<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------
FORM 10-KSB
(Mark One)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended September 30, 1996
[_] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
--------------- ------------
Commission File No. 0-25704
FIRST FEDERAL BANCORPORATION
----------------------------
(Exact name of registrant as specified in its charter)
Minnesota 41-1796238
- - ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
214 5th Street, Bemidji, Minnesota 56601
- - ------------------------------------------ -------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (218) 751-5120
Securities registered pursuant to Section 12(b) of the Act:
Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $.01 per share
--------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or such shorter period that the registrant was required to
file such reports) and (2) has been subject to such filing requirements for the
past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year: $7.96 million.
As of December 12, 1996, the aggregate market value of the 422,868 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $7,558,765 based on the closing sale price of
$17.875 per share of the registrant's Common Stock on December 12, 1996 as
listed on the National Association of Securities Dealers Automated Quotation
Small Cap Market. For purposes of this calculation, it is assumed that the
277,698 shares held by directors, officers, the Employee Stock Ownership Plan,
the Stock Ownership Plan and Management Recognition Plan Trusts, and beneficial
owners of more than 10% of the registrant's outstanding voting stock, are shares
held by affiliates.
Number of shares of Common Stock outstanding as of December 12, 1996: 700,566
DOCUMENTS INCORPORATED BY REFERENCE
The following lists the documents incorporated by reference and
the Part of the Form 10-K into which the document is incorporated:
1. Portions of the Annual Report to Stockholders for the fiscal year
ended September 30, 1996. (Parts I, II and IV)
2. Portions of Proxy Statement for 1996 Annual Meeting of Stockholders.
(Part III)
<PAGE>
PART I
Item 1. Business
- - -----------------
General
First Federal Bancorporation. First Federal Bancorporation (the
"Company") was incorporated under the laws of the State of Minnesota in
September 1994 at the direction of the Board of Directors of First Federal
Banking and Savings, FSB ("First Federal" or the "Bank") for the purpose of
serving as a savings and loan holding company of the Bank upon the acquisition
of all of the capital stock issued by the Bank upon its conversion from the
mutual to the stock form of ownership (the "Conversion"). Prior to the
Conversion, the Company did not engage in any material operations. Currently,
the Company's principal business is the business of the Bank. The Company has no
significant assets other than the outstanding capital stock of the Bank,
$461,000 of cash and cash equivalents and $1.00 million in securities available
for sale. At September 30, 1996, the Company had total consolidated assets of
$107.26 million, deposits of $81.05 million and stockholders' equity of $12.32
million.
The Company's executive offices are located at 214 5th Street, Bemidji,
Minnesota 56601, and its main telephone number is (218) 751-5120.
First Federal Banking & Savings, FSB. First Federal was originally
chartered in 1910 as Beltrami County Savings and Building Association, a
state-chartered savings institution, and commenced operations in that same year.
First Federal has been a member of the Federal Home Loan Bank ("FHLB") of Des
Moines since 1933, and its deposits have been federally insured since 1938.
First Federal currently operates as a federally chartered savings bank through
its main office located in Bemidji, Minnesota and four branch offices, which are
located in Bemidji, Bagley, Baudette and Walker, Minnesota. The Bank's market
area is located approximately 200 miles northwest of Minneapolis, Minnesota. At
September 30, 1996, First Federal had total assets of $105.40 million, deposits
of $81.51 million, mortgage-backed and related securities and investment
securities totaling $45.91 million and stockholders' equity of $9.93 million.
First Federal is primarily engaged in the business of attracting
deposits from the general public and originating loans secured by first
mortgages on owner occupied one- to four-family residences in First Federal's
market area. First Federal also originates loans on commercial real estate
(including motels), multi-family real estate, home equity lines of credit and
other consumer loans, and commercial business loans. Due to limited loan demand
in its market area, First Federal has invested excess funds in mortgage-backed
and related securities and in other investment securities, and during fiscal
1996 became more active in originating and purchasing participation interests in
commercial real estate loans.
The Bank is subject to examination and comprehensive regulation by the
Office of Thrift Supervision ("OTS"), and the Bank's savings deposits are
insured up to applicable limits by the Savings Association Insurance Fund
("SAIF"), which is administered by the Federal Deposit Insurance Corporation
("FDIC"). The Bank is a member of, and owns capital stock in the Federal Home
Loan Bank ("FHLB") of Des Moines, which is one of 12 regional banks in the FHLB
System. The Bank is further subject to regulations of the Board of Governors of
the Federal Reserve System (the "Federal Reserve Board") governing reserves to
be maintained and certain other matters.
The Bank's executive offices are located at 214 5th Street, Bemidji,
Minnesota 56601, and its main telephone number is (218) 751-5120.
2
<PAGE>
Market Area
First Federal serves the Bemidji, Minnesota marketplace, which is
located in northwestern Minnesota approximately 200 miles northwest of
Minneapolis, Minnesota. The primary market area of First Federal consists of the
five counties of Beltrami, Cass, Hubbard, Clearwater and Lake of the Woods in
Minnesota. These counties are served by the Bank's main office and a new branch
office located in Bemidji and three branch offices located in Bagley, Baudette
and Walker, Minnesota. These communities are the county seats and largest towns
in each of the counties where the branches are located. No branch office is
located in Hubbard County, but the northern border of Hubbard County is only
four miles from the Bank's main office. Bemidji is the largest community in the
market area, while the balance of the Bank's market area consists primarily of
rural areas and small towns. The primary market area also includes three Indian
reservations, a portion of which land is owned by the federal government in
trust for the Native Americans. This portion of the area is not open to mortgage
lending, therefore, an enforceable lien is not possible. The Bank does receive a
limited number of consumer loan applications from the area. In addition, the
Bank's primary market area also includes large tracts of land covered by water
and national and state forests and, thus, not available for home building.
In the Bank's most critical market, Beltrami County, median household
income of $23,500 at March 31, 1994 was two-thirds that of the median for the
state of Minnesota and 70.0% of the United States at large. Both Minnesota and
national medians show modest household income growth, the result of projected
low inflation and continued modest economic growth, while the median household
income in Beltrami County, the major population center of the Bank's market area
is expected to decline through the end of the century. The decreases in the
median household income in the major population center of the region suggests
limited economic growth in the Bank's market area which would likely result in
limited lending and savings growth. However, the Bank opened an additional
branch office in the Spring of 1995 in a newer commercial and retail area of
Bemidji, Minnesota, and may consider acquiring additional branch offices in
order to increase its loan origination activity.
The Bank's limited lending opportunities are primarily a function of
Bemidji's economy, which exhibits slow growth. For the period from 1980 to 1990,
the population of the Bank's market area increased 6.15%, as compared to an
increase of 7.33% for the State of Minnesota, and an increase of 9.79% for the
United States as a whole. Lacking growth in local residential loan originations,
First Federal has been forced to turn toward out-of-area real estate lending,
multi-family and commercial real estate lending, and to investment in
mortgage-backed and other securities. Such "out-of-area" real estate lending
constituted 4.32% of the Bank's gross loan portfolio at September 30, 1996 while
loans on multi-family and commercial real estate constituted 24.80% of the
Bank's gross loan portfolio at that date.
Recent Developments
BIF-SAIF Premium Disparity; Deposit Insurance Assessment. The Bank's
savings deposits are insured by the SAIF. The assessment rate currently ranges
from 0.23% of deposits for well capitalized institutions to 0.31% of deposits
for undercapitalized institutions.
The FDIC also administers the Bank Insurance Fund ("BIF"), which has
the same designated reserve ratio as the SAIF. The FDIC amended the BIF
risk-based assessment schedule which lowered the deposit insurance assessment
rate for most commercial banks and other depository institutions with deposits
insured by the BIF to a range of 0.31% of insured deposits for undercapitalized
BIF-insured institutions to a statutory minimum of $2,000 for well-capitalized
institutions, which constitute over 90% of BIF-insured institutions. These
revisions to the BIF assessment rate schedule created a substantial disparity in
the deposit premiums paid by BIF and SAIF members and placed SAIF-insured
savings institutions such as the Bank at a significant competitive disadvantage
to BIF-insured institutions.
As a result of this premium disparity, BIF-insured institutions have
had a significant competitive advantage over SAIF-insured institutions in
attracting and retaining deposits. For instance, SAIF-insured institutions could
have
3
<PAGE>
lost deposits to BIF-insured institutions that, because of the premium
disparity, were able to pay higher rates of interest on deposits with little or
no impact on their net interest income. In contrast, SAIF-insured institutions
that attempted to compete by similarly raising their interest rates in order to
maintain their existing deposit base increased their overall cost of funds and
thus possibly reduced their net interest income. Further, while other sources of
funds are generally available to savings associations, they usually bear a
higher rate than the average cost of funds of a savings association's deposit
base. The continuance of this premium disparity would have had a material
adverse effect on its results of operations and financial condition in future
periods.
Recently enacted legislation effectively eliminated this premium
disparity by providing for a one-time additional assessment of SAIF-insured
institutions of approximately 65.7 basis points of insured deposits as of March
31, 1995. The payment of the special assessment will increase the SAIF reserve
level to 1.25% of SAIF-insured deposits, which is the same level attained by the
BIF prior to the reduction of BIF premium rates. The special assessment resulted
in a charge to the Bank of $347,000 (net of tax effect) during the year ended
September 30, 1996). As a result of the special assessment, the SAIF will be
fully recapitalized, and it will have the effect of reducing the Bank's deposit
insurance premiums to the SAIF, thereby increasing net income in future periods,
and restoring competitive equality between BIF-insured and SAIF-insured
institutions.
In addition, under the recently enacted legislation, both BIF and SAIF
members will be assessed an amount for the Financing Corporation Bond payments.
BIF members will be assessed approximately 1.3 basis points while the SAIF rate
will be approximately 6.4 basis points until January 1, 2000. At that time, BIF
and SAIF members will begin pro rata sharing of the payment at an expected rate
of 2.43 basis points.
Lending Activities
General. First Federal's principal lending activity consists of the
origination of loans secured by first mortgages on owner occupied one- to
four-family residences in the Bank's market area, which consists of the
Minnesota Counties of Beltrami, Cass, Hubbard, Clearwater and Lake of the Woods.
First Federal serves these counties through its main office and a branch office
located in Bemidji and three branch offices located in Bagley, Baudette and
Walker, Minnesota. The largest concentration of First Federal's loans are within
a ten mile radius of the main office in Bemidji. To a lesser extent, First
Federal also originates loans secured by multi-family properties such as
apartment houses and commercial properties such as motels and retail
developments, as well as home equity and home improvement loans, other consumer
loans and commercial business loans.
Beginning in the early 1980's, management of the Bank sought to build a
rate sensitive loan portfolio and to manage First Federal's interest rate risk
by emphasizing the origination of one-year adjustable-rate mortgage loans and
short-term (10 years or less) fixed-rate mortgage loans. Fixed-rate mortgage
loans continue to be offered by the Bank, but substantially all such loans are
sold in the secondary market. To date, such loan sale activities have not been a
significant contributor to the Bank's profitability. First Federal offers a full
range of mortgage products, including conventional adjustable-rate and
fixed-rate mortgage loans, short-term mortgages, and FHA and VA insured loans.
First Federal has also participated in the Minnesota Housing Finance Agency
("MHFA") housing program, and has originated and purchased participation
interests in multi-family and commercial mortgage loans.
4
<PAGE>
Loan Portfolio Composition. The following table sets forth selected
data relating to the composition of First Federal's loan portfolio by type of
loan at the dates indicated. At September 30, 1996, First Federal had no
concentrations of loans exceeding 10% of total loans other than as disclosed
below.
<TABLE>
<CAPTION>
At September 30,
------------------------------------------------------------------
1996 1995 1994
------------------- ------------------- -----------------
Amount % Amount % Amount %
---------- ----- ---------- ----- --------- -----
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Type of Loan:
- - -------------
Real estate loans --
Construction loans........................ $ 307 0.59 $ 99 .20% $ 521 1.10%
One- to four-family residential........... 25,988 49.95 28,947 58.63 30,310 63.79
Multi-family residential.................. 2,410 4.63 2,489 5.04 2,576 5.42
Commercial................................ 10,494 20.17 8,003 16.21 5,164 10.87
Consumer loans --
Automobiles............................... 2,753 5.29 1,232 2.50 1,156 2.43
Mobile home loans......................... 381 0.73 341 .69 376 .79
Savings account loans..................... 364 0.70 548 1.11 549 1.16
Home improvement loans.................... 1,681 3.23 1,560 3.16 1,504 3.16
Home equity lines of credit............... 507 0.98 514 1.04 565 1.19
Other consumer loans...................... 5,001 9.61 4,171 8.45 4,082 8.59
Commercial business loans................... 2,142 4.12 1,467 2.97 711 1.50
-------- ------- -------- ------- ------- -------
52,028 100.00% 49,371 100.00% 47,514 100.00%
-------- ====== -------- ====== ------- ======
Less:
Loans in process.......................... 627 744 511
Deferred fees and discounts (premiums).... (56) 92 93
Allowance for loan losses................. 454 491 529
-------- -------- -------
Total................................... $ 51,003 $ 48,044 $46,381
======== ======== =======
</TABLE>
5
<PAGE>
Loan Maturity. The following table sets forth certain information at
September 30, 1996, regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity. Loans having no stated
schedule of repayments and no stated maturity, and overdrafts are reported as
due in one year or less. Scheduled contractual principal repayments of loans do
not necessarily reflect the actual life of such assets. The average life of
long-term loans is substantially less than their contractual terms, due to
prepayments. The average life of mortgage loans tends to increase when current
mortgage loan market rates are substantially higher than rates on existing
mortgage loans and tends to decrease when current mortgage loan market rates are
substantially lower than rates on existing mortgage loans.
<TABLE>
<CAPTION>
Due during the year ending Due after
September 30, 3 through
------------------------------------ 5 years after
1997 1998 1999 9/30/96
------ ------ ------- -----------
(In thousands)
<S> <C> <C> <C> <C>
Real estate mortgage...................... $ 976 $ 368 $ 2,018 $ 3,810
Real estate construction.................. 307 -- -- --
Consumer.................................. 1,589 1,054 1,281 2,734
Commercial................................ 386 243 362 709
---------- --------- ---------- --------
Total................................ $ 3,258 $ 1,665 $ 3,661 $ 7,253
========== ========= ========== ========
<CAPTION>
Due after Due after
5 through 10 through Due after 15
10 years after 15 years after years after
9/30/96 9/30/96 9/30/96 Total
----------- ------------ ------------- -------
(In thousands)
<S> <C> <C> <C> <C>
Real estate mortgage...................... $ 11,498 $ 7,004 $ 13,218 $ 38,892
Real estate construction.................. -- -- -- 307
Consumer.................................. 2,122 1,680 227 10,687
Commercial................................ 232 210 -- 2,142
--------- -------- --------- ---------
Total................................ $ 13,852 $ 8,894 $ 13,445 $ 52,028
========= ======== ========= =========
</TABLE>
Loan Repricing. The following table sets forth at September 30, 1996, the
dollar amount of all loans due one year after September 30, 1996 which have
predetermined interest rates and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rate Adjustable Rates
-------------- ----------------
(In thousands)
<S> <C> <C>
Real estate mortgage............................... $ 6,988 $ 30,928
Real estate construction........................... -- --
Consumer........................................... 2,004 7,095
Commercial......................................... 1,204 551
----------- -----------
$ 10,196 $ 38,574
=========== ===========
</TABLE>
6
<PAGE>
Loan Originations, Purchases and Sales. The following table sets forth
certain information with respect to First Federal's loan originations during the
periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------------------
1996 1995 1994
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Loans originated:
Real estate loans:
Construction loans......................................... $ 1,372 $ 599 $ 2,326
One- to four-family residential............................ 4,520 2,901 4,099
Multi-family residential................................... -- -- 550
Commercial................................................. -- 300 243
Consumer loans............................................... 8,241 5,165 5,329
Commercial business.......................................... 341 166 415
--------- --------- ---------
$ 14,474 $ 9,131 $ 12,962
========= ========= =========
Loans purchased:
Real estate loans:
Multi-family residential................................... $ -- $ -- $ 200
Commercial................................................. 3,159 3,425 399
Commercial business.......................................... 612 913 250
--------- --------- ---------
Total loans purchased..................................... $ 3,771 $ 4,338 $ 849
========= ========= =========
Loans sold:
Whole loans.................................................. $ 2,075 $ 569 $ 1,992
Participation loans.......................................... -- -- --
--------- --------- ---------
Total loans sold.......................................... $ 2,075 $ 569 $ 1,992
========= ========= =========
</TABLE>
First Federal's primary lending activity has been the origination of
residential and commercial mortgages for its loan portfolio. The Bank has
aggressively pursued mortgages in its market area in recent years but has been
constrained in building its portfolio by a combination of lack of economic
growth in the Bemidji area and prepayments, which generally equalled or exceeded
loan originations. First Federal sells substantially all fixed-rate mortgage
loans it originates in the secondary market. For the five years ended September
30, 1996, 121 fixed-rate mortgage loans, secured by single-family homes totaling
$7.77 million were sold in the secondary market, with servicing rights released.
First Federal generally does not purchase one- to four-family mortgage loans.
Due to limited demand for one- to four-family residential real estate
loans in its market area, First Federal has also purchased participation
interests in multi-family and commercial mortgage loans in recent years.
Specifically, during the last five years, First Federal purchased participation
interests in 34 commercial real estate and multi-family residential real estate
loans originated by other lenders totaling $7.50 million. Twelve of these loans
totaling $1.83 million were participation interests in commercial real estate
loans on properties outside the Bank's primary market area, with a total loan
balance at September 30, 1996 of $1.60 million. Of the 35 participation
interests in commercial real estate loans, 16 loans totaling $10.90 million were
purchased during the year ended September 30, 1996. See "Commercial and
Multi-Family Real Estate Lending." First Federal has not sold any whole or
participation interests in commercial real estate or multi-family loans within
the past five years.
7
<PAGE>
One- to Four-Family Residential Lending. The Bank historically has been
and continues to be an originator of owner occupied, one- to four-family
residential properties located in its market area. At September 30, 1996,
approximately $25.99 million or 49.95% of the Bank's loan portfolio consisted of
loans secured by one- to four-family residential properties.
First Federal began originating adjustable-rate residential mortgage
loans in 1980. Since that time, substantially all one- to four-family mortgage
loans originated by the Bank for retention in the Bank's portfolio have been
adjustable-rate loans which provide for annual interest rate adjustments, and
have terms to maturity of from 15 to 30 years. While the Bank does offer
"teaser" or reduced interest rates for the initial one-year adjustment period,
all borrowers are qualified at the fully-indexed interest rate. After the
initial one-year period, the rate adjustments on the Bank's adjustable-rate
loans are indexed to the rate paid on one-year U.S. Treasury Bills. The interest
rates on these mortgages include limitations on adjustments of two percentage
points per adjustment period, and a lifetime cap of six percentage points.
At September 30, 1996, the Bank's loan portfolio included $21.03
million in adjustable-rate one- to four-family residential mortgage loans, or
40.42% of the Bank's loan portfolio.
The retention of adjustable-rate loans in First Federal's portfolio
mitigates First Federal's exposure to increases in market interest rates.
However, there are unquantifiable credit risks resulting from potential
increases in costs to borrowers in the event of upward repricing of
adjustable-rate loans. It is possible that during periods of rising interest
rates, the risk of default on adjustable-rate loans may increase due to
increases in interest costs to borrowers. Further, although adjustable-rate
loans allow First Federal to increase the sensitivity of its interest-earning
assets to changes in interest rates, the extent of this interest sensitivity is
limited by the repricing frequency and the periodic and lifetime interest rate
adjustment limitations. Accordingly, there can be no assurance that yields on
First Federal's adjustable-rate loans will fully adjust to compensate for
increases in First Federal's cost of funds. Finally, adjustable-rate loans
increase First Federal's exposure to decreases in market interest rates,
although decreases in First Federal's cost of funds tend to offset this effect.
In general, First Federal originates residential mortgage loans with
loan-to-value ratios of up to 95%, with private mortgage insurance required for
loans with loan-to-value ratios greater than 80%. The Bank also originates FHA
and VA loans and participates in the MHFA housing programs. The majority of
these loans are long term, fixed-rate loans, which are primarily originated for
sale in the secondary market or sold to the MHFA.
Construction and Land Lending. First Federal offers construction loans
to qualified borrowers for construction of one- to four-family residences in
First Federal's market area. At September 30, 1996, one- to four-family
residential construction loans constituted $307,000, or .59%, of First Federal's
total loans. Typically, First Federal limits its construction lending to
single-settlement, construction-permanent loans to individuals building their
primary residences and second homes or vacation homes. These loans generally
have adjustable interest rates and are underwritten in accordance with the same
standards as First Federal's mortgages on existing properties, except the loans
generally provide for disbursement in stages during a construction period of up
to twelve months, during which period the borrower is required to make monthly
payments of accrued interest on the outstanding loan balance. Construction loans
generally have a maximum loan-to-value ratio of 80%. Borrowers must satisfy all
credit requirements which would apply to First Federal's permanent mortgage loan
financing for the subject property.
Construction lending is considered to involve a higher degree of risk
of loss than long-term financing on improved, occupied real estate. Risk of loss
on a construction loan is dependent largely upon the accuracy of the initial
estimate of the property's value at completion of development or construction
and the estimated cost (including interest) thereof. During the construction
phase, a number of factors could result in delays and cost overruns. If the
estimate of construction costs proves to be inaccurate, First Federal may be
required to advance funds beyond the amount originally committed to permit
completion of the project. If the estimate of value proves to be inaccurate,
First Federal may be confronted, at or prior to the maturity of the loan, with a
project having a value
8
<PAGE>
which is insufficient to assure full repayment. The ability of a developer to
sell developed lots or a builder to sell completed dwelling units will depend
on, among other things, demand, pricing, availability of comparable properties
and economic conditions. First Federal has sought to minimize this risk by
limiting construction lending to qualified borrowers in First Federal's market
area and by limiting the aggregate amounts of outstanding construction loans.
Commercial and Multi-Family Real Estate Lending. The Bank is active in
the origination of commercial and multi-family real estate loans, in part due to
limited residential lending opportunities in the Bank's market area. The Bank's
primary emphasis in its commercial and multi-family real estate lending has been
loans on motel properties which totaled $2.47 million, or 4.73%, of gross loans
at September 30, 1996, and loans on apartment houses, which constituted $2.41
million, or 4.63%, of gross loans at September 30, 1996. Commercial real estate
loans (including motel loans) totaled $10.49 million, or 20.17%, of gross loans
at September 30, 1996, an increase of 31.12% from the balance of $8.0 million at
September 30, 1995. Mortgages secured by multi-family real estate (including
apartment houses) had a balance of $2.41 million at September 30, 1996, compared
to $2.49 million at the same date in 1995.
As discussed above, in recent years, the Bank has become more active in
the origination of multi-family and commercial real estate lending. During the
year ended September 30, 1996, the Bank did not originate any multi-family or
commercial real estate loans, but purchased participation interests in 16 loans
secured by commercial real estate projects or properties, in amounts ranging
from $36,000 to $500,000, and totaling $3.26 million. These loans are secured by
(i) one telemarketing center; (ii) four multi-tenant office buildings; (iii) two
manufacturing companies; (iv) a strip shopping center; and (v) one nursing home.
The seven remaining properties are government guaranteed (SBA or FMHA) loans on
commercial properties. Of these 16 properties, six are located in Minnesota, and
the Bank holds an approximate one-third or less participation interest in each
project/property. While the Bank believes it has taken the appropriate steps in
accordance with its lending policies and procedures in originating these loans,
or purchasing these participation interests, there are significant risks
attendant to this type of lending.
At September 30, 1996, the Bank's portfolio includes both originated
mortgages and purchased loan participations on commercial and multi-family
properties generally located in the State of Minnesota. On both participations
and on loan originations, the Bank lends based on a project's cash flow and
ability to meet debt service requirements. Each property is appraised by a Board
of Directors-approved appraiser. Credit verification on the borrower is obtained
and personal guarantees are required of all borrowers. Annual financial
statements or tax returns are required on the securing property.
As of September 30, 1996, the Bank's largest loan was for $880,908 and
was one of three loans secured by motels, all three of which are located in
either the western suburbs of Minneapolis or in Bemidji, Minnesota. The other
two loans secured by motels had outstanding balances of $699,187 and $514,853 at
September 30, 1996. The Bank has several loans in the $300,000 to $500,000 range
secured by an assortment of properties, which are described above.
As noted above, included in the Bank's $10.49 million in commercial
real estate loans at September 30, 1996 were three loans on motel properties,
all located in Minnesota, with balances outstanding totalling $2.09 million at
September 30, 1996. The higher loan amounts and dependence on income and cash
flow of the property to cover operating expenses and debt service means these
loans involve significantly more credit risk than loans on one- to four-family
properties. While the Bank has not in recent years experienced losses from its
loans secured by motel properties or other commercial real estate, such losses
are possible, and if incurred, could have a significant effect on the Bank's net
income and capital position. All of the Bank's loans secured by multi-family and
commercial real estate are performing within their terms.
9
<PAGE>
Commercial and multi-family real estate lending entails significant
additional risks compared with one- to four-family residential lending. For
example, commercial and multi-family real estate loans typically involve large
loan balances to single borrowers or groups of related borrowers, the payment
experience on such loans typically is dependent on the successful operation of
the real estate project, and these risks can be significantly impacted by supply
and demand conditions in the market for multi-family residential units and
commercial office, retail and warehouse space, and for motel loans, tourism and
general economic conditions. While the Bank has not experienced significant
losses from its multi-family residential and commercial real estate lending
activities in recent years, the higher loan balances on each of these loans
means that if the Bank experiences problems with any one of these loans, its net
income and financial condition could be severely impacted.
The aggregate amount of loans which federally chartered savings
institutions may make on the security of liens on commercial real estate may not
exceed 400% of the institution's capital; however, the limits on commercial real
estate lending do not require divestiture of any loan or investment that was
lawful when made. See "-- Loan Solicitation and Processing."
Consumer Lending. First Federal offers consumer loans as part of a
broad commitment to be a full-service consumer-oriented banking institution.
Such lending activities have increased in recent years as the Bank has used its
excess funds to increase its consumer loan origination activities. The consumer
loans originated by the Bank include automobile loans, savings account loans and
mobile home loans, as well as home equity loans and home improvement loans, and
unsecured consumer loans. At September 30, 1996, the Bank's consumer loan
balance totaled $10.69 million, or 20.54%, of its total loan portfolio. Of the
consumer loan balance at September 30, 1996, $2.75 million were automobile
loans, $507,000 were home equity lines of credit, $1.68 million were home
improvement loans, $381,000 were mobile home loans and $364,000 were savings
account loans. The Bank has not aggressively pursued consumer loans outside its
customer base but relies instead on cross-sales of existing customers through
flyers in checking account statements and loan payment envelopes.
In addition, included in the Bank's consumer loan portfolio at
September 30, 1996 were $5.00 million in other consumer loans, which included:
$3.39 million in home equity loans; $275,000 in loans secured by recreational
vehicles such as Rvs, boats, motorcycles or snowmobiles; $343,000 in loans
secured by automobiles; $406,000 in other secured loans; $215,000 in unsecured
overdraft protection; and $377,000 in unsecured loans.
The Bank's automobile loans are generally underwritten in amounts up to
90% of the purchase price or the N.A.D.A. book value. The terms of the loan
generally do not exceed 60 months for new vehicles or 42 months for used
vehicles. The Bank requires that the vehicles be insured and the Bank be listed
as loss payee on the insurance policy.
The Bank's home equity lines of credit are made on the security of
residential real estate, do not exceed 80% of the estimated value of the
property, less the outstanding principal of the first mortgage, and have terms
of up to ten years. The Bank makes loans secured by savings accounts for up to
90% of the depositor's savings account balance. The interest rate is normally
three percentage points above the rate paid on the savings account, and the
account must be pledged as collateral to secure the loan.
Consumer loans generally entail greater risk than do residential
mortgage loans, particularly in the case of consumer loans which are unsecured
or secured by rapidly depreciable assets. Consumer loans are generally priced
relative to the Bank's assessment of the risk associated with the loan.
Virtually all consumer loans in the Bank's portfolio are either adjustable-rate
or of short or intermediate term. Adjustable-rate consumer loans are priced off
the prime rate and increments are added based on risk assessment as determined
by the Bank's senior lending and executive officers.
