<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the year ended _________________.
OR
[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from July 1, 1997 to December 31, 1997
Commission File Number:
001-13949
LOCAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 65-0424192
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3601 N.W. 63RD, OKLAHOMA CITY, OK 73116
---------------------------------------- -------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (405) 841-2298
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 [ ]
Number of shares outstanding of the registrant's $0.01 par value common stock as
of August 14, 1998 were as follows:
NUMBER OF SHARES
----------------
20,537,209
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LOCAL FINANCIAL CORPORATION
1998 TRANSITION REPORT ON FORM 10K
TABLE OF CONTENTS
PART I
<TABLE>
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PAGE NO.
<S> <C> <C>
Item 1 Business 1
Item 2 Properties 45
Item 3 Legal Proceedings 48
Item 4 Submission of Matters to a Vote of Security-Holders 49
PART II
Item 5 Market for Registrant's Common Equity and Debt and
Related Stockholder Matters 49
Item 6 Selected Financial Data 50
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 52
Item 7A Quantitative and Qualitative Disclosure about Market Risk 68
Item 8 Financial Statements and Supplementary Data 75
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 75
PART III
Item 10 Directors and Executive Officers of the Registrant 76
Item 11 Executive Compensation 79
Item 12 Security Ownership of Certain Beneficial Owners and
Management 80
Item 13 Certain Relationships and Related Transactions 80
PART IV
Item 14 Exhibits, Financial Statements Schedules, and Reports
on Form 8-K. 80
</TABLE>
<PAGE> 3
ITEM 1. BUSINESS
THE COMPANY
General. The Company is a Delaware corporation headquartered in
Oklahoma City, Oklahoma. The Company was chartered in 1992 to become the holding
company of Local Federal Bank, F.S.B. ("Local Federal"), a federally chartered
savings institution. Local Federal was organized in 1908 under the name Local
Building and Loan Association, changed to a federal mutual charter in 1935 and
converted to the stock form of organization in 1983. Local Federal's
wholly-owned subsidiaries include Local America Inc. and its wholly-owned
subsidiary, Local America Bank of Tulsa, F.S.B. ("Local America"), a federally
chartered savings institution. Local Federal and Local America are collectively
referred to herein as the "Banks." The Company also owns through Local Federal
two indirect automobile finance subsidiaries, Local Acceptance Company of
Florida ("Local Acceptance" or "LAC") and Star Financial Services Corporation
("Star") of Oklahoma. The loan receivables of LAC and Star were sold in late
December 1997. See "Business--Lending Activities--Consumer Loans". At December
31, 1997, the Company had consolidated assets of $1.88 billion, substantially
all of which is comprised of its direct and indirect 100% ownership interest in
the Banks, consolidated liabilities of $1.80 billion, consolidated deposits of
$1.60 billion and consolidated stockholders' equity of $82.6 million.
As of December 31, 1997, the Banks conducted business through forty-one
branch offices located throughout the state of Oklahoma, with heavy
concentration in the Oklahoma City and Tulsa areas. Twenty-eight branch offices
operated under the Local Federal name. Seven of these branch offices are located
in Oklahoma City and nine additional branches are within a fifty mile radius.
Local America operated thirteen branches in the Tulsa area. According to SNL
Securities, as of May 31, 1998, the Banks ranked fifth in Oklahoma by deposit
market share among depository institutions and first in deposit market share
among thrift institutions.
Prior to the Private Placement and the Redemption (as defined and
described below), the Banks' strategy was to run a low cost institution
structured around the following areas: (i) a nationally diversified wholesale
commercial real estate mortgage portfolio; (ii) an Oklahoma-based retail deposit
franchise operated on a low-overhead basis delivering a traditional set of
thrift products and services, including conforming single-family residential
home loans, home equity, student guaranteed, direct automobile and installment
loans through its branch network; (iii) a wholesale securities portfolio
involving derivative mortgage securities funded both by retail as well as
wholesale funding through advances from the Federal Home Loan Bank ("FHLB") of
Topeka and securities sold under agreements to repurchase ("reverse repurchase
agreements"); and (iv) during the past few years, origination of indirect
sub-prime automobile finance contracts purchased from dealerships in Oklahoma
and Florida. Portfolios of residential loans packaged and sold by the Resolution
Trust Corporation ("RTC") and the Federal Deposit Insurance Corporation ("FDIC")
were also purchased. Both LAC and Star were incorporated in an attempt to engage
in the purchase and servicing of sub-prime automobile finance contracts in their
respective markets.
Operating Results. The Company reported net income of $13.6 million,
$14.4 million and $52.5 million during the years ended June 30, 1996, 1995 and
1994, respectively. However, beginning in fiscal 1996, the Company's results of
operations have been adversely impacted by
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increases to the provision for loan losses to cover realized and inherent losses
associated with the Company's indirect automobile receivables. During fiscal
1996, net income declined by $847,000 or 5.9% from fiscal 1995 levels, as the
Company's provision for loan losses increased by $4.0 million to $5.1 million.
An aggregate of $4.5 million of such provision was related to the indirect
automobile receivables portfolio. The Company's financial position deteriorated
further during fiscal 1997. For the fiscal year ended June 30, 1997, the Company
experienced a net loss of $30.0 million. This loss reflects a $28.4 million
provision for loan losses which primarily related to the Company's indirect
automobile receivables. The loss during fiscal 1997 was also due to $29.9
million of losses which were recognized on the sale of a portion of the
Company's adjustable-rate collateralized mortgage obligations ("CMOs") with
interest rate adjustments tied to the FHLB Eleventh District Cost of Funds Index
("COFI"), and a non-recurring $10.3 million special assessment (before
applicable tax benefits) which was recorded in fiscal 1997 in connection with
legislation which recapitalized the Savings Association Insurance Fund ("SAIF").
Primarily as a consequence of actions taken in connection with the
Private Placement and the Redemption (described below), during the six months
ended December 31, 1997, the Company incurred a net loss of $86.0 million.
Specifically, the Company incurred $125.5 million of losses on the sale of
securities, of which an aggregate loss of $53.4 million was incurred in
connection with the liquidation or write-off of the Company's hedging contracts,
and an aggregate loss of $72.0 million was incurred on the sale and
mark-to-market of the Company's securities portfolio (which primarily related to
the sale and mark-to-market of the Company's COFI-based CMOs). The market for
fixed income securities improved during the three month period ended December
31, 1997 and the Company sold a portion of the remaining COFI-based CMO
portfolio for a gain of $12.8 million. The Company also recorded a $25.6 million
provision for loan losses during the six months ended December 31, 1997,
primarily to cover realized and inherent losses with respect to the Company's
portfolio of indirect automobile receivables. This portfolio was sold in late
December 1997. See also "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
The Private Placement and the Redemption. On August 25, 1997, the
Company entered into a Redemption Agreement, as amended on September 5, 1997
(the "Redemption Agreement"), with Barron Collier and Miles Collier, the sole
stockholders of the Company (the "Selling Stockholders"), pursuant to which the
Company agreed to redeem all of the Company's issued and outstanding shares of
Common Stock for consideration of $154.0 million, subject to adjustment as
described under "The Private Placement and the Redemption Transactions--The
Redemption Agreement" (the "Redemption"), and the satisfaction of various
conditions, including the raising of funds through a private placement of at
least $190.0 million of Common Stock and at least $70.0 million of Senior Notes.
In addition, pursuant to the Redemption Agreement, the Company agreed to prepay
a promissory note payable to the mother of the Selling Stockholders at a price
equal to the principal amount thereof plus accrued and unpaid interest thereon
to the date of prepayment (i.e., $7.2 million).
On September 8, 1997, the Company entered into a Purchase Agreement
with Friedman Billings, Ramsey & Co., Inc. ("FBR" or the "Placement Agent") and
the various purchasers of the Local Securities (the "Purchase Agreement"), which
provided, among other things, for the purchase on such date of an aggregate of
$197.0 million of Common Stock and $80.0 million of Senior
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Notes. A closing was held on such date at which the Redemption was consummated.
In connection therewith, Edward A. Townsend, the present Chairman of the Board
and Chief Executive Officer of the Company and the Banks, Jan A. Norton, the
present President of the Company and the Banks and Joseph A. Leone, a director
of Local Federal, were elected directors of the Company and all of the persons
then serving as directors of the Company resigned. The remaining directors who
presently serve as directors of the Company were then elected and management
appointments were made. In connection with the Private Placement, the Company on
September 8, 1997 also entered into the Registration Rights Agreement with the
initial purchasers of the Local Securities and the Placement Agent, pursuant to
which, among other things, the Company agreed to file within 120 days a shelf
registration statement with the Commission providing for the offer and sale of
the Local Securities. The Registration Statement was filed on January 6, 1998 in
satisfaction of such requirement and declared effective April 20, 1998.
Initiatives by New Management. Since the completion of the Private
Placement and the Redemption, new management has been actively implementing the
measures that are described in Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations. These actions include reducing
the level of the Company's CMOs with interest rate adjustments tied to the COFI,
eliminating all swap and hedging contracts and resolving the Company's portfolio
of indirect automobile loans. While the actions taken are expected to favorably
impact the Company on a going forward basis, as described above under
"--Operating Results," during the six months ended December 31, 1997, the
implementation of these measures resulted in a net loss of $86.0 million. The
Company's results for the six months ending December 31, 1997 were significantly
impacted by nonrecurring charges relating to disposition of the hedging
contracts, the writedown and disposition of securities and additional reserves
taken by management. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
New management of the Company has already implemented several
initiatives since consummation of the Private Placement and the Redemption which
are intended to enhance the Banks' franchise, particularly in the Oklahoma
markets where the Company operates. In the commercial real estate lending area,
the Company has hired an individual with over fifteen years experience in the
Oklahoma City market. In addition, the Company intends to establish a commercial
business lending function, and has recruited two experienced senior executives
from the Oklahoma City market. These individuals have worked together
successfully in Local Financial's markets and are highly visible to area
entrepreneurs and small business owners.
The Company is presently in the process of updating 13 branch
facilities. The projects include drive-in expansions to better accommodate
checking account growth, interior renovations to provide greater customer
privacy, parking lot remodeling to improve customer accessibility and space
availability and interior teller line expansion to more efficiently provide
customer service. In addition, the Company has received regulatory approval for
a second Edmond branch and has notified the OTS regarding its plans to relocate
the Purcell branch to a new larger site location.
The Company will also consider acquisition opportunities when it
perceives such acquisitions will enhance the Company's franchise value. The
Company anticipates that its focus will be on the acquisition of
community-oriented commercial banks and savings institutions which
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are located in communities outside of the larger metropolitan markets of
Oklahoma City and Tulsa and in smaller, less urban markets.
Finally, the Company is attempting to establish more of a sales culture
at both Local Federal and Local America. The Company's marketing department is
actively working on a number of campaigns to promote Local Federal and Local
America, including: a new checking account campaign; a corporate image
advertising campaign focusing on the Company's commitment to local markets; a
home equity loan campaign; and a campaign featuring the Company's new commercial
and industrial lending capabilities. The Company's emphasis is to work on ways
to better serve the Banks' customers, as well as to promote additional fee
income through investment products and overdraft protection.
Acquisition of Green Country Banking Corporation. On October 22, 1997,
Local Financial and Local America entered into an Agreement and Plan of Merger
(the "Merger Agreement") with Green Country and its wholly owned subsidiary,
Green Country Bank, FSB ("Green Country Bank"), pursuant to which Green Country
would be merged with and into the Company, with the Company as the surviving
corporation, and in connection therewith, Green Country Bank would be merged
with and into Local America (collectively, the "Merger"). The Merger was
consummated on February 16, 1998 and, in connection therewith, each outstanding
share of common stock and preferred stock of Green Country was converted into
27.907 and 4,150.27 newly-issued shares, respectively, of the Company's Common
Stock. As a result of the foregoing, an aggregate of 837,209 shares of the
Company's Common Stock were issued in connection with the Merger to the three
existing shareholders of Green Country, which include Edward A. Townsend,
Chairman and Chief Executive Officer of the Company, and Jan A. Norton,
President and Chief Operating Officer of the Company. The shares of Company
Common Stock issued in connection with the Merger are subject to the terms and
conditions of the Registration Rights Agreement. The Merger was accounted for
under the purchase method of accounting. At December 31, 1997, Green Country
Bank operated out of three full-service offices located in Miami, Grove and
Commerce, Oklahoma, and had consolidated assets, liabilities, deposits and
stockholders' equity of $106.5 million, $100.4 million, $77.0 million and $6.1
million, respectively.
Acquisition of BankSouth Corporation. On June 18, 1998, Local entered into an
agreement to purchase BankSouth Corporation, a state bank holding company based
in Lawton, Oklahoma (BankSouth) for approximately $20,600,000 cash. Local's
resultant wholly-owned subsidiary, Citizens Bank, which was formerly the
wholly-owned subsidiary bank of BankSouth, will be subsequently merged into
Local, with Local being the surviving bank. The purchase is subject to
regulatory approval.
The acquisition of BankSouth will be accounted for under purchase accounting
treatment. Total assets and liabilities of BankSouth at March 31, 1998, are
approximately $177,000,000 and $165,000,000, respectively. Final purchase price
adjustments will be made upon closing of the transaction and will be based on
the fair values of assets and liabilities at that date. Calendar year 1998
earnings retained prior to the closing date will affect the allocation of the
purchase price to the extent they affect net asset values at closing. The excess
of the purchase price over the amounts assigned to identifiable assets acquired
less liabilities assumed will be recorded as
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goodwill. The resulting goodwill of approximately $8,700,000 will be amortized
on a straight-line basis over 15 years.
The Company, as a registered savings and loan holding company, is
subject to examination and regulation by the Office of Thrift Supervision (the
"OTS"). The Banks, as federally chartered savings banks, are subject to
comprehensive regulation and examination by the OTS, as their chartering
authority and primary regulator, and by the FDIC, which administers the SAIF,
which insures the Banks' deposits to the maximum extent permitted by law. The
Banks are members of the FHLB of Topeka, which is one of the 12 regional banks
which comprise the FHLB System. The Banks are further subject to regulations of
the Board of Governors of the Federal Reserve System (the "Federal Reserve
Board") governing reserves required to be maintained against deposits and
certain other matters.
The Company's executive offices are located at 3601 NW 63rd Street,
Oklahoma City, Oklahoma 73116-2087.
LENDING ACTIVITIES
General. The Company has historically generated loans through its own
branch network in the case of residential and consumer loans and, in the case of
commercial real estate loans, through a network of loan brokers, mortgage
bankers and unaffiliated financial institutions. All commercial real estate and
residential real estate mortgages are generally secured by first trust deeds on
real property. Consumer loans are comprised of direct automobile loans
originated by the Banks as well as an indirect automobile finance receivables
portfolio, a mix of home equity and other secured and unsecured consumer loans.
As of December 31, 1997, the Company's net loans receivable portfolio amounted
to $953.5 million or 50.7% of the Company's total consolidated assets.
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The following table presents information on the Company's consolidated
loan portfolio as of the dates indicated:
<TABLE>
<CAPTION>
June 30,
----------------------------------------------------------------------------
December 31,
1997 1997 1996 1995 1994 1993
----------- ----------- ----------- ----------- ----------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Single-family residential real $ 287,262 $ 282,034 $ 280,173 $ 282,319 $ 292,119 $ 272,089
estate loans
Construction loans -- -- -- 5,000 -- 332
Commercial real estate loans(1) 645,240 638,091 606,811 496,803 404,572 260,373
Commercial business loans 4,043 -- -- -- -- --
Consumer loans(2) 45,751 122,908 165,380 42,189 32,846 28,451
----------- ----------- ----------- ----------- ----------- -----------
Total gross loans $ 982,296 $ 1,043,033 $ 1,052,364 $ 826,311 $ 729,537 $ 561,245
=========== =========== =========== =========== =========== ===========
Less:
Unaccreted discounts $ (7,824) $ (12,522) $ (16,163) $ (15,451) $ (16,880) $ (13,918)
Unearned interest -- (4,479) (13,959) (890) (142) --
Allowance for loan losses (20,484)(3) (11,435)(3) (3,228) (4,593) (3,689) (2,172)
Loans in process -- -- -- -- (3) (42)
Deferred income (518) (773) (879) (767) (257) (660)
----------- ----------- ----------- ----------- ----------- -----------
Loans receivable, net $ 953,470 $ 1,013,824 $ 1,018,135 $ 804,610 $ 708,566 $ 544,453
=========== =========== =========== =========== =========== ===========
</TABLE>
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(1) Includes loans secured by multi-family residential properties.
(2) At December 31, 1997 and June 30, 1997, 1996, 1995, 1994 and 1993,
includes $0, $82.2 million, $33.3 million, $21.7 million, $1.9 million
and $0 of indirect automobile loan receivables.
(3) See "--Allowance for Loan Losses" for information on the increase in
the Company's allowance for loan losses during fiscal 1997 and the six
months ended December 31, 1997.
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Contractual Principal Repayments and Interest Rates. The following
table sets forth scheduled contractual amortization of the Company's total loan
portfolio at December 31, 1997, as well as the dollar amount of such loans which
are scheduled to mature after one year which have fixed or adjustable interest
rates. Demand loans, loans having no schedule of repayments and no stated
maturity and overdraft loans are reported as due in one year or less.
<TABLE>
<CAPTION>
Principal Repayments Contractually Due or Repricing
In Year(s) Ended December 31,
--------------------------------------------------------------------
Total at
December 31, There-
1997 1998 1999 2000 2001 2002 after
------------ ---------- ---------- ---------- ---------- --------- ---------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Residential real estate $ 287,262 $ 607 $ 1,016 $ 1,863 $ 3,148 $ 4,176 $ 276,452
Commercial real estate 649,283 38,627 31,964 47,627 93,630 60,145 377,290
Consumer 45,751 15,083 1,658 2,209 2,879 2,280 21,642
------------ ---------- ---------- ---------- ---------- --------- ---------
Total(1) $ 982,296 $ 54,317 $ 34,638 $ 51,699 $ 99,657 $ 66,601 $ 675,384
============ ========== ========== ========== ========== ========= =========
</TABLE>
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(1) Of the $928.0 million of loan principal repayments contractually due
after December 31, 1998, $529.3 million have fixed rates of interest
and $398.7 million have adjustable rates of interest. Commercial,
consumer and total loans are presented net of undistributed loan
proceeds.
Scheduled contractual principal repayments do not reflect the actual
maturities of loans. The average maturity of loans is substantially less than
their contractual terms because of prepayments and, in the case of conventional
mortgage loans, due-on-sale clauses, which generally give the Banks 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 rates are substantially higher than rates on existing mortgage
loans and, conversely, decrease when current mortgage loan rates are
substantially lower than rates on existing mortgages (due to refinancings of
adjustable-rate and fixed-rate loans at lower rates).
Origination, Purchase and Sale of Loans. The lending activities of the
Banks are subject to the written, non-discriminatory underwriting standards and
loan origination procedures established by the Banks' Boards of Directors and
management. Loan originations are obtained by a variety of sources, including
referrals from real estate brokers, loan brokers, mortgage bankers, unaffiliated
financial institutions, existing customers, walk-in customers and advertising.
In its present marketing efforts, the Banks emphasize their customized personal
service, competitive rates, and an efficient underwriting and approval process.
Property valuations are performed by the Banks' staff as well as by independent
outside appraisers approved by the Banks' Boards of Directors. The Banks
generally require title, hazard and, to the extent applicable, flood insurance
on its security property.
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A savings institution generally may not make loans to any one borrower
and related entities in an amount which exceeds 15% of its unimpaired capital
and surplus, although loans in an amount equal to an additional 10% of
unimpaired capital and surplus may be made to a borrower if the loans are fully
secured by readily marketable securities. At December 31, 1997, Local Federal's
and Local America's regulatory limit on loans-to-one borrower was $21.9 million
and $15.2 million, respectively. As of such date, the five largest loans or
groups of loans-to-one borrower, including related entities, held in the Banks'
portfolios aggregated $25.9 million, $22.2 million, $21.2 million, $18.0 million
and $16.8 million. All of the loans which exceed the Banks' respective lending
limits were originated during periods when the asset size of the Banks was
greater and the Banks' lending limits were higher. As a result, such loans are
grandfathered and comply with such OTS regulations. All of these five largest
loans or loan concentrations were secured by commercial real estate and were
performing in accordance with their terms at December 31, 1997.
The following table shows the activity in the Company's loan portfolio
during the periods indicated.
<TABLE>
<CAPTION>
Years Ended June 30,
Six Months Ended -----------------------------------------------------
December 31, 1997 1997 1996 1995
----------------- ----------- ----------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Gross loans held at beginning
of period $ 1,043,033 $ 1,052,364 $ 826,311 $ 729,537
Originations of loans:
Single-family residential 27,331 41,115 50,126 20,032
Commercial real estate 33,245 118,527 114,818 121,554
Commercial business 4,449 -- -- --
Consumer 20,460 73,627 179,554 54,222
----------- ----------- ----------- -----------
Total originations 85,485 233,269 344,498 195,808
----------- ----------- ----------- -----------
Purchases of loans:
Single-family residential -- -- -- 3,524
Commercial real estate 32,503 86,939 87,714 142,516
Commercial business 700 -- -- --
Consumer -- -- -- 5,000
----------- ----------- ----------- -----------
Total purchases 33,203 86,939 87,714 151,040
----------- ----------- ----------- -----------
Total originations
and purchases 118,688 320,208 432,212 346,848
----------- ----------- ----------- -----------
Loans sold:
Consumer loans(1) 1,735 11,974 15,009 27,537
Consumer (indirect auto) 54,135 -- -- --
Single-family residential -- -- 13 --
Commercial real estate -- -- -- 62,147
----------- ----------- ----------- -----------
Total sold 55,870 11,974 15,022 89,684
Repayments(2) (123,231) (316,559) (186,173) (159,185)
Transfers to real estate owned (324) (1,006) (4,964) (1,205)
Net activity in loans (60,737) (9,331) 226,053 96,774
----------- ----------- ----------- -----------
Gross loans held at end of
period $ 982,296 $ 1,043,033 $ 1,052,364 $ 826,311
=========== =========== =========== ===========
</TABLE>
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- ----------------
(1) Consists solely of guaranteed student loans.
(2) Includes repossessions with respect to indirect automobile loans.
Commercial Real Estate Loans. As of December 31, 1997, commercial real
estate loans (which include multi-family residential loans) amounted to $645.2
million or 65.7% of the Company's total loan portfolio. The Banks originate and
purchase whole loans and loan packages through a network of loan brokers,
mortgage bankers and institutions throughout the country with whom the Banks
have relationships, who find potential loans based upon the Banks' established
underwriting and pricing guidelines. All originations and purchases undergo a
three-step underwriting and evaluation process. First, an initial review of the
loan package is conducted by the originator to determine conformity to
guidelines and consistency with the Banks' lending philosophy. An indication of
pricing and terms may be issued in the case of loans which have already been
originated. Second, once the indication is accepted by the borrower and a
completed application submitted, a detailed underwriting is conducted in which
both the originator and the Banks' in-house appraiser conduct an onsite
inspection and analysis. Rent rates are analyzed and compared to market rents,
reported occupancy is checked against evidence onsite, environmental issues are
identified and the appropriate level of investigation is conducted and a final
credit write-up is prepared. Finally, the Banks' closing department reviews the
totality of work, including completeness of analysis and documentation, title
searches, borrower background checks, appraisal and environmental reports and
other pertinent data. Only after these three broad steps is a final approval and
disbursement made.
The Company also purchases packages of commercial real estate loans
from a financial institution located in Oregon and a financial institution
located in Utah. These loans are secured primarily by multi-family residential
and nonresidential real estate and are generally purchased on a servicing
retained basis. Commercial real estate loans purchased by the Company are
underwritten pursuant to the same guidelines as direct loan originations. The
Company purchased a total of $32.5 million and $86.9 million of commercial real
estate loans during the six months ending December 31, 1997 and the year ended
June 30, 1997, respectively.
The Banks impose in-house lending limits which are below statutory
lending limits. While the OTS statutory limit is 15% of an institution's
unimpaired capital and surplus (or with respect to Local Federal and Local
America, approximately $21.9 million and $15.2 million, respectively, at
December 31, 1997), new management of the Company generally restricts single
loans to $12 to $15 million in size and generally limits exposure to any single
borrower to $20 million.
The Company originates both fixed-rate and adjustable rate commercial
real estate loans. Fixed-rate commercial real estate loans generally have terms
to maturity of between five and ten years and amortize over a period of up to 30
years. Adjustable-rate commercial real estate loans have interest rates which
generally adjust every six months, one year, three years and five years in
accordance with a designated index (either the London Interbank Offer Rate, the
prime rate quoted in the Wall Street Journal or U.S. Treasury rates).
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Loan-to-value ratios on commercial real estate loans are generally
limited to a maximum of 80% for apartments and manufactured housing communities
(loans on real estate as distinguished from manufactured homes), 75% on
mini-storage units and multi-tenant warehouses, 70% for offices and 65% for
hotels and retail properties.
Wholesale commercial real estate origination/acquisition volume was
relatively stable in fiscal 1996 and 1997, amounting to $202.5 million and
$205.4 million, respectively, and amounting to $65.7 million for the six months
ended December 31, 1997.
By virtue of its nationwide wholesale commercial mortgage originations,
the commercial real estate portfolio is diversified geographically. As of
December 31, 1997, the states in which the highest geographic concentration of
assets existed were Oregon (14.0%), California (13.9%), New York (12.1%) and
Texas (11.3%). In terms of primary collateral type, as of December 31, 1997,
$282.8 million or 43.7% of the commercial mortgage portfolio was secured by
apartment buildings, $118.5 million or 18.3% of the commercial mortgage
portfolio was secured by hotels and motels and $99.4 million or 15.4% of the
commercial mortgage portfolio was secured by manufactured housing communities.
The largest single commercial real estate loan as of such date had an
outstanding principal balance of $15.9 million and is secured by a 100-unit
apartment building located in Tennessee. Multiple commercial mortgage loans to
one borrower are generally cross-collateralized and cross-defaulted.
Under prior management, the Company originated and purchased commercial
real estate loans secured by properties located throughout the United States.
New management expects to continue the origination and purchase of commercial
and multi-family residential loans throughout the United States but plans to
emphasize the origination and purchase of loans secured by multi-family and
commercial real estate located within the State of Oklahoma and surrounding
states. The Company recently hired an experienced commercial real estate lender
with over 15 years of experience in the Oklahoma City market. As a result, the
Company expects to expand its origination of commercial real estate loans,
particularly within its local market area.
The Company also anticipates that during fiscal 1998 it will begin to
originate within the State of Oklahoma commercial business loans. The Company
has recently hired two senior loan officers from the Oklahoma City market who
have significant commercial business lending experience and who have worked
together in the past and are well known in the local business community.
Commercial lending entails different and significant risks when
compared to single-family residential lending because such loans typically
involve large loan balances to single borrowers and because the payment
experience on such loans is typically dependent on the successful operation of
the project or the borrower's business. The risks relating to commercial real
estate lending can also be significantly affected by supply and demand
conditions in the local market for apartments, offices, warehouses or other
commercial space. The Company attempts to minimize its risk exposure by imposing
stringent underwriting standards and continually monitoring the operation and
physical condition of the collateral.
10
<PAGE> 13
As shown under "--Asset Quality," the Company's nonperforming
commercial real estate loans amounted to $162,000 or 0.03% of total commercial
real estate loans at December 31, 1997, as compared to $2.0 million or 0.3% of
total commercial real estate loans at June 30, 1997. The Company had no
commercial real estate owned at December 31, 1997, as compared to $6.2 million
or 71.4% of total foreclosed assets as of June 30, 1997. The decline was
primarily due to the transfer of a $6.0 million retail shopping center from real
estate owned to real estate held for investment. Local Federal has profitably
managed the shopping center since it became real estate owned. The property was
transferred to real estate held for investment during the period because the
Company had exceeded the 5-year regulatory limit for holding real estate owned.
Single-Family Residential Real Estate Loans. At December 31, 1997, the
Company's single-family residential mortgage loan portfolio amounted to $287.3
million or 29.2% of the total loan portfolio. All of the Company's single-family
residential mortgage loans are secured by properties located in the State of
Oklahoma. The majority of the single-family residential loan portfolio consist
of conforming loans (i.e., not insured or guaranteed by a federal agency) with
an average balance of below $100,000 per loan. For the six months ended December
31, 1997 and the year ended June 30, 1997, the Company originated $27.1 million
and $41.1 million of single-family residential mortgage loans, respectively. The
single-family residential loan portfolio was originated through the Banks'
retail branch network as well as through a centralized residential loan
origination center. New management expects to increase the Banks' emphasis on
single-family residential lending within its primary market area in Oklahoma.
The loan-to-value ratio, maturity and other provisions of the loans
made by the Banks generally have reflected the policy of making less than the
maximum loan permissible under applicable regulations, in accordance with market
conditions and underwriting standards established by the Banks. The Company's
lending policies on single-family residential mortgage loans generally limits
the maximum loan-to-value ratio to 95% of the lesser of the appraised value or
purchase price of the property and generally all single-family residential loans
in excess of an 80% loan-to-value ratio require private mortgage insurance.
The Banks offer fixed-rate single-family residential loans with terms
of 15 to 30 years. Such loans are amortized on a monthly basis with principal
and interest due each month and customarily include "due-on-sale" clauses, which
are provisions giving the Banks the right to declare a loan immediately due and
payable in the event the borrower sells or otherwise disposes of the real
property subject to the mortgage and the loan is not repaid.
Since the early 1980s, the Banks have been offering adjustable-rate
loans in order to decrease the vulnerability of its operations to changes in
interest rates. At December 31, 1997, $66.2 million or 23.1% of the
single-family residential loans in the Company's total loan portfolio consisted
of adjustable-rate loans.
The Banks' single-family residential adjustable-rate loans are fully
amortizing loans with contractual maturities of up to 30 years. These loans have
interest rates which are scheduled to adjust every year in accordance with a
designated index (i.e., the weekly average yield on U.S. Treasury securities
adjusted to a constant comparable maturity, as made available by the Federal
11
<PAGE> 14
Reserve Board). There is a 2% cap on the rate adjustment per period and a 6% cap
on the rate adjustment over the life of the loan. The Banks' adjustable-rate
loans are not currently convertible into fixed-rate loans, are not assumable, do
not contain prepayment penalties and do not produce negative amortization.
The demand for adjustable-rate loans in the Company's primary market
area has been a function of several factors, including the level of interest
rates, the expectations of changes in the level of interest rates and the
difference between the interest rates and loan fees offered for fixed-rate loans
and adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate
residential loans that can be originated at any time is largely determined by
the demand for each in a competitive environment.
Adjustable-rate loans decrease the risks associated with changes in
interest rates but involve other risks, primarily because as interest rates
rise, the payment by the borrower rises to the extent permitted by the terms of
the loan, thereby increasing the potential for default. At the same time, the
marketability of the underlying property may be adversely affected by higher
interest rates. The Company believes that these risks, which have not had a
material adverse effect on the Company to date, generally are less than the
risks associated with holding only fixed-rate loans in an increasing interest
rate environment.
At December 31, 1997, total non-performing single-family residential
mortgages and foreclosed single-family residential assets amounted to $413,000
and $264,000, respectively.
Consumer Loans. Consumer loans totaled $45.8 million as of December 31,
1997 and consisted of $27.8 million of home equity loans, $7.6 million of
deposit secured loans, $7.1 million of guaranteed student loans, $3.0 million of
automobile finance loans and $332,000 of property improvement and personal
loans. These loans are originated through the Banks' branch network. Under the
Banks' home equity underwriting guidelines, loans are restricted to not more
than $100,000, and the loan-to-value may not exceed 100% at origination.
Applications are taken at the branch level but underwriting, except in the case
of cash secured loans, is done centrally. New management expects to increase the
Banks' emphasis on consumer lending within its primary market area in Oklahoma.
As of December 31, 1997, the Banks had $51,000 of nonperforming consumer loans
and had $31,000 in foreclosed consumer loans.
From February 1994 until February 1997, the Banks, through LAC and
Star, purchased sub-prime automobile finance receivables from auto dealers. LAC,
established in 1993, purchased contracts, normally on a discounted basis, from
dealers in and around Hollywood, Florida. Star, established in 1995, purchased
auto contracts from dealers in Oklahoma and operated a branch origination office
in Tulsa. All purchases of automobile paper by the Banks were performed by these
subsidiaries. Summarized financial reports were submitted to the Board of
Directors of the Banks. All dealer relationships, underwriting, pricing,
purchasing and servicing of contracts were controlled at the subsidiary level.
Evidence of significant credit problems came to the attention of the
former Board of Directors of the Company during the fourth calendar quarter of
1996. Upon additional scrutiny of the causes of this deterioration, it became
evident that both Star and LAC were going to
12
<PAGE> 15
continue to incur credit losses and that these losses were mounting rapidly.
Management of the Banks further believe that it has uncovered evidence of fraud
at LAC and has notified law enforcement authorities. In February 1997, the Banks
stopped originations permanently and dismantled the origination infrastructure
of the two subsidiaries. Since such date, the two subsidiaries have only been
servicing and collecting remaining contracts.
The condition of the indirect automobile finance receivables portfolio
has had a direct and material adverse impact on the Company's results of
operations. During the six months ended December 31, 1997 and the years ended
June 30, 1997 and 1996, the Company provided an aggregate of $23.4 million,
$28.1 million and $4.5 million in provisions for loan losses to cover realized
and inherent losses associated with respect to this portfolio. At December 31,
1997, the Company's portfolio of indirect automobile receivables had been sold.
ASSET QUALITY
Loan Delinquencies. When a borrower fails to make a required payment on
a loan, the Company attempts to cure the deficiency by contacting the borrower
and seeking payment. Contacts are generally made following the 15th day after a
payment is due (30th day in the case of commercial real estate loans), at which
time a late payment fee is assessed. In most cases, deficiencies are cured
promptly. If a delinquency extends beyond 15 days (30 days in the case of
commercial real estate loans), the loan and payment history is reviewed and
efforts are made to collect the loan. While the Company generally prefers to
work with borrowers to resolve such problems, when the account becomes 90 days
delinquent, the Company does institute foreclosure or other proceedings, as
necessary, to minimize any potential loss.
13
<PAGE> 16
The following table presents information as of December 31, 1997 with
respect to the delinquent loans of the Company on a consolidated basis:
<TABLE>
<CAPTION>
Loans Delinquent For:
---------------------------------------------------------------------
Total Loans Delinquent
60 - 89 Days 90 Days and Over 60 Days or More
------------------------------- --------------------------------- ----------------------------
Percent of Percent of Percent of
Loan Loan Loan
Number Amount Category Number Amount Category Number Amount Category
------ ------ ---------- ------ ------ ---------- ------ ------ -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Single-family residential 27 $ 693 0.24% 16 $ 342 0.12% 43 $1,035 0.36%
Commercial real estate 2 162 0.03 2 1,224 0.19 4 1,386 0.22
Consumer 8 155 0.34 5 65 0.14 13 220 0.48
---- ------ ---- ------ -- ------
Total 37 $1,010 0.11% 23 $1,631 0.17% 60 $2,641 0.27%
==== ====== ====== ==== ====== ==== == ====== ====
</TABLE>
14
<PAGE> 17
Nonperforming Assets. All loans are reviewed on a regular basis and are
placed on non-accrual status when, in the opinion of management, the collection
of additional interest is deemed insufficient to warrant further accrual. As a
matter of policy, the Company does not accrue interest on loans past due 90 days
or more except when the estimated value of the collateral and collection efforts
are deemed sufficient to ensure full recovery. Consumer loans generally are
written down when the loan becomes over 120 days delinquent. Interest accrued
and unpaid at the time a loan is placed on non-accrual status is charged against
interest income. Subsequent payments are either applied to the outstanding
principal balance or recorded as interest income, depending on the assessment of
the ultimate collectibility of the loan.
Assets acquired through foreclosure and repossession are recorded at
estimated fair value, net of estimated selling costs at the date of foreclosure
or repossession. The values of assets acquired through foreclosure and
repossession are monitored by the Company continually through sales and rental
activities, and by updated appraisals and other valuation methods when needed.
The allowance for losses on assets acquired through foreclosure and repossession
represents an amount which management believes will be adequate to absorb losses
from the disposition and/or revaluation of these assets. Additions or reversals
of the allowance for losses on assets acquired through foreclosure and
repossession are provided as an expense or a benefit, respectively, through the
provisions for uninsured risks and losses on assets acquired through foreclosure
and repossession in the accompanying Consolidated Statements of Operations. The
allowance for losses is charged or reduced as losses through sales or
revaluations are incurred. At December 31, 1997, the allowance for losses on
assets acquired through foreclosure and repossession amounted to $35,000. See
Note 8 of the Notes to Consolidated Financial Statements.
15
<PAGE> 18
The following table presents information on the Company's nonperforming
assets at the dates indicated. The Company did not have any troubled debt
restructurings at any of the dates presented.
<TABLE>
<CAPTION>
June 30,
------------------------------------------------------------------------
December 31,
1997 1997 1996 1995 1994 1993
--------- --------- --------- --------- --------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Non-accruing loans:
Single-family residential $ 413 $ 927 $ 220 $ 329 $ 539 $ 698
Commercial real estate 162 1,977 3,574 2,778 2,785 315
Consumer loans(1) 51 604 -- -- 18 18
--------- --------- --------- --------- --------- ---------
Total $ 626 $ 3,508 $ 3,794 $ 3,107 $ 3,342 $ 1,031
--------- --------- --------- --------- --------- ---------
Accruing loans greater than
90 days delinquent(2) -- 415 1,548 -- -- --
Foreclosed assets:
Single-family residential 264 236 304 419 116 1,174
Commercial real estate -- 6,170 6,570 7,363 7,503 8,959
Construction -- -- -- -- -- --
Consumer(1) 31 2,241 3,969 -- -- --
--------- --------- --------- --------- --------- ---------
Total foreclosures 295 8,647 10,843 7,782 7,619 10,133
--------- --------- --------- --------- --------- ---------
Total non-performing assets $ 921 $ 12,570 $ 16,185 $ 10,889 $ 10,961 $ 11,164
========= ========= ========= ========= ========= =========
Total non-performing assets
as a percentage of total
assets 0.05% 0.48% 0.49% 0.33% 0.33% 0.48%
========= ========= ========= ========= ========= =========
</TABLE>
- ----------------
(1) Consists primarily of indirect automobile finance receivables.
(2) Consists solely of indirect automobile finance receivables.
The decline in nonperforming assets during the six months ended
December 31, 1997 reflected a $2.9 million decline in non-accrual loans
(primarily commercial real estate loans) and a $8.4 million decline in
foreclosed assets (which was primarily due to the transfer of a $6.0 million
retail shopping center from real estate owned to real estate held for investment
during the period).
Classified Assets. The Company adheres to internal procedures and
controls to review and classify its assets. All assets are reviewed on a
periodic basis. If warranted, all or a portion of any assets exhibiting the
characteristics of risk associated with adverse classifications are assigned
those classifications. To monitor loans and to establish loss reserves, the
Company classifies its assets into the following five categories: pass, special
mention, substandard, doubtful, and loss. Under federal regulations, each
insured savings institution must classify its assets on a regular basis. In
connection with examinations of insured institutions, federal examiners have
authority to identify problem assets and, if appropriate, classify them.
16
<PAGE> 19
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the insured institution will sustain some loss if
the deficiencies are not corrected. Doubtful assets have the weaknesses of
substandard assets, with the additional characteristic that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified loss is considered uncollectible and of such little value that
continuance as an asset of the institution is not warranted. Special mention
assets is a category established and maintained for assets which do not
currently expose an insured institution to a sufficient degree of risk to
warrant classification as substandard, doubtful or loss. Assets classified as
substandard or doubtful require the institution to establish general allowances
for loan losses. If an asset or portion thereof is classified loss, the insured
institution must either establish specific allowances for loan losses in the
amount of 100% of the portion of the asset classified loss, or charge-off such
amount. General loss allowances established to cover possible losses related to
assets classified substandard or doubtful may be included in determining an
institution's regulatory capital up to certain amounts, while specific valuation
allowances for loan losses do not qualify as regulatory capital. Federal
examiners may disagree with an insured institution's classifications and amounts
reserved. As of December 31, 1997, excluding assets which were classified as a
loss and completely written down, the Company's classified assets consisted of
$31.9 million of loans which were classified as special mention and $10.3
million of loans which were classified as substandard.
