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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB/A
[X] AMENDED ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended June 30, 1999
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
Commission File Number: 0-25023
FIRST CAPITAL, INC.
- --------------------------------------------------------------------------------
(Name of small business issuer in its charter)
Indiana 35-2056949
- ------------------------------------- --------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
220 Federal Way, N.W., Corydon, Indiana 47112
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (812) 738-2198
--------------------
Securities registered under 12(b) of the
Exchange Act: None
Securities registered under Section 12(g)
of the Exchange Act: Title of each class
---------------------------------------
Common Stock, par value $0.01 per share
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes [X]
No [_]
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this
Form 10-KSB/A or any amendment to this Form 10-KSB/A. X
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The issuer's revenues for the most recent fiscal year were $7.8 million.
The aggregate market value of the voting common equity held by non-
affiliates as of June 30, 1999 was $12,930,000. This figure is based on the
closing price on the Nasdaq Stock Market for a share of the issuer's common
stock on June 30, 1999, which was $11.25. For purposes of this calculation, the
issuer is assuming that the issuer's directors and executive officers are
affiliates.
As of June 30, 1999, there were 1,292,752 shares of the Registrant's Common
Stock outstanding.
Transitional Small Business Disclosure Format: Yes [_] No [X]
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This report contains certain "forward-looking statements" concerning the
future operations of First Capital, Inc. Forward-looking statements are used to
describe future plans and strategies, including expectations of future financial
results. Management's ability to predict results or the effect of future plans
or strategies is inherently uncertain. Factors which could affect actual results
include interest rate trends, the general economic climate in the market area in
which First Capital, Inc. operates, as well as nationwide, First Capital, Inc.'s
ability to control costs and expenses, competitive products and pricing, loan
delinquency rates, changes in federal and state legislation and regulation, and
the impact of Year 2000 issues. These factors should be considered in evaluating
the forward-looking statements and undue reliance should not be placed on such
statements.
PART I
Item 1. Description of Business.
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General
First Capital, Inc. ("Company") was incorporated under Indiana law in
September 1998. The Company was organized for the purpose of becoming the
holding company for First Federal Bank, A Federal Savings Bank ("Bank") upon the
Bank's reorganization as a wholly owned subsidiary of the Company resulting from
the conversion of First Capital, Inc., M.H.C. ("MHC"), from a federal mutual
holding company to a stock holding company ("Conversion and Reorganization").
In connection with the Conversion and Reorganization, which was completed on
December 31, 1998, the Company sold 768,767 shares of its common stock to the
public at $10 per share in a public offering ("Offering") and issued 523,057
shares in exchange for the outstanding shares of the Bank held by the Bank's
stockholders other than the MHC.
The Company has no significant assets, other than all of the outstanding
shares of the Bank and the portion of the net proceeds from the Offering
retained by the Company, and no significant liabilities. Management of the
Company and the Bank are substantially similar and the Company neither owns nor
leases any property, but instead uses the premises, equipment and furniture of
the Bank. Accordingly, the information set forth in this report, including the
consolidated financial statements and related financial data, relates primarily
to the Bank.
The Bank is regulated by the OTS and the Federal Deposit Insurance
Corporation ("FDIC"). The Bank's deposits have been federally-insured by the
FDIC since 1961 and are currently insured by the FDIC under the Savings
Association Insurance Fund ("SAIF"). The Bank is a member of the Federal Home
Loan Bank System.
Proposed Merger
On July 19, 1999, the Company entered into an Agreement and Plan of Merger
("Merger Agreement") with HCB Bancorp ("HCB") pursuant to which the Company and
HCB will combine in a merger of equals. The Merger Agreement provides that FC
Acquisition Corp., a wholly-owned subsidiary of the Company, will be merged with
and into HCB, with HCB being the surviving entity ("Merger") and becoming a
wholly-owned subsidiary of the Company. Immediately following consummation of
the Merger, HCB will adopt a plan of liquidation pursuant to which it will merge
with and into the Company. Immediately following the combination of the Company
and HCB, Harrison County Bank, a bank organized under the laws of the State of
Indiana and a subsidiary of HCB ("HC Bank"), will merge with and into the Bank.
Pursuant to the terms of the Merger Agreement, each share of HCB common
stock, no par value per share, issued and outstanding at the effective time of
the Merger, shall become and be converted into the right to receive 15.5 shares
of common stock of the Company. Upon consummation of the Merger, the Company's
Board of Directors will be increased from seven to fourteen members and will
consist of the then-current members of the Boards of Directors of the Company
and HCB, and the Bank's Board of Directors also will be increased from seven to
fourteen members and will consist of the then-current members of the Boards of
Directors of the Bank and HC Bank.
Consummation of the Merger is subject to various conditions, including the
approval of the shareholders of the Company and HCB and the receipt of all
requisite regulatory approvals.
Market Area and Competition
The Bank considers Harrison County as its primary market area because
substantially all of the Bank's depositors live in the areas surrounding its
main office and branch office and most of the Bank's loans are made to persons
in Harrison County, Indiana. Corydon, the county seat of Harrison County, is
located approximately 35 miles west of Louisville, Kentucky. Major employers in
Harrison County include Keller Manufacturing Corporation, South Harrison
Community School District and the Harrison County Hospital. The Bank faces
intense competition in its
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primary market area for the attraction of deposits (its primary source of
lendable funds) and in the origination of loans. Its most direct competition for
deposits has historically come from the four commercial banks operating in
Corydon and, to a lesser extent, from other financial institutions, such as
brokerage firms and insurance companies. Three of the four commercial banks in
Corydon are affiliated with large, multi-state bank holding companies and,
therefore, have significantly greater resources than the Bank. Particularly in
times of high interest rates, the Bank has faced additional significant
competition for investors' funds from short-term money market securities and
other corporate and government securities. The Bank's competition for loans
comes primarily from the commercial banks operating in its primary market area.
Lending Activities
General. The principal lending activity of the Bank is the origination of
residential mortgage loans. To a lesser extent, the Bank also originates
consumer, commercial business, commercial real estate (including farm
properties) and residential construction loans.
Loan Portfolio Analysis. The following table sets forth the composition of
the Bank's loan portfolio by type of loan at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
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1999 1998
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Amount Percent Amount Percent
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(Dollars in thousands)
<S> <C> <C> <C> <C>
Mortgage Loans:
Residential (1)...................... $63,531 71.71% $57,825 74.57%
Land................................. 1,018 1.15 218 0.28
Commercial real estate............... 3,678 4.15 4,371 5.64
Residential construction............. 8,346 9.42 3,787 4.88
------- ------ ------- ------
Total mortgage loans............... 76,573 86.43 66,201 85.37
------- ------ ------- ------
Consumer Loans:
Home equity and second mortgage
loans............................. 2,999 3.39 2,799 3.61
Automobile loans..................... 1,615 1.82 1,574 2.03
Loans secured by savings accounts.... 400 0.45 466 0.60
Mobile home loans.................... 193 0.22 223 0.29
Unsecured loans...................... 190 0.21 125 0.16
Other (2)............................ 1,015 1.15 1,110 1.43
------- ------ ------- ------
Total consumer loans............... 6,412 7.24 6,297 8.12
------- ------ ------- ------
Commercial business loans............ 5,607 6.33 5,048 6.51
------- ------ ------- ------
Total loans....................... 88,592 100.00% 77,546 100.00%
------- ====== ------- ======
Less:
Due to borrowers on loans in process. 4,019 1,932
Deferred loan fees net of direct 211
costs............................... 204
Allowance for loan losses............ 482 516
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Total loans receivable, net.......... $83,887 $74,887
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</TABLE>
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(1) Includes conventional one- to four-family and multi-family residential
loans.
(2) Includes loans secured by lawn and farm equipment, unimproved land, and
other personal property.
Residential Loans. The Bank's lending activities have concentrated on the
origination of residential mortgages, primarily for retention in the Bank's loan
portfolio. At June 30, 1999, residential mortgages constituted $57.8 million, or
74.6% of total loans. Residential mortgages secured by multi-family properties
are an immaterial portion of the residential loan portfolio. Substantially all
residential mortgages are collateralized by properties within the Bank's market
area.