Commercial Business Lending. The Bank maintains in portfolio a small
amount of commercial business loans as an additional service to its already
existing banking relationships. At September 30, 1996, these loans
10
<PAGE>
amounted to $2.14 million, or 4.12%, of gross loans. These loans are for a
variety of commercial purposes and are secured by inventories, receivables and
other business assets from companies in the Bemidji area, including retail
establishments and restaurants. The Bank underwrites commercial business loans
based on the financial condition of the business and the creditworthiness of the
borrower. The Bank seeks personal guarantees whenever possible and, as
appropriate, will cross-collateralize business loans with other assets tied to
the business.
Commercial business loans generally involve more credit risk than first
mortgage loans. Repossessed collateral for a defaulted loan may not provide an
adequate source of repayment of the outstanding credit obligation as a result of
damage, loss or depreciation. In such circumstances, the remaining deficiency
often does not warrant further substantial collection efforts against the
obligor. In addition, collections are dependent on the obligor's continuing
financial stability, and thus are more likely to be adversely affected by job
loss, divorce, illness or personal bankruptcy. Further, the application of
various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered. These financings
may also give rise to claims and defenses by an obligor against First Federal,
and an obligor may be able to assert against First Federal claims and defenses
which it has against the seller of the underlying collateral. First Federal's
risks associated with commercial loans have been minimized by the immaterial
amount of such loans made by First Federal.
Loan Solicitation and Processing. First Federal's loan originations are
derived from a number of sources, including promotional activity, real estate
brokers, walk-in customers and current customers of the Bank. Construction loans
are often originated through existing customers.
The Bank's Loan Committee is responsible for review and approval of all
loans originated or purchased by the Bank. Loans in excess of $250,000 may be
approved by the Bank's President, but usually receive the pre- approval of a
committee consisting of four members of the Board of Directors or the entire
Board of Directors. The list of outside appraisers is approved annually by the
Board of Directors. All appraisers are fee appraisers and not members of the
Bank's staff.
Under the Bank's loan policy, the loan officer processing an
application is responsible for ensuring that all documentation is obtained prior
to submission of the application to the Loan Committee. In addition, the loan
officer verifies that the application meets the underwriting guidelines of the
Bank. All of the Bank's lending is subject to its written underwriting standards
and to loan origination procedures. Decisions on loan applications are made on
the basis of detailed applications and property valuations. The loan
applications are designed primarily to determine the borrower's ability to repay
the loan. More significant items on the application are verified through use of
credit reports, financial statements, tax returns and written confirmations.
Each individual loan officer is subject to a maximum lending authority
established by the Board of Directors. Loans in excess of an individual's
lending authority are submitted to an officer with sufficient lending authority,
or the Loan Committee for approval. After a loan is closed, it is assigned to a
reviewing officer who reviews the file to assure its accuracy and completeness.
The Bank generally relies on attorneys' opinions of title in its loan
processing. Title insurance is required on all mortgage loans closed for sale in
the secondary market. The Bank also requires title insurance for loans secured
by properties exhibiting unique title conditions which may involve additional
risk. The Bank requires fire and extended coverage casualty insurance in amounts
at least equal to the principal amount of the loan or the value of improvements
on the property, depending on the type of loan. The Bank also requires flood
insurance to protect the property securing its interest when the property is
located on a flood plain, although generally the Bank's primary market area is
not within a designated flood plain.
The Bank makes up to a 90-day loan commitment for each loan approved.
If the borrower desires a longer commitment, the commitment may be extended for
good cause and upon written approval. No fees are charged in connection with the
issuance of a commitment letter.
11
<PAGE>
Under applicable law, with certain limited exceptions, loans and
extensions of credit by a savings institution to a person outstanding at one
time shall not exceed 15% of the institution's unimpaired capital and surplus.
Loans and extensions of credit fully secured by readily marketable collateral
may comprise an additional 10% of unimpaired capital and surplus. Applicable law
additionally authorizes savings institutions to make loans to one borrower, for
any purpose, in an amount not to exceed $500,000 or in an amount not to exceed
the lesser of $30,000,000 or 30% of unimpaired capital and surplus to develop
residential housing, provided (1) the purchase price of each single-family
dwelling in the development does not exceed $500,000, (2) the savings
institution is and continues to be in compliance with its fully phased-in
regulatory capital requirements, (3) the loans comply with applicable
loan-to-value requirements, (4) the aggregate amount of loans made under this
authority does not exceed 150% of unimpaired capital and surplus, and (5) the
Director of OTS, by order, permits the savings institution to avail itself of
this higher limit. Under these limits, the Bank's loans to one borrower were
limited to $1.78 million at September 30, 1996. At that date, the Bank had no
lending relationships in excess of the OTS's loans-to-one-borrower limit. The
Bank's five largest loans ranged from $515,000 to $881,000 at September 30,
1996. All of these loans were current as of September 30, 1996.
Interest Rates and Loan Fees. Interest rates charged by First Federal
on mortgage loans are primarily determined by competitive loan rates offered in
its market area and First Federal's yield objectives. Mortgage loan rates
reflect factors such as prevailing market interest rate levels, the supply of
money available to the savings industry and the demand for such loans. These
factors are in turn affected by general economic conditions, the monetary and
fiscal policies of the federal government, including the Federal Reserve Board,
the general supply of money in the economy, tax policies and governmental budget
matters.
First Federal receives fees in connection with loan modifications, late
payments and for miscellaneous services related to its loans. Such loan fees
have not been significant in recent years.
Asset Classification, Allowances for Losses and Non-Performing Assets.
Federal regulations require savings institutions to classify their assets on the
basis of quality on a regular basis. An asset is classified as substandard if it
is determined to be inadequately protected by the current net worth and paying
capacity of the obligor or of the collateral pledged, if any. An asset is
classified as doubtful if full collection is highly questionable or improbable.
An asset is classified as loss if it is considered uncollectible, even if a
partial recovery could be expected in the future. The regulations also provide
for a special mention designation, described as assets which do not currently
expose a savings institution to a sufficient degree of risk to warrant
classification but do possess credit deficiencies or potential weaknesses
deserving management's close attention. Assets classified as substandard or
doubtful require a savings institution to establish general allowances for loan
losses. If an asset or portion thereof is classified loss, a savings institution
must either establish a specific allowance for loss in the amount of the portion
of the asset classified loss, or charge off such amount. Federal examiners may
disagree with a savings institution's classifications. If a savings institution
does not agree with an examiner's classification of an asset, it may appeal this
determination to the OTS Regional Director. First Federal regularly reviews its
assets to determine whether any assets require classification or
re-classification. The Board of Directors reviews and approves all
classifications. At September 30, 1996, First Federal had $1,000 of assets
classified as loss, $26,000 of assets classified as doubtful and $602,000 of
assets classified as substandard. At September 30, 1996, assets designated as
special mention totalled $3,000.
Management will continue to actively monitor First Federal's asset
quality and will establish loan loss reserves and will charge off loans and
properties acquired in settlement of loans against the allowances for losses on
such loans and such properties when appropriate and will provide specific loss
allowances when necessary. Although management believes it uses the best
information available to make determinations with respect to the allowances for
losses, future adjustments may be necessary if economic conditions differ
substantially from the economic conditions in the assumptions used in making the
initial determinations.
12
<PAGE>
The Bank's allowance for loan losses is established through a provision
for loan losses charged to earnings based on management's evaluation of the risk
inherent in it's entire loan portfolio and changes in the nature and volume of
its loan activity. Such evaluation, which includes a review of all loans of
which full collectibility may not be reasonably assured, considers specific
occurrences, general and local economic conditions, loan portfolio composition,
historical and local experience and other factors that warrant recognition in
providing for an adequate allowance for loan losses. In determining the general
reserves under these policies, historical charge-offs and recoveries, changes in
the mix and levels of the various types of loans, net realizable values, the
current loan portfolio and current economic conditions are considered. The
Bank's Asset Classification Policy establishes rates for establishing a general
valuation allowance on risk assets. Each risk asset receives a percentage of
asset rate, which is then the multiplier used in determining the required
reserve for that specific asset in the composition of the general valuation
reserve. These reserve rates vary from 0.05% to 3.00% in establishing the amount
of reserve necessary for unclassified assets. Special mention assets have a
reserve rate of 2.00%. Substandard assets have a 15.0% reserve rate, while
doubtful assets currently have a 50.00% reserve rate. The Bank may also require
additional or specific reserves for certain classified assets.
The above reserve rates establish a minimum general valuation
allowance. As of September 30, 1996, the Bank maintained a higher general
valuation allowance than the reserve rates would dictate. Reserves determined by
using the reserve rating system were $389,000. The general valuation allowance
on September 30, 1996, was in the amount of $454,000, indicating additional
reserves of $65,000.
Real estate acquired as a result of foreclosure or by deed-in-lieu of
foreclosure is classified as real estate in-judgment for the six months or one
year redemption period, and thereafter, as real estate owned until sold. When
property is acquired through the foreclosure process, it is recorded at the
lower of cost or estimated fair value, less the estimated cost of disposition.
After acquisition, all costs incurred in maintaining the property are expensed.
Costs relating to improvement of the property, however, are capitalized to the
extent of fair value, less estimated costs of disposition.
In December 1993 the banking regulatory agencies, including the OTS,
adopted a policy statement regarding maintenance of an adequate allowance for
loan and lease losses and an effective loan review system. This policy includes
an arithmetic formula for checking the reasonableness of an institution's
allowance for loan loss estimate compared to the average loss experience of the
industry as a whole. Examiners will review an institution's allowance for loan
losses and compare it against the sum of (i) 50% of the portfolio that is
classified doubtful; (ii) 15% of the portfolio that is classified as
substandard; and (iii) for the portions of the portfolio that have not been
classified (including those loans designated as special mention), estimated
credit losses over the upcoming twelve months given the facts and circumstances
as of the evaluation date. This amount is considered neither a "floor" nor a
"safe harbor" of the level of allowance for loan losses an institution should
maintain, but examiners will view a shortfall relative to the amount as an
indication that they should review management's policy on allocating these
allowances to determine whether it is reasonable based on all relevant factors.
13
<PAGE>
The following table sets forth an analysis of First Federal's allowance
for loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------------------
1996 1995 1994
------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of period................................. $ 491 $ 529 $ 549
------- ------- -------
Loans charged-off:
Real estate -- mortgages:
Residential................................................ (14) (6) --
Commercial................................................. -- -- (3)
Real estate -- construction.................................. -- -- --
Commercial business.......................................... (2) -- --
Consumer..................................................... (33) (43) (54)
------- ------- -------
Total charge-offs.............................................. (49) (49) (57)
------- ------- -------
Recoveries:
Real estate -- mortgages:
Residential................................................ -- -- --
Commercial................................................. -- -- --
Real estate -- construction.................................. -- -- --
Commercial business.......................................... -- -- --
Consumer..................................................... 12 7 20
------- ------- -------
Total recoveries............................................... 12 7 20
------- ------- -------
Net loans charged-off.......................................... (37) (42) (37)
------- ------- -------
Provision for loan losses...................................... -- 4 17
------- ------- -------
Balance at end of period....................................... $ 454 $ 491 $ 529
======= ======= =======
Ratio of net charge-offs to average
loans outstanding during the period.......................... 0.06% .09% .08%
======= ======= =======
</TABLE>
The following table allocates the allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
September 30,
-------------------------------------------------------------------------
1996 1995 1994
---------------------- ------------------- ------------------
Percent of Percent of Percent of
Loans in Loans in Loans in
Category to Category to Category to
Amount Total Loans Amount Total Loans Amount Total Loans
------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate - mortgage:
Residential........................... $ 151 54.58% $ 279 63.67% $ 344 69.21%
Commercial............................ 88 20.17 75 16.21 55 10.87
Real estate - construction.............. 3 0.59 -- 0.20 4 1.10
Commercial business..................... 37 4.12 14 2.97 5 1.50
Consumer................................ 175 20.54 123 16.95 121 17.32
-------- ------- ------- ------- ------- -------
Total allowance for loan losses..... $ 454 100.00% $ 491 100.00% $ 529 100.00%
======== ====== ======= ====== ======= ======
</TABLE>
14
<PAGE>
While management believes First Federal has established its existing
loss allowances in accordance with generally accepted accounting principles,
there can be no assurance that regulators, in reviewing First Federal's assets,
will not make First Federal increase its loss allowance, thereby negatively
affecting First Federal's reported financial condition and results of
operations.
The following table sets forth information with respect to First
Federal's non-performing assets at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
----------------------------------------------
1996 1995 1994
------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C>
Loans accounted for on a non-accrual basis: (1)
Real estate:
Residential................................................... $ 55 $ 14 $ 26
Commercial.................................................... -- -- --
Commercial business.............................................. -- -- --
Consumer......................................................... -- -- --
-------- -------- --------
Total....................................................... $ 55 $ 14 $ 26
======== ======== ========
Accruing loans which are contractually past due 90 days or more:
Real Estate:
Residential................................................... $ -- $ -- $ 2
Commercial.................................................... -- -- --
Commercial business.............................................. 132 -- --
Consumer......................................................... 24 73 61
-------- -------- --------
Total....................................................... $ 156 $ 73 $ 63
======== ======== ========
Total of non-accrual and 90 days past due loans............. $ 211 $ 87 $ 89
======== ======== ========
Percentage of total loans.......................................... 0.41% .18% .19%
======== ======== ========
Other non-performing assets (2).................................... $ 194 $ 152 $ 102
======== ======== ========
</TABLE>
------------------
(1) Non-accrual status denotes loans on which, in the opinion of
management, the collection of additional interest is unlikely. Payments
received on a non-accrual loan are either applied to the outstanding
principal balance or recorded as interest income, depending on
assessment of the collectibility of the loan. Generally, loans
contractually past due 90 days or more are placed on non-accrual except
for loans insured for credit loss.
(2) Other non-performing assets represents property acquired by First
Federal through foreclosure or repossession or accounted for as a
foreclosure in-substance. These properties are carried at the lower of
fair market value, less estimated costs of disposition, or the
principal balance of the related loan, whichever is lower. At September
30, 1996 "Other non-performing assets" included one commercial real
estate property valued at $533,000 based on market information
available to the Bank, in which the Bank has a 37.50% participation
interest.
At September 30, 1996, the Bank had no loans which were not currently
classified as non-accrual, 90 days past due or restructured but where known
information about possible credit problems of borrowers causes management to
have serious concerns as to the ability of the borrowers to comply with present
loan repayment terms.
During the year ended September 30, 1996, gross interest income of
$4,552 would have been recorded on loans accounted for on a non-accrual basis if
the loans had been current throughout the period. Interest on such loans
included in income during such period amounted to $0 for the year ended
September 30, 1996. At September 30, 1996, the Bank had no restructured loans.
Investment Activities
General. First Federal is permitted under federal law to make certain
investments, including investments in securities issued by various federal
agencies and state and municipal governments, deposits at the FHLB of Des
Moines, certificates of deposits in federally insured institutions, certain
bankers' acceptances and federal funds. First Federal may also invest, subject
to certain limitations, in commercial paper having one of the four highest
investment ratings of a nationally recognized credit rating agency, and certain
other types of corporate debt securities and mutual
15
<PAGE>
funds. Federal regulations require First Federal to maintain an investment in
FHLB of Des Moines stock and a minimum amount of liquid assets which may be
invested in cash and specified securities. The Bank is also permitted to invest
in related securities. From time to time, the OTS adjusts the percentage of
liquid assets which savings associations are required to maintain. For
additional information, see "Regulation -- Regulation of the Bank -- Liquidity
Requirements."
First Federal makes investments in order to diversify its assets,
manage cash flow, obtain yields and maintain the minimum levels of liquid assets
required by regulatory authorities. Under the Bank's current investment policy,
the amount invested with any one issuer may not exceed the lesser of $500,000 or
the net worth of the issuing corporation, except for U.S. Treasury and U.S.
Government Agency Securities and mutual fund investments. The Board of Directors
reviews all securities purchased on a monthly basis.
The investment activities of the Bank consist primarily of investments
in mortgage-backed and related securities and other investment securities,
consisting primarily of securities issued or guaranteed by the United States
Government or agencies thereof. Typical investments include federally sponsored
agency mortgage pass-throughs, and federally sponsored agency and related
securities. Investment and aggregate investment limitations and credit quality
parameters of each class of investment are prescribed in the Bank's investment
policy. The Bank performs analyses on related securities prior to purchase and
on an ongoing basis to determine the impact on earnings and market value under
various interest rate and prepayment conditions. First Federal also invests in
mortgage-related products, which include collateralized mortgage obligations
("CMOs") and real estate mortgage investment conduits ("REMICs"). The CMOs and
REMICs purchased by the Bank comply fully with regulatory requirements
concerning this type of investment. Both the REMICs and CMOs owned by the Bank
are of short- or intermediate-term targeted amortization class securities rated
AA or better.
In accordance with Statement of Financial Accounting Standards ("SFAS")
No. 115, the Bank categorizes the securities it purchases as "Trading
Securities," "Available for Sale Securities" and "Held to Maturity Securities."
Securities that are categorized as "Held to Maturity" are securities that the
Bank has the ability and intent to hold to maturity. Upon acquisition,
securities are classified as to the Bank's intent. Securities "Held to Maturity"
are held for investment purposes and are carried at amortized cost. Securities
categorized as "Available for Sale" are securities that the Bank does not intend
to hold to maturity and thus are carried at aggregate market value with
unrealized gains and losses, net of taxes, recognized in stockholders' equity.
As of September 30, 1996, in accordance with SFAS No. 115, the Company
classified $26.16 million of its investment securities and $19.90 million of its
mortgage-backed and related securities as "Available for Sale". Such
classification gives the Company the ability to sell these securities. The
Company has no "Trading Securities."
Investment Securities. The following table sets forth the carrying
value of the Company's investment securities portfolio at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
--------------------------------------------
1996 1995 1994
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Investment securities:
U.S. government and agency securities........................ $ 16,174 $ 7,065 $ 5,071
Corporate bonds and notes.................................... 7,407 6,390 6,630
Municipal obligations........................................ 498 250 --
Mutual funds................................................. 2,083 1,927 1,530
-------- -------- --------
Total investment securities............................... 26,162 15,632 13,231
Interest-earning deposits and certificates..................... 3,309 8,432 7,448
FHLB stock..................................................... 701 686 686
-------- -------- --------
Total investments......................................... $ 30,172 $ 24,750 $ 21,365
======== ======== ========
</TABLE>
16
<PAGE>
The following table sets forth information regarding the scheduled
maturities, market value and weighted average yields for First Federal's
investments at September 30, 1996.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years More than Ten Years
------------------ ------------------ ------------------ --------------------
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
------- ------- ------- ------- ------- ------- ------ ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available for sale:
U.S. government and agency
securities.................. $ 246 4.27% $ 12,076 6.53% $ 3,852 7.17% $ -- %
Corporate bonds and notes........ 1,132 7.08 5,187 6.63 797 9.68 291 7.47
Municipal obligations.......... -- 246 6.22 -- 252 9.29
Interest-earning deposits and.....
certificates of deposit......... 3,309 5.74 -- -- --
--------- ---------- --------- ---------
Total........................ $ 4,687 5.98 $ 17,509 6.55 $ 4,649 7.60 $ 543 8.32
========= ========== ========= =========
<CAPTION>
Total Investment Portfolio
----------------------------
Carrying Market Average
Value Value Yield
------- ----- ------
(Dollars in thousands)
<S> <C> <C> <C>
Securities available for sale:
U.S. government and agency
securities.................. $ 16,174 $ 16,174 6.64%
Corporate bonds and notes........ 7,407 7,407 7.06
Municipal obligations.......... 498 498 7.78
Interest-earning deposits and.....
certificates of deposit......... 3,309 3,309 5.74
--------- ---------
Total........................ $ 27,388 $ 27,388 6.67
========= =========
Securities with no stated maturity:
Mutual funds.................... $ 2,083 2,083 4.47
FHLB stock...................... 701 701 7.29
--------- ---------
Total investment securities....... $ 30,172 $ 30,172 6.53
========= =========
</TABLE>
17
<PAGE>
Mortgage-Backed Securities. Mortgage-backed securities represent a
participation interest in a pool of single-family or multi-family mortgages, the
principal and interest payments on which are passed from the mortgage
originators through intermediaries that pool and repackage the participation
interest in the form of securities to investors such as the Bank. Such
intermediaries may include quasi-governmental agencies such as Federal Home Loan
Mortgage Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA")
and Government National Mortgage Association ("GNMA") which guarantee the
payment of principal and interest to investors. Mortgage-backed securities
generally increase the quality of the Bank's assets by virtue of the guarantees
that back them, are more liquid than individual mortgage loans and may be used
to collateralize borrowings or other obligations of the Bank.
Mortgage-backed securities typically are issued with stated principal
amounts and the securities are backed by pools of mortgages that have loans with
interest rates that are within a range and have similar maturities. The
underlying pool of mortgages can be composed of either fixed-rate mortgages or
adjustable rate mortgage ("ARM") loans. Mortgage-backed securities generally are
referred to as mortgage participation certificates or pass-through certificates.
As a result, the interest rate risk characteristics of the underlying pool of
mortgages, i.e., fixed-rate or adjustable-rate, as well as prepayment risk, are
passed on to the certificate holder. The life of a mortgage-backed pass-through
security is equal to the life of the underlying mortgages.
The actual maturity of a mortgage-backed security varies, depending on
when the mortgagors prepay or repay the underlying mortgages. Prepayments of the
underlying mortgages may shorten the life of the investment, thereby adversely
affecting its yield to maturity and the related market value of the
mortgage-backed security. The yield is based upon the interest income and the
amortization of the premium or accretion of the discount related to the
mortgage-backed security. Premiums and discounts on mortgage-backed securities
are amortized or accreted over the estimated term of the securities using a
level yield method. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed security and these assumptions are reviewed
periodically to reflect the actual prepayment. The actual prepayment experience
of the underlying mortgages, the geographical location of the underlying real
estate collateralizing the mortgages and general levels of market interest
rates. The difference between the interest rates on the underlying mortgages and
the prevailing mortgage interest rates is an important determinant in the rate
of prepayments. During periods of falling mortgage interest rates, prepayments
generally increase. If the coupon rate of the underlying mortgage significantly
exceeds the prevailing market interest rates offered for mortgage loans,
refinancing generally increases and accelerates the prepayment of the underlying
mortgages. Prepayment experience is more difficult to estimate for
adjustable-rate mortgage-backed securities.
The Bank's mortgage-backed securities portfolio consists primarily of
seasoned fixed-rate and adjustable-rate mortgage-backed securities. At September
30, 1996, the Bank had $9.49 million in mortgage-backed securities (representing
98.49% of the Bank's gross mortgage-backed securities portfolio or 8.85% of
total assets) insured or guaranteed by FNMA, FHLMC or GNMA. At September 30,
1996, $146,000 (representing 1.51% of the Bank's gross mortgage-backed
securities portfolio, or .14% of total assets) consisted of privately issued
securities which are not guaranteed by FHLMC, FNMA, GNMA or any governmental or
quasi-governmental agency.
The Bank's mortgage-backed securities portfolio contains fixed-rate and
floating rate securities. Certain of the Bank's mortgage-backed securities yield
above-market rates of interest and are subject to substantial risk of
prepayment. In the recent declining interest rate environment, the Bank has
experienced significant prepayments of both fixed and adjustable-rate
mortgage-backed and related securities. In a rising interest rate environment,
the prepayments would likely cease, market yields of these securities would be
less attractive, and the market value of the Bank's mortgage-backed securities
would decline.
18
<PAGE>
Mortgage-Related Securities. CMOs and REMICs are typically issued by a
special purpose entity, which may be organized in a variety of legal forms, such
as a trust, a corporation or a partnership. The entity aggregates pools of
mortgage loans or pass-through securities, which are used to collateralize the
related securities. Once combined, the cash flows can be divided into "tranches"
or "classes" of individual securities, thereby creating more predictable average
lives for each security than the underlying pass-through pools. Accordingly,
under this security structure all principal paydowns from the various mortgage
pools are allocated to a related securities' class or classes structured to have
priority until it has been paid off. These securities generally have fixed
interest rates, and as a result, changes in interest rates generally would
affect the market value and possibly the prepayment rates of such securities.
Some related securities instruments are like traditional debt instruments
due to their stated principal amounts and traditionally defined interest rate
terms. Purchasers of certain other related securities instruments are entitled
to the excess, if any, of the issuer's cash inflows. These related securities
instruments may include instruments designated as residual interest and are
riskier in that they could result in the loss of a portion of the original
investment. Cash flows from residual interests are very sensitive to prepayments
and, thus, contain a high degree of interest rate risk.
At September 30, 1996, the Bank had $11.11 million in CMOs and REMICs or
10.36% of total assets. The Bank's CMOs and REMICs had a weighted average yield
of 6.36% at September 30, 1996. The Bank's current policy is to purchase CMOs
and REMICs rated AA or better at the time of purchase by nationally recognized
rating services or issued by U.S. government agencies. As of September 30, 1996,
$244,000 of the securities in the Bank's mortgage-backed and related securities
portfolio were privately issued securities, $244,000 were rated as AAA.
The following table sets forth the carrying value of the Bank's
mortgage-backed and related securities at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
--------------------------------------------
1996 1995 1994
------ ------ ------
(In thousands)
<S> <C> <C> <C>
GNMA......................................................... $ 508 $ 429 $ 520
FNMA......................................................... 3,451 3,282 2,777
FHLMC........................................................ 5,535 5,205 4,498
FHA.......................................................... 146 178 212
Collateralized mortgage obligations.......................... 11,109 12,429 6,658
---------- ---------- ---------
Total................................................... $ 20,749 $ 21,523 $ 14,665
========== ========== =========
</TABLE>
19
<PAGE>
The following table sets forth the scheduled maturities, carrying values,
market values and average yields for the Bank's mortgage-backed and related
securities at September 30, 1996.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years More than Ten Years
------------------- -------------------- -------------------- --------------------
Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield
------- ------- ------- ------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
GNMA.............................. $ 6 12.29% $ 18 9.22% $ 28 8.19% $ 456 9.01%
FNMA.............................. -- 976 5.86 348 6.32 2,127 6.47
FHLMC............................. 300 6.57 2,193 6.13 183 9.01 2,859 6.99
FHA............................... -- -- 146 10.39 --
Collateralized mortgage
obligations..................... -- 1,130 6.48 3,489 6.33 6,490 6.36
-------- -------- -------- --------
Total........................ $ 306 6.68 $ 4,317 6.17 $ 4,194 6.60 $ 11,932 6.63
======== ======== ======== ========
<CAPTION>
Total Investment Portfolio
------------------------------
Carrying Market Average
Value Value Yield
------- ------- ------
(Dollars in thousands)
<S> <C> <C> <C>
GNMA.............................. $ 508 $ 508 9.01%
FNMA.............................. 3,451 3,449 6.28
FHLMC............................. 5,535 5,544 6.69
FHA............................... 146 146 10.39
Collateralized mortgage
obligations..................... 11,109 11,109 6.36
-------- --------
Total........................ $ 20,749 $ 20,756 6.43
======== ========
</TABLE>
20
<PAGE>
Deposit Activity and Other Sources of Funds
General. Deposits are the primary source of First Federal's funds for
lending and other investment activities and general operational purposes. In
addition to deposits, First Federal derives funds from loan and mortgage-backed
and related securities principal repayments, maturities of investment securities
and interest payments. Loan repayments and interest payments are a relatively
stable source of funds, while deposit inflows and outflows are significantly
influenced by prevailing market interest rates and money market conditions.
Borrowings may be used to supplement First Federal's available funds. First
Federal has access to borrow from the FHLB of Des Moines and the Federal Reserve
Bank.
Deposits. First Federal attracts deposits principally from within its
market area by offering a variety of deposit instruments, including savings
accounts, money market accounts, retirement savings accounts and certificates of
deposit which range in term from three to 96 months. Deposit terms vary
principally on the basis of the minimum balance required, the length of time the
funds must remain on deposit and the interest rate. Maturities, terms, service
fees and withdrawal penalties for its deposit accounts are established by the
Bank on a periodic basis. The Bank reviews its deposit mix and pricing on an
ongoing basis. In determining the characteristics of its deposit accounts, the
Bank considers the rates offered by competing institutions, funds acquisition
and liquidity requirements, growth goals, and federal regulations. The Bank does
not accept brokered deposits.