Allowance for Loan Losses. The Company has established valuation
allowances for estimated inherent losses in its loan portfolio by charging
earnings for estimated losses on loans, including the related accrued interest,
using a specific and percentage reserve method. The allowance for loan losses is
established and maintained through a periodic review and evaluation of various
factors which affect the loans' collectibility; any additional allowances
required result in provisions for loan losses. The determination of specific
valuation allowances includes a periodic evaluation of the financial status of
individual borrowers or collateral relating to loans specifically identified as
containing elements of potential risk in the loan portfolio. Numerous factors
are considered in the evaluation, including a review of (i) individual
borrowers' financial status, credit standing and available collateral, (ii) loss
experience in relation to outstanding loans and the overall loan portfolio
quality, (iii) management's judgment regarding prevailing and anticipated
economic conditions and (iv) other relevant factors. The general valuation
allowance is based upon a number of factors, including historical loss
experience, composition of the loan portfolio, prevailing and forecasted
economic conditions and management's judgment. It is the Company's policy to
charge off any loan or portion thereof when deemed uncollectible in the ordinary
course of business. Losses and recoveries are charged or credited directly to
the allowance. The OTS and the FDIC, as an integral part of their examination
process, periodically review the Banks' allowances for possible loan losses.
Such agencies may require the Banks to recognize additions to such allowances
based on their judgments about information available to them at the time of
their examination.
17
<PAGE> 20
The following table provides information on the Company's allowance for
loan losses as of the dates indicated:
<TABLE>
<CAPTION>
Six Months Ended
December 31, Years Ended June 30,
----------------------- ---------------------------------------------------------------
1997 1996 1997 1996 1995 1994 1993
-------- -------- -------- -------- -------- ------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at beginning of $ 11,435 $ 3,228 $ 3,228 $ 4,593 $ 3,689 $ 2,172 $ 2,746
period
Loans charged off:
Single-family
residential (5) -- (3) (143) (191) (320) (516)
Commercial real estate (14) -- -- (1,368) (4) (48) (2,677)
Consumer (4) (6) (15) (1) (22) (11) (71)
Autos (indirect) (16,531) (8,077) (20,275) (5,025) (145) -- --
Recoveries:
Single-family
residential -- 1 2 11 39 27 145
Commercial real estate 2 1 53 3 68 104 881
Consumer 1 -- 1 1 2 1 10
Autos (indirect) 22 594 16 40 -- -- --
Allowance of acquired
Institution -- -- -- -- -- -- 84
-------- -------- -------- -------- -------- ------- --------
Net loans charged off (16,529) (7,487) (20,221) (6,482) (253) (247) (2,144)
Provision for loan losses 25,578 9,734 28,428 5,117 1,157 1,764 1,570
-------- -------- -------- -------- -------- ------- --------
Balance at end of period $ 20,484 $ 5,475 $ 11,435 $ 3,228 $ 4,593 $ 3,689 $ 2,172
======== ======== ======== ======== ======== ======= ========
Allowance for loan losses to
total nonperforming loans
at end of period 3272.20% 56.22% 291.49% 60.43% 147.82% 110.38% 210.66%
======== ======== ======== ======== ======== ======= ========
Allowance for loan losses to
total loans at end of period 2.09% 0.50% 1.10% 0.31% 0.57% 0.52% 0.40%
======== ======== ======== ======== ======== ======= ========
</TABLE>
18
<PAGE> 21
The following table sets forth information concerning the allocation of
the Company's allowance for loan losses by loan category at the dates indicated.
<TABLE>
<CAPTION>
June 30,
----------------------------------------------------------------------------------
December 31, 1997 1997 1996 1995 1994
-------------------- ------------------- --------------------- ------------------ -------------------
Percent to Percent to Percent to Percent to Percent to
Total Total Total Total Total
Amount Allowance Amount Allowance Amount Allowance Amount Allowance Amount Allowance
------- ---------- ------- ---------- --------- ---------- ------- ----------- ------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Single-family residential $ 412 2.01% $ 427 3.73% $ 407 12.61% $ 411 8.95% $ 467 12.66%
Commercial real estate 10,459 51.06 2,836 24.80 2,624 81.29 3,644 79.34 3,023 81.95
Consumer 6,203 30.28 8,172 71.47 197 6.10 538 11.71 199 5.39
General unallocated 3,410 16.65 -- -- -- -- -- -- -- --
------- ------ ------- ------ --------- ------ ------- ------ ------- ------
Total $20,484 100.00% $11,435 100.00% $ 3,228 100.00% $ 4,593 100.00% $ 3,689 100.00%
======= ====== ======= ====== ========= ====== ======= ====== ======= ======
<CAPTION>
June 30,
----------------------
1993
----------------------
Percent to
Total
Amount Allowance
-------- ----------
<S> <C> <C>
Single-family residential $ 453 20.86%
Commercial real estate 1,521 70.02
Consumer 198 9.12
General unallocated -- --
-------- ------
Total $ 2,172 100.00%
======== ======
</TABLE>
19
<PAGE> 22
INVESTMENT ACTIVITIES
The Company's securities portfolio is managed in accordance with a
written investment policy adopted by the Board of Directors and administered by
the Company's Investment Committee. All transactions must be approved by the
Investment Committee and reported to the Board of Directors.
The Banks are authorized to invest in obligations issued or fully
guaranteed by the U.S. Government, certain federal agency obligations, certain
time deposits, negotiable certificates of deposit issued by commercial banks and
other insured financial institutions, investment grade corporate debt securities
and other specified investments such as mortgage-backed and related securities.
The Company invests in mortgage-backed and related securities,
including mortgage participation certificates, which are insured or guaranteed
by U.S. Government agencies and government sponsored enterprises, and CMOs and
real estate mortgage investment conduits ("REMICs"). Mortgage-backed securities
(which also are known as mortgage participation certificates or pass-through
certificates) represent a participation interest in a pool of single-family or
multi-family mortgages, the principal and interest payments on which are passed
from the mortgage originators, through intermediaries (generally U.S. Government
agencies and government sponsored enterprises) that pool and repackage the
participation interests in the form of securities, to investors such as the
Company. Such U.S. Government agencies and government sponsored enterprises,
which guarantee the payment of principal and interest to investors, primarily
include the Federal Home Loan Mortgage Corporation ("FHLMC"), the Federal
National Mortgage Association ("FNMA") and the Government National Mortgage
Association ("GNMA").
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
characteristics of the underlying pool of mortgages, i.e., fixed-rate or
adjustable-rate, as well as prepayment risk, are passed on to the certificate
holder. The term of a mortgage-backed pass-through security thus approximates
the term of the underlying mortgages.
The Company's mortgage-backed and related securities include CMOs,
which include securities issued by entities which have qualified under the
Internal Revenue Code of 1986, as amended ("Code"), as REMICs. CMOs and REMICs
(collectively CMOs) have been developed in response to investor concerns
regarding the uncertainty of cash flows associated with the prepayment option of
the underlying mortgagor and are typically issued by governmental agencies,
government sponsored enterprises and special purpose entities, such as trusts,
corporations or partnerships, established by financial institutions or other
similar institutions. A CMO can be collateralized by loans or securities which
are insured or guaranteed by FNMA, FHLMC or GNMA. In contrast to pass-through
mortgage-backed securities, in which cash flow is received pro rata by all
security holders, the cash flow from the mortgages underlying a CMO is segmented
and paid in accordance with a predetermined priority to investors holding
various CMO classes. By allocating the principal and interest cash flows from
the underlying collateral
20
<PAGE> 23
among the separate CMO classes, different classes of bonds are created, each
with its own stated maturity, estimated average life, coupon rate and prepayment
characteristics.
Beginning in 1993, the Company began to implement an investment
strategy whereby it purchased mortgage-backed and related securities and
financed those securities primarily through reverse repurchase agreements and
FHLB advances. The Company predominantly purchased adjustable-rate FNMA and
FHLMC CMOs tied to COFI. As a result, at June 30, 1996, the Company's securities
portfolio amounted to $2.1 billion ($1.9 billion of which consisted of
COFI-based CMOs) or 65.1% of total assets. The COFI is a compilation of the
average rates paid by savings institutions which are members of the 11th
District of the FHLB system, and the COFI generally adjusts more slowly to
changes in market rates of interest when compared to adjustable-rate loans and
securities with interest rates based on other indices. As a result of recent
fluctuations in the level of interest rates as well as the structure of the
COFI, the values of the Company's COFI-based CMOs have declined in recent
periods. At June 30, 1996, the Company had $48.5 million of unrealized losses
with respect to its securities portfolio (net of applicable tax benefits).
In late 1996 and in anticipation of the proposed sale of the Company,
the Company began reducing its securities, particularly its CMO holdings,
through periodic bulk sale transactions. During fiscal 1997, the Company sold
$743.9 million of securities and recognized $29.6 million of losses with respect
to such sales. At June 30, 1997, the Company's securities portfolio amounted to
$1.4 billion ($1.1 billion of which consisted of COFI-based CMOs) or 53.1% of
total assets. As of such date, the Company had $32.0 million of unrealized
losses with respect to its securities portfolio (net of applicable tax
benefits).
During September 1997 and in connection with the Private Placement and
the Redemption, new management of the Company determined that its CMO portfolio
was "other than temporarily impaired" and, in accordance with GAAP, wrote-down
its remaining CMO portfolio by $54.7 million. In addition, since assuming
control of the Company on September 8, 1997, new management has been
accelerating the disposition of its securities portfolio, particularly its
COFI-based CMOs. During the three months ended September 30, 1997, the Company
sold $539.2 million of securities and recognized $17.3 million of losses with
respect to such sales. The market for fixed income securities improved during
the three-month period ended December 31, 1997 and during such period the
Company sold a portion of the remaining COFI-based CMO portfolio for a gain of
$12.7 million. The Company has utilized the proceeds of such sales to repay all
of its outstanding reverse repurchase agreements and $451.0 million or 84.9% of
its outstanding FHLB advances. The remaining proceeds were invested in
short-term investments. At December 31, 1997 the Company's securities portfolio
amounted to $518.1 million ($428.6 million of which consisted of COFI-based
mortgage-related securities) or 27.5% of assets. As of such date, all of the
Company's securities were classified as available for sale. Pursuant to SFAS No.
115, securities classified as available for sale are carried at fair value with
any resulting unrealized gains or losses credited or charged to stockholders'
equity. As of December 31, 1997, the Company had unrealized gains with respect
to its securities portfolio of $2.3 million (net of applicable taxes).
21
<PAGE> 24
The following table sets forth information regarding the carrying and
market value of the Company's securities at the dates indicated.
<TABLE>
<CAPTION>
June 30,
-------------------------------------------------------
December 31, 1997 1997 1996
------------------------- ------------------------- -------------------------
Carrying Market Carrying Market Carrying Market
Value Value Value Value Value Value
---------- ---------- ---------- ---------- ---------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Available for sale (at market):
FHLMC $ 186,706 $ 186,706 $ 473,963 $ 473,963 $ 884,936 $ 884,936
FNMA 267,826 267,826 483,508 483,508 810,963 810,963
GNMA 386 386 -- -- -- --
Private 57,175 57,175 28,046 28,046 41,174 41,174
U.S. Government agency securities 6,000 6,000 -- -- -- --
Equity securities 14 14 -- -- 11,604 11,604
Interest rate caps and floors -- -- 48 48 4,652 4,652
---------- ---------- ---------- ---------- ---------- ----------
$ 518,107 $ 518,107 $ 985,565 $ 985,565 $1,753,329 $1,753,329
========== ========== ========== ========== ========== ==========
Held to maturity:
FHLMC $ -- $ -- $ 206,915 $ 201,924 $ 248,006 $ 239,996
FNMA -- -- 88,070 84,552 90,301 86,713
GNMA -- -- 429 417 504 488
Private -- -- 38,674 37,805 53,513 51,807
U.S. Government agency securities -- -- 74,119 74,219 -- --
---------- ---------- ---------- ---------- ---------- ----------
$ -- $ -- $ 408,207 $ 398,917 $ 392,324 $ 379,004
========== ========== ========== ========== ========== ==========
<CAPTION>
June 30,
-------------------------
1995
-------------------------
Carrying Market
Value Value
---------- ----------
(In Thousands)
<S> <C> <C>
Available for sale (at market):
FHLMC $ 89,183 $ 89,183
FNMA 272,219 272,219
GNMA -- --
Private -- --
U.S. Government agency securities -- --
Equity securities 12,287 12,287
Interest rate caps and floors -- --
---------- ----------
$ 373,689 $ 373,689
========== ==========
Held to maturity:
FHLMC $1,173,807 $1,151,783
FNMA 691,313 680,201
GNMA 607 590
Private 118,029 113,163
U.S. Government agency securities -- --
---------- ----------
$1,983,756 $1,945,737
========== ==========
</TABLE>
The following table sets forth the activity in the Company's aggregate
securities portfolio during the periods indicated.
<TABLE>
<CAPTION>
Years Ended June 30,
-------------------------------------------
Six Months Ended
December 31, 1997 1997 1996 1995
----------------- --------- ----------- -----------
(In Thousands)
<S> <C> <C> <C> <C>
Securities at beginning of period $ 1,393,772 $ 2,145,653 $ 2,357,445 $ 2,469,356
Purchases 80,441 73,388 9,040 37,708
Loan securitizations -- -- -- 60,824
Proceeds from securities sales (865,146) (743,943) (50,321) (95,255)
Proceeds from swap terminations -- -- (3,637) --
Loss on termination of options (2,234) -- -- --
Gain (loss) from securities sales (4,610) (29,582) (181) 2,298
Mark-to-market on securities other
than temporarily impaired (54,724) -- -- --
Repayments and prepayments (80,789) (65,406) (80,976) (113,845)
Amortization and accretion (2) (10,355) (11,905) (6,898)
Accretion of deferred (gains) or losses
from swap terminations -- 1,888 1,154 --
Decrease (increase) in unrealized losses
on available-for-sale securities(1) 52,824 25,408 (74,966) 3,257
Charge-offs and transfers to loans (1,425) (3,279) -- --
----------- ----------- ----------- -----------
Securities at end of period $ 518,107 $ 1,393,772 $ 2,145,653 $ 2,357,445
=========== =========== =========== ===========
</TABLE>
22
<PAGE> 25
- ----------------
(1) At December 31, 1997, the cumulative unrealized gains on securities
classified as available-for-sale amounted to $3.6 million.
At December 31, 1997, the Company's securities portfolio had an
aggregate carrying value of $518.1 million, $512.1 million of which consisted of
mortgage-backed and related securities and $6.0 million of which consisted of
U.S. Government agency securities. At December 31, 1997, of the Company's $512.1
million of mortgage-backed and related securities, $43.4 was scheduled to mature
in one year or less (which had a weighted average yield of 5.75%), $1.0 million
was scheduled to mature in between one and five years (which had a weighted
average yield of 7.04%, $6.4 million was scheduled to mature in between five and
ten years (which had a weighted average yield of 6.96%), and $461.3 million was
scheduled to mature after ten years (which had a weighted average yield of
7.00%).
The actual maturity of a mortgage-backed or related security is less
than its stated maturity due to prepayments of the underlying mortgages.
Prepayments that are faster than anticipated may shorten the life of the
security and affect its yield to maturity. The yield to maturity is based upon
the interest income and the amortization of any premium or discount related to
the security. In accordance with GAAP, premiums and discounts are amortized over
the estimated lives of the loans, which decrease and increase interest and
dividend income, respectively. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed or related security, and these assumptions are
reviewed periodically to reflect actual prepayments. Although prepayments of
underlying mortgages depend on many factors, including the type of mortgages,
the coupon rate, the age of mortgages, the geographical location of the
underlying real estate collateralizing the mortgages and general levels of
market interest rates, the difference between the interest rates on the
underlying mortgages and the prevailing mortgage interest rates generally is the
most significant determinant of the rate of prepayments. During periods of
falling mortgage interest rates, if the coupon rate of the underlying mortgages
exceeds the prevailing market interest rates offered for mortgage loans,
refinancing generally increases and accelerates the prepayment of the underlying
mortgages and the related security.
All of the $6.0 million of U.S. Government agency securities held by
the Company at December 31, 1997 (which had a weighted average yield of 5.77%)
was scheduled to mature in one year or less.
SOURCES OF FUNDS
General. Deposits are the primary source of the Company's funds for
lending and other investment purposes. In addition to deposits, the Company
derives funds from loan principal repayments and advances from the FHLB of
Topeka. Furthermore, in prior periods, the Company utilized reverse repurchase
agreements in order to fund its lending and investing activities. Loan
repayments are a relatively stable source of funds, while deposit inflows and
outflows are significantly influenced by general interest rates and money market
conditions. Borrowings may be used on a short-term basis to compensate for
reductions in the availability of
23
<PAGE> 26
funds from other sources. They may also be used on a longer-term basis for
general business purposes.
Deposits. As of December 31, 1997, the Banks accepted deposits through
their 41 branch offices. Deposits are solicited on a regular basis directly
through the Banks' customer base and through various advertising media within
its markets. The Banks offer several savings account and checking account plans
to its customers. Among savings account plans, the Banks offer basic savings,
short- and long-term certificates of deposit, a variable rate IRA/Keogh and
regular IRAs and Keoghs. The Banks offer checking account plans that range from
a no-fee, no-interest plan to a variable-fee, bundled product plan that includes
services or products such as personalized checks, ATM cards, overdraft
protection, no annual fee Visa/MasterCard membership, safe deposit box
discounts, and assistance with travelers checks.
According to SNL Securities, as of May 31, 1998, the Company operated
on a consolidated basis the largest thrift institution in terms of total
deposits in the State of Oklahoma. The Banks ranked fifth overall among all
depository institutions as of such date, with 6.5% of the state's deposit market
share, adjusted for pending mergers and acquisitions.
Interest rates paid, maturity terms, service fees and withdrawal
penalties are established by the Banks, on a periodic basis. Determination of
rates and terms are predicated on funds acquisition and liquidity requirements,
rates paid by competitors, growth goals and federal regulations.
The Banks do not advertise for deposits outside their local market
areas or utilize the services of deposit brokers.
24
<PAGE> 27
The following table presents the average balance of each deposit type
and the average rate paid on each deposit type of the Company for the periods
indicated.
<TABLE>
<CAPTION>
Years Ended June 30,
---------------------------------------
Six Months Ended
December 31, 1997 1997
--------------------------------------- ---------------------------------------
Average Average
Average Rate Average Rate
Balance Interest Paid Balance Interest Paid
---------- ---------- ------- ---------- ---------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Noninterest-
bearing deposits $ 57,778 $ -- --% $ 52,087 $ -- --%
Passbook accounts 78,731 1,009 2.56 72,441 2,092 2.89
NOW and money
market accounts 187,381 2,594 2.77 195,606 5,381 2.75
Term certificates 1,301,703 37,069 5.70 1,329,463 75,618 5.69
---------- ---------- ---------- ----------
Total deposits $1,625,593 $ 40,672 5.00% $1,649,597 $ 83,091 5.04%
========== ========== ==== ========== ========== ====
<CAPTION>
Years Ended June 30,
----------------------------------------------------------------------------------
1996 1995
--------------------------------------- ---------------------------------------
Average Average
Average Rate Average Rate
Balance Interest Paid Balance Interest Paid
---------- ---------- ------- ---------- ---------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Noninterest-
bearing deposits $ 46,791 $ -- --% $ 38,356 $ -- --%
Passbook accounts 75,359 2,190 2.91 93,699 2,742 2.93
NOW and money
market accounts 204,752 5,638 2.75 248,752 6,937 2.79
Term certificates 1,271,079 73,345 5.77 1,149,834 58,556 5.09
---------- ---------- ---------- ----------
Total deposits $1,597,981 $ 81,173 5.08% $1,530,641 $ 68,235 4.46%
========== ========== ==== ========== ========== ====
</TABLE>
25
<PAGE> 28
The following table sets forth activity in the Company's deposits
during the periods indicated.
<TABLE>
<CAPTION>
Six Months
Ended December 31, Years ended June 30,
------------------ ---------------------------------------------
1997 1997 1996 1995
----------- ----------- ----------- -----------
(In Thousands)
<S> <C> <C> <C> <C>
Beginning balance $ 1,644,356 $ 1,602,460 $ 1,577,821 $ 1,474,171
Net increase (decrease)
before interest (82,495) (41,195) (56,534) 35,415
Interest credited 40,672 83,091 81,173 68,235
----------- ----------- ----------- -----------
Net increase (decrease) in
deposits (41,823) 41,896 24,639 103,650
----------- ----------- ----------- -----------
Ending balance $ 1,602,533 $ 1,644,356 $ 1,602,460 $ 1,577,821
=========== =========== =========== ===========
</TABLE>
The following table sets forth by various average interest rate
categories the term certificates with the Company at the dates indicated.
<TABLE>
<CAPTION>
June 30,
December 31, ------------------------------------------
Average Rate Paid 1997 1997 1996 1995
- ----------------- ------------ ---------- ---------- ----------
(In Thousands)
<S> <C> <C> <C> <C>
0.00% to 3.99% $ -- $ -- $ 2,860 $ 4,539
4.00% to 4.99% 4,327 21,105 7,039 7,408
5.00% to 5.99% 994,844 1,008,889 1,024,706 877,469
6.00% to 6.99% 286,421 293,583 254,328 351,744
7.00% to 7.99% 740 881 1,290 4,169
---------- ---------- ---------- ----------
$1,286,332 $1,324,458 $1,290,223 $1,245,329
========== ========== ========== ==========
</TABLE>
The following table sets forth the amount and remaining maturities of
the Company's term certificates at December 31, 1997.
<TABLE>
<CAPTION>
Over Six Months Over One Year Over Two Years
Six Months Through One Through Two Through Three Over Three
and Less Year Years Years Years
-------- --------------- ------------- -------------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C>
0.00% to 3.99% $ 10 $ -- $ -- $ -- $ --
4.00% to 4.99% 27,087 1,345 243 30 --
5.00% to 5.99% 491,487 260,256 161,752 18,883 10,450
6.00% to 6.99% 96,110 91,230 66,500 10,036 6,174
7.00% to 7.99% 8,303 7,331 16,152 11,461 1,311
8.00% to 8.99% 171 10 -- -- --
-------- -------- -------- ------- -------
$623,168 $360,172 $244,647 $40,410 $17,935
======== ======== ======== ======= =======
</TABLE>
26
<PAGE> 29
As of December 31, 1997, the aggregate amount of outstanding time
certificates of deposit in amounts greater than or equal to $100,000, was
approximately $153.5 million. The following table presents the maturity of these
time certificates of deposit at such dates.
<TABLE>
<CAPTION>
December 31
1997
-------------
(In Thousands)
<S> <C>
3 months or less $ 34,360
Over 3 months through 6 months 36,359
Over 6 months through 12 months 43,901
Over 12 months 38,860
-------------
$ 153,480
=============
</TABLE>
Borrowings. Other than deposits, the Company's primary sources of funds
have historically consisted of reverse repurchase agreements and advances from
the FHLB of Topeka. Although a substantial portion of the Company's growth in
its securities portfolio in recent periods has been funded through the use of
reverse repurchase agreements and FHLB advances, new management is in the
process of reducing its securities holdings and utilizing the proceeds therefrom
to pay down borrowings. Consequently, reverse repurchase agreements declined
from $1.1 billion at June 30, 1996 to $0 at December 31, 1997. Similarly,
advances from the FHLB of Topeka declined from $439.0 million at June 30, 1996
to $80.1 million at December 31, 1997. For additional information, see Notes 10
and 11 of the Notes to Consolidated Financial Statements.
Prior to the Private Placement and the Redemption, the Company had
outstanding a promissory note payable to Isabel Collier Read, a former
stockholder and the mother of the Selling Shareholders. At June 30, 1997 and
1996, the promissory note had an outstanding principal balance of $7.0 million
and $14.0 million, respectively. The promissory note required annual
installments of $7.0 million plus accrued interest and bore interest at a
specified prime lending rate which could not exceed 8.0% nor fall below 5.7%. On
September 8, 1997 in connection with closing of the Private Placement and the
Redemption, the Company prepaid the promissory note at a price equal to the
principal amount thereof plus accrued and unpaid interest thereon. For
additional information, see Note 12 of the Notes to Consolidated Financial
Statements.
Pursuant to the Private Placement, the Company issued $80.0 million of
Senior Notes which are due in September 2004 and which bear interest at the rate
of 11.0%, payable semi-annually. The Company has established an interest reserve
account with an independent trustee which contains $8.8 million, which is
sufficient to pay the aggregate interest payments scheduled to be made with
respect to the first two interest payment dates on the Senior Notes. Amortized
debt issuance costs of approximately $4.3 million at December 31, 1997 was
capitalized and is included in other assets as of such date. For additional
information, see "Description of the Senior Notes" and Note 13 of the Notes to
Consolidated Financial Statements.
27
<PAGE> 30
The following table sets forth certain information regarding the
short-term borrowings of the Company at or for the dates indicated.
<TABLE>
<CAPTION>
At or For the Six Months
Ended December 31, At or For the Years Ended June 30,
-------------------------- ------------------------------------------
1997 1996 1997 1996 1995
---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
FHLB OF TOPEKA ADVANCES:
Average balance outstanding $ 391,711 $ 987,618 $ 848,733 $ 869,568 $ 952,373
Maximum amount outstanding at any
month-end during the period 839,347 1,311,735 1,311,735 1,588,618 1,227,829
Balance outstanding at end of period 80,136 371,612 531,161 439,011 703,202
Average interest rate during the period 7.09% 6.50% 6.77% 6.71% 5.85%
Average interest rate at end of period 6.06% 5.59% 5.73% 5.70% 6.24%
SECURITIES SOLD UNDER AGREEMENTS TO PURCHASE:
Average balance outstanding $ 55,235 $ 567,000 $ 418,784 $ 686,558 $ 634,282
Maximum amount outstanding at any
month-end during the period 239,914 942,325 942,315 1,079,194 865,713
Balance outstanding at end of period -- 942,325 310,801 1,079,194 779,626
Average interest rate during the period(1) 7.45% 6.45% 6.73% 6.76% 5.76%
Average interest rate at end of period -- % 5.38% 5.55% 5.36% 6.11%
</TABLE>
- ----------
(1) Average interest rate during the period reflects the effect of the
Company's interest rate swaps.
POSSIBLE EFFECT OF COMPETITION ON THE COMPANY'S BUSINESS
The Company experiences substantial competition both in attracting and
retaining deposits and in making loans. Its most direct competition for deposits
historically has come from other thrift institutions, commercial banks and
credit unions doing business in its market areas. In addition, as with all
banking organizations, the Company has experienced increasing competition from
nonbanking sources. For example, the Company competes for funds with full
service and discount broker-dealers and with other investment alternatives, such
as mutual funds and corporate and governmental debt securities. The Company's
competition for loans comes principally from other thrift institutions,
commercial banks, mortgage banking companies, consumer finance companies,
insurance companies and other institutional lenders. A number of institutions
with which the Company competes for deposits and loans have significantly
greater assets, capital and other resources than the Company. In addition, many
of the Company's competitors are not subject to the same extensive federal
regulation that governs savings and loan holding companies such as the Company
and federally-chartered and federally-insured savings institutions such as the
Banks. As a result, many of the Company's competitors have advantages over the
Company in conducting certain businesses and providing certain services.
SUBSIDIARIES
The Banks are permitted to invest up to 2% of their assets in the
capital stock of, or secured or unsecured loans to, subsidiary corporations,
with an additional investment of 1% of
28
<PAGE> 31
assets when such additional investment is primarily for community development
purposes. In addition, the Banks are permitted to make an unlimited investment
in one or more operating subsidiaries, which are permitted to engage only in
activities that the Banks may undertake directly. As of December 31, 1997, Local
Federal maintained six direct or indirect subsidiaries, consisting of Local
America Inc., Local America, Local Acceptance, Star, Local Mortgage Corporation,
Star Properties, Inc., Service Corporation of Tulsa, Inc. and Oklahoma Financial
Services Corporation. At December 31, 1997, Local Federal's investment in its
subsidiaries amounted to $149.7 million in the aggregate.
Local America, Inc. is the parent holding company for Local America and
does not conduct any independent operations. Local Acceptance and Star
previously operated as indirect automobile finance subsidiaries. As discussed
under "Business--Lending Activities--Consumer Loans" the loan origination
infrastructure of Local Acceptance and Star has been dismantled and the
automobile receivables have been sold as of December 31, 1997.
Local Mortgage Corporation was organized in 1995 as a Connecticut
corporation for the primary purpose of originating commercial real estate loans.
Local Mortgage Corporation was licensed to do business in Connecticut, Illinois
and Texas. As of February 1998, all Local Mortgage Corporation offices were
closed.
Star Properties, Inc. was organized in 1981 as an Oklahoma corporation
for the purpose of acquiring, maintaining and managing real estate to be used
for offices and related facilities of the Banks, as well as other fixed assets.
Star Properties, Inc. leases to the Banks, pursuant to certain written
agreements, office furniture and fixtures at the Banks' branch offices. Star
Properties, Inc. has not made any purchases of real estate or office furniture
and fixtures since 1985.
Service Corporation of Tulsa, Inc. was organized in 1970 as an Oklahoma
corporation for the purpose of engaging in real estate development activities.
This service corporation is currently inactive.
Oklahoma Financial Services Corporation was organized in 1981 as an
Oklahoma corporation in order to engage in real estate development. Oklahoma
Financial Services Corporation has not engaged in any real estate development
since 1984. Annuities, mutual funds and various other insurance products are
marketed to the Bank's customers.
REGULATION
General. The Banks are federally chartered and insured stock savings
banks subject to extensive regulation and supervision by the OTS, as the primary
federal regulator of savings institutions, and the FDIC, as the administrator of
the SAIF.
The federal banking laws contain numerous provisions affecting various
aspects of the business and operations of savings institutions and savings and
loan holding companies. The following description of statutory and regulatory
provisions and proposals, which is not intended to be a complete description of
these provisions or their effects on Local Financial or the Banks,
29
<PAGE> 32
is qualified in its entirety by reference to the particular statutory or
regulatory provisions or proposals.
REGULATION OF SAVINGS AND LOAN HOLDING COMPANIES
Holding Company Acquisitions. Local Financial is a registered savings
and loan holding company. The HOLA and OTS regulations generally prohibit a
savings and loan holding company, without prior OTS approval, from acquiring,
directly or indirectly, the ownership or control of any other savings
association or savings and loan holding company, or all, or substantially all,
of the assets or more than 5% of the voting shares thereof. These provisions
also prohibit, among other things, any director or officer of a savings and loan
holding company, or any individual who owns or controls more than 25% of the
voting shares of such holding company, from acquiring control of any savings
association not a subsidiary of such savings and loan holding company, unless
the acquisition is approved by the OTS.
Holding Company Activities. Local Financial currently operates as a
multiple savings and loan holding company by virtue of its direct ownership of
Local Federal and its indirect ownership of Local America. Multiple savings and
loan holding company are subject to substantial restrictions, as described
below, although such restrictions have not limited the Company's operations to
date. The Company intends to consider consolidating Local America into Local
Federal by the end of the year. At such time, the Company will operate as a
unitary savings and loan holding company. Generally, there are limited
restrictions on the activities of a unitary savings and loan holding company and
its non-savings association subsidiaries.
Multiple savings and loan holding companies are subject to restrictions
which do not apply to unitary savings and loan holding companies. Among other
things, no multiple savings and loan holding company or subsidiary thereof which
is not a savings institution shall commence or continue for a limited period of
time after becoming a multiple savings and loan holding company or subsidiary
thereof any business activity, upon prior notice to, and no objection by the
OTS, other than: (i) furnishing or performing management services for a
subsidiary savings institution; (ii) conducting an insurance agency or escrow
business; (iii) holding, managing, or liquidating assets owned by or acquired
from a subsidiary savings institution; (iv) holding or managing properties used
or occupied by a subsidiary savings institution; (v) acting as trustee under
deeds of trust; (vi) those activities authorized by regulation as of March 5,
1987 to be engaged in by multiple savings and loan holding companies; or (vii)
unless the Director of the OTS by regulation prohibits or limits such activities
for savings and loan holding companies, those activities authorized by the
Federal Reserve Board as permissible for bank holding companies. Those
activities described in (vii) above also must be approved by the Director of the
OTS prior to being engaged in by a multiple savings and loan holding company.
In addition, if the Director of the OTS determines that there is
reasonable cause to believe that the continuation by a savings and loan holding
company of an activity constitutes a serious risk to the financial safety,
soundness or stability of its subsidiary savings institution, the Director may
impose such restrictions, as deemed necessary to address such risk, including
limiting (i) payment of dividends by the savings institution; (ii) transactions
between the savings institution and its affiliates; and (iii) any activities of
the savings
30
<PAGE> 33
institution that might create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the savings institution.
The HOLA requires every savings association subsidiary of a savings and
loan holding company to give the OTS at least 30 days' advance notice of any
proposed dividends to be made on its guarantee, permanent or other
non-withdrawable stock, or else such dividend will be invalid. See "--Regulation
of Federal Savings Institutions--Capital Distribution Regulation."
Affiliate Restrictions. Transactions between a savings association and
its "affiliates" are subject to quantitative and qualitative restrictions under
Sections 23A and 23B of the Federal Reserve Act. Affiliates of a savings
association include, among other entities, the savings association's holding
company and companies that are under common control with the savings
association.
In general, Sections 23A and 23B and OTS regulations issued in
connection therewith limit the extent to which a savings association or its
subsidiaries may engage in certain "covered transactions" with affiliates to an
amount equal to 10% of the association's capital and surplus, in the case of
covered transactions with any one affiliate, and to an amount equal to 20% of
such capital and surplus, in the case of covered transactions with all
affiliates. In addition, a savings association and its subsidiaries may engage
in covered transactions and certain other transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction" is
defined to include a loan or extension of credit to an affiliate; a purchase of
investment securities issued by an affiliate; a purchase of assets from an
affiliate, with certain exceptions; the acceptance of securities issued by an
affiliate as collateral for a loan or extension of credit to any party; or the
issuance of a guarantee, acceptance or letter of credit on behalf of an
affiliate.
In addition, under the OTS regulations, a savings association may not
make a loan or extension of credit to an affiliate unless the affiliate is
engaged only in activities permissible for bank holding companies; a savings
association may not purchase or invest in securities of an affiliate other than
shares of a subsidiary; a savings association and its subsidiaries may not
purchase a low-quality asset from an affiliate; and covered transactions and
certain other transactions between a savings association or its subsidiaries and
an affiliate must be on terms and conditions that are consistent with safe and
sound banking practices. With certain exceptions, each loan or extension of
credit by a savings association to an affiliate must be secured by collateral
with a market value ranging from 100% to 130% (depending on the type of
collateral) of the amount of the loan or extension of credit.
The OTS regulation generally excludes all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve Board decides to treat
such subsidiaries as affiliates. The regulation also requires savings
associations to make and retain records that reflect affiliate transactions in
reasonable detail, and provides that certain classes of savings associations may
be required to give the OTS prior notice of affiliate transactions.
31
<PAGE> 34
REGULATION OF FEDERAL SAVINGS INSTITUTIONS
Regulatory System. As federally insured savings banks, lending
activities and other investments of the Banks must comply with various statutory
and regulatory requirements. The Banks are regularly examined by the OTS and
must file periodic reports concerning its activities and financial condition.
Although the OTS is the Banks' primary regulator, the FDIC has "backup
enforcement authority" over the Banks. The Banks' eligible deposit accounts are
insured by the FDIC under the SAIF, up to applicable limits.
Federal Home Loan Banks. The Banks are members of the FHLB System.
Among other benefits, FHLB membership provides the Banks with a central credit
facility. The Banks are required to own capital stock in an FHLB in an amount
equal to the greater of: (i) 1% of its aggregate outstanding principal amount of
its residential mortgage loans, home purchase contracts and similar obligations
at the beginning of each calendar year, (ii) .3% of total assets, or (iii) 5% of
its FHLB advances (borrowings).
Liquid Assets. Under OTS regulations, for each calendar month, a
savings institution is required to maintain an average daily balance of liquid
assets (including cash, certain time deposits and savings accounts, bankers'
acceptances, certain government obligations and certain other investments) not
less than a specified percentage of the average daily balance of its net
withdrawable accounts plus short-term borrowings (its liquidity base) during the
preceding calendar month. This liquidity requirement, which is currently at
4.0%, may be changed from time to time by the OTS to any amount between 4.0% to
10.0%, depending upon certain factors. The Banks maintain liquid assets in
compliance with this regulation.
Regulatory Capital Requirements. OTS capital regulations require
savings institutions to satisfy minimum capital standards: risk-based capital
requirements, a leverage requirement and a tangible capital requirement. Savings
institutions must meet each of these standards in order to be deemed in
compliance with OTS capital requirements. In addition, the OTS may require a
savings institutions to maintain capital above the minimum capital levels.
All savings institutions are required to meet a minimum risk-based
capital requirement of total capital (core capital plus supplementary capital)
equal to 8% of risk-weighted assets (which includes the credit risk equivalents
of certain off-balance sheet items). In calculating total capital for purposes
of the risk-based requirement, supplementary capital may not exceed 100% of core
capital. Under the leverage requirement, a savings institution is required to
maintain core capital equal to a minimum of 3% of adjusted total assets. (In
addition, under the prompt corrective action provisions of the OTS regulations,
all but the most highly-rated institutions must maintain a minimum leverage
ratio of 4% in order to be adequately capitalized. See "--Prompt Corrective
Action.") A savings institution is also required to maintain tangible capital in
an amount at least equal to 1.5% of its adjusted total assets.
32
<PAGE> 35
These capital requirements are viewed as minimum standards by the OTS,
and most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings institutions, upon a determination that the savings
institution's capital is or may become inadequate in view of its circumstances.
The OTS regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others: (1) a
savings institution has a high degree of exposure to interest rate risk,
prepayment risk, credit risk, concentration of credit risk, certain risks
arising from nontraditional activities, or similar risks or a high proportion of
off-balance sheet risk; (2) a savings institution is growing, either internally
or through acquisitions, at such a rate that supervisory problems are presented
that are not dealt with adequately by OTS regulations; and (3) a savings
institution may be adversely affected by activities or condition of its holding
company, affiliates, subsidiaries or other persons or savings institutions with
which it has significant business relationships. The Banks are not subject to
any such individual minimum regulatory capital requirement. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources--Capital Resources."
Certain Consequences of Failure to Comply with Regulatory Capital
Requirements. A savings institution's failure to maintain capital at or above
the minimum capital requirements may be deemed an unsafe and unsound practice
and may subject the savings institution to enforcement actions and other
proceedings. Any savings institution not in compliance with all of its capital
requirements is required to submit a capital plan that addresses the
institution's need for additional capital and meets certain additional
requirements. While the capital plan is being reviewed by the OTS, the savings
institution must certify, among other things, that it will not, without the
approval of its appropriate OTS Regional Director, grow beyond net interest
credited or make capital distributions. If a savings institution's capital plan
is not approved, the institution will become subject to additional growth and
other restrictions. In addition, the OTS, through a capital directive or
otherwise, may restrict the ability of a savings institution not in compliance
with the capital requirements to pay dividends and compensation, and may require
such a bank to take one or more of certain corrective actions, including,
without limitation: (i) increasing its capital to specified levels, (ii)
reducing the rate of interest that may be paid on savings accounts, (iii)
limiting receipt of deposits to those made to existing accounts, (iv) ceasing
issuance of new accounts of any or all classes or categories except in exchange
for existing accounts, (v) ceasing or limiting the purchase of loans or the
making of other specified investments, and (vi) limiting operational
expenditures to specified levels.
The HOLA permits savings institutions not in compliance with the OTS
capital standards to seek an exemption from certain penalties or sanctions for
noncompliance. Such an exemption will be granted only if certain strict
requirements are met, and must be denied under certain circumstances. If an
exemption is granted by the OTS, the savings institution still may be subject to
enforcement actions for other violations of law or unsafe or unsound practices
or conditions.
Prompt Corrective Action. The prompt corrective action regulation of
the OTS, promulgated under the Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA"), requires certain mandatory actions and authorizes
certain other discretionary actions
33
<PAGE> 36
to be taken by the OTS against a savings institution that falls within certain
undercapitalized capital categories specified in the regulation.
The regulation establishes five categories of capital classification:
"well capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," and "critically undercapitalized." Under the regulation, the
ratio of total capital to risk-weighted assets, core capital to risk-weighted
assets and the leverage ratio are used to determine an institution's capital
classification. At December 31, 1997, each of the Banks met the capital
requirements of a "well capitalized" institution under applicable OTS
regulations.
In general, the prompt corrective action regulation prohibits an
insured depository institution from declaring any dividends, making any other
capital distribution, or paying a management fee to a controlling person if,
following the distribution or payment, the institution would be within any of
the three undercapitalized categories. In addition, adequately capitalized
institutions may accept brokered deposits only with a waiver from the FDIC and
are subject to restrictions on the interest rates that can be paid on such
deposits. Undercapitalized institutions may not accept, renew or roll-over
brokered deposits.
