SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________
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, 2000
Commission File Number: 0-22423
HCB BANCSHARES, INC.
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(Exact Name of Registrant as Specified in Its Charter)
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
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (870) 836-6841
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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: $9,525,366 (1,494,175 shares at the last
sale price on August 31, 1999 ($6.375 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: 2,046,580 shares of common
stock as of August 31, 2000.
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, 2000. (Parts II and IV)
2. Portions of Proxy Statement for the 2000 Annual Meeting of Stockholders.
(Part III)
<PAGE>
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, 2000, the Company had consolidated total assets of $291.2
million, deposits of $144.9 million and stockholders' equity of $28.2 million,
or 9.7% 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.
1
<PAGE>
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. On February 16, 2000, the bank received
approval from OTS to convert its loan production office in Bryant, Arkansas to a
full service branch. Construction is in progress with an expected open date of
October 30, 2000. 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 a 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, 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").
2
<PAGE>
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. In addition, industries in the Bryant area
include Bryant School District as the largest employer, with Alcoa as the
largest industrial business, and United Auto Group as the second largest
employer.
COMPETITION
The Bank experiences substantial competition both in attracting and
retaining savings deposits and in the originating 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-locally headquartered
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 collateralized by mortgages on existing single-family residences,
commercial real estate, and multifamily properties in the Bank's primary market
area. The Bank also makes a variety of consumer and commercial business loans.
Management expects to continue and to expand on these types of lending.
3
<PAGE>
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 collateralized 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 regulatory 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, 2000, the maximum
aggregate amount that the Bank could have lent to any one borrower under the 15%
limit was $4.7 million. At such date, the largest aggregate amount of loans that
the Bank had outstanding to any one borrower was $4.3 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, 2000, the Bank and Bancshares'
loans to the borrower referred to above totaled approximately $5.0 million with
Bancshares carrying $0.7 million of the loans.
4
<PAGE>
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, 2000, the Bank had no concentrations of loans
exceeding 10% of gross loans other than as disclosed below.
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------------------
2000 1999 1998
------------------- ----------------- ------------------
Amount % Amount % Amount %
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Type of Loan
------------
Real estate loans:
One-to-four family
residential $ 61,198,180 42.26% $ 53,622,417 43.74% $ 49,267,399 44.75%
Multi-family loans 9,220,931 6.37 9,226,426 7.53 12,577,034 11.43
Non-residential 48,756,744 33.67 41,907,368 34.18 35,321,040 32.08
Loans to facilitate sale of
foreclosed real estate -- -- -- -- 473,476 0.43
Land and other mortgage loans 5,644,050 3.90 3,547,514 2.89 598,860 0.54
Consumer loans:
Loans secured by savings
deposits 2,320,915 1.60 2,021,141 1.65 2,215,441 2.01
Home improvement 40,851 0.03 125,990 0.10 1,291,174 1.17
Auto 6,589,480 4.55 4,269,898 3.48 4,070,750 3.70
Other consumer 2,260,697 1.56 2,517,190 2.05 1,569,076 1.43
Commercial 8,769,131 6.06 5,367,611 4.38 2,708,927 2.46
------------- ------ ------------ ------ ------------ ------
Total $ 144,800,979 100.00% $122,605,555 100.00% $110,093,177 100.00%
------------- ------ ------------ ------ ------------ ------
Less:
Loans in process $ 8,100,982 $ 6,150,810 $ 3,921,787 $
Deferred loan fees and
discounts (158,217) (37,339) 122,679
Allowance for loan losses 1,231,709 1,329,201 1,468,546
------------- ------------ ------------
Total $ 135,626,505 $115,162,883 $104,580,165
============= ============ ============
<CAPTION>
At June 30,
---------------------------------------------
1997 1996
------------------- -----------------
Amount % Amount %
------ ----- ------ -----
<S> <C> <C> <C> <C>
Type of Loan
------------
Real estate loans:
One-to-four family
residential $ 62,340,601 60.90% $ 61,650,286 70.79%
Multi-family loans 8,873,156 8.67 6,819,212 7.83
Non-residential 18,814,701 18.38 13,746,549 15.78
Loans to facilitate sale of
foreclosed real estate 616,660 0.60 720,749 0.83
Land and other mortgage loans 483,236 0.47 36,944 0.04
Consumer loans:
Loans secured by savings
deposits 2,434,621 2.38 1,832,180 2.10
Home improvement 1,665,244 1.63 204,776 0.24
Auto 2,399,648 2.34 786,656 0.90
Other consumer 2,629,442 2.58 418,027 0.48
Commercial 2,101,963 2.05 880,311 1.01
------------- ------ ------------ ------
Total $ 102,359,272 100.00% $ 87,095,690 100.00%
------------- ------ ------------ ------
Less:
Loans in process $ 2,057,095 $ 1,544,097