The Bank offers both fixed-rate mortgage loans and ARM loans typically with
terms of 15 to 30 years. Although the Bank originates all residential mortgage
loans for investment, the Bank uses loan documents approved by the Federal
National Mortgage Corporation ("Fannie Mae") and the Federal Home Loan Mortgage
Corporation ("Freddie Mac"). ARM loans originated have interest rates that
adjust at regular intervals of one year, with 1.5% annual and 5% lifetime caps,
and at intervals of five years with 2% per adjustment period and 6% lifetime
caps, based upon changes in the prevailing interest rates on U.S. Treasury
Bills. The Bank does not use below market interest rates and other marketing
inducements to attract ARM loan borrowers. The majority of ARM loans provide
that the amount of any increase or decrease in the interest rate is limited to
two percentage points (upward or downward) per adjustment
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period and generally contain minimum and maximum interest rates. Borrower demand
for ARMs versus fixed-rate mortgage loans is a function of the level of interest
rates, the expectations of changes in the level of interest rates and the
difference between the interest rates and loan fees offered for fixed-rate
mortgage loans and interest rates and loan fees for ARM loans. The relative
amount of fixed-rate and ARM loans that can be originated at any time is largely
determined by the demand for each in a competitive environment.
The Bank's lending policies generally limit the maximum loan-to-value ratio
on fixed-rate and ARM loans to 90% of the lesser of the appraised value or
purchase price of the underlying residential property unless private mortgage
insurance to cover the excess over 90% is obtained, in which case the mortgage
is limited to 95% (or 97% under a new Freddie Mac program) of the lesser of
appraised value or purchase price. The loan-to-value ratio, maturity and other
provisions of the loans made by the Bank are generally reflected in the policy
of making less than the maximum loan permissible under federal regulations, in
accordance with established lending practices, market conditions and
underwriting standards maintained by the Bank. The Bank requires title, fire
and extended insurance coverage on all mortgage loans originated. All of the
Bank's real estate loans contain due on sale clauses. The Bank obtains
appraisals on all its real estate loans from outside appraisers.
Construction Loans. At June 30, 1999, the Bank had $8.3 million, or 9.4%
of total loans, of construction loans for single-family residences. At June 30,
1999, speculative construction loans, for which there is not a commitment for
permanent financing in place at the time the construction loan was originated,
amounted to $1.6 million.
Although the Bank originates construction loans that are repaid with the
proceeds of a permanent mortgage loan obtained by the borrower from another
lender, the majority of the construction loans that the Bank originates are
construction/permanent loans, which are originated with one loan closing at
either a fixed or variable rate of interest and for terms up to 30 years.
Construction loans originated without a commitment by the Bank to provide
permanent financing are generally originated for a term of six to 12 months and
at a variable interest rate based on the prime rate. In the case of
construction/permanent loans, the construction loan is also generally for a term
of six to 12 months and the rate charged is the rate chosen by the borrower for
the permanent loan. Accordingly, if the borrower chooses a fixed interest rate
for the permanent loan, the construction loan rate is also fixed at the same
rate. At June 30, 1999, the largest non-speculative construction loan was in
the amount of $450,000 and with an outstanding balance of $374,000. This loan
was performing according to its terms at June 30, 1999.
The Bank originates speculative construction loans to approximately six
builders operating and based in the Bank's primary market area and with whom the
Bank has well-established business relationships. The Bank generally limits the
number of speculative construction loans outstanding at any one time to any one
builder to two loans. At June 30, 1999, the largest speculative construction
loan relationship with a builder consisted of four loans in the committed
aggregate amount of $470,000 with an aggregate outstanding balance of $181,000.
Such loans were performing according to their respective terms at that date.
All construction loans are originated with a loan-to-value ratio not to
exceed 90% of the appraised estimated value of the completed property. The
construction loan documents require the disbursement of the loan proceeds in
increments as construction progresses. Disbursements are based on periodic on-
site inspections by an independent appraiser and/or Bank personnel approved by
the Board of Directors.
Construction lending is inherently riskier than one- to four-family
mortgage lending. Construction loans, on average, generally have higher loan
balances than one- to four-family mortgage loans. In addition, the potential
for cost overruns because of the inherent difficulties in estimating
construction costs and, therefore, collateral values and the difficulties and
costs associated with monitoring construction progress, among other things, are
major contributing factors to this greater credit risk. Speculative
construction loans have the added risk that there is not an identified buyer for
the completed home when the loan is originated, with the risk that the builder
will have to service the construction loan debt and finance the other carrying
costs of the completed home for an extended time period until a buyer is
identified. Furthermore, the demand for construction loans and the ability of
construction loan borrowers to service their debt depends highly on the state of
the general economy, including market interest rate levels, and the state of the
economy of the Bank's primary market area. A material downturn in economic
conditions would be expected to have a material adverse effect on the credit
quality of the construction loan portfolio.
Commercial Real Estate Loans. The Bank had commercial real estate loans
outstanding of $3.7 million at June 30, 1999, or 4.2% of total loans.
Commercial real estate loans are generally secured by small retail stores,
professional office space and, in certain instances, farm properties.
Commercial real estate loans are generally originated with a loan-to-value
ratio not to exceed 80% of the appraised value of the property. Property
appraisals are performed by independent appraisers approved by the Bank's Board
of Directors. The Bank attempts to originate commercial real estate loans at
variable interest rates based on the U.S. Treasury Bill rate for terms not to
exceed five years. However, in the current low interest rate environment,
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borrower demand for variable rate loans is low and the Bank is generally
originating commercial real estate loans with fixed interest rates for terms
ranging between ten and 15 years over which principal and interest is fully
amortized.
At June 30, 1999, the largest commercial real estate loan was a
construction loan in the amount of $1.2 million and with an outstanding balance
of $636,000 and was secured by a commercial office and retail facility. This
loan was performing according to its terms at that date.
Commercial real estate lending affords the Bank an opportunity to receive
interest at rates higher than those generally available from one- to four-family
residential lending. However, loans secured by such properties usually are
greater in amount, more difficult to evaluate and monitor and, therefore,
involve a greater degree of risk than one- to four-family residential mortgage
loans. Because payments on loans secured by multi-family and commercial
properties are often dependent on the successful operation and management of the
properties, repayment of such loans may be affected by adverse conditions in the
real estate market or the economy. The Bank seeks to minimize these risks by
limiting the maximum loan-to-value ratio to 75% and strictly scrutinizing the
financial condition of the borrower, the quality of the collateral and the
management of the property securing the loan. The Bank also obtains loan
guarantees from financially capable parties based on a review of personal
financial statements.
Commercial Business Loans. At June 30, 1999, the Bank's commercial business
loan portfolio amounted to $5.6 million, or 6.3% of total loans. Unsecured
commercial business loans are an immaterial amount of the portfolio. Commercial
business loans are generally secured by inventory, accounts receivable, and
business equipment such as trucks and tractors. Many commercial business loans
also have real estate as collateral. The Bank generally requires a personal
guaranty of payment by the principals of a corporate borrower, and reviews the
personal financial statements and income tax returns of the guarantors.
Commercial business loans are generally originated with loan-to-value ratios not
exceeding 75%.
Aside from lines of credit, commercial business loans are generally
originated for terms not to exceed seven years with variable interest rates
based on the Bank's cost of funds. Approved credit lines totalled $1.3 million
at June 30, 1999, of which $694,000 was outstanding. Lines of credit are
originated at fixed interest rates for one year renewable terms.
A director of the Bank is a shareholder of a farm implement dealership that
has contracted with the Bank to provide sales financing to the dealership's
customers. The Bank does not grant preferential credit under this arrangement.
All sales contracts are presented to the Bank on a 50% recourse basis, with the
dealership responsible for the sale and disposition of any repossessed
equipment. During the fiscal year ended June 30, 1999, the Bank granted
approximately $768,000 of credit to customers of the dealership and such loans
had an aggregate outstanding balance of $1.4 million at June 30, 1999. At June
30, 1999, none of these loans were delinquent 30 days or more.
At June 30, 1999, the largest commercial business loan had an outstanding
balance of $788,000 and was unsecured. Such loan was performing according to its
terms at that date.
Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential and commercial real estate lending. Real estate
lending is generally considered to be collateral-based lending with loan amounts
based on predetermined loan-to-collateral values and liquidation of the
underlying real estate collateral is viewed as the primary source of repayment
in the event of borrower default. Although commercial business loans are often
collateralized by equipment, inventory, accounts receivable or other business
assets, the liquidation of collateral in the event of a borrower default is
often an insufficient source of repayment because accounts receivable may be
uncollectible and inventories and equipment may be obsolete or of limited use,
among other things. Accordingly, the repayment of a commercial business loan
depends primarily on the creditworthiness of the borrower (and any guarantors),
while liquidation of collateral is a secondary and often insufficient source of
repayment.
