<PAGE> 1
Filed pursuant to Rule 424(b)(1)
Registration No. 333-63369
1,450,000 SHARES
MEGABANK FINANCIAL CORPORATION
MEGABANK LOGO
COMMON STOCK
Of the 1,450,000 shares of Common Stock offered hereby (the "Offering"),
1,200,000 shares are being offered by MegaBank Financial Corporation (the
"Company") and 250,000 shares are being offered by Thomas R. Kowalski, the
Company's Chairman and Chief Executive Officer (the "Selling Shareholder"). See
"Principal and Selling Shareholders."
Prior to the Offering, there has been no public market for the Common
Stock. For information relating to the determination of the initial public
offering price of the Common Stock, see "Underwriting." The Company's Common
Stock has been approved for inclusion on the Nasdaq National Market(R) under the
symbol "MBFC."
SEE "RISK FACTORS" BEGINNING ON PAGE 6 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK.
------------------------
THE SHARES OF COMMON STOCK OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS OR DEPOSITS
AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE BANK
INSURANCE FUND, THE SAVINGS ASSOCIATION INSURANCE FUND OR ANY OTHER GOVERNMENT
AGENCY.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
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PROCEEDS TO
PRICE TO UNDERWRITING PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) STOCKHOLDER(2)
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<S> <C> <C> <C> <C>
Per Share.............. $11.00 $0.77 $10.23 $10.23
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Total(3)............... $15,950,000 $1,116,500 $12,276,000 $2,557,500
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</TABLE>
(1) See "Underwriting" for information concerning indemnification arrangements
with the Underwriters.
(2) Before deducting expenses of the Offering payable by the Company estimated
at $300,000 and by the Selling Shareholder estimated at $5,000.
(3) The Company and the Selling Shareholder have granted the Underwriters a
30-day option to purchase up to an additional 192,500 shares and 25,000
shares of Common Stock, respectively, solely to cover over-allotments, if
any, on the same terms and conditions as shown above. If such option is
exercised in full, the total Price to Public, Underwriting Discount and
Proceeds to Company and Proceeds to Selling Shareholder will be $18,342,500,
$1,283,975, $14,245,275, and $2,813,250, respectively.
The shares of Common Stock are offered hereby severally by the Underwriters
named herein, subject to receipt and acceptance by them and subject to the right
to reject any order in whole or in part. See "Underwriting." It is anticipated
that delivery of the shares of Common Stock will be made against payment
therefor on or about November 20, 1998.
------------------------
HOWE BARNES INVESTMENTS, INC.
November 16, 1998
<PAGE> 2
[MEGABANK LOGO]
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS IN SUCH
COMMON STOCK, AND THE IMPOSITION OF A PENALTY BID, IN CONNECTION WITH THE
OFFERING. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
------------------------
IN CONNECTION WITH THE OFFERING, CERTAIN PERSONS MAY ENGAGE IN PASSIVE
MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET(R)
IN ACCORDANCE WITH RULE 103 UNDER REGULATION M.
------------------------
The Company intends to furnish its shareholders with annual reports
containing audited financial statements, together with a report from its
independent auditors, and quarterly reports for the first three quarters of each
fiscal year containing unaudited financial information. The Company is a
reporting company under the Securities Exchange Act of 1934. See "Available
Information."
2
<PAGE> 3
PROSPECTUS SUMMARY
This summary should be read in conjunction with, and is qualified in its
entirety by, the more detailed information, including "Risk Factors" and the
Consolidated Financial Statements and related notes included elsewhere in this
Prospectus. Unless otherwise indicated, all information in this Prospectus (i)
gives effect to the 30-for-1 stock split of the Company's Common Stock (the
"Common Stock"), effected in September 1998, (ii) assumes that the Underwriters'
over-allotment option is not exercised, and (iii) for purposes of regulatory
disclosure, gives effect to the Company's and Bank's conversion to a unitary
thrift holding company and federal savings bank, respectively, effected in
September 1998.
THE COMPANY
MegaBank Financial Corporation (the "Company") was founded in 1984 by its
Chairman and Chief Executive Officer, Thomas R. Kowalski, with the objective of
building a banking franchise in the Denver, Colorado metropolitan area that
would deliver a broad based package of products and services to businesses and
individuals. The Company's banking subsidiary, MegaBank (the "Bank") was
organized in 1983. Since the advent of branch banking in Colorado in 1993, the
Bank has opened seven additional banking locations throughout the Denver area
for a total of eight locations, with two more branches in the planning and
construction phases.
Since inception, the Bank has specialized its lending practice in the
residential construction industry. The Company's Chairman has extensive
experience in the home building industry and has expanded the Bank's lending
practice to date such that the Bank is one of the area's leading originators of
land development and residential construction loans to small- and medium-sized
homebuilders. Currently, the Bank can finance a builder or developer from the
acquisition and development loan process, including assistance with special
district financing, through the construction loan phase. During the five years
ended December 31, 1997, the Bank originated over $750 million in total loans
and during the nine months ended September 30, 1998, originated an additional
$231 million in such loans. While some of these loans remain on the Company's
balance sheet, most have been repaid, refinanced or participated out to other
financial institutions.
The Company has achieved significant growth measured from the end of 1995.
Total assets have increased to $217 million as of September 30, 1998, from $158
million, $119 million and $102 million as of December 31, 1997, 1996 and 1995,
respectively. This represents a 31.30% average growth in assets over the past
two-and-three-quarters years. During the same time period, net income increased
to $2.8 million for the year ended December 31, 1997 from $2.4 million and $1.6
million for the years ended December 31, 1996 and 1995, respectively. During the
past three years ended December 31, 1997, the Company's return on average assets
and return on average equity has averaged 2.20% and 29.83%, respectively. For
the nine months ended September 30, 1998, net income was $2.8 million
representing a 38.95% increase over the $2.0 million of net income earned in the
first nine months of 1997. On an annualized basis, as of September 30, 1998,
return on average assets for the Company equaled 2.05% while return on average
equity equaled 29.30%. With respect to the Bank, a recent industry publication
ranked it 35th nationally in overall profitability for banks between $100
million and $1 billion in assets with a return on average assets of 2.21% during
the five years ended December 31, 1997.
In September 1998, the Company changed its status to a unitary thrift
holding company within the meaning of the Home Owners' Loan Act of 1933, as
amended ("HOLA"). The Company is registered with the Office of Thrift
Supervision ("OTS") and is subject to OTS regulations, examinations, supervision
and reporting requirements. Also, in September 1998, the Bank converted its
charter from a Colorado state-chartered commercial bank to a federal savings
bank. Management believes that the flexibilities and opportunities with a thrift
charter complement the Bank's current lending practices and should enhance the
Company's long-term plans, including the establishment of a real estate
subsidiary. Management's plan is that the real estate subsidiary will purchase
undeveloped real estate in the Denver, Colorado area, and develop and sell the
land to small- to medium-sized homebuilders who do not have resources to develop
land but are able to build homes economically. The Company would receive income
from the land sales as well as fee and
3
<PAGE> 4
interest income upon funding the homebuilders' loans through the Bank. The
Company also contemplates entering into related activities, such as the
formation or purchase of a title company.
The Bank intends to continue to focus on its niche of residential
construction lending in addition to providing a complete array of products and
services for its customers. High quality customer service has been a fundamental
tenet of the Bank's operating strategy since its inception. The Bank intends to
continue to pursue its strategies and concentrate on increasing its market share
through referrals from existing customers and the implementation of advertising
and marketing strategies.
The Company's principal executive office is located at 8100 East Arapahoe
Road, Englewood, Colorado 80112, and its telephone number is (303) 740-2265.
THE OFFERING
Common Stock offered by the
Company.................. 1,200,000 shares
Common Stock offered by the
Selling Shareholder...... 250,000
Common Stock to be
outstanding after the
Offering(1).............. 7,607,340
Nasdaq National Market(R)
symbol................... MBFC
Use of Proceeds............ The Company intends to contribute approximately
$5.0 million of capital to the Bank, contribute
approximately $3.5 million to a planned real estate
subsidiary, use approximately $1.5 million to
complete the Bank's tenth branch location which is
expected to begin operations in 1999, and use the
remainder of the proceeds for general corporate
purposes, which may include, without limitation,
the purchase and construction of future bank branch
locations, additional capital contributions to the
Bank and subsidiaries (including a real estate
title company) and possible future acquisitions of
financial institutions. See "Use of Proceeds."
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(1) As of September 1, 1998. Excludes up to 500,000 shares of Common Stock
reserved for possible issuance pursuant to existing and future grants of
options or other rights to officers, directors and employees of the Company
under the Company's 1998 Long-Term Incentive Plan.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Statements contained in this Prospectus that relate to the Company's
beliefs or expectations as to future events relating to, among other things, (i)
the success of the Company's growth strategy, (ii) the competitive banking
environment, (iii) the sufficiency of the Company's allowance for loan losses,
(iv) risks relating to the Company's concentration of land development and
construction loans, (v) changes in economic conditions, including interest
rates, management's ability to manage interest rates, and credit risks, and (vi)
the impact of future regulations, are not statements of historical fact and are
forward-looking statements. Although the Company believes that the assumptions
upon which such forward-looking statements are based are reasonable within the
bounds of its knowledge of its business and operations, it can give no assurance
that the assumptions will prove to have been correct. Reference to sections in
this Prospectus which contain forward-looking statements and important factors
that could cause actual results to differ materially and adversely from the
Company's expectations and beliefs are set out under "Risk Factors" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." These factors should be carefully considered by potential
investors.
4
<PAGE> 5
SELECTED CONSOLIDATED FINANCIAL DATA
The consolidated statements of operations data for the years ended December
31, 1997 and 1996 and the consolidated balance sheet data as of December 31,
1997 are derived from the Company's consolidated financial statements and notes
thereto which have been audited by Fortner, Bayens, Levkulich & Co., P.C.,
independent public accountants and are included elsewhere in this Prospectus.
The consolidated statements of operations data for the years ended December 31,
1995 and 1994 and the balance sheet data as of December 31, 1996 and 1995 are
derived from the Company's consolidated financial statements which have been
audited by Fortner, Bayens, Levkulich & Co., P.C. but are not included herein.
The consolidated statements of operations data for the nine months ended
September 30, 1998 and 1997, and the consolidated balance sheet data at
September 30, 1998 and 1997, have been derived from unaudited consolidated
financial statements, which, in the opinion of the Company, reflect all
adjustments, consisting only of normal recurring accruals, necessary for a fair
presentation of the financial position and results of operations of the Company
for those periods. The statements of operations data for interim periods are not
necessarily indicative of results for subsequent periods or the full year. The
following information should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Consolidated Financial Statements and related notes included elsewhere in
this Prospectus.
<TABLE>
<CAPTION>
AT OR FOR THE NINE
MONTHS ENDED AT OR FOR THE YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
------------------- ------------------------------
1998 1997 1997 1996 1995
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Interest income............................................. $ 14,756 $ 11,085 $ 15,383 $ 11,359 $ 8,427
Interest expense............................................ 4,983 3,619 4,966 3,131 2,154
Net interest income......................................... 9,773 7,466 10,417 8,228 6,273
Provision for loan losses................................... 410 360 880 457 280
Other income................................................ 696 540 996 961 807
Other expenses.............................................. 5,889 4,584 6,427 4,959 4,136
Income tax expense.......................................... 1,348 1,031 1,272 1,353 1,017
Net income.................................................. 2,822 2,031 2,834 2,420 1,647
CONSOLIDATED BALANCE SHEET DATA:
Total assets................................................ $217,273 $158,850 $157,880 $118,929 $102,076
Total loans................................................. 166,709 115,719 126,087 94,973 68,845
Allowance for loan losses................................... 2,491 1,567 2,083 1,150 759
Investment securities available for sale.................... 16,613 12,100 13,999 11,137 6,985
Investment securities held to maturity...................... -- -- -- -- 550
Nonperforming assets(1)..................................... 1,291 1,677 1,604 14 76
Deposits.................................................... 188,894 143,266 141,878 104,661 90,192
Shareholders' equity........................................ 14,360 10,962 11,578 8,827 6,393
PER COMMON SHARE(2):
Basic earnings per share.................................... $ .44 $ .32 $ .44 $ .38 $ .26
Book value per share........................................ 2.24 1.71 1.80 1.38 1.00
Tangible book value per share............................... 2.24 1.71 1.80 1.38 1.00
SELECTED FINANCIAL RATIOS:
Return on average assets.................................... 2.05% 1.93% 1.96% 2.36% 2.27%
Return on average common equity............................. 29.30 27.37 27.78 31.80 29.92
Net interest margin(3)...................................... 8.08 8.01 8.14 9.01 9.81
Net interest spread(3)...................................... 6.79 6.70 6.83 7.60 8.34
Shareholders' equity to total assets........................ 6.61 6.90 7.33 7.42 6.26
Tangible and core (tier 1) capital ratios (Bank only)....... 10.34 7.59 8.02 8.97 8.93
Risk-based capital ratio (Bank only)........................ 13.20 10.70 10.30 12.62 13.18
Nonperforming assets to total assets........................ 0.59 1.06 1.02 0.01 0.07
Nonperforming loans to total loans.......................... 0.77 1.45 1.27 0.01 0.11
Allowance for loan losses to total loans.................... 1.49 1.35 1.65 1.21 1.10
Allowance for loan losses to nonperforming loans............ 192.95 93.43 129.92 8,463.03 998.23
</TABLE>
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(1) Includes loans 90 days or more delinquent and still accruing interest,
nonaccrual loans and restructured loans.
(2) No difference exists between basic and diluted earnings per share. Gives
effect to the 30-for-1 stock split of the Company's Common Stock in
September 1998.
(3) On a tax equivalent basis.
5
<PAGE> 6
RISK FACTORS
Prospective purchasers of the Common Stock should carefully consider the
following risk factors, as well as the other information contained in this
Prospectus in evaluating the Company and its business and in deciding whether to
purchase any of the Common Stock offered hereby.
Loan and Business Concentration. Since the 1980's the Bank has been one of
the leading originators of land development and residential construction loans
to small- and medium-sized builders in the Denver, Colorado area. As of
September 30, 1998 these loans, in the aggregate, comprised 71.91% of the Bank's
total loans. Also, the Company's planned expansion into real estate through a
real estate subsidiary that will buy and develop land for resale to homebuilders
will further concentrate the Company in the home building industry and subject
the Company to risks associated with holding real property, such as holding
costs, maintenance costs and illiquidity of the investment. Accordingly, adverse
economic conditions in the home building industry could materially impact the
Company's primary business. These conditions could occur as a result of
significant increases in interest rates, moratoriums on new building by
municipalities, overbuilding of new homes in the Denver area and a general
economic downturn. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Economic Conditions and Impact of Interest Rates. Results of operations for
financial institutions, including the Company, may be materially and adversely
affected by changes in prevailing economic conditions, including declines in
real estate values, housing starts, rapid changes in interest rates and the
monetary and fiscal policies of the federal government. The profitability of the
Company is in part a function of the spread between the interest rates earned on
assets and the interest rates paid on deposits and other interest-bearing
liabilities. Although management believes that the maturities of the Company's
assets are moderately balanced in relation to maturities of liabilities
("asset/liability management"), asset/liability management involves estimates as
to how changes in the general level of interest rates will impact the yields
earned on assets and the rates paid on liabilities. A decrease in interest rate
spreads would have a negative effect on the net interest income and
profitability of the Company, and there can be no assurance that this spread
will not decrease. Although economic conditions in the market area of the
Company have been generally stronger than those in many other regions of the
country, there can be no assurance that such conditions will continue to
prevail. Moreover, substantially all of the loans of the Company are to
individuals and businesses in the Denver area, and any decline in the economy of
this market area could have an adverse impact on the Company. There can be no
assurance that positive trends or developments discussed in this Prospectus will
continue or that negative trends or developments will not have a material
adverse effect on the Company. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Growth and Acquisition Risks. The Company has pursued and intends to
continue to pursue an internal growth strategy, the success of which will depend
primarily on generating an increasing level of loans and deposits at acceptable
risk levels and terms without proportionate increases in noninterest expenses. A
significant portion of the net proceeds from the sale by the Company of the
Common Stock hereunder is intended to be used to support future growth,
including the establishment of the Bank's tenth branch. The Company has grown
and intends to grow by the establishment of new branches. Establishing new
branches through land purchase and development takes significant amounts of
capital and time to build. Delays can be encountered in the process as a result
of zoning, building moratoriums by municipalities, and general construction and
weather problems. In addition, successful growth through branch expansion will
depend on the Company's ability to maintain sufficient regulatory capital levels
and on continued favorable economic conditions in the Company's market. There
can be no assurance that the Company will be successful in continuing its
internal growth strategy.
The Company will also face risks in attempting to achieve growth through
the planned establishment of a real estate subsidiary whose purpose is to
develop land for resale to homebuilders. Among the risks the Company faces are:
having adequate staff to oversee acquisition and development of land;
establishing and maintaining proper internal controls with respect to land
inventory and development; using adequate procedures to ensure compliance with
zoning requirements; and other risks associated with the establishment of new
operations. Although the Company does not presently have any discussions or
negotiations underway
6
<PAGE> 7
relating to acquisitions, the Company in the future intends to review and
solicit acquisition opportunities and, at any given time, may attempt to acquire
financial institutions. However, the Company may not be successful in
identifying acquisition candidates, integrating acquired institutions or
preventing deposit erosion at acquired institutions. In addition, the Company
faces significant competition in making acquisitions in its market area. As a
result, the Company may not be able to acquire institutions on terms beneficial
to the Company, if at all.
Government Regulation, Recent Legislation and Monetary Policy. The Company
and the Bank are subject to extensive federal and state legislation, regulation
and supervision which is intended primarily to protect depositors and the Bank
Insurance Fund, rather than investors. Recently enacted, proposed and future
legislation and regulations designed to strengthen the banking industry have had
and may have a significant impact on the banking industry. Although some of the
legislative and regulatory changes may benefit the Company and the Bank, others
may increase their costs of doing business or otherwise adversely affect them
and create competitive advantages for non-bank competitors. In addition, federal
economic and monetary policy may affect the Bank's ability to attract deposits,
make loans and achieve satisfactory interest spreads. In addition, the House of
Representatives is considering legislation with respect to certain thrifts which
may adversely affect the Company's status as a thrift. See "Supervision and
Regulation."
Competitive Banking Environment. The banking business in the Denver
metropolitan area is highly competitive. The Company competes for loans and
deposits with commercial banks, other savings and loan associations, finance
companies, mutual funds, credit unions and mortgage bankers. In addition to
traditional financial institutions, the Company also competes for loans with
brokerage and investment banking companies, nonfinancial institutions, including
retail stores that maintain their own credit programs, and governmental agencies
that make available low cost or guaranteed loans to certain borrowers.
Particularly in times of high interest rates, the Company also faces significant
competition for deposits from sellers of short-term money market securities and
other corporate and government securities. Many of the Company's competitors
have substantially greater resources and lending limits than the Company and
perform other functions that the Company offers only through correspondents.
Interstate banking is permitted in Colorado, and, since January 1, 1997,
unlimited state-wide branch banking has been permitted. As a result, the
Company's results of operations and cash flows may be adversely affected by an
increase in competition. Moreover, recent legislation has focused on expanding
the ability of participants in the banking industry to engage in other lines of
business. The enactment of additional legislation could put the Company at a
competitive disadvantage because it may not have the capital to participate in
other lines of business to the same extent as more highly capitalized holding
companies. See "Business -- Competition" and "Supervision and Regulation."
Allowance for Loan Losses. Inability of borrowers to repay loans can erode
earnings and capital. Like all financial institutions, the Bank maintains an
allowance for loan losses to provide for loan defaults and nonperformance. The
allowance is based on prior experience with loan losses, as well as an
evaluation of the risks in the current portfolio, and is maintained at a level
considered adequate by management to absorb anticipated losses. The amount of
future losses is susceptible to changes in economic, operating and other
conditions, including changes in interest rates, that may be beyond management's
control, and such losses may exceed current estimates. At September 30, 1998,
the Company had nonperforming loans of $1.3 million and an allowance for loan
losses of $2.5 million or 1.49% of total loans and 192.95% of nonperforming
loans. At December 31, 1997, the Company had nonperforming loans of $1.6 million
and an allowance for loan losses of $2.1 million or 1.65% of total loans and
129.92% of nonperforming loans. There can be no assurance that the Company's
allowance for loan losses will be adequate to cover actual losses. Future
provisions for loan losses could materially and adversely affect results of
operations of the Company. See Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Dependence on Key Person. The Company is highly dependent on the continued
services of Thomas R. Kowalski, its Chairman and Chief Executive Officer. The
Company does not have an employment agreement with Mr. Kowalski. Although the
Company has a $3.0 million key man life insurance policy on Mr. Kowalski,
proceeds under the policy paid to the Company will, at the option of certain
affiliated shareholders of Mr. Kowalski, be utilized by the Company for the
repurchase of all or a portion of such shareholders' Common Stock. The loss of
the services of Mr. Kowalski could adversely affect the Company. See
Management."
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<PAGE> 8
Year 2000 Compliance. As the year 2000 approaches, a significant business
issue has emerged regarding how existing application software programs and
operating systems can accommodate the date value for the year 2000. Many
existing software application products, including software application products
used by the Bank and its suppliers and customers, were designed to accommodate
only a two-digit date value, which represents the year. For example, information
relating to the year 1996 is stored in the system as "96." As a result, the year
1999 (i.e., "99") could be the maximum date value that these systems will be
able to process accurately. In response to concerns about this issue, regulatory
agencies have begun to monitor holding companies' and banks' readiness for the
year 2000 as part of the regular examination process. The Company presently
believes that with modifications to existing software and conversion to new
software, the year 2000 issue will not pose significant operational problems for
the Company's computer systems or business operations. Implementation of the
Company's plan to test in-house and out-sourced software has been underway since
the first quarter of 1998. Testing of applications considered to be "mission
critical" are scheduled for completion by first quarter of 1999. Total
compliance for all systems is expected by management to be completed by the
third quarter of 1999; management currently estimates that such compliance will
cost $150,000. However, if such modifications and conversions are not made, or
are not completed timely, the year 2000 issue could have a material adverse
impact on the operations of the Company. In addition, there can be no assurance
that unforeseen problems in the Company's computer systems, or the systems of
third parties on which the Company's computers rely, will not have an adverse
effect on the Company's systems or operations. Additionally, failure of the
Bank's customers to prepare for year 2000 compatibility could have a significant
adverse effect on such customers' operations and profitability, thus inhibiting
their ability to repay loans and adversely affecting the Bank's operations. The
Company does not have sufficient information accumulated from customers of the
Bank to enable the Company to assess the degree to which customers' operations
are susceptible to potential problems relating to the year 2000 issue. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Year 2000 Considerations."
Potential Liability for Undercapitalized Subsidiary. Under federal law, a
thrift holding company may be required to guarantee a capital plan filed by an
undercapitalized bank subsidiary with its primary regulator. If the subsidiary
defaults under the plan, the holding company may be required to contribute to
the capital of the subsidiary bank an amount equal to the lesser of 5% of the
bank's assets at the time it became undercapitalized or the amount necessary to
bring the bank into compliance with the applicable capital standards. Therefore,
it is possible that the Company will be required to contribute capital to the
Bank or any other bank that it may acquire in the event that such bank becomes
undercapitalized. Moreover, the Company may be required to make such capital
contribution at a time when it has other significant capital needs, and,
therefore, such requirement may adversely affect the Company's business,
financial condition, results of operations and cash flows. See "Supervision and
Regulation."
Need for Technological Change. The banking industry is undergoing
technological change, with introductions of new technology-driven products and
services. The Company's future success will depend, in part, on its ability to
address the needs of its customers by using technology to provide products and
services that will satisfy customer demands for convenience, as well as its
ability to create additional efficiencies in its operations. Many of the
Company's competitors have substantially greater resources to invest in
technological improvements. There can be no assurance that the Company will be
able to implement new technology-driven products and services effectively or be
successful in marketing such products and services to its customers.
No Prior Market. Prior to the Offering, there has been no public market for
the Common Stock. Although the Common Stock has been approved for listing on the
Nasdaq National Market(R), there can be no assurance that a market for the
Common Stock will develop or, if developed, will be sustained. The Company and
Howe Barnes Investments, Inc. have had discussions with other investment firms
regarding market making activity and such firms, as well as Howe Barnes
Investments, Inc., have indicated a willingness to act as market makers with
respect to the Common Stock. See "Description of Capital Stock."
No Dividends, Restrictions on Payments of Dividends. The Company has not
paid cash dividends on its Common Stock and does not intend to pay cash
dividends in the foreseeable future. The Company intends to retain earnings to
support the growth of its business. Pursuant to the terms of the Company's
outstanding 8.75% Junior Subordinated Debentures, the Company generally cannot
pay dividends if interest payments on
8
<PAGE> 9
the debentures have been deferred or the Company is in default on the
debentures. Moreover, the Company's ability to pay a cash dividend on its Common
Stock, if it determines to do so, is largely dependent upon the payment of
dividends by the Bank to the Company. The Bank's ability to pay dividends to the
Company is restricted by federal regulations. Without prior regulatory approval,
the Bank cannot pay dividends during any calendar year in excess of the sum of
its earnings during that year and one-half of its capital in excess of its
capital requirements (less previous capital distributions during that period).
See "Dividend Policy," "Supervision and Regulation" and "Description of Capital
Stock."
Concentration of Ownership. As of September 30, 1998, directors, executive
officers and key employees of the Company beneficially owned 58.6% of the Common
Stock. Upon completion of the Offering, directors, executive officers and key
employees of the Company will beneficially own 46.1% of the Common Stock.
Accordingly, such persons will be in a position to exercise substantial
influence over the affairs of the Company and may impede the acquisition of
control of the Company by a third party. See "Management" and "Principal and
Selling Shareholders."
Anti-takeover Provisions. The Company's Articles of Incorporation and
Bylaws include provisions that may have the effect of encouraging persons
considering unsolicited tender offers or other unilateral takeover proposals to
negotiate with the Board of Directors of the Company rather than pursue
non-negotiated takeover attempts such as tender offers, proxy contests, open
market purchases or otherwise. These provisions include preferred stock as to
which the Company's Board of Directors has the authority to issue additional
series and to fix the rights, preferences and limitations thereof without
shareholder approval and the availability for issuance of authorized but
unissued Common Stock. See "Description of Capital Stock." In addition, no
person or entity, individually or together with persons or entities acting in
concert with such person or entity, may acquire the ownership, control, right to
vote or right to acquire 10% or more of the Company's total outstanding Common
Stock, without first complying with the requirements of the HOLA. These
requirements also may have the effect of delaying or preventing a change of
control of the Company. See "Supervision and Regulation."
Dilution. Purchasers of the Common Stock offered hereby will incur
substantial and immediate dilution in net tangible book value per share of
Common Stock. The net tangible book value of the Company at September 30, 1998
was approximately $14.4 million or $2.24 per share of Common Stock. Based upon
an initial public offering price of $11 per share, the dilution per share to new
investors in the Offering would be $7.54. See "Dilution."