Institutions that are classified as undercapitalized are subject to
certain mandatory supervisory actions, including: (i) increased monitoring by
the appropriate federal banking agency for the institution and periodic review
of the institution's efforts to restore its capital, (ii) a requirement that the
institution submit a capital restoration plan acceptable to the appropriate
federal banking agency and implement that plan, and that each company having
control of the institution guarantee compliance with the capital restoration
plan in an amount not exceeding the lesser of 5% of the institution's total
assets at the time it received notice of being undercapitalized, or the amount
necessary to bring the institution into compliance with applicable capital
standards at the time it fails to comply with the plan, and (iii) a limitation
on the institution's ability to make any acquisition, open any new branch
offices, or engage in any new line of business without the prior approval of the
appropriate federal banking agency for the institution or the FDIC.
The regulation also provides that the OTS may take any of certain
additional supervisory actions against an undercapitalized institution if the
agency determines that such actions are necessary to resolve the problems of the
institution at the least possible long-term cost to the deposit insurance fund.
These supervisory actions include: (i) requiring the institution to raise
additional capital or be acquired by another institution or holding company if
certain grounds exist, (ii) restricting transactions between the institution and
its affiliates, (iii) restricting interest rates paid by the institution on
deposits, (iv) restricting the institution's asset growth or requiring the
institution to reduce its assets, (v) requiring replacement of senior executive
officers and directors, (vi) requiring the institution to alter or terminate any
activity deemed to pose excessive risk to the institution, (vii) prohibiting
capital distributions, (viii) requiring the institution to divest certain
subsidiaries, or requiring the institution's holding company to divest the
institution or certain affiliates of the institution, and (ix) taking any other
supervisory action that the agency believes would better carry out the purposes
of the prompt corrective action provisions of FDICIA.
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Institutions classified as undercapitalized that fail to submit a
timely, acceptable capital restoration plan or fail to implement such a plan are
subject to the same supervisory actions as significantly undercapitalized
institutions. Significantly undercapitalized institutions are subject to the
mandatory provisions applicable to undercapitalized institutions. The regulation
also makes mandatory for significantly undercapitalized institutions certain of
the supervisory actions that are discretionary for institutions classified as
undercapitalized, creates a presumption in favor of certain discretionary
supervisory actions, and subjects significantly undercapitalized institutions to
additional restrictions, including a prohibition on paying bonuses or raises to
senior executive officers without the prior written approval of the appropriate
federal bank regulatory agency. In addition, significantly undercapitalized
institutions may be subjected to certain of the restrictions applicable to
critically undercapitalized institutions.
The regulation requires that an institution be placed into
conservatorship or receivership within 90 days after it becomes critically
undercapitalized, unless the OTS, with concurrence of the FDIC, determines that
other action would better achieve the purposes of the prompt corrective action
provisions of FDICIA. Any such determination must be renewed every 90 days. A
depository institution also must be placed into receivership if the institution
continues to be critically undercapitalized on average during the fourth quarter
after the institution initially became critically undercapitalized, unless the
institution's federal bank regulatory agency, with concurrence of the FDIC,
makes certain positive determinations with respect to the institution.
Critically undercapitalized institutions are also subject to the
restrictions generally applicable to significantly undercapitalized institutions
and to a number of other severe restrictions. For example, beginning 60 days
after becoming critically undercapitalized, such institutions may not pay
principal or interest on subordinated debt without the prior approval of the
FDIC. (However, the regulation does not prevent unpaid interest from accruing on
subordinated debt under the terms of the debt instrument, to the extent
otherwise permitted by law.) In addition, critically undercapitalized
institutions may be prohibited from engaging in a number of activities,
including entering into certain transactions or paying interest above a certain
rate on new or renewed liabilities.
If the OTS determines that an institution is in an unsafe or unsound
condition, or if the institution is deemed to be engaging in an unsafe and
unsound practice, the OTS may, if the institution is well capitalized,
reclassify it as adequately capitalized; if the institution is adequately
capitalized but not well capitalized, require it to comply with restrictions
applicable to undercapitalized institutions; and, if the institution is
undercapitalized, require it to comply with certain restrictions applicable to
significantly undercapitalized institutions.
Enforcement Powers. The OTS and, under certain circumstances, the FDIC,
have substantial enforcement authority with respect to savings institutions,
including authority to bring various enforcement actions against a savings
institution and any of its "institution-affiliated parties" (a term defined to
include, among other persons, directors, officers, employees, controlling
stockholders, agents and stockholders who participate in the conduct of the
affairs of the institution). This enforcement authority includes, without
limitation: (i) the ability to terminate a savings institution's deposit
insurance, (ii) institute cease-and-desist proceedings, (iii) bring suspension,
removal, prohibition and criminal proceedings against institution-affiliated
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parties, and (iv) assess substantial civil money penalties. As part of a
cease-and-desist order, the agencies may require a savings institution or an
institution-affiliated party to take affirmative action to correct conditions
resulting from that party's actions, including to make restitution or provide
reimbursement, indemnification or guarantee against loss; restrict the growth of
the institution; and rescind agreements and contracts.
Capital Distribution Regulation. In addition to the prompt corrective
action restriction on paying dividends, OTS regulations limit certain "capital
distributions" by OTS-regulated savings institutions. Capital distributions are
defined to include, in part, dividends and payments for stock repurchases and
cash-out mergers.
Under the regulation, an institution that meets its fully phased-in
capital requirements both before and after a proposed distribution and has not
been notified by the OTS that it is in need of more than normal supervision (a
"Tier 1 institution") may, after prior notice to but without the approval of the
OTS, make capital distributions during a calendar year up to the higher of: (i)
100% of its net income to date during the calendar year plus the amount that
would reduce by one-half its surplus capital ratio at the beginning of the
calendar year, or (ii) 75% of its net income over the most recent four-quarter
period. A Tier 1 institution may make capital distributions in excess of the
above amount if it gives notice to the OTS and the OTS does not object to the
distribution. A savings institution that meets its regulatory capital
requirements both before and after a proposed distribution but does not meet its
fully phased-in capital requirement (a "Tier 2 institution") is authorized,
after prior notice to the OTS but without OTS approval, to make capital
distributions in an amount up to 75% of its net income over the most recent
four-quarter period, taking into account all prior distributions during the same
period. Any distribution in excess of this amount must be approved in advance by
the OTS. A savings institution that does not meet its current regulatory capital
requirements (a "Tier 3 institution") cannot make any capital distribution
without prior approval from the OTS, unless the capital distribution is
consistent with the terms of a capital plan approved by the OTS.
In connection with the OTS' most recent regulatory examination of Local
Federal, the OTS informed Local Federal that as a result of Local Federal's
recent financial condition and operating results, it was being deemed an
institution in need of more than normal supervision and, consequently, was being
designated as a Tier 3 institution for purposes of the OTS' capital distribution
regulation. Tier 3 institutions may not make capital distributions without
obtaining the prior approval of the OTS. In addition, the OTS can impose growth
restrictions on savings institutions which are in need of more than normal
supervision. However, as a result of, among other things, the capital raised in
the Private Placement and the initiatives undertaken by new management in
connection with the Private Placement and the Redemption, the Midwest Regional
Office of the OTS forwarded a letter to Local Federal, dated as of December 8,
1997, indicating that the OTS upgraded Local Federal's status to a Tier 1
institution.
A Tier 1 institution is authorized to make capital distributions
without OTS approval during a calendar year of up to the higher of (i) 100
percent of its net income to the date of such distribution during the calendar
year plus the amount that would reduce by one-half its surplus capital ratio, as
defined, at the beginning of the calendar year; or (ii) 75% of its net income
over the most recent four-quarter period. Applicable regulations require,
however, that all savings
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institutions give the OTS at least 30 days advance notice of any capital
distributions, and the OTS may prohibit any capital distribution that it
determines would constitute an unsafe or unsound practice. As of January 1,
1998, under applicable regulations of the OTS, the total capital available for
the payment of dividends by Local Federal to the Company was $27.5 million,
assuming application of the OTS' safe harbor for capital distributions.
The OTS has proposed to amend its capital distribution regulation to
conform its requirements to the OTS prompt corrective action regulation. Under
the proposed regulation, an institution that would remain at least adequately
capitalized after making a capital distribution, and that was owned by a holding
company, would be required to provide notice to the OTS prior to making a
capital distribution. "Troubled" institutions and undercapitalized institutions
would be allowed to make capital distributions only by filing an application and
receiving OTS approval, and such applications would be approved under certain
limited circumstances.
Qualified Thrift Lender Test. In general, savings institutions are
required to maintain at least 65% of their portfolio assets in certain qualified
thrift investments (which consist primarily of loans and other investments
related to residential real estate and certain other assets). A savings
institution that fails the qualified thrift lender test is subject to
substantial restrictions on activities and to other significant penalties.
Recent legislation permits a savings association to qualify as a
qualified thrift lender not only by maintaining 65% of portfolio assets in
qualified thrift investments (the "QTL test") but also, in the alternative, by
qualifying under the Code as a "domestic building and loan association." The
Banks are domestic building and loan associations as defined in the Code.
Recent legislation also expands the QTL test to provide savings
institutions with greater authority to lend and diversify their portfolios. In
particular, credit card and educational loans may now be made by savings
associations without regard to any percentage-of-assets limit, and commercial
loans may be made in an amount up to 10 percent of total assets, plus an
additional 10 percent for small business loans. Loans for personal, family and
household purposes (other than credit card, small business and educational
loans) are now included without limit with other assets that, in the aggregate,
may account for up to 20% of total assets. At December 31, 1997, the Banks met
the QTL test.
FDIC Assessments. The deposits of the Banks are insured to the maximum
extent permitted by the SAIF, which is administered by the FDIC, and are backed
by the full faith and credit of the U.S. Government. As insurer, the FDIC is
authorized to conduct examinations of, and to require reporting by, FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious threat
to the FDIC. The FDIC also has the authority to initiate enforcement actions
against savings institutions, after giving the OTS an opportunity to take such
action.
Under FDIC regulations, institutions are assigned to one of three
capital groups for insurance premium purposes--"well capitalized," "adequately
capitalized", and "undercapitalized"-- which are defined in the same manner as
the regulations establishing the prompt corrective action system, as discussed
below. These three groups are then divided into
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subgroups which are based on supervisory evaluations by the institution's
primary federal regulator, resulting in nine assessment classifications.
Effective January 1, 1997, assessment rates for both SAIF-insured institutions
and BIF-insured institutions ranged from 0% of insured deposits for
well-capitalized institutions with minor supervisory concerns to .27% of insured
deposits for undercapitalized institutions with substantial supervisory
concerns. In addition, an additional assessment of 6.4 basis points and 1.3
basis points is added to the regular SAIF-assessment and the regular
BIF-assessment, respectively, until December 31, 1999 in order to cover
Financing Corporation debt service payments.
Both the SAIF and the BIF are required by law to attain and thereafter
maintain a reserve ratio of 1.25% of insured deposits. The BIF has achieved the
required reserve ratio, and as a result, the FDIC reduced the average deposit
insurance premium paid by BIF-insured banks to a level substantially below the
average premium previously paid by savings institutions. Banking legislation was
enacted on September 30, 1996 to eliminate the premium differential between
SAIF-insured institutions and BIF-insured institutions. The legislation provided
that all insured depository institutions with SAIF-assessable deposits as of
March 31, 1995 pay a special one-time assessment to recapitalize the SAIF.
Pursuant to this legislation, the FDIC promulgated a rule that established the
special assessment necessary to recapitalize the SAIF at 65.7 basis points of
SAIF-assessable deposits held by affected institutions as of March 31, 1995.
Based upon their level of SAIF deposits as of March 31, 1995, the Banks paid a
special assessment of $10.3 million. The assessment was accrued in the quarter
ended September 30, 1996.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Banks, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. There are no pending proceedings to terminate the deposit insurance of
the Banks.
Conservatorship/Receivership. In addition to the grounds discussed
under "--Prompt Corrective Action," the OTS (and, under certain circumstances,
the FDIC) may appoint a conservator or receiver for a savings institution if any
one or more of a number of circumstances exist, including, without limitation,
the following: (i) the institution's assets are less than its obligations to
creditors and others, (ii) a substantial dissipation of assets or earnings due
to any violation of law or any unsafe or unsound practice, (iii) an unsafe or
unsound condition to transact business, (iv) a willful violation of a final
cease-and-desist order, (v) the concealment of the institution's books, papers,
records or assets or refusal to submit such items for inspection to any examiner
or lawful agent of the appropriate federal banking agency or state bank or
savings association supervisor, (vi) the institution is likely to be unable to
pay its obligations or meet its depositors' demands in the normal course of
business, (vii) the institution has incurred, or is likely to incur, losses that
will deplete all or substantially all of its capital, and there is no reasonable
prospect for the institution to become adequately capitalized without federal
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assistance, (viii) any violation of law or unsafe or unsound practice that is
likely to cause insolvency or substantial dissipation of assets or earnings,
weaken the institution's condition, or otherwise seriously prejudice the
interests of the institution's depositors or the federal deposit insurance fund,
(ix) the institution is undercapitalized and the institution has no reasonable
prospect of becoming adequately capitalized, fails to become adequately
capitalized when required to do so, fails to submit a timely and acceptable
capital restoration plan, or materially fails to implement an accepted capital
restoration plan, (x) the institution is critically undercapitalized or
otherwise has substantially insufficient capital, or (xi) the institution is
found guilty of certain criminal offenses related to money laundering.
Cross-Guarantee Liability and Effect of a Resolution of the Banks.
Depository institutions insured by the FDIC, such as the Banks, can be held
liable for any loss incurred, or reasonably expected to be incurred, by the FDIC
in connection with (i) the default of a commonly controlled FDIC-insured
depository institution or (ii) any assistance provided by the FDIC to a commonly
controlled depository institution in danger of default. "Default" is defined
generally as the appointment of a conservator or receiver and "in danger of
default" is defined generally as the existence of certain conditions indicating
that a "default" is likely to occur in the absence of regulatory assistance.
Accordingly, to the extent that the FDIC incurs or anticipates incurring any
loss in connection with either of the Banks, the other Bank could be required to
compensate the FDIC by reimbursing it for the amount of such loss. Such
cross-guarantee liability can result in the ultimate failure or insolvency of
all insured depository institutions in a holding company structure. Any
obligation or liability owed by a banking subsidiary to its parent company, any
other shareholder or any of the banking subsidiary's other affiliates is
subordinate to the banking subsidiary's cross-guarantee liability.
Because the Company is a legal entity separate and distinct from the
Banks and its other subsidiaries, the Company's right to participate in the
distribution of assets of any subsidiary upon the subsidiary's liquidation or
reorganization will be subject to the prior claims of the subsidiary's
creditors. In the event of a liquidation or other resolution of either of the
Banks, the claims of depositors and other general or subordinated creditors of
such Bank would be entitled to a priority of payment over the claims of holders
of any obligation of the Bank to its shareholders, including any depository
institution holding company (such as the Company) or any shareholder or creditor
of such holding company.
Thrift Charter. Congress has been considering legislation in various
forms that would require federal thrifts, such as the Banks, to convert their
charters to national or state bank charters. Recent legislation required the
Treasury Department to prepare for Congress a comprehensive study on development
of a common charter for federal savings associations and commercial banks; and,
in the event that the thrift charter was eliminated by January 1, 1999, would
require the merger of the BIF and the SAIF into a single Deposit Insurance Fund
on that date. The Banks cannot determine whether, or in what form, such
legislation may eventually be enacted and there can be no assurance that any
legislation that is enacted would contain adequate grandfather rights for the
Banks and their parent holding companies.
Community Reinvestment Act and the Fair Lending Laws. Savings
institutions have a responsibility under the Community Reinvestment Act ("CRA")
and related regulations of the
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OTS to help meet the credit needs of their communities, including low-and
moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and
the Fair Housing Act (together, the "Fair Lending Laws") prohibit lenders from
discriminating in their lending practices on the basis of characteristics
specified in those statutes. An institution's failure to comply with the
provisions of CRA could, at a minimum, result in regulatory restrictions on its
activities, and failure to comply with the Fair Lending Laws could result in
enforcement actions by the OTS, as well as other federal regulatory agencies and
the Department of Justice.
New Safety and Soundness Guidelines. The OTS and the other federal
banking agencies have established guidelines for safety and soundness,
addressing operational and managerial, as well as compensation matters for
insured financial institutions. Institutions failing to meet these standards are
required to submit compliance plans to their appropriate federal regulators. The
OTS and the other agencies have also established guidelines regarding asset
quality and earnings standards for insured institutions.
Change of Control. Subject to certain limited exceptions, no company
can acquire control of a savings association without the prior approval of the
OTS, and no individual may acquire control of a savings association if the OTS
objects. Any company that acquires control of a savings association becomes a
savings and loan holding company subject to extensive registration, examination
and regulation by the OTS. Conclusive control exists, among other ways, when an
acquiring party acquires more than 25% of any class of voting stock of a savings
association or savings and loan holding company, or controls in any manner the
election of a majority of the directors of the company. In addition, a
rebuttable presumption of control exists if, among other things, a person
acquires more than 10% of any class of a savings association or savings and loan
holding company's voting stock (or 25% of any class of stock) and, in either
case, any of certain additional control factors exist.
Under recent legislation, companies subject to the Bank Holding Company
Act that acquire or own savings associations are no longer defined as savings
and loan holding companies under the HOLA and, therefore, are not generally
subject to supervision and regulation by the OTS. OTS approval is no longer
required for a bank holding company to acquire control of a savings association,
although the OTS has a consultative role with the Federal Reserve Board in
examination, enforcement and acquisition matters.
TAXATION
FEDERAL TAXATION
General. The Company and its subsidiaries, including the Banks, are
subject to federal income taxation under the Code in the same general manner as
other corporations with some exceptions discussed below. The following
discussion of federal taxation is intended only to summarize certain pertinent
federal income tax matters and is not a comprehensive description of the tax
rules applicable to the Banks. The Company's and its subsidiaries' consolidated
federal income tax returns have been audited or closed without audit by the
Internal Revenue Service ("IRS") through 1993.
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Method of Accounting. For federal income tax purposes, the Company and
its subsidiaries, including the Banks, currently report their income and
expenses on the accrual method of accounting and use a tax year ending June 30
for filing their consolidated federal income tax returns. The Small Business
Protection Act of 1996 (the "1996 Act") eliminated the use of the reserve method
of accounting for bad debt reserves by savings institutions, effective for
taxable years beginning after 1995.
Bad Debt Reserves. Prior to the 1996 Act, the Banks were permitted to
establish a reserve for bad debts and to make annual additions to the reserve.
These additions could, within specified formula limits, be deducted in arriving
at the Banks' taxable income. As a result of the 1996 Act, the Banks must use
the specific chargeoff method in computing their bad debt deduction beginning
with their 1996 Federal tax return. In addition, the 1996 Act requires the
recapture (over a six year period) of the excess of tax bad debt reserves at
June 30, 1996 over those established as of June 30, 1988. The amounts of such
reserves subject to recapture as of December 31, 1997 are approximately $11.5
million and $5.7 million for Local Federal and Local America, respectively.
Taxable Distributions and Recapture. Prior to the 1996 Act, bad debt
reserves created prior to July 1, 1988 were subject to recapture into taxable
income should the Banks fail to meet certain thrift asset and definitional
tests. Federal legislation eliminated these thrift related recapture rules.
However, under current law, pre-1988 reserves remain subject to recapture should
the Banks make certain non-dividend distributions or cease to maintain a bank
charter.
At December 31, 1997, the total federal pre-1988 reserves were
approximately $11.6 million and $1.7 million for Local Federal and Local
America, respectively. This reserve reflects the cumulative effects of federal
tax deductions by the Banks for which no Federal income tax provision has been
made.
Minimum Tax. The Code imposes an alternative minimum tax ("AMT") at a
rate of 20% on a base of regular taxable income plus certain tax preferences
("alternative minimum taxable income" or "AMTI"). The AMT is payable to the
extent such AMTI is in excess of an exemption amount. Net operating losses can
offset no more than 90% of AMTI. Certain payments of alternative minimum tax may
be used as credits against regular tax liabilities in future years. The Banks
have not been subject to the alternative minimum tax and has no such amounts
available as credits for carryover.
Net Operating Loss Carryovers. A corporation may carry back net
operating losses to the preceding three taxable years and forward to the
succeeding 15 taxable years. This provision applies to losses incurred in
taxable years beginning after 1986. At December 31, 1997, the Company and its
subsidiaries had $40.8 million of net operating loss carryforwards for federal
income tax purposes which expire in 2013. For taxable years beginning after
August 5, 1997, a corporation may carry back net operating losses to the two
preceding taxable years and carry forward and deduct from taxable income for the
20 succeeding taxable years.
Consummation of the Private Placement and the transactions contemplated
by the Redemption Agreement caused an "ownership change" with respect to the
Company for federal
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income tax purposes. As a result, the Company is subject to certain limitations
in its ability to use any unrealized built-in losses and any net operating
losses it may have had immediately prior to the ownership change to offset
taxable income generated in taxable periods ending after the ownership change.
Specifically, the Company's ability to use (i) any net unrealized
built-in-losses possessed by the Company immediately before the ownership change
to offset taxable income generated in taxable periods ending after the ownership
change will be subject to an annual limitation (as described below) (the "Annual
Limitation"), and (ii) any net operating losses, tax credits, or certain other
losses and deductions possessed by the Company immediately before the ownership
change to offset taxable income generated in taxable periods ending after the
ownership change will be similarly subject to the Annual Limitation. The Annual
Limitation is generally equal to the product of the value of the Company's
outstanding stock immediately before the Private Placement (less certain capital
contributions and after taking into account the value of certain redemptions or
other corporate contractions that occur in connection with the ownership change)
and the "long-term tax-exempt rate" (as defined in Section 382(f) of the Code).
At the present time, the Company believes that it will be able to apply
any tax attributes described in (i) and (ii) above that were possessed by the
Company immediately before the ownership change in their entirety against
taxable income in the preceding taxable years. As such, the Company does not
believe it will be subject to the Annual Limitation.
Corporate Dividends-Received Deduction. The Company may exclude from
its income 100% of dividends received from its subsidiaries, including the
Banks, as a member of the same affiliated group of corporations. The corporate
dividends-received deduction is 80% in the case of dividends received from
corporations with which a corporate recipient does not file a consolidated tax
return, and corporations which own less than 20% of the stock of a corporation
distributing a dividend may deduct only 70% of dividends received or accrued on
their behalf.
STATE AND LOCAL TAXATION
Oklahoma State Taxation. The Company and its subsidiaries, including
the Banks, are subject to an annual Oklahoma corporate income tax of 6% of their
federal taxable income as computed under the Code, subject to certain prescribed
adjustments. In addition to the Oklahoma corporate income tax, the Company and
its subsidiaries are subject to an annual Oklahoma franchise tax, which is
imposed at a rate of .125% on the capital used, invested or employed in
Oklahoma, with a maximum franchise tax equal to $20,000 per annum. At December
31, 1997, the Company had approximately $190.4 million of net operating loss
carryforwards available for Oklahoma state income tax purposes. The state net
operating loss carryforwards expire in varying amounts between 2006 and 2013.
Delaware State Taxation. As a Delaware holding company not earning
income in Delaware, the Company is exempt from Delaware corporate income tax but
is required to file an annual report with and pay an annual franchise tax to the
State of Delaware. The Delaware franchise tax based on the Company's authorized
capital stock or on its assumed par and no-par capital, whichever yields a lower
result. Under the authorized capital method, each share is taxed at a graduated
rate based on the number of authorized shares with a maximum aggregate
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tax of $150,000 per year. Under the assumed par value capital method, Delaware
taxes each $1,000,000 of assumed par-capital at the rate of $200.
PERSONNEL
As of December 31, 1997, the Company (on a consolidated basis) has 430
full-time employees and 95 part-time employees. The employees are not
represented by a collective bargaining agreement and the company believes that
it has good relations with its employees.
FORWARD LOOKING STATEMENTS
Certain statements contained in this Transition Report on Form 10-K
which are not statements of historical fact constitute forward-looking
statements within the meaning of the Private Securities Litigation Reform Act
(the "Act"), including, without limitation, the statements specifically
identified as forward-looking statements within this document. In addition,
certain statements in future filings by the Company with the Securities and
Exchange Commission, in press releases, and in oral and written statements made
by or with the approval of the Company which are not statements of historical
fact constitute forward-looking statements within the meaning of the Act.
Examples of forward-looking statements include, but are not limited to: (i)
projections of revenues, income or loss, earnings or loss per share, the payment
or nonpayment of dividends, capital structure and other financial items, (ii)
statements of plans and objectives of the Company or its management or Board of
Directors, including those relating to products or services, (iii) statements of
future economic performance and (iv) statements of assumptions underlying such
statements. Words such as "believes," "anticipates," "expects," "intends,"
"targeted" and similar expressions are intended to identify forward-looking
statements but are not the exclusive means of identifying such statements.
In particular, this Transition Report on Form 10-K contains
forward-looking statements which include but are not limited to: management's
efforts to refocus the Company's operations and implement new initiatives; the
adequacy of the allowance for credit losses; interest rate risk management; Year
2000 data systems compliance issues; and the effect of legal proceedings on the
Company's consolidated financial position, liquidity or results of operations.
Forward-looking statements involve risks and uncertainties which may
cause actual results to differ materially from those in such statements. Factors
that could cause actual results to differ from those discussed in the
forward-looking statements include, but are not limited to: (i) the strength of
the U.S. economy in general and the strength of the local economies in which
operations are conducted; (ii) the effects of and changes in trade, monetary and
fiscal policies and laws, including interest rate policies of the Board of
Governors of the Federal Reserve System; (iii) inflation, interest rate, market
and monetary fluctuations; (iv) the timely development of and acceptance of new
products and services and perceived overall value of these products and services
by users; (v) changes in consumer spending, borrowing and savings habits; (vi)
technological changes (including Year 2000 data systems compliance issues);
(vii) acquisitions and integration of acquired businesses; (viii) the ability to
increase market share and control expenses; (ix) the effect of changes in laws
and regulations (including laws and regulations concerning taxes, banking,
securities and insurance) with which the Company and its
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subsidiaries must comply; (x) the effect of changes in accounting policies and
practices, as may be adopted by the regulatory agencies as well as the Financial
Accounting Standards Board; (xi) changes in the Company's organization,
compensation and benefit plans; (xii) the costs and effects of litigation and of
unexpected or adverse outcomes in such litigation; and (xiii) the success of the
Company at managing the risks involved in the foregoing.
Such forward-looking statements speak only as of the date on which such
statements are made, and the Company undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement is made to reflect the occurrence of unanticipated events.
44
<PAGE> 47
ITEM 2. PROPERTIES
OFFICES AND OTHER MATERIAL PROPERTIES
The following table provides information on the Company's consolidated
branch network as of December 31, 1997:
<TABLE>
<CAPTION>
BRANCH OFFICE INFORMATION Net Book Value of
Property and
Leasehold
Ownership Size Deposits as of Improvements at
Status Lease Terms (Square Feet) 12/31/1997(1) December 31, 1997
-----------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C> <C>
CORPORATE HEADQUARTERS
3601 N.W. 63rd Owned - 70,000 $ 32,314 $ 3,565
Oklahoma City, OK 73116
LOCAL FEDERAL BRANCH OFFICES:
Downtown Office Leased $1,212.50/mo. 1,164 17,668 9
100 West Park Avenue 5 Years
Oklahoma City, OK 73102 Expires 1/31/99
May Avenue Office Owned - 14,090 79,458 334
5701 North May Avenue
Oklahoma City, OK 73112
Norman Office Owned - 5,000 48,328 182
2201 West Main Street
Norman, OK 73069-6499
Midwest City Office Owned - 5,500 94,086 354
414 North Air Depot
Midwest City, OK 73110
Springbrook Office Owned - 5,200 45,998 264
6233 N.W. Expressway
Oklahoma City, OK 73132
Bethany Office Owned - 2,650 50,047 75
7723 N.W. 23rd Street
Bethany, OK 73008
Penn South Office Owned - 2,650 53,070 50
8700 South Pennsylvania
Oklahoma City, OK 73159
Quail Creek Office Owned - 3,250 34,915 179
12241 North May Avenue
Oklahoma City, OK 73120
Portland Office Owned - 1,800 43,424 236
1924 North Portland
Oklahoma City, OK 73107
Purcell Office Leased $600/mo. 722 18,652 -
422 West Main 2 Years
Purcell, OK 73080 Expires 7/31/99
Chandler Office Owned - 1,600 16,631 145
1804 East First Street
Chandler, OK 74834
Edmond Office Leased $1,530/mo. 2,160 34,847 5
301 South Bryant 10 Years
Edmond, OK 73034 Expires 1/31/2008
</TABLE>
45
<PAGE> 48
<TABLE>
<CAPTION>
BRANCH OFFICE INFORMATION Net Book Value of
Property and
Leasehold
Ownership Size Deposits as of Improvements at
Status Lease Terms (Square Feet) 12/31/1997(1) December 31, 1997
-----------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Shawnee Office Owned - 2,650 $ 37,025 $ 81
2512 North Harrison
Shawnee, OK 74801
Yukon Office Leased $1,500/mo. 1,500 21,045 7
1203 Cornwell 5 Years
Yukon, OK 73099 Expires 6/30/99
Lindsay Office Owned - 1,200 21,193 17
420 South Main
Lindsay, OK 73052
Elk City Office Owned - 10,300 63,091 202
200 Broadway
Elk City, OK 73644
Moore Office Owned - 1,500 20,167 62
513 Northeast 12th Street
Moore, OK 73160
Crown Heights Office Owned - 1,800 21,157 155
4716 North Western
Oklahoma City, OK 73118
Pauls Valley Office Owned - 2,280 24,082 102
700 West Grant
Pauls Valley, OK 73075
Weatherford Office Owned - 3,000 19,097 87
109 East Franklin
Weatherford, OK 73096
Clinton Office Owned - 2,000 39,473 37
1002 West Frisco
Clinton, OK 73601
Duncan Downtown Office Owned - 2,500 57,134 124
1006 West Main Street
Duncan, OK 73533
Duncan North Office Owned - 3,000 31,576 91
2210 North Highway 81
Duncan, OK 73533
Sulphur Office Owned - 3,000 19,791 79
2009 West Broadway
Sulphur, OK 73086
Chickasha Office Owned - 3,143 47,609 100
628 Grand Avenue
Chickasha, OK 73018
Lawton Downtown Office Leased $5,156/mo. 5,320 91,480 -
1 S. W. 11th Street 10 Years 6,000
Lawton, OK 73501 Expires 3/31/03
Lawton Willow Creek Owned - 1,500 18,346 173
7210 N. W. Cache Road
Lawton, OK 73505
Ardmore Office Owned - 7,066 44,004 131
313 W. Broadway
Ardmore, OK 73401
</TABLE>
46
<PAGE> 49
<TABLE>
<CAPTION>
BRANCH OFFICE INFORMATION Net Book Value of
Property and
Leasehold
Ownership Size Deposits as of Improvements at
Status Lease Terms (Square Feet) 12/31/1997(1) December 31, 1997
-----------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C> <C>
LOCAL AMERICA BRANCH OFFICES:
Corporate Totals $ 5,774 $ 2
Hudson Office Leased $6,676.17/mo. 6,374 29,110 -
5801 East 41st Street Note(2)
Tulsa, OK 74135 5 Years
Expires 6/30/99
Downtown Tulsa Office Leased $2,279.75/mo 3,316 16,520 6
111 West 5th Street 3 Years
Tulsa, OK 74103 Expires 11/30/98
Harvard Office Leased $2,291.67/mo 2,500 50,701 1
3332 East 51st Street Note (2)
Tulsa, OK 74135 5 Years
Expires 5/31/03
Yale Office Leased $1,300/mo. 2,400 75,010 -
2118 South Yale 5 Years
Tulsa, OK 74114 Expires 2/28/00
Broken Arrow Office Leased $2,020/mo. 2,424 30,173 7
3359 South Elm Place 3 Years
Broken Arrow, OK 74012 Expires 5/31/99
Sand Springs Office Leased $1,912.50/mo. 3,214 43,953 1
800 East Charles Page Blvd. 10 Years
Sand Springs, OK 74063 Expires 3/31/03
Springs Village Leased $1,368.50/mo. 1,642 14,861 3
3973 South Highway 97 3 Years
Sand Springs, OK 74063 Expires 5/31/99
Memorial Office Leased $3,060/mo. 3,060 30,522 2
8202 East 71st Street 5 Years
Tulsa, OK 74133 Expires 5/31/02
Sapulpa Office Owned - 1,300 26,413 419
911 East Taft
Sapulpa, OK 74066
Lewis Office Leased Rent: See Note (3) 4,685 23,117 3
2250 East 73rd Street 5 Years
Tulsa, OK 74136 Expires 11/30/01
Claremore Office Owned - 15,100 57,959 910
1050 Lynn Riggs Blvd.
Claremore, OK 74017
Owasso Office Owned - 1,100 18,387 87
201 East 2nd Street
Owasso, OK 74055
Muskogee Office Leased $2,200/mo. 3,400 32,415 2
2401 East Chandler 5 Years
Muskogee, OK 74403 Expires 7/31/98
</TABLE>
- ---------------------
(1) Deposit accounts totaling $1.9 million cannot be identified with a specific
branch office and are, consequently, not included in this table.
(2) Subject to rent increases each year on July 1.
47
<PAGE> 50
(3) Monthly rent derived as follows: $3,768 (1st year); $4,003.50 (2nd year);
$4,239 (3rd year); $4,474.50 (4th year); and $4,710 (5th year).
ITEM 3. LEGAL PROCEEDINGS
In conjunction with Local Federal's acquisition of Local America
during 1989, Local Federal and Local America entered into an Assistance
Agreement with the Federal Savings and Loan Insurance Corporation ("FSLIC"), the
fund which previously insured all savings institutions' deposits. Under the
terms of the Assistance Agreement, the FSLIC Resolution Fund (the "Fund"), which
is currently managed by the FDIC, is entitled to receive certain portions of the
tax benefits attributable to acquired net operating loss carryforwards and
deductions resulting from certain items for which the Fund has agreed to provide
assistance, provided that such tax benefits are realized by Local Federal on a
consolidated basis.
In connection with the Assistance Agreement, a dispute exists between
Local America and the FDIC regarding certain tax benefits. Management, after
consultation with legal counsel and based on available facts and proceedings to
date, has determined that Local America will have some liability to the FDIC
with respect to such tax benefits. At December 31, 1997, the Company estimated
this liability to be approximately $13.0 million, which has been reserved for
and is included in other liabilities in the Consolidated Statements of Financial
Condition included elsewhere herein. The Company believes that as of December
31, 1997, the FDIC's estimate of this liability was approximately $23.0 million.
Pursuant to the terms of the Redemption Agreement, the Selling Stockholders have
agreed to indemnify the Company with respect to the Assistance Agreement to the
extent the Company is found to be liable for an amount in excess of the amount
of the reserve in respect of such dispute which is reflected on the Company's
audited balance sheet as of December 31, 1997. Upon consummation of the
Redemption, the Company deposited a portion of the amount to be paid to the
Selling Stockholders (i.e., $10.0 million) into the FDIC Dispute Escrow Account
in order to fund any potential payments which may be required to be made by the
Selling Stockholders to the Company in connection with such indemnification.
The Company has filed a lawsuit in the United States District Court for
the Western District of Oklahoma in order to collect amounts it believes are due
pursuant to the Redemption Agreement relating to the liquidation of the
Company's hedging contracts as of September 8, 1997. Under the terms of the
Redemption Agreement, if the sale or termination of the Company's existing
hedging contracts results in an aggregate pre-tax loss to the Company in excess
of $42.5 million, the Selling Stockholders will pay to the Company such excess,
net of any related tax benefit. If the sale or termination of the Company's
existing hedging contracts results in an aggregate pre-tax loss to the Company
which is less than $42.5 million, the Company will pay to the Selling
Stockholders such difference, net of any related tax benefit. The Company is
currently attempting to collect such difference (which it estimates to amount to
$4.6 million) from the Selling Stockholders.
Pursuant to the Redemption Agreement, if the Company's unaudited
consolidated stockholders' equity (after adding back to total stockholders'
equity (i) any provisions for loan losses recognized by the Company after May
31, 1997, (ii) the amount of any unrealized loss on COFI-based CMOs categorized
as available for sale under SFAS No. 115, (iii) the after-tax amount of certain
losses on the sale of available for sale CMOs during June of 1997, and (iv)
48
<PAGE> 51
certain legal fees and expenses incurred by the company in connection with the
Private Placement and the Redemption, as adjusted, the "Adjusted Closing
Equity") as of the closing date of the Redemption is less than $144.5 million,
then the Purchase Price will be reduced by the amount of such shortfall and the
Selling Stockholders will pay to the Company the amount of such shortfall. If,
on the other hand, the Adjusted Closing Equity is greater than $144.5 million,
then the Purchase Price will be increased by the amount of such excess, and the
Company will pay to the Selling Stockholders the amount of such excess. Upon
consummation of the Redemption, the Company deposited $5 million of the total
Purchase Price to be paid to the Selling Stockholders in an escrow account to be
available to use to effect such equity adjustment if there is such a shortfall.
The Company and the Selling Stockholders have been unable to agree on the
Adjusted Closing Equity in accordance with the procedures set forth in the
Redemption Agreement and, pursuant to the specific terms of the Redemption
Agreement, the matter has been referred to binding arbitration before an
independent certified public accountant who was designated as the arbitrator for
this purpose by the Judge in the above-referenced lawsuit currently pending
between the Company and the Selling Stockholders in the United States District
Court for the Western District of Oklahoma. The issues have been fully briefed
and presented to the arbitrator and the parties are currently awaiting his
decision. If it is determined by the arbitrator that the Adjusted Closing Equity
is less than the amount of $144.5 million, the Company should be able to recover
the amount of the shortfall that would be owing to the Company by the Selling
Stockholders from the escrowed funds that are available for payment of such
amount. On the other hand, it is not possible to ascertain with any certainty
the amount which the Company might be required to pay to the Selling
Stockholders in the event the arbitrator should determine that the Adjusted
Closing Equity is in excess of the amount of $144.5 million. No assurance can be
given that the Company might not have to pay some amount to the Selling
Stockholders as additional purchase price in that regard.
The Company is also involved in routine legal proceedings occurring in
the ordinary course of business which, in the aggregate, are believed by
management to be immaterial to the financial condition and results of operation
of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the periods
covered by this report.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
Market Information. Local Financial Common stock trades on the American Stock
Exchange under the symbol "LO". The stock began trading in such market on April
22, 1998. Local Financial Common Stock did not trade on any established public
trading market during the periods for which financial information is presented
in this report.
Holders. As of July 31, 1998, Local Financial had approximately 570 holders of
common stock.
Dividends. The Board of Directors of the Company does not presently intend to
implement a policy of paying dividends on the common stock. Rather, the Company
expects to retain earnings to increase capital.
49
<PAGE> 52
ITEM 6. SELECTED FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The selected consolidated financial data of the Company set forth below
should be read in conjunction with, and is qualified in its entirety by, the
Consolidated Financial Statements of the Company, including the related Notes,
included herein.
