<PAGE> 1
Filed pursuant to Rule 424(b)(4)
Registration No. 333-94189
PROSPECTUS
[NORTHERN STAR FINANCIAL LOGO]
NORTHERN STAR FINANCIAL, INC.
1,000,000 SHARES
OF
COMMON STOCK
Northern Star Financial, Inc. is offering a minimum of 500,000 and a
maximum of 1,000,000 shares of common stock.
Our common stock is quoted on the OTC Bulletin Board under the symbol
"NSBK."
The shares will be sold primarily by our sales agent, Banc Stock Financial
Services, Inc. The sales agent has agreed to use its best efforts to sell the
shares offered but must sell a minimum of 500,000 shares in order to sell any
shares. The offering is scheduled to end on June 26, 2000, but we may extend the
offering until September 24, 2000 at the latest. The minimum purchase
requirement is 100 shares and the maximum purchase is 45,000 shares.
We will place all the money we receive in the offering with an independent
escrow agent who will hold the money until we sell at least 500,000 shares. If
we do not meet this condition before the end of the offering period, we will
return all funds to subscribers with interest earned.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------
UNDERWRITING
DISCOUNTS AND PROCEEDS TO THE
PRICE TO PUBLIC COMMISSIONS COMPANY
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share............................ $10.50 $0.735 $9.765
- -------------------------------------------------------------------------------------------------------------
Total (Minimum 500,000 shares)....... $ 5,250,000 $367,500 $4,882,500
(Maximum 1,000,000 shares)..... $10,500,000 $735,000 $9,765,000
- -------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------
</TABLE>
OUR COMMON STOCK IS A RISKY INVESTMENT. IT IS NOT A DEPOSIT OR AN ACCOUNT
AND IS NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY OTHER
GOVERNMENT AGENCY. BEFORE INVESTING, YOU SHOULD READ THE "RISK FACTORS" SECTION,
WHICH BEGINS ON PAGE 10 OF THIS PROSPECTUS.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of the common stock or determined if this
prospectus is truthful and complete. Any representation to the contrary is a
criminal offense.
[BANCSTOCK FINANCIAL SERVICES, INC. LOGO]
Selling Group Members
LARSONALLEN FINANCIAL, LLC EAGLE ONE INVESTMENTS, LLC
The date of this Prospectus is March 28, 2000
<PAGE> 2
NORTHERN STAR FINANCIAL, INC.
PRINCIPAL MARKET AREAS
AFTER MERGER WITH
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
[NORTHERN STAR FINANCIAL LOGO][FIRST FEDERAL SAVINGS BANK LOGO]
[PRINCIPAL MARKET AREAS IMAGE]
[HOME MORT LOGO][NORTHERN STAR BANK LOGO][WEST CENTRAL INVESTMENTS LOGO]
Northern Star Financial's merger with First Federal is subject to completion of
certain conditions, including the sale of at least the minimum number of shares
in this offering.
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<PAGE> 3
PROSPECTUS SUMMARY
We encourage you to read the entire prospectus carefully before investing
in our common stock. Please note that an investment in our common stock is not a
deposit or savings account and is not insured or guaranteed by the FDIC or any
other governmental agency.
OUR COMPANY
Northern Star Financial is a one-bank holding company. We provide
commercial and retail banking services through our operating subsidiary,
Northern Star Bank. We formed Northern Star Bank as a Minnesota start-up bank in
January 1999. We serve customers and borrowers located primarily in Mankato,
Minnesota and the counties of Blue Earth and Nicollet. On July 15, 1999, we
acquired 49% of Homeland Mortgage, LLC, a loan servicer and originator. We
jointly operate Homeland with First Federal Savings Bank, a wholly-owned
subsidiary of First Federal Holding Company of Morris, Inc.
We are primarily a community bank providing a broad range of commercial and
retail banking services designed to meet the borrowing and depository needs of
small and medium-sized businesses and consumers in the communities we serve. We
offer a full range of deposit accounts that are typically available at banks and
savings associations, including checking accounts, commercial accounts, savings
accounts and other time deposit accounts. We also provide a range of lending
services, including commercial, real estate and consumer loans to individuals,
small and medium-sized businesses and professional associations.
We believe that many businesses and individuals in our market area are
under-served by larger regional and national lending institutions that have
established operations in our principal market area. As a community bank, we
seek to provide our banking customers with the technological and staff support
that today's market requires, and make available a broad range of products while
providing personalized service. We are managed by individuals who have lived and
worked in our market for many years and believe that we can leverage the
experience of our management to grow our business. By combining support with the
products and services our customers require and our local management and
personalized service, we seek to foster a business that enables us to
effectively compete in our market with other financial banking institutions of
all sizes.
Our principal executive offices are located at 1650 Madison Avenue,
Mankato, Minnesota 56001, and our telephone number is (507) 387-2265.
PENDING MERGER WITH FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
On September 30, 1999, we entered into an agreement to merge with First
Federal Holding Company of Morris, Inc. First Federal will merge with and into
Northern Star Financial and we will be the surviving company. Under the
agreement, we will issue approximately 870,559 shares of our common stock for
all of the outstanding shares of First Federal's common stock. The merger is
subject to a variety of conditions, including the sale of at least 350,000
shares of our stock at a price not less than $10 per share, Federal Reserve
Board approval, and approval of the merger by our and First Federal's
shareholders. The sale of the minimum number of shares in this offering will
satisfy our condition to sell at least 350,000 shares. We expect to complete the
merger before the end of our fiscal year on June 30, 2000.
First Federal is a savings and loan holding company. It owns approximately
90% of the outstanding capital stock of First Federal Savings Bank, which is the
majority owner of Homeland Mortgage, LLC. First Federal Savings Bank is a thrift
institution that operates retail banking offices
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in Morris, Benson, and Breckenridge, Minnesota and is expected to open a new
branch in Big Lake, Minnesota by May 2000. First Federal Savings Bank engages in
financial services including mortgage, commercial and consumer lending, and
various deposit and savings plans. First Federal Savings Bank owns West Central
Investments, Inc., which provides investment and brokerage services to the
general public in several First Federal Savings Bank locations.
Following the merger, we will continue to operate Northern Star Bank, First
Federal Savings Bank and its affiliates, utilizing current management personnel
in a manner consistent with their current operations. The following persons are
expected to serve as our officers following the merger:
<TABLE>
<CAPTION>
CURRENT TITLE TITLE POST-MERGER
------------- -----------------
<S> <C> <C>
Thomas Stienessen Northern Star Financial President Chairman and Chief Executive
and Chief Executive Officer Officer
Frank Gazzola Northern Star Financial Chief Chief Financial Officer, Secretary
Financial Officer, Secretary and and Treasurer
Treasurer
Allan Thoren First Federal Chairman and Chief Vice Chairman and Chief Operating
Executive Officer Officer
</TABLE>
In addition, the following persons are expected to serve as members of our
board of directors following the merger:
<TABLE>
<CAPTION>
CURRENT NORTHERN STAR FINANCIAL DIRECTORS CURRENT FIRST FEDERAL DIRECTORS
- ----------------------------------------- -------------------------------
<S> <C>
Dean Doyscher Lloyd Fehr
Frank Gazzola Kenneth Johnson
Thomas Reynolds Neil Schmidgall
Thomas Stienessen Allan Thoren
</TABLE>
We anticipate that our organizational structure following the merger will
be as follows:
[ORGANIZATIONAL STRUCTURE FOLLOWING MERGER FLOW CHART]
ANTICIPATED BENEFITS OF THE MERGER
We believe our proposed merger with First Federal furthers our business
strategy by geographically diversifying and expanding our community banking
presence and balance sheet. In
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addition, the merger will diversify our non-community banking activities to
include mortgage banking and investment and brokerage services. We believe the
merger with First Federal will provide us the following benefits:
- The merger builds upon our efforts to expand and diversify our community
banking organization within and outside of Minnesota.
- The merger provides opportunities to branch into new geographic markets.
Because savings associations like First Federal may establish branches
without many of the regulatory restrictions imposed on banks, the merger
will facilitate expansion within and outside of Minnesota. The merger
will also enhance our ability to establish branches within Minnesota,
since savings associations are not subject to state laws that restrict
branching.
- The merger increases our size and strength to allow us to serve a broader
segment of the community banking market, in particular larger and more
complex business organizations. For example, assuming that the merger
with First Federal had occurred on December 31, 1999 and the sale of the
minimum number of shares in this offering, we would have had $82,461,790
in total assets, and $11,649,311 in shareholder's equity, and if we
completed the sale of the maximum number of shares, we would have had
$87,576,790 in total assets and $16,764,311 in shareholder's equity at
that time.
- We diversify our market and balance sheet thereby reducing our reliance
on a single bank and a single market.
- We anticipate that it will contribute to our profitability. For example,
assuming that we and First Federal had been combined as of and for the
quarter ended December 31, 1999, as well as the year ended June 30, 1999,
our pro forma net income (loss) for the six month period ended December
31, 1999 and year ended June 30, 1999 would have been ($195,479) or
($0.15) per share and $300,647 or $0.26 per share, respectively.
- It enhances our access to capital markets.
- It enhances our ability to attract and retain skilled employees.
- The merger will provide additional flexibility to extend our loan
portfolio within regulatory lending limitations.
STRATEGY
We believe that rewarding business opportunities exist in the community
banking business. The acquisition and consolidation of many community banks by
large national and regional banks has diminished or eliminated the presence of
community banks from many rural and suburban communities. We believe that there
is a need and support for locally operated and managed community banks in many
of these communities.
Our plan is to grow our community banking business through acquisition and
branching, and diversify our revenue sources by providing other traditional and
non-traditional financial services. We intend to diversify and grow our
community banking business by expanding our geographic presence in and outside
the State of Minnesota. In connection with our geographic expansion, we intend
to expand and diversify our balance sheet to be able to provide a greater level
of commercial and agricultural lending and other financial services.
We intend to grow our community banking business while maintaining the
critical components we believe support successful community banking. We intend
to operate each of our affiliated
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<PAGE> 6
community banks using local management and board of directors. We intend to rely
on the local community bank's management and board of directors to determine the
best interests of each community bank within their particular community and each
bank will have authority to make all decisions affecting credit, pricing and the
marketing of bank services. We believe the strength and success of a community
bank rests, in large part, in the customer's ability to put a human face and
touch to their bank service provider. As we increase our number of affiliated
community banks, we intend to develop and implement a technology integration
strategy to integrate and improve our and our affiliate banks' information
management systems and enhance customer service.
We intend to diversify and expand our business to provide traditional and
non-traditional banking services. The recent adoption of the Gramm-Leach-Bliley
Act, commonly referred to as the "New Financial Modernization Legislation" may
present new opportunities to us by allowing us to provide directly to our
customers non-traditional banking services such as insurance and securities
brokerage services. We intend to explore our expansion, through acquisition,
internal development and the use of strategic alliances with third parties, into
non-community banking services.
THE OFFERING
Common Stock Offered................ Minimum: 500,000 Maximum: 1,000,000
Offering Price...................... $10.50 per share.
Common Stock Outstanding............ After the Minimum: 925,600 shares
After the Maximum: 1,425,600 shares
In addition, on December 31, 1999 we
had options outstanding to purchase
79,600 shares of our common stock
and warrants outstanding to purchase
10,000 shares of our common stock.
Use of Proceeds..................... We intend to use the net proceeds to
provide additional equity capital to
our Bank, and if the merger with
First Federal is completed, to the
Savings Bank, to support our growth
strategy.
Proposed Purchases of Common
Stock............................... Our directors and senior officers
and certain of our shareholders may
purchase common stock in the
offering.
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NORTHERN STAR FINANCIAL SUMMARY FINANCIAL DATA
The following table summarizes certain historical financial data of
Northern Star Financial and its subsidiary on a consolidated basis as of and for
the six months ending December 31, 1999 and as of and for the fiscal years
ending June 30, 1998 and 1999. You should read this table in conjunction with
our financial statements and related notes appearing elsewhere in this
prospectus.
<TABLE>
<CAPTION>
JUNE 30,
DECEMBER 31, ---------------------
1999 1999 1998
------------- ---------- -------
(UNAUDITED)
<S> <C> <C> <C>
STATEMENT OF INCOME:
Interest income..................................... $ 420,510 $ 154,875 --
Interest expense.................................... 155,728 40,012 --
----------- ----------
Net interest income................................. 264,782 114,863 --
Provision for loan losses........................... 67,500 56,250 --
Other non-interest income........................... 39,860 42,449 --
Non-interest expense................................ 605,285 594,734 --
----------- ----------
Income (loss) before income tax expense............. (368,143) (493,672) --
Income tax expense (benefit)........................ -- -- --
----------- ---------- -------
Net income (loss)................................... $ (368,143) $ (493,672) $(3,959)
=========== ========== =======
BALANCE SHEET:
Assets.............................................. $16,668,493 $9,635,608 $14,806
Allowance for loan losses........................... 123,750 56,250 --
Deposits............................................ 13,138,387 6,164,569 --
Stockholders' equity................................ 3,070,079 3,423,702 (3,859)
PER SHARE DATA:
Net income (loss) -- basic.......................... $ (0.86) $ (1.60) --
Net income (loss) -- diluted........................ (0.86) (1.60) --
Book value.......................................... 7.12 8.04 --
OTHER DATA:
Average shares outstanding -- basic................. 425,600 307,831 10
Average shares outstanding -- diluted............... 425,600 307,831 --
FINANCIAL RATIOS:
Return on average assets............................ (6.36)% (22.61)% --
Return on average stockholders' equity.............. (22.82)% (69.87)% --
Net interest margin................................. 5.01% 6.15% --
Tier 1 leverage ratio............................... 19.60% 36.50% --
Tier 1 capital to risk-weighted assets.............. 22.90% 43.30% --
Total capital to risk-weighted assets............... 24.02% 44.20% --
ASSET QUALITY RATIOS:
Nonperforming assets to total assets................ N/A N/A
Nonperforming assets to total loans and other real
estate owned...................................... N/A N/A
Allowance for loan losses to total loans............ 1.37% 1.00% --
</TABLE>
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<PAGE> 8
FIRST FEDERAL SUMMARY FINANCIAL DATA
The following table summarizes certain historical financial data of First
Federal and its subsidiaries on a consolidated basis as of and for the quarter
ending December 31, 1999 and as of and for the fiscal years ending September 30,
1998 and 1999. You should read this table in conjunction with First Federal's
financial statements and related notes appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
SEPTEMBER 30,
DECEMBER 31, --------------------
1999 1999 1998
------------ -------- --------
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C> <C>
STATEMENT OF INCOME:
Interest income.................................... $ 1,080 $ 4,337 $ 4,422
Interest expense................................... 559 2,203 2,260
---------- -------- --------
Net interest income................................ 521 2,134 2,162
Provision for credit losses........................ -- 2 12
Non-interest income................................ 181 536 513
Non-interest expense............................... 707 2,078 1,771
---------- -------- --------
Income (loss) before income tax & minority
interest......................................... (5) 590 892
Income tax expense................................. 9 220 301
---------- -------- --------
Net income (loss) before minority interest......... (14) 370 591
Minority interest.................................. (35) 1 54
---------- -------- --------
Net income (loss).................................. $ 21 $ 369 $ 537
========== ======== ========
BALANCE SHEET:
Assets............................................. $ 61,060 $ 57,566 $ 57,364
Loans Receivable, net.............................. 45,943 45,163 40,421
Savings deposits................................... 52,528 48,484 49,928
Stockholders' equity............................... 3,674 3,666 3,320
PER SHARE DATA:
Net income -- basic................................ $ 20.47 $ 362.68 $ 522.98
Net income -- diluted.............................. 20.47 362.68 522.98
Book value......................................... 3,612.81 3,604.93 3,264.68
OTHER DATA:
Average shares outstanding -- basic................ 1,017 1,017 1,026
Average shares outstanding -- diluted.............. 1,017 1,017 1,026
FINANCIAL RATIOS:
Return on average assets........................... 0.14% 0.64% 0.95%
Return on average equity........................... 2.12% 10.56% 17.13%
Equity to asset ratio.............................. 6.73% 6.07% 5.59%
Net interest rate spread........................... 3.80% 3.91% 3.73%
Net yield on average interest-bearing assets....... 3.83% 4.01% 3.98%
Tier 1 leverage ratio.............................. 8.43 8.70 8.15
Tier 1 capital to risk-weighted assets............. 10.49 10.46 10.77
Total capital to risk-weighted assets.............. 11.53 11.53 11.89
ASSET QUALITY RATIOS:
Non-performing loans to total assets............... 0.05% 0.29% 0.64%
Non-performing loans to total loans................ 0.06% 0.36% 0.85%
Allowance for loan losses to total loans........... 1.10% 1.12% 1.10%
Allowance for loan losses to nonperforming loans... 1,750.00% 315.57% 129.86%
</TABLE>
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SUMMARY PRO FORMA FINANCIAL DATA
The following table summarizes certain unaudited pro forma condensed
combined financial information to show you what we might have looked like had we
and First Federal been combined as of and for the six months ended December 31,
1999, as well as for the year ended June 30, 1999. Because we had no operations
before 1999 and our activities were limited solely to organizational matters,
comparative pro forma condensed combined financial information for prior periods
is not material and is not presented below.
Please note that we may be unable to complete the proposed merger with
First Federal. The merger is subject to various conditions, any of which may
fail to be satisfied.
<TABLE>
<CAPTION>
AS OF AND FOR THE
SIX MONTHS ENDED AS OF AND FOR THE
DECEMBER 31, YEAR ENDED
1999 JUNE 30, 1999
----------------- -----------------
<S> <C> <C>
STATEMENT OF INCOME:
Interest income........................................ $ 2,507,768 $4,570,286
Interest expense....................................... 1,248,788 2,276,066
----------- ----------
Net interest income.................................... 1,258,980 2,294,220
Provision for loan losses.............................. 67,500 61,250
Non-interest income.................................... 401,597 549,767
Non-interest expense................................... 1,772,643 2,242,490
----------- ----------
Income (loss) before income tax & minority interest.... (179,566) 540,247
Income tax expense (benefit)........................... -- 194,485
----------- ----------
Net income (loss) before minority interest............. (179,566) 345,762
Minority interest...................................... 15,913 45,115
----------- ----------
Net income (loss)...................................... $ 195,479 $ 300,647
BALANCE SHEET:
Assets................................................. $77,516,790 --
Loans Receivable, Net.................................. 54,797,701 --
Deposits............................................... 65,666,587 --
Stockholders' equity................................... 6,704,311 --
PER SHARE DATA:
Net income (loss) -- basic............................. $ (0.15) $ 0.26
Net income (loss) -- diluted........................... (0.15) 0.26
Book value............................................. 5.17 --
OTHER DATA:
Average shares outstanding -- basic.................... 1,296,159 1,178,390
Average shares outstanding -- diluted.................. 1,296,159 1,178,390
</TABLE>
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RISK FACTORS
An investment in our common stock involves a high degree of risk. You
should invest only after carefully considering the risks described below and
elsewhere in this prospectus and only if you can afford to lose your entire
investment. An investment in our common stock is not a deposit or savings
account and is not insured or guaranteed by the FDIC or any other governmental
agency.
WE MAY NOT COMPLETE OUR PROPOSED MERGER WITH FIRST FEDERAL IN A TIMELY MANNER,
OR AT ALL.
Our proposed merger with First Federal requires regulatory approval and
satisfactory completion of other conditions. In order to complete our merger
with First Federal, we must obtain approval from the Federal Reserve Board. We
have submitted an application for the Federal Reserve Board's approval. While we
believe that our application will be approved, we cannot assure you that the
Federal Reserve Board will approve our application. In addition to Federal
Reserve Board approval, several additional conditions must be satisfied before
we complete the merger with First Federal, including without limitation the
following:
- Each of the parties must perform in all material respects its obligations
under the merger agreement;
- Each of the parties' representations and warranties contained in the
merger agreement must continue to be true and correct in all material
respects;
- Our shareholders must approve the merger;
- First Federal's shareholders must approve the merger;
- All required governmental agencies must approve the merger;
- First Federal's counsel must provide a legal opinion that the merger will
be a tax-free reorganization for federal income tax purposes;
- Our and First Federal's independent accountants must provide opinions
that "pooling of interests" accounting treatment will be appropriate for
the merger;
- We must complete the sale of at least 350,000 shares of our common stock
at a price not less than $10 per share in this offering;
- An employment agreement between Allan Thoren and us must be in effect;
and
- No material adverse change has occurred since June 30, 1999 (other than
changes in banking laws or regulations that affect the banking industry
generally or changes in the general level of interest rates).
This is not an exhaustive list of all the conditions that must be satisfied
before we complete the proposed merger. Satisfaction of several of these
conditions depends on the occurrence of events beyond our control, including the
approval of the merger by our and First Federal's shareholders and the issuance
of securities in this offering. If any of these conditions is not satisfied or
the Federal Reserve Board fails to approve our application, we will not be able
to complete our proposed merger with First Federal and our business may be
materially adversely affected.
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WE HAVE A LIMITED OPERATING HISTORY AND HAVE INCURRED AND EXPECT TO INCUR
OPERATING LOSSES.
We just recently commenced banking operations in January 1999. Since that
time, we have incurred a net loss of $493,672 for our fiscal year ended June 30,
1999 and a net loss of $368,143 for the six months ended December 31, 1999. We
believe that we will continue to incur losses at least through our third quarter
ending March 31, 2000. We cannot assure you that we will attract deposits and
develop a loan portfolio sufficient to become profitable in 2000 or at any time
in the future.
WE MAY NOT BE ABLE TO SUCCESSFULLY IMPLEMENT OUR GROWTH STRATEGY.
In order to achieve and maintain profitability, we must aggressively grow
our business. We intend to use the proceeds from this offering to support
anticipated increases in our loan portfolio and investments and expansion. Our
ability to grow depends in part on our ability to successfully attract deposits,
identify loan and investment opportunities, and expand into new markets either
through acquisition or by opening new branch locations. In order to successfully
manage this growth, we must also maintain cost controls and asset quality
throughout our operations. If we are unable to effectively implement our growth
strategies, our business may be adversely affected.
CHANGES IN INTEREST RATES MAY ADVERSELY IMPACT OUR PROFITABILITY.
Our net income depends principally upon our net interest income. Net
interest income is the difference between interest earned on loans, investments
and other interest-earning assets and the interest paid on deposits and borrowed
funds. Any change in general market interest rates, whether a result of changes
in monetary policies of the Federal Reserve Board or otherwise, can have a
significant effect on our net income.
We attempt to manage risks due to changes in market interest rates by
controlling the mix of interest rate sensitive assets and interest rate
sensitive liabilities. However, interest rate management techniques do not
always produce the financial results anticipated and a rapid increase or
decrease in interest rates could adversely effect our financial performance.
First Federal is subject to similar risks relating to changes in interest
rates, and if we complete our proposed merger with First Federal, our combined
financial performance will continue to be sensitive to rapid interest rate
changes.
OUR EXPOSURE TO CREDIT RISK IS INCREASED BECAUSE WE FOCUS ON COMMERCIAL LENDING.
We make various types of loans, including commercial, consumer, residential
mortgage and construction loans. We incur risk in making our loans. These risks
include interest rate changes over the time period in which loans may be repaid,
risks resulting from changes in our regional economy, risks inherent in dealing
with individual borrowers, and in the case of a loan backed by collateral, risks
resulting from uncertainties about the future value of the collateral.
Our loans to small and medium-sized businesses are generally riskier than
single-family mortgage loans. Typically, the success of a small or medium-sized
business depends on the management talents and efforts of one or two persons or
a small group of persons, and the death, disability or resignation of one or
more of these persons could have a material adverse impact on our business. In
addition, small and medium-sized businesses frequently have smaller market
shares than their competition, may be vulnerable to economic downturns, often
need substantial additional capital to expand or compete and may experience
substantial variations in operating results, any of which may impair a
borrower's ability to repay a loan. Because our loan portfolio contains a
significant number of
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<PAGE> 12
commercial loans, the failure of these loans to perform as expected could result
in a loss of earnings from these loans, an increase in the provision for loan
losses and an increase in loan charge-offs.
ADVERSE ECONOMIC CONDITIONS IN OUR PRIMARY MARKET MAY HAVE AN ADVERSE IMPACT ON
US.
Substantially all our business is with customers located within Mankato,
Minnesota and the counties of Blue Earth and Nicollet. The businesses to whom we
make loans are small and medium-sized businesses and are dependent upon the
regional economy. Adverse economic and business conditions in our market area
could affect our borrowers, their ability to repay their loans and consequently
our financial condition and performance.
A WEAK AGRICULTURAL ECONOMY MAY HAVE AN ADVERSE EFFECT ON FIRST FEDERAL.
Substantially all First Federal Savings Bank's business is with customers
located in the Minnesota counties of Stevens, Swift and Wilkin, a predominantly
rural area of west central Minnesota heavily dependent upon the agricultural
economy. A weakness in the local agricultural economy, including a weakness
caused by low commodities prices, could affect borrowers, their ability to repay
their loans and consequently First Federal Savings Bank's financial condition
and performance.
OUR ALLOWANCES FOR LOAN LOSSES MAY BE INADEQUATE TO ABSORB ACTUAL FUTURE LOAN
LOSSES.
We believe that our allowance for loan losses is adequate to absorb any
inherent losses in our loan portfolio. Management's estimates are used to
determine the allowance that is considered adequate to absorb losses in our loan
portfolio. Management's estimates are based on historical loan loss experience,
specific problem loans, value of underlying collateral, economic conditions and
other relevant factors. These estimates are subjective and their accuracy
depends on the outcome of future events. Actual losses may differ from current
estimates. Depending on changes in economic, operating and other conditions,
including changes in interest rates that are generally beyond our control,
actual loan losses could increase significantly. As a result, such loan losses
could exceed current loan allowance estimates.
First Federal is subject to similar risks related to its allowance for loan
losses, and if we complete our proposed merger with First Federal, our combined
financial performance could be adversely affected if loan losses exceed current
loan allowance estimates.
Because we have a short operating history, we do not have a seasoned loan
portfolio and the ratio of the loan allowance for loan losses to total loans,
will likely be increased as our loan portfolio matures. If it becomes necessary
to increase the ratio of the allowance for loan losses to total loans, such
increases would be accomplished through higher provisions for loan losses, which
will adversely impact net income or will increase operating losses.
In addition, bank regulatory agencies, as an integral part of their
supervisory function, periodically review the adequacy of our allowance for loan
losses. Regulatory agencies may require us to increase our provision for loan
losses or to recognize further charge-offs based upon judgments different from
those of management. Any increase in the allowance required by regulatory
agencies could have a negative impact on our operating results. We cannot assure
you that charge-offs in future periods will not exceed the allowances for loan
losses or that additional increases in the allowance for loan losses will not be
required. Additions to the allowance for loan losses would result in a decrease
in our net income, or an increase in our operating losses, and possibly a
decrease in our capital.
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<PAGE> 13
GOVERNMENT REGULATIONS SIGNIFICANTLY AFFECT OUR BUSINESS.
As a bank holding company, we are primarily regulated by the Board of
Governors of the Federal Reserve System. Our Bank is regulated by the Department
of Commerce of the State of Minnesota and the FDIC.
Federal laws and the laws of the State of Minnesota govern numerous aspects
of our Bank's operation including:
- adequate capital and financial conditions;
- permissible types and amounts of extensions of credit and investments;
- permissible non-banking activities; and
- restrictions on dividend payments.
Federal and the State of Minnesota regulatory agencies have extensive
discretion and power to prevent or remedy unsafe or unsound practices or
violations of law by our Bank and by us. We also undergo periodic examinations
and inspections by one or more regulatory agencies. Following such examinations,
we may be required, among other things, to change our asset valuations or the
amounts of required loan loss allowance or to restrict our operations. Those
actions would result from the regulators' judgments based on information
available to them at the time of their examination.
Government regulations also affect First Federal's business. First Federal
Savings Bank is primarily regulated by the Office of Thrift Supervision, which
has discretion and power to prevent or remedy unsafe or unsound practices or
violations of law by the Savings Bank. If we complete our proposed merger with
First Federal, our combined operations may be affected by actions of the Office
of Thrift Supervision.
Our and First Federal's operations must comply with a variety of state and
federal consumer protection and similar laws and regulations. Federal and state
regulatory restrictions limit the manner in which we may conduct business and
obtain financing. These laws and regulations can and do change significantly
from time to time, and any such change could adversely affect us.
WE ARE DEPENDENT UPON OUR MANAGEMENT.
Our future success depends, in large part, upon the continuing
contributions of our key management personnel, including our president, Thomas
Stienessen. Mr. Stienessen has been critical to our formation and operation and
we believe his leadership is critical to executing our business plan and growing
our business. Mr. Stienessen has an employment agreement with us.
Upon completing our proposed merger with First Federal, the success of the
combined business will also depend largely on the efforts of Allan Thoren, who
has served as First Federal Savings Bank's president and chief executive officer
since 1990. We anticipate that Mr. Thoren will become our vice chairman and
chief operating officer after the merger. We will have an employment agreement
with Mr. Thoren, effective upon completing the merger.
WE MAY NOT BE ABLE TO SUCCESSFULLY COMPETE WITH OTHER FINANCIAL INSTITUTIONS,
EVEN IF WE COMPLETE THE PROPOSED MERGER WITH FIRST FEDERAL.
We face substantial competition in originating loans and in attracting
deposits. The competition in originating loans comes principally from other
banks, savings institutions, mortgage banking companies and other lenders. Many
of our competitors have advantages including greater financial resources, a
wider geographic presence or more accessible branch office locations, the
ability to offer a wider array of services, or more favorable pricing
alternatives and lower origination and operating
13
<PAGE> 14
costs. This competition could decrease the number and size of loans which we
originate and the interest rate which we receive on these loans.
In attracting deposits, we compete with other depository institutions,
including banks, savings institutions and credit unions, as well as institutions
offering uninsured investment alternatives, including money market funds. These
competitors may offer higher interest rates than we do, which could decrease the
deposits that we attract or require us to increase our rates to attract new
deposits. Increased deposit competition could increase our cost of funds and
adversely affect our ability to generate the funds necessary for lending
operations.
FIRST FEDERAL WILL INCUR SUBSTANTIAL STARTUP COSTS WITH ITS NEW BRANCH IN BIG
LAKE, MINNESOTA.
First Federal Savings Bank has recently received regulatory approval to
establish a new branch office in Big Lake, Minnesota (the "Big Lake Office").
First Federal Savings Bank has acquired a commercial building site and will
incur substantial expenses remodeling the building that currently occupies the
site and adding the equipment necessary to provide banking services, including a
vault, safety deposit vault, security devices, drive up banking facilities, data
processing equipment and furnishings. In addition, the Big Lake Office will
require staff, training and supervision, beginning several weeks before the
office can be opened for business. First Federal Savings Bank will incur
substantial startup costs, and there is no assurance when or whether the Big
Lake Office will attract deposits and develop a loan portfolio sufficient to
become profitable.
FORWARD-LOOKING STATEMENTS MAY PROVE INACCURATE.
The Private Securities Litigation Reform Act of 1995 provides a safe harbor
for forward-looking statements made by or on behalf of us. We have made, and may
continue to make, various written or verbal forward-looking statements with
respect to business and financial matters, including statements contained in
this report, filings with the Securities and Exchange Commission, and reports to
stockholders. All statements which address our beliefs regarding our market,
strategy, events or developments that we expect or anticipate will occur in the
future, including those expected as a result of our proposed merger with First
Federal found under the Sections entitled "Our Company," "Anticipated Benefits
of Our Merger with First Federal," "Strategy," "Northern Star Financial's
Reasons for the Merger," "Management's Discussion and Analysis of Financial
Condition of and Results of Operations," "Northern Star Financial,
Inc. -- Business -- Strategy and Competition," are forward-looking statements
within the meaning of the Act. The forward-looking statements are and will be
based on management's then current views and assumptions regarding future events
and operating performance. Certain factors that could affect financial
performance or cause actual results to vary significantly from estimates
contained in or underlying forward looking statements include:
- Interest rate fluctuations and other market conditions.
- Strength of the agricultural, consumer and commercial credit sectors, as
well as real estate markets.
- Changes in laws and regulations, including changes in accounting
standards and taxation requirements (including tax rate changes, new tax
laws, and revised tax law interpretation).
- Competitive pricing and other pressures on loans and deposits and our
ability to maintain market shares in its trade areas.
- The inherent uncertainties relating to Year 2000 compliance, including
compliance by our vendors, suppliers, and loan customers.
14
<PAGE> 15
- A downturn in local economic conditions in our primary markets, including
the markets served by First Federal.
- The failure to achieve any of the economic benefits from our merger with
First Federal, as a result of an increase in the costs to complete the
merger and the failure of First Federal or Northern Star Financial to
achieve their anticipated results of operations.
- Those risks identified under the Section entitled "Risk Factors."
- Other risks and uncertainties as detailed from time to time in our
filings with the Securities and Exchange Commission.
USE OF PROCEEDS
We will receive net proceeds of approximately $4,712,500 upon completing
the sale of the minimum number of shares in this offering and $9,595,000 upon
completing the sale of the maximum number of shares, after deducting expenses of
the offering (estimated at $170,000) and the sales agent's commission.
The following table sets forth the anticipated use of the net proceeds
(after deducting the estimated offering expenses and sales agent's commission)
by Northern Star Financial based on the sale of the minimum and maximum number
of shares.
<TABLE>
<CAPTION>
MINIMUM(1) MAXIMUM(2)
-------------------------- ---------------------------
DOLLAR PERCENTAGE OF DOLLAR PERCENTAGE OF
AMOUNT NET PROCEEDS AMOUNT NET PROCEEDS
---------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Net Proceeds................................ $4,712,500 100% $ 9,595,000 100%
Savings Bank(3)............................. $2,500,000 53.1% $ 2,500,000 26.1%
Northern Star Bank(3)....................... $1,000,000 21.2% $ 1,500,000 15.6%
Finance Growth Strategy(4).................. $1,212,500 25.7% $ 5,595,000 58.3%
</TABLE>
(1) Assumes the sale of 500,000 shares at $10.50 per share.
(2) Assumes the sale of 1,000,000 shares of $10.50 per share.
(3) Proceeds will be used by First Federal Savings Bank and Northern Star Bank
to make additional loans, increase their interest-earning assets, and
enhance their capital ratios.
(4) Northern Star intends to use proceeds to support its growth strategy. See
"Prospectus Summary -- Strategy." We intend to use proceeds to develop or
acquire additional bank or thrift branch offices, acquire other banks or
thrifts or enter into joint ventures. We have not identified any specific
acquisition or expansion opportunity at this time.
Although we intend to use the proceeds for these purposes, we may allocate
proceeds that we have allocated to finance our growth strategy to Northern Star
Bank and the Savings Bank, if required to preserve their capital ratio
requirements. If we fail to complete our proposed merger with First Federal, we
will use the $2,500,000 in proceeds to finance our growth strategy.
Pending utilization of the net proceeds of this offering, we plan to invest
net proceeds in short-term money market investments, high grade commercial paper
and interest-bearing bank accounts.
DIVIDEND POLICY
Substantially all of the funds available for the payment of cash dividends
are derived from Northern Star Bank. Future cash dividends will depend primarily
upon our Bank's earnings, financial condition, need for funds, and government
policies and regulations that apply to Northern Star Bank and to us and, if we
complete the merger with First Federal, to First Federal Savings Bank as well.
We have not and do not currently contemplate the payment of any dividends in the
near future. We intend to follow a policy of retaining any earnings to provide
funds to operate and expand our business.
15
<PAGE> 16
CAPITALIZATION
The following table summarizes our capitalization as of December 31, 1999,
and our pro forma capitalization as adjusted to reflect the sale of the minimum
and maximum number of shares in this offering at $10.50 per share and the
application of the estimated proceeds from such offerings as described in the
"Use of Proceeds" section of this prospectus. The following table does not
reflect the proposed merger with First Federal. You should read this table in
conjunction with our consolidated financial statements (including the notes
thereto) included elsewhere in this prospectus.
<TABLE>
<CAPTION>
DECEMBER 31, 1999
-----------------------------------------------
AS ADJUSTED
---------------------------------
ACTUAL MINIMUM MAXIMUM
---------- ------------------ -----------
<S> <C> <C> <C>
Shareholders' equity:
Common stock, $0.01 par value; 20,000,000
shares authorized; 425,600 shares
issued and outstanding (925,600 shares
as adjusted for the Minimum and
1,425,600 shares as adjusted for the
Maximum)(1)............................ $ 4,256 $ 9,256 $ 14,256
Paid-in capital........................... 3,919,577 8,627,077 13,504,577
Accumulated deficit and comprehensive
loss(2)................................ (893,754) (893,754) (893,754)
---------- ---------- -----------
Total shareholders' equity.................. $3,030,079 $7,742,579 $12,625,079
========== ========== ===========
</TABLE>
- -------------------------
(1) Does not include: (i) 36,000 shares of common stock issuable upon exercise
of outstanding nonqualified stock options granted to our non-employee
directors pursuant to our 1998 Equity Incentive Plan; (ii) 30,800 shares of
common stock issuable upon exercise of other outstanding nonqualified
options; (iii) 12,800 shares of common stock issuable upon exercise of
outstanding incentive stock options; and (iv) 10,000 shares of common stock
reserved for issuance under outstanding warrants.
(2) The accumulated deficit and comprehensive loss as of December 31, 1999 is
comprised of operating expenses incurred since inception, less operating
revenues.
PRICE RANGE OF COMMON STOCK
Our common stock has been quoted on the OTC Bulletin Board under the symbol
"NSBK" since February 2, 1999. Quotations in the following table represent
inter-dealer prices, without retail markups, markdowns or commissions, and do
not necessarily represent actual transactions.
<TABLE>
<CAPTION>
COMMON STOCK
-------------------
FISCAL QUARTER ENDED HIGH BID LOW BID
- -------------------- -------- -------
<S> <C> <C>
March 31, 1999.............................................. $10.00 $10.00
June 30, 1999............................................... 11.50 9.50
September 30, 1999.......................................... 12.00 10.00
December 31, 1999........................................... 11.00 10.00
Through March 17, 2000...................................... 10.50 8.75
</TABLE>
On March 17, 2000 the last sale price for our common stock was $8.75 per
share. On December 31, 1999, there were issued and outstanding 425,600 shares of
our common stock held by 49 shareholders of record. Record ownership includes
ownership by nominees who may hold for multiple owners.
16
<PAGE> 17
THE MERGER
The following summary of the merger of First Federal into Northern Star
Financial and related matters is not complete and is qualified in its entirety
by reference to the Agreement and Plan of Reorganization, which has been filed
with Northern Star Financial's quarterly report on Form 10-QSB for the quarter
ended September 30, 1999.
On September 30, 1999, we entered into an Agreement and Plan of
Reorganization with First Federal, which provides that First Federal will be
merged with and into us. At the effective time of the merger, each issued and
outstanding share of First Federal common stock will be converted into the right
to receive approximately 856 shares of our common stock. Under the Agreement and
Plan of Reorganization, a variety of conditions must be satisfied in order to
complete the merger.
BACKGROUND OF THE MERGER
The terms of the merger agreement are the result of arm's length
negotiations between our representatives and representatives of First Federal.
The following briefly discusses the background of these negotiations and related
matters.
Over the last several years the financial services industry has become
increasingly competitive, with many financial institutions expanding their size
and market area through consolidation. This trend has accelerated with a number
of mergers announced whose effects would continue to increase the competition in
the banking and the financial services industry in First Federal's marketplace.
As part of its effort to remain competitive within this environment, First
Federal's management and Board of Directors have continually analyzed various
strategic options available to First Federal, including the following:
1. remaining as an independent financial institution via operational
improvements, internal growth, continued investment in technology, and
shareholder capital infusions.
2. pursuing growth through a potential merger-of-equals transaction;
and
3. entering into a business combination with a larger entity.
In spring and early summer of 1997, First Federal's Board of Directors
contemplated First Federal's role in this increasingly competitive environment
and the internal operating efficiencies and investments that would have to take
place in order to continue to remain competitive. After discussions of various
alternatives for First Federal, including a continuation of, or changes in,
First Federal's own operations and programs, various types of affiliations with
other companies, a stock sale program and other matters to enhance shareholder
value, First Federal's Board of Directors determined it was appropriate to
expand the scope of its review of the strategic options available to First
Federal to maximize shareholder value and, accordingly authorized management to
explore opportunities for pursuing growth through a potential merger-of-equals
transaction.
This authorization led to discussions with our Board of Directors.
Thomas Stienessen, our President, and Allan Thoren, the President of First
Federal Savings Bank became acquainted in 1996 as both participated with a
consortium of bankers placing a bid for branch office locations that were being
spun off by a larger regional bank. In addition, the two individuals served as
industry leaders active in a banking trade association. The possibility of a
strategic business relationship was first discussed in very preliminary terms in
conversations between Mr. Stienessen and Mr. Thoren in the summer of 1997 at a
trade association meeting in St. Cloud, Minnesota while Mr. Stienessen served as
the Chief Executive Officer and President of SGL, Inc., a holding company for
the Family Bank.
17
<PAGE> 18
Mr. Stienessen resigned his positions with the SGL organization in December
1997 and organized Northern Star Financial. During the period between December
1997 and the summer of 1998, Mr. Stienessen and Mr. Thoren engaged in various
telephone conversations regarding the feasibility of a business combination with
Northern Star Financial and First Federal.
Messrs. Stienessen, Frank Gazzola and Thomas Reynolds as organizers of
Northern Star Bank, met with the members of First Federal's Board of Directors
in New Ulm, Minnesota in late summer of 1998 to discuss a potential strategic
alliance.
Subsequently, after review and discussion, Mr. Stienessen advised Mr.
Thoren that Northern Star Financial was not interested in pursuing an alliance
at that date, but might be willing to entertain proposals in the future. No
agreement was reached and no other proposal was submitted.
In the Fall of 1998, Mr. Thoren met with Mr. Stienessen to review the
construction of Northern Star Bank in Mankato, Minnesota. Discussions between
the individuals regarding a possible business combination resurfaced. From
January 1999 through April 1999, Mr. Stienessen conducted a due diligence
investigation and explored the possibility of a business combination with Mr.
Thoren. The Board of Directors of both organizations concluded that a joint
venture in First Federal's affiliated mortgage banking company would be in their
mutual interest and would serve as a suitable format to conduct further
discussions regarding a potential combination of banking organizations. Northern
Star Financial filed with the Federal Reserve Bank of Minneapolis, Minnesota a
Notice for Prior Approval to invest in a joint venture with First Federal. The
Notice for Prior Approval was approved on July 2, 1999 and Northern Star
Financial's investment in Homeland Mortgage, LLC was made on July 15, 1999.
Detailed discussions and negotiations regarding a possible merger between
the two banking organizations and due diligence investigations continued
following the commencement of the joint venture and resulted in the execution of
an Agreement and Plan of Reorganization on September 30, 1999. Such discussions
and negotiations included an analysis of an appropriate rate of exchange of the
stock of the respective organizations.
Representatives from Northern Star Financial met several times with the
representatives of the Board of Directors of First Federal to discuss a
combination of First Federal and Northern Star Financial prior to signing the
merger agreement.
In negotiating the final exchange ratio, First Federal and Northern Star
Financial considered the relative book value and earnings of each entity, as
well as certain special factors relating to historical performance, market
growth potential, ancillary businesses and future growth plans. First Federal
and Northern Star Financial did not follow a precise formula in the negotiation
of the final exchange ratio, which was based on a determination by management of
each institution that the exchange ratio fairly represented equivalent value for
the stockholders of each institution participating in the merger.