Shares of Common Stock Eligible for Future Sale. Following completion of
the Offering, the Company will have 7,607,340 shares of Common Stock outstanding
(7,799,840 if the Underwriters' over-allotment option is exercised in full),
assuming no exercise of any outstanding options to purchase shares of Common
Stock. The 1,450,000 shares offered hereby (1,667,500 shares if the
Underwriters' over-allotment option is exercised in full) will be freely
tradeable without restriction under the Securities Act of 1933, as amended (the
"Securities Act"), except for any shares which are purchased by affiliates of
the Company. The directors, executive officers and certain shareholders of the
Company, who will hold an aggregate of 5,075,270 shares upon completion of the
Offering, have agreed not to offer, sell, or contract to sell any Common Stock
for a period of 180 days after the date of this Prospectus without the prior
written consent of the Representative. See "Underwriting." Upon expiration of
this 180-day period all of these shares (representing 66.7% of the total number
of shares which will be outstanding following completion of the Offering) could
be resold by these and other persons who are affiliates of the Company, subject
to certain requirements of Rule 144 under the Securities Act, including a limit
on the number of shares that may be sold in any three-month period equal to the
greater of (a) 1% of the shares outstanding (approximately 76,000 shares
following completion of the Offering or approximately 78,000 if the
over-allotment option is exercised in full) or (b) the average weekly trading
volume of shares of Common Stock for the four-week period prior to the time of
such resale. Sales of a significant number of shares of Common Stock in the
public market following the Offering, or the perception that such sales could
occur, could adversely affect the market price of the Common Stock. See "Shares
Eligible for Future Sale."
9
<PAGE> 10
USE OF PROCEEDS
The net proceeds to the Company from the sale of the Common Stock in the
Offering, after deducting the underwriting discount and estimated offering
expenses, are estimated to be $12.0 million ($13.9 million if the over-allotment
option is exercised in full).
The Company intends to contribute approximately $5.0 million of capital to
the Bank, to contribute approximately $3.5 million to a planned subsidiary of
the Company which will invest in real estate for the purpose of development and
resale, and to use approximately $1.5 million of the net proceeds to complete
the Bank's tenth branch location, which is expected to begin operations in 1999,
with the remainder to be used for general corporate purposes, which may include,
without limitation, purchase and construction of future bank branch locations,
additional capital contributions to the Bank and subsidiaries (including a title
company) and possible future acquisitions of financial institutions. The $5.0
million of additional capital contribution to the Bank will result in an
increased legal lending limit which is designed to further the Bank's internal
growth objectives. Although the Company does not presently have any discussions
or negotiations underway relating to acquisitions, the Company in the future
intends to review and solicit acquisition opportunities and, at any given time,
may attempt to acquire financial institutions. Pending their application, the
net proceeds may be invested in short-term, marketable, investment grade
interest-bearing securities.
DIVIDEND POLICY AND NO PRIOR MARKET
The Company's current policy is to retain its earnings to support the
growth of its business. The Board of Directors of the Company has not declared
cash dividends on the Common Stock and does not plan to do so in the foreseeable
future. The ability of the Company to pay cash dividends largely depends on the
amount of cash dividends paid to it by the Bank. Capital distributions,
including dividends, by institutions such as the Bank are subject to
restrictions tied to the institutions' earnings and capital. Without prior
regulatory approval, the Bank cannot pay dividends during any calendar year in
excess of the sum of its earnings during that year and one-half of its capital
in excess of its capital requirements (less previous capital distributions
during that period). The Company's ability to pay cash dividends will also be
significantly limited if it is in default of, or defers interest payments on,
the 8.75% Junior Subordinated Debentures.
Prior to the Offering, there has been no public market for the Common
Stock. Although the Common Stock has been approved for listing on the Nasdaq
National Market(R), there can be no assurance that a market for the Common Stock
will develop or, if developed, will be sustained. The 8.75% Cumulative Trust
Preferred Securities issued by the Company's subsidiary, MB Capital I, are
traded on the American Stock Exchange under the symbol MFC.Pr.A. See
"Supervision and Regulation" and "Description of Capital Stock."
10
<PAGE> 11
DILUTION
The net tangible book value of the Company at September 30, 1998 was
approximately $14.4 million, or approximately $2.24 per share of Common Stock.
"Net tangible book value" is defined as the total shareholders' equity of the
Company less intangible assets. "Net tangible book value per share" is
determined by dividing the net tangible book value of the Company by the number
of outstanding shares of Common Stock.
After giving effect to the Offering and the application of the net proceeds
therefrom, the net tangible book value of the Common Stock at September 30, 1998
would have been approximately $26.3 million, or $3.46 per share. This represents
an immediate dilution of $7.54 per share to investors who purchase shares of
Common Stock in the Offering. "Dilution" is the difference between the Offering
price per share and the pro forma net tangible book value per share as adjusted
for the Offering.
The following table illustrates this per share dilution as of September 30,
1998, which is determined by subtracting the net tangible book value per share
after the Offering from the price paid by a new investor.
<TABLE>
<S> <C> <C>
Initial public offering price per share(1).................. $11.00
Net tangible book value per share of Common Stock at
September 30, 1998..................................... $2.24
Increase per share of Common Stock attributable to new
investors(2)........................................... 1.22
-----
Pro forma net tangible book value per share of Common Stock
after the Offering........................................ 3.46
------
Dilution per share of Common Stock to new investors......... $ 7.54
======
</TABLE>
- ---------------
(1) Before deducting the underwriting discount and estimated offering expenses.
(2) After deducting the underwriting discount and estimated offering expenses.
There have been no shares of Common Stock issued by the Company during the
past five years.
11
<PAGE> 12
CAPITALIZATION
The following table sets forth the consolidated borrowings and
capitalization of the Company at September 30, 1998 and as adjusted to give
effect to the issuance and sale by the Company of 1,200,000 shares of the Common
Stock in the Offering at an initial public offering price of $11 per share and
the use of net proceeds therefrom as described in "Use of Proceeds."
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
-----------------------
ACTUAL AS ADJUSTED
-------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Borrowings:
Securities sold under agreements to repurchase............ $ 556 $ 556
------- -------
Total borrowings.................................. $ 556 $ 556
======= =======
Company obligated mandatorily redeemable preferred
securities of subsidiary trust holding solely Junior
Subordinated Debentures(1)................................ $12,000 $12,000
------- -------
Shareholders' equity:
Preferred Stock, 10,000,000 shares authorized; no shares
issued or outstanding.................................. $ -- $ --
Common Stock, 50,000,000 shares authorized; 6,407,340
shares issued and outstanding, 7,607,340 shares
issued and outstanding, as adjusted................. 1,961 13,937
Retained earnings................................. 12,400 12,400
Accumulated other comprehensive income............ (1) (1)
------- -------
Total shareholders' equity........................ $14,360 $26,336
------- -------
Total capitalization.............................. $26,360 $38,336
======= =======
Bank regulatory capital ratios(2):
Tangible capital requirement ratio (1.5%)......... 10.34% 12.39%
Core capital requirement ratio (3%)............... 10.34% 12.39%
Risk-based capital requirement ratio (8%)......... 13.20% 15.88%
</TABLE>
- ---------------
(1) MB Capital I, formed by the Company, holds as its sole asset, $12.4 million
principal amount of Junior Subordinated Debentures issued by the Company.
The Junior Subordinated Debentures will mature on February 9, 2028, which
date may be shortened by the Company to a date not earlier than February 9,
2003 if certain conditions are met. See "Description of Capital
Stock -- Securities of Subsidiary Trust."
(2) Adjusted to reflect a $5.0 million capital contribution to the Bank. See
"Use of Proceeds."
12
<PAGE> 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS ENVIRONMENT AND RISK FACTORS
The following discussion should be read in conjunction with the
Consolidated Financial Statements and related notes included elsewhere herein.
The Company's future operating results may be affected by various trends and
factors that are beyond the Company's control. These include, among other
factors, the competitive banking environment in which the Company operates,
provisions for loan losses, risks relating to the Company's concentration of
loans related to residential construction, changes in general economic
conditions and interest rates, rapid or unexpected changes in technologies and
other uncertain business conditions that may affect the Company's business.
Accordingly, past results and trends may not be reliable indicators of future
results or trends.
With the exception of historical information, the matters discussed below
include forward-looking statements that involve risks and uncertainties. The
Company wishes to caution readers that a number of important factors discussed
herein could affect the Company's actual results and cause actual results to
differ materially from those in the forward-looking statements.
OVERVIEW
Since inception, the Company, through the Bank, has specialized its lending
practice in the land development and residential construction industry. The
Company's Chairman has extensive experience in the home building industry and
has expanded the Bank's lending practice to date such that the Bank is one of
the area's leading originators of land development and residential construction
loans to small- and medium-sized homebuilders. Currently, the Bank can finance a
builder or developer from the acquisition and development loan process,
including assistance with special district financing, through the construction
loan phase.
The Company has achieved significant profitable growth measured from the
end of 1995. Total assets have increased to $217 million as of September 30,
1998, from $158 million, $119 million and $102 million as of December 31, 1997,
1996 and 1995, respectively. This represents a 31.30% average growth in assets
over the past two-and-three quarters years. During the same time period, net
income increased to $2.8 million for the year ended December 31, 1997 from $2.4
million and $1.6 million for the years ended December 31, 1996 and 1995,
respectively. During the past three years ended December 31, 1997, the Company's
return on average assets and return on average equity has averaged 2.20% and
29.83%, respectively. For the nine months ended September 30, 1998, net income
was $2.8 million representing a 38.95% increase over the $2.0 million of net
income earned in the first nine months of 1997. On an annualized basis, as of
September 30, 1998, return on average assets for the Company equaled 2.05% while
return on average equity equaled 29.30%. With respect to the Bank, a recent
industry publication ranked it 35th nationally in overall profitability for
banks between $100 million and $1 billion in assets with a return on average
assets of 2.21% during the five years ended December 31, 1997.
RESULTS OF OPERATIONS
Net Interest Income. The Company's income is derived primarily from net
interest income. Net interest income is the difference between interest income
(including loan fees), principally from loans, investment securities and funds
sold, and interest expense, principally on customer deposits. Changes in net
interest income result from changes in volume, net interest spread and net
interest margin. Volume refers to the average dollar levels of interest-earning
assets and interest-bearing liabilities. Net interest spread refers to the
difference between the average yield on interest-earning assets and the average
cost of interest-bearing liabilities. Net interest margin refers to net interest
income divided by average interest-earning assets and is influenced by the level
and relative mix of interest-earning assets and interest-bearing liabilities.
13
<PAGE> 14
The following tables set forth the average balances, net interest income
and expense and average yields and rates for the Company's earning assets and
interest-bearing liabilities for the indicated periods on a tax-equivalent basis
assuming a 34% tax rate.
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,(1)
-------------------------------------------------------------
1998 1997
----------------------------- -----------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED YIELD AVERAGE EARNED YIELD
BALANCE OR PAID OR COST BALANCE OR PAID OR COST
-------- -------- ------- -------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS
Investment securities:
Taxable.............................................. $ 6,524 $ 317 6.48% $ 4,224 $ 209 6.60%
Tax exempt (tax equivalent).......................... 8,402 850 13.49 6,203 626 13.46
Funds sold and interest-bearing deposits............. 10,815 430 5.30 11,981 481 5.35
Loans(2)............................................. 142,481 13,448 12.58 106,806 9,982 12.46
Allowance for loan losses............................ (2,243) -- (1,357) --
-------- ------- ----- -------- ------- -----
Total interest-earning assets.................. $165,979 $15,045 12.09 $127,857 $11,298 11.78
======== ======= ===== ======== ======= =====
INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Demand, interest-bearing........................... $ 67,185 $ 2,290 4.54 $ 51,509 $ 1,776 4.60%
Savings............................................ 5,088 127 3.33 4,769 119 3.33
Certificates of deposit:
Under $100,000................................... 30,040 1,299 5.77 23,361 1,009 5.76
$100,000 and over................................ 10,762 448 5.55 10,610 454 5.71
-------- ------- ----- -------- ------- -----
Total interest-bearing deposits................ 113,075 4,164 4.91 90,249 3,358 4.96
Advances from the Federal Home Loan Bank and federal
funds purchased(4)................................. 1,177 82 9.29 2,560 126 6.56
Notes payable........................................ 10,333 707 9.12 2,250 135 8.00
Repurchase agreements................................ 766 30 5.22 -- -- --
-------- ------- ----- -------- ------- -----
Total interest-bearing liabilities............. $125,351 4,983 5.30 $ 95,059 3,619 5.08
======== ======= ===== ======== ======= =====
Net interest income (tax equivalent)........... $10,062 $ 7,679
======= =======
Net interest margin(3)............................... 8.08% 8.01%
Net interest spread.................................. 6.79% 6.70%
Ratio of average interest-bearing liabilities to
average interest-earning assets...................... 75.52% 74.35%
</TABLE>
- ---------------
(1) Yields and costs are annualized.
(2) Loans are net of unearned discount. Nonaccrual loans are included in average
loans outstanding. Loan fees are included in interest income as follows for
the nine months ended September 30, 1998 -- $2,085,668; 1997 -- $1,879,441.
(3) Net interest margin is net interest income divided by average total
interest-earning assets (on an annualized basis).
(4) Includes a one-time prepayment penalty incurred on the early retirement of
FHLB advances which management determined was advantageous to the Company
compared to the cost of such funds.
Net interest income, on a tax-equivalent basis, was $10.1 million for the
nine months ended September 30, 1998, an increase of $2.4 million from $7.7
million for the same period in 1997. Interest income for the nine months ended
September 30, 1998 and 1997 was $15.0 million and $11.3 million, respectively.
The increase of $3.7 million is primarily due to higher balances of
interest-earning assets. The various changes in the mix of taxable investment
securities and tax exempt securities as well as funds sold were a result of the
Company attempting to maximize its yield on interest-earning assets other than
loans. The Company achieved an increase of $38.1 million or 29.82% in average
interest-earning assets to $166.0 million for the nine months ended September
30, 1998 from $127.9 million for the same period in 1997. The majority of the
increase in interest-earning assets was attributable to the $35.7 million
increase in average loans outstanding. The majority of the loans in the
Company's lending portfolio are floating rate loans tied to the prime rate. The
14
<PAGE> 15
average yield on interest-earning assets increased to 12.09% for the nine months
ended September 30, 1998 from 11.78% for the comparable period in 1997 on a tax
equivalent basis.
Interest expense increased $1.4 million to $5.0 million for the nine months
ended September 30, 1998 compared to $3.6 million for the same period in 1997.
The increase in average demand, interest-bearing deposits to $67.2 million for
the nine months ended September 30, 1998 from $51.5 million for the comparable
period in 1997 was due to the Bank's growth at existing facilities, as well as
the opening of two additional branches. The increase in average balances of
certificates of deposit under $100,000 to $30.0 million for the nine months
ended September 30, 1998 from $23.4 million for the comparable period in 1997
was due to the Bank's growth as well as promotional campaigns by the Bank
directed at obtaining new accounts. The increase in average notes payable to
$10.3 million for the nine months ended September 30, 1998 from $2.2 million for
the comparable period in 1997 was due to the Company's issuance of $12.4 million
of Junior Subordinated Debentures in February 1998, and the corresponding
retirement of its note with a commercial lender with a portion of the proceeds
of issuance. The cost of interest-bearing liabilities for the nine months ended
September 30, 1998 and 1997 was 5.30% and 5.08%, respectively, and, when
combined with noninterest-bearing deposits, the cost of funds for the nine
months ended September 30, 1998 and 1997 was 3.92% and 3.72%, respectively. See
" -- Deposits." The increase in cost of funds was primarily due to an increase
in the cost of the Federal Home Loan Bank ("FHLB") borrowings to 9.29% from
6.56% due to a one-time prepayment penalty incurred on the early retirement of
FHLB advances which management determined was advantageous to the Company
compared to the costs of such funds. Management expects that borrowings will
continue to supplement deposits with FHLB advances when necessary to fund the
lending and investing activities of the Bank. Despite the foregoing, net
interest margin, on a tax-equivalent basis, increased slightly to 8.08% for the
nine months ended September 30, 1998 from 8.01% for the comparable period in
1997.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1997 1996
----------------------------- ----------------------------
INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED YIELD AVERAGE EARNED YIELD
BALANCE OR PAID OR COST BALANCE OR PAID OR COST
-------- -------- ------- ------- -------- -------
(DOLLARS IN THOUSANDS
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS
Investment securities:
Taxable................................................ $ 4,486 $ 286 6.38% $7,127 $ 487 6.83%
Tax exempt (tax equivalent)............................ 6,667 897 13.45 2,780 374 13.45
Funds sold and interest-bearing deposits............... 12,876 699 5.43 3,471 215 6.19
Loans(1)............................................... 109,167 13,806 12.65 80,213 10,410 12.98
Allowance for loan losses.............................. (1,446) -- (909) --
-------- ------- ----- ------- ------- -----
Total interest-earning assets.................... $131,750 $15,688 11.91 $92,682 $11,486 12.39
======== ======= ===== ======= ======= =====
INTEREST-BEARING LIABILITIES
Interest-bearing deposits:
Demand, interest-bearing............................. $ 53,370 $ 2,453 4.60 $37,983 $ 1,717 4.52
Savings.............................................. 4,775 160 3.35 5,442 186 3.42
Certificates of deposit:
Under $100,000..................................... 25,295 1,444 5.71 9,639 522 5.42
$100,000 and over.................................. 9,749 578 5.93 6,885 369 5.36
-------- ------- ----- ------- ------- -----
Total interest-bearing deposits.................. 93,189 4,635 4.97 59,949 2,794 4.66
Advances from the Federal Home Loan Bank and federal
funds purchased...................................... 2,281 152 6.66 1,771 97 5.48
Notes payable.......................................... 2,250 179 7.96 3,673 240 6.53
Repurchase agreements.................................. -- -- -- -- -- --
-------- ------- ----- ------- ------- -----
Total interest-bearing liabilities............... $ 97,720 4,966 5.08 $65,393 3,131 4.79
======== ------- ===== ======= ------- =====
Net interest income (tax equivalent)............. $10,722 $ 8,355
======= =======
Net interest margin(2)................................. 8.14% 9.01%
Net interest spread.................................... 6.83% 7.60%
Ratio of average interest-bearing liabilities to average
interest-earning assets................................ 74.17% 70.56%
</TABLE>
15
<PAGE> 16
- ---------------
(1) Loans are net of unearned discount. Nonaccrual loans are included in average
loans outstanding. Loan fees are included in interest income as follows:
1997 -- $2,723,678; 1996 -- $2,239,017.
(2) Net interest margin is net interest income divided by average total
interest-earning assets.
Net interest income, on a tax-equivalent basis, was $10.7 million for the
year ended December 31, 1997, an increase of $2.3 million from $8.4 million in
1996. Interest income increased $4.2 million to $15.7 million in 1997 from $11.5
million in 1996. This increase resulted primarily from an increase of $39.1
million in average interest-earning assets to $131.8 million in 1997 from $92.7
million in 1996. The majority of the asset growth was due to growth in the loan
portfolio. Average loans increased $29.0 million or 36.1% to $109.2 million in
1997 from $80.2 million in 1996 due primarily to growth in the Company's market
and continuing demand for land development and residential construction loans.
The change in the relative mix of interest-earning assets other than loans was
due primarily to the Company's objective of maximizing its yield on funds not
used for loans, including investing in double tax exempt securities. The average
yield on interest-earning assets decreased to 11.91% in 1997 from 12.39% in 1996
on a tax equivalent basis.
Interest expense increased $1.9 million to $5.0 million in 1997 from $3.1
million in 1996. A $15.4 million increase in interest-bearing demand deposits
accounted for $736,000 of the increase. These deposits increased due to the
Company's growth, including the addition of two new branches in 1997 and
corresponding marketing efforts. Changes in the relative mix of average
interest-bearing liabilities included a $510,000 increase in advances from the
FHLB. The cost of interest-bearing liabilities for the years ended December 31,
1997 and 1996 was 5.08% and 4.79%, respectively, and, when combined with
noninterest-bearing deposits, the cost of funds was 3.72% in 1997 compared to
3.31% in 1996, see " -- Deposits." As a result of lower interest earning asset
yields and the higher cost of funds, net interest margin, on a tax-equivalent
basis, decreased to 8.14% in 1997 from 9.01% in 1996.
16
<PAGE> 17
The following table illustrates, for the periods indicated, the changes in
the Company's net interest income (on a tax-equivalent basis) due to changes in
volume and changes in interest rates. Changes in net interest income due to both
volume and rate have been allocated to volume and rate in proportion to the
relationship of the absolute dollar amounts of the change in each.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
---------------------- ----------------------- -------------------------
1998 COMPARED TO 1997: 1997 COMPARED TO 1996: 1996 COMPARED TO 1995:
---------------------- ----------------------- -------------------------
INCREASE (DECREASE) IN INCREASE (DECREASE) IN INCREASE (DECREASE) IN
NET INTEREST INCOME NET INTEREST INCOME NET INTEREST INCOME
DUE TO CHANGE IN DUE TO CHANGE IN DUE TO CHANGE IN
---------------------- ----------------------- -------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL VOLUME RATE TOTAL
------ ---- ------ ------ ----- ------ ------ ----- ------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Taxable securities.................. $ 111 $ (3) $ 108 $(168) $ (33) $ (201) $ (17) $ 20 $ 3
Tax exempt securities (tax
equivalent)....................... 223 1 224 523 -- 523 374 -- 374
Fund sold........................... (47) (4) (51) 511 (27) 484 31 (120) (89)
Loans............................... 3,366 100 3,466 3,661 (265) 3,396 3,373 (602) 2,771
------ ---- ------ ------ ----- ------ ------ ----- ------
Total interest-earning
assets...................... 3,653 94 3,747 4,527 (325) 4,202 3,761 (702) 3,059
------ ---- ------ ------ ----- ------ ------ ----- ------
Interest-bearing liabilities:
Demand, interest bearing............ 535 (21) 514 707 29 736 696 17 713
Savings............................. 8 -- 8 (22) (4) (26) 24 5 29
Certificates of deposit:
Under $100,000.................... 289 1 290 894 28 922 87 8 95
$100,000 and over................. 6 (12) (6) 170 39 209 99 7 106
Advances from the Federal Home Loan
Bank and federal funds
purchased......................... (96) 52 (44) 34 21 55 76 (2) 74
Notes payable....................... 553 19 572 (113) 52 (61) (4) (36) (40)
Repurchase agreements............... 30 -- 30 -- -- -- -- -- --
------ ---- ------ ------ ----- ------ ------ ----- ------
Total interest-bearing
liabilities................. 1,325 39 1,364 1,670 165 1,835 978 (1) 977
------ ---- ------ ------ ----- ------ ------ ----- ------
Net increase (decrease) in net
interest income (tax
equivalent)................. $2,328 $ 55 $2,383 $2,857 $(490) $2,367 $2,783 $(701) $2,082
====== ==== ====== ====== ===== ====== ====== ===== ======
</TABLE>
Other Income. The following table sets forth the Company's other income for
the indicated periods.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
-------------- ------------
1998 1997 1997 1996
----- ----- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Service charges............................................. $106 $ 52 $ 68 $ 56
Bank charges................................................ 285 202 267 269
Building rent............................................... 79 111 130 206
Payroll services............................................ -- -- -- 233
Gain on sale of subsidiary.................................. -- -- -- 65
Gain on sale of investment securities....................... 25 -- 341 --
Other....................................................... 201 175 190 132
---- ---- ---- ----
Total other income................................ $696 $540 $996 $961
==== ==== ==== ====
</TABLE>
During the nine months ended September 30, 1998 total other income
increased to $696,000 from $540,000 for the comparable period in 1997 due
primarily to an increase in fee income including fees from ATM operations. Other
income for the year ended December 31, 1997 compared to 1996 increased by
approximately $35,000 due primarily to a recognition of gain following the sale
of investment securities which offset decreases in other areas. Management sold
the payroll services operation in 1996.
17
<PAGE> 18
Other Expenses. The following table sets forth the Company's operating
expenses for the indicated periods.
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
------------------ ------------------
1998 1997 1997 1996
------ ------ ------ ------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Salaries and employee benefits..................... $3,183 $2,216 $3,135 $2,261
Occupancy expense of premises...................... 688 539 708 642
Furniture and equipment expense.................... 337 221 342 298
Payroll services................................... -- -- -- 384
Contract labor..................................... 55 59 74 130
Printing........................................... 45 44 65 19
Computer systems and services...................... 100 83 133 42
Postage and freight................................ 31 52 95 55
Supplies........................................... 131 110 154 113
Consulting fees.................................... 47 49 78 55
Loan, legal and collection fees.................... 76 130 234 73
Other.............................................. 1,196 1,081 1,409 887
------ ------ ------ ------
Total other expenses..................... $5,889 $4,584 $6,427 $4,959
</TABLE>
During the nine months ended September 30, 1998 total other expenses
increased by $1.3 million over the comparable 1997 period to $5.9 million,
primarily as a result of salaries and employee benefits increasing by $967,000
due to increased operations of the Bank and salary increases to Bank personnel.
Generally, the remaining expenses increased due to an increased level of
operations and increased expenses associated with opening two additional
branches in 1997 and 1998. Payroll services expenses were not incurred in 1997
as a result of the sale of the payroll services operation in 1996. During the
year ended December 31, 1997 total operating expenses increased $1.5 million to
$6.4 million from $4.9 million in 1996, with increases occurring among the
various components due to the Company's continued growth.
Federal Income Tax. The Company's consolidated income tax rate varies from
statutory rates principally due to interest income from tax-exempt securities
and loans. The provision for income taxes was increased to $1.3 million for the
nine months ended September 30, 1998 from $1.0 million for the comparable period
in 1997. The Company recorded income tax expenses totaling $1.3 million in 1997
and $1.4 million in 1996. Although net income increased in 1997 compared to
1996, the decrease in income tax expense for 1997 was due to an increase in tax
exempt income for the same period.
18
<PAGE> 19
FINANCIAL CONDITION
Loan Portfolio Composition. The following table sets forth the composition
of the Company's loan portfolio by type of loan at the dates indicated.
Management believes that the balance sheet information as of the dates indicated
should be read in conjunction with the average balance information in the tables
above under " -- Net Interest Income." As indicated above, the Company
specializes its lending practice in the land development and residential
construction industry. Depending on life cycles of real estate development,
balances of the Company's commercial loans, land development and construction
loans may fluctuate significantly. Therefore, the data below are not necessarily
indicative of trends within a particular category.