<TABLE>
<CAPTION>
December 31, June 30,
------------ -------------------------
1997 1997 1996
------------ ---------- ----------
<S> <C> <C> <C>
BALANCE SHEET AND OTHER DATA:
Total assets $1,881,365 $2,625,181 $ 3,278,511
Cash and due from banks 34,152 15,904 13,640
Loans receivable, net 953,470 1,013,824 1,018,135
Securities available for sale 518,107 985,565 1,741,725
Securities and other investment securities held to maturity -- 408,207 392,324
Equity securities available for sale -- -- 11,604
Non-performing assets(1) 921 12,570 16,185
Deposits 1,602,533 1,644,356 1,602,460
Securities sold under agreements to repurchase -- 310,801 1,079,194
Promissory note payable -- 7,010 14,020
Senior notes payable 80,000 -- --
FHLB advances 80,136 531,161 439,011
Total liabilities 1,798,740 2,522,552 3,170,452
Stockholders' equity 82,625 102,629 108,059
Number of full service customer facilities 41 41 41
Approximate number of employees 525 546 536
<CAPTION>
June 30,
---------------------------------------
1995 1994 1993
--------- --------- ----------
<S> <C> <C> <C>
BALANCE SHEET AND OTHER DATA:
Total assets $ 3,264,850 $ 3,325,613 $2,306,605
Cash and due from banks 14,497 11,678 16,639
Loans receivable, net 804,610 708,566 544,453
Securities available for sale 361,402 373,532 700,396
Securities and other investment securities held to maturity 1,983,756 2,078,748 897,577
Equity securities available for sale 12,287 17,076 1,764
Non-performing assets(1) 10,889 10,961 11,164
Deposits 1,577,821 1,474,171 1,416,098
Securities sold under agreements to repurchase 779,626 381,829 52,540
Promissory note payable 21,030 28,040 35,050
Senior notes payable -- -- --
FHLB advances 703,202 1,287,377 703,767
Total liabilities 3,121,631 3,198,925 2,228,490
Stockholders' equity 143,219 126,688 78,115
Number of full service customer facilities 41 41 42
Approximate number of employees 471 423 378
</TABLE>
<TABLE>
<CAPTION>
Six Months
Ended December 31, Years Ended June 30,
--------------------------- ---------------------------
1997 1996 1997 1996
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
OPERATIONS DATA:
Interest and dividend income $ 85,204 $ 119,100 $ 222,664 $ 236,156
Interest expense 59,823 92,562 169,761 187,488
--------- --------- --------- ---------
Net interest income 25,381 26,538 52,903 48,668
Provision for loan losses (25,578)(2) (9,734) (28,428)(2) (5,117)
--------- --------- --------- ---------
Net interest income (loss) after provision for loan losses (197) 16,804 24,475 43,551
Noninterest income (loss) (107,149)(3) 2,185 (17,124)(3) 10,316
Noninterest expense 22,685 29,372 49,256 35,427
--------- --------- --------- ---------
Income (loss) before provision for income taxes and
cumulative effect of change in accounting principle and
extraordinary item (130,031) (10,383) (41,905) 18,440
Provision (benefit) for income taxes (44,075) (3,573) (11,860) 4,872
--------- --------- --------- ---------
Income before cumulative effect of change in accounting
principle and extraordinary item (85,956) (6,810) (30,045) 13,568
Cumulative effect of change in accounting principle -- -- -- --
Utilization of net operating loss carryforwards -- -- -- --
--------- --------- --------- ---------
Net income (loss) $ (85,956) $ (6,810) $ (30,045) $ 13,568
========= ========= ========= =========
Historical basic and diluted net income (loss) per share(4) $ (4.76) $ (0.44) $ (1.95) $ 0.88
========= ========= ========= =========
Proforma basic and diluted net income (loss) per share(5) $ (4.36) N/A $ (1.53) N/A
========= ========= ========= =========
Dividends declared per share(4) $ -- $ 0.03 $ 0.03 $ 0.69
========= ========= ========= =========
<CAPTION>
Year Ended June 30,
---------------------------------------
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
OPERATIONS DATA:
Interest and dividend income $ 214,558 $ 175,143 $ 141,991
Interest expense 162,590 104,496 85,301
--------- --------- ---------
Net interest income 51,968 70,647 56,690
Provision for loan losses (1,157) (1,764) 580
--------- --------- ---------
Net interest income (loss) after provision for loan losses 50,811 68,883 57,270
Noninterest income (loss) 16,632 29,916 14,256
Noninterest expense 46,460 25,089 35,775
--------- --------- ---------
Income (loss) before provision for income taxes and
cumulative effect of change in accounting principle and
extraordinary item 20,983 73,710 35,751
Provision (benefit) for income taxes 6,568 27,516 4,884
--------- --------- ---------
Income before cumulative effect of change in accounting
principle and extraordinary item 14,415 46,194 30,867
Cumulative effect of change in accounting principle -- 6,266 --
Utilization of net operating loss carryforwards -- -- 4,284
--------- --------- ---------
Net income (loss) $ 14,415 $ 52,460 $ 35,151
========= ========= =========
Historical basic and diluted net income (loss) per share(4) $ 0.94 $ 3.40 $ 2.28
========= ========= =========
Proforma basic and diluted net income (loss) per share(5) N/A N/A N/A
========= ========= =========
Dividends declared per share(4) $ 1.28 $ 0.99 $ 1.43
========= ========= =========
</TABLE>
50
<PAGE> 53
<TABLE>
<CAPTION>
At or For the Six Months
Ended
December 31, At or For the Years Ended June 30,
------------------------ ---------------------------------
1997 1996 1997 1996
-------- --------- -------- --------
<S> <C> <C> <C> <C>
PERFORMANCE RATIOS(6):
Return on assets (3.84)% (0.21)% (0.98)% 0.41%
Return on common equity (101.45) (6.35) (28.77) 10.00
Dividend payout ratio(7) -- N/A N/A 77.98
Net interest spread(8) 2.13 1.45 1.57 1.36
Net interest margin(9) 2.34 1.62 1.78 1.52
Noninterest expense to average assets(10) 0.99 0.87 1.56 1.04
Efficiency ratio(11)(12) N/A 56.14 56.14 57.07
CAPITAL RATIOS(13)
Local Federal Bank, F.S.B.
Tangible 6.89 4.99 5.17 4.94
Core 6.98 5.07 5.25 5.04
Risk-based 14.14 12.59 12.34 12.71
Local America Bank F.S.B.
Tangible 15.80 10.58 11.97 10.54
Core 15.90 10.69 12.07 10.69
Risk-based 28.45 24.66 25.31 28.14
ASSET QUALITY RATIOS:
Nonperforming assets to total assets at
end of period(1) 0.05 0.93 0.48 0.49
Nonperforming loans to total loans at
end of period(1) 0.06 0.82 0.38 0.51
Allowance for loan losses to total loans
at end of period 2.09 0.50 1.10 0.31
Allowance for loan losses to nonperforming
loans at end of period(1) 3,272.20 56.22 291.49 60.43
<CAPTION>
At or For the Years Ended June 30,
------------------------------------
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
PERFORMANCE RATIOS(6):
Return on assets 0.43% 1.58% 1.52%
Return on common equity 10.59 41.41 49.99
Dividend payout ratio(7) 137.38 29.09 62.74
Net interest spread(8) 1.32 1.80 2.29
Net interest margin(9) 1.59 2.46 2.75
Noninterest expense to average assets(10) 1.36 0.75 1.55
Efficiency ratio(11)(12) 72.75 28.67 52.21
CAPITAL RATIOS(13)
Local Federal Bank, F.S.B.
Tangible 4.89 4.45 4.78
Core 5.03 4.60 5.10
Risk-based 13.22 13.60 14.50
Local America Bank F.S.B.
Tangible 10.13 10.31 10.81
Core 10.33 10.60 11.30
Risk-based 26.23 33.70 36.60
ASSET QUALITY RATIOS:
Nonperforming assets to total assets at
end of period(1) 0.33 0.33 0.48
Nonperforming loans to total loans at
end of period(1) 0.38 0.46 0.18
Allowance for loan losses to total loans
at end of period 0.56 0.51 0.39
Allowance for loan losses to nonperforming
loans at end of period(1) 147.82 110.38 210.66
</TABLE>
- ----------------
(1) Nonperforming loans consist of nonaccrual loans and loans delinquent 90
days or more but still accruing interest, and nonperforming assets consist
of nonperforming loans, real estate acquired through foreclosure or
deed-in-lieu thereof and repossessions (such as automobiles), net of
writedowns and reserves.
(2) Primarily reflects provisions established by management to cover realized
and inherent losses with respect to the Company's portfolio of indirect
automobile receivables. See "Business--Lending Activities--Consumer Loans."
(3) Primarily reflects losses incurred by the Company relating to the
liquidation or disposition of certain hedging contracts and the disposition
of investment securities and adjustments to reflect market values. See
"Business--the company--Initiatives by New Management" and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations."
(4) Net income (loss) per share and dividends per share are based upon the
weighted average number of shares outstanding during the period. As a
result of the Private Placement and the Redemption transactions described
under "The Private Placement and the Redemption", the weighted average
number of shares used in the computation of income (loss) per share and
dividends per share is 15,400,000 for each of the years in the three-year
period ended June 30, 1997 (based on an equivalent number of shares for the
60 shares outstanding prior to the recapitalization). For the six months
ended December 31, 1997 the weighted average number of shares is
18,066,000. See also Note 1 of the Notes to Consolidated Financial
Statements.
(5) Pro forma net income (loss) per share assumes that the 19,700,000 shares
issued in the recapitalization were outstanding for the six months ended
December 31, 1997 and for the year ended June 30, 1997.
(6) With the exception of end of period ratios, all ratios are based on average
monthly balances during the periods presented. All ratios are annualized
where appropriate.
(7) The dividend payout ratio represents dividends declared per share divided
by net income per share.
(8) Net interest spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
(9) Net interest margin represents net interest income as a percent of average
interest-earning assets.
51
<PAGE> 54
(10) Noninterest expense excludes the amortization of intangibles.
(11) Represents noninterest expense (exclusive of amortization of intangibles)
divided by the aggregate of net interest income before provision for loan
losses and noninterest income (exclusive of gains and losses on sales of
assets).
(12) For the year ended June 30, 1997 and the six months ended December 31,
1996, the efficiency ratio does not reflect the $10.3 million one-time
special assessment (before applicable tax benefits) to recapitalize the
SAIF which was accrued during the quarter ended September 30, 1996. See
"Business--Regulation."
(13) The tangible and core capital ratios are calculated as a percent of
adjusted total assets and the risk-based capital ratio is calculated as a
percent of total risk-weighted assets. See "Business--Regulation" for
information with respect to the Banks' regulatory capital requirements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
Consolidated Financial Statements of the Company and the Notes thereto.
CHANGES IN FINANCIAL CONDITION
General. Total assets decreased by $743.8 million or 28.3% during the
six months ended December 31, 1997 and by $653.3 million or 19.9% during the
year ended June 30, 1997. The substantial decrease in total assets during fiscal
1997 and the three months ending September 30, 1997 was primarily due to the
sale of an aggregate of $1.63 billion of mortgage-backed and other securities
and, during the three months ended September 30, 1997, and a $54.7 million
write-down with respect to the Company's remaining COFI-based CMO portfolio. The
sale of mortgage-backed and other securities reflects the implementation of new
management's strategy to reduce the Company's securities portfolio, particularly
its COFI-based CMO portfolio. The proceeds from such sales were used primarily
to repay outstanding reverse repurchase agreements and advances from the FHLB of
Topeka. As a result of the foregoing, reverse repurchase agreements, which
amounted to $1.1 billion at June 30, 1996, were fully paid off as of December
31, 1997, and advances from the FHLB of Topeka declined from $439.0 million at
June 30, 1996 to $80.1 million at December 31, 1997, a reduction of $358.9
million or 81.8%. The shift in the composition of the Company's asset and
liability mix reflects new management's operational philosophy. See
"Business--The Company."
Cash and Cash Equivalents. Cash and cash equivalents (consisting of
cash and due from banks and interest-bearing deposits with other banks) amounted
to $54.2 million, $105.4 million and $13.6 million at December 31, 1997 and June
30, 1997 and 1996, respectively. The Company manages its cash and cash
equivalents based upon the Company's operating, investing and financing
activities. See "Business--Liquidity and Capital Resources."
Securities. Beginning in 1993, the Company under its prior management
began to implement an investment strategy whereby it purchased mortgage-backed
and related securities and financed those securities primarily through reverse
repurchase agreements and FHLB advances. The Company predominantly purchased
adjustable-rate Federal National Mortgage Association ("FNMA") and Federal Home
Loan Mortgage Corporation ("FHLMC") CMOs tied to COFI. As a result, at June 30,
1996, the Company's securities portfolio amounted to $2.1 billion ($1.9 billion
of which consisted of COFI-based CMOs) or 65.1% of total assets. The COFI is a
compilation of the average rates paid by savings institutions which are members
of the 11th District of the FHLB system, and the COFI generally adjusts more
slowly to changes in market rates of interest when compared to adjustable-rate
loans and securities with interest rates based on other indices. As a result of
recent fluctuations in the level of interest rates as well as the structure of
the COFI, the
52
<PAGE> 55
values of the Company's COFI-based CMOs have declined in recent periods. At June
30, 1996, the Company had $48.5 million of unrealized losses with respect to its
securities portfolio (net of applicable tax benefits).
In late 1996 and in anticipation of the proposed sale of the Company,
the Company began reducing its securities, particularly its CMO holdings,
through periodic bulk sale transactions. During fiscal 1997, the Company sold
$743.9 million of securities and recognized $29.6 million of losses with respect
to such sales. At June 30, 1997, the Company's securities portfolio amounted to
$1.4 billion ($1.1 billion of which consisted of COFI-based CMOs) or 53.1% of
total assets. As of such date, the Company had $32.0 million of unrealized
losses with respect to its securities portfolio (net of applicable tax
benefits).
During September 1997 and in connection with the Private Placement and
the Redemption, new management of the Company determined that its CMO portfolio
was "other than temporarily impaired" (as defined in SFAS No. 115) and, in
accordance with GAAP, wrote-down its CMO portfolio by $54.7 million. In
addition, since assuming control of the Company on September 8, 1997, new
management has been accelerating the disposition of its securities portfolio,
particularly its COFI-based CMOs. During the six months ended December 31, 1997,
the Company sold $869.8 million of securities and utilized the proceeds of such
sales to repay all of its outstanding reverse repurchase agreements and $451.0
million or 84.9% of its outstanding FHLB advances. The remaining proceeds were
invested in short-term investments. At December 31, 1997, the Company's
securities portfolio amounted to $518.1 million ($428.6 million of which
consisted of COFI-based mortgage-related securities) or 27.5% of assets. As of
such date, all of the Company's securities were classified as available for sale
and the Company had unrealized gains with respect to the portfolio of $2.3
million (net of applicable taxes) and the Company had no trading securities.
Management may continue to reduce its securities portfolio, particularly its CMO
holdings, as market conditions permit. For additional information, see
"Business--Investment Activities," and Note 5 of the Notes to Consolidated
Financial Statements.
Loans Receivable. Net loans receivable amounted to $953.5 million,
$1.01 billion and $1.02 billion at December 31, 1997 and June 30, 1997 and 1996,
respectively. Net loans receivable decreased by $60.4 million or 6.0% during the
six months ended December 31, 1997 and by $4.3 million or 0.4% during the year
ended June 30, 1997. During the six months ended December 31, 1997, the Company
sold $1.7 million of guaranteed student loans and $54.9 million of indirect
automobile receivables and experienced $123.2 million of loan repayments, which
was partially offset by $118.7 million of loan originations and purchases.
During the year ended June 30, 1997, the Company sold $12.0 million of
guaranteed student loans and experienced $316.6 million of loan repayments,
which was partially offset by $320.2 million of loan originations and purchases.
New management intends to emphasize lending activities as opposed to investing
activities in order to enhance the weighted average yield on its interest
earning assets and, thus, its results of operations. Consequently, management
expects its loan portfolio to grow over the next several years. For additional
information, see "Business--Lending Activities" and Note 6 of the Notes to
Consolidated Financial Statements.
Nonperforming Assets and Allowance for Loan Losses. Nonperforming
assets (consisting of non-accruing loans, accruing loans greater than 90 days
delinquent and foreclosed assets) have declined significantly since June 30,
1996. At December 31, 1997, nonperforming assets amounted to $921,000 or .05% of
total assets, as compared to $12.6 million or .48% and $16.2 million or
53
<PAGE> 56
.49% as of June 30, 1997 and 1996, respectively. The decline in nonperforming
assets during the six months ended December 31, 1997 reflected a $2.9 million
decline in non-accrual loans (primarily commercial real estate loans) and an
$8.4 million decline in foreclosed assets, and was primarily due to the transfer
of a $6.0 million retail shopping center from real estate owned to real estate
held for investment during the period. Local Federal has profitably managed the
shopping center since it became real estate owned. The property was transferred
to real estate held for investment during the period because the Company had
exceeded the five year regulatory limit for holding real estate owned.
At December 31, 1997, the Company's allowance for loan losses amounted
to $20.5 million, as compared to $11.4 million and $3.2 million at June 30, 1997
and 1996, respectively. In connection with the Private Placement and the
Redemption, new management increased the Company's reserves, particularly with
respect to the Company's indirect automobile portfolio which was sold as of
December 31, 1997. See "Business--Lending Activities--Consumer Loans" The
increase with respect to the Commercial Real Estate portfolio came as a result
of the portfolio review performed by an independent third party for new
management during the due diligence process. Their recommendations for increase
were based on industry standards for real estate portfolios, OTS supervisory
guidelines, high dollar concentration in out-of-market loans and discovery of 11
loans considered classified OAEM (Other Assets Especially Mentioned) by the
review team that were previously unclassified by the Company. The allowance for
consumer loans includes the estimated probable losses that may arise from the
Representations and Warranties issued in conjunction with the sale of the
indirect auto portfolio. The Company's allowance for loan losses represented
2.09% of the total loan portfolio, which the Company believes is adequate given
the asset-based lending nature of their commercial real estate portfolio. Total
nonperforming loans had declined at December 31, 1997, for the reasons stated
above and the allowance covered many multiples of the risk from this source. At
June 30, 1997 the ratios were 1.01% of total loans and 291.49% of total
nonperforming loans as compared to 0.31% and 60.43%, respectively, at June 30,
1996. Although management of the Company believes that its allowance for loan
losses was adequate at December 31, 1997 based on facts and circumstances
available to it, there can be no assurance that additions to such allowance will
not be necessary in future periods. For additional information, see
"Business--Asset Quality."
Deposits. At December 31, 1997, deposits totaled $1.60 billion, as
compared to $1.64 billion and $1.60 billion at June 30, 1997 and 1996,
respectively. One of the Company's strategies is to promote retail deposit
growth as a cost-efficient funding source as well as a source of fee income and
cross-selling opportunities. In connection with the acquisition of Green
Country, the Company acquired three branch offices and assumed $77.0 million of
Green Country Bank's deposits (as of December 31, 1997). In addition, Local
Federal has received OTS approval to open a second branch office in Edmond,
Oklahoma. The Company expects to continue to focus on expanding its branch
network and retail deposit franchise. For additional information, see
"Business--Sources of Funds--Deposits" and Note 9 of the Notes to Consolidated
Financial Statements.
Borrowings. Other than deposits, the Company's primary sources of funds
have historically consisted of the sale of securities under agreements to
repurchase (consisting of agreements to purchase on a specified later date the
same securities or substantially identical securities) ("reverse repurchase
agreements") and advances from the FHLB of Topeka. Although a substantial
portion of the Company's growth in its securities portfolio in recent periods
has been funded through the use
54
<PAGE> 57
of reverse repurchase agreements and FHLB advances, new management is in the
process of reducing its securities holdings and utilizing the proceeds therefrom
to pay down borrowings. Consequently, reverse repurchase agreements declined
from $1.1 billion at June 30, 1996 to $0 at December 31, 1997. Similarly,
advances from the FHLB of Topeka declined from $439.0 million at June 30, 1996
to $80.1 million at December 31, 1997. For additional information, see
"Business--Sources of Funds--Borrowings" and Notes 10 and 11 of the Notes to
Consolidated Financial Statements.
Prior to the Private Placement and the Redemption, the Company had
outstanding a promissory note payable to Isabel Collier Read, a former
stockholder and the mother of the Selling Stockholders. At June 30, 1997 and
1996, the promissory note had an outstanding principal balance of $7.0 million
and $14.0 million, respectively. The promissory note required annual
installments of $7.0 million plus accrued interest and bore interest at a
specified prime lending rate which could not exceed 8.0% nor fall below 5.7%. On
September 8, 1997 in connection with the closing of the Private Placement and
the Redemption, the Company prepaid the promissory note at a price equal to the
remaining principal balance thereof plus accrued and unpaid interest thereon.
For additional information, see "Business--Sources of Funds--Borrowings" and
Note 12 of the Notes to Consolidated Financial Statements.
Pursuant to the Private Placement, the Company issued $80.0 million of
Senior Notes which are due in September 2004 and which bear interest at the rate
of 11.0%, payable semi-annually. The Company has established an interest reserve
account with an independent trustee which contains $8.8 million, which is
sufficient to pay the aggregate interest payments scheduled to be made with
respect to the first two interest payment dates on the Senior Notes. Debt
issuance costs of approximately $4.3 million at December 31, 1997 were
capitalized and reflected as Other Assets. For additional information, see
"Business--Sources of Funds--Borrowings" and Note 13 of the Notes to
Consolidated Financial Statements.
Stockholders' Equity. Stockholders' equity declined from $108.1 million
at June 30, 1996 to $102.6 million at June 30, 1997 and further declined to
$82.6 million at December 31, 1997. The decline in stockholders' equity during
fiscal 1997 was primarily due to the $30.0 million net loss recognized during
the year. The decline in stockholders' equity during the six months ended
December 31, 1997 reflected certain charges recognized by the Company as a
result of certain initiatives undertaken by new management in connection with
the Private Placement and the Redemption, which was partially offset by the
capital raised from the sale of Local Securities in the Private Placement. Such
charges included (i) a $25.6 million provision for loan losses, which primarily
related to the Company's indirect automobile portfolio, (ii) $53.4 million of
losses recognized with respect to the liquidation or write-off of all of the
Company's outstanding hedging contracts, (iii) $72.0 million of losses on the
sale and mark-to-market of the Company's securities portfolio (which primarily
related to the sale and mark-to-market of the Company's COFI-based CMOs). The
market for fixed income securities improved during the three month period ended
December 31, 1997 and during such period the Company sold a portion of the
remaining COFI-based CMO portfolio for a gain of $12.7 million. At December 31,
1997, the ratio of the Company's stockholders' equity to total assets amounted
to 4.4% and both of the Banks exceeded their respective minimum regulatory
capital requirements. See "--Liquidity and Capital Resources."
55
<PAGE> 58
RESULTS OF OPERATIONS
General. The Company's results of operations depend substantially on
its net interest and dividend income, which is the difference between interest
and dividend income on interest-earning assets, which consist primarily of loans
receivable, mortgage-backed and investment securities and various other
short-term investments, and interest expense on interest-bearing liabilities,
which consist primarily of deposits and borrowings. The Company's results of
operations have also been significantly affected by the net costs of hedging its
interest rate exposure; its provisions for losses on loans resulting from the
Company's assessment of the adequacy of its allowance for losses on loans; the
level of its noninterest income, including deposit related income, loan fees and
service charges and net gains (losses) on sales of assets; the level of its
noninterest expense, such as compensation and employee benefits, deposit
insurance premiums, provisions for losses on foreclosed assets, equipment and
data processing expense and occupancy expense; and provisions (benefits) for
income taxes.
Net Income (Loss). The Company reported net income (loss) of $(86.0)
million, $(6.8) million, $(30.0) million, $13.6 million and $14.4 million during
the six months ended December 31, 1997 and 1996 and the years ended June 30,
1997, 1996 and 1995, respectively. The net loss reported for the six months
ended December 31, 1997 is attributable to deliberate actions taken by the
Company's new management subsequent to the Private Placement and Redemption to
restructure the Company's balance sheet. Specifically, the Company incurred
$125.5 million of losses on the sale and write-down of assets, of which an
aggregate loss of $53.4 million was incurred in connection with the liquidation
or write-off of the hedging contracts which the Company had entered into in
order to reduce its exposure to interest rates. See "Quantitative and
Qualitative Disclosure about Market Risk--Asset and Liability Management." In
addition, the Company recognized a loss of $72.0 million on the sale and
mark-to-market of the Company's securities portfolio (which primarily related to
the sale and mark-to-market of the Company's COFI-based CMOs). The Company also
recorded a $25.4 million provision for loan losses during the three-months ended
September 30, 1997, primarily to cover realized and inherent losses with respect
to the Company's portfolio of indirect automobile receivables which had been
sold as of December 31, 1997. See "Business--Lending Activities--Consumer
Loans." The market for fixed income securities improved during the three-month
period ended December 31, 1997 and the Company sold $330.6 million of the
remaining COFI-based CMO portfolio for a gain of $12.7 million in furtherance of
its plan to accelerate the disposition of the COFI-based CMOs. The effect of
these transactions on the Company's operating results for the six months ending
December 31, 1997 is shown below.
56
<PAGE> 59
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------
December 31, 1997 September 30, 1997
------------------ ------------------
(In Thousands)
<S> <C> <C>
Net interest income before provision for loan losses $ 13,109 $ 12,272
Provision for loan losses (225) (25,353)
------------------ ------------------
Net interest income (loss) after provision for loan losses 12,884 (13,081)
Net gains (losses) on sale of assets 12,816 (125,485)
Other noninterest income 2,632 2,888
------------------ ------------------
Total noninterest income (loss) 15,448 (122,597)
Total noninterest expense 9,117 13,568
------------------ ------------------
Income (loss) before (provision) benefit for income taxes 19,215 (149,246)
(Provision) benefit for income taxes (6,720) 50,795
------------------ ------------------
Net income (loss) $ 12,495 $ (98,451)
================== ==================
</TABLE>
The net loss recognized during the fiscal year ended June 30, 1997 was
primarily attributable to a $28.4 million provision for loan losses, which was
principally associated with the Company's indirect automobile finance
receivables, $29.9 million of losses which were related to the sale of CMOs with
interest rate adjustments tied to COFI, and a non-recurring $10.3 million
special assessment (before applicable tax benefits) which was recorded in
connection with legislation in 1996 which recapitalized the SAIF.
The Company recognized net income of $13.6 million during the year
ended June 30, 1996, as compared to net income of $14.4 million during the year
ended June 30, 1995. The $847,000 or 5.9% decrease in the Company's net income
during fiscal 1996 was primarily due to a $6.3 million decrease in noninterest
income, a $4.0 million increase in the provision for loan losses, and a $3.3
million decrease in net interest and dividend income, which was substantially
offset by a $11.0 million decrease in noninterest expense and a $1.7 million
decline in the provision for income taxes.
Net Interest and Dividend Income. Net interest and dividend income is
determined by the Company's net interest spread (i.e., the difference between
the yields earned on its interest-earning assets and the rates paid on its
interest-bearing liabilities) and the relative amounts of interest-earning
assets and interest-bearing liabilities.
Net interest and dividend income totaled $25.4 million, $26.5 million,
$52.9 million, $48.7 million and $52.0 million during the six months ended
December 31, 1997 and 1996 and the years ended June 30, 1997, 1996 and 1995,
respectively. Net interest and dividend income decreased by $1.2 million or 4.4%
during the six months ended December 31, 1997, as compared to the same period in
the prior year, due to a significant decline in the average balance of
securities of $1.1 billion during the period, which is attributable to the sale
and writedown of such securities. Net interest and dividend income increased by
$4.2 million or 8.7% during the year ended June 30, 1997 due to a $22.1 million
increase net interest-earning assets and a 21 basis point increase in the
Company's net interest spread. Net interest and dividend income declined by $3.3
million or 6.4% during the year ended June 30, 1996 due to a $83.6 million
decline in net interest-earning assets, which was partially offset by an
increase in the Company's interest rate spread of 4 basis points.
57
<PAGE> 60
AVERAGE BALANCES, NET INTEREST INCOME, YIELDS EARNED AND RATES PAID
The following table sets forth, for the periods indicated, information regarding
(i) the total dollar amount of interest income of the Company from
interest-earning assets and the resultant average yields; (ii) the total dollar
amount of interest expense on interest-bearing liabilities and the resultant
average rates; (iii) net interest income; (iv) interest rate spread; and (v) net
interest margin. Information is based on average daily balances during the
indicated periods.
<TABLE>
<CAPTION>
SIX MONTHS ENDED DECEMBER 31,
-------------------------------------------------------------------------
1997 1996
----------------------------------------- -----------------------------
AVERAGE
AVERAGE YIELD/ AVERAGE
BALANCE INTEREST COST BALANCE INTEREST
---------- ------------- ---------- --------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable(1) $1,009,843 $ 49,788 9.78% $1,020,534 $ 53,179
Securities(2) 1,000,808 31,306 6.21% 2,107,408 62,176
Securities purchased under agreements to resell 60,000 1,711 5.66% 38,921 1,040
Other earning assets(3) 76,415 2,399 6.23% 78,544 2,705
---------- ---------- ---------- ----------
Total interest-earning assets 2,147,066 85,204 7.87% 3,245,407 119,100
---------- ======= ----------
Noninterest-earning assets 92,823 55,873
---------- ----------
Total assets $2,239,889 $3,301,280
========== ==========
Interest-bearing liabilities:
Deposits:
Transaction accounts(4) $ 266,112 $ 3,603 2.69% $ 269,044 $ 3,776
Term certificates of deposit 1,301,703 37,069 5.65% 1,308,314 37,443
---------- ---------- ---------- ----------
Total deposits 1,567,815 40,672 5.15% 1,577,358 41,219
Borrowings:
FHLB advances 391,711 14,005 7.09% 987,618 32,353
Securities sold under agreements to
repurchase 55,235 2,073 7.44% 567,000 18,426
Promissory note payable 2,591 108 8.27% 14,020 564
Senior notes 49,565 2,965 11.87% -- --
---------- ---------- ---------- ----------
Total interest-bearing liabilities 2,066,917 59,823 5.74% 3,145,996 92,562
---------- ======= ----------
Noninterest-bearing liabilities 88,248 48,071
---------- ----------
Total liabilities 2,155,165 3,194,067
Stockholders' equity 84,724 107,213
---------- ----------
Total liabilities and stockholders'
equity $2,239,889 $3,301,280
========== ==========
Net interest-earning assets $ 80,149 $ 99,411
========== ==========
Net interest income/interest rate spread $ 25,381 2.13% $ 26,538
========== ======= ==========
Net interest margin 2.34%
=======
Ratio of average interest-earning assets to
average interest-bearing liabilities 103.88%
=======
<CAPTION>
YEARS ENDED JUNE 30,
-------------------------------------------------------------
1996 1997 1996
---------- ----------------------------------------- ---------------
AVERAGE AVERAGE
YIELD/ AVERAGE YIELD/ AVERAGE
COST BALANCE INTEREST COST BALANCE
---------- ------------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable(1) 10.34% $1,041,342 $ 107,715 10.34% $ 867,151
Securities(2) 5.85% 1,845,179 109,224 5.92% 2,255,318
Securities purchased under agreements to resell 5.30% 27,174 1,488 5.48% 4,467
Other earning assets(3) 6.83% 65,903 4,237 6.43% 79,847
---------- ---------- ----------
Total interest-earning assets 7.28% 2,979,598 222,664 7.47% 3,206,783
======= ---------- =======
Noninterest-earning assets 92,630 89,147
---------- ----------
Total assets $3,072,228 $3,295,930
========== ==========
Interest-bearing liabilities:
Deposits:
Transaction accounts(4) 2.78% $ 268,047 $ 7,473 2.79% $ 280,111
Term certificates of deposit 5.68% 1,329,463 75,618 5.69% 1,271,079
---------- ---------- ----------
Total deposits 5.18% 1,597,510 83,091 5.20% 1,551,190
Borrowings:
FHLB advances 6.50% 848,733 57,442 6.77% 869,568
Securities sold under agreements to
repurchase 6.45% 418,784 28,202 6.73% 686,558
Promissory note payable 7.98% 12,852 1,026 7.98% 19,862
Senior notes -- -- -- -- --
---------- ---------- ----------
Total interest-bearing liabilities 5.84% 2,877,879 169,761 5.90% 3,127,178
======= ---------- ======
Noninterest-bearing liabilities 89,914 33,075
---------- ---------
Total liabilities 2,967,793 3,160,253
Stockholders' equity 104,435 135,677
---------- ---------
Total liabilities and stockholders'
equity $3,072,228 $3,295,930
========== ==========
Net interest-earning assets $ 101,719 $ 79,605
========== ==========
Net interest income/interest rate spread 1.45% $ 52,903 1.57%
======= ========== ======
Net interest margin 1.62% 1.78%
======= ======
Ratio of average interest-earning assets to
average interest-bearing liabilities 103.16% 103.53%
======= ======
<CAPTION>
---------------------------------------------------------------------------
1996 1995
-------------------------- ----------------------------------------------
AVERAGE AVERAGE
YIELD/ AVERAGE YIELD/
INTEREST COST BALANCE INTEREST COST
-------- --------- ---------- ------------ ----------
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable(1) $ 95,839 11.05% $ 769,943 $ 74,791 9.71%
Securities(2) 134,761 5.98% 2,425,301 134,051 5.53%
Securities purchased under agreements to resell 322 7.21% -- -- --
Other earning assets(3) 5,234 6.56% 73,807 5,716 7.74%
---------- ---------- ----------
Total interest-earning assets 236,156 7.36% 3,269,051 214,558 6.56%
---------- ======= ---------- =========
Noninterest-earning assets 58,674
----------
Total assets $3,327,725
==========
Interest-bearing liabilities:
Deposits:
Transaction accounts(4) $ 7,828 2.79% $ 342,451 $ 9,679 2.83%
Term certificates of deposit 73,345 5.77% 1,149,834 58,556 5.09%
---------- ---------- ----------
Total deposits 81,173 5.23% 1,492,285 68,235 4.57%
Borrowings:
FHLB advances 58,309 6.71% 952,373 55,747 5.85%
Securities sold under agreements to
repurchase 46,400 6.76% 634,282 36,503 5.76%
Promissory note payable 1,606 8.09% 26,872 2,105 7.83%
Senior notes -- -- -- -- --
---------- ---------- ---------- ----------
Total interest-bearing liabilities 187,488 6.00% 3,105,812 162,590 5.24%
---------- ======= ---------- ==========
Noninterest-bearing liabilities 85,744
---------
Total liabilities 3,191,556
Stockholders' equity 136,169
---------
Total liabilities and stockholders'
equity $3,327,725
==========
Net interest-earning assets $ 163,239
==========
Net interest income/interest rate spread $ 48,668 1.36% $ 51,968 1.32%
========== ======= ========== ==========
Net interest margin 1.52% 1.59%
======= ==========
Ratio of average interest-earning assets to
average interest-bearing liabilities 102.55% 105.26%
======= ==========
</TABLE>
- -------------------------
(1) The average balance of loans receivable includes nonperforming loans,
interest on which is recognized on a cash basis, and excludes the allowance
for loan losses which is included in noninterest-earning assets.
(2) Includes all securities classified as held to maturity and available for
sale, including the market valuation accounts.
(3) Includes cash and due from banks, equity securities, and FHLB stock.
(4) Includes passbook, NOW, and money market accounts.
58
<PAGE> 61
RATE/VOLUME ANALYSIS
The following table sets forth the effects of changing rates and volumes on
net interest income of the Company. Information is provided with respect to
(i) effects on interest income attributable to changes in volume (changes in
volume multiplied by prior rate); (ii) effects on interest income
attributable to changes in rate (changes in rate multiplied by prior
volume); and (iii) changes in rate/volume (change in rate multiplied by
change in volume).
<TABLE>
<CAPTION>
SIX MONTHS ENDED DECEMBER 31, 1997
COMPARED TO SIX MONTHS ENDED
DECEMBER 31, 1996
---------------------------------------------------
INCREASE (DECREASE) DUE TO
------------------------------------
TOTAL
RATE/ NET INCREASE
RATE VOLUME VOLUME (DECREASE)
-------- -------- -------- ----------------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable $ (2,864) $ (557) $ 30 $ (3,391)
Securities 3,745 (32,649) (1,966) (30,870)
Securities purchased under agreements resell 70 563 38 671
Other earning assets (239) (73) 6 (306)
-------- -------- -------- --------
Total net change in income on interest-earning
assets 712 (32,716) (1,892) (33,896)
-------- -------- -------- --------
Interest-bearing liabilities:
Deposits:
Transaction accounts (133) (41) 1 (173)
Term certificates of deposit (186) (189) 1 (374)
-------- -------- -------- --------
Total deposits (319) (230) 2 (547)
Borrowings:
FHLB advances 2,958 (19,521) (1,785) (18,348)
Securities sold under agreements to
repurchase 2,854 (16,631) (2,576) (16,353)
Promissory note payable 20 (460) (16) (456)
Senior notes -- -- 2,965 2,965
-------- -------- -------- --------
Total net change in expense on interest-bearing
liabilities 5,513 (36,842) (1,410) (32,739)
-------- -------- -------- --------
Change in net interest income $ (4,801) $ 4,126 $ (482) $ (1,157)
======== ======== ======== ========
<CAPTION>
YEAR ENDED JUNE 30, 1997
COMPARED TO 1996
-----------------------------------------------------
INCREASE (DECREASE) DUE TO
-------------------------------------- TOTAL NET
RATE/ INCREASE
RATE VOLUME VOLUME (DECREASE)
----------- ---------- -------- ----------
<S> <C> <C>
Interest-earning assets:
Loans receivable $ (6,142) $ 19,252 $ (1,234) $ 11,876
Securities (1,259) (24,507) 229 (25,537)
Securities purchased under agreements resell (77) 1,637 (394) 1,166
Other earning assets (101) (914) 18 (997)
-------- -------- -------- --------
Total net change in income on interest-earning
assets (7,579) (4,532) (1,381) (13,492)
-------- -------- -------- --------
Interest-bearing liabilities:
Deposits:
Transaction accounts (19) (337) 1 (355)
Term certificates of deposit (1,048) 3,369 (48) 2,273
-------- -------- -------- --------
Total deposits (1,067) 3,032 (47) 1,918
Borrowings:
FHLB advances 543 (1,397) (13) (867)
Securities sold under agreements to
repurchase (165) (18,098) 65 (18,198)
Promissory note payable (20) (567) 7 (580)
Senior notes -- -- -- --
-------- -------- -------- --------
Total net change in expense on interest-bearing
liabilities (709) (17,030) 12 (17,727)
-------- -------- -------- --------
Change in net interest income $ (6,870) $ 12,498 $ (1,393) $ 4,235
======== ======== ======== ========
YEAR ENDED JUNE 30, 1996 COMPARED TO 1995
----------------------------------------------------
INCREASE (DECREASE) DUE TO
------------------------------------
TOTAL NET
RATE/ INCREASE
RATE VOLUME VOLUME (DECREASE)
-------- -------- -------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable $ 10,304 $ 9,443 $ 1,301 $ 21,048
Securities 10,867 (9,395) (762) 710
Securities purchased under agreements resell -- -- 322 322
Other earning assets (878) 467 (71) (482)
-------- -------- -------- --------
Total net change in income on interest-earning
assets 20,293 515 790 21,598
-------- -------- -------- --------
Interest-bearing liabilities:
Deposits:
Transaction accounts (109) (1,762) 20 (1,851)
Term certificates of deposit 7,793 6,174 822 14,789
-------- -------- -------- --------
Total deposits 7,684 4,412 842 12,938
Borrowings:
FHLB advances 8,115 (4,847) (706) 2,562
Securities sold under agreements to
repurchase 6,364 3,008 525 9,897
Promissory note payable 68 (549) (18) (499)
Senior notes -- -- -- --
-------- -------- -------- --------
Total net change in expense on interest-bearing
liabilities 22,231 2,024 643 24,898
-------- -------- -------- --------
Change in net interest income $ (1,938) $ (1,509) $ 147 $ (3,300)
======== ======== ======== ========
</TABLE>
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Interest Income. Total interest and dividend income decreased by $33.9
million or 28.5% during the six months ended December 31, 1997, as compared to
the same period in the prior year, decreased by $13.5 million or 5.7% during the
year ended June 30, 1997 and increased by $21.6 million or 10.1% during the year
ended June 30, 1996. Interest income on loans receivable decreased by $3.4
million or 6.4% during the six months ended December 31, 1997, as compared to
the same period in the prior year, and increased by $11.9 million or 12.4% and
$21.0 million or 28.1% during the years ended June 30, 1997 and 1996,
respectively. The decrease in interest on loans receivable during the six months
ended December 31, 1997 was due to a decline in the average yield earned on the
Company's loan portfolio of 56 basis points. This decline in the average yield
reflected, in part, the discontinuance of the Company's third-party automobile
loan purchase activity. Such loans generally carry higher yields than
traditional real estate secured loans. The increase in interest on loans
receivable during the years ended June 30, 1997 and 1996 was primarily due to
increases in the average balance of loans outstanding of $174.2 million and
$97.2 million, respectively. During fiscal 1997, prior management significantly
increased its originations of third-party automobile loans, and, during fiscal
1997 and 1996, the Company continued its emphasis on the origination and
purchase of commercial real estate loans. During such years, the Company
originated and purchased a total of $320.2 and $432.2 million of loans, which
included $73.6 million and $179.6 million of third-party automobile loans and
$205.5 million and $202.5 million of commercial real estate loans, respectively.
Interest income on securities and other interest-earning assets (which
include mortgage-backed and related securities, including CMOs, U.S. Government
and agency securities, FHLB stock and, during fiscal 1997 and 1996, interest
rate caps and floors and Student Loan Marketing Association preferred stock)
decreased by $30.5 million or 46.3% during the six months ended December 31,
1997, as compared to the same period in the prior year, decreased by $25.4
million or 18.1% during the year ended June 30, 1997 and increased slightly by
$550,000 or 0.4% during the year ended June 30, 1996. The decline in interest
income on such investments during the six months ended December 31, 1997 and the
year ended June 30, 1997 was primarily due to the decreases in the average
balance of such investments of $1.1 billion and $410.1 million during such
respective periods. During fiscal 1997, the Company began reducing its
securities holdings (primarily its COFI-based CMO's) through periodic bulk sale
transactions which resulted in the sale of $743.9 million of securities during
the year. During the first half of fiscal 1998 and in connection with the
Private Placement and the Redemption, new management of the Company determined
that its remaining CMO portfolio was "other than temporarily impaired" in
accordance with SFAS No. 115 and, pursuant to GAAP, wrote-down the portfolio by
$54.7 million. In addition, since assuming control of the Company on September
8, 1997, new management has been accelerating the disposition of its securities
portfolio, particularly its COFI-based CMOs. During the six months ended
December 31, 1997, the Company sold $865.1 million of securities. Management
expects to continue to reduce what remains of the portfolio as market conditions
permit.