Deferred loan fees and 167,069 137,335
Allowance for loan losses 1,492,473 1,283,234
------------- ------------
Total $ 98,642,635 $ 84,131,024
============= ============
</TABLE>
5
<PAGE>
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, 2000. 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......................... $ 11,244 $ 13,066 $ 36,888 $ 61,198
Other mortgage loans............ 10,522 13,439 39,661 63,622
Commercial loans.................. 5,216 2,863 690 8,769
Consumer loans:
Loans secured by savings
deposits..................... 1,727 594 -- 2,321
Other.......................... 1,094 7,274 523 8,891
---------- ----------- --------- ---------
Total........................ $ 29,803 $ 37,236 $ 77,762 $ 144,801
========== =========== ========= =========
</TABLE>
The following table sets forth as of June 30, 2000, dollar amounts of
loans due one year or more after June 30, 2000 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.... $ 31,186 $ 18,768 $ 49,954
Other mortgage loans................. 42,182 10,918 53,100
Commercial loans....................... 3,488 65 3,553
Consumer loans:
Loans secured by savings deposits.... 594 -- 594
Other consumer loans................. 7,797 -- 7,797
---------- ---------- ----------
Total.............................. $ 85,247 $ 29,751 $ 114,998
========== ========== ==========
</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.
6
<PAGE>
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,
-----------------------------------------------
2000 1999 1998
----------- ------------ -------------
<S> <C> <C> <C>
Loans originated:
Real estate loans:
One-to-four family residential............................ $ 46,925,450 $ 24,486,365 $ 9,242,608
Other mortgage loans...................................... 29,145,079 18,804,077 19,404,722
Commercial loans............................................ 7,973,954 7,350,903 3,098,085
Consumer loans.............................................. 13,515,847 5,380,714 5,437,188
------------- ------------ -------------
Total loans originated................................... $ 97,560,330 $ 56,022,059 $ 37,182,603
============= ============ =============
Loans purchased:
Real estate loans........................................... $ 82,547 $ -- $ 8,257,199
============= ============ =============
Loans sold.................................................... $ 10,160,826 $ 13,140,464 $ 4,952,961
============= ============ =============
</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 $67,500. At
June 30, 2000, $61.2 million, or 42.3%, of the Bank's total loans were
collateralized 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 30-year one-to-four family portfolio loans, due
to the interest rate risks associated with such longer term 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 $46.9 million with $10.9 million or 23% 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.
7
<PAGE>
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, 2000, the Bank's loan portfolio included
$5.0 million of loans collateralized 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 collateralized 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. It is anticipated that the Bank will continue to make
loans through this broker 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
collateralized 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 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 collateralized 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, 2000, the Bank had 178 commercial and
multi-family loans, with an average loan balance of approximately $289,000. At
that date, 48 of these loans totaling approximately $10.2 million were
collateralized 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.
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
8
<PAGE>
fixed for up to 20 years. Under certain circumstances, these longer-term loans
may be match funded with similar term FHLB advances to reduce interest rate
risk.
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 collateralized 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
collateralized by savings deposits at the Bank and automobiles. These loans
totaled $2.3 million and $6.6 million, respectively, at June 30, 2000.
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 collateralized 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 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, 2000, the Bank's commercial business loans
totaled $8.8 million and primarily consisted of recreational vehicle floor plan
loans,
9
<PAGE>
inventory loans, and equipment loans. At that date, the Bank had two commercial
business loans with outstanding commitments exceeding $500,000.
One loan is collateralized by new recreational vehicles for an in-state
RV dealership. The loan requires regular payments of interest monthly, with
principal payments as vehicles are sold. At June 30, 2000, the Bank had
committed to lend up to $1,300,000, and the outstanding balance was $1,241,036.
The loan had experienced some problems and while the loan was designated as
special mention by management, no loss is anticipated.
A second loan is collateralized by inventory and accounts receivable
for an in-state retail furniture store. The loan requires regular payments of
principal and interest monthly. At June 30, 2000, the outstanding balance for
this fully funded loan was $1,660,000, the loan was fully performing in
accordance with its terms, and was not adversely classified 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.