To assist the Board of Directors of First Federal with its deliberations on
whether to approve and recommend the merger, the Board of Directors retained
counsel to help in negotiating the terms of the merger agreement. Likewise, the
Board of Directors of Northern Star Financial retained the services of counsel
to review the proposed agreement.
The Board of Directors of First Federal and its counsel met on September
28, 1999, to discuss the merger agreement and the merger. Prior to that meeting,
the Board received a special board package that contained a draft of the
negotiated merger agreement. After review of the matters considered by the Board
of Directors, the Board of Directors of First Federal unanimously approved the
merger agreement and authorized the President and Chief Executive Officer of
First Federal Savings Bank and the Chairman of First Federal to take the
appropriate actions necessary to execute the merger agreement.
18
<PAGE> 19
The Board of Directors of Northern Star Financial met on September 15,
1999, to discuss the merger agreement and related agreements. After review of
the matters relating to the merger, the Board of Directors of Northern Star
Financial unanimously approved the merger agreement and authorized the President
and Chief Executive Officer of Northern Star Financial to take the appropriate
actions necessary to execute the merger agreement in substantially the form
approved by the Board.
The merger agreement was executed as of September 30, 1999.
NORTHERN STAR FINANCIAL'S REASONS FOR THE MERGER
We believe our proposed merger with First Federal will further our
strategic goal to grow and diversify our community banking business. We believe
the proposed merger with First Federal will provide us the following benefits:
- The merger builds upon our efforts to expand and diversify our community
banking organization within and outside of Minnesota.
- The merger diversifies our market and balance sheet, reducing our
reliance on a single bank and a single market.
- The merger provides opportunities to branch into new geographic markets.
Because savings associations like First Federal may establish branches
without many of the regulatory restrictions imposed on banks, the merger
will facilitate expansion within and outside of Minnesota. The merger
will also enhance our ability to establish branches within Minnesota,
since savings associations are not subject to state laws that restrict
branching.
- The merger increases our size and strength to allow us to serve a broader
segment of the community banking market, in particular larger and more
complex business organizations.
- We anticipate that the merger will contribute to our profitability.
- The merger will provide additional flexibility to expand our loan
portfolio within regulatory lending limitations.
- The merger enhances our access to capital markets.
- The merger enhances our ability to attract and retain skilled employees.
In reaching our determination that the proposed merger is in the best interest
of our shareholders, we consulted with our senior management with respect to
strategic and operational matters, legal counsel with respect to the legal
duties of our board of directors and regulatory and tax matters and our
independent accountants with respect to the accounting treatment of the merger.
Our board of directors carefully considered the following material factors
before unanimously approving the merger:
- The historical financial information of First Federal, including First
Federal's business, asset quality, market share and growth prospects and
the composition of the earning assets portfolio of First Federal;
- The financial terms of the merger, including the relationship of the
value of the consideration we will give First Federal shareholders in
relation to First Federal's historical book value and earnings;
- The non-financial terms of the merger, including the treatment of the
merger as a tax-free exchange of First Federal common stock for our
common stock for federal income tax purposes;
19
<PAGE> 20
- The likelihood of the merger being approved by applicable regulatory
authorities without undue conditions or delay;
- The opportunity for reducing the non-interest expense of the operations
of First Federal and Northern Star Financial and the ability of the
operations of First Federal after the effective date of the merger to
contribute to our consolidated earnings;
- The attractiveness of the First Federal franchise, the market position of
First Federal in West Central Minnesota and the northwestern suburbs of
Minneapolis, Minnesota, the compatibility of the franchise with our
operations and the ability of First Federal to contribute to our business
strategy;
- The opportunity to leverage our infrastructure to grow our earnings.
While each member of our board of directors individually considered the
foregoing factors, the board of directors did not collectively assign any
specific or relative weights to the factors considered and did not make any
determination with respect to any individual factor. Our board of directors
collectively made its determination with respect to the merger based on the
unanimous conclusion reached by its members, in light of the factors that each
of them consider as appropriate, that the merger is in our best interests and
the best interests of our shareholders.
The financial terms of the merger, including the exchange ratio, were the
result of arm's-length negotiations between us and representatives of First
Federal.
In arriving at a fair value of First Federal Savings Bank and determining
the exchange ratio, we reviewed publicly available information regarding recent
acquisitions of banks, information provided by First Federal and performed
studies and analysis as we deemed appropriate to determine the appropriate
exchange ratio. In arriving at the exchange ratio, we:
- Discussed the past and current operations and financial conditions and
the prospects of Northern Star Financial;
- Reviewed certain unaudited interim and audited financial statements, call
reports, budget reports, operating and performance data and other
information of First Federal;
- Discussed the past and current operations and financial condition and the
future prospects of First Federal with senior executives of First
Federal;
- Reviewed the financial terms of reported bank acquisitions, including
banks similar in size to First Federal;
- Reviewed and compared the performance of our common stock and its trading
activity with that of certain other comparable public traded companies;
- Prepared and reviewed pro forma financial information and performed other
analysis and considered such other factors as we deemed appropriate in
connection with the merger.
We analyzed and compared the financial performance of First Federal based
on various measures of earnings performance, operating efficiency, capital
adequacy and asset quality and various measures of market performance. For
purposes of this analysis, we reviewed the historical performance of First
Federal Savings Bank as reflected in First Federal Savings Bank's financial
statements as of and for the year ended September 30, 1998 and subsequent
interim financial data. We compared some of this information to publicly
available information regarding prices paid, during the first six months of
1999, for banks similar in size to First Federal.
We also considered the market price and trading volume of our common stock
as traded and quoted on the OTC Bulletin Board for the ten day period prior to
the execution of the Merger Agreement. Based upon the limited number of shares
traded, the average bid and ask prices quoted
20
<PAGE> 21
and our limited operating history, we assigned a value to our common stock, for
purposes of computing the consideration to be issued in the merger, equal to
$10.50 per share.
Our analysis of First Federal Savings Bank's financial performance for the
year ended September 30, 1998, showed the following concerning First Federal
Savings Bank's financial performance:
- return on equity was 12.44%, compared with a published average of 12.80%
for its peer group of banks of similar size;
- return on assets was 1.0% compared with a published average of 1.06% for
the peer group; and
- the equity to asset ratio was 8.70% compared to a published average of
8.93%.
We reviewed published financial data relating to comparable acquisitions of
banks similar in size to First Federal Savings Bank that were completed during
the first six months of 1999. Our analysis of the merger consideration to be
paid in relation to First Federal Savings Bank's financial performance and
position shows that we will pay:
- approximately 2.24 times First Federal Savings Bank's book value,
compared to a published average consideration paid for banks of similar
size of 2.22 times book value;
- approximately 16.23 times First Federal Savings Bank's 1998 earnings,
after tax, compared to published average consideration paid for banks of
similar size of 17.55 times earnings;
- approximately 11.5% of First Federal Savings Bank's core deposits as of
September 30, 1998 compared to published median premium/core deposits
paid for thrifts in the first quarter of 1999 of 11.9%, and second
quarter of 1999 of 10.7%.
We also performed a pro forma merger analysis that combined our and First
Federal's financial information to assess the feasibility of a merger and its
potential impact on Northern Star Financial following the merger. We made
assumptions regarding accounting treatment, acquisition adjustments, cost
savings, the number of shares to be issued in the merger and we assumed that we
would also purchase the minority interest in First Federal Savings Bank. This
analysis showed that based upon the merger being completed as of June 30, 1999,
the merger is expected to: (i) be accretive to earnings (excluding the effect of
a nonrecurring merger charge incurred in connection with the merger), (ii)
increase estimated return on equity and (iii) decrease the fully diluted
tangible book value. The pro forma information was prepared solely for our
management. The actual results achieved by us following the merger will likely
vary from our pro forma results and these variations may prove to be material.
We believe that after careful consideration of all the tangible and
intangible benefits that are expected to materialize as a result of our merger
with First Federal and the financial and non-financial terms of the merger, that
the terms of the merger are fair and the merger is in our and our shareholders'
best interest.
21
<PAGE> 22
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION
The following financial information is presented to assist you in your
understanding of the financial impact of our proposed merger with First Federal.
This information is unaudited and has been derived from the audited and
unaudited financial statements of Northern Star Financial and First Federal.
The following combined historical condensed balance sheet, as of December
31, 1999, reflects the merger of Northern Star Financial and First Federal. This
pro forma balance sheet merely reflects the companies on a combined historical
basis and does not take into account this offering. See "The Offering".
The following combined historical condensed statements of operations for
the six-month period ended December 31, 1999 and for the year ended June 30,
1999 give pro forma effect to the merger as if it had been in effect throughout
the periods presented. The merger of Northern Star Financial and First Federal
will be accounted for as a business combination by the pooling-of-interests
method. The combined historical statements do not take into account the receipt
of the net proceeds from the proposed offering, and may not be indicative of the
results that actually would have occurred if the combination had been effective
during the periods shown.
The pro forma balance sheet and pro forma operating statements should be
read in connection with the Financial Statements of Northern Star Financial and
First Federal and the Notes thereto contained elsewhere herein.
22
<PAGE> 23
NORTHERN STAR FINANCIAL, INC. AND FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
DECEMBER 31, 1999
<TABLE>
<CAPTION>
NORTHERN STAR FIRST PRO FORMA NORTHERN STAR
FINANCIAL FEDERAL ADJUSTMENTS AND FINANCIAL
(HISTORICAL) (HISTORICAL) ELIMINATIONS PRO FORMA
------------- ------------ ---------------- -------------
<S> <C> <C> <C> <C>
ASSETS
Cash and due from banks...................... $ 249,088 $ 4,296,544 -- $ 4,545,632
Federal funds sold........................... 2,159,781 -- -- 2,159,781
Securities available for sale................ 4,465,492 4,156,324 -- 8,621,816
Securities held to maturity.................. -- 722,341 -- 722,341
FHLB stock at cost........................... 21,300 211,200 -- 232,500
Loans held for sale.......................... 66,440 1,568,300 -- 1,634,740
Loans receivable............................. 8,950,055 45,943,346 (95,700)(2) 54,797,701
Accrued interest receivable.................. 128,981 730,834 -- 859,815
Premises and equipment, net.................. 465,957 1,106,907 -- 1,572,864
Cash surrender value of life insurance....... -- 1,660,914 -- 1,660,914
Other assets................................. 161,399 663,109 (115,822)(1) 708,686
----------- ----------- --------- -----------
Total assets............................... $16,668,493 $61,059,819 $(211,522) $77,516,790
=========== =========== ========= ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits..................................... $13,138,387 $52,528,200 $ -- $65,666,587
Advances from FHLB........................... 425,000 2,293,421 -- 2,718,421
Notes Payable................................ -- 1,097,038 (95,700)(2) 1,001,338
Advances from borrowers for tax and
insurance.................................. 5,436 140,637 -- 146,073
Other liabilities............................ 69,591 725,695 -- 795,286
----------- ----------- --------- -----------
Total liabilities.......................... 13,638,414 56,784,991 (95,700) 70,327,705
Minority interest............................ -- 600,596 (115,822)(1) 484,774
SHAREHOLDERS' EQUITY
Common stock................................. 4,256 104,200 -- 108,456
Additional paid in capital................... 3,919,577 288,337 -- 4,207,914
(Accumulated deficit) retained earnings...... (865,774) 3,441,469 -- 2,575,695
Accumulated other comprehensive income
(loss)..................................... (27,980) (27,774) -- (55,754)
Treasury stock............................... -- (132,000) -- (132,000)
----------- ----------- --------- -----------
Total shareholders' equity................. 3,030,079 3,674,232 -- 6,704,311
----------- ----------- --------- -----------
Total liabilities and shareholders'
equity................................ $16,668,493 $61,059,819 $(211,522) $77,516,790
=========== =========== ========= ===========
</TABLE>
- -------------------------
(1) Eliminate Northern Star Financial's 49% ownership in Homeland Mortgage, LLC,
which was recorded on the equity method, with the minority interest recorded
by First Federal Holding Company. First Federal owns the controlling 51% of
Homeland Mortgage which is recorded by First Federal on the consolidated
method.
(2) Eliminated First Federal Holding Company's line of credit payable to
Northern Star Financial.
23
<PAGE> 24
NORTHERN STAR FINANCIAL, INC. AND FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED JUNE 30, 1999
<TABLE>
<CAPTION>
NORTHERN STAR FIRST PRO FORMA NORTHERN STAR
FINANCIAL FEDERAL ADJUSTMENTS AND FINANCIAL
(HISTORICAL) (HISTORICAL) ELIMINATIONS PRO FORMA
------------- ------------ --------------- -------------
<S> <C> <C> <C> <C>
Interest income
Loans....................................... $ 120,005 $3,928,809 $ -- $4,048,814
Other interest earning assets............... 34,870 486,602 -- 521,472
--------- ---------- --------- ----------
Total interest income.................... 154,875 4,415,411 -- 4,570,286
Interest expense
Deposits.................................... 40,012 2,000,394 -- 2,040,406
Borrowings.................................. -- 235,660 -- 235,660
--------- ---------- --------- ----------
40,012 2,236,054 -- 2,276,066
Net interest income........................... 114,863 2,179,357 -- 2,294,220
Provision for loan losses..................... 56,250 5,000 -- 61,250
--------- ---------- --------- ----------
Net interest income after provision for loan
losses...................................... 58,613 2,174,357 -- 2,232,970
Non-interest income
Fees and service charges.................... 45,499 318,875 -- 364,374
Gain(loss) on sale of loan.................. (3,050) 110,854 -- 107,804
Other....................................... -- 77,589 -- 77,589
--------- ---------- --------- ----------
Total non-interest income................ 42,449 507,318 -- 549,767
Non-interest expense
Compensation and employee benefits.......... 247,497 1,148,937 (40,364)(1) 1,396,434
Occupancy................................... 39,556 208,967 -- 248,523
Advertising................................. 6,937 29,079 -- 36,016
FDIC and OTS assessments.................... -- 54,590 -- 54,590
Other....................................... 300,744 510,183 (263,636)(1) 547,291
--------- ---------- --------- ----------
Total non-interest expense............... 594,734 1,951,756 (304,000) 2,242,490
Net income (loss) before income taxes......... (493,672) 729,919 304,000 540,247
Income taxes.................................. -- 249,385 (54,900)(2) 194,485
--------- ---------- --------- ----------
Net income (loss) before minority interest.... (493,672) 480,534 358,900 345,762
Minority interest............................. -- 45,115 -- 45,115
--------- ---------- --------- ----------
Net income.................................... $(493,672) $ 435,419 $ 358,900 $ 300,647
========= ========== ========= ==========
Basic (loss) earnings per share............... $ (1.60) $ 0.50 $ 0.26
========= ========== ==========
Weighted average shares(3).................... 307,831 870,559 1,178,390
</TABLE>
- -------------------------
(1) Eliminate nonrecurring organization and pre-opening expenses for Northern
Star Financial as explained in Northern Star's Management Discussion and
Analysis of the results of operations.
(2) Tax effect of pro-forma combined income adjustments.
(3) Pro-forma weighted average shares are computed by adding Northern Star's
historical 307,831 amount with the 870,559 shares expected to be issued to
First Federal's shareholders.
24
<PAGE> 25
NORTHERN STAR FINANCIAL, INC. AND FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
NORTHERN STAR FIRST PRO FORMA NORTHERN STAR
FINANCIAL FEDERAL ADJUSTMENTS AND FINANCIAL
(HISTORICAL) (HISTORICAL) ELIMINATIONS PRO FORMA
------------- ------------ --------------- -------------
<S> <C> <C> <C> <C>
Interest income
Loans................................. $ 323,040 $1,968,196 $ -- $2,291,236
Other interest earnings assets........ 97,470 119,062 -- 216,532
--------- ---------- -------- ----------
Total interest income............... 420,510 2,087,258 -- 2,507,768
Interest expense
Deposits.............................. 152,758 970,000 -- 1,122,758
Borrowings............................ 2,970 123,060 -- 126,030
--------- ---------- -------- ----------
156,728 1,093,060 -- 1,248,788
Net interest income..................... 264,782 994,198 -- 1,258,980
Provision for loan losses............... 67,500 -- -- 67,500
--------- ---------- -------- ----------
Net interest income after provision for
loan losses........................... 197,282 994,198 -- 1,191,480
Non-interest income
Fees and service charges.............. 14,036 188,291 -- 202,327
Gain (loss) on sale of loan........... 25,824 37,245 -- 63,069
Other................................. -- 136,201 -- 136,201
--------- ---------- -------- ----------
Total non-interest income........... 39,860 361,737 -- 401,597
Non-interest expense
Compensation and employee benefits.... 201,985 483,990 -- 685,975
Occupancy............................. 48,257 118,242 -- 166,499
Other................................. 355,043 678,534 (80,178)(1) 920,169
(33,230)(2)
--------- ---------- -------- ----------
Total non-interest expense.......... 605,285 1,280,766 (113,408) 1,772,643
Net income (loss) before income taxes
and minority shares................... (368,143) 75,169 113,408 (179,566)
Income taxes............................ -- 31,790 (31,790)(3) --
--------- ---------- -------- ----------
Net income (loss) before minority
interest.............................. (368,143) 43,379 145,198 (179,566)
Minority interest....................... -- (64,265) (80,178)(1) 15,913
--------- ---------- -------- ----------
Net (loss) income....................... $(368,143) $ 107,644 $ 65,020 $ (195,479)
========= ========== ======== ==========
Basic (loss) earnings per share......... $ (0.86) $ 0.12 $ (0.15)
========= ========== ==========
Weighted average shares(4).............. 425,600 870,559 1,298,159
</TABLE>
- -------------------------
(1) Eliminate Northern Star Financial's 49% ownership in Homeland Mortgage, LLC,
recorded as a minority interest by First Federal.
(2) Eliminate nonrecurring expenses related to the proposed merger transaction.
(3) Tax effect of pro-forma combined income eliminates income tax expense.
(4) Pro forma weighted average shares are computed by adding Northern Star's
historical 425,600 amount with the 870,559 shares expected to be issued to
First Federal's shareholders.
25
<PAGE> 26
SHAREHOLDINGS OF PRINCIPAL SHAREHOLDERS AND MANAGEMENT
OF NORTHERN STAR FINANCIAL FOLLOWING THE PROPOSED MERGER (PRO FORMA)
The following table provides information concerning the anticipated
beneficial ownership, immediately following completion of Northern Star
Financial's proposed merger with First Federal, of outstanding Northern Star
Financial common stock by (i) each person anticipated to be the beneficial owner
of more than 5% of Northern Star Financial's outstanding common stock, (ii) by
each anticipated director and executive officer of Northern Star Financial, and
(iii) by all anticipated directors and executive officers as a group. The
information assumes that: (i) Northern Star Financial issues 870,559 shares of
its common stock to consummate the merger, and (ii) no directors or executive
officers purchase or sell any Northern Star Financial common stock from December
31, 1999 through the date when the merger is completed. The table gives effect
to the sale of the minimum and maximum number of shares that may be issued in
this offering. Unless otherwise indicated, the shareholders listed in the table
have sole voting and investment powers with respect to the shares indicated.
<TABLE>
<CAPTION>
NUMBER OF NUMBER OF PERCENTAGE OF OUTSTANDING
SHARES SHARES SHARES BENEFICIALLY OWNED
BENEFICIALLY BENEFICIALLY ASSUMING THE SALE OF THE
OWNED PRIOR TO OWNED AFTER THE --------------------------
NAME AND ADDRESS OF BENEFICIAL OWNER THE MERGER(1) MERGER(1) MINIMUM MAXIMUM
- ------------------------------------ -------------- --------------- ----------- -----------
<S> <C> <C> <C> <C>
Frank L. Gazzola(2)(3)..................... 43,400 43,400 2.40% 1.88%
Thomas P. Stienessen(2)(4)................. 41,400 41,400 2.29% 1.80%
Thomas J. Reynolds(2)(5)................... 43,400 43,400 2.40% 1.88%
Dean M. Doyscher(2)(6)..................... 35,000 35,000 1.94% 1.52%
Neil Schmidgall(8)......................... 3,000 148,606 8.27% 6.47%
Edward Morrison(8)......................... 2,500 148,106 8.25% 6.45%
Lloyd Fehr(8).............................. 1,000 146,606 8.16% 6.38%
Wayne Riser(8)............................. 0 145,606 8.11% 6.34%
Leonard Wulf............................... 0 145,606 8.11% 6.34%
Kenneth Johnson(8)......................... 0 106,572 5.93% 4.64%
Allan Thoren(8)............................ 1,000 36,952 2.06% 1.61%
All directors and executive officers as a
group (8 persons)(7)..................... 168,200 601,936 32.74% 25.74%
</TABLE>
- -------------------------
(1) Shares not outstanding but deemed beneficially owned by virtue of the right
of a person to acquire them as of December 31, 1999, or within sixty days of
such date are treated as outstanding only when determining the percent owned
by such individual and when determining the percent owned by a group.
(2) The owner's address is 1650 Madison Avenue, Mankato, Minnesota 55401.
(3) Includes 11,400 shares purchasable upon exercise of options presently
exercisable or exercisable within 60 days of December 31, 1999.
(4) Includes 9,400 shares purchasable upon exercise of options presently
exercisable or exercisable within 60 days of December 31, 1999. Mr.
Stienessen shares voting and investment power over such shares with his
wife.
(5) Includes 11,400 shares purchasable upon exercise of options presently
exercisable or exercisable within 60 days of December 31, 1999. Mr. Reynolds
shares voting and investment power over such shares with his wife.
(6) Includes 10,000 shares purchasable upon exercise of options presently
exercisable or exercisable within 60 days of December 31, 1999. Mr. Doyscher
shares voting and investment power over such shares with his wife.
(7) Includes 38,200 shares purchasable upon exercise of options presently
exercisable or exercisable within 60 days of December 31, 1999.
(8) The owner's address is 532 Atlantic Avenue, P.O. Box 656, Morris, Minnesota
56267.
26
<PAGE> 27
NORTHERN STAR FINANCIAL, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following discussion in conjunction with our
consolidated financial statements and the related notes for the years ended June
30, 1998 and 1999 and for the six months ended December 31, 1999 included
elsewhere this prospectus. Our consolidated financial statements include
Northern Star Financial, Inc. and Northern Star Bank, our wholly-owned
subsidiary.
OVERVIEW
Northern Star Financial, Inc. was incorporated in Minnesota on January 22,
1998. We are a bank holding company and own all of the outstanding capital stock
of Northern Star Bank. Our operations during the period from its inception
through January 25, 1999, when our Bank commenced operations, consisted solely
of organizing activities. Our organizing activities consisted primarily of: (i)
preparing and coordinating its application for deposit insurance with the
Federal Deposit Insurance Corporation; (ii) preparing and coordinating our
Bank's application with the Minnesota Department of Commerce; (iii) conducting
the private placement of shares of our common stock to our officers and
directors; and (iv) preparing and filing with the Securities and Exchange
Commission a registration statement relating to our initial public offering of
common stock. The SEC declared our registration statement effective on October
9, 1998. On October 16, 1998, the Department of Commerce approved the
application of our Bank to become a state-chartered community bank, and on
December 24, 1998, the FDIC approved our application for deposit insurance for
our Bank. On December 31, 1998, we completed the private placement of 154,000
shares of common stock to our officers and directors and the public offering of
146,000 shares of common stock. Our Bank began operations on January 25, 1999 at
its only banking location in Mankato, Minnesota. On April 1, 1999, we completed
the sale of an additional 125,600 shares of common stock to complete our initial
public offering. We raised a total of $3,923,733 in net proceeds from our
private placement and initial public offering.
During the development stage, from January 1998 to January 25, 1999, we
accumulated a net loss of $226,103. The net loss from the date our Bank opened
on January 25, 1999 to June 30, 1999 amounted to $271,529. During fiscal 1999
our total assets grew from $14,806 to $9,635,608, and our net loss amounted to
$493,672, or $1.60 per share, including $55,691 in organizational expenditures.
During the first quarter of fiscal 2000 our total assets grew from $9,635,608 to
$11,003,196, and our net loss amounted to $173,149 or $0.41 per share.
RESULTS OF OPERATIONS
Our operating results depend primarily on net interest income. Our net
interest income is determined by interest rate spread, the relative amounts of
interest-earning assets and interest-bearing liabilities, and the degree of
mismatch in the maturing and repricing characteristics of interest earning
assets and interest-bearing liabilities. Interest rate spread is the difference
between the yield earned on interest-bearing assets and the rates paid on
interest-bearing liabilities. Our operations are also affected by the
establishment of provisions for loan losses and the level of other income,
including service charges on deposit accounts and sold real estate loan fees, as
well as other expenses and income tax provisions.
Our results of operations as of and for the fiscal year ended June 30, 1999
reflect organizational activities and the results of five months of operations
following the opening of our Bank on January 25, 1999. We do not have any
results of operations to report for the fiscal year ended June 30, 1998 or for
the six months ended December 31, 1998 since we did not engage in any operating
activity for these periods, other than those organizing activities described
above.
27
<PAGE> 28
FISCAL YEAR ENDED JUNE 30, 1999
We reported interest income of $154,875 for the fiscal year ended June 30,
1999. Net interest income before the provision for loan losses of $114,863 was
earned for the period after incurring an interest expense of $40,012. Loan
interest income of $120,005 represented the largest portion of our interest
income, since we had the largest portion of earning assets in our loan
portfolio. The weighted average yield earned on our interest-bearing assets of
$1,866,661 was 8.30% for the period and the average rate paid on our interest
bearing liabilities of $901,088 was 4.44% for the period. The net interest
spread, the difference between the average yield earned on interest earning
assets and the average rate paid on interest-bearing liabilities was 3.86%.
The provision for loan losses was established at $56,250 at June 30, 1999,
reflecting our estimate of the amount necessary to adequately reflect possible
loan losses. Our allowance for loan losses as a percentage of our year-end loans
was 1.14%. Our judgment as to the adequacy of the allowance is based upon an
evaluation of the inherent risks in the loan portfolios, which we believe to be
reasonable, which may or may not prove to be accurate. Thus, we cannot assure
you that charge-offs in future periods will not exceed the allowance for loan
losses or that an additional increase in the loan loss allowance will not be
required. We had no charge-offs in 1999.
We earned non-interest income of $45,499 for the fiscal year ending June
30, 1999, representing service charges on deposit accounts and gains on the sale
of residential mortgage loans, partially offset by a loss on the sale of loans
of $3,050. As a percentage of average assets, non-interest income was 1.77% for
our truncated year of operations ended June 30, 1999.
We incurred other non-interest expenses of $594,734 for fiscal year ended
June 30, 1999, inclusive of costs associated with setting up our Bank's
operations. We incurred nonrecurring pre-opening expenses of approximately
$304,000 in organizing our Bank's operations. The pre-opening expenses also
include $248,000 in organizational costs expensed due to a change in accounting.
Staffing at our Bank was at a full-service level beginning the first part of
December 1998 for training in preparation for our Bank's opening on January 25,
1999, and other non-interest expenses were incurred in operating our Bank.
Non-interest expense included $40,364 in salaries and employee benefits incurred
during our initial start-up phase and approximately $15,636 in opening expenses.
As a percentage of average assets, non-interest expenses were 24.8%.
Our net loss for the year ended June 30, 1999 was $493,672.
At June 30, 1999, we had total assets of $9,635,608, which consisted of
cash and due from the Northern Star Bank of $210,662, federal funds sold of
$2,533,236, securities and short-term investments of $745,119, FHLB stock of
$16,400, net loans of $5,563,095, accrued interest receivable of $59,527,
property and equipment of $486,685 and other assets of $20,884. At June 30,
1999, we had liabilities of $6,164,569 in deposits and $47,337 in other
liabilities. Stockholders' equity at June 30, 1999 was $3,423,702.
FISCAL QUARTER ENDED DECEMBER 31, 1999
From our Bank's opening date on January 25, 1999 through December 31, 1999,
our Bank attracted $13,138,387 in deposits, and made net loans of $9,016,495.
Our net loss for the six months ending December 31, 1999 equaled $364,143
compared to a net loss of $115,321 for the six months ending December 31, 1998.
A direct comparison of the results of operations during these time periods would
not be meaningful. Although staffing at our Bank had been initiated in
preparation of the Bank's January 25, 1999 opening and other noninterest
expenses were incurred in opening the Bank, we did not engage in any operating
activity during 1998 other than in the organization of the Company and our Bank.
28
<PAGE> 29
Net interest income earned during the six-month period ending December 31,
1999 totaled $197,282. Net interest income for the quarter ending December 31,
1999 was $105,872. The increase in net interest income in the three month period
ending December 31, 1999 over the prior quarter is the result of the higher
level of earning assets held during the second quarter. Total interest income
for the six-month period ending December 31, 1999 was $420,510 as compared to
total interest income of $239,274 for the three-month period ending December 31,
1999. The increase of $58,000 in total interest income represents a 32% increase
in interest income in the second quarter over the first quarter. Interest income
from loans receivable of $180,408 represented the largest portion of interest
income because our loan portfolio represented the largest portion of our earning
assets.
During the six-month period ending December 31, 1999, our Bank sold
residential mortgage loans totaling $2.87 million and recognized gains on those
sales of $25,824. This compares to residential mortgage loan sales of $1.61
million for the three-month period ending December 31, 1999, during which
recognized gains amounted to $20,722. Our noninterest expenses during the
quarter and six months ended December 31, 1999 were $326,624 and $605,285,
respectively. The second quarter increase of nearly $50,000 in noninterest
expenses over first quarter levels resulted from our expanded activities in
mortgage banking and the pending merger with First Federal. Noninterest expenses
for the period included $40,130 of equity loan associated with our joint venture
in Homeland Mortgage LLC and $36,918 of expenses related to the pending merger
with First Federal. Employee compensation and benefits represented our largest
noninterest expense during the period, totaling $101,205. This expense category
is expected to remain relatively flat for the duration of fiscal year ending
June 30, 2000.
Since our Bank had no historical loan loss experience, we established an
additional provision for loan losses of $33,750 for the three-month period ended
December 31, 1999 based upon our periodic evaluation of the inherent risk in the
loan portfolios, which we believe to be reasonable, which may or may not prove
to be accurate. Thus, there can be no assurance that our charge-offs in future
periods will not exceed the allowance for loan losses or that an additional
increase in the loan loss allowance will not be required. We had no charge-offs
during the quarter ended December 31, 1999.
Total consolidated assets equaled $16.67 million as of December 31, 1999
compared to $9.64 million as of June 30, 1999. Cash and cash equivalents
decreased $0.34 million from June 30 to December 31, 1999. Net loans receivable
increased $4.07 million during the six months ending December 31, 1999 and loans
held for sale decreased $0.62 million. Deposits increased $6.97 million during
the period.
29
<PAGE> 30
AVERAGE BALANCES, YIELDS AND RATES
The following tables summarize our weighted average yields earned, weighted
average rates paid, interest rate spread and net yield on earning assets and
interest-bearing liabilities.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED JUNE 30, 1999
-----------------------------------
AVERAGE
AVERAGE YIELD OR
BALANCE INTEREST RATES
----------- -------- --------
<S> <C> <C> <C>
ASSETS
Federal Funds Sold.................................... $ 544,083 $ 26,089 4.79%
Investment Securities................................. 60,531 3,590 5.93%
Loans................................................. 1,098,420 120,005 10.93%
Other Interest-Earning Assets......................... 163,637 5,191 3.17%
----------- -------- -----
Total Earning Assets.................................. 1,866,661 154,875 8.30%
Non Interest-Earning Assets........................... 526,684
-----------
Total Assets.......................................... $ 2,393,345
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest Bearing Deposits............................. $ 901,088 $ 40,012 4.44%
Non Interest Bearing Deposits......................... 255,238
Other Liabilities..................................... 71,765
Stockholders' Equity.................................. 1,165,254
-----------
Total Liability and Stockholders' Equity.............. $ 2,393,345
===========
Net Interest Spread................................... 3.86%
Net Interest Income/Margin............................ $114,863 6.15%
======== =====
Ratio of Average Interest
Earning Assets to Average Interest-Bearing
Liabilities......................................... 2.07x
<CAPTION>
FOR THE SIX MONTHS ENDED
DECEMBER 31, 1999
-----------------------------------
AVERAGE
AVERAGE YIELD OR
BALANCE INTEREST RATES
----------- -------- --------
<S> <C> <C> <C>
ASSETS
Loans Receivable...................................... $ 7,344,675 $323,041 8.80%
Investment Securities................................. 1,946,247 64,285 6.61%
Federal Funds Sold.................................... 1,271,661 33,185 5.22%
----------- -------- -----
Total Earning Assets.................................. 10,562,583 420,511 7.96%
Non Interest-Earning Assets........................... 1,021,390
-----------
Total Assets.......................................... $11,583,973
===========
</TABLE>
30
<PAGE> 31
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED
DECEMBER 31, 1999
-----------------------------------
AVERAGE
AVERAGE YIELD OR
BALANCE INTEREST RATES
----------- -------- --------
<S> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest Bearing Deposits............................. $ 7,072,125 152,758 4.32%
Non Interest Bearing Deposits......................... 1,192,111
Other Liabilities..................................... 99,321 2,970 5.98%
Stockholders' Equity.................................. 3,220,416
----------- -------- -----
Total Liability and Stockholders' Equity.............. 11,583,973 155,728
----------- --------
Net Interest Spread................................... $264,783 3.62%
======== =====
Net Interest Income/Margin............................ 5.01%
Ratio of Average Interest Earning Assets to Average
Interest-Bearing Liabilities........................ 1.47x
</TABLE>
The average balances for the year ended June 30, 1999 were calculated on an
annualized basis, even though we did not have operations for the entire fiscal
year.
RATE/VOLUME ANALYSIS
Net interest income can be analyzed in terms of the impact of changing
rates and changing volume. As described above, we commenced operations in
January 1999. Because we have no prior period results for comparison purposes,
we have omitted information analyzing period to period changes in net interest
income.
LIQUIDITY AND RATE SENSITIVITY
Asset/liability management is the process by which we monitor and control
the mix and maturities of our assets and liabilities. The essential purposes of
asset/liability management are to ensure adequate liquidity and to maintain an
appropriate balance between interest sensitive assets and liabilities to
minimize potentially adverse impacts on earnings from changes in market interest
rates.
Our primary sources of liquidity are a stable base of deposits, scheduled
repayments on our loans, and interest and maturities of our investments. We hold
these funds in various forms of investments with various degrees of liquidity.
All our securities holdings have been classified as available-for-sale. If
necessary, we have the ability to sell a portion of our investment securities to
manage interest sensitivity gap or liquidity. We also may utilize our cash and
due from banks and federal funds sold to meet liquidity needs. Additionally, we
have an unsecured line of credit with a correspondent bank in the amount of
$250,000. No borrowings have been drawn on this line of credit.
As a monitoring technique, we measure our interest sensitivity "gap", which
is the positive or negative dollar difference between assets and liabilities
that are subject to interest rate repricing within a given period of time.
Interest rate sensitivity can be managed by repricing assets or liabilities,
selling securities available-for-sale, replacing an asset or liability at
maturity, or adjusting the interest rate during the life of an asset or
liability. Managing the amount of assets and liabilities repricing in this same
time interval helps to minimize interest rate risk and manage net interest
income in changing interest rate environments. Our net interest income generally
would benefit from rising interest rates when we are in an asset-sensitive gap
position. Conversely, our net interest income
31
<PAGE> 32
generally would benefit from decreasing rates of interest when we are in a
liability-sensitive gap position.
Because our Bank has been open only since January 25, 1999, and has not yet
generated a substantial amount of loans, we were asset sensitive for the year
and quarter. However, our gap analysis is not a precise indicator of our
interest sensitivity position, because the analysis presents only a static view
of the timing of maturities and repricing opportunities without taking into
consideration that changes in interest rates do not affect all assets and
liabilities equally. For example, rates paid on a substantial portion of core
deposits may change contractually within a relatively short time frame, but we
view those rates as significantly less interest-sensitive than market-based
rates such as those paid on non-core deposits. Net interest income may be
impacted by other significant factors in a given interest rate environment,
including changes in the volume and mix of earning assets and interest-bearing
liabilities.
INTEREST RATE SENSITIVITY ANALYSIS
We continually evaluate the asset mix of our balance sheet in terms of
several variables: yields, credit quality, appropriate funding sources and
liquidity. To effectively manage the liability mix of the balance sheet, we
focus on expanding various funding sources. The interest rate sensitivity
position at June 30 and December 31, 1999 is summarized in the following tables.
The difference between rate sensitive assets and rate sensitive liabilities, or
the interest rate sensitivity gap, for each period is shown at the bottom of
each table. Since all interest rates and yields do not adjust at the same
velocity, the gap is only a general indicator of rate sensitivity. The tables
may not be indicative of our rate sensitivity position at other points in time.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1999
---------------------------------------------------------
WITHIN AFTER THREE AFTER ONE
THREE BUT WITHIN BUT WITHIN AFTER
MONTHS TWELVE MONTHS FIVE YEARS FIVE YEARS TOTAL
------ ------------- ---------- ---------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Interest Earning Assets
Federal Funds Sold............... $2,533 $ -- $ -- $ -- $2,533
Investment Securities............ -- -- -- 745 745
Loans............................ 2,877 241 1,488 1,014 5,620
------ ------- ------- ------ ------
Total Earning Assets............... $5,410 $ 241 $ 1,488 $1,759 $8,898
====== ======= ======= ====== ======
Interest Bearing Liabilities
Money Market & Now............... $ 127 $ -- $ -- $ -- $ 127
Regular Savings.................. 3,244 -- -- -- 3,244
Time Deposits.................... 30 1,420 329 -- 1,779
------ ------- ------- ------ ------
Total Interest Bearing
Liabilities...................... $3,401 $ 1,420 $ 329 $ 0 $5,150
====== ======= ======= ====== ======
Interest Sensitivity Gap........... $2,009 $(1,179) $ 1,159 $1,759 $3,748
Cumulative Interest Sensitivity
Gap.............................. $2,009 $ 830 $ 1,989 $3,748 $3,748
Ratio of Interest Sensitivity Gap
to total earning assets.......... 22.58% (13.25)% 13.03% 19.77% 42.13%
Ratio of Cumulative Interest
Sensitivity Gap to total earning
assets........................... 22.58% 9.33% 22.36% 42.13% 42.13%
</TABLE>
32
<PAGE> 33
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
----------------------------------------------------------
WITHIN AFTER THREE AFTER ONE
THREE BUT WITHIN BUT WITHIN AFTER
MONTHS TWELVE MONTHS FIVE YEARS FIVE YEARS TOTAL
------ ------------- ---------- ---------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Interest Earning Assets
Federal Funds Sold.............. $2,160 $ -- $ -- $ -- $ 2,160
Investment Securities........... 497 -- 3,276 692 4,465
Loans........................... 3,547 646 3,241 1,700 9,134
------ ------- ------- ------- -------
Total Earning Assets.............. $6,204 $ 646 $ 6,517 $ 2,392 $15,759
====== ======= ======= ======= =======
Interest Bearing Liabilities
Money Market & Now.............. $ 685 $ -- $ -- $ -- $ 685
Regular Savings................. 4,373 -- -- -- 4,373
Time Deposits................... 505 4,505 957 -- 5,967
------ ------- ------- ------- -------
Total Interest Bearing
Liabilities..................... $5,563 $ 4,505 $ 957 $ -- $11,025
====== ======= ======= ======= =======
Interest Sensitivity Gap.......... $ 641 $(3,859) $ 5,560 $ 2,392 $ 4,734
Cumulative Interest Sensitivity
Gap............................. 641 (3,218) 2,342 4,734 4,734
Ratio of Interest Sensitivity Gap
to total earning assets......... 4.07% -24.49% 35.28% 15.18% 30.04%
Ratio of Cumulative Interest
Sensitivity Gap to total earning
assets.......................... 4.07% -20.42% 14.86% 30.04% 30.04%
</TABLE>
As evidenced by the tables above, we are cumulatively asset-sensitive at
one year. In a rising interest rate environment, an asset-sensitive position (a
positive gap ratio) is generally more advantageous since assets re-price sooner
than liabilities. Conversely, in a declining interest rate environment, a
liability-sensitive position (a negative gap ratio) is generally more
advantageous as interest-bearing liabilities re-price sooner than earning
assets. In our case, an increase in interest rates would result in increased
earnings, while a decline in interest rates would decrease income. This,
however, assumes that all other factors affecting income remain constant.
LOAN PORTFOLIO
Since loans typically provide higher interest yields than do other types of
earning assets, our intent is to channel a substantial percentage of our earning
assets into the loan category. However since our Bank commenced operations only
recently, that category has not yet grown to a percentage of total earning
assets comparable to other banks that are well established. Average loans on an
annualized basis were $1,098,222 for the year ended June 30, 1999. Total gross
loans outstanding, including loans held for sale, were $5,619,345 as of June 30,
1999 and $9,134,233 as of December 31, 1999.
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<PAGE> 34
The following table summarizes the composition of our loan portfolio:
<TABLE>
<CAPTION>
AS OF JUNE 30, 1999 AS OF DECEMBER 31, 1999
------------------------ ------------------------
AMOUNT % OF TOTAL AMOUNT % OF TOTAL
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Commercial, Lease & Agricultural........ $1,843,707 32.81% $2,668,664 29.22%
Real Estate -- individual............... 1,496,460 26.63 1,600,518 17.52
Real Estate -- other.................... 843,394 15.01 2,106,990 23.07
Consumer Loans.......................... 1,435,784 25.55 2,758,061 30.19
---------- ------ ---------- ------
Total Loans............................. $5,619,345 100.00% $9,134,233 100.00%
---------- ====== ---------- ======
Less: Allowance for Loan Loss........... (56,250) (123,750)
---------- ----------
Total Net Loans......................... $5,563,095 $9,010,483
========== ==========
</TABLE>
The principal components of our loan portfolio were mortgage loans and
commercial loans which represented 74% of the portfolio at June 30, 1999 and 70%
at December 31, 1999. Due to the short time the portfolio has existed, the
current mix of loans may not be indicative of the ongoing portfolio mix. We will
attempt to maintain a relatively diversified loan portfolio to help reduce the
risk inherent in concentration of collateral.
MATURITIES AND SENSITIVITY OF LOANS TO CHANGES IN INTEREST RATES
The information in the following tables is based on the contractual
maturities of individual loans, including loans which may be subject to renewal
at their contractual maturity. Renewal of these loans is subject to review and
credit approval, as well as modification of terms upon their maturity. Actual
repayments of loans may differ from maturities reflected below because borrowers
have the right to prepay obligations with or without prepayment penalties. The
following tables summarize loan maturities, by type, and related interest rate
characteristics:
<TABLE>
<CAPTION>
AS OF JUNE 30, 1999
-----------------------------------------------------------
ONE YEAR AFTER ONE BUT AFTER
OR LESS WITHIN FIVE YEARS FIVE YEARS TOTAL
---------- ----------------- ---------- ----------
<S> <C> <C> <C> <C>
Commercial, Lease & Agricultural... $ 916,272 $ 927,435 $ -- $1,843,707
Real Estate -- individual.......... 812,173 334,318 349,969 1,496,460
Real Estate -- other............... 448,020 297,574 97,800 843,394
Consumer Loans..................... 1,144,982 290,802 -- 1,435,784
---------- ---------- -------- ----------
Total............................ $3,321,447 $1,850,129 $447,769 $5,619,345
========== ========== ======== ==========
Loans maturing after one year with:
Fixed Interest Rates............. $ 903,715
Floating Interest Rates.......... $1,394,183
</TABLE>
34
<PAGE> 35
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
-----------------------------------------------------------
ONE YEAR AFTER ONE BUT AFTER
OR LESS WITHIN FIVE YEARS FIVE YEARS TOTAL
---------- ----------------- ---------- ----------
<S> <C> <C> <C> <C>
Commercial, Lease &
Agricultural.................... $ 684,209 $1,436,855 $ 548,601 $2,669,664
Real Estate -- individual......... 49,000 717,682 833,836 1,600,518
Real Estate -- other.............. 542,554 1,188,982 375,454 2,106,990
Consumer Loans.................... 2,044,071 527,779 184,789 2,756,639
---------- ---------- ---------- ----------
Total........................... $3,319,834 $3,871,297 $1,942,679 $9,133,811
========== ========== ========== ==========
Loans maturing after one year
with:
Fixed Interest Rates............ $4,939,768
Floating Interest Rates......... $ 873,208
</TABLE>
PROVISION AND ALLOWANCE FOR LOAN LOSSES
We have developed policies and procedures for evaluating the overall
quality of our credit portfolio and the timely identification of potential
credit problems. Additions to the allowance for loan losses will be made
periodically to maintain the allowance at an appropriate level based on our
analysis of the potential risk in the loan portfolio.