The Bank competes for deposits, including individual retirement
accounts ("IRA") and Keogh Plan funds, with other institutions in its market
area by offering deposit instruments that are competitively priced and by
providing customer service through convenient and attractive offices,
knowledgeable and efficient staff and hours of service that meet customers'
needs. The Bank generally does not use premiums to attract savings deposits.
Savings deposits in First Federal at September 30, 1996 were
represented by the various types of savings programs described below.
<TABLE>
<CAPTION>
Interest Minimum Minimum Percentage of
Rate(1) Term Category Amount Balances Total Savings
- - ------- ------- -------- -------- -------- -------------
(In thousands)
<S> <C> <C> <C> <C> <C>
1.58% None NOW Accounts $ 100 $ 10,518 12.98%
2.00 None Passbook Statement Accounts 100 8,540 10.54
3.00 None Money Market Deposit Accounts 1,000 8,757 10.80
Certificates of Deposit
-----------------------
5.00 91 days 3-month money market 1,000 2,101 2.59
5.08 182 days 6-month money market 1,000 5,576 6.88
5.36 12-month Fixed-term, fixed-rate 500 7,342 9.06
5.51 18-month Fixed-term, fixed-rate 500 872 1.08
5.95 24-month Fixed-term, fixed-rate 500 3,646 4.50
5.71 30-month Fixed-term, fixed-rate 500 3,967 4.89
5.78 36-month Fixed-term, fixed-rate 500 5,815 7.18
6.15 48-month Fixed-term, fixed-rate 500 2,889 3.56
6.35 60-month Fixed-term, fixed-rate 500 11,693 14.43
2.50 96 month Fixed-term, fixed-rate -- 2 --
5.86 18 month 18-month, IRA accounts 100 6,738 8.31
5.63 14 days Negotiated Jumbo (2) 100,000 2,591 3.20
-------- -------
$ 81,047 100.00%
======== ======
</TABLE>
- - -----------------
(1) Represents weighted average interest rate at September 30, 1996.
(2) Municipal deposits.
21
<PAGE>
The following table sets forth the change in dollar amount of deposits
in the various types of accounts offered by First Federal between the dates
indicated.
<TABLE>
<CAPTION>
Balance at Balance at
September 30, % Increase September 30, % Increase
1996 Deposits (Decrease) 1995 Deposits (Decrease)
-------------- -------- ---------- -------------- -------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
NOW accounts............................ $ 10,518 12.98% $ 416 $ 10,102 12.31% $ 101
Jumbo certificates (1).................. 2,591 3.20 (1,524) 4,115 5.02 215
Money market demand accounts............ 8,757 10.80 (222) 8,979 10.94 458
Passbook and regular savings............ 8,540 10.54 (771) 9,311 11.35 (915)
Six month money market certificates..... 5,576 6.88 (61) 5,637 6.87 (61)
IRA accounts............................ 11,109 13.70 174 10,935 13.32 (175)
Other................................... 33,956 41.90 975 32,981 40.19 2,811
----------- ------- ----------- ----------- ------- ----------
Total.............................. $ 81,047 100.00% $ (1,013) $ 82,060 100.00% $ 2,434
=========== ====== =========== =========== ====== ==========
<CAPTION>
Balance at
September 30, %
1994 Deposits
-------------- --------
<S> <C> <C>
NOW accounts............................ $ 10,001 12.56%
Jumbo certificates (1).................. 3,900 4.90
Money market demand accounts............ 8,521 10.70
Passbook and regular savings............ 10,226 12.84
Six month money market certificates..... 5,698 7.16
IRA accounts............................ 11,110 13.95
Other................................... 30,170 37.89
----------- -------
Total.............................. $ 79,626 100.00%
=========== ======
</TABLE>
- - ----------------
(1) Municipal deposits.
The following table sets forth the average balances and interest rates
based on daily balances for interest-bearing demand and savings deposits and
time deposits as of the dates indicated.
<TABLE>
<CAPTION>
September 30,
------------------------------------------------------------------------------------------------
1996 1995 1994
----------------------------- ------------------------------ -----------------------------
Interest-Bearing Interest-Bearing Interest-Bearing
Demand and Time Demand and Time Demand and Time
Savings Deposits Deposits Savings Deposits Deposits Savings Deposits Deposits
---------------- -------- ---------------- -------- ---------------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Average Balance................ $ 27,631 $ 54,101 $ 28,152 $ 52,452 $ 28,731 $ 48,802
Average Rate................... 2.18% 5.79% 2.35% 5.47% 1.91% 4.69%
</TABLE>
22
<PAGE>
The following table sets forth the time deposits in First Federal
classified by rates at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
---------------------------------------------
1996 1995 1994
------ ------ ------
(In thousands)
<S> <C> <C> <C>
0 - 2.99%.................................. $ 4 $ 4 $ 3
3 - 3.99%.................................. 2 763 6,187
4 - 4.99%.................................. 3,459 4,274 24,508
5 - 5.99%.................................. 31,199 27,053 13,912
6 - 6.99%.................................. 16,015 18,555 5,241
7 - 7.99%.................................. 2,553 3,019 797
8 - 8.99%.................................. -- -- 230
-------- -------- --------
$ 53,232 $ 53,668 $ 50,878
======== ======== ========
</TABLE>
The following table sets forth the amount and maturities of time
deposits in First Federal at September 30, 1996.
<TABLE>
<CAPTION>
Amount Due
-------------------------------------------------------------------------
Less Than After
Rate One Year 1-2 Years 2-3 Years 3 Years Total
---- -------- --------- --------- ------- -----
(In thousands)
<S> <C> <C> <C> <C> <C>
0 - 2.99%.............. $ 1 $ -- $ -- $ 3 $ 4
3 - 3.99%.............. 2 -- -- -- 2
4 - 4.99%.............. 2,993 253 213 -- 3,459
5 - 5.99%.............. 20,063 6,795 3,035 1,306 31,199
6 - 6.99%.............. 6,554 3,879 2,358 3,224 16,015
7 - 7.99%.............. 46 246 841 1,420 2,553
--------- ---------- ---------- ---------- ----------
$ 29,659 $ 11,173 $ 6,447 $ 5,953 $ 53,232
========= ========== ========== ========== ==========
</TABLE>
The following table indicates the amount of the certificates of deposit
of $100,000 or more in First Federal by time remaining until maturity at
September 30, 1996.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposits
--------------- ------------
(In thousands)
<S> <C>
Three months or less....................... $ 659
Over three through six months.............. 1,063
Over six through 12 months................. 851
Over 12 months............................. 3,542
------------
Total.................................. $ 6,115
============
</TABLE>
23
<PAGE>
The following table sets forth the deposit activities of First Federal
for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
-------------------------------------------------
1996 1995 1994
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Deposits....................................................... $ 191,203 $ 181,706 $ 179,216
Withdrawals.................................................... (195,237) (181,943) (179,307)
Net increase (decrease) before interest credited............. (4,034) (237) (91)
Interest credited.............................................. 3,021 2,671 2,204
------------ ------------ ------------
Net increase (decrease) in savings deposits.................... $ (1,013) $ 2,434 $ 2,113
============ ============ ============
</TABLE>
Borrowings. Savings deposits historically have been the primary source
of funds for First Federal's lending, investment and general operating
activities. First Federal is authorized, however, to use advances from the FHLB
of Des Moines to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. The FHLB of Des Moines functions as a central reserve
bank providing credit for savings institutions and certain other member
financial institutions. As a member of the FHLB System, First Federal is
required to own stock in the FHLB of Des Moines and is authorized to apply for
advances. Advances are made pursuant to several different programs, each of
which has its own interest rate and range of maturities. The Bank is also
eligible to borrow from the Federal Reserve Bank. At September 30, 1996, the
Bank had $6.94 million in advances outstanding with the FHLB.
From time to time the Bank utilizes reverse repurchase agreements
issued to local government units. The form of reverse repurchase agreement used
by the Bank involves the sale of securities owned by the Bank with a commitment
to repurchase the same or substantially the same securities at a predetermined
price at a future date, typically one to 180 days thereafter. At September 30,
1996, the Bank had $4.95 million in reverse repurchase agreements outstanding.
Subsidiary Activities
As a federally chartered savings bank, the Bank is permitted to invest
an amount equal to 2% of its assets in subsidiaries, with an additional
investment of 1% of assets where such investment serves primarily community,
inner-city and community development purposes. Under such limitations, as of
September 30, 1996, the Bank was authorized to invest up to approximately $3.16
million in the stock of or loans to subsidiaries, including the additional 1%
investment for community inner-city and community development purposes.
Institutions meeting their applicable minimum regulatory capital requirements
may invest up to 50% of their regulatory capital in conforming first mortgage
loans to subsidiaries in which they own 10% or more of the capital stock.
The Bank has one wholly owned subsidiary: First Federal Service
Corporation ("First Federal Service"). First Federal Service, a Minnesota
corporation, sells credit, life and disability insurance. At September 30, 1996,
the Bank's total investment in First Federal Service was $67,000.
SAIF-insured savings institutions must give the FDIC and OTS 30 days'
prior notice before establishing or acquiring a new subsidiary, or commencing
any new activity through an existing subsidiary. Both the FDIC and OTS have
authority to order termination of subsidiary activities determined to pose a
risk to the safety or soundness of the institution. In addition, capital
requirements require savings institutions to deduct from capital the amount of
their investments in and extensions of credit to subsidiaries engaged in
activities not permissible to national banks in determining regulatory capital
compliance. The activities of First Federal Service are not permissible for
national banks. See "-- Regulation of the Bank -- Regulatory Capital
Requirements."
24
<PAGE>
Competition
First Federal faces strong competition for deposits and loans. First
Federal's principal competitors for deposits are other banking institutions,
such as commercial banks, credit unions and other savings institutions, as well
as mutual funds and other investments. First Federal principally competes for
deposits by offering a variety of deposit accounts, convenient business hours
and branch locations, customer service and a well trained staff. First Federal
competes for loans with other depository institutions, as well as specialty
mortgage lenders and brokers and consumer finance companies. First Federal
principally competes for loans on the basis of interest rates and the loan fees
it charges, the types of loans it originates and the convenience and quick
service it provides to borrowers. In addition, First Federal believes it has
developed strong relationships with the businesses, realtors, builders and
general public in its market area. First Federal is the fourth largest financial
institution in its market area, based on deposit and asset information at
September 30, 1996. Of the three larger institutions, two are located in
Bemidji, within two blocks of the Bank's headquarters. The three largest
financial institutions in Minnesota do not serve the Bank's market area.
Employees
As of September 30, 1996, the Bank had 33 full-time and 14 part-time
employees, none of whom was represented by a collective bargaining agreement.
Regulation
General. As a federally chartered savings bank, the Bank is subject to
extensive regulation by the OTS and FDIC and to OTS regulations governing such
matters as capital standards, mergers, establishment of branch offices,
subsidiary investments and activities and general investment authority. The
lending activities and other investments of the Bank must comply with various
federal regulatory requirements. The OTS periodically examines the Bank for
compliance with various regulatory requirements. The FDIC also has the authority
to conduct special examinations of the Bank because its deposits are insured by
the SAIF. The Bank must file reports with OTS describing its activities and
financial condition and is also subject to certain reserve requirements
promulgated by the Federal Reserve Board. This supervision and regulation is
intended primarily for the protection of depositors. Certain of these regulatory
requirements are referred to below or appear elsewhere herein.
Regulation of the Bank
Federal Home Loan Bank System. The Bank is a member of the FHLB
System, which consists of 12 district FHLBs subject to supervision and
regulation by the Federal Housing Finance Board ("FHFB"). The FHLBs provide a
central credit facility primarily for member institutions. As a member of the
FHLB of Des Moines, the Bank is required to acquire and hold shares of capital
stock in the FHLB of Des Moines in an amount at least equal to 1% of the
aggregate unpaid principal of its home mortgage loans, home purchase contracts,
and similar obligations at the end of each year, or 1/20 of its advances
(borrowings) from the FHLB of Des Moines, whichever is greater. The Bank was in
compliance with this requirement with an investment in FHLB of Des Moines stock
at September 30, 1996 of $700,500.
The FHLB of Des Moines serves as a reserve or central bank for its
member institutions within its assigned district. It is funded primarily from
proceeds derived from the sale of consolidated obligations of the FHLB System.
It makes advances to members in accordance with policies and procedures
established by the FHFB and the Board of Directors of the FHLB of Des Moines.
Long-term advances may only be made for the purpose of providing funds for
residential housing finance. At September 30, 1996, the Bank had $6.94 million
in advances outstanding from the FHLB of Des Moines. See "-- Deposit Activity
and Other Sources of Funds -- Borrowings."
25
<PAGE>
Liquidity Requirements. The Bank is required to maintain average daily
balances of liquid assets (cash, deposits maintained pursuant to Federal Reserve
Board requirements, time and savings deposits in certain institutions,
obligations of the United States and states and political subdivisions thereof,
shares in mutual funds with certain restricted investment policies, highly rated
corporate debt, and mortgage loans and mortgage-related securities with less
than one year to maturity or subject to pre-arranged sale within one year) equal
to the monthly average of not less than a specified percentage (currently 5%) of
its net withdrawable savings deposits plus short-term borrowings. The Bank is
also required to maintain average daily balances of short-term liquid assets at
a specified percentage (currently 1%) of the total of its net withdrawable
savings accounts and borrowings payable in one year or less. Monetary penalties
may be imposed for failure to meet liquidity requirements. The average
regulatory liquidity ratio of the Bank for the month of September 1996 was
19.26% with respect to liquid assets and 3.02% with respect to short-term liquid
assets.
Qualified Thrift Lender Test. A savings institution that does not meet
the Qualified Thrift Lender ("QTL") test must either convert to a bank charter
or comply with the following restrictions on its operations: (i) the institution
may not engage in any new activity or make any new investment, directly or
indirectly, unless such activity or investment is permissible for a national
bank; (ii) the branching powers of the institution shall be restricted to those
of a national bank; (iii) the institution shall not be eligible to obtain any
advances from its FHLB; and (iv) payment of dividends by the institution shall
be subject to the rules regarding payment of dividends by a national bank. Upon
the expiration of three years from the date the institution ceases to be a QTL,
it must cease any activity and not retain any investment not permissible for a
national bank and immediately repay any outstanding FHLB advances (subject to
safety and soundness considerations).
To meet the QTL test, an institution's "Qualified Thrift Investments"
must total at least 65% of "portfolio assets." Under OTS implementing
regulations, portfolio assets are defined as total assets less intangibles,
property used by a savings institution in its business and liquidity investments
in an amount not exceeding 20% of assets. Qualified Thrift Investments consist
of (i) loans, equity positions and certain securities related to domestic,
residential real estate or manufactured housing and (ii) subject to an aggregate
20% of portfolio assets limit, shares of stock in the FHLMC and the FNMA, loans
for personal, family, household or education purposes, 50% of the dollar amount
of residential mortgage loans originated and sold within 90 days of origination,
and 200% of an institution's investments in loans to finance "starter homes" and
loans for construction, development or improvement of housing and community
service facilities or for financing small businesses in "credit-needy" areas.
In addition, a savings institution must maintain its status as a QTL on
a monthly basis in nine out of every 12 months. A savings institution that fails
to maintain Qualified Thrift Lender status will be permitted to requalify once,
and if it fails the QTL test a second time, it will become immediately subject
to all penalties as if all time limits on such penalties had expired. Failure to
qualify as a QTL results in a number of sanctions, including the imposition of
certain operating restrictions imposed on national banks and a restriction on
obtaining additional advances from the FHLB System. At September 30, 1996, the
Bank qualified as a QTL.
Uniform Lending Standards. Under OTS regulations, savings banks must
adopt and maintain written policies that establish appropriate limits and
standards for extensions of credit that are secured by liens or interests in
real estate or are made for the purpose of financing permanent improvements to
real estate. These policies must establish loan portfolio diversification
standards, prudent underwriting standards, including loan-to-value limits, that
are clear and measurable, loan administration procedures and documentation,
approval and reporting requirements. The real estate lending policies must
reflect consideration of the Interagency Guidelines for Real Estate Lending
Policies (the "Interagency Guidelines") that have been adopted by the federal
bank regulators.
The Interagency Guidelines, among other things, call upon depository
institutions to establish internal loan-to-value limits for real estate loans
that are not in excess of the following supervisory limits: (i) for loans
secured by raw land, the supervisory loan-to-value limit is 65% of the value of
the collateral; (ii) for land development loans (i.e., loans for the purpose of
improving unimproved property prior to the erection of structures), the
supervisory
26
<PAGE>
limit is 75%; (iii) for loans for the construction of commercial, multifamily or
other nonresidential property, the supervisory limit is 80%; (iv) for loans for
the construction of one- to four-family properties, the supervisory limit is
85%; and (v) for loans secured by other improved property (e.g., farmland,
completed commercial property and other income-producing property including
non-owner-occupied, one- to four-family property), the limit is 85%. Although no
supervisory loan-to-value limit has been established for owner-occupied, one- to
four-family and home equity loans, the Interagency Guidelines state that for any
such loan with a loan-to-value ratio that equals or exceeds 90% at origination,
an institution should require appropriate credit enhancement in the form of
either mortgage insurance or readily marketable collateral.
The Interagency Guidelines state that it may be appropriate in
individual cases to originate or purchase loans with loan-to-value ratios in
excess of the supervisory loan-to-value limits, based on the support provided by
other credit factors. The aggregate amount of loans in excess of the supervisory
loan-to-value limits, however, should not exceed 100% of total capital and the
total of such loans secured by commercial, agricultural, multifamily and other
non-one-to-four family residential properties should not exceed 30% of total
capital. The supervisory loan-to-value limits do not apply to certain categories
of loans including loans insured or guaranteed by the U.S. government and its
agencies or by financially capable state, local or municipal governments or
agencies, loans backed by the full faith and credit of a state government, loans
that are to be sold promptly after origination without recourse to a financially
responsible party, loans that are renewed, refinanced or restructured without
the advancement of new funds, loans that are renewed, refinanced or restructured
in connection with a workout, loans to facilitate sales of real estate acquired
by the institution in the ordinary course of collecting a debt previously
contracted and loans where the real estate is not the primary collateral.
Management believes that the Bank's current lending policies conform to
the Interagency Guidelines and does not anticipate that the Interagency
Guidelines will have a material effect on its lending activities.
Regulatory Capital Requirements. Under OTS capital standards, savings
institutions must maintain "tangible" capital equal to 1.5% of adjusted total
assets, "core" capital equal to 3% of adjusted total assets and a combination of
core and "supplementary" capital equal to 8% of "risk-weighted" assets. In
addition, the OTS has recently adopted regulations which impose certain
restrictions on savings institutions that have a total risk-based capital ratio
that is less than 8%, a ratio of Tier 1 capital to risk-weighted assets of less
than 4% or a ratio of Tier 1 capital to adjusted total assets of less than 4%
(or 3% if the institution is rated Composite 1 under the OTS examination rating
system). See "-- Prompt Corrective Regulatory Action." For purposes of these
regulations, Tier 1 capital has the same definition as core capital. Core
capital is defined as common stockholders' equity (including retained earnings),
noncumulative perpetual preferred stock and related surplus, minority interests
in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Core capital is generally reduced by the amount of the savings
institution's intangible assets for which no market exists. Limited exceptions
to the rule requiring the deduction of intangible assets are provided for
mortgage servicing rights, purchased credit card relationships and qualifying
supervisory goodwill held by an eligible savings institution. Tangible capital
is given the same definition as core capital but does not include qualifying
supervisory goodwill and is reduced by the amount of all the savings
institution's intangible assets with only a limited exception for subscribed for
mortgage servicing rights and subscribed for credit card relationships.
Both core and tangible capital are further reduced by an amount equal
to a gradually increasing percentage of the savings institution's debt and
equity investments in subsidiaries engaged in activities not permissible for
national banks, other than subsidiaries engaged in activities undertaken as
agent for customers or in mortgage banking activities and depository
institutions or holding companies therefor. At September 30, 1996, the Bank had
no such investments.
Adjusted total assets for purposes of the core and tangible capital
requirements are a savings institution's total assets as determined under
generally accepted accounting principles, adjusted for certain goodwill amounts,
and increased by a pro rated portion of the assets of subsidiaries in which the
savings institution holds a minority interest
27
<PAGE>
and which are not engaged in activities for which the capital rules require the
savings institution to net its debt and equity investments in such subsidiaries
against capital, as well as a pro rated portion of the assets of other
subsidiaries for which netting is not fully required under the phase-in rules.
Adjusted total assets are reduced by the amount of assets that have been
deducted from capital, the portion of the savings institution's investments in
subsidiaries that must be netted against capital under the capital rules and,
for purposes of the core capital requirement, qualifying supervisory goodwill.
At September 30, 1996, the Bank's adjusted total assets for purposes of the core
and tangible capital requirements, were $105.67 million.
In determining compliance with the risk-based capital requirement, a
savings association is allowed to use both core capital and supplementary
capital, provided the amount of supplementary capital used does not exceed the
savings association's core capital. Supplementary capital is defined to include
certain preferred stock issues, nonwithdrawable accounts and pledged deposits
that do not qualify as core capital, certain approved subordinated debt, certain
other capital instruments and a portion of the savings association's general
loan and lease loss allowances. Total core and supplementary capital are reduced
by the amount of capital instruments held by other depository institutions
pursuant to reciprocal arrangements and by an increasing percentage of the
savings institution's high loan-to-value ratio land loans and non-residential
construction loans and equity investments other than those deducted from core
and tangible capital. As of September 30, 1996, the Bank had no equity
investments for which OTS regulations required a phased deduction from total
capital after July 1, 1990.
The risk-based capital requirement is measured against risk-weighted
assets which equal the sum of each asset and the credit-equivalent amount of
each off-balance sheet item after being multiplied by an assigned risk weight.
Under the OTS risk-weighting system, one- to four-family first mortgages not
more than 90 days past due with loan-to-value ratios under 80% and average
annual occupancy rates of at least 80% and certain qualifying loans for the
construction of one-to-four family residences pre-sold to home purchasers are
assigned a risk weight of 50%. Consumer and residential construction loans are
assigned a risk weight of 100%. Mortgage-backed securities issued, or fully
guaranteed as to principal and interest, by the FNMA or FHLMC are assigned a 20%
risk weight. Cash and U.S. Government securities backed by the full faith and
credit of the U.S. Government are given a 0% risk weight. As of September 30,
1996, the Bank's risk-weighted assets were approximately $54.35 million.
28
<PAGE>
The table below provides information with respect to the Bank's
compliance with its regulatory capital requirements at September 30, 1996.
<TABLE>
<CAPTION>
Percent
Amount of Assets(1)
------ ------------
(Dollars in thousands)
<S> <C> <C>
Tangible capital...................... $ 10,087 9.55%
Tangible capital requirement.......... 1,585 1.50
----------- ------
Excess.............................. $ 8,502 8.05%
=========== =====
Core capital.......................... $ 10,087 9.55%
Core capital requirement (2).......... 3,170 3.00
----------- ------
Excess.............................. $ 6,917 6.55%
=========== =====
Risk-based capital.................... $ 10,540 19.39%
Risk-based capital requirement (3).... 4,348 8.00
----------- -----
Excess.............................. $ 6,192 11.39%
=========== ======
</TABLE>
- - ----------------
(1) Based on adjusted total assets for purposes of the tangible capital and
core capital requirements, and risk-weighted assets for purpose of the
risk-based capital requirement.
(2) Reflects the capital requirement which the Bank must satisfy to avoid
regulatory restrictions that may be imposed pursuant to prompt
corrective action regulations. The core requirement applicable to the
Bank may increase if the OTS amends its capital regulations, as it has
proposed, in response to the more stringent leverage ratio adopted by
the Office of the Comptroller of the Currency for national banks.
(3) Represents total capital required at September 30, 1996. Does not
reflect any additional capital requirement as a result of recently
adopted OTS regulations regarding the interest rate risk component of
capital.
The risk-based capital standards of the OTS require savings
institutions with more than a "normal" level of interest rate risk to maintain
additional total capital. A savings institution's interest rate risk is measured
in terms of the sensitivity of its "net portfolio value" to changes in interest
rates. Net portfolio value is defined, generally, as the present value of
expected cash inflows from existing assets and off-balance sheet contracts less
the present value of expected cash outflows from existing liabilities. A savings
institution will be considered to have a "normal" level of interest rate risk
exposure if the decline in its net portfolio value after an immediate 200 basis
point increase or decrease in market interest rates (whichever results in the
greater decline) is less than 2.0% of the current estimated economic value of
its assets. A savings institution with a greater than normal interest rate risk
will be required to deduct from total capital, for purposes of calculating its
risk-based capital requirement, an amount (the "interest rate risk component")
equal to one-half the difference between the institution's measured interest
rate risk and the normal level of interest rate risk, multiplied by the economic
value of its total assets.
The OTS calculates the sensitivity of a savings institution's net
portfolio value based on data submitted by the institution in a schedule to its
quarterly Thrift Financial Report and using the interest rate risk measurement
model adopted by the OTS. The amount of the interest rate risk component, if
any, to be deducted from a savings institution's total capital is based on the
institution's Thrift Financial Report filed two quarters earlier. Savings
institutions with less than $300 million in assets and a risk-based capital
ratio above 12% are generally exempt from filing the interest rate risk schedule
with their Thrift Financial Reports. However, the OTS requires any exempt
savings institution that it determines may have a high level of interest rate
risk exposure to file such schedule on a quarterly basis and may be subject to
an additional capital requirement based upon its level of interest rate risk as
compared to its peers. The Bank has determined that, on the basis of current
financial data, it will not be deemed
29
<PAGE>
to have more than normal level of interest rate risk under the new rule and
believes that it will not be required to increase its total capital as a result
of the rule.
The OTS has proposed an amendment to its capital regulations
establishing a minimum core capital ratio of 3.0% for savings institutions rated
composite 1 under the OTS CAMEL examination rating system. For all other savings
institutions, the minimum core capital ratio will be from 4.0 to 5.0%. In
determining the amount of additional core capital, the OTS would assess both the
quality of risk management systems and the level of overall risk in each
individual savings institution through the supervisory process on a case-by-case
basis.
In addition to requiring generally applicable capital standards for
savings institutions, the OTS is authorized to establish the minimum level of
capital for a savings institution at such amount or at such ratio of
capital-to-assets as the OTS determines to be necessary or appropriate for such
institution in light of the particular circumstances of the institution. The OTS
may treat the failure of any savings institution to maintain capital at or above
such level as an unsafe or unsound practice and may issue a directive requiring
any savings institution which fails to maintain capital at or above the minimum
level required by the OTS to submit and adhere to a plan for increasing capital.
Such an order may be enforced in the same manner as an order issued by the FDIC.
At September 30, 1996, the Bank exceeded all regulatory minimum capital
requirements.
Prompt Corrective Regulatory Action. Under the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA"), the federal banking
regulators are required to take prompt corrective action if an insured
depository institution fails to satisfy certain minimum capital requirements,
including a leverage limit, a risk-based capital requirement, and any other
measure of capital deemed appropriate by the federal banking regulators for
measuring the capital adequacy of an insured depository institution. All
institutions, regardless of their capital levels, are restricted from making any
capital distribution or paying any management fees if the institution would
thereafter fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") may be: (i) subject
to increased monitoring by the appropriate federal banking regulator; (ii)
required to submit an acceptable capital restoration plan within 45 days; (iii)
subject to asset growth limits; and (iv) required to obtain prior regulatory
approval for acquisitions, branching and new lines of businesses. The capital
restoration plan must include a guarantee by the institution's holding company
that the institution will comply with the plan until it has been adequately
capitalized on average for four consecutive quarters, under which the holding
company would be liable up to the lesser of 5% of the institution's total assets
or the amount necessary to bring the institution into capital compliance as of
the date it failed to comply with its capital restoration plan. A "significantly
undercapitalized" institution, as well as any undercapitalized institution that
did not submit an acceptable capital restoration plan, may be subject to
regulatory demands for recapitalization, broader application of restrictions on
transactions with affiliates, limitations on interest rates paid on deposits,
asset growth and other activities, possible replacement of directors and
officers, and restrictions on capital distributions by any bank holding company
controlling the institution. Any company controlling the institution could also
be required to divest the institution or the institution could be required to
divest subsidiaries. The senior executive officers of a significantly
undercapitalized institution may not receive bonuses or increases in
compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
action provisions. If an institution's ratio of tangible capital to total assets
falls below a "critical capital level," the institution will be subject to
conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund. Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized.