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.
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
10
<PAGE>
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, 2000, the Bank had $27,100 assets classified as loss,
$10,213 classified doubtful, $1,534,794 assets classified substandard, and $2.4
million of assets designated as special mention. The Bank's total adversely
classified assets represented approximately 0.5% of the Bank's total assets and
5.0% of the Bank's tangible regulatory capital plus allowance for loan loss at
June 30, 2000. At that date, a majority of the Bank's adversely classified
assets were one-to-four family residences in the Bank's primary market area. At
June 30, 2000, 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 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.
11
<PAGE>
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 collateralized
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, 2000, the Bank held no
properties acquired in settlement of loans for which estimated 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.
12
<PAGE>
During the year ended June 30, 2000, 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 $1.2
million, or 0.85% 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,
------------------------------------------------------------------------
2000 1999 1998 1997 1996
--------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Balance at beginning of period................. $ 1,329,201 $1,468,546 $1,492,473 $ 1,283,234 $ 728,491
---------- ----------- ---------- ----------- -----------
Loans charged-off:
Real estate mortgage:
One-to-four family residential............. 4,960 26,883 5,466 11,317 12,130
Other mortgage loans....................... -- -- -- -- --
Commercial..................................... 50,047 37,742 -- -- --
Consumer....................................... 44,791 79,632 43,100 11,668 --
----------- ----------- ---------- ----------- -----------
Total charge-offs.............................. 99,798 144,257 48,566 22,985 12,130
----------- ----------- ---------- ----------- -----------
Recoveries:
Real estate mortgage:
One-to-four family residential............. -- 865 -- 6,333 250
Other mortgage loans....................... -- -- -- -- --
Commercial................................... -- -- -- -- --
Consumer..................................... 2,306 4,047 639 4,220 --
----------- ----------- ---------- ----------- -----------
Total recoveries............................... 2,306 4,912 639 10,553 250
----------- ----------- ---------- ----------- -----------
Net loans charged-off.......................... 97,492 139,345 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....................... $ 1,231,709 $ 1,329,201 $1,468,546 $ 1,492,473 $ 1,283,234
=========== =========== ========== =========== ===========
Ratio of net charge-offs to average
loans outstanding during the period.......... 0.08% 0.13% 0.05% 0.013% 0.018%
========= =========== ========== ============ =============
</TABLE>
13
<PAGE>
The following table allocates the allowance for loan losses by asset
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
At June 30,
--------------------------------------------------------------------------
2000 1999 1998
---------------------- ----------------------- ----------------------
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...... $ 440,709 42.3% $ 422,000 43.7% $ 504,000 45.18%
Multi-family, non-residential, and
land.............................. 551,000 43.9 603,000 44.6 557,000 44.05
Consumer loans........................ 91,000 7.7 101,000 7.3 123,000 8.31
Commercial loans...................... 149,000 6.1 82,000 4.4 72,000 2.46
Unallocated........................... -- -- 121,201 -- 212,546 --
----- ----- ------
Total.......................... $1,231,709 100.0% $1,329,201 100.0% $1,468,546 100.00%
========== ===== ========== ===== ========== ======
<CAPTION>
At June 30,
---------------------------------------------------
1997 1996
---------------------- -------------------------
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...... $ 954,093 61.50% $ 935,354 71.62%
Multi-family, non-residential, and
land.............................. 296,018 27.52 278,650 23.65
Consumer loans........................ 67,700 8.93 17,635 3.72
Commercial loans...................... 81,250 2.05 -- 1.01
Unallocated........................... 93,412 -- 51,595 --
------ ------
Total.......................... $1,492,473 100.00% $1,283,234 100.00%
========== ====== ========== ======
</TABLE>
14
<PAGE>
The Bank's increasing emphasis on the origination of commercial and
multi-family real estate 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,
-------------------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- ------- -------- --------
<S> <C> <C> <C> <C> <C>
Loans accounted for on a nonaccrual basis: 1
Real estate:
One-to-four family residential........... $ 655,988 $ 462,205 $ 648,012 $ 133,386 $ 166,228
Other mortgage loans..................... -- 22,139 -- -- --
Consumer................................... 102,003 81,648 138,747 -- --
---------- --------- ---------- --------- ---------
Total.................................... $ 757,991 $ 565,992 $ 786,759 $ 133,386 $ 166,228
========= ========= ========== ========= =========
Accruing loans which are contractually past
due 90 days or more:
Real estate:
One-to-four family residential........... $ 140,000 $ -- $ 41,770 $ 323,478 $ 725,487
Other mortgage loans..................... -- -- -- -- --
Consumer loans............................. 21,524 -- -- 56,904 127,142
---------- --------- ---------- --------- ---------
Total.................................... $ 161,524 $ -- $ 41,770 $ 380,382 $ 852,629
========== ========= ========== ========= =========
Total nonperforming loans................ $ 919,515 $ 565,992 $ 828,529 $ 513,768 $1,018,857
========== ========= ========== ========= ==========
Percentage of total loans.................... 0.64% 0.46% 0.75% 0.50% 1.17%
==== ==== ==== ==== ====
Other nonperforming assets 2................. $ 52,919 $ 20,289 $ 17,001 $ 65,005 $ 168,206
========== ========= ========== ========= =========
Loans modified in troubled debt restructurings $ -- $ -- $ 392,000 $ 281,441 $ 298,195
========== ========= ========== ========= =========
<FN>
____________
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.