On June 30, 1999, our allowance for loan losses was $56,250 or 1.14% of
$4,937,752 in loans receivable (net of loans held for sale). On December 31,
1999, our allowance for loan losses was $123,750 or 1.36% of $9,067,793 in loans
receivable (net of loans held for sale). Our Bank has not charged off any loans
since commencing operations. The provision for loan losses was established
primarily as a result of our assessment of general loan loss risk as our Bank
recorded its first loans.
The following tables summarize our Bank's loan loss experience and the
allowance for possible loan losses:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED SIX MONTHS ENDED
JUNE 30, 1999 DECEMBER 31, 1999
------------------ -----------------
<S> <C> <C>
Balance at Beginning of Period....................... $ -- $ 56,250
Charge-offs.......................................... -- --
Recoveries........................................... -- --
Net Charge Offs...................................... -- --
Additions charged to operations...................... 56,250 67,500
------- --------
Balance at End of Period............................. $56,250 $123,750
======= ========
</TABLE>
35
<PAGE> 36
The allowance for loan losses was allocated as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE SIX MONTHS ENDED
JUNE 30, 1999 DECEMBER 31, 1999
--------------------------- ----------------------------
PERCENT OF LOANS PERCENT OF LOANS
IN EACH CATEGORY IN EACH CATEGORY
AMOUNT TO TOTAL LOANS AMOUNT TO TOTAL LOANS
------- ---------------- -------- ----------------
<S> <C> <C> <C> <C>
Commercial Lease & Agricultural... $13,310 32.81% $ 19,105 29.22%
Real Estate -- individual......... 10,974 26.63% 11,669 17.52%
Real Estate -- other.............. 5,288 15.01% 13,041 23.07%
Consumer Loans.................... 5,808 25.55% 11,164 30.19%
Unallocated....................... 20,870 -- 68,771 --
------- ------ -------- ------
Total............................. $56,250 100.00% $123,750 100.00%
======= ====== ======== ======
</TABLE>
INVESTMENT PORTFOLIO
At June 30, 1999, our investment securities portfolio represented
approximately 8.42% of our earning assets of $8,897,899. We held investments in
U.S. Government agency securities with a fair market value of $745,119 and an
amortized cost of $749,286, for an unrealized loss of $2,500, net of income
taxes. We also held investments in stock of the Federal Home Loan Bank in the
amount of $16,400.
At December 31, 1999, our investment securities portfolio represented
approximately 29% of our earning assets of $15,663,068. We held securities
available for sale with a fair market value of $4,465,492 and an amortized cost
of $4,512,125, for an unrealized loss of $46,633. We also held investments in
stock of the Federal Home Loan Bank in the amount of $21,300.
Contractual maturities and yields on our investments (all available for
sale) are summarized in the following table. Expected maturities may differ from
contractual maturities because issuers may have the right to call or prepay
obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
OVER ONE
WITHIN BUT WITHIN OVER FIVE
ONE YEAR YIELD FIVE YEARS YIELD YEARS YIELD TOTAL YIELD
-------- ----- ---------- ----- --------- ----- ---------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
As of June 30, 1999:
US Government
Agencies.......... -- -- $ 549,286 6.12% $200,000 7.04% $ 749,286 6.36%
As of December 31,
1999:
US Government
Agencies.......... -- -- $3,276,324 6.59% $691,637 7.13% $3,968,161 6.68%
Corporate Bonds...... $497,331 5.75% -- -- -- -- $ 497,331 5.75%
-------- ---- ---------- ---- -------- ---- ---------- ----
Total................ $497,331 5.75% $3,276,324 6.59% $691,837 7.13% $4,465,492 6.58%
</TABLE>
Short-term investments in the amount of $2,533,236 at June 30, 1999 and
$2,159,781 at December 31, 1999 comprised a significant portion of total earning
assets. These funds were invested in Federal funds sold on an overnight basis.
As our Bank continues to grow, we expect a shift from primarily overnight
investments into the loan portfolio and, to a lesser extent, into the investment
securities portfolio.
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<PAGE> 37
DEPOSITS AND OTHER INTEREST-BEARING LIABILITIES
As of June 30 and December 31, 1999, deposits were the only component of
interest-bearing liabilities. Average total deposits were $1,156,326 and average
interest-bearing deposits were $901,088 for the year ended June 30, 1999, on an
annualized basis. The following tables summarize deposits by category.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1999
-------------------------------------------------------------
PERCENTAGE
PERCENTAGE OF TOTAL
ENDING OF TOTAL AVERAGE AVERAGE EFFECTIVE
BALANCE DEPOSITS BALANCE DEPOSITS COST
---------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Demand Deposit....................... $ 998,017 16.20% $ 255,512 22.20% --
Now.................................. 127,387 2.10% 52,395 4.50% 2.46%
Savings.............................. 3,244,444 52.60% 375,076 32.40% 3.55%
Time Accounts less than $100,000..... 1,379,249 22.50% 336,573 29.20% 5.30%
Time Accounts of $100,000 or more.... 400,000 6.60% 135,342 11.70% 5.45%
---------- ------ ---------- ------ ----
Total Deposits....................... $6,149,097 100.00% $1,154,898 100.00%
========== ====== ========== ======
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
--------------------------------------------------------------
PERCENTAGE
PERCENTAGE OF TOTAL
ENDING OF TOTAL AVERAGE AVERAGE EFFECTIVE
BALANCE DEPOSITS BALANCE DEPOSITS COST
---------- ---------- ----------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Demand Deposit...................... $2,205,378 16.79% $ 1,191,094 11.77% 0.00%
Now................................. 292,342 2.23% 238,972 2.36% 2.59%
Savings............................. 4,674,284 35.58% 4,842,436 47.84% 3.72%
Time Accounts less than $100,000.... $2,970,922 22.61% 2,476,489 24.47% 5.72%
Time Accounts of $100,000 or more... 2,995,462 22.80% 1,372,655 13.56% 6.09%
---------- ------ ----------- ------ ----
Total Deposits...................... $13,138,387 100.00% $10,121,646 100.00%
========== ====== =========== ======
</TABLE>
Core deposits, which exclude time deposits of $100,000 or more, provide a
relatively stable funding source for our loan portfolio and other earning
assets. Our core deposits were $5,749,097 at June 30, 1999 and $10,142,925 at
December 31, 1999. Our loan to deposit ratio was 90% at June 30, 1999 and 69% at
December 31, 1999. The maturity distribution of our time deposits is as follows:
<TABLE>
<CAPTION>
OVER 3 OVER 6
3 MONTHS MONTHS TO MONTHS TO OVER 12
OR LESS 6 MONTHS 12 MONTHS MONTHS TOTAL
-------- --------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C>
As of June 30, 1999:
Time Accounts less than $100,000... $ 30,000 $133,787 $ 866,625 $348,837 $1,379,249
Time Accounts of $100,000 or
more............................ -- -- 400,000 -- 400,000
-------- -------- ---------- -------- ----------
Total........................... $ 30,000 $133,787 $1,266,625 $348,837 $1,779,249
======== ======== ========== ======== ==========
</TABLE>
37
<PAGE> 38
<TABLE>
<CAPTION>
OVER 3 OVER 6
3 MONTHS MONTHS TO MONTHS TO OVER 12
OR LESS 6 MONTHS 12 MONTHS MONTHS TOTAL
-------- ---------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C>
As of December 31, 1999:
Time Accounts less than
$100,000...................... $109,974 $1,118,337 $ 886,663 $857,034 $2,972,008
Time Accounts of $100,000 or
more.......................... 395,462 500,000 2,000,000 100,000 2,995,462
-------- ---------- ---------- -------- ----------
Total......................... $505,436 $1,618,337 $2,886,663 $957,034 $5,967,470
======== ========== ========== ======== ==========
</TABLE>
RETURN ON EQUITY AND ASSETS
The following table summarizes our return (loss) on average assets (net
loss divided by average total assets), return on average equity (net loss
divided by average equity), and equity to assets ratio (average equity divided
by average total assets). Since inception, we have not paid any cash dividends.
The payment of dividends by our Bank is subject to limitations imposed by law
and governmental regulations.
<TABLE>
<CAPTION>
FOR THE FOR THE
YEAR ENDED SIX MONTHS
JUNE 30, 1999 ENDED DECEMBER 31, 1999
------------- -----------------------
<S> <C> <C>
Return (loss) on average assets..................... (22.61)% (6.36)%
Return (loss) on average equity..................... (69.87)% (22.82)%
------ ------
Equity to assets ratio.............................. 35.53% 27.80%
</TABLE>
SHORT TERM BORROWINGS
We had no short-term borrowings during fiscal year 1999. During the quarter
ended December 31, 1999, we borrowed $425,000 from the Federal Home Loan Bank
due October 18, 2000 bearing interest at an annual rate of 5.85%.
CAPITAL ADEQUACY
There are now two primary measures of capital adequacy for banks and
banking holding companies: (i) risk-based capital guidelines and (ii) leverage
ratio.
The risk based capital guidelines measure the amount of a bank's required
capital in relation to the degree of risk perceived in its assets and its
off-balance sheet items. Under the risk-based capital guidelines, capital is
divided into two "tiers." "Tier 1 capital" consists of common stockholders'
equity, qualifying preferred stock, and minority interests in the equity
accounts of consolidated subsidiaries, less certain items such as goodwill and
certain other intangible assets. Tier 2 capital consists of hybrid capital
instruments, perpetual debt, mandatory convertible debt securities, a limited
amount of subordinated debt, preferred stock that does not qualify as Tier 1
capital, and a limited amount of the allowance for credit losses. Banks are
required to maintain a minimum risk-based capital ratio of 8.0% with at least
4.0% consisting of Tier 1 capital.
The second measure of capital adequacy relates to the leverage ratio. The
Federal Deposit Insurance Corporation has established a 3.0% minimum leverage
ratio requirement. Note that the leverage ratio is computed by dividing Tier 1
capital into average assets. For all except the highest rated banks, the minimum
leverage ratio should be 3.0% plus an additional cushion of at least 1 to 2
percent, depending upon risk profiles and other factors.
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<PAGE> 39
The Federal Reserve Board and the FDIC rules add a measure of interest rate
risk to the determination of supervisory capital adequacy. In connection with
this rule, the agencies have adopted a measurement process to measure interest
rate risk. Under this rule, all items reported on the balance sheet, as well as
off-balance sheet items, are reported according to maturity, re-pricing dates
and cash flow characteristics. A bank's weighted position is used in assessing
capital adequacy. The objective of this complex rule is to determine the
sensitivity of banks to various rising and declining interest rate scenarios.
The Federal Deposit Insurance Corporation Improvement Act ("FDICIA"), as
well as other requirements, established five capital tiers: well-capitalized,
adequately capitalized, under capitalized, significantly under capitalized, and
critically under capitalized. A depository institution's capital tier depends on
its capital levels in relation to various relevant capital measures and certain
other factors. Depository institutions that are not classified as well
capitalized are subject to various restrictions regarding capital distributions,
payment of management fees, acceptance of brokered deposits and other operating
activities.
The tables below illustrate our regulatory capital (in thousands) and
ratios:
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED
FOR CAPITAL UNDER PROMPT
ADEQUACY CORRECTIVE
ACTUAL PURPOSES ACTION PROVISION
---------------- --------------- ----------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------ ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1999:
Tier II Capital (to Risk Weighted
Assets)............................. $2,785 44.20% $504 8.00% $ 630 10.00%
Tier I Capital (to Risk Weighted
Assets)............................. $2,729 43.30% $252 4.00% $ 378 6.00%
Leverage Ratio Tier I Capital (to
Average Assets)..................... $2,729 36.50% $299 4.00% $ 374 5.00%
As of December 31, 1999:
Total Capital (to Risk Weighted
Assets)............................. $2,665 24.0% $888 8.0% $1,109 10.0%
Tier I Capital (to Risk Weighted
Assets)............................. $2,541 22.9% $444 4.0% $ 666 6.0%
Tier I Capital (to Average Assets)..... $2,541 19.6% $519 4.0% $ 648 5.0%
</TABLE>
At December 31, 1999, our Bank is classified as well-capitalized and is in
compliance with all regulatory capital requirements. Management anticipates our
Bank will continue to be classified as well-capitalized.
As of December 31, 1999, there were no significant commitments outstanding
for capital expenditures.
IMPACT OF INFLATION AND CHANGING PRICES
The effect of relative purchasing power over time due to inflation has not
been taken into effect in our financial statements. Rather, the statements have
been prepared on an historical cost basis in accordance with generally accepted
accounting principles.
Since most of the assets and liabilities of a financial institution are
monetary in nature, the effect of changes in interest rates will have a more
significant impact on our performance than will the effect of changing prices
and inflation in general. Interest rates may generally increase as the rate of
inflation increases, although not necessarily in the same magnitude.
39
<PAGE> 40
ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). This statement establishes
accounting and reporting standards for derivative instruments and hedging
activities. SFAS No. 133 is effective for fiscal years beginning after June 15,
2000. Retroactive application to financial statements of prior periods is not
required. We do not currently have any derivative instruments nor are we
involved in hedging activities.
In April 1998, the Accounting Standards Executive Committee issued
Statement of Position 98-5, "Reporting on the Cost of Start-up Activities" ("SOP
98-5"), which requires costs of start-up activities and organization costs to be
expenses as incurred. SOP 98-5 is effective for fiscal years beginning after
December 15, 1998, with earlier application encouraged. We elected to adopt SOP
98-5 early for the year ended June 30, 1999 and as a result, recognized
approximately $248,000 in our 1999 consolidated statement of loss which under
previous accounting policies would have been amortized over 60 months.
INDUSTRY DEVELOPMENTS
The recent adoption of the Gramm-Leach-Bliley Act, commonly referred to as
the "New Financial Modernization Legislation" may present new opportunities to
us by allowing us to provide non-traditional banking services such as insurance
and securities brokerage services. See "Supervision and Regulation."
From time to time, various bills are introduced in the United States
Congress with respect to the regulation of financial institutions. We cannot
predict whether any of these proposals will be adopted or, if adopted, how these
proposals would affect us.
YEAR 2000
Like many financial institutions, we rely on computers to conduct our
business and information systems processing. Industry experts were concerned
that on January 1, 2000, some computers might not be able to interpret the new
year properly, causing computer malfunctions. Some banking industry experts
remain concerned that some computers may not be able to interpret additional
dates in the year 2000 properly. We have operated and evaluated our computer
operating systems following January 1, 2000 and have not identified any errors
or experienced any computer system malfunctions. We will continue to monitor our
information systems to assess whether our systems are at risk of misinterpreting
any future dates and will develop appropriate contingency plans to prevent any
potential system malfunction or correct any system failures. We have surveyed
our key customers to determine their exposure to the year 2000 issue and, based
upon our key customers' reports, we believe we will not have any material
exposure to our loan portfolio as a result of the year 2000 issue.
40
<PAGE> 41
NORTHERN STAR FINANCIAL, INC.
BUSINESS
Our operating subsidiary is a community bank providing a broad range of
commercial and retail banking services designed to meet the borrowing and
depository needs of small and medium sized businesses and consumers in the
communities we serve. We offer a full range of deposit accounts that are
typically available from most banks and savings associations, including checking
accounts, commercial accounts, savings accounts and other time deposit accounts.
We provide a range of lending services including commercial, real estate and
consumer loans to individuals, small or medium-sized businesses and professional
associations.
We believe that these businesses and individuals in our market area are
under-served by the larger regional and national lending institutions that have
acquired local banking and savings institutions. As a community bank, we seek to
provide our banking customers with the technological and staff support that
today's market requires, and make available a broad range of products while
providing personalized service. We are managed by individuals who have lived and
worked in our market for many years and believe that we can leverage the
experience of our management to grow our business. By combining support with the
products and services our customers require and our local management and
personalized service, we seek to foster a business that enables us to
effectively compete in our market with other financial institutions of all
sizes.
STRATEGY
We believe that rewarding business opportunities exist in the community
banking business. The acquisition and consolidation of many community banks by
large national and regional banks has diminished or eliminated the presence of
community banks from many rural and suburban communities. We believe that there
is a need and support for locally operated and managed community banks in many
of these communities.
Our plan is to grow our community banking business through acquisition and
branching, and diversify our revenue sources by providing other traditional and
non-traditional financial services. We intend to diversify and grow our
community banking business by expanding our geographic presence in and outside
the State of Minnesota. In connection with our geographic expansion, we intend
to expand and diversify our balance sheet to be able to provide a greater level
of commercial and agricultural lending and other financial services.
We intend to grow our community banking business while maintaining the
critical components we believe support successful community banking. We intend
to operate each of our affiliated community banks using local management and
board of directors. We intend to rely on each local community bank's management
and board of directors to determine the best interests of the community bank
within their particular community and each bank will have authority to make all
decisions affecting credit, pricing and the market of bank service. We believe
the strength and success of a community bank rests, in large part, in the
customer's ability to put a human face and touch to their bank service provider.
As we increase our number of affiliated community banks, we intend to develop
and implement a technology integration strategy to integrate and improve our and
our affiliate banks' information management systems and enhance customer
service.
We intend to diversify and expand our business to provide traditional and
non-traditional banking services. The recent adoption of the Gramm-Leach-Bliley
Act, commonly referred to as the "New Financial Modernization Legislation" may
present new opportunities to us by allowing us to provide non-traditional
banking services such as insurance and securities brokerage services. See
"Supervision and Regulation." We intend to explore our expansion, through
acquisition, internal development and the use of strategic alliances with third
parties, into non-community banking services.
41
<PAGE> 42
PRODUCTS AND SERVICES
We provide a wide variety of commercial and consumer lending and deposit
services. We offer these traditional banking products and services to our
customers through our loan representatives at our banking office.
DEPOSITS. Deposits are our principal source of funds. We offer a full
range of deposit products that are typically available in most banks and savings
associations, including checking accounts, commercial accounts, tiered money
market and savings accounts, and other time deposits of various types, ranging
from daily money market accounts to longer-term certificates of deposit and
sweep accounts. We attempt to offer transaction accounts and time certificates
at rates competitive to those offered in the Mankato area. In addition, we offer
certain retirement account services and Individual Retirement Accounts (IRAs).
LENDING ACTIVITIES. We emphasize a range of lending services, including
commercial, real estate, and consumer loans, to individuals and small to
medium-sized businesses and professional concerns that are located in or conduct
a substantial portion of their business in our market area.
We offer a variety of commercial, lease and agricultural loans. Equipment
loans are typically for a term of five years or less at fixed or variable rates,
with the loan fully amortized over the term and secured by the financed
equipment and with a loan-to-value ratio of 80% or less. Working capital loans
typically have terms not exceeding one year and will usually be secured by
accounts receivable, inventory, or personal guarantees of the principal owners
of the business. For loans secured by accounts receivable or inventory, the
principal amount of a loan will typically be repaid as the assets securing the
loan are converted into cash, and in other cases, the principal amount of a loan
will typically be due at maturity.
Our Bank also grants a variety of real estate loans secured by first or
second mortgages. These loans generally consist of commercial real estate loans,
construction and development loans, and residential real estate loans (home
equity loans are included as they are classified as consumer loans). The
underwriting criteria for home equity loans and lines of credit will generally
be the same as the criteria used when making a first mortgage loan. Home equity
lines of credit typically expire ten years or sooner after origination. Loan
terms generally are limited to five years or less, although payments may be
structured on a longer amortization basis. Interest rates may be fixed or
adjustable, and will more likely be fixed in the case of short-term loans. We
attempt to reduce our credit risk in our commercial real estate portfolio by
emphasizing loans on owner-occupied office and retail buildings where the
loan-to-value ratio, established by independent appraisals, does not exceed 80%.
In addition, we often review the personal financial statements of the principal
owners and require personal guarantees of the principal owners of the collateral
property.
In addition we provide a variety of consumer loans to individuals for
personal and household purposes, including secured and unsecured installment and
term loans, home equity loans and lines of credit, and revolving lines of credit
such as credit cards. These consumer loans typically carry balances of less than
$25,000 and, in the case of non-revolving loans, are amortized over a period not
to exceed 60 months. Ninety-day term loans typically bear interest at a fixed
rate. The revolving loans typically bear interest at a fixed rate and require
monthly payments of interest and a portion of the principal balance.
Our loan approval policies provide for various levels of officer lending
authority. When the amount of aggregate loans to a single borrower exceeds that
individual officer's lending authority, the loan request is considered and
approved, if appropriate, by one of our designated senior loan officers. We have
established a directors' loan committee that has lending limits, and any loan in
excess of this lending limit must be approved by the directors' loan committee.
We do not make any loans to any of our directors, officers, or employees, unless
the loan is approved by our Bank's board of
42
<PAGE> 43
directors and is made on terms not more favorable to such person than would be
available to a person not affiliated with us.
Our lending activities are subject to a variety of lending limits imposed
by federal law. While differing lending limits apply in certain circumstances
based on the type of loan or the nature of the borrower (including the
borrower's relationship to our Bank), in general, our Bank is subject to a
loan-to-one-borrower limit. Since the enactment of the FIRREA in 1989, we
generally may not make loans to one borrower and related entities in an amount
which exceeds 15% of our 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.
Unless we are able to sell participations in our loans to other financial
institutions, we will not be able to meet all of the lending needs of loan
customers requiring aggregate extensions of credit above these limits.
OTHER BANKING SERVICES. We provide a variety of other services, including
cash management services, safe deposit boxes, traveler's checks, and direct
deposit of payroll and social security checks. We offer telephone banking and we
intend to provide in the future automatic drafts for various accounts. We are
associated with a shared network of automated teller machines that may be used
by our customers throughout Minnesota and other regions and permit customers to
access their funds 24 hours a day from locations outside our primary market
area. We also offer MasterCard and VISA credit card services through a
correspondent bank as an agent for our Bank.
We entered into a joint venture in July 1999 with First Federal to form
Homeland Mortgage Company, LLC. Homeland was established to serve as a mortgage
servicer and originator. Under the terms of the joint venture agreement, we
acquired a 49% equity interest in Homeland.
LOCATIONS AND SERVICE AREA
Our principal market area is the Minnesota counties of Blue Earth and
Nicollet, which includes the communities of Mankato, North Mankato, LeHiller,
Eagle Lake and Skyline, Minnesota, from which we expect to draw a significant
portion of our business. Approximately 85,000 people reside in our principal
market area. The 1997 median household income of residents living in our
principal market area was approximately $43,000.
MARKETING FOCUS
Local bank branches of large regional banks and a limited number of small
community banks provide the majority of the banking services within our
principal market area. We believe there is a need for a locally operated and
managed community bank and that we can successfully fill this need. We focus our
marketing efforts on attracting and servicing small to medium-sized businesses
and individuals. We have utilized, or plan to utilize in the future, newspaper,
radio and billboard advertising in our principal market area to promote our
products and services and intend to continue to emphasize the customer benefits
of our local management and ownership, our community focus, our commitment to
providing personalized customer service and our competitive products and
services.
COMPETITION
Our business is highly competitive. We compete with community and national
banks, credit unions, thrifts, and non-financial institutions such as insurance
companies and investment banks. Currently, our principal market area, the two
Minnesota counties of Blue Earth and Nicollet, are served by approximately 40
offices of 21 different banks, two federal savings banks and five credit unions.
The Mankato and North Mankato communities are served by four locally chartered
commercial banks. During 1999 two of the four bank charters were acquired and a
savings bank
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<PAGE> 44
charter was converted to a commercial bank charter and relocated. Banks and
credit unions located outside of the counties of Blue Earth and Nicollet also
compete with us. Most, if not all, of our competitors have substantially greater
financial resources than us. We believe our competitive strength will lie in
providing long-term, relationship-oriented banking services by management and
employees with strong ties to the Mankato area. We attempt to target all
residents of our principal market area, especially local businesses and
homeowners.
EMPLOYEES
As of December 31, 1999, our Bank had 8 full-time employees and one
part-time employee. Northern Star Financial has only one employee, Thomas
Stienessen, who is also the President and Chief Executive Officer of our Bank.
Our Bank's employees are not represented by a collective bargaining agreement.
PROPERTIES
Our headquarters and our Bank's office is located at 1650 Madison Avenue,
Mankato, Minnesota. We have entered into a 10 year lease agreement to rent
approximately 5,000 square feet. Pursuant to the lease agreement, we pay monthly
rent of approximately $6,042 during the first three years of the lease, $6,250 a
month for the next three years, and $6,458 per month for the last four years of
the lease term. We have the option to extend the lease term for two consecutive
five year periods with a right of first refusal on any additional space that
becomes available. Our Bank's office includes a teller line with three tellers,
two platform positions, a drive-through window and executive and administrative
offices.
LEGAL PROCEEDINGS
There are no material litigation or other legal proceedings pending against
us or any of our property.
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<PAGE> 45
NORTHERN STAR FINANCIAL, INC.
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table lists our directors and executive officers and the
senior officers of our Bank. Our directors also serve as directors of our Bank.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- ----------------------------------------
<S> <C> <C>
Thomas P. Stienessen.................... 54 Chief Executive Officer, President and
Class II Director
Robert H. Dittrich...................... 62 Class II Director
Dean M. Doyscher(1)..................... 55 Class III Director
Frank L. Gazzola(1)..................... 71 Chief Financial Officer, Treasurer,
Secretary and a Class II Director
Steven A. Loehr......................... 50 Class I Director
Michael P. Reynolds(1).................. 57 Class I Director
Thomas J. Reynolds(1)................... 62 Class III Director
</TABLE>
- -------------------------
(1) Member of the Compensation and Audit Committees of the Board of Directors.
THOMAS P. STIENESSEN, has been Chief Executive Officer, President and a
Class II director since our formation. He also serves as Chief Executive Officer
of our Bank. Prior to forming Northern Star Financial, Mr. Stienessen served as
Chief Executive Officer and President of SGL, Inc., a holding company for the
Family Bank, where Mr. Stienessen served as Chairman, Chief Executive Officer,
President and a Director as well as a member of the Executive and Operating
Committees since January 1991. Mr. Stienessen has more than 25 years of
experience in banking and in mortgage banking, including consumer, residential,
construction, commercial and commercial real estate lending. Mr. Stienessen's
experience includes bank marketing, branch management, branch operations,
accounting, planning and budgeting, underwriting and correspondent banking and
lending. Previous banking experiences include positions as Senior Vice President
of TCF Mortgage Corporation and Vice President and Regional Manager of TCF Bank.
ROBERT H. DITTRICH has been a Class II director of Northern Star Financial
since March 1999. Mr. Dittrich has been involved in banking as an owner and
director since 1972. Mr. Dittrich is currently the owner and Chairman of
American Community Banks and Insurance Agencies in Sleepy Eye, Medford and
Chanhassen, Minnesota. Mr. Dittrich is also the owner of Dittrich Specialties of
New Ulm and Inver Grove Heights, Minnesota, and Midwest Commodities Brokers and
Traders, Inc. in New Ulm, Minnesota.
DEAN M. DOYSCHER has been a Class III director of Northern Star Financial
since its formation. Mr. Doyscher has served as President of Security Management
and Realty, Inc. since 1978. Security Management and Realty, Inc. owns and
manages commercial property throughout all of rural Minnesota including rural
housing projects in over 55 Minnesota cities. Mr. Doyscher attended Mankato
State University where he earned both undergraduate and graduate degrees in
Urban and Regional Planning. Mr. Doyscher was employed as the Deputy Director of
the Model Cities Program for Lewiston, Maine before becoming the Director of
Planning for the City of Mankato and Blue Earth County in 1972. During 1973-1976
Mr. Doyscher served as the first Executive Director of the Region Nine
Development Commission serving nine counties in South Central Minnesota. Prior
to forming his own management and realty company in 1988, Mr. Doyscher served
from 1976-1988 as
45
<PAGE> 46
a consultant with Professional Planning and Development, providing rural
Minnesota cities with tax increment financing, economic development, zoning and
housing plans. Professional Planning and Development was named Minnesota's
Economic Developer of the Year in 1988. Mr. Doyscher's other relevant experience
includes service as President, Minnesota Planning Association; Director,
Minnesota Council for Affordable and Rural Housing; and past member of the Board
of Directors, Mid-America, Bank South.
FRANK L. GAZZOLA has been Chief Financial Officer, Treasurer, Secretary
and a Class II director of Northern Star Financial since its formation. Mr.
Gazzola has served as President of Frank L. Gazzola, Chartered, Certified Public
Accountants since 1987. Mr. Gazzola has been engaged in public accounting for
over 25 years, for most of that time as the founder and managing partner of one
of Southern Minnesota's largest CPA firms. Mr. Gazzola was a founder of SGL,
Inc., a holding company for the Family Bank and served as an officer and
director until April 1998. He has served on the boards of numerous civic,
commercial and financial enterprises including Mankato District 77 School Board
and as a Director and Treasurer of American Western Corporation, a manufacturer
of extruded plastic products. Mr. Gazzola attended Columbia University, the
University of Minnesota, and Mankato State University from which he received a
B.S. in Business Administration.
STEVEN A. LOEHR has been a Class I director of Northern Star Financial
since March 1999. Mr. Loehr had served as President of Homeland Mortgage, LLC, a
mortgage banker, from July 1999 through December 31, 1999. From February 1992 to
September 1998 he served as Senior Vice President of Voyager Bank.
MICHAEL P. REYNOLDS has been a Class I director of Northern Star Financial
since its formation. Mr. Reynolds has served as Vice-President of Reynolds
Welding Supply Company in Mankato, Minnesota and Welders Supply Company in
Wilmar, Minnesota since 1963. Reynolds Welding Supply Company is engaged in the
sale of industrial gases and welding supplies and operates in three states. Mr.
Reynolds has been involved in many fund raising efforts for the Mankato State
University Athletic Department. He previously served as volunteer for the
Mankato United Way and is a past president of the Mankato Golf Club. Mr.
Reynolds is the brother of Thomas Reynolds.
THOMAS J. REYNOLDS has been a Class III director of Northern Star
Financial since its formation. Mr. Reynolds is a Mankato native and has served
as President of Welders Supply Company and Reynolds Welding Supply since 1952.
Mr. Reynolds served on the Board of Directors for the National Bank of Commerce,
presently called Mid-America Bank, for six years from 1984 to 1990. Mr. Reynolds
is the brother of Michael Reynolds.
The number of directors is determined by the shareholders at their annual
meeting, subject to the right of the shareholders to change such number between
annual meetings and the right of the Board to increase such number between
annual meetings. The Board of Directors consists of three classes of directors:
Class I who hold office until the 2002 Annual Shareholders Meeting, Class II who
hold office until the 2000 Annual Shareholders Meeting and Class III who hold
office until the 2001 Annual Shareholders Meeting, or in all cases until their
successors are elected. Executive officers are appointed by and serve at the
discretion of the Board of Directors. The Board of Directors has a Compensation
Committee which provides recommendations concerning salaries and other
compensation to be paid to executive officers and administers our employee stock
plans and an Audit Committee which is responsible for reviewing our audit
process.
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<PAGE> 47
NORTHERN STAR FINANCIAL, INC.
COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS
DIRECTOR COMPENSATION
Directors currently receive directors' fees in the amount of $1,000 per
year plus $500 for each Board or Committee meeting attended. In addition, under
our 1998 Equity Incentive Plan, persons who were nonemployee directors at the
time of adoption of the Plan or who are subsequently elected to the Board of
Directors are automatically granted a nonqualified option to purchase 3,000
shares of common stock at fair market value. Each nonemployee director who is
re-elected as a director or whose term of office continues after a meeting at
which directors are elected is automatically granted an option to purchase 3,000
shares of common stock at fair market value. During fiscal 1999, each current
director except Mr. Stienessen received an option to purchase 3,000 shares at
$10 per share pursuant to the Plan.
SUMMARY COMPENSATION TABLE
The following table sets forth certain information regarding compensation
paid to the Chief Executive Officer since our formation. No other executive
officer received total salary and bonus compensation in excess of $100,000 for
fiscal 1999.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
----------------------- ------------------
SECURITIES
SALARY BONUS UNDERLYING OPTIONS
NAME AND PRINCIPAL POSITION YEAR ($)(1) ($) (# OF SHARES)
- --------------------------- ---- -------- ----- ------------------
<S> <C> <C> <C> <C>
Thomas P. Stienessen............................. 1999 $100,000 -- 9,400
Chief Executive Officer and 1998 -- -- --
President of Northern Star
Financial & Northern Star Bank
</TABLE>
- -------------------------
(1) Compensation to Mr. Stienessen is paid by Northern Star Bank, our
wholly-owned subsidiary.
EMPLOYMENT AGREEMENT
We have entered into a three-year employment agreement with Thomas P.
Stienessen pursuant to which Mr. Stienessen will serve as the President and
Chief Executive Officer of our Bank. During the term of the agreement, Mr.
Stienessen will be paid an annual salary determined by the Board (currently
$100,000) and is eligible to participate in discretionary bonuses that may be
authorized by the Board of Directors to senior management of our Bank. Mr.
Stienessen will be eligible to participate in any management incentive program
of our Bank or any long-term equity incentive program and will be eligible for
grants of stock options and other awards thereunder. Additionally, Mr.
Stienessen will participate in any retirement, welfare and other benefit
programs established by our Bank and is entitled to a life insurance policy and
an accident liability policy and reimbursement for automobile expenses, club
dues, and travel and business expenses. Furthermore, if in connection with a
change of control of our Bank, Mr. Stienessen is terminated without cause or
voluntarily quits because of certain specified reasons, he is entitled to a lump
sum payment of 2.99 times his annual base salary.
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<PAGE> 48
OPTION/SAR GRANTS DURING 1999 FISCAL YEAR
The following table sets forth options we have granted to the Chief
Executive Officer during our last fiscal year ended June 30, 1999. We have not
granted any stock appreciation rights.
<TABLE>
<CAPTION>
NUMBER OF PERCENT OF TOTAL
SECURITIES OPTIONS/SARS
UNDERLYING GRANTED TO EXERCISE OR
OPTIONS/SARS EMPLOYEES IN BASE PRICE EXPIRATION
NAME GRANTED FISCAL YEAR ($/SHARE) DATE
- ---- ------------ ---------------- ----------- ---------------
<S> <C> <C> <C> <C>
Thomas P. Stienessen.......... 6,400(1) 51.6% $10.00 8/10/08
3,000(2) 24.2% $10.00 12/31/08
</TABLE>
- -------------------------
(1) Such option was exercisable immediately on the date of grant.
(2) Such option is exercisable in three equal annual installments of 1,000
shares each commencing December 31, 1999.
AGGREGATED OPTION/SAR EXERCISES DURING 1999 FISCAL YEAR
AND FISCAL YEAR END OPTION/SAR VALUES
No options were exercised by the Chief Executive Officer during fiscal
1999. The following table provides information related to the number and value
of options held at fiscal year end by the Chief Executive Officer:
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FISCAL YEAR END AT FISCAL YEAR END(1)
-------------------------- ---------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Thomas P. Stienessen................ 6,400 3,000 -- --
</TABLE>
- -------------------------
(1) Value of exercisable/unexercisable in-the-money options is equal to the
difference between the fair market value of the common stock at fiscal year
end and the option exercise price per share multiplied by the number of
shares subject to options. The closing bid price as of June 30, 1999, as
quoted on the OTC Bulletin Board, was $10.00.
INTERESTS OF MANAGEMENT AND OTHERS IN CERTAIN TRANSACTIONS
Our wholly-owned subsidiary, Northern Star Bank, has entered into a 10-year
lease agreement with Colonial Square Partners, Inc. to lease approximately 5,000
square feet of a 18,000 square foot single level, multi-tenant colonial style
office building. Dean Doyscher, one of our directors and principal shareholders,
is a partner of Colonial Square Partners, Inc. Our Bank invested approximately
$204,000 for leasehold improvements, including the construction of walls,
windows, and doors, paint, floor tile and carpet, electrical and a drive-through
canopy. We obtained an independent appraisal of market rents in our Bank's
proposed market. We believe that this transaction is on terms no less favorable
to our Bank than could be obtained from an unaffiliated third party.
Mr. Thomas Stienessen, our President and Chief Executive Officer, paid the
organizational expenses of Northern Star Financial and Northern Star Bank until
December 31, 1998, when the closing occurred on the minimum amount of our
initial public offering. At that time we reimbursed Mr. Stienessen for such
expenses in the amount of $72,981 from the proceeds of the offering.
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<PAGE> 49
We believe that all prior transactions between us and our officers,
directors or other affiliates were on terms no less favorable than could have
been obtained from unaffiliated third parties on an arm's-length basis. All
future transactions, loans and any forgiveness of loans, with directors,
officers or stockholders holding more than 5% of our outstanding common stock,
or affiliates of any such persons, will be made for bona fide business purposes,
will be on terms no less favorable than could be obtained from an unaffiliated
third party and will be approved by a majority of the independent outside
directors who do not have an interest in the transactions and who have access,
at our expense, to our independent legal counsel.
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<PAGE> 50
NORTHERN STAR FINANCIAL, INC.
SHAREHOLDINGS OF PRINCIPAL SHAREHOLDERS AND MANAGEMENT
The following table provides information as of December 31, 1999, and as
adjusted to reflect the sale of the minimum and maximum number of shares in this
offering, concerning the beneficial ownership of our common stock by each person
known by us to be the beneficial owner of more than 5% of our outstanding common
stock, by each executive officer named in the Summary Compensation Table, by
each director, and by all of our directors and executive officers as a group.
Unless otherwise indicated, the shareholders listed in the table have sole
voting and investment powers with respect to the shares indicated.
<TABLE>
<CAPTION>
PERCENTAGE OF
PERCENTAGE OF OUTSTANDING SHARES
NUMBER OF SHARES OUTSTANDING SHARES BENEFICIALLY OWNED
BENEFICIALLY OWNED BENEFICIALLY OWNED AFTER OFFERING
PRIOR TO THE PRIOR TO THE ------------------
NAME AND ADDRESS OF BENEFICIAL OWNED OFFERING(1) OFFERING MINIMUM MAXIMUM
- ------------------------------------ ------------------ ------------------ ------- -------
<S> <C> <C> <C> <C>
Frank L. Gazzola(2)(3)........... 43,400 9.9% 4.6% 3.0%
Steven A. Loehr(2)(4)............ 42,400 9.7% 4.5% 3.0%
Thomas P. Stienessen(2)(5)....... 41,400 9.5% 4.4% 2.9%
Thomas J. Reynolds(2)(6)......... 43,400 9.9% 4.6% 3.0%
Robert H. Dittrich(2)(7)......... 36,000 8.4% 3.9% 2.5%
Dean M. Doyscher(2)(8)........... 35,000 8.0% 3.7% 2.4%
Michael P. Reynolds(2)(9)........ 6,200 1.4% 0.7% 0.4%
Joyce Larson(10)................. 50,000 11.7% 5.4% 3.5%
Melvin Larson(10)................ 50,000 11.7% 5.4% 3.5%
Mesirow Financial Inc.(11)....... 33,950 8.0% 3.7% 2.4%
Catalytic Combustion Corp. 401(k)
Plan(12)....................... 30,000 7.0% 3.2% 2.1%
Susan L. Baker(13)............... 30,000 7.0% 3.2% 2.1%
All directors and executive officers
as a group (7 persons)(14)..... 247,800 50.8% 25.1% 16.7%
</TABLE>
- -------------------------
(1) Shares not outstanding but deemed beneficially owned by virtue of the right
of a person to acquire them as of December 31, 1999, or within sixty days
of such date are treated as outstanding only when determining the percent
owned by such individual and when determining the percent owned by a group.
(2) The address of each person is 1650 Madison Avenue, Mankato, Minnesota
55401.
(3) Includes 11,400 shares purchasable upon exercise of options presently
exercisable or exercisable within 60 days of December 31, 1999.
(4) Includes 10,400 shares purchasable upon exercise of options presently
exercisable or exercisable within 60 days of December 31, 1999.
(5) Includes 7,400 shares purchasable upon exercise of options presently
exercisable or exercisable within 60 days of December 31, 1999. Mr.
Stienessen shares voting and investment power over such shares with his
wife.
(6) Includes 11,400 shares purchasable upon exercise of options presently
exercisable or exercisable within 60 days of December 31, 1999. Mr.
Reynolds shares voting and investment power over such shares with his wife.
(7) Includes 4,000 shares purchasable upon exercise of options presently
exercisable or exercisable within 60 days of December 31, 1999.
(8) Includes 10,000 shares purchasable upon exercise of options presently
exercisable or exercisable within 60 days of December 31, 1999. Mr.
Doyscher shares voting and investment power over such shares with his wife.
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<PAGE> 51
(9) Includes 5,200 shares purchasable upon exercise of options presently
exercisable or exercisable within 60 days of December 31, 1999.
(10) Includes 25,000 shares held by Melvin Larson and 25,000 shares held by
Joyce Larson. The address of both Melvin and Joyce Larson is 5231 Agate
Road, Upsala, Minnesota 56384.
(11) The owner's address is 350 North Clark, Chicago, Illinois 60610.
(12) The owner's address is 909 21st Avenue, Bloomer, Wisconsin 54724.
(13) The owner's address is 455 Grove Street, Upper Montclair, New Jersey,
07043.
(14) Includes 58,800 shares purchasable upon exercise of options presently
exercisable or exercisable within 60 days of December 31, 1999.
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<PAGE> 52
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion in conjunction with First
Federal's consolidated financial statements and the related notes for the fiscal
years ended September 30, 1998 and 1999, included elsewhere in this prospectus.
First Federal's consolidated financial statements include First Federal Holding
Company of Morris, Inc. and First Federal Savings Bank ("Savings Bank"), its
wholly-owned subsidiary bank, as well as West Central Investments, Inc., which
is a wholly-owned subsidiary of the Savings Bank and Homeland Mortgage, LLC
("Homeland").
OVERVIEW
First Federal Holding Company of Morris, Inc. ("First Federal") is a
savings and loan holding company that was incorporated in Minnesota on December
16, 1991. First Federal owns 90.29% of the common stock of the Savings Bank.
The Savings Bank provides various financial services to communities of
Morris, Benson and Breckenridge, Minnesota and the surrounding areas. These
financial services include mortgage, commercial and consumer lending, and
various deposit and savings plans. The Savings Bank is the sole shareholder of
West Central Investments, Inc. ("Investments"), which provides investment and
brokerage services through the three savings bank locations. The Savings Bank
also holds 51% ownership interest in Homeland, which originates and services one
to four family real estate mortgage loans through offices in Morris, Minnesota.