In 1993, the Bank purchased, without recourse, lease obligations originated
by Bennett Funding Group, Inc., Syracuse, New York ("Bennett Funding"). During
the fiscal year ended June 30, 1996, Bennett Funding filed for Chapter 11
bankruptcy protection after securities fraud and other violations were alleged
against it by the U.S. Attorney's Office and the Securities and Exchange
Commission. The Bank entered into a settlement agreement with Bennett Funding on
March 18, 1997. The Bank chose an option which allows for a maximum recovery of
approximately $158,000 (77.5%) of the aggregate outstanding balance. As of June
30, 1998, the Bank had recovered approximately $124,000, net of fees charged by
the bankruptcy trustee. During the fiscal year ended June 30, 1999, the Bank
charged- off the balance of the asset totaling $78,000 as no additional recovery
is expected.
As an incident to its commercial business lending activities, the Bank
issues standby letters of credit or performance bonds as an accommodation to its
borrowers.
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Consumer Loans. Consumer loans totalled $6.4 million at June 30, 1999, or
7.2% of the Bank's total loan portfolio. The Bank views consumer lending as an
important component of its business because consumer loans generally have
shorter terms and higher yields, thus reducing exposure to changes in interest
rates. In addition, the Bank believes that offering consumer loans expands and
creates stronger ties to its customer base. Subject to market conditions, the
Bank intends to expand its consumer lending activities.
The Bank offers a variety of secured or guaranteed consumer loans,
including automobile and truck loans (both new and used), home equity loans,
home improvement loans, student loans, boat loans, mobile home loans, and loans
secured by savings deposits. In addition, the Bank offers unsecured consumer
loans. Consumer loans are generally originated at fixed interest rates and for
terms not to exceed seven years. The largest portion of the Bank's consumer
loan portfolio consists of home equity and second mortgage loans ($3.0 million
at June 30, 1999) followed by automobile and truck loans ($1.6 million at June
30, 1999). Automobile and truck loans are originated on both new and used
vehicles. Such loans are generally originated at fixed interest rates for terms
up to seven years and at loan-to-value ratios up to 90% of the blue book value
in the case of used vehicles and 90% of the purchase price in the case of new
vehicles. The Bank does not engage in indirect automobile and truck lending.
Home equity and second mortgage loans are generally originated for terms
not to exceed 15 years and at fixed rates of interest. The loan-to-value ratio
on such loans is limited to 95%, taking into account the outstanding balance on
the first mortgage loan.
The Bank employs strict underwriting standards for consumer loans. These
procedures include an assessment of the applicant's payment history on other
debts and ability to meet existing obligations and payments on the proposed
loans. Although the applicant's creditworthiness is a primary consideration,
the underwriting process also includes a comparison of the value of the
security, if any, to the proposed loan amount. The Bank underwrites and
originates the majority of its consumer loans internally, which management
believes limits exposure to credit risks relating to loans underwritten or
purchased from brokers or other outside sources.
Consumer loans generally entail greater risk than do residential mortgage
loans, particularly in the case of consumer loans which are unsecured or secured
by assets that depreciate rapidly, such as automobiles. In the latter case,
repossessed collateral for a defaulted consumer loan may not provide an adequate
source of repayment for the outstanding loan and the remaining deficiency often
does not warrant further substantial collection efforts against the borrower.
In addition, consumer loan collections are dependent on the borrower's
continuing financial stability, and thus are more likely to be adversely
affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the
application of various federal and state laws, including federal and state
bankruptcy and insolvency laws, may limit the amount which can be recovered on
such loans. Such loans may also give rise to claims and defenses by the
borrower against the Bank as the holder of the loan, and a borrower may be able
to assert claims and defenses which it has against the seller of the underlying
collateral. Of the Bank's consumer loan portfolio, $19,000 was delinquent 30
days or more at June 30, 1999.
Loan Maturity and Repricing
The following table sets forth certain information at June 30, 1999
regarding the dollar amount of loans maturing in the Bank's portfolio based on
their contractual terms to maturity, but does not include potential prepayments.
Demand loans, loans having no stated schedule of repayments and no stated
maturity, and overdrafts are reported as due in one year or less. Loan balances
do not include undisbursed loan proceeds, unearned income and allowance for loan
losses.
<TABLE>
<CAPTION>
After After After After
One Year 3 Years 5 Years 10 Years
Within Through Through Through Through After
One Year 3 Years 5 Years 10 Years 15 Years 15 Years Total
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(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Mortgage loans:
Residential real estate..... $ 2,933 $ 5,546 $5,829 $19,901 $11,891 $17,431 $63,531
Commercial real estate...... 457 682 612 1,575 1,263 107 4,696
Residential construction.... 8,346 -- -- -- -- -- 8,346
Consumer loans.............. 2,749 2,109 1,006 407 122 19 6,412
Commercial business............ 2,361 1,678 1,078 456 8 26 5,607
------- ------- ------ ------- ------- ------- -------
Total gross loans........ $16,846 $10,015 $8,525 $22,339 $13,284 $17,583 $88,592
======= ======= ====== ======= ======= ======= =======
</TABLE>
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The following table sets forth the dollar amount of all loans due after
June 30, 2000, which have fixed interest rates and have floating or adjustable
interest rates.
<TABLE>
<CAPTION>
Floating- or
Fixed- Adjustable-
Rates Rates
-------- -----------
(In thousands)
<S> <C> <C>
Mortgage loans:
Residential............................. 47,643 12,955
Commercial real estate.................. 2,939 1,300
Consumer loans.......................... 3,663 --
Commercial business........................ 3,246 --
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Total gross loans.................... $57,491 $14,255
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</TABLE>
Loan Solicitation and Processing. A majority of the loans originated by
the Bank are made to existing customers. Walk-ins and customer referrals are
also an important source of loans originations. Upon receipt of a loan
application, a credit report is ordered to verify specific information relating
to the loan applicant's employment, income and credit standing. A loan
applicant's income is verified through the applicant's employer or from the
applicant's tax returns. In the case of a real estate loan, an appraisal of the
real estate intended to secure the proposed loan is undertaken, generally by an
independent appraiser approved by the Bank. The mortgage loan documents used by
the Bank conform to secondary market standards.
Individual loan officers have individual lending limits commensurate with
their experience. All loans in excess of $150,000 or that are an exception to
lending policy are approved by the Loan Committee, consisting of the Bank's
President, Vice President, Treasurer and Operations Officer. All loans in
excess of $500,000 must be approved by the Bank's Board of Directors.
The Bank's policy is to require borrowers to obtain certain types of
insurance to protect its interest in the collateral securing the loan. The Bank
requires either a title insurance policy insuring that the Bank has a valid
first lien on the mortgaged real estate or an opinion by an attorney regarding
the validity of title. Fire and casualty insurance is also required on
collateral for loans. The Bank requires escrows for insurance on all loans with
a loan-to-value exceeding 90%.
The Bank's lending practices generally limit the maximum loan to value
ratio on conventional residential mortgage loans to 90% (or 97% under a new
Freddie Mac program) of the appraised value of the property as determined by an
independent appraisal or the purchase price, whichever is less, and 80% for
commercial real estate loans.
Loan Commitments and Letters of Credit. The Bank issues commitments for
fixed- and adjustable-rate single-family residential mortgage loans conditioned
upon the occurrence of certain events. Such commitments are made in writing on
specified terms and conditions and are honored for up to 60 days from the date
of application, depending on the type of transaction. The Bank had outstanding
net loan commitments of approximately $1.9 million at June 30, 1999.
As an accommodation to its commercial business loan borrowers, the Bank
issues standby letters of credit or performance bonds usually in favor of
municipalities for whom its borrowers are performing services. At June 30,
1999, the Bank had outstanding letters of credit of $224,000.
Loan Origination and Other Fees. The Bank, in most instances, receives
loan origination fees and discount "points." Loan fees and points are a
percentage of the principal amount of the mortgage loan that are charged to the
borrower for funding the loan. The Bank usually charges origination fees of
0.5% to 3.0% on one- to four-family residential real estate loans, long-term
commercial real estate loans and residential construction loans. Current
accounting standards require loan origination fees and certain direct costs of
underwriting and closing loans to be deferred and amortized into interest income
over the contractual life of the loan. Deferred fees and costs associated with
loans that are sold are recognized as income at the time of sale. The Bank had
$204,000 of net deferred loan fees at June 30, 1999.
Delinquencies. The Bank's collection procedures provide for a series of
contacts with delinquent borrowers. A late charge is assessed and a late charge
notice is sent to the borrower after the 15th day of delinquency. A delinquency
notice is mailed to the borrower after the 30th day of delinquency. When
payment becomes 60 days past due, the Loan Collection Committee of the Board of
Directors generally meets and issues a default letter to the borrower. If a
loan continues in a delinquent status for 90 days or more, the Bank generally
initiates foreclosure proceedings. In certain instances, however, the Loan
Collection Committee may decide to modify the loan or grant a limited moratorium
on loan payments to enable the borrower to reorganize his financial affairs.
