals as of July 31, 1996. The Company
experienced delays in terminating the Plan and on June 18, 1998, a resolution
was adopted to terminate the Plan as of September 1, 1998, with benefit accruals
remaining frozen as of July 31, 1996. Settlement of the related pension
obligation occurred subsequent to June 30, 1999, and Plan assets were
distributed to participants on August 30, 1999.
All active participants became fully vested for their accrued benefits. The
Plan provides that any excess assets will be allocated to participants. As such,
based on the funded status of the Plan, no gain or loss occurred upon
settlement.
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
RECONCILIATION OF FUNDED STATUS:
Actuarial present value of accumulated benefit obligations:
Vested portion $ 450,170 $ 417,651
Vested part of excess assets 98,310 141,752
Non-vested portion -- --
-------------- --------------
Accumulated benefit obligation 548,480 559,403
Effect of estimated future pay growth -- --
-------------- --------------
Projected benefit obligation 548,480 559,403
Plan assets at fair value 548,480 559,403
------- -------
FUNDED STATUS:
Unrecognized net (gain) or loss -- --
Unrecognized prior service cost -- --
Unrecognized net transition obligation -- --
-------------- --------------
(Accrued) prepaid pension cost -- --
============== ==============
Determination of pension cost:
Service cost -- --
Interest cost $ 33,564 $ 33,099
Actual return on assets 10,923 (75,820)
Net amortization and deferral (44,487) 42,721
-------------- --------------
Net periodic pension cost -- --
============== ==============
</TABLE>
The weighted average interest rate used in determining the projected
benefit obligation was 6.0% in 1999 and 1998. The expected long-term rate of
return on assets was 6.0% for 1999 and 1998.
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 whereby funds are to be set aside annually in a grantor
trust, with the Bank acting as
36
<PAGE> 37
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. Future funding is dependent
on continued service to the Bank and therefore is expensed as the plan is funded
each year. For the years ended June 30, 1999, 1998 and 1997, contributions to
the plan totaled $162,421, $154,088, and $232,308, respectively.
401(k) PLAN - 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 reaching age 21 and completing one
year of service. At its discretion, the Bank may make matching contributions to
the plan. Employer contributions vest 20% each year beginning in the third year
of service and become 100% vested in seven years. The Bank made no matching
contribution during the years ended June 30, 1999 and June 30, 1998. Matching
contributions to the plan was $25,997 year ended June 30, 1997.
EMPLOYMENT AGREEMENTS - Certain executive officers of the Bank and the
Company have employment agreements with three-year renewable terms. Such
agreements provide for termination pay and other benefits under certain
circumstances. Aggregate termination pay is approximately $950,000.
12. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Those instruments involve, to varying degrees, elements of
credit risk in excess of the amount recognized in the consolidated statements of
financial condition. The Company does not use financial instruments with
off-balance sheet risk as part of its asset/liability management program or for
trading purposes. The Company's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for commitments to
extend credit and standby letters of credit is represented by the contractual
amounts of those instruments. The Company uses the same credit policies in
making commitments and conditional obligations as it does for on-balance sheet
instruments.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses.
The Company evaluates each customer's creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Company upon
extension of credit, is based on management's credit evaluation of the credit
applicant. Such collateral consists primarily of residential properties. Standby
letters of credit are conditional commitments issued by the Company to guarantee
the performance of a customer to a third party. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan facilities to customers.