30
<PAGE>
The federal banking regulators have adopted regulations implementing
the prompt corrective action provisions of FDICIA. Under such regulations, the
federal banking regulators will generally measure a depository institution's
capital adequacy on the basis of the institution's total risk-based capital
ratio (the ratio of its total capital to risk-weighted assets), Tier 1
risk-based capital ratio (the ratio of its core capital to risk-weighted assets)
and leverage ratio (the ratio of its core capital to adjusted total assets).
Under the regulations, a depository institution that is not subject to an order
or written directive by its primary federal regulator to meet or maintain a
specific capital level is deemed "well capitalized" if it also has: (i) a total
risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based capital
ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0% or greater. An
"adequately capitalized" depository institution is an institution that does not
meet the definition of well capitalized and has: (i) a total risk-based capital
ratio of 8.0% or greater; (ii) a Tier 1 capital risk-based ratio of 4.0% or
greater; and (iii) a leverage ratio of 4.0% or greater (or 3.0% or greater if
the institution has a composite 1 CAMEL rating). An "undercapitalized
institution" is a depository institution that has (i) a total risk-based capital
ratio less than 8.0%; or (ii) a Tier 1 risk-based capital ratio of less than
4.0%; or (iii) a leverage ratio of less than 4.0% (or 3.0% if the institution
has a composite 1 CAMEL rating). A "significantly undercapitalized" institution
is defined as a depository institution that has: (i) a total risk-based capital
ratio of less than 6.0%; or (ii) a Tier 1 risk-based capital ratio of less than
3.0%; or (iii) a leverage ratio of less than 3.0%. A "critically
undercapitalized" institution is defined as a depository institution that has a
ratio of "tangible equity" to total assets of less than 2.0%. "Tangible equity"
is defined as core capital plus the institution's outstanding cumulative
perpetual preferred stock (and related surplus) less all intangibles other than
qualifying supervisory goodwill and certain purchased mortgage servicing rights.
The appropriate federal banking agency may reclassify a well capitalized
depository institution as adequately capitalized and may require an adequately
capitalized or undercapitalized institution to comply with the supervisory
actions applicable to institutions in the next lower capital category (but may
not reclassify a significantly undercapitalized institution as critically
undercapitalized) if the OTS determines, after notice and an opportunity for a
hearing, that the depository institution is in an unsafe or unsound condition or
that the institution has received and not corrected a less-than-satisfactory
rating for any CAMEL rating category. As of September 30, 1996, the Bank was
classified as "well capitalized" under the prompt corrective action regulations.
Deposit Insurance. The Bank is required to pay assessments based on a
percentage of its insured deposits to the FDIC for insurance of its deposits by
the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as in the prompt
corrective action regulations. See "-- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken.
The assessment rate for SAIF members had ranged from 0.23% of deposits
for well capitalized institutions in Subgroup A to 0.31% of deposits for
undercapitalized institutions in Subgroup C while assessments for over 90% of
the BIF members had been the statutory minimum of $2,000. Recently enacted
legislation provided for a one-time assessment of 65.7 basis points of insured
deposits as of March 31, 1995, that will fully capitalize the SAIF and had the
effect of reducing future SAIF assessments. Accordingly, although the special
assessment collected on November 27, 1996, resulted in a one-time charge to the
Bank of approximately $588,000 pre-tax, the recapitalization of the SAIF will
have the effect of reducing the Bank's future deposit insurance premiums to the
SAIF. Under the recently enacted legislation, both BIF and SAIF members will be
assessed an amount for the Financing Corporation Bond
31
<PAGE>
payments. BIF members will be assessed approximately 1.3 basis points while the
SAIF rate will be approximately 6.4 basis points until January 1, 2000. At that
time, BIF and SAIF members will begin pro rata sharing of the payment at an
expected rate of 2.43 basis points.
The FDIC has proposed a rule that would lower the regular semi-annual
SAIF assessment rates by establishing a base assessment rate schedule ranging
from 4 to 31 basis points effective October 1, 1996. The rule widens the range
between the lowest and highest assessment rates among healthy and troubled
institutions with the intent of creating an incentive for savings institutions
to control risk-taking behavior. The rule also prevents the FDIC from collecting
more funds than needed to maintain the SAIF's capitalization at 1.25% of insured
deposits.
Under law, the FDIC may not impose semi-annual assessments which would
cause it to collect more funds than are necessary to maintain the SAIF's
designated reserve ratio. As a result, the base assessment rate schedule will be
immediately modified in two ways. The first modification, applying to
institutions such as certain BIF- members and SAIF-member banks that do not pay
assessments to the FICO, reduces the base assessment rate by 4 basis points for
a range from 0 to 27 basis points. The second modification sets a special
interim rate schedule from 18 to 27 basis points for the period from October 1,
1996 to December 31, 1996 for SAIF-member savings associations that pay
assessments to the FICO. After December 31, 1996, the special interim rates
would terminate and these institutions would also pay the base assessment rate
as reduced by the 4 basis point adjustment. Any excess funds collected by the
FDIC in the last six months of 1996 would be refunded or credited, with
interest, to the institution.
Federal Reserve System. Pursuant to regulations of the Federal Reserve
Board, all FDIC-insured depository institutions must maintain average daily
reserves against their net transaction accounts. This percentage is subject to
adjustment by the Federal Reserve Board. No reserves are required to be
maintained on the first $4.4 million of transaction accounts, reserves equal to
3% must be maintained on the next $49.3 million of transaction accounts, and a
reserve of 10% must be maintained against all remaining transaction accounts.
Because required reserves must be maintained in the form of vault cash or in a
non interest-bearing account at a Federal Reserve Bank, the effect of the
reserve requirement is to reduce the amount of the institution's
interest-earning assets. As of September 30, 1996, the Bank met its reserve
requirements.
Dividend Restrictions. Under OTS regulations, the Bank may not pay
dividends on its capital stock if its regulatory capital would thereby be
reduced below the amount then required for the liquidation account established
for the benefit of certain depositors of the Bank at the time of the Bank's
conversion to stock form. In addition, the Bank, as a savings institution
subsidiary of a savings and loan holding company, is required by OTS regulations
to provide at least 30 days' prior notice of any proposed declaration of
dividends to the Company.
OTS regulations impose additional limitations on the payment of
dividends and other capital distributions (including stock repurchases and cash
mergers) by the Bank. Under these regulations, a savings institution that,
immediately prior to, and on a pro forma basis after giving effect to, a
proposed capital distribution, has total capital (as defined by OTS regulations)
that is equal to or greater than the amount of its fully phased-in capital
requirements (a "Tier 1 Association") is generally permitted, without OTS
approval after notice, to make capital distributions during a calendar year in
the amount equal to the greater of: (i) 75% of its net income for the previous
four quarters; or (ii) up to 100% of its net income to date during the calendar
year plus an amount that would reduce by one-half the amount by which its
capital-to-assets ratio exceeded regulatory requirements at the beginning of the
calendar year. A savings institution with total capital in excess of current
minimum capital ratio requirements (a "Tier 2 Association") is permitted after
notice, to make capital distributions without OTS approval of up to 75% of its
net income for the previous four quarters, less dividends already paid for such
period. A savings institution that fails to meet current minimum capital
requirements (a "Tier 3 Association") is prohibited from making any capital
distributions without the prior approval of the OTS. A Tier 1 Association that
has been notified by the OTS that its is in need of more than normal supervision
will be treated as either a Tier 2 or Tier 3 Association. The Bank is a Tier 1
Association. Under the OTS' prompt corrective action regulations, the Bank is
also prohibited from
32
<PAGE>
making any capital distributions if after making the distribution, the Bank
would have: (i) a total risk-based capital ratio of less than 8.0%; (ii) a Tier
1 risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less
than 4.0%. The OTS, after consultation with the FDIC, however, may permit an
otherwise prohibited stock repurchase if made in connection with the issuance of
additional shares in an equivalent amount and the repurchase will reduce the
institution's financial obligations or otherwise improve the institution's
financial condition. See "-- Prompt Corrective Regulatory Action."
Furthermore, earnings of the Bank appropriated to bad debt reserves for
federal income tax purposes are not available for payment of cash dividends or
other distributions to the Company without payment of taxes at the then current
tax rate by the Bank on the amount of earnings removed from the reserves for
such distributions. See "-- Taxation." The Company intends to make full use of
this favorable tax treatment afforded to the Bank and the Company and does not
contemplate use of any post-Conversion earnings of the Bank in a manner which
would limit either institution's bad debt deduction or create federal tax
liabilities.
Transactions with Related Parties. Transactions between savings
institutions and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of a savings institution is any company or
entity which controls, is controlled by or is under common control with the
savings institution. In a holding company context, the parent holding company of
a savings institution (such as the Company) and any companies which are
controlled by such parent holding company are affiliates of the savings
institution. Generally, Sections 23A and 23B (i) limit the extent to which the
savings institution or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10% of such institution's capital
stock and surplus, and contain an aggregate limit on all such transactions with
all affiliates to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable, to the institution or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings institution may (i) make a loan or otherwise extend credit to an
affiliate, except for any affiliate which engages only in activities which are
permissible for bank holding companies, or (ii) purchase or invest in any
stocks, bonds, debentures, notes or similar obligations of any affiliate, except
for affiliates which are subsidiaries of the savings institution.
Savings institutions are also subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act and the Federal Reserve's Regulation O
thereunder on loans to executive officers, directors and principal stockholders.
Under Section 22(h), loans to a director, executive officer and to a greater
than 10% stockholder of a savings institution and certain affiliated interests
of such persons, may not exceed, together with all other outstanding loans to
such person and affiliated interests, the institution's loans-to-one-borrower
limit (generally equal to 15% of the institution's unimpaired capital and
surplus) and all loans to such persons may not exceed the institution's
unimpaired capital and unimpaired surplus. Section 22(h) also prohibits loans,
above amounts prescribed by the appropriate federal banking agency, to
directors, executive officers and greater than 10% stockholders of a savings
institution, and their respective affiliates, unless such loan is approved in
advance by a majority of the board of directors of the institution with any
"interested" director not participating in the voting. Regulation O prescribes
the loan amount (which includes all other outstanding loans to such person) as
to which such prior board of director approval is required, as being the greater
of $25,000 or 5% of capital and surplus (up to $500,000). Further, Section 22(h)
requires that loans to directors, executive officers and principal stockholders
be made on terms substantially the same as offered in comparable transactions to
other persons. Section 22(h) also generally prohibits a depository institution
from paying the overdrafts of any of its executive officers or directors.
Savings institutions are also subject to the requirements and
restrictions of Section 22(g) of the Federal Reserve Act and the Federal
Reserve's Regulation O thereunder on loans to executive officers and the
restrictions of 12 U.S.C. ss. 1972 on certain tying arrangements and extensions
of credit by correspondent banks. Section 22(g) of the Federal Reserve Act
requires that loans to executive officers of depository institutions not be made
on terms more favorable than those afforded to other borrowers, requires
approval by the board of directors of a depository
33
<PAGE>
institution for extension of credit to executive officers of the institution,
and imposes reporting requirements for and additional restrictions on the type,
amount and terms of credits to such officers. Section 1972 (i) prohibits a
depository institution from extending credit to or offering any other services,
or fixing or varying the consideration for such extension of credit or service,
on the condition that the customer obtain some additional service from the
institution or certain of its affiliates or not obtain services of a competitor
of the institution, subject to certain exceptions, and (ii) prohibits extensions
of credit to executive officers, directors, and greater than 10% stockholders of
a depository institution by any other institution which has a correspondent
banking relationship with the institution, unless such extension of credit is on
substantially the same terms as those prevailing at the time for comparable
transactions with other persons and does not involve more than the normal risk
of repayment or present other unfavorable features.
Safety and Soundness Standards. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each federal banking agency is required to establish safety and soundness
standards for institutions under its authority. On July 10, 1995, the federal
banking agencies, including the OTS, released Interagency Guidelines
Establishing Standards for Safety and Soundness and published a final rule
establishing deadlines for submission and review of safety and soundness
compliance plans. The final rule and the guidelines went into effect on August
9, 1995. The guidelines require savings institutions to maintain internal
controls and information systems and internal audit systems that are appropriate
for the size, nature and scope of the institution's business. The guidelines
also establish certain basic standards for loan documentation, credit
underwriting, interest rate risk exposure, and asset growth. The guidelines
further provide that savings institutions should maintain safeguards to prevent
the payment of compensation, fees and benefits that are excessive or that could
lead to material financial loss, and should take into account factors such as
comparable compensation practices at comparable institutions. If the OTS
determines that a savings institution is not in compliance with the safety and
soundness guidelines, it may require the institution to submit an acceptable
plan to achieve compliance with the guidelines. A savings institution must
submit an acceptable compliance plan to the OTS within 30 days of receipt of a
request for such a plan. Failure to submit or implement a compliance plan may
subject the institution to regulatory sanctions. Management believes that the
Bank already meets substantially all the standards adopted in the interagency
guidelines, and therefore does not believe that implementation of these
regulatory standards will materially affect the Bank's operations.
Additionally, under FDICIA, as amended by the CDRI Act, the federal
banking agencies are required to establish standards relating to the asset
quality and earnings that the agencies determine to be appropriate. On July 10,
1995, the federal banking agencies, including the OTS, issued proposed
guidelines relating to asset quality and earnings. Under the proposed
guidelines, a savings institution should maintain systems, commensurate with its
size and the nature and scope of its operations, to identify problem assets and
prevent deterioration in those assets as well as to evaluate and monitor
earnings and ensure that earnings are sufficient to maintain adequate capital
and reserves. Management believes that the asset quality and earnings standards,
in the form proposed by the banking agencies, would not have a material effect
on the Bank's operations.
Regulation of the Company
General. The Company is a unitary savings and loan holding company as
defined by the Home Owners' Loan Act ("HOLA"). As such, the Company is
registered with the OTS and is subject to OTS regulation, examination,
supervision and reporting requirements. As a subsidiary of a savings and loan
holding company, the Bank is subject to certain restrictions in its dealings
with the Company and affiliates thereof. The Company is required to file certain
reports with, and otherwise comply with the rules and regulations of the
Securities and Exchange Commission ("SEC") under federal securities laws.
Activities Restrictions. The Board of Directors of the Company
presently intends to operate the Company as a unitary savings and loan holding
company. There are generally no restrictions on the activities of a unitary
savings and loan holding company. However, if the Director of the OTS determines
that there is reasonable cause
34
<PAGE>
to believe that the continuation by a savings and loan holding company of an
activity constitutes a serious risk to the financial safety, soundness or
stability of its subsidiary savings institution, the Director of the OTS may
impose such restrictions as deemed necessary to address such risk including
limiting: (i) payment of dividends by the savings institution; (ii) transactions
between the savings institution and its affiliates; and (iii) any activities of
the savings institution that might create a serious risk that the liabilities of
the holding company and its affiliates may be imposed on the savings
institution. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
institution subsidiary of such a holding company fails to meet the QTL test,
then such unitary holding company shall also presently become subject to the
activities restrictions applicable to multiple holding companies and, unless the
savings institution requalifies as a QTL within one year thereafter, register
as, and become subject to, the restrictions applicable to a bank holding
company. See "-- Regulation of the Bank -- Qualified Thrift Lender Test."
If the Company were to acquire control of another savings institution,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions. Among other things, no multiple savings and loan holding
company or subsidiary thereof which is not a savings institution shall commence
or continue for a limited period of time after becoming a multiple savings and
loan holding company or subsidiary thereof, any business activity, upon prior
notice to, and no objection by, the OTS, other than: (i) furnishing or
performing management services for a subsidiary savings institution; (ii)
conducting an insurance agency or escrow business; (iii) holding, managing, or
liquidating assets owned by or acquired from a subsidiary savings institution;
(iv) holding or managing properties used or occupied by a subsidiary savings
institution; (v) acting as trustee under deeds of trust; (vi) those activities
authorized by regulation as of March 5, 1987 to be engaged in by multiple
holding companies; or (vii) unless the Director of the OTS by regulation
prohibits or limits such activities for savings and loan holding companies,
those activities authorized by the Federal Reserve Board as permissible for bank
holding companies. Those activities described in (vii) above must also be
approved by the Director of the OTS prior to being engaged in by a multiple
holding company.
Restrictions on Acquisitions. Savings and loan holding companies are
prohibited from acquiring, without prior approval of the Director of OTS, (i)
control of any other savings institution or savings and loan holding company or
substantially all the assets thereof or (ii) more than 5% of the voting shares
of a savings institution or holding company thereof which is not a subsidiary.
Under certain circumstances, a registered savings and loan holding company is
permitted to acquire, with the approval of the Director of the OTS, up to 15% of
the voting shares of an under-capitalized savings institution pursuant to a
"qualified stock issuance" without that savings institution being deemed
controlled by the holding company. In order for the shares acquired to
constitute a "qualified stock issuance," the shares must consist of previously
unissued stock or treasury shares, the shares must be acquired for cash, the
savings and loan holding company's other subsidiaries must have tangible capital
of at least 6-1/2% of total assets, there must not be more than one common
director or officer between the savings and loan holding company and the issuing
savings institution, and transactions between the savings institution and the
savings and loan holding company and any of its affiliates must conform to
Sections 23A and 23B of the Federal Reserve Act. Except with the prior approval
of the Director of the OTS, no director or officer of a savings and loan holding
company or person owning or controlling by proxy or otherwise more than 25% of
such company's stock, may also acquire control of any savings institution, other
than a subsidiary savings institution, or of any other savings and loan holding
company.
The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state if: (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office in the state of the institution to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes
35
<PAGE>
of the state in which the institution to be acquired is located specifically
permit institutions to be acquired by state-chartered institutions or savings
and loan holding companies located in the state where the acquiring entity is
located (or by a holding company that controls such state-chartered savings
institutions). The OTS has recently amended its regulations to permit federal
savings institutions to branch in any state or states of the United States and
its territories. Except in supervisory cases or when interstate branching is
otherwise permitted by state law or other statutory provision, a federal savings
institution may not establish an out-of-state branch unless (i) the federal
savings institution qualifies as a "domestic building and loan institution"
under ss.7701(a)(19) of the Internal Revenue Code and the total assets
attributable to all branches of the savings institution in the state would
qualify such branches taken as a whole for treatment as a domestic building and
loan association and (ii) such branch would not result in (a) formation of a
prohibited multi-state multiple savings and loan holding company or (b) a
violation of certain statutory restrictions on branching by savings institution
subsidiaries of banking holding companies. Federal savings institutions
generally may not establish new branches unless the savings institution meets or
exceeds minimum regulatory capital requirements. The OTS will also consider the
savings institution's record of compliance with the Community Reinvestment Act
of 1977 in connection with any branch application.
The Bank Holding Company Act of 1956, authorizes the Federal Reserve
Board to approve an application by a bank holding company to acquire control of
any savings institution. Pursuant to rules promulgated by the Federal Reserve
Board, owning, controlling or operating a savings institution is a permissible
activity for bank holding companies, if the savings institution engages only in
deposit-taking activities and lending and other activities that are permissible
for bank holding companies. In approving such an application, the Federal
Reserve Board may not impose any restriction on transactions between the savings
institution and its holding company affiliates except as required by Sections
23A and 23B of the Federal Reserve Act. A bank holding company that controls a
savings institution may merge or consolidate the assets and liabilities of the
savings institution with, or transfer assets and liabilities to, any subsidiary
bank which is a member of the BIF with the approval of the appropriate federal
banking agency and the Federal Reserve Board. The resulting bank will be
required to continue to pay assessments to the SAIF at the rates prescribed for
SAIF members on the deposits attributable to the merged savings institution plus
an annual growth increment. In addition, the transaction must comply with the
restrictions on interstate acquisitions of commercial banks under the Bank
Holding Company Act.
Taxation
General. The Company and its subsidiaries (including the Bank) file a
consolidated federal income tax return on a fiscal year basis. Consolidated
returns have the effect of eliminating intercompany distributions, including
dividends, from the computation of taxable income for the taxable year in which
the distributions occur.
Federal Income Taxation. Included in the Small Business Job Protection
Act of 1996 are provisions which repeal the special bad debt reserve method for
savings and loan associations for taxable years beginning after December 31,
1995. The legislation requires institutions to recapture the portion of the tax
bad debt reserves that exceeds the pre-1988 tax bad debt reserve over a period
of six to eight years. The recapture can be deferred for one to two years if the
institution meets a residential loan origination requirement.
For taxable years beginning after December 31, 1995, the bad debt
method for savings and loan associations is conformed to that of banks.
Institutions that qualify as a "small bank" will be able to use the reserve
method for bad debts. Reasonable additions to the reserve for bad debts are
calculated using the experience method. A small bank is an institution with
assets less than $500 million. Institutions that do not qualify as a small bank
will not be allowed to use the reserve method for bad debts.
Earnings appropriated to an institution's bad debt reserve and claimed
as a tax deduction are not available for the payment of cash dividends or for
distribution to shareholders (including distributions made on dissolution or
liquidation), unless such amount is included in taxable income, along with the
amount deemed necessary to pay the resulting federal income tax.
36
<PAGE>
The Bank's federal corporate income tax returns have not been audited
in the last five years.
State Income Taxation. The State of Minnesota imposes a corporate
franchise tax at the rate of 9.8% on income which is considered Minnesota
taxable income. Taxable income for the State of Minnesota is substantially the
same as federal taxable income.
For additional information regarding taxation, see Note 11 of Notes to
Consolidated Financial Statements.
Item 2. Properties
- - -------------------
The following table sets forth information regarding the Company's
offices at September 30, 1996.
<TABLE>
<CAPTION>
Year Owned or Book Value at Approximate Deposits at
Opened Leased September 30, 1996 Square Footage September 30, 1996
------ ------ ------------------ -------------- ------------------
(Deposits in thousands)
<S> <C> <C> <C> <C> <C>
Main Office:
214 5th Street 1910 Owned $ 1.14 million 10,990 $ 48,464
Bemidji, Minnesota 56601
Branch Offices:
22 First Street, NE 1977 Owned 160,000 1,789 15,929
Bagley, Minnesota 56621
109 Main Street West 1983 Owned 323,000 3,083 10,300
Baudette, Minnesota 56623
527 Minnesota Avenue 1987 Owned 62,000 1,700 5,889
Walker, Minnesota 56484
550 Paul Bunyan Drive, N.W. 1995 Leased 259,000 2,158 465
Bemidji, Minnesota 56601
</TABLE>
The book value of the Bank's investment in premises and equipment
totaled $1.94 million at September 30, 1996. See Note 9 of Notes to Consolidated
Financial Statements.
Item 3. Legal Proceedings.
- - -------------------------
A dispute regarding a license agreement for one of the motel properties
noted above, a motel property previously operated as a "Days Inn," and located
in Bemidji, Minnesota, resulted in a lawsuit being filed in the United States
District Court, District of Minnesota, in October 1994, by a national motel
chain against a prior partnership which operated that property (Days Inn of
-----------
America v. Bemidji Partners). Because the Bank took possession of the property
- - ---------------------------
for a brief period, and due to the agreement between the prior partnership and
the Bank, the Bank was required to defend the lawsuit. The complaint called for
damages "in excess of $50,000, to be specifically determined at trial, plus
interest," as redress for the alleged breach of the license agreement originally
executed by the national motel chain and the prior partnership. The Bank
believed that the licensing agreement was not breached, and with the assistance
of counsel vigorously contested the lawsuit. A settlement was reached, and the
lawsuit was dismissed by the Court, with prejudice, during the quarter ended
June 30, 1996. The Bank had previously established a reserve of $50,000 to cover
expected litigation and other costs, which covered the amount the Bank was
required to pay in the settlement.
At September 30, 1996, there were no other legal proceedings to which
the Company or First Federal was a party, or to which any of their property was
subject, which were expected by management to result in a material
37
<PAGE>
loss to the Company or the Bank, except for the matter discussed above relating
to one of the Bank's loans secured by a motel property located in Bemidji.
Item 4. Submission of Matters to Vote of Security Holders.
- - ----------------------------------------------------------
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year ended September 30, 1996.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholders'
- - ---------------------------------------------------------------------------
Matters
- - -------
The information contained under the sections captioned "Market and
Dividend Information" in the Company's Annual Report to Stockholders for the
Fiscal Year Ended September 30, 1996 (the "Annual Report") filed as Exhibit 13
hereto is incorporated herein by reference.
Item 6. Management's Discussion and Analysis of Financial Condition and
- - ------------------------------------------------------------------------
Results of Operations
- - ---------------------
The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in the
Annual Report is incorporated herein by reference.
Item 7. Financial Statements
- - -----------------------------
The Consolidated Financial Statements, Notes to Consolidated Financial
Statements and Independent Auditors' Report in the Annual Report, which are
listed under Item 13 herein, are incorporated herein by reference.
Item 8. Changes in and Disagreements With Accountants on Accounting and
- - ------------------------------------------------------------------------
Financial Disclosure
- - --------------------
Not applicable.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
- - ----------------------------------------------------------------------
Compliance with Section 16(a) of the Exchange Act
- - -------------------------------------------------
For information concerning the Board of Directors and executive
officers of the Company, the information contained under the section captioned
"Proposal I -- Election of Directors" in the Company's definitive proxy
statement for the Company's 1997 Annual Meeting of Stockholders (the "Proxy
Statement") is incorporated herein by reference.
For information regarding delinquent filers, as required by Item 405 of
Regulation S-B, reference is made to "Security Ownership of Management" in the
Proxy Statement, which is incorporated herein by reference.
38
<PAGE>
Item 10. Executive Compensation
- - --------------------------------
The information contained under the sections captioned "Proposal
I --Election of Directors -- Executive Compensation" "-- Director
Compensation," "--Employment Agreements" and "-- Supplemental Executive
Retirement Agreement" in the Proxy Statement is incorporated herein by
reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management
- - ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by
reference to the section captioned "Voting Securities and
Principal Holders Thereof" in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by
reference to the sections captioned "Voting Securities and
Principal Holders Thereof" and "Proposal I -- Election of
Directors" in the Proxy Statement.
(c) Changes in Control
Management of the Company knows of no arrangements, including
any pledge by any person of securities of the Company, the
operation of which may at a subsequent date result in a change
in control of the registrant.
Item 12. Certain Relationships and Related Transactions
- - --------------------------------------------------------
The information required by this item is incorporated herein by
reference to the section captioned "Proposal I -- Election of Directors --
Transactions with Management" in the Proxy Statement.
PART IV
Item 13. Exhibits List and Reports on Form 8-K.
- - -----------------------------------------------
(a) List of Documents Filed as Part of this Report
(1) Financial Statements. The following consolidated financial
statements are incorporated by reference from Item 8 hereof (see Exhibit 13):
Independent Auditors' Report
Consolidated Statements of Financial Condition -
September 30, 1996 and 1995
Consolidated Statements of Earnings - Years ended
September 30, 1996, 1995 and 1994
Consolidated Statements of Stockholders' Equity - Years ended
September 30, 1996, 1995 and 1994
Consolidated Statements of Cash Flows - Years ended
September 30, 1996, 1995 and 1994
Notes to Consolidated Financial Statements
39
<PAGE>
(2) Financial Statement Schedules. All schedules for which provision
is made in the applicable accounting regulations of the Securities and Exchange
Commission are omitted because of the absence of conditions under which they are
required or because the required information is included in the consolidated
financial statements and related notes thereto.
(3) Exhibits. The following is a list of exhibits filed as part of
this Annual Report on Form 10-K and is also the Exhibit Index.
<TABLE>
<CAPTION>
No. Description
-- -----------
<S> <C> <C>
3.1 Articles of Incorporation of First Federal Bancorporation *
3.2 Bylaws of First Federal Bancorporation *
4 Form of Common Stock Certificate of First Federal
Bancorporation **
10.1 First Federal Bancorporation 1995 Stock Option and
Incentive Plan **
10.2 First Federal Bancorporation Management Recognition Plan *
10.3(a) Employment Agreement between First Federal Bancorporation
and William R. Belford *
10.3(b) Employment Agreement between First Federal Banking & Savings, FSB
and William R. Belford *
10.4 First Federal Banking & Savings, FSB Retirement Plan
for Non-Employee Directors *
10.5 First Federal Banking & Savings, FSB Deferred Compensation
Plan, as Amended and Restated *
10.6 First Federal Banking & Savings, FSB Supplemental
Retirement Plan *
13 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23 Consent of KPMG Peat Marwick LLP
27 Financial Data Schedule
</TABLE>
- - ----------------
(*) Incorporated herein by reference from Registration Statement on Form S-1
filed February 8, 1995 (File No. 33-86964).