Interest Expense. Total interest expense decreased by $32.7 million or
35.4% during the six months ended December 31, 1997, as compared to the same
period in the prior year, decreased by $17.7 million or 9.5% during the year
ended June 30, 1997 and increased by $24.9 million or 15.3% during the year
ended June 30, 1996. Interest expense on deposits, the largest component of the
Company's interest-bearing liabilities, decreased by $547,000 or 1.3% during
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the six months ended December 31, 1997, as compared to the same period in the
prior year, and increased by $1.9 million or 2.4% and $12.9 million or 19.0%
during the years ended June 30, 1997 and 1996, respectively. The Company has
increased its average balance of deposits during each of the periods presented
in accordance with the Company's strategy to promote retail deposit growth.
Interest expense on FHLB advances decreased by $18.3 million or 56.7%
during the six months ended December 31, 1997, as compared to the same period in
the prior year, decreased slightly by $867,000 or 1.5% during the year ended
June 30, 1997 and increased by $2.6 million or 4.6% during the year ended June
30, 1996. Similarly, interest expense on reverse repurchase agreements decreased
by $16.4 million or $88.8 during the three months ended September 30, 1997, as
compared to the same period in the prior year, decreased by $18.2 million or
39.2% during the year ended June 30, 1997 and increased by $9.9 million or 27.1%
during the year ended June 30, 1996. As discussed previously, beginning in 1993,
the Company began to implement an investment strategy whereby it purchased
mortgage-backed and related securities and financed those securities primarily
through reverse repurchase agreements and FHLB advances. However, during fiscal
1997 and continuing through the quarter ending September 30, 1997, the Company
has begun to reduce its securities holdings through periodic bulk sale
transactions and has utilized the proceeds therefrom to pay off its reverse
repurchase agreements and pay down FHLB advances.
During the periods presented, interest expense on notes payable
consisted of interest paid on a promissory note payable to Isabel Collier Read
and, since September 8, 1997, interest accrued with respect to the Senior Notes.
Interest expense on the promissory note amounted to $108,000, $282,000, $1.0
million, $1.6 million and $2.1 million during the six months ended December 31,
1997 and 1996 and the years ended June 30, 1997, 1996 and 1995, respectively.
Interest expense on the Senior Notes (which began to accrue on September 8,
1997) amounted to $2.7 million during the six months ended December 31, 1997. On
September 8, 1997, in connection with the closing of the Private Placement and
the Redemption, the Company issued $80.0 million of the Senior Notes (which are
due in September 2004 and bear interest at the rate of 11.0% payable
semi-annually) and prepaid the promissory note held by Ms. Read at a price equal
to the principal amount thereof plus accrued and unpaid interest thereon.
Provision for Loan Losses. The provision for loan losses is charged to
earnings to bring the total allowance for loan losses to a level considered
appropriate by management based on (i) an estimate by management of loan losses
that occurred during the current period and (ii) an ongoing adjustment of prior
estimates of losses occurring in prior periods. To serve as a basis for making
this provision each quarter, the Company maintains an extensive credit risk
monitoring process that considers several factors, including among other things,
current economic conditions affecting the Company's customers, the payment
performance of individual large loans and pools of homogeneous small loans,
portfolio seasoning, changes in collateral values, and detailed reviews of
specific large loan relationships. For large loans deemed to be impaired due to
an expectation that all contractual payments will probably not be received,
impairment is measured by comparing the Company's recorded investment in the
loan to the present value of expected cash flows discounted at the loans'
effective interest rate, the fair value of the collateral or the loan's
observable market price. While management endeavors to use the
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<PAGE> 64
best information available in making its evaluations, future adjustments to the
allowance for loan losses may be necessary if economic conditions change
substantially from the assumptions used in making the evaluations. In addition,
regulatory examiners may require the Banks to recognize additions to their
allowances based upon their judgments about information available to them at the
time of their examination.
The Company established provisions for loan losses of $25.6 million,
$9.7 million, $28.4 million, $5.1 million and $1.2 million during the six months
ended December 31, 1997 and 1996 and the years ended June 30, 1997, 1996 and
1995, respectively. During such respective periods, loan charge-offs (net of
recoveries) amounted to $16.5 million, $7.5 million, $20.2 million, $6.5 million
and $253,000. The $25.6 million and $28.4 million provisions established during
the six months ended December 31, 1997 and the year ended June 30, 1997 were
intended primarily to cover realized and inherent losses with respect to the
Company's portfolio of indirect automobile receivables. At December 31, 1997,
the Company's portfolio of such indirect automobile loans had been sold. See
"Business--Lending Activities--Consumer Loans."
Noninterest Income. Total noninterest income (loss) amounted to
$(107.1) million, $2.2 million, $(17.1) million, $10.3 million and $16.6 million
during the six months ended December 31, 1997 and 1996 and the years ended June
30, 1997, 1996 and 1995, respectively. The components of noninterest income
consist of deposit related income, loan fees and loan service charges, net gains
(losses) on sale of assets and other miscellaneous income. The noninterest
losses recognized during the six months ended December 31, 1997 and the year
ended June 30, 1997 primarily related to losses incurred on the sale of
securities. Specifically, during the three months ended September 30, 1997, the
Company incurred $125.5 million of losses on the sale and write-down of assets,
of which an aggregate loss of $53.4 million was incurred in connection with the
liquidation of the hedging contracts previous management had entered into in an
attempt to reduce the Company's exposure to interest rates. See "Qualitative and
Quantitative Disclosure about Market Risk--Asset and Liability Management." In
addition, the Company recognized a loss of $17.3 million on the sale of
securities ($16.0 million of which related to the sale of CMOs with interest
rate adjustments tied to COFI) and a loss of $54.7 million which related to the
write-down of the Company's remaining COFI-based CMO portfolio to reflect market
values. The market for fixed income securities improved during the three month
period ended December 31, 1997 and the Company sold a portion of the remaining
COFI-based CMO portfolio for a gain of $12.7 million. During the year ended June
30, 1997, the Company recognized $29.6 million of losses on the sale of
securities ($29.9 million of which related to the sale of CMOs with interest
rate adjustments tied to COFI).
Noninterest Expense. Total noninterest expense decreased by $6.7
million or 22.8% during the six months ended December 31, 1997, as compared to
the same period in the prior year, increased by $13.8 million or 39.0% during
the year ended June 30, 1997 and decreased by $11.0 million or 23.7% during the
year ended June 30, 1996. The decrease in noninterest expense during the six
months ended December 31, 1997 was primarily due to the absence of the $10.3
million (before applicable tax benefits) special assessment which was recognized
by the Company in September 1996 in connection with the recapitalization of the
SAIF, which was partially offset by a $5.0 million increase in miscellaneous
other expenses. Pursuant to legislation effective September 30, 1996, all SAIF
member institutions were required to pay a
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<PAGE> 65
one-time special assessment equal to 65.7 basis points for all SAIF-assessable
deposits as of March 31, 1995. This legislation resulted in the recapitalization
of the SAIF and, consequently, during the fourth calendar quarter of 1996, the
FDIC lowered the Banks' assessment rates. See "Business--Regulation of Federal
Savings Institutions--FDIC Assessments." The increase in miscellaneous other
expense recognized by the Company during the three months ended September 30,
1997 primarily reflected non-recurring charges which were related to the Private
Placement and the Redemption which were consummated on September 8, 1997.
The increase in noninterest expense during the year ended June 30, 1997
was due primarily to the one-time special SAIF assessment which was recognized
by the Company in September 1996, as discussed above. In addition, during fiscal
1997, the Company's provision for uninsured risk and losses increased by $1.9
million or 140.5% due to the Company's reassessment of its potential liability
with respect to the FDIC Dispute. See "Legal Proceedings."
The decrease in noninterest expense during the year ended June 30, 1996
was due primarily to a $9.6 million or 40.4% decrease in compensation and
employee benefits which reflected bonuses and other payments which were made
during fiscal 1995 to the former senior management of the Company pursuant to
certain employment agreements with such individuals. In addition, during fiscal
1996, the Company's provision for uninsured risk and losses declined by $4.4
million or 76.0% as the Company continued to reassess the adequacy of its
reserves for any potential liability to the FDIC in connection with the FDIC
Dispute. See "Legal Proceedings." Partially offsetting these decreases during
the fiscal year was a $1.1 million or 17.0% increase in miscellaneous other
expense (consisting primarily of expenses relating to the operations of Star,
which commenced business in January 1995).
Provision (Benefit) for Income Taxes. During the six months ended
December 31, 1997 and 1996 and the years ended June 30, 1997, 1996 and 1995, the
Company recognized $(44.1) million, $(3.6) million, $(11.9) million, $4.9
million and $6.6 million of provisions (benefits) for income taxes. At December
31, 1997, the Company had approximately $40.8 million and $190.5 million of net
operating loss carryforwards available for federal and state income tax
purposes, respectively. The state net operating loss carryforwards expire in
varying amounts between 2006 and 2013. The federal net operating loss
carryforwards expire in 2013. At December 31, 1997, a valuation allowance for
all available state net operating loss carryforwards was established as it was
determined to be more likely than not that the benefit of the deferred tax asset
would not be realized. Historically, the Company has generated income for
federal income tax purposes. Based on the current strategy of new management, no
valuation allowance for other deferred tax assets has been established as the
Company believes it is more likely than not that sufficient income for federal
income tax purposes will be realized. The change in ownership of the Company did
not result in a limitation on the utilization of the net operating losses. See
"Business--Taxation" and Note 15 of the Notes to Consolidated Financial
Statements.
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<PAGE> 66
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. Liquidity refers to the Company's ability to generate
sufficient cash to meet the funding needs of current loan demand, savings
deposit withdrawals, principal and interest payments with respect to outstanding
borrowings and to pay operating expenses. It is management's policy to maintain
greater liquidity than required in order to be in a position to fund loan
originations, to meet withdrawals from deposit accounts, to make principal and
interest payments with respect to outstanding borrowings and to make investments
that take advantage of interest rate spreads. The Company monitors its liquidity
in accordance with guidelines established by the Company and applicable
regulatory requirements. The Company's need for liquidity is affected by loan
demand, net changes in deposit levels and the scheduled maturities of its
borrowings. The Company can minimize the cash required during the times of heavy
loan demand by modifying its credit policies or reducing its marketing effort.
Liquidity demand caused by net reductions in deposits are usually caused by
factors over which the Company has limited control. The Company derives its
liquidity from both its assets and liabilities. Liquidity is derived from assets
by receipt of interest and principal payments and prepayments, by the ability to
sell assets at market prices and by utilizing unpledged assets as collateral for
borrowings. Liquidity is derived from liabilities by maintaining a variety of
funding sources, including deposits, advances from the FHLB of Topeka and other
short and long-term borrowings.
The Company's liquidity management is both a daily and long-term
function of funds management. Liquid assets are generally invested in short-term
investments such as overnight money funds and short-term government agency
securities. If the Company requires funds beyond its ability to generate them
internally, various forms of both short and long-term borrowings provide an
additional source of funds. At December 31, 1997, the Company had $328.0 million
in borrowing capacity under a collateralized line of credit with the FHLB of
Topeka, of which $4.1 million was outstanding as of such date. The Bank does not
currently accept brokered deposits as a source of liquidity, and does not
anticipate a change in this practice in the foreseeable future.
At December 31, 1997, the Company had outstanding commitments
(including unused lines of credit) to originate and/or purchase mortgage and
non-mortgage loans of $67.4 million. Certificates of deposit which are scheduled
to mature within one year totaled $983.3 million at December 31, 1997, and
borrowings that are scheduled to mature within the same period amounted to $4.1
million. The Company anticipates that it will have sufficient funds available to
meet its current loan commitments and that, based upon past experience and
current pricing policies, it can adjust the rates of certificates of deposit to
retain a substantial portion of its maturing certificates and also, to the
extent deemed necessary, refinance the maturing borrowings.
Beginning March 1, 1998, the Company is required to begin making
interest payments on the Senior Notes, which is expected to be initially funded
through an interest reserve account established with an independent trustee and
subsequently through dividends from the Banks. The Senior Notes have an annual
debt reserve requirement of $8.8 million (or $4.4 million for each semi-annual
period). The Interest Reserve Account currently contains cash and other
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<PAGE> 67
investments permitted by the Indenture governing the Senior Notes sufficient to
pay the aggregate interest payments scheduled to be made on March 1, 1998 and
September 1, 1998.
Capital Resources. Federally insured savings institutions such as the
Banks are required to maintain minimum levels of regulatory capital. See
"Business--Regulation of Federal Savings Institutions--Regulatory Capital
Requirements." The following table reflects the Banks' actual levels of
regulatory capital and applicable regulatory capital requirements at December
31, 1997.
<TABLE>
<CAPTION>
Required(4) Actual Excess
------------------------ ------------------------- --------------------------
Percent Amount Percent Amount Percent Amount
--------- -------- ---------- ----------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Local Federal:
Tangible capital 1.50% $ 27,665 6.89% $ 127,024 5.39% $ 99,359
Core capital(1) 3.00 55,384 6.98 128,803 3.98 73,419
Risk-based capital(2)(3) 8.00 76,022 14.14 134,331 6.14 58,309
Local America:
Tangible capital 1.50 9,230 15.80 97,246 14.30 88,016
Core capital(1) 3.00 18,482 15.90 97,975 12.90 79,493
Risk-based capital(2)(3) 8.00 28,511 28.45 101,398 20.45 72,887
</TABLE>
(1) Does not reflect amendments which were proposed by the OTS in April 1991,
which would increase this requirement to between 4% and 5%.
(2) Does not reflect the interest-rate risk component to the risk-based capital
requirement, the effective date of which has been postponed.
(3) Tangible and core capital are computed as a percentage of adjusted total
assets and risk-based capital is computed as a percentage of adjusted
risk-weighted assets.
(4) Does not reflect the requirements to be met in order for an institution to
be deemed "adequately capitalized" under applicable laws and regulations.
See "Business--Regulation of Federal Savings Institutions--Prompt
Corrective Action."
INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and related data presented herein
have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and operating results in
terms of historical dollars (except with respect to available for sale
securities which are carried at market value), without considering changes in
the relative purchasing power of money over time due to inflation. Unlike most
industrial companies, substantially all of the assets and liabilities of the
Company are monetary in nature. As a result, interest rates have a more
significant impact on the Company's performance than the effects of general
levels of inflation. Interest rates do not necessarily move in the same
direction or in the same magnitude as the prices of goods and services.
RECENT ACCOUNTING PRONOUNCEMENTS
Set forth below are recent accounting pronouncements which may have a
future effect on the Company's operations. These pronouncements should be read
in conjunction with the significant accounting policies which the Company has
adopted that are set forth in the Company's Notes to Consolidated Financial
Statements.
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<PAGE> 68
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 125, which was
effective, on a prospective basis, for transactions occurring after December 31,
1996. SFAS No. 125 provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishment of liabilities based on
consistent application of a financial-components approach that focuses on
control. SFAS No. 125 extends the "available for sale" and "trading" approach of
SFAS No. 115 to non-security financial assets that can be contractually prepaid
or otherwise settled in such a way that the holder of the asset would not
recover substantially all of its recorded investment. The extension of the SFAS
No. 115 approach to certain non-security financial assets and the amendment to
SFAS No. 115 are effective for financial assets held on or acquired after
January 1, 1997. The adoption of SFAS No. 125 did not have a material adverse
effect on the Company's consolidated financial condition or results of
operations.
In February 1997, the FASB released SFAS No. 128, "Earnings Per Share."
SFAS No. 128 establishes standards for computing and presenting earnings per
share ("EPS") and applies to entities with publicly held common stock or
potential common stock. SFAS No. 128 simplifies the standards for computing
earnings per share previously found in APB Opinion No. 15, Earnings Per Share
and makes them comparable to international EPS standards. It replaces the
presentation of primary EPS with a presentation of basic EPS. It also requires
dual presentation of basic and diluted EPS on the face of the income statement
for all entities with complex capital structures and requires a reconciliation
of the numerator and denominator of the basic EPS computation to the numerator
and denominator of the diluted EPS computation.
Basic EPS excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock that then shared in the earnings of the entity. Diluted EPS is computed
similarly to fully diluted EPS pursuant to APB Opinion No. 15.
SFAS No. 128 is effective for financial statements issued for periods
ending after December 15, 1997, including interim periods; earlier application
is not permitted. SFAS No. 128 requires restatement of all prior-period EPS data
presented. This Statement did not have a material adverse impact on the
consolidated financial position, the results of operations of the Company or the
net income (loss) per share reported in the consolidated financial statements.
In March 1997, the FASB issued SFAS No. 129, "Disclosure of Information
About Capital Structure". SFAS No. 129 continues the existing requirements to
disclose the pertinent rights and privileges of all securities other than
ordinary common stock but expands the number of companies subject to portions of
its requirements. Specifically, the Statement requires all entities to provide
the capital structure disclosures previously required by APB Opinion No. 15.
Companies that were exempt from the provisions of APB Opinion No. 15 will now
need to make those disclosures.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income". SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its
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<PAGE> 69
components (revenues, expenses, gains, and losses) in a full set of general
purpose financial statements. SFAS No. 130 requires that all items that are
required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. SFAS No. 130 requires that an
enterprise (a) classify items of other comprehensive income by their nature in a
financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of a statement of financial position. SFAS No. 130
is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. Management does not anticipate that this
Statement will have a material adverse impact on the consolidated financial
position or the results of operations of the Company.
In July 1997, the FASB issued SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information". SFAS No. 131 requires disclosures for
each segment that are similar to those required under current standards with the
addition of quarterly disclosure requirements and a finer partitioning of
geographic disclosures. It requires limited segment data on a quarterly basis.
It also requires geographic data by country, as opposed to broader geographic
regions as permitted under current standards. SFAS No. 131 is effective for
fiscal years beginning after December 15, 1997 with earlier application
permitted. Management does not anticipate that this Statement will have a
material adverse impact on the consolidated financial position or the results of
operations of the Company.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically designated as (a) a
hedge of the exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment, (b) a hedge of the exposure to
variable cash flows of a forecasted transaction, or (c) a hedge of the foreign
currency exposure of a net investment in a foreign operation, an unrecognized
firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction.
SFAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999 with earlier application permitted. Management
does not anticipate that this Statement will have a material adverse impact on
the consolidated financial position of the results of operations of the Company.
YEAR 2000 COMPLIANCE
Many computer programs process transactions based on using two digits
for the year of the transaction rather than a full four digits (e.g., "98" for
1998). Systems that process Year 2000 transactions with the year "00" may
encounter significant processing inaccuracies or inoperability. Management has
determined that, like most other companies, it will be required to
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<PAGE> 70
modify or replace portions of its software so that its information systems will
be able to properly utilize dates subsequent to December 31, 1999. The Year 2000
issue will be addressed through either the modification to existing software or
conversion to new software. However, if such modifications are not made or
completed on a timely basis, the Year 2000 issue could impact the operations of
the Company.
A plan has been developed and is being followed to ensure that the
modifications and conversions are implemented and thoroughly tested on a timely
basis. Based on progress made to date, management anticipates that software for
the primary information systems will be Year 2000-compliant by the end of 1998.
Other less essential software applications will be modified and/or replaced
during 1999 which would enable all internal software applications to become Year
2000-compliant prior to the year 2000.
The Company utilizes software provided by outside suppliers which must
also become Year 2000-compliant. Management has initiated discussions with
outside suppliers and commitment letters from such suppliers that they will take
the necessary actions to become Year 2000-compliant on a timely basis have been
required. Management is actively monitoring the progress of outside suppliers in
their efforts to become Year 2000-compliant and actions deemed necessary will be
taken in order to mitigate the exposure to the Year 2000 issue. However, there
is no guarantee that the software of other suppliers for which the Company's
information systems rely will be converted on a timely basis, or that failure to
convert would not adversely effect the Company's operations.
Both internal and external resources will be utilized to modify,
replace or test the software for Year 2000 modifications. The Company estimates
that it will incur roughly $150,000 in total costs to become Year
2000-compliant.
Year 2000 costs and the date on which the Year 2000 modifications are
expected to be completed are based on management's best estimates, which were
derived utilizing numerous assumptions of future events including the
availability of certain resources, third party modifications and other factors.
However, there can be no guarantee that these estimates will be achieved and
actual results could differ materially from those plans. Specific factors that
might cause material differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to locate
and correct all relevant computer codes and similar uncertainties.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
ASSET AND LIABILITY MANAGEMENT
Asset and liability management is concerned with the timing and
magnitude of the repricing of assets and liabilities. It is the objective of the
Company to attempt to control risks associated with interest rate movements. In
general, management's strategy is to match asset and liability balances within
maturity categories to limit the Company's exposure to earnings variations and
variations in the value of assets and liabilities as interest rates change over
time.
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The Company's asset and liability management strategy is formulated and
monitored by the Asset/Liability Management Committee, which is comprised of the
Chief Executive Officer, the President, the Chief Financial Officer, the
Treasurer, the Director of Retail Operations and the Director of Commercial Real
Estate of the Company, in accordance with policies approved by the Board of
Directors of the Company. The Asset/Liability Management Committee meets at
least monthly to review, among other things, the sensitivity of the Company's
assets and liabilities to interest rate changes, the book and market values of
assets and liabilities, unrealized gains and losses, including those
attributable to hedging transactions, purchase and sale activity, and maturities
and prepayments of loans, investments and borrowings. The Asset/Liability
Management Committee also approves and establishes pricing and funding decisions
with respect to overall asset and liability composition and reports to the full
Board of Directors.
One of the primary goals of the Company's Asset/Liability Management
Committee is to effectively increase the duration of the Company's liabilities
and/or effectively contract the duration of the Company's assets so that the
respective durations are matched as closely as possible. This duration
adjustment can be accomplished either internally by restructuring the Company's
balance sheet, or externally by adjusting the duration of the Company's assets
and/or liabilities through the use of hedging contracts, such as interest rate
swaps, caps and floors. Although the Company has in the past hedged its interest
rate exposure externally through the use of various hedging contracts, the
Company's current strategy is to hedge internally through the use of core
transaction deposit accounts which are not as rate sensitive as other deposit
instruments and FHLB advances, together with an emphasis on investing in
shorter-term or adjustable rate assets which are more responsive to changes in
interest rates, such as adjustable rate U.S. Government agency mortgage-backed
securities, short-term U.S. Government agency securities and commercial and
consumer loans. The foregoing strategies are more fully described below.
Internal hedging through balance sheet restructuring generally involves
either the attraction of longer-term or less rate sensitive funds (i.e., core
transaction deposit accounts which are not as rate sensitive as other deposit
instruments or FHLB advances) or the investment in certain types of shorter-term
or adjustable-rate assets such as adjustable-rate mortgage-backed securities,
shorter-term U.S. Government agency securities and commercial and consumer
loans.
External hedging has generally involved the Company's use of interest
rate swaps, caps and floors. The Company previously utilized interest rate swaps
to hedge its outstanding FHLB advances and reverse repurchase agreements while
the Company previously utilized interest rate caps and floors to hedge the
Company's COFI-based CMO portfolio. The notional amount of hedging contracts
represents the underlying amount on which periodic cash flows are calculated and
exchanged between counterparties. However, this notional amount does not
represent the amount of borrowings or securities which would effectively be
hedged by that hedging contract. In selecting the type and amount of hedging
contract to utilize, the Company compares the duration of a particular contract,
or its change in value for a 100 basis point movement in interest rates, to that
of the borrowings or securities to be hedged. A hedging rate contract with the
appropriate offsetting duration often may have a notional amount much greater
than the face amount of the borrowings and/or securities being hedged.
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<PAGE> 72
During the six months ended December 31, 1997, the Company terminated
all outstanding interest rate swaps, caps and floors. Specifically, the Company
terminated interest rate swaps with an aggregate notional value of $500.0
million which resulted in losses of $47.3 million (excluding applicable tax
benefits). The Company also terminated interest rate cap and floor agreements
with an aggregate notional value of $2.4 billion, which resulted in losses of
$2.2 million (excluding applicable tax benefits). Upon termination of the
foregoing interest rate swap, cap and floor agreements, the Company recognized
all deferred gains and losses which resulted from prior hedging activities,
which resulted in an additional loss of approximately $3.9 million (excluding
applicable tax benefits). The foregoing losses resulted in an aggregate net tax
benefit of approximately $18.7 million.
Pursuant to the Redemption Agreement, the Selling Stockholders are
responsible to the Company for any aggregate pre-tax loss (net of any related
tax benefit) to the Company in excess of $42.5 million which results from the
sale or termination of the Company's existing hedging contracts. The Company is
currently attempting to collect such difference (which it estimates to amount to
$4.6 million) from the Selling Stockholders and has filed a lawsuit in the
United States District Court for the Western District of Oklahoma in order to
facilitate such recovery. However, no assurance can be made that the Company
will be able to recover from the Selling Stockholders all or a portion of such
$4.6 million. See "Legal Proceedings".
The Asset/Liability Management Committee's methods for evaluating
interest rate risk include an analysis of the Company's interest rate
sensitivity "gap," which is defined as the difference between interest-earning
assets and interest-bearing liabilities maturing or repricing within a given
time period. A gap is considered positive when the amount of interest-rate
sensitive assets exceeds the amount of interest-rate sensitive liabilities. A
gap is considered negative when the amount of interest rate sensitive
liabilities exceeds interest-rate sensitive assets. During a period of falling
interest rates, a negative gap would tend to result in an increase in net
interest income, while a positive gap would tend to affect net interest income
adversely. Because different types of assets and liabilities with the same or
similar maturities may react differently to changes in overall market rates or
conditions, changes in interest rates may affect net interest income positively
or negatively even if an institution were perfectly matched in each maturity
category.
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<PAGE> 73
The following table summarizes the anticipated maturities or repricing
of the Company's interest-earning assets and interest-bearing liabilities as of
December 31, 1997, based on the information and assumptions set forth in the
notes below.
<TABLE>
<CAPTION>
More Than
Three to More Than Three Years
Within Three Twelve One Year to to Five Over Five
Months Months Three Years Years Years Total
-------------- ----------- ------------- ------------ ----------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets(1):
Loans receivable(2):
Single-family residential loans . $ 17,489 $ 59,544 $ 54,484 $ 35,672 $ 119,660 $ 286,849
Commercial real estate .......... 230,594 99,262 92,871 101,623 124,771 649,121
Consumer ........................ 5,748 14,530 9,289 6,964 9,169 45,700
Securities(1)(3) .................. 459,147 19,741 6,548 5,927 23,147 514,510
Other interest-earning assets(4) ....... 277,299 -- -- -- -- 277,299
---------- ---------- ---------- ---------- ---------- ----------
Total ............................. $ 990,277 $ 193,077 $ 163,192 $ 150,186 $ 276,747 $1,773,479
========== ========== ========== ========== ========== ==========
Interest-bearing liabilities:
Deposits(5):
Money market and NOW
accounts ........................ $ 10,189 $ 30,566 $ 53,964 $ 31,623 $ 53,942 $ 180,284
Passbook accounts ............... 2,401 7,202 15,379 11,393 32,562 68,937
Certificates of deposit ......... 298,636 682,206 288,328 16,727 435 1,286,332
Borrowings:
FHLB advances ................... 30,100 -- -- 50,000 36 80,136
Senior notes .................... -- -- -- -- 80,000 80,000
---------- ---------- ---------- ---------- ---------- ----------
Total ............................. $ 341,326 $ 719,974 $ 357,671 $ 109,743 $ 166,975 $1,695,689
========== ========== ========== ========== ========== ==========
Excess (deficiency) of interest-earning
assets over interest-bearing
liabilities ....................... $ 648,951 $ (526,897) $ (194,479) $ 40,443 $ 109,772 $ 77,790
========== ========== ========== ========== ========== ==========
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities ...... $ 648,951 $ 122,054 $ (72,425) $ (31,982) $ 77,790 $ 77,790
========== ========== ========== ========== ========== ==========
Cumulative excess (deficiency) of
interest-earning assets over
interest-bearing liabilities as
a percent of total assets ......... 34.49% 6.49% (3.85)% (1.70)% 4.13% 4.13%
========== ========== ========== ========== ========== ==========
</TABLE>
- ------------------
(1) Adjustable-rate loans and securities are included in the period in which
interest rates are next scheduled to adjust rather than in the period in
which they are due and fixed-rate loans and securities are included in the
periods in which they are scheduled to be repaid, based on scheduled
amortization, in each case as adjusted to take into account estimated
prepayments based on, among other things, historical performance.
(2) Balances have been reduced for non-performing loans, which amounted to
$626,000 at December 31, 1997.
(3) Does not include unrealized gain on securities classified as available for
sale of $3.6 million.
(4) Comprised of cash and due from banks, deposits with other banks, repurchase
agreements and FHLB stock.
(5) Adjusted to take into account assumed annual decay rates which were applied
against money market, NOW and passbook accounts of 31.31%, 17.07% and
13.93%, respectively. Exclusive of non-interest bearing deposit accounts.
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<PAGE> 74
Although interest rate sensitivity gap is a useful measurement and
contributes toward effective asset and liability management, it is difficult to
predict the effect of changing interest rates based solely on that measure. As a
result, the Asset/Liability Management Committee also regularly reviews interest
rate risk by forecasting the impact of alternative interest rate environments on
net interest income and net portfolio value ("NPV"), which is defined as the net
present value of an institution's existing assets, liabilities and off-balance
sheet instruments, and evaluating such impacts against the maximum potential
changes in net interest income and NPV that is authorized by the Board of
Directors of the Company. For information with respect to the estimated
percentage change of the Company's net interest income over a four-quarter
period and NPV based on an indicated change in interest rates, see
"Business--Regulation of Federal Savings Institutions--Regulatory Capital
Requirements."
Under OTS regulations, a savings institution with a greater than
"normal" level of interest rate exposure must deduct an interest rate risk
("IRR") component in calculating its total capital for purposes of determining
whether it meets its risk-based capital requirement. Interest rate exposure is
measured, generally, as the decline in an institution's net portfolio value that
would result from a 200 basis point increase or decrease in market interest
rates (whichever would result in lower net portfolio value), divided by the
estimated economic value of the savings association's assets. The interest rate
risk component to be deducted from total capital is equal to one-half of the
difference between an institution's measured exposure and "normal" IRR exposure
(which is defined as 2%), multiplied by the estimated economic value of the
institution's assets. In August 1995, the OTS indefinitely delayed
implementation of its IRR regulation.
72
<PAGE> 75
The following tables set forth for the indicated dates the estimated
dollar and percentage change in the Company's net interest income over a four
quarter period and NPV based on the indicated changes in interest rates.
<TABLE>
<CAPTION>
June 30, 1997 December 31, 1997
Net Interest Income Net Interest Income
(next four quarters) (next four quarters)
- --------------------------- ------------------------------------------- -------------------------------------------------
Estimated Change Estimated Change
Change (in Basis Points) in From Base % Change from Base % Change
Interest Rates (1) (000's) from Base (000's) from Base
- --------------------------- ------------------- --------------- ----------------------- ------------------
<S> <C> <C> <C> <C> <C>
+400 ($4,680) (10)% ($3,215) (7)%
+300 (4,131) (8) (1,985) (4)
+200 (3,841) (8) (947) (2)
+100 (3,263) (7) (341) (1)
0 48,979(2) -- 47,508(2) --
-100 1,925 4 129 0
-200 5,573 11 467 1
-300 13,044 27 2,408 5
-400 14,888 30 873 2
</TABLE>
<TABLE>
<CAPTION>
June 30, 1997 December 31, 1997
NPV NPV
------------------------------------------------ -----------------------------------------------
Estimated Change Estimated Change
Change (in Basis Points) in From Base % Change from Base % Change
Interest Rates (1) (000's) from Base (000's) from Base
- ---------------------------- ----------------------- ------------------- ------------------------- -----------------
<S> <C> <C> <C> <C> <C>
+400 ($6,251) (6)% ($56,518) (37)%
+300 (58,323) (52) (38,218) (25)
+200 (44,681) (40) (20,141) (13)
+100 (18,598) (16) (7,101) (5)
0 112,881 -- 153,545 --
-100 14,867 13 2,606 2
-200 4,851 4 (2,235) (1)
-300 (15,293) (14) (8,469) (6)
-400 (59,769) (53) (25,404) (17)
</TABLE>
- -------------------
(1) Assumes an instantaneous uniform change in interest rates at all
maturities.
(2) The base net interest income is an estimate made by utilizing yields and
rates on assets and liabilities in the existing balance sheet as of the
dates shown adjusted for assumptions based on, among other things, future
loan and deposit changes and estimated loan prepayment speeds. All
interest-rate risk hedges that existed at June 30, 1997 had been eliminated
as of September 8, 1997. Interest rates were held flat through the next
four quarters.
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<PAGE> 76
At June 30, 1997, the rate of change on net interest income is affected
by an increase in loan prepayment speeds, which is reinvested in lower yielding
short-term investments during down shocks. Also, lower rate-paying deposit
accounts such as passbooks, money market and NOW accounts do not drop below 0%
in 300 and 400 basis points down shocks. Conversely, the rate of change in net
interest income in up shocks is affected by a decrease in loan prepayment speeds
while all deposit accounts are able to reprice fully in each 100 basis point
increment. Further, there were off-balance sheet hedges in place at June 30,
1997, which acted to stabilize net interest income after a 200 basis point
increase.
Subsequent to September 8, 1997, the Company no longer had any hedges
in place. However, it did continue to hold a reduced portfolio of COFI-indexed
securities. The Company utilizes a COFI-index forecast available on Bloomberg
L.P. This is a lagging index and the Company understands that the COFI-index is
forecast by a historically-based projection model which keeps the index
relatively flat from the 200 to 300 basis point decrease and then drops in the
400 basis point decrease. The other factors mentioned above as affecting June
30, 1997 would also cause the indicated effect at December 31, 1997.
The differences between June 30, 1997 and December 31, 1997 are mainly
due to the sale of COFI-based CMOs and mortgage backed securities, the
elimination of cap, floor and swap contracts, the addition of the senior notes
and the addition of fixed-rate FHLB advances. This balance sheet restructuring
is discussed in more detail in "Business--Lending Activities--Consumer Loans."
In addition, assumptions related to the calculation of the duration of
non-maturing deposit accounts was changed after June 30, 1997 to correspond with
the OTS decay rates resulting in a longer duration for these deposits as of
December 31, 1997.
The model reflects only the effects of assumptions made by management
while running the different interest rate shocks. The only variables between the
different rate shocks are the interest rates and the prepayment speeds.
The prepayment assumptions used in the model are based on historical
and market estimates. Standard present value calculation methodology is used to
discount the estimated future cash flows of assets and liabilities at
appropriate discount rates. The market value for COFI-based CMOs is obtained
through the Bloomberg calculator designated by the OTS.
Management of the Company believes that the assumptions used by it to
evaluate the vulnerability of the Company's operations to changes in interest
rates approximate actual experience and considers them reasonable; however, the
interest rate sensitivity of the Company's assets and liabilities and the
estimated effects of changes in interest rates on the Company's net interest
income and NPV could vary substantially if different assumptions were used or
actual experience differs from the historical experience on which they are
based. See "Business--Regulation of Federal Savings Institutions--Regulatory
Capital Requirements" for a discussion of a proposed OTS regulation which would
subject an institution with a greater than "normal" level of interest rate
exposure to a deduction of an interest rate risk ("IRR") component in
calculating its total capital for risk-based capital purposes.
74
<PAGE> 77
The preceding discussion about the Company's risk management activities
includes "forward-looking statements" that involve risks and uncertainties.
Actual results could differ materially from those projected in the
forward-looking statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Consolidated Financial statements at F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On October 8, 1997, pursuant to authorization of its Board of
Directors, the Company dismissed the firm of Arthur Andersen LLP ("Arthur
Andersen") as its auditors and retained KPMG Peat Marwick LLP. Arthur Andersen's
report for each of the three fiscal years ended June 30, 1997 did not contain an
adverse opinion or a disclaimer of opinion and was not qualified or modified as
to audit scope or accounting principles.
During the Company's two most recent fiscal years and the subsequent
interim period immediately preceding the change in accountants, there were no
disagreements with Arthur Andersen on any matter of accounting principles or
practice, financial statement disclosure, or auditing scope or procedure, which
if not resolved to the satisfaction of Arthur Andersen would have caused them to
make reference to the subject matter of the disagreement in connection with
their reports on the Company's financial statements. During the Company's two
most recent fiscal years and the subsequent interim period immediately preceding
the change in accountants, there was one reportable event (as that term is used
in Regulation S-K, Item 304(a)(1)(v)(A) through (D) of the Exchange Act), as
discussed in the next paragraph.
In connection with its audit of the Company's consolidated financial
statements as of and for the year ended June 30, 1997, Arthur Andersen reported
to the audit committee of the Company's board of directors that a material
weakness existed in the system of internal control, specifically that an
adequate system of control was not in effect at June 30, 1997, to provide
reasonable assurance that Local Federal was able to estimate and establish an
adequate allowance for loan losses with respect to its indirect automobile loan
portfolio. Management reported and Arthur Andersen concurred with management's
assertion in the reports required by the FDICIA that Local Federal maintained an
effective internal control structure over financial reporting as of June 30,
1997, except for the internal control structure over estimating and establishing
an adequate allowance for loan losses with respect to its indirect automobile
loan portfolio. This portfolio had been sold as of December 31, 1997. See
"Business--Lending Activities--Consumer Loans."
During fiscal 1997 and 1996, prior to their appointment as certifying
accountants, the Company did not consult KPMG Peat Marwick LLP regarding any of
the matters or events set forth in Item 304(a)(2)(i) and (ii) of Regulation S-K.
75
<PAGE> 78
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
Pursuant to the terms of the Purchase Agreement, upon consummation of
the Private Placement, each of the persons then serving as directors of the
Company resigned and Edward A. Townsend, Jan A. Norton and Joseph A. Leone were
appointed as directors of the Company. Following such resignations and
appointments, the new members of the Board of Directors caused Robert A.
Kotecki, George Nigh, and Kenneth W. Townsend to be appointed to the Company's
Board of Directors. Subsequently, J. David Rosenberg joined the Company's Board.
Following the reconstitution of the Board of Directors, the Company elected the
persons named below as directors of the Banks.
The following table sets forth information with respect to the
directors of the Company and the Banks. Except as described above, there were
and are no arrangements or understandings between the Company and the Banks and
any person pursuant to which such person has been elected as a director, and no
director is related to any other director or executive officer of the Company or
the Banks by blood, marriage or adoption. At December 31, 1997, all directors
and officers of the Company as a group owned 43,000 shares or 0.2% of the issued
and outstanding Common Stock.
<TABLE>
<CAPTION>
DIRECTOR TERM
NAME AGE(1) SINCE(2) EXPIRATION
- ---------------------------- -------------- ------------ ------------
<S> <C> <C> <C>
THE COMPANY:
Robert A. Kotecki 33 1997 2000
Joseph A. Leone 64 1973 1999
George Nigh 70 1997 1998
Jan A. Norton 50 1997 1999
Edward A. Townsend 55 1997 2000
Kenneth W. Townsend 54 1997 1998
J. David Rosenberg 48 1998 2000
LOCAL FEDERAL:
Gene C. Howard 71 1996 1999
Robert A. Kotecki 33 1997 2000
Joseph A. Leone 64 1973 1999
George Nigh 70 1997 1998
Jan A. Norton 50 1997 1999
Edward A. Townsend 55 1997 2000
Kenneth W. Townsend 54 1997 1998
Robert L. Vanden 50 1993 1998
Andrew M. Coats 62 1997 2000
</TABLE>
76
<PAGE> 79
<TABLE>
<CAPTION>
DIRECTOR TERM
NAME AGE(1) SINCE(2) EXPIRATION
- ---------------------------- -------------- ------------ ------------
<S> <C> <C> <C>
LOCAL AMERICA:
Gene C. Howard 71 1996 1999
Robert A. Kotecki 33 1997 2000
Joseph A. Leone 64 1973 1999
George Nigh 70 1997 1998
Jan A. Norton 50 1997 1999
Edward A. Townsend 55 1997 2000
Kenneth W. Townsend 54 1997 1998
Robert L. Vanden 50 1993 1998
Andrew M. Coats 62 1997 2000
</TABLE>
- -------------------
(1) As of December 31, 1997.