The Company had the following outstanding commitments at June 30, 1999:
<TABLE>
<S> <C>
Undisbursed construction loans $ 5,931,682
Commitments to originate commercial/consumer loans 378,927
Commitments to originate mortgage loans 798,125
Letters of credit 26,000
Unused lines of credit 219,101
------------
Total $ 7,353,835
=========
</TABLE>
The funding period for construction loans is generally less than nine
months and commitments to originate mortgage loans are generally outstanding for
60 days or less. At June 30, 1999, interest rates on commitments are believed by
management to approximate market rates.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value amounts have been determined by the Company using
available market information and appropriate valuation methodologies. However,
considerable judgment is required to interpret market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
The estimated fair values of financial instruments are as follows:
37
<PAGE> 38
<TABLE>
<CAPTION>
JUNE 30, 1999 JUNE 30, 1998
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
<S> <C> <C> <C> <C>
ASSETS:
Cash and due from banks $ 3,560,884 $ 3,560,884 $ 1,531,363 $ 1,531,363
Interest bearing deposits with banks 975,330 975,330 2,291,035 2,291,035
Other interest bearing deposits with banks 718,000 718,000 2,782,000 2,782,000
Investment securities:
Available for sale 147,119,689 147,119,689 99,472,916 99,472,916
Held to maturity -- -- 27,503,257 27,476,304
Loans receivable, net 115,162,883 115,598,738 104,580,165 104,737,165
Accrued interest receivable 1,717,823 1,717,823 1,839,326 1,839,326
Federal Home Loan Bank stock 5,379,100 5,379,100 3,448,900 3,448,900
LIABILITIES
Deposits:
Demand, NOW, money
market and regular savings 38,002,720 38,002,720 36,561,988 36,561,988
Certificates of deposit 108,293,878 107,991,000 105,369,342 105,492,342
Federal Home Loan Bank advances 104,523,419 101,550,000 68,121,068 68,435,068
Liability to purchase MRP shares -- -- 846,400 793,500
Advance payments by
borrowers for taxes and insurance 128,442 128,442 209,242 209,242
Accrued interest payable 815,197 815,197 643,887 643,887
Note payable 240,000 245,000 320,000 320,000
</TABLE>
For cash and due from banks, interest bearing deposits with banks, other
interest bearing deposits with banks, Federal Home Loan Bank stock and accrued
interest receivable, the carrying value is a reasonable estimate of fair value
primarily because of the short-term nature of instruments or, as to Federal Home
Loan Bank stock, the ability to sell the stock back to the Federal Home Loan
Bank at cost. The fair value of investment securities is based on quoted market
prices, dealer quotes and prices obtained from independent pricing services. The
fair value of loans receivable is estimated based on present values using
risk-adjusted spreads to appropriate indexes to approximate current entry-value
interest rates considering anticipated prepayment speeds, maturity and credit
risks.
The fair value of demand deposit accounts, NOW accounts, savings accounts
and money market deposits is the amount payable on demand at the reporting date.
The fair value of fixed-maturity certificates of deposit, Federal Home Loan Bank
advances, and note payable is estimated using the rates currently offered for
deposits and borrowings of similar remaining maturities at the reporting date.
The fair value of the liability for MRP shares was determined by the product of
the number of shares to be purchased and their market value at June 30, 1998.
For advance payments by borrowers for taxes and insurance and accrued interest
payable the carrying value is a reasonable estimate of fair value, primarily
because of the short-term nature of instruments. Commitments are generally made
at prevailing interest rates at the time of funding and, therefore, there is no
difference between the contract amount and fair value.
The fair value estimates presented herein are based on pertinent
information available to management as of June 30, 1999 and 1998. Although
management is not aware of any factors that would significantly affect the
estimated fair value amounts, such amounts have not been comprehensively
revalued for purposes of these financial statements since the reporting date
and, therefore, current estimates of fair value may differ significantly from
the amounts presented herein.
14. COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Company has various outstanding
commitments and contingent liabilities that are not reflected in the
accompanying consolidated financial statements. In addition, the Company is a
defendant in certain claims and legal actions arising in the ordinary course of
business. In the opinion of
38
<PAGE> 39
management, after consultation with legal counsel, the ultimate disposition of
these matters is not expected to have a material adverse effect on the
consolidated financial statements of the Company.
During the year ended June 30, 1998, a circuit court entered a judgment
against the Bank in the amount of $78,000 for breach of contract regarding its
alleged failure to provide a party the right to purchase real estate formerly
used as a branch location. The Company has appealed the judgment to the court of
appeals. The Company and its counsel believe there is a reasonable likelihood
that the merits of the case will result in a reversal of the lower court's
decision. No accrual of this possible loss has been made in the consolidated
financial statements.