(**) Incorporated herein by reference from Registration Statement on Form 8-A
filed March 15, 1995 (File No. 0-25704).
(b) Reports on Form 8-K. During the quarter ended September 30, 1996,
-------------------
the Registrant did not file any Current Reports on Form 8-K.
(c) Exhibits. The exhibits required by Item 601 of Regulation S-B are
--------
either filed as part of this Annual Report on Form 10-KSB or incorporated by
reference herein.
(d) Financial Statements and Schedules Excluded from Annual Report.
--------------------------------------------------------------
There are no other financial statements and financial statement schedules which
were excluded from the Annual Report to Stockholders pursuant to Rule 14a-3(b)
which are required to be included herein.
40
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST FEDERAL BANCORPORATION
December 18, 1996
By: /s/ William R. Belford
----------------------------
William R. Belford
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ William R. Belford December 18, 1996
- - -----------------------------------------
William R. Belford
President, Chief Executive Officer
and Director
(Principal Executive Officer)
/s/ Dennis M. Vorgert December 18, 1996
- - -----------------------------------------
Dennis M. Vorgert
Vice President and Treasurer
(Principal Financial and Accounting Officer)
/s/ Ralph T. Smith December 18, 1996
- - -----------------------------------------
Ralph T. Smith
Chairman of the Board
/s/ Martin R. Sathre December 18, 1996
- - -----------------------------------------
Martin R. Sathre
Vice Chairman of the Board
/s/ Walter R. Fankhanel December 18, 1996
- - -----------------------------------------
Walter R. Fankhanel
Director
/s/ James R. Sharp December 18, 1996
- - -----------------------------------------
James R. Sharp
Director
/s/ Dean J. Thompson December 18, 1996
- - -----------------------------------------
Dean J. Thompson
Director
<PAGE>
Exhibit 13
[LOGO OF FIRST FEDERAL BANCORPORATION APPEARS HERE]
FIRST FEDERAL BANCORPORATION
ANNUAL REPORT FOR
THE YEAR ENDED
SEPTEMBER 30, 1996
<PAGE>
[LETTERHEAD OF FIRST FEDERAL
BANCORPORATION APPEARS HERE]
December 23, 1996
To Our Stockholders:
It gives me great pleasure following our successful stock offering in 1995, to
give you our progress and profitability report for First Federal Bancorporation
and its principal subsidiary, First Federal Banking and Savings, FSB. This
report represents an exciting and productive year at First Federal detailing
our first full year as a public company.
Total consolidated net earnings for the year ended September 30, 1996, was
$316,500. Consolidated stockholders equity was $12,322,698 at September 30,
1996, which represents 11.48% of total assets. Recently enacted federal
legislation provided for a one-time additional assessment of our SAIF insured
institution of $347,000 (net of tax effect) during this fiscal year. As a result
of this special assessment, the SAIF will be fully capitalized and it will have
the effect of reducing the bank's future deposit insurance premiums to the SAIF,
thereby increasing net income in future periods.
In the ensuing years, First Federal will continue its philosophy of increasing
shareholder value by working to maintain quality loan portfolios and increase
fee based income. During this year we have increased our consumer and commercial
real estate loan portfolios by 28% and 31%, respectively, while maintaining
adequate loan loss reserves. During this year we also increased our service
charge income 36% over last year.
Since our initial public offering, the company has repurchased 161,934 shares,
or 18.7%, of the original 862,500 shares. First Federal Bancorporation has
700,566 shares of Common Stock outstanding.
We believe this repurchase effort and our commitment to increasing earnings will
enhance shareholder value in future years.
We thank you for your support and pledge our continuing time and energy toward
future success.
Sincerely,
/s/ William R. Belford
William R. Belford
President
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
At September 30, Change
------------------- --------------------
1996 1995 Amount Percent
--------- -------- ---------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Financial Position:
Total assets......................... $107,256 $ 99,507 $ 7,749 7.79%
Loans receivable, net................ 51,003 48,044 2,959 6.16
Mortgage-backed and related
securities.......................... 20,749 21,523 (774) (3.60)
Investment securities................ 26,162 15,632 10,530 67.36
Deposits............................. 81,047 82,060 (1,013) (1.23)
Stockholders' equity................. 12,323 15,091 (2,768) (18.34)
Number of common shares outstanding.. 700,566 862,500 (161,934) (18.77)
<CAPTION>
For the Year Ended
September 30, Change
------------------- -------------------
1996 1995 Amount Percent
--------- -------- --------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Results of Operations:
Interest income...................... $ 7,429 $ 6,732 $ 697 10.35%
Interest expense..................... 4,016 3,547 469 13.22
Net interest income.................. 3,413 3,185 228 7.16
Provision for loan losses............ -- 4 (4) (100.00)
Net interest income after provision
for loan losses..................... 3,413 3,181 232 7.29
Non-interest income.................. 533 361 172 47.65
Non-interest expense................. 3,414 2,387 1,027 43.02
Earnings before cumulative effect
of accounting change................ 532 682 (150) (21.99)
Net earnings......................... 316 682 (266) (45.70)
</TABLE>
1
<PAGE>
SELECTED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Summary of Financial Condition
At September 30,
-------------------------------------------------
1996 1995 1994 1993 1992
--------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total amount of:
Assets..................... $107,256 $99,507 $87,256 $85,075 $85,834
Loans receivable, net...... 51,003 48,044 46,381 48,947 53,454
Investment securities:
Available for sale......... 26,162 15,632 13,231 -- --
Held to maturity........... -- -- 1,669 15,477 17,104
Mortgage-backed and related
securities:
Available for sale......... 19,903 20,417 13,230 -- --
Held to maturity........... 846 1,106 1,435 11,500 10,193
Deposit accounts............ 81,047 82,060 79,626 77,513 78,919
Advances from FHLB.......... 6,943 -- -- -- 140
Other borrowings............ 4,955 1,000 -- -- --
Stockholders' equity........ 12,323 15,091 6,566 6,553 5,893
<CAPTION>
Summary of Operations
Year Ended September 30,
------------------------------------------------
1996 1995 1994 1993 1992
-------- ------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest income............. $ 7,429 $ 6,732 $ 5,613 $ 6,001 $ 7,025
Interest expense............ 4,016 3,547 2,841 3,206 4,195
-------- ------- ------- ------- -------
Net interest income before
provision for loan losses.. 3,413 3,185 2,772 2,795 2,830
Provision for loan losses... -- 4 16 12 5
Non-interest income......... 533 361 354 358 235
Non-interest expense........ 3,414 2,387 2,163 2,090 2,255
-------- ------- ------- ------- -------
Earnings before income tax
expense and cumulative
effect of accounting
change..................... 532 1,155 947 1,051 805
Income tax expense.......... 216 473 410 391 360
-------- ------- ------- ------- -------
Earnings before cumulative
effect of accounting
change..................... 316 682 537 660 445
Cumulative effect of
accounting change.......... -- -- 120 -- --
-------- ------- ------- ------- -------
Net earnings................ 316 $ 682 $ 657 $ 660 $ 445
======== ======= ======= ======= =======
- - --------------------------------------------------------------------------------
Per Share Data:
Net earnings.............. $ .42 .49 -- -- --
Pro forma net earnings.... -- .86 -- -- --
Book value................ 17.59 17.50 -- -- --
</TABLE>
2
<PAGE>
Key Operating Ratios
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------------
1996 1995 1994 1993 1992
-------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Return on assets (net
earnings divided
by average total assets)... 0.31% 0.73% 0.77% 0.77% 0.52%
Return on equity (net
earnings divided by
average equity)............ 2.31 6.45 9.52 10.61 7.72
Tangible-equity-to-assets
ratio (average equity
divided by average total
assets).................... 13.25 11.40 8.10 7.21 6.74
Interest rate spread........ 3.02 3.29 3.26 3.29 3.41
Net interest margin (1)..... 3.51 3.63 3.42 3.41 3.51
Non-performing loans to
total loans (2)............ 0.41 0.18 0.19 0.83 0.38
Non-performing assets to
total assets (3)........... 0.38 0.24 0.22 0.52 0.31
Allowance for loan losses
to total loans............. 0.88 0.99 1.11 1.10 1.13
Allowance for loan losses to
non-performing loans....... 214.93 564.37 594.38 135.80 300.49
Net charge-offs to average
loans...................... 0.08 0.09 0.08 0.15 0.08
Non-interest expense to
average assets............. 3.30 2.57 2.54 2.42 2.63
Average interest-earning
assets to average
interest-bearing
liabilities................ 111.96 108.27 104.52 103.20 101.96
- - --------------------
</TABLE>
(1) Net interest income/average interest earning assets.
(2) Includes non-accruing loans and loans delinquent 90 days or more.
(3) Includes non-performing loans and real estate owned.
Note: The following discussion is provided to assist readers in their
understanding of the consolidated financial statements of First Federal
Bancorporation. This discussion should be read in conjunction with the
consolidated financial statements and other financial information presented
elsewhere in this report.
3
<PAGE>
BUSINESS OF THE COMPANY AND THE BANK
First Federal Bancorporation
First Federal Bancorporation (the "Company") was incorporated under
the laws of the State of Minnesota in September 1994 at the direction of the
Board of Directors of First Federal Banking & Savings, FSB ("First Federal" or
the "Bank") for the purpose of serving as a savings and loan holding company of
the Bank upon the acquisition of all of the capital stock issued by the Bank
upon its conversion from the mutual to the stock form of ownership (the
"Conversion"). On April 3, 1995, the Bank completed the Conversion and the
Company completed its offering of Common Stock through the sale and issuance of
862,500 shares of Common Stock at a price of $10.00 per share, realizing gross
proceeds of $8.63 million and net proceeds of $7.96 million. Prior to the
Conversion, the Company did not engage in any material operations. Currently,
the Company's principal business is the business of the Bank. The Company has
no significant assets other than the outstanding capital stock of the Bank,
$461,000 of cash and cash equivalents and $1.0 million in securities available
for sale, and $948,000 in other assets.
First Federal Banking & Savings, FSB
First Federal was originally chartered in 1910 as Beltrami County
Savings and Building Association, a state-chartered savings institution, and
commenced operations in that same year. First Federal has been a member of the
Federal Home Loan Bank ("FHLB") of Des Moines since 1933, and its deposits have
been federally insured since 1938. First Federal currently operates as a
federally chartered savings bank through its main office located in Bemidji,
Minnesota and four branch offices, which are located in Bemidji, Bagley,
Baudette and Walker, Minnesota. The Bank's market area is located approximately
200 miles north of Minneapolis, Minnesota.
First Federal is primarily engaged in the business of attracting
deposits from the general public and originating loans secured by first
mortgages on owner occupied one- to four-family residences in First Federal's
market area. First Federal also originates loans on commercial real estate
(including motels), multi-family real estate, home equity lines of credit and
other consumer loans, and commercial business loans. Due to limited loan demand
in its market area, First Federal has invested excess funds in mortgage-backed
and related securities and in other investment securities, and during fiscal
1995 became more active in originating and purchasing participation interests in
commercial real estate loans.
The Bank is subject to examination and comprehensive regulation by the
Office of Thrift Supervision ("OTS"), and the Bank's savings deposits are
insured up to applicable limits by the Savings Association Insurance Fund
("SAIF"), which is administered by the Federal Deposit Insurance Corporation
("FDIC"). The Bank is a member of, and owns capital stock in the FHLB of Des
Moines, which is one of 12 regional banks in the FHLB System. The Bank is
further subject to regulations of the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board") governing reserves to be maintained and
certain other matters.
The Company's and the Bank's executive offices are located at 214 5th
Street, Bemidji, Minnesota 56601, and the main telephone number is (218) 751-
5120.
Recent Developments
The Deposit Insurance Fund Act of 1996 (DIFA) was enacted on September
30, 1996. DIFA addressed the inadequate funding of the Savings Association
Insurance Fund (SAIF), which had resulted in a large deposit insurance premium
disparity between banks insured by the Bank Insurance Fund (BIF) and SAIF-
insured thrifts, which were required to pay significantly higher deposit
insurance premiums. As a result of this new legislation, a one-time special
assessment was imposed on thrift institutions, and the Company recognized a
$588,444 pretax charge for assessments imposed on savings deposits at the Bank.
The legislation also provides for a reduction in deposit insurance premiums in
subsequent periods.
4
<PAGE>
The second major area addressed by DIFA was funding for bond
obligations of the Financing Corp. (FICO). Thrifts will pay 6.4 basis points
per $100 of deposits from January 1, 1997 to December 31, 1999. From January 1,
2000 until the FICO bonds are retired in 2019 the estimated assessment to retire
the FICO bonds is expected to be 2.5 basis points per $100 of deposits.
The third area addressed by DIFA was the BIF-SAIF merger and Thrift
charter conversions. DIFA proposed that the BIF and SAIF insurance funds will
be merged on January 1, 1999, provided no insured depository institution is a
savings association on that date. DIFA also directed the Secretary of the
Treasury to present recommendations to Congress for establishment of a common
depository institution charger by March 31, 1997.
Other recently enacted federal legislation repealed the reserve method
of accounting for thrift bad debt reserves. This legislation eliminated the
recapture of a thrift institution's bad debt reserve under certain
circumstances, including the institution's conversion to a bank or as a result
of similar charter changes.
5
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
First Federal Bancorporation completed its stock offering on April 3,
1995, upon the conversion of First Federal Banking & Savings, FSB from mutual to
stock form, which offering generated net proceeds of $7.96 million. The Company
purchased all of the stock of the Bank with a portion of the conversion
proceeds. The information in this report represents the financial condition and
the results of operation for the consolidated Company for 1995 and only the Bank
for 1994. The Bank is primarily engaged in the business of attracting deposits
from the general public and originating loans secured by mortgages on owner
occupied one- to four-family residences in the Bank's market area. First
Federal also originates loans on commercial real estate (including motels),
multi-family real estate, home equity lines of credit and other consumer loans.
In recent years, due to limited loan demand in the Bank's market area, First
Federal has invested excess funds in mortgage-backed and related securities and
in other investment securities.
The Bank's net income is dependent primarily on its net interest
income, which is the difference between interest earned on loans and
investments, and the interest paid on interest bearing liabilities, primarily
deposits. Net interest income is determined by (i) the difference between the
yield earned on interest-earning assets and rates paid on interest-bearing
liabilities ("interest rate spread") and (ii) the relative amounts of interest-
earning assets and interest-bearing liabilities. The Bank's interest rate
spread is also affected by regulatory, economic and competitive factors that
influence interest rates, loan demand and deposit flows. The Bank's net income
is also affected by the generation of non-interest income, which primarily
consists of fees and service charges. In addition, net income is affected by
the level of operating expenses and provisions for loan losses.
The operations of financial institutions, including the Bank, are
significantly affected by prevailing economic conditions, competition and
regulatory policies, and the monetary and fiscal policies of the U.S. Government
and government agencies. Lending activities are influenced by the demand for,
and supply of housing, competition among lenders, the level of interest rates
and the availability of funds. Deposit flows and costs of funds are influenced
by prevailing market rates of interest primarily on competing investments,
account maturities and the levels of personal income and savings in the market
area of the Bank.
Asset and Liability Management
The interest rate sensitivity of assets and liabilities may be
analyzed by examining the extent to which such assets and liabilities will
mature or reprice within the same period. The interest rate sensitivity gap is
defined as the difference between the amount of interest-earning assets maturing
or repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within that time period. A gap is considered
positive within a particular period when the amount of interest rate sensitive
assets exceeds the amount of interest rate sensitive liabilities, and is
considered negative when the amount of interest rate sensitive liabilities
exceeds the amount of interest rate sensitive assets. Generally, during a
period of rising interest rates, a negative gap would adversely affect net
interest income while a positive gap would result in an increase in net interest
income. Conversely, during a period of falling interest rates, a negative gap
would result in an increase in net interest income and a positive gap would
adversely affect net interest income.
To the extent consistent with its interest rate spread objectives, the
Bank attempts to reduce its interest rate risk and has taken a number of steps
to restructure its assets and liabilities. First, the Bank sells substantially
all fixed-rate one- to four-family residential loans it originates in the
secondary mortgage market. Second, the Bank has primarily focused its one- to
four-family residential lending program on loans having adjustable interest
rates. At September 30, 1996, $21.03 million, or 80.92% of the Bank's one- to
four-family residential loans were adjustable-rate loans. Third, the Bank
originates adjustable-rate consumer loans, and commercial real estate and multi-
family residential real estate loans. At September 30, 1996, $17.42 million, or
66.89% of the Company's loans
6
<PAGE>
which were other than one- to four-family residential loans were adjustable-rate
loans. Fourth, the Company generally maintains a significant portfolio of
investment securities and liquid assets with weighted average remaining
maturities of four years or less. At September 30, 1996, the Company had $29.47
million of investment securities and interest bearing deposits in other banks,
with a weighted average remaining maturity of less than two years. Fifth, the
Company maintains a significant portfolio of collateralized mortgage obligations
("CMOs") and real estate mortgage investment conduits ("REMICS") with expected
weighted average lives of five years or less. At September 30, 1996, the
Company had $11.11 million of CMOs and REMICS and similar securities with
weighted average lives of five years or less. Sixth, the Company also has a
portfolio of adjustable-rate mortgage-backed and related securities. At
September 30, 1996, the Company had $3.08 million of adjustable-rate mortgage-
backed and related securities.
Management's principal strategy in managing the Company's interest
rate risk has been to maintain short and intermediate-term assets in portfolio,
including locally originated adjustable-rate mortgage loans. In addition, in
managing its portfolio of investment securities, the Company seeks to purchase
investment securities that mature on a basis that approximates as closely as
possible the estimated maturities of the Company's liabilities.
Financial Condition and Results of Operations
Financial Condition. The Company's total assets increased by $7.75
million, or 7.78%, from $99.51 million at September 30, 1996 to $107.26 million
at September 30, 1996. The increase in total assets resulted primarily from an
increase in investment securities of $10.53 million, an increase in loans
receivable, net of $2.96 million, offset by a decrease in cash and cash
equivalents of $5.50 million.
Investment securities and mortgage-backed and related securities
totaling $46.91 million at September 30, 1996, consisted of $46.07 million in
securities classified as available for sale and $846,000 in securities
classified as held to maturity. Loans receivable, net increased $2.96 million
as a result of an excess of new loan originations and purchases over repayments
and refinances.
The Company experienced a decrease in deposits during fiscal 1996 of
$1.01 million, or 1.24%. This decrease was primarily due to government funds
being channeled from traditional deposit accounts to accounts collateralized by
retail repurchase agreements. Repurchase agreements increased $3.95 million, or
395.46%, from $1.00 million at September 30, 1995 to $4.95 million at September
30, 1996.
The Company has made extensive use of the Federal Home Loan Bank
Advance program during the twelve months ended September 30, 1996. Federal Home
Loan Bank advances have increased from $0 at September 30, 1995 to $6.94 million
at September 30, 1996.
Comparison of Operating Results for the Years Ended September 30, 1996 and
September 30, 1995.
Net Earnings. The Company had net earnings of $316,500 for the year
ended September 30, 1996, as compared to $682,000 for the year ended September
30, 1995. As discussed below, the decrease in net earnings of $365,500 was due
to an increase in net interest income of $227,500, an increase in non-interest
income of $172,500, offset by an increase in non-interest expense of $1.03
million, and a decrease in income tax expense of $257,000.
Net Interest Income. Net interest income increased $227,500, or
7.14%, from $3.18 million for the year ended September 30, 1995 to $3.41 million
for the year ended September 30, 1996. This increase was primarily due to a net
increase in average interest-earning assets over average interest-bearing
liabilities, along with a decrease in the interest rate spread from 3.29% for
the year ended September 30, 1995 to 3.02% for the year ended September 30,
1996.
Interest Income. Interest income increased by $696,000, or 10.34%,
from $6.73 million for the year ended September 30, 1995 to $7.43 million for
the year ended September 30, 1996. This increase was due primarily to
7
<PAGE>
an increase in the average outstanding balance of interest-earning assets.
Total average interest-earning assets increased 10.56% during the year ended
September 30, 1996. At the same time the overall yield on interest-earning
assets remained relatively unchanged for the same period.
Interest Expense. Interest expense increased by $469,000, or 13.22%,
from $3.55 million for the year ended September 30, 1995 to $4.02 million for
the year ended September 30, 1996. This increase was primarily the result of
the increased interest rates paid on certificate accounts during the year ended
September 30, 1995, which contributed to a $173,000 increase in interest expense
on certificates. In addition to the increase in interest expense caused by the
increase in interest paid on certificates during the year ended September 30,
1996, the increase in average FHLB advances and repurchase agreements
contributed an additional $236,000 increase in interest expense.
Provision for Losses on Loans. The decrease of $3,700, or 100.00%, in
the provision for losses on loans for the year ended September 30, 1996 as
compared with the year ended September 30, 1995 was the result of management's
evaluation of the loan portfolio. The Bank will continue to monitor and modify
its allowance for losses as conditions dictate. Although the Bank maintains its
allowance for losses at a level it considers adequate to provide for probable
losses, there can be no assurance that such losses will not exceed the estimated
amounts or that additional provisions for loan losses will not be required in
future periods.
Non-interest Income. Total non-interest income increased by $172,000,
or 47.82%, from $361,000 for the year ended September 30, 1995 to $533,000 for
the year ended September 30, 1996. This increase was related to a $109,000
increase in fees and service charges, a $15,000 increase in gains on sales of
securities, a $3,000 gain on the sale of foreclosed real estate, and a $45,000
increase in other income.
Non-interest Expense. Non-interest expense increased by $1.02
million, or 42.99%, from $2.39 million for the year ended September 30, 1995 to
$3.41 million for the year ended September 30, 1996. This increase was
primarily the result of the federal deposit insurance special assessment of
$588,000. This increase was also due to a $185,000 increase in compensation and
employee benefits expense, an $80,000 increase in occupancy expense, an $8,000
increase in advertising expense, and a $180,000 increase in other non-interest
expenses. The increases in compensation and employee benefits, occupancy, and
other non-interest expenses were primarily due to increasing costs of being a
public company, and the opening of a new branch office.
Income Tax Expense. Income tax expense decreased from $473,000 for
the year ended September 30, 1995 to $216,000 for the year ended September 30,
1996 due to decreased income before income tax expense.
Comparison of Operating Results for the Years Ended September 30, 1995 and
September 30, 1994.
Net Earnings. The Company had net earnings of $682,000 for the year
ended September 30, 1995, as compared to $657,000 for the year ended September
30, 1994. As discussed below, the increase in net earnings of $25,000, or
3.77%, was due to an increase in net interest income of $413,000, a decrease in
the provision for losses on loans of $13,000 and an increase in non-interest
income of $6,000, offset by an increase in non-interest expense of $224,000 and
the impact on net income of a $120,000 charge resulting from the implementation
of Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for
Income Taxes, during fiscal year ended September 30, 1994, and an increase in
income tax expense of $63,000.
Net Interest Income. Net interest income increased $413,000, or
14.89%, from $2.77 million for the year ended September 30, 1994 to $3.18
million for the year ended September 30, 1995. This increase was due primarily
to a net increase in average interest-earning assets over average interest-
bearing liabilities, along with an increase in the interest rate spread from
3.26% for the year ended September 30, 1994 to 3.29% for the year ended
September 30, 1995.
Interest Income. Interest income increased by $1.12 million, or
19.95%, from $5.61 million for the year ended September 30, 1994 to $6.73
million for the year ended September 30, 1995. This increase was due primarily
8
<PAGE>
to an increase in the average outstanding balance of interest-earning assets
which was enhanced by an increase in the overall yield on interest-earning
assets. Total average interest-earning assets increased 8.42% during the year
ended September 30, 1995 due primarily to the investment of the $7.93 million in
net proceeds from the public offering. At the same time the overall yield on
interest earning assets increased from 6.93% for the year ended September 30,
1994 to 7.66% for the year ended September 30, 1995.
Interest Expense. Interest expense increased by $707,000, or 24.88%,
from $2.84 million for the year ended September 30, 1994 to $3.55 million for
the year ended September 30, 1995. This increase was primarily the result of
the increased interest rates paid on certificate accounts during the year ended
September 30, 1995 which contributed to a $397,000 increase in interest expense
on certificates. In addition to the increase in interest expense caused by the
increase in interest rates paid on certificates during the year ended September
30, 1995, the increase in average certificates of deposits contributed an
additional $178,000 increase in interest expense on certificates. The remaining
increase in interest expense was primarily due to an increase in rates paid on
other deposit accounts during the year ended September 30, 1995.
Provision for Losses on Loans. The decrease of $13,000, or 77.31%, in
the provision for losses on loans for the year ended September 30, 1995 as
compared with the year ended September 30, 1994 was the result of management's
evaluation of the loan portfolio. The Bank will continue to monitor and modify
its allowance for losses as conditions dictate. Although the Bank maintains its
allowance for losses at a level it considers adequate to provide for probable
losses, there can be no assurance that such losses will not exceed the estimated
amounts or that additional provisions for loan losses will not be required in
future periods.
Non-interest Income. Total non-interest income increased by $6,000,
or 1.75%, from $355,000 for the year ended September 30, 1994 to $361,000 for
the year ended September 30, 1995. This increase was related to an $11,000
increase in fees and service charges, a $10,000 decrease in losses on the sale
of securities, a $5,000 gain on the sale of foreclosed real estate, and a
$20,000 decrease in other income.
Non-interest Expense. Non-interest expense increased by $224,000, or
10.37%, from $2.16 million for the year ended September 30, 1994 to $2.39
million for the year ended September 30, 1995. This increase was related to a
$178,000 increase in compensation and employee benefits expense, an $18,000
increase in occupancy expense, and a $28,000 increase in advertising expense.
The increase in non-interest expense for the year ended September 30, 1995 was
primarily due to increasing costs of being a public company, related benefit
plans, and the opening of a new branch office.
Income Tax Expense. Income tax expense increased from $410,000 for
the year ended September 30, 1994 to $473,000 for the year ended September 30,
1995 due to increased income before income tax expense.
Allowance for Loan Losses
In originating loans, the Company recognizes that credit losses will
be experienced and that the risk of loss will vary with, among other things, the
type of loan being made, the creditworthiness of the borrower over the term of
the loan, general economic conditions and, in the case of a secured loan, the
quality of the security for the loan. It is management's policy to maintain an
adequate allowance for loan losses based on, among other things, the Company's
historical loan loss experience, evaluation of economic conditions, regular
reviews of delinquencies and loan portfolio quality. The Company increases its
allowance for loan losses by charging provisions for loan losses against the
Company's income. Management will continue to actively monitor the Company's
asset quality and allowance for loan losses. Management will charge off loans
and properties acquired in settlement of loans against the allowance for losses
on such loans and such properties when appropriate and will provide specific
loss allowances when necessary. Although management believes it uses the best
information available to make determinations with respect to the allowance for
losses, future adjustments may be necessary if economic conditions differ
substantially from the economic conditions in the assumptions used in making the
initial determination.
9
<PAGE>
The following table reflects the activity in the allowance for loan losses.
<TABLE>
<CAPTION>
At or for the
Year Ended September 30,
------------------------------
1996 1995 1994
------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C>
Balance at the beginning of the year....... $ 491 $ 529 $ 549
Provision for losses....................... -- 4 17
Charge-offs................................ (49) (49) (57)
Recoveries................................. 12 7 20
----- ----- -----
Net charge-offs.......................... (37) (38) (20)
----- ----- -----
Balance at end of the year................. $ 454 $ 491 $ 529
===== ===== =====
Ratio of net charge-offs to average loans
outstanding during the period............. 0.08% 0.09% 0.08%
===== ===== =====
Ratio of allowance for loan losses
to total loans............................ 0.87% 0.99% 1.11%
===== ===== =====
</TABLE>
Non-Performing Assets
Non-performing assets totaled $405,000 at September 30, 1996 compared
to $239,000 at September 30, 1995 and $176,000 at September 30, 1994.
Non-performing assets are summarized in the following table.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------
1996 1995 1994
-------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C>
Non-performing loans............................... $ 211 $ 87 $ 89
Foreclosed assets.................................. 194 152 87
------- ------- -------
Total non-performing assets....................... $ 405 $ 239 $ 176
======= ======= =======
Non-performing assets to total assets.............. 0.38% 0.24% 0.22%
======= ======= =======
Non-performing assets to total loans............... 0.78% 0.18% 0.19%
======= ======= =======
Allowance for loan losses to non-performing loans.. 215.16% 564.37% 594.38%
======= ======= =======
</TABLE>
The non-performing loans reflected above consist of non-accruing loans
and accruing loans 90 days or more past due.