During the period from September 30, 1997 to September 30, 1999, total
assets grew approximate $2.3 million to $57,566,000, while total loans, net of
reserves, similarly increased from $41,598,000 to $45,163,000. Total assets
increased further during the first quarter of fiscal 2000, to $61,060,000, along
with total loans, net of reserves, which grew 1.7%, to $45,943,000. During
fiscal 1999, First Federal had net income of $369,000, compared with net income
of $537,000 during fiscal 1998. Net income for the fiscal quarter ending
December 31, 1999 was $21,000, compared with net income of $124,000 for the same
period in the prior fiscal year. The decline in net income during fiscal 1999
and the first quarter of fiscal 2000 is the result of several factors: expenses
associated with the conversion of the Savings Bank's data processing system, a
nonqualified retirement plan for directors and officers, and operating losses at
Homeland, particularly operating losses associated with Homeland's previous
Edina, Minnesota office, which was closed on December 31, 1999.
RESULTS OF OPERATIONS
First Federal's operating results depend primarily on its net interest
income. Net interest income is determined by interest rate spread, the relative
amounts of interest-earning assets and interest-bearing liabilities, and the
degree of mismatch in the maturing and repricing characteristics of
interest-earning assets and interest-bearing liabilities. The interest rate
spread is the difference between the yield earned on interest-bearing assets and
the rates paid on interest-bearing liabilities. Operations are also affected by
the establishment of provisions for loan losses and the level of other income,
including service charges on deposit accounts and sold real estate loan fees, as
well as other expenses and income tax provisions.
FISCAL YEAR ENDED SEPTEMBER 30, 1999
First Federal reported net interest income of $2,134,000 for the fiscal
year ended September 30, 1999. Net interest income before the provision for
credit losses of $2,000 was earned for the period after incurring an interest
expense of $2,203,000. Loan interest income of $3,936,000 represented the
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<PAGE> 53
largest portion of our interest income, since First Federal had the largest
portion of earning assets in its loan portfolio. The weighted average yields
earned on interest-bearing assets of $53,279,000 were 8.14% for the period and
the average rate paid on interest-bearing liabilities of $52,054,000 were 4.23%
for the period. The interest rates spread (the difference between the average
yield earned on interest-earning assets and the average rate paid on
interest-bearing liabilities) was 3.91%. This compares with 1998 weighted
average yields of 8.15%, average rates paid of 4.42%, and an interest rate
spread of 3.73%.
The provision for loan losses was $527,000 at September 30, 1999,
reflecting management's estimate of the amount necessary to adequately reflect
possible loan losses. The allowance for credit losses as a percentage of
year-end loans was 1.12%, which is approximately the same allowance percentage
at September 30, 1998. Management's judgment as to the adequacy of the allowance
is based upon an evaluation of the inherent risks in the loan portfolio, which
management believes to be reasonable, but this may or may not prove to be
accurate. Thus, there is no assurance that charge-offs in future periods will
not exceed the allowance for loan losses or that an additional increase in the
loan loss allowance will not be required. First Federal had a total of $51,000
net bad debt recoveries in fiscal 1999, compared with net chargeoffs of $42,000
in fiscal year 1998.
First Federal earned non-interest income of $536,000 for the period,
representing loan origination fees and service charges on deposit accounts, a
gain on sale of investments and gains on the sale of residential mortgage loans.
As a percentage of average assets, non-interest income was 0.93% for the fiscal
year ended September 30, 1999 and 0.91% for the fiscal year ended September 30,
1998.
First Federal incurred non-interest expenses of $2,078,000 for fiscal year
ended September 30, 1999, consisting of compensation and employee benefits of
$1,203,000, occupancy expense and equipment costs of $218,000, federal deposit
insurance premiums of $55,000 and other general and administrative costs of
$602,000. As a percentage of average assets, non-interest expenses were 3.62%
for the fiscal year ended September 30, 1999, compared with 3.16% for the fiscal
year ended September 30, 1998.
Net income for First Federal for the year ended September 30, 1999 was
$369,000, compared with net income of $537,000 during fiscal year 1998, a
reduction of 31%. The decline in net income during fiscal 1999 is the result of
several factors: expenses associated with the conversion of the Savings Bank's
data processing system, expenses associated with the implementation of a
nonqualified retirement plan for directors and officers, and operating losses at
Homeland, particularly operating losses associated with Homeland's recently
closed Edina, Minnesota office.
At September 30, 1999, First Federal had total assets of $57,566,000, which
consisted of net loans of $45,163,000, loans held for sale of $1,516,000,
mortgage-backed securities of $2,478,000, investment securities of $2,258,000
and cash and cash equivalents of $2,180,000. Non-interest earning assets of
$3,971,000 consisted of total investment in premises and equipment of $752,000,
cash surrender value of life insurance of $1,703,000 and other assets of
$1,516,000. At September 30, 1999, First Federal had deposit liabilities of
$48,484,000, FHLB advances at $2,598,000 and other borrowings of $1,002,000.
Stockholder's equity at September 30, 1999 was $3,666,000, compared with
stockholders' equity of $3,320,000 at September 30, 1998.
FIRST QUARTER ENDED DECEMBER 31, 1999
First Federal reported net interest income of $521,000 for the fiscal
quarter ended December 31, 1999, after incurring an interest expense of
$559,000. Loan interest income of $996,000 again represented the largest portion
of interest income. The weighted average yields earned on interest-bearing
assets of $54,368,000 were 7.95% for the period and the average rates paid on
interest-bearing liabilities of $53,883,000 were 4.15% for the period. The
interest rates spread (the
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<PAGE> 54
difference between the average yield earned on interest-earning assets and the
average rate paid on interest-bearing liabilities) was 3.80%. This compares with
weighted average yields of 8.23% average rates paid of 4.38%, and an interest
rate spread of 3.85% during the same period a year earlier.
The provision for loan losses was $525,000 at December 31, 1999, reflecting
management's estimate of the amount necessary to adequately reflect possible
loan losses. The allowance for credit losses as a percentage of quarter end
loans was 1.10%, which is approximately the same allowance percentage at
December 31, 1998 and at September 30, 1999. Management's judgment as to the
adequacy of the allowance is based upon an evaluation of the inherent risks in
the loan portfolio, which management believes to be reasonable, but this may or
may not prove to be accurate. Thus, there is no assurance that charge-offs in
future periods will not exceed the allowance for loan losses or that an
additional increase in the loan loss allowance will not be required. First
Federal had a total of $2,000 net bad debt charge-offs in the first quarter of
fiscal 2000, compared with net recoveries of $47,000 in the first quarter of
fiscal year 1999.
First Federal earned non-interest income of $181,000 for the period,
representing loan origination fees and service charges on deposit accounts, a
gain in cash surrender value of life insurance and gains on the sale of
residential mortgage loans. As a percentage of average assets, non-interest
income was 0.3% for the fiscal quarter ended December 31, 1999 and 0.2% for the
fiscal quarter ended December 31, 1998.
First Federal incurred non-interest expenses of $708,000 for fiscal quarter
ended December 31, 1999, including compensation and employee benefits of
$367,000 occupancy expense and equipment costs of $64,000 and other general and
administrative costs of $277,000. As a percentage of average assets,
non-interest expenses were 1.2% for the fiscal quarter ended December 31, 1999,
compared with 0.8% for the fiscal quarter ended December 31, 1998.
Net income for First Federal for the fiscal quarter ended December 31, 1999
was $21,000, compared with net income of $125,000 during the fiscal quarter
ended December 31, 1998, a reduction of 83%. The decline in net income during
the fiscal quarter ended December 31, 1999 continued the decline in net income
during the 1999 fiscal year and was the result of the same factors: expenses
associated with the conversion of the Saving Bank's data processing system,
expenses associated with the implementation of a nonqualified retirement plan
for directors and officers, and operating losses at Homeland, particularly
operating losses associated with Homeland's recently closed Edina, Minnesota
office.
At December 31, 1999, First Federal had total assets of $61,060,000, which
consisted of net loans of $45,943,000, loans held for sale of $1,568,000,
mortgage-backed securities of $2,267,000 investment securities of $2,823,000 and
cash and cash equivalents of $4,297,000. Non-interest earning assets of
$4,162,000 consisted of total investment in premises and equipment of
$1,107,000, cash surrender value of life insurance of $1,724,000 and other
assets of $1,331,000. At December 31, 1999, First Federal had deposit
liabilities of $52,528,000. FHLB advances at $2,293,000 and other borrowings of
$1,097,000. Stockholders' equity at December 31, 1999 was $3,674,000 compared
with stockholders' equity of $3,439,000 at December 31, 1998.
54
<PAGE> 55
AVERAGE BALANCE SHEET
The following tables set forth certain information relating to First
Federal's average balance sheet and reflects the average yield on assets and
average cost of liabilities for the periods indicated and the average yields
earned and rates paid. Such yields and costs are derived by dividing income or
expense by the average balance of assets or liabilities, respectively, for the
periods presented.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED SEPTEMBER 30,
-----------------------------------------------------------
1999 1998
---------------------------- ----------------------------
AVERAGE AVERAGE
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST
------- -------- ------- ------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable...................................... $45,588 $3,936 8.63% $42,869 $3,843 8.96%
Mortgage-backed securities............................ 3,369 219 6.50% 4,725 314 6.65%
Investment securities................................. 4,322 182 4.21% 6,687 265 3.96%
------- ------ ------- ------
Total interest-earning assets....................... 53,279 4,337 8.14% 54,281 4,422 8.15%
------ ------
Non-interest-earning assets........................... 4,186 1,797
------- -------
Total assets........................................ $57,465 $56,078
======= =======
Interest-bearing liabilities:
Savings accounts...................................... $48,512 1,947 4.01% $48,821 2,067 4.23%
Other liabilities..................................... 3,542 256 7.23% 2,376 193 8.12%
------- ------ ------- ------
Total interest-bearing liabilities.................. 52,054 2,203 4.23% 51,197 2,260 4.42%
------ ------
Non-interest bearing liabilities........................ 1,918 1,748
------- -------
Total liabilities..................................... 53,972 52,945
Stockholders' Equity.................................... 3,493 3,133
------- -------
Total liabilities and stockholders' equity............ $57,465 $56,078
======= =======
Net interest income..................................... $2,134 $2,162
====== ======
Interest rate spread.................................... 3.91% 3.73%
Net yield on interest-earning assets.................... 4.01% 3.98%
Ratio of average interest-earning assets to
average interest-bearing liabilities.................. 1.02x 1.06x
======= =======
</TABLE>
55
<PAGE> 56
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
DECEMBER 31, 1999
---------------------------------
AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST
------- -------- ----------
<S> <C> <C> <C>
Interest-earning assets:
Loans receivable......................................... 47,402 $ 996 8.40%
Mortgage-backed securities............................... 2,358 39 6.62%
Investment securities.................................... 4,608 45 3.91%
------- ------
Total interest-earning assets......................... $54,368 $1,080 7.95%
Non-interest earning assets.............................. 4,568
-------
Total assets.......................................... $58,936
=======
Interest-bearing liabilities:
Savings accounts......................................... $50,352 $ 499 3.96%
Other liabilities........................................ 3,531 60 6.80%
------- ------
Total interest-bearing liabilities.................... $53,883 $ 559 4.15%
------
Non-interest bearing liabilities........................... 1,089
-------
Total liabilities........................................ $54,972
Stockholders' equity....................................... 3,964
-------
Total liabilities and stockholders' equity............... $58,936
=======
Net interest income........................................ $ 521
======
Interest rate spread....................................... 3.80%
Net yield on interest-earning assets....................... 3.83%
Ratio of average interest-earning assets
to average interest-bearing liabilities.................. 1.01x
</TABLE>
56
<PAGE> 57
RATE/VOLUME ANALYSIS
The tables below set forth certain information regarding changes in
interest income and interest expenses of First Federal for periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(changes in average volume multiplied by old rate); (ii) changes in rates
(changes in rate multiplied by old average volume); (iii) changes in rate-volume
(changes in rate multiplied by the change in average volume).
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
1999 VS. 1998
-----------------------------------
INCREASE (DECREASE) DUE TO
-----------------------------------
RATE/
VOLUME RATE VOLUME NET
------ ------ ------ -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest income:
Loans receivable.................................. $242 $(141) $ (9) $ 92
Mortgage-backed securities........................ (90) (7) 2 (95)
Investment securities............................. (94) 18 (6) (82)
Other interest earning assets..................... -- -- -- --
---- ----- ---- -----
Total interest-earning assets.................. 58 (130) (13) (85)
---- ----- ---- -----
Interest expense:
Savings accounts.................................. (13) (107) 1 (119)
Other liabilities................................. 93 (21) (10) 62
---- ----- ---- -----
Total interest-bearing liabilities............. 80 (128) (9) (57)
---- ----- ---- -----
Net change in net interest income................... $(22) $ (2) $ (4) $ (28)
==== ===== ==== =====
</TABLE>
<TABLE>
QUARTER ENDED DECEMBER 31,
1999 VS. 1998
----------------------------------
INCREASE (DECREASE) DUE TO
----------------------------------
RATE/
VOLUME RATE VOLUME NET
------ ------ ------ ----
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest income:
Loans receivable................................... $ 80 $(76) $(6) $ (2)
Mortgage-backed securities......................... (29) (2) 1 (30)
Investment securities.............................. (27) -- -- (27)
Other interest earning assets...................... -- -- -- --
---- ---- --- ----
Total interest-earning assets................... 24 (78) (5) $(59)
---- ---- --- ----
Interest expense:
Savings accounts................................... 7 (29) -- (22)
Other liabilities.................................. 26 (10) (5) 11
---- ---- --- ----
Total interest-bearing liabilities.............. 33 (39) (5) (11)
---- ---- --- ----
Net change in net interest income.................... $ (9) $(39) $-- $(48)
==== ==== === ====
</TABLE>
57
<PAGE> 58
Net interest income decreased slightly during the fiscal year ended
September 30, 1999 and for the fiscal quarter ended December 31, 1999, due to
the shift of approximately $1.7 million of earning assets to the nonqualified
retirement plan for directors and officers. The income from these assets is not
included in the calculation of net interest income (but is included in
non-interest income).
INTEREST RATE SENSITIVITY ANALYSIS
The following table sets forth the amount of interest-earning assets and
interest-bearing liabilities outstanding at September 30, 1999, which are
expected to reprice or mature in each of the future time periods shown. The
amount of assets or liabilities shown which reprice or mature during a
particular period were determined by the contractual terms of the asset or
liability. The table assumes prepayments and scheduled principal amortization of
fixed-rate loans and mortgage-backed securities, and assumes the adjustable rate
mortgage loans will reprice at contractual repricing intervals. No consideration
has been provided for the impact of future commitments and loans in process.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
--------------------------------------------------------------------------------------
FOUR OVER ONE OVER OVER TEN
LESS THAN MONTHS THROUGH THREE OVER FIVE THROUGH OVER
THREE THROUGH THREE THROUGH THROUGH TWENTY TWENTY
MONTHS ONE YEAR YEARS FIVE YEARS TEN YEARS YEARS YEARS TOTAL
--------- -------- -------- ---------- --------- -------- ------ -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Mortgage loans and MBS... $ 788 $ 2,048 $ 3,991 $ 2,348 $ 7,957 $ 7,618 $1,697 $26,447
Other loans.............. 1,917 2,961 4,393 10,918 2,589 424 -- 23,202
Investment securities.... 150 317 1,576 -- -- -- 3 2,046
-------- -------- -------- -------- -------- ------- ------ -------
Total interest-earning
assets............... 2,855 5,326 9,960 13,266 10,546 8,042 1,700 51,695
-------- -------- -------- -------- -------- ------- ------ -------
Interest-bearing
liabilities:
Non-interest bearing
deposits............... 3,770 3,770
NOW and Super NOW
accounts............... 5,106 5,106
Savings accounts......... 5,339 5,339
Money market deposit
accounts............... 2,727 2,727
Certificates of
deposit................ 6,124 16,947 7,578 893 -- -- -- 31,542
FHLB Advances............ 304 776 1,518 -- -- -- -- 2,598
Notes Payable............ 0 417 112 122 351 -- -- 1,002
-------- -------- -------- -------- -------- ------- ------ -------
Total interest-bearing
liabilities.......... 23,370 18,140 9,208 1,015 351 -- -- 52,084
-------- -------- -------- -------- -------- ------- ------ -------
Interest sensitivity gap... $(20,515) $(12,814) $ 752 $ 12,251 $ 10,195 $ 8,042 $1,700 $ (389)
======== ======== ======== ======== ======== ======= ====== =======
Cumulative interest
sensitivity gap.......... $(20,515) $(33,329) $(32,577) $(20,326) $(10,131) $(2,089) $ (389) $ (389)
======== ======== ======== ======== ======== ======= ====== =======
Cumulative ratio of
interest-earning assets
to interest-bearing
liabilities.............. 12.22% 19.71% 35.77% 60.71% 80.55% 95.99% 99.26% 99.25%
======== ======== ======== ======== ======== ======= ====== =======
Cumulative ratio of
cumulative gap to total
assets................... (35.64)% (57.90)% (56.59)% (35.31)% (17.60)% (3.63)% (0.68)% (0.68)%
======== ======== ======== ======== ======== ======= ====== =======
</TABLE>
The following table sets forth the amount of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 1999 which are expected
to reprice or mature in each of the future time periods shown. The amount of
assets or liabilities shown which reprice or mature during the particular period
were determined by the contractual terms of the asset or liability.
58
<PAGE> 59
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
---------------------------------------------------------------------------------------
FOUR OVER ONE OVER OVER TEN
LESS THAN MONTHS THROUGH THREE OVER FIVE THROUGH OVER
THREE THROUGH THREE THROUGH THROUGH TWENTY TWENTY
MONTHS ONE YEAR YEARS FIVE YEARS TEN YEARS YEARS YEARS TOTAL
--------- -------- -------- ---------- --------- -------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Mortgage loans and MBS.. $ 826 $ 2,081 $ 3,772 $ 2,154 $ 7,612 $ 7,561 $ 2,111 $26,117
Other loans............. 3,995 1,566 4,491 11,175 2,598 340 24,165
Investment securities... 154 1,015 1,395 30 3 2,597
-------- -------- -------- -------- -------- ------- ------- -------
Total interest-earning
assets.............. 4,975 4,662 9,658 13,329 10,240 7,901 2,114 52,879
-------- -------- -------- -------- -------- ------- ------- -------
Interest-bearing
liabilities:
Non-interest bearing
deposits.............. 4,892 4,892
NOW and Super NOW
accounts.............. 5,851 5,851
Savings accounts........ 5,646 5,646
Money market deposit
accounts.............. 1,580 1,580
Certificates of
deposit............... 6,221 14,768 12,733 837 34,559
FHLB Advances........... 758 18 1,517 2,293
Notes Payable........... 96 417 112 122 350 1,097
-------- -------- -------- -------- -------- ------- ------- -------
Total interest-bearing
liabilities......... 25,044 15,203 14,362 959 350 -0- -0- 55,918
-------- -------- -------- -------- -------- ------- ------- -------
Interest sensitivity
gap..................... $(20,069) $(10,541) $ (4,704) $ 12,370 $ 9,890 $ 7,901 $ 2,114 $(3,039)
======== ======== ======== ======== ======== ======= ======= =======
Cumulative interest
sensitivity gap......... $(20,069) $(30,610) $(35,314) $(22,944) $(13,054) $(5,153) $(3,039) $(3,039)
======== ======== ======== ======== ======== ======= ======= =======
Cumulative ratio of
interest-earning assets
to interest-bearing
liabilities............. 19.87% 23.94% 35.33% 58.71% 76.66% 90.78% 94.57% 94.57%
======== ======== ======== ======== ======== ======= ======= =======
Cumulative ratio of
cumulative gap to total
assets.................. (32.87)% (50.13)% (57.83)% (37.58)% (21.38)% (8.44)% (4.98)% (4.98)%
======== ======== ======== ======== ======== ======= ======= =======
</TABLE>
Interest rate sensitivity is the result of differences in the amounts and
repricing dates of rate-sensitive assets and rate-sensitive liabilities. These
differences, or interest rate repricing "gap", provide an indication of the
extent to which First Federal's net interest income is affected by future
changes in interest rates. A gap is considered positive when the amount of
interest rate sensitive assets exceeds the amount of interest 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. Conversely, during a period of rising interest rates, a
negative gap would tend to result in a decrease in net interest income, while a
positive gap would tend to result in an increase in net interest income. At
September 30, 1999 and again at December 31, 1999, First Federal was
asset-sensitive over short- and mid-terms and liability-sensitive over the
longer terms. However, this analysis is not a precise indicator of First
Federal's interest-sensitivity position, because the analysis presents only a
static view of the timing of maturities and repricing opportunities.
Certain shortcomings are inherent in the method of analysis presented in
the previous tables. For example, although certain assets and liabilities may
have similar maturities or periods of repricing,
59
<PAGE> 60
they may react in different degrees to changes in market interest rates. Also,
the interest rates on certain types of assets and liabilities may fluctuate in
advance of changes in market interest rates, while interest rates on other types
may lag behind changes in market rates. Additionally, certain assets, such as
adjustable-rate mortgage loans, have features which restrict changes in interest
rates on a short-term basis over the life of the assets. Further, in the event
of a change in interest rates, prepayment levels and decay rates on core
deposits may deviate significantly from those assumed in calculating the table.
ANALYSIS OF LOAN PORTFOLIO
Set forth below is selected data relating to the composition of First
Federal's loan portfolio by type of loan at the date indicated. Totals include
loans held for sale.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
-----------------------------------------
1999 1998
------------------ ------------------
PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL
------- -------- ------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Type of Loans:
Construction loans............................. $ 288 0.62% $ 177 0.41%
Residential.................................... 9,800 20.99% 12,222 28.59%
Commercial..................................... 13,881 29.74% 12,901 30.17%
Commercial business loans........................ 6,906 14.79% 5,876 13.74%
Consumer loans................................... 16,296 34.91% 12,036 28.15%
Other
Less:
Deferred loan origination fees and costs....... 36 0.08% 20 0.05%
Allowance for loan losses...................... (527) (1.13)% (474) (1.11)%
------- ------- ------- -------
Total loans, Net................................. $46,680 100.00% $42,758 100.00%
======= ======= ======= =======
Type of Security:
Residential real estate 1-4 family............. $10,088 21.61% $12,400 29.00%
Other dwelling units........................... 978 2.10% 1,010 2.36%
Commercial real estate......................... 12,902 27.64% 11,891 27.81%
Commercial business loans...................... 6,906 14.79% 5,876 13.74%
Savings accounts............................... 321 0.69% 274 0.64%
Home improvement............................... 32 0.07% 43 0.10%
Automobiles.................................... 7,988 17.11% 6,041 14.13%
Other.......................................... 7,956 17.04% 5,677 13.28%
Less:
Deferred loan origination fees and costs....... 36 0.08% 20 0.05%
Allowance for loan losses...................... (527) (1.13)% (474) (1.11)%
------- ------- ------- -------
Total loans................................. $46,680 100.00% $42,758 100.00%
======= ======= ======= =======
</TABLE>
60
<PAGE> 61
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
1999
------------------
PERCENT
AMOUNT OF TOTAL
------- --------
<S> <C> <C>
Type of Loans:
Construction loans........................................ $ 275 0.56%
Residential............................................... 9,833 19.88%
Commercial................................................ 13,728 28.03%
Commercial business loans................................... 7,322 14.95%
Consumer loans.............................................. 16,843 37.58%
Other..................................................... --
Less:
Deferred loan origination fees and costs.................. 36 0.07%
Allowance for loan losses................................. (525) (1.07)%
------- -------
Total loans, Net............................................ $47,512 100.00%
======= =======
Type of Security:
Residential real estate 1-4 family........................ $ 9,177 18.54%
Other dwelling units...................................... 930 1.90%
Commercial real estate.................................... 13,728 28.03%
Commercial business loans................................. 7,322 14.95%
Savings accounts.......................................... 241 0.49%
Home improvement.......................................... 31 0.06%
Automobiles............................................... 8,346 17.04%
Other..................................................... 8,226 19.99%
Less:
Deferred loan origination fees & costs.................... 36 0.07%
Allowance for loan losses................................. (525) (1.07)%
------- -------
Total loans............................................ $47,512 100.00%
======= =======
</TABLE>
At September 30, 1999, gross loans outstanding, including loans held for
sale, were $47,171,000, compared with total gross loans outstanding as of
September 30, 1998 of $43,212,000, an increase of 9.16%. Approximately half of
this increase was attributable to a special loan program to fund purchases of
interests in a local ethanol cooperative processing plant by producer/members.
Gross loans outstanding increased slightly to $48,001,000 as of December 31,
1999. The principal components of First Federal's loan portfolio as of September
30, 1999 and December 31, 1999 were commercial and residential real estate loans
and commercial business loans (including agricultural loans), all of which
represented, in aggregate, over 65% of the loan portfolio. The balance of the
portfolio consisted primarily of consumer loans.
LOAN MATURITY TABLES
The following tables set forth the maturity of First Federal's loan
portfolio at September 30, 1999 and at December 31, 1999. The table does not
include prepayments or scheduled principal repayments. Adjustable rate mortgage
loans are shown as maturing based on contractual maturities.
61
<PAGE> 62
Totals include loans held for sale. Actual repayments of the loans may differ
from maturities reflected below because borrowers have the right to prepay
obligations with or without prepayment penalties.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
-------------------------------------------------------------
1-4 FAMILY OTHER
REAL ESTATE RESIDENTIAL
MORTGAGE COMMERCIAL CONSTRUCTION CONSUMER TOTAL
----------- ----------- ------------ -------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Non-performing................... $ 35 $ 113 $ -- $ 19 $ 167
Amounts Due:
Within 3 months................ 164 2,085 144 312 2,705
3 Months to 1 Year............. 230 3,075 144 927 4,376
After 1 Year:
1 to 3 years................... 569 2,268 -- 3,835 6,672
3 to 5 years................... 945 3,330 -- 8,818 13,093
5 to 10 years.................. 1,850 6,316 -- 2,254 10,420
10 to 20 years................. 4,306 3,630 -- 105 8,041
Over 20 years.................. 1,552 145 -- -- 1,697
------ ------- ---- ------- -------
Total due after one year......... 9,222 15,689 -- 15,012 39,923
------ ------- ---- ------- -------
Total amount due................. $9,651 $20,962 $288 $16,270 47,171
------ ------- ---- ------- -------
Less:
Allowance for loan losses........ (527)
Loans in process................. --
Deferred loan fees............... 36
-------
Loans receivable, net plus
Loans held for sale......... $46,680
=======
</TABLE>
62
<PAGE> 63
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
-------------------------------------------------------------
1-4 FAMILY OTHER
REAL ESTATE RESIDENTIAL
MORTGAGE COMMERCIAL CONSTRUCTION CONSUMER TOTAL
----------- ----------- ------------ -------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Non-performing................... $ 16 $ -- $ -- $ 14 $ 30
Amounts Due:
Within 3 months................ 60 4,361 -- 399 4,820
3 Months to 1 Year............. 765 1,579 275 1,028 3,647
After 1 Year:
1 to 3 years................... 390 2,247 -- 3,885 6,522
3 to 5 years................... 903 3,237 -- 9,036 13,176
5 to 10 years.................. 1,794 6,154 -- 2,224 10,172
10 to 20 years................. 4,167 3,709 -- 25 7,901
Over 20 years.................. 1,291 442 -- -- 1,733
------ ------- ---- ------- -------
Total due after one year......... $8,545 $15,789 -- $15,170 $39,504
------ ------- ---- ------- -------
Total amount due................. $9,386 $21,729 $275 $16,611 $48,001
------ ------- ---- ------- -------
Less:
Allowance for loan losses........ (525)
Loans in process................. --
Deferred loan fees............... 36
-------
Loans receivable, net plus
Loans held for sale......... $47,512
=======
</TABLE>
The following tables set forth as of September 30, 1999 and as of December
31, 1999 the dollar amount of all loans due after the indicated dates which have
pre-determined interest rates and which have floating or adjustable interest
rates.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
------------------------------------------
FLOATING OR
FIXED RATES ADJUSTABLE RATES TOTAL
----------- ---------------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
One-to-four-family................................ $ 8,868 $ 783 $ 9,651
Commercial........................................ 16,203 4,759 20,962
Construction...................................... 288 -- 288
Consumer.......................................... 16,189 81 16,270
------- ------ -------
Total........................................... $41,548 $5,623 $47,171
======= ====== =======
</TABLE>
63
<PAGE> 64
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
------------------------------------------
FLOATING OR
FIXED RATES ADJUSTABLE RATES TOTAL
----------- ---------------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
One-to-four-family................................ $ 8,642 $ 744 $ 9,386
Commercial........................................ 16,147 5,582 21,729
Construction...................................... 275 -- 275
Consumer.......................................... 16,541 70 16,611
------- ------ -------
Total........................................... $41,605 $6,396 $48,001
======= ====== =======
</TABLE>
ORIGINATION, PURCHASE AND SALE OF LOANS
The following table sets forth total loans originated, purchased, sold and
repaid during the periods indicated.
<TABLE>
<CAPTION>
FOR THE YEAR
FOR THE THREE MONTHS ENDED
ENDED DECEMBER 31, SEPTEMBER 30,
-------------------- ------------------
1999 1999 1998
-------------------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Total gross loans receivable at beginning of period.... $47,171 $43,212 $42,876
------- ------- -------
Loans originated:
1 to 4 family residential............................ 2,454 8,045 11,135
Commercial real estate............................... 452 5,377 2,315
Construction loans................................... 59 567 133
Consumer loans....................................... 2,593 12,917 9,886
Commercial business loans............................ -- 3,302 3,160
------- ------- -------
Total loans originated................................. $ 5,558 30,208 26,629
Loans purchased:
Commercial real estate, other residential............ -- -- 150
Mortgage-backed securities........................... -- -- 1,032
------- ------- -------
Total loans purchased.................................. -- -- 1,182
------- ------- -------
Loans sold:
Whole loans.......................................... 733 3,606 8,567
Mortgage-backed securities........................... -- -- --
------- ------- -------
Total loans sold....................................... 733 3,606 8,567
------- ------- -------
Loan principal repayments.............................. 3,994 22,643 18,908
Net loan activity...................................... 831 3,959 336
------- ------- -------
Total gross loans receivable at end of
period..................................... $48,002 $47,171 $43,212
======= ======= =======
</TABLE>
The foregoing information includes loans originated by Homeland Mortgage,
LLC, a mortgage originator and servicer established in July 1999.
64
<PAGE> 65
NON-PERFORMING ASSETS
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF SEPTEMBER 30,
------------------ --------------------
1999 1999 1998
---- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
Loans accounted for on a non-accrual basis:
Mortgage loans:
Permanent loans secured by 1-4 dwelling units.... $ 16 $ 35 $ 27
All other mortgage loans......................... -- -- 283
Non-mortgage loans:
Commercial....................................... -- 113 37
Consumer......................................... 14 19 18
----- ---- ----
Total.............................................. 30 167 365
===== ==== ====
Accruing loans which are contractually past due 90
days of more:
Mortgage loans:
Mortgage loans other than 1-4 family............. -- -- --
----- ---- ----
Total.............................................. -- -- --
===== ==== ====
Total non-accrual and accrual loans................ 30 167 365
Real estate owned.................................. -- -- 32
----- ---- ----
Total non-performing assets........................ $ 30 $167 $397
===== ==== ====
Total non-accrual and accrual loans to net
loans(1)......................................... 0.06% 0.36% 0.85%
===== ==== ====
Total non-accrual and accrual loans to total
assets........................................... 0.05% 0.29% 0.64%
===== ==== ====
Total non-performing assets to total assets........ 0.05% 0.29% 0.69%
===== ==== ====
</TABLE>
- -------------------------
(1) Net loans include loans held for sale.
65
<PAGE> 66
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
The following table summarizes First Federal's loan loss experience:
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF SEPTEMBER 30,
------------------ --------------------
1999 1999 1998
------------------ -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Total loans outstanding(1).......................... $47,512 $47,171 $43,212
======= ======= =======
Average loans outstanding........................... $47,402 $45,588 $42,848
======= ======= =======
Allowance balances (at beginning of period)......... $ 527 $ 474 $ 504
------- ------- -------
Provision (credit)
Residential....................................... -- -- --
Commercial real estate............................ -- 2 12
Consumer.......................................... -- -- --
Net (charge-offs) recoveries
Residential....................................... (2) 6 (28)
Commercial real estate............................ -- -- --
Consumer.......................................... -- 45 (14)
------- ------- -------
Allowance balance (at end of period)................ $ 525 $ 527 $ 474
======= ======= =======
Allowance for loan losses as a percent of total
loans outstanding................................. 1.10 % 1.12% 1.10%
Net loans charged off as a percent of average loans
outstanding....................................... 0.00 % 0.11% (0.10)%
======= ======= =======
</TABLE>
- -------------------------
(1) Includes loans held for sale.
First Federal had net recoveries of $51,000 during the fiscal year ended
September 30, 1999, compared with net charge-offs of $42,000 during the fiscal
year ended September 30, 1998. First Federal had net charge-offs of $2,000
during the fiscal quarter ended December 31, 1999, compared with net recoveries
of $47,000 during the same period in the prior fiscal year.
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
<TABLE>
<CAPTION>
AS OF DECEMBER 31 AS OF SEPTEMBER 30,
----------------- -------------------------------------
1999 1999 1998
----------------- ----------------- -----------------
PERCENT PERCENT PERCENT
OF LOANS OF LOANS OF LOANS
TO TOTAL TO TOTAL TO TOTAL
AMOUNT LOANS AMOUNT LOANS AMOUNT LOANS
------ -------- ------ -------- ------ --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
At end of period allocated to:
One-to-four-family......................... $ 67 18.94% $ 69 20.78% $ 88 28.28%
Commercial real estate and multi-family.... 114 30.58% 114 29.43% 139 29.86%
Construction............................... 2 15.72% 2 0.61% 1 0.41%
Consumer and other loans................... 342 34.76% 342 49.18% 246 41.45%
---- ------ ---- ------ ---- ------
Total allowance................... $525 100.00% $527 100.00% $474 100.00%
==== ====== ==== ====== ==== ======
</TABLE>
66
<PAGE> 67
First Federal has developed policies and procedures for evaluating the
overall quality of its credit portfolio and identifying potential collection
problems. Additions to the allowance for credit losses are made periodically,
based on management's analysis of potential credit risks. On September 30, 1999,
First Federal's allowance for credit losses was $527,000, or 1.18% of
$45,655,000 in loans receivable (net of loans held for sale). On December 31,
1999, First Federal's allowance for credit losses was $525,000, or 1.13% of
$46,433,000 in loans receivable (net of loans held for sale).
INVESTMENT PORTFOLIO
The following table, set forth the carrying value of First Federal's
investment securities portfolio, short-term investments, FHLB stock, and
mortgage-backed securities at the dates indicated. At September 30, 1999, the
fair value of First Federal's investment securities portfolio and mortgage-
backed securities portfolio were $2.023 million and $2.478 million,
respectively, compared with amortized costs of $2.048 million and $2.482
million, respectively, for an unrealized loss of $14,970, net of income taxes.
At December 31, 1999, the fair value of First Federal's investment securities
portfolio and mortgage-backed securities portfolio were $1.899 million and
$2.281 million, respectively, compared with amortized costs of $1.860 million
and $2.267 million, respectively, for an unrealized loss of $27,774, net of
income taxes.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF SEPTEMBER 30,
------------------ --------------------
1999 1999 1998
---- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Investment Securities:
U.S. Government Securities........................ $ -- $ -- $ --
U.S. Agency Securities............................ 1,465 1,476 --
Corporate Notes and Bonds......................... 395 547 1,318
State and Political Subdivisions.................. 33 3 74
Other securities.................................. 719 20 30
------ ------ ------
Total investment securities.................... 2,612 2,046 1,422
Federal funds sold.................................. -- -- --
FHLB stock.......................................... 211 211 183
Mortgage-backed securities held for sale............ 2,267 2,479 4,729
------ ------ ------
Total Investments.............................. $5,090 $4,736 $6,334
====== ====== ======
</TABLE>
67
<PAGE> 68
INVESTMENT PORTFOLIO MATURITIES
The following tables set forth certain information regarding the carrying
values, weighted average yields and maturities of First Federal's investment
securities portfolio at September 30, 1999 and at December 31, 1999. Expected
maturities may differ from contractual maturities because issuers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
---------------------------------------------------------------------------------
ONE TO FIVE FIVE TO TEN MORE THAN 10
ONE YEAR OR LESS YEARS YEARS YEARS
------------------ ------------------ ------------------ ------------------
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD
-------- ------- -------- ------- -------- ------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Government
Obligations............. $ -- --% $ -- --% $ -- --% $ -- --%
U.S. Agency Obligations... -- -- 1,476 5.26% -- -- -- --
Municipal Obligations..... -- -- -- -- -- -- -- --
Corporate Notes and
Bonds................... 150 6.40% 397 6.00% -- -- -- --
Other Securities.......... 23 6.07% -- -- -- -- -- --
---- ---- ------ ---- ----- ---- ----- ----
Total................... $173 6.36% $1,873 5.42% $ -- --% $ -- --%
==== ==== ====== ==== ===== ==== ===== ====
<CAPTION>
AS OF SEPTEMBER 30, 1999
-----------------------------
TOTAL INVESTMENT SECURITIES
-----------------------------
CARRYING AVERAGE MARKET
VALUE YIELD VALUE
-------- ------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
U.S. Government
Obligations............. $ -- --% $ --
U.S. Agency Obligations... 1,476 5.26% 1,476
Municipal Obligations..... -- -- --
Corporate Notes and
Bonds................... 547 6.11% 547
Other Securities.......... 23 6.07% 23
------ ---- ------
Total................... $2,046 5.50% $2,046
====== ==== ======
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
---------------------------------------------------------------------------------
ONE TO FIVE FIVE TO TEN MORE THAN 10
ONE YEAR OR LESS YEARS YEARS YEARS
------------------ ------------------ ------------------ ------------------
CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE
VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD
-------- ------- -------- ------- -------- ------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Government
Obligations............. $ -- 0.00% $ -- 0.00% $ -- 0.00% $ -- 0.00%
U.S. Agency Obligations... 296 4.98% 1,169 5.30% -- 0.00% -- 0.00%
Municipal Obligations..... 3 0.00% -- 0.00% 30 4.72% -- 0.00
Corporate Notes and
Bonds................... -- 0.00% 395 6.00% -- 0.00% -- 0.00%
Other Securities.......... 719 6.09% -- 0.00% -- 0.00% -- 0.00%
------ ---- ------ ---- ----- ---- ----- ----
Total................... $1,018 5.75% $1,564 5.48% $ 30 4.72% $ -- 0.00%
====== ==== ====== ==== ===== ==== ===== ====
<CAPTION>
AS OF DECEMBER 31, 1999
-----------------------------
TOTAL INVESTMENT SECURITIES
-----------------------------
CARRYING AVERAGE MARKET
VALUE YIELD VALUE
-------- ------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
U.S. Government
Obligations............. $ -- 0.00% $ --
U.S. Agency Obligations... 1,465 5.26% 1,465
Municipal Obligations..... 33 4.72% 33
Corporate Notes and
Bonds................... 395 6.00% 395
Other Securities.......... 719 6.09% 719
------ ---- ------
Total................... $2,612 5.59% $2,612
====== ==== ======
</TABLE>
68
<PAGE> 69
DEPOSIT PORTFOLIO
Deposits in First Federal Savings Bank as of September 30,1999 and December
31, 1999, were represented by various types of savings programs as described
below.
<TABLE>
<CAPTION>
MINIMUM BALANCE AS OF PERCENTAGE
BALANCE SEPTEMBER 30, OF TOTAL
CATEGORY TERM INTEREST RATE(1) AMOUNT 1999 DEPOSITS
-------- ------------- ---------------- ------- -------------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Now Accounts................ None 0 to 2.50% 100 $ 8,876 18.31%
Regular Savings............. None 1.50% 100 5,339 11.01%
Money Market Accounts....... None 1 to 2.50% 1000 2,727 5.62%
Certificates of Deposit:
Fixed Term, Fixed Rate...... 1-3 Months 3.00% 500 195 0.40%
Fixed Term, Fixed Rate...... 4-6 Months 4.25% 500 1,008 2.08%
Fixed Term, Fixed Rate...... 7-12 Months 4.75% 500 9,427 19.44%
Fixed Term, Fixed Rate...... 13-24 Months 6.18% 500 14,856 30.65%
Fixed Term, Fixed Rate...... 25-36 Months 6.30% 500 2,093 4.32%
Fixed Term, Fixed Rate...... 36-48 Months 5.25% 500 681 1.40%
Fixed Term, Fixed Rate...... 49-120 Months 5.25% 500 1,478 3.05%
Jumbo Certificates.......... 100,000 1,216 2.51%
------- ------
Accrued interest on
deposits.................. 588 1.21%
------- ------
Total....................... $48,484 100.00%
======= ======
</TABLE>
- -------------------------
(1)Current interest rate offerings as of September 30, 1999
<TABLE>
<CAPTION>
MINIMUM BALANCE AS OF PERCENTAGE
BALANCE DECEMBER 31, OF TOTAL
CATEGORY TERM INTEREST RATE(1) AMOUNT 1999 DEPOSITS
-------- ------------- ---------------- ------- -------------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Now/Checking Accounts....... None 0 to 2.50% 100 $10,743 20.45%
Regular Savings............. None 1.50% 100 5,646 10.75%
Money Market Accounts....... None 1 to 5.00% 1,000 1,580 3.01%
Certificates of Deposit:
Fixed Term, Fixed Rate...... 1-3 Months 3.00% 500 66 0.13%
Fixed Term, Fixed Rate...... 4-6 Months 4.25% 500 977 1.86%
Fixed Term, Fixed Rate...... 7-12 Months 4.75% 500 9,013 17.16%
Fixed Term, Fixed Rate...... 13-24 Months 4.75 to 5.25% 500 14,889 28.34%
Fixed Term, Fixed Rate...... 25-36 Months 5.25% 500 4,308 8.20%
Fixed Term, Fixed Rate...... 36-48 Months 5.25% 500 634 1.21%
Fixed Term, Fixed Rate...... 49-120 Months 5.25% 500 1,289 2.45%
Jumbo Certificates.......... 100,000 2,880 5.48%
------- ------
Accrued interest on
deposits.................. 503 0.96%
------- ------
Total....................... $52,528 100.00%
======= ======
</TABLE>
- -------------------------
(1)Current interest rate offerings as of December 31, 1999.
Core deposits, which exclude time deposits of $100,000 or more, provide the
primary funding source for First Federal's loan portfolio and other earning
assets. Core deposits were $47,268,000 at
69
<PAGE> 70
September 30, 1999 and $49,648,000 at December 31, 1999. First Federal's
loan-to-deposit ratio was 94.16% at September 30, 1999, and 88.21% at December
31, 1999.
TIME DEPOSITS BY RATE
The following table sets forth the time deposits in First Federal Savings
Bank classified by interest rate as of the dates indicated.
<TABLE>
<CAPTION>
AT DECEMBER 31, AT SEPTEMBER 30,
--------------- ------------------
1999 1999 1998
--------------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Interest Rate 2.01 - 4.00%............................ $ 2,160 $ 1,370 $ 72
4.01 - 6.00%.......................................... 24,086 28,056 13,821
6.01 - 8.00%.......................................... 7,826 1,528 17,507
Accrued interest on certificate accounts.............. 487 588 624
------- ------- -------
Total............................................... $34,559 $31,542 $32,024
======= ======= =======
</TABLE>
TIME DEPOSITS MATURITY SCHEDULE
The following table sets forth the amount and maturities of time deposits
at September 30, 1999.
