<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, 1997
[_] 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
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FIRST FEDERAL BANCORPORATION
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MINNESOTA 41-1796238
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
214 5TH STREET, BEMIDJI, MINNESOTA 56601
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(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
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(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 ___
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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. [ X]
State issuer's revenues for its most recent fiscal year: $8.46 million.
As of December 10, 1997, the aggregate market value of the 324,836 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $8,770,572 based on the closing sale price of $27.00
per share of the registrant's Common Stock on December 10, 1997 as listed on the
National Association of Securities Dealers Automated Quotation SmallCap Market.
For purposes of this calculation, it is assumed that the 340,702 shares held by
directors, officers, the Employee Stock Ownership Plan (unallocated shares
only), 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 10, 1997: 665,538
(prior to a 3-for-2 stock split paid in the form of a 50% stock dividend on
December 18, 1997).
DOCUMENTS INCORPORATED BY REFERENCE
The following lists the documents incorporated by reference and the
Part of the Form 10-KSB into which the document is incorporated:
1. Portions of the Annual Report to Stockholders for the fiscal year
ended September 30, 1997. (Parts I and III)
2. Portions of Proxy Statement for 1998 Annual Meeting of
Stockholders. (Parts II and IV)
<PAGE>
PART I
ITEM 1. BUSINESS
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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, $433,000 of cash and cash
equivalents, $260,000 in securities available for sale, and $603,000 in Other
Assets, consisting primarily of loans. At September 30, 1997, the Company had
total consolidated assets of $111.49 million, deposits of $83.0 million and
stockholders' equity of $11.94 million. Because substantially all of the
Company's operations consist of the operations of the Bank, this Form 10-K
largely is a discussion of the Bank's operations.
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 Bank. 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. In August 1997, the Bank
changed its name from "First Federal Banking and Savings, FSB" to its current
name. 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. At September 30, 1997, First Federal had total assets of $110.73
million, deposits of $83.44 million, mortgage-backed and related securities and
investment securities totaling $47.86 million and stockholders' equity of $10.73
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, 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 1997 continued to be active in
originating and purchasing participation interests in commercial real estate
loans, and development of consumer lending activities in the local markets.
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
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MARKET AREA
First Federal serves the Bemidji, Minnesota marketplace, which is located
in northwestern Minnesota approximately 200 miles north 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 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.
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 8.27% of the Bank's gross loan portfolio at September
30, 1997 while loans on multi-family and commercial real estate constituted
24.48% of the Bank's gross loan portfolio at that date.
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 (15 years or less) fixed-rate mortgage loans. Fixed-rate mortgage
loans continue to be offered by the Bank, but substantially all such loans in
excess of 15 year terms 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.
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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, 1997, First Federal had no concentrations
of loans exceeding 10% of total loans other than as disclosed below.
<TABLE>
<CAPTION>
At September 30,
--------------------------------------------------------
1997 1996 1995
---------------- ----------------- ----------------
Amount % Amount % Amount %
------- ------- -------- ------- ------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Type of Loan:
- - ------------
Real estate loans --
Construction loans...................... $ 750 1.36% $ 307 0.59% $ 99 .20%
One- to four-family residential......... 26,111 47.50 25,988 49.95 28,947 58.63
Multi-family residential................ 2,059 3.75 2,410 4.63 2,489 5.04
Commercial.............................. 11,397 20.73 10,494 20.17 8,003 16.21