10
<PAGE>
Average Balance, Interest and Average Yields and Rates
The following table sets forth certain information relating to the
Company's average interest-earning assets and interest-bearing liabilities and
reflects the average yield on assets and average cost of liabilities for the
periods indicated. Such yields and costs are derived by dividing income or
expense by the average balance of assets or liabilities, respectively, for the
periods presented. Average balances are derived from daily balances.
The table also presents information for the periods indicated with
respect to the difference between the weighted average yield earned on interest-
earning assets and weighted average rate paid on interest-bearing liabilities,
or "interest rate spread," which savings institutions have traditionally used as
an indicator of profitability. Another indicator of an institution's net
interest income is its "net yield on interest-earning assets," which is its net
interest income divided by the average balance of interest-earning assets or
"net interest margin." Net interest income is affected by the interest rate
spread and by the relative amounts of interest-earning assets and interest-
bearing liabilities. When interest-earning assets approximate or exceed
interest-bearing liabilities, any positive interest rate spread will generate
net interest income.
11
<PAGE>
<TABLE>
<CAPTION>
For the Year Ended September 30,
--------------------------------------------------------------------------------
At September 30,
1996 1996 1995 1994
----------------- -------------------------- -------------------------- --------------------------
Average Average Average Average
Yield/ Average Yield/ Average Yield/ Average Yield/
Balance Cost Balance Interest Cost Balance Interest Cost Balance Interest Cost
-------- -------- -------- -------- -------- ------- --------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable......... $ 51,003 9.07% $ 48,954 $4,471 9.13% $47,485 $ 4,274 9.00% $47,669 $3,893 8.17%
Other marketable
securities.............. 26,162 6.43 20,763 1,339 6.45 16,222 1,021 6.29 15,007 855 5.70
Mortgage-backed and
related securities...... 20,749 6.43 21,676 1,407 6.49 17,581 1,156 6.59 12,989 736 5.67
Short-term investment
and other
interest-earning assets 4,010 6.01 5,745 212 3.69 6,572 281 4.28 5,370 129 2.39
-------- -------- ------ ------- ------- ------- ------
Total interest-earning
assets................ 101,924 7.73 97,138 7,429 7.65 87,860 6,732 7.66 81,035 5,613 6.93
------ ------- ------
Non-interest-earning assets 5,332 5,287 4,965 4,151
-------- -------- ------- -------
Total assets........... 107,256 102,425 $92,825 $85,186
======== ======== ======= =======
Interest-bearing
liabilities:
Deposits:
NOW accounts........... $ 10,518 1.59 $ 9,945 157 1.58 $ 9,633 158 1.64 $ 9,627 128 1.33
Passbook accounts...... 8,540 2.00 8,903 186 2.09 9,542 234 2.46 10,460 214 2.05
Money market deposits.. 8,757 3.00 8,782 260 2.96 8,869 263 2.97 8,644 207 2.39
Certificate accounts... 53,231 5.77 54,101 3,133 5.79 52,452 2,867 5.47 48,802 2,292 4.69
Borrowings:
FHLB advances.......... 6,943 5.61 2,654 151 5.69 656 25 3.76 -- -- --
Repurchase agreements.. 4,955 5.47 2,374 129 5.43 -- -- -- -- -- --
-------- -------- ------ ------- ------- ------- ------
Total
interest-bearing
liabilities......... 92,944 4.66 86,759 4,016 4.63 81,152 3,547 4.37 77,533 2,841 3.66
------ ------- ------
Non-interest-bearing
liabilities............... 1,989 1,235 1,094 751
-------- -------- ------- -------
Total liabilities...... 94,933 87,994 82,246 78,254
Stockholders' equity....... 12,323 14,431 10,579 6,902
-------- -------- ------- -------
Total liabilities and
retained earnings...... $107,256 $102,425 $92,825 $85,186
======== ======== ======= =======
Net interest income........ $3,413 $ 3,185 $2,772
====== ======= ======
Interest rate spread....... 3.07% 3.02% 3.29% 3.26%
==== ==== ====== ====
Net interest margin........ 3.48% 3.51% 3.63% 3.42%
==== ==== ====== ====
Ratio of average
interest-earning assets
to average interest-
bearing liabilities 109.66% 111.96% 108.27% 104.52%
====== ====== ====== ======
</TABLE>
12
<PAGE>
Rate/Volume Analysis
The table below sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by old rate); and (ii) changes in rates (change in
rate multiplied by old volume). For purposes of this table, changes
attributable to both rate and volume which cannot be segregated have been
allocated proportionately to the change due to volume and change due to rate.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------------------
1996 vs. 1995 1995 vs. 1994
-------------------------- -----------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
--------------------------- -----------------------
Volume Rate Total Volume Rate Total
--------- -------- ------ -------- ----- ------
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loans receivable......... $ 134 $ 63 $ 197 $ (15) $ 396 $ 381
Mortgage-backed and
related securities...... 292 26 318 288 132 420
Other marketable
securities.............. 269 (18) 251 38 128 166
Other interest-earning
assets.................. (33) (36) (69) 34 118 152
----- ----- ----- ----- ---- ------
Total interest-earning
assets............... 662 35 697 345 774 1,119
Interest expense:
Deposits:
NOW accounts........... 5 (6) (1) -- 30 30
Passbook accounts...... (15) (33) (48) (20) 40 20
Money market accounts.. (2) (1) (3) 5 51 56
Certificates........... 93 173 266 178 397 575
Borrowings:
FHLB advances.......... 107 19 126 25 -- 25
Repurchase agreements.. 129 -- 129 -- -- --
----- ----- ----- ----- ---- ------
Total interest-bearing
liabilities......... 317 152 469 188 518 706
----- ----- ----- ----- ---- ------
Change in net interest
income.................... $ 345 $(117) $ 228 $ 157 $ 256 $ 413
===== ===== ===== ===== ==== ======
</TABLE>
Liquidity and Capital Resources
The Company's primary sources of funds for operations are deposits
from its market area; principal and interest payments on loans, securities
available for sale and securities held to maturity; proceeds from the sale or
maturation of securities and advances from the FHLB of Des Moines. While
maturities and scheduled amortization of loans and securities are predictable
sources of funds, deposit flows and mortgage prepayments are greatly influenced
by general interest rates, economic conditions, and competition.
The primary investing activities of the Company are the origination of
one-to four-family loans, the origination of consumer loans and the purchase of
securities. During the years ended September 30, 1996, 1995 and 1994, the
Bank's loan originations totaled $14.47 million, $9.13 million and $12.96
million, respectively. The Company purchased investment securities and mortgage
backed and related securities during the years ended September 30, 1996, 1995
and 1994 of $23.05 million, $20.18 million and $15.67 million, respectively.
13
<PAGE>
The primary financing activity of the Company is the attraction of
deposits. During the year ended September 30, 1996, the Bank experienced a net
decrease in deposits of $1.01 million. During the year ended September 30,
1995, the Bank experienced a net increase in deposits of $2.43 million. During
the year ended September 30, 1994, the Bank experienced a decrease in deposits
of $2.11 million.
During the year ended September 30, 1996, the Bank has become actively
involved in the area of repurchase agreements. Repurchase agreements at
September 30, 1996 totaled $4.95 million compared to a total of $1.00 million at
September 30, 1995.
The Bank has the ability to borrow additional funds from the FHLB of
Des Moines by pledging additional securities. At September 30, 1996, the Bank
had an undrawn borrowing capacity with the FHLB for $14.52 million. At
September 30, 1996 the Bank had $6.94 million in advances outstanding with the
FHLB.
The Bank is required to maintain minimum levels of liquid assets as
defined by OTS regulations. This requirement, which may be varied by the OTS
depending upon economic conditions and deposit flows, is based upon a percentage
of deposits and short-term borrowings. The required minimum liquidity ratio is
currently 5.0% and the short-term liquidity ratio is 1.0%. The Bank's average
daily liquidity ratio for the month of September 1996 was 19.26% and its short-
term liquidity for the same month was 3.02%.
The Company's most liquid assets are cash and cash equivalents, which
consist of short-term highly liquid investments with original maturities of less
than three months that are readily convertible to known amounts of cash and
interest-bearing deposits. The level of these assets is dependent on the
Company's operating, financing and investing activities during any given period.
At September 30, 1996, 1995, and 1994, cash and cash equivalents totaled $4.69
million, $10.19 million and $7.27 million, respectively.
The Bank anticipates that it will have sufficient funds available to
meet its current commitments. At September 30, 1996, the Bank had commitments
to originate loans of $425,000 and commitments to purchase mortgage-backed
securities of $500,000. Certificates of deposit which are scheduled to mature
in one year or less at September 30, 1996, totaled $30.98 million. Management
believes that a significant portion of such deposits will remain with the Bank.
At September 30, 1996, the Bank exceeded each of the three regulatory
capital requirements.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and Notes thereto presented
herein have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars without considering the change in the
relative purchasing power of money over time and due to inflation. The impact
of inflation is reflected in the increased cost of the Bank's operations.
Unlike most industrial companies, nearly all the assets and liabilities of the
Company are monetary. As a result, interest rates have a greater impact on the
Company's performance than do the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same
extent as the price of goods and services.
Impact of New Accounting Standards
Disclosures of Fair Value of Financial Instruments. In December 1991,
the Financial Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards ("SFAS") No. 107, "Disclosures About Fair Value of
Financial Instruments." SFAS No. 107 requires all entities to disclose the fair
value of financial instruments (both assets and liabilities recognized and not
recognized in the statements of financial condition) for which it is practicable
to estimate the fair value, except those financial instruments specifically
excluded. The disclosure shall be either in the body of the financial
statements or in the accompanying notes and shall include the methods and
14
<PAGE>
significant assumptions used to estimate the fair value of a financial
instrument or a class of financial instruments as well as the reasons why it is
not practicable to estimate fair value. SFAS No. 107 is effective for fiscal
years ending after December 15, 1992 for companies with assets of greater than
$150 million. For companies with assets of less than $150 million, SFAS No. 107
is effective for fiscal years ending after December 15, 1995. The Bank adopted
the disclosure requirements of SFAS No. 107 for the fiscal year ended June 30,
1996.
Accounting for Impaired Loans. In September 1993, the FASB issued
SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." SFAS No. 114
requires that specified impaired loans be measured based on the present value of
expected future cash flows discounted at the loan's effective interest rate, or,
as an alternative, at the fair value of the collateral or the observable market
price of the loan. SFAS No. 114 does not apply to large groups of small
balance, homogeneous loans that are collectively evaluated for impairment.
Subsequent to October 1994, the FASB issued SFAS No. 118 "Accounting by
Creditors for Impairment of a Loan -- Income Recognition and Disclosures" as an
amendment to SFAS No. 114. SFAS No. 118 amends the disclosure requirements of
SFAS No. 114 to require information about the recorded investment in certain
impaired loans and about how a creditor recognizes interest income related to
those impaired loans. SFAS No. 114, as amended by SFAS No. 118, is effective
for years beginning after December 15, 1994. The Company adopted SFAS No. 114
as of July 1, 1995, as required, without a material effect on the Company's
consolidated financial condition or results of operations.
Accounting for ESOP. In November 1993, the AICPA approved Statement
of Position ("SOP") No. 93-6, "Employers' Accounting for Employee Stock
Ownership Plans." SOP 93-6 changed the measure of compensation recorded by
employers from the cost of ESOP shares to their fair value. To the extent that
the fair value of the Company's ESOP shares, committed to be released directly
to compensate employees differs from the cost of such shares, compensation
expenses and a related charge or credit to additional paid-in capital will be
reflected in the Company's financial statements. SOP No. 93-6 also requires
that shares committed to be released be considered as outstanding for earnings
per share computations. Management adopted SOP No. 93-6 in fiscal 1996 without
a material effect on the Company's consolidated financial condition or results
of operations.
Accounting for Stock-Based Compensation. In October 1994, the FASB
issued SFAS No. 123 entitled "Accounting for Stock Based Compensation." SFAS
No. 123 establishes a fair value based method of accounting for stock-based
compensation paid to employees. SFAS No. 123 recognizes the fair value of an
award of stock or stock options on the grant date and is effective for
transactions occurring after December 1995. Companies are allowed to continue
to measure compensation cost for those plans using the intrinsic value based
method of accounting, which generally does not result in compensation expense
recognition for most plans. Companies that elect to remain with the existing
accounting are required to disclose in a footnote to the financial statements
pro forma net earnings and, if presented, earnings per share, as if SFAS No. 123
had been adopted. Management has determined that the Company will continue to
account for stock-based compensation pursuant to Accounting Principles Board
Opinion No. 25, and therefore adoption of the disclosure provisions set forth in
SFAS No. 123 will not have a material effect on the Company's consolidated
financial condition or results of operations.
Derivative Financial Instruments. In October 1994, the FASB issued
SFAS No. 119, "Disclosure about Derivative Financial Instruments and Fair Value
of Financial Instruments," which is applicable for financial statements issued
for fiscal years ending after December 15, 1994, except for entities with less
than $150 million in total assets for which it is effective for fiscal years
ending after December 15, 1995. SFAS No. 119 requires the disclosure of the
amounts, nature and terms of derivative financial instruments that are not
subject to SFAS No. 105 because they do not result in off-balance sheet risk of
accounting loss. SFAS No. 119 requires that a distinction be made between
financial instruments held or issued for trading purposes and financial
instruments held or issued for purposes other than trading. It also amends SFAS
No. 105 and SFAS No. 107 to require that distinction in certain disclosures
required by those statements. The Company adopted SFAS No. 119 on July 1, 1995,
as required, without material effect on consolidated financial condition or
results of operations.
15
<PAGE>
Accounting for Transfers of Financial Assets. In June 1996, the FASB
issued SFAS No. 125, "Accounting for Transfer of Financial Assets, Servicing
Rights, and Extinguishment of Liabilities," that provides accounting guidance on
transfers of financial assets, servicing of financial assets, and extinguishment
of liabilities. SFAS No. 125 introduces an approach to accounting for transfers
of financial assets that provides a means of dealing with more complex
transactions in which the seller disposes of only a partial interest in the
assets, retains rights or obligations, makes use of special purpose entities in
the transaction, or otherwise has continuing involvement with the transferred
assets. The new accounting method, the financial components approach, provides
that the carrying amount of the financial assets transferred be allocated to
components of the transaction based on their relative fair values. SFAS No. 125
provides criteria for determining whether control of assets has been
relinquished and whether a sale has occurred. If the transfer does not qualify
as a sale, it is accounted for as a secured borrowing. Transactions subject to
the provisions of SFAS No. 125 include, among others, transfers involving
repurchase agreements, securitizations of financial assets, loan participations,
factoring arrangements, and transfers of receivables with recourse.
An entity that undertakes an obligation to service financial assets
recognizes either a servicing asset or liability for the servicing contract
(unless related to a securitization of assets, and all the securitized assets
are retained and classified as held-to-maturity). A servicing asset or
liability that is purchased or assumed is initially recognized at its fair
value. Servicing assets and liabilities are amortized in proportion to and over
the period of estimated net servicing income or net servicing loss and are
subject to subsequent assessments for impairment based on fair value.
SFAS No. 125 provides that a liability is removed from the balance
sheet only if the debtor either pays the creditor and is relieved of its
obligations for the liability or is legally released from being the primary
obligor. SFAS No. 125 is effective for transfers and servicing of financial
assets and extinguishment of liabilities occurring after December 31, 1996 and
is to be applied prospectively. Earlier or retroactive application is not
permitted. Management does not believe that adoption of SFAS No. 125 will have
a material adverse effect on the Company's consolidated financial position or
results of operations.
CONSOLIDATED FINANCIAL STATEMENTS
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
Page
<S> <C>
Independent Auditors' Report 17
Consolidated Statements of Financial Condition 18
September 30, 1996 and 1995
Consolidated Statements of Earnings for the years ended 19
September 30, 1996, 1995, and 1994
Consolidated Statements of Stockholders' Equity for the years ended 20
September 30, 1996, 1995, and 1994
Consolidated Statements of Cash Flows for the years ended 21
September 30, 1996, 1995, and 1994
Notes to Consolidated Financial Statements 23
</TABLE>
16
<PAGE>
[LETTERHEAD OF KPMG PEAT MARWICK LLP APPEARS HERE]
KPMG Peat Marwick LLP
4200 Norwest Center
90 South Seventh Street
Minneapolis, MN 55402
Independent Auditors' Report
The Board of Directors
First Federal Bancorporation:
We have audited the accompanying consolidated statements of financial condition
of First Federal Bancorporation and subsidiaries (the Company) as of September
30, 1996 and 1995, and the related consolidated statements of earnings,
stockholders' equity, and cash flows for each of the years in the three-year
period ended September 30, 1996. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the 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 financial position of First Federal
Bancorporation and subsidiaries at September 30, 1996 and 1995, and the results
of their operations and their cash flows for each of the years in the three-year
period ended September 30, 1996, in conformity with generally accepted
accounting principles.
As discussed in note 2 to the consolidated financial statements, the Company
changed its method of accounting for income taxes during the year ended
September 30, 1994 to adopt the provisions of Statement of Financial Accounting
Standards No. 109, Accounting for Income Taxes, and its method of accounting for
securities during the year ended September 30, 1994 to adopt the provisions of
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities.
/s/ KPMG Peat Marwick LLP
October 25, 1996
17
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
Consolidated Statements of Financial Condition
September 30, 1996 and 1995
<TABLE>
<CAPTION>
Assets 1996 1995
- - ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash $ 1,376,853 1,753,449
Interest-bearing deposits with banks 3,308,983 8,432,369
- - ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash eguivalents 4,685,836 10,185,818
- - ------------------------------------------------------------------------------------------------------------------------------------
Securities available for sale (amortized cost in 1996 and 1995 of $46,321,763
and $36,309,490, respectively):
Mortgage-backed and related securities 19,903,383 20,417,009
Other marketable securities 26,162,483 15,631,682
- - ------------------------------------------------------------------------------------------------------------------------------------
Total securities available for sale 46,065,866 36,048,691
- - ------------------------------------------------------------------------------------------------------------------------------------
Securities held to maturity (estimated market value of $852,112 and $1,119,855
in 1996 and 1995, respectively):
Mortgage-backed and related securities 845,605 1,106,402
- - ------------------------------------------------------------------------------------------------------------------------------------
Total securities he]d to maturity 845,605 1,106,402
- - ------------------------------------------------------------------------------------------------------------------------------------
Loans receivable, net 51,003,105 48,043,625
Federal Home Loan Bank stock, at cost 700,500 686,700
Foreclosed real estate, net 193,823 152,074
Accrued interest receivable 862,732 650,989
Premises and equipment, net 1,944,754 2,116,857
Other assets 953,880 515,671
- - ------------------------------------------------------------------------------------------------------------------------------------
$107,256,101 99,506,827
====================================================================================================================================
Liabilities and Stockholders' Equity
====================================================================================================================================
Deposits 81,046,519 82,060,466
Repurchase agreements 4,954,620 1,000,000
FHLB advances 6,943,258 0
Advance payments by borrowers for taxes and insurance 156,730 122,086
Accrued interest payable 587,779 525,064
Accrued SAIF assessment 588,444 0
Accrued expenses and other liabilities 656,053 708,609
- - ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 94,933,403 84,416,225
Commitments and contingencies
Stockholders' equity:
Common stock ($.01 par value): Authorized 4,000,000 shares;
issued 700,566 and 862,500 shares in 1996 and 1995 7,006 8,625
Additional paid-in capital 6,372,253 7,964,894
Retained earnings, subject to certain restrictions 7,558,604 7,892,170
Unrealized loss on securities available for sale, net (150,979) (154,087)
Unearned employee stock ownership plan shares (552,000) (621,000)
Unearned management recognition plan shares (377,775) 0
Treasury stock, at cost, 36,563 shares (534,411) 0
- - ------------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 12,322,698 15,090,602
- - ------------------------------------------------------------------------------------------------------------------------------------
$107,256,101 99,506,827
====================================================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
18
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
Consolidated Statements of Earnings
Years ended September 30, 1996, 1995, and 1994
<TABLE>
<CAPTION>
1996 1995 1994
- - ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income:
Loans receivable $ 4,470,858 4,273,919 3,893,067
Mortgage-backed and related securities 1,406,698 1,155,578 736,054
Other marketable securities 1,339,367 1,021,520 855,300
Interest-bearing deposits with banks 161,052 230,511 71,391
Other 50,561 50,665 56,788
- - ------------------------------------------------------------------------------------------------------------------------------------
Total interest income 7,428,536 6,732,193 5,612,600
- - ------------------------------------------------------------------------------------------------------------------------------------
Interest expense:
Deposits 3,736,423 3,522,637 2,840,485
Borrowings 279,768 24,684 0
- - ------------------------------------------------------------------------------------------------------------------------------------
Total interest expense 4,016,191 3,547,321 2,840,485
- - ------------------------------------------------------------------------------------------------------------------------------------
Net interest income 3,412,345 3,184,872 2,772,115
Provision for loan losses 0 3,701 16,310
- - ------------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision
for loan losses 3,412,345 3,181,171 2,755,805
- - ------------------------------------------------------------------------------------------------------------------------------------
Noninterest income:
Fees and service charges 409,631 300,430 289,380
Gain (loss) on sales of securities 5,350 (10,029) (20,283)
Gain (loss) on sales of foreclosed real estate 5,643 2,558 (2,353)
Other 112,722 67,841 87,840
- - ------------------------------------------------------------------------------------------------------------------------------------
Total noninterest income 533,346 360,800 354,584
- - ------------------------------------------------------------------------------------------------------------------------------------
Noninterest expense:
Compensation and employee benefits 1,423,486 1,238,222 1,059,831
Occupancy 498,075 418,083 399,857
Federal deposit insurance premiums 220,710 216,158 205,778
SAIF assessment 588,444 0 0
Data processing 70,161 70,045 66,595
Advertising 93,535 84,971 57,407
Provision for real estate losses 0 26,836 10,759
Other 519,133 332,945 362,783
- - ------------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 3,413,544 2,387,260 2,163,010
- - ------------------------------------------------------------------------------------------------------------------------------------
Earnings before income tax expense and
cumulative effect of accounting change 532,147 1,154,711 947,379
Income tax expense 215,647 472,926 410,383
- - ------------------------------------------------------------------------------------------------------------------------------------
Earnings before cumulative effect of
accounting change 316,500 681,785 536,996
Cumulative effect of accounting change 0 0 120,000
- - ------------------------------------------------------------------------------------------------------------------------------------
Net earnings $ 316,500 681,785 656,996
====================================================================================================================================
Earnings per common share $ .42 .49 N/A
Pro forma earnings per common share N/A .86 N/A
Weighted average number of shares outstanding 746,019 797,004 N/A
</TABLE>
N/A--Not applicable.
The accompanying notes are an integral part of these financial statements.
19
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years ended September 30, 1996, 1995, and 1994
<TABLE>
<CAPTION>
Unrealized Unearned
loss on employee Unearned
Additional securities stock management
Common paid-in Retained available ownership recognition Treasury
stock capital earnings for sale, net plan shares plan shares stock Total
- - ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1993 $ 0 0 6,553,389 0 0 0 0 6,553,389
Net earnings 0 0 656,996 0 0 0 0 656,996
Change in accounting for
securities, net of
tax effect 0 0 0 (644,342) 0 0 0 (644,342)
- - ----------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 1994 0 0 7,210,385 (644,342) 0 0 0 6,566,043
Net earnings 0 0 681,785 0 0 0 0 681,785
Change in net unrealized loss
on securities available for
sale, net of tax effect 0 0 0 490,255 0 0 0 490,255
Sale of common stock 8,625 7,950,519 0 0 0 0 0 7,959,144
Adoption of employee stock
ownership plan 0 0 0 0 (690,000) 0 0 (690,000)
Earned employee stock
ownership plan shares 0 14,375 0 0 69,000 0 0 83,375
- - ----------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 1995 8,625 7,964,894 7,892,170 (154,087) (621,000) 0 0 15,090,602
Net earnings 0 0 316,500 0 0 0 0 316,500
Change in net unrealized loss
on securities available for
sale, net of tax effect 0 0 0 3,108 0 0 0 3,108
Purchase of treasury stock 0 0 0 0 0 0 (1,008,341) (1,008,341)
Purchase and retirement of
common stock (1,619) (1,617,721) (650,066) 0 0 0 0 (2,269,406)
Adoption of management
recognition plan 0 (1,711) 0 0 0 (472,219) 473,930 0
Earned management recognition
plan shares 0 0 0 0 0 94,444 0 94,444
Earned employee stock
ownership plan shares 0 26,791 0 0 69,000 0 0 95,791
- - ----------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 1996 $ 7,006 6,372,253 7,558,604 (150,979) (552,000) (377,775) (534,411) 12,322,698
==================================================================================================================================
</TABLE>
The accompanying notes are an integral part of these financial statements.
20
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended September 30, 1996, 1995, and 1994
<TABLE>
<CAPTION>
1996 1995 1994
- - ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating activities:
Net earnings $ 316,500 681,785 656,996
Adjustments to reconcile net earnings to net
cash provided by operations:
Provision for loan and real estate losses 0 30,537 27,069
Depreciation 281,862 165,396 228,679
Amortization of premium and discount, net 6,404 59,422 101,177
(Increase) decrease in accrued interest receivable (211,743) (93,508) 64,358
Increase in accrued interest payable 62,715 185,541 71,242
FHLB stock dividend (13,800) 0 0
(Gain) loss on sales of securities (5,350) 10,029 20,283
(Gain) loss on sales of foreclosed real estate (5,643) (2,558) 2,353
SAIF assessment 588,044 0 0
(Increase) decrease in other assets (438,209) 476,899 (294,603)
Increase (decrease) in accrued expenses and other liabilities (52,556) 143,780 32,149
Earned ESOP shares priced above original cost 26,791 14,375 0
Decrease in unearned ESOP shares 69,000 69,000 0
Decrease in unamortized restricted stock 94,444 0 0
Other, net 11,305 (49,277) 25,264
- - -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by
operating activities 729,764 1,691,421 934,967
- - -----------------------------------------------------------------------------------------------------------------------------------
Investing activities:
Net (increase) decrease in loans receivable (2,959,480) (1,666,407) 2,549,660
Purchases of:
Securities available for sale (23,046,489) (14,832,131) (1,590,670)
Securities held to maturity 0 (5,350,829) (14,077,623)
Premises and equipment (109,759) (351,041) (145,494)
Proceeds from sales of:
Securities available for sale 2,434,785 84,230 0
Securities held to maturity 0 0 209,436
Proceeds from maturities of:
Securities available for sale 6,828,824 3,598,798 0
Securities held to maturity 0 6,842,000 7,661,558
Principal payments on mortgage-backed and related securities:
Available for sale 3,761,386 2,207,120 0
Held to maturity 261,908 331,254 4,064,026
Net increase in foreclosed real estate (41,749) (89,374) (74,079)
- - -----------------------------------------------------------------------------------------------------------------------------------
Net cash used by investing
activities (12,870,574) (9,226,380) (1,403,186)
- - -----------------------------------------------------------------------------------------------------------------------------------
Financing activities:
Net increase (decrease) in deposits (1,013,947) 2,434,458 2,113,076
Increase (decrease) in advance payments by
borrowers for taxes and insurance 34,644 (37,860) 48,519
Increase in repurchase agreements 3,954,620 1,000,000 0
Increase in FHLB advances 6,943,258 0 0
Adoption of ESOP 0 (690,000) 0
Proceeds from the sale of common stock 0 7,959,144 0
Purchase of treasury stock (1,008,341) 0 0
Purchase and retirement of common stock (2,269,406) 0 0
- - ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by
financing activities 6,640,828 10,665,742 2,161,595
- - -----------------------------------------------------------------------------------------------------------------------------------
(Continued)
</TABLE>
21
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
1996 1995 1994
- - ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Increase (decrease) in cash
and cash equivalents $ (5,499,982) 3,130,783 1,693,376
Cash and cash equivalents, beginning of year 10,185,818 7,268,855 5,575,479
- - ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 4,685,836 10,399,638 7,268,855
- - ------------------------------------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 3,953,476 3,361,780 2,769,243
Income taxes 487,076 476,592 429,200
Noncash investing activities:
Transfer of loans to foreclosed real estate, net 50,756 89,374 74,079
Transfer of securities held to maturity to
securities available for sale 0 O 27,485,604
</TABLE>
The accompanying notes are an integral part of these financial statements.