In May, 1999, a shareholder filed a class action complaint against the
Company and several current and former officers alleging that the defendants
defrauded the plaintiff and other shareholder class members through various
public statements and reports thereby artificially inflating the price of the
Company's common stock and causing the plaintiff and other shareholder class
members to purchase the Company's common stock at inflated prices.
The Company and its counsel have reviewed the complaint and intend to
contest the allegations vigorously. Management is unable to determine the
likelihood of an unfavorable outcome of the suit or the amount of damages
that the Company may have to pay, if any. The Company will incur costs through
the payment of legal fees and the related costs of litigation. The extent of
these costs is not determinable at this time.
15. RETAINED EARNINGS
Upon the Conversion, the Company established a special liquidation account
for the benefit of eligible account holders and the supplemental eligible
account holders in an amount equal to the net worth of the Bank as of the date
of its latest statement of financial condition contained in the final offering
circular used in connection with the Conversion. The liquidation account will be
maintained for the benefit of eligible account holders and supplemental eligible
account holders who continue to maintain their accounts in the Bank after
Conversion. In the event of a complete liquidation (and only in such event),
each eligible and supplemental eligible account holder will be entitled to
receive a liquidation distribution from the liquidation account in an amount
proportionate to the current adjusted qualifying balances for accounts then
held.
The Bank may not declare or pay cash dividends on its shares of common
stock if the effect thereof would cause the Bank's stockholders' equity to be
reduced below applicable regulatory capital maintenance requirements for insured
institutions or below the special liquidation account referred to above. This
requirement effectively limits the dividend paying ability of the Company in
that the Company must maintain an investment in equity of the Bank sufficient to
enable the Bank to meet its requirements as noted above. Required capital
amounts are shown in Note 16 to the consolidated financial statements.
Liquidation account balances are not maintained because of the cost of
maintenance and the remote likelihood of complete liquidation. Additionally, the
Bank is limited to distributions it may make to Bancshares without OTS approval
if the distribution would cause the total distributions to exceed the Bank's net
income for the year to date plus the Bank's net income (less distributions) for
the preceding two years. Bancshares may use assets other than its investment in
the Bank as a source of dividends.
16. REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered
by federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory--and possible additional discretionary--actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of tangible capital (as defined in the regulations) to tangible assets
(as defined) and core capital (as defined) to adjusted total assets (as
defined), and of total risk-based capital (as defined) to risk-weighted assets
(as defined).
39
<PAGE> 40
As of June 30, 1999 and 1998, the most recent notification from the Office
of Thrift Supervision categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum core (Tier I core), Tier I
risk-based, and total risk-based ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the Bank's category.
The Bank's actual capital amounts (in thousands) and ratios are also
presented in the tables:
<TABLE>
<CAPTION>
TO BE CATEGORIZED
AS WELL CAPITALIZED
UNDER PROMPT
FOR CAPITAL CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------------- ------------------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
AS OF JUNE 30, 1999:
Tier I (Core) Capital to Adjusted Total Assets $ 30,063 10.50 % $ 11,448 4.00 % $ 14,310 5.00 %
Total Risk-Based Capital to Risk-weighted Assets 31,285 25.44 % 9,840 8.00 % 12,300 10.00 %
Tier I (Core) Capital to Risk-weighted Assets 30,063 24.44 % N/A N/A 7,380 6.00 %
Tangible Capital to Tangible Assets 30,063 10.50 % 4,293 1.50 % N/A N/A
AS OF JUNE 30, 1998:
Tier I (Core) Capital to Adjusted Total Assets $ 29,224 11.64 % $ 10,027 4.00 % $ 12,526 5.00 %
Total Risk-Based Capital to Risk-weighted Assets 31,021 29.09 % 8,531 8.00 % 10,664 10.00 %
Tier I (Core) Capital to Risk-weighted Assets 29,224 27.04 % N/A N/A 6,466 6.00 %
Tangible Capital to Tangible Assets 29,261 11.67 % 3,759 1.50 % N/A N/A
</TABLE>
Regulations require the Bank to maintain an amount equal to 4% of deposits
(net of loans collateralized by deposits) plus short-term borrowings in cash and
U.S. Government and other approved securities.