Consumer loans --
Automobiles............................. 5,010 9.11 2,753 5.29 1,232 2.50
Mobile home loans....................... 444 0.81 381 0.73 341 .69
Savings account loans................... 525 0.96 364 0.70 548 1.11
Home improvement loans.................. 1,821 3.31 1,681 3.23 1,560 3.16
Home equity lines of credit............. 434 0.79 507 0.98 514 1.04
Other consumer loans.................... 5,264 9.58 5,001 9.61 4,171 8.45
Commercial business loans................. 1,156 2.10 2,142 4.12 1,467 2.97
------- ------ ------- ------ ------- ------
$54,971 100.00% 52,028 100.00% 49,371 100.00%
======= ====== ------- ====== ------- ======
Less:
Loans in process........................ 1,025 627 744
Deferred fees and discounts (premiums).. (70) (56) 92
Allowance for loan losses............... 427 454 491
------- ------- -------
Total................................. 53,589 $51,003 $48,044
======= ======= =======
</TABLE>
4
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Loan Maturity. The following table sets forth certain information at
September 30, 1997, 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 after Due after Due after
Due during the year ending 3 through 5 through 10 through Due after 15
September 30, 5 years after 10 years after 15 years after years after
----------------------------
1998 1999 2000 9/30/97 9/30/97 9/30/97 9/30/97 Total
------ ------ ------ -------- -------- -------- -------- -------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate mortgage........ $ 1,155 $ 1,231 $ 1,232 $ 3,963 $ 11,022 $ 6,857 $ 14,107 $ 39,567
Real estate construction.... 250 500 -- -- -- -- -- 750
Consumer.................... 1,710 1,040 1,744 4,168 2,473 1,795 568 13,498
Commercial.................. 54 273 458 201 170 -- -- 1,156
-------- ------ ------- -------- -------- -------- -------- --------
Total.................. $ 3,169 $ 3,044 $ 3,434 $ 8,332 $ 13,665 $ 8,652 $ 14,675 $ 54,971
======== ======= ======= ======== ======== ======== ======== ========
</TABLE>
Loan Repricing. The following table sets forth at September 30, 1997, the
dollar amount of all loans due one year after September 30, 1997 which have
predetermined interest rates and have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Predetermined Floating or
Rate Adjustable Rates
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(In thousands)
<S> <C> <C>
Real estate mortgage...... $ 7,339 $ 31,073
Real estate construction.. -- 500
Consumer.................. 3,968 7,820
Commercial................ 732 370
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$ 12,039 $ 39,763
======== =========
</TABLE>
5
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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,
----------------------------------
1997 1996 1995
------- ------- -------
(In thousands)
<S> <C> <C> <C>
Loans originated:
Real estate loans:
Construction loans............................. $ 525 $ 1,372 $ 599
One- to four-family residential................ 3,843 4,520 2,901
Multi-family residential....................... -- -- --
Commercial..................................... 409 -- 300
Consumer loans................................... 10,241 8,241 5,165
Commercial business.............................. 244 341 166
-------- -------- -------
$ 15,262 $ 14,474 $ 9,131
======== ======== =======
Loans purchased:
Real estate loans:
One-to-four-family residential................. $ 1,421 $ -- $ --
Multi-family residential....................... 500 -- --
Commercial..................................... 2,732 3,159 3,425
Commercial business.............................. -- 612 913
-------- -------- -------
Total loans purchased......................... $ 4,653 $ 3,771 $ 4,338
======== ======== =======
Loans sold:
Whole loans...................................... $ 328 $ 2,075 $ 569
Participation loans.............................. -- -- --
-------- -------- -------
Total loans sold.............................. $ 328 $ 2,075 $ 569
======== ======== =======
</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 equaled or exceeded
loan originations. First Federal sells substantially all long-term, fixed-rate
mortgage loans it originates in the secondary market. For the five years ended
September 30, 1997, 104 fixed-rate mortgage loans, secured by single-family
homes totaling $6.46 million were sold in the secondary market, with servicing
rights released.
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
41 commercial real estate and multi-family residential real estate loans
originated by other lenders totaling $9.94 million. Fifteen of these loans
totaling $2.79 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, 1997 of $2.20 million. Of the 39 participation
interests in commercial real estate loans, 10 loans totaling $2.73 million were
purchased during the year ended September 30, 1997. 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.