</FN>
</TABLE>
During the years ended June 30, 2000 and 1999, gross interest income of
$70,933 and $48,032, 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 $20,045 and $14,237, respectively.
At June 30, 2000, management had identified approximately $0.8 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 asset amounts at that date. Of this aggregate amount,
approximately $417,000 was attributable to 13 one-to-four family residential
loans, $283,000 was attributable to four commercial or multi-family real estate
loans, and $121,000 was attributable to 17 consumer
15
<PAGE>
loans. At June 30, 2000, 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 allowed 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 collateralized 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
one of the quasi-governmental agencies or rated in one of the top two categories
by a recognized rating organization.
All of the Bank's privately issued securities were rated "AA" or higher
by a nationally recognized credit rating agency at the time of purchase.
Management regularly monitors the ratings of the Bank's privately issued
holdings by reference to nationally published rating media and by communication
with the issuer when necessary. At June 30, 2000, no privately issued securities
were rated below AA except as follows:
16
<PAGE>
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, 2000, the Bank estimated the value of the
security at approximately $54,000 less than its face value. The Bank's
carrying value for this security at that date was approximately
$249,862 after recognition of impairment loss.
A DLJ Mortgage Acceptance Corp. Pass-Through Class A-3
Certificate was rated "CAA2" by Moody. The downgrade reflected
deterioration in the performance of the mortgage pools underlying the
security. As of June 30, 2000, the deterioration affected the credit
support and not the principal or interest of the security itself.
Management had not identified any expected losses on principal or
interest on the security as of that date. The Bank's carrying value for
this security at that date was $486,120.
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, 2000, 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, 2000 was $112,522.
The Bank's privately issued securities consist of collateralized
mortgage obligations (CMOs) and mortgage pass-through securities. At June 30,
2000, all of the privately issued securities had adjustable interest rates with
a weighted average yield of 6.18% and a weighted average term to maturity of
21.3 years. The carrying value of the privately issued securities was $6,477,701
or 6.3% 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.
17
<PAGE>
The following table sets forth information regarding carrying values of the
Company's investment securities at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
------------------------------------------------
2000 1999 1998
----------- ------------ -------------
<S> <C> <C> <C>
Securities available for sale:
U.S. government and agencies............................... $ 5,880,903 $ 6,368,125 $ 22,491,930
Municipal securities....................................... 28,201,198 26,704,416 18,283,877
Collateralized mortgage obligations........................ 11,805,058 12,346,191 9,673,443
Other mortgage-backed securities........................... 86,602,281 101,640,582 49,023,666
Equity securities.......................................... 53,625 60,375 --
------------- ------------- --------------
$ 132,543,065 $ 147,119,689 $ 99,472,916
============= ============= ==============
Securities held to maturity:
U.S. government and agencies............................... $ -- $ -- $ --
Collateralized mortgage obligations........................ -- -- 3,984,684
Other mortgage-backed securities........................... -- -- 23,518,573
------------- ------------- --------------
$ -- $ -- $ 27,503,257
============= ============= ==============
Total......................................................... $ 132,543,065 $ 147,119,689 $ 126,976,173
============= ============= ==============
</TABLE>
18
<PAGE>
The following table sets forth information regarding scheduled
maturities of the Company's investment portfolio at June 30, 2000. Yields on
municipal securities are not tax-effected.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years More than Ten Years
-------------------- ---------------------- ---------------------- -------------------
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
-------- ------- -------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. government and agencies $ -- -- % $3,997,504 6.25% $ 1,883,399 6.56% $ -- --%