(2) Includes service as a director of the Company, Local Federal and/or Local
America
BIOGRAPHICAL INFORMATION
Information concerning the principal position and principal occupation
of each director of the Company and the Banks during the past five years is set
forth below.
Andrew M. Coats. Mr. Coats was elected as a director of the Banks in
October 1997. Mr. Coats served as the District Attorney of Oklahoma County from
1976 to 1980. Mr. Coats won the Democratic nomination for U.S. Senate from
Oklahoma in 1980. In 1983, Mr. Coats was elected Mayor of Oklahoma City where he
served until April 1987. Mr. Coats served as President of the law firm of Crowe
& Dunlevy in 1987 and 1988 and served as President of the Oklahoma Bar
Association in 1992. Mr. Coats is currently serving as the President of the
American College of Trial Lawyers. On July 1, 1996, Mr. Coats became the Dean of
the University of Oklahoma College of Law.
Gene C. Howard. Mr. Howard was elected as a director of the Banks
immediately following consummation of the Private Placement. Mr. Howard was
initially elected to the Board of Directors of Local Federal in 1996 and has
served as an attorney and senior partner with the law firm of Howard, Widdows,
Bufogle & Vaughn, P.C., Tulsa, Oklahoma, since 1952.
Robert A. Kotecki. Mr. Kotecki was elected as a director of the Company
and the Banks immediately following consummation of the Private Placement. Mr.
Kotecki has served as Senior Vice President of Friedman, Billings, Ramsey & Co.,
Inc., Arlington, Virginia, which served as the Placement Agent in connection
with the Private Placement, since March 1993. From November 1988 through March
1993, Mr. Kotecki served as an Associate with Trident Financial Corp., an
investment banking firm located in Raleigh, North Carolina.
77
<PAGE> 80
Joseph A. Leone. Mr. Leone was elected as a director of the Company and
the Banks immediately upon consummation of the Private Placement. Mr. Leone was
initially elected to the Board of Directors of Local Federal in 1973. Since
1987, Mr. Leone has served as managing partner with MBI, Inc., a limited
partnership which owns several commercial real estate properties located within
Oklahoma. From 1978 through 1987, Mr. Leone served as Executive Vice Chancellor
and Chancellor of the Oklahoma State System of Higher Education.
George Nigh. Governor Nigh was elected as a director of the Company and
the Banks immediately following the consummation of the Private Placement.
Governor Nigh is currently retired. From July 1992 through June 1997, Governor
Nigh served as President of the University of Central Oklahoma, where he had
served as Distinguished Statesman in Residence for the previous five years. From
January 1979 through 1987, Governor Nigh served as Governor of the State of
Oklahoma. Prior to 1979, Governor Nigh served 16 years at Lt. Governor and eight
years in the House of Representatives of the State of Oklahoma. Governor Nigh
currently serves on the Board of Directors for J.C. Penney Company and is a
consultant for Express Services Personnel.
Jan A. Norton. Mr. Norton was elected as a director of the Company and
the Banks immediately upon consummation of the Private Placement. In addition,
Mr. Norton became President of the Company and the Banks following consummation
of the Private Placement. Mr. Norton has served as President of Green Country
Bank since May 1994. From May 1992 through April 1994, Mr. Norton served as a
principal with the Thistle Group, a corporate financial consulting firm located
in Dallas, Texas.
J. David Rosenberg. Mr. Rosenberg has been a partner of Keating Muthing
& Klekamp, a law firm engaged in private practice, since prior to 1992. Mr.
Rosenberg is a director of Roses Holding, Inc. formerly Roses Stores, Inc.,
Henderson, North Carolina, which was formerly engaged in the operation of
general merchandise variety stores and which currently conducts no operations.
Mr. Rosenberg was elected as a director of the Company in February 1998.
Edward A. Townsend. Mr. Townsend was elected as a director of the
Company and the Banks immediately upon consummation of the Private Placement. In
addition, Mr. Townsend became Chairman and Chief Executive Officer of the
Company and the Banks following consummation of the Private Placement. Since
April 1994, Mr. Townsend has served as Chairman and Chief Executive Officer of
Green Country Bank and President of Green Country. From January 1993 through
March 1994, Mr. Townsend served as Senior Vice President of Stifel, Nicolaus &
Company, an investment banking firm located in St. Louis, Missouri. From October
1988 through September 1992, Mr. Townsend served as Chairman and President of
Local Federal. From 1967 to 1987, Mr. Townsend was employed in various positions
at InterFirst Corporation.
Kenneth W. Townsend. Mr. Townsend was elected as a director of the
Company and the Banks immediately following consummation of the Private
Placement. Mr. Townsend has served as Executive Director of the National Cowboy
Hall of Fame, Oklahoma City, Oklahoma, since January 1997. From August 1991
through June 1997, Mr. Townsend served as President of Boatmen's First National
Bank of Oklahoma, Oklahoma City, Oklahoma.
78
<PAGE> 81
Robert L. Vanden. Mr. Vanden was elected as a director of the Banks
immediately following consummation of the Private Placement. In addition, Mr.
Vanden began serving as Executive Vice President of the Banks upon consummation
of the Private Placement. From January 1997 until September 1997, Mr. Vanden
served as President and Chief Executive Officer of Local Federal. Since February
1990 through December 1996, Mr. Vanden served as Executive Vice President of
Local Federal in charge of wholesale commercial lending. Prior to joining Local
Federal in February 1990, Mr. Vanden served as Executive Vice President of the
Richard Gill Company and Gill Savings.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
Set forth below is information concerning the executive officers of the
Company and the Banks who do not serve on the Board of Directors of the Company
or the Banks. All executive officers were elected by the Board of Directors of
the Company and/or the Banks following consummation of the Private Placement and
serve until their successors are elected and qualified. No executive officer is
related to any director or other executive officer of the Company or the Banks
by blood, marriage or adoption, and there are no arrangements or understandings
between a director of the Company or the Banks and any other person pursuant to
which such person was elected an executive officer.
Richard L. Park. Mr. Park, who is 66 years old, began serving as
Executive Vice President and Chief Financial Officer of the Company and the
Banks in charge of finance and operations following consummation of the Private
Placement. Mr. Park has served as Chief Financial Officer of Green Country Bank
since October 1996. From January 1991 through May 1996, Mr. Park was Chief
Financial Officer of Western Farm Credit Bank in Sacramento, California, the
Eleventh District Bank in the Federal Farm Credit System. Mr. Park is a
Certified Public Accountant.
Christopher C. Turner. Mr. Turner, who is 39 years old, has served as
Executive Vice President of the Banks in charge of residential and consumer
lending and branch administration since October 1996. Prior to October 1996, Mr.
Turner held various positions in the Internal Audit Department of the Company
which he joined in November 1980. Prior to November 1980, Mr. Turner served as
an internal auditor with Continental Federal Savings and Loan.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is set forth under the caption "OTHER
INFORMATION ABOUT DIRECTORS, OFFICERS AND CERTAIN STOCKHOLDERS--Executive
Compensation" in the Company's definitive Proxy Statement filed in connection
with its 1998 Special Meeting of Stockholders and is incorporated herein by
reference.
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<PAGE> 82
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Local Financial became subject to the reporting requirements of the Securities
Exchange Act of 1934 on April 20, 1998. Prior to that time, there were no SEC
filing requirements applicable to its officers, directors and greater than ten
percent beneficial owners.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Banks' provide loans to its directors and offices in the ordinary
course of their business, on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for comparable
transactions with other persons. Such loans do not involve more than the normal
risk of collectibility or present other unfavorable features. As of December 31,
1997, mortgage and consumer loans to directors and officers in excess of $60,000
aggregated $210,426 or 0.26% of the Company's consolidated stockholders' equity
as of such date.
The Company had previously entered into the Merger Agreement with Green
Country, pursuant to which, effective February 16, 1998, Green Country was
merged with and into the Company, with the Company as the surviving corporation,
and in connection therewith, Green Country Bank was merged with and into Local
America. Messrs. Edward A. Townsend and Jan A. Norton, the Chairman and Chief
Executive Officer of the Company and the President and Chief Operating Officer
of the Company, respectively, were two of the three stockholders of Green
Country, each of whom received shares of Common Stock of the Company in
connection with the consummation of the transactions contemplated by the Merger
Agreement. See "Business--The Company--Acquisition of Green Country Banking
Corporation".
The Company has entered into the Post Placement Engagement with FBR,
which acted as the Company's Placement Agent in connection with the Private
Placement and the Redemption. Mr. Robert A. Kotecki, a director of the Company
and the Banks, is a Senior Vice President of FBR.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements. The following financial statements for the six
months ended December 31, 1997 and for the Years Ended June 30, 1997, 1996 and
1995 are filed as part of this report:
Independent Auditors' Report
Report of Independent Public Accountants
Consolidated Statements of Financial Condition as of December 31, 1997,
June 30, 1997 and June 30, 1996.
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<PAGE> 83
Consolidated Statements of Operations for the Six Months Ended December
31, 1997 and for the Years ended June 30, 1997, 1996 and 1995.
Consolidated Statements of Stockholders' Equity for the Six Months
Ended December 31, 1997 and for the Years ended June 30, 1997, 1996 and 1995.
Consolidated Statements of Cash Flows for the Six Months Ended December
31, 1997 and for the Years ended June 30, 1997, 1996 and 1995.
Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules.
No financial statement schedules are included because they are not
required, not applicable, or the required information is contained elsewhere.
(a)(3) Management Contracts or Compensatory Plan Arrangements
See exhibits marked with a double asterisk in Item 14(c) below.
(b) Reports on Form 8-K
On June 16, 1998, the Company filed a Form 8-K current report to report
that the Company's Board of Directors adopted a resolution changing the
fiscal year end from June 30 to December 31. No financial statements
were filed with this report.
On June 18, 1998, the Company filed a Form 8-K current report to report
that the Company's wholly-owned subsidiary, Local Federal Bank, F.S.B.,
had entered into a definitive agreement to acquire BankSouth
Corporation, a state bank holding company based in Lawton, Oklahoma. No
financial statements were filed with this report.
(c) List of Exhibits.
Exhibit
Number Description of Exhibit
- ------- ----------------------
3.1* Certificate of Incorporation of Local Financial Corporation
("Local Financial")
3.2* Certificate of Amendment or Certificate of Incorporation
of Local Financial
3.3* Bylaws of Local Financial
4.1* Purchase Agreement among Local Financial, Friedman
Billings, Ramsey & Co., Inc. ("FBR") and the Purchasers
Named therein, dated September 8, 1997
4.2* Registration Rights Agreement between Local Financial, FBR
81
<PAGE> 84
and the Purchasers, named therein, dated September 8, 1997
4.3* Indenture between Local Financial and The Bank of New York
("BONY"), as Trustee, dated September 8, 1997
4.4* Form of Common Stock certificate of Local Financial
4.5* Form of Senior Note (included in Exhibit 4.3)
5.0* Opinion of Elias, Matz, Tiernan & Herrick L.L.P.
re: legality
10.1* Redemption Agreement between Local Financial and Barron
Collier and Miles Collier (collectively, the "Selling
Stockholders")
Dated August 25, 1997
10.2* Amendment to Redemption Agreement between Local Financial and
the Selling Stockholders, dated September 5, 1997
10.3* Security Agreement between Local Financial and BONY, as
Trustee, dated September 8, 1997
10.4* Escrow Agreement between Local Financial, the Selling
Stockholders and BONY, as Escrow Agent, dated September 8,
1997
10.5* Common Interest Agreement between Local America, Inc., Local
America Bank of Tulsa, F.S.B., Local Federal Bank, F.S.B. and
the Selling Stockholders, dated September 8, 1997
10.6* Warrant of Local Financial to FBR to purchase 591,000 shares
of Common Stock, dated September 8, 1997
10.7* Employment Agreement between Local Financial and Edward A.
Townsend, dated September 8, 1997
10.8* Employment Agreement between Local Financial and Jan A.
Norton, dated September 8, 1997
10.9* Local Financial Stock Option Plan**
10.10* Local Financial Stock Option Agreement between Local Financial
and Edward A. Townsend, dated September 8, 1997**
16.0* Letter re: Change in certifying Accountant
21.0* Subsidiaries of the Registrant (see "Business--Subsidiaries"
in the Prospectus)
23.1* Consent of Eliaz, Matz, Tiernan & Herrick L.L.P.
(included in Exhibit 5.0)
24.0* Statement of Eligibility of Trustee
27.0 Financial Data Schedule
- ------------------
*These exhibits were filed with the Company's Registration Statement Form S-1,
Registration No. 333-43727 and are incorporated by reference herein:
**Exhibits 10.9 and 10.10 are compensatory plans or arrangements.
82
<PAGE> 85
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.
LOCAL FINANCIAL CORPORATION
Date: August 26, 1998 By: /s/Edward A. Townsend
---------------------------------
Edward A. Townsend, Chairman
and Chief Executive Officer
Date: August 26, 1998 By: /s/Richard L. Park
---------------------------------
Richard L. Park, Executive Vice
President and Chief Financial
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Date: August 26, 1998 By: /s/Robert A. Kotecki
--------------------------------
Robert A. Kotecki, Director
Date: August 26, 1998 By: /s/Joseph A. Leone
--------------------------------
Joseph A. Leone, Director
Date: August 26, 1998 By: /s/George Nigh
--------------------------------
George Nigh, Director
Date: August 26, 1998 By: /s/Jan A. Norton
--------------------------------
Jan A. Norton, Director
Date: August 26, 1998 By: /s/Edward A. Townsend
--------------------------------
Edward A. Townsend, Director
Date: August 26, 1998 By: /s/Kenneth W. Townsend
--------------------------------
Kenneth W. Townsend, Director
Date: August 26, 1998 By: /s/J. David Rosenberg
--------------------------------
J. David Rosenberg, Director
83
<PAGE> 86
LOCAL FINANCIAL CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report.........................................................F-1
Report of Independent Public Accountants.............................................F-2
Audited Consolidated Financial Statements:
Consolidated Statements of Financial Condition
as of December 31, 1997 and June 30, 1997 and 1996........................F-3
Consolidated Statements of Operations
for the Six Months Ended December 31, 1997 and
the Years Ended June 30, 1997, 1996 and 1995..............................F-4
Consolidated Statements of Stockholders' Equity
for the Six Months Ended December 31, 1997 and
the Years Ended June 30, 1997, 1996 and 1995..............................F-5
Consolidated Statements of Cash Flows
for the Six Months Ended December 31, 1997 and
the Years Ended June 30, 1997, 1996 and 1995..............................F-6
Notes to Consolidated Financial Statements
for December 31, 1997, June 30, 1997, 1996 and 1995.......................F-9
</TABLE>
84
<PAGE> 87
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Local Financial Corporation:
We have audited the accompanying consolidated statement of financial condition
of Local Financial Corporation and subsidiary (the Company) as of December 31,
1997, and the related consolidated statements of operations, stockholders'
equity, and cash flows for the six months ended December 31, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Local Financial
Corporation and subsidiary as of December 31, 1997, and the results of their
operations and their cash flows for the six months ended December 31, 1997, in
conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Oklahoma City, Oklahoma
February 6, 1998
F-1
<PAGE> 88
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Local Financial Corporation:
We have audited the accompanying consolidated statements of financial condition
of Local Financial Corporation and subsidiary (the "Company"), as of June 30,
1997 and 1996, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended June 30, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Local Financial
Corporation and subsidiary as of June 30, 1997 and 1996, and the results of
their operations and their cash flows for each of the three years in the period
ended June 30, 1997, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Oklahoma City, Oklahoma
August 27, 1997 (except with
respect to the matter discussed
in Note 2, as to which the date
is September 8, 1997)
F-2
<PAGE> 89
LOCAL FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except share data)
<TABLE>
<CAPTION>
December 31, June 30,
----------- ---------------------------
ASSETS 1997 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash and due from banks $ 34,152 $ 15,904 $ 13,640
Interest bearing deposits with other banks 20,000 89,500 --
Securities purchased under agreements to resell 178,000 -- --
Securities available for sale 518,107 985,565 1,741,725
Securities held to maturity -- 408,207 392,324
Equity securities available for sale -- -- 11,604
Loans receivable, net of allowance for loan losses of $20,484
at December 31, 1997, $11,435 at June 30, 1997, and $3,228 at
June 30, 1996 953,470 1,013,824 1,018,135
Federal Home Loan Bank of Topeka stock, at cost 45,147 40,046 23,421
Premises and equipment, net 10,646 11,060 11,035
Assets acquired through foreclosure and repossession, net 260 8,399 10,582
Intangible assets, net 1,779 2,398 3,636
Deferred tax asset, net 26,058 16,976 24,439
Current income taxes receivable 28,427 13,568 6,281
Other assets 65,319 19,734 21,689
----------- ----------- -----------
Total assets $ 1,881,365 $ 2,625,181 $ 3,278,511
=========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Demand $ 247,264 $ 248,322 $ 238,511
Savings 68,937 71,576 73,726
Time 1,286,332 1,324,458 1,290,223
----------- ----------- -----------
Total deposits 1,602,533 1,644,356 1,602,460
Advances from borrowers for taxes and insurance 5,046 7,481 6,939
Securities sold under agreements to repurchase -- 310,801 1,079,194
Advances from the Federal Home Loan Bank of Topeka 80,136 531,161 439,011
Senior notes 80,000 -- --
Note payable -- 7,010 14,020
Other liabilities 31,025 21,743 28,828
----------- ----------- -----------
Total liabilities 1,798,740 2,522,552 3,170,452
----------- ----------- -----------
Commitments and contingencies
Stockholders' equity:
Common stock, $0.01 par value, 25,000,000 shares authorized;
19,700,060 shares issued and 19,700,000 shares outstanding at
December 31, 1997; 2,000 shares authorized; 60 shares issued
and outstanding at June 30, 1997 and 1996 197 -- --
Preferred stock, $0.01 par value, 5,000,000 shares authorized;
none outstanding -- -- --
Additional paid-in capital 197,766 16,896 8,797
Retained earnings 31,760 117,716 147,761
Treasury stock, 60 shares, at cost (149,436) -- --
Unrealized gains (losses) on securities available for
sale, net of income tax provision (benefit) of $1,259,
($17,222) and ($26,114), respectively 2,338 (31,983) (48,499)
----------- ----------- -----------
Total stockholders' equity 82,625 102,629 108,059
----------- ----------- -----------
Total liabilities and stockholders' equity $ 1,881,365 $ 2,625,181 $ 3,278,511
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
<PAGE> 90
LOCAL FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share data)
<TABLE>
<CAPTION>
Six Months
Ended
December 31, Years Ended June 30,
--------- -------------------------------------
1997 1997 1996 1995
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Interest and dividend income:
Loans $ 49,788 $ 107,715 $ 95,839 $ 74,791
Securities available for sale 28,113 81,861 61,939 19,767
Securities held to maturity 3,193 27,363 72,822 114,284
Federal Home Loan Bank of Topeka stock 1,677 3,658 3,220 3,719
Other investments 2,433 2,067 2,336 1,997
--------- --------- --------- ---------
Total interest and dividend
income 85,204 222,664 236,156 214,558
--------- --------- --------- ---------
Interest expense:
Deposit accounts 40,672 83,091 81,173 68,235
Advances from the Federal Home Loan
Bank of Topeka 14,005 57,442 58,309 55,747
Securities sold under agreements to
repurchase 2,073 28,202 46,400 36,503
Notes payable 3,073 1,026 1,606 2,105
--------- --------- --------- ---------
Total interest expense 59,823 169,761 187,488 162,590
--------- --------- --------- ---------
Net interest and dividend income 25,381 52,903 48,668 51,968
Provision for loan losses (25,578) (28,428) (5,117) (1,157)
--------- --------- --------- ---------
Net interest and dividend income (loss) after
provision for loan losses (197) 24,475 43,551 50,811
--------- --------- --------- ---------
Noninterest income:
Deposit related income 4,105 7,410 5,800 5,507
Loan fees and loan service charges 981 2,730 2,197 2,010
Net gains (losses) on sale of assets (112,669) (29,183) 1,248 8,145
Other 434 1,919 1,071 970
--------- --------- --------- ---------
Total noninterest income (loss) (107,149) (17,124) 10,316 16,632
--------- --------- --------- ---------
Noninterest expense:
Compensation and employee benefits 7,731 14,588 14,177 23,776
Deposit insurance premiums 522 12,470 3,617 3,535
Provision for uninsured risk -- 3,300 1,372 5,728
Equipment and data processing 1,485 3,080 2,847 2,600
Occupancy 1,416 2,873 2,595 2,361
Advertising 522 1,556 1,131 1,310
Professional fees 984 1,152 825 970
Other 10,025 10,237 8,863 6,180
--------- --------- --------- ---------
Total noninterest expense 22,685 49,256 35,427 46,460
--------- --------- --------- ---------
Income (loss) before provision (benefit) for
income taxes (130,031) (41,905) 18,440 20,983
Provision (benefit) for income taxes (44,075) (11,860) 4,872 6,568
--------- --------- --------- ---------
Net income (loss) $ (85,956) $ (30,045) $ 13,568 $ 14,415
========= ========= ========= =========
Historical basic and diluted net income (loss)
per share $ (4.76) $ (1.95) $ 0.88 $ 0.94
========= ========= ========= =========
Pro forma basic and diluted net income (loss)
per share $ (4.36) $ (1.53) N/A N/A
========= ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-4
<PAGE> 91
LOCAL FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED DECEMBER 31, 1997
AND FOR THE YEARS ENDED JUNE 30, 1997, 1996 AND 1995
(Dollars in thousands)
<TABLE>
<CAPTION>
Unrealized
Gains (Losses)
Additional on Securities Total
Common Paid-in Retained Treasury Available for Stockholders'
Stock Capital Earnings Stock Sale, Net Equity
-------- --------- --------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1994 $ -- $ 8,797 $ 119,778 $ -- $ (1,887) $ 126,688
Net income -- -- 14,415 -- -- 14,415
Net change in unrealized gains
on securities available for sale,
net of income tax of $1,141 -- -- -- -- 2,116 2,116
-------- --------- --------- -------- -------- --------
Balance, June 30, 1995 -- 8,797 134,193 -- 229 143,219
Net income -- -- 13,568 -- -- 13,568
Unrealized losses on securities
transferred from held to
maturity to available for sale,
net of income tax benefit of ($5,832) -- -- -- -- (10,831) (10,831)
Net change in unrealized
losses on securities available
for sale, net of income tax
benefit of ($20,406) -- -- -- -- (37,897) (37,897)
-------- --------- --------- -------- -------- --------
Balance, June 30, 1996 -- 8,797 147,761 -- (48,499) 108,059
Net loss -- -- (30,045) -- -- (30,045)
Net change in unrealized gains on
securities available for sale, net of
income tax of $8,892 -- -- -- -- 16,516 16,516
Capital contribution -- 8,099 -- -- -- 8,099
-------- --------- --------- -------- -------- --------
Balance, June 30, 1997 -- 16,896 117,716 -- (31,983) 102,629
-------- --------- --------- -------- -------- --------
Net loss -- -- (85,956) -- -- (85,956)
Net change in unrealized gains on
securities available for sale, net of
income tax of $18,481 -- -- -- -- 34,321 34,321
Issuance of common stock 197 180,870 -- -- -- 181,067
Purchase of treasury stock -- -- -- (149,436) -- (149,436)
-------- --------- --------- -------- -------- --------
Balance, December 31, 1997 $ 197 $197,766 $ 31,760 $(149,436) $ 2,338 $ 82,625
======== ========= ========= ======== ========= ========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-5
<PAGE> 92
LOCAL FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months
Ended
December 31, Years Ended June 30,
--------- -------------------------------------
1997 1997 1996 1995
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
CASH PROVIDED BY OPERATING ACTIVITIES:
Net income (loss) $ (85,956) $ (30,045) $ 13,568 $ 14,415
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Provisions for loan losses and uninsured
risk and losses on assets acquired through
foreclosure and repossession 25,641 31,804 6,673 6,821
Deferred income tax expense (benefit) (27,585) (1,429) 1,961 (6,033)
Accretion of discounts on loans acquired (2,963) (6,019) (4,281) (5,169)
Amortization of deferred (gains) losses on
interest rate swaps 806 73 (671) (11)
Net amortization (accretion) of premium on
securities available for sale (95) 8,265 11,905 6,898
Net amortization (accretion) of premium on
securities held to maturity 97 2,090 -- --
Depreciation and amortization 1,347 2,688 2,450 2,392
Proceeds from the sales of loans 11,416 12,132 15,155 27,861
(Gain) loss on sale of assets 112,669 29,183 (1,248) (8,145)
Stock dividends received from Federal Home
Loan Bank stock (1,677) (3,658) -- --
Change in other assets (15,299) (5,332) (1,504) (7,341)
Change in other liabilities 9,282 (9,296) (3,013) 10,455
--------- --------- --------- ---------
Net cash provided by operating
activities 27,683 30,456 40,995 42,143
--------- --------- --------- ---------
CASH PROVIDED (ABSORBED) BY INVESTING
ACTIVITIES:
Proceeds from sales of securities available
for sale 865,146 730,957 50,321 70,243
Proceeds from principal collections on
securities available for sale 52,735 13,245 80,977 113,845
Proceeds from principal collections on
securities held to maturity 28,054 52,161 -- --
Purchases of securities available for sale (6,001) -- (5,320) (17,715)
Purchases of securities held to maturity (74,440) (73,389) -- (15,058)
Purchases of interest rate caps -- -- (3,720) (4,935)
Payments on termination of interest rate swap
agreements (47,283) -- (3,344) --
Proceeds from termination of interest rate
swap agreements -- -- 3,637 --
Proceeds from sales of equity securities
available for sale -- 12,986 -- 5,017
Proceeds from sales of securities held to
maturity -- -- -- 19,995
Purchases of securities under agreements to
resell (424,000) -- -- --
Proceeds from maturity of securities purchased
under agreements to resell 246,000 -- -- --
Purchases of Federal Home Loan Bank stock (3,424) (80,850) (71,425) (7,564)
</TABLE>
F-6
<PAGE> 93
LOCAL FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months
Ended
December 31, Years Ended June 30,
----------- -------------------------------------------
1997 1997 1996 1995
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Proceeds from the sale of Federal Home Loan
Bank stock $ -- $ 67,883 $ 83,400 $ 61,105
Loans made by non-bank subsidiary (26) (29,213) (133,914) (20,746)
Repayments of loans made by non-bank subsidiary 13,710 49,755 39,411 1,964
Change in loans receivable, net (24,814) (63,247) (142,412) (158,875)
Proceeds from disposal of assets acquired
through foreclosure and repossession 6,381 18,257 5,806 2,516
Purchases of premises and equipment (465) (1,480) (1,649) (622)
Proceeds from sales of premises and equipment 25 9 72 230
----------- ----------- ----------- -----------
Net cash provided (absorbed) by investing
activities 631,598 697,074 (98,160) 49,400
----------- ----------- ----------- -----------
CASH PROVIDED (ABSORBED) BY FINANCING
ACTIVITIES:
Change in transaction accounts (3,697) 7,635 (20,256) (95,139)
Change in time deposits (38,126) 34,261 44,894 198,790
Change in securities sold under agreements to
repurchase (312,774) (770,223) 299,568 397,797
Proceeds from advances from the Federal
Home Loan Bank 1,303,599 9,978,290 4,679,967 1,399,513
Repayments of advances from the Federal
Home Loan Bank (1,757,377) (9,886,271) (4,941,297) (1,983,677)
Proceeds from issuance of common stock 181,067 -- -- --
Proceeds from issuance of senior notes 80,000 -- -- --
Payments of debt issuance costs (4,344) -- -- --
Repayments of note payable (7,010) -- (7,010) (7,010)
Purchase of treasury stock (149,436) -- -- --
Change in advances by borrowers for taxes
and insurance (2,435) 542 442 1,002
----------- ----------- ----------- -----------
Net cash provided (absorbed) by
financing activities (710,533) (635,766) 56,308 (88,724)
----------- ----------- ----------- -----------
Net change in cash and cash equivalents (51,252) 91,764 (857) 2,819
Cash and cash equivalents at beginning of period 105,404 13,640 14,497 11,678
----------- ----------- ----------- -----------
Cash and cash equivalents at end of period $ 54,152 $ 105,404 $ 13,640 $ 14,497
=========== =========== =========== ===========
Supplemental disclosures of cash flow information:
Cash paid (received) during the period for:
Interest $ 60,190 $ 173,920 $ 186,052 $ 169,313
=========== =========== =========== ===========
Income taxes $ (1,631) $ -- $ 9,250 $ 14,000
=========== =========== =========== ===========
Supplemental schedule of noncash investing and
financing activities:
Loans made to facilitate the sale of assets
acquired through foreclosure and repossession $ -- $ 79 $ 592 $ 652
=========== =========== =========== ===========
Transfers of loans to assets acquired through
foreclosure and repossession $ 4,273 $ 16,000 $ 8,137 $ 1,204
=========== =========== =========== ===========
</TABLE>
F-7
<PAGE> 94
LOCAL FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months
Ended
December 31, Years Ended June 30,
----------- -----------------------------------------
1997 1997 1996 1995
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Transfer of investments from held to maturity to
available for sale at estimated market value
(amortized cost of $454,496 for the six months
ended December 31, 1997 and $1,500,793 for
the year ended June 30, 1996) $ 448,180 $ -- $ 1,484,130 $ --
=========== =========== =========== ===========
Transfer of loans to mortgage-backed
certificates available for sale $ -- $ -- $ -- $ 60,824
=========== =========== =========== ===========
Transfer of debt securities to available for
sale loans $ 1,425 $ -- $ -- $ --
=========== =========== =========== ===========
Repayment of note payable and accrued interest
by shareholders $ -- $ 8,099 $ -- $ --
=========== =========== =========== ===========
Transfer of assets acquired through foreclosure
and repossession to other assets $ 6,045 $ -- $ -- $ --
=========== =========== =========== ===========
Receivable on loans sold in other assets $ 34,594 $ -- $ -- $ --
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
F-8
<PAGE> 95
LOCAL FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, JUNE 30, 1997, 1996 AND 1995
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Local Financial Corporation ("Local Financial") is a thrift holding company
which owns 100% of the outstanding common stock of Local Federal Bank, a Federal
Savings Bank ("Local"). The accounting and reporting practices of the Company
reflect industry practices and are in accordance with generally accepted
accounting principles. The financial information and results of operations as of
and for the six months ended December 31, 1997 are not necessarily indicative of
the financial position and results of operations that may be obtained for a full
fiscal year. The more significant policies are described below.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Local
Financial, and its wholly owned subsidiary, Local, as well as Local's
subsidiaries, Local America Bank of Tulsa, a Federal Savings Bank ("LAB"), Local
Acceptance Company ("Local Acceptance"), Star Financial Services Corporation
("Star Financial"), Local Mortgage Corporation ("Local Mortgage"), Oklahoma
Financial Services Corporation, and Star Properties, Incorporated ("Star
Properties"). Local and LAB are insured depository institutions which obtain
deposit funds primarily through retail branches throughout the State of Oklahoma
and lend those funds throughout the United States. Local Acceptance's and Star
Financial's principal activities were originating auto loan contracts through
dealerships in Florida and Oklahoma, respectively (operations ceased as of
December 31, 1997). Local Mortgage's principal activity is originating
commercial real estate loans. Oklahoma Financial Services Corporation has an
ownership interest in a credit life insurance company through which Local writes
credit life insurance. Star Properties' principal activities are the ownership
and leasing of certain office properties and related equipment to Local. Local
Financial and its subsidiary, Local, are collectively referred to as the
Company. All significant intercompany accounts and transactions have been
eliminated in the accompanying consolidated financial statements.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions. Those estimates and assumptions relate
principally to the determination of the allowance for loan losses, income taxes,
the valuation of assets acquired through foreclosure and repossession and the
fair value of financial instruments. Actual results could differ from those
estimates. The accounting policies for these items and other significant
accounting policies are presented below. Certain reclassifications to 1996 and
1995 balances have been made to provide consistent financial statement
classifications in the periods presented herein. Such reclassifications had no
effect on net income (loss) and no material effect on total assets.
Statements of Cash Flows
For the purpose of the consolidated statements of cash flows, the Company
defines cash and cash equivalents as cash and due from banks and interest
bearing deposits with other banks.
F-9
<PAGE> 96
Securities
Federal regulations require the Company to maintain average monthly liquid
assets, primarily cash and U. S. Government and other approved securities, in an
amount at least equal to 5% of deposit accounts (net of loans on deposit
accounts) plus short-term borrowings. For the six months ended and month ended
December 31, 1997, the Company's average liquidity totaled approximately 10% and
16%, respectively. For the year and month ended June 30, 1997, the Company's
average liquidity totaled approximately 5% and 8%, respectively.
The Company's securities consist primarily of mortgage-backed certificates and
U. S. Government and agencies securities. Mortgage-backed certificates consist
of mortgage-backed pass-through certificates ("MBS") and mortgage-derivative
securities ("MDS") such as collateralized mortgage obligations and real estate
mortgage investment conduits. The Company does not own any principal only,
interest only or residual tranches of mortgage-backed certificates. The Company
classifies its securities as held to maturity, available for sale and held for
trading, as applicable. The Company did not hold any trading securities during
the six months ended December 31, 1997 or the fiscal years ended June 30, 1997,
1996 and 1995.
Held to Maturity Securities
The Company classified certain mortgage-backed securities and agencies
securities as held to maturity. Management had the positive intent and the
Company had the ability to hold to maturity these securities at June 30, 1997,
as part of its portfolio of long-term interest-earning assets. Held to maturity
securities are carried at cost, adjusted for amortization of premiums and
accretion of discounts. Premiums and discounts are amortized or accreted in the
consolidated statements of operations to approximate a level yield over the life
of the related security.
Available for Sale Securities
The Company has classified certain mortgage-backed securities and equity
securities as available for sale. At the time of purchase, the Company
classifies securities as available for sale when such securities may be sold at
a future date or if there are foreseeable circumstances under which the Company
would sell such securities prior to maturity.
Securities classified as available for sale are recorded at their estimated
market value. Changes in the estimated market value of securities available for
sale are included in stockholders' equity as unrealized gains or losses, net of
the related income tax effect. Unrealized losses on available for sale
securities, which are judged to be other than temporary, are charged to earnings
in the consolidated statements of operations (see Note 5). Gains and losses on
available for sale securities are computed on a specific identification basis.
Premiums and discounts are amortized or accreted in the consolidated statements
of operations to approximate a level yield over the life of the related
security.
Loans Receivable
Loans receivable are recorded at the contractual amounts owed by borrowers, less
deferred income, unearned interest, the allowance for loan losses, undisbursed
funds, and discounts on loans acquired or originated. Interest on loans is
credited to income as earned, to the extent deemed collectible. Discounts on
loans and unearned interest on consumer loans are accreted into interest income
to approximate a level yield over the contractual lives of the loans, adjusted
for actual prepayments.
Loans are placed on nonaccrual status when they become 90 days past due.
Previously accrued but uncollected interest on loans placed on nonaccrual status
is reversed unless determined to be fully collectible. Payments received on
nonaccrual loans are generally applied to principal as they are received. Upon
full collection of the principal balance or determination that future collection
of principal is probable, interest income is recognized as received.
F-10
<PAGE> 97
Provision and Allowance for Loan Losses
Each period the provision for loan losses in the consolidated statements of
operations results from the combination of a) an estimate by management of loan
losses that occurred during the current period and b) the ongoing adjustment of
prior estimates of losses occurring in prior periods.
To serve as a basis for making this provision each quarter, the Company
maintains an extensive credit risk monitoring process that considers several
factors including: current economic conditions affecting the Company's
customers, the payment performance of individual large loans and pools of
homogeneous small loans, portfolio seasoning, changes in collateral values, and
detailed reviews of specific large loan relationships. For large loans deemed to
be impaired due to an expectation that all contractual payments will probably
not be received, impairment is measured by comparing the Company's recorded
investment in the loan to the present value of expected cash flows discounted at
the loan's effective interest rate, the fair value of the collateral or the
loan's observable market price.
The provision for loan losses increases the allowance for loan losses, a
valuation account which is netted against loans on the consolidated statements
of financial condition. As the specific customer and amount of a loan loss is
confirmed by gathering additional information, taking collateral in full or
partial settlement of the loan, bankruptcy of the borrower, etc., the loan is
written down, reducing the allowance for loan losses. If, subsequent to a
writedown, the Company is able to collect additional amounts from the customer
or obtain control of collateral worth more than previously estimated, a recovery
is recorded, thus increasing the allowance for loan losses.
Loan Origination Fees, Loan Commitment Fees and Related Costs
The Company defers loan origination fees, loan commitment fees and the
incremental direct costs (principally compensation and benefits relating to
successful underwriting efforts) relative to loans originated. These deferred
fees and costs are amortized into interest income to approximate a level yield
over the life of the related loans, adjusted for actual prepayments. Other loan
fees such as loan servicing fees, late payment fees and prepayment penalties are
included as a component of noninterest income in the accompanying consolidated
statements of operations.
Loans Held for Sale and Gains and Losses from the Sale of Loans
Loans originated and intended for sale are carried at the lower of cost or
estimated market value in the aggregate. Net unrealized losses are recognized
through a valuation allowance by charges to income. There were no loans other
than student loans held for sale at December 31, 1997, June 30, 1997 and 1996.
Gains and losses resulting from the sale of loans are determined by the specific
identification method and reflect the extent that sales proceeds exceed or are
less than the carrying value of the loans sold. In some cases, the Company sells
loans and continues to service such loans for the investor. In these cases, the
Company recognizes either a servicing asset, at its allocated previous carrying
amount based on relative fair value, or a servicing liability at fair value. Any
servicing assets recognized as part of the sale are amortized as a deduction
from servicing income in proportion to and over the period of estimated net
servicing income. To the extent sales of loans involve the sale of part of a
loan or a pool of loans, the cost basis is allocated based upon the relative
fair value of the portion sold and the portion retained. Impairment of servicing
assets is assessed based on the fair value of those assets. Fair values are
estimated using discounted cash flows based on a current market interest rate.
At December 31, 1997, June 30, 1997 and June 30, 1996, the carrying value of
servicing assets was not impaired.
F-11
<PAGE> 98
Loan Servicing
Loans serviced by the Company for others are primarily the result of the Company
selling loans while retaining the servicing of those loans. These loans are not
included with loans receivable or any other asset in the accompanying
consolidated statements of financial condition. Fees earned for servicing loans
owned by investors are reported as income when the related loan payments are
collected. Loan servicing costs are charged to expense as incurred. Loans
serviced for others totaled approximately $124,525,000, $144,498,000 and
$178,836,000 at December 31, 1997, June 30, 1997, and June 30, 1996,
respectively. Servicing fees earned totaled approximately $291,000, $521,000,
$581,000 and $821,000 for the six months ended December 31, 1997, and for the
years ended June 30, 1997, 1996, and 1995, respectively, and are included as a
component of loan fees and loan service charges in the accompanying consolidated
statements of operations.
Premises and Equipment
Buildings, building improvements, furniture, fixtures and equipment are stated
at cost, less accumulated depreciation and amortization. Depreciation and
amortization is computed using the straight-line method over the estimated
useful lives of the related assets. Estimated lives range from 25 to 30 years
for buildings and building improvements and 3 to 10 years for furniture,
fixtures and equipment.
Maintenance and repairs are charged to expense as incurred and building
improvements are capitalized. The costs and accumulated depreciation relating to
premises and equipment retired or otherwise disposed of are eliminated from the
accounts and any resulting gains or losses are credited or charged to income.
Assets Acquired Through Foreclosure and Repossession
Assets acquired through foreclosure and repossession are recorded at estimated
fair value, net of estimated selling costs at the date of foreclosure or
repossession. The values of assets acquired through foreclosure and repossession
are monitored by the Company continually through sales and rental activities,
and by updated appraisals and other valuation methods when needed. The allowance
for losses on assets acquired through foreclosure and repossession is an amount
which management believes will be adequate to absorb losses from the disposition
and/or revaluation of these assets. Additions or reversals of the allowance for
losses on assets acquired through foreclosure and repossession are provided as
an expense or a benefit, respectively, through other expense in the accompanying
consolidated statements of operations. The allowance for losses is charged or
reduced as losses through sales or reevaluations are incurred.
Debt Issuance Costs
Debt issuance costs of approximately $4,344,000 at December 31, 1997, were
capitalized and are included in other assets in the consolidated statements of
financial condition. Debt issuance costs are amortized over the life of the
senior notes as a yield adjustment to notes payable interest expense in the
consolidated statements of operations.
Intangible Assets
Intangible assets consist of core deposit premiums paid in the acquisitions of
other depository institutions. These premiums are capitalized and amortized over
the expected lives of the core deposits, estimated to be eight to ten years,
using the straight-line method. Amortization expense totaled approximately
$619,000 for the six months ended December 31, 1997, and $1,238,000 for each of
the years ended June 30, 1997, 1996 and 1995. Accumulated amortization of core
deposit premiums at December 31, 1997, and June 30, 1997 and 1996, totaled
approximately $9,539,000, $8,920,000 and $7,682,000, respectively.