22
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1996
(1) Description of the Business
First Federal Bancorporation (the Company) was incorporated under the
laws of the State of Minnesota for the purpose of becoming the savings
and loan holding company of First Federal Banking and Savings, FSB (the
Bank) in connection with the Bank's conversion from a federally
chartered mutual savings bank to a federally chartered stock savings
bank. The Company commenced on September 23, 1994, a Subscription and
Community Offering of its stock in connection with the conversion of the
Bank (the Offering). The Offering was closed on March 31, 1995 and the
conversion was consummated on April 3, 1995.
The consolidated financial statements included herein are for the Company,
the Bank, and the Bank's wholly-owned subsidiary, First Federal Service
Corporation. All significant intercompany accounts and transactions have
been eliminated in consolidation. All financial information prior to
April 3, 1995 contained herein relates solely to the Bank and its
subsidiary.
(2) Summary of Significant Accounting Policies
The accounting and reporting policies of the Company and its subsidiaries
conform to generally accepted accounting principles and to general
practice within the savings and loan industry. The following is a
description of the more significant of those policies that the Company
follows in preparing and presenting its consolidated financial
statements.
Material Estimates
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 statement of financial condition and
revenues and expenses for the period. Actual results could differ
significantly from those estimates. A material estimate that is
particularly susceptible to significant change in the near-term relates
to the determination of the allowance for loan losses.
Management believes that the allowance for loan losses is adequate. While
management used available information to recognize losses on loans,
future additions to the allowance may be necessary based on changes in
economic conditions. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the
allowance for loan losses. Such agencies may require additions to the
allowance based on their judgment about information available to them at
the time of their examination.
(Continued)
23
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
Securities
In May 1993 the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 115, Accounting for Certain
Investments in Debt and Equity Securities. This statement addresses the
accounting and reporting for investments by classifying them into three
categories: trading, available for sale, or held to maturity. Trading
securities are bought and held principally for the purpose of selling them in
the near term. Securities available for sale include securities that
management intends to use as part of its asset/liability strategy or that may
be sold in response to changes in interest rate, changes in prepayment risk,
or other factors. Management has the ability and intent to hold securities,
other than those designated as trading or available for sale, to maturity.
The Bank adopted SFAS No. 115 as of September 30, 1994. Upon implementation
of SFAS No. 115, certain collateralized mortgage obligations, U.S. government
and agency securities, and corporate bonds and notes classified as securities
held to maturity at September 30, 1994, with a carrying amount aggregating
$27,485,604 and an approximate market value of $26,461,299, were transferred
to a portfolio of securities available for sale. The impact of adoption on
the Bank's consolidated financial statements was a decrease in stockholders'
equity of $644,342 as of September 30, 1994.
Securities available for sale are carried at market value at September 30, 1996
and 1995. Net unrealized gains and losses, net of tax effect, are credited or
charged to stockholders' equity. Securities held to maturity are carried at
amortized cost unless a decline in market value is determined to be other
than a temporary decline, when a loss in the value of the investment would be
recognized. Gains and losses on sales of securities are recognized at the
time of sale and are calculated based on the specific identification method.
Premiums and discounts are amortized using the interest method over the term of
the securities.
Loans Receivable
Loans are considered long-term investments and, accordingly, are carried at
historical cost.
Discounts and premiums on loans originated or purchased are amortized to income
using the interest method over the estimated average loan life.
The allowance for loan losses is maintained at an amount considered adequate to
provide for probable losses. The allowance for loan losses is based on
periodic analysis of the loan portfolio by management. In this analysis
management considers factors including, but not limited to, specific
occurrences, general economic conditions, loan portfolio composition, and
historical experience. Loans are charged off to the extent they are deemed to
be uncollectible.
Loan origination and commitment fees and certain direct loan origination costs
are deferred and amortized over the life of the related loans using the
interest method.
(Continued)
24
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
Interest income is recognized on an accrual basis except when collectibility is
in doubt. When interest accruals are suspended, interest previously accrued
is reversed. Interest is subsequently recognized as income to the extent cash
is received when, in management's judgment, principal is collectible.
Effective October 1, 1995, the Company adopted SFAS No. 114, Accounting by
Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors
for Impairment of a Loan--Income Recognition and Disclosures. SFAS No. 114
requires that impaired loans, including all loans that are restructured in a
troubled debt restructuring involving a modification of terms, be measured at
the present value of expected future cash flows discounted at the loan's
initial effective interest rate. The fair value of the collateral of an
impaired collateral-independent loan or an observable market price, if one
exists, may be used as an alternative to discounting. If the measure of the
impaired loan is less than the recorded investment in the loan, impairment is
to be recognized through the allowance for loan losses. A loan is considered
impaired when, based on current information and events, it is probable that a
creditor will be unable to collect all amounts due according to the
contractual terms of the loan agreement. SFAS No. 118 amends SFAS No. 114 to
allow a creditor to use existing methods for recognizing interest income on
impaired loans and to clarify disclosure requirements. The adoption of SFAS
No. 114 and SFAS No. 118 did not impact the Company's results of operations
for fiscal 1996 or any prior period. In accordance with SFAS No. 114 and SFAS
No. 118, prior period financial statements have not been restated to reflect
the change in accounting method.
Foreclosed Real Estate
Real estate acquired in the settlement of loans is carried at the lower of the
unpaid loan balance plus settlement costs or estimated fair market value less
selling costs at the time of foreclosure. The carrying value of individual
properties is periodically evaluated and reduced to the extent cost exceeds
estimated fair value less selling costs. Costs of developing and improving
such properties are capitalized. Expenses related to holding such real
estate, net of rental and other income, are charged against income as
incurred.
Premises and Equipment
Land is carried at cost. Office buildings, improvements, furniture, and
equipment are carried at cost less accumulated depreciation.
Depreciation is computed on a straight-line basis over the estimated useful
lives of 20 to 40 years for office buildings and improvements and 3 to 10
years for furniture and equipment.
(Continued)
25
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
Income Taxes
In February 1992, the FASB issued SFAS No. 109, Accounting for Income Taxes. The
Company adopted SFAS No. 109 as of October 1, 1993. Prior to adopting SFAS
No. 109, the Company accounted for income taxes in accordance with Accounting
Principles Board Opinion (APB) No. 11, Accounting for Income Taxes. SFAS No.
109 requires a change from the deferred method of accounting for income taxes
of APB No. 11 to the asset and liability method of SFAS No. 109. Under the
asset and liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to temporary
differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected
to be recovered or settled. Under SFAS No. 109, the effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date. The cumulative effect of the
application of SFAS No. 109 increased net earnings for the year ended
September 30, 1994 by $120,000.
Cash Equivalents
Cash equivalents primarily represent amounts on deposit at other financial
institutions and highly liquid financial instruments with original maturities
at the date of purchase of three months or less
Earnings per Share
The earnings per share for 1995 were computed by dividing net earnings of
$393,779 from the date of conversion, April 3, 1995, to the end of the year,
September 30, 1995, by the weighted average common stock shares outstanding
of 797,004 for the period. Pro forma earnings per common share were computed
by dividing net income of $681,785 for the year ended September 30, 1995, by
the weighted average common stock shares outstanding of 797,004 for the
period. This computation does not reflect the pro forma effects of the
investment income that would have been received had the net proceeds from the
stock offering been received at the beginning of the year. Earnings per share
amounts have not been presented for the year ended September 30, 1994, which
was prior to the stock conversion.
Reclassifications
Certain prior year amounts have been reclassified to conform with the 1996
presentation.
(Continued)
26
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
New Accounting Standards
In October 1995, the Financial Accounting Standards Board (FASB) issued SFAS No.
123, Accounting for Stock-Based Compensation. This statement establishes
financial Accounting and reporting standards for stock-based employee
compensation plans. This statement defines a fair value based method of
accounting for an employee stock option or similar equity instrument and
encourages all entities to adopt that method of accounting for all of their
employee stock compensation plans. However, it also allows an entity to
continue to measure compensation cost for those plans using the intrinsic
value base method of accounting prescribed by APB Opinion No. 25, Accounting
for Stock Issued to Employees. The statement requires pro forma disclosures
of net income and earnings per share computed as if the fair value based
method had been applied in financial statements of companies that continue to
follow current practice in accounting for such arrangements under Opinion 25.
The changes required by the new statement could affect employers' financial
statements in a number of ways. Companies that historically have provided
fixed stock options to employees or have established broad-based plans will
generally experience a negative earnings impact (either in the basic income
statement or in the required pro forma net income disclosures). Conversely,
compensation cost will generally be reduced for companies that rely
predominantly on performance-based or other variable plan awards. The effect
on net income (or pro forma net income), whether positive or negative, will
be amplified for companies that rely heavily on stock-based compensation
awards as a critical element in their overall compensation strategy. The
accounting requirements of this statement are effective for transactions
entered into in fiscal years that begin after December 15, 1995, although
they may be adopted on issuance. The disclosure requirements of this
statement are effective for financial statements for fiscal years beginning
after December 15, 1995, or for an earlier fiscal year for which this
statement is initially adopted for recognizing compensation cost. The
adoption of this statement will not have a significant impact on the
Company's financial condition or results of operations.
In June 1996, the FASB issued SFAS No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities. This
statement establishes accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities. Those
standards are based on consistent application of a financial-components
approach that focuses on control. Under that approach, after a transfer of
financial assets, an entity recognizes the financial and servicing assets it
controls and the liabilities it has incurred, derecognizes financial assets
when control has been surrendered, and derecognizes liabilities when
extinguished. This statement provides consistent standards for distinguishing
transfers of financial assets that are sales from transfers that are secured
borrowings.
(Continued)
27
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
This statement is effective for transfers and servicing of financial assets
and extinguishments of liabilities occurring after December 31, 1996, and
is to be applied prospectively. Earlier or retroactive application is not
permitted. The adoption of this statement will not have a significant
impact on the Company's financial condition or results of operations.
(3) Securities Available for Sale
A summary of securities available for sale at September 30, 1996 and 1995
is as follows:
<TABLE>
<CAPTION>
1996
---------------------------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized market
Description cost gains losses value
-----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed
securities:
FNMA $ 3,325,833 10,480 (77,117) 3,259,196
GNMA 442,206 15,071 (2,127) 455,150
FHLMC 5,383,467 10,241 (103,876) 5,289,832
Collateralized mortgage
obligations and
REMICS 10,976,862 28,500 (106,157) 10,899,205
-----------------------------------------------------------------------------------------------------------
Total
mortgage-
backed and
related
securities 20,128,368 64,292 (289,277) 19,903,383
-----------------------------------------------------------------------------------------------------------
Other marketable
securities:
U.S. government and
agency securities 16,389,327 8,122 (223,844) 16,173,605
Corporate bonds and
notes 7,461,252 31,822 (85,601) 7,407,473
Municipal bonds 497,815 4,685 (4,089) 498,411
Mutual funds 1,845,001 286,874 (48,881) 2,082,994
-----------------------------------------------------------------------------------------------------------
Total other
marketable
securities 26,193,395 331,503 (362,415) 26,162,483
-----------------------------------------------------------------------------------------------------------
$ 46,321,763 395,795 (651,692) 46,065,866
===========================================================================================================
</TABLE>
(Continued)
28
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
1996
---------------------------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized market
Description cost gains losses value
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed
securities:
FNMA $ 3,068,640 25,217 (39,288) 3,054,569
GNMA 313,510 22,404 0 335,914
FHLMC 4,920,673 21,810 (52,501) 4,889,982
Collateralized mortgage
obligations and REMICS 12,225,300 36,274 (125,030) 12,136,544
-----------------------------------------------------------------------------------------------------------
Total
mortgage-
backed and
related
securities 20,528,123 105,705 (216,819) 20,417,009
-----------------------------------------------------------------------------------------------------------
Other marketable securities:
U.S. government and
agency securities 7,255,927 6,640 (197,874) 7,064,693
Corporate bonds and
notes 6,439,279 29,572 (78,416) 6,390,435
Municipal funds 1,836,161 119,857 (29,464) 1,926,554
Mutual bonds 250,000 0 0 250,000
-----------------------------------------------------------------------------------------------------------
Total other
marketable
securities 15,781,367 156,069 (305,754) 15,631,682
-----------------------------------------------------------------------------------------------------------
$ 36,309,490 261,774 (522,573) 36,048,691
-----------------------------------------------------------------------------------------------------------
(Continued)
</TABLE>
29
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
The amortized cost and estimated market value of other marketable
securities available for sale at September 30, 1996 and 1995, by
contractual maturity, is shown below. Expected maturities may differ from
contractual maturities because obligors may have the right to call or
prepay obligations with or without ail or prepayment penalties:
<TABLE>
<CAPTION>
September 30, 1996 September 30, 1995
---------------------------------- --------------------------------
Estimated Estimated
Amortized market Amortized market
Cost value cost value
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Due in one year or less $ 1,376,103 1,378,018 2,455,240 2,457,959
Due after one year
through five years 17,729,883 17,508,632 10,491,658 10,255,906
Due after five years
through ten years 4,694,594 4,649,339 748,308 741,263
Due after ten years 547,814 543,500 250,000 250,000
Mutual funds with no
stated maturity 1,845,001 2,082,994 1,836,161 1,926,554
-------------------------------------------------------------------------------------------------------------------
$ 26,193,395 26,162,483 15,781,367 15,631,682
</TABLE>
Proceeds from the sale of securities available for sale that were sold
during 1996 were $2,434,785 resulting in gross gains of $7,537 and gross
losses of $2,187.
Proceeds from the sale of securities available for sale that were sold
during 1995 were $84,230 resulting in gross losses of $10,029.
(4) Securities Held to Maturity
A summary of securities held to maturity at September 30, 1996 and 1995
is as follows:
<TABLE>
<CAPTION>
1996
------------------------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized market
Description cost gains losses value
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities:
FNMA $ 192,177 330 (2,386) 190,121
GNMA 52,628 737 (268) 53,097
FHLMC 244,921 8,942 0 253,863
FHA 145,662 0 (68) 145,594
-------------------------------------------------------------------------------------------------------------------
Collateralized mortgage
obligations and REMICS 210,217 3,022 (3,802) 209,437
-------------------------------------------------------------------------------------------------------------------
Total mortgage-backed and
related securities $ 845,605 13,031 (6,524) 852,112
-------------------------------------------------------------------------------------------------------------------
(Continued)
</TABLE>
30
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
1995
----------------------------------------------------------------------
Gross Gross Estimated
Amortized unrealized unrealized market
Description cost gains losses value
----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities:
FNMA $ 227,666 823 (1,875) 226,614
GNMA 93,508 2,730 (688) 95,550
FHLMC 314,946 12,565 0 327,511
FHA 177,609 0 (102) 177,507
Collateralized mortgage
obligations and REMICS 292,673 0 0 292,673
----------------------------------------------------------------------------------------------------------------
Total mortgage-
backed and
related securities $ 1,106,402 16,118 (2,665) 1,119,855
================================================================================================================
</TABLE>
There were no sales of securities held to maturity during the years ended
September 30, 1996 or 1995. Proceeds from the sale of securities held to
maturity that were sold during 1994 were $209,436 resulting in gross
losses of $20,283.
(5) Loans Receivable
Loans receivable consisted of the following:
<TABLE>
<CAPTION>
September 30
----------------------------
1996 1995
-------------------------------------------------------------------------------------------------------------
<S> <C> <C>
One-to-four-family residential loans $ 26,294,685 29,045,912
Commercial real estate and multifamily residential
loans 12,904,658 10,491,578
Consumer loans 10,686,848 8,366,181
Commercial business loans 2,141,805 1,467,337
-------------------------------------------------------------------------------------------------------------
52,027,996 49,371,008
Less:
Loans in process 627,273 744,134
Deferred fees and discounts (premiums) (55,842) 91,867
Allowance for loan losses 453,460 491,382
-------------------------------------------------------------------------------------------------------------
$ 51,003,105 48,043,625
=============================================================================================================
Weighted average contractual interest rate 9.07% 9.21%
=============================================================================================================
</TABLE>
(Continued)
31
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
Nonaccrual loans totaled $55,434 and $13,905 at September 30, 1996 and 1995,
respectively. There were no restructured loans at September 30, 1996 and 1995.
Nonaccrual loans are the only loans that are considered to be impaired by the
Company under the criteria established by SFAS No. 114 and SFAS No. 118. The
related allowance for credit losses as of September 30, 1996 was $8,315. The
average investment in impaired loans during fiscal 1996 was $24,100.
The effect of impaired and nonaccrual loans on interest income for the years
ended September 30 were:
<TABLE>
<CAPTION>
1996 1995 1994
- - ----------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income:
As originally contracted $ 4,552 1,281 2,152
As recognized 0 0 0
- - ----------------------------------------------------------------------------
Reduction of interest income $ 4,552 1,281 2,152
- - ----------------------------------------------------------------------------
</TABLE>
There are no material commitments to lend additional funds to customers whose
loans were classified as nonaccrual.
The aggregate amount of loans to directors and executive officers was $135,423,
$163,056, and $111,019 at September 30, 1996, 1995, and 1994, respectively.
Activity with respect to these loans during fiscal 1996 included loan
originations of $24,040 and loan repayments of $51,673. Activity with respect
to these loans during fiscal 1995 included loan originations of $79,869 and
loan repayments of $27,832. Activity with respect to these loans during fiscal
1994 included loan originations of $22,200 and loan repayments of $26,611. Such
loans were made in the ordinary course of business on normal credit terms,
including interest rate and collateralization, and do not represent more than
normal risk of collection.
The Bank grants residential and commercial real estate loans and consumer loans
primarily to customers in northern Minnesota. Although the Bank has a
diversified loan portfolio, a substantial portion of its debtors' abilities to
honor their loans are dependent upon the local economy in northern Minnesota.
At September 30, 1996, 1995, and 1994 the Bank was servicing real estate loans
for others with aggregate unpaid principal balances of approximately $192,474,
$237,162, and $313,310, respectively.
(Continued)
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
(6) Allowance for Losses on Loans Receivable and Foreclosed Real Estate
<TABLE>
<CAPTION>
Loans Real
receivable estate Total
-----------------------------------------------------------------
<S> <C> <C> <C>
Balance September 30, 1993 $ 549,352 4,590 553,942
Provision for losses 16,310 10,759 27,069
Charge-offs (56,916) 0 (56,916)
Recoveries 19,927 0 19,927
-----------------------------------------------------------------
Balance September 30, 1994 528,673 15,349 544,022
Provision for losses 3,701 26,836 30,537
Charge-offs (48,617) (15,349) (63,966)
Recoveries 7,625 0 7,625
-----------------------------------------------------------------
Balance September 30,1995 491,382 26,836 518,218
Provision for losses 0 0 0
Charge-offs (49,801) 0 (49,801)
Recoveries 11,879 7,368 19,247
-----------------------------------------------------------------
Balance September 30, 1996 $ 453,460 34,204 487,664
=================================================================
</TABLE>
(7) Foreclosed Real Estate
Foreclosed real estate consisted of the following:
<TABLE>
<CAPTION>
September 30
----------------------
1996 1995
---------------------------------------------------------------------
<S> <C> <C>
Real estate acquired through foreclosure or
deed in lieu of foreclosure $ 189,077 0
Real estate injudgment (subject to redemption) 38,950 178,910
---------------------------------------------------------------------
228,027 178,910
Less allowance for losses 34,204 26,836
---------------------------------------------------------------------
$ 193,823 152,074
=====================================================================
</TABLE>
(Continued)
33
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
(8) Accrued Interest Receivable
Accrued interest receivable is summarized as follows:
<TABLE>
<CAPTION>
September 30
-----------------------
1996 1995
--------------------------------------------------------------------
<S> <C> <C>
Mortgage-backed and related securities $ 59,218 65,252
Other marketable securities 453,891 272,531
Loans receivable 349,623 313,206
--------------------------------------------------------------------
$ 862,732 650,989
--------------------------------------------------------------------
</TABLE>
(9) Premises and Equipment
Premises and equipment consisted of the following:
<TABLE>
<CAPTION>
September 30
------------------------
1996 1995
--------------------------------------------------------------------
<S> <C> <C>
Land and improvements $ 222,667 204,431
Office buildings 1,561,513 1,562,721
Furniture and equipment 1,752,722 1,789,082
Leasehold improvements 170,965 170,965
Automobile 27,519 27,519
--------------------------------------------------------------------
3,735,386 3,754,718
Less accumulated depreciation and
amortization (1,790,632) (1,637,861)
--------------------------------------------------------------------
$ 1,944,754 2,116,857
</TABLE>
(Continued)
34
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
(10) Deposits
Deposits consisted of the following at September 30:
<TABLE>
<CAPTION>
1996 1995
---------------------------------------------- ------------------------------------------------
Weighted Weighted
average Percent average Percent
rate Amount of total rate Amount of total
- - ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Noninterest
NOW 0.00% $ 2,366,924 2.92% 0.00% $ 2,070,576 2.52%
NOW 2.05 8,150,951 10.06 2.11 8,031,538 9.79
Passbook 2.00 8,539,868 10.53 2.50 9,310,788 11.35
Money
market 3.00 8,757,336 10.81 3.00 8,979,453 10.94
---------------------------- ---------------------------
2.16 27,815,079 34.32 2.37 28,392,355 34.60
---------------------------- ---------------------------
Certificates:
2-2.99% 2.43 3,693 0.00 2.50 3,924 0.00
3-3.99% 3.90 1,603 0.00 3.83 762,582 0.93
4-4.99% 4.73 3,459,019 4.27 4.46 4,274,458 5.21
5-5.99% 5.44 31,198,668 38.49 5.57 27,053,471 32.97
6-6.99% 6.41 16,015,025 19.77 6.39 18,554,901 22.61
7-7.99% 7.19 2,553,432 3.15 7.21 3,018,775 3.68
---------------------------- ---------------------------
5.77 53,231,440 65.68 5.83 53,668,111 65.40%
---------------------------- ---------------------------
4.53 $ 81,046,519 100.00% 4.63 $ 82,060,466 100.00%
---------------------------- ---------------------------
</TABLE>
At September 30, 1996 and 1995 the Bank had $8,196,119 and
$8,388,837, respectively, of deposit accounts with balances of
$100,000 or more. The Bank did not have any brokered deposits at
September 30, 1996 or 1995.
Certificates had the following remaining maturities at September 30:
<TABLE>
<CAPTION>
1996 1995
-------------------------- --------------------------
Weighted Weighted
average average
Amount rate Amount rate
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
0-6 months $ 19,776,416 5.46% $ 17,973,152 5.50%
7-12 months 9,881,489 5.65 11,072,622 5.70
13-36 months 17,621,005 5.94 17,409,952 5.98
Over 36 months 5,952,530 6.49 7,212,385 6.54
------------ ------------
$ 53,231,440 5.77 $ 53,668,111 5.83
------------ ------------
</TABLE>
(Continued)
35
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
Mortgage-backed securities with an amortized cost of $7,475,855 and
$l0,627,225 at September 30, 1996 and 1995, respectively, were
pledged as collateral for certain deposits.
Interest expense on deposits is summarized as follows for the years
ended September 30:
<TABLE>
<CAPTION>
1996 1995 1994
------------------------------------------------------------------
<S> <C> <C> <C>
NOW $ 156,807 136,308 127,828
Passbook 186,057 234,468 213,763
Money Market 260,403 262,952 206,555
Certificates 3,133,156 2,888,909 2,292,339
------------------------------------------------------------------
$ 3,736,423 3,522,637 2,840,485
==================================================================
</TABLE>
(11) Income Taxes
Federal and state income tax expense (benefit) is as follows for the
years ended September 30:
<TABLE>
<CAPTION>
1996 1995 1994
------------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ 408,257 405,813 282,262
State 136,086 129,669 90,191
------------------------------------------------------------------
Total current 544,343 535,482 372,453
------------------------------------------------------------------
Deferred:
Federal (246,522) (47,408) 28,745
State (82,174) (15,148) 9,185
------------------------------------------------------------------
Total deferred (328,696) (62,556) 37,930
------------------------------------------------------------------
$ 215,647 472,926 410,383
==================================================================
</TABLE>
The actual effective tax rate differs from the "expected" income tax
rate, computed at the statutory federal corporate tax rate, as
follows:
<TABLE>
<CAPTION>
Year ended September 30
--------------------------
1996 1995 1994
------------------------------------------------------------------
<S> <C> <C> <C>
Statutory federal rate 34.0% 34.0% 34.0%
State tax, net of federal benefit 6.7 6.5 6.9
Other (0.2) 0.5 2.4
------------------------------------------------------------------
40.5% 41.0% 43.3%
------------------------------------------------------------------
(Continued)
</TABLE>
36
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
The tax effects of temporary differences that give rise to the deferred
tax assets and deferred tax liabilities are as follows at September
30:
<TABLE>
<CAPTION>
1996 1995
---------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses $ 172,768 121,278
Deferred compensation 207,810 161,207
Deferred loan fees 25,206 37,179
Unrealized loss on securities available for sale 102,639 103,587
SAIF assessment 238,143 0
Other 8,651 13,368
---------------------------------------------------------------------------------------
Total gross deferred tax assets 755,217 436,619
---------------------------------------------------------------------------------------
Deferred tax liabilities:
Premises and equipment 152,741 169,473
FHLB stock 102,632 97,047
Accrued real estate taxes 25,313 24,119
Prepaid insurance 19,471 18,668
---------------------------------------------------------------------------------------
Total deferred tax liabilities 300,157 309,307
---------------------------------------------------------------------------------------
Net deferred tax asset $ 455,060 127,312
=======================================================================================
</TABLE>
No valuation allowance was required as of September 30, 1996 and 1995.
Under the Internal Revenue Code, the Company is permitted to deduct an
annual addition to a reserve for bad debts. Bad debt deductions for
income tax purposes are included in taxable income of later years
only if the bad debt reserves are used for purposes other than to
absorb bad debt losses. Because the Bank does not intend to use the
reserve for purposes other than to absorb losses, no deferred
income taxes have been provided. Retained earnings at September 30,
1996 include approximately $2,860,l00 for which no deferred taxes
have been provided.
(12) Short-term Borrowings
Repurchase agreements consist of sales of securities under agreements
to repurchase the identical securities. The agreements generally
mature within 180 days and bear a weighted average interest rate of
approximately 5.5% at September 30, 1996 and 1995, respectively.
The agreements are treated as financings with the obligations to
repurchase securities reflected as a liability and the dollar
amount of the securities collateralizing the agreements remaining
in the asset accounts. The securities collateralizing the
agreements are in safekeeping at the Federal Home Loan Bank of Des
Moines in the Bank's account. At September 30, 1996, the agreements
were collateralized by securities totaling approximately
$5,450,000.
(Continued)
37
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
Advances from the Federal Home Loan Bank (FHLB) of Des Moines as of
September 30, 1996 are summarized as follows:
<TABLE>
<CAPTION>
Average
Year due rate Amount
-------------------------------------------------------------------
<S> <C> <C>
1997 5.63% $ 6,860,718
1998 6.24 22,589
1999 6.24 23,810
2000 6.24 25,193
2001 6.24 10,948
-------------------------------------------------------------------
5.64 $ 6,943,258
===================================================================
</TABLE>
At September 30, 1996, the FHLB advances are secured by the FHLB stock,
mortgage loans, and government agency securities totaling
approximately $8,336,000.
(13) Stock Repurchases
In December 1995, the Company repurchased 34,500 shares of the
Company's outstanding common stock. The average repurchase price was
$13.70 per share. Repurchased shares are held as treasury shares and
will be utilized for the issuance of shares in conjunction with the
Management Recognition Plan.
In February 1996, the Company repurchased and retired 43,125 shares of
the Company's outstanding common stock. The average repurchase price
was $14.00 per share.
In May 1996, the Company repurchased and retired 40,969 shares of the
Company's outstanding common stock. The average repurchase price was
$13.50 per share.
In August 1996, the Company repurchased and retired 77,840 shares of
the Company's outstanding common stock. The average repurchase price
was $14.29 per share.
In August 1996, the Company repurchased 15,000 shares of the Company's
outstanding common stock. The average repurchase price was $13.95
per share. Repurchased shares are held as treasury shares and will
be utilized for the issuance of shares in conjunction with the Stock
Option Plan.