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
----------------- -------------------------------------
1998 1997 1996
----------------- ----------------- ----------------
AMOUNT % AMOUNT % AMOUNT %
-------- ----- -------- ----- ------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Land development and
construction..................... $121,026 73.7% $ 88,825 71.7% $47,306 50.4%
Commercial......................... 39,602 24.1 33,530 27.0 44,356 47.2
Installment and other.............. 7,673 4.7 4,710 3.8 4,103 4.4
Mortgage........................... -- -- -- -- 67 .1
Loans held for sale................ -- -- -- -- -- --
-------- ----- -------- ----- ------- -----
Total face amount of loans......... 168,301 102.5 127,065 102.5 95,832 102.1
Deferred loan fees, discounts and
costs, net....................... (1,592) (1.0) (978) (.8) (859) (.9)
-------- ----- -------- ----- ------- -----
Loans.............................. 166,709 101.5 126,087 101.7 94,973 101.2
Less allowance for loan losses..... (2,491) (1.5) (2,083) (1.7) (1,150) (1.2)
-------- ----- -------- ----- ------- -----
Net loans.......................... $164,218 100.0% $124,004 100.0% $93,823 100.0%
======== ===== ======== ===== ======= =====
</TABLE>
As of September 30, 1998, loans were $166.7 million, or $40.6 million
greater than loans of $126.1 million as of December 31, 1997. The difference is
due primarily to a greater amount of both land development and construction
loans and commercial loans. Loans as of December 31, 1997 were up $31.1 million
compared to December 31, 1996, principally due to greater amounts of land
development and construction loans and commercial loans, which reflect the
Company's growth discussed above.
The Company's two primary categories of loans, land development and
construction loans and commercial loans, trended upward as indicated at the
various dates. These loans as a group were $160.6 million as of September 30,
1998, $38.2 million over the $122.4 million balance as of December 31, 1997,
which in turn was $30.7 million greater than such loans as of December 31, 1996.
In addition, the significantly lower commercial loans as of December 31, 1997
compared to December 31, 1996 is in large part due to the Company's
reclassification in 1997 of land and acquisition loans to land development and
construction loans, with the corresponding increase in construction loans.
Installment loans increased to a balance of $7.7 million as of September
30, 1998 compared to $4.7 million as of December 31, 1997. Installment loan
balances were relatively constant during 1997 with a balance of $4.1 million as
of December 31, 1996.
Mortgage loans have comprised less than 1% of the Company's loan portfolio
since year-end 1994. As discussed earlier, the Company concentrates on land
development and construction lending rather than residential mortgage lending.
Although the risk of non-payment exists for a variety of reasons with
respect to all loans, certain other more specific risks are associated with each
type of loan. Several risks are present in land development and construction
loans, including economic conditions in the home building industry, fluctuating
land values, the failure of the contractor to complete the work and the
borrower's inability to repay. The primary risks of land loans include a general
slowdown in the market resulting in fewer building permits and lower absorption
of newly developed sites to major homebuilders, building moratoriums by
municipalities, the general economy,
19
<PAGE> 20
and the fiscal condition of the developer. Risks associated with commercial
loans are quality of the borrower's management and the impact of local economic
factors. Installment loans also have risks associated in a single type of loan.
Installment loans additionally face the risk of a borrower's unemployment as a
result of deteriorating economic conditions as well as the personal
circumstances of the borrower.
The Company believes that its philosophy in extending credit is relatively
conservative in nature, with a presumption that most credit should have both a
primary and a secondary source of repayment, and that the primary source should
generally be operating cash flows, while the secondary source should generally
be disposition of collateral. The Company engages in very little unsecured
lending, and generally requires personal guarantees of principals for business
obligations. The Company practices a system of concurrence in the approval of
commercial credit whereby the documented concurrence of the loan committee is
obtained in addition to that of the recommending loan officer.
At September 30, 1998, net loans totaled approximately 86.94% of total
deposits and approximately 75.58% of total assets.
Loan Maturities. The following tables present, at September 30, 1998 and
December 31, 1997, loans by maturity in each major category of the Company's
portfolio based on contractual repricing schedules. Actual maturities may differ
from the contractual repricing maturities shown below as a result of renewals
and prepayments. Loan renewals are re-evaluated as necessary.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
-----------------------------------------------------------------------------
OVER ONE YEAR
THROUGH FIVE YEARS OVER FIVE YEARS
ONE YEAR -------------------------- --------------------------
OR LESS FIXED RATE FLOATING RATE FIXED RATE FLOATING RATE TOTAL
-------- ---------- ------------- ---------- ------------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Land development and
construction.............. $118,577 $ 1,549 $ -- $ 900 $ -- $121,026
Commercial.................. 24,768 11,201 -- 3,633 -- 39,602
Installment and other....... 4,656 2,968 -- 49 -- 7,673
Mortgage.................... -- -- -- -- -- --
-------- ------- ---- ------ ------- --------
Total face amount of
loans.................. $148,001 $15,718 $ -- $4,582 $ -- $168,301
Deferred loans fees......... (1,258) (309) -- (25) -- (1,592)
-------- ------- ---- ------ ------- --------
Total loans............... $146,743 $15,409 $ -- $4,557 $ -- $166,709
======== ======= ==== ====== ======= ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------------------------------------------------------------
OVER ONE YEAR
THROUGH FIVE YEARS OVER FIVE YEARS
ONE YEAR -------------------------- --------------------------
OR LESS FIXED RATE FLOATING RATE FIXED RATE FLOATING RATE TOTAL
-------- ---------- ------------- ---------- ------------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Land development and
construction.............. $ 88,516 $ 309 $ -- $ -- $ -- $ 88,825
Commercial.................. 24,504 7,823 -- 1,203 -- 33,530
Installment and other....... 1,455 3,255 -- -- -- 4,710
Mortgage.................... -- -- -- -- -- --
-------- ------- ---- ------ ------- --------
Total face amount of
loans.................. $114,475 $11,387 $ -- $1,203 $ -- $127,065
Deferred loans fees......... (777) (190) -- (11) -- (978)
-------- ------- ---- ------ ------- --------
Total loans............... $113,698 $11,197 $ -- $1,192 $ -- $126,087
======== ======= ==== ====== ======= ========
</TABLE>
Nonperforming Loans. Nonperforming loans consist of loans 90 days or more
delinquent and still accruing interest, nonaccrual loans and restructured loans.
When, in the opinion of management, a reasonable doubt exists as to the
collectibility of interest, regardless of the delinquency status of a loan, the
accrual of interest income is discontinued and interest accrued during the
current year is reversed through a charge to current year's earnings. While the
loan is on nonaccrual status, interest income is recognized only upon receipt
20
<PAGE> 21
and then only if, in the judgment of management, there is no reasonable doubt as
to the collectibility of the principal balance. Loans 90 days or more delinquent
generally are changed to nonaccrual status unless the loan is in the process of
collection and management determines that full collection of principal and
accrued interest is probable.
Restructured loans are those for which concessions, including the reduction
of interest rates below a rate otherwise available to the borrower or the
deferral of interest or principal, have been granted due to the borrower's
weakened financial condition. Interest on restructured loans is accrued at the
restructured rates when it is anticipated that no loss of original principal
will occur. The Company did not have any restructured loans as of September 30,
1998, December 31, 1997 or December 31, 1996.
The following table sets forth information concerning the nonperforming
assets of the Company at the dates indicated:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
------------- -------------
1998 1997 1996
------------- ------ ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Nonaccrual loans:........................................... $1,291 $1,604 $ 14
Other loans 90 days past due................................ -- -- --
Other real estate........................................... -- -- --
------ ------ ----
Total nonperforming loans................................... $1,291 $1,604 $ 14
====== ====== ====
Ratio of nonaccrual and other loans 90 days past due to
total loans............................................... 0.77% 1.27% 0.01%
Ratio of nonperforming assets to total loans plus other real
estate.................................................... 0.77 1.27 0.01
Ratio of nonperforming assets to total assets............... 0.59 1.02 0.01
</TABLE>
Of the amount of nonaccrual loans as of September 30, 1998 and December 31,
1997, $1.3 million is the Bank's portion of five related loans totaling $4.0
million which are subject to a Chapter 11 bankruptcy proceeding. Principal
reductions on these loans were made in April and July 1998. The loans were
originated by the Bank and were made at various times during 1994, 1995 and 1996
in connection with a real estate development on which the developer has
constructed a residential building assembly plant. The loans are secured by real
estate, certificates of deposit, two personal guarantees from the owners of the
developer, as well as guaranteed by a related limited partnership. Management
believes that the Company is adequately collateralized on these loans.
Management is not aware of any adverse trend relating to the Company's loan
portfolio.
As of September 30, 1998, there was no significant balance of loans
excluded from nonperforming loans set forth above, where known information about
possible credit problems of borrowers caused management to have serious doubts
as to the ability of such borrowers to comply with the present loan repayment
terms and which may result in such loans becoming nonperforming.
Analysis of Allowance for Loan Losses. The allowance for loan losses
represents management's recognition of the risks of extending credit and its
evaluation of the quality of the loan portfolio. The allowance is maintained at
a level considered adequate to provide for anticipated loan losses based on
management's assessment of various factors affecting the loan portfolio,
including a review of problem loans, business conditions, historical loss
experience, evaluation of the quality of the underlying collateral and holding
and disposal costs. The allowance is increased by additional charges to
operating income and reduced by loans charged off, net of recoveries.
21
<PAGE> 22
The following table sets forth information regarding changes in the
allowance for loan losses of the Company for the periods indicated.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------- ------------------------
1998 1997 1996
------------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Average total loans.............................. $142,481 $109,167 $ 80,213
======== ======== ========
Total loans at end of period..................... $166,709 $126,087 $ 94,973
======== ======== ========
Allowance at beginning of year................... $ 2,083 $ 1,150 $ 759
Charge-offs:
Land development and construction.............. -- -- --
Commercial..................................... (2) (1) --
Installment.................................... (6) (7) (78)
Mortgage....................................... -- -- --
Other.......................................... -- (1) (1)
-------- -------- --------
Total charge-offs...................... (8) (9) (79)
Recoveries:
Land development and construction.............. -- -- --
Commercial..................................... 3 -- 10
Installment.................................... 3 62 3
Mortgage....................................... -- -- --
Other.......................................... -- -- --
-------- -------- --------
Total recoveries....................... 6 62 13
-------- -------- --------
Net (charge-offs) recoveries..................... (2) 53 (66)
Provisions for loan losses....................... 410 880 457
-------- -------- --------
Allowance at end of period....................... $ 2,491 $ 2,083 $ 1,150
======== ======== ========
Ratio of net (charge-offs) recoveries to average
total loans.................................... 0.00% 0.05% (0.08%)
Allowance to total loans at end of period........ 1.49% 1.65% 1.21%
Allowance to nonperforming loans................. 192.95% 129.92% 8,463.03%
</TABLE>
Net charge-offs during the nine months ended September 30, 1998 totaled
approximately $2,000 or less than .01% of average loans. Net recoveries during
1997 totaled approximately $53,000 or .05% of average loans compared to net
charge offs of approximately $66,000 or .08% of average loans in 1996.
The Company's lending personnel are responsible for continuous monitoring
of the quality of loan portfolios. The loan portfolios are also monitored and
examined by the Company loan review personnel. These reviews assist in loan
grading which in turn aids the identification of potential and probable losses,
and also in the determination of the level of the allowance for loan losses. The
allowance for loan losses is based primarily on management's estimates of
possible loan losses from the foregoing processes and historical experience.
These estimates involve ongoing judgments and may be adjusted over time
depending on economic conditions and changing historical experience.
Federal regulatory agencies, as an integral part of their examination
process, usually review the Company's loans and its allowance for loan losses.
Management believes that the Company's allowance for loan losses is adequate to
cover anticipated losses. There can be no assurance, however, that management
will not determine a need to increase the allowance for loan losses or that
regulators, when reviewing the Company's loan portfolios in the future, will not
require the Company to increase such allowance, either of which could adversely
affect the Company's earnings. Further, there can be no assurance that the
Company's actual loan losses will not exceed its allowance for loan losses.
22
<PAGE> 23
The following tables set forth an allocation of the allowance for loan
losses by loan category as of the dates indicated. Portions of the allowance
have been allocated to categories based on analysis of the status of particular
loans; however, the majority of the allowance is utilized as a single
unallocated allowance available for all loans. The allocation table should not
be interpreted as an indication of the specific amounts, by loan classification,
to be charged to the allowance. Management believes that the table may be a
useful device for assessing the adequacy of the allowance as a whole. The table
has been derived in part by applying historical loan loss ratios to both
internally classified loans and the portfolio as a whole in determining the
allocation of the loan losses attributable to each category of loans.
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
---------------------- ------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
LOANS IN LOANS IN LOANS IN
CATEGORY CATEGORY CATEGORY
AS A AS A AS A
AMOUNT PERCENTAGE AMOUNT PERCENTAGE AMOUNT PERCENTAGE
OF GROSS OF TOTAL OF GROSS OF TOTAL OF GROSS OF TOTAL
ALLOWANCE LOANS ALLOWANCE LOANS ALLOWANCE LOANS
--------- ---------- --------- ---------- --------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Land development and
construction............... $ 141 71.9% $ 155 69.9% $ 155 49.3%
Commercial................... 97 23.5 127 26.4 33 46.3
Installment and other........ 14 4.6 16 3.7 4 4.2
Mortgage..................... -- 0.0 -- 0.0 -- 0.2
Unallocated.................. 2,239 0.0 1,785 0.0 958 0.0
------ ----- ------ ----- ------ -----
Total.............. $2,491 100.0% $2,083 100.0% $1,150 100.0%
====== ====== ======
</TABLE>
As of September 30, 1998, the Company increased its loan loss reserve by
$410,000 compared to December 31, 1997 due to a significant increase in loan
production of $95.0 million over the amount originated in the first nine months
of 1997 and management's expectation of continued increases in total loans in
1998. The total loan loss reserve at December 31, 1997 was $2.1 million or 1.65%
of total loans and 129.92% of nonperforming assets. The loan loss reserve
increase at September 30, 1998 compared to December 31, 1997 was included in the
unallocated category.
The allocation for loan losses takes into account many factors such as the
Company's prior experience with loan losses and an evaluation of the risks in
the loan portfolio at any given time, including changes in economic, operating
and other conditions of borrowers, and changes in the Denver and national
economies. As indicated in the table above, a majority of the loan loss
allowance was not allocated to a single category. The Company's loan portfolio
contains a significant amount of loans that are land development and
construction loans, and management assesses general risks to the portfolio that
are common to both categories. These risks include the economic conditions in
the building industry that could effect a slowdown in the market resulting in
fewer building permits and lower absorption of newly developed sites,
fluctuating land values, building moratoriums by municipalities, and the overall
general economy of the Company's area of operations.
Management believes that the approximate amount of charge-offs by category
during 1998 and 1999 will be in the range of 0.23% to 0.27% for consumer loans,
0.14% to 0.17% for construction loans, and 0.12% to 0.15% for commercial loans,
for an overall total of approximately 0.15% of total loans. The foregoing is a
good faith best estimate only and is subject to several factors beyond the
control of the Company, including the risks discussed above.
Investments. The Company's investment policy is designed to ensure
liquidity for cash-flow requirements; to help manage interest rate risk; to
ensure collateral is available for public deposits, FHLB advances and repurchase
agreements; and to manage asset quality diversification. Investments are managed
centrally to maximize compliance and effectiveness of overall investing
activities. The Bank's President is responsible for implementing investment
strategy. Ongoing review of the performance of the investment portfolio, market
values, market conditions, current economic conditions, profitability, capital
ratios, liquidity needs, collateral position with the FHLB and other matters
related to investing activities is made.
23
<PAGE> 24
The Company's investment portfolio at September 30, 1998 is comprised of
U.S. Treasury bonds and bills, corporate equity securities and general
obligation and revenue municipal bonds. Although the municipal securities are
non-rated and privately placed, none of these investments are derivatives,
structured notes or similar instruments that are classified as "High-Risk
Securities" as defined by the Federal Financial Institutions Examinations
Counsel. In accordance with the principles of the Financial Accounting Standards
Board ("FASB") in its statement of financial accounting standards no. 115 ("FASB
115"), Accounting for Certain Investment in Debt and Equity Securities, all
investments are accounted for as "Available for Sale."
The following table sets forth the estimated market value of the available
for sale securities in the Company's investment portfolio by type at the dates
indicated.
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
------------- ------------------
1998 1997 1996
------------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
U.S. Treasury securities........................... $ 4,554 $ 4,774 $ 4,390
Corporate debt securities.......................... 2,734 -- --
Corporate equity securities........................ 444 454 231
FHLB Stock......................................... 480 368 313
Municipal securities(1)............................ 8,401 8,403 6,203
------- ------- -------
Total.................................... $16,613 $13,999 $11,137
======= ======= =======
</TABLE>
- ---------------
(1) Exempt from both federal and state income taxation.
Investment Maturities and Yield. The following table sets forth the
estimated market value and approximate yield of debt securities in the
investment portfolio by type and maturity at September 30, 1998.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
----------------------
TYPE AND MATURITY AMOUNT YIELD
----------------- --------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
U.S. Treasury securities:
One year or less.......................................... $ 3,026 5.85%
Over one through five years............................... 1,528 6.20
Over five through 10 years................................ -- --
Over 10 years............................................. -- --
-------
Total............................................. $ 4,554 5.97
=======
Corporate debt securities:
One year or less.......................................... $ -- --
Over one through five years............................... -- --
Over five through 10 years................................ -- --
Over 10 years............................................. 2,734 7.33
-------
Total............................................. $ 2,734 7.33
=======
Municipal securities:
One year or less.......................................... $ -- --
Over one through five years............................... -- --
Over five through 10 years................................ 717 9.00
Over 10 years............................................. 7,684 8.93
-------
Total............................................. $ 8,401 8.94
=======
Total investment in debt securities:
One year or less.......................................... $ 3,026 5.85
Over one through five years............................... 1,528 6.20
Over five through 10 years................................ 717 9.00
Over 10 years............................................. 10,418 8.51
-------
Total............................................. $15,689 8.00
=======
</TABLE>
24
<PAGE> 25
Deposits. The Company's primary source of funds has historically been
customer deposits, and deposits have experienced significant growth in recent
years with average deposits increasing to $157.3 million for the nine months
ended September 30, 1998 from $128.9 million for the year ended December 31,
1997 and $89.0 million for the year ended December 31, 1996. These increases are
primarily a result of two new branch openings and overall growth. At September
30, 1998, average noninterest-bearing deposits comprised 28.1% of average total
deposits. Management believes this ratio may decrease as the mix of deposits in
new branches tend to be more interest-bearing rather than noninterest-bearing
due to start up marketing activities.
The following table presents the average balances for each major category
of deposits and the weighted average interest rates paid for interest-bearing
deposits for the period indicated.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-------------------
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------- ----------------------------------------
1998 1997 1996
---- ---- ----
AVERAGE AVERAGE AVERAGE
AVERAGE INTEREST AVERAGE INTEREST AVERAGE INTEREST
BALANCE COST BALANCE COST BALANCE COST
-------- -------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Demand, interest-bearing.............. $ 67,185 4.54% $ 53,370 4.60% $37,983 4.52%
Savings............................... 5,088 3.33 4,775 3.35 5,442 3.42
Certificates of deposit under
$100,000............................ 30,040 5.77 25,295 5.71 9,639 5.42
Certificates of deposit $100,000 and
over................................ 10,762 5.55 9,749 5.93 6,885 5.36
-------- -------- -------
Total interest-bearing
demand deposits........... 113,075 4.91 93,189 4.97 59,949 4.66
Noninterest-bearing demand deposits... 44,175 35,683 29,096
-------- -------- -------
Total Deposits.............. $157,250 $128,872 $89,045
======== ======== =======
</TABLE>
The increases in average costs in 1998 and 1997 from 1996 were due
primarily to higher rates offered in connection with new branch promotions. See
" -- Net Interest Income."
The following table sets forth the amount and maturity of certificates of
deposit that had balances of more than $100,000 at September 30, 1998.
<TABLE>
<CAPTION>
REMAINING MATURITY
------------------ (IN THOUSANDS)
<S> <C>
Less than three months............................... $ 465
Three months up to six months........................ 4,316
Six months up to one year............................ 8,685
One year and over.................................... 861
-------
Total...................................... $14,327
=======
</TABLE>
FHLB Borrowings. The Bank is a member of the Federal Home Loan Bank of
Topeka, which is one of 12 regional FHLB's. The FHLB system functions as a
central bank providing credit for members. As a member of the FHLB, the Bank is
entitled to borrow funds from the FHLB and is required to own FHLB stock in an
amount determined by a formula based upon the Bank's total assets and its FHLB
borrowings. The Bank may use FHLB borrowings to supplement deposits as a source
of funds. See "Liquidity -- Asset/ Liability Management." Average FHLB
borrowings for the nine months ended September 30, 1998 were $547,000 compared
to $2.0 million and $874,000 for the years ended December 31, 1997 and 1996,
respectively. At September 30, 1998, based on its FHLB stockholdings, the Bank's
total available and unused borrowing capacity based on the Bank's current FHLB
stockholdings was approximately $7.0 million, which was available through a line
of credit and term advances. FHLB borrowings are collateralized by the Bank's
FHLB stock, other investment securities and certain loans.
A variety of borrowing terms and maturities can be chosen from the FHLB.
Maturities available range generally from one day to 10 years. Interest rates
can be either fixed or variable and prepayment options are available if desired.
The FHLB offers both amortizing and nonamortizing advances. To date, FHLB stock
has
25
<PAGE> 26
been redeemable at the preset price of $100 per share, but there can be no
assurance that this will continue to be the case.
CAPITAL RESOURCES
The Company monitors compliance with federal regulatory capital
requirements, focusing primarily on risk-based capital guidelines. Under the
risk-based capital method of capital measurement, the ratio computed is
dependent upon the amount and composition of assets recorded on the balance
sheet, and the amount and composition of off-balance sheet items, in addition to
the level of capital.
The following tables set forth the Bank's capital ratios as of the
indicated dates.
TANGIBLE RATIOS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
---------------- -----------------------------------
1998 1997 1996
---------------- ---------------- ----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ----- -------- ----- -------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Core (Tier 1) capital.................. $ 22,044 10.34% $ 12,579 8.02% $ 10,632 8.97%
Core (Tier 1) capital minimum
requirement(1)....................... 6,394 3.00 4,707 3.00 3,555 3.00
-------- ----- -------- ----- -------- ----
Excess................................. $ 15,650 7.34 $ 7,872 5.02 $ 7,077 5.97
======== ===== ======== ===== ======== ====
Tangible capital....................... $ 22,044 10.34 $ 12,579 8.02 $ 10,632 8.97
Tangible capital minimum
requirement(1)....................... 3,197 1.50 2,354 1.50 1,777 1.50
-------- ----- -------- ----- -------- ----
Excess................................. $ 16,847 8.84 $ 10,225 6.52 $ 8,855 7.47%
======== ===== ======== ===== ======== ====
Adjusted tangible assets............... $213,129 $156,909 $118,484
======== ======== ========
</TABLE>
- ---------------
(1) Based on risk-based capital guidelines of the Office of Thrift Supervision,
a savings association is required to maintain a Core (Tier 1) capital
requirement of 3% of adjusted tangible assets and a tangible capital
requirement of 1.5% of tangible assets. See "Supervision and
Regulation -- Federal Savings Association Regulation -- OTS Capital
Requirements" for definitions of the ratio terms.
RISK-BASED CAPITAL RATIOS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
---------------- ----------------------------------
1998 1997 1996
---------------- ---------------- ---------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
-------- ----- -------- ----- ------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Risk-Based capital...................... $ 23,915 13.20% $ 14,321 10.30% $11,782 12.62%
Minimum requirement(1).................. 13,694 8.00 11,122 8.00 7,471 8.00
-------- ----- -------- ----- ------- -----
Excess.................................. $ 10,221 5.20% $ 3,199 2.30% $ 4,311 4.62%
======== ===== ======== ===== ======= =====
Total risk-based assets....... $181,179 $139,023 $93,391
======== ======== =======
</TABLE>
- ---------------
(1) Based on risk-based capital guidelines of the Office of Thrift Supervision,
a savings association generally is required to maintain a total capital to
risk-based assets ratio of 8%. See "Supervision and Regulation -- Federal
Savings Association Regulation -- OTS Capital Requirement" for definitions
of terms relating to the ratio.
26
<PAGE> 27
LIQUIDITY
Sources of Liquidity. The Company manages its liquidity in order to satisfy
cash flow requirements of depositors and borrowers and allow the Company to meet
its own cash flow needs. The Company has two basic sources of liquidity. The
first is its retail deposit market served by its banking offices. The Company
has increased core deposits through growth of its existing deposits and through
promotions directed at existing and potential customers. Average deposits
increased by $28.4 million, or 22.02% in the nine months ended September 30,
1998 compared to average deposits at December 31, 1997, and by $39.8 million, or
44.73% in 1997 compared to 1996.
The second source of the Company's liquidity is FHLB advances and Company
lines of credit. FHLB advances are used regularly in the cash management
function both to fund a portion of the investment portfolio and to manage the
day-to-day fluctuations in liquidity resulting from needs of depositors and
borrowers. At September 30, 1998 the Company had available $7.0 million of
unused borrowing capacity from the FHLB and $10.0 million from its other lenders
in unsecured credit lines. The Company anticipates that it will continue to rely
primarily upon customer deposits, FHLB borrowings, other lending sources, loan
repayments, loan sales and retained earnings to provide liquidity, and will use
funds so provided primarily to make loans and to purchase investment securities.
Asset/Liability Management. A principal function of asset/liability
management is to coordinate the levels of interest-sensitive assets and
liabilities to minimize net interest income fluctuations in times of fluctuating
market interest rates. Interest-sensitive assets and liabilities are those that
are subject to repricing in the near term, including both variable rate
instruments and those fixed-rate instruments which are approaching maturity.
Changes in net yield on interest-sensitive assets arise when interest rates on
those assets (e.g. loans and investment securities) change in a different time
period from that of interest rates on liabilities (e.g. time deposits). Changes
in net yield on interest-sensitive assets also arise from changes in the mix and
volumes of earning assets and interest-bearing liabilities.
27
<PAGE> 28
The following table sets forth the interest rate sensitivity of the
Company's assets and liabilities as of September 30, 1998, and sets forth the
repricing dates of the Company's interest-earning assets and interest-bearing
liabilities as of that date, as well as the Company's interest rate sensitivity
gap percentages for the periods presented. The table is based upon assumptions
as to when assets and liabilities will reprice in a changing interest rate
environment, and since such assumptions can be no more than estimates, certain
assets and liabilities indicated as maturing or otherwise repricing within a
stated period may, in fact, mature or reprice at different times and at
different volumes than those estimated. Also, the renewal or repricing of
certain assets and liabilities can be discretionary and subject to competitive
and other pressures. Therefore, the following table does not and cannot
necessarily indicate the actual future impact of general interest rate movements
on the Company's net interest income.