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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, 1997,
approximately $26.11 million or 47.50% 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, 1997, the Bank's loan portfolio included $20.60 million in
adjustable-rate one- to four-family residential mortgage loans, or 37.47% 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. 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 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
7
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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 $2.34 million, or 4.25%, of gross loans
at September 30, 1997, and loans on apartment houses, which constituted $2.06
million, or 3.75%, of gross loans at September 30, 1997. Commercial real estate
loans (including motel loans) totaled $11.40 million, or 20.73%, of gross loans
at September 30, 1997, an increase of 8.60% from the balance of $10.49 million
at September 30, 1996. Mortgages secured by multi-family real estate (including
apartment houses) had a balance of $2.06 million at September 30, 1997, compared
to $2.41 million at the same date in 1996.
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, 1997, the Bank originated $409,000 in commercial real estate
loans, and purchased participation interests in 10 loans secured by commercial
real estate projects or properties, in amounts ranging from $150,000 to
$500,000, and totaling $2.73 million. These loans are secured by (i) two office
buildings; (ii) two warehouses; and (iii) one each of the following: shopping
center, grocery store, gaming establishment, medical clinic, nursing home and
assisted living facility. Of these 10 properties, five are located in
Minnesota, and the Bank holds an approximate one-third or less participation
interest in each project/property. The other five are located in Wisconsin,
Illinois and Colorado. The lead lenders on each of these loans are institutions
with whom the Bank is familiar, and has done business in the past. 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, 1997, 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, 1997, the Bank's largest loan was for $819,427 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 $678,161 and $473,059 at
September 30, 1997. 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 $11.40 million in commercial real
estate loans at September 30, 1997 were three loans on motel properties, all
located in Minnesota, with balances outstanding totaling $1.97 million at
September 30, 1997. 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.
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
8
<PAGE>
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, 1997, the Bank's consumer loan
balance totaled $13.50 million, or 24.56%, of its total loan portfolio. Of the
consumer loan balance at September 30, 1997, $5.01 million were automobile
loans, $434,000 were home equity lines of credit, $1.82 million were home
improvement loans, $444,000 were mobile home loans and $525,000 were savings
account loans. The Bank has more aggressively pursued consumer loans outside its
customer base but within the markets it serves.
In addition, included in the Bank's consumer loan portfolio at September
30, 1997 were $5.26 million in other consumer loans, which included: $4.03
million in home equity loans; $305,000 in loans secured by recreational vehicles
such as RVs, boats, motorcycles or snowmobiles; $310,000 in other secured loans;
$209,000 in unsecured overdraft protection; and $400,000 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 48 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 fifteen 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, 1997, these loans amounted to
$1.16 million, or 2.10%, 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
9
<PAGE>
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.
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
10
<PAGE>
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 $2.02 million at September 30, 1997. 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 $496,000 to $819,000 at September 30,
1997. All of these loans were current as of September 30, 1997.
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, 1997, First Federal had no
assets classified as loss, $11,000 of assets classified as doubtful and $1.12
million of assets classified as substandard. At September 30, 1997, there were
no assets designated as special mention.
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.
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
11
<PAGE>
reserve rates vary from 0.05% to 2.00% 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, 1997, the Bank maintained a higher general valuation
allowance than the reserve rates would dictate. Reserves determined by using
the reserve rating system were $420,000. The general valuation allowance on
September 30, 1997, was in the amount of $427,000, indicating additional
reserves of $7,000.
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.