F-12
<PAGE> 99
Interest Rate Swap, Cap and Floor Agreements
Interest rate swap, cap and floor agreements are entered into as a hedge to
stabilize the Company's funding cost and to stabilize the Company's yield on
floating rate debt securities, and as part of the Company's overall
asset/liability management program. The most frequently used derivative products
are various types of interest rate swaps. However, interest rate caps and floors
are also utilized. These derivatives are typically classified as either hedges
or synthetic alterations. The criteria that must be satisfied for each of these
classifications are as follows: (i) Hedge - the asset or liability to be hedged
exposes the Company, as a whole, to interest rate risk; (ii) Synthetic
alteration - the asset or liability converted exposes the Company, as a whole,
to interest rate risk and the derivative is designed and effective as a
synthetic alteration of a statement of financial condition item. Net interest
income or expense from the interest rate swap, cap and floor agreements is
recorded as an adjustment to the interest income/expense of the hedged
asset/liability, respectively. Premiums paid for caps and floors are amortized
over their contractual lives using the straight-line method. When interest rate
swap agreements are sold or settled without the simultaneous disposition of a
hedged item, any gain or loss is deferred and amortized into interest income or
expense over the remaining term of the swap agreement or until disposition of
the hedged item. As the assets or liabilities being hedged are sold or
liquidated, a proportionate amount of the deferred gain or loss and unamortized
premiums is also recognized. Deferred gains or losses and unamortized premiums
are reflected as an adjustment to the carrying value of the hedged item in the
accompanying consolidated statements of financial condition.
Income Taxes
Deferred tax assets and liabilities are reflected at currently enacted income
tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.
Net Income (Loss) Per Share
Basic net income (loss) per share is based upon the weighted average number of
shares outstanding during the period. Stock options and warrants to purchase
common stock are considered in diluted income per share calculations, if
dilutive, and are computed using the treasury stock method. As a result of the
recapitalization discussed in Note 2, the weighted average number of shares used
in the computation of income (loss) per share is 15,400,000 for each of the
years in the three-year period ended June 30, 1997 (based on an equivalent
number of shares for the 60 shares outstanding prior to the recapitalization).
For the six months ended December 31, 1997 the weighted average number of shares
is 18,066,000. Stock options and warrants to purchase common stock discussed in
Notes 2 and 18 were outstanding during the six months ended December 31, 1997,
but were not included in the computation of diluted income (loss) per share
because of the net loss for the six months ended December 31, 1997.
Pro forma net income (loss) per share assumes that the 19,700,000 shares issued
in the recapitalization were outstanding for the six months ended December 31,
1997 and for the year ended June 30, 1997.
New Accounting Pronouncements
During 1996, the Financial Accounting Standards Board ("FASB") issued SFAS No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities." This statement provides accounting and reporting
standards for transfers and servicing of financial assets and extinguishments of
liabilities. Under this statement, after a transfer of financial assets, an
entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished. This statement
provides consistent standards for distinguishing transfers of financial assets
which are sales from transfers that are secured borrowings. This statement is
effective for transactions entered into after December 31, 1996. There was not a
material adverse impact on the
F-13
<PAGE> 100
consolidated financial position or the results of operations of the Company due
to the adoption of this new accounting pronouncement.
During 1997, the FASB issued SFAS No. 128, "Earnings per Share." This statement
establishes standards for computing and presenting earnings per share. This
statement requires all previously reported financial statements to be restated
to report earnings per share as calculated under SFAS No. 128. The Company
adopted this statement effective December 31, 1997, and it did not have an
impact on the consolidated financial position of the Company, or the net income
(loss) per share as reported herein.
In March 1997, the FASB issued SFAS No. 129, "Disclosure of Information About
Capital Structure." SFAS No. 129 continues the existing requirements to disclose
the pertinent rights and privileges of all securities other than ordinary common
stock but expands the number of companies subject to portions of its
requirements. Specifically, the Statement requires all entities to provide the
capital structure disclosures previously required by APB Opinion No. 15.
Companies that were exempt from the provisions of APB Opinion No. 15 will now
need to make those disclosures. This Statement had no impact on the Company's
disclosures.
The FASB has also issued SFAS No. 130, "Reporting Comprehensive Income." This
statement is required to be adopted by the Company in fiscal 1999. Management
does not anticipate this statement to have a material adverse impact on the
consolidated financial position or the results of operations of the Company.
In July 1997, the FASB issued SFAS No. 131, "Disclosure About Segments of an
Enterprise and Related Information." This statement requires disclosure for each
segment that are similar to those required under current standards with the
addition of quarterly disclosure requirements and a finer partitioning of
geographic disclosures. It requires limited segment data on a quarterly basis.
It also requires geographic data by country, as opposed to broader geographic
regions as permitted under current standards. The statement is required to be
adopted by the Company in fiscal 1999. Management does not anticipate this
statement to have a material adverse impact on the consolidated financial
position or the results of operations of the Company.
2. CHANGE IN OWNERSHIP AND MANAGEMENT:
On September 8, 1997, the Company completed a securities offering in which,
after increasing the number of authorized shares from 2,000 to 25,000,000,
19,700,000 shares of common stock totaling $197,000,000 and $80,000,000 of 11%
Senior Notes were issued to individual investors. Of the total net proceeds
received in the offering ($257,300,000), $7,200,000 was used to repay the note
payable and associated accrued interest to Isabel Collier Read (see Note 12) and
approximately $154,000,000 was used to redeem all of the previously issued and
outstanding shares of the Company's common stock. The redemption amount is
subject to adjustment under terms set forth in the Redemption Agreement, as
defined. Subsequent to September 8, 1997, adjustments totaling $5,000,000 were
assessed against shareholders and were reflected as a reduction to the cost of
treasury stock with a corresponding receivable from the Selling Shareholders of
approximately $5,000,000 recorded in other assets in the consolidated statements
of financial condition. The remainder of the proceeds was used to make capital
contributions to Local of approximately $83,839,000, as well as establish an
interest reserve account for the Senior Notes of approximately $8,800,000 and an
other reserve account of approximately $3,000,000.
In connection with the securities offering and redemption, the existing board of
directors resigned and a new board of directors was appointed. In addition, a
new chief executive officer and a new president of the Company were appointed.
Prior to the securities offering and change in management, the Company's
strategy had been to operate a low cost institution structured around the
following areas: (i) a nationally diversified wholesale commercial real estate
mortgage portfolio; (ii) a retail deposit franchise within Oklahoma operated on
a low-overhead basis delivering a traditional set of thrift products and
services, including conforming single-family residential home loans, equity,
student guaranteed, direct automobile and installment loans through its branch
F-14
<PAGE> 101
network; (iii) a wholesale securities portfolio involving derivative mortgage
securities funded both by retail, as well as, wholesale funding through advances
from the Federal Home Loan Bank of Topeka ("FHLB") and securities sold under
agreements to repurchase; and (iv) origination of indirect subprime automobile
finance contracts through dealerships in Oklahoma and Florida (originations
ceased in fiscal 1997). New management has indicated that, among other things,
they intend to (i) cease the wholesale securities strategy previously employed
by the Company and cause the Company to sell all or a substantial portion of its
derivative mortgage portfolio and (ii) utilize the proceeds to repay outstanding
advances from the FHLB and securities sold under agreements to repurchase, as
well as terminate and liquidate the Company's interest rate contracts associated
with the derivative mortgage portfolio and the advances from the FHLB and
securities sold under agreements to repurchase.
At June 30, 1997, the carrying value of the Company's mortgaged-backed
securities and associated interest rate contracts (see Notes 5 and 20) totaled
approximately $1,393,772,000 with an estimated market value of $1,384,482,000.
The carrying value of the Company's advances from the FHLB and securities sold
under agreements to repurchase and associated interest rate contracts (see Notes
10, 11 and 20) totaled approximately $841,962,000 at June 30, 1997, with an
estimated market value of $884,059,000.
Since the events described above occurred subsequent to June 30, 1997, no
adjustments have been made to the accompanying June 30, 1997, consolidated
financial statements to reflect assets and liabilities at amounts that may
ultimately be recovered or settled by the Company as a result of changes in
operations or strategies intended by new management. All such adjustments have
been recorded in the consolidated statement of operations for the six months
ended December 31, 1997.
In connection with the securities offering, warrants to buy 591,000 shares of
common stock of the Company were issued to the placement agent. The warrants
will be exercisable for a five year period commencing upon the date of
consummation, September 8, 1997, at an exercise price of $10 per share.
The issuance of new shares of common stock and Senior Notes and redemption of
all previously issued common stock have been accounted for as a recapitalization
with no adjustments to the carrying amounts of assets and liabilities since none
of the new investors individually or in concert control the Company. Regulatory
approval of the change in ownership was not required as the Office of Thrift
Supervision (OTS) does not require regulatory approval unless an investor or
group of investors in concert own more than 9.9% of the voting common stock.
3. SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL:
Securities purchased under agreements to resell at December 31, 1997, are
summarized as follows (in thousands):
<TABLE>
<S> <C>
Average outstanding balance $ 60,000
Maximum month-end balance 178,000
Mortgage-backed securities securing the
agreements at period-end:
Carrying value 178,000
Estimated market value 184,000
</TABLE>
Securities purchased under agreements to resell are held by the broker-dealers
who arranged the transactions. The agreements generally mature within one month.
F-15
<PAGE> 102
4. EQUITY SECURITIES:
A summary of equity securities available for sale as of June 30, 1996, is as
follows (in thousands):
<TABLE>
<CAPTION>
Gross Gross Estimated
Unrealized Unrealized Market
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Student Loan Marketing
Association Preferred stock $ 12,679 $ -- $ 1,075 $ 11,604
========== ========== ========== ==========
</TABLE>
Proceeds from the sale of equity securities during 1997 were approximately
$12,986,000. Gross gains of $307,000 were realized in 1997. There were no sales
of equity securities in 1996. Proceeds from the sale of equity securities during
1995 were approximately $5,017,000. Gross gains of $228,000 were realized in
1995.
5. SECURITIES:
A comparative summary of securities available for sale is as follows (in
thousands):
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
December 31, 1997:
U.S. Government and agency
securities $ 6,001 $ -- $ 1 $ 6,000
Collateralized mortgage
obligations:
FNMA 265,088 2,199 1,088 266,199
FHLMC 140,781 1,773 61 142,493
Private Issuer 19,966 249 31 20,184
Mortgage-backed securities:
FHLMC 44,085 143 1 44,227
Private Issuer 36,584 407 -- 36,991
FNMA 1,619 8 -- 1,627
GNMA 386 1 1 386
---------- ---------- ---------- ----------
$ 514,510 $ 4,780 $ 1,183 $ 518,107
========== ========== ========== ==========
June 30, 1997:
Collateralized mortgage obligations:
FNMA $ 506,249 $ -- $ 22,741 $ 483,508
FHLMC 496,695 -- 22,732 473,963
Mortgage-backed securities:
Private Issuer 28,798 -- 752 28,046
Interest rate caps and floors 3,051 -- 3,003 48
---------- ---------- ---------- ----------
$1,034,793 $ -- $ 49,228 $ 985,565
========== ========== ========== ==========
June 30, 1996:
Collateralized mortgage obligations:
FHLMC $ 915,781 $ -- $ 30,845 $ 884,936
FNMA 844,549 -- 33,586 810,963
Mortgage-backed securities:
Private Issuer 42,190 -- 1,016 41,174
Interest rate caps and floors 12,742 -- 8,090 4,652
---------- ---------- ---------- ----------
$1,815,262 $ -- $ 73,537 $1,741,725
========== ========== ========== ==========
</TABLE>
F-16
<PAGE> 103
A comparative summary of securities held to maturity at June 30 is as follows
(in thousands):
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
-------- -------- -------- --------
<S> <C> <C> <C> <C>
June 30, 1997:
U.S. Government and agency
securities $ 74,119 $ 100 $ -- $ 74,219
Collateralized mortgage obligations -
FNMA 77,759 -- 3,314 74,445
FHLMC 53,077 -- 2,733 50,344
Private Issuer 24,502 -- 640 23,862
Mortgage-backed securities -
FHLMC 153,838 10 2,268 151,580
Private Issuer 14,172 5 234 13,943
FNMA 10,311 62 266 10,107
GNMA 429 -- 12 417
-------- -------- -------- --------
$408,207 $ 177 $ 9,467 $398,917
======== ======== ======== ========
June 30, 1996:
Collateralized mortgage obligations -
FNMA $ 77,794 $ -- $ 3,244 $ 74,550
FHLMC 53,082 -- 1,643 51,439
Private Issuer 31,950 -- 1,105 30,845
Mortgage-backed securities -
FHLMC 194,924 -- 6,367 188,557
Private Issuer 21,563 95 696 20,962
FNMA 12,507 74 418 12,163
GNMA 504 -- 16 488
-------- -------- -------- --------
$392,324 $ 169 $ 13,489 $379,004
======== ======== ======== ========
</TABLE>
During the period following June 30, 1997, and prior to the change in ownership
of the Company on September 8, 1997, the Company purchased approximately
$74,440,000 in agency securities for the held to maturity portfolio. These
short-term securities were purchased to meet liquidity requirements. Subsequent
to the change in ownership of the Company, new management elected to classify
the held to maturity portfolio as available for sale. The amortized cost of
securities held to maturity transferred to securities available for sale was
approximately $454,496,000 with an unrealized loss of approximately $6,316,000.
Also, soon after the change in ownership, the Company sold approximately
$118,480,000 in agency securities, approximately $75,482,000 in mortgage backed
certificates and approximately $345,176,000 in floating rate securities for a
gross loss of approximately $17,336,000. Management also has the intent to sell
the remaining floating rate securities portfolio in the near future. Management
is of the opinion that the fair value of the floating rate security portfolio
will not recover to approximately the amortized cost of the portfolio prior to
the expected time of sale. As a result, the Company recognized through earnings
the unrealized loss on the remaining floating rate portfolio of $54,724,000
which is included in net gains (losses) on sale of assets in the accompanying
consolidated statement of operations for the six months ended December 31, 1997.
F-17
<PAGE> 104
At December 31, 1997, June 30, 1997 and 1996, securities held to maturity and
available for sale included floating rate securities with an amortized cost of
approximately $425,491,000, $1,158,988,000 and $1,918,886,000, respectively, and
fixed-rate securities of approximately $83,018,000, $206,842,000 and
$275,961,000, respectively. The floating-rate securities' weighted average yield
was 6.51%, 5.60% and 5.70% at December 31, 1997, June 30, 1997 and 1996,
respectively, including the effects of interest rate caps and floors hedging
these securities. The fixed rate securities' weighted average yield was 6.97%,
6.05% and 6.10% at December 31, 1997, June 30, 1997 and 1996, respectively. The
overall weighted average yield of securities was 6.83%, 5.66% and 5.75% at
December 31, 1997, June 30, 1997 and 1996, respectively.
The remaining contractual maturity of substantially all mortgage-backed
certificates at December 31, 1997, was more than ten years. Management expects
the actual maturities to be considerably shorter than their contractual
maturities, as borrowers may prepay obligations without prepayment penalties.
During fiscal 1997, the Company purchased approximately $73,389,000 in agency
securities held to maturity having a weighted average yield of 5.83% and
maturity dates of one year or less.
At December 31, 1997 and June 30, 1997, securities with a total par amount of
$73,957,000 and $1,250,299,000, respectively, were pledged to secure various
deposits, borrowings, interest rate swaps and securitization transactions.
Accrued interest receivable on securities of approximately $2,842,000,
$7,427,000 and $11,250,000 was included in other assets at December 31, 1997,
June 30, 1997 and 1996, respectively.
Proceeds from sales of securities available for sale for the six months ended
December 31, 1997, and for the years ended June 30, 1997, 1996 and 1995, were
approximately $865,146,000, $730,957,000, $50,321,000 and $70,243,000,
respectively. Gross gains of approximately $12,788,000, $1,000 and $2,185,000
were realized for the six months ended December 31, 1997, and for the years
ended June 30, 1996 and 1995, respectively. No gross gains were realized for the
year ended June 30, 1997. Gross losses of $17,398,000, $29,889,000, $182,000 and
$110,000 were realized for the six months ended December 31, 1997, and for the
years ended June 30, 1997, 1996 and 1995, respectively, and are included in net
gains (losses) on sale of assets in the accompanying consolidated statements of
operations. No sales of securities held to maturity occurred for the six months
ended December 31, 1997, and for the years ended June 30, 1997, 1996 and 1995.
In December 1995, concurrent with the adoption of its implementation guide on
SFAS No. 115, the FASB allowed a one-time reassessment of the SFAS No. 115
classifications of all securities currently held. Any reclassifications would be
accounted for at estimated market value in accordance with SFAS No. 115 and any
reclassifications from the held to maturity portfolio that resulted from this
one-time reassessment would not call into question the Company's intent to hold
other securities to maturity in the future. The Company used the opportunity
under this one-time reassessment to reclassify $1,500,793,000 in securities from
held to maturity to the available for sale portfolio. In connection with this
reclassification, gross unrealized losses of $16,663,000 were recorded in
available for sale securities. This reclassification resulted in a reduction of
stockholders' equity of $10,831,000 (net of tax).
F-18
<PAGE> 105
6. LOANS RECEIVABLE:
Loans receivable are summarized below (in thousands):
<TABLE>
<CAPTION>
December 31, June 30,
----------- ---------------------------
1997 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Residential real estate loans $ 287,262 $ 282,034 $ 280,173
Commercial real estate loans 645,240 638,091 606,811
Commercial business loans 4,043 -- --
Consumer loans 45,751 122,908 165,380
----------- ----------- -----------
Total gross loans 982,296 1,043,033 1,052,364
Less:
Unaccreted discounts (7,824) (12,522) (16,163)
Unearned interest -- (4,479) (13,959)
Allowance for loan losses (20,484) (11,435) (3,228)
Deferred income (518) (773) (879)
----------- ----------- -----------
Loans receivable, net $ 953,470 $ 1,013,824 $ 1,018,135
=========== =========== ===========
</TABLE>
Accrued interest receivable on loans of approximately $7,129,000, $7,107,000 and
$7,049,000 was included in other assets at December 31, 1997, and June 30, 1997
and 1996, respectively.
The Company acquires commercial real estate loans from various sources. These
loans are secured primarily by multi-family residential and nonresidential real
estate. The purchased loans are geographically diverse and have no significant
concentrations of credit with any single borrower.
During the six months ended December 31, 1997 and the years ended June 30, 1997,
1996 and 1995, approximately $1,735,000, $11,974,000, $15,009,000, and
$27,537,000, respectively, in guaranteed student loans were sold resulting in
gains of $24,000, $158,000, $146,000, and $324,000, respectively. The Company
continues to market student loans throughout the State of Oklahoma. The Student
Loan Marketing Association ("Sallie Mae") handles the application processing,
disbursement and servicing responsibilities on behalf of the Company. The
Company sells student loans to Sallie Mae approximately 60 days after the loans
are fully funded. At December 31, 1997, June 30, 1997 and 1996, student loans
totaling approximately $7,133,000, $1,433,000 and $841,000, respectively, were
held for sale and are included as a component of loans receivable in the
accompanying consolidated statements of financial condition.
F-19
<PAGE> 106
An analysis of the allowance for loan losses is as follows (in thousands):
<TABLE>
<CAPTION>
Six Months
Ended
December 31, Years Ended June 30,
-------- ----------------------------------
1997 1997 1996 1995
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Balance at beginning of period $ 11,435 $ 3,228 $ 4,593 $ 3,689
Loans charged off (16,554) (20,293) (6,537) (362)
Recoveries 25 72 55 109
-------- -------- -------- --------
Net loans charged off (16,529) (20,221) (6,482) (253)
Provision for loan losses, primarily
related to indirect automobile loans 25,578 28,428 5,117 1,157
-------- -------- -------- --------
Balance at end of period $ 20,484 $ 11,435 $ 3,228 $ 4,593
======== ======== ======== ========
</TABLE>
Beginning in fiscal 1994, the Company initiated a subprime indirect automobile
financing program, through dealerships in Oklahoma and Florida. Loans were
generated through a network of principally used automobile dealers and were
extended to borrowers who typically were not eligible for traditional bank
financing, due to past credit problems or inadequate credit history. Loans were
typically extended in amounts to include the purchase price of the automobile,
tag, tax and license fees and optional credit life and vehicle maintenance
warranty insurance coverage. Loan terms included interest rates ranging from
13.9% to 30.9% and payment periods ranging from 12 months to 60 months. Due to
the nature of the borrowers involved, a higher than normal risk of borrower
default and inability to collect all amounts due was likely. During fiscal 1997,
the Company experienced greater than expected borrower defaults and resultant
losses and chose to cease all further origination activities. At June 30, 1997,
the subprime loan portfolio totaled approximately $75,545,000, net of discounts
and unearned interest, in which an allowance for loan losses of approximately
$7,684,000, or 10%, of the carrying value of the subprime loan portfolio had
been established. From inception of the program through December 31, 1997, loan
originations totaled approximately $187,832,000 with associated charge offs of
approximately $28,650,000 or 15%. The allowance for loan losses has been
established for estimated inherent losses that exist in the auto loan portfolio
at June 30, 1997, based primarily on the delinquency status of the loan
portfolio, the estimated value of the underlying collateral and historical loss
experience. Based on losses experienced to date, additional provisions for loan
losses are likely to be made in future periods as such losses become known. Such
future losses may be greater than losses experienced to date, due to the recent
cessation of indirect auto loan origination, as well as the dependence upon the
Company's collection efforts to ultimately realize the value of the underlying
collateral of defaulted loans.
Additional losses were recognized subsequent to the change in ownership on
September 8, 1997, due to a decision by management to classify the subprime loan
portfolio as held for sale and reflect the portfolio balance at the lower of
cost or market. In December 1997, the Company sold the subprime loan portfolio
for approximately $43,968,000 which approximated the Company's book value less
the valuation allowance. Included in other assets in the consolidated statements
of financial condition at December 31, 1997 was a receivable from the sale of
loans of approximately $34,594,000, which was subsequently collected.
At December 31, 1997, and June 30, 1997, the Company classified approximately
$655,000 and $2,770,000, respectively, of loans as impaired, as defined by SFAS
No. 114, "Accounting by Creditors for Impairment of a Loan." The average
recorded investment in impaired loans for the six months ended December 31,
1997, and the year ended June 30, 1997, was approximately $655,000 and
$6,315,000, respectively. Interest payments received on impaired loans are
recorded as interest income, unless collection of the remaining recorded
investment is doubtful, at which time the loan is placed on nonaccrual status
and payments received are recorded as reductions of principal. The
F-20
<PAGE> 107
Company recognized interest income on impaired loans of approximately $52,000
and $383,000 for the six months ended December 31, 1997, and year ended June 30,
1997, respectively.
During 1995, the Company securitized and sold approximately $62,147,000 of fixed
rate multi-family commercial real estate loans. The Company received mortgage
participation certificates collateralized by the loans securitized in fiscal
1995. As a result of the securitization, a servicing asset was recognized
totaling approximately $3,309,000. At December 31, 1997, and June 30, 1997 and
1996, unamortized servicing assets were approximately $1,363,000, $1,726,000 and
$2,732,000, respectively, and are included in other assets. Amortization of
these assets totaling approximately $363,000, $1,006,000, $1,262,000, and
$247,000 was charged against loan servicing income for the six months ended
December 31, 1997 and the years ended June 30, 1997, 1996, and 1995,
respectively.
At December 31, 1997, and June 30, 1997 and 1996, loans to directors, officers
and employees of the Company aggregated approximately $1,500,000, $1,802,000 and
$1,974,000, respectively. During the six months ended December 31, 1997 and the
year ended June 30, 1997, approximately $392,000 and $931,000, respectively, of
loan advances were made and repayments totaled approximately $694,000 and
$1,103,000, respectively. In management's opinion, such transactions were made
on substantially the same terms as those prevailing at the time for comparable
transactions with other persons and did not involve more than normal risk.
7. PREMISES AND EQUIPMENT:
Premises and equipment consisted of the following (in thousands):
<TABLE>
<CAPTION>
December 31, June 30,
-------- ---------------------
1997 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Land $ 3,033 $ 3,057 $ 3,057
Buildings and building improvements 11,920 11,865 11,520
Furniture, fixtures and equipment 10,938 10,870 9,764
-------- -------- --------
25,891 25,792 24,341
Less accumulated depreciation and
amortization (15,245) (14,732) (13,306)
-------- -------- --------
$ 10,646 $ 11,060 $ 11,035
======== ======== ========
</TABLE>
Depreciation and amortization expense relating to premises and equipment for the
six months ended December 31, 1997 and the years ended June 30, 1997, 1996, and
1995 was approximately $692,000, $1,450,000, $1,213,000, and $1,155,000,
respectively.
F-21
<PAGE> 108
8. ASSETS ACQUIRED THROUGH FORECLOSURE AND REPOSSESSION:
Assets acquired through foreclosure and repossession are summarized as follows
(in thousands):
<TABLE>
<CAPTION>
December 31, June 30,
------------ ---------------------
1997 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Commercial property $ -- $ 6,170 $ 6,570
Repossessed automobiles 31 2,241 3,969
Residential property 264 236 304
-------- -------- --------
295 8,647 10,843
Less allowance for losses (35) (248) (261)
-------- -------- --------
$ 260 $ 8,399 $ 10,582
======== ======== ========
</TABLE>
On July 1, 1997, real estate held for investment with a book value of
approximately $6,045,000 was transferred from assets acquired through
foreclosure and repossession to other assets in the consolidated statements of
financial condition as required by the OTS.
For the six months ended December 31, 1997, and for the years ended June 30,
1997, 1996, and 1995, income from assets acquired through foreclosure and
repossession totaled approximately $69,000, $873,000, $1,902,000, and
$3,060,000, respectively, which includes approximately $77,000, $320,000,
$1,273,000, and $2,200,000 of gains from dispositions, respectively. Income from
assets acquired through foreclosure and repossessions is included in other
noninterest income, while the gain portion is included in net gains (losses) on
sale of assets.
An analysis of the allowance for losses on assets acquired through foreclosure
and repossession is as follows (in thousands):
<TABLE>
<CAPTION>
Six Months Ended
December 31, Years Ended June 30,
------------ --------------------------------
1997 1997 1996 1995
----- ----- ----- -----
<S> <C> <C> <C> <C>
Balance at beginning of period $ 248 $ 261 $ 29 $ 5
Provision charged (credited) to
expense 63 76 184 (64)
Net amounts credited (charged)
to allowance (276) (89) 48 88
----- ----- ----- -----
Balance at end of period $ 35 $ 248 $ 261 $ 29
===== ===== ===== =====
</TABLE>
F-22
<PAGE> 109
9. DEPOSIT ACCOUNTS:
Deposits and the related interest expense are summarized below (in thousands):
<TABLE>
<CAPTION>
Deposits Interest Expense
---------------------------------------- -------------------------------------------------------
Six Months
Ended
December 31, June 30, December 31, Years Ended June 30,
---------- ------------------------- ---------- ----------------------------------------
1997 1997 1996 1997 1997 1996 1995
---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
NOW and MMDA $ 247,264 $ 248,322 $ 238,511 $ 2,594 $ 5,381 $ 5,638 $ 6,937
---------- ---------- ---------- ---------- ---------- ---------- ----------
Savings 68,937 71,576 73,726 1,009 2,092 2,190 2,742
---------- ---------- ---------- ---------- ---------- ---------- ----------
Time:
Less than 4.00% -- -- 2,860
4.00% to 4.99% 4,327 21,105 7,039
5.00% to 5.99% 994,844 1,008,889 1,024,706
6.00% to 6.99% 286,421 293,583 254,328
7.00% to 7.99% 740 881 1,290
---------- ---------- ----------
Total Time 1,286,332 1,324,458 1,290,223 37,069 75,618 73,345 58,556
---------- ---------- ---------- ---------- ---------- ---------- ----------
$1,602,533 $1,644,356 $1,602,460 $ 40,672 $ 83,091 $ 81,173 $ 68,235
========== ========== ========== ========== ========== ========== ==========
</TABLE>
Accrued interest on deposit accounts of approximately $3,865,000, $4,314,000 and
$3,459,000 was included in other liabilities in the accompanying consolidated
statements of financial condition at December 31, 1997, and June 30, 1997 and
1996, respectively.
The aggregate amount of certificates of deposits with a denomination greater
than $100,000 was approximately $86,000,000, $74,000,000 and $65,000,000 at
December 31, 1997 and June 30, 1997 and 1996, respectively.
Contractual maturities of time deposits at December 31, 1997, are summarized as
follows (dollars in thousands):
<TABLE>
<CAPTION>
Weighted Average
Contractual
Year ending June 30, Amount Rate
-------------------- ------ ----------------
<S> <C> <C>
1998 $ 623,168 5.48%
1999 493,671 5.69
2000 138,831 6.20
2001 17,504 5.79
2002 and thereafter 13,158 6.08
-------------
$ 1,286,332 5.65%
============= =====
</TABLE>
Legislation was enacted in fiscal 1997 which required institutions holding
deposits insured by the Savings Association Insurance Fund ("SAIF") to pay a
one-time fee of approximately 65 cents for each $100 of SAIF insured deposits.
The Company accrued its one-time assessment of approximately $10,311,000 during
September 1996.
F-23
<PAGE> 110
10. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE:
Securities sold under agreements to repurchase are summarized as follows
(dollars in thousands):
<TABLE>
<CAPTION>
December 31, June 30,
---------- ------------------------------------------
1997 1997 1996 1995
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Average outstanding balance $ 57,579 $ 421,706 $ 685,601 $ 634,281
Weighted average interest rate during the period 5.61% 5.45% 5.83% 5.76%
Maximum month-end balance $ 239,914 $ 942,315 $1,079,194 $ 865,713
Outstanding balance at the end of the period -- 310,801 1,079,194 779,626
Weighted average rate at the end of the period -- 5.55% 5.36% 6.11%
Mortgage-backed securities securing the
agreements at period-end:
Carrying value $ -- $ 335,202 $1,171,395 $ 860,323
Estimated market value -- 322,451 1,115,428 813,796
Accrued interest payable at the end of the period -- 1,327 5,799 6,877
</TABLE>
Securities sold under agreements to repurchase were delivered to the
broker-dealers who arranged the transactions. The agreements generally matured
within one month.
Additional interest expense incurred on interest rate swaps not included in the
above average rates totaled approximately $444,000, $5,227,000, $6,428,000, and
$1,448,000 for the six months ended December 31, 1997, and the years ended June
30, 1997, 1996, and 1995, respectively.
There are no securities sold under agreements to repurchase at December 31,
1997. All agreements outstanding at June 30, 1997, were either retired or
replaced with FHLB advances as part of the Company's ongoing asset/liability
management strategy.
11. ADVANCES FROM THE FEDERAL HOME LOAN BANK OF TOPEKA:
Advances from the FHLB are summarized as follows (dollars in thousands):
<TABLE>
<CAPTION>
December 31, June 30,
-------------------------- -------------------------------------------------------
1997 1997 1996
-------------------------- ------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Contractual Contractual Contractual
Balance Rate Balance Rate Balance Rate
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Variable rate $ 30,100 5.75% $ 224,324 5.61% $ 374,671 5.41%
Fixed rate 50,036 6.26 306,837 5.77 64,340 7.22
----------- ----------- -----------
$ 80,136 6.06% $ 531,161 5.73% $ 439,011 5.70%
=========== ===== =========== ==== =========== ====
</TABLE>
Although no specific assets are pledged, the FHLB requires the Company to hold
eligible assets with a lending value, as defined, at least equal to FHLB
advances, which can include such items as first mortgage loans, investment
securities, federal funds sold and interest bearing deposits, which are not
already pledged or encumbered.
F-24
<PAGE> 111
Scheduled principal repayments of advances from the FHLB at December 31, 1997,
are as follows (dollars in thousands):
<TABLE>
<CAPTION>
Weighted
Average
Contractual
Year ending June 30, Amount Rate
-------------------- ------ -----------
<S> <C> <C>
1998 $ - - %
1999 4,100 5.15
2000 - -
2001 - -
2002 and thereafter 76,036 6.11
---------
$ 80,136 6.06%
========= ====
</TABLE>
Additional interest expense incurred on interest rate swaps not included in the
above average rates totaled approximately $2,547,000, $10,186,000 and $8,146,000
for the six months ended December 31, 1997, and for the years ended June 30,
1997 and 1996, respectively.
12. NOTE PAYABLE:
Local Financial had a note payable to Isabel Collier Read, a former stockholder
and the mother of the stockholders of the Company prior to September 8, 1997.
The note required annual installments of $7,010,000 plus accrued interest.
During 1997, the stockholders of the Company made the required annual payment of
interest and principal on the note payable on behalf of the Company. The payment
has been reflected as a capital contribution in the accompanying consolidated
statement of stockholders' equity. The note bore interest equal to the prime
lending rate set by Morgan Guaranty Trust. The rate of the note was not to
exceed 8.0% nor fall below 5.7%. During the years ended June 30, 1997 and 1996,
the average note rate was 8.0%. During the year ended June 30, 1995, the average
note rate was 7.84%. The note was secured by the common stock of Local. Accrued
interest payable on the note of approximately $94,000 and $202,000 was included
in other liabilities in the accompanying consolidated statements of financial
condition at June 30, 1997 and 1996, respectively.
On September 8, 1997, principal and interest on the note payable from Local
Financial to Isabel Collier Read were paid in full.
13. SENIOR NOTES:
Senior notes of $80,000,000 at 11% and issued to individual investors were
outstanding at December 31, 1997. Senior notes are due September 8, 2004 and pay
interest semiannually. Senior notes are general unsecured obligations of Local
Financial and will rank senior to such other indebtedness as the Company may
incur that is not expressly subordinated to the senior notes. The indenture
generally restricts the incurrence of additional indebtedness by the Company,
except for certain junior indebtedness. An interest reserve account in the
amount of approximately $8,800,000, representing an annual amount of interest on
the senior notes, was established in the event dividends from Local are not
sufficient to pay interest and is included as a component of cash and due from
banks in the accompanying consolidated statements of financial condition.
14. INTEREST RATE SWAP, CAP AND FLOOR AGREEMENTS:
The Company is a party to financial instruments with off-balance sheet risk, in
the normal course of business, to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit, options written, standby
letters of credit and financial guarantees, interest rate caps and floors
written, interest rate swaps, and forward and futures contracts. Those
instruments involve, to varying degrees, elements
F-25
<PAGE> 112
of credit and interest rate risk in excess of the amount recognized in the
consolidated statements of financial condition. The contract or notional amounts
of those instruments reflect the extent of the Company's involvement in
particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit,
standby letters of credit, and financial guarantees written is represented by
the contractual notional amount of those instruments. The Company uses the same
credit policies in making commitments and conditional obligations as it does for
on-balance sheet instruments. For interest rate caps, floors, and swap
transactions, forward and futures contracts, and options written, the contract
or notional amounts do not represent exposure to credit loss. The Company
controls the credit risk of its interest rate swap, cap and floor agreements,
and forward and futures contracts through credit approvals, limits, and
monitoring procedures.
Unless noted otherwise, the Company does not require collateral or other
security to support financial instruments with credit risk.
The Company enters into a variety of interest-rate swap transactions in managing
its interest rate exposure. Interest rate swap transactions generally involve
the exchange of fixed and floating rate interest payment obligations without the
exchange of the underlying principal amounts. The Company minimizes its credit
exposure to interest rate counterparties by entering into the transactions with
counterparties that have been rated in one of the top three investment ratings
by at least two nationally recognized credit rating agencies. The Company also
utilized interest rate caps and floors to manage its interest rate exposure
through the use of these instruments.
Effective with the change in ownership on September 8, 1997, all outstanding
interest rate swap, cap and floor agreements were terminated and are included in
net gains (losses) on sale of assets in the consolidated statements of
operations. The termination of the interest rate swap agreements, totaling
approximately $500,000,000 notional principal amount, resulted in realized gross
losses of approximately $47,283,000. The termination of cap and floor agreements
totaling approximately $2,350,000,000 notional principal amount resulted in
realized gross losses of $2,234,000. Upon termination of the interest rate swap,
cap and floor agreements, and the corresponding liquidation of the underlying
hedged items, the Company recognized all remaining deferred gains and losses
which resulted in an additional loss of approximately $3,920,000. The above
losses resulted in a net tax benefit of approximately $18,703,000.
Interest rate swap, cap and floor agreements outstanding at June 30 are as
follows (dollars in thousands):
<TABLE>
<CAPTION>
Interest Rate
Notional --------------------- Variable
Maturity Date Balance Pay Receive Rate Index
------------- ------- ------- ------- -----------
<S> <C> <C> <C> <C>
1997
INTEREST RATE SWAPS
FIXED VARIABLE
January 8, 2005 $ 200,000 7.848% 5.563% 3 month LIBOR
February 14, 2005 100,000 7.880 5.813 3 month LIBOR
March 22, 2005 100,000 8.027 5.781 3 month LIBOR
May 8, 2005 50,000 8.463 5.816 3 month LIBOR
May 18, 2005 50,000 8.439 5.813 3 month LIBOR
INTEREST RATE FLOORS
INDEX FLOOR
February 19, 1998 $ 100,000 5.813% 5.678% 3 month LIBOR
March 22, 1998 100,000 5.781 5.404 3 month LIBOR
May 19, 1998 100,000 5.813 5.455 3 month LIBOR
</TABLE>
F-26
<PAGE> 113
<TABLE>
<CAPTION>
Interest Rate
Notional --------------------- Variable
Maturity Date Balance Pay Receive Rate Index
------------- ------- ------- ------- -----------
<S> <C> <C> <C> <C>
1997 CONT.
INTEREST RATE CAPS
CAP INDEX
July 1, 1998 $ 450,000 7.000% 5.762% 3 month LIBOR
October 27, 1997 800,000 9.500 6.510 10 year CMT
November 5, 1997 800,000 10.000 6.510 10 year CMT
1996
INTEREST RATE SWAPS
FIXED VARIABLE
January 8, 2005 $ 300,000 7.848% 5.461% 3 month LIBOR
February 14, 2005 100,000 7.880 5.500 3 month LIBOR
March 22, 2005 100,000 8.027 5.563 3 month LIBOR
May 8, 2005 50,000 8.463 5.500 3 month LIBOR
May 18, 2005 50,000 8.439 5.488 3 month LIBOR
INTEREST RATE FLOORS
INDEX FLOOR
February 19, 1998 $ 100,000 5.563% 5.678% 3 month LIBOR
March 22, 1998 100,000 5.488 5.404 3 month LIBOR
May 19, 1998 100,000 5.488 5.455 3 month LIBOR
INTEREST RATE CAPS
CAP INDEX
July 1, 1998 $ 450,000 7.000% 5.469% 3 month LIBOR
September 16, 1996 300,000 8.360 6.730 10 year CMT
October 27, 1997 800,000 9.500 6.730 10 year CMT
November 5, 1997 800,000 10.000 6.730 10 year CMT
</TABLE>
The notional principal amounts shown represent an agreed upon amount on which
calculations of amounts to be exchanged are based. They do not represent direct
credit exposures. The Company's credit exposure is limited to the net difference
between the calculated pay and receive amounts on each transaction, which is
generally netted and paid at least quarterly.
The interest rate swaps are utilized to hedge the FHLB advance borrowings and
the securities sold under agreements to repurchase, each of which have
short-term maturities. As of June 30, 1997, management intended to continue to
renew these borrowings to support the interest rate swaps hedging such
borrowings (see Note 2 for events occurring subsequent to June 30, 1997). The
interest rate caps and floors are utilized to hedge the available for sale
mortgage-backed floating rate securities.
During fiscal 1997, the Company terminated interest rate swaps used to hedge
securities sold under agreements to repurchase and FHLB advances with a notional
principal amount of $100,000,000 resulting in a loss of approximately $3,825,000
which is being amortized over the life of the original swap agreement of
approximately 7 years. (See discussion above on termination of interest rate
swaps in connection with the change in ownership on September 8, 1997.) During
fiscal 1996, the Company terminated interest rate swaps used to hedge a portion
of the available for sale portfolio with a notional principal of $300,000,000
resulting in a gain of $3,637,000 which is being amortized over the original
swap agreement of approximately 3 years. The Company also terminated interest
rate swaps during fiscal 1996 used to hedge a portion of the securities sold
under agreements to repurchase and FHLB advances with a notional principal
amount of $200,000,000 resulting in a loss of approximately $3,344,000 which is
being amortized over the original swap agreement of
F-27
<PAGE> 114
approximately 2 years. As a result of interest rate swap terminations,
amortization of deferred gains and losses resulted in the recognition of
approximately $73,000 in net losses during fiscal year 1997 and $671,000 and
$11,000 in net gains during fiscal years 1996 and 1995, respectively. At June
30, 1997 and 1996, net unamortized deferred losses from interest rate swap
terminations were approximately $4,130,000 and $378,000, respectively. There
were no deferred gains or losses at June 30, 1995.