<TABLE>
<CAPTION>
ESTIMATED MATURITY OR REPRICING AT SEPTEMBER 30, 1998
----------------------------------------------------------------
THREE MONTHS
LESS THAN TO LESS THAN ONE TO OVER
THREE MONTHS ONE YEAR FIVE YEARS FIVE YEARS TOTAL
------------ ------------ ---------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Funds sold and interest-bearing
deposits............................ $ 13,388 $ -- $ -- $ -- $ 13,388
Investment securities available for
sale................................ -- 3,026 1,528 11,135 15,689
Loans.................................. 141,371 5,372 15,409 4,557 166,709
-------- -------- ------- ------- --------
Total interest-earning
assets....................... 154,759 8,398 16,937 15,692 195,786
Interest-bearing liabilities:
Deposits:
Demand, interest-bearing............ 70,567 -- -- -- 70,567
Savings............................. 5,964 -- -- -- 5,964
Certificates of deposit under
$100,000.......................... 6,389 22,475 7,852 -- 36,716
$100,000 and over................. 465 13,001 861 -- 14,327
Federal Home Loan Bank borrowings... -- -- -- -- --
8.75% Junior Subordinated
Debentures........................ -- -- -- 12,000 12,000
Repurchase agreements............... 556 -- -- -- 556
-------- -------- ------- ------- --------
Total interest-bearing
liabilities.................. 83,941 35,476 8,713 12,000 140,130
-------- -------- ------- ------- --------
Interest rate gap........................ $ 70,818 $(27,078) $ 8,224 $ 3,692 $ 55,656
======== ======== ======= ======= ========
Cumulative interest rate gap at June 30,
1998................................... $ 70,818 $ 43,740 $51,964 $55,656
======== ======== ======= =======
Cumulative interest rate gap to total
assets................................. 32.59% 20.13% 23.92% 25.62%
======== ======== ======= =======
</TABLE>
Due to the volume of loans that reprice with changes in the prime lending
rate and the volume of noninterest-bearing deposits, the Company has experienced
a positive gap in assets and deposits that reprice or mature in less than three
months. Of the total interest-earning assets at September 30, 1998, 79.04%
reprice or mature in less than three months while 59.90% of all interest-bearing
liabilities reprice or mature in that same time frame. The Bank's positive
interest rate gaps indicate that the Bank's net income would increase in the
event of rising interest rates and would decrease in the event of decreasing
interest rates. In the highly unlikely event of an immediate, parallel and
sustained shift of market interest rates of 200 basis points, management
estimates that the Bank's net income during the 12 months ending September 30,
1999 would likely increase greater than 10% compared to the prior like 12-month
period if interest rates rose by 200 basis points and likely fall by greater
than 10% compared to the prior like 12-month period if rates fell of the same
amount. These are good faith estimates assuming all other factors do not change
materially, and, in management's belief, are not necessarily indicative of what
actually could occur in the event of immediate interest rate increases or
deceases of this magnitude. Management believes that it is highly unlikely that
such changes would occur in a short time period. As interest-bearing assets and
liabilities reprice at different time frames and proportions to market interest
rate movements, various assumptions must be made based on historical
relationships of these variables in reaching any conclusion. Since these
correlations are based on competitive
28
<PAGE> 29
and market conditions, future results would, in management's belief, be
materially different from the foregoing estimates.
EFFECTS OF INFLATION AND CHANGING PRICES
Unlike most industrial companies, virtually all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates generally have a more significant impact on a financial
institution's performance than inflation. Although interest rates do not
necessarily move in the same direction or to the same extent as the prices of
goods and services, increases in inflation generally have resulted in increased
interest rates. Over short periods of time interest rates may not move in the
same direction or magnitude as inflation.
YEAR 2000 CONSIDERATIONS
As the year 2000 approaches, a significant business issue has emerged
regarding how existing application software programs and operating systems can
accommodate the date value for the year 2000. Many existing software application
products, including software application products used by the Bank and its
suppliers and customers, were designed to accommodate only a two-digit date
value, which represents the year. For example, information relating to the year
1996 is stored in the system as "96." As a result, the year 1999 (i.e., "99")
could be the maximum date value that these systems will be able to process
accurately. In response to concerns about this issue, regulatory agencies have
begun to monitor holding companies' and banks' readiness for the year 2000 as
part of the regular examination process. The Company presently believes that
with modifications to existing software and conversion to new software, the year
2000 issue will not pose significant operational problems for the Company's
computer systems or business operations. Implementation of the Company's plan to
test in-house and out-sourced software has been underway since the first quarter
of 1998. Testing of applications considered to be "mission critical" are
scheduled for completion by first quarter of 1999. Total compliance for all
systems is expected by management to be completed by the third quarter of 1999;
management currently estimates that such compliance will cost $150,000. The team
for the plan is responsible for the implementation of the plan and reports to
the Company's Board of Directors on a quarterly basis until October 1998 and on
a monthly basis thereafter until the plan is completed. However, if such
modifications and conversions are not made, or are not completed timely, the
year 2000 issue could have a material adverse impact on the operations of the
Company. In addition, there can be no assurance that unforeseen problems in the
Company's computer systems, or the systems of third parties on which the
Company's computers rely, will not have an adverse effect on the Company's
systems or operations. Additionally, failure of the Bank's customers to prepare
for year 2000 compatibility could have a significant adverse effect on such
customers' operations and profitability, thus inhibiting their ability to repay
loans and adversely affecting the Bank's operations. The Company does not have
sufficient information accumulated from customers of the Bank to enable the
Company to assess the degree to which customers' operations are susceptible to
potential problems relating to the year 2000 issue.
29
<PAGE> 30
BUSINESS
GENERAL
MegaBank Financial Corporation (the "Company") was founded in 1984 by its
Chairman and Chief Executive Officer, Thomas R. Kowalski, with the objective of
building a banking franchise in the Denver, Colorado metropolitan area that
would deliver a broad based package of products and services to businesses and
individuals. The Company's banking subsidiary, MegaBank (the "Bank") was
organized in 1983. Since the advent of branch banking in Colorado in 1993, the
Bank has opened seven additional banking locations throughout the Denver area
and has two more locations in the planning and construction phase.
Since inception, the Bank has specialized its lending practice in the
residential construction industry. The Company's Chairman has extensive
experience in the home building industry and has expanded the Bank's lending
practice to date such that the Bank is one of the area's leading originators of
land development and residential construction loans to small- and medium-sized
homebuilders. Currently, the Bank can finance a builder or developer from the
acquisition and development loan process, including assistance with special
district financing, through the construction loan phase. During the five years
ended December 31, 1997, the Bank originated over $750 million in total loans
and during the nine months ended September 30, 1998, originated an additional
$231 million of loans. While some of these loans remain on the Company's balance
sheet, most have been repaid, refinanced or participated out to other financial
institutions.
In September 1998, the Company changed its status to a unitary savings and
loan holding company within the meaning of HOLA. The Company is registered with
the OTS and is subject to OTS regulations, examinations, supervision and
reporting requirements. Also in September 1998, the Bank converted its charter
from a state-chartered stock institution to a federal stock savings bank.
Management believes that the flexibilities and opportunities with a thrift
charter complement the Bank's current lending practices and its long-term plans
which are discussed below under "Strategy."
The Bank intends to continue to focus on its niche of residential land
development and construction lending in addition to providing a complete array
of products and services for its customers. High quality customer service has
been a fundamental tenet of the Bank's operating strategy since its inception.
The Bank intends to continue to pursue its strategies and concentrate on
increasing its market share through referrals from existing customers and focus
on the implementation of advertising and marketing strategies.
In addition to the Company's core business of residential land development
and construction lending through the Bank, the Company intends to expand its
activities into other areas which complement its current business, such as
establishing a subsidiary for purposes of investing in real estate and is
considering starting or acquiring a real estate title business.
STRATEGY
Bank Growth. The Bank's goal in continuing its expansion is to maintain a
profitable, customer-focused financial institution. Management believes that the
Company's existing capital structure, management, data and operational systems
are sufficient to achieve further growth in asset size, revenues and capital.
This growth should allow the Bank to increase its lending limits, thereby
enabling it to continue to serve the needs of its customers.
The Bank expects to continue its growth strategy primarily through internal
growth and potentially through acquisitions. Management believes that the Bank's
largest source of growth is through referrals by existing customers, and that
the primary reason for referrals is positive customer feedback regarding the
Bank's customer service and response time. The Colorado banking market is
dominated by large national and regional financial institutions. This dominance
was achieved through the purchase of Colorado-based holding companies over the
past several years, which resulted in a significant consolidation of the
Colorado banking industry. Management believes that small- and medium-size
businesses often are not of sufficient size to be of interest to these large
banks, particularly as it relates to residential land development and
construction lending, and that individuals frequently have difficulty in finding
personalized banking services. Many of these
30
<PAGE> 31
customers seek a banking relationship with a smaller and more service-oriented
community banking organization such as the Bank. Through the Bank's primary
emphasis on customer service, management's experience and the Company's product
line, the Company will continue to focus on attracting these customers in
achieving internal growth. Management also believes that the economic expansion
in the Company's market area contributes significantly to internal growth.
The Bank's market area is the Denver metropolitan area, which is the most
densely populated area in the Rocky Mountain region. Total population is
approximately 2.2 million. Employment in the area is diversified across the
manufacturing, construction, financial services, tourism, transportation,
technology, cable television, retail trade, services and government sectors. Job
growth in 1997 gained an estimated 51,000 jobs, or a 4.4% increase, representing
the largest job gain in the 1990's. In addition, according to the Denver
Homebuilders Association, the number of units authorized by permit in the first
four months of 1998 was up 16% over the same period last year.
In addition to internal growth, management believes there are opportunities
to grow through branching. The Bank has recently opened its eighth branch, has a
ninth branch under construction, and has a tenth branch in the planning stage.
The ninth and tenth branches are expected to begin operations in 1999. Branching
opportunities have also arisen through eliminations by bank holding companies of
certain overlapping branches resulting from acquisitions. As a result, branch
locations have become available from time to time for purchase by the Company.
To date, the Company has acquired one such branch from a large bank holding
company. Also, management intends to pursue acquisitions of financial
institutions, although the sales prices of such institutions are currently at
significant premiums over those paid the past few years. Thus, it may be
difficult to complete such a transaction. Management has considered and intends
to consider a variety of criteria when evaluating expansion. These include (i)
the geographic location, (ii) the investment required for, and opportunity costs
of, the branch or acquisition, (iii) the financial strength of a potential
acquisition target and (iv) economies of scale that may be achieved.
Proposed Expansion Activities. The Company intends to expand its business
by entering into activities which complement its core banking activities in
residential land development and construction lending. Currently, management is
considering the following expansion activities.
- The Company intends to use approximately $3.5 million of the proceeds
from the Offering to establish and fund a subsidiary that will purchase
real estate for development and sale to homebuilders. Management believes
that this activity will supplement the Company's revenues since many
smaller homebuilders do not have the resources to develop sites for home
building. Management believes that the subsidiary can generate revenues
through the sale to these homebuilders of individual or bulk lots. Also,
management believes that the Bank can provide construction lending in
connection with the sales of lots to homebuilders, thereby providing
additional loans to the Bank.
- The Company is also considering engaging in the real estate title
business, which management believes will complement its banking services
and proposed real estate investment and development activities. Since
this activity is only in the planning stage, the Company has not
allocated any proceeds from the Offering to establishing or acquiring a
real estate title business.
Management believes that the addition of the foregoing activities should
complement the Company's existing banking business. Management envisions a
"one-stop" service network whereby homebuilders can obtain developed or
undeveloped building sites, construction lending and real estate title services
from one source. Management believes that offering these combined services
should allow the Company to remain competitive in the Bank's lending activities.
Operations and Marketing. The Bank's objective is to continue to build a
profitable, growing community banking franchise. Management believes that, in
meeting the needs of consumers and small- to medium-sized businesses in its
market area, the Bank's first and foremost strategy is to provide excellent
customer service. This strategy is emphasized above all others of the Company,
from top management down to each bank teller. The Bank's operational systems
have been designed to complement customer service. Management believes
31
<PAGE> 32
the Company's banking locations are small enough to facilitate personalized
services and decision-making, yet of sufficient size to meet most customers'
needs.
The Bank seeks to maximize operational and support efficiencies consistent
with maintaining high quality customer service. Various management and
administrative functions are consolidated, including consumer credit
administration and lending, investment management and accounting, enabling
branch personnel to better focus on customer service and sales.
In expanding its banking franchise, the Bank has focused on identifying and
developing products and services that satisfy customer needs, particularly
customer service. The Bank offers a wide range of consumer deposit products
including regular checking, checking with interest, money market accounts,
regular savings, certificates of deposit, and IRAs. The Bank also offers
additional access to its customers with an ATM/Visa Debit Card. The Bank's
consumer loan products are customized to meet the needs and requests of its
customers. The Bank also offers installment loans, including auto, recreational
vehicle, classic car and other secured and unsecured loans sourced directly by
its branches and from indirect sources. See "Loans" below for a discussion of
products that the Bank provides to commercial accounts.
LOANS
The Company has the ability to provide a broad range of commercial and
retail lending services. However, the vast majority of the Bank's loans are land
development and residential construction loans. The Company follows a uniform
credit policy which sets forth underwriting and loan administration criteria,
including levels of loan commitment, loan types, credit criteria, concentration
limits, loan administration, loan review and grading and related matters. In
addition, the Company obtains outside independent loan reviews, operates a
centralized processing, underwriting and servicing center for consumer loans and
manages problem assets centrally. At September 30, 1998, substantially all loans
outstanding were to customers within the Company's market area. For a discussion
of risks associated with the Company's various types of loans, see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Financial Condition -- Loan Portfolio Composition."
Land Development and Construction Loans. Land development and construction
loans include real estate construction loans and land loans. Real estate
construction loans are principally made to builders to construct single family
residences. These loans typically have maturities of six to 12 months and
adjustable interest rates, and are subject to origination fees. Terms may vary
depending upon many factors, including, but are not limited to, location, type
of project and financial condition of the builder.
Land loans consist of loans made on raw land for the acquisition and/or
development of real property. At September 30, 1998, approximately $59.4 million
in loans were land loans to customers where the collateral for the loan is raw
or partially developed land. These loans typically have maturities of 12 to 18
months and variable interest rates. Terms may vary depending upon many factors,
including adverse economic conditions in the home building industry, location,
type of project and financial condition of the builder.
Commercial Loans. Commercial loans consist primarily of loans to businesses
for various purposes, including revolving lines of credit, equipment financing,
and commercial real estate lending. The commercial loans secured by real estate
are typically 20 to 25 year amortizing loans, callable in three to five years,
with fixed interest rates. The loans secured by collateral other than real
estate generally mature within one year, have adjustable interest rates and are
secured by inventory, accounts receivable or other commercial assets. Revolving
lines of credit generally are for business purposes, generally mature annually
and have adjustable interest rates.
Installment Loans. Installment loans to individuals which are not secured
by real estate generally have terms of two to five years and bear interest at
fixed rates. These loans usually are secured by motor vehicles, equipment,
receivables, inventory, investment securities or other personal assets, and in
some instances are unsecured.
32
<PAGE> 33
The Company maintains a loan committee approach to commercial lending,
which it believes yields positive results in both responsiveness to customer
needs and asset quality. The loan committee usually meets twice per week to
review and discuss new loan requests.
Interest rates charged on loans vary with the degree of risk, maturity,
underwriting and servicing costs, loan amount, and extent of other banking
relationships maintained with customers, and are further subject to competitive
pressures, money market rates, availability of funds and government regulations.
Most of the loans in the Company's portfolio at September 30, 1998, had interest
rates that float with the prime rate.
In the ordinary course of business, the Company issues letters of credit.
See Note N of Notes to Consolidated Financial Statements. The Company applies
the same credit standards to these commitments as it uses in all its lending
activities and has included these commitments in its lending risk evaluations.
The Company's exposure to credit loss under letters of credit is represented by
the amount of these commitments. Under applicable federal law, permissible loans
to one borrower were limited to an aggregate of $3.2 million for the Company at
September 30, 1998. With the infusion of approximately $5.0 million in capital
to the Bank (see "Use of Proceeds"), the Company expects that the Bank's lending
limit will increase by approximately $750,000 to a total of $4.0 million.
COMPETITION
The Company faces a high degree of competition. In its marketplace, there
are numerous small banks and several larger national and regional financial
banking groups. The Company also competes with insurance companies, savings and
loan associations, credit unions, leasing companies, mortgage companies, and
other financial service providers. Many of the banks and other financial
institutions with which the Company competes have capital resources and legal
lending limits substantially in excess of the capital resources and legal
lending limits of the Company.
The Company competes for loans and deposits principally based on the range
and quality of services provided, interest rates, loan fees and office
locations. The Company actively solicits deposit customers and competes by
offering them superior customer service and a complete product line. Over the
past few years, competition has increased as a result of changes in Colorado
banking laws that permit statewide branching and allow out-of-state holding
companies to acquire Colorado-based financial institutions. The Company believes
its customer service, broad product line and banking franchise enable it to
compete in its market area.
The Company will also face significant competition from other financial
institutions in any potential acquisitions. Many of these competitors have
substantially greater resources than the Company as well as the ability to issue
marketable equity securities that can be used as part of the purchase price.
PROPERTIES
The principal offices of both the Company and the Bank are located in a
three story building at 8100 East Arapahoe Road, Englewood, Colorado. The
building is owned by Nagrom LLC. See "Related Party Transactions." The Company
and the Bank lease approximately 22,300 square feet at this facility.
The Bank maintains seven branch banking facilities in the Denver
metropolitan area. The North Denver Branch is located at 4988 Federal Boulevard,
Denver; the land is leased from an unaffiliated third party but the facility,
consisting of approximately 3,000 square feet, is owned by the Company. The
Monaco Branch is located at 777 South Monaco, Denver, and the Company owns the
land and building at this site, of which the banking facility is approximately
3,000 square feet. The South Broadway Branch is located at 4600 South Broadway,
Englewood, and the Company owns the land and the building. The South Broadway
facility comprises approximately 3,000 square feet. The West Highland Branch is
located at 3804 West 32nd Avenue, Denver, and the Company leases the land and
facility, comprising approximately 2,600 square feet, from 1996 Newton LLC. See
"Related Party Transactions." The Greenwood Village Branch is located at 6300
South Syracuse Way, Greenwood Village, and the Company leases the facilities
from an unaffiliated third party. The Greenwood Village facility comprises
approximately 850 square feet. The Lower Downtown ("LoDo") Branch is located at
1401 17th Street, and the Company leases the 3,400 square foot facility from
33
<PAGE> 34
an unaffiliated third party. The Northglenn branch is located at 120th Street
and Pennsylvania, and the Company owns the land and the 5,200 square foot
building.
The Bank is renovating a 6,390 square foot building located at 3734 Osage
Street, Denver. Given its central Denver location, this facility will be used as
a central processing center for the Bank and its branch system. The facility is
leased from Osage 3734, LLC. See "Related Party Transactions."
LEGAL PROCEEDINGS
The Company and its subsidiaries are from time to time parties to various
legal actions arising in the normal course of business. Management believes that
there is no proceeding threatened or pending against the Company or any of its
subsidiaries which, if determined adversely, would have a material adverse
effect on the financial condition or results of operations of the Company.
EMPLOYEES
As of September 30, 1998, the Company had 103 full-time equivalent
employees. Management considers its relationship with its employees to be good.
34
<PAGE> 35
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company, their respective ages
and positions as of October 1, 1998, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITIONS
---- --- ---------
<S> <C> <C>
Thomas R. Kowalski...... 58 Chairman of the Board and Chief Executive Officer of the
Company and the Bank
Larry A. Olsen(1)....... 53 President, Chief Operating Officer and Director of the
Company and the Bank
Raymond L. Anilionis.... 51 Vice President and Director of the Company and Director of
the Bank
Susan A. Putland........ 51 Vice President, Finance and Secretary of the Company and
Vice President, Financial Services and Secretary of the Bank
Hiram J. Welton......... 48 Treasurer and Chief Accounting Officer of the Company and
Vice President, Finance and Treasurer of the Bank
Dr. Donald B. 69
Brown(1).............. Director of the Company and the Bank
William F. Sievers(1)... 54 Director of the Company and the Bank
</TABLE>
- ---------------
(1) Member of the Audit Committee.
There are no family relationships among any of the directors and executive
officers of the Company or the Bank except that Thomas R. Kowalski is the father
of the Bank's Vice President of Real Estate and Director of the Bank, Ryan
Kowalski. All directors of the Company hold office until the next meeting of
shareholders or until their successors are elected and qualified.
THOMAS R. KOWALSKI has been Chairman of the Board and Chief Executive
Officer of the Company since he founded it in 1984, and has served in the same
positions for the Bank since November 1983. Since 1980 he has been Chairman of
the Board and Chief Executive Officer of the First State Bank of Hotchkiss, a
Colorado bank. Mr. Kowalski is also Chief Executive Officer, and beneficial
owner of approximately 97.0% of the outstanding stock, of Orchard Valley
Financial Corporation, the bank holding company that owns First State Bank of
Hotchkiss. From October 1972 through September 1992, Mr. Kowalski was President
of Realtek Company, a general contractor and real estate development corporation
he sold to Ryan Kowalski in 1992.
LARRY A. OLSEN has been President, Chief Operating Officer and Director of
the Company since 1997 and has served in the same positions of the Bank since
1994. From 1989 to 1994, Mr. Olsen was the Chief Operating Officer of Non-Legal
Affairs for Codilis and Stawiarski, P.C., a law firm. From 1972 to 1988, Mr.
Olsen was employed by Columbia Savings & Loan Association, having served from
1986 to 1988 as President and Chief Operating Officer.
RAYMOND L. ANILIONIS has been a Vice President and Director of the Company
since 1984 and a Director of the Bank since 1984. Since January 1994, Mr.
Anilionis has been the President of Landmark Realty Advisors, a real estate
consulting and appraisal company. From 1974 to December 1993, Mr. Anilionis was
employed in the mortgage banking and real estate development and management
industry by Mortgage Investment Company and Associated Investment Company in
various positions, including Senior Vice President. He is also the owner of
First Fidelity Service Corp., a real estate consulting firm.
SUSAN A. PUTLAND has been Vice President, Finance and Secretary of the
Company since 1997 and Vice President, Financial Services for the Bank since
1996. Ms. Putland also serves as an independent director of FirstPlus Funding
Corp. CITGO Funding Corporation and CITGO Funding Corporation II, special
purpose finance securitization entities. Ms. Putland was Vice President,
Structured Finance for The Chotin Group Corporation and its affiliates, a
privately-held securities issuer and investor, from 1989 to December 1995.
35
<PAGE> 36
HIRAM J. WELTON has been Treasurer and Chief Accounting Officer of the
Company since 1997 and Vice President, Finance for the Bank since April 1998.
Mr. Welton was Vice President of Red Rocks Federal Credit Union from 1996 to
1997. He was Vice President of Trepp Risk Management from 1994 to 1996. Prior to
1994, Mr. Welton was Manager of GRA, Thompson, White & Co. P.A., an accounting
and consulting firm.
DR. DONALD B. BROWN has been a Director of the Company since 1997 and a
Director of the Bank since 1989. Dr. Brown previously served as a Director of
the Company from 1989 to 1994. Dr. Brown has practiced medicine as an
endocrinologist since 1961.
WILLIAM F. SIEVERS has been a Director of both the Company and the Bank
since 1997. Since 1994, Mr. Sievers has been employed with Lucent Technologies
as Program Management Vice President in the Network Systems Division.
Previously, he worked for AT&T for over 30 years in several capacities,
including the senior management positions of Manufacturing Vice President and
Regional Vice President.
Directors of the Company receive $500 for each board meeting attended plus
$200 per board meeting attended in their capacities as Directors of the Bank. In
addition, directors are reimbursed for expenses incurred in attending board
meetings.
EXECUTIVE COMPENSATION
Cash Compensation. The following table sets forth the cash compensation
paid by the Company to its Chairman and Chief Executive Officer for 1997, 1996
and 1995. No other executive officer of the Company received compensation from
the Company exceeding $100,000 during 1997, 1996 or 1995.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
AWARDS PAYOUTS
---------- SECURITIES -------
OTHER UNDER-
ANNUAL RESTRICTED LYING ALL OTHER
COMPEN- STOCK OPTIONS/ LTIP COMPEN-
NAME SALARY BONUS SATION AWARD(S) SARS PAYOUTS SATION
AND PRINCIPAL POSITION YEAR ($) ($) ($) ($) (#) ($) ($)
- ------------------------------------------ ---- ------- ------- ------- ---------- ---------- ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Thomas R. Kowalski,....................... 1997 150,000 275,000 -- -- -- -- --
Chairman of the Board and 1996 150,000 238,101 -- -- -- -- --
Chief Executive Officer 1995 150,000 143,500 -- -- -- -- --
</TABLE>
Stock Incentive Plan. In August 1998, the Company adopted the 1998
Long-Term Incentive Plan (the "Incentive Plan"). The purpose of the Incentive
Plan is to provide continuing incentives to the Company's and its subsidiaries'
key employees, which may include officers and members of the Board of Directors.
The Incentive Plan provides for an authorization of 500,000 shares of Common
Stock to be reserved for issuance thereunder. Under the Incentive Plan, the
Company may grant to participants awards of stock options, restricted stock,
stock appreciation rights, performance shares or any combination thereof. The
Incentive Plan is to be administered by the Board of Directors or a Compensation
Committee of the Board of Directors composed of at least two non-employee
members. Subject to the terms of the Incentive Plan, the Board or Compensation
Committee determines, among other matters, the persons to whom awards are
granted and the terms of the awards. Currently, the Company does not have a
compensation committee.
Under the stock option component of the Incentive Plan, the Company may
grant both incentive stock options ("incentive stock options") intended to
qualify under Section 422 of the Internal Revenue Code of 1986, as amended (the
"Code"), and options which are not qualified as incentive stock options.
Incentive stock options may not be granted at an exercise price of less than the
fair market value of the Common Stock on the date of grant, while non-qualified
stock options may be granted at any exercise price. The exercise price may be
paid in cash, in shares of Common Stock (valued at fair market value at the date
of exercise) or by a combination of such means of payment, as may be determined
by the Board or Compensation Committee.
Under the restricted stock component of the Incentive Plan, the Company may
award shares of restricted stock upon payment of consideration as determined by
the Board or Compensation Committee. Upon the award, a restriction period (not
to exceed 10 years) and/or performance goal may be set. Subject to the terms
36
<PAGE> 37
of each individual award, a restricted stock award is forfeited upon termination
of employment by the recipient during the restriction period and any
consideration paid by the participant is returned.
An award of a stock appreciation right allows a recipient to receive a cash
payment or shares of Common Stock to the extent of any appreciation in the book
value or the fair market value of the Common Stock of the Company over a
specified period of time. Stock appreciation rights may also be awarded in
tandem with stock options, and recipients of such tandem awards may elect to
exercise the award as a stock option or as a stock appreciation right.
Under the performance share component of the Incentive Plan, recipients are
awarded a specified number of shares of Common Stock of the Company subject to
the recipient or the Company attaining specified performance goals as the Board
or Compensation Committee may determine. The Board or Compensation Committee,
under certain circumstances, may waive or modify performance criteria on
existing performance share awards.