12
<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,
---------------------------
1997 1996 1995
-------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C>
Balance at beginning of period......... $ 454 $ 491 $ 529
----- ----- -----
Loans charged-off:
Real estate -- mortgages:
Residential........................ (10) (14) (6)
Commercial......................... -- -- --
Real estate -- construction.......... -- -- --
Commercial business.................. (2) --
Consumer............................. (28) (33) (43)
----- ----- -----
Total charge-offs...................... (38) (49) (49)
----- ----- -----
Recoveries:
Real estate -- mortgages:
Residential........................ -- -- --
Commercial......................... -- -- --
Real estate -- construction.......... -- -- --
Commercial business.................. -- -- --
Consumer............................. 11 12 7
----- ----- -----
Total recoveries....................... 11 12 7
----- ----- -----
Net loans charged-off.................. (27) (37) (42)
----- ----- -----
Provision for loan losses.............. -- -- 4
----- ----- -----
Balance at end of period............... $ 427 $ 454 $ 491
===== ===== =====
Ratio of net charge-offs to average
loans outstanding during the period.. 0.05% 0.06% .09%
===== ===== =====
</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,
---------------------------------------------------------------------
1997 1996 1995
------------------------- -------------------- --------------------
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........................ $ 69 51.25% $151 54.58% $ 279 63.67%
Commercial......................... 141 20.73 88 20.17 75 16.21
Real estate - construction........... 2 1.36 3 0.59 -- 0.20
Commercial business.................. 9 2.10 37 4.12 14 2.97
Consumer............................. 206 24.56 175 20.54 123 16.95
---- ------ ---- ------ ----- ------
Total allowance for loan losses.. $427 100.00% $454 100.00% $ 491 100.00%
==== ====== ==== ====== ===== ======
</TABLE>
13
<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,
-------------------------------------
1997 1996 1995
------ ------ ------
(Dollars in thousands)
<S> <C> <C> <C>
Loans accounted for on a non-accrual basis: (1)
Real estate:
Residential.................................................. $ -- $ 55 $ 14
Commercial................................................... -- -- --
Commercial business............................................. -- -- --
Consumer........................................................ -- -- --
----- ----- -----
Total...................................................... -- $ 55 $ 14
===== ===== =====
Accruing loans which are contractually past due 90 days or more:
Real Estate:
Residential.................................................. $ 4 $ -- $ --
Commercial................................................... -- -- --
Commercial business............................................. -- 132 --
Consumer........................................................ 88 24 73
----- ----- -----
Total...................................................... $ 92 $ 156 $ 73
===== ===== =====
Total of non-accrual and 90 days past due loans............ $ 92 $ 211 $ 87
===== ===== =====
Percentage of total loans......................................... 0.17% 0.41% .18%
===== ===== =====
Other non-performing assets (2)................................... $ 263 $ 194 $ 152
===== ===== =====
</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, 1997 "Other non-performing assets" included one
commercial real estate property valued at $400,000 based on market
information available to the Bank, in which the Bank has a 37.50%
participation interest.
At September 30, 1997, 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.
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 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."
14
<PAGE>
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 may not 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, 1997, in accordance with SFAS No. 115, the Company
classified $28.76 million of its investment securities and $18.83 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, other than mortgage-
backed securities, at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
---------------------------------
1997 1996 1995
------- ------ ------
(In thousands)
<S> <C> <C> <C>
Investment securities:
U.S. government and agency securities.............. $21,659 $16,174 $ 7,065
Corporate bonds and notes.......................... 5,622 7,407 6,390
Municipal obligations.............................. 500 498 250
Mutual funds....................................... 976 1,671 1,927
------- ------- -------
Total investment securities..................... $28,757 $25,750 $15,632
======= ======= =======
</TABLE>
15
<PAGE>
The following table sets forth information regarding the scheduled
maturities, market value and weighted average yields for First Federal's
investments, other than mortgage-backed securities, at September 30, 1997.
<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.......................... $ 1,348 4.95% $ 9,156 6.52% $ 10,656 7.03% $ 499 7.26%
Corporate bonds and notes............ 1,704 5.79 3,683 6.91 -- 235 7.39
Municipal obligations............... -- 250 6.11 -- 250 9.38
-------- -------- --------- --------
Total............................ $ 3,052 5.42 $ 13,089 6.63 $ 10,656 7.03 $ 984 7.83
======== ======== ========= ========
Securities with no stated maturity:
Mutual funds.........................
Total investment securities...........