In September 1996, the Company repurchased 21,563 shares of the
Company's outstanding common stock. The average repurchase price was
$l5.07 per share. Repurchased shares are held as treasury shares and
will be used for general corporate purposes.
(14) Retained Earnings and Regulatory Capital
The Bank, as a member of the Federal Home Loan Bank System, is required
to hold a specified number of shares of capital stock, which is
carried at cost, in the Federal Home Loan Bank of Des Moines. In
addition, the Bank is required to maintain cash and other liquid
assets in an amount equal to 5% of its deposit accounts and other
obligations due within one year. The Bank has met these
requirements.
(Continued)
38
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and
possibly additional discretionary actions by regulators that, if
undertaken, could have a direct material effect on the Company's
financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must
meet specific capital guidelines that involve quantitative
measures of the Bank assets, liabilities, and certain off-balance
sheet items as calculated under regulatory accounting practices.
The Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulations to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios
(set forth in the following table) of Tangible, Core, and Risk-
based capital (as defined in the regulations) to total assets
(as defined). Management believes, as of September 30, 1996,
that the Bank meets ail capital adequacy requirements to which
it is subject.
As of September 30, 1996, the most recent notification from the
Office of Thrift Supervision categorized the Bank as "well
capitalized." There are no conditions or events since that
notification that management believes have changed the Bank's
category.
The Bank's actual capital amounts and ratios are also presented
in the table:
<TABLE>
<CAPTION>
Actual Requirement Excess Capital
----------------------------- ---------------------------- -----------------------------
Percent Percent Percent
of of of
Amount assets (1) Amount assets (1) Amount assets (1)
- - ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Bank's stock-
holders' equity $ 9,928,068
Plus:
Net unrealized
loss on
certain
securities
available
for sale 159,014
-----------
Tangible 10,087,082 9.55% $ 1,585,045 1.50% $ 8,502,037 8.05%
capital -----------
Cure capital 10,087,082 9.55% 3,170,090 3.0% 6,916,992 6.55
-----------
Plus:
Allowable
portion of
general
allowance
for loan
losses 453,460
-----------
Risk-based
capital $ 10,540,542 19.39% 4,348,080 8.00% 6,192,462 11.39%
===========
</TABLE>
(1) Based on the Bank's adjusted total assets for the purpose of the
tangible and core capital ratios and risk-weighted assets for the
purpose of the risk-based capital ratio.
(Continued)
39
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARlES
(15) Employee Benefits
Employee Stock Ownership Plan
During fiscal 1995, the Company adopted an Employee Stock Ownership
Plan (the ESOP), which met the requirements of Section 4975(e)(7) of
the Internal Revenue Code and Section 407(d)(6) of the Employee
Retirement Income Security Act of 1974, as amended (ERISA), and, as
such, the ESOP was empowered to borrow in order to finance purchases
of the common stock of the Company. The ESOP borrowed $690,000 from
the Company to purchase 69,000 shares of common stock of the Company
on the date of the Conversion. The Bank has committed to make annual
contributions to the ESOP necessary to repay the loan, including
interest.
As the debt is repaid, ESOP shares that were initially pledged as
collateral for its debt are released from collateral and allocated to
active employees, based on the proportion of debt service paid in the
year. The Company accounts for its ESOP in accordance with Statement
of Position 93-6, Employers' Accounting for Employee Stock Ownership
Plans. Accordingly, the shares pledged as collateral are reported as
unearned ESOP shares in stockholders' equity. As shares are
determined to be ratably released from collateral, the Company
reports compensation expense equal to the current market price of the
shares, and the shares become outstanding for earnings per share
computations. ESOP compensation benefit expense was $95,791 and
$83,375 for 1996 and 1995, respectively.
All employees of the Company are eligible to participate in the ESOP
after they attain age 21 and complete one year of service during
which they worked at least 1,000 hours. In 1996 and 1995, the Company
committed to release 6,900 shares of common stock each year which
were allocated to eligible participants subject to the restrictions
of the ESOP.
<TABLE>
<S> <C>
Shares released and allocated 13,800
Unreleased shares 55,200
--------------------------------------------------------------------
Total ESOP shares 69,000
====================================================================
Fair value of unreleased shares at September 30, 1996 $ 924,600
</TABLE>
Management Recognition Plan
The Company adopted a Management Recognition Plan (MRP) in October
1995. The MRP provides for the grant of shares of stock to eligible
directors and employees in the form of restricted stock, which vest
over a five-year period at the rate of 20% per year. Under the MRP,
34,500 shares of restricted stock were granted. MRP expense for 1996
was $94,444.
(Continued)
40
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
Stock Option Plan
The Company adopted a stock option plan in October 1995. The plan
provides for the granting of options for the purpose of attracting
and retaining key personnel and to facilitate their purchase of a
stock interest in the Company. Options on 86,250 shares were
granted at an exercise price $13.6875 per share. The options become
exercisable over a five-year period at the rate of 20% per year. If
unused, the options expire in October 2005.
(16) Retirement Plans
The Company has a defined Contribution profit sharing plan that covers
all full-time employees meeting certain minimum employment service
requirements. Profit sharing plan expense for the years ended
September 30, 1996, 1995, and 1994 was $48,072, $38,107, and
$35,844, respectively.
During the year ended September 30, 1994 the Company adopted a
retirement plan for non-employee directors. The Company recorded
expense of approximately $25,000, $26,000, and $26,000 during the
years ended September 30, 1996, 1995, and 1994, respectively, for
this plan.
(17) Stockholders' Equity
The Company was incorporated for the purpose of becoming the savings
and loan holding company of the Bank in connection with the Bank's
conversion from a federally chartered mutual savings bank to a
federally chartered stock savings bank, pursuant to a Plan of
Conversion adopted on August 15, 1994. The Company commenced on
September 23, 1994, a Subscription and Community Offering of its
shares in connection with the conversion of the Bank (the
Offering). The Offering was closed on March 23, 1995 and the
conversion was consummated on April 3, 1995, with the issuance of
862,500 shares of the Company's common stock at a price of $10 per
share. Total proceeds from the conversion of $7,959,144, net of
costs relating to the conversion of $665,856, have been recorded as
common stock and additional paid-in capital. The Company received
all of the capital stock of the Bank in exchange for 50% of the net
proceeds of the conversion.
In order to grant a priority to eligible account holders in the event
of future liquidation, the Bank, at the time of conversion,
established a liquidation account equal to its regulatory capital
as of December 31, 1994. In the event of future liquidation of the
Bank, eligible account holders who continue to maintain their
deposit accounts shall be entitled to receive a distribution from
the liquidation account. The total amount of the liquidation
account will be decreased as the balance of eligible account
holders are reduced subsequent to the conversion, based on an
annual determination of such balance.
(Continued)
41
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
The Bank may not declare or pay a cash dividend to the Company in
excess of 100% of its net income to date during the current
calendar year plus the amount that would reduce by one-half the
Bank's surplus capital ratio at the beginning of the calendar year
without prior notice to the Office of Thrift Supervision (OTS).
Additional limitations on dividends declared or paid on, or
repurchases of, the Bank's capital stock are tied to the Bank's
level of compliance with its regulatory capital requirements.
(18) Financial Instruments With Off-balance-sheet Risk
The Bank is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs
of its customers. These financial instruments include commitments
to extend credit. These instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount
recognized in the balance sheet. The contractual amount of these
instruments reflects the extent of involvement by the Bank.
The Bank's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to
extend credit is represented by the contractual amount of these
commitments. The Bank uses the same credit policies in making
commitments as it does for on-balance-sheet instruments.
The contractual amount of these financial instruments at September 30,
1996 and 1995 is approximately $425,000 and $797,000, respectively.
Included in total commitments to originate loans are commitments to
originate fixed rate loans aggregating approximately $0 and $82,500
as of September 30, 1996 and 1995, respectively. The interest rate
on these commitments was 7.625% at September 30, 1995.
Commitments to extend credit are agreements to lend to a customer
provided 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 a
portion of the commitments may expire without being drawn upon, the
total commitment amount does not necessarily represent future cash
requirements. The Bank evaluates each customer's creditworthiness
on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank upon extension of credit, is based on
the loan type and on management's credit evaluation of the
borrower. Collateral consists primarily of residential real estate
and personal property.
(Continued)
42
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
(19) Fair Value of Financial Instruments
SFAS No. 107, Disclosures About Fair Values of Financial Instruments,
requires disclosures of estimated fair values of the Company's
financial instruments, including assets, liabilities, and off-balance
sheet items for which it is practicable to estimate fair value. The
fair value estimates are made as of September 30, 1996 based upon
relevant market information, if available, and upon the
characteristics of the financial instruments themselves. Because no
market exists for a significant portion of the Company's financial
instruments, fair value estimates are based upon judgments regarding
future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors.
The estimates are subjective in nature and involve uncertainties and
matters of significant judgment and therefore cannot be determined
with precision. Changes in assumptions could significantly affect the
estimates.
Fair value estimates are based only on existing financial instruments
without attempting to estimate the value of anticipated future
business or the value of assets and liabilities that are not
considered financial instruments. In addition, the tax ramifications
related to the realization of the unrealized gains and losses can
have a significant effect on the fair value estimates and have not
been considered in any of the estimates.
The estimated fair value of the Company's financial instruments as of
September 30, 1996 are shown below. Following the table, there is an
explanation of the methods and assumptions used to estimate the fair
value of each class of financial instruments.
<TABLE>
<CAPTION>
1996
-------------------------------
Estimated
Carrying fair
amount value
---------------------------------------------------------------------------------
<S> <C> <C>
Financial assets:
Cash and cash equivalents $ 4,685,836 4,685,836
Securities available for sale 46,065,866 46,065,866
Securities held to maturity 845,605 852,112
Loans receivable 51,003,105 51,395,390
Federal Home Loan Bank stock 700,500 700,500
Accrued interest receivable 862,732 862,732
Financial liabilities:
Deposits 81,046,519 81,171,807
Borrowings 11,897,878 11,885,878
Accrued interest payable 587,779 587,779
</TABLE>
Cash and Cash Equivalents
The carrying amount of cash and cash equivalents approximates their
fair value.
(Continued)
43
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
Securities Available for Sale and Securities Held to Maturity
The fair value of securities are based upon quoted market prices.
Loans Receivable
The fair values of loans receivable were estimated for groups of loans with
similar characteristics. The fair value of the loan portfolio was calculated
by discounting the scheduled cash flows through the estimated maturity using
anticipated prepayment speeds and using discount rates that reflect the credit
and interest rate risk inherent in each loan portfolio. The fair value of the
adjustable loan portfolio was estimated by grouping the loans with similar
characteristics and comparing the characteristics of each group to the prices
quoted for similar types of loans in the secondary market.
Federal Home Loan Bank Stock
The carrying amount of FHLB stock approximates its fair value.
Accrued Interest Receivable
The carrying amount of accrued interest receivable approximates its fair value
since it is short-term in nature and does not present unanticipated credit
concerns.
Deposits
Under SFAS No. 107, the fair value of deposits with no stated maturity, such as
checking, savings, and money market accounts, is equal to the amount payable
on demand. The fair value of certificates of deposit is based on the
discounted value of contractual cash flows using as discount rates the rates
that were offered by the Bank as of September 30, 1996 for deposits with
maturities similar to the remaining maturities of the existing certificates of
deposit.
The fair value estimate for deposits does not include the benefit that results
from the low cost funding provided by the Bank's existing deposits and long-
term customer relationships compared to the cost of obtaining different
sources of funding. This benefit is commonly referred to as the core deposit
intangible.
Borrowings
The fair value of borrowings is based on the discounted value of contractual
cash flows using as discount rates the rates that were available to the Bank
as of September 30, 1996 for borrowings with maturities similar to the
remaining maturities of the existing borrowings.
Accrued Interest Payable
The carrying amount of accrued interest payable approximates its fair value
since it is short-term in nature.
(Continued)
44
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
(20) Recent Legislative and Regulatory Developments
The Deposit Insurance Fund Act of 1996 (DIFA) was enacted on September
30, 1996. DIFA addressed the inadequate funding of the Savings
Association Insurance Fund (SAIF), which had resulted in a large
deposit insurance premium disparity between banks insured by the Bank
Insurance Fund (BIF) and SAIF-insured thrifts, which were required to
pay significantly higher deposit insurance premiums As a result of
this new legislation, a one-time special assessment was imposed on
thrift institutions, and the Company recognized a $588,444 pretax
charge for assessments imposed on savings deposits at the Bank. The
legislation also provides for a reduction in deposit insurance
premiums in subsequent periods.
The second major area addressed by DIFA was funding for bond
obligations of the Financing Corp. (FICO). Thrifts will pay 6.4 basis
points per $100 of deposits from January 1, 1997 to December 31,
1999. From January 1, 2000 until the FICO bonds are retired in 2019
the estimated assessment to retire the FICO bonds is expected to be
2.5 basis points per $100 of deposits.
The third area addressed by DIFA was the BIF-SAIF merger and Thrift
charter conversions. DIFA proposed that the BIF and SAIF insurance
funds will be merged on January 1, 1999, provided no insured
depository institution is a savings association on that date. DIFA
also directed the Secretary of the Treasury to present
recommendations to Congress for establishment of a common depository
institution charter by March 31, 1997.
Other recently enacted federal legislation repealed the reserve method
of accounting for thrift bad debt reserves. This legislation
eliminated the recapture of a thrift institution's bad debt reserve
under certain circumstances, including the institution's conversion
to a bank or as a result of similar charter changes.
(Continued)
45
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
(21) First Federal Bancorporation Financial Information (Parent Company
Only)
The following are the condensed financial statements for the parent
company only as of September 30, 1996 and 1995 and for the year ended
September 30, 1996 and for the period from April 3, 1995 to September
30, 1995:
<TABLE>
<CAPTION>
1996 1995
-------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Condensed Statement of Financial Condition:
Assets:
Cash and cash equivalents $ 460,779 653,959
Securities available for sale 1,002,321 2,283,614
Investment in subsidiary 9,928,068 11,669,346
Other assets 948,101 493,113
-------------------------------------------------------------------------------------------------------------
Total assets $ 12,339,269 15,100,032
=============================================================================================================
Liabilities and Stockholders' Equity:
Accrued expenses 16,571 9,430
Stockholders' equity 12,322,698 15,090,602
-------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 12,339,269 15,100,032
-------------------------------------------------------------------------------------------------------------
Condensed Statement of Earnings:
Interest income $ 239,078 47,231
Noninterest income 8,897 0
Equity in earnings of subsidiary 250,437 665,852
Noninterest expense (136,524) (20,676)
-------------------------------------------------------------------------------------------------------------
Income before income tax expense 361,888 692,407
Income tax expense 45,388 10,622
-------------------------------------------------------------------------------------------------------------
Net earnings $ 316,500 681,785
-------------------------------------------------------------------------------------------------------------
Condensed Statement of Cash Flows:
Operating activities:
Net earnings $ 316,500 681,785
Increase in other assets (454,988) (493,113)
Increase in accrued expenses 7,141 9,430
Equity in earnings of subsidiary (250,437) (665,852)
Earned employee stock ownership shares priced above original cost 26,791 14,375
Decrease in unamortized restricted stock 94,444 0
Decrease in unearned ESOP shares 69,000 69,000
Other (5,177) 30,662
-------------------------------------------------------------------------------------------------------------
Net cash used by operating activities (196,726) (353,713)
-------------------------------------------------------------------------------------------------------------
Investing activities:
Purchase of Bank stock 0 (3,979,572)
Purchase of securities available for sale (738,651) (2,281,900)
Proceeds from maturities of securities available for sale 297,287 0
Proceeds from sales of securities available for sale 1,722,657 0
-------------------------------------------------------------------------------------------------------------
Net cash provided (used) by investing activities 1,281,293 (6,261,472)
-------------------------------------------------------------------------------------------------------------
Financing activities:
Proceeds from sale of common stock 0 7,959,144
Adoption of ESOP 0 (690,000)
Purchase and retirement of common stock (2,269,406) 0
Purchase of treasury stock (1,008,341) 0
Cash dividend from subsidiary 2,000,000 0
-------------------------------------------------------------------------------------------------------------
Net cash (used) provided by financing activities (1,277,747) 7,269,144
-------------------------------------------------------------------------------------------------------------
Decrease (increase) in cash and cash equivalents (193,180) 653,959
-------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, beginning of period 653,959 0
-------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 460,779 653,959
=============================================================================================================
</TABLE>
(Continued)
46
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
(22) Quarterly Financial Data (Unaudited)
Summarized quarterly financial data for fiscal 1996 and 1995 are as
follows:
<TABLE>
<CAPTION>
Three months ended
--------------------------------------------------------------------------
September 30, June 30, March 31, December 31,
Selected Operations Data 1996 1996 1996 1995
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest income $ 1,921,583 1,863,500 1,808,105 1,835,348
Interest expense 1,094,108 984,436 967,519 970,128
-----------------------------------------------------------------------------------------------------------------
Net interest
income 827,475 879,064 840,586 865,220
Provision for loan losses 0 0 0 0
Non-interest income 162,248 159,557 101,120 110,421
Non-interest expense 1,319,616 691,489 717,311 685,128
Income tax expense
(benefit) (135,392) 142,227 91,907 116,905
-----------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ (194,501) 204,905 132,488 173,608
=================================================================================================================
Earnings (loss) per $(.24) $ .27 .17 .22
common share
<CAPTION>
Three months ended
----------------------------------------------------------------------
September 30, June 30, March 31, December 31,
1995 1995 1995 1994
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest income $ 1,776,205 1,774,675 1,622,069 1,559,244
Interest expense 935,363 911,742 873,495 826,721
-----------------------------------------------------------------------------------------------------------------
Net interest
income 840,842 862,933 748,574 732,523
Provision (reversal) for
loan losses 0 (11,808) 11,808 3,701
Non-interest income 110,380 92,866 83,210 74,344
Non-interest expense 630,787 615,905 621,198 519,370
Income tax expense 133,412 144,946 78,936 115,632
-----------------------------------------------------------------------------------------------------------------
Net earnings $187,023 206,756 119,842 168,164
=================================================================================================================
Earnings per common share $ .23 .26 N/A N/A
Pro forma earnings per
common share N/A N/A .15 .21
</TABLE>
(Continued)
47
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
September 30, June 30, March 31, December 31,
Selected Financial Condition Data 1996 1996 1996 1995
- - ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total assets $ 107,256,101 104,968,978 100,533,100 100,590,508
Securities 46,911,732 45,671,263 40,685,165 41,978,560
Net loans 51,003,105 49,133,631 48,748,853 48,018,499
Deposits 81,046,519 79,860,343 82,055,419 83,179,874
Stockholders' equity 12,322,698 13,917,684 14,457,528 15,100,320
September 30, June 30, March 31, December 31,
1995 1995 1995 1994
- - ----------------------------------------------------------------------------------------------------------------------------
Total assets $ 99,506,827 96,235,753 99,246,186 89,395,094
Securities 37,155,093 34,287,886 31,355,686 30,903,256
Net loans 48,043,625 47,884,109 47,640,520 47,463,701
Deposits 82,060,466 80,151,285 80,403,436 81,652,150
Stockholders' equity 15,090,602 14,819,239 6,951,842 6,418,540
</TABLE>
48
<PAGE>
MARKET AND DIVIDEND INFORMATION
Trading in the Common Stock
The Company's Common Stock is traded on the NASDAQ "SmallCap" market.
There are currently 700,566 shares of the Common Stock outstanding and
approximately 236 holders of record of the Common Stock (not including shares
held in "street name") as of December 12, 1996. The December 12, 1996 closing
sale price of the Common Stock as traded on the SmallCap Market was $17.875 per
share.
The following table sets forth certain information as to the range of
the high and low bid prices for the Company's Common Stock for the calendar
quarters indicated and since the common stock's issuance on April 3, 1995.
<TABLE>
<CAPTION>
High Bid (1) Low Bid (1) Dividends Paid
------------ ----------- --------------
<S> <C> <C> <C>
Fiscal 1995:
Third Quarter $12 1/4 $10 1/2 $ --
Fourth Quarter 13 3/4 11 1/4 --
Fiscal 1996:
First Quarter 14 1/2 13 1/4 --
Second Quarter 14 3/4 13 1/4 --
Third Quarter 14 1/2 12 3/4 --
Fourth Quarter 16 1/4 12 1/4 --
Fiscal 1997:
First Quarter (through
12/12/96) 18 15 3/4
</TABLE>
- - ---------------------
(1) Quotations reflect inter-dealer price, without retail mark-up, mark-
down or commissions, and may not represent actual transactions.
Dividend Restrictions
Under OTS regulations, First Federal may not pay dividends on its
capital stock if its regulatory capital would thereby be reduced below the
amount then required for the liquidation account established for the benefit of
certain depositors of First Federal at the time of the Conversion. In addition,
savings institution subsidiaries of savings and loan holding companies are
required to give the OTS 30 days' prior notice of any proposed declaration of
dividends to the holding company.
OTS regulations impose additional limitations on the payment of
dividends and other capital distributions (including stock repurchases and cash
mergers) by First Federal. Under these regulations, a savings institution that,
immediately prior to, and on a pro forma basis after giving effect to, a
proposed capital distribution, has total capital (as defined by OTS regulation)
that is equal to or greater than the amount of its capital requirements (a "Tier
1 Association") is generally permitted, without OTS approval, to make capital
distributions during a calendar year in the amount equal to the greater of: (i)
75% of its net income for the previous four quarters; or (ii) up to 100% of its
net income to date during the calendar year plus an amount that would reduce by
one-half the amount by which its capital-to-assets ratio exceeded regulatory
requirements at the beginning of the calendar year. A savings institution with
total capital in excess of current minimum capital ratio requirements (a "Tier 2
Association") is permitted to make capital distributions without OTS approval of
up to 75% of its net income for the previous four quarters, less dividends
already paid for such period. A savings institution that fails to meet current
minimum capital
49
<PAGE>
requirements (a "Tier 3 Association") is prohibited from making any capital
distributions without the prior approval of the OTS. A Tier 1 Association that
has been notified by the OTS that it is in need of more than normal supervision
will be treated as either a Tier 2 or Tier 3 Association. First Federal is a
Tier 1 Association. Under the OTS' prompt corrective action regulations, First
Federal is also prohibited from making any capital distribution if after making
the distribution, First Federal would have: (i) a total risk-based capital ratio
of less than 8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or
(iii) a leverage ratio of less than 4.0%. The OTS, after consultation with the
FDIC, however, may permit an otherwise prohibited stock repurchase if made in
connection with the issuance of additional shares in an equivalent amount and
the repurchase will reduce the institution's financial obligations or otherwise
improve the institution's financial condition.
Furthermore, earnings of the Bank appropriated to bad debt reserves for
federal income tax purposes are not available for payment of cash dividends or
other distributions to the Company without payment of taxes at the then current
tax rate by First Federal on the amount of earnings removed from the reserves
for such distributions. The Company intends to make full use of this favorable
tax treatment afforded to First Federal and the Company and does not contemplate
use of any post-Conversion earnings of First Federal in a manner which would
limit either the Bank's bad debt deduction or create federal tax liabilities.
50
<PAGE>
<TABLE>
<CAPTION>
BOARD OF DIRECTORS
<S> <C> <C>
Ralph T. Smith William R. Belford Walter R. Fankhanel
Chairman of the Board of President and Chief Director of the Company
the Company and the Bank Executive Officer of the and the Bank
Company and the Bank
Martin R. Sathre James R. Sharp Dean J. Thompson
Vice Chairman and Director Director of Company and Director of the Company
of the Company and the the Bank and the Bank
Bank
EXECUTIVE OFFICERS
Ralph T. Smith Martin R. Sathre William R. Belford
Chairman of the Board of Vice Chairman and President and Chief
the Company and the Bank Director of the Company Executive Officer of
and the Bank the Company and the Bank
Dennis M. Vorgert Karen Jacobson
Treasurer of the Company Secretary of the Company
and the Bank and the Bank
OFFICE LOCATIONS
Main Office: Branch Offices:
214 5th Street 22 First Street, NE 109 Main Street West
Bemidji, Minnesota 56601 Bagley, Minnesota 56621 Baudette, Minnesota 56623
527 Minnesota Avenue 550 Paul Bunyan Drive, N.W.
Walker, Minnesota 56484 Bemidji, Minnesota 56601
GENERAL INFORMATION
Independent Public Accountants Annual Meeting Annual Report on Form 10-K
KPMG Peat Marwick LLP The 1997 Annual Meeting of A copy of the Company's Annual
Certified Public Accountants Stockholders will be held on Report on Form 10-KSB for the
Minneapolis, Minnesota January 21, 1997 at 2:30 p.m. at fiscal year ended September 30,
the main office, 214 5th Street, 1996 as filed with the Securities
General Counsel Bemidji, Minnesota 56601. and Exchange Commission will
Smith Law Firm be furnished without charge to
Bemidji, Minnesota 56601 Transfer Agent and Registrar stockholders as of the record date
Stock Transfer Department for the 1997 Annual Meeting
Special Counsel Norwest Bank, N.A. upon written request to Karen
Housley Kantarian P.O. Box 119 Jacobson, 214 5th Street,
& Bronstein, P.C. So. St. Paul, Minnesota 55075-9988 Bemidji, Minnesota 56601.
1220 19th Street, N.W. Suite 700
Washington, D.C. 20036
</TABLE>
51
<PAGE>
EXHIBIT 21
Subsidiaries of the Registrant
<TABLE>
<CAPTION>
State or Other
Jurisdiction of Percentage
Incorporation Ownership
------------- ---------
<S> <C> <C>
Parent
- - ------
First Federal Bancorporation Minnesota N/A
Subsidiary (1)
- - ----------
First Federal Banking & Savings, FSB United States 100%
Subsidiaries of First Federal Banking & Savings, FSB (1)
- - ----------------------------------------------------
First Federal Service Corporation Minnesota 100%
</TABLE>
- - ----------------
(1) The assets, liabilities and operations of the subsidiaries are included in
the consolidated financial statements contained in the Annual Report to
Stockholders attached hereto as an exhibit.
<PAGE>
[LOGO OF KPMG PEAT MARWICK LLP APPEARS HERE]
Exhibit 23
Consent of Independent Public Accountants
The Board of Directors
First Federal Bancorporation:
We consent to incorporation by reference in the registration statement (No.
33-89682) on Form S-8 of First Federal Bancorporation of our report dated
October 25, 1996, relating to the consolidated statements of financial condition
of First Federal Bancorporation and subsidiaries as of September 30, 1996 and
1995, and the related consolidated statements of earnings, stockholders' equity,
and cash flows for each of the years in the three-year period ended September
30, 1996, which report appears in the September 30, 1996 annual report on Form
10-KSB of First Federal Bancorporation.
/s/ KPMG Peat Marwick LLP
December 13, 1996
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1996
<PERIOD-START> OCT-01-1995
<PERIOD-END> SEP-30-1996
<CASH> 1,376,853
<INT-BEARING-DEPOSITS> 3,308,983
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 46,065,866
<INVESTMENTS-CARRYING> 845,605
<INVESTMENTS-MARKET> 852,112
<LOANS> 51,456,555
<ALLOWANCE> 453,460
<TOTAL-ASSETS> 107,256,101
<DEPOSITS> 81,046,519
<SHORT-TERM> 11,897,878
<LIABILITIES-OTHER> 1,989,006
<LONG-TERM> 0
0
0
<COMMON> 7,006
<OTHER-SE> 12,315,692
<TOTAL-LIABILITIES-AND-EQUITY> 107,256,101
<INTEREST-LOAN> 4,470,858
<INTEREST-INVEST> 2,746,065
<INTEREST-OTHER> 211,613
<INTEREST-TOTAL> 7,428,536
<INTEREST-DEPOSIT> 3,736,423
<INTEREST-EXPENSE> 4,016,191
<INTEREST-INCOME-NET> 3,412,345
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 5,350
<EXPENSE-OTHER> 3,413,544
<INCOME-PRETAX> 532,147
<INCOME-PRE-EXTRAORDINARY> 532,147
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 316,500
<EPS-PRIMARY> .42
<EPS-DILUTED> 0
<YIELD-ACTUAL> 3.51
<LOANS-NON> 55,434
<LOANS-PAST> 156,059
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 491,382
<CHARGE-OFFS> 49,801
<RECOVERIES> 11,879
<ALLOWANCE-CLOSE> 453,460
<ALLOWANCE-DOMESTIC> 389,080
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 64,380
</TABLE>