The Incentive Plan will be discontinued in the event of the dissolution or
liquidation of the Company or in the event of a reorganization (such as a
merger, consolidation, or sale of substantially all of the assets of the
Company) in which the Company is not the surviving or acquiring company, or in
which the Company is or becomes a wholly-owned subsidiary of another company
after the effective date of the reorganization and no plan or agreement
respecting the reorganization is established which specifically provides for the
continuation of the Incentive Plan and the change, conversion, or exchange of
the Common Stock relating to existing awards under the Incentive Plan for
securities of another corporation. Upon the dissolution of the Incentive Plan,
all awards will become fully vested and all outstanding options and stock
appreciation rights will become immediately exercisable by the holder thereof.
In the case of any reclassification, recapitalization, stock dividend,
stock split or other similar event, the Board or Compensation Committee is
empowered to make adjustments as to the number and kind of securities covered by
each outstanding award and, where applicable to adjust the exercise price
thereunder.
On September 1, 1998, the Company granted options that will become
effective only upon the completion of this public offering to purchase up to
58,500 shares of Common Stock to various officers, directors and employees of
the Company. All options are exercisable at a price of $10 per share, vest as to
30% of the shares on September 1, 2001, and vest as to the remaining 70% of the
shares on September 1, 2002. The Company also granted an option for 50,000
shares to Thomas R. Kowalski, Chairman and Chief Executive Officer of the
Company, which is exercisable at a price of $11 per share and vests as to 20% of
the shares on September 1, 2000, an additional 30% of the shares on September 1,
2001, and vests as to the remaining shares on September 1, 2002.
Stock Purchase Agreement. In December 1990, the Company, Thomas R.
Kowalski, Ryan R. Kowalski Trust, Realtek Company Profit Sharing Plan and Trust,
Thomas Investments and Orchard Valley Financial Corporation (the "Shareholders")
entered into a Stock Purchase Agreement in order to provide for the orderly
continuation of the affairs of the Company. The agreement, as amended, provides
that upon the death of Thomas R. Kowalski, the Shareholders will have the option
to require the Company to purchase their shares of Company Common Stock to the
extent the Company receives proceeds from a life insurance policy on the life of
Thomas R. Kowalski. As of September 30, 1998, the Shareholders held an aggregate
of 2,959,650 shares of Common Stock. The agreement specifies that the purchase
price for the stock shall be the greater of 80% of the average closing price of
the Common Stock of the Company on any national securities exchange or
recognized quotation system for five trading days preceding the death of Thomas
R. Kowalski or the appraised value as determined by an appraiser selected
mutually by the Company and the surviving Shareholders.
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<PAGE> 38
INDEMNIFICATION
The Company's Articles of Incorporation provide that the board of directors
is authorized, without the need for shareholder approval, to indemnify
directors, officers and other persons without regard to whether or not such
powers are expressly provided for by Colorado law; provided, however, that the
exercise of such indemnification powers by the board of directors are consistent
with Colorado law. Generally under Colorado law, any director or officer who is
made or threatened to be made a party to any suit or proceeding may be
indemnified if such director or officer acted in good faith and had no
reasonable basis to believe that (i) in the case of conduct in an official
capacity with the Company, his or her conduct was in the Company's best
interests; and (ii) in all other cases, his or her conduct was at least not
opposed to the best interests of the Company; and, with respect to any criminal
proceeding, he or she had no reasonable cause to believe his or her conduct was
unlawful. Colorado law further provides that such indemnification is not
exclusive of any other rights to which such individuals may be entitled under a
company's Articles of Incorporation or Bylaws, or pursuant to any agreement,
insurance policies, vote of shareholders or disinterested directors or
otherwise.
In addition, the Company's Articles of Incorporation provide that to the
fullest extent permitted by Colorado law, the Company's directors will not be
liable for monetary damages for breach of the directors' fiduciary duty of care
to the Company and its shareholders. Notwithstanding such limitations on
liability, each director will continue to be subject to liability for breach of
the director's duty of loyalty to the Company or its shareholders, for acts or
omissions not in good faith or involving intentional misconduct or knowing
violations of law, for certain activities prohibited by Colorado law (relating
primarily to the unlawful payment of dividends, repurchase of stock or improper
loans or guarantees to directors), and for any transaction from which the
director derived an improper personal benefit. This provision also does not
affect a director's responsibilities under any other laws, such as the federal
securities laws or state or federal environmental laws.
There is no pending litigation or proceeding involving a director, officer,
employee or other agent of the Company as to which indemnification is being
sought. The Company is not aware of any other threatened litigation that may
result in claims for indemnification by any director, officer, employee or other
agent.
RELATED PARTY TRANSACTIONS
Nagrom LLC, a Colorado limited liability company, owns the building and
land in which the Company's principal office is located. The Company and the
Bank lease office space in the building. The lease began in 1995 and is for a
period of 10 years. The rent for 1997 was approximately $328,000, and will
increase 3.5% per year. The Board of Directors of the Company believes that the
rates are comparable to those which could be obtained from unaffiliated third
parties. Nagrom LLC is beneficially owned by Kowalski Capital LLC, a Colorado
limited liability company (71.0%), Raymond L. Anilionis (13.0%), an officer and
director of the Company, and Med Partnership (16.0%) an entity controlled by
Warren P. Cohen, a director of the Bank. Kowalski Capital LLC is owned 95.0% by
the Thomas R. Kowalski Irrevocable Trust. The beneficiaries of the trust are
Ryan Kowalski (the adult son of Thomas R. Kowalski) and Ryan Kowalski's minor
daughter. The remaining 5.0% of Kowalski Capital LLC is owned by Respond Corp.,
of which Thomas R. Kowalski is the sole shareholder.
1996 Newton LLC, a Colorado limited liability company, leases space to the
Bank for its branch at 32nd Avenue and Newton, Denver. 1996 Newton LLC is owned
by Kowalski Capital (50.0%), Raymond L. Anilionis (25.0%) and the Warren P.
Cohen Beneficial Trust (25.0%). The lease commenced in May 1996 and runs for a
period of 10 years. Rent is approximately $30,300 for the period of May 1997
through May 1998, and incrementally increases to $36,000 per year for the last
five years of the lease. The Board of Directors of the Company believes that the
rates are comparable to those which could be obtained from unaffiliated third
parties.
Osage 3734, LLC, a Colorado limited liability company, leases space to the
Bank for its new centralized processing center at 3734 Osage Street, Denver.
Osage 3734, LLC is owned equally by Raymond L. Anilionis, Ryan Kowalski, Vice
President and Director of the Bank and son of Thomas R. Kowalski, and Respond
Corporation, an entity owned by Thomas R. Kowalski. The building is currently
undergoing renovations to suit
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<PAGE> 39
the needs of the Bank. The Bank expects to occupy the building in 1999 under the
terms of a ten-year triple net lease. The Board of Directors of the Company
believes that the leasing terms are comparable to those which could be obtained
from unaffiliated third parties.
In July 1995, Thomas R. Kowalski, Raymond L. Anilionis and Warren P. Cohen
(the "Guarantors"), all of whom are officers and/or directors of the Company
and/or the Bank and significant shareholders of the Company, entered into an
agreement with the Company in connection with their personal guarantee of a $3.0
million loan to the Bank from First Interstate Bank of Denver. In return for the
guarantee, the Company agreed to indemnify the Guarantors for all liabilities,
costs or expenses relating to the guarantee and to provide additional
compensation to the Guarantors. The additional compensation consisted of an
aggregate fee, allocated among the three Guarantors, equal to 1.5% of the
outstanding balance of the loan on each anniversary date plus a performance
bonus based on earnings of the Bank as specified in the agreement. The loan was
repaid in February 1998. The fees paid to the Guarantors from 1995 through
September 30, 1998 in the aggregate were as follows: Mr. Kowalski -- $507,965;
Mr. Anilionis -- $121,191; and Mr. Cohen -- $121,191. No further fees will be
paid to the Guarantors.
In March 1997, the Bank entered into a Consulting Agreement with First
Fidelity Service Corp. ("First Fidelity"), a consulting firm which is
wholly-owned by Raymond L. Anilionis. The agreement provides that First Fidelity
will render services regarding bank site acquisitions, real estate acquisitions,
management of construction projects, evaluation and assistance with negotiations
of complex loans and work out transactions and any other services reasonably
requested by the Bank. The term of the agreement is for one year, but
automatically renews each year unless terminated by either party upon 30 days
notice. Pursuant to the terms of the consulting agreement, First Fidelity is
paid $5,000 per month for its services.
The Bank has entered into certain loan participations with First State Bank
of Hotchkiss, an entity controlled by Thomas R. Kowalski. Approximate loan
principal balances outstanding under these participations are summarized as
follows:
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
------------- ----------------
1998 1997 1996
------------- ------ -------
(IN THOUSANDS)
<S> <C> <C> <C>
Participations sold........................... $10,150 $8,227 $10,916
Participations purchased...................... 1,316 3,459 250
</TABLE>
The Bank has also sold loan participations to shareholders, officers and
directors of the Company on the same terms as sold to third parties. At
September 30, 1998, the participations sold to related parties were
approximately $2.3 million. At December 31, 1997 and 1996, the participations
sold to related parties were approximately $2.4 million and $7.9 million,
respectively.
In September 1993 the Bank entered into an agreement with First State Bank
of Hotchkiss to purchase its branching rights. In total, the Bank paid First
State Bank of Hotchkiss $2,500 a month over 40 months ending in September 1997.
The officers, directors and principal shareholders of the Company and
members of their immediate families and businesses in which they hold
controlling interests are customers of the Bank. Credit transactions with these
parties are subject to review by the Bank's board of directors. All outstanding
loans and extensions of credit by the Bank to these parties were made in the
ordinary course of business on substantially the same terms, including interest
rates and collateral, as those prevailing at the time for comparable
transactions with other persons, and in the opinion of management did not
involve more than the normal risk of collectibility or present other unfavorable
features. At September 30, 1998, the aggregate balance of loans and advances
under existing lines of credit to these parties was approximately $1.3 million
or 0.76% of the Bank's total loans.
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<PAGE> 40
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of September 30, 1998, and as
adjusted to reflect the sale of the Common Stock offered hereby, for: (a) each
of the Company's directors; (b) each person known by the Company to own
beneficially more than 5% of the outstanding Common Stock; (c) each executive
officer; and (d) the Company's executive officers and directors as a group. All
information with respect to beneficial ownership by the Company's directors,
officers or beneficial owners has been furnished by the respective director,
officer or beneficial owners, as the case may be. Except as otherwise described
in the notes below, the following beneficial owners have sole voting power and
sole investment power with respect to all Common Stock set forth opposite their
names.
<TABLE>
<CAPTION>
COMPANY COMMON SHARES BENEFICIALLY OWNED
----------------------------------------------------
BEFORE THE OFFERING SHARES AFTER THE OFFERING
-------------------- BEING -------------------
BENEFICIAL OWNER NUMBER PERCENT OFFERED NUMBER PERCENT
---------------- --------- ------- ------- --------- -------
<S> <C> <C> <C> <C> <C>
Thomas R. Kowalski.......................... 2,959,650(1) 46.2% 250,000 2,709,650 35.6%
8100 East Arapahoe Road
Englewood, Colorado 80112
Raymond L. Anilionis........................ 642,780(2) 10.0% -- 642,780 8.4%
9034 East Easter Place, Suite 202
Englewood, Colorado 80112
Warren P. Cohen............................. 712,500 11.1% -- 712,500 9.4%
595 South Broadway, Suite 200
Denver, Colorado 80209
Orchard Valley Financial Corporation........ 319,950(3) 5.0% -- 319,950 4.2%
8100 East Arapahoe Road
Englewood, Colorado 80112
Realtek Company Employees'.................. 614,820(3) 9.6% -- 614,820 8.1%
Profit Sharing Plan and Trust
8100 East Arapahoe Road, Suite 214
Englewood, Colorado 80112
Vernon J. Purdy............................. 468,750 7.3% -- 468,750 6.2%
1900 East Girard, Suite 509
Englewood, Colorado 80110
William D. Kenny............................ 390,000 6.1% -- 390,000 5.1%
38 Eagle Drive
Littleton, Colorado 80123
Larry A. Olsen.............................. 151,590 2.4% -- 151,590 2.0%
8100 East Arapahoe Road
Englewood, Colorado 80112
Dr. Donald B. Brown......................... -- -- -- -- --
4545 East Ninth Avenue
Denver, Colorado 80220
William F. Sievers.......................... -- -- -- -- --
26 West Dry Creek Circle, Suite 750
Littleton, Colorado 80120
All executive officers and directors as a
group (seven persons)..................... 3,754,020 58.6% 250,000 3,504,020 46.1%
</TABLE>
- ---------------
(1) Of this amount, 1,644,690 shares are owned directly, and all other shares
owned indirectly through entities or persons controlled by Mr. Kowalski.
(2) Of this amount, 544,000 shares are owned directly, and all other shares are
owned by an entity controlled by Mr. Anilionis.
(3) Due to Mr. Kowalski's significant beneficial ownership of the named
entities, these shares are included in the ownership of Thomas R. Kowalski
in the table.
40
<PAGE> 41
SUPERVISION AND REGULATION
GENERAL
The Bank is chartered under federal law by the Office of Thrift Supervision
("OTS"). It is a member of the Federal Home Loan Bank ("FHLB") System, and its
deposit accounts are insured up to legal limits by the Federal Deposit Insurance
Corporation ("FDIC") under the Bank Insurance Fund ("BIF"). The OTS is charged
with overseeing and regulating the Bank's activities and monitoring its
financial condition. This regulatory framework sets parameters for the Bank's
activities and operations and grants the OTS extensive discretion with regard to
its supervisory and enforcement powers and examination policies. The Bank files
periodic reports with the OTS concerning its activities and financial condition,
must obtain OTS approval prior to entering into certain transactions or
initiating new activities, and is subject to periodic examination by the OTS to
evaluate the Bank's compliance with various regulatory requirements.
The Company is a unitary savings and loan holding company and, like the
Bank, is subject to regulation by the OTS. As part of this regulation, the
Company is required to file certain reports with, and is subject to periodic
examination by, the OTS.
PENDING FINANCIAL MODERNIZATION LEGISLATION
In June 1998, the Senate began hearings on the legislation on a sweeping
financial modernization bill, H.R. 10, "The Financial Services Act of 1998",
which was passed by the U.S. House of Representatives. If passed by the Senate,
the bill would not become law unless it is signed by the President, whose
Administration has commented publicly that it will not support the legislation
in the form passed by the House. Accordingly, whether the bill will pass in the
near future remains uncertain, and the ultimate form the legislation might take
if enacted cannot be predicted at this time.
The bill, among other things, addresses the ongoing debate concerning
mixing banking and commerce. Under the proposal, banks could affiliate with
insurance and securities companies in a holding company structure, subject to
functional regulation. The proposal provides for further study of the issues
relating to merging the SAIF and BIF. If adopted, the legislation would
represent the most significant overhaul of financial services laws since the
1930's when the Glass-Steagall Act of 1933 was enacted.
With respect to the thrift industry, H.R. 10 does not contain provisions
eliminating the federal thrift charter and requiring all federal thrifts to
convert to national banks within two years. The version of the bill passed by
the House allows unitary thrift holding companies to continue operating, but
prohibits the establishment of new unitary thrifts if the application for
unitary thrift status is filed after March 31, 1998. In its review of the bill,
the Senate has changed this date to September 3, 1998. A unitary thrift holding
company is defined as a company that owns one savings association, provided the
savings association that it owns meets the "Qualified Thrift Lender" test. See
" -- Federal Savings Association Regulation -- Qualified Thrift Lender Test."
The Company is a unitary thrift holding company, and as such it generally is not
restricted under existing laws as to the types of business activities in which
it may engage. See " -- Holding Company Regulation." The Company filed its
application to become a savings and loan holding company on April 14, 1998.
Accordingly, if the House version of H.R. 10 is enacted into law and the March
31, 1998 grandfather date is retained, the Company could lose its unitary thrift
holding company status, thereby subjecting the Company to more restrictive
regulation of its activities. Considering the Senate's revision of this date,
management of the Company believes that the Company's status as a unitary thrift
holding company will not be affected by the bill. However, if the bill is
enacted, the form of the final legislation cannot be predicted at this time,
including the grandfather date for unitary savings and loan holding company
powers. Prior versions of the bill would have eliminated the federal thrift
charter, while allowing existing unitary thrift holding companies to retain
their status and affiliations with nonfinancial enterprises and to engage in all
currently permissible activities.
41
<PAGE> 42
FEDERAL SAVINGS ASSOCIATION REGULATION
Business Activities. The activities of savings associations are governed by
the Home Owners' Loan Act of 1933, as amended (the "HOLA"), and, in certain
respects, the Federal Deposit Insurance Act (the "FDI Act"). The HOLA and the
FDI Act were amended by the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA") and the Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA"). FIRREA was enacted for the purpose of
resolving problem savings associations, establishing a new thrift insurance
fund, reorganizing the regulatory structure applicable to savings associations,
and imposing bank-like standards on savings associations. FDICIA, among other
things, requires that federal banking regulators intervene promptly when a
depository institution experiences financial difficulties, mandates the
establishment of a risk-based deposit insurance assessment system and requires
imposition of numerous additional operational standards and restrictions
regarding safety and soundness. FIRREA and FDICIA both contain provisions
affecting numerous aspects of the operations and regulations of federally-
insured savings associations and empowers the OTS and the FDIC, among other
agencies, to promulgate regulations implementing its provisions.
Qualified Thrift Lender Test. Savings associations are required to satisfy
a qualified thrift lender test ("QTL" test) by (i) maintaining 65% of their
portfolio assets (defined as all assets minus intangible assets, property used
by the association in conducting its business and liquid assets equal to 20% of
total assets) in certain "qualified thrift investments" (primarily residential
mortgages and related investments, including certain mortgage-backed securities,
along with small business, credit card, agriculture and education loans) on a
monthly basis in nine out of every twelve months, or (ii) maintaining a
similar-but different 60% asset test under the Internal Revenue Code.
If a federal savings association fails the QTL test, it must convert to a
bank or conform its activities to those permitted to a national bank (but which
activities also are not inconsistent with the powers permitted to a savings
association), particularly as they relate to investments, branching and
dividends, and it also becomes ineligible for new advances from any Federal Home
Loan Bank. A federal savings association that fails the QTL test may requalify.
As of September 30, 1998, the Bank satisfied the QTL test.
Branching. A federally-chartered savings association, like the Bank, can
establish branches in any state or states in the United States and its
territories, subject to a few exceptions. The exercise by the OTS of its
authority to permit interstate branching by federal savings associations is
preemptive of any state law purporting to address the subject of branching by a
federal savings association.
Commercial and Consumer Lending Authority. Federal savings associations may
lend up to 20% of their assets in commercial business loans (i.e., secured or
unsecured loans for commercial, corporate, business or agricultural purposes),
provided that amounts in excess of 10% may be used only for small business loans
and, subject to OTS approval for a higher amount, up to 400% of their capital in
commercial real estate loans. In addition, federal savings associations are
permitted to make consumer loans (i.e., loans for personal, family or household
purposes) in an amount not to exceed 35% of their assets. Credit card and
educational loans are exempted from any percentage of asset limitations
applicable to consumer loans.
Loans to One Borrower. Savings associations are generally subject to the
national bank limits regarding loans to one borrower, meaning they may not make
a loan or extend credit to a single or related group of borrowers in excess of
15% of the association's unimpaired capital and surplus, where the borrowing is
not fully secured by readily-marketable collateral. An additional amount may be
lent, equal to 10% of the association's unimpaired capital and surplus, if such
additional borrowing is secured by readily-marketable collateral at least equal
to the amount of such additional funds. At September 30, 1998, the Bank had no
outstanding loans or commitments that exceeded the loans to one borrower limit
at the time made or committed.
Enforcement. The OTS has primary enforcement responsibility over savings
associations and has the authority to bring enforcement action against all
"institution-related 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 association. Civil
penalties cover a wide range of violations and actions. Criminal penalties for
most financial association crimes include fines and imprisonment. In addition,
42
<PAGE> 43
regulators have substantial discretion to impose enforcement action on an
association that fails to comply with its regulatory requirements, particularly
with respect to amounts of capital. Possible enforcement action ranges from
requiring the preparation of a capital plan or imposition of a capital directive
to receivership, conservatorship or the termination of deposit insurance. Under
the FDI Act, the FDIC has the authority to recommend to the Director of OTS
enforcement action be taken with respect to a particular savings association. If
action is not taken by the Director, the FDIC has authority to take enforcement
action under certain circumstances.
Assessments. Savings associations are required by OTS regulation to pay
assessments to the OTS to fund the operations of the OTS. In the past, the
general assessment paid on a semi-annual basis has been computed based upon the
savings association's total assets, including consolidated subsidiaries, as
reported in the association's latest quarterly thrift financial report. The OTS
announced in August 1998 that it intends to propose a regulation revising its
assessment schedule, so that assessments will be based on the asset size and
financial condition of the institution and the complexity of its operations.
Federal Home Loan Bank System. The Bank is a member of the FHLB System,
which consists of 12 regional FHLB's. The FHLB provides a central credit
facility primarily for member associations. The Bank, as a member of the
FHLB-Topeka, is required to acquire and hold shares of capital stock in that
FHLB in an amount at least equal to 1% of the aggregate principal amount of its
unpaid residential mortgage loans and similar obligations at the beginning of
each year, or 1/20th of its advances from the FHLB-Topeka, whichever is greater.
The Bank is in compliance with this requirement, with an investment in
FHLB-Topeka stock at September 30, 1998 of $480,000. FHLB advances must be
secured by specified types of collateral and may be obtained only for the
purpose of purchasing or funding new residential housing finance assets.
OTS Capital Requirements. The OTS capital regulations require savings
associations to meet three capital standards: a 1.5% tangible capital standard,
a 3% leverage ratio (or core capital ratio) and an 8% risk-based capital
standard.
Tangible capital is defined as common stockholders' equity (including
retained earnings), noncumulative perpetual preferred stock and related
earnings, certain non-withdrawable accounts and pledged deposits of mutual
savings associations, and minority interests in equity accounts of fully
consolidated subsidiaries, less (i) intangible assets (other than purchased
credit card relationships and core deposit intangibles), (ii) non-mortgage
servicing assets, (iii) purchased credit card relationships, (iv) the amount of
mortgage servicing assets in excess of the lesser of 90 percent of their fair
market value, determined pursuant to a special OTS valuation formula, or 100
percent of their remaining unamortized book value, subject to certain aggregate
limits applicable to inclusion of servicing assets in tangible capital, and (v)
certain equity and debt investments in "non-qualifying subsidiaries"
(subsidiaries engaged in activities not permissible for a national bank). For
purposes of determining capital under OTS capital standards, the term
"intangible assets" means those assets considered to be intangible under
generally accepted accounting principles, such as goodwill, core deposit
premiums, purchased credit card relationships and favorable leaseholds.
Servicing assets are not intangible assets, and interest-only strips receivable
and other non-security financial instruments are not intangible assets under
this definition.
Core capital (or leverage) ratio is the ratio of core capital to adjusted
tangible assets. Core capital is defined as common stockholders' equity
(including retained earnings), certain noncumulative perpetual preferred stock
and related surplus, minority interests in equity accounts of consolidated
subsidiaries, certain non-withdrawable accounts and pledged deposits of mutual
savings associations, certain amounts of goodwill resulting from prior
regulatory accounting practices, less (i) intangible assets (other than
purchased credit card relationships and core deposit intangibles), (ii) the
amount of servicing assets in excess of the lesser of 90 percent of their fair
market value, determined pursuant to a special OTS valuation formula, or 100
percent of their remaining unamortized book value, subject to certain aggregate
limits applicable to inclusion of servicing assets and sub-limits applicable to
inclusion of non-mortgage-related servicing assets in core capital, and (iii)
certain equity and debt investments in non-qualifying subsidiaries, such as the
proposed real estate investment and title subsidiaries.
43
<PAGE> 44
The OTS' risk-based capital standard requires that savings associations
maintain a ratio of total capital (which is defined as core capital and
supplementary capital) to risk-weighted assets of 8%. In calculating total
capital, a savings association must deduct reciprocal holdings of depository
institution capital instruments, all equity investments and that portion of land
loans and nonresidential construction loans in excess of 80% loan-to-value ratio
and its interest rate risk component (as discussed below), in addition to the
assets that must be deducted in calculating core capital. In determining the
amount of risk-weighted assets, all assets, including certain off-balance sheet
assets, are multiplied by a risk-weight of 0% to 100%, as assigned by the OTS
capital regulation based on the risks OTS believes are inherent in the type of
asset. Also, savings associations with "above normal" interest rate risk
exposure would be subject to a deduction from total capital for purposes of
calculating their risk-based capital requirements. Savings associations with
assets of less than $300 million and risk-based capital ratios in excess of 12%
are not subject to the interest rate risk component. As of September 30, 1998,
the Bank was not subject to interest rate risk exposure for purposes of
calculating its risk-based capital requirements.
The components of core capital are equivalent to those discussed above
under the 3% leverage standard. The components of supplementary capital include
cumulative preferred stock, long-term perpetual preferred stock, mutual capital
certificates, certain non-withdrawable accounts and pledged deposits, certain
net worth certificates, income capital certificates, certain perpetual
subordinated debt, mandatory convertible subordinated debt, certain
intermediate-term preferred stock, certain mandatorily redeemable preferred
stock and allowance for loan and lease losses (up to 1.25% of risk-weighted
assets). Allowance for loan and lease losses includable in supplementary capital
is limited to a maximum of 1.25%. Overall, the amount of capital counted toward
supplementary capital cannot exceed 100% of core capital. The table below sets
forth the Bank's capital ratios at September 30, 1998.
<TABLE>
<CAPTION>
AT SEPTEMBER 30, 1998
-------------------------
RATIO ACTUAL MINIMUM REQUIRED
----- ------ ----------------
<S> <C> <C>
Tangible capital..................................... 10.34% 1.50%
Core (Tier 1) capital................................ 10.34% 3.00%
Risk-Based capital................................... 13.20% 8.00%
</TABLE>
In 1991, the OTS issued a proposal to amend its regulatory capital
regulation to establish a new framework for assessing capital adequacy. The new
regulation has yet to be enacted, and if enacted in final form as proposed,
management does not believe that the proposed regulation would have a material
effect on the Bank.
Liquidity. The Bank is required to maintain an average daily balance of
liquid assets (e.g., cash, accrued interest on liquid assets, certain time
deposits, savings accounts, bankers' acceptances, specified United States
Government, state or federal agency obligations, shares of certain mutual funds
and certain corporate debt securities and commercial paper) equal to not less
than a specified percentage of the average daily balance of its net withdrawal
deposit accounts plus short-term borrowings. This liquidity requirement may be
changed from time to time by the OTS to any amount within the range of 4% to 10%
depending upon economic conditions and the savings flows of member associations;
this requirement is currently 4%.