Municipal securities -- -- -- -- 1,085,089 5.17 27,116,109 5.00
Collateralized mortgage
obligations -- -- -- -- 479,855 7.26 11,325,203 6.49
Other mortgage-backed securities 22,914 9.25 2,323,178 6.87 7,728,715 6.53 76,527,474 6.33
-------- ---- ---------- ---- ----------- ---- ------------ ----
Total $ 22,914 9.25% $6,320,682 6.48% $11,177,058 6.43% $114,968,786 6.03%
======== ==== ========== ==== =========== ==== ============ ====
Equity securities
<CAPTION>
Total Investment Portfolio
--------------------------------
Carrying Market Average
Value Yield Yield
-------- ------ -------
<S> <C> <C> <C>
U.S. government and agencies $ 5,880,903 $ 5,880,903 6.35%
Municipal securities 28,201,198 28,201,198 5.01
Collateralized mortgage
obligations 11,805,058 11,805,059 6.52
Other mortgage-backed securities 86,602,281 86,602,280 6.37
------------ ------------ ----
Total $132,489,440 $132,489,440 6.09%
============ ============ ====
Equity securities 53,625 53,625
------------ ------------
$132,543,065 $132,543,065
============ ============
</TABLE>
19
<PAGE>
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS
GENERAL. Deposits are the primary source of the Bank's funds for
lending, investment activities and general operational purposes. While the Bank,
like most independent savings institutions, historically has relied on
certificates of deposit for a substantial portion of its 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 typically 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,
-----------------------------------------------------------------------
2000 1999 1998
------------------ ----------------- -------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
NOW accounts.......................... $ 14,170,075 1.73% $ 10,505,515 1.46 % $ 6,101,535 2.73%
Money market savings deposits......... 16,093,630 3.84 20,474,110 3.57 17,937,404 4.13
Savings deposits - statement.......... 7,955,898 2.58 7,325,746 2.81 8,136,269 2.95
Certificates of deposit............... 104,443,704 5.21 103,414,235 5.35 112,427,056 5.41
------------ ---- ----------- ---- ----------- ----
Total............................. $142,663,307 4.56% $141,719,606 4.67% $144,602,264 5.03%
=========== ==== =========== ==== =========== ====
</TABLE>
20
<PAGE>
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
2000 Deposits (Decrease) 1999 Deposits (Decrease)
---------- -------- --------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
NOW accounts............................ $ 23,553,466 16.26% $ 11,141,534 $ 12,411,932 8.49% $1,747,386
Money market savings deposits........... 9,360,191 6.46 (8,259,150) 17,619,341 12.04 (765,494)
Savings deposits - statement............ 7,530,432 5.20 (441,015) 7,971,447 5.45 458,840
Certificates of deposit................ 104,428,982 72.08 (3,864,896) 108,293,878 74.02 2,924,536
------------- ------ ------------- ------------ ------ ----------
$144,873,071 100.00% $ (1,423,527) $146,296,598 100.00% $4,365,268
============ ====== ============ ============ ====== ==========
<CAPTION>
Balance at
June 30, % of
1998 Deposits
----------- --------
<S> <C> <C>
NOW accounts............................ $10,664,546 7.51%
Money market savings deposits........... 18,384,835 12.95
Savings deposits - statement............ 7,512,607 5.29
Certificates of deposit................ 105,369,342 74.25
------------ ------
$141,931,330 100.00%
============ ======
</TABLE>
21
<PAGE>
The following table sets forth information regarding certificates of
deposits classified by rates at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
-------------------------------------------------
2000 1999 1998
-------- ------- ----------
<S> <C> <C> <C>
4.00 -5.99%............................................. $ 68,258,761 $107,158,894 $ 96,276,980
6.00 -7.99%............................................. 36,170,221 1,134,984 9,092,362
------------ ------------ ------------
$104,428,982 $108,293,878 $105,369,342
============ ============ ============
</TABLE>
The following table sets forth information regarding amounts and
maturities of certificates of deposits at June 30, 2000.
<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%.................... $50,479,581 $16,116,804 $1,653,371 $9,005 $ 68,258,761
6.00 - 7.99%.................... 27,446,730 7,626,323 1,097,168 -- 36,170,221
----------- ----------- ---------- ------ ------------
$77,926,311 $23,743,127 $2,750,539 $9,005 $104,428,982
=========== =========== ========== ====== ============
</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, 2000.