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Nonperforming Assets. Loans are reviewed regularly and when loans become
90 days delinquent, the loan is placed in nonaccrual status and the previously
accrued interest income is reversed. Typically, payments received on a
nonaccrual loan are applied to the outstanding principal and interest as
determined at the time of collection of the loan.
The following table sets forth information with respect to the Bank's
nonperforming assets for the periods indicated. At the dates indicated, the
Bank had no restructured loans within the meaning of SFAS No. 15 and no accruing
loans which were past due 90 days or more.
<TABLE>
<CAPTION>
At June 30,
------------------------------------
1999 1998
-------------- ------------
(In thousands)
<S> <C> <C>
Loans accounted for on a nonaccrual basis:
Residential real estate................................. $ -- $ 117
Residential construction................................ -- --
Commercial real estate.................................. -- 25
Commercial business..................................... -- 80
Consumer................................................ -- --
------------ ------------
Total................................................. -- 222
------------ ------------
Foreclosed real estate, net............................... -- 104
------------ ------------
Total nonperforming assets................................ $ -- $ 326
============ ============
Total loans delinquent 90 days or more to net loans....... --% 0.30%
Total loans delinquent 90 days or more to total assets.... --% 0.24%
Total nonperforming assets to total assets................ --% 0.35%
</TABLE>
The Bank does not accrue interest on loans over 90 days past due. However,
if interest on nonaccrual loans had been accrued, interest income of
approximately $11,000 would have been recorded for the year ended June 30, 1999.
The Bank received and recorded approximately $6,000 of interest income on
nonaccrual loans for the year ended June 30, 1999.
Classified Assets. The OTS has adopted various regulations regarding
problem assets of savings institutions. The regulations require that each
insured institution review and classify its assets on a regular basis. In
addition, in connection with examinations of insured institutions, OTS examiners
have authority to identify problem assets and, if appropriate, require them to
be classified. There are three classifications for problem assets:
substandard, doubtful and loss. Substandard assets have one or more defined
weaknesses and are characterized by the distinct possibility that the insured
institution will sustain some loss if the deficiencies are not corrected.
Doubtful assets have the weaknesses of substandard assets with the additional
characteristic that the weaknesses make collection or liquidation in full on the
basis of currently existing facts, conditions and values questionable, and there
is a high possibility of loss. An asset classified as loss is considered
uncollectible and of such little value that continuance as an asset of the
institution is not warranted. If an asset or portion thereof is classified as
loss, the insured institution establishes specific allowances for loan losses
for the full amount of the portion of the asset classified as loss. All or a
portion of general loan loss allowances established to cover possible losses
related to assets classified substandard or doubtful can be included in
determining an institution's regulatory capital, while specific valuation
allowances for loan losses generally do not qualify as regulatory capital.
Assets that do not currently expose the insured institution to sufficient risk
to warrant classification in one of the aforementioned categories but possess
weaknesses are designated "special mention" and monitored by the Bank.
On July 1, 1995, the Bank adopted SFAS No. 114, "Accounting by Creditors
for Impairment of a Loan," which requires that impaired loans be measured based
on the present value of expected future cash flows discounted at the loan's
effective interest rate, or if expedient, at the loan's observable market price
or the fair value of collateral if the loan is collateral dependent. A loan is
classified as impaired by management when, based on current information and
events, it is probable that the Bank will be unable to collect all amounts due
in accordance with the terms of the loan agreement. If the fair value, as
measured by one of these methods, is less than the recorded investment in the
impaired loan, the Bank establishes a valuation allowance with a provision
charged to expense. Management reviews the valuation of impaired loans on a
quarterly basis to consider changes due to the passage of time or revised
estimates. Assets that do
7
<PAGE>
not expose the Bank to risk sufficient to warrant classification in one of the
aforementioned categories, but which possess some weaknesses, are required to be
designated "special mention" by management.
An insured institution is required to establish and maintain an allowance
for loan losses at a level that is adequate to absorb estimated credit losses
associated with the loan portfolio, including binding commitments to lend.
General allowances represent loss allowances which have been established to
recognize the inherent risk associated with lending activities. When an insured
institution classifies problem assets as "loss," it is required either to
establish an allowance for losses equal to 100% of the amount of the assets, or
charge off the classified asset. The amount of its valuation allowance is
subject to review by the OTS which can order the establishment of additional
general loss allowances. The Bank regularly reviews the loan portfolio to
determine whether any loans require classification in accordance with applicable
regulations.
At June 30, 1999, 1998 and 1997 the aggregate amounts of the Bank's
classified assets, general loss allowances for the periods then ended, were as
follows:
<TABLE>
<CAPTION>
At June 30,
-------------------------------------
1999 1998
-------------- -------------
(In thousands)
<S> <C> <C>
Classified assets:
Loss.................................................. $ -- $ --
Doubtful (impaired)................................... -- 79
Substandard........................................... 63 293
General loss allowances:
Impaired loans....................................... -- 55
Other................................................ 482 461
</TABLE>
Foreclosed Real Estate. Foreclosed real estate held for sale is carried at
the lower of fair value minus estimated costs to sell, or cost. Costs of
holding foreclosed real estate are charged to expense in the current period,
except for significant property improvements, which are capitalized. Valuations
are periodically performed by management and an allowance is established by a
charge to non-interest expense if the carrying value exceeds the fair value
minus estimated costs to sell. The net income from operations of foreclosed
real estate held for sale is reported in non-interest income. At June 30, 1999,
the Bank had no foreclosed real estate.
Allowance for Loan Losses. Management evaluates the adequacy of the
allowance for losses on loans each year based on estimated losses on specific
loans and other procedures, including a review of all loans for which full
collectibility may not be reasonably assured and considers, among other matters,
the estimated market value of the underlying collateral of problem loans, prior
loss experience, economic conditions and overall portfolio quality. These
provisions for losses are charged against earnings in the year they are
established. The allowance for loan losses at June 30, 1999 was $482,000, or
0.54% of total loans outstanding, compared with $516,000 or 0.67% of total loans
outstanding, at June 30, 1998. Management's estimate of specific and inherent
credit losses in the loan portfolio as described above is intended to provide a
reasonable allowance for loan losses applicable to all loan categories. The
allowance for loan losses as a percentage of total loans outstanding as of the
end of a given period represents an estimated loss percentage for the total loan
portfolio and a general measure of adequacy. However, in accordance with GAAP,
management assigns an estimated loss percentage or a range of loss to each loan
category in estimating the total allowance for loan losses. Management's
estimate also includes specifically identified loans having potential losses.
It is management's assessment that the allowance for loan losses at June 30,
1999, 1998 and 1997 was adequate and represents a reasonable estimate of the
specific and inherent credit losses consistent with the composition of the loan
portfolio and credit quality trends.
Although management believes that it uses the best information available to
make such determinations, future adjustments to the allowance for loan losses
may be necessary and results of operations could be significantly and adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations. Furthermore, while the Bank believes it has
established its existing allowance for loan losses in accordance with GAAP,
there can be no assurance that regulators, in reviewing the Bank's loan
portfolio, will not request the Bank to increase significantly its allowance for
loan losses. In addition, because future events affecting borrowers and
collateral cannot be predicted with certainty, there can be no assurance that
the existing allowance for loan losses is adequate or that substantial increases
will not be necessary should the quality of any loans deteriorate as a result of
the factors discussed above. Any material increase in the allowance for loan
losses may adversely affect the Bank's financial condition and results of
operations.
8
<PAGE>
The following table sets forth an analysis of the Bank's allowance for loan
losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------
1999 1998
-------------- --------------
(Dollars in thousands)
<S> <C> <C>
Allowance at beginning of period........................ $ 516 $ 519
Provision for loan losses............................... 44 --
----- -----
560 519
----- -----
Recoveries:
Residential real estate................................ -- --
Commercial business.................................... -- --
Consumer............................................... -- --
----- -----
Total recoveries.................................... -- --
----- -----
Charge-offs:
Residential real estate................................ -- 2
Commercial business.................................... 78 --
Consumer............................................... -- 1
----- -----
Total charge-offs................................... 78 3
----- -----
Net charge-offs......................................... (78) (3)
----- -----
Allowance at end of period.............................. $ 482 $ 516
===== =====
Ratio of allowance to total loans outstanding at the
end of the period...................................... 0.54% 0.67%
Ratio of net charge-offs to average loans outstanding
during the period...................................... 0.10% --%
</TABLE>
Allowance for Loan Losses Analysis
The following table sets forth the breakdown of the allowance for loan
losses by loan category at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
----------------------------------------------------------
1999 1998
--------------------------- ---------------------------
Percent of Percent of
Outstanding Outstanding
Loans in Loans in
Amount Category Amount Category
------ ------------ ------ ------------
(Dollars in thousands) <C>
<S> <C> <C> <C>
Residential real estate(1).................... $ 228 81.13% $ 215 82.44%
Commercial real estate and land loans......... 82 5.30 36 5.92
Commercial business........................... 98 6.33 117 4.52
Consumer...................................... 74 7.24 32 7.12
Unallocated................................... -- -- 116 --
----- ------ ----- ------
Total allowance for $ 482 100.00% $ 516 100.00%
loan losses................................. ===== ====== ===== ======
</TABLE>
__________________
(1) Includes residential construction loans.