<TABLE>
<CAPTION>
AMOUNT DUE
-----------------------------------------------------------------------
AFTER
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2000 2001 2002 2002 TOTAL
------------- ------------- ------------- ------------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Interest Rate
2.01 - 4.00%................. $ 2,893 $ -- $ -- $ -- $ 2,893
4.01 - 6.00%................. 15,357 6,319 1,004 688 23,368
6.01 - 8.00%................. 4,233 43 212 205 4,693
Accrued interest on
Certificate Accounts....... 588 -- -- -- 588
------- ------ ------ ---- -------
Total...................... $23,071 $6,362 $1,216 $893 $31,542
======= ====== ====== ==== =======
</TABLE>
The following table sets for the amount and maturities of time deposits at
December 31, 1999.
<TABLE>
<CAPTION>
AFTER
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2000 2001 2002 2002 TOTAL
------------ ------------ ------------ ------------ -------
<S> <C> <C> <C> <C> <C>
Interest Rate
2.01 - 4.00%................... $ 2,154 $ 3 $ 3 $ -- $ 2,160
4.01 - 6.00%................... 16,837 6,390 530 329 24,086
6.01 - 8.00%................... 1,511 3,250 2,711 354 7,826
Accrued interest on Certificate
Accounts..................... 487 -- -- -- 487
------- ------ ------ ---- -------
Total........................ $20,989 $9,643 $3,244 $683 $34,559
======= ====== ====== ==== =======
</TABLE>
70
<PAGE> 71
JUMBO CERTIFICATES OF DEPOSIT
The following table indicates the amount of First Federal Savings Bank's
certificates of deposit of $100,000 or more by time remaining until maturity as
of September 30 and December 31, 1999.
<TABLE>
<CAPTION>
AS OF AS OF
MATURITY PERIOD DECEMBER 31, 1999 SEPTEMBER 30, 1999
- --------------- ----------------- ------------------
(IN THOUSANDS)
<S> <C> <C>
Within three months.................................... $ 100 $ 100
Three through six months............................... 110 100
Six through twelve months.............................. 1,370 916
Over twelve months..................................... 1,300 100
------ ------
$2,880 $1,216
====== ======
</TABLE>
SAVINGS DEPOSIT ACTIVITY
The following table sets forth the savings activities of First Federal
Savings Bank for the periods indicated:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE YEAR
ENDED DECEMBER 31, ENDED SEPTEMBER 30,
-------------------- --------------------
1999 1999 1998
-------------------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Opening balance................................. $48,484 $49,928 $47,906
Net deposits (withdrawals)...................... 3,468 (2,954) 529
Interest credit on deposits..................... 576 1,510 1,493
------- ------- -------
Ending balance.................................. 52,528 48,484 49,928
======= ======= =======
Total increase (decrease) deposits............ $ 4,044 $(1,444) $ 2,022
======= ======= =======
Percentage increase (decrease).................. 8.34% (2.89)% 4.22%
</TABLE>
Savings deposit activity is primarily the result of area economic activity
and the relative competitive position of First Federal to secure savings
deposits. Savings deposits declined by $1,444,000 for the fiscal year ended
September 30, 1999, after increasing by $2,022,000 during the fiscal year ended
September 30, 1998. Savings deposits increased by $4,044,000 during the fiscal
quarter ended December 31, 1999.
BORROWINGS
Savings deposits are the primary source of funds for First Federal Savings
Bank's lending and investment activities for its general business purposes. The
Savings Bank, if the need arises, may rely upon advances from the Federal Home
Loan Bank of Des Moines to supplement its supply of lendable funds and to meet
deposit withdrawal requirements. Advances from the FHLB are typically secured by
the Savings Bank's stock in the FHLB and a portion of its residential mortgage
loans and other assets (principally securities which are obligations of or
guaranteed by the U.S. Government).
71
<PAGE> 72
The following table sets forth certain information as to the Savings Bank's
FHLB advances at the date indicated.
<TABLE>
<CAPTION>
AS OF AND FOR THE
THREE MONTHS ENDED AS OF AND FOR THE YEARS ENDED
DECEMBER 31, SEPTEMBER 30,
------------------ -----------------------------
1999 1999 1998 1997
------------------ ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Maximum balance.......................... $2,598 $3,722 $1,317 $4,788
Average balance.......................... 2,353 2,510 1,293 2,058
Balance at end of period................. 2,293 2,598 1,247 1,321
Weighted average rate:
at end of period....................... 5.42% 5.29% 7.24% 7.24%
during the period...................... 5.42% 5.89% 7.24% 6.83%
</TABLE>
INTEREST RATE RISK EXPOSURE
Market risk is the risk of loss arising from adverse changes in market
prices and rates. First Federal's market risk is comprised primarily of interest
rate risk resulting from its core banking activities of lending and deposit
taking. Interest rate risk is the risk that changes in market interest rates
might adversely affect First Federal's net interest income or the fair value of
its portfolio of assets and liabilities.
First Federal primarily relies on the OTS Net Portfolio Value Model (the
"Model") to measure its susceptibility to interest rate changes. Net Portfolio
Value ("NPV") is defined as the present value of expected cash flows from
existing assets minus the present value of expected net cash flows from existing
liabilities plus or minus the present value of net expected cash flows from
existing off-balance sheet contracts. First Federal does not currently own any
derivative financial instruments whose values are determined from underlying
instruments or market indices and whose notional or contractual amounts would
not be recognized in the financial statements. The Model estimates the current
economic value of each type of asset, liability and off-balance sheet contract
after various assumed instantaneous, parallel shifts in the Treasury yield
curve, both upward and downward.
The NPV model uses an option-based pricing approach to value one-to-four
family mortgages, mortgages serviced by others, and firm commitments to buy,
sell or originate mortgages. This approach makes use of an interest rate
simulation program to generate numerous random interest rate paths that, in
conjunction with a prepayment model, are used to estimate mortgage cash flows.
Prepayment options and interest rate caps and floors contained in mortgages and
mortgage-related securities introduce significant uncertainty in estimating the
timing of cash flows for these instruments that warrants the use of this
sophisticated methodology. All other financial instruments are valued using a
static discounted cash flow method. Under this approach, the present value is
determined by discounting the cash flows that the instrument is expected to
generate by the yields currently available to investors from an instrument of
comparable risk and duration.
The following tables set forth First Federal's present value estimates as
of September 30 and December 31, 1999, as calculated by its NPV Model. The table
shows the NPV of First Federal under rate shock scenarios of -300 basis points
to +300 basis points in increments of 100 basis points. As market rates
increase, the market value of First Federal's portfolio of mortgage loans and
securities declines and prepayments slow down. As rates decrease, the market
value of mortgage loans and securities increases due to prepayment risk,
periodic rate caps and other embedded options.
72
<PAGE> 73
Actual changes in market value will differ from estimated changes set forth in
this table due to various risks and uncertainties.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
------------------------------------------------------------------------
CHANGE PERCENT OF CHANGE IN NPV
INTEREST RATES AMOUNT OF ESTIMATED RATIO(4)
(BASIS POINTS) ESTIMATED NPV CHANGE(1) NPV(2) NPV RATIO(3) (BASIS POINTS)
- -------------- ------------- ---------- ---------- ------------- --------------
<S> <C> <C> <C> <C> <C>
+300 4,286 (1,535) -26% 7.72% -233bp
+200 4,811 (1,010) -17% 8.54% -151bp
+100 5,331 (490) -8% 9.33% -72bp
-- 5,821 -- -- 10.05% --
-100 6,276 456 +8% 10.70% +65bp
-200 6,835 1,014 +17% 11.49% +144bp
-300 7,477 1,656 +28% 12.37% +232bp
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1999
------------------------------------------------------------------------
CHANGE PERCENT OF CHANGE IN NPV
INTEREST RATES AMOUNT OF ESTIMATED RATIO(4)
(BASIS POINTS) ESTIMATED NPV CHANGE(1) NPV(2) NPV RATIO(3) (BASIS POINTS)
- -------------- ------------- ---------- ---------- ------------- --------------
<S> <C> <C> <C> <C> <C>
+300 4,346 (1,102) -20% 7.41% -153bp
+200 4,728 (720) -13% 7.96% -99bp
+100 5,102 (346) -6% -- -46bp
-- 5,448 -- -- 8.95% --
-100 5,744 296 +5% 9.33% +38bp
-200 6,128 679 +12% 9.83% +88bp
-300 6,554 1,106 +20% 10.37% +143bp
</TABLE>
- -------------------------
(1) Represents the excess (deficiency) assuming the indicated change in interest
rates minus the estimated NPV assuming no change in interest rates.
(2) Calculated as the amount of change in the estimated NPV divided by the
estimated NPV assuming no change in interest rates.
(3) Calculated as the estimated NPV divided by average total assets.
(4) Calculated as the excess (deficiency) of the NPV ratio assuming the
indicated change in interest rates over the estimated NPV ratio assuming no
change in interest rates.
Savings associations are subject to an interest rate risk ("IRR") component
in calculating their required regulatory capital. An institution's IRR is
measured as the change to its NPV as a result of a hypothetical 200 basis points
change in market interest rates. A resulting change in NPV of more than 2% of
the estimated market value of its assets will require the institution to deduct
from its capital 50% of that excess change. The following table as computed by
the OTS determined that First Federal had no IRR modification required to its
regulatory capital requirement.
73
<PAGE> 74
<TABLE>
<CAPTION>
AS OF AS OF AS OF AS OF
DECEMBER 31 DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------ ------------ ------------- -------------
<S> <C> <C> <C> <C>
Risk Measures: 200 bp rate shock
Pre-Shock NPV Ratio: NPV as % of PV
of Assets....................... 8.95% 8.39% 10.05% 8.88%
Exposure Measure:
Post-Shock NPV Ratio............... 7.96% 7.68% 8.54% 8.33%
Sensitivity Measure: Change in NPV
Ratio........................... 99bp 71bp 151bp 54bp
Calculation of Capital Component
Change in NPV as % of PV of
Assets.......................... -1.18% -1.43% -1.74% -0.72%
Interest Rate Risk Capital
Component (9000)................ -- -- -- --
</TABLE>
Computations of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit runoffs, and should not be relied upon as
indicative of actual results. Further, the computations do not contemplate any
actions First Federal may undertake in response to changes in the interest
rates.
Although First Federal is not subject to the IRR component reduction
discussed above, First Federal is still subject to interest rate risk and, as
can be seen above, rising interest rates will reduce First Federal's net asset
value. The OTS has the authority to require otherwise exempt institutions to
comply with the rule concerning interest rate risk.
74
<PAGE> 75
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
BUSINESS
GENERAL
First Federal Holding Company of Morris, Inc. ("First Federal") is a
savings and loan holding company and parent of First Federal Savings Bank (the
"Savings Bank"), a federally-chartered savings bank with its principal office in
Morris, Minnesota and branch offices in Benson and Breckenridge, Minnesota. The
Savings Bank has obtained regulatory approval for an additional branch in Big
Lake, Minnesota, and anticipates opening the branch in May 2000. The Savings
Bank currently serves customers and the borrowers located in west central
Minnesota, particularly in the communities of Morris, Benson and Breckenridge
and the counties of Stevens, Swift and Wilkin. At December 31, 1999, First
Federal had consolidated assets of $61.1 million, deposits of $52.5 million and
shareholders' equity of $3.7 million.
The Savings Bank was organized in 1922 as Morris Building and Loan
Association. In 1958, the name was changed to First Federal Savings and Loan
Association of Morris, which merged with Breckenridge Federal Savings and Loan
Association in 1973. The name was changed to First Federal Savings Bank in 1983.
The Savings Bank was converted from mutual to stock form in 1992, when First
Federal was organized as a savings and loan holding company and acquired
majority control of the Savings Bank.
The Savings Bank provides a broad range of commercial and retail banking
services designed to meet the borrowing and depository needs of consumers and
small and medium-sized businesses in the communities it serves. The Savings Bank
offers a full range of deposit accounts that are typically made available by
most banks and savings associations, including checking accounts, commercial
accounts, savings accounts and time deposit accounts. The Savings Bank provides
a range of lending services including real estate mortgages, consumer loans and
loans to businesses and farms.
First Federal believes that such businesses and individuals are
under-served in its market by the larger regional and national financial
institutions that have acquired other local banking and savings institutions. As
a community-based savings bank, the Savings Bank seeks to provide its customers
with personal service and support, and to make available to them a broad range
of products and services. The Savings Bank is managed by individuals who have
lived and worked in the markets for many years and believes that it can leverage
the experience of local management to attract business and make knowledgeable
credit decisions. First Federal believes that the Savings Bank competes
effectively with financial institutions of all sizes in these markets by
delivering products and services its customers require, through local management
and personalized service.
SAVINGS BANK PRODUCTS AND SERVICES
The Savings Bank offers a wide variety of consumer and commercial lending
and deposit services through representatives at its offices and its mortgage
subsidiary.
Deposits. Deposits are the Savings Bank's principal source of funds. The
Savings Bank offers a full range of deposit products that are typically
available in most banks and savings associations, including checking accounts,
commercial accounts, savings accounts, time deposits of various types, ranging
from daily money market accounts to longer-term certificates of deposit. The
Savings Bank offers direct deposit of payroll and social security checks.
Transaction accounts and time certificates are offered at rates competitive to
those offered in the Savings Bank's market areas. In addition, the Savings Bank
offers individual retirement accounts and other retirement account services.
Lending Activities. As a federally-chartered savings bank, the Savings
Bank has historically emphasized home mortgages and second mortgages, although
in recent years, the Savings Bank has
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offered a range of other lending services, including consumer loans and loans to
small to medium-sized farms and businesses that are located in the Savings
Bank's market areas.
The Savings Bank offers a variety of real estate loans secured by first or
second mortgages on real estate. These loans generally consist of one to
four-family residential real estate loans, multi-family real estate loans,
construction and development loans and farm land and commercial real estate
loans. Additionally, the Savings Bank is the majority shareholder of Homeland
Mortgage, LLC, which originates real estate loans through its office located in
Morris, Minnesota. Approximately 80% of first mortgage loans originated by the
savings bank or by Homeland are sold on the secondary market through such
programs as Freddie Mac and Fannie Mae. The Savings Bank is also certified as an
approved lender in the Minnesota Housing and Rural Development Authority. The
Savings Bank has a loan servicing portfolio of approximately $18.2 million
one-to-four-family residential real estate loans, which provide servicing fee
income to the Savings Bank.
The Savings Bank offers a variety of consumer loans to individuals for
personal and household purposes, including secured and unsecured installment and
term loans, home equity loans and lines of credit, and checking account
overdraft protection. These consumer loans typically carry balances of less than
$30,000 and, in the case of non-revolving loans, are amortized over a period not
to exceed sixty months. Ninety-day term loans typically bear interest at a fixed
rate. Revolving loans typically bear interest at a fixed rate and require
monthly payments of interest and a portion of the principal balance.
The Savings Bank also offers a variety of commercial and agricultural
loans, although by law and regulation, no more than 20% of total assets may be
represented by these types of loans. Equipment loans are typically for a term of
five years or less at fixed or variable rates, with the loan fully amortized
over the term and secured by the financed equipment and with a loan-to-value
ratio of 80% or less. Working capital loans typically have terms not exceeding
one year and will usually be secured by accounts receivable, inventory or
personal guarantees of the principal owners of the business. For loans secured
by accounts receivable inventory, the principal amount of the loan will
typically be repaid as the assets securing the loan are converted into cash, and
in other cases, the principal amount of a loan would typically be due at
maturity.
Loan approval policies provide for various levels of officer lending
authority. When the amount of aggregate loans to a single borrower exceeds that
individual officer's lending authority, the loan request is considered and
approved, if appropriate, by other officers. The Savings Bank has established a
loan committee that has lending limits, and any loan in excess of this lending
limit must be approved by the Board of Directors. In compliance with law and
regulation, the Savings Bank does not make any loans to any of its directors,
officers or employees, unless the loan is approved by the Savings Bank's Board
of Directors and is made on terms not more favorable to such person than would
be available to a person not affiliated with the Savings Bank.
The Savings Bank's lending activities are subject to a variety of lending
limits imposed by federal law. While different lending limits apply in certain
circumstances based on the type of loan or the nature of the borrower (including
the borrower's relationship to the Savings Bank), in general, the Savings Bank
may not currently make loans to one borrower and related entities in an amount
which exceeds $850,000. Unless the Savings Bank is able to sell participations
in loans to other financial institutions, the Savings Bank is not able to meet
all of the lending needs of loan customers requiring aggregate extensions of
credit above this limit.
Other Financial Services. The Savings Bank provides a variety of other
services, including cash management services, safe deposit boxes, travelers'
checks and direct deposit of payroll and social security checks. The Savings
Bank is associated with a shared network of automated teller machines that may
be used by customers throughout Minnesota and other regions and permits
customers to
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access their funds twenty-four hours a day. The Savings Bank also offers
MasterCard and Visa credit card services through a correspondent bank as an
agent for the Savings Bank.
In addition to products and services provided by through the Savings Bank,
First Federal also provides financial services through certain non-bank
affiliates. First Federal organized a mortgage subsidiary in 1998, West Central
Service Corporation ("Service"). The Savings Bank acquired the assets of Service
and contributed them in a joint venture with Northern Star Financial in July
1999 to form Homeland Mortgage Company LLC ("Homeland"). Homeland was
established to serve as a mortgage servicer and originator, from its office in
Morris, Minnesota. Homeland primarily originates and services one-to-four-family
real estate mortgage loans, including a variety of guaranteed and conventional
loan programs. Under the terms of the joint venture agreement, the Savings Bank
acquired a 51% equity interest in Homeland.
First Federal organized an investment services subsidiary in 1986, West
Central Investments, Inc. ("Investments"). Investments is a wholly-owned
subsidiary of First Federal offering a variety of investment products, including
mutual funds, securities, insurance and annuities, all through a third-party
provider arrangement with Eagle One Investments. The investment officer visits
the three Savings Bank offices on a rotating basis through the week.
LOCATION AND SERVICE AREA
The principal market areas of the Savings Bank are the Minnesota counties
of Stevens, Swift and Wilkin, which includes the communities of Morris, Benson
and Breckenridge, Minnesota, from which it draws a significant portion of its
business. Beginning in spring 2000, with the anticipated opening of the Big
Lake, Minnesota branch, the Savings Bank's market will expand to Sherburne
County, including the communities of Monticello, Big Lake, Elk River and
Clearwater, from which the Savings Bank hopes to draw significant additional
business. Approximately 30,000 people reside in the Savings Bank's current
principal market area, with an additional 50,000 people in the new Sherburne
market area. The 1995 median household income of residents living in the
principal market area was approximately $30,000; the 1995 median household
income of residents living in the Sherburne County market area was approximately
$48,000.
COMPETITION
The banking business is highly competitive. The Savings Bank competes with
community and national banks, credit unions, thrifts and non-financial
institutions such as insurance companies and mutual funds. Currently, in
addition to the Savings Bank, the Savings Bank's principal market areas of the
three Minnesota counties of Stevens, Swift and Wilkin are served by seventeen
offices of eleven different banks, plus a credit union. The Sherburne County
market area is served by twelve offices of nine different banks, plus a credit
union and an industrial loan and thrift. Financial institutions located outside
these counties also compete with the Savings Bank. Most, if not all, of these
competitors have substantially greater financial resources than the Savings
Bank. The Savings Bank believes its competitive strength will lie in providing
long-term relationship-oriented banking services by management and employees
with strong ties to the local market areas. The Savings Bank attempts to target
all residents of its principal market areas, especially the homeowners and local
businesses.
EMPLOYEES
As of December 31, 1999, the Savings Bank had 25 full-time employees and 4
part-time employees and Homeland had 9 full-time employees. The Savings Bank's
employees are not represented by a collective bargaining agreement.
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PROPERTIES
The Savings Bank's headquarters and principal office is located at 532
Atlantic Avenue, Morris, Minnesota. The Savings Bank's branches are currently
located at 1329 Pacific Avenue, Benson, Minnesota and 214 North Fifth Street,
Breckenridge, Minnesota; the planned Big Lake branch is located at 240 Jefferson
Boulevard, Big Lake, Minnesota. The Savings Bank owns all of the facilities. The
principal office of the Savings Bank is the largest facility, with a teller line
with 5 tellers, a drive-through window and executive and administrative offices.
LEGAL PROCEEDINGS
There are no material litigation or other legal proceedings pending against
the Savings Bank or any of its properties.
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FIRST FEDERAL HOLDING COMPANY OF MORRIS
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table set forth the directors and executive officers of the
Savings Bank:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Allan R. Thoren...................... 54 President, Chairman and Chief Executive Officer
Terry Singsaas....................... 50 Senior Vice President
William L. Heikkila.................. 48 Vice President and Chief Financial Officer
Lloyd Fehr........................... 59 Director
Kenneth E. Johnson................... 65 Director
Edward J. Morrison................... 79 Director
Wayne Riser.......................... 60 Director
Neil E. Schmidgall................... 54 Director
Leonard Wulf......................... 73 Director
</TABLE>
ALLAN R. THOREN has been President, Chairman and Chief Executive Officer of
First Federal Savings Bank since July 1990. He has also served as President and
a director of West Central Service Corporation and as President, Chairman and
Chief Executive Officer of West Central Investments, Inc. since July 1990, as a
director of First Federal since September 1992 and as Chairman and governor of
Homeland Mortgage, LLC since July 1999.
TERRY SINGSAAS has been Senior Vice President of First Federal Savings Bank
since November 1997, and served as Branch Manager from May 1989 to November
1997.
WILLIAM L. HEIKKILA has been Vice President and Chief Financial Officer of
First Federal Savings Bank since August 1990, and has also served as Chief
Financial Officer and Treasurer of Homeland Mortgage, LLC since 1999.
LLOYD FEHR has been director of First Federal and First Federal Savings
Bank since September 1992. He has been a shareholder of Riverview Farm since
1990, a shareholder of Riverview Dairy since 1995 and owner of Riverview Feedlot
since 1996.
KENNETH JOHNSON has been a director of First Federal since December 1992
and a director of First Federal Savings Bank since January 1970. Since 1962, Mr.
Johnson has been the owner of Kenneth E. Johnson, CPA, an accounting firm in
Morris, Minnesota.
EDWARD J. MORRISON has been a director of First Federal since 1991 and a
director of First Federal Savings Bank and its predecessor since April 1954. He
has been a private investor since 1963.
WAYNE RISER has been a director of First Federal since September 1992 and
of First Federal Savings Bank since 1972. He has been employed as a pilot since
1988, and has served as corporate pilot for Superior Industries, Morris,
Minnesota, since September 1996. From 1968 to 1988, he was President and owner
of Concrete Minnesota, Inc. and Conrock Materials, Inc.
NEIL E. SCHMIDGALL has been a director of First Federal and First Federal
Savings Bank since September 1992. For more than five years, he has been the
owner of Superior Industries of
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Morris, Inc., a manufacturing company, and of Midwest Equipment, Inc., which is
engaged in sales of used equipment.
LEONARD WULF has been a director of First Federal and First Federal Savings
Bank since September 1992. He has been President of Leonard Wulf & Sons, Inc., a
livestock and grain farming company since 1978.
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SUPERVISION AND REGULATION
The following discussion of statutes and regulations affecting bank holding
companies and banks is a summary thereof and is qualified in its entirety by
reference to such statutes and regulations.
GENERAL
Commercial banking is highly regulated at both the federal and state level.
In addition to a variety of generally applicable state and federal laws
governing businesses and employers, we are extensively regulated by special laws
applicable only to financial institutions. Virtually all aspects of our
operations are subject to specific requirements or restrictions and general
regulatory oversight. Deposits, reserves, capital, investments, loans, issuance
of securities, payment of dividends, mergers and consolidations, electronic
funds transfers, management practices, the scope of activities and other aspects
of our operations are subject to regulation. With few exceptions, state and
federal banking laws have as their principal objective either the maintenance of
the safety and soundness of the financial institution and the federal deposit
insurance system or the protection of consumers or classes of consumers, rather
than the specific protection of our shareholders.
The highly regulated environment in which we operate is subject to frequent
change. Significantly, on November 12, 1999, President Clinton signed the
Gramm-Leach-Bliley Act. This Act repeals portions of the Glass-Steagall Act,
amends The Bank Holding Company Act of 1956 ("BHC Act"), and modifies other laws
thereby broadening the permissible range of affiliations among banks, securities
firms, insurance companies, and other financial service providers. We cannot
fully predict the nature or the extent of any effects which this new law or
other possible regulatory changes may have on our business and earnings. Such
changes may have the effect of increasing or decreasing the cost of doing
business, modifying permissible activities, or enhancing the competitive
position of other financial institutions.
BANK HOLDING COMPANY REGULATION
As noted earlier, Northern Star Financial, Inc. is a bank holding company.
A bank holding company is a form of bank ownership and provides an alternative
to individuals directly owning a bank's stock. In general, a bank holding
company is any company, corporation, or business entity that controls the
operation of a bank, whether through stock ownership or other means. Individual
investors generally hold stock in the parent holding company instead of directly
owning bank stock.
In addition to serving as a means for holding and owning a bank stock, the
holding company structure can be used as a vehicle for acquiring additional
banks or for expanding into a wide range of activities. Holding companies also
offer a way of consolidating management and operations across these various
interests.
The BHC Act, as amended, is the primary federal law governing the ownership
and control of banks by companies. Under the BHC Act, a company considered to be
a bank holding company is subject to supervision by the Board of Governors of
the Federal Reserve System ("Board"). Further, the Board has responsibility and
authority to issue regulations governing bank holding companies. A primary
regulation issued by the Board under this authority is Regulation Y.
Supervision. As a bank holding company, we are subject to supervision by
the Board. This supervision generally consists of financial reporting and
inspections. With respect to financial reporting, we are required to file with
the Board quarterly and annual reports and such additional information as the
Board may require. Inspections can be conducted either off-site or on-site as
deemed necessary and appropriate by the Board. Further, the Board has authority
to take action
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against us for failing to comply with applicable laws and regulations. Such
action is commonly referred to as "enforcement action" and can take several
different forms. Examples include cease and desist orders, civil money
penalties, and the removal of management officials. The Board may also require
that we terminate an activity or terminate control of or liquidate or divest
certain nonbank subsidiaries or affiliates when the Board believes the activity
or the control of the subsidiary or affiliate constitutes a significant risk to
the financial safety, soundness or stability of any of our insured depository
subsidiaries.
Regulation. As indicated above, bank holding companies such as ours are
subject to the BHC Act and Regulation Y, as well as other state and federal laws
and regulations. Thus, the following types of activities are subject to
regulatory requirements:
Payment of Dividends. The Board has indicated that banking organizations
should generally pay cash dividends out of current operating earnings and the
current rate of earnings retention should be consistent with the organization's
capital needs, asset quality and overall financial condition. Board policy
states that it is inappropriate for a banking organization that is experiencing
serious financial problems or that has inadequate capital to borrow to pay
dividends. Similarly, the payment of dividends based solely or largely on gains
resulting from unusual or nonrecurring events may not be prudent or warranted.
Further, the Board believes that a bank holding company should not maintain a
level of cash dividends to its shareholders that places undue pressure on the
capital of depository institution subsidiaries or are funded from borrowings or
other arrangements that undermine the bank holding company's ability to serve as
a source of strength to the subsidiaries. The Board may, and in certain
circumstances must, prohibit a bank holding company from making any capital
distributions without prior approval of the Board, if the subsidiary depository
institution is undercapitalized. The Board also may impose limitations on the
payment of dividends as a condition to its approval of certain applications,
including applications for approval of mergers or acquisitions.
In addition to the restrictions on dividends imposed by the Board, under
the Minnesota Business Corporation Act, the discretion of our board of directors
is constrained by Minnesota Statutes, section 302A.551. Under that section, the
board may authorize a dividend only if the directors in good faith, in a manner
they reasonably believe to be in the best interests of the corporation, and with
the care an ordinarily prudent person in a like position would exercise under
similar circumstances, determine that we will be able to pay our debts in the
ordinary course of business after making a distribution.
Regulatory Capital Requirements. The Board's capital guidelines establish
minimum regulatory capital requirements for bank holding companies for the
following categories: (i) a capital leverage measure expressed as a percentage
of total assets, (ii) a risk-based measure expressed as a percentage of total
risk-weighted assets, and (iii) a Tier 1 leverage measure expressed as a
percentage of average total consolidated assets. Tier 1 capital consists of
common stockholders' equity, qualifying preferred stock, and minority interests
in the equity accounts of consolidated subsidiaries. The failure of a bank
holding company to meet its capital requirements may result in supervisory
action, as well as an inability to obtain approval of any regulatory
applications and, potentially, increased frequency of examinations and
inspections. The federal bank regulators have previously indicated a desire to
raise minimum capital requirements for banking organizations and have suggested
that revisions to the capital requirements should be made. The effect of any
future change in our required capital ratios cannot be determined at this time.
Activity Limitations. Under the BHC Act, we must obtain Board approval
before we acquire direct or indirect ownership or control of any voting
securities of a bank or bank holding company if the acquisition results in our
control of more than 5% of the outstanding shares of any class of voting
securities of the entity, unless we already own a majority of the voting
securities of the entity. We
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also must obtain prior Federal Reserve approval before we acquire all or
substantially all of the assets of a bank or merge or consolidate with another
bank holding company. The BHC Act also, in general, limits the activities that
we and our subsidiaries may engage in to those so closely related to banking or
managing or controlling banks and activities that are so closely related to
banking as to be a proper incident thereto. The Board, in making such
determinations, considers whether performance of the activities can reasonably
be expected to produce benefits to the public without any adverse effects such
as undue concentration of resources, decreased or unfair competition, conflicts
of interest or unsound banking practices. Under Regulation Y, we may engage,
subject to Board guidelines and approvals, in such closely-related activities
as: (1) extending credit and servicing loans; (2) activities related to
extending credit including real estate and personal property appraising,
arranging commercial real estate equity financing, check-guaranty services,
collection agency services, credit bureau services, asset management, servicing,
and collection activities, and acquiring debt in default; (3) leasing personal
or real property; (4) operating nonbank depository institutions; (5) trust
company functions; (6) financial and investment advisory activities; (7) agency
transactional services for customer investments including securities brokerage,
riskless principal transactions, private-placement services, futures commission
merchant, and other transactional services; (8) investment transactions as
principal including underwriting and dealing in government obligations and money
market instruments, investing and trading activities, buying and selling bullion
and related activities; (9) management consulting and counseling activities;
(10) support services including courier services and printing and selling
MICR-encoded items; (11) insurance agency and underwriting; (12) community
development activities; (13) retail sale of money orders, savings bonds, and
traveler's checks; and (14) data processing.
Under the Gramm-Leach-Bliley Act enacted on November 12, 1999, bank holding
companies that decide to become "financial holding companies" and that meet the
qualifying criteria will be able to engage in additional activities.
Specifically, financial holding companies will be able to engage in activities
that are financial in nature or incidental to such financial activities and
activities that are complementary to financial activities. The Act identifies a
number of activities as financial in nature, including insurance, underwriting,
dealing in, or making a market in securities, and merchant banking. These
identified activities are in addition to the closely related activities just
enumerated. To qualify as a financial holding company, all of the company's
subsidiary depository institutions must be well capitalized and well managed and
have a satisfactory rating under the Community Reinvestment Act.
BANK REGULATION
The continued earnings and growth of our Bank will be influenced by general
economic conditions, the monetary and fiscal policies of the federal government,
and the policies of regulatory agencies, particularly the Board. The Board
implements national monetary policies by its open-market operations in United
States Government securities, by adjusting the required level of reserves for
financial institutions subject to its reserve requirement and by varying the
discount rate applicable to borrowings by banks from the Federal Reserve System.
The actions of the Board in these areas influence the growth of bank loans,
investments and deposits and also affect interest rates charged on loans and
deposits. The nature and impact of any future changes in monetary policies
cannot be predicted.
Supervision. Our Bank, as a state chartered banking corporation, is
subject to primary supervision, examination and regulation by the Minnesota
Department of Commerce ("DOC") and the Federal Deposit Insurance Corporation
("FDIC"). Various requirements and restrictions under the laws of the State of
Minnesota and the United States also affect the operation of our Bank. These
statutes and regulations relate to many aspects of the operations of our Bank,
including reserves against deposits, loans, investments, mergers and
acquisitions, borrowings, dividends and locations of
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branch offices. Some of these statutes and regulations and their effect on our
Bank are discussed below. Moreover, from time to time, legislation is enacted
which has the effect of increasing the cost of doing business, limiting or
expanding permissible activities or affecting the competitive balance between
banks and other financial intermediaries. Proposals to change the laws and
regulations governing the operations and taxation of banks, bank holding
companies and other financial intermediaries are frequently made. The likelihood
of any major changes and the impact of such changes are impossible to predict.
Deposit Insurance. As an FDIC-insured institution, our Bank will be
required to pay deposit insurance premium assessments to the FDIC. The amount
each insured depository institution pays for FDIC deposit insurance coverage is
determined in accordance with a risk-based assessment system under which all
insured depository institutions are placed into one of nine categories and
assessed insurance premiums based upon their level of capital and supervisory
evaluation. BIF-member institutions classified as well capitalized (as defined
by the FDIC) and considered healthy pay the lowest premium (currently 0% of
deposits) while BIF-member institutions that are under capitalized (as defined
by the FDIC) and considered of substantial supervisory concern pay the highest
premium (currently up to 0.27% of deposits).
The FDIC may terminate the deposit insurance of any insured depository
institution if the FDIC determines, after a hearing, that the institution has
engaged in 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 in writing by, or under agreement
with, the FDIC. The FDIC may also suspend deposit insurance temporarily during
the hearing process for a permanent termination of insurance if the institution
has no tangible capital. We are not aware of any activity or condition that
could result in termination of our Bank's deposit insurance.
Payment of Dividends by our Bank. There are state and federal statutory
and regulatory requirements limiting the amount of dividends which may be paid
to us by our Bank. Generally, a bank may pay cash dividends out of current
operating earnings to the extent that the current rate of earnings retention is
consistent with our Bank's capital needs, asset quality and overall financial
condition. The governing regulatory agency has the authority to prohibit our
Bank from engaging in business practices which the governing regulatory agency
considers to be unsafe or unsound. It is possible, depending upon the financial
condition of our Bank, that the governing regulatory agency may determine that
the payment of dividends to us by our Bank might, under some circumstances, be
such an unsafe and unsound practice.
For example, as a prerequisite to the payment of dividends, Minnesota
Statutes, section 48.09, subd. 1, requires our Bank to set aside all of its net
profits to a surplus fund until the surplus fund is equal to 20% of our Bank's
capital stock, and 10% of its net profits while the surplus fund is equal to
between 20% and 50% of our Bank's capital stock. Even when the surplus fund
requirements are met, all bank decisions regarding dividends are subject to the
approval of the Department of Commerce.
Common Liability. Under federal law, a depository institution insured by
the FDIC can be held liable for any loss incurred by, or reasonably expected to
be incurred by, the FDIC in connection with the default of a commonly controlled
FDIC-insured depository institution or any assistance provided by the FDIC to a
commonly controlled FDIC-insured institution in danger of default.
Affiliate Transaction Limitations. Our Bank is subject to certain
restrictions imposed by federal law on "covered transactions" between our Bank
and its affiliates. These covered transactions are (i) loans or extensions of
credit by our Bank to an affiliate, (ii) a purchase of or investment in
securities issued by an affiliate, (iii) a purchase of assets from an affiliate
(subject to certain exemptions the Board may allow), (iv) the acceptance by our
Bank of securities issued by the
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affiliate as security for a loan to any person or company, and (v) the issuance
by our Bank of any guaranty, acceptance, or letter of credit on behalf of an
affiliate. In general, (i) covered transactions with any one affiliate cannot
exceed 10% of our Bank's capital and transactions with all affiliates cannot
exceed 20% of our Bank's capital; (ii) extensions of credit to an affiliate must
be collateralized; (iii) low quality assets cannot be purchased from an
affiliate; and (iv) all transactions must be on safe and sound terms.
All covered transactions, and certain other transactions between our bank
and our affiliates, must be on terms and under circumstances, including credit
standards, that are substantially the same, or at least as favorable to our Bank
as those prevailing at the time for comparable transactions with nonaffiliated
companies. In the absence of comparable transactions, the terms and
circumstances for the affiliate transaction must be those that in good faith
would be offered to nonaffiliated companies.
Regulatory Capital Requirements. Our Bank is required to comply with
capital adequacy standards set by the FDIC. The FDIC may establish higher
minimum requirements if, for example, a bank has previously received special
attention or has a high susceptibility to interest rate risk. Banks with capital
ratios below the required minimum are subject to certain administrative actions.
More than one capital adequacy standard applies, and all applicable standards
must be satisfied for an institution to be considered to be in compliance. There
are three basic measures of capital adequacy: a total risk-based capital
measure, a Tier 1 risk-based capital ratio, and a leverage ratio.
The risk-based capital measure was adopted to assist in the assessment of
capital adequacy of financial institutions by, (i) making regulatory capital
requirements more sensitive to differences in risk profiles among organizations;
(ii) introducing off-balance-sheet items into the assessment of capital
adequacy; (iii) reducing the disincentive to holding liquid, low-risk assets;
and (iv) achieving greater consistency in evaluation of capital adequacy of
major banking organizations throughout the world. The risk-based guidelines
include both a definition of capital and a framework for calculating
risk-weighted assets by assigning assets and off-balance-sheet items to broad
risk categories. An institution's risk-based capital ratios are calculated by
dividing its qualifying capital by its risk-weighted assets.
Qualifying capital consists of two types of capital components: "core
capital elements" ("Tier 1" capital) and "supplementary capital elements" ("Tier
2" capital). Tier 1 capital is generally defined as the sum of core capital
elements less goodwill and other intangibles. Core capital elements consist of
(i) common shareholders' equity, (ii) noncumulative perpetual preferred stock,
subject to certain limitations, and (iii) minority interest in the equity
accounts of consolidated subsidiaries. Supplementary capital ("Tier 2" capital)
consists of elements such as (i) allowance for loan and lease losses (subject to
limitations); (ii) perpetual preferred stock which does not qualify as Tier 1
capital (subject to certain conditions); (iii) hybrid capital instruments and
mandatory convertible debt securities; and (iv) term subordinated debt and
intermediate-term preferred stock (subject to limitations). The maximum amount
of Tier 2 capital that may be included in qualifying total capital is limited to
100% of Tier 1 capital (net of goodwill and certain other intangible assets).
Under current capital adequacy standards, our Bank must meet a minimum
ratio of qualifying total capital to risk-weighted assets of 8%. Of that ratio,
at least half, or 4%, must be in the form of Tier 1 capital.
Banks must also meet a leverage capital requirement. In general the minimum
leverage capital requirement is not less than 3 percent Tier 1 capital to total
assets if the bank has the highest regulatory rating and is not anticipating or
experiencing any significant growth. All other banks should have a minimum of
100 to 200 basis points higher and thus a minimum leverage capital standard of
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not less than 4 percent. Thus, banks normally are out of compliance with
regulatory capital requirements if they have a Tier 1 leverage capital ratio of
less than 4 percent.
As a result of the FDIC Improvement Act of 1991, the federal bank
regulatory agencies adopted regulations defining banks as "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized"
and "critically undercapitalized." Under the law, depending upon a bank's
classification, a bank may be directed to prepare and implement a capital
restoration plan, to be guaranteed by its parent bank holding company. Further,
banks are subject to increased restrictions upon activities and heightened
regulatory management as capital classifications decline.
Generally, under regulations adopted by all of the bank federal regulatory
agencies, "well capitalized" has been defined as an institution with a total
capital to risk-based asset ratio of 10%, a Tier 1 capital to risk-based asset
ratio of 6% and a Tier 1 leverage ratio of 5%. The regulations further provide
that an "adequately capitalized" institution must have a total capital to
risk-based asset ratio of at least 8%, a Tier 1 capital to risk-based asset
ratio of 4% and a Tier 1 leverage ratio of 4%. An institution will be deemed
"undercapitalized" if it has total risk-based capital ratio that is less than 8%
or has a leverage ratio that is less than 4% (or less than 3% if rated CAMEL 1).
Institutions with a total risk-based capital ratio of less than 6%, a Tier 1
risk-based capital ratio of less than 3%, or a leverage ratio that is less than
3% will be deemed "significantly undercapitalized." Finally, the regulations
provide that an institution that has a ratio of tangible equity to total assets
that is equal to or less than 2% will be deemed "critically undercapitalized."
Federal bank regulatory agencies, including the FDIC, are authorized to
down-grade a financial institution from one capital category to the next if an
examination reveals that the asset quality, management, earnings or liquidity of
that institution are less than satisfactory. Under the regulations, as of
September 30, 1999 our Bank is classified as "well capitalized."
Acquisitions and Branching. Banks, including our Bank, have the authority
under Minnesota law to establish branches (referred to under Minnesota law as
"detached facilities") in any municipality in the state of Minnesota, subject to
receipt of all required regulatory approvals, except a municipality having a
population of 10,000 or less, unless all the banks having a principal office in
the municipality have consented in writing to the establishment of the branch
(this rule is often called the "home town protection rule.")
Effective June 1, 1997, the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "RNA") allows the responsible Federal banking agency
to approve applications for mergers of depository institutions across state
lines without regard to whether such activity is contrary to state law. Any
state could, however, by adoption of a non-discriminatory law after September
29, 1994 and before June 1, 1997, either elect to have this provision take
effect before June 1, 1997 or opt-out of the provision. The effect of opting out
is to prevent banks chartered by, or having their main office located in, such
state from participating in any interstate branch merger. Each state is
permitted to retain a minimum age requirement of up to five years, a
non-discriminatory deposit cap, and non-discriminatory notice or filing
requirements. Only Texas opted-out of the interstate merger provision. The
Minnesota legislature has taken action to opt in and has authorized interstate
branching effective June 1, 1997. It exercised its discretion, however, to
retain a minimum age requirement (or "seasoning requirement") of 5 years.
Therefore, our Bank may not be acquired by an out-of-state bank nor may our Bank
merge into an out-of-state bank for 5 years after its creation. Nevertheless,
the RNA could present acquisition and branching opportunities to the Company,
and could allow out-of-state banks easy access to markets currently served by
the Company thereby increasing competition.
Community Reinvestment Act. The Community Reinvestment Act of 1977 ("CRA")
requires a financial institution to help meet the credit needs of its entire
community, including low-income and
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moderate-income areas. Federal banking agencies may take CRA compliance into
account when regulating and supervising bank and holding company activities; for
example, CRA performance may be considered in approving proposed bank
acquisitions. The banks are also subject to a variety of consumer protection
laws and fair lending laws. Violations of these laws may cause regulators to
impose substantial penalties or take other administrative action.
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<PAGE> 88
DESCRIPTION OF OUR CAPITAL STOCK
GENERAL
Our Amended and Restated Articles of Incorporation (the "Articles")
authorize the issuance of 20,000,000 shares of capital stock having a par value
of $0.01 per share, of which 15,000,000 shares are common stock and 5,000,000
shares are undesignated.
COMMON STOCK
General. As of December 31, 1999, 425,600 shares of common stock were
issued and outstanding. No share of common stock is entitled to preference over
any other share and each such share is equal to other shares of common stock in
all respects. In any distribution of capital assets, whether voluntary or
involuntary, holders of common stock are entitled to receive pro rata the assets
remaining after creditors and holders, if any, of stock with a liquidation
preference have been paid in full.
Voting. Common shareholders are entitled to one vote for each share held
of record on each matter submitted to a vote of the common shareholders.