17. PARENT COMPANY ONLY FINANCIAL INFORMATION
The following condensed statements of financial condition as of June 30,
1999 and 1998, and condensed statements of income and cash flows for the years
ended June 30, 1999 and 1998, for HCB Bancshares, Inc. should be read in
conjunction with the consolidated financial statements and the notes herein.
HCB BANCSHARES, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 1999 AND 1998
<TABLE>
<CAPTION>
ASSETS 1999 1998
<S> <C> <C>
Deposit in Bank $ 2,866,424 $ 8,030,275
Investment in Bank 27,800,471 29,709,482
Loan 2,413,019
Investment securities 60,375
Other assets 156,461 11,714
------------ ------------
TOTAL ASSETS $ 33,296,750 $ 37,751,471
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses and other liabilities $ 1,179,190 $ 72,547
Stockholders' equity 32,117,560 37,678,924
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 33,296,750 $ 37,751,471
============ ============
</TABLE>
40
<PAGE> 41
CONDENSED STATEMENTS OF INCOME
YEARS ENDED JUNE 30, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
INCOME:
Interest and dividend income $ 395,595
EXPENSES:
Operating expenses 242,402 $ 83,974
--------- ---------
INCOME (LOSS) BEFORE INCOME TAXES AND EQUITY IN
UNDISTRIBUTED EARNINGS OF BANK SUBSIDIARY 153,193 (83,974)
INCOME TAX PROVISION (BENEFIT) (31,220) 45,725
--------- ---------
INCOME (LOSS) BEFORE EQUITY IN UNDISTRIBUTED
EARNINGS OF BANK SUBSIDARY 184,413 (129,699)
EQUITY IN UNDISTRIBUTED EARNINGS OF BANK SUBSIDIARY 231,228 514,812
--------- ---------
NET INCOME $ 415,641 $ 385,113
========= =========
</TABLE>
HCB BANCSHARES, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 415,641 $ 385,113
Adjustments to reconcile net income to net cash provided (used) by
operating activities:
Equity in undistributed earnings of Bank subsidiary (231,228) (514,812)
Changes in operating assets and liabilities:
Other assets (143,649) 15,048
Accrued expenses and other liabilities 1,106,643 29,409
---------- ----------
Net cash provided (used) by operating activities 1,147,407 (85,242)
---------- ----------
INVESTING ACTIVITIES:
Purchase of investments (63,100)
Purchase loan, net of repayments (2,413,019)
----------- ---------
Net cash used by investing activities (2,476,119)
----------- ---------
FINANCING ACTIVITIES:
Dividends paid (592,612) (529,000)
Purchase of treasury stock (3,242,527)
----------- ----------
Net cash used by financing activities (3,835,139) (529,000)
----------- ----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (5,163,851) (614,242)
CASH AND CASH EQUIVALENTS:
Beginning of period 8,030,275 8,644,517
--------- ---------
End of period $ 2,866,424 $ 8,030,275
========= =========
</TABLE>
41
<PAGE> 42
18. OTHER COMPREHENSIVE INCOME (LOSS)
The amount of income tax expense or benefit allocated to each component of
comprehensive income, including reclassification adjustments, are shown below:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, 1999
---------------------------------------------------------------
BEFORE TAX TAX EXPENSE NET-OF-TAX
AMOUNT (BENEFIT) AMOUNT
<S> <C> <C> <C>
UNREALIZED GAINS (LOSSES) ON SECURITIES:
Unrealized holding gain (loss) on securities
arising during period $ (3,790,398) $ (1,288,735) $ (2,501,663)
Less reclassification adjustment for
(gains) losses included in net income (261,996) (89,079) (172,917)
------------- ------------- -------------
Other comprehensive income (loss) $ (4,052,394) $ (1,377,814) $ (2,674,580)
============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, 1998
-------------------------------------------------------
BEFORE TAX TAX EXPENSE NET-OF-TAX
AMOUNT (BENEFIT) AMOUNT
<S> <C> <C> <C>
UNREALIZED GAINS (LOSSES) ON SECURITIES:
Unrealized holding gain (loss) on securities
arising during period $ 154,470 $ 52,520 $ 101,950
Less reclassification adjustment for
(gains) losses included in net income (22,257) (7,567) (14,690)
--------- ---------- ---------
Other comprehensive income (loss) $ 132,213 $ 44,953 $ 87,260
========= ========== =========
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, 1997
-----------------------------------------------
BEFORE TAX TAX EXPENSE NET-OF-TAX
AMOUNT (BENEFIT) AMOUNT
<S> <C> <C> <C>
UNREALIZED GAINS (LOSSES) ON SECURITIES:
Unrealized holding gain (loss) on securities
arising during period $ 362,055 $ 123,097 $ 238,958
Less reclassification adjustment for
(gains) losses included in net income 21,215 7,213 14,002
-------- ----------- ----------
Other comprehensive income (loss) $ 383,270 $ 130,310 $ 252,960
========= ========= =========
</TABLE>
42
<PAGE> 43
19. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables represent summarized data for each of the four
quarters in the years ended June 30, 1999 and June 30, 1998.