Insurance of Deposit Accounts and Deposit Insurance Premiums. FDICIA
required the FDIC to establish a risk-based assessment system for insured
depository associations that takes into account the risks attributable to
different categories and concentrations of assets and liabilities. Under the
rule, the FDIC assigns an association to one of three capital categories
consisting of (i) "well capitalized," (ii) "adequately capitalized" or (iii)
"undercapitalized," and one of three supervisory subcategories consisting of
Group "A" (for financially solid institutions with only a few minor weaknesses),
Group "B" (for those institutions with weaknesses which, if uncorrected could
cause substantial deterioration of the institution and increase the risk to the
deposit insurance fund) and Group "C" (for those institutions with a substantial
probability of loss to the fund absent effective corrective action). The
supervisory subgroup to which an association is assigned is based on a
supervisory evaluation provided to the FDIC by the association's primary federal
regulator and information that the FDIC determines to be relevant to the
association's financial condition and the risk posed
44
<PAGE> 45
to the deposit insurance funds (which may include, if applicable, information
provided by the association's state supervisor). An association's assessment
rate depends on the capital category and supervisory category to which it is
assigned. There are nine assessment risk classifications (i.e., combinations of
capital groups and supervisory subgroups) to which different assessment rates
are applied. Assessment rates range from 23 basis points for an association in
the highest category (i.e., well-capitalized and healthy) to 31 basis points for
an association in the lowest category (i.e., undercapitalized and of substantial
supervisory concern).
Although the Bank recently converted its charter from a Colorado
state-chartered commercial bank to a federal savings bank, the Bank will
continue as a member of the Bank Insurance Fund ("BIF"), rather than the Savings
Association Insurance Fund ("SAIF").
On September 30, 1996, President Clinton signed the Deposit Insurance Funds
Act of 1996 ("DIFA") that was part of the omnibus spending bill enacted by
Congress at the end of its 1996 session. DIFA mandated, among other things, the
merger of the SAIF and BIF, effective January 1, 1999, but only if no insured
depository institution is a savings association on that date. The combined
deposit insurance fund, if the funds are merged, will be called the "Deposit
Insurance Fund," or "DIF."
Prompt Corrective Regulatory Action. FDICIA establishes a system of prompt
corrective action to resolve the problems of undercapitalized associations.
Under this system, the OTS is required to take certain supervisory actions
against undercapitalized associations, the severity of which depends upon the
association's degree of undercapitalization. Generally, subject to a narrow
exception, FDICIA requires the OTS to appoint a receiver or conservator for an
association that is critically undercapitalized. FDICIA authorizes the OTS to
specify the ratio of tangible equity to assets at which an association becomes
critically undercapitalized and requires that ratio be no less than 2% of
assets.
Under OTS regulations, a savings association is considered to be
undercapitalized if it has risk-based capital of less than 8% or has a Tier 1
risk-based capital ratio that is less than 4% or has a leverage ratio that is
less than 4% or has a leverage ratio less than 3% if the savings association is
rated composite 1 under the composite numerical rating assigned to the
association by the OTS under the Uniform Financial Institutions Rating System or
an equivalent rating under a comparable rating system adopted by the OTS in the
most recent rating of which the association has been notified in writing (the
"UFIRS"). A savings association that has risk-based capital less than 6% or a
Tier 1 risk-based capital ratio that is less than 3% or a leverage ratio that is
less than 3% would be considered to be "significantly undercapitalized." A
savings association that has a tangible equity to total assets ratio equal to or
less than 2% would be deemed to be "critically undercapitalized." Generally, a
capital restoration plan must be filed with the OTS within 45 days of the date
an association receives notice that it is undercapitalized, significantly
undercapitalized or critically undercapitalized. In addition, numerous mandatory
supervisory actions become immediately applicable to the association, including,
but not limited to, restrictions on growth, investment activities, capital
distributions, and affiliate transactions. In addition, the OTS could issue a
capital directive to the savings association that includes additional
discretionary restrictions on the savings association.
Limitation on Capital Distributions. The OTS regulations impose limitations
upon all capital distributions by savings associations, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to shareholders
of another association in a cash-out merger and other distributions charged
against capital. The regulations establish three tiers of associations. An
association that exceeds all fully phased-in capital requirements before and
after the proposed capital distribution ("Tier 1 Association") and has not been
advised by the OTS that it is in need of more than normal supervision, could,
after prior notice but without the approval of the OTS, make capital
distributions during a calendar year up to the higher of (a) 100% of its net
income to date during the calendar year plus the amount that would reduce by
one-half its "surplus capital ratio" (the excess capital over its fully
phased-in capital requirements) at the beginning of the calendar year or (b) 75%
of its net reserve over the most recent four-quarter period. Any additional
capital distributions would require prior regulatory approval. In computing the
association's permissible percentage of capital distributions, previous
distributions made during the prior four quarter period must be included. As of
September 30, 1998, the Bank met the requirements of a Tier 1 Association. In
the event the Bank's capital fell below its fully phased-in requirement or the
OTS notified it that it was in need of more than normal
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<PAGE> 46
supervision, the Bank's ability to make capital distributions could be
restricted. In addition, the OTS could prohibit a proposed capital distribution
by any association, which would otherwise be permitted by regulation, if the OTS
determines that such distribution would constitute an unsafe or unsound
practice.
On March 9, 1998, the OTS issued a Notice of Proposed Rulemaking that, if
adopted in final form, would amend its capital distribution regulation. The
proposed rule updates, simplifies, and streamlines the capital distribution
regulation to reflect OTS's implementation of the system of prompt corrective
action established under FDICIA.
Community Reinvestment. The OTS, the FDIC, the Federal Reserve Board and
the OCC have jointly issued a final rule (the "Final Rule") under the Community
Reinvestment Act (the "CRA"). The Final Rule eliminates the existing CRA
regulation's 12 assessment factors and substitutes a performance based
evaluation system. The Final Rule was phased in over a period of time and became
fully effective by July 1, 1997. Under the Final Rule, an institution's
performance in meeting the credit needs of its entire community, including
low-and moderate-income areas, as required by the CRA, is generally evaluated
under three tests: the "lending test," the "investment test," and the "service
test."
An independent financial institution with assets of less than $250 million,
or a financial institution with assets of less than $250 million that is a
subsidiary of a holding company with assets of less than $1 billion, will be
evaluated under a streamlined assessment method based primarily on its lending
record. As of September 30, 1998, the Company's assets were approximately $217
million, thereby meeting the streamlined assessment method. The streamlined test
considers an institution's loan-to-deposit ratio adjusted for seasonal variation
and special lending activities, its percentage of loans and other lending
related activities in the assessment area, its record of lending to borrowers of
different income levels and businesses and farms of different sizes, the
geographic distribution of its loans, and its record of taking action, if
warranted, in response to written complaints. In lieu of being evaluated under
the three assessment tests or the streamlined test, a financial institution can
adopt a "strategic plan" and elect to be evaluated on the basis of achieving the
goals and benchmarks outlined in the strategic plan.
Failure to comply with the CRA's regulations could jeopardize future growth
plans of the Bank. The Bank is currently in compliance with the CRA.
Transactions with Related Parties. The Bank's authority to engage in
transactions with related parties or "affiliates," (i.e., any company that
controls or is under common control with an association) including the Company
and its non-savings-association subsidiaries or to make loans to certain
insiders, is limited by the Federal Reserve Act ("FRA"). The FRA limits the
aggregate amount of transactions with any individual affiliate to 10% of the
capital and surplus of the savings association and also limits the aggregate
amount of transactions with all affiliates to 20% of the savings association's
capital and surplus. Certain transactions with affiliates are required to be
secured by collateral in an amount and of a type described in the FRA and the
purchase of low quality assets from affiliates is generally prohibited. Also,
certain transactions with affiliates, including loans and asset purchases, must
be on terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the association as those
prevailing at the time for comparable transactions with non-affiliated
companies. In the absence of comparable transactions, such transactions may only
occur under terms and circumstances, including credit standards, that in good
faith would be offered to or would apply to non-affiliated companies.
Notwithstanding the above, FIRREA prohibits any savings association from lending
to any affiliate that is engaged in activities that are not permissible for bank
holding companies under Section 4(c) of the Bank Holding Company Act ("BHC
Act"). Further, no savings association may purchase the securities of any
affiliate other than a subsidiary.
Real Estate Lending Standards. The OTS and the other federal banking
agencies have uniform regulations prescribing real estate lending standards. The
OTS regulation requires each savings association to establish and maintain
written internal real estate lending standards consistent with safe and sound
banking practices and appropriate to the size of the institution and the nature
and scope of its real estate lending activities. The policy must also be
consistent with accompanying OTS guidelines, which include maximum loan-to-value
ratios for the following types of real estate loans: raw land (65%), land
development (75%), nonresidential construction (80%), improved property (85%)
and one- to four-family residential construction
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<PAGE> 47
(85%). Owner-occupied one- to four-family mortgage loans and home equity loans
do not have maximum loan-to-value ratio limits, but those with a loan-to-value
ratio at origination of 90% or greater are to be backed by private mortgage
insurance or readily marketable collateral. Institutions are also permitted to
make a limited amount of loans that do not conform to the proposed loan-to-value
limitations so long as such exceptions are appropriately reviewed and justified.
The guidelines also list a number of lending situations in which exceptions to
the loan-to-value standard are justified.
Standards for Safety and Soundness. As required by FDICIA and subsequently
amended by the Riegle Community Development and Regulatory Improvement Act of
1994, the federal banking regulators adopted interagency guidelines establishing
standards for safety and soundness for depository institutions on matters such
as internal controls, loan documentation, credit underwriting, interest-rate
risk exposure, asset growth, compensation and other benefits and asset quality
and earnings (the "Guidelines"). The agencies expect to request a compliance
plan from an institution whose failure to meet one or more of the standards is
of such severity that it could threaten the safe and sound operation of the
institution. FDIC regulations enacted under FDICIA also require all depository
institutions to be examined annually by the banking regulators and depository
institutions having $500 million or more in total assets to have an annual
independent audit, an audit committee comprised solely of outside directors, and
to hire outside auditors to evaluate the institution's internal control
structure and procedures and compliance with laws and regulations relating to
safety and soundness. The FDIC, in adopting the regulations, reiterated its
belief that every depository institution, regardless of size, should have an
annual independent audit and an independent audit committee.
Proposed Rules Governing Financial Derivatives. In April 1998, the OTS
published a Notice of Proposed Rulemaking that, if adopted in final form, would
apply to all financial derivatives and would replace its regulations on forward
commitments, futures transactions, and financial options transactions. The
proposal would continue to permit a savings association to engage in
transactions involving financial derivatives to the extent that these
transactions are authorized under applicable law and are otherwise safe and
sound. In addition, the proposed rule would describe the responsibilities of a
savings association's board of directors and management with respect to
financial derivatives. The rule defines a financial derivative as a financial
contract whose value depends on the value of one or more underlying assets,
indices, or reference rates. The most common types of financial derivatives are
futures, forward commitments, options, and swaps. A mortgage derivative
security, such as a collateralized mortgage obligation or a real estate mortgage
investment conduit, is not a financial derivative under the proposed rule. As of
September 30, 1998, the Bank did not own any financial derivatives as defined
under the proposed rule.
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), non-personal time deposits (those
which are transferable or held by a person other than a natural person) with an
original maturity of less than one and one-half years and certain money market
accounts. The Federal Reserve Board regulations generally require that reserves
of 3% must be maintained against aggregate transaction accounts of $47.8 million
or less (subject to adjustment by the Federal Reserve Board) and an initial
reserve of $1.4 million plus 10% against that portion of total transaction
accounts in excess of $47.8 million. The first $4.7 million of otherwise
reservable balances (subject to adjustments by the Federal Reserve Board) are
exempted from the reserve requirements. As of September 30, 1998, the Bank is in
compliance with the foregoing requirements.
The balances maintained to meet the reserve requirements imposed by the
Federal Reserve Board may be used to satisfy liquidity requirements by the OTS.
Because required reserves must be maintained in the form of either vault cash, a
non-interest-bearing account at a Federal Reserve Bank or a pass-through account
as defined by the Federal Reserve Board, the effect of this reserve requirement
is to reduce the Bank's interest-earning assets.
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<PAGE> 48
FHLB System members are also authorized to borrow from the Federal Reserve
"discount window," but Federal Reserve Board regulations require institutions to
exhaust all FHLB sources before borrowing from a Federal Reserve Bank.
HOLDING COMPANY REGULATION
The Company is considered a non-diversified, savings and loan holding
company within the meaning of the HOLA, has registered as a savings and loan
holding company with the OTS and is subject to OTS regulations, examinations,
supervision and reporting requirements. In addition, the OTS has enforcement
authority over the Company and its non-savings association subsidiaries. Among
other things, this authority permits the OTS to restrict or prohibit activities
that are determined to be a serious risk to the subsidiary savings association.
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from (i) acquiring control of,
or acquiring by merger or purchase of assets, another savings association or
holding company thereof, without prior written approval of the OTS; (ii)
acquiring or retaining, with certain exceptions, more than 5% of a
non-subsidiary savings association, a non-subsidiary holding company, or a
non-subsidiary company engaged in activities other than those permitted by the
HOLA; or (iii) acquiring or retaining control of an institution that is not
federally insured. In evaluating applications by holding companies to acquire
savings associations, the OTS must consider the financial and managerial
resources and future prospects of the company and institution involved, the
effect of the acquisition on the risk to the insurance funds, the convenience
and needs of the community and competitive factors.
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 its savings association subsidiary continues to
satisfy the QTL test. Upon any acquisition by the Company of a savings
association or a state-chartered BIF-insured savings bank meeting the QTL test
that is deemed to be a savings institution by OTS, except for a supervisory
acquisition, the Company would become a multiple savings and loan holding
company (if the acquired institution is held as a separate subsidiary) and would
be subject to extensive limitations on the types of business activities in which
it could engage. The HOLA, as amended by the FIRREA, limits the activities of a
multiple savings and loan holding company and its non-insured institution
subsidiaries primarily to activities permissible for bank holding companies
under Section 4(c)(8) of the BHC Act, subject to the prior approval of the OTS,
and activities in which multiple savings and loan holding companies were
authorized by regulation to engage in on March 5, 1987. Such activities include,
among others, mortgage banking, consumer finance, operation of a trust company,
and certain types of securities brokerage.
DESCRIPTION OF CAPITAL STOCK
COMMON STOCK
The Company is authorized to issue 50,000,000 shares of Common Stock, of
which 6,407,340 shares of Common Stock were issued and outstanding as of
September 1, 1998. Holders of shares of Common Stock are entitled to dividends
as and when declared by the Company's Board of Directors from funds legally
available therefor, and upon liquidation, dissolution or winding up of the
Company to share ratably in all assets remaining after payment of liabilities.
The Company has not paid any dividends to date nor does it anticipate paying any
dividends on its Common Stock in the foreseeable future. It is the Company's
present policy to retain earnings, if any, for use in the development and
expansion of its business. The holders of shares of the Common Stock are
entitled to one vote for each share held of record by them, and do not have the
right to cumulate their votes for election of directors. The holders of shares
of Common Stock do not have preemptive rights.
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<PAGE> 49
PREFERRED STOCK
The Company is authorized to issue up to 10,000,000 shares of Preferred
Stock with such designations, rights and preferences as may be determined from
time to time by the Board of Directors. Accordingly, the Board of Directors is
empowered, without shareholder approval, to issue Preferred Stock with dividend,
liquidation, conversion, voting or other rights that could aversely affect the
voting power or other rights of the holders of the Company's Common Stock. In
the event of issuance, the Preferred Stock could be utilized, under certain
circumstances, as a method of discouraging, delaying or preventing a change in
control of the Company. The Company has no present intention to issue any shares
of its Preferred Stock, and no shares of Preferred Stock are currently
outstanding.
CERTAIN ANTI-TAKEOVER PROVISIONS
The Company's Articles of Incorporation and Bylaws, along with savings bank
regulations, include provisions that may have the effect of hindering or
delaying a change in control of the Company or the sale of substantially all of
the assets of the Company. These provisions include: (i) preferred stock as to
which the Company's Board of Directors has the authority to issue additional
series and to fix the rights, preferences and limitations thereof without
shareholder approval and the availability for issuance of authorized but
unissued Common Stock; (ii) no person or entity, individually or together with
persons or entities acting in concert with such person or entity, may acquire
the ownership, control, right to vote or right to acquire 10% or more of the
Company's total outstanding Common Stock, without first complying with the
requirements of HOLA; (iii) an affirmative vote of at least two-thirds of the
capital stock then issued and outstanding and entitled to vote is required to
approve the sale of all or substantially all of the assets of the Company; and
(iv) an affirmative vote of at least two-thirds of the shares entitled to vote
thereon is required to approve an amendment to the Company's Articles of
Incorporation.
SECURITIES OF SUBSIDIARY TRUST
In February 1998, the Company, through MB Capital I (the "Trust"), a
wholly-owned subsidiary, completed the sale of $12 million of 8.75% Cumulative
Trust Preferred Securities (the "Trust Preferred Securities"). The Trust was
formed for the sole purpose of issuing the Trust Preferred Securities and
investing the proceeds thereof into 8.75% Junior Subordinated Debentures (the
"Debentures") which were issued by the Company and mature on February 9, 2028,
which date may be shortened by the Company. The interest payable to the Trust by
the Company on the Debentures funds the distributions payable to the holders of
the Trust Preferred Securities.
Holders of the Trust Preferred Securities are entitled to receive
preferential cumulative cash distributions payable quarterly in arrears on the
15th day of January, April, July and October of each year (subject to possible
deferral as described below) at the annual rate of 8.75% of the Liquidation
Amount of $10 per Trust Preferred Security ("Distributions"). The Company has
the right to defer payments of interest on the Debentures at any time or from
time to time for a period not exceeding 20 consecutive quarters with respect to
each deferral period (each, an "Extension Period"), provided that no Extension
Period may extend beyond the Stated Maturity of the Debentures. Upon the
termination of any such Extension Period and the payment of all amounts then
due, the Company may elect to begin a new Extension Period subject to the
requirements set forth herein. If interest payments on the Debentures are so
deferred, Distributions on the Trust Preferred Securities will also be deferred
and the Company will not be permitted, subject to certain exceptions, to declare
or pay any cash distributions with respect to its capital stock or to make any
payment with respect to its debt securities that rank pari passu with or junior
to the Debentures. During an Extension Period, interest on the Debentures will
continue to accrue (and the amount of Distributions to which holders of the
Trust Preferred Securities are entitled will accumulate) at the rate of 8.75%
per annum, compounded quarterly. Similar dividend restrictions apply if the
Company is in default on the Debentures.
The Company has, through a Guarantee and other documents, fully,
irrevocably and unconditionally guaranteed, on a subordinated basis, all of the
Trust's obligations under the Trust Preferred Securities. Under the Guarantee,
the Company guarantees the payment of Distributions by the Trust and payments on
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<PAGE> 50
liquidation of or redemption of the Trust Preferred Securities (subordinate to
the right to payment of senior and subordinated debt of the Company) to the
extent of funds held by the Trust. The Guarantee does not cover payment of
Distributions when the Trust does not have sufficient funds to pay such
Distributions. If the Company does not make required payments on the Debentures,
in such event a holder of the Trust Preferred Securities may institute a legal
proceeding directly against the Company to enforce payment of such Distributions
to such holder. The obligations of the Company under the Guarantee and the
Debentures are subordinate and junior in right of payment to all senior and
subordinated Debt of the Company.
The Trust Preferred Securities are subject to mandatory redemption, in
whole or in part, upon repayment of the underlying Debentures at maturity or to
the extent of their earlier redemption in an amount equal to the amount of
Debentures maturing or being redeemed. The redemption price will equal the
aggregate liquidation preference of the Trust Preferred Securities plus any
accumulated and unpaid Distributions thereon to the date of redemption. The
Debentures are redeemable prior to maturity at the option of the Company,
subject to any required prior approval of the Federal Reserve, (i) on or after
February 9, 2003, in whole at any time or in part from time to time, or (ii) at
any time, in whole (but not in part), upon the occurrence and continuation of a
certain tax or securities event, in each case at a redemption price equal to the
accrued and unpaid interest on the Debentures to the date fixed for redemption,
plus 100% of the principal amount thereof.
The Company will have the right at any time to terminate the Trust and
cause the Debentures to be distributed to the holders of the Trust Preferred
Securities in liquidation of the Trust, subject to the Company having received
prior approval of the Federal Reserve if required. The Debentures are unsecured
and subordinated to all senior and subordinated debt, which essentially consists
of all debt of the Company. The terms of the Debentures place no limitation on
the amount of senior and subordinated debt that the Company can incur.
TRANSFER AGENT
Corporate Stock Transfer, Inc., Denver, Colorado will act as transfer agent
for the Company's Common Stock.
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<PAGE> 51
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offering, the Company will have 7,607,340 shares of
Common Stock outstanding (or 7,799,840 shares of Common Stock if the
Underwriters' over-allotment option is exercised in full). The shares of Common
Stock sold in the Offering will be freely transferable without restriction under
the Securities Act, by persons who are not deemed to be affiliates of the
Company or acting as underwriters, as those terms are defined in the Securities
Act. The remaining 6,157,340 shares of Common Stock held by existing
shareholders are "restricted securities" within the meaning of Rule 144.
Consequently, such shares may not be resold unless they are registered under the
Securities Act or are sold pursuant to an applicable exemption from
registration, such as Rule 144.
In general, under Rule 144, as currently in effect, if at least one year
has elapsed since shares of Common Stock that constitute restricted securities
were last acquired from the Company or an affiliate of the Company, the holder
is entitled to sell within any three-month period a number of shares that does
not exceed the greater of one percent of the total shares of Common Stock then
outstanding or the average weekly trading volume of the Common Stock in the
over-the-counter market during the four calendar weeks preceding the date on
which notice of the sale is filed with the Securities and Exchange Commission.
Sales under Rule 144 are subject to certain manner of sale provisions, notice
requirements and the availability of current public information about the
Company. If at least two years have elapsed since the shares were last acquired
from the Company or an affiliate, a person who has not been an affiliate of the
Company at any time during the three months preceding the sale is entitled to
sell such shares under Rule 144(k) without regard to volume limitations, manner
of sale provisions, notice requirements or the availability of current public
information concerning the Company.
The Company, its directors and executive officers and certain other
shareholders, who will hold an aggregate of 5,075,270 shares upon completion of
the Offering, have agreed that they will not, with certain limited exceptions,
issue, offer for sale, sell, transfer, grant options to purchase or otherwise
dispose of any shares of Common Stock without the prior written consent of the
Representative for a period of 180 days from the date of this Prospectus.
Prior to the Offering, there was no public market for the Common Stock, and
there can be no assurance that a significant public market for the Common Stock
will develop or be sustained after the Offering. Any future sale of substantial
amounts of Common Stock in the open market or the perception that such sales may
occur could adversely affect the market price of the Common Stock offered
hereby.
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<PAGE> 52
UNDERWRITING
The Company and the Selling Shareholder have entered into an Underwriting
Agreement (the "Underwriting Agreement") with the underwriters listed in the
table below (referred to individually as "Underwriter" and collectively as
"Underwriters"), for whom Howe Barnes Investments, Inc. is acting as
representative (the "Representative"). Subject to the terms and conditions set
forth in the Underwriting Agreement, the Company and the Selling Shareholder
have agreed to sell to each of the Underwriters, and each of the Underwriters
has severally agreed to purchase from the Company and the Selling Shareholder,
the number of shares of Common Stock set forth below opposite each Underwriter's
name in the table below.
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF
UNDERWRITERS COMMON STOCK
------------ ------------
<S> <C>
Howe Barnes Investments, Inc. .............................. 895,000
ABN AMRO Incorporated....................................... 40,000
EVEREN Securities, Inc. .................................... 40,000
Fahnestock & Co., Inc. ..................................... 40,000
Friedman, Billings, Ramsey & Co., Inc. ..................... 40,000
Hanifen, Imhoff, Inc. ...................................... 40,000
Morgan Keegan & Company, Inc. .............................. 40,000
Pacific Crest Securities.................................... 40,000
Roney & Co., L.L.C. ........................................ 40,000
Ryan, Beck & Co., Inc. ..................................... 40,000
Southeast Research Partners, Inc. .......................... 40,000
Stifel, Nicolaus & Company, Incorporated.................... 40,000
Van Kasper & Company........................................ 40,000
Chicago Capital, Inc. ...................................... 25,000
Hoefer & Arnett Inc. ....................................... 25,000
David A. Noyes & Company.................................... 25,000
---------
Total....................................................... 1,450,000
=========
</TABLE>
Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters have agreed to purchase all of the Common Stock being sold pursuant
to the Underwriting Agreement if any is purchased (excluding shares covered by
the over-allotment option granted therein). In the event of a default by any
Underwriter, the Underwriting Agreement provides that, in certain circumstances,
purchase commitments of the nondefaulting Underwriters may be increased or the
Underwriting Agreement may be terminated.
The Representative has advised the Company and the Selling Shareholder that
the Underwriters propose to offer the Common Stock to the public initially at
the public offering price set forth in the cover page of this Prospectus and to
selected dealers at such price less a concession of not more than $0.39 per
share. Additionally, the Underwriters may allow, and such dealers may reallow, a
concession not in excess of $0.25 per share to certain other dealers. After the
initial public offering, the public offering price and other selling terms may
be changed by the Underwriters.
The Company and the Selling Shareholder have granted to the Underwriters
options, exercisable within 30 days after the date of this Prospectus, to
purchase up to an additional 217,500 shares of Common Stock at the same price
per share to be paid by the Underwriters for the other shares offered hereby. If
the Underwriters purchase any of such additional shares pursuant to this option,
each Underwriter will be committed to purchase such additional shares in
approximately the same proportion as set forth in the table above. The
Underwriters may exercise the option only for the purpose of covering
over-allotments, if any, made in connection with the distribution of the Common
Stock offered hereby.
The initial public offering price of the shares of Common Stock has been
determined by negotiation between the Company and the Representative. Among the
factors considered in determining the initial public offering price were
prevailing market and economic conditions, revenues and earnings of the Company,
52
<PAGE> 53
estimates of the business potential and prospects of the Company, the present
state of the Company's business operations, an assessment of the Company's
management and the consideration of the above factors in relation to market
valuations of companies in related businesses.
The Representative has informed the Company that the Underwriters will not,
without customer authority, confirm sales to any accounts over which they
exercise discretionary authority.
The Company and the Selling Shareholder have jointly and severally agreed
to indemnify the Underwriters and their controlling persons against certain
liabilities, including civil liabilities under the Securities Act, or to
contribute to payments the Underwriters may be required to make in respect
thereof.
Until the distribution of the Common Stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the Underwriters and
certain selling group members to bid for and purchase shares of Common Stock. As
an exception to these rules, the Representative is permitted to engage in
certain transactions that stabilize the price of the Common Stock. Such
transactions may consist of bids or purchases for the purpose of pegging, fixing
or maintaining the price of the Common Stock.