Dividends, Distributions and Redemptions. Subject to the preferential
dividend rights of any subsequent classes or series of stock with such rights
and preferences superior to the common stock as our board of directors may
designate, the common stock shareholders are entitled to receive dividends as
and when declared by our board of directors. However, dividends on our common
stock are not contemplated in the foreseeable future. Under the Minnesota
Business Corporation Act (the "MBCA"), we may declare and pay dividends on the
common stock only if we will be able to pay its debts in the ordinary course of
business after making the distribution. In addition, our primary source of cash
to make dividend payments is dividends that we receive from our Bank, which may
be unable to make payments to us under various applicable regulations. See
"-- Dividend Policy" and "Supervision and Regulation."
Federal and state banking laws regulate our ability to pay dividends and
redeem our equity securities. No redemptions of any equity securities are
permitted without the approval of the Federal Reserve Board if the aggregate
amount of such redemptions exceeds 10% of our net worth over a 12-month period.
In addition, no redemption of or dividend on the common stock is permitted if it
would constitute an unsafe or unsound practice according to the Federal Reserve
Board.
If we were liquidated, our common stockholders would be entitled to
receive, pro rata, all assets available for distribution to them after
satisfaction of our liabilities and any payment applicable to any preferred
stock then outstanding.
No Cumulative Voting. Our Articles provide that our shareholders will not
have cumulative voting rights in the electing of directors. Under cumulative
voting, a shareholder could cast that number of votes equal to such
shareholder's shares multiplied by the number of directors to be elected in
favor of one candidate or among several candidates. Cumulative voting makes it
possible for less than a majority of the shareholders to elect one or more
members of the board of directors. Under non-cumulative voting, a majority of
the voting power of the shareholders entitled to vote can elect the entire board
of directors.
No Preemptive Rights. Our Articles provide that our shareholders will not
have any preemptive rights to subscribe for or purchase additional shares of our
capital stock. This means that our shareholders will not be entitled to acquire
a certain fraction of the unissued securities or rights to purchase our
securities before we may offer them to other persons. Preemptive rights enable
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<PAGE> 89
a shareholder to maintain the shareholder's proportional voting power and
proportional rights to receive and other distributions by the company.
UNDESIGNATED STOCK
Under governing Minnesota law and our Articles, no action by our
shareholders is necessary, and only action of the board of Directors is
required, to authorize the issuance of any of the undesignated stock. The board
of directors is empowered to establish and to designate each class or series of
the undesignated shares and to set the terms of such shares (including terms
with respect to redemption, sinking fund, dividend, liquidation, preemptive,
conversion and voting rights and preferences). Accordingly, the board of
directors, without shareholder approval, may issue such undesignated shares in
one or more series of preferred stock having rights, preferences, privileges or
restrictions, including voting rights, that may be greater than the rights of
holders of common stock, provided, however, that the issuance of preferred stock
is approved by a majority of our independent directors who do not have an
interest in the transaction and who have access, at our expense, to our or
independent legal counsel.
It is not possible to state the actual effect of the issuance of any shares
of preferred stock upon the rights of holders of the common stock until the
board of directors determines the specific rights of the holders of such
preferred stock. However, the effects might include, among other things,
restricting dividends on the common stock, diluting the voting power of the
common stock, impairing the liquidation rights of the common stock and delaying
or preventing a change in control of Northern Star Financial without further
action by the shareholders. We have no present plans to issue any shares of
preferred stock.
LIMITATION OF DIRECTOR LIABILITY, INDEMNIFICATION
The Minnesota Business Corporations Act ("MBCA") permits Minnesota
corporations, in their Articles of Incorporation or Bylaws, to limit or
eliminate the personal liability of directors to corporations and their
shareholders for monetary damages for breach of directors' fiduciary duty of
care. The duty of care requires that, when acting on behalf of a corporation,
directors must exercise an informed business judgment based on all material
information reasonably available to them. Absent the limitations authorized by
the MBCA, directors are accountable to corporations and their shareholders for
monetary damages for conduct constituting gross negligence in the exercise of
their duty of care. Although the MBCA provision does not change directors' duty
of care, it enables corporations to limit available relief to equitable remedies
such as injunction or rescission. Our Bylaws state that our directors will not
be personally liable for monetary damages for breach of their fiduciary duty as
a director, except for liability for (i) any breach of the director's duty of
loyalty to the company or its shareholders, (ii) acts or omissions not in good
faith or which involve intentional misconduct or a knowing violation of law,
(iii) corporate distributions which are in contravention of restrictions in the
MBCA, our Articles of Incorporation or Bylaws, or any agreement to which we are
a party, or (iv) any transaction from which the director derives an improper
personal benefit. Our Bylaws also provide that if the MBCA is later amended,
then the liability of our directors will be eliminated or limited to the fullest
extent permitted by the MBCA, as so amended. The inclusion of this provision in
our Bylaws may have the effect of reducing the likelihood of derivative
litigation against directors and may discourage or deter shareholders or
management from bringing a lawsuit against directors for breach of their duty of
care, even though such an action, if successful, might otherwise have benefited
us and our shareholders.
Minnesota Statutes Section 302A.521 provides that our officers and
directors have the right to indemnification from us for liability arising out of
certain actions. We have included in our Bylaws
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a provision to indemnify our directors and officers for expenses and liabilities
to the fullest extent permitted by Minnesota law.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to our directors, officers and controlling persons pursuant to
the foregoing provisions, or otherwise, we have been advised that in the opinion
of the Securities and Exchange Commission (the "Commission") such
indemnification is against public policy as expressed in the Securities Act, and
is, therefore, unenforceable.
ANTI-TAKEOVER PROVISIONS
Certain provisions of Minnesota law and our Articles described below could
have an anti-takeover effect. These provisions are intended to provide
management flexibility to enhance shareholder value, the likelihood of
continuity and stability in the composition of our board of directors and in the
policies formulated by the board and to discourage an unsolicited takeover, if
the board determines that such a takeover is not in our best interests and the
best interests of our shareholders. However, these provisions could have the
effect of discouraging certain acquisition attempts, which could deprive our
shareholders of opportunities to sell their shares of common stock at prices
higher than prevailing market prices.
Section 302A.671 of the Minnesota Statutes applies, with certain
exceptions, to any acquisitions of our voting stock (from a person other than
us, and other than in connection with certain mergers and exchanges to which we
are a party) resulting in the beneficial ownership of 20% or more of the voting
stock then outstanding. Section 302A.671 requires approval of the granting of
voting rights for the shares received pursuant to any such acquisition by a
majority vote of our shareholders. In general, shares acquired without such
approval are denied voting rights and are redeemable by us at the then fair
market value within 30 days after the acquiring person has failed to deliver a
timely information statement to us or the date the shareholders voted not to
grant voting rights to the acquiring person's shares.
Section 302A.673 of the Minnesota Statutes generally prohibits any business
combination by us, or any of our subsidiaries, with any shareholder who
purchases 10% or more of our voting shares (an "interested shareholder") within
four years following such interested shareholder's share acquisition date,
unless the business combination is approved by a committee of all of the
disinterested members of our board of directors before the interested
shareholder's share acquisition date.
Our board of directors may authorize the issuance of additional shares of
common stock or, from the 5,000,000 shares of undesignated stock, preferred
stock without further action by our shareholders, unless such action is required
in a particular case by applicable laws or regulation. The authority to issue
additional common stock or preferred stock provides us with the flexibility
necessary to meet our future needs without the delay resulting from seeking
shareholder approval. The unissued common stock or preferred stock may be issued
from time to time for any corporate purposes, including without limitation,
stock splits, stock dividends, employee benefit and compensation plans,
acquisitions and public and private sales for cash as a means of raising
capital. Such shares could be used to dilute the stock ownership of persons
seeking to obtain control of us. In addition, the sale of a substantial number
of shares of common stock or preferred stock to persons who have an
understanding with us concerning the voting of such shares, or the distribution
or dividend of common stock or preferred stock (or right to receive such shares)
to our shareholders, may have the effect of discouraging or otherwise increasing
the cost of unsolicited attempts to acquire control of us. Further, because our
board has the power to determine the voting, conversion or other rights of the
preferred stock, the issuance of a series of preferred stock to persons friendly
to management could effectively discourage or preclude consummation of a change
in control transaction or have the effect
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of maintaining the position of our incumbent management. We do not currently
have any plans or commitments to use our authority to effect any such issuance,
but we reserve the right to take any action that the board of directors deems to
be in the best interests of Northern Star Financial and its shareholders.
Furthermore, as a Minnesota corporation, we are subject to provisions of the
Minnesota Business Corporations Act ("MBCA") that could have an anti-takeover
effect.
In addition, certain provisions of our Bylaws will impede changes in
majority control of our board of directors. Our Bylaws provide that the board of
directors will be divided into three classes, with directors in each class
elected for three-year staggered terms. Thus assuming five directors, as
currently is the case, it would take two annual meetings for the election of
directors to replace a majority of the board.
TRANSFER AGENT AND REGISTRAR
Our Stock Transfer Agent and Registrar is Continental Stock Transfer and
Trust Company.
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been only a limited public market for our
common stock. Future sales of substantial amounts of common stock in the open
market may adversely affect the price of the common stock offered hereby and our
ability to raise equity capital in the future.
Upon completion of this offering, we will have a minimum of 925,600 and a
maximum of 1,425,600 shares of common stock outstanding, assuming no exercise of
outstanding warrants and options. Of the aggregate amount outstanding, 121,000
shares of common stock are "restricted securities" as that term is defined in
Rule 144 under the Securities Act, and may be sold in the public market only if
registered or if they qualify for an exemption from registration under Rule 144
or otherwise.
The shares sold in this offering will be freely tradable, without resale
restrictions or further registration under the Securities Act, unless purchased
by an "Affiliate" of Northern Star Financial, whose sales would be subject to
certain volume limitations and other restrictions described below. An affiliate
of the issuer is defined in Rule 144 under the Securities Act as a person that
directly or indirectly, through one or more intermediaries, controls, is
controlled by, or is under common control with the issuer. Rule 405 under the
Securities Act defines the term "control" to mean the possession, direct or
indirect, of the power to direct or cause the direction of the management and
policies of the person whether through the ownership of voting securities, by
contract or otherwise. Our directors and directors of our Bank would likely be
deemed to be affiliates.
In general, under Rule 144, an affiliate or a person holding restricted
shares may sell, within any three-month period, a number of shares not greater
than 1% of the then outstanding shares of the common stock or the average weekly
trading volume of the common stock during the four calendar weeks preceding the
sale, whichever is greater. Rule 144 also requires that the securities must be
sold in "brokers' transactions," as defined in the Securities Act, and the
person selling the securities may not solicit orders or make any payment in
connection with the offer or sale of securities to any person other than the
broker who executes the order to sell the securities. This requirement may make
the sale of the common stock by our affiliates pursuant to Rule 144 difficult if
no trading market develops in the common stock. Rule 144 also requires persons
holding restricted securities to hold the shares for at least one year prior to
sale.
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THE OFFERING
GENERAL
We are offering for sale a minimum of 500,000 shares and a maximum of
1,000,000 shares of our common stock at a price of $10.50 per share to raise
gross proceeds of between $5,250,000 and $10,500,000. The minimum purchase for
any one investor (together with the investor's affiliates) is 100 shares and the
maximum purchase is 45,000 shares, unless we, in our sole discretion, accept a
subscription for a lesser or greater number of shares.
Our officers and directors and certain shareholders may purchase shares in
this offering, including purchases necessary to sell the minimum number of
shares. Because purchases by these individuals may be substantial, investors
should not place any reliance on the sale of a specified minimum offering amount
as an indication of the merits of this offering or that such officer's,
director's or shareholder's investment decision is shared by unaffiliated
investors. See "Northern Star Financial Management."
Subscriptions to purchase shares will be received until midnight,
Minneapolis, Minnesota time, on June 26, 2000, unless all of the shares are
earlier sold or we terminate the offering earlier. See "Conditions to the
Offering and Release of Funds." We reserve the right to terminate the offering
at any time or to extend the expiration date for additional periods not to
extend beyond September 24, 2000. The date the offering terminates is referred
to herein as the "Expiration Date." No written notice of an extension of the
offering period need be given prior to any extension and any such extension will
not alter the binding nature of subscriptions we have already accepted.
Extension of the Expiration Date might cause an increase in the expenses
incurred with this offering. We intend to use Banc Stock Financial Services,
Inc. to sell the shares. See "Plan of Distribution."
After we accept a subscription, such subscription will be binding on the
subscriber and may not be revoked by the subscriber except with our consent. In
addition, we reserve the right to cancel accepted subscriptions at any time and
for any reason until the proceeds of this offering are released from escrow (as
discussed in greater detail in "Conditions to the Offering and Release of Funds"
below), and we reserve the right to reject, in whole or in part and in our sole
discretion, any subscription. We may, in our sole discretion, allocate shares
among subscribers in the event of an oversubscription for the shares. In
determining which subscriptions to accept, in whole or in part, we may take into
account any factors we consider relevant, including the order in which
subscriptions are received, a subscriber's potential to do business with, or to
direct customers to, our Bank, and our desire to have a broad distribution of
stock ownership. If we reject any subscription, or accept a subscription but in
our discretion subsequently elect to cancel all or part of such subscription, we
will refund promptly the amount remitted that corresponds to $10.50 multiplied
by the number of shares as to which the subscription is rejected or canceled. We
will promptly issue certificates representing shares duly subscribed and paid
for after the offering conditions are satisfied and escrowed funds are delivered
to us.
CONDITIONS TO THE OFFERING AND RELEASE OF FUNDS
Subscription proceeds for the initial 500,000 shares subscribed for in this
offering will be promptly deposited in an escrow account with Firstar Bank, N.A.
as escrow agent until the conditions to this offering have been satisfied or the
offering has been terminated. The offering will be terminated, no shares will be
issued, and no subscription proceeds will be released from escrow to us, unless
on or before the Expiration Date we have accepted subscriptions and payment in
full for a minimum of 500,000 shares in this offering. If this condition is
satisfied, the subscription amounts for
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this offering held in escrow may be paid to us and shares issued to subscribers.
Once we have closed the sale of the minimum number of shares in this offering,
the Escrow Agreement with Firstar Bank, N.A. will be terminated, and any
subscription proceeds accepted after satisfaction of the condition before
termination of this offering will not be deposited in escrow but will be
available for our immediate use. See "Use of Proceeds."
If the minimum number of shares is not subscribed for by the Expiration
Date or the offering is otherwise earlier terminated, (i) accepted subscription
agreements will be of no further force or effect and subscribers in this
offering will not receive shares of our common stock, (ii) the funds held in the
escrow account shall not be subject to the claims of any of our creditors or
available to defray the expenses of this offering, and (iii) the full amount of
all subscription funds will be returned promptly to subscribers, with interest.
The escrow agent has not investigated the desirability or advisability of
an investment in the shares by prospective investors and has not approved,
endorsed, or passed upon the merits of an investment in the shares. Subscription
funds held in escrow will be invested in interest-bearing savings accounts,
short-term United States Treasury securities, FDIC-insured bank deposits, or
such other permissible investments as we and the escrow agent shall agree. We do
not intend to invest the subscription proceeds held in escrow in instruments
that would mature after the Expiration Date of the offering.
PLAN OF DISTRIBUTION
We have entered into a sales agency agreement with Banc Stock Financial
Services, Inc., a subsidiary of The Banc Stock Group, Inc. The sales agent has
agreed to use its best efforts to sell between 500,000 and 1,000,000 shares of
common stock to the public at the offering price. The sales agent may not sell
any shares unless it can sell at least 500,000 shares. The sales agent will
receive a 2.5% commission on shares sold in the offering to our officers,
directors and employees, a 5.5% commission on shares sold in the offering to
certain investors through the IPOdepot.com website, and a 7.0% commission on
other shares sold in the offering. We will also pay the sales agent's expenses
in the offering, up to a maximum of $35,000, and its legal fees up to $25,000.
The sales agent may, with our consent, sell shares through other dealers who are
members of the National Association of Securities Dealers, Inc. The selected
dealers will receive a selling commission not to exceed $0.53 per share.
The sales agent has the right to terminate the sales agency agreement under
some circumstances, for example, if the sales agent believes that there is not a
favorable public market for the sale of the shares. If the sales agent
terminates the sales agency agreement, we may sell the shares ourselves through
our officers and directors, or we may engage one or more other broker/dealers.
We do not currently have arrangements with any other broker/dealers. Until we
have sold the minimum number of shares, we will promptly forward all funds we
receive from the sale of shares to the escrow agent.
The sales agency agreement provides for reciprocal indemnification between
us and the sales agent against certain liabilities in connection with this
offering, including liabilities under the securities laws. The SEC has advised
us that it believes that such indemnification is against public policy and may
be unenforceable.
HOW TO SUBSCRIBE
Shares may be subscribed for by delivering the subscription agreement
attached hereto as Exhibit A, completed and executed in full, to the sales
agent, on or prior to the Expiration Date. Subscribers should retain a copy of
their completed subscription agreement for their records. The
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subscription price is due and payable when the subscription agreement is
delivered. Payment must be made in United States dollars by cash or by check,
bank draft or money order drawn to the order of "FIRSTAR BANK, N.A., ESCROW
ACCOUNT FOR NORTHERN STAR FINANCIAL, INC." in the amount of $10.50 multiplied by
the number of shares subscribed for.
LEGAL MATTERS
The validity of the issuance of the shares offered hereby will be passed
upon for us by Fredrikson & Byron, P.A., whose business address is 900 Second
Avenue South, Minneapolis, Minnesota 55402. Certain legal matters relating to
this offering will be passed upon for Banc Stock Financial Services, Inc. by
Howard & Howard Attorneys, P.C., whose business address is 211 Fulton Street,
Peoria, Suite 600, Illinois 61602.
EXPERTS
The audited financial statements of Northern Star Financial, Inc. as of
June 30, 1999, included in this prospectus and elsewhere in the registration
statement, have been audited by Bertram Cooper & Co., LLP, independent public
accountants, as indicated in their report with respect thereto, and are included
herein in reliance upon the authority of said firm as experts in giving said
report. The audited financial statements of First Federal Holding Company of
Morris, Inc. as of September 30, 1999, included in this prospectus and elsewhere
in this registration statement, have been audited by Michael L. Anderson &
Associates, PLLC, independent public accountants, as indicated in their report
with respect thereto, and are included herein in reliance upon the authority of
said firm as experts in giving said report.
WHERE YOU CAN GET MORE INFORMATION
We have filed a registration statement on Form SB-2 under the Securities
Act with the SEC in connection with the common stock offered by this prospectus.
This prospectus omits certain information, exhibits and undertakings set forth
in the registration statement which we have filed with the SEC. You may inspect
and copy those materials upon payment of prescribed rates, at the Public
Reference Room of the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549 and at
the regional office of the SEC at the following locations: Seven World Trade
Center, Suite 1300, New York, New York 10048 and 500 West Madison Street, Suite
1400, Chicago, Illinois 60661. You may obtain information on the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. This information
is also available on the Internet at the SEC's website. The address for the web
site is: http://www.sec.gov. For further information about us, reference is
hereby made to the registration statement and the exhibits thereto. Statements
contained in this prospectus concerning the provisions of any contract,
agreement or other document are not necessarily complete, and in each instance
reference is made to the copy of such contract, agreement or other document
filed as an exhibit to the registration statement for a full statement of the
provisions thereof. Each such statement in this prospectus is qualified in all
respects by such reference.
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INDEX TO FINANCIAL STATEMENTS
NORTHERN STAR FINANCIAL, INC.
<TABLE>
<S> <C>
Independent Auditors' Report................................ F-2
Consolidated Statement of Financial Condition as of December
31, 1999 (unaudited) and June 30, 1999 and 1998........... F-3
Consolidated Statements of Operations for the six months
ended December 31, 1999 and 1998 (unaudited) and for the
year ended June 30, 1999 and for the period from inception
(January 22, 1998) to June 30, 1998....................... F-4
Statement of Changes in Stockholders' Equity for the Period
From Inception (January 22, 1998) to June 30, 1999........ F-5
Statement of Cash Flows for the six months ended December
31, 1999 and 1998 (unaudited) and for the year ended June
30, 1999 and for the period from inception (January 22,
1998) to June 30, 1998.................................... F-6
Notes to Quarterly Financial Statements as of and for the
Period ending December 31, 1999........................... F-8
Notes to Financial Statements as of and for the Period from
Inception (January 22, 1998) to June 30, 1999............. F-11
</TABLE>
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
<TABLE>
<S> <C>
Independent Auditors' Report................................ F-26
Consolidated Balance Sheets as of December 31, 1999
(unaudited) and September 30, 1999 and 1998............... F-27
Consolidated Statements of Income for the three months ended
December 31, 1999 and 1998 (unaudited) and for the years
ended September 30, 1999 and 1998......................... F-28
Consolidated Statements of Changes in Stockholders' Equity
for the years ended September 30, 1999 and 1998........... F-29
Consolidated Statements of Cash Flows for the three months
ended December 31, 1999 and 1998 (unaudited) and for the
years ended September 30, 1999 and 1998................... F-30
Notes to Quarterly Financial Statements as of and for the
quarter ended December 31, 1999........................... F-32
Notes to Consolidated Financial Statements years ended
September 30, 1999 and 1998............................... F-34
</TABLE>
F-1
<PAGE> 96
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
Northern Star Financial, Inc. and Subsidiary
Mankato, Minnesota 56001
We have audited the accompanying consolidated statements of financial
condition of Northern Star Financial, Inc. and Subsidiary (the Company) as of
June 30, 1999 and 1998 and the related consolidated statements of operations,
changes in shareholders' equity, and cash flows for the year ended June 30, 1999
and for the period from inception, January 22, 1998 to June 30, 1998. These
financial statements are the responsibility of management. Our responsibility is
to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Northern Star
Financial, Inc. and Subsidiary as of June 30, 1999 and 1998, and the
consolidated results of their operations and their cash flows for the respective
year and period then ended, in conformity with generally accepted accounting
principles.
As discussed in Note 1 to the consolidated financial statements, the
Company changed its method of accounting for organization costs.
BERTRAM COOPER & CO., LLP
Waseca, Minnesota
August 5, 1999
F-2
<PAGE> 97
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
JUNE 30,
DECEMBER 31, ---------------------
1999 1999 1998
------------ ---------- -------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents:
Cash and due from bank............................ $ 249,088 $ 210,662 $ --
Federal funds sold................................ 2,159,781 2,533,236 --
----------- ---------- -------
Total cash and cash equivalents................ 2,408,869 2,743,898 --
Securities available for sale, at fair value........ 4,465,492 745,119 --
FHLB stock, at cost................................. 21,300 16,400 --
Loans held for sale................................. 66,440 681,593 --
Loans receivable, net of allowance for loan losses
of $56,250 in 1999 and $-0- in 1998............... 8,950,055 4,881,502 --
Accrued interest receivable......................... 128,981 59,527 --
Premises and equipment, net......................... 465,957 486,685 --
Other assets........................................ 45,577 20,884 14,806
Investment Homeland Mortgage........................ 115,822 -- --
----------- ---------- -------
Total Assets.............................. $16,668,493 $9,635,608 $14,806
=========== ========== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Demand deposits................................... $ 2,497,720 $1,121,450 $ --
Savings deposits.................................. 4,674,284 3,244,444 --
Time deposits..................................... 5,966,384 1,798,675 --
----------- ---------- -------
Total deposits................................. 13,138,387 6,164,569 --
Advances from FHLB.................................. 425,000 -- --
Advances from borrowers for taxes and insurance..... 5,436 23,941 --
Other liabilities................................... 69,591 23,396 18,665
----------- ---------- -------
Total Liabilities.............................. 13,638,414 6,211,906 18,665
Shareholders' equity:
Common stock, par value $0.01 per share, 15,000,000
shares authorized, 425,600 shares issued.......... 4,256 4,256 --
Undesignated stock, par value $0.01 per share,
5,000,000 shares authorized, no shares issued..... -- -- --
Paid in capital..................................... 3,919,577 3,919,577 100
Accumulated deficit................................. (865,774) (497,631) (3,959)
Accumulated comprehensive income (loss)............. (27,980) (2,500) --
----------- ---------- -------
Total shareholders' equity..................... 3,030,079 3,423,702 (3,859)
----------- ---------- -------
Total liabilities and shareholders equity...... $16,668,493 $9,635,608 $14,806
=========== ========== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 98
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, YEAR ENDED PERIOD FROM
---------------------- JUNE 30, INCEPTION TO
1999 1998 1999 JUNE 30, 1998
--------- --------- ---------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
INTEREST INCOME:
Loans receivable.................... $ 323,040 $ -- $ 120,005 $ --
Securities available for sale....... 64,285 -- 3,590 --
Due from banks...................... -- 4,613 5,191 --
Federal funds sold.................. 33,185 -- 26,089 --
--------- --------- --------- -------
Total interest income............ 420,510 4,613 154,875 --
Interest expense:..................... --
Demand deposits..................... 2,801 -- 1,430 --
Savings deposits.................... 66,404 -- 13,363 --
Time deposits....................... 83,553 -- 25,219 --
Borrowed Funds...................... 2,970 -- -- --
--------- --------- --------- -------
Total interest expense........... 155,728 -- 40,012 --
--------- --------- --------- -------
Net interest income................. 264,782 4,613 114,863 --
Provision for loan losses........... 67,500 -- (56,250) --
--------- --------- --------- -------
Net interest income after
provision for loan losses...... 197,282 4,613 58,613 --
--------- --------- --------- -------
Noninterest income:
Other fees and service charges...... 14,036 -- 45,499 --
Gain/(loss) on sale of loans........ 25,824 -- (3,050) --
--------- --------- --------- -------
Total noninterest income......... 39,860 -- 42,449 --
--------- --------- --------- -------
Noninterest expenses:
Compensation and employee
benefits......................... 201,985 -- 247,497 --
Board fees.......................... 48,636 -- 70,429 --
Occupancy........................... 48,257 -- 39,556 --
Legal and accounting................ 35,790 -- 35,806 --
Printing and supplies............... 21,094 -- 22,261 --
Furniture, fixtures and equipment
depreciation..................... 33,337 -- 19,453 --
Data processing..................... 23,956 -- 16,758 --
Organizational expenditures......... -- 42,074 55,691 --
Merger expense...................... 37,310 -- -- --
Other............................... 68,295 77,860 87,283 3,959
Joint Venture....................... 86,624 -- -- --
--------- --------- --------- -------
Total noninterest expense........ 605,285 115,321 594,734 3,959
--------- --------- --------- -------
Net loss before income tax benefit.... (368,143) (115,321) (493,672) (3,959)
Income tax benefit.................... -- -- -- --
--------- --------- --------- -------
Net loss.............................. $(368,143) $(115,321) $(493,672) $(3,959)
--------- --------- --------- -------
Basic (loss) per share of common
stock............................... $ (0.86) N/A $ (1.60) N/A
========= ========= ========= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 99
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE
COMMON UNDESIGNATED PAID-IN ACCUMULATED INCOME COMPREHENSIVE
STOCK STOCK SURPLUS DEFICIT NET OF TAX INCOME TOTAL
------ ------------ ---------- ----------- ------------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, June 30,
1997.................. $ -- $-- $ -- $ -- $ -- $ -- $ --
Issuance of common
stock.............. -- -- 100 -- -- -- 100
Net loss for a period
of inception to
June 30, 1998...... -- -- -- (3,959) -- (3,959) (3,959)
Comprehensive loss.... -- -- -- -- -- $ (3,959) --
------ -- ---------- --------- ------- --------- ----------
Balance, June 30,
1998.................. -- -- 100 (3,959) -- -- (3,859)
Issuance of common
stock.............. 4,256 -- 4,251,744 -- -- -- 4,256,000
Offering costs........ -- -- (332,267) -- -- -- (332,267)
Net loss for the year
ended June 30,
1999............... -- -- -- (493,672) -- (493,672) (493,672)
Unrealized loss on
available-for-sale
securities net of
tax of $1,667...... -- -- -- -- (2,500) (2,500) (2,500)
Comprehensive loss.... -- -- -- -- -- -- --
------ -- ---------- --------- ------- --------- ----------
Balance, June 30,
1999.................. $4,256 -- $3,919,577 $(497,631) $(2,500) $(496,172) $3,423,702
====== == ========== ========= ======= ========= ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 100
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, YEAR ENDED PERIOD FROM
------------------------ JUNE 30, INCEPTION TO
1999 1998 1999 JUNE 30, 1998
----------- ---------- ----------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Interest received on loans and
investments........................ $ 352,924 $ 4,613 $ 95,343 $ --
Interest paid......................... (95,661) -- (20,391) --
Other fees, commissions, and income
received........................... 14,036 -- 42,449 --
Cash paid to suppliers, employees and
others............................. (549,956) (16,136) (552,833) (9,539)
Contributions to charities............ -- (185) --
Loans originated for sale............. (2,230,974) -- (1,866,642) --
Proceeds from sale of loans........... 2,871,950 -- 1,188,100 --
----------- ---------- ----------- -------
Net cash used in operating
activities....................... 362,319 (11,523) (1,114,159) (9,539)
----------- ---------- ----------- -------
Cash flows from investing activities:
Purchases of available-for-sale
securities......................... (4,097,722) (749,281) --
Maturities of available-for-sale
securities......................... 350,000 -- -- --
Purchase of FHLB stock................ (4,900) -- (16,400) --
Investment in Joint Venture........... (196,000) -- -- --
Loan originations and principal
payments on loans, net............. (4,136,053) -- (4,940,802) --
Deferred organizational costs......... -- -- -- (9,226)
Purchase of property and equipment.... (12,609) -- (509,419) --
----------- ---------- ----------- -------
Net cash used in investing
activities....................... (8,097,284) (6,215,902) (9,226)
----------- ---------- ----------- -------
Cash flows from financing activities:
Net increase in non-interest bearing
demand and savings deposit
accounts........................... 2,825,640 -- 4,365,700 --
Net increase in time deposits......... 4,167,801 -- 1,779,250 --
FHLB Borrowings....................... 425,000 -- -- --
Net increase in mortgage escrow
funds.............................. (18,505) -- 23,941 --
(Payment of) advances from
organizers......................... -- (18,665) 18,665
Proceeds from sale of common stock net
of offering costs.................. -- 3,087,353 3,923,733 100
----------- ---------- ----------- -------
Net cash provided by financing
activities....................... 7,399,936 3,087,353 10,073,959 18,765
----------- ---------- ----------- -------
</TABLE>
F-6
<PAGE> 101
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, YEAR ENDED PERIOD FROM
------------------------ JUNE 30, INCEPTION TO
1999 1998 1999 JUNE 30, 1998
----------- ---------- ----------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Net increase in cash and cash
equivalents........................... (335,029) 3,075,830 2,743,898 --
Cash and cash equivalents at beginning
of year............................... 2,743,898 -- -- --
----------- ---------- ----------- -------
Cash and cash equivalents at end of
year.................................. $ 2,408,869 $3,075,830 $ 2,743,898 $ --
=========== ========== =========== =======
Net loss on joint venture............... $ (80,178) $ -- $ -- $ --
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES
Net loss.............................. (368,144) (115,321) (493,672) (3,959)
Adjustments:
Depreciation....................... 33,337 -- 22,732 --
Joint venture loss................. 80,178 -- -- --
Provision for loan losses.......... 67,500 -- 56,250 --
Premiums accretion on
investments...................... (238) -- (39) --
Discount amortization on
investment....................... 2,107 -- 34 --
Loss on sale of loans.............. -- -- 3,050 --
(Increase) decrease in:
Loans held for sale.............. 615,513 -- (681,593) --
Accrued interest receivable...... (69,454) -- (59,527) --
Other assets..................... (24,694) (1,600) (4,600) (5,580)
Increase in:
Accrued interest payable......... 60,067 -- 19,621 --
Other liabilities................ (33,493) 105,398 23,396 --
----------- ---------- ----------- -------
Net cash provided by (used in)
operating activities.......... $ 362,679 $ (11,523) $(1,114,159) $(9,539)
=========== ========== =========== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE> 102
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 (UNAUDITED)
NOTE 1: PRINCIPLES OF CONSOLIDATION
The unaudited consolidated financial statements as of and for the six month
period ended December 31, 1999, include the accounts of Northern Star Financial,
Inc. (the "Company") and its wholly owned subsidiary Northern Star Bank (the
"Bank"). All significant intercompany accounts and transactions have been
eliminated in consolidation.
NOTE 2: BASIS OF PRESENTATION
GENERAL: The accompanying unaudited interim consolidated financial
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information. Accordingly, they do not include
all information and disclosures required by generally accepted accounting
principles for complete financial statements. The accompanying consolidated
financial statements do not purport to contain all the necessary financial
disclosures required by generally accepted accounting principles that might
otherwise be necessary in the circumstances and should be read with the fiscal
1999 consolidated financial statements and notes of Northern Star Financial,
Inc. included in its annual report for the year ended June 30, 1999.
In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for fair presentations have been
included. The results of operations for the six month period ended December 31,
1999, are not necessarily indicative of the results that may be expected for the
entire fiscal year or any other period.
NOTE 3: ORGANIZATION OF THE BUSINESS
The Company was incorporated under the laws of the State of Minnesota on
January 22, 1998, for the purpose of becoming a bank holding company for a state
chartered commercial bank. The Bank's charter became effective January 25, 1999.
The Company prior to January 25, 1999, reported as a development stage
enterprise because its activities included raising capital and establishing a
new bank. Upon opening the Bank, the Company's primary attention turned to
routine, ongoing bank activities and it ceased to be a development stage
enterprise.
F-8
<PAGE> 103
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4: COMPREHENSIVE INCOME
Accumulated comprehensive income (loss) is composed of the following:
<TABLE>
<S> <C>
Unrealized loss on available-for-sale securities
Beginning balance -- June 30, 1999........................ $ (2,500)
Current -- period change.................................. (25,480)
---------
Ending balance -- December 31, 1999....................... $ (27,980)
=========
Comprehensive income (loss) for the six months ended
December 31, 1999:
Net loss.................................................. $(361,143)
---------
Other comprehensive loss.................................. (25,480)
=========
Total..................................................... $(393,623)
=========
</TABLE>
NOTE 5: EARNINGS PER SHARE
The earnings per share amounts were computed using the weighted average
number of shares outstanding during the periods presented. For the six-month
period ended December 31, 1999, the weighted average number of shares
outstanding for basic and diluted earnings per share computation were 425,600.
There were options to purchase 66,200 shares of common stock that were not
included in the calculation of diluted earnings per share because they were
antidilutive.
NOTE 6: JOINT VENTURE
In July 1999, the Company acquired a 49 percent joint venture interest in
Homeland Mortgage Company, LLC (Homeland Mortgage), a limited liability company,
in exchange for a total cash consideration of $196,000. The investment in
Homeland Mortgage is being accounted for using the equity method. Homeland
Mortgage's primary business is originating residential real estate loans that
are secured by first and second mortgages and sold into the secondary mortgage
market.
NOTE 7: BUSINESS COMBINATION INITIATED
On September 30, 1999 the Company and First Federal Holding Company of
Morris, Inc. ("Morris") entered into an Agreement and Plan of Reorganization for
the merger of Morris with and into the Company. Under terms of the Agreement,
Morris shareholders will exchange their Morris common stock for approximately
870,559 shares of Company common stock, subject to certain adjustments as
specified in the Agreement. Completion of the merger is subject to regulatory
approvals and approval by the shareholders of both companies. The transaction
will be accounted for using the pooling of interest method of accounting.
Morris is a savings and loan holding company and through its subsidiary,
First Federal Savings Bank, provides various financial services including
mortgage, commercial and consumer lending and various deposits and savings plan.
At September 30, 1999 Morris had total assets of $57.5 million and shareholder
equity of $3.7 million.
F-9
<PAGE> 104
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Upon completion of the merger, the Company will have banking offices
located in Mankato, Morris, Benson, Breckenridge, and Big Lake, Minnesota and
mortgage banking offices located in Morris and Edina, Minnesota.
NOTE 8: SECONDARY STOCK OFFERING INITIATED
The Company filed a Registration Statement on Form SB-2 with the Securities
and Exchange Commission to register the sale of up to 1,000,000 shares of its
common stock. The shares will be offered and sold to the public on a best
efforts basis at a price to be negotiated between the company and its agent.
F-10
<PAGE> 105
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999 AND 1998
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following summarizes the significant accounting policies Northern Star
Financial, Inc. (the Company) follows in presenting its financial statements.
PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements
include the accounts of the Company and its wholly owned subsidiary Northern
Star Bank (the Bank). All significant intercompany transactions and balances are
eliminated in consolidation.
ORGANIZATION OF THE BUSINESS -- The Company was incorporated under the laws
of the State of Minnesota on January 22, 1998, for the purpose of becoming a
bank holding company for a state chartered commercial bank. On October 9, 1998,
the Company commenced an initial public offering of its common stock at $10.00
per share. The Company accepted subscriptions (including subscriptions from the
Bank's organizers to purchase an aggregate of 154,000 shares) to purchase an
aggregate of 425,600 shares of its common stock. The proceeds from the stock
subscriptions amounted to $3,923,733, net of selling expenses. The Bank's
charter became effective January 25, 1999 and the Company injected $3,000,500
into the Bank's capital accounts.
The Company prior to January 25, 1999, reported as a development stage
enterprise because its activities included raising capital and establishing a
new bank. Upon opening, the Bank and the Company's primary attention turned to
routine, ongoing bank activities and it ceases to be a development stage
enterprise.
NATURE OF BUSINESS -- The Company is a bank holding company whose
subsidiary provides financial services. The Bank's business is that of a
financial intermediary and consists primarily of attracting deposits from the
general public and using such deposits, together with borrowings and other
funds, to make secured and unsecured loans to business and professional concerns
and mortgage loans secured by residential real estate and other consumer loans.
At June 30, 1999, the Bank operated one retail banking office in Minnesota. The
Bank is subject to significant competition from other financial institutions,
and is also subject to regulation by certain federal and state agencies and
undergoes periodic examinations by those regulatory authors.
USE OF ESTIMATES -- In preparing the consolidated financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the balance sheets,
and income and expenses for the period. Actual results could differ from those
estimates. Material estimates that are particularly susceptible to significant
change relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with the determination of the allowance for
losses on loans and foreclosed real estate, management obtains independent
appraisals for significant properties.
While management uses available information to recognize losses on loans
and foreclosed assets, future additions to the allowances may be necessary based
on changes in local economic conditions. In addition, regulatory agencies, as an
integral part of their examination process, periodically review the Bank's
allowance for losses on loans and foreclosed real estate. Such agencies may
require the Bank to recognize additions to the allowances based on their
judgments about information available to them at the time of their examination.
F-11
<PAGE> 106
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CASH EQUIVALENTS -- For purposes of reporting cash flows, cash and cash
equivalents include cash on hand, amounts due from banks and federal funds sold.
Generally, federal funds are purchased and sold for one-day periods.
INVESTMENT SECURITIES -- Investment securities available for sale are
reported at fair market value, with unrealized gains and losses reported as a
separate component of stockholders' equity, net of the related tax effect.
Premiums and discounts on all investment securities are amortized
(deducted) and accreted (added), respectively, to interest income on the
straight-line and interest methods over the period to the maturity of the
related security.
The Bank, as a member of the Federal Home Loan Bank System, is required to
maintain an investment in capital stock of the Federal Home Loan Bank of Des
Moines. Because no ready market exists for this stock, and it has no quoted
market value, the Bank's investment in this stock is carried at cost.
Effective July 1, 1998, the Company adopted Statement of Financial
Standards ("SFAS") No. 130, "Reporting Comprehensive Income." The statement
establishes standards for reporting and display of comprehensive income and its
components in a full set of financial statements. The statement requires that
all items that are required to be recognized under accounting standards as
components of comprehensive income to be disclosed in the financial statements.
Comprehensive income is defined as the change in equity during a period from
transactions and other events from non-owner sources. Comprehensive income is
the total of net income and other comprehensive income, which for the Company is
comprised entirely of unrealized gains and losses on securities available for
sale.
LOANS HELD FOR SALE -- Mortgage loans originated and intended for sale in
the secondary market 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. Gains or losses on the sale of loans are
recorded in noninterest income, based on the net proceeds received and the
recorded investment in the loan.
LOANS RECEIVABLE -- Loans receivable that management has the intent and
ability to hold for the foreseeable future or until maturity or pay-off are
reported at their outstanding principal balance adjusted for any charge-off, the
allowance for loan losses, unamortized premiums, any deferred fees or costs on
originated loans and/or discounts on purchased loans. Discounts and premiums on
purchased residential real estate loans are amortized to income using the
interest method over the remaining period to contractual maturity, adjusted for
anticipated prepayments. Discounts and premiums on purchased consumer loans are
recognized over the expected lives of the loans using the level yield method.
The allowance for loan loss was established by a charge to income based on
management's evaluation of the known and inherent risks in the loan portfolio,
adverse situations that may affect the borrower's ability to repay, the
estimated value of any underlying collateral, and current economic conditions.
Uncollectible interest on loans contractually past due for three months is
charged off or an allowance is established based on management's periodic
evaluation. The allowance is established by a charge to or against interest
income equal to all interest previously accrued. Income is subsequently
F-12
<PAGE> 107
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
recognized only to the extent cash payments are received until, in management's
judgment, the borrower's ability to make periodic interest and principal
payments returns to normal, in which case the loan is returned to accrual
status.
Loan origination fees and certain direct origination costs are capitalized,
with the net fee or cost recognized as an adjustment to interest income using
the interest method.
MORTGAGE LOAN-SERVICING RIGHTS -- The Bank has established accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities based on the consistent application of the
financial-components approach. This approach requires the recognition of
financial assets and servicing assets that are controlled by the Bank, and the
derecognition of financial assets and liabilities when control is extinguished.
Liabilities and derivatives incurred or obtained in conjunction with the
transfer of financial assets are measured at fair value, if practicable.
Servicing assets and other retained interest in transferred assets are measured
by allocating the carrying amount between the assets sold and the interest
retained, based on their relative fair value. The Bank had no servicing assets
as of June 30, 1999.
PREMISES AND EQUIPMENT -- Leasehold improvements, furniture and equipment
are carried at cost less accumulated depreciation. Depreciation is computed by
the straight-line method over the estimated useful lives of the assets, which
range from three to forty years.
INCOME TAXES -- Deferred income taxes are recognized for the tax
consequences of temporary differences by applying enacted statutory tax rates
applicable to future years to differences between the financial statement
carrying amounts and the tax basis of existing assets and liabilities. The
effect on deferred taxes of a change in tax rates is recognized in income in the
period that includes the enactment date. The measurement of deferred tax assets
is reduced, if necessary, by the amount of any tax benefits that, based on
available evidence, are not expected to be realized. The effect of a change in
the beginning-of-the-year balance of a valuation allowance that results from a
change in judgment about the realizability of deferred tax assets, is included
in income.
The Company files consolidated income tax returns with the Bank and they
have entered into a tax sharing agreement which provides that the Bank will pay
to the Company, or receive a refund from the Bank's taxable income, as if the
Bank's portion of income tax liability or benefit was separately determined
based on taxable income or loss.
ORGANIZATIONAL COSTS -- The Company has elected early adoption of Statement
of Position 98-5 ("Reporting on the Costs of Start-up Activities" issued April
3, 1998 by the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants) and has expensed its cumulative
organization and start-up costs. Costs deferred in the period ended June 30,
1998, of $9,226 were expensed in the current period.
EARNINGS PER SHARE -- Basic earnings per share (EPS) is based on the
weighted average outstanding common shares. Diluted EPS is based on the weighted
average outstanding shares reduced by the effect of stock options and warrants.
The stock subscriptions described in Organization of the Business were
continently issuable subject to the Bank charter approval which occurred January
25, 1999 and included in the denominator of EPS as of the date of the Company's
Registration Statement, resulting in 307,831 weighted average shares.