<CAPTION>
Total Investment Portfolio
------------------------------
Carrying Market Average
Value Value Yield
-------- ------- --------
<S> <C> <C> <C>
Securities available for sale:
U.S. government and agency
securities........................... $ 21,659 $ 21,659 6.69%
Corporate bonds and notes. 5,622 5,622 6.59
Municipal obligations................ 500 500 7.75
--------- --------
Total............................. $ 27,781 $ 27,781 6.69
========= ========
Securities with no stated maturity:
Mutual funds......................... $ 976 $ 976 6.38
--------- --------
Total investment securities........... $ 28,757 $ 28,757 6.68
========= ========
</TABLE>
16
<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, 1997, the Bank had $8.45 million in mortgage-backed securities
(representing 98.63% of the Bank's gross mortgage-backed securities portfolio or
7.58% of total assets) insured or guaranteed by FNMA, FHLMC or GNMA. At
September 30, 1997, $117,000 (representing 1.37% of the Bank's gross mortgage-
backed securities portfolio, or 0.10% 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 prepayment. In a
declining interest rate environment, the Bank may experience prepayments of both
fixed and adjustable-rate mortgage-backed and related securities. In a rising
interest rate environment, the prepayments may cease, market yields of these
securities may be less attractive, and the market value of the Bank's mortgage-
backed securities may decline.
17
<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, 1997, the Bank had $10.8 million in CMOs and REMICs or
9.69% of total assets. The Bank's CMOs and REMICs had a weighted average yield
of 6.3% at September 30, 1997. 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,
1997, $117,000 of the securities in the Bank's mortgage-backed and related
securities portfolio were privately issued securities, $117,000 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,
-----------------------------------
1997 1996 1995
-------- -------- -------
(In thousands)
<S> <C> <C> <C>
GNMA................................. $ 410 $ 508 $ 429
FNMA................................. 3,000 3,451 3,282
FHLMC................................ 5,037 5,535 5,205
FHA.................................. 117 146 178
Collateralized mortgage obligations.. 10,800 11,109 12,429
-------- -------- --------
Total........................... $ 19,364 $ 20,749 $ 21,523
======== ======== ========
</TABLE>
18
<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, 1997.
<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....................... $ -- -- % $ -- -- % $ 147 7.59% $ 263 7.30%
FNMA....................... -- -- 844 6.18 511 6.62 1,645 6.33
FHLMC...................... 495 5.68 1,320 6.17 902 6.83 2,320 7.01
FHA........................ -- -- -- -- 117 10.40 -- --
Collateralized mortgage
obligations.............. 289 6.23 423 6.43 3,685 6.29 6,403 6.30
---- ------ ------ -------
Total................. $784 5.88 $2,587 6.21 $5,362 6.54 $10,631 6.49
==== ====== ====== =======
<CAPTION>
Total Investment Portfolio
---------------------------
Carrying Market Average
Value Value Yield
-------- ------- --------
<S> <C> <C> <C>
GNMA....................... $ 410 $ 411 7.41%
FNMA....................... 3,000 3,000 6.34
FHLMC...................... 5,037 5,039 6.63
FHA........................ 117 117 10.40
Collateralized mortgage
obligations.............. 10,800 10,803 6.30
------- -------
Total................. $19,364 $19,370 6.20
======= =======
</TABLE>
19
<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, 1997 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>
1.59% None NOW Accounts $ 100 $10,823 13.04%
2.00 None Passbook Statement Accounts 100 8,061 9.71
3.00 None Money Market Deposit Accounts 1,000 8,955 10.79
Certificates of Deposit
-----------------------
4.98 91 days 3-month money market 1,000 2,139 2.58
5.23 182 days 6-month money market 1,000 5,310 6.40
6.11 11-month Fixed-term, fixed-rate 500 95 0.11
5.47 12-month Fixed-term, fixed-rate 500 7,646 9.21
5.97 15-month Fixed-term, fixed-rate 500 1,168 1.41
5.52 18-month Fixed-term, fixed-rate 500 956 1.15
5.77 24-month Fixed-term, fixed-rate 500 4,305 5.19
5.65 30-month Fixed-term, fixed-rate 500 3,603 4.34
5.99 36-month Fixed-term, fixed-rate 500 5,711 6.88
6.21 48-month Fixed-term, fixed-rate 500 2,956 3.56
6.35 60-month Fixed-term, fixed-rate 500 13,199 15.90
2.50 96 month Fixed-term, fixed-rate -- 3 --
5.70 18 month 18-month, IRA accounts 100 6,154 7.42
5.90 14 days Negotiated Jumbo (2) 100,000 1,919 2.31
------- ------
$83,003 100.00%
======= ======
</TABLE>
____________________
(1) Represents weighted average interest rate at September 30, 1997.