At June 30, 1997 and 1996, net accrued interest on interest rate swaps, caps and
floors totaled a net payable of approximately $1,504,000 and $2,282,000,
respectively, and is included in other assets and other liabilities in the
accompanying consolidated statements of financial condition, dependent upon the
asset or liability to which the hedge is related. Unamortized interest rate cap
and floor premiums were approximately $3,051,000 and $12,741,000 at June 30,
1997 and 1996, respectively, and are included in the carrying amount of the
assets hedged.
The swaps, caps and floors are secured by mortgaged-backed securities with an
estimated market value of approximately $74,330,000 and $68,757,000 at June 30,
1997 and 1996, respectively.
The net effect of the interest rate swaps, caps and floors on net interest
income was a decrease of approximately $21,148,000 ($13,746,000 net of income
tax), $21,509,000 ($14,772,000 net of income tax) and $7,782,000 ($5,345,000 net
of income tax) for the years ended June 30, 1997, 1996, and 1995, respectively.
Such decrease was attributable primarily to interest rate swaps used to hedge a
portion of the Company's cost of borrowings in periods of rising interest rates.
15. INCOME TAXES:
The provision (benefit) for income taxes has been allocated as follows,
including the tax effect of the changes in unrealized gains (losses) on
available for sale securities (in thousands):
<TABLE>
<CAPTION>
Six Months
Ended Years Ended
December 31, June 30,
------------ --------------------------------------------
1997 1997 1996 1995
------------ ----------- ----------- ----------
<S> <C> <C> <C> <C>
Income (loss) from operations $ (44,075) $ (11,860) $ 4,872 $ 6,568
Stockholders' equity 18,481 8,892 (26,238) 1,141
------------ ----------- ----------- ----------
$ (25,594) $ (2,968) $ (21,366) $ 7,709
============ =========== =========== ==========
</TABLE>
Components of the provision (benefit) for income taxes from operations are as
follows (in thousands):
<TABLE>
<CAPTION>
Six Months
Ended Years Ended
December 31, June 30,
------------ --------------------------------------------
1997 1997 1996 1995
------------ ----------- ----------- ----------
<S> <C> <C> <C> <C>
Current income tax expense
(benefit) $ (16,490) $ (10,431) $ 2,911 $ 12,601
Deferred income tax expense
(benefit) (27,585) (1,429) 1,961 (6,033)
------------- ----------- ----------- ----------
$ (44,075) $ (11,860) $ 4,872 $ 6,568
============= =========== =========== ===========
</TABLE>
F-28
<PAGE> 115
The effective income tax rates differ from the statutory federal income tax rate
of 35%. A reconciliation of the provision (benefit) for income taxes based on
the statutory rates with the effective rates is as follows (in thousands):
<TABLE>
<CAPTION>
Six Months
Ended Years Ended
December 31, June 30,
------------ ------------------------------------
1997 1997 1996 1995
------------ -------- -------- --------
<S> <C> <C> <C> <C>
Income tax at statutory rate
(35%) $(45,511) $(14,667) $ 6,453 $ 7,344
Provision for deferred
tax assets 742 2,000 -- --
Effect of state income tax
(benefit), net of federal (5,236) (3,013) (675) (607)
Refund of taxes
previously paid, net -- -- (800) --
Change in valuation
allowance 6,254 2,949 -- --
Other, net (324) 871 (106) (169)
-------- -------- -------- --------
Provision (benefit) for income
taxes $(44,075) $(11,860) $ 4,872 $ 6,568
======== ======== ======== ========
</TABLE>
Deferred income tax assets and liabilities consisted of the following (in
thousands):
<TABLE>
<CAPTION>
December 31, June 30,
------------ ----------------------
1997 1997 1996
------------ -------- --------
<S> <C> <C> <C>
Deferred income tax assets:
Unrealized losses on available for
sale securities $ -- $ 17,222 $ 26,114
Realized losses on available for sale securities 10,787 -- --
Federal net operating loss carryforwards 14,283 -- --
State net operating loss carryforwards 9,203 4,071 1,058
Allowance for loan losses 4,109 -- --
Other 1,365 2,288 4,446
-------- -------- --------
39,747 23,581 31,618
-------- -------- --------
Deferred income tax liabilities:
Allowance for loan losses -- (1,012) (4,361)
Stock dividends receivable (1,602) (1,015) (650)
Depreciation and amortization (364) (373) (472)
Deferred loan fees (970) (805) (471)
Unrealized gains on available for sale securities (1,259) -- --
Other (291) (451) (1,225)
-------- -------- --------
(4,486) (3,656) (7,179)
-------- -------- --------
Net deferred tax asset 35,261 19,925 24,439
Valuation allowance (9,203) (2,949) --
-------- -------- --------
Deferred tax asset, net $ 26,058 $ 16,976 $ 24,439
======== ======== ========
</TABLE>
F-29
<PAGE> 116
At December 31, 1997, the Company had approximately $40,809,000 and $190,466,000
of operating loss carryforwards available for federal and state income tax
purposes, respectively. The state net operating losses expire in varying amounts
between 2006 and 2013. The federal net operating losses expire in 2013. At June
30, 1997, the Company had no net operating loss carryforwards available for
federal income tax purposes and approximately $106,458,000 available for state
income tax purposes.
During 1997, the Company established a valuation allowance for the portion of
the available state net operating loss carryforwards for which it was determined
to be more likely than not that the benefit of the deferred tax asset would not
be realized. At December 31, 1997, a valuation allowance for all available state
net operating loss carryforwards was established as it was determined to be more
likely than not that the benefit of the deferred tax asset would not be
realized. Historically, the Company has generated income for federal income tax
purposes. The tax loss for the year ended June 30, 1997, and the six months
ended December 31, 1997, was a result of the Company exiting the indirect
subprime automobile lending program, terminating the interest rate swap
agreements, and discontinuing the wholesale securities strategy previously
employed by former management. Based on the current strategy of new management,
no valuation allowance for other deferred tax assets has been established as the
Company believes it is more likely than not that sufficient income for federal
income tax purposes will be realized.
As a result of the Small Business Job Protection Act, the Company was required
to change its method of accounting for bad debts from the reserve method to the
direct charge-off method for income tax purposes during 1997. The Company will
be required to recapture the excess of the qualifying and nonqualifying tax loan
loss reserves over the base year tax loan loss reserves over a six-year period.
The recapture amount is estimated to be $17,244,000 and the qualifying and
nonqualifying base year tax reserves totaled approximately $8,116,000 and
$1,373,000, respectively. The Company expects to be eligible to defer this
recapture period for two years.
In accordance with SFAS No. 109, "Accounting for Income Taxes," a deferred tax
liability has not been recognized for the tax bad debt reserve and supplemental
reserves of the Company that arose in tax years that began prior to December 31,
1987. At December 31, 1997 and June 30, 1997 and 1996, the portion of the tax
bad debt reserve and supplemental reserves attributable to pre-1988 tax years
was approximately $13,329,000. The amount of unrecognized deferred tax liability
at December 31, 1997 and June 30, 1997 and 1996, was approximately $4,665,000.
This deferred tax liability could be recognized if certain distributions are
made with respect to the stock of Local, or the bad debt reserve is used for any
purpose other than absorbing bad debt losses.
During 1997, the Company's federal income tax returns were examined by and/or
settled with the Internal Revenue Service through fiscal year 1993. As a result
of these examinations and related claims for refund, the Company received a
refund of taxes previously paid of approximately $800,000 which had not been
anticipated by the Company prior to the examination.
16. COMMITMENTS AND CONTINGENCIES:
In conjunction with the acquisition of LAB during fiscal 1989, the Company and
LAB entered into an Assistance Agreement with the Federal Savings and Loan
Insurance Corporation (the "FSLIC"). Under the terms of the Assistance
Agreement, the FSLIC Resolution Fund (the "FUND"), which is managed by the
Federal Deposit Insurance Corporation (the "FDIC"), is entitled to receive 100%
of the tax benefits attributable to acquired net operating loss carryforwards
and deductions resulting from certain items, other than covered asset losses,
for which the FUND has agreed to provide assistance to the extent such tax
benefits are realized by the consolidated group. LAB is entitled to share in
realized tax benefits of a portion of the FUND assistance on a 50-50 basis.
Under the LAB Assistance Agreement, a dispute exists between LAB and the FDIC
regarding tax benefits which have been received. Management, after consultation
with legal counsel and based on available facts and proceedings to date, has
determined that it is probable that LAB has some liability to the FDIC with
regard to the tax benefits. The Company's estimate of this liability is
F-30
<PAGE> 117
approximately $13,000,000, which is included in other liabilities in the
accompanying December 31, 1997, and June 30, 1997, consolidated statements of
financial condition. The Company provided for this liability through a provision
for uninsured risk in the consolidated statements of operations for the years
ended 1997, 1996 and 1995. The FDIC's estimate of this liability is
approximately $23,000,000. Management of the Company is of the opinion that the
FDIC's estimate does not give credit to the Company for certain tax benefits
originally contracted for in the Assistance Agreement, but later eliminated as a
result of the Revenue Reconciliation Act of 1993. Management intends to
vigorously defend its estimate of the liability.
Pursuant to the terms of the Redemption Agreement discussed in Note 2, the
Selling Shareholders have agreed to indemnify the Company with respect to the
Assistance Agreement to the extent the Company is found to be liable for an
amount in excess of approximately $13,000,000. In addition, the Selling
Shareholders have agreed to be solely and exclusively responsible for all
reasonable litigation costs and expenses which are incurred by the Company in
connection with the prosecution, defense and settlement with the FDIC.
In the ordinary course of business, the Company is subject to other legal
actions and complaints. Management, after consultation with legal counsel, and
based on available facts and proceedings to date, believes the ultimate
liability, if any, arising from such legal actions or complaints, will not have
a material adverse effect on the Company's consolidated financial position or
future results of operations.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. The Company evaluates each customers' creditworthiness
on a case-by-case basis. The amount of collateral obtained, if it is deemed
necessary by the Company upon extension of credit, is based on management's
credit evaluation of the counterparty. Collateral held varies but may include
accounts receivable, inventory, property, plant and equipment, and
income-producing commercial properties. At December 31, 1997, the Company had
approximately $67,377,000 of outstanding loan commitments consisting of
residential real estate, commercial real estate and commercial industrial loans
approved but unfunded.
During 1995, the Company securitized and sold approximately $62,147,000 of fixed
rate multi-family commercial loans with recourse (See Note 6). The maximum
contractual recourse obligation of the Company is 10% of the total unpaid
principal balance of the mortgages on the settlement date. At December 31, 1997,
the unpaid principal balance of loans sold totaled approximately $33,289,000.
The Company has pledged assets, consisting primarily of mortgage-backed
securities totaling approximately $6,824,000 under the recourse provision of the
securitization transaction. Management does not expect any material losses to be
incurred as a result of the recourse provision.
Standby letters of credit and financial guarantees written are conditional
commitments issued by the Company to guarantee the performance of a customer to
a third party. Those guarantees are primarily issued to support public and
private borrowing arrangements, including commercial paper, bond financing and
similar transactions. The Company holds marketable securities as collateral
supporting those commitments for which collateral is deemed necessary.
The Company leases certain real estate and equipment under operating leases. For
the six months ended December 31, 1997, and for the years ended June 30, 1997,
1996, and 1995 lease expense totaled approximately $387,000, $730,000, $618,000,
and $465,000, respectively. Future obligations under operating leases at
December 31, 1997, are summarized as follows (in thousands):
F-31
<PAGE> 118
<TABLE>
<CAPTION>
Year Ending June 30,
--------------------
<S> <C>
1998 $ 645
1999 506
2000 251
2001 183
2002 and thereafter 214
-------
$ 1,799
=======
</TABLE>
17. REGULATORY MATTERS:
Local and LAB are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possible additional
discretionary--actions by regulators that, if undertaken, could have a direct
material effect on Local's consolidated financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
Local and LAB must meet specific capital guidelines that involve quantitative
measures of Local's and LAB's assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices. Local's and LAB's
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require Local and LAB to maintain minimum amounts and ratios (set forth in the
following table) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), of core capital (as defined) to adjusted
tangible assets (as defined) and of tangible capital (as defined) to tangible
assets. Management believes, as of December 31, 1997 and June 30, 1997, that
Local and LAB meet all capital adequacy requirements to which they are subject.
As of June 30, 1997 and 1996, the most recent notifications from the OTS
categorized Local and LAB as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized Local and LAB
must maintain minimum total capital, core capital, and Tier I capital as set
forth in the table. There are no conditions or events since that notification
that management believes have changed Local's or LAB's category.
F-32
<PAGE> 119
<TABLE>
<CAPTION>
To Be Well Capitalized
Actual Minimum For Capital For Prompt Corrective
Adequacy Purposes Action Provisions
--------------------- ----------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
------ ------ ------ ------ ------ ------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1997:
Total capital (to risk weighted assets):
Local Federal Bank Consolidated $134,331 14.14% $ 76,022 8.00% $ 95,027 10.00%
Local America Bank 101,398 28.45% 28,511 8.00% 35,639 10.00%
Core capital (to adjusted tangible assets):
Local Federal Bank Consolidated 128,803 6.98% 55,384 3.00% 92,307 5.00%
Local America Bank 97,975 15.90% 18,482 3.00% 30,803 5.00%
Tangible capital (to tangible assets):
Local Federal Bank Consolidated 127,024 6.89% 27,665 1.50% n/a n/a
Local America Bank 97,246 15.80% 9,230 1.50% n/a n/a
Tier I Capital (to risk weighted assets):
Local Federal Bank Consolidated 128,803 13.55% n/a n/a 57,016 6.00%
Local America Bank 97,975 27.49% n/a n/a 21,383 6.00%
As of June 30, 1997:
Total capital (to risk weighted assets):
Local Federal Bank Consolidated $145,132 12.34% $ 94,062 8.00% $117,578 10.00%
Local America Bank 112,842 25.31% 35,671 8.00% 44,589 10.00%
Core capital (to adjusted tangible assets):
Local Federal Bank Consolidated 140,442 5.25% 80,187 3.00% 133,645 5.00%
Local America Bank 111,482 12.07% 27,711 3.00% 46,185 5.00%
Tangible capital (to tangible assets):
Local Federal Bank Consolidated 138,044 5.17% 40,062 1.50% n/a n/a
Local America Bank 110,411 11.97% 13,839 1.50% n/a n/a
Tier I Capital (to risk weighted assets):
Local Federal Bank Consolidated 140,442 11.94% n/a n/a 70,547 6.00%
Local America Bank 111,482 25.00% n/a n/a 26,754 6.00%
As of June 30, 1996:
Total capital (to risk weighted assets):
Local Federal Bank Consolidated $172,055 12.71% $108,336 8.00% $135,419 10.00%
Local America Bank 115,638 28.14% 32,870 8.00% 41,088 10.00%
Core capital (to adjusted tangible assets):
Local Federal Bank Consolidated 168,975 5.04% 100,513 3.00% 167,522 5.00%
Local America Bank 114,577 10.69% 32,155 3.00% 53,591 5.00%
Tangible capital (to tangible assets):
Local Federal Bank Consolidated 165,339 4.94% 50,247 1.50% n/a n/a
Local America Bank 112,822 10.54% 16,096 1.50% n/a n/a
Tier I Capital (to risk weighted assets):
Local Federal Bank Consolidated 168,975 12.48% n/a n/a 81,252 6.00%
Local America Bank 114,577 27.89% n/a n/a 24,653 6.00%
</TABLE>
F-33
<PAGE> 120
Management intends to continue compliance with all regulatory capital
requirements.
Federal regulations allow Local and LAB to pay dividends during a calendar year
up to the amount that would reduce Local's and LAB's surplus capital ratio, as
defined, to one-half of Local's and LAB's surplus capital ratio at the beginning
of the calendar year, adjusted to reflect Local's and LAB's net income to date
during the calendar year. At the beginning of calendar year 1998, under
applicable regulations of the OTS, the total capital available for the payment
of dividends by Local to the Company was $27.5 million plus 1998 net income
subject to the maintenance of required capital guidelines. The surplus capital
ratio is defined as the percentage by which Local's and LAB's net capital to
assets ratio would exceed the ratio of its fully phased-in capital requirement
to its assets.
18. STOCK COMPENSATION:
Effective with the securities offering and redemption in September 1997, the
board of directors adopted a stock option plan. The stock option plan has
1,420,370 shares of common stock authorized and the stock option plan will
provide for the granting of incentive stock options intended to comply with the
requirements of Section 422 of the Internal Revenue Code as well as
non-incentive or compensatory stock options and stock appreciation rights. At
September 8, 1997, incentive stock options for 1,116,005 shares of common stock
were granted to executive officers of the Company at an exercise price of $10
per share. At December 3, 1997, incentive stock options for 158,000 shares of
common stock were granted to officers and compensatory stock options for 60,000
shares of common stock were granted to directors of the Company at an exercise
price of $11.75 per share. Stock options to buy 1,141,005 and 193,000 shares of
common stock shall be exercisable in three and five equal annual installments,
respectively, commencing with the end of the first twelve month period following
the date the stock options were granted. The stock options expire ten years from
the dates the options first become exercisable by officers and directors.
The per share weighted-average fair value of stock options granted for the six
months ended December 31, 1997, was $2.36 on the date of grant using the
Black-Scholes option-pricing model with the following assumptions: risk-free
interest rate of 5.29%, expected life of 5 years, and no expected dividend yield
or volatility.
The Company applies APB Opinion No. 25 and related interpretations in accounting
for its stock option plan. Accordingly, no compensation cost has been recognized
for its stock option rights. Had the Company determined compensation cost based
on the fair value at the grant date for its stock options under SFAS No. 123,
"Accounting for Stock Based Compensation," the Company's net loss for the six
months ended December 31, 1997, would have been increased to the pro forma
amounts below.
<TABLE>
<S> <C> <C>
Net loss As reported $ (85,956)
Pro forma (86,148)
Basic and Diluted net loss per share As reported $ (4.76)
Pro forma (4.77)
</TABLE>
Stock options of 1,334,005 were outstanding at December 31, 1997, with a range
of exercise prices of $10.00 - $11.75, weighted average exercise price of
$10.29, and weighted average contractual life of outstanding options of 11.8
years. No options were exercisable at December 31, 1997.
19. EMPLOYEE BENEFITS:
The Company has a retirement plan (the "Plan"), which is a noncontributory
defined benefit pension plan, covering substantially all of its full-time
employees. The benefits are based on years of service and the employees'
compensation during the last five years of employment. The Company's policy,
generally, is to fund pension costs unless the Plan is overfunded and no
contribution is required. Contributions are intended to provide not only for
benefits attributed to service to date but also for
F-34
<PAGE> 121
those expected to be earned in the future. No contributions were made during the
six months ended December 31, 1997, and the years ended June 30, 1997, 1996 or
1995, as the Plan is overfunded.
The following table sets forth the Plan's funded status and amounts recognized
in the Company's consolidated statements of financial condition and operations
at June 30 and for the years then ended (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including
vested benefits of $6,549, in 1997, $6,097
in 1996 and $5,313 in 1995 $ (7,159) $ (6,293) $ (5,827)
======== ======== ========
Projected benefit obligation for service rendered
to date $ (9,332) $ (8,226) $ (7,739)
Plan assets at market value, primarily stocks and
cash equivalents 17,339 14,040 10,310
-------- -------- --------
Plan assets in excess of projected benefit 8,007 5,814 2,571
Unrecognized net gain from past experience
different from that assumed (6,588) (4,937) (1,809)
Unrecognized prior service cost (531) (566) (601)
Unrecognized net asset being recognized over 15
years (253) (337) (422)
-------- -------- --------
Prepaid (accrued) pension cost $ 635 $ (26) $ (261)
======== ======== ========
Net pension benefit:
Service cost-benefits earned during the period $ 515 $ 490 $ 388
Interest cost on projected benefit obligation 627 553 516
Actual return on plan assets (3,820) (4,150) (2,449)
Net amortization and deferral 2,017 2,871 1,438
-------- -------- --------
Net periodic pension benefit $ (661) $ (236) $ (107)
======== ======== ========
</TABLE>
A weighted average discount rate of 7.5% in each of the years 1997, 1996 and
1995 and a rate of increase in future compensation levels of 5.5% was used in
determining the actuarial present value of the projected benefit obligation for
1997, 1996 and 1995. The expected long-term rate of return on assets was 11.0%
for 1997, 1996 and 1995.
The Company is currently reviewing the Plan and has changed the investment
manager which is in the process of liquidating the equity investment portfolio.
The Company had a projected net periodic pension benefit for the year ended June
30, 1998, based on the June 30, 1997, valuation; however, the Company did not
record any prepaid pension benefit for the six months ended December 31, 1997,
due to the uncertainty of any changes made by new management. At December 31,
1997, prepaid pension cost was approximately $635,000.
The Company does not provide postretirement benefits other than pensions.
At June 30, 1997, the Company employed 481 full-time equivalent persons compared
to 492 at June 30, 1996 and 425 at June 30, 1995.
20. FAIR VALUE OF FINANCIAL INSTRUMENTS:
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires
that the Company disclose estimated fair values for its financial instruments.
Fair value estimates, methods and assumptions set forth below for the Company's
financial instruments, are made solely to comply with the requirements of SFAS
No. 107.
F-35
<PAGE> 122
Fair values are based on estimates or calculations at the transaction level
using present value techniques in instances where quoted market prices are not
available. Because broadly traded markets do not exist for most of the Company's
financial instruments, the fair value calculations attempt to incorporate the
effect of current market conditions at a specific time. Fair valuations are
management's estimates of the values, and they are often calculated based on
current pricing policy, the economic and competitive environment, the
characteristics of the financial instruments, expected losses and other such
factors. These calculations are subjective in nature, involve uncertainties and
matters of significant judgment and do not include tax ramifications; therefore,
the results cannot be determined with precision, substantiated by comparison to
independent markets and may not be realized in an actual sale or immediate
settlement of the instruments. The Company has not included certain material
items in its disclosure, such as the value of the long-term relationships with
the Company's depositors, since this intangible is not a financial instrument.
There may be inherent weaknesses in any calculation technique, and changes in
the underlying assumptions used, including discount rates and estimates of
future cash flows, could significantly affect the results. For all of these
reasons, the aggregation of the fair value calculations presented herein do not
represent, and should not be construed to represent, the underlying value of the
Company.
The following table presents a summary of the Company's financial instruments,
as defined by SFAS No. 107 (in thousands):
<TABLE>
<CAPTION>
December 31, 1997 June 30, 1997 June 30, 1996
------------------------- ------------------------- -------------------------
Carrying Estimated Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value Value Fair Value
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Financial Assets:
Cash and cash
equivalents $ 54,152 $ 54,152 $ 105,404 $ 105,404 $ 13,640 $ 13,640
Securities purchased under
agreements to resell 178,000 178,000 -- -- -- --
Securities 518,107 518,107 1,393,724 1,384,434 2,129,397 2,116,077
Equity securities -- -- -- -- 11,604 11,604
Loans receivable, net 953,470 972,820 1,013,824 1,014,243 1,018,135 1,032,297
FHLB stock 45,147 45,147 40,046 40,046 23,421 23,421
Interest rate caps and floors -- -- 48 48 4,652 4,652
Financial Liabilities:
Deposits $1,602,533 $1,608,540 $1,644,356 $1,641,328 $1,602,460 $1,597,150
Securities sold under
agreements to
repurchase -- -- 310,801 312,789 1,079,194 1,079,203
Advances from the FHLB 80,136 80,173 531,161 533,732 439,011 440,957
Notes payable 80,000 80,000 7,010 7,010 14,020 14,020
Interest rate swaps -- -- -- 37,538 -- 41,631
</TABLE>
The following are descriptions of the methods used to determine the estimated
fair values:
Cash and Cash Equivalents and Securities Purchased Under Agreements to Resell
The carrying amount is a reasonable estimate of fair value because of the
relatively short period of time between the origination of the instrument and
its expected realization.
Securities and Equity Securities
The carrying value and estimated fair value of equity securities available for
sale and securities at December 31, 1997, and June 30, 1997 and 1996, are set
forth in Notes 4 and 5, respectively. The estimated fair value of interest rate
caps and floors used to hedge securities is based on the replacement cost
(mark-to-market) of the agreements. The estimated fair value of FHLB stock
approximates the carrying value as of December 31, 1997 and June 30, 1997 and
1996.
F-36
<PAGE> 123
Loans
The fair valuation calculation process differentiates loans based on their
financial characteristics, such as product classification, loan category,
pricing features and remaining maturity. Prepayment estimates are evaluated by
product and loan rate. In establishing the credit risk component of the fair
value calculations for loans, the Company considered several approaches,
including the use of variable discount rates based on relative credit quality,
forecasting cash flows, net of projected losses and secondary market pricing for
certain third party loan sale transactions. After evaluating such information,
the Company concluded that the allowance for loan losses represented a
reasonable estimate of the credit risk component of the fair value of loans at
December 31, 1997, and June 30, 1997 and 1996.
The fair value of commercial real estate loans, other real estate mortgage loans
and real estate construction loans is calculated by discounting contractual cash
flows using discount rates that reflect the Company's current pricing for loans
with similar characteristics and remaining maturity.
For real estate single family first and junior lien mortgages, fair value is
calculated by discounting contractual cash flows, adjusted for prepayment
estimates, using discount rates based on the Company's current pricing for loans
of similar size, type, remaining maturity and repricing characteristics.
For other consumer loans, the fair value is calculated by discounting the
contractual cash flows, adjusted for prepayment estimates, using discount rates
based on the company's current pricing for loans of similar size, type, and
remaining maturity.
Deposit Liabilities
SFAS No. 107 states that the fair value of deposits with no stated maturity,
such as noninterest-bearing demand deposits, interest-bearing checking and
savings deposits and market rate savings, is equal to the amount payable on
demand at the measurement date. Although SFAS No. 107's requirements for these
categories is not consistent with the market practice of using prevailing
interest rates to value these amounts, the amount included for these deposits in
the previous table is their carrying value at December 31, 1997, and June 30,
1997 and 1996. The fair value of certificates of deposit and other time deposits
is calculated based on the discounted value of contractual cash flows. The
discount rate is estimated using the rates currently offered for similar
duration deposits.
Advances from the Federal Home Loan Bank of Topeka and Securities Sold Under
Agreements to Repurchase, Notes Payable and Senior Notes
The estimated fair value of FHLB advances and securities sold under agreements
to repurchase is based on the discounted value of contractual cash flows. The
discount rate is estimated using the current market rate for similar duration
borrowings. The estimated fair market value of interest rate swap agreements
used to hedge FHLB advances and securities sold under agreements to repurchase
is based on the replacement cost (mark-to-market value) of the agreements.
Commitments are related primarily to variable rate loans originated at current
market rates. The estimate of fair value of these commitments is considered to
be immaterial. The estimate of value of notes payable and senior notes is based
on the discounted value of contractual cash flows.
Limitations
The information presented in this footnote is based on market quotes and fair
value calculations as of December 31, 1997, and June 30, 1997 and 1996. These
amounts have not been updated since period end; therefore, the valuations may
have changed since that point in time.
F-37
<PAGE> 124
21. PROPOSED ACQUISITION:
On October 22, 1997, the Company entered into an agreement to purchase Green
Country Banking Corporation (the Holding Company) which is majority owned by the
Chief Executive Officer and President of the Company. Regulatory approval has
been received and the acquisition is expected to occur on February 16, 1998. The
Company will issue 837,209 shares of its common stock to acquire 100% of the
Holding Company with the Company being the surviving corporation. The Company's
resultant wholly-owned subsidiary, Green Country Bank, FSB, which was formerly
the wholly-owned subsidiary bank of the Holding Company, will be subsequently
merged into LAB, with LAB being the surviving bank.
The acquisition of the Holding Company will be accounted for under purchase
accounting treatment. Total assets and liabilities of the Holding Company at
December 31, 1997, are approximately $106,463,000 and $103,553,000,
respectively. Purchase accounting adjustments to estimated fair values will be
made with respect to the assets and liabilities based upon preliminary estimates
and evaluations as of December 31, 1997, resulting in a decrease in net assets
of approximately $425,000. Final purchase price adjustments will be made upon
closing of the transaction and will be based on the fair values of assets and
liabilities at that date. Earnings retained between December 31, 1997, and the
closing date will affect the allocation of the purchase price to the extent they
affect net asset values at closing. The excess of the purchase price over the
amounts assigned to identifiable assets acquired less liabilities assumed will
be recorded as goodwill. The resulting goodwill of approximately $6,800,000 will
be amortized on a straight-line basis over 15 years.
Pro forma results of operations assuming the proposed acquisition of Holding
Company occurred on July 1, 1995, are not material.
22. PARENT COMPANY FINANCIAL INFORMATION:
Condensed financial information for Local Financial Corporation is as follow (in
thousands):
Statements of Financial Condition
<TABLE>
<CAPTION>
December 31, June 30,
--------- ------------------------
1997 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Assets:
Cash and due from banks, substantially restricted $ 11,840 $ 3 $ 29
Investment in subsidiary 143,917 109,682 122,517
Other assets 10,061 135 272
--------- --------- ---------
Total assets $ 165,818 $ 109,820 $ 122,818
========= ========= =========
Liabilities and Stockholders' Equity:
Note payable $ -- $ 7,010 $ 14,020
Senior notes 80,000 -- --
Other liabilities 3,193 181 739
--------- --------- ---------
Total liabilities 83,193 7,191 14,759
--------- --------- ---------
Common stock 197 -- --
Additional paid-in capital 197,766 16,896 8,797
Retained earnings 31,760 117,716 147,761
Treasury stock (149,436) -- --
Unrealized gains (losses) on securities available
for sale, net of income tax 2,338 (31,983) (48,499)
--------- --------- ---------
Total stockholders' equity 82,625 102,629 108,059
--------- --------- ---------
Total liabilities and stockholders' equity $ 165,818 $ 109,820 $ 122,818
========= ========= =========
</TABLE>
F-38
<PAGE> 125
Statements of Operations
<TABLE>
<CAPTION>
Six Months Ended Years Ended
December 31, June 30,
-------- -----------------------------------
1997 1997 1996 1995
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Income:
Dividend income from subsidiary $ -- $ 500 $ 10,600 $ 19,757
Equity in undistributed earnings (losses)
of subsidiary (83,925) (29,886) 5,124 3,119
Other -- 200 43 10
-------- -------- -------- --------
Total income (loss) (83,925) (29,186) 15,767 22,886
Expense:
Interest expense 3,073 1,026 1,606 2,105
Compensation and employee benefits -- -- 871 11,468
Other 52 145 828 285
-------- -------- -------- --------
Total expense 3,125 1,171 3,305 13,858
Benefit for income taxes 1,094 312 1,106 5,387
-------- -------- -------- --------
Net income (loss) $(85,956) $(30,045) $ 13,568 $ 14,415
======== ======== ======== ========
</TABLE>
Statements of Cash Flows
<TABLE>
<CAPTION>
Six Months Ended Years Ended
December 31, June 30,
--------- ---------------------------------------
1997 1997 1996 1995
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
CASH PROVIDED (ABSORBED) BY OPERATING ACTIVITIES:
Net income (loss) $ (85,956) $ (30,045) $ 13,568 $ 14,415
Adjustments to reconcile net income to net cash
provided (absorbed) by operating activities:
Equity in undistributed losses (earnings) of
subsidiary 83,925 29,886 (5,124) (3,119)
Change in other liabilities 3,012 (558) 531 (126)
Change in other assets (5,582) (398) (1,937) (4,166)
--------- --------- --------- ---------
Net cash provided (absorbed) by operating activities (4,601) (1,115) 7,038 7,004
--------- --------- --------- ---------
CASH ABSORBED BY INVESTING ACTIVITY:
Investment in subsidiary (83,839) -- -- --
--------- --------- --------- ---------
Net cash absorbed by investing activity (83,839) -- -- --
--------- --------- --------- ---------
CASH PROVIDED (ABSORBED) BY FINANCING ACTIVITIES:
Proceeds from issuance of common stock 181,067 -- -- --
Capital contribution -- 8,099 -- --
Purchase of treasury stock (149,436) -- -- --
Repayment of note payable (7,010) (7,010) (7,010) (7,010)
Proceeds from issuance of senior notes 80,000 -- -- --
Payments of debt issuance costs (4,344) -- -- --
--------- --------- --------- ---------
Net cash provided (absorbed) by financing activities 100,277 1,089 (7,010) (7,010)
--------- --------- --------- ---------
Net change in cash and cash equivalents 11,837 (26) 28 (6)
Cash and cash equivalents at beginning of period 3 29 1 7
--------- --------- --------- ---------
Cash and cash equivalents at end of period $ 11,840 $ 3 $ 29 $ 1
========= ========= ========= =========
Supplemental schedule of noncash investing activity:
Tax benefit contributed to subsidiary $ -- $ 535 $ 1,752 $ 5,386
========= ========= ========= =========
</TABLE>
F-39
<PAGE> 126
23. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS:
The consolidated financial statements of Local Financial Corporation and
Subsidiary as of and for the six months ended December 31, 1996 are unaudited
and, in the opinion of management, include all adjustments necessary (which
consist of only normal recurring adjustments) for a fair presentation of the
financial position, results of operations and cash flows for the interim period.
The financial information and results of operations of the interim periods are
not necessarily indicative of the financial position and results of operations
that may be obtained for a full fiscal year and are included for comparability
purposes.
UNAUDITED CONSOLIDATED STATEMENT OF FINANCIAL CONDITION
December 31, 1996
(Dollars in thousands, except share data)
<TABLE>
ASSETS
<S> <C>
Cash and due from banks $ 16,122
Securities available for sale 1,597,794
Securities held to maturity 360,609
Loans receivable, net of allowance for loan losses 1,067,608
Federal Home Loan Bank of Topeka stock, at cost 19,847
Premises and equipment, net 11,251
Assets acquired through foreclosure and repossession, net 14,281
Intangible assets, net 3,017
Deferred tax asset, net 24,985
Current income taxes receivable 7,500
Other assets 22,931
-----------
Total assets $ 3,145,945
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Demand $ 252,239
Savings 71,643
Time 1,359,777
-----------
Total deposits 1,683,659
Advances from borrowers for taxes and insurance 5,677
Securities sold under agreements to repurchase 940,945
Advances from the Federal Home Loan Bank of Topeka 370,932
Note payable 14,020
Other liabilities 26,410
-----------
Total liabilities 3,041,643
-----------
Commitments and contingencies
Stockholders' equity:
Common stock --
Additional paid-in capital 8,797
Retained earnings 140,950
Unrealized gains (losses) on securities available for
sale, net of income tax provision (benefit) (45,445)
-----------
Total stockholders' equity 104,302
-----------
Total liabilities and stockholders' equity $ 3,145,945
===========
</TABLE>
F-40
<PAGE> 127
UNAUDITED CONSOLIDATED STATEMENT OF OPERATIONS
Six Months Ended December 31, 1996
(Dollars in thousands, except share data)
<TABLE>
<S> <C>
Interest and dividend income:
Loans $ 53,179
Securities available for sale 51,158
Securities held to maturity 11,018
Federal Home Loan Bank of Topeka stock 2,265
Other investments 1,480
-----------
Total interest and dividend income 119,100
-----------
Interest expense:
Deposit accounts 41,219
Advances from the Federal Home Loan Bank of Topeka 32,353
Securities sold under agreements to repurchase 18,426
Notes payable 564
-----------
Total interest expense 92,562
-----------
Net interest and dividend income 26,538
Provision for loan losses (9,734)
-----------
Net interest and dividend income after provision for loan losses 16,804
-----------
Noninterest income:
Deposit related income 3,665
Loan fees and loan service charges 1,029
Net gains (losses) on sale of assets (3,024)
Other 515
-----------
Total noninterest income 2,185
-----------
Noninterest expense:
Compensation and employee benefits 7,160
Deposit insurance premiums 11,942
Provision for uninsured risk 600
Equipment and data processing 1,530
Occupancy 1,480
Advertising 875
Professional fees 575
Other 5,210
-----------
Total noninterest expense 29,372
-----------
Income (loss) before provision (benefit) for income taxes (10,383)
Provision (benefit) for income taxes (3,573)
-----------
Net income (loss) $ (6,810)
===========
Historical basic and diluted net income (loss) per share $ (.44)
===========
Pro forma basic and diluted net income (loss) per share N/A
===========
</TABLE>
F-41
<PAGE> 128
UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS
Six Months Ended December 31, 1996
(Dollars in thousands)
<TABLE>
<S> <C>
CASH PROVIDED BY OPERATING ACTIVITIES:
Net income (loss) $ (6,810)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Provisions for loan losses and uninsured risk and losses on
assets acquired through foreclosure and repossession 10,390
Deferred income tax expense (benefit) (2,354)
Accretion of discounts on loans acquired (2,263)
Amortization of deferred (gains) losses on interest rate swaps (250)
Net amortization (accretion) of premium on securities available for sale 4,506
Net amortization (accretion) of premium on securities held to maturity 898
Depreciation and amortization 1,695
Proceeds from the sales of loans 1,411
(Gain) loss on sale of assets 3,024
Stock dividends received from Federal Home Loan Bank stock (2,265)
Change in other assets (2,460)
Change in other liabilities (2,855)
-------------
Net cash provided by operating activities 2,667
-------------
CASH PROVIDED BY INVESTING ACTIVITIES:
Proceeds from sales of securities available for sale 131,388
Proceeds from principal collections on securities available for sale 9,210
Proceeds from principal collections on securities held to maturity 26,523
Proceeds from sales of equity securities available for sale 12,986
Purchases of Federal Home Loan Bank stock (53,085)
Proceeds from the sale of Federal Home Loan Bank stock 58,924
Loans made by non-bank subsidiary (27,627)
Repayments of loans made by non-bank subsidiary 30,821
Change in loans receivable, net (88,745)
Proceeds from disposal of assets acquired through foreclosure and repossession 27,544
Purchases of premises and equipment (938)
Proceeds from sales of premises and equipment 5
-------------
Net cash provided by investing activities 127,006
-------------
CASH ABSORBED BY FINANCING ACTIVITIES:
Change in transaction accounts 11,645
Change in time deposits 69,554
Change in securities sold under agreements to repurchase (136,868)
Proceeds from advances from the Federal Home Loan Bank 5,807,316
Repayments of advances from the Federal Home Loan Bank (5,877,576)
Change in advances by borrowers for taxes and insurance (1,262)
-------------
Net cash absorbed by financing activities (127,191)
-------------
Net change in cash and cash equivalents 2,482
Cash and cash equivalents at beginning of period 13,640
-------------
Cash and cash equivalents at end of period $ 16,122
=============
Supplemental disclosures of cash flow information: Cash paid during the period
for:
Interest $ 89,847
=============
Income taxes $ -
=============
Supplemental schedule of noncash investing and financing activities:
Transfers of loans to assets acquired through foreclosure and repossession $ 13,891
=============
</TABLE>
F-42
<PAGE> 129
FORM 10-K
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBITS DESCRIPTION
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JUL-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 34,152
<INT-BEARING-DEPOSITS> 20,000
<FED-FUNDS-SOLD> 178,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 518,107
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 953,470
<ALLOWANCE> 20,484
<TOTAL-ASSETS> 1,881,365
<DEPOSITS> 1,602,533
<SHORT-TERM> 80,136
<LIABILITIES-OTHER> 31,025
<LONG-TERM> 80,000
0
0
<COMMON> 197
<OTHER-SE> 82,428
<TOTAL-LIABILITIES-AND-EQUITY> 1,881,365
<INTEREST-LOAN> 49,788
<INTEREST-INVEST> 35,416
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 85,204
<INTEREST-DEPOSIT> 40,672
<INTEREST-EXPENSE> 59,823
<INTEREST-INCOME-NET> 25,381
<LOAN-LOSSES> 25,578
<SECURITIES-GAINS> (112,770)
<EXPENSE-OTHER> 10,025
<INCOME-PRETAX> (130,031)
<INCOME-PRE-EXTRAORDINARY> (130,031)<F1>
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (85,956)
<EPS-PRIMARY> (4.76)
<EPS-DILUTED> (4.76)
<YIELD-ACTUAL> 7.87
<LOANS-NON> 626
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 11,435
<CHARGE-OFFS> 16,554
<RECOVERIES> 25
<ALLOWANCE-CLOSE> 20,484
<ALLOWANCE-DOMESTIC> 20,484
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 3,410
<FN>
<F1>Tag 17 is a gross loan balance.
</FN>
</TABLE>