In addition, if the Representative over-allots (i.e., if it sells more
shares of Common Stock than are set forth on the cover page of this Prospectus),
and thereby creates a short position in the Common Stock in connection with the
Offering, the Representative may reduce that short position by purchasing Common
Stock in the open market. The Representative also may elect to reduce any short
position by exercising all or part of the over-allotment option described
herein.
The Representative also may impose a penalty bid on certain Underwriters
and selling group members. This means that if the Representative purchases
shares of Common Stock in the open market to reduce the Underwriters' short
position or to stabilize the price of the Common Stock, it may reclaim the
amount of the selling concession from the Underwriters and selling group members
who sold those shares as part of the Offering.
In general, purchases of the Common Stock for the purpose of stabilization
or to reduce a syndicate short position could cause the price of the Common
Stock to be higher than it might otherwise be in the absence of such purchases.
The imposition of a penalty bid might have an effect on the price of the Common
Stock to the extent that it were to discourage resales of the security by
purchasers in the Offering.
Certain of the Underwriters acting as market makers for the Common Stock
may engage in passive market making in the Common Stock on the Nasdaq National
Market(R) in accordance with Rule 103 of Regulation M under the Securities
Exchange Act of 1934, as amended. Subject to certain conditions, Rule 103
permits underwriters participating in a distribution to engage in limited market
making transactions during the period when Regulation M would otherwise prohibit
such activity. Rule 103 generally prohibits underwriters engaged in passive
market making activities from entering a bid or effecting a purchase at a price
which exceeds the highest bid by a market maker not participating in the
distribution. Rule 103 also limits the volume of purchases which may be made by
an underwriter in passive market making activities. Subject to these
limitations, certain Underwriters and other members of the selling group intend
to engage in passive market making in the Common Stock.
None of the Company, the Selling Shareholder nor any of the Underwriters
makes any representation or prediction as to the direction or magnitude of any
effect that the transactions described above may have on the price of the Common
Stock. In addition, none of the Company, the Selling Shareholder nor any of the
Underwriters makes any representation that the Representative will engage in
such transactions or that such transactions, once commenced, will not be
discontinued without notice.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Jones & Keller, P.C., Denver, Colorado. Certain legal matters in
connection with the Offering will be passed upon for the Underwriters by Chapman
and Cutler, Chicago, Illinois.
53
<PAGE> 54
EXPERTS
The Consolidated Financial Statements of the Company as of December 31,
1997 and for each of the years in the two-year period ended December 31, 1997
have been included and incorporated herein by reference in reliance upon the
report of Fortner, Bayens, Levkulich & Co., P.C., independent certified public
accountants, appearing elsewhere herein, and upon the authority of said firm as
experts in accounting and auditing.
AVAILABLE INFORMATION
The Company is subject to the information requirements of the Securities
Exchange Act of 1934, as amended, and in accordance therewith files reports and
other information with the Securities and Exchange Commission (the
"Commission"). Such reports and other information filed by the Company with the
Commission may be inspected and copied at the public reference facilities
maintained by the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549,
and are also available for inspection and copying at the regional offices of the
Commission located at 500 West Madison Street, Suite 140, Chicago, Illinois
60661 and at 75 Park Place, New York, New York 10007. Copies of such information
can also be obtained by mail from the Public Reference Section of the Commission
at 450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed rates. In
addition, the Commission maintains a worldwide web site that contains reports,
proxy and information statements and other information. The address of the site
is http://www.sec.gov.
The Company has filed with the Commission a Registration Statement on Form
SB-2 (the "Registration Statement") (which term shall encompass all amendments,
exhibits and schedules thereto) under the Securities Act of 1933, as amended,
with respect to the securities being offered hereby. This Prospectus does not
contain all the information set forth in the Registration Statement, certain
parts of which are omitted in accordance with the rules and regulations of the
Commission, and to which reference is hereby made. Statements made in this
Prospectus as to the contents of any contract, agreement or other document
referred to are not necessarily complete. With respect to each such contract,
agreement or other document filed as an exhibit to the Registration Statement,
reference is made to the exhibit for a more complete description of the matter
involved, and each such statement shall be deemed qualified in its entirety by
such reference. Copies of the Registration Statement together with exhibits may
be inspected at the office of the Commission in Washington, D.C. without charge
and copies thereof may be obtained therefrom upon payment of a prescribed fee.
54
<PAGE> 55
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report................................ F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Income........................... F-4
Consolidated Statements of Comprehensive Income............. F-5
Consolidated Statement of Shareholders' Equity.............. F-6
Consolidated Statements of Cash Flows....................... F-7
Notes to Consolidated Financial Statements.................. F-8
</TABLE>
F-1
<PAGE> 56
INDEPENDENT AUDITORS' REPORT
Board of Directors
MegaBank Financial Corporation
Englewood, Colorado
We have audited the consolidated balance sheet of MegaBank Financial
Corporation and Subsidiary as of December 31, 1997 and the related consolidated
statements of income, comprehensive income, shareholders' equity and cash flows
for each of the two years in the period ended December 31, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
MegaBank Financial Corporation and Subsidiary at December 31, 1997 and the
consolidated results of their operations and consolidated cash flows for each of
the two years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
/s/ FORTNER, BAYENS, LEVKULICH AND CO.,
P.C.
-------------------------------------------
Denver, Colorado
February 11, 1998 (except for note Q, as
to which the date is September 1, 1998)
F-2
<PAGE> 57
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
Cash and due from banks..................................... $ 12,148 $ 9,910
Interest-bearing deposits................................... 88 1,470
Federal funds sold.......................................... 13,300 1,775
Investment securities available for sale.................... 16,613 13,999
Loans....................................................... 166,709 126,087
Less allowance for loan losses.............................. (2,491) (2,083)
-------- --------
164,218 124,004
Bank premises, leasehold improvements and equipment, net.... 7,974 4,799
Accrued interest receivable................................. 1,176 898
Deferred tax asset.......................................... 778 636
Trust preferred securities issuance costs, net.............. 734 255
Other....................................................... 244 134
-------- --------
$217,273 $157,880
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Demand, non-interest bearing........................... $ 61,320 $ 42,515
Demand, interest bearing............................... 70,567 56,339
Savings................................................ 5,964 4,562
Time, $100,000 and over................................ 14,327 10,141
Other time............................................. 36,716 28,321
-------- --------
188,894 141,878
Federal Home Loan Bank borrowings......................... -- 1,423
Securities sold under agreements to repurchase............ 556 --
Income taxes payable...................................... 162 132
Accrued interest payable.................................. 399 152
Note payable.............................................. -- 2,000
Other..................................................... 902 717
-------- --------
Total liabilities................................. 190,913 146,302
Company obligated mandatorily redeemable preferred
securities of subsidiary trust holding solely Junior
Subordinated Debentures................................... 12,000 --
Commitments (notes I, J, and L)
Shareholders' equity
Preferred stock; no par value, 10,000,000 shares
authorized, none issued................................ -- --
Common stock; no par value, 50,000,000 shares authorized,
6,407,340 shares issued and outstanding (note Q)....... 1,961 1,961
Retained earnings......................................... 12,400 9,578
Accumulated other comprehensive income.................... (1) 39
-------- --------
14,360 11,578
-------- --------
$217,273 $157,880
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE> 58
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEARS ENDED
SEPTEMBER 30, DECEMBER 31,
----------------------- -----------------------
1998 1997 1997 1996
---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Interest income
Loans, including fees....................... $ 13,448 $ 9,982 $ 13,806 $ 10,410
Taxable investment securities............... 231 209 286 487
Nontaxable investment securities............ 561 413 592 247
Funds sold.................................. 381 447 636 180
Other interest.............................. 135 34 63 35
---------- ---------- ---------- ----------
Total interest income............... 14,756 11,085 15,383 11,359
Interest expense
Deposits.................................... 4,164 3,358 4,635 2,794
Borrowed funds.............................. 112 126 152 97
Trust preferred securities.................. 688 -- -- --
Notes payable............................... 19 135 179 240
---------- ---------- ---------- ----------
Total interest expense.............. 4,983 3,619 4,966 3,131
---------- ---------- ---------- ----------
Net interest income................. 9,773 7,466 10,417 8,228
Provision for loan losses..................... 410 360 880 457
---------- ---------- ---------- ----------
Net interest income after provision for loan
losses...................................... 9,363 7,106 9,537 7,771
Other income
Service charges on deposit accounts......... 391 253 335 325
Payroll services............................ -- -- -- 233
Gain on sale of investment securities....... 25 -- 341 --
Other income................................ 280 287 320 403
---------- ---------- ---------- ----------
Total other income.................. 696 540 996 961
Other expenses
Salaries and employee benefits.............. 3,183 2,216 3,135 2,261
Occupancy expenses of premises.............. 688 539 708 642
Furniture and equipment expense............. 337 221 342 298
Payroll services............................ -- -- -- 384
Other expenses.............................. 1,681 1,608 2,242 1,374
---------- ---------- ---------- ----------
Total other expenses................ 5,889 4,584 6,427 4,959
---------- ---------- ---------- ----------
Income before income taxes.......... 4,170 3,062 4,106 3,773
Income tax expense............................ 1,348 1,031 1,272 1,353
---------- ---------- ---------- ----------
NET INCOME.................................... $ 2,822 $ 2,031 $ 2,834 $ 2,420
========== ========== ========== ==========
Income per share
Basic and diluted earnings per share........ $ 0.44 $ 0.32 $ 0.44 $ 0.38
========== ========== ========== ==========
Weighted average and common shares
outstanding (note Q)..................... 6,407,340 6,407,340 6,407,340 6,407,340
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE> 59
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEARS ENDED
SEPTEMBER 30, DECEMBER 31,
----------------- ---------------
1998 1997 1997 1996
------- ------- ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C>
Net income................................................. $2,822 $2,031 $2,834 $2,420
Other comprehensive income, net of tax:
Unrealized gains (losses) on investment securities
available for sale.................................... (40) 104 (83) 14
------ ------ ------ ------
Other comprehensive income (loss).......................... (40) 104 (83) 14
------ ------ ------ ------
Comprehensive income....................................... $2,782 $2,135 $2,751 $2,434
====== ====== ====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE> 60
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
TWO YEARS ENDED DECEMBER 31, 1997
AND NINE MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED)
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMMON RETAINED COMPREHENSIVE
STOCK EARNINGS INCOME TOTAL
------ -------- ------------- -------
<S> <C> <C> <C> <C>
Balance at January 1, 1996.......................... $1,961 $ 4,324 $108 $ 6,393
Comprehensive income
Net income........................................ -- 2,420 -- 2,420
Other comprehensive income........................ -- -- 14 14
------ ------- ---- -------
Balance at December 31, 1996........................ 1,961 6,744 122 8,827
Comprehensive income
Net income........................................ -- 2,834 -- 2,834
Other comprehensive income (loss)................. -- -- (83) (83)
------ ------- ---- -------
Balance at December 31, 1997........................ 1,961 9,578 39 11,578
Comprehensive income
Net income........................................ -- 2,822 -- 2,822
Other comprehensive income (loss)................. -- -- (40) (40)
------ ------- ---- -------
Balance at September 30, 1998 (unaudited)........... $1,961 $12,400 $ (1) $14,360
====== ======= ==== =======
</TABLE>
The accompanying notes are an integral part of this statement.
F-6
<PAGE> 61
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEARS ENDED
SEPTEMBER 30, DECEMBER 31,
------------------- -------------------
1998 1997 1997 1996
-------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
Cash flows from operating activities
Net income................................................ $ 2,822 $ 2,031 $ 2,834 $ 2,420
Adjustments to reconcile net income to net cash provided
by operating activities
Provision for loan losses............................... 410 360 880 457
Depreciation and amortization of fixed assets........... 350 203 325 238
Amortization of preferred securities issuance costs..... 16 -- -- --
Net discount accretion on investment securities......... (12) (21) (29) (20)
Stock dividend.......................................... (23) (16) (16) (15)
Gain on sale of investment securities available for
sale.................................................. (25) -- (341) --
Deferred income taxes................................... (126) 6 (336) (78)
Changes in deferrals and accruals
Accrued interest receivable............................. (278) (214) (217) (76)
Accrued interest payable................................ 247 46 46 (1)
Income taxes payable.................................... 30 (109)
Other, net.............................................. 75 374 723 237
-------- -------- -------- --------
Net cash provided by operating activities.......... 3,486 2,660 3,869 3,162
Cash flows from investing activities
Net (increase) decrease in federal funds sold............. (11,525) (10,475) (990) 11,985
Net (increase) decrease in interest-bearing deposits...... 1,382 (1,542) (1,470) --
Purchase of securities available for sale................. (4,476) (3,531) (6,214) (6,676)
Proceeds from maturities of securities available for
sale.................................................... 1,250 2,850 3,160 2,550
Proceeds from maturities of securities held to maturity... -- -- 550
Proceeds from sales of securities available for sale...... 616 -- 495 --
Net increase in loans..................................... (40,624) (20,689) (31,061) (26,195)
Expenditures for bank premises and equipment.............. (3,525) (1,462) (2,494) (1,623)
-------- -------- -------- --------
Net cash used in investing activities.............. (56,902) (34,849) (38,574) (19,409)
Cash flows from financing activities
Net increase in deposits.................................. 47,016 38,605 37,217 14,469
Trust preferred securities issuance costs................. (495) -- (255) --
Increase (decrease) in Federal Home Loan Bank
borrowings.............................................. (1,423) (484) (849) 2,272
Increase (decrease) in securities sold under repurchase
agreements.............................................. 556 -- -- --
Proceeds from issuance of trust preferred securities...... 12,000 -- -- --
Principal payments on notes payable....................... (2,000) (628) (628) (735)
-------- -------- -------- --------
Net cash provided by financing activities.......... 55,654 37,493 35,485 16,006
-------- -------- -------- --------
Net increase (decrease) in cash and due from banks.......... 2,238 5,304 780 (241)
Cash and due from banks at beginning of period.............. 9,910 9,130 9,130 9,371
-------- -------- -------- --------
Cash and due from banks at end of period.................... $ 12,148 $ 14,434 $ 9,910 $ 9,130
======== ======== ======== ========
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest expense........................................ $ 4,735 $ 3,573 $ 4,920 $ 3,077
Income taxes............................................ 1,408 1,168 1,499 1,433
Noncash transaction:
Note receivable exchanged for extinguishment of note
payable............................................... $ -- $ -- $ -- $ 1,700
</TABLE>
The accompanying notes are an integral part of these statements.
F-7
<PAGE> 62
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
NOTE A -- SUMMARY OF ACCOUNTING POLICIES
Nature of Operations
MegaBank Financial Corporation ("the Company") owns the shares of and acts
as parent holding company for MegaBank ("the Bank"). The Bank provides a full
range of banking services to individual and corporate customers principally in
the Denver metropolitan area. A majority of the Bank's loans are related to real
estate (principally residential construction) and commercial activities. The
Bank is subject to competition from other financial institutions for loans and
deposit accounts. The Bank is also subject to regulation by certain governmental
agencies and undergoes periodic examinations by those regulatory agencies. In
connection with an offering of Cumulative Trust Preferred Securities in 1998,
the Company formed MB Capital I, which is treated as a wholly-owned subsidiary
of the Company.
Basis of Financial Statement Presentation
The financial statements have been prepared in conformity with generally
accepted accounting principles. In preparing the 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 sheet
and revenues and expenses for the period. Actual results could differ
significantly from those estimates.
Material estimates that are particularly susceptible to significant change
in the near-term relate to the determination of the allowance for loan losses.
In connection with the determination of the allowance for loan losses,
management obtains independent appraisals for significant properties and
assesses estimated future cash flows from borrowers' operations and the
liquidation of loan collateral.
Management believes that the allowance for loan losses is adequate. While
management uses available information to recognize loan losses, changes in
economic conditions may necessitate revisions in future years. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to recognize additional losses based on their judgments about
information available to them at the time of their examination.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries, MegaBank and, in 1998, MB Capital I. All intercompany
accounts and transactions have been eliminated in the consolidated financial
statements.
Interim Financial Information (Unaudited)
The unaudited interim financial statements have been prepared in conformity
with generally accepted accounting principles and include all adjustments which
are, in the opinion of management, normal and recurring in nature and necessary
to a fair presentation of the interim periods presented. Results of operations
for the nine months ended September 30, 1998 are not necessarily indicative of
the results to be expected for the full year.
Investment Securities
Management determines the classification of debt securities at the time of
purchase and reevaluates such designation as of each balance sheet date. Debt
securities are classified as held-to-maturity when the Bank has the positive
intent and ability to hold the securities to maturity. Held-to-maturity
securities are stated at amortized cost.
F-8
<PAGE> 63
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
Debt securities not classified as held to maturity are classified as
available for sale. Available for sale securities are stated at fair value, with
the unrealized gains and losses, net of tax, reported as a component of retained
earnings in shareholders' equity.
The amortized cost of debt securities classified as held to maturity or
available for sale is adjusted for amortization of premiums and accretion of
discounts to maturity or, in the case of mortgage-backed securities, over the
estimated life of the security. Such amortization and accretion is included as
an adjustment to interest income from investments. Realized gains and losses and
declines in value judged to be other-than-temporary are included in net
securities gains (losses). The cost of securities sold is based on the specific
identification method.
Loans
Loans are reported at the principal amount outstanding, net of loan fees
and the allowance for credit losses. Interest on loans is calculated by using
the simple interest method on the daily balance of the principal amount
outstanding.
Loan fees which represent an adjustment to interest yield are deferred and
amortized over the estimated life of the loan. Most of the loans originated by
the Company are short-term.
Loans on which the accrual of interest has been discontinued are designated
as nonaccrual loans. Accrual of interest on loans is discontinued either when
reasonable doubt exists as to the full, timely collection of interest or
principal or when a loan becomes contractually past due by ninety days or more
with respect to interest or principal. When a loan is placed on nonaccrual
status, all interest previously accrued but not collected is reversed against
current period interest income. Interest accruals are resumed on such loans only
when they are brought fully current with respect to interest and principal and
when, in the judgement of management, the loans are estimated to be fully
collectible as to both principal and interest.
Renegotiated loans are those loans on which concessions in terms have been
granted because of a borrower's financial difficulty. Interest is generally
accrued on such loans in accordance with the new terms.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan
losses charged to expenses. Loans are charged against the allowance for loan
losses when management believes that the collectibility of the principal is
unlikely or, with respect to consumer installment loans, according to an
established delinquency schedule. The allowance is an amount that management
believes will be adequate to absorb losses inherent in existing loans, leases
and commitments to extend credit, based on evaluations of the collectibility and
prior loss experience of loans, leases and commitments to extend credit. The
evaluations take into consideration such factors as changes in the nature and
volume of the portfolio, overall portfolio quality, loan concentrations,
specific problem loans, leases and commitments, and current and anticipated
economic conditions that may affect the borrowers' ability to pay.
Impaired loans are measured based on the present value of expected future
cash flows discounted at the loan's original effective interest rate. As a
practical expedient, impairment may be measured based on the loan's observable
market price or the fair value of the collateral if the loan is collateral
dependent. When the measure of the impaired loan is less than the recorded
investment in the loan, the impairment is recorded through a valuation
allowance.
F-9
<PAGE> 64
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
Leasehold Improvements and Equipment
Leasehold improvements and equipment are stated at cost. Depreciation is
provided for in amounts sufficient to relate the cost of depreciable assets to
operations over their estimated service lives, principally on the straight-line
method.
Trust Preferred Securities Issuance Costs
Direct costs incurred in connection with the issuance of Trust Preferred
Securities have been capitalized. These costs are amortized on a straight-line
basis through the maturity date of the securities.
Income Taxes
Provisions for income taxes are based on taxes payable or refundable for
the current year (after exclusion of non-taxable income such as interest on
state and municipal securities) and deferred taxes on temporary differences
between the amount of taxable income and pretax financial income and between the
tax bases of assets and liabilities and their reported amounts in the financial
statements. Deferred tax assets and liabilities are included in the financial
statements at currently enacted income tax rates applicable to the period in
which the deferred tax assets and 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.
Statement of Cash Flows
For purposes of the Statement of Cash Flows, the Company has defined cash
equivalents as those amounts included in the balance sheet caption "Cash and Due
from Banks".
Per Share Computations
Basic earnings per share is based on the weighted average number of common
shares outstanding during each year. Share amounts have been adjusted to reflect
a planned thirty-for-one common stock split. The Company had no material
dilutive-potential common shares and therefore has not presented per share
earnings data on a diluted basis.
Stock-Based Compensation
The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees, (APB 25) and related
interpretations in accounting for any stock options issued to employees. Under
APB 25, no compensation expense is recorded for any stock options for which the
exercise price equals the market price of the underlying stock on the date of
the grant. The Company has adopted the disclosure-only provisions of Statement
of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123).
Accounting Changes
COMPREHENSIVE INCOME
The Company adopted Financial Accounting Standards Board No. 130, Reporting
Comprehensive Income, (SFAS No. 130), effective January 1, 1998. SFAS No. 130
establishes standards for reporting comprehensive income and its components
(revenues, expenses, gains, and losses). Components of comprehensive income are
net income and all other non-owner changes in equity. The statement requires
that an enterprise (a) classify items of other comprehensive income by their
nature in a financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and
F-10
<PAGE> 65
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
additional paid-in capital in the equity section of a statement of financial
position. Reclassification of financial statements for earlier periods provided
for comparative purposes is required.
The Company has disclosed comprehensive income in a separate income
statement.
The only component of comprehensive income consists of unrealized holding
gains and losses on available for sale investment securities.
OPERATING SEGMENTS
The Company adopted Financial Accounting Standards Board Statement No. 131,
Disclosures About Segments of an Enterprise and Related Information, (SFAS No.
131) effective January 1, 1998. This statement establishes standards for
reporting information about segments in annual and interim financial statements.
SFAS No. 131 introduces a new model for segment reporting called the "management
approach". The management approach is based on the way the chief operating
decision-maker organizes segments within the company for making operating
decisions and assessing performance. Reportable segments are based on products
and services, geography, legal structure, management structure and any other in
which management disaggregates a company. Based on the "management approach"
model, the Company has determined that its business is comprised of a single
operating segment and that SFAS No. 131 therefore has no impact on its financial
statements.
NOTE B -- INVESTMENT SECURITIES
At December 31, 1997, the Company had securities with the following
amortized cost and estimated fair market values (in thousands):
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
Securities available for sale
U.S. Treasury securities.................. $ 4,734 $40 $ -- $ 4,774
State and political subdivisions.......... 8,371 34 (2) 8,403
Federal Home Loan Bank stock.............. 368 -- -- 368
Corporate equity securities............... 466 -- (12) 454
------- --- ---- -------
$13,939 $74 $(14) $13,999
======= === ==== =======
</TABLE>
The amortized cost and estimated market value of debt securities at
December 31, 1997 by contractual maturity are shown below (in thousands).
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations without call or prepayment
penalties.
<TABLE>
<CAPTION>
AMORTIZED MARKET
COST VALUE
--------- -------
<S> <C> <C>
Due in one year or less..................................... $ 1,241 $ 1,244
Due after one year through five years....................... 3,494 3,531
Due after five years through ten years...................... 715 717
Due after ten years......................................... 7,655 7,685
------- -------
$13,105 $13,177
======= =======
</TABLE>
F-11
<PAGE> 66
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
Securities included in the accompanying balance sheet at December 31, 1997
with a carrying amount of $6,120,000 have been pledged as collateral for public
deposits and for other purposes as required or permitted by law.
Available for sale securities were sold in 1997 for a gross gain of
$341,000.
NOTE C -- LOANS AND ALLOWANCE FOR POSSIBLE LOAN LOSSES
The components of the loan portfolio are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
Land development and construction........................... $121,026 $ 88,825
Commercial.................................................. 39,602 33,530
Installment and other....................................... 7,673 4,710
-------- --------
168,301 127,065
Less unearned loan fees..................................... (1,592) (978)
-------- --------
$166,709 $126,087
======== ========
</TABLE>
Transactions in the allowance for loan losses are as follows (in
thousands):
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
NINE MONTHS ENDED ---------------
SEPTEMBER 30, 1998 1997 1996
------------------ ------ ------
(UNAUDITED)
<S> <C> <C> <C>
Balance at beginning of period..................... $2,083 $1,150 $ 759
Provision for loan losses.......................... 410 880 457
Recoveries......................................... 6 62 13
Loans charged off.................................. (8) (9) (79)
------ ------ ------
Balance at end of period........................... $2,491 $2,083 $1,150
====== ====== ======
</TABLE>
There were no accruing loans having payments delinquent more than ninety
days at December 31, 1997 and 1996.
Loans on which the accrual of interest has been discontinued or reduced
amounted to $1,604,000 and $14,000 at December 31, 1997 and 1996, respectively.
No component of the allowance for loan losses was specifically allocated to
these loans.
Unaudited data as of September 30, 1998, follows:
<TABLE>
<S> <C>
Outstanding principal balance of accruing loans having
payments delinquent more than 90 days..................... $ --
Loans on which the accrual of interest has been
discontinued.............................................. 1,291,000
</TABLE>
Substantially all of the balances of nonaccrual loans as of September 30,
1998 and December 31, 1997, relate to one borrower.
No loans were transferred to foreclosed real estate in 1998, 1997 or 1996.
The Company is not committed to lend funds to debtors whose loans have been
modified.
F-12
<PAGE> 67
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
NOTE D -- BANK PREMISES, LEASEHOLD IMPROVEMENTS AND EQUIPMENT
At December 31, 1997, bank premises, leasehold improvements and equipment,
less accumulated depreciation and amortization, consisted of the following (in
thousands):
<TABLE>
<S> <C>
Buildings and improvements.................................. $ 2,216
Leasehold improvements...................................... 383
Equipment................................................... 2,223
Land........................................................ 1,137
-------
5,959
Less accumulated depreciation and amortization.............. (1,160)
-------
$ 4,799
=======
</TABLE>
NOTE E -- DEPOSITS
At December 31, 1997, the scheduled maturities of certificates of deposit
are as follows (in thousands):
<TABLE>
<S> <C>
1998....................................................... $23,680
1999....................................................... 8,829
2000....................................................... 2,793
2001....................................................... 1,615
2002....................................................... 136
Thereafter................................................. 1,409
-------
$38,462
=======
</TABLE>
NOTE F -- FEDERAL HOME LOAN BANK BORROWINGS
As of December 31, 1997, the Bank had $1,423,000 in Federal Home Loan Bank
borrowings. The advances outstanding at December 31, 1997 are as follows (in
thousands):
<TABLE>
<CAPTION>
INTEREST
AMOUNT RATE
- ------ --------
<C> <S> <C>
$ 506 ..................................................... 6.90%
102 ..................................................... 6.87
439 ..................................................... 6.81
100 ..................................................... 6.76
176 ..................................................... 6.72
100 ..................................................... 6.58
- ------
$1,423
======
</TABLE>
The Bank has a blanket pledge agreement with the FHLB of Topeka
collateralizing the above advances.