(2) Municipal deposits.
20
<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 Balance at
September 30, % Increase September 30, % Increase September 30, %
1997 Deposits (Decrease) 1996 Deposits (Decrease) 1995 Deposits
------------ -------- ---------- ------------ -------- ---------- ------------- ---------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
NOW accounts................. $10,823 13.04% $ 305 $10,518 12.98% $ 416 $10,102 12.31%
Jumbo certificates (1)....... 1,919 2.31 (672) 2,591 3.20 (1,524) 4,115 5.02
Money market demand accounts. 8,955 10.79 198 8,757 10.80 (222) 8,979 10.94
Passbook and regular savings. 8,061 9.71 (479) 8,540 10.54 (771) 9,311 11.35
Six month money market
certificates................ 5,310 6.40 (266) 5,576 6.88 (61) 5,637 6.87
IRA accounts................. 11,493 13.85 384 11,109 13.70 174 10,935 13.32
Other........................ 36,442 43.90 2,486 33,956 41.90 975 32,981 40.19
------- ------ ------ ------- ------ ------- ------- ------
Total................... $83,003 100.00% $1,956 $81,047 100.00% $(1,013) $82,060 100.00%
======= ====== ====== ======= ====== ======= ======= ======
</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,
--------------------------------------------------------------------------------------------------
1997 1996 1995
----------------------------- ------------------------------- ---------------------------
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.. $28,024 $54,406 $27,631 $54,101 $28,152 $52,452
Average Rate..... 2.15% 5.75% 2.18% 5.79% 2.35% 5.47%
</TABLE>
21
<PAGE>
The following table sets forth the time deposits in First Federal
classified by rates at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
------------------------------
1997 1996 1995
------ ------ ------
(In thousands)
<S> <C> <C> <C>
0 - 2.99%................... $ 3 $ 4 $ 4
3 - 3.99%................... -- 2 763
4 - 4.99%................... 2,043 3,459 4,274
5 - 5.99%................... 32,902 31,199 27,053
6 - 6.99%................... 17,684 16,015 18,555
7 - 7.99%................... 2,532 2,553 3,019
------- ------- -------
$55,164 $53,232 $53,668
======= ======= =======
</TABLE>
The following table sets forth the amount and maturities of time deposits
in First Federal at September 30, 1997.
<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%.............. $ -- $ -- $ -- $ 3 $ 3
3 - 3.99%.............. -- -- -- -- --
4 - 4.99%.............. 1,906 137 -- -- 2,043
5 - 5.99%.............. 22,566 6,721 2,557 1,058 32,902
6 - 6.99%.............. 6,684 4,234 2,407 4,359 17,684
7 - 7.99%.............. 246 824 1,462 -- 2,532
-------- ---------- --------- -------- -------
$ 31,402 $ 11,916 $ 6,426 $ 5,420 $55,164
======== ========== ========= ======== =======
</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, 1997.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposits
--------------- -----------
(In thousands)
<S> <C>
Three months or less................. $ 1,173
Over three through six months........ 1,064
Over six through 12 months........... 1,271
Over 12 months....................... 3,364
----------
Total............................. $ 6,872
==========
</TABLE>
22
<PAGE>
The following table sets forth the deposit activities of First Federal for
the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------------
1997 1996 1995
------ ------ ------
(In thousands)
<S> <C> <C> <C>
Deposits................................................. $ 214,400 $ 191,203 $ 181,706
Withdrawals.............................................. (215,410) (195,237) (181,943)
Net increase (decrease) before interest credited....... (1,010) (4,034) (237)
Interest credited........................................ 2,966 3,021 2,671
--------- --------- ---------
Net increase (decrease) in savings deposits.............. $ 1,956 $ (1,013) $ 2,434
========= ========= =========
</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, 1997, the Bank had $9.53
million in advances outstanding with the FHLB.