Investment Activities
Federally chartered savings institutions have authority to invest in
various types of liquid assets, including U.S. Treasury obligations, securities
of various federal agencies and of state and municipal governments, deposits at
the applicable FHLB, certificates of deposit of federally insured institutions,
certain bankers' acceptances and federal funds. Subject to various restrictions,
such savings institutions may also invest a portion of their assets in
commercial paper,
9
<PAGE>
corporate debt securities and mutual funds, the assets of which conform to the
investments that federally chartered savings institutions are otherwise
authorized to make directly. Savings institutions are also required to maintain
minimum levels of liquid assets which vary from time to time. The Bank may
decide to increase its liquidity above the required levels depending upon the
availability of funds and comparative yields on investments in relation to
return on loans.
The Bank is required under federal regulations to maintain a minimum amount
of liquid assets and is also permitted to make certain other securities
investments. The balance of the Bank's investments in short-term securities in
excess of regulatory requirements reflects management's response to the
significantly increasing percentage of deposits with short maturities. It is the
intention of management to hold securities with short maturities in the Bank's
investment portfolio in order to enable the Bank to match more closely the
interest-rate sensitivities of its assets and liabilities.
The Bank periodically invests in mortgage-backed securities, including
mortgage-backed securities guaranteed or insured by either Government National
Mortgage Association ("Ginnie Mae"), Fannie Mae or Freddie Mac. Mortgage-backed
securities generally increase the quality of the Bank's assets by virtue of the
guarantees that back them, are more liquid than individual mortgage loans and
may be used to collateralize borrowings or other obligations of the Bank. Of the
Bank's total mortgage-backed securities portfolio, securities with a book value
of $1.2 million have adjustable-rates as of June 30, 1999.
Investment decisions are made by the Investment Committee, consisting of
James G. Pendleton, Samuel E. Uhl and M. Chris Frederick. The Bank's investment
objectives are: (i) to provide and maintain liquidity within regulatory
guidelines; (ii) to maintain a balance of high quality, diversified investments
to minimize risk; (iii) to provide collateral for pledging requirements; (iv) to
serve as a balance to earnings; and (v) to maximize returns.
At June 30, 1999, neither the Company nor the Bank had no investment in
securities (other than U.S. Government and agency securities and mutual funds
that invest in such securities) which exceeded 10% of the Company's
stockholders' equity at that date.
10
<PAGE>
The following table sets forth the securities portfolio at the dates
indicated.
<TABLE>
<CAPTION>
At June 30,
----------------------------------------------------------------------------
1999 1998
---------------------------------------------------- -------------------
Percent Weighted
Fair Amortized of Average Fair Amortized
Value Cost Portfolio Yield(2) Value Cost
------------ --------- ---------- --------- ------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Securities Held to Maturity (1)
Debt securities:
U.S. agency:
Due after one year through five years........... $ -- $ -- -- $1,493 $1,500
Due after five years through ten years.......... 8,320 8,480 28.15% 6.43% -- --
Due after ten years through fifteen years....... -- -- -- -- --
Municipal:
Due in one year or less......................... -- -- -- 80 80
Due after one year through five years........... -- -- -- -- --
Mortgage-backed securities (3)..................... 743 767 2.55% 6.51% 1,463 1,473
------- ------- ----- ------ ------
$ 9,063 $ 9,247 30.70% $3,036 $3,053
======= ======= ===== ====== ======
Securities Available for Sale
Debt securities:
U.S. agency:
Due after five years through ten years......... $10,655 $11,000 36.51% 6.17% -- --
Due after ten years through fifteen years...... 2,864 3,000 9.96% 6.70% 4,002 4,000
Mortgage-backed securities (3)................. 4,487 4,583 15.21% 6.06% -- --
Municipal:
Due after five years through ten years......... 618 655 2.17% 4.15% -- --
Due after ten years............................ 596 638 2.12% 4.60% -- --
Equity securities:
Mutual fund (4)................................ 985 1,003 3.33% N/A 847 844
------- ------- ----- ------ ------
$20,205 $20,879 69.30% $4,849 $4,844
======= ======= ===== ====== ======
<CAPTION>
---------------------------------
Percent Weighted
of Average
Portfolio Yield(2)
-------------- ------------
<S> <C> <C>
Securities Held to Maturity (1)
Debt securities:
U.S. agency:
Due after one year through five years........... 19.00% 4.53%
Due after five years through ten years.......... -- --
Due after ten years through fifteen years....... -- --
Municipal:
Due in one year or less......................... 1.01 3.90
Due after one year through five years........... -- --
Mortgage-backed securities (3)..................... 18.65 6.74
-----
38.66%
=====
Securities Available for Sale
Debt securities:
U.S. agency:
Due after five years through ten years......... -- --
Due after ten years through fifteen years...... 50.65 7.01
Mortgage-backed securities (3)................. -- --
Municipal:
Due after five years through ten years......... -- --
Due after ten years............................ -- --
Equity securities:
Mutual fund (4)................................ 10.69 N/A
-----
61.34%
=====
</TABLE>
________________________________
(1) Securities held to maturity are carried at amortized cost.
(2) Yields are calculated on a fully taxable equivalent basis using a marginal
federal income tax rate of 34%.
(3) The expected maturities of mortgage-backed securities may differ from
contractual maturities because the mortgages underlying the obligations may
be prepaid without penalty.
(4) The mutual fund invests primarily in U.S. Government agency securities.
11
<PAGE>
Deposit Activities and Other Sources of Funds
General. Deposits and loan repayments are the major source of the Bank's
funds for lending and other investment purposes. Loan repayments are a
relatively stable source of funds, while deposit inflows and outflows and loan
prepayments are significantly influenced by general interest rates and money
market conditions. Borrowing may be used on a short-term basis to compensate for
reductions in the availability of funds from other sources or may also be used
on a longer term basis for general business purposes.
Deposit Accounts. Deposits are attracted from within the Bank's primary
market area through the offering of a broad selection of deposit instruments,
including negotiable order of withdrawal ("NOW") accounts, money market
accounts, regular savings accounts, certificates of deposit and retirement
savings plans. Deposit account terms vary, according to the minimum balance
required, the time periods the funds must remain on deposit and the interest
rate, among other factors. In determining the terms of its deposit accounts, the
Bank considers the rates offered by its competition, profitability to the Bank,
matching deposit and loan products and its customer preferences and concerns.
The Bank generally reviews its deposit mix and pricing weekly.
The following table presents the maturity distributions of time deposits of
$100,000 or more as of June 30, 1999.
<TABLE>
<CAPTION>
Maturity Period Amount
--------------- ---------------
(In thousands)
<S> <C>
Three months or less................................. $ 2,107
Over three through six months........................ 2,075
Over six through 12 months........................... 2,633
Over twelve months................................... 5,974
-------
Total............................................. $12,789
=======
</TABLE>
The following table sets forth the balances of savings deposits in the
various types of savings accounts offered by the Bank at the dates indicated.
<TABLE>
<CAPTION>
At June 30,
-----------------------------------------------------------------------
1999 1998
---------------------------------------- ----------------------------
Percent Percent
of Increase of
Amount Total (Decrease) Amount Total
-------- --------- ---------- ------------ ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Non-interest-bearing demand....................... $ 4,093 4.45% $ 997 $ 3,096 4.00%
NOW accounts...................................... 11,897 12.93 858 11,039 14.24
Cash management................................... 88 0.10 4 84 0.11
Regular savings accounts.......................... 5,867 6.38 1,062 4,805 6.20
Money market accounts............................. 20,574 22.36 10,127 10,447 13.49
90-day passbooks.................................. 242 0.26 24 218 0.28
Fixed rate time deposits which mature:
Within one year................................ 21,434 23.29 1,856 19,578 25.28
After one year, but
within three years............................ 18,910 20.55 (1,600) 20,510 26.48
After three years, but
within five years.............................. 7,717 8.39 1,080 6,637 8.57
After five years................................ 1,045 1.13 47 998 1.29
Club accounts..................................... 147 0.16 97 50 0.06
------- ------ ------- ------- ------
Total........................................ $92,014 100.00% $14,552 $77,462 100.00%
======= ====== ======= ======= ======
</TABLE>
12
<PAGE>
The following table sets forth the amount and maturities of time deposits
by rates at June 30, 1999.