Certificates
Maturity Period of Deposit
--------------- ------------
Three months or less .................................... $ 3,097,646
Over three through six months ........................... 2,160,247
Over six through 12 months .............................. 4,686,429
Over 12 months .......................................... 1,617,452
-----------
Total ............................................... $11,561,774
===========
The following table sets forth information regarding savings activities
of the Bank for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------------------------
2000 1999 1998
-------- ------- ----------
<S> <C> <C> <C>
Net decrease before
interest credited......................................... $ (8,032,919) $ (2,521,766) $ (5,923,685)
Deposits divested........................................... -- -- (8,541,747)
Interest credited........................................... 6,609,392 6,887,034 5,204,171
-------------- -------------- --------------
Net increase (decrease) in
savings deposits...................................... $ (1,423,527) $ 4,365,268 $ (9,261,261)
============== ============== ==============
</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 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
22
<PAGE>
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 collateralized by the
Bank's stock in the FHLB of Dallas, qualifying first mortgage loans and
mortgage-backed investment securities.
The following table sets forth certain information regarding borrowings by
the Bank for the periods indicated. Averages are based on monthly balances.
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------------------------------
2000 1999 1998
-------- ------- ----------
<S> <C> <C> <C>
Amounts outstanding at end of period:
FHLB advances............................................... $ 115,609,029 $ 104,523,419 $ 68,121,068
Weighted average rate....................................... 6.07% 5.63% 5.89%
Maximum amount of borrowings outstanding at any month end:
FHLB advances............................................... $ 117,040,406 $ 104,523,419 $ 68,121,068
Approximate average borrowings during the year outstanding
with respect to:
FHLB advances............................................... $ 112,554,831 $ 95,124,165 $ 27,108,184
Weighted average rate....................................... 5.85% 5.73% 6.07%
</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, 2000 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, 2000, the Bank's aggregate investment in, and loans
to, the subsidiary service corporation totaled $575,928.
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.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB System,
which consists of 12 district FHLB's subject to supervision and regulation by
the Federal Housing Finance Board ("FHFB"). The FHLB's 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.
23
<PAGE>
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 and small businesses, small farms and small agri-businesses. At June 30,
2000, the Bank had $115.6 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 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, 2000 was 23.4%.
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, value of
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. 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 4.0% (or 3.0% if the institution is
rated CAMELS 1 under the OTS examination rating system) 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 regulations 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
24
<PAGE>
engaged in activities undertaken as agent for customers or in mortgage banking
activities and depository institutions or their holding companies). As of June
30, 2000, the Bank had $575,928 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.
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, 2000, the Bank had
one land or non-residential construction loan in excess of an 80% loan-to-value
ratio for a deduction of $27,000, and $576,000 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, 2000.
<TABLE>
<CAPTION>
Percent of
Amount Assets(1)
------ ---------
(Dollars in thousands)
<S> <C> <C>
Tangible capital............................... $ 29,437 10.02%
Tangible capital requirement................... 4,408 1.50
--------- ------
Excess...................................... $ 25,029 8.52%
========= ======
Core capital................................... $ 29,437 10.02%
Core capital requirement....................... 11,756 4.00
--------- ------
Excess...................................... $ 17,681 6.02%
========= ======
Total capital.................................. $ 30,669 21.79%
Risk-based capital requirement................. 11,262 8.00
--------- ------
Excess..................................... $ 19,407 13.79%
========= ======
<FN>
____________
(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.
</FN>
</TABLE>
25
<PAGE>
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 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.
The SAIF deposit insurance assessment rates set by the FDIC range from
zero for "well capitalized" institutions with the highest supervisory ratings to
0.27% of insured savings deposits for institutions in the highest risk-based
premium category. Until December 31, 1999, SAIF-insured institutions were
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 were assessed for these
obligations at the rate of 1.3 basis points. After December 31, 1999, both BIF
and SAIF members are assessed at the same rate for FICO payments.
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.
26
<PAGE>
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 $44.3
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 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
27
<PAGE>
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 collateralized 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.
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
28
<PAGE>
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-satisfactory rating for any CAMELS rating category. As of June 30,
2000, 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.
29
<PAGE>
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.