F-13
<PAGE> 108
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Diluted EPS is the same as basic EPS because the option and warrant shares
were granted at a price which is equal to the current operating period market
price and those shares are not "in the money."
Ten shares were outstanding at June 30, 1998 and presentation of EPS for
the initial development period from inception would not be meaningful.
FAIR VALUES OF FINANCIAL INSTRUMENTS -- SFAS No. 107, "Disclosures about
Fair Value of Financial Instruments," requires disclosure of fair value
information about financial instruments, whether or not recognized in the
statement of financial condition. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimated cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate settlement of the instruments. SFAS No. 107 excludes certain
financial instruments and all nonfinancial assets and liabilities from its
disclosure requirements. Accordingly, the aggregate fair value amounts presented
do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in
estimating its fair value disclosures presented in Note 11, for financial
instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the statements
of financial condition for cash and cash equivalents equal their fair values.
DEBT AND EQUITY SECURITIES: Fair values for debt and equity securities are
based on quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments.
FHLB STOCK: The carrying amount of FHLB stock approximates fair value.
LOANS: For variable-rate loans that reprice frequently with no significant
change in credit risk, fair values are based on carrying amounts. The fair
values for other loans (for example, fixed rate commercial real estate, rental
property mortgage loans, and commercial and industrial loans) are estimated
using discounted cash flow analyses, based on interest rates currently being
offered for loans with similar terms to borrowers of similar credit quality
giving consideration to estimated prepayment and credit loss factors. Loan fair
value estimates include judgments regarding future expected loss experience and
risk characteristics. Fair values for impaired loans are estimated using
discounted cash flow analysis or underlying collateral values, where applicable.
ACCRUED INTEREST RECEIVABLE: The carrying amount of accrued interest
receivable approximates fair value.
DEPOSITS: The fair values disclosed for demand deposits are, by
definition, equal to the amount payable on demand at the reporting date (that
is, their carrying amounts). Fair values for time deposits are estimated using a
discounted cash flow calculation that applies interest rates currently offered
on certificates to a schedule of aggregated expected monthly maturities on time
deposits. The carrying amount of accrued interest payable approximates fair
value.
ADVANCE PAYMENTS BY BORROWERS FOR TAXES AND INSURANCE (ESCROW
ACCOUNTS): The carrying amount of escrow accounts approximate fair value.
F-14
<PAGE> 109
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
LOAN COMMITMENTS: Commitments to extend credit were evaluated and fair
value was estimated using the fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
present creditworthiness of the counterparties. For fixed-rate loan commitments,
fair value also considers the difference between current levels of interest
rates and the committed rates. The carrying value and fair value of commitments
to extend credit are not considered material for disclosure.
NOTE 2. DEBT AND EQUITY SECURITIES
The amortized costs and approximate fair values of debt and equity
securities are summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
JUNE 30, 1999:
Debt securities available for
sale:
U.S. Government and agency
obligations.................. $749,286 $ -- $(4,167) $745,119
======== ====== ======= ========
</TABLE>
There were no sales of securities during the year ended June 30, 1999.
The amortized cost and estimated market value of debt securities at June
30, 1999, by contractual maturity, are shown below.
<TABLE>
<CAPTION>
AVAILABLE FOR SALE
-----------------------
AMORTIZED ESTIMATED
COST FAIR VALUE
--------- ----------
<S> <C> <C>
Due from one to five years................................ $549,286 $545,119
Due from five to ten years................................ 200,000 200,000
-------- --------
Total................................................... $749,286 $745,119
======== ========
</TABLE>
F-15
<PAGE> 110
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. LOANS RECEIVABLE
Loans receivable at June 30, 1999, consist of the following:
<TABLE>
<S> <C>
Commercial.................................................. $1,843,707
Real Estate................................................. 1,658,261
Consumer.................................................... 1,435,784
----------
Total loans receivable.................................... $4,937,752
Less:
Allowance for loan losses................................. (56,250)
----------
Loans receivable, net..................................... $4,881,502
==========
</TABLE>
A summary of the activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
JUNE 30, 1999
-------------
<S> <C>
Balance, beginning of period................................ $ -0-
Provision for losses........................................ 56,250
-------
Balance, end of period...................................... $56,250
=======
</TABLE>
In the ordinary course of business, the Bank has granted loans to certain
executive officers, directors and their related interests. Related party loans
are made on substantially the same terms as those prevailing at the time for
comparable transactions with unrelated persons and do not involve more than the
normal risk of collectibility. Loan activity in these accounts for the year
ended June 30, 1999, is as follows:
<TABLE>
<S> <C>
Beginning balance........................................... $ -0-
New loans................................................... 1,569,076
Less: Repayments............................................ (321,940)
----------
Ending balance.............................................. $1,247,136
==========
</TABLE>
NOTE 4. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable at June 30, 1999, is summarized as follows:
<TABLE>
<S> <C>
Investment securities....................................... $12,191
Loans receivable............................................ 47,336
-------
Total..................................................... $59,527
=======
</TABLE>
F-16
<PAGE> 111
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5. PREMISES AND EQUIPMENT
Premises and equipment at June 30, 1999, consists of the following:
<TABLE>
<S> <C>
Leasehold improvements...................................... $200,035
Furniture and equipment..................................... 309,382
--------
Total..................................................... 509,417
Less accumulated depreciation............................... (22,732)
--------
Premises and equipment, net............................... $486,685
========
</TABLE>
NOTE 6. DEPOSITS
The aggregate amount of certificates of deposit with a minimum denomination
of $100,000 was approximately $400,000 at June 30, 1999. Deposited amounts in
excess of $100,000 per account holder are not insured by the Federal Deposit
Insurance Company.
At June 30, 1999, the scheduled maturities of time deposits are as follows:
<TABLE>
<S> <C>
2000........................................................ $1,449,748
2001........................................................ 348,837
----------
Total..................................................... $1,798,585
==========
</TABLE>
Deposits by related parties were approximately $658,000 at June 30, 1999.
NOTE 7. INCOME TAXES
The following are the components of income tax expense as provided:
<TABLE>
<CAPTION>
FOR THE
FOR THE PERIOD FROM
YEAR ENDED INCEPTION TO
JUNE 30, 1999 JUNE 30, 1998
------------- -------------
<S> <C> <C>
Current income tax provision......................... $ -- $ --
Deferred income tax benefit.......................... -- --
------ ------
$ -- $ --
====== ======
</TABLE>
F-17
<PAGE> 112
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation of income taxes computed at the federal statutory income
tax rate to total income taxes is as follows:
<TABLE>
<CAPTION>
FOR THE
FOR THE PERIOD FROM
YEAR ENDED INCEPTION TO
JUNE 30, 1999 JUNE 30, 1998
------------- -------------
<S> <C> <C>
Pretax loss.......................................... $(493,672) $(3,959)
--------- -------
Income tax (benefit) computed at federal statutory
tax rate........................................... $(167,848) $(1,346)
Increase (decrease) resulting from:
Nondeductible expenses............................. 718 --
State income tax benefit, net of federal tax
benefit......................................... (28,751) (238)
Valuation allowance................................ 195,881 1,584
--------- -------
$ -- $ --
========= =======
</TABLE>
Temporary differences between financial statement carrying amounts and the
tax basis of assets and liabilities that create deferred tax assets and
liabilities are as follows:
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1999 1998
--------- --------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward........................... $ 131,400 $ 1,584
Deferred organization expenses............................ 48,450 --
Allowance for loan losses................................. 22,500 --
Securities unrealized losses.............................. 1,667 --
Less valuation allowance.................................. (197,465) (1,584)
--------- -------
Subtotal.................................................. 6,552 --
--------- -------
Deferred tax liabilities:
Depreciation and basis adjustment......................... 4,885 --
--------- -------
Subtotal.................................................. 4,885 --
--------- -------
Net deferred tax assets................................. $ 1,667 $ --
========= =======
</TABLE>
At June 30, 1999, the Company had cumulative net operating loss
carryforward for tax purposes of approximately $320,000 subject to a 20 year
limitation.
NOTE 8. STOCK OPTIONS
In August 1998, the Company adopted the 1998 Equity Incentive Plan (the
"Plan") and reserved 41,700 shares of common stock for issuance pursuant to the
Plan to certain employees and directors of the Company and its subsidiary. In
addition, the Company granted to its organizing
F-18
<PAGE> 113
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
directors options to purchase an aggregate 30,800 shares outside the Plan. These
plans provide for the granting of incentive stock options as defined in Section
422 of the Internal Revenue Code as well as nonincentive stock options
(collectively stock options). The options vest over a period ranging from
immediate (36,800 shares) to 3 years (18,000 shares) and must be exercised
within 10 years of the grant date.
A summary of the status of the stock options as of and for the year ended
June 30, 1999 is presented below:
<TABLE>
<CAPTION>
WEIGHTED AVG.
SHARES EXERCISE PRICE
------ --------------
<S> <C> <C>
Granted.................................................. 54,800 $10.00
Outstanding.............................................. 54,800 $10.00
Exercisable.............................................. 36,800 $10.00
</TABLE>
The weighted average fair value of the options granted is $4.33 per share
and the weighted average remaining contractual life of options outstanding is
9.7 years.
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), provides for companies to recognize
compensation expense associated with stock-based compensation plans over the
anticipated service period based on the fair value of the award on the date of
grant. However, SFAS 123 allows companies to continue to measure compensation
costs prescribed by Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25").
The Company elected to follow APB 25 and related interpretations in
accounting for its employee stock options. Under APB 25, the exercise price of
the Company's employee stock options equal the market price of the underlying
stock on the date of grant and, therefore, no compensation expense is
recognized. Performance information regarding net income and earnings per share
is required by SFAS No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
statement. Pro forma net income/(loss) and earnings/(loss) per share for fiscal
1999 follows:
<TABLE>
<CAPTION>
LOSS PER
NET LOSS COMMON SHARE
--------- ------------
<S> <C> <C>
As reported........................................... $(493,672) $(1.60)
Pro forma............................................. $(661,584) $(2.15)
</TABLE>
The above disclosed pro forma effects of applying SFAS No. 123 to
compensation costs may not be representative of the effects on reported pro
forma net income for future years.
F-19
<PAGE> 114
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The fair value for each option grant is estimated on the date of the grant
using the Black Scholes Model. The model incorporates the following assumptions:
<TABLE>
<S> <C>
Risk-free interest rate..................................... 5.129%
Expected life............................................... 5 Yrs.
Expected volatility......................................... 26.00%
Expected dividends.......................................... None
</TABLE>
NOTE 9. COMMITMENTS
At June 30, 1999, the Bank was obligated under operating leases for office
space and equipment. Net rental expense under these operating leases, included
in occupancy and other, was $33,945 for the year ended June 30, 1999. The office
space is leased from a lessor entity in which a Company board member has a
significant interest. Minimum lease payments under the operating leases are as
follows:
<TABLE>
<CAPTION>
FOR THE YEAR OFFICE EQUIPMENT
ENDED LEASE LEASE
- ------------ -------- ---------
<S> <C> <C>
2000...................................................... $ 77,907 $ 4,044
2001...................................................... 77,907 4,044
2002...................................................... 78,560 2,022
2003...................................................... 79,212 --
2004...................................................... 79,212 --
2005 and thereafter....................................... 365,526 --
-------- -------
Total................................................... $758,324 $10,110
======== =======
</TABLE>
The Bank has an option to renew the office lease for two additional five
year terms.
NOTE 10. STOCK WARRANTS
On October 9, 1998, the Company entered into an agency agreement for
services to sell the Company's common stock. The Agent was compensated, in part,
with warrants to acquire 10,000 shares of the Company's stock at $12.00 per
share at any time prior to October 9, 2003.
NOTE 11. FINANCIAL INSTRUMENTS
The Bank is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments are commitments to extend credit and involve, to
varying degrees, elements of credit risk in excess of the amount recognized in
the balance sheet. The Bank's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for commitments to
extend credit is represented by the contractual amount of those instruments. The
Bank uses the same credit policies in making commitments as it does for
on-balance sheet instruments.
F-20
<PAGE> 115
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. Commitments to extend credit represent credit
risk totaling $961,207 for unused lines of credit at June 30, 1999.
Commitments to sell loans amounted to $681,593 at June 30, 1999.
The estimated fair values of the Company's financial instruments are as
follows:
<TABLE>
<CAPTION>
JUNE 30, 1999
------------------------
CARRYING FAIR
AMOUNT VALUE
---------- ----------
<S> <C> <C>
Financial assets:
Cash and cash equivalents............................ $2,816,398 $2,816,398
Investment securities................................ 745,199 745,119
FHLB stock........................................... 16,400 16,400
Loans receivable..................................... 4,790,752 4,790,752
Loans held for sale.................................. 681,593 681,593
Accrued interest receivable.......................... 59,527 59,527
Financial liabilities:
Deposits............................................. $6,164,570 $6,164,570
Advance payments by borrowers........................ 23,941 23,941
</TABLE>
The market rates on loans and deposits at June 30, 1999 did not change
materially from their contractual rates resulting in fair value being equal to
the carrying amount.
NOTE 12. SIGNIFICANT CONCENTRATION OF CREDIT RISK
A significant portion of the Bank's loans receivable are to borrowers
located in Mankato, Minnesota and the surrounding counties. This geographic
concentration amounted to approximately 70% of the total loans receivable
balance for the year ended June 30, 1999.
The Bank maintains its cash in bank deposit accounts which at times, may
exceed federal deposit insurance limits. The Bank has not experienced any losses
in such accounts and believes it is not exposed to any significant credit risk
on cash.
NOTE 13. STOCKHOLDERS' EQUITY AND REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements administered
by the Federal Deposit Insurance Corporation (FDIC). Failure to meet minimum
capital requirements can initiate certain mandatory and possible additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities and certain off-balance sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
F-21
<PAGE> 116
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
classification are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
following table below) of total and Tier 1 capital (as defined in the
regulation), to risk-weighted assets (as defined), and of Tier 1 capital (as
defined) to average assets (as defined). Management believes, as of June 30,
1999, that the Bank meets all of capital adequacy requirements to which it is
subject.
As of June 30, 1999, the most recent notification from the FDIC categorized
the Bank as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized the Bank must maintain
minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set
forth in the table. There are no conditions or events since that notification
that management believes have changed the Bank's category.
The Bank's actual capital amounts and ratios are also presented in the
table below (in thousands):
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED
FOR CAPITAL UNDER PROMPT
ADEQUACY CORRECTIVE
ACTUAL PURPOSES ACTION PROVISION
---------------- ---------------- ----------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------ ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
As of June 30, 1999:
Total Capital
(to Risk Weighted Assets)....... $2,785 44.2% $504 8.0% $630 10.0%
Tier 1 Capital
(to Risk Weighted Assets)....... $2,729 43.3% $252 4.0% $378 6.0%
Tier 1 Capital
(to Average Assets)............. $2,729 36.5% $299 4.0% $374 5.0%
</TABLE>
The Bank may not declare or pay cash dividends to the Company if the effect
would be to reduce capital below applicable regulatory requirements or if such
declaration and payment would otherwise violate regulatory requirements.
NOTE 14. EFFECTS OF NEW FINANCIAL ACCOUNTING STANDARDS
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" -- Issued June 1998, establishes accounting and reporting standards
for derivative instruments, including certain derivative instruments embedded in
other contracts, (collectively referred to as derivatives) 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. This statement is effective for the fiscal year
beginning July 1, 2000, and management believes adoption will not have a
material effect.
F-22
<PAGE> 117
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 15. PARENT ONLY CONDENSED FINANCIAL INFORMATION
This information should be read in conjunction with the other Notes to
Consolidated Financial Statements. On January 25 1999, the Company issued $4.3
million of common stock and contributed $3,000,500 of the net proceeds to the
Bank as equity capital.
STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1999 1998
---------- --------
<S> <C> <C>
ASSETS
Cash(1)..................................................... $ 704,700 $ --
Investment in Bank subsidiary............................... 2,726,471 --
Prepaid assets.............................................. -- 5,580
Deferred organizational costs............................... -- 9,226
---------- -------
Total..................................................... $3,431,171 $14,806
========== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Other liabilities........................................... $ 7,469 $18,665
Shareholder's equity........................................ 3,423,702 (3,859)
---------- -------
Total..................................................... $3,431,171 $14,806
========== =======
</TABLE>
- -------------------------
(1) The parent company cash is deposited in the Bank and eliminated on the
consolidated statements of financial condition.
F-23
<PAGE> 118
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
JUNE 30, 1999 JUNE 30, 1998
------------- -------------
<S> <C> <C>
Interest from:
Deposits in subsidiary...................................... $ 7,565 $ --
Nonaffiliated bank.......................................... 5,191 --
--------- -------
Total income.............................................. $ 12,756 --
Expenses:
Non-interest expenses....................................... 234,899 3,959
Income tax (refund) expense................................. -- --
--------- -------
Total expenses............................................ 234,899 3,959
--------- -------
Loss before equity in undistributed net loss of Bank
subsidiary................................................ (222,143) (3,959)
Equity reduction from undistributed net comprehensive loss
of Bank subsidiary........................................ (274,029) --
--------- -------
Net comprehensive loss...................................... $(496,172) $(3,959)
========= =======
</TABLE>
F-24
<PAGE> 119
NORTHERN STAR FINANCIAL, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE FOR THE
YEAR ENDED YEAR ENDED
JUNE 30, JUNE 30,
1999 1998
----------- ----------
<S> <C> <C>
Net loss.................................................... $ (222,143) $(3,959)
Adjustments:
Decrease (increase) in other assets....................... 5,580 (5,580)
Increase in other liabilities............................. 7,469 --
----------- -------
Net cash used in operations................................. (209,094) (9,539)
----------- -------
Cash flows from investing activities:
Investment in Bank subsidiary............................. (3,000,500) --
Deferred organizational costs............................. -- (9,226)
----------- -------
Net cash (used in) investing activities..................... (3,000,500) (9,226)
----------- -------
Cash flows from financing activities:
Proceeds from sale of common stock........................ 4,256,000 100
Payments for stock issuance costs......................... (332,267) --
Decrease in prepaid organizational costs.................. 9,226 --
(Refunds to) Advances from organizers..................... (18,665) 18,665
----------- -------
Net cash provided by financing activities................... 3,914,294 18,765
----------- -------
Increase in cash and cash equivalents....................... 704,700 --
Cash and cash equivalents
Beginning of year......................................... -- --
----------- -------
End of year............................................... $ 704,700 $
=========== =======
</TABLE>
F-25
<PAGE> 120
INDEPENDENT AUDITORS' REPORT
Board of Directors
First Federal Holding Company of Morris, Inc.
Morris, Minnesota
We have audited the accompanying consolidated balance sheets of First
Federal Holding Company of Morris, Inc. and subsidiaries as of September 30,
1999 and 1998, and the related consolidated statements of income, changes in
stockholders' equity and cash flows for the years then ended. These consolidated
financial statements are the responsibility of management. Our responsibility is
to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of First Federal Holding
Company of Morris, Inc. and subsidiaries as of September 30, 1999 and 1998, and
the consolidated results of their operations and their cash flows for the years
then ended in conformity with generally accepted accounting principles.
MICHAEL L. ANDERSON & ASSOCIATES, PLLC
Alexandria, Minnesota
October 21, 1999
F-26
<PAGE> 121
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30,
DECEMBER 31, --------------------------
1999 1999 1998
------------ ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and Due from Banks..................................... $ 4,296,544 $ 2,180,409 $ 6,382,462
Available-for-Sale Securities, at fair value -- Note 2...... 4,156,323 4,501,331 6,048,086
Held-to-Maturity Securities -- Note 2....................... 722,340 23,340 103,792
Federal Home Loan Bank Stock, at cost....................... 211,200 211,200 182,500
Loans Held for Sale......................................... 1,568,300 1,516,300 2,336,700
Loans Receivable -- Note 3
(net of allowance for loan losses of $525,329, $527,398
and $474,332).......................................... 45,943,346 45,163,267 40,421,225
Accrued Interest Receivable -- Note 4....................... 730,834 1,036,395 900,497
Loan Servicing Rights -- Note 5............................. 151,864 153,181 129,093
Foreclosed Real Estate -- Note 6............................ -0- -0- 31,600
Premises and Equipment -- Note 7............................ 1,106,907 752,042 578,183
Cash Surrender Value of Life Insurance...................... 1,723,619 1,702,705 -0-
Cost in Excess of Book Value -- Note 8...................... 100,619 102,740 111,224
Income Tax Refunds Receivable............................... 44,014 96,324 -0-
Prepaid Expenses and Other Assets........................... 303,909 127,247 138,409
----------- ----------- -----------
Total Assets.............................................. $61,059,819 $57,566,481 $57,363,771
=========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits -- Note 9........................................ $52,528,200 $48,484,169 $49,928,293
Advances from Federal Home Loan Bank -- Note 10........... 2,293,421 2,597,551 1,247,154
Note Payable -- First National Bank in Winnebago -- Note
11..................................................... 637,038 638,179 698,057
Notes Payable -- Shareholders -- Note 11.................. 364,300 364,300 364,300
Notes Payable LOC to NSF................................. 95,700 -0- -0-
Accrued Interest Payable on Notes......................... 24,365 32,209 -0-
Advance Payments by Borrowers for Taxes and Insurance..... 140,637 51,740 206,418
Current Income Taxes Payable.............................. 962 910 198,692
Deferred Income Taxes Payable -- Note 12.................. 77,444 88,128 105,342
Accrued Salary Continuation Payable....................... 39,463 29,597 -0-
Accrued Expenses and Other Liabilities.................... 583,461 976,476 838,747
----------- ----------- -----------
Total Liabilities......................................... 56,784,991 53,263,259 53,587,003
Minority Interest........................................... 600,596 637,004 456,589
Stockholders' Equity:
Common Stock -- $100 par value, 5,000 shares authorized,
1,042 shares issued, 1,017 shares outstanding.......... 104,200 104,200 104,200
Additional Paid in Capital................................ 288,337 288,337 288,337
Retained Earnings......................................... 3,441,469 3,420,651 3,051,801
Accumulated Other Comprehensive Income (Loss)............. (27,774) (14,970) 7,841
Treasury Stock (25 shares)................................ (132,000) (132,000) (132,000)
----------- ----------- -----------
Total Stockholders' Equity............................. 3,674,232 3,666,218 3,320,179
----------- ----------- -----------
Total Liabilities and Stockholders' Equity........... $61,059,819 $57,566,481 $57,363,771
=========== =========== ===========
</TABLE>
The accompanying Notes to Financial Statements are an integral part of these
statements.
F-27
<PAGE> 122
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31, SEPTEMBER 30,
------------------------ ------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Interest Income:
Loans.................................................. $ 996,390 $ 998,119 $3,935,512 $3,843,465
Investment Securities.................................. 31,379 30,850 113,513 77,288
Mortgage-Backed Securities............................. 38,562 69,410 218,808 313,521
Interest-Bearing Deposits.............................. 13,979 39,329 69,584 187,924
---------- ---------- ---------- ----------
Total Interest Income................................ 1,080,310 1,137,708 4,337,417 4,422,198
Interest Expense:
Demand Deposits........................................ 26,697 30,829 115,468 121,692
Savings Deposits....................................... 23,177 21,712 81,669 87,752
Certificate of Deposits................................ 449,435 467,021 1,750,093 1,857,726
Advances from FHLB..................................... 31,894 22,994 151,647 94,927
Notes Payable.......................................... 28,244 25,743 104,093 98,470
---------- ---------- ---------- ----------
Total Interest Expense............................... 559,447 568,299 2,202,970 2,260,567
---------- ---------- ---------- ----------
Net Interest Income...................................... 520,863 569,409 2,134,447 2,161,631
Provision for Loan Losses -- Note 3...................... -- (2,000) (2,000) (12,000)
---------- ---------- ---------- ----------
Net Interest Income After Provision for Loan Losses.... 520,863 567,409 2,132,447 2,149,631
Non-Interest Income:
Other Fees and Service Charges......................... 119,975 83,878 311,390 283,722
Loan Servicing Fees, net of amortization............... 6,068 4,427 27,945 21,443
Gain on Sale of Loans.................................. 16,473 32,190 94,909 152,463
Gain (Loss) on Sale of ORE and Other Assets............ 1,134 (2,642) (2,642) 1,959
Increase in Cash Surrender Value of Life Insurance..... 20,914 -- 62,705 -0-
Other Income........................................... 16,782 12,899 41,876 53,788
---------- ---------- ---------- ----------
Total Non-Interest Income............................ 181,346 130,752 536,183 513,375
Non-Interest Expense:
Compensation, Benefits, and Payroll Taxes.............. 325,171 247,984 1,069,230 967,547
Directors Fees......................................... 42,300 31,400 134,000 124,500
Occupancy.............................................. 63,849 20,042 217,572 183,150
Advertising............................................ 19,207 6,447 28,943 34,147
FDIC and OTS Assessments............................... 8,424 12,200 55,287 52,497
Legal and Professional Services........................ 37,838 11,629 86,914 35,805
Office Supplies........................................ 21,140 20,737 94,606 77,091
Postage................................................ 9,563 8,344 42,603 41,088
Telephone.............................................. 10,898 8,669 46,498 40,479
Other General and Administrative....................... 169,161 85,992 302,408 214,619
---------- ---------- ---------- ----------
Total Non-Interest Expense........................... 707,551 453,444 2,078,061 1,770,923
---------- ---------- ---------- ----------
Net Income (Loss) Before Income Taxes and Minority
Interest............................................... (5,342) 244,717 590,569 892,083
Income Tax Expense -- Note 12.......................... 8,871 108,664 220,294 300,840
---------- ---------- ---------- ----------
Net Income (Loss) Before Minority Interest............... (14,213) 136,053 370,275 591,243
Minority Interest........................................ (35,031) 11,911 1,425 54,666
---------- ---------- ---------- ----------
NET INCOME............................................... $ 20,818 124,142 $ 368,850 $ 536,577
========== ========== ========== ==========
Basic Earnings Per Share................................. 20.47 122.07 $ 362.68 $ 522.98
========== ========== ========== ==========
</TABLE>
The accompanying Notes to Financial Statements are an integral part of these
statements.
F-28
<PAGE> 123
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 1999 AND 1998
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY STOCKHOLDERS' COMPREHENSIVE
STOCK CAPITAL EARNINGS INCOME STOCK EQUITY INCOME
-------- ---------- ---------- ------------- --------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
September 30, 1997...... $104,200 $288,337 $2,515,224 $ 37,470 $ -0- $2,945,231
Net Income............ 536,577 536,577 $536,577
Unrealized loss on
available-for-sale
securities, net of
deferred income
taxes of $20,140.... (29,629) (29,629) (29,629)
Purchase of Treasury
Stock (25 shares)... (132,000) (132,000)
-------- -------- ---------- -------- --------- ---------- --------
September 30, 1998...... 104,200 288,337 3,051,801 7,841 (132,000) 3,320,179 $509,948
========
Net Income............ 368,850 368,850 $368,850
Unrealized loss on
available-for-sale
securities, net of
deferred income
taxes of $15,505.... (22,811) (22,811) (22,811)
-------- -------- ---------- -------- --------- ---------- --------
September 30, 1999...... $104,200 $288,337 $3,420,651 $(14,970) $(132,000) $3,666,218 $346,039
======== ======== ========== ======== ========= ========== ========
</TABLE>
The accompanying Notes to Financial Statements are an integral part of these
statements.
F-29
<PAGE> 124
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31, SEPTEMBER 30,
------------------------- -------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Cash Flows from Operating Activities:
Net Income................................... $ 20,818 $ 124,142 $ 368,850 $ 536,577
Adjustments to Reconcile Net Income to
Net Cash Provided by Operating Activities:
Depreciation............................... 45,297 9,171 51,719 29,995
Amortization of Cost in Excess of Book
Value................................... 2,121 2,121 8,484 8,484
Amortization of Servicing Rights........... 3,733 8,769 25,259 25,832
Premium Amortization -- Investment
Securities.............................. 192 3,342 8,062 1,551
Discount Accretion -- Investment
Securities.............................. (642) (451) (3,871) (4,048)
Amortization of Deferred Loan Costs
(Fees).................................. 11,424 (9,088) 9,367 26,309
Accretion of Deferred Gain on Sale of
Loans................................... -0- -0- (5,971) (4,798)
Provision for Loan Losses.................. -0- 2,000 2,000 12,000
Gain on Sale of Loans...................... (16,473) (32,190) (94,909) (152,463)
(Gain) Loss on Sale of ORE and Other
Assets.................................. (1,134) 2,642 2,642 (1,959)
Loss from Wildwoods Apartments Limited
Partnership............................. -0- -0- 1,372 1,179
Net Minority Interest Share of Earnings and
Dividends............................... (35,031) 11,911 (13,133) 40,108
(Increase) Decrease in Loans Held for
Sale.................................... (52,000) 833,100 820,400 (1,530,475)
(Increase) Decrease in Accrued Interest
Receivable.............................. 305,561 202,779 (135,898) 92
(Increase) in Cash Surrender Value of Life
Insurance............................... (20,914) -0- (62,705) -0-
(Increase) Decrease in Prepaid Expenses and
Accounts Receivable..................... (176,662) 47,208 9,656 (39,181)
Increase (Decrease) in Accrued Interest
Payable................................. (94,507) (77,139) (5,054) 75,131
Increase (Decrease) in Current Income Taxes
Payable................................. 52,362 (61,472) (294,106) 271,137
Deferred Tax Expense (Benefit)............. (194) (32,961) (42) (123,974)
Increase in Accrued Salary Continuation
Payable................................. 9,866 -0- 29,597 -0-
Increase (Decrease) in Accrued Expenses and
Other Liabilities....................... (393,015) 249,716 137,729 221,157
----------- ----------- ----------- -----------
Net Cash Provided (Used) by Operating
Activities............................ (339,198) 1,283,600 859,448 (607,346)
Cash Flows from Investing Activities:
Proceeds from Certificates of Deposits
Maturing................................... -0- -0- 30,000 372,000
Purchase of Certificates of Deposit.......... (699,000) -0- (20,000) (30,000)
Proceeds from State and Political
Subdivisions Maturing...................... -0- 70,000 70,000 330,000
Purchase of State and Political
Subdivisions............................... (29,944) -0- -0- -0-
Principal Received from Benson Industrial
Development Bond........................... -0- -0- 452 427
Proceeds from Corporate Debt Securities
Maturing................................... 150,000 -0- 770,000 -0-
Purchase of Corporate Debt Securities........ -0- -0- -0- (1,325,552)
Proceeds from U.S. Government Agencies
Maturing................................... -0- -0- -0- 1,000,000
Purchase of U.S. Government Agencies......... -0- (1,000,000) (1,497,647) -0-
</TABLE>
F-30
<PAGE> 125
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31, SEPTEMBER 30,
------------------------- -------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Principal Received on Mortgage-Backed
Securities................................. 200,731 805,174 2,227,776 1,543,578
Purchase of Mortgage-Backed Securities....... -0- -0- -0- (1,050,560)
Proceeds from FHLB stock..................... -0- -0- -0- 225,700
Purchase of FHLB stock....................... -0- -0- (28,700) -0-
Net (Increase) Decrease in Loans
Receivable................................. (777,446) (2,379,533) (4,674,676) 1,159,001
Proceeds from Sale of ORE and Other Assets... 1,795 1,758 1,758 3,100
Premises and Equipment Acquired.............. (400,823) (19,112) (225,578) (129,765)
Investment in Life Insurance................. -0- (1,810,000) (1,810,000) -0-
Refund of Life Insurance..................... -0- -0- 170,000 -0-
Distribution from Wildwoods Apartments
Limited Partnership........................ -0- -0- 134 -0-
----------- ----------- ----------- -----------
Net Cash Provided (Used) by Investing
Activities............................ (1,554,687) (4,331,713) (4,986,481) 2,097,929
Cash Flows from Financing Activities:
Net Increase (Decrease) in Demand and Savings
Deposits................................... $ 921,067 $ 95,375 $ (960,401) $ 1,119,634
Net Increase (Decrease) in Certificates of
Deposit.................................... 3,209,627 1,274,752 (446,460) 275,533
Net Advances by Borrowers for Taxes and
Insurance.................................. 88,897 (60,486) (154,678) 10,244
Advances from Federal Home Loan Bank......... 500,000 -0- 2,300,000 -0-
Principal Payments made to Federal Home Loan
Bank....................................... (804,130) (14,762) (949,603) (74,303)
Principal Payments on Note Payable........... (1,141) -0- (59,878) (173,523)
Proceeds from Shareholder Debt............... -0- -0- 204,000 132,000
Principal Payments on Shareholder Debt....... -0- -0- (204,000) -0-
Proceeds from Line of Credit................. 95,700 -0- -0- -0-
Minority Investment in Homeland Mortgage,
LLC........................................ -0- -0- 196,000 -0-
Purchase of Treasury Stock................... -0- -0- -0- (132,000)
----------- ----------- ----------- -----------
Net Cash Provided (Used) by Financing
Activities.............................. 4,010,020 1,294,879 (75,020) 1,157,585
----------- ----------- ----------- -----------
Net Increase (Decrease) in Cash and Due from
Banks........................................ 2,116,135 (1,753,234) (4,202,053) 2,648,168
Cash and Due from Banks, Beginning of Year..... 2,180,409 6,382,462 6,382,462 3,734,294
----------- ----------- ----------- -----------
Cash and Due from Banks, Ending Balance........ $ 4,296,544 $ 4,629,228 $ 2,180,409 $ 6,382,462
=========== =========== =========== ===========
Supplemental Disclosure of Cash Flow
Information:
Cash Paid for Interest....................... $ 653,954 $ 645,438 $ 2,208,024 $ 2,185,436
Cash Paid for Income Taxes................... $ 910 198,692 $ 514,442 $ 169,429
Significant Noncash Transactions:
Loan servicing rights valued as an asset to
be amortized over the expected repayment
term on the loans that increased the gains
on sale of loans........................... $ 2,416 $ 10,829 $ 49,347 $ 104,478
ORE repossessed.............................. -0- -0- -0- 31,600
ORE sold on contract for deed................ -0- 27,200 27,200 -0-
Trade old copy machine for new copy
machine.................................... -0- -0- -0- 2,883
</TABLE>
The accompanying Notes to Financial Statements are an integral part of these
statements.
F-31
<PAGE> 126
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO QUARTERLY FINANCIAL STATEMENTS
AS OF AND FOR THE QUARTER ENDED DECEMBER 31, 1999 (UNAUDITED)
NOTE 1: PRINCIPLES OF CONSOLIDATION
The unaudited consolidated financial statements as of and for the three
month period ended December 31, 1999, include the accounts of First Federal
Holding Company of Morris, Inc. (the "Company") and its majority owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated in consolidation.
NOTE 2: BASIS OF PRESENTATION
GENERAL: The accompanying unaudited interim consolidated financial
statements have been prepared in accordance with generally accepted accounting
principles for interim financial information. Accordingly, they do not include
all information and disclosures required by generally accepted accounting
principles for complete financial statements. The accompanying consolidated
financial statements do not purport to contain all the necessary financial
disclosures required by generally accepted accounting principles that might
otherwise be necessary in the circumstances and should be read with the fiscal
1999 consolidated financial statements and notes of First Federal Holding
Company, Inc. and its subsidiaries included in our annual report for the year
ended September 30, 1999.
In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for fair presentations have been
included. The results of operations for the three month period ended December
31, 1999, are not necessarily indicative of the results that may be expected for
the entire fiscal year or any other period.
NOTE 3: COMPREHENSIVE INCOME
<TABLE>
<S> <C>
Accumulated comprehensive income (loss) is comprised of the following:
Unrealized loss on available-for-sale securities:
Beginning balance -- September 30, 1999..................... $(14,970)
Current -- period change.................................... (12,804)
--------
Ending balance -- December 31, 1999......................... $(27,774)
========
Comprehensive income (loss) for the three months
Ended December 31, 1999:
Net income................................................ $ 20,818
Other comprehensive loss.................................. (12,804)
--------
Comprehensive income...................................... $ 8,014
========
</TABLE>
NOTE 4: EARNINGS PER SHARE
The earnings per share amounts were computed using the weighted average
number of shares outstanding during the period presented. For the three month
periods ended December 31, 1999 and 1998, the weighted average number of shares
outstanding for basic and diluted earnings per share computation were 1,017.
F-32
<PAGE> 127
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO QUARTERLY FINANCIAL STATEMENTS
AS OF AND FOR THE QUARTER ENDED
DECEMBER 31, 1999 (UNAUDITED) -- (CONTINUED)
NOTE 5: BUSINESS COMBINATION INITIATED
On September 30, 1999, the Company and Northern Star Financial, Inc.
("Northern") entered into an Agreement and Plan of Reorganization for the merger
of the Company with and into Northern. Under terms of the Agreement, the
Company's shareholders will exchange their common stock for approximately
870,559 shares of Northern's common stock, subject to certain adjustments as
specified in the Agreement. Completion of the merger is subject to regulatory
approvals and approval by the shareholders of both companies. The transaction
will be accounted for using the pooling of interest method of accounting.
Northern is a bank holding company and through its subsidiary, Northern
Star Bank, provides various financial services including mortgage, commercial,
and consumer lending and various deposits and savings plans. Northern Star Bank
is located in Mankato, Minnesota.
F-33
<PAGE> 128
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999 AND 1998
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
First Federal Holding Company of Morris, Inc. (the "Company") is a savings
and loan holding company that was incorporated on December 16, 1991. The Company
owns 90.2945684% of the common stock of First Federal Savings Bank (the "Bank").
The Bank provides various financial services to Morris, Benson and
Breckenridge, Minnesota and the surrounding areas, including mortgage,
commercial and consumer lending, and various deposit and savings plans. The Bank
is subject to regulation by the Office of Thrift Supervision. All accounts are
insured by the Federal Deposit Insurance Corporation (FDIC) through the Savings
Association Insurance Fund (SAIF).
West Central Investments, Inc. was incorporated in July of 1986 and is
wholly owned by the Bank. West Central Investments, Inc. provides investment and
brokerage services.
On July 16, 1999, the Bank formed a new mortgage servicing company:
Homeland Mortgage, LLC (the "LLC"). The Bank contributed assets of $204,000,
including most of the fixed assets and loans receivable of West Central Service
Corp. (a wholly-owned subsidiary of the Company), to obtain a 51% ownership.
Northern Star Financial, Inc., a Minnesota bank holding company, owns the
remaining 49%. The LLC currently has offices in Morris and Edina, Minnesota.
Homeland Mortgage, LLC has elected to be taxed as a partnership, with the income
or loss passing through to the members. Therefore, no provision for income taxes
has been established.
The consolidated organization chart is as follows:
<TABLE>
<S> <C> <C>
First Federal Holding Company of Morris, Inc.
First Federal Savings Bank West Central Service Corp.
90.2945684% 100%
West Central Investments Homeland Mortgage, LLC
100% 51%
</TABLE>
The accounting and reporting policies of the Company and its subsidiaries
conform to generally accepted accounting principles and to general practices of
the savings and loan industry. The Corporations maintain their accounts using
the accrual basis of accounting. Under the accrual basis of accounting, revenues
are recognized when earned and expenses are recognized when incurred. All
material intercompany accounts and transactions have been eliminated in the
consolidation.
On September 30, 1999 the Company and Northern Star Financial, Inc.
("Northern") entered into an Agreement and Plan of Reorganization for the merger
of the Company with and into Northern. Under terms of the Agreement, the
Company's shareholders will exchange their common stock for approximately
870,559 shares of Northern's common stock, subject to certain adjustments as
specified in the Agreement. Completion of the merger is subject to regulatory
approvals and approval
F-34
<PAGE> 129
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
by the shareholders of both companies. The transaction will be accounted for
using the pooling of interest method of accounting.
Northern is a bank holding company and through its subsidiary, Northern
Star Bank, provides various financial services including mortgage, commercial,
and consumer lending and various deposits and savings plans. Northern Star Bank
is located in Mankato, Minnesota.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for losses on loans and the
valuation of real estate acquired in connection with foreclosures or in
satisfaction of loans. In connection with determination of the allowances for
losses on loans and foreclosed real estate, management obtains independent
appraisals for significant properties.
While management uses available information to recognize losses on loans
and foreclosed real estate, future additions to the allowances may be necessary
based on changes in local economic conditions. In addition, regulatory agencies,
as an integral part of their examination process, periodically review the Bank's
allowances for losses on loans and foreclosed real estate. Such agencies may
require the Bank to recognize additions to the allowances based on their
judgments about information available to them at the time of their examination.
Because of these factors, it is reasonably possible that the allowances for
losses on loans and foreclosed real estate may change materially in the near
term.
CASH EQUIVALENTS
The Company considers all cash amounts due from depository institutions,
interest-bearing deposits in other banks, money market accounts, and federal
funds sold to be cash equivalents for purposes of the statements of cash flows.
Cash includes short-term interest-bearing deposits in other depository
institutions of $1,469,694 and $4,822,543 at September 30, 1999 and 1998,
respectively.
INVESTMENT SECURITIES
TRADING SECURITIES: Securities that are held for short-term resale are
classified as trading account securities and recorded at their fair values.
Realized and unrealized gains and losses on trading account securities are
included in other income. There were no securities classified as trading
securities.
SECURITIES HELD-TO-MATURITY: U.S. Treasury Notes, State and Political
Subdivision obligations and other Securities that management has the positive
intent and ability to hold to maturity are reported at cost, adjusted for
amortization of premiums and accretion of discounts that are recognized in
interest income using the interest method over the period to maturity.
F-35
<PAGE> 130
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SECURITIES AVAILABLE-FOR-SALE: Available-for-sale securities consist of
investment securities not classified as trading securities nor as
held-to-maturity securities and mortgage-backed securities. Mortgage-backed
securities represent participating interests in pools of long-term first
mortgage loans originated and serviced by issuers of the securities. Unrealized
holding gains and losses, net of tax, on available-for-sale securities are
reported as a net amount in a separate component of stockholders' equity until
realized. Gains and losses on the sale of available-for-sale securities are
determined using the specific-identification method. The amortization of
premiums and the accretion of discounts are recognized in interest income using
methods approximating the interest method over the period of maturity.
Declines in the fair value of individual held-to-maturity and
available-for-sale securities below their cost that are other than temporary
result in write-downs of the individual securities to their fair value. The
related write-downs are included in earnings as realized losses.
FHLB STOCK
The Bank, as a member of the Federal Home Loan Bank System, is required to
maintain an investment in capital stock of the Federal Home Loan Bank of Des
Moines. Because no ready market exists for this stock, and it has no quoted
market value, the Bank's investment is carried at cost.
LOANS HELD FOR SALE
Mortgage loans originated and intended for sale in the secondary market 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.
LOANS RECEIVABLE
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at their outstanding
principal adjusted by any charge-offs, the allowance for loan losses, and any
deferred fees or costs on originated loans and unamortized premiums or discounts
on purchased loans. Discounts and premiums on purchased real estate loans are
amortized to income using the interest method over the remaining period to
contractual maturity, adjusted for anticipated prepayments. Discounts and
premiums on purchased consumer loans are recognized over the expected lives of
the loans using the level yield method.
Loan origination fees and certain direct origination costs are capitalized
with the net fee or cost recognized as an adjustment to interest income using
the interest method.