<TABLE>
<CAPTION>
Amount Due
----------------------------------------------------------
Percent
of Total
Less Than 1 - 3 3-5 After 5 Time
One Year Years Years Years Total Deposits
--------- ------- ------ ------- ------- --------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Below 5.00%....................... $ 7,670 $ 5,689 $1,112 $ 188 $14,659 29.85%
5.00% -- 5.99%................... 6,653 8,172 3,892 95 18,812 38.31
6.00% -- 6.99%................... 4,988 3,441 2,535 415 11,380 23.18
7.00% -- 7.99%................... 1,853 185 138 347 2,523 5.14
8.00% -- 8.99%................... 90 837 40 -- 967 1.97
9.00% -- 9.99%................... 180 585 -- -- 764 1.55
------- ------- ------ ------ ------- ------
Total........................... $21,434 $18,910 $7,717 $1,045 $49,106 100.00%
======= ======= ====== ====== ======= ======
</TABLE>
The following table sets forth the deposit activity of the Bank for the
periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
---------------------
1999 1998
------- -------
(In thousands)
<S> <C> <C>
Beginning balance............................................................ $77,462 $70,756
------- -------
Net increase (decrease) before interest credited............................. 11,187 3,622
Interest credited............................................................ 3,365 3,084
------- -------
Net increase (decrease) in deposits.......................................... 14,552 6,706
------- -------
Ending balance............................................................... $92,014 $77,462
======= =======
</TABLE>
Borrowings. Deposits are the primary source of funds for the Bank's lending
and investment activities and for its general business purposes. The Bank has at
times relied upon advances from the FHLB of Indianapolis to supplement its
supply of lendable funds and to meet deposit withdrawal requirements. Advances
from the FHLB of Indianapolis are secured by certain first mortgage loans and
investment and mortgage-backed securities. At June 30, 1999, the Bank had
advances from the FHLB of Indianapolis of $12.3 million.
The FHLB functions as a central reserve bank providing credit for savings
and loan associations and certain other member financial institutions. As a
member, the Bank is required to own capital stock in the FHLB and is authorized
to apply for advances on the security of such stock and certain of its mortgage
loans and other assets (principally securities which are obligations of, or
guaranteed by, the United States) provided certain standards related to
creditworthiness have been met. Advances are made pursuant to several different
programs. Each credit program has its own interest rate and range of maturities.
Depending on the program, limitations on the amount of advances are based either
on a fixed percentage of an institution's net worth or on the FHLB's assessment
of the institution's creditworthiness. Under its current credit policies, the
FHLB generally limits advances to 20% of a member's assets, and short-term
borrowing of less than one year may not exceed 10% of the institution's assets.
The FHLB determines specific lines of credit for each member institution.
13
<PAGE>
The following table sets forth certain information regarding borrowings by
the Bank at the end of and during the periods indicated:
<TABLE>
<CAPTION>
At or For the Year
Ended June 30,
---------------------------------
1999 1998
------- --------
(In thousands)
<S> <C> <C>
Maximum amount of FHLB advances
outstanding at any month end.................................................. $12,250 $6,250
Approximate average FHLB advances outstanding.................................. 7,528 4,874
Year end balance of FHLB advances outstanding.................................. 12,250 5,250
Approximate weighted average rate paid on
FHLB advances at end of year.................................................. 5.45% 5.54%
Approximate weighted average rate paid on
FHLB advances during year..................................................... 5.55% 6.24%
</TABLE>
Subsidiary Activities
As of June 30, 1999, the Bank was the Company's only subsidiary, and was
wholly-owned by the Company. The Bank has no subsidiaries.
Personnel
As of June 30, 1999, the Bank had 33 full-time employees and 8 part-time
employees. The employees are not represented by a collective bargaining unit and
the Bank considers its relationship with its employees to be good.
REGULATION AND SUPERVISION
General
As a savings and loan holding company, the Company is required by federal
law to file reports with, and otherwise comply with, the rules and regulations
of the OTS. The Bank is subject to extensive regulation, examination and
supervision by the OTS as its chartering agency and the FDIC, as the deposit
insurer. The activities of federal savings institutions are governed by the Home
Owners' Loan Act, as amended ("HOLA") and, in certain respects, the Federal
Deposit Insurance Act ("FDIA") and the regulations issued by the OTS and FDIC to
implement these statutes. The Bank must file reports with the OTS and the FDIC
concerning its activities and financial condition in addition to obtaining
regulatory approvals prior to entering into certain transactions such as mergers
with, or acquisitions of, other savings institutions. The OTS and the FDIC
conduct periodic examinations to test the Bank's safety and soundness and
compliance with various regulatory requirements. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the insurance fund and
depositors. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement
activities and examination policies, including policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. Any change in such regulatory requirements and
policies, whether by the OTS, the FDIC or the Congress, could have a material
adverse impact on the Company, the Bank and their operations. Certain of the
regulatory requirements applicable to the Bank and to the Company are referred
to below or elsewhere herein. The description of statutory provisions and
regulations applicable to savings institutions and their holding companies set
forth in this Form 10-KSB does not purport to be a complete description of such
statutes and regulations and their effects on the Bank and the Company.
14
<PAGE>
Holding Company Regulation
The Company is a non-diversified unitary savings and loan holding company
within the meaning of federal law. As a unitary savings and loan holding
company, the Company generally is not restricted under existing laws as to the
types of business activities in which it may engage, provided that the Bank
continues to be a qualified thrift lender. See "Federal Savings Institution
Regulation--QTL Test." Upon any non-supervisory acquisition by the Company of
another savings institution or savings bank that meets the qualified thrift
lender test and is deemed to be a savings institution by the OTS, the Company
would become a multiple savings and loan holding company (if the acquired
institution is held as a separate subsidiary) and would generally be limited to
activities permissible for bank holding companies under Section 4(c)(8) of the
Bank Holding Company Act, subject to the prior approval of the OTS, and certain
activities authorized by OTS regulation.
A savings and loan holding company is prohibited from, directly or
indirectly, acquiring more than 5% of the voting stock of another savings
institution or savings and loan holding company, without prior written approval
of the OTS and from acquiring or retaining control of a depository institution
that is not insured by the FDIC. In evaluating applications by holding companies
to acquire savings institutions, the OTS considers the financial and managerial
resources and future prospects of the company and institution involved, the
effect of the acquisition on the risk to the deposit insurance funds, the
convenience and needs of the community and competitive factors.
The OTS may not approve any acquisition that would result in a multiple
savings and loan holding company controlling savings institutions in more than
one state, subject to two exceptions: (i) the approval of interstate supervisory
acquisitions by savings and loan holding companies and (ii) the acquisition of a
savings institution in another state if the laws of the state of the target
savings institution specifically permit such acquisitions. The states vary in
the extent to which they permit interstate savings and loan holding company
acquisitions.
Although savings and loan holding companies are not subject to specific
capital requirements or specific restrictions on the payment of dividends or
other capital distributions, federal regulations do prescribe such restrictions
on subsidiary savings institutions as described below. The Bank must notify the
OTS 30 days before declaring any dividend to the Company. In addition, the
financial impact of a holding company on its subsidiary institution is a matter
that is evaluated by the OTS and the agency has authority to order cessation of
activities or divestiture of subsidiaries deemed to pose a threat to the safety
and soundness of the institution.
Federal Savings Institution Regulation
Business Activities. The activities of federal savings institutions are
governed by federal law and regulations. These laws and regulations delineate
the nature and extent of the activities in which federal associations may
engage. In particular, many types of lending authority for federal associations,
e.g., commercial, non-residential real property loans and consumer loans, are
limited to a specified percentage of the institution's capital or assets.