FINANCIAL MODERNIZATION LEGISLATION. On November 12, 1999, President
Clinton signed legislation which could have a far-reaching impact on the
financial services industry. The Gramm-Leach-Bliley ("G-L-B") Act authorizes
affiliations between banking, securities and insurance firms and authorizes bank
holding companies and national banks to engage in a variety of new financial
activities. Among the new activities that will be permitted to bank holding
companies are securities and insurance brokerage, securities underwriting,
insurance underwriting and merchant banking. The Federal Reserve Board, in
consultation with the Secretary of the Treasury, may approve additional
financial activities. The G-L-B Act, however, prohibits future acquisitions of
existing unitary savings and loan holding companies, like the Company, by firms
which are engaged in commercial activities and limits the permissible activities
of unitary holding companies formed after May 4, 1999.
The G-L-B Act imposes new requirements on financial institutions with
respect to customer privacy. The G-L-B Act generally prohibits disclosure of
customer information to non-affiliated third parties unless the customer has
been given the opportunity to object and has not objected to such disclosure.
Financial institutions are further required to disclose their privacy policies
to customers annually. Financial institutions, however, will be required to
comply with state law if it is more protective of customer privacy than the
G-L-B Act. The G-L-B Act directs the federal banking agencies, the National
Credit Union Administration, the Secretary of the Treasury, the Securities and
Exchange Commission and the Federal Trade Commission, after consultation with
the National Association of Insurance Commissioners, to promulgate implementing
regulations within six months of enactment. The privacy provisions will become
effective in November 2000, with full compliance required by July 1, 2001.
The G-L-B Act contains significant revisions to the FHLB System. The G-L-B
Act imposes new capital requirements on the FHLBs and authorizes them to issue
two classes of stock with differing dividend rates and redemption requirements.
The G-L-B Act deletes the current requirement that the FHLBs annually contribute
$300 million to pay interest on certain government obligations in favor of a 20%
of net earnings formula. The G-L-B Act expands the permissible uses of FHLB
advances by community financial institutions (under $500 million in assets) to
include funding loans to small businesses, small farms and small
agri-businesses. The G-L-B Act makes membership in the FHLB voluntary for
federal savings associations.
The G-L-B Act contains a variety of other provisions including a
prohibition against ATM surcharges unless the customer has first been provided
notice of the imposition and amount of the fee. The G-L-B Act reduces the
frequency of Community Reinvestment Act examinations for smaller institutions
and imposes certain reporting requirements on depository institutions that make
payments to non-governmental entities in connection with the Community
Reinvestment Act. The G-L-B Act eliminates the SAIF special reserve and
authorizes a federal savings association that converts to a national or state
bank charter to continue to use the term "federal" in its name and to retain any
interstate branches.
The Company is unable to predict the impact of the G-L-B Act on its
operations at this time. Although the G-L-B Act reduces the range of companies
with which may acquire control of the Company, it may facilitate affiliations
with companies in the financial services industry.
30
<PAGE>
REGULATION OF BANCSHARES
GENERAL. Bancshares is a savings and loan 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 and loan holding company.
There are generally no restrictions on the activities of a unitary savings and
loan holding company. However, if the Director of the OTS determines that there
is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings institution, the
Director 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."
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 and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
test, 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 and loan 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 and loan holding companies,
those activities authorized by the Federal Reserve Board as permissible for bank
holding companies. A multiple savings and loan holding company must obtain the
approval of the OTS prior to engaging in the activities described in (vii)
above.
RESTRICTIONS ON ACQUISITIONS. Savings and loan holding companies may
not acquire, without prior approval of the Director of the OTS, (i) control of
any other savings institution or savings and loan holding company or
substantially all the assets thereof, or (ii) more than 5% of the voting shares
of an institution or holding company thereof which is not a subsidiary. Under
certain circumstances, a registered savings and loan holding company is
permitted to acquire, with the approval of the Director of the OTS, up to 15% of
the voting shares of an under-capitalized savings institution pursuant to a
"qualified stock issuance" without that savings institution being deemed
controlled by the holding company. In order for the shares acquired to
constitute a "qualified stock issuance," the shares must consist of previously
unissued stock or treasury shares, the shares must be acquired for cash, the
savings and loan 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 and loan holding company and the issuing
savings institution, and transactions between the savings institution and the
savings and loan holding company and any of its affiliates must conform to
Sections 23A and 23B of the Federal Reserve Act. Except with the prior
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<PAGE>
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 and loan holding company.
The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state if: (i) the multiple savings and loan
holding company involved controls 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 and loan holding companies located in the state where the acquiring
entity is located (or by a holding company that controls such state-chartered
savings institutions).