The Allowance for Loan Losses is maintained at an amount considered
adequate to provide for potential losses. The allowance is based on periodic
analysis of the loan portfolio and real estate and other property acquired by
Management. In this analysis, Management considers factors including but not
limited to, general economic conditions, loan portfolio composition and
historical experience. The allowance for loan losses is increased by charges to
income and decreased by charge-offs (net of recoveries). Management's periodic
evaluation of the adequacy of the allowance is based on the Bank's past loan
loss experience, known and inherent risks in the portfolio, adverse situations
that may affect the borrower's ability to repay, estimated value of any
underlying collateral, and current economic conditions. Loans are considered
impaired if full principal or interest payments are not
F-36
<PAGE> 131
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
anticipated in accordance with the contractual loan terms. Impaired loans are
carried at the present value of expected future cash flows discounted at the
loan's effective interest rate or at the fair value of the collateral if the
loan is collateral dependent. A portion of the allowance for loan losses is
allocated to impaired loans if the value of such loans is deemed to be less than
the unpaid balance. If these allocations cause the allowance for loan losses to
require an increase, such an increase is reported as a component of the
provision for loan losses. Loans are charged against the allowance when they are
deemed to be uncollectible. Real estate and other property acquired are
charged-down to fair value.
Loans are reviewed regularly by Management and are placed in a non-accrual
status when the loan is 90 days or more past due and/or the collection of
interest or principal is considered unlikely. When a loan is placed on a
non-accrual basis, any uncollected interest accrued in the current year is
charged against current income. Subsequent interest on non-accrual loans is
recognized as income only when collected.
Interest Income is accrued on loan balances outstanding. Loans are reviewed
regularly by Management and are placed on a non-accrual status when the loan is
90 days or more past due, and/or the collection of interest or principal is
considered unlikely. Also, the Bank has started foreclosure or judgment
procedures against some of the non-accrual loans. When the Bank has acquired
control or title to the real estate or other property, it is transferred to real
estate and other property acquired in settlement of loans.
Interest income on loans is recognized on the accrual basis and includes
the accretion and amortization of deferred loan fees and costs as required by
SFAS 91. Deferred loan fees and costs are amortized and accreted using the
effective interest method.
LOAN SERVICING RIGHTS
The cost of loan servicing rights is amortized in proportion to, and over
the period of, estimated net servicing revenues. Impairment of loan servicing
rights is assessed based on the fair value of those rights. Amortization is
computed in proportion to and over the period of estimated net servicing income.
Fair values are estimated using discounted cash flows based on a current
market interest rate. The Bank evaluates the mortgage servicing rights strata
for impairment by estimating the fair value based on anticipated future net cash
flows, taking into consideration prepayment predictions. The predominant
characteristics used as the basis for stratifying are loan types, period of
origination, and interest rates. The amount of impairment recognized is the
amount by which the capitalized mortgage servicing rights for a stratum exceed
their fair value.
FORECLOSED REAL ESTATE
Real estate properties acquired through, or in lieu of, loan foreclosure
are initially recorded at fair value at the date of foreclosure establishing a
new cost basis. After foreclosure, valuations are periodically performed by
management and the real estate is carried at the lower of carrying amount or
fair value minus estimated costs to sell. Revenue and expenses from operations
and changes to the valuation allowance are included in operations.
F-37
<PAGE> 132
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Real estate and other property acquired in settlement of loans are recorded
at the lower of the following at the time of foreclosure:
1) The fair value of the property, or;
2) The recorded amount of the loan at the time of foreclosure.
Subsequent to foreclosure, the assets are recorded at the lower of:
1) The lower of 1 or 2 above, or;
2) The fair value minus the estimated costs to sell.
Gains or losses on the sale of real estate and other property acquired are
charged to operations. Write-downs resulting from periodic revaluation of the
real estate and other property are charged to expense. Rental income and
expenses of real estate and other property acquired are charged to operations.
PREMISES AND EQUIPMENT
Land is carried at cost. Buildings, leasehold improvements and equipment
are carried at cost, less accumulated depreciation. Buildings and equipment are
depreciated using the straight-line method over the estimated useful lives of
the assets as follows:
<TABLE>
<S> <C>
Premises.................................................... 10-40 years
Furniture and equipment..................................... 3-10 years
</TABLE>
Expenditures for additions, major renewals, and improvements are
capitalized and maintenance and repairs are charged to expense as incurred. Net
gains and losses on disposal or retirement of premises and equipment are
included in other income.
INCOME TAXES
The Company and Subsidiaries (except Homeland Mortgage, LLC) file a
consolidated federal income tax return on a fiscal year ending September 30th.
Income taxes are provided for the tax effects of the transactions reported
in the financial statements and consist of taxes currently due plus deferred
taxes related primarily to differences between the basis of available-for-sale
securities, allowance for loan losses, accumulated depreciation, the remaining
Section 481(a) adjustment attributable to the recapture of the excess bad debt
reserves, and FHLB stock dividends for financial and income tax reporting. The
deferred tax assets and liabilities represent the future tax return consequences
of those differences, which will either be taxable or deductible when the assets
and liabilities are recovered or settled.
Deferred tax assets and liabilities are reflected at 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.
Any tax benefit from the utilization of a net operating loss in the
consolidated federal and state unitary income tax returns is paid to the loss
companies, utilizing the separate return method of income tax allocation.
F-38
<PAGE> 133
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
TREASURY STOCK
Treasury stock is recorded at cost. In the event of subsequent reissue, the
treasury stock account will be reduced by the cost of such stock on the average
cost basis with any excess proceeds credited by additional paid-in capital.
Treasury stock is available for general corporate purposes. On February 12, 1998
the Company repurchased 25 shares of its own common stock from an individual
shareholder for $132,000.
COMPREHENSIVE INCOME
Effective October 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income. The statement establishes standards for reporting and
display of comprehensive income and its components in a full set of
general-purpose financial statements. The statement requires that all items that
are required to be recognized under accounting standards as components of
comprehensive income to be disclosed in the financial statements. Comprehensive
income is defined as the change in equity during a period from transactions and
other events from non-owner sources. Comprehensive income is the total of net
income and other comprehensive income, which for the Company is comprised
entirely of unrealized gains and losses on securities available for sale.
EARNINGS PER SHARE
Basic earnings per share amounts are computed by dividing the net income by
the weighted average number of common shares outstanding. Diluted earnings per
share is the same as basic earnings per share due to the lack of dilutive items
in the Company.
FAIR VALUES OF FINANCIAL INSTRUMENTS
Effective September 30, 1999, the Company adopted SFAS No. 107, Disclosures
About Fair Value of Financial Instruments.
The following methods and assumptions were used by the Company in
estimating fair values of financial instruments as disclosed herein:
CASH AND DUE FROM BANKS -- The carrying value approximates fair value.
INVESTMENT SECURITIES -- Fair values of available-for-sale securities
have been estimated using quoted market prices. The carrying value of
held-to-maturity securities and FHLB stock approximates fair value.
LOANS -- For variable rate loans, loans with balloon maturities, loans
with relatively near-term maturities (such as consumer installment loans)
carrying values approximate fair values. The fair value of long-term fixed
rate loans has been estimated using present value cash flows, discounted at
a rate approximating current market rates and giving consideration to
estimated prepayment risk and credit loss factors. The estimated fair value
of loans held for sale is based on quoted market prices of similar
instruments trading in the secondary market.
LOAN SERVICING RIGHTS -- Fair value is estimated at 1.7 times carrying
value.
ACCRUED INTEREST -- The carrying amount approximates fair value.
LIFE INSURANCE POLICIES -- Cash value of the policies approximates
fair value.
F-39
<PAGE> 134
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DEPOSIT LIABILITIES -- The fair values of demand deposits are, by
definition, equal to the amount payable on demand at the reporting date
(that is, their carrying amounts). The carrying amounts of variable-rate,
fixed term money market accounts and certificates of deposits approximate
their fair values at the reporting date. Fair values for fixed-rate
certificates of deposit are estimated using a discounted cash flow
calculation that applies interest rates currently being offered on
certificates to a schedule of aggregate expected monthly maturities on time
deposits.
SHORT-TERM BORROWINGS -- The carrying amounts of advances from the
Federal Home Loan Bank (FHLB) of Des Moines maturing within 90 days
approximate their fair values. Advance payments by borrowers for taxes and
insurance approximate fair value.
LONG-TERM BORROWINGS -- The carrying amounts of amounts of long-term
borrowings are estimated using discounted cash flow analysis based on the
Bank's current incremental borrowing rates for similar types of borrowing
arrangements.
OFF-BALANCE-SHEET ITEMS -- Fair value for off-balance-sheet lending
commitments are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and
the counterparties' credit standings. The carrying value and fair value of
commitments to extend credit are not considered material for disclosure.
NOTE 2 -- INVESTMENT SECURITIES
The amortized cost and approximate fair values of investment securities are
as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
SEPTEMBER 30, 1999
Available-for-Sale:
U.S. Government Agencies.............. $1,498,111 $ -0- $21,861 $1,476,250
Corporate Debt Securities............. 549,552 -0- 2,716 546,836
---------- ------- ------- ----------
2,047,663 -0- 24,577 2,023,086
Mortgage-Backed Securities............ 2,481,516 4,412 7,683 2,478,245
---------- ------- ------- ----------
Total Debt Securities.............. $4,529,179 $ 4,412 $32,260 $4,501,331
========== ======= ======= ==========
Held-to-Maturity:
Certificates of Deposit............... $ 20,000 $ -0- $ -0- $ 20,000
State & Political Subdivisions........ 3,340 -0- -0- 3,340
---------- ------- ------- ----------
Total Debt Securities.............. $ 23,340 $ -0- $ -0- $ 23,340
========== ======= ======= ==========
</TABLE>
F-40
<PAGE> 135
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
SEPTEMBER 30, 1998
Available-for-Sale:
U.S. Government Agencies.............. $ -0- $ -0- $ -0- $ -0-
Corporate Debt Securities............. 1,325,552 -0- 7,581 1,317,971
---------- ------- ------- ----------
1,325,552 -0- 7,581 1,317,971
Mortgage-Backed Securities............ 4,707,947 38,946 16,778 4,730,115
---------- ------- ------- ----------
Total Debt Securities.............. $6,033,499 $38,946 $24,359 $6,048,086
========== ======= ======= ==========
Held-to-Maturity:
Certificates of Deposit............... $ 30,000 $ -0- $ -0- $ 30,000
State & Political Subdivisions........ 73,792 -0- -0- 73,792
---------- ------- ------- ----------
Total Debt Securities.............. $ 103,792 $ -0- $ -0- $ 103,792
========== ======= ======= ==========
</TABLE>
The amortized cost and estimated fair value of debt securities at September
30, 1999, by contractual maturity, are shown below. Mortgage-backed securities
have been aggregated and disclosed separately, rather than allocated over
several maturity groupings, since they lack a single maturity date and because
borrowers retain the right to prepay the obligations.
<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE HELD-TO-MATURITY
------------------------ --------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
---------- ---------- --------- -------
<S> <C> <C> <C> <C>
Due in one year or less.................. $ 150,192 $ 150,168 $23,340 $23,340
Due from one to five years............... 1,897,471 1,872,918 -0- -0-
Due from five to ten years............... -0- -0- -0- -0-
Due after ten years...................... -0- -0- -0- -0-
---------- ---------- ------- -------
2,047,663 2,023,086 23,340 23,340
Mortgage-Backed Securities............... 2,481,516 2,478,245 -0- -0-
---------- ---------- ------- -------
$4,529,179 $4,501,331 $23,340 $23,340
========== ========== ======= =======
</TABLE>
Mortgage-Backed Securities pledged against public deposits were $394,526
(fair value of $396,982) at September 30, 1999 and $688,818 (fair value of
$699,870) at September 30, 1998.
Tax-exempt interest income earned was $223 and $9,917 for the years ended
September 30, 1999 and 1998.
F-41
<PAGE> 136
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3 -- LOANS RECEIVABLE
Loans receivable at September 30, 1999 and 1998 consist of the following:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Commercial........................................... $ 2,775,286 $ 2,533,083
Residential Construction............................. 287,616 176,575
Commercial Real Estate............................... 3,111,840 3,325,301
Residential Real Estate.............................. 18,939,373 19,350,424
Real Estate Sold on Contract......................... 113,912 111,819
Non-Mortgage Agricultural............................ 4,130,590 3,342,419
Loans on Deposit Accounts............................ 320,717 274,332
Home Improvement..................................... 31,539 43,236
Educational.......................................... 33,895 35,229
Auto................................................. 7,988,328 6,041,455
Mobile Home.......................................... 1,578 3,428
Consumer............................................. 7,805,341 5,568,176
Demand Deposit....................................... 79,467 60,941
Overdrafts........................................... 35,559 8,885
----------- -----------
Total Loans Receivable............................. 45,655,041 40,875,303
Less:
Allowance For Loan Losses.......................... (527,398) (474,332)
Deferred Loan Costs (net of deferred fees)......... 45,704 36,305
Deferred Gain on Sale of Loans..................... (10,080) (16,051)
----------- -----------
Loans Receivable, Net................................ $45,163,267 $40,421,225
=========== ===========
</TABLE>
The following is an analysis of the allowance for loan losses for the years
ended September 30, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Beginning Balance......................................... $474,332 $504,180
Provision Charged to Operations........................... 2,000 12,000
Charge Offs............................................... (23,692) (48,808)
Recoveries................................................ 74,758 6,960
-------- --------
Ending Balance.......................................... $527,398 $474,332
======== ========
</TABLE>
The Bank had no loans classified as impaired at September 30, 1999, and
1998.
The Bank has granted loans to certain directors and executive officers.
Such loans were made in the ordinary course of business of the Bank and do not
involve more than the normal risk of
F-42
<PAGE> 137
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
collectibility and do not exceed the loan amount which would be available to
members of the general public of similar credit status applying for such loans.
Loan activity in these related-party accounts for the years ended September
30, 1999 and 1998 is as follows:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Beginning Balance.................................... $ 472,008 $ 362,699
New Loans............................................ 2,021,797 1,134,100
Repayments........................................... (1,448,574) (1,024,791)
----------- -----------
Ending Balance..................................... $ 1,045,231 $ 472,008
=========== ===========
</TABLE>
NOTE 4 -- ACCRUED INTEREST RECEIVABLE
Accrued Interest Receivable consists of the following:
<TABLE>
<CAPTION>
1999 1998
---------- --------
<S> <C> <C>
Loans.................................................... $ 961,173 $836,325
Investment Securities.................................... 34,316 11,885
Mortgage-Backed Securities............................... 40,906 52,287
---------- --------
Total.................................................. $1,036,395 $900,497
========== ========
</TABLE>
Non-accrual loans totaled $132,102 and $364,597 at September 30, 1999 and
1998, respectively. The effect of these non-accruing loans on revenues were
$8,933 and $52,538 for the years ending September 30, 1999 and 1998,
respectively.
NOTE 5 -- LOAN SERVICING RIGHTS
The following is a summary of servicing rights activity:
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Beginning Balance......................................... $129,093 $ 50,447
New Loan Servicing Rights................................. 49,347 104,478
Amortization.............................................. (25,259) (25,832)
-------- --------
Ending Balance.......................................... $153,181 $129,093
======== ========
</TABLE>
Loans serviced for others are not included in the accompanying consolidated
statements of balance sheets. The unpaid principal balances of loans serviced
for others was $21,358,123 and $23,270,386 at September 30, 1999 and 1998,
respectively.
NOTE 6 -- FORECLOSED REAL ESTATE
On July 6, 1998 the Company repossessed residential property valued at
$31,600. The property was subsequently resold on October 8, 1998, at a loss of
$2,642.
F-43
<PAGE> 138
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 7 -- PREMISES AND EQUIPMENT
The schedule of premises and equipment as of September 30, 1999 and 1998 is
as follows:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Land................................................... $ 89,360 $ 89,360
Buildings and Improvements............................. 726,668 726,668
Furniture and Equipment................................ 852,238 637,294
---------- ----------
Cost................................................. 1,668,266 1,453,322
Accumulated Depreciation............................... (916,224) (875,139)
---------- ----------
Net Book Value....................................... $ 752,042 $ 578,183
========== ==========
</TABLE>
Depreciation expense for the years ended September 30, 1999 and 1998
totaled $51,719 and $29,995, respectively.
The Company has entered into a three-year lease agreement for premises in
Edina, Minnesota. The minimum annual rental commitments under this lease is as
follows:
<TABLE>
<S> <C>
September 30, 2000................................... $24,090
2001.............................................. 24,090
2002.............................................. 19,071
2003.............................................. -0-
2004.............................................. -0-
2005 and Thereafter............................... -0-
-------
$67,251
=======
</TABLE>
The Company has the option to renew the lease at the end of the term. The
Company has also entered into an operating lease agreement with a director of
the Company for premises in Morris, Minnesota. The agreement is month-to-month,
resulting in no minimum annual rental commitments.
Total rent expense under operating leases was $10,062 and $100 for the
years ended September 30, 1999 and 1998.
NOTE 8 -- COST OF EXCESS OF BOOK VALUE
In prior years, the Company has purchased stock from minority shareholders
of the Bank. The purchase price of this stock exceeded its book value. This
excess is being amortized on the straight-line method over fifteen years. Annual
amortization expense was $8,484 for the years ended September 30, 1999 and 1998.
F-44
<PAGE> 139
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- DEPOSITS
Deposits at September 30, 1999 and 1998 consist of the following:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Demand Deposits...................... $11,603,134 $12,134,004
Savings Deposits..................... 5,339,250 5,770,458
----------- -----------
16,942,384 17,904,462
Certificates of Deposit.............. 31,541,785 32,023,831
----------- -----------
Total Deposits..................... $48,484,169 $49,928,293
=========== ===========
</TABLE>
The aggregate amount of certificates of deposit with a minimum denomination
of $100,000 was $1,215,717 and $1,105,614 at September 30, 1999 and 1998.
Deposited amounts in excess of $100,000 per account holder are not insured by
the Federal Deposit Insurance Company.
At September 30, 1999, the scheduled maturities of certificates of deposit
are as follows:
<TABLE>
<S> <C>
September 30, 2000................................. $23,070,786
2001............................................. 6,362,369
2002............................................. 1,215,614
2003............................................. 452,644
2004............................................. 440,372
-----------
Total......................................... $31,541,785
===========
</TABLE>
Deposits by related parties were $2,017,415 and $2,146,341 at September 30,
1999 and 1998.
NOTE 10 -- ADVANCES FROM FEDERAL HOME LOAN BANK
Advances from the Federal Home Loan Bank consists of the following:
<TABLE>
<CAPTION>
INTEREST
DATED MATURITY RATE 1999 1998
- ----- -------- -------- ---------- ----------
<S> <C> <C> <C> <C>
07-06-94.......................... 07-06-01 7.06% $ 35,715 $ 53,572
02-22-95.......................... 02-22-00 7.75% 261,836 277,585
08-15-96.......................... 08-15-11 7.10% -0- 915,997
01-27-99.......................... 01-28-02 4.94% 2,000,000 -0-
02-12-99.......................... 02-14-00 5.85% 300,000 -0-
---------- ----------
$2,597,551 $1,247,154
========== ==========
</TABLE>
F-45
<PAGE> 140
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The advances are secured under a Blanket Security Agreement with qualifying
mortgage loans of the Bank. The interest on the advances is paid monthly. The
principal is to be repaid as follows:
<TABLE>
<S> <C>
September 30, 2000.................................. $1,079,693
2001.............................................. 517,858
2002.............................................. 1,000,000
2003.............................................. -0-
2004.............................................. -0-
2005 and Thereafter............................... -0-
----------
Total.......................................... $2,597,551
==========
</TABLE>
At September 30, 1999 the Company can borrow an additional $4,000,000 from
FHLB. With sufficient collateral, the total borrowing limit is approximately
$8,600,000.
NOTE 11 -- NOTES PAYABLE
FIRST NATIONAL BANK IN WINNEBAGO
The Company has a multiple advance note payable to the First National Bank
in Winnebago dated September 19, 1996. The note is a demand loan with a total
available credit line of $925,000. The note requires semiannual interest and
annual principal payments. If no demand is made, the note is scheduled to be
paid off by April 1, 2009. The interest rate is variable at 1% below the
lender's base rate, and is currently at 8.25%. The interest is subject to change
annually on September 1. The note is secured by 95,454 shares of the common
stock of the Bank and the personal guarantees of the common stockholders of the
Company.
At the present 8.25% interest rate, scheduled principal payments are due as
follows:
<TABLE>
<S> <C>
September 30, 2000.................................... $ 52,847
2001................................................ 55,027
2002................................................ 57,297
2003................................................ 59,661
2004................................................ 62,121
2005 and Thereafter................................. 351,226
--------
Total............................................ $638,179
========
</TABLE>
Interest expense was $56,094 and $70,625 for the years ended September 30,
1999 and 1998, respectively.
SHAREHOLDERS
The Company entered into loan agreements with its shareholders on January
23, 1997 and March 18, 1998. The loans are secured by the Bank stock and are due
on demand. The interest rate on the loans is 10%. Interest expense on the loans
for the years ended September 30, 1999 and 1998 was $47,999 and $27,845,
respectively.
F-46
<PAGE> 141
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12 -- INCOME TAXES
The consolidated provision for income taxes consisted of the following for
the years ended September 30:
<TABLE>
<CAPTION>
1999 1998
-------- ---------
<S> <C> <C>
CURRENT TAX PROVISION
Federal................................................ $167,440 $ 320,269
State.................................................. 52,896 104,545
-------- ---------
Total Current Provision............................. 220,336 424,814
DEFERRED TAX PROVISION (BENEFIT)
-------- ---------
Federal................................................ (1,067) (92,660)
State.................................................. 1,025(a) (31,314)
-------- ---------
Total Deferred Provision............................ (42) (123,974)
-------- ---------
Total Income Tax Provision............................... $220,294 $ 300,840
======== =========
</TABLE>
- -------------------------
(a) State provision is an expense due to the decrease in the state net operating
loss carryforward.
The reconciliation of income taxes computed at the federal statutory income
tax rate to total income taxes for the years ended September 30, 1999 and 1998
is as follows:
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Book income before tax.................................... $590,569 $892,083
======== ========
Income tax computed at federal statutory tax rate of
34%..................................................... 200,793 303,308
State income taxes, net of federal tax benefit (effective
rate of 6.468%)......................................... 38,198 57,700
Amortization of acquisition benefit of $111,934 (effective
rate of 40.468%)........................................ (45,297) (45,297)
Other, net................................................ 26,600 (14,871)
-------- --------
Total Income Tax Provision................................ $220,294 $300,840
======== ========
</TABLE>
F-47
<PAGE> 142
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred tax assets and liabilities included in liabilities at September 30
consist of the following:
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Deferred Tax Liabilities:
Accumulated depreciation................................ $ 24,931 $ 29,615
FHLB stock dividend..................................... 73,854 73,854
Section 481(a) adjustment............................... 58,895 78,527
Accrued interest on life insurance...................... 25,375 -0-
Investment in Homeland Mortgage, LLC.................... 8,455 -0-
Net unrealized gain on Available-for-Sale Securities.... -0- 5,903
-------- --------
Total Deferred Tax Liabilities....................... 191,510 187,899
Deferred Tax Assets:
Allowance for loan losses............................... 75,856 75,047
Salary Continuation Payable............................. 11,977 -0-
Discount on mortgage loans purchased.................... 4,079 6,495
Net unrealized loss on Available-for-Sale Securities.... 11,269 -0-
State net operating loss carryforward................... 201 1,015
-------- --------
Total Deferred Tax Assets............................ 103,382 82,557
-------- --------
Net Deferred Tax Liability................................ $ 88,128 $105,342
======== ========
</TABLE>
The net operating loss (NOL) carryforward is scheduled to expire on
September 30, 2005. The NOL is anticipated to be used prior to expiration,
therefore, no valuation allowance has been established.
NOTE 13 -- REGULATORY MATTERS
The Bank is subject to certain restrictions on the amount of dividends that
it may declare without prior regulatory approval. At September 30, 1999,
approximately $368,850 of retained earnings were available for dividend
declaration without prior regulatory approval.
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory -- and possibly additional
discretionary -- actions by regulators that, if undertaken, could have a direct
material effect on the Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier I capital (as defined) to
F-48
<PAGE> 143
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
average assets (as defined) and Tangible capital (as defined) to adjusted total
assets. Management believes, as of September 30, 1999 and 1998, that the Bank
meets all capital adequacy requirements to which it is subject.
As of September 30, 1999 and 1998, the most recent notifications from the
Office of Thrift Supervision categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum total risk-based, Tier I risk-based,
Tier I leverage, and Tangible Capital ratios as set forth in the table. There
are no conditions or events since that notification that management believes
have changed the institution's category. The Bank's actual capital amounts and
ratios are also presented in the table.
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------------------- ------------------- -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
---------- ----- ---------- ----- ---------- -----
<S> <C> <C> <C> <C> <C> <C>
As of September 30, 1999:
Total Capital
(to Risk Weighted
Assets).............. $5,493,185 11.53% $3,812,763 8% $4,765,954 10%
Tier I Capital
(to Risk Weighted
Assets).............. $4,983,928 10.46% $1,906,381 4% $2,859,572 6%
Tier I Capital
(to Average
Assets).............. $4,983,928 8.70% $2,290,698 4% $2,863,372 5%
As of September 30, 1998:
Total Capital
(to Risk Weighted
Assets).............. $5,046,334 11.89% $3,396,556 8% $4,245,695 10%
Tier I Capital
(to Risk Weighted
Assets).............. $4,572,002 10.77% $1,698,278 4% $2,547,417 6%
Tier I Capital
(to Average
Assets).............. $4,572,002 8.15% $2,245,232 4% $2,806,540 5%
</TABLE>
The Bank's tangible capital ratios were 8.70% and 8.15% as of September 30,
1999 and 1998, respectively. Every thrift is required to maintain a tangible
capital ratio equal to or greater than 1.5%.
NOTE 14 -- EMPLOYEE BENEFITS
SALARY CONTINUATION PLAN (DEFINED BENEFIT)
On December 28, 1998, the Bank established a nonqualified salary
continuation plan for all officers and directors. The Plan provides fixed
payments for a specified number of years during retirement (ten to fifteen
years). The estimated liability under the Plan is charged to income over the
expected remaining years of employment. The Bank's policy is to fund the costs
accrued with
F-49
<PAGE> 144
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
insurance contracts. Salary continuation expense amounted to $29,597 for the
year ended September 30, 1999.
401(k) PLAN (DEFINED CONTRIBUTION)
The employees of the Bank are covered under a 401(k) defined contribution
plan that was established in January, 1993. All employees of the Bank with
service of over one year are eligible to participate in the plan. The Bank pays
an amount equal to the employee's contribution to the plan, up to 3% of the
employee's salary. The expense of the Bank including administrative costs was
$15,873 and $18,341 for the years ended September 30, 1999 and 1998,
respectively.
COMPENSATED ABSENCES
Full time, year round employees are entitled to paid vacation depending on
the length of service and other factors. Accrued vacation pay at September 30,
1999 and 1998 was deemed immaterial and not accrued.
NOTE 15 -- COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company makes various commitments and
incurs certain contingent liabilities that are not reflected in the accompanying
financial statements. The Company does not anticipate any material losses as a
result of these commitments and contingent liabilities.
Commitments to originate loans were as follows:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Loans Secured by 1 - 4 Dwelling Units.................. $ 270,000 $1,407,000
Loans Secured by 5 or more Dwelling Units.............. -0- -0-
Loans Secured by Other Real Estate..................... 462,000 871,000
---------- ----------
Total Commitments to Originate Loans................... $ 732,000 $2,278,000
========== ==========
Commitments To Sell Loans.............................. $1,516,000 $2,337,000
========== ==========
</TABLE>
NOTE 16 -- SUBSEQUENT EVENTS
On November 5, 1999, the Bank purchased a building in Big Lake, Minnesota
for $394,000. The Bank plans to modify the building to house a new branch.
Earnest money of $5,000 was paid prior to September 30, 1999, and is included in
prepaid expenses and other assets.
The purchase price will be allocated as follows:
<TABLE>
<S> <C>
Land.................................................. $100,000
Building.............................................. 244,000
Equipment............................................. 50,000
--------
$394,000
========
</TABLE>
F-50
<PAGE> 145
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
After September 30, 1999, the Bank reached an agreement with directors
Edward Morrison and Leonard Wulf. The agreement will pay each director $25,000
up front, in lieu of the salary continuation plan available to the other
directors.
NOTE 17 -- FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and commercial
letters of credit. These instruments involve, to varying degrees, elements of
credit risk in excess of the amount recognized in the statement of financial
position. The contract or notional amounts of these instruments reflect the
extent of involvement the Bank has in particular classes of financial
instruments.
The Bank's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
commercial letters of credit is represented by the contractual notional amount
of these instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments.
<TABLE>
<CAPTION>
CONTRACT OR
NOTIONAL AMOUNT
------------------------
1999 1998
---------- ----------
<S> <C> <C>
Financial Instruments Whose Contract Amounts Represent
Credit Risk:
Commitments to Extend Credit
Open-End Consumer Lines................................ $ 241,000 $ 211,000
Commercial Lines....................................... 2,591,000 2,807,000
Letters of Credit...................................... 23,500 13,500
---------- ----------
$2,855,500 $3,031,500
========== ==========
</TABLE>
Commitments to extend credit and commercial letters of credit are
agreements to lend to a customer. Commitments and letters of credit generally
have fixed expiration dates or other termination clauses. Since many of the
commitments and letters of credit are expected to expire without being drawn
upon, the amounts do not necessarily represent future cash requirements. The
Bank evaluates each customer's credit worthiness on a case-by-case basis. The
amount of collateral obtained by the Bank upon extension of credit is based on
Management's credit evaluation of the customer. Collateral held varies but may
include accounts receivable, inventory, property, plant and equipment, and
income producing commercial properties. The credit risk involved in issuing
commitments and letters of credit is essentially the same as that involved in
extending loans to customers.
F-51
<PAGE> 146
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 18 -- ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments at
September 30, 1999 are as follows:
<TABLE>
<CAPTION>
CARRYING FAIR
AMOUNT VALUE
----------- -----------
<S> <C> <C>
Financial Assets:
Cash and Due from Banks............................ $ 2,180,409 $ 2,180,409
Available-for-Sale Securities...................... 4,501,331 4,501,331
Held-to-Maturity Securities........................ 46,926 46,926
FHLB Stock......................................... 211,200 211,200
Loans Held for Sale................................ 1,516,300 1,516,300
Loans Receivable, Net.............................. 45,163,267 44,792,000
Accrued Interest Receivable........................ 1,036,395 1,036,395
Loan Servicing Rights.............................. 153,181 260,408
Cash Surrender Value of Life Insurance............. 1,702,705 1,702,705
----------- -----------
Total Financial Assets.......................... $56,511,714 $56,247,674
=========== ===========
Financial Liabilities:
Deposits........................................... $48,484,169 $48,408,000
Advances from FHLB................................. 2,597,551 2,561,000
Notes Payable -- FNB in Winnebago.................. 638,179 643,000
Notes Payable -- Shareholders...................... 364,300 364,300
Accrued Interest Payable........................... 32,209 32,209
Advance Payments by Borrowers...................... 51,740 51,740
----------- -----------
Total Financial Liabilities..................... $52,168,148 $52,060,249
=========== ===========
</TABLE>
F-52
<PAGE> 147
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 19 -- PARENT ONLY CONDENSED FINANCIAL INFORMATION
CONDENSED BALANCE SHEETS
AS OF SEPTEMBER 30, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
ASSETS
Cash and Due from Banks..................................... $ 80,853 $ 55,507
Due from Affiliates......................................... 30,542 34,625
Investment in Bank Subsidiary............................... 4,483,526 4,247,877
Investment in Non-Bank Subsidiary........................... 27,040 45,237
Cost in Excess of Book Value................................ 102,740 111,224
---------- ----------
Total Assets.............................................. $4,724,701 $4,494,470
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Note Payable -- FNB in Winnebago............................ $ 638,179 $ 698,057
Notes Payable -- Shareholders............................... 364,300 364,300
Accrued Interest Payable.................................... 32,209 -0-
Net Assets Acquired in Excess of Cost..................... -0- 111,934
---------- ----------
Total Liabilities......................................... 1,034,688 1,174,291
Stockholders' Equity(a)..................................... 3,690,013 3,320,179
---------- ----------
Total Liabilities and Stockholders' Equity................ $4,724,701 $4,494,470
========== ==========
</TABLE>
- -------------------------
(a) The stockholders' equity of the Parent Company exceeds the consolidated
stockholders' equity by $23,795 at September 30, 1999. This represents the
intercompany gain on the transfer of future servicing rights from West
Central Service Corp. to Homeland Mortgage, LLC.
F-53
<PAGE> 148
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED STATEMENTS OF INCOME
YEARS ENDED SEPTEMBER 30, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
INCOME
Interest Income:
Bank Subsidiary........................................... $ 1,573 $ 1,751
Loans..................................................... -0- 8,461
-------- --------
1,573 10,212
Dividends................................................... 135,442 135,442
Acquisition Benefit......................................... 111,934 111,932
-------- --------
Total Income........................................... 248,949 257,586
EXPENSES
Interest Expense:
Bank Subsidiary........................................... -0- 1,230
Notes Payable............................................. 104,093 98,470
-------- --------
104,093 99,700
Non-Interest Expenses..................................... 57,064 62,383
Income Tax (Benefit)...................................... (64,590) (62,993)
-------- --------
Total Expenses......................................... 96,567 99,090
-------- --------
Income Before Equity in Undistributed Earnings of
Subsidiaries.............................................. 152,382 158,496
Equity in Undistributed Earnings (Losses) of Subsidiaries:
Bank Subsidiary........................................... 258,460 373,144
Non-Bank Subsidiary....................................... (18,197) 4,937
-------- --------
240,263 378,081
-------- --------
NET INCOME.................................................. $392,645 $536,577
======== ========
</TABLE>
F-54
<PAGE> 149
FIRST FEDERAL HOLDING COMPANY OF MORRIS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Cash Flows from Operating Activities:
Net Income................................................ $392,645 $536,577
Adjustments to Reconcile Net Income to Net Cash Provided by
Operating Activities:
Acquisition Benefit....................................... (111,934) (111,932)
Amortization of Cost in Excess............................ 8,484 8,484
Equity in Undistributed Earnings of Subsidiaries.......... (240,263) (378,081)
Decrease in Accrued Interest Receivable................... -0- 918
Increase (Decrease) in Accrued Interest Payable........... 32,209 (3,952)
-------- --------
Net Cash Provided by Operating Activities.............. 81,141 52,014
Cash Flows from Investing Activities:
(Increase) Decrease in Due from Affiliates................ 4,083 (9,365)
Net Decrease in Loans..................................... -0- 137,893
-------- --------
Net Cash Provided by Investing Activities.............. 4,083 128,528
Cash Flows from Financing Activities:
Principal Payments on Notes Payable....................... (59,878) (173,523)
Proceeds from Shareholder Debt............................ 204,000 132,000
Principal Payments on Shareholder Debt.................... (204,000) -0-
Purchase of Treasury Stock................................ -0- (132,000)
-------- --------
Net Cash Used in Financing Activities.................. (59,878) (173,523)
-------- --------
Net Increase in Cash and Due from Banks................... 25,346 7,019
Cash and Due from Banks, Beginning of Year.................. 55,507 48,488
-------- --------
Cash and Due from Banks, Ending Balance..................... $ 80,853 $ 55,507
======== ========
</TABLE>
F-55
<PAGE> 150
NORTHERN STAR FINANCIAL, INC.
STOCK ORDER FORM &
CERTIFICATION
NOTE: PLEASE READ THE STOCK ORDER FORM GUIDE AND INSTRUCTIONS ACCOMPANYING THIS
FORM, BEFORE COMPLETION.
- --------------------------------------------------------------------------------
DEADLINE: The offering began March 28, 2000. A condition of the offering is that
the minimum offering (sale of 500,000 shares of common stock) must be completed
on or before June 26, 2000, unless extended by the board of directors for up to
an additional 90 days, or the offering will be terminated. If the minimum
offering is completed, the offering will continue so long as shares remain
available or until 5:00 p.m. Minneapolis time, on June 26, 2000, whichever
occurs first, unless terminated or extended by Northern Star Financial
beforehand.
NUMBER OF SHARES
<TABLE>
<S> <C> <C> <C> <C>
(1) Number of Shares Price Per Share (2) Total Amount Due
X $10.50 = $
</TABLE>
The minimum number of shares that may be subscribed for is 100. The maximum any
individual and their related party may subscribe for in the offering is 45,000
shares. See the Section entitled "THE OFFERING" on page 92 of the prospectus
dated March 28, 2000.
METHOD OF PAYMENT AND PURCHASE INFORMATION
(3) Enclosed is a check, bank draft or money order payable to: "Firstar Bank,
N.A., Escrow Agent for Northern Star
Financial, Inc." for $________________.
BROKER DEALER NAME AND ADDRESS
(4) If purchased through a broker/dealer, please list the name, address, and
phone number in the space provided.
<TABLE>
<S> <C>
Company Name: City: ---------------------------------------
----------------------------------------------------
</TABLE>
<TABLE>
<S> <C> <C>
Broker Name: State: Zip Code: ------------
------------------------------------------------------ --------------
</TABLE>
<TABLE>
<S> <C>
Street Address: Phone Number: -----------------------------
-----------------------------------------------------
</TABLE>
STOCK REGISTRATION ONE OWNERSHIP PER STOCK ORDER FORM
(5) Form of stock ownership
<TABLE>
<S> <C> <C>
[ ] Individual [ ] Uniform Transfer to Minors [ ] Partnership
minor's soc. sec. #
required
[ ] Joint Tenants [ ] Uniform Gift to Minors [ ] IRA (Custodian name & signature required
[ ] Tenants in [ ] Corporation [ ] Fiduciary/Trust (Under Agreement Dated __________)
Common
</TABLE>
<TABLE>
<S> <C>
Name Social Security or Tax I.D.
- -------------------------------------------------------------------------------------------------------------------
Name Daytime Telephone
- -------------------------------------------------------------------------------------------------------------------
Street Address Evening Telephone
- -------------------------------------------------------------------------------------------------------------------
City State Zip Code State of Residence
</TABLE>
<TABLE>
<S> <C>
OFFICE USE Batch # ------------
Date Rec'd ---------- /---------- / Order #------------------------------------
----------
Check # ----------------------------------- Category-----------------------------------
Amount $ ---------------------------------- Initials-------------------------------------
</TABLE>
<PAGE> 151
- --------------------------------------------------------------------------------
NASD AFFILIATION (This section only applies to those individuals who meet the
delineated criteria)
- --------------------------------------------------------------------------------
[ ] Check here if you are a member of the National Association of Securities
Dealers, Inc. ('NASD'), a person associated with an NASD member, a member
of the immediate family of any such person to whose support such person
contributes, directly or indirectly, or the holder of an account in which
an NASD member or person associated with an NASD member has a beneficial
interest. To comply with conditions under which an exemption from the
NASD's Interpretation with Respect to Free-Riding and Withholding is
available, you agree, if you have checked the NASD affiliation box: (1) not
to sell, transfer or hypothecate the shares subscribed for herein for a
period of three months following the issuance, and (2) to report this
subscription in writing to the applicable NASD member within one day of the
payment therefor.
- --------------------------------------------------------------------------------
ACKNOWLEDGEMENTS
- --------------------------------------------------------------------------------
1. By signing below, I acknowledge receipt of the prospectus dated March 28,
2000 and that I have reviewed all provisions therein. I understand that I may
not change or revoke my order once it is received by Northern Star Financial,
Inc. I also certify that this stock order is for my account and there is no
agreement or understanding regarding any further sale or transfer of these
shares.
2. Under penalties of perjury, I further certify that:
(i) the social security number or taxpayer identification number given herein
is correct; and
(ii) I am not subject to backup withholding.
If you have been notified by the Internal Revenue Service that you are
subject to backup withholding because of under-reporting interest or
dividends on your tax return, you must cross out Item (ii) above.
3. By signing below, I also acknowledge that I have not waived any rights under
the Securities Act of 1933 and the Securities Exchange Act of 1934.
4. By signing below, I hereby represent to Northern Star Financial, Inc. that
the purchase of shares subscribed for complies with the purchase limitations
set forth in the prospectus dated March 28, 2000.
5. By signing below, I certify that before purchasing the common stock of
Northern Star Financial, Inc. that I received a copy of the prospectus dated
March 28, 2000, which discloses the nature of the common stock being offered
thereby and describes certain risks involved in an investment in the common
stock under the heading "Risk Factors" beginning on page 10 of the
prospectus.
6. ACCEPTANCE OF SUBSCRIPTION. It is understood and agreed that Northern Star
Financial, Inc. shall have the right to accept or reject this subscription in
whole or in part, for any reason whatsoever. Northern Star Financial, Inc.
may reduce the number of shares for which the Subscriber has subscribed,
indicating acceptance of less than all of the shares subscribed on Northern
Star Financial, Inc.'s written form of acceptance.
7. RESIDENCE. The Subscriber represents and warrants that the Subscriber is a
bona fide resident (or if an entity is organized or incorporated under the
laws of, and is domiciled in) of the State indicated on the first page
hereof.
THIS FORM MUST BE SIGNED AND DATED. THIS ORDER IS NOT VALID IF THE STOCK ORDER
FORM IS NOT SIGNED. YOUR ORDER WILL BE FILLED IN ACCORDANCE WITH THE PROVISIONS
OF THE PROSPECTUS.
When purchasing as a custodian, corporate officer, etc.; include your full
title.
SIGNATURE TITLE (IF APPLICABLE) DATE
- --------------------------------------------------------------------------------
1.
- --------------------------------------------------------------------------------
2.
- --------------------------------------------------------------------------------
3.
THE SHARES OF COMMON STOCK OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS AND ARE NOT
INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE BANK
INSURANCE FUND OR ANY OTHER GOVERNMENTAL AGENCY.
RETURN THIS FORM TO:
BANC STOCK FINANCIAL SERVICES, INC.
ATTN: LISA R. HUNTER, VICE PRESIDENT
1105 SCHROCK ROAD, SUITE 437
COLUMBUS, OHIO 43229
<PAGE> 152
- ------------------------------------------------------
- ------------------------------------------------------
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT. WE HAVE
NOT AUTHORIZED ANYONE TO PROVIDE ANY DIFFERENT OR ADDITIONAL INFORMATION. THIS
PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IS NOT SOLICITING AN
OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS ILLEGAL.
THE INFORMATION IN THIS PROSPECTUS IS COMPLETE AND ACCURATE AS OF THE DATE ON
THE COVER, BUT THE INFORMATION MAY CHANGE IN THE FUTURE.
-------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary................................. 3
Risk Factors............................ 10
Use of Proceeds......................... 15
Dividend Policy......................... 15
Capitalization.......................... 16
Price Range of Common Stock............. 16
The Merger.............................. 17
Unaudited Pro Forma Condensed Combined
Financial Information................. 22
Northern Star Financial Management's
Discussion............................ 27
Northern Star Financial Business........ 41
Northern Star Financial Management...... 45
Northern Star Financial Compensation of
Executive Officers and Directors...... 47
Northern Star Financial Principal
Shareholders.......................... 50
First Federal Management's Discussion... 52
First Federal Business.................. 75
First Federal Management................ 79
Supervision and Regulation.............. 81
Description of Our Capital Stock........ 88
Shares Eligible for Future Sale......... 91
The Offering............................ 92
Legal Matters........................... 94
Experts................................. 94
Where You Can Get More Information...... 94
Index to Financial Statements........... F-1
</TABLE>
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
[NORTHERN STAR FINANCIAL LOGO]
COMMON STOCK
-------------------------
PROSPECTUS
-------------------------
[BANCSTOCK FINANCIAL SERVICES, INC. LOGO]
Selling Group Members
LARSONALLEN FINANCIAL, LLC
EAGLE ONE INVESTMENTS, LLC
March 28, 2000
- ------------------------------------------------------
- ------------------------------------------------------