Maturities of the aforementioned borrowings are as follows (in thousands):
<TABLE>
<S> <C>
1998........................................................ $ 176
1999........................................................ 1,247
------
$1,423
======
</TABLE>
These borrowings were repaid in 1998.
F-13
<PAGE> 68
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
NOTE G -- NOTE PAYABLE
At December 31, 1997, the Company has a note payable to Wells Fargo Bank
for $2,000,000. This loan was repaid in February 1998 from proceeds of the
Company's Cumulative Trust Preferred Securities Offering.
NOTE H -- COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES
In February 1998, MB Capital I, a special-purpose wholly-owned Delaware
trust subsidiary of the Company, completed an offering of 1,200,000 shares
(issue price of $10 per share) totaling $12.0 million of fixed-rate 8.75%
Cumulative Trust Preferred Securities (Preferred Securities), which are
guaranteed by the Company. MB Capital I invested the total proceeds it received
in 8.75% Junior Subordinated Deferrable Interest Debentures (Debentures) issued
by the Company. Interest paid on the Debentures will be distributed to the
holders of the Preferred Securities. As a result, under current tax law,
distributions to the holders of the Preferred Securities will be tax deductible
by the Company. Distributions payable on the Preferred Securities are recorded
as interest expense in the consolidated statements of income. These Debentures
are unsecured and rank junior and are subordinate in right of payment to all
senior debt of the Company.
The distribution rate payable on the Preferred Securities is cumulative and
payable quarterly in arrears commencing on April 15, 1998. The Company has the
right, subject to events of default, to defer payments of interest on the
Debentures at any time by extending the interest payment period for a period not
exceeding 20 consecutive quarters with respect to each deferral period, provided
that no extension period may extend beyond the redemption or maturity date of
the Debentures. The Preferred Securities are subject to mandatory redemption
upon repayment of the Debentures. The Debentures mature on February 9, 2028,
which may be shortened to not earlier than February 9, 2003, if certain
conditions are met, or at any time upon the occurrence and continuation of
certain changes in either the tax treatment or the capital treatment of MB
Capital I, the Debentures or the Preferred Securities. The Company has the right
to terminate MB Capital I and cause the Debentures to be distributed to the
holders of the Capital Securities in liquidation of such trust, all subject to
the Company having received prior approval of the Office of Thrift Supervision,
if required.
NOTE I -- FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and stand-by
letters of credit.
Those instruments involve, to a varying degree, elements of credit risk in
excess of the amount recognized in the statement of financial position. The
contract amounts of those instruments reflect the extent of involvement the Bank
has in particular classes of financial instruments.
The Company's exposure to credit loss in the event of non-performance by
the other party to the financial instrument for commitments to extend credit and
stand-by letters of credit is represented by the contractual notional amount of
those instruments. The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Financial instruments whose contract amounts represent
credit risk
Commitments to extend credit.............................. $106,149 $51,758
Stand-by letters of credit................................ 12,409 9,277
</TABLE>
F-14
<PAGE> 69
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
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. Since many of the commitments may expire
without being drawn upon or be participated to other financial institutions, the
total commitment amounts do not necessarily represent future cash requirements.
The Company evaluates each customer's credit-worthiness on a case-by-case basis.
The amount of collateral obtained if deemed necessary by the Company upon
extension of credit is based on management's credit evaluation. Collateral held
varies, but may include accounts receivable, inventory, property, plant and
equipment and income-producing commercial properties.
Stand-by letters of credit are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party. The credit
risk involved in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers.
NOTE J -- LEASE COMMITMENTS
Future minimum rental and lease payments under noncancellable operating
leases for premises, expiring at various dates through 2006 are as follows (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1998........................................................ $ 403
1999........................................................ 361
2000........................................................ 359
2001........................................................ 353
2002........................................................ 353
Thereafter.................................................. 1,121
------
$2,950
======
</TABLE>
Total lease expense for all operating leases was $436,000 and $382,000 for
the years ended December 31, 1997 and 1996, respectively.
NOTE K -- INCOME TAXES
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
1997 1996
------ ------
(IN THOUSANDS)
<S> <C> <C>
Current
Federal................................................... $1,406 $1,262
State..................................................... 202 169
------ ------
1,608 1,431
Deferred
Federal................................................... (299) (74)
State..................................................... (37) (4)
------ ------
(336) (78)
------ ------
$1,272 $1,353
====== ======
</TABLE>
F-15
<PAGE> 70
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
The effective income tax rate varies from the statutory federal rate
because of several factors, the most significant being nontaxable interest
income earned on obligations of state and municipalities. The following table
reconciles the Company's effective tax rate to the statutory federal rate.
<TABLE>
<CAPTION>
1997 1996
------------------------ ------------------------
AMOUNT PERCENT AMOUNT PERCENT
-------------- ------- -------------- -------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C>
Tax expense at statutory rate..................... $1,396 34.0% $1,283 34.0%
Increase (decrease) in taxes due to:
Tax exempt municipal interest................... (187) (4.5) (84) (2.2)
State tax, net of federal tax effect............ 122 3.0 109 2.9
Other........................................... (59) (1.5) 45 1.2
------ ---- ------ ----
Total provision for income taxes........ $1,272 31.0% $1,353 35.9%
====== ==== ====== ====
</TABLE>
Deferred tax assets and liabilities are recorded based on the differences
between financial statement and tax basis of assets and liabilities and the tax
rates in effect when these differences are expected to reverse. Timing
differences in the recognition of revenue and expense for tax and financial
reporting purposes resulted in a deferred tax asset as of December 31, 1997 as
follows (in thousands):
<TABLE>
<S> <C>
Deferred tax assets
Provision for loan losses................................. $686
Recognition of loan fees.................................. 37
Other..................................................... 7
----
Total deferred tax assets......................... 730
Deferred tax liabilities
Depreciation.............................................. (68)
Market value adjustment to investment securities available
for sale............................................... (20)
Other..................................................... (6)
----
Total deferred tax liabilities.................... (94)
----
Net deferred tax asset............................ $636
====
</TABLE>
NOTE L -- RELATED PARTY TRANSACTIONS
The Bank has entered into certain loan participations with First State Bank
of Hotchkiss, a financial institution related through common ownership.
Approximate loan principal balances outstanding under these participations are
summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
SEPTEMBER 30, ----------------
1998 1997 1996
------------- ------ -------
(UNAUDITED)
<S> <C> <C> <C>
Participations sold................................... $10,150 $8,227 $10,916
Participations purchased.............................. 1,316 3,459 250
</TABLE>
The Bank has also sold loan participations to other related parties
(shareholders, directors, family members, businesses related through common
ownership). At December 31, 1997 and 1996, the participations sold to related
parties were approximately $2,391,000 and $7,882,000, respectively. As of
September 30, 1998, participations sold to related parties were approximately
$2,252,000.
F-16
<PAGE> 71
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
The following is an analysis of loans that were made to shareholders,
directors and executive officers of the Company, and to corporations and others
associated with those individuals (in thousands):
<TABLE>
<S> <C>
Balance at January 1, 1997.................................. $ 1,062
New loans................................................... 1,299
Repayments.................................................. (1,831)
-------
Balance at December 31, 1997................................ $ 530
=======
</TABLE>
Certain officers, directors, and shareholders of the Company personally
guaranteed the Company's note payable (note G). In return for the guarantee, the
Company agreed to indemnify the guarantors for all liabilities, costs or
expenses relating to the guarantee and to provide additional compensation to the
guarantors. The additional compensation has consisted of an aggregate fee equal
to 1.5% of the outstanding balance of the loan on each anniversary date plus a
performance bonus based on earnings of the Bank as specified in the agreement.
Total fees paid to the guarantors were $329,000 and $40,000 in 1997 and 1996,
respectively.
In March 1997, the Company entered into a consulting agreement with a
company owned by an individual who is an officer, director and shareholder of
the Company. Payments by the Company under the agreement are $5,000 per month.
The term of the agreement is for one year, but automatically renews unless
explicitly terminated by either party.
NOTE M -- EMPLOYEE BENEFITS
The Bank has an IRA contribution plan available for all personnel who have
been employed at least nine months. If an employee contributes 2 1/2% of his or
her salary to an IRA the Company will provide a contribution of up to two times
the employee's contribution to an aggregate total of $2,000. Contributions in
1997 and 1996 were $32,000 and $29,000, respectively.
NOTE N -- FAIR VALUE OF FINANCIAL INSTRUMENTS
The following summary presents the methodologies and assumptions used to
estimate the fair value of the Company's financial instruments. The Company
operates as a going concern and except for its investment portfolio, no active
market exists for its financial instruments. Much of the information used to
determine fair value is highly subjective and judgmental in nature and,
therefore, the results may not be precise. The subjective factors include, among
other things, estimates of cash flows, risk characteristics, credit quality and
interest rates, all of which are subject to change. Since the fair value is
estimated as of the balance sheet date, the amounts which will actually be
realized or paid upon settlement or maturity of the various financial
instruments could be significantly different.
Cash and Cash Equivalents
For these short-term instruments, the carrying amount approximates fair
value.
Investments
For securities held as investments, fair value equals quoted market price,
if available. If a quoted market price is not available, fair value is estimated
using quoted market prices for similar securities. The carrying amount of
accrued interest receivable approximates its fair value.
F-17
<PAGE> 72
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
Loans
The fair value of fixed rate loans is estimated by discounting the future
cash flows using the current rates at which similar loans would be made to
borrowers with similar credit ratings and for the same remaining maturities. For
variable rate loans, the carrying amount is a reasonable estimate of fair value.
For loans where collection of principal is in doubt, an allowance for losses has
been estimated. Loans with similar characteristics were aggregated for purposes
of the calculations. The carrying amount of accrued interest approximates its
fair value.
Deposits
The fair value of demand deposits, savings accounts, NOW accounts, and
certain money market deposits is the amount payable on demand at the reporting
date (i.e. their carrying amount). The fair value of fixed maturity time
deposits is estimated using a discounted cash flow calculation that applies the
rates currently offered for deposits of similar remaining maturities. The
carrying amount of accrued interest payable approximates its fair value.
Short-term Borrowings
For short-term borrowings, the carrying amount is a reasonable estimate of
fair value.
Long-term Borrowings
The fair value of long-term borrowings is estimated by discounting the
future cash flows using the current rate at which a similar loan could be
financed.
Commitments to Extend Credit, Standby Letters of Credit and Lines of Credit
The fair value of commitments is estimated using the fees currently charged
to enter into similar agreements, taking into account the remaining terms of the
agreements and the present credit worthiness of the counterparts. For fixed-rate
loan commitments, fair value also considers the difference between current
levels of interest rates and the committed rates. The fair value of letters of
credit and lines of credit is based on fees currently charged for similar
agreements or on the estimated cost to terminate them or otherwise settle the
obligations with the counterparts at the reporting date.
F-18
<PAGE> 73
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
The following table presents estimated fair values of the Company's
financial instruments as of December 31, 1997:
<TABLE>
<CAPTION>
CARRYING FAIR
AMOUNT VALUE
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Financial assets
Cash and due from banks................................... $ 9,910 $ 9,910
Interest-bearing deposits................................. 1,775 1,775
Investment securities available for sale.................. 13,999 13,999
Loans, less allowance for loan losses..................... 124,004 123,926
Accrued interest receivable............................... 898 898
Financial liabilities
Deposits
Non-interest bearing................................... 42,515 42,515
Interest bearing....................................... 99,363 99,374
Other borrowings.......................................... 3,423 3,423
Accrued interest payable.................................. 152 152
Unrecognized financial instruments (net of contract
amount)
Commitments to extend credit........................... 51,452 51,452
Standby letters of credit.............................. 9,277 9,277
</TABLE>
NOTE O -- SHAREHOLDERS' EQUITY AND REGULATORY RESTRICTIONS
The Company has a Stock Purchase Agreement with certain of its
shareholders. This agreement, as amended and restated on December 4, 1997,
provides that upon the death of the Company's Chairman of the Board of
Directors, the shareholders will have the option to require the Company to
purchase a pro rata portion of their shares of the Company's stock to the extent
the Company receives proceeds from a life insurance policy on the life of the
Chairman. These shareholders currently hold an aggregate of 3,285,300 shares of
common stock (on a post-stock split basis). The agreement specifies that each
year the shareholders are to determine the value of the stock for purposes of
establishing the purchase price to be paid by the Company. If the shareholders
do not determine a value, the value of the most recent determination will be
used, subject to appropriate adjustment to reflect book value per share of the
Company since the effective date of the last valuation. On February 19, 1998,
the Board of Directors of the Company determined the value to be $4 per share
(on a post-stock split basis). The Company has purchased a life insurance policy
in the amount of $3,000,000 on the Chairman. Based on the current set value of
the stock, a purchase of all of the shares of the shareholders who are a party
to the agreement would be approximately $13.1 million. As described in note Q,
the terms of this agreement were amended on September 1, 1998.
Cash dividends paid to the Company by the Bank amounted to $1,000,000 and
$950,000 in 1997 and 1996, respectively. The payment of dividends to the Company
by the Bank is subject to various state and federal regulatory limitations.
Effective January 15, 1998, the Company increased its authorized capital
stock to 50 million shares of Common Stock and authorized 10 million shares of
Preferred Stock. The increase was made to provide for possible future needs of
the Company.
The Company 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 Company's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt
F-19
<PAGE> 74
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
corrective action, the Company 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
Company'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 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average
assets (as defined). Management believes, as of December 31, 1997, that the
Company meets all capital adequacy requirements to which it is subject.
The Company is adequately capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, institutions
must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage
ratios as set forth in the table. Capital ratios as of December 31, 1997,
presented on a consolidated basis, are as follows:
<TABLE>
<CAPTION>
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
--------------- ------------------ -------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ----- --------- ------ --------- -------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Total capital to risk weighted
assets.......................... $13,226 9.7% $$10,864 $8.0% $$13,579 $10.0%
Tier 1 capital to risk weighted
assets.......................... 11,539 8.5% $5,432 $4.0% $8,148 $6.0%
Tier 1 capital to average
assets.......................... 11,539 7.2% $6,371 $4.0% $7,964 $5.0%
</TABLE>
Effective September 1, 1998, in connection with its charter conversion, the
Bank is subject to the regulations of the Office of Thrift Supervision (OTS).
Under OTS standards, regulatory capital ratios are determined only for the Bank
and not on a consolidated basis.
Unaudited capital ratios for the Bank as of September 30, 1998, are as
follows:
<TABLE>
<S> <C>
Core (Tier 1) capital to adjusted tangible assets........... 10.34%
Tangible capital to adjusted tangible assets................ 10.34%
Risk-based capital to risk-based assets..................... 13.20%
</TABLE>
The Federal Reserve Board requires banks to maintain reserve balances
composed of cash on hand and balances maintained at the Federal Reserve Bank.
These reserve balances are based primarily on deposit levels and totaled
approximately $271,000 at December 31, 1997.
NOTE P -- CONDENSED FINANCIAL STATEMENTS -- PARENT COMPANY ONLY
The following presents the condensed balance sheets as of September 30,
1998 (unaudited) and December 31, 1997 and statements of income and of cash
flows for the nine months ended September 30, 1998 and 1997 (unaudited) and for
each of the two years ended December 31, 1997 for MegaBank Financial
Corporation.
F-20
<PAGE> 75
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
MEGABANK FINANCIAL CORPORATION
BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
Cash and interest bearing deposits.......................... $ 319 $ 296
Investment securities available for sale.................... 1,841 454
Investment in bank subsidiary............................... 22,155 12,626
Investment in trust subsidiary.............................. 371 --
Investment in future bank premises.......................... 1,239 --
Trust preferred securities issuance cost, net............... 734 255
Other assets................................................ 345 277
------- -------
Total assets...................................... $27,004 $13,908
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Note payable................................................ $ -- $ 2,000
Accrued interest and other liabilities...................... 273 330
Company obligated mandatorily redeemable preferred
securities of subsidiary trust holding solely Junior
Subordinated Debentures................................... 12,371 --
Shareholders' equity........................................ 14,360 11,578
------- -------
Total liabilities and shareholders' equity........ $27,004 $13,908
======= =======
</TABLE>
F-21
<PAGE> 76
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
MEGABANK FINANCIAL CORPORATION
STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEARS ENDED
SEPTEMBER 30, DECEMBER 31,
------------------ ---------------
1998 1997 1997 1996
-------- ------- ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C>
Income
Dividends from bank subsidiary.......................... $ -- $1,000 $1,000 $ 950
Interest................................................ 83 9 12 32
Rental income from subsidiary........................... 305 245 341 263
Other rental income..................................... 86 111 137 206
Gain on sale of investment securities available for
sale................................................. 25 -- 341 --
------- ------ ------ ------
Total income.................................... 499 1,365 1,831 1,451
Expenses
Interest................................................ 727 135 179 240
Occupancy and equipment expense......................... 370 298 362 360
Other................................................... 422 424 463 203
------- ------ ------ ------
Total expenses.................................. 1,519 857 1,004 803
------- ------ ------ ------
Income (loss) before income taxes and equity in
undistributed net income of subsidiaries................ (1,020) 508 827 648
Income tax benefit........................................ 377 167 64 114
------- ------ ------ ------
Income (loss) before undistributed net income of
subsidiaries............................................ (643) 675 891 762
Equity in undistributed net income of subsidiaries........ 3,465 1,356 1,943 1,658
------- ------ ------ ------
Net income................................................ $ 2,822 $2,031 $2,834 $2,420
======= ====== ====== ======
</TABLE>
F-22
<PAGE> 77
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
MEGABANK FINANCIAL CORPORATION
STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEARS ENDED
SEPTEMBER 30, DECEMBER 31,
----------------- -----------------
1998 1997 1997 1996
------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C>
Cash flows from operating activities
Net income........................................... $ 2,822 $ 2,031 $ 2,834 $ 2,420
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation...................................... 13 2 3 5
Amortization of preferred securities issuance
costs........................................... 16 -- -- --
Equity in undistributed net income of
subsidiaries.................................... (3,465) (1,356) (1,942) (1,658)
Gain on sale of investment securities available
for sale........................................ (25) -- (341) --
(Increase) decrease in other assets............... (68) (74) (67) (158)
Increase (decrease) in accrued expenses and other
liabilities..................................... 4 (33) 268 (12)
------- ------- ------- -------
Net cash provided by (used in) operating
activities................................. (703) 570 755 597
Cash flows from investing activities
Purchase of securities available for sale............ (2,516) -- (466) --
Proceeds for sales of securities available for
sale.............................................. 616 -- 495 --
Investment in future bank premises................... (1,250) -- -- --
Capital investment in bank subsidiary................ (6,000) -- -- --
------- ------- ------- -------
Net cash provided by (used in) investing
activities................................. (9,150) -- 29 --
Cash flows from financing activities
Preferred securities issuance costs.................. (495) -- (255) --
Principal payments on note payable................... (2,000) (500) (500) (656)
Proceeds from issuance of preferred securities....... 12,371 -- -- --
------- ------- ------- -------
Net cash provided by (used in) financing
activities................................. 9,876 (500) (755) (656)
------- ------- ------- -------
Net increase (decrease) in cash........................ 23 70 29 (59)
Cash, beginning of period.............................. 296 267 267 326
------- ------- ------- -------
Cash, end of period.................................... $ 319 $ 337 $ 296 $ 267
======= ======= ======= =======
</TABLE>
NOTE Q -- SUBSEQUENT EVENTS (UNAUDITED)
Stock Split
As part of its strategy in completing an initial public offering of common
stock, the Company effected a thirty-for-one stock split effective September 1,
1998. Accordingly, references in the accompanying financial statements to
numbers of shares and per share amounts have been retroactively restated to
reflect the stock split.
401(k) Plan
On May 21, 1998, the Board of Directors of the Bank approved the MegaBank
401(k) Savings Plan. The Plan is effective July 1, 1998. Employees who have
completed one year of service, and meet other conditions, are eligible for the
Plan. The Bank will match 50% of the first 6% of compensation which employees
F-23
<PAGE> 78
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
contribute to the Plan. The Bank's contributions to the Plan vest ratably over
six years. The Plan replaces the existing IRA contribution plan.
Charter Conversion
The Company has applied to the Office of Thrift Supervision, Department of
Treasury, to change its status to a savings and loan holding company within the
meaning of the Home Owners' Loan Act of 1933 ("HOLA"), as amended. Under the
proposal, the Company will be registered with the Office of Thrift Supervision
("OTS") and subject to OTS regulations, examinations, supervision and reporting
requirements. In addition, the Bank has applied to the Office of Thrift
Supervision to convert the Bank's charter from a state-chartered stock
institution to a federal stock savings bank. Management believes that the Bank's
balance sheet is currently more reflective of a thrift than a commercial bank,
and that the flexibilities and opportunities with a thrift charter are more in
line with the long range plans of the Bank than those that are available under
its present charter. The Office of Thrift Supervision approved the applications.
The Company effected both of the conversions on September 1, 1998. In connection
with its charter conversion, the Bank changed its name from MegaBank of Arapahoe
to MegaBank.
Stock Incentive Plan
In August 1998, the Company adopted the 1998 Long-Term Incentive Plan (the
"Incentive Plan"). The purpose of the Incentive Plan is to provide continuing
incentives to the Company's and its subsidiaries' key employees, which may
include officers and members of the Board of Directors. The Incentive Plan
provides for an authorization of 500,000 shares of common stock for issuance
thereunder. Under the Incentive Plan, the Company may grant to participants
awards of stock options, restricted stock, stock appreciation rights,
performance shares or any combination thereof.
The Incentive Plan is to be administered by the Board of Directors or a
Compensation Committee of the Board of Directors composed of at least two
non-employee members. Subject to the terms of the Incentive Plan, the Board or
Compensation Committee determines, among other matters, the persons to whom
awards are granted and the terms of the awards.
Under the stock option component of the Incentive Plan, the Company may
grant both incentive stock options ("incentive stock options") intended to
qualify under Section 422 of the Internal Revenue Code of 1986, as amended (the
"Code"), and options which are not qualified as incentive stock options.
Incentive stock options may not be granted at an exercise price of less than the
fair market value of the common stock on the date of grant, while non-qualified
stock options may be granted at any exercise price. The exercise price may be
paid in cash, in shares of common stock (valued at fair market value at the date
of exercise) or by a combination of such means of payment, as may be determined
by the Board or Compensation Committee.
Under the restricted component of the Incentive Plan, the Company may award
shares of restricted stock upon payment of consideration as determined by the
Board or Compensation Committee. Upon the award, a restriction period (not to
exceed ten years) and/or performance goals may be set. Subject to the terms of
each individual award, a restricted stock award is forfeited upon termination of
employment by the recipient during the restriction period and any consideration
paid by the participant is returned.
An award of a stock appreciation right allows a recipient to receive a cash
payment or shares of common stock to the extent of any appreciation in the book
value or the fair market value of the common stock of the Company over a
specified period of time. Stock appreciation rights may also be awarded in
tandem with stock options, and recipients of such tandem awards may elect to
exercise the award as a stock option or as a stock appreciation right.
F-24
<PAGE> 79
MEGABANK FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 IS
UNAUDITED)
Under the performance share component of the Incentive Plan, recipients are
awarded a specified number of shares of common stock of the Company subject to
the recipient or the Company attaining specified performance goals as the Board
or Compensation Committee may determine. The Board or Compensation Committee,
under certain circumstances, may waive or modify performance criteria on
existing performance share awards.
The Incentive Plan will be discontinued in the event of the dissolution or
liquidation of the Company or in the event of a reorganization (such as a
merger, consolidation, or sale of substantially all of the assets of the
Company) in which the Company is not the surviving or acquiring company, or in
which the Company is or becomes a wholly-owned subsidiary of another company
after the effective date of the reorganization and no plan or agreement
respecting the reorganization is established which specifically provides for the
continuation of the Incentive Plan and the change, conversion, or exchange of
the common stock relating to existing awards under the Incentive Plan for
securities of another corporation. Upon the dissolution of the Incentive Plan,
all awards will become fully vested and all outstanding options and stock
appreciation rights will become immediately exercisable by the holder thereof.
On September 1, 1998, the Company granted options to purchase up to 108,500
shares of common stock (on a post-stock split basis) to directors and employees
of the Company, exercisable as follows:
<TABLE>
<CAPTION>
OPTIONS EXERCISE PRICE
GRANTED PER SHARE
------- --------------
<S> <C>
58,500...................................................... $10
50,000...................................................... 11
</TABLE>
These options are contingently issuable upon the successful completion of
the Company's public stock offering.
Of the 108,500 options issued, 15,000 were nonqualified stock options and
93,500 were incentive stock options. The exercise price of the options was
estimated fair market value of the Company's common stock as of the date
granted. Options must be exercised within a ten-year period. Options to purchase
shares of common stock are exercisable as follows:
<TABLE>
<CAPTION>
EXERCISABLE
ON OR AFTER OPTIONS
----------- -----------
<S> <C>
September 1, 2000........................................... 10,000
September 1, 2001........................................... 32,550
September 1, 2002........................................... 65,950
-------
108,500
=======
</TABLE>
The effect of these options for the determination of diluted earnings per
share for each of the periods, computed under the "treasury-stock" method, is
immaterial.
Amendment of Stock Purchase Agreement
The terms of the Company's Stock Purchase Agreement are described in note
O. On September 1, 1998, the method of determining the purchase price to be paid
by the Company in the event of the death of the Company's Chairman of the Board
of Directors was amended. Under the amendment, the purchase price of the common
stock would be based on the greater of 80% of its average closing price on any
national securities exchange or recognized quotation system for a designated
period or its appraised value.
F-25
<PAGE> 80
- ------------------------------------------------------
- ------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFER CONTAINED HEREIN AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR ANY UNDERWRITERS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE AS OF
WHICH INFORMATION IS SET FORTH HEREIN. THIS PROSPECTUS DOES NOT CONSTITUTE AN
OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED
HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH
OFFER OR SOLICITATION.
---------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary......................... 3
Selected Consolidated Financial Data....... 5
Risk Factors............................... 6
Use of Proceeds............................ 10
Dividend Policy and No Prior Market........ 10
Dilution................................... 11
Capitalization............................. 12
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................... 13
Business................................... 30
Management................................. 35
Related Party Transactions................. 38
Principal and Selling Shareholders......... 40
Supervision and Regulation................. 41
Description of Capital Stock............... 48
Shares Eligible for Future Sale............ 51
Underwriting............................... 52
Legal Matters.............................. 53
Experts.................................... 54
Available Information...................... 54
Index to Financial Statements.............. F-1
</TABLE>
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
1,450,000 SHARES
MEGABANK FINANCIAL
CORPORATION
LOGO
COMMON STOCK
------------------------------
PROSPECTUS
------------------------------
HOWE BARNES INVESTMENTS, INC.
November 16, 1998
------------------------------------------------------
------------------------------------------------------