Capital Requirements. The OTS capital regulations require savings
institutions to meet three minimum capital standards: a 1.5% tangible capital
ratio, a 3% leverage ratio and an 8% risk-based capital ratio. In addition, the
prompt corrective action standards discussed below also establish, in effect, a
minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions
receiving the highest rating on the CAMEL financial institution rating system),
and, together with the risk-based capital standard itself, a 4% Tier 1 risk-
based capital standard. The OTS regulations also require that, in meeting the
tangible, leverage and risk-based capital standards, institutions must generally
deduct investments in and loans to subsidiaries engaged in activities as
principal that are not permissible for a national bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier 1 (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, are multiplied by a risk-weight
factor of 0% to 100%, assigned by the OTS capital regulation based on the risks
believed inherent in the type of asset. Core (Tier 1) capital is defined as
common stockholders' equity (including retained earnings), certain non-
cumulative perpetual preferred stock and related surplus, and minority interests
in equity accounts of consolidated subsidiaries less intangibles other than
certain mortgage servicing rights and credit card relationships. The components
of supplementary capital currently include cumulative preferred stock, long-term
perpetual preferred stock, mandatory convertible securities, subordinated debt
and intermediate preferred stock and the allowance for loan and lease losses
limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of
supplementary capital included as part of total capital cannot exceed 100% of
core capital.
15
<PAGE>
The capital regulations also incorporate an interest rate risk component.
Savings institutions with "above normal" interest rate risk exposure are subject
to a deduction from total capital for purposes of calculating their risk-based
capital requirements. For the present time, the OTS has deferred implementation
of the interest rate risk component. At June 30, 1999, the Bank met each of its
capital requirements.
Prompt Corrective Regulatory Action. The OTS is required to take certain
supervisory actions against undercapitalized institutions, the severity of which
depends upon the institution's degree of undercapitalization. Generally, a
savings institution that has a ratio of total capital to risk weighted assets of
less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less
than 4% or a ratio of core capital to total assets of less than 4% (3% or less
for institutions with the highest examination rating) is considered to be
"undercapitalized." A savings institution that has a total risk-based capital
ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio
that is less than 3% is considered to be "significantly undercapitalized" and a
savings institution that has a tangible capital to assets ratio equal to or less
than 2% is deemed to be "critically undercapitalized." Subject to a narrow
exception, the OTS is required to appoint a receiver or conservator for an
institution that is "critically undercapitalized." The regulation also provides
that a capital restoration plan must be filed with the OTS within 45 days of the
date a savings institution receives notice that it is "undercapitalized,"
"significantly undercapitalized" or "critically undercapitalized." Compliance
with the plan must be guaranteed by any parent holding company. In addition,
numerous mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion. The OTS could also take any one of a number of discretionary
supervisory actions, including the issuance of a capital directive and the
replacement of senior executive officers and directors.
Insurance of Deposit Accounts. Deposits of the Bank are presently insured
by the SAIF. The FDIC maintains a risk-based assessment system by which
institutions are assigned to one of three categories based on their
capitalization and one of three subcategories based on examination ratings and
other supervisory information. An institution's assessment rate depends upon the
categories to which it is assigned. Assessment rates for SAIF member
institutions are determined semiannually by the FDIC and currently range from
zero basis points for the healthiest institutions to 27 basis points for the
riskiest.
In addition to the assessment for deposit insurance, institutions are
required to make payments on bonds issued in the late 1980's by the Financing
Corporation ("FICO") to recapitalize the predecessor to the SAIF. During 1998,
FICO payments for SAIF members approximated 6.10 basis points, while Bank
Insurance Fund ("BIF") members paid 1.22 basis points. By law, there will be
equal sharing of FICO payments between SAIF and BIF members on the earlier of
January 1, 2000 or the date the SAIF and BIF are merged.
The Bank's assessment rate for fiscal 1999 ranged from 5.8 to 6.1 basis
points and total premiums paid for this period were $47,000. The FDIC has
authority to increase insurance assessments. A significant increase in SAIF
insurance premiums would likely have an adverse effect on the operating expenses
and results of operations of the Bank. Management cannot predict what insurance
assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that the
institution has engaged in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC or the OTS. The
management of the Bank does not know of any practice, condition or violation
that might lead to termination of deposit insurance.
Thrift Rechartering Legislation. Legislation enacted in 1996 provided that
the BIF and SAIF were to have merged on January 1, 1999 if there were no more
savings associations as of that date. Various proposals to eliminate the federal
savings association charter, create a uniform financial institutions charter,
abolish the OTS and restrict savings and loan holding company activities have
been introduced in Congress. The Bank is unable to predict whether such
legislation will be enacted or the extent to which the legislation would
restrict or disrupt its operations.
Loans to One Borrower. Federal law provides that savings institutions are
generally subject to the limits on loans to one borrower applicable to national
banks. A savings institution may not make a loan or extend credit to a single or
related group of borrowers in excess of 15% of its unimpaired capital and
surplus. An additional amount may be lent, equal to 10% of unimpaired capital
and surplus, if secured by specified readily-marketable collateral. At June 30,
1999, the Bank's limit on loans to one borrower was $3.7 million, and the Bank's
largest aggregate outstanding balance of loans to one borrower was $939,000.
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QTL Test. The HOLA requires savings institutions to meet a qualified thrift
lender test. Under the test, a savings association is required to either qualify
as a "domestic building and loan association" under the Internal Revenue Code or
maintain at least 65% of its "portfolio assets" (total assets less: (i)
specified liquid assets up to 20% of total assets; (ii) intangibles, including
goodwill; and (iii) the value of property used to conduct business) in certain
"qualified thrift investments" (primarily residential mortgages and related
investments, including certain mortgage-backed securities) in at least 9 months
out of each 12 month period.
A savings institution that fails the qualified thrift lender test is
subject to certain operating restrictions and may be required to convert to a
bank charter. As of June 30, 1999, the Bank maintained 71.5% of its portfolio
assets in qualified thrift investments and, therefore, met the qualified thrift
lender test. Recent legislation has expanded the extent to which education
loans, credit card loans and small business loans may be considered "qualified
thrift investments."
Limitation on Capital Distributions. OTS regulations impose limitations
upon all capital distributions by a savings institution, including cash
dividends, payments to repurchase its shares and payments to shareholders of
another institution in a cash-out merger. The rule effective in 1998 established
three tiers of institutions based primarily on an institution's capital level.
An institution that exceeded all capital requirements before and after a
proposed capital distribution ("Tier 1 Association") and had not been advised by
the OTS that it was in need of more than normal supervision, could, after prior
notice but without obtaining approval of the OTS, make capital distributions
during the calendar year equal to the greater of (i) 100% of its net earnings to
date during the calendar year plus the amount that would reduce by one-half the
excess capital over its capital requirements at the beginning of the calendar
year or (ii) 75% of its net income for the previous four quarters. Any
additional capital distributions required prior regulatory approval. At June 30,
1999, the Bank was a Tier 1 Association. Effective April 1, 1999, the OTS's
capital distribution regulation changed. Under the new regulation, an
application to and the prior approval of the OTS will be required prior to any
capital distribution if the institution does not meet the criteria for
"expedited treatment" of applications under OTS regulations (i.e., generally,
examination ratings in the two top categories), the total capital distributions
for the calendar year exceed net income for that year plus the amount of
retained net income for the preceding two years, the institution would be
undercapitalized following the distribution or the distribution would otherwise
be contrary to a statute, regulation or agreement with OTS. If an application is
not required, the institution must still provide prior notice to OTS of the
capital distribution. In the event the Bank's capital fell below its regulatory
requirements or the OTS notified it that it was in need of more than normal
supervision, the Bank's ability to make capital distributions could be
restricted. In addition, the OTS could prohibit a proposed capital distribution
by any institution, which would otherwise be permitted by the regulation, if the
OTS determines that such distribution would constitute an unsafe or unsound
practice.
Liquidity. The Bank is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a specified
percentage of its net withdrawable deposit accounts plus short-term borrowings.
This liquidity requirement is currently 4%, but may be changed from time to time
by the OTS to any amount within the range of 4% to 10%. Monetary penalties may
be imposed for failure to meet these liquidity requirements. The Bank's
liquidity ratio for June 30, 1999 was 9.5%, which exceeded the applicable
requirements. The Bank has never been subject to monetary penalties for failure
to meet its liquidity requirements.
Assessments. Savings institutions are required to pay assessments to the
OTS to fund the agency's operations. The general assessments, paid on a semi-
annual basis, are computed upon the savings institution's total assets,
including consolidated subsidiaries, as reported in the Bank's latest quarterly
thrift financial report. The assessments paid by the Bank for the fiscal year
ended June 30, 1999 totaled $29,000.