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 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 and loan 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"). 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 collateralized 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 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
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<PAGE>
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, 2000, the Bank had 94 full-time equivalent employees,
none of whom was represented by a collective bargaining agreement. Management
considers the Bank's relationships with its employees to be good.
33
<PAGE>
ITEM 2. PROPERTIES
-------------------
The following table sets forth information regarding the Bank's offices
at June 30, 2000.
<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 $ 285,508 12,000
Camden, Arkansas
Branch Offices:
22461 Interstate 30, Suite 1100A 1996 Leased -- 1,800
Landers Corporate Plaza
Bryant, Arkansas
1125 Fairview Road, SW
Suite 208 1981 Owned 219,948 1,200
Camden, Arkansas
610 West 4th Street 1969 Owned 727,506 3,500
Fordyce, Arkansas
473 Highway 425 North 1996 Owned 1,254,144 7,400
Monticello, Arkansas
108 South Main 1996 Owned 1,084,515 5,500
Sheridan, Arkansas
</TABLE>
At June 30, 2000, the Bank had one full-service branch office under
construction located at 4937 Highway 5 North, Bryant, Arkansas. This office will
replace the loan production office currently being leased at 22461 Interstate
30, Suite 1100A. The total project cost is currently estimated to be $1,676,000
of which $538,687 had been disbursed as of June 30, 2000. The balance of the
project cost will be disbursed as work is completed on the project, and the new
office is expected to be open for business on October 30, 2000.
In addition to the offices described above, at June 30, 2000 the Bank
held four 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 June 30, 2000, the aggregate net
book value of these properties totaled $1,209,077 of which $314,189 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 $6.6 million at June 30, 2000. See
Note 7 of the Notes to Consolidated Financial Statements in the Annual Report to
Stockholders for June 30, 2000.
34
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
--------------------------
From time to time, the Bank is a party to various legal proceedings
incident to its business. At June 30, 2000, 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 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.
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
------------------------------------------------------------
There were no matters submitted to a vote of the security holders
during the fourth quarter of the fiscal year ended June 30, 2000.
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.
35
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
--------------------------------------------------------------------------------
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 Report on Form 8-K dated October 7, 1998,
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 2000 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.
36
<PAGE>
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' Report
Consolidated Statements of Financial Condition as of June 30, 2000 and
1999
Consolidated Statements of Income and Comprehensive Income for the
years ended June 30, 2000, 1999 and 1998
Consolidated Statements of Stockholders' Equity for the years ended
June 30, 2000, 1999 and 1998
Consolidated Statements of Cash Flows for the years ended June 30,
2000, 1999 and 1998
Notes to Consolidated Financial Statements for the years ended June
30, 2000, 1999 and 1998
(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.
NO. DESCRIPTION
--- -----------
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 * +
37
<PAGE>
10.5 Heartland Community Bank Directors' Retirement Plan, as
amended* +
21 Subsidiaries
23 Consent of Deloitte & Touche, LLP
27 Financial Data Schedule
___________
* 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 did not file any Current Reports on Form 8-K
(c) EXHIBITS. The exhibits required by Item 601 of Regulation S-K are
--------
either filed as part of this Annual Report on Form 10-K or incorporated by
reference herein.
(D) FINANCIAL STATEMENTS AND SCHEDULES EXCLUDED FROM ANNUAL REPORT. There
---------------------------------------------------------------
are no other financial statements and financial statement schedules which were
excluded from the Annual Report to Stockholders pursuant to Rule 14a-3(b) which
are required to be included herein.
38
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HCB BANCSHARES, INC.
Date: September 26, 2000 By: /s/ Cameron D. McKeel
-------------------------------------
Cameron D. McKeel
President and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant in the capacities and on the dates indicated.
By: /s/ Cameron D. McKeel September 26, 2000
-------------------------------------------------
Cameron D. McKeel
Director, President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Scott A. Swain September 26, 2000
-------------------------------------------------
Scott A. Swain
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
By: /s/ Vida H. Lampkin September 26, 2000
-------------------------------------------------
Vida H. Lampkin
Chairman of the Board
By:
-------------------------------------------------
Roy Wayne Moseley
Director
By:
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Bruce D. Murry
Director
By: /s/ Carl E. Parker, Jr. September 26, 2000
-------------------------------------------------
Carl E. Parker, Jr.
Director
By: /s/ Lula Sue Silliman September 26, 2000
-------------------------------------------------
Lula Sue Silliman
Director
By: /s/ Cameron D. McKeel September 26, 2000
-------------------------------------------------
Clifford Steelman
Director