<TABLE>
<CAPTION>
1999
(IN THOUSANDS, EXCEPT SHARE DATA)
---------------------------------------------------
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
<S> <C> <C> <C> <C>
Interest income $ 4,474 $ 4,621 $ 4,655 $ 4,525
Interest expense 3,015 3,000 3,120 2,959
----- ----- ----- -----
Net interest income 1,459 1,621 1,535 1,566
Provision for loan losses -- -- -- --
Net interest income after provision
for loan losses 1,459 1,621 1,535 1,566
Noninterest income 196 214 308 301
Noninterest expenses 1,673 1,880 1,888 1,407
----- ----- ----- -----
Income (loss) before income taxes (18) (45) (45) 460
Income tax provision (benefit) (93) (63) (58) 150
-------- -------- -------- ------
Net income 75 18 13 310
Basic earnings per common share 0.03 0.01 0.01 0.13
Diluted earnings per common share 0.03 0.01 0.01 0.13
Cash dividends declared per common share 0.06 0.06 0.06 0.06
Average common shares and common stock
equivalents outstanding 2,220,650 2,326,208 2,388,538 2,459,585
</TABLE>
<TABLE>
<CAPTION>
1998
(IN THOUSANDS, EXCEPT SHARE DATA)
---------------------------------------------------
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
<S> <C> <C> <C> <C>
Interest income $ 4,048 $ 3,808 $ 3,547 $ 3,625
Interest expense 2,608 2,256 2,046 2,032
----- ----- ----- -----
Net interest income 1,440 1,552 1,501 1,593
Provision for loan losses 4 20
Net interest income after provision
for loan losses 1,440 1,552 1,497 1,573
Noninterest income (loss) 135 236 185 154
Noninterest expense 1,929 1,785 1,467 1,227
----- ----- ----- -----
Income (loss) before income taxes (354) 3 215 500
Income tax provision (benefit) (248) (19) 74 172
----- ------- ------- -------
Net income (loss) (106) 22 141 328
Basic income (loss) per common share (0.04) 0.01 0.06 0.13
Diluted income (loss) per common share (0.04) 0.01 0.06 0.13
Cash dividends declared per common share 0.05 0.05 0.05 0.05
Average common shares and common stock
equivalents outstanding 2,471,997 2,464,560 2,457,123 2,449,686
</TABLE>
43
<PAGE> 44
CORPORATE INFORMATION
DIRECTORS
Vida H. Lampkin
Chairman of the Board, President and Chief
Executive Officer
Cameron D. McKeel
Executive Vice President
Roy Wayne Moseley
Self-employed
Fordyce, Arkansas
Bruce D. Murry
Self-employed
Camden, Arkansas
Carl E. Parker, Jr.
General Manager, Camden Monument Co.
Camden, Arkansas
Lula Sue Silliman
Retired
Camden, Arkansas
Clifford Steelman
Human Resources Manager, International
Paper Co., Kraft Packaging Plant
Camden, Arkansas
EXECUTIVE OFFICERS
William C. Lyon
Senior Vice President and Chief Lending Officer
ANNUAL STOCKHOLDERS
MEETING:
November __, 1999 - __:__ _.m.