Transactions with Related Parties. The Bank's authority to engage in
transactions with "affiliates" (e.g., any company that controls or is under
common control with an institution, including the Company and its non-savings
institution subsidiaries) is limited by federal law. The aggregate amount of
covered transactions with any individual affiliate is limited to 10% of the
capital and surplus of the savings institution. The aggregate amount of covered
transactions with all affiliates is limited to 20% of the savings institution's
capital and surplus. Certain transactions with affiliates are required to be
secured by collateral in an amount and of a type described in federal law. The
purchase of low quality assets from affiliates is generally prohibited. The
transactions with affiliates must be on terms and under circumstances that are
at least as favorable to the institution as those prevailing at the time for
comparable transactions with non-affiliated companies. In addition, savings
institutions are prohibited from lending to any affiliate that is engaged in
activities that are not permissible for bank holding companies and no savings
institution may purchase the securities of any affiliate other than a
subsidiary.
The Bank's authority to extend credit to executive officers, directors and
10% shareholders ("insiders"), as well as entities such persons control, is also
governed by federal law. Such loans are required to be made on terms
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substantially the same as those offered to unaffiliated individuals and not
involve more than the normal risk of repayment. Recent legislation created an
exception for loans made pursuant to a benefit or compensation program that is
widely available to all employees of the institution and does not give
preference to insiders over other employees. The law limits both the individual
and aggregate amount of loans the Bank may make to insiders based, in part, on
the Bank's capital position and requires certain board approval procedures to be
followed.
Enforcement. The OTS has primary enforcement responsibility over savings
institutions and has the authority to bring actions against the institution and
all institution-affiliated parties, including stockholders, and any attorneys,
appraisers and accountants who knowingly or recklessly participate in wrongful
action likely to have an adverse effect on an insured institution. Formal
enforcement action may range from the issuance of a capital directive or cease
and desist order to removal of officers and/or directors to institution of
receivership, conservatorship or termination of deposit insurance. Civil
penalties cover a wide range of violations and can amount to $25,000 per day, or
even $1 million per day in especially egregious cases. The FDIC has the
authority to recommend to the Director of the OTS that enforcement action to be
taken with respect to a particular savings institution. If action is not taken
by the Director, the FDIC has authority to take such action under certain
circumstances. Federal law also establishes criminal penalties for certain
violations.
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines prescribing Standards for Safety and Soundness.
The guidelines set forth the safety and soundness standards that the federal
banking agencies use to identify and address problems at insured depository
institutions before capital becomes impaired. If the OTS determines that a
savings institution fails to meet any standard prescribed by the guidelines, the
OTS may require the institution to submit an acceptable plan to achieve
compliance with the standard.
Federal Home Loan Bank System
The Bank is a member of the FHLB System, which consists of 12 regional
FHLBs. The FHLB provides a central credit facility primarily for member
institutions. The Bank, as a member of the FHLB, is required to acquire and
hold shares of capital stock in that FHLB in an amount at least equal to 1.0% of
the aggregate principal amount of its unpaid residential mortgage loans and
similar obligations at the beginning of each year, or 1/20 of its advances
(borrowings) from the FHLB, whichever is greater. The Bank was in compliance
with this requirement with an investment in FHLB stock at June 30, 1999, of
$662,500. FHLB advances must be secured by specified types of collateral
and all long-term advances may only be obtained for the purpose of providing
funds for residential housing finance.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to their
members and could also result in the FHLBs imposing a higher rate of interest on
advances to their members. If dividends were reduced, or interest on future
FHLB advances increased, the Bank's net interest income would likely also be
reduced.
Federal Reserve System
The Federal Reserve Board regulations require savings institutions to
maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The regulations generally
provide that reserves be maintained against aggregate transaction accounts as
follows: for accounts aggregating $46.5 million or less (subject to adjustment
by the Federal Reserve Board) the reserve requirement is 3%; and for accounts
aggregating greater than $46.5 million, the reserve requirement is $1.395
million plus 10% (subject to adjustment by the Federal Reserve Board between 8%
and 14%) against that portion of total transaction accounts in excess of $46.5
million. The first $4.9 million of otherwise reservable balances (subject to
adjustments by the Federal Reserve Board) are exempted from the reserve
requirements. The Bank complies with the foregoing requirements.
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FEDERAL AND STATE TAXATION
Federal Taxation
General. The Company and the Bank report their income on a fiscal year
basis using the accrual method of accounting and will be subject to federal
income taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company. The Bank has not been audited by the IRS in the past five
years.
Bad Debt Reserve. For taxable years beginning after December 31, 1995, the
Bank is entitled to take a bad debt deduction for federal income tax purposes
which is based on its current or historic net charge-offs. For tax years
beginning prior to December 31, 1995, the Bank as a qualifying thrift had been
permitted to establish a reserve for bad debts and to make annual additions to
such reserve, which were deductible for federal income tax purposes. Under such
prior tax law, generally the Bank recognized a bad debt deduction equal to 8% of
taxable income.
Under the 1996 Tax Act, the Bank is required to recapture all or a portion
of its additions to its bad debt reserve made subsequent to the base year (which
is the Bank's last taxable year beginning before January 1, 1988). This
recapture is required to be made, after a deferral period based on certain
specified criteria, ratably over a six-year period commencing in the Bank's
calendar 1998 tax year. The Bank, in fiscal 1997, recorded a deferred tax
liability for this bad debt recapture. As a result, the recapture is not
anticipated to effect the Bank's future net income or federal income tax expense
for financial reporting purposes.
Potential Recapture of Base Year Bad Debt Revenue. The Bank's bad debt
reserve as of the base year is not subject to automatic recapture as long as the
Bank continues to carry on the business of banking. If the Bank no longer
qualifies as a bank, the balance of the pre-1988 reserves (the base year
reserves) are restored to income over a six-year period beginning in the tax
year the Bank no longer qualifies as a bank. Such base year bad debt reserve is
subject to recapture to the extent that the Bank makes "non-dividend
distributions" that are considered as made from the base year bad debt. To the
extent that such reserves exceed the amount that would have been allowed under
the experience method ("Excess Distributions"), then an amount based on the
amount distributed will be included in the Bank's taxable income. Non-dividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, distributions in redemption of stock, and
distributions in partial or complete liquidation. However, dividends paid out
of the Bank's current or accumulated earnings and profits, as calculated for
federal income tax purposes, will not be considered to result in a distribution
from the Bank's bad debt reserve. Thus, any dividends to the Company that would
reduce amounts appropriated to the Bank's bad debt reserve and deducted for
federal income tax purposes would create a tax liability for the Bank. The
amount of additional taxable income created from an Excess Distribution is an
amount that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Thus, if, after the Conversion, the Bank makes a
"non-dividend distribution," then approximately one and one-half times the
amount so used would be includable in gross income for federal income tax
purposes, assuming a 34% corporate income tax rate (exclusive of state and local
taxes). The Bank does not intend to pay dividends that would result in a
recapture of any portion of its bad debt reserve.
Corporate Alternative Minimum Tax. The Code imposes a tax on alternative
minimum taxable income ("AMTI") at a rate of 20%. The excess of the bad debt
reserve deduction claimed by the Bank over the deduction that would have been
allowable under the experience method is treated as a preference item for
purposes of computing the AMTI. Only 90% of AMTI can be offset by net operating
loss carryovers of which the Bank currently has none. AMTI is increased by an
amount equal to 75% of the amount by which the Bank's adjusted current earnings
exceeds its AMTI (determined without regard to this preference and prior to
reduction for net operating losses). In addition, for taxable years beginning
after June 30, 1986 and before January 1, 1996, an environmental tax of 0.12% of
the excess of AMTI (with certain modifications) over $2.0 million is imposed on
corporations, including the Bank, whether or not an Alternative Minimum Tax
("AMT") is paid. The Bank does not expect to be subject to the AMT.
Dividends Received Deduction and Other Matters. The Company may exclude
from its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank own more than 20% of the stock of a
corporation distributing a dividend then 80% of any dividends received may be
deducted.
Indiana Taxation
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Indiana imposes an 8.5% franchise tax based on a financial institution's
adjusted gross income as defined by statute. In computing adjusted gross
income, deductions for municipal interest, U.S. Government interest, the bad
debt deduction computed using the reserve method and pre-1990 net operating
losses are disallowed. The Bank's state income tax returns were audited for the
years ended June 30, 1993, 1994 and 1995 without amendment and without
additional tax liability. The Bank's state income tax returns have not been
audited for any subsequent period.
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SIGNATURES
Pursuant to the requirements of section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amended report to be
signed on its behalf by the undersigned, thereunto duly authorized.
FIRST CAPITAL, INC.
Date: September 21, 1999 By: /s/ James G. Pendleton
--------------------------------
James G. Pendleton
Chairman of the Board and
Chief Executive Officer
(Duly Authorized Representative)