Charles O. Ross Center
746 California Avenue, S.W.
Camden, Arkansas
Record Date - , 1999
-------------------
MAIN OFFICE:
237 Jackson Street, S.W.
Camden, Arkansas
44
<PAGE> 45
BRANCH OFFICES:
23233 Interstate 30, No. 20
Bryant, Arkansas
208 Cardinal Shopping Center
Camden, Arkansas
610 West 4th Street
Fordyce, Arkansas
473 Highway 425 North
Monticello, Arkansas
108 South Main Street
Sheridan, Arkansas
INDEPENDENT AUDITOR:
Deloitte & Touche, LLP
111 Center Street, Suite 1800
Little Rock, Arkansas 72201
GENERAL COUNSEL:
Robert S. Laney, Esquire
P.O. Box 777
Camden, Arkansas 71711-0777
SECURITIES AND REGULATORY
COUNSEL:
Housley Kantarian & Bronstein, P.C.
1220 19th Street, N.W., Suite 700
Washington, D.C. 20036
STOCK REGISTRAR & TRANSFER
AGENT
Registrar and Transfer Company
Cranford, New Jersey 07016-3572
45
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES
<TABLE>
<CAPTION>
STATE OR OTHER PERCENTAGE
PARENT JURISDICTION OF INCORPORATION OWNERSHIP
- ------ ----------------------------- ---------
<S> <C> <C>
HCB Bancshares, Inc. Oklahoma
Subsidiaries (1)
- ----------------
HEARTLAND Community Bank United States 100%
Subsidiary of HEARTLAND Community Bank
- --------------------------------------
HCB Properties, Inc. Arkansas 100%
</TABLE>
- ----------
(1) The assets, liabilities and operations of the subsidiaries are included in
the Consolidated Financial Statements contained in Item 8 hereof.
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
333-51927 of HCB Bancshares, Inc. on Form S-8 of our report dated September 10,
1999, incorporated by reference in the Annual Report on Form 10-K of HCB
Bancshares, Inc. for the year ended June 30, 1999.
/s/ Deloitte & Touche, LLP
Little Rock, Arkansas
September 27, 1999
<PAGE> 1
EXHIBIT 23.2
[MILLER ENGLAND & COMPANY LETTERHEAD]
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
333-51927 of HCB Bancshares, Inc. on Form S-8 of our report dated September 5,
1997, appearing in the Annual Report on Form 10-K of HCB Bancshares, Inc. for
the year ended June 30, 1999.
/s/ Miller, England & Company
Little Rock, Arkansas
September 27, 1999
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-END> JUN-30-1999
<CASH> 3,560,884
<INT-BEARING-DEPOSITS> 1,693,330
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 147,119,689
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 116,492,084
<ALLOWANCE> 1,329,201
<TOTAL-ASSETS> 285,396,885
<DEPOSITS> 146,296,598
<SHORT-TERM> 24,425,000
<LIABILITIES-OTHER> 2,219,308
<LONG-TERM> 80,338,419
0
0
<COMMON> 26,450
<OTHER-SE> 32,091,110
<TOTAL-LIABILITIES-AND-EQUITY> 285,396,885
<INTEREST-LOAN> 8,984,708
<INTEREST-INVEST> 8,786,557
<INTEREST-OTHER> 503,382
<INTEREST-TOTAL> 18,274,647
<INTEREST-DEPOSIT> 6,620,808
<INTEREST-EXPENSE> 12,093,603
<INTEREST-INCOME-NET> 6,181,044
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 261,996
<EXPENSE-OTHER> 6,847,715
<INCOME-PRETAX> 351,983
<INCOME-PRE-EXTRAORDINARY> 351,983
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 415,641
<EPS-BASIC> 0.18
<EPS-DILUTED> 0.18
<YIELD-ACTUAL> 6.91
<LOANS-NON> 565,992
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 2,417,364
<ALLOWANCE-OPEN> 1,468,546
<CHARGE-OFFS> 144,257
<RECOVERIES> 4,912
<ALLOWANCE-CLOSE> 1,329,201
<ALLOWANCE-DOMESTIC> 1,329,201
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