From time to time the Bank utilizes repurchase agreements issued primarily
to local government units. The form of 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,
1997, the Bank had $4.70 million in 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,
1997, the Bank was authorized to invest up to approximately $3.32 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, 1997, the Bank's
total investment in First Federal Service was $80,500.
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."
23
<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, in addition to
a substantial ATM network. 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, 1997. 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, 1997, the Company and the Bank had 34 full-time and 13
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,
1997 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, 1997, the Bank had $9.53 million in advances
outstanding from the FHLB of Des Moines. See "-- Deposit Activity and Other
Sources of Funds -- Borrowings."
24
<PAGE>
Liquidity Requirements. The Bank is required to maintain average daily
balances of liquid assets (cash, certain time deposits, bankers' acceptance,
highly rated corporate debt and commercial paper, securities of certain mutual
funds and specified United States government, state or federal agency
obligations) 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 1997 was 14.97% with respect to liquid assets and 4.01% 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 both a
national bank and a savings institution; (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. In addition, any company that controls
a savings institution that fails to qualify as a QTL will be required to
register as, and to be deemed, a bank holding company subject to all of the
provisions of the Bank Holding Company Act of 1956 (the "BHCA") and other
statutes applicable to bank holding companies. 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 both a national bank
and a savings institution and immediately repay any outstanding FHLB advances
(subject to safety and soundness considerations).
To qualify as a QTL, a savings institution must either qualify as a
"domestic building and loan association" under the Internal Revenue Code or
maintain at least 65% of its "portfolio assets" in Qualified Thrift Investments.
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. All of the following may be included as Qualified
Thrift Investments: investments in residential mortgages, home equity loans,
loans made for educational purposes, small business loans, credit card loans and
shares of stock issued by an FHLB. Subject to a 20% of portfolio assets limit,
savings institutions are also able to treat the following as Qualified Thrift
Investments: (i) 50% of the dollar amount of residential mortgage loans subject
to sale under certain conditions, (ii) investments, both debt and equity, in the
capital stock or obligations of and any other security issued by a service
corporation or operating subsidiary, provided that such subsidiary derives at
least 80% of its annual gross revenues from activities directly related to
purchasing, refinancing, constructing, improving or repairing domestic
residential housing or manufactured housing, (iii) 200% of their investments in
loan 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, (iv) loans for the purchase, construction,
development or improvement of community service facilities, (v) loans for
personal, family, household or educational purposes, and (vi) shares of stock
issued by FNMA or FHLMC.
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. At September 30,
1997, 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.
25
<PAGE>
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 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 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, 1997, the Bank had no such
investments.
26
<PAGE>
Adjusted total assets are a savings institution's total assets as
determined under generally accepted accounting principles increased by certain
goodwill amounts and by a pro rated portion of the assets of unconsolidated
includible subsidiaries in which the savings institution holds a minority
interest. Adjusted total assets are reduced by the amount of assets that have
been deducted from capital, the savings institution's investments in includible
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, 1997, the Bank's adjusted total assets for purposes of the core
and tangible capital requirements, were $110.76 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, 1997, the Bank had no equity
investments for which OTS regulations required a deduction from total capital.
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% 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, 1997, the Bank's
risk-weighted assets were approximately $58.15 million.
27
<PAGE>
The table below provides information with respect to the Bank's compliance
with its regulatory capital requirements at September 30, 1997.
<TABLE>
<CAPTION>
Percent
Amount of Assets(1)
------ ------------
(Dollars in thousands)
<S> <C> <C>
Tangible capital...................... $10,744 9.70%
Tangible capital requirement.......... 1,661 1.50
------- -----
Excess.............................. $ 9,083 8.20%
======= =====
Core capital.......................... $10,744 9.70%
Core capital requirement (2).......... 3,323 3.00
------- -----
Excess.............................. $ 7,421 6.70%
======= =====
Risk-based capital.................... $11,171 19.21%
Risk-based capital requirement........ 4,652 8.00
------- -----
Excess.............................. $ 6,519 11.21%
======= =====
</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 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 to have more than normal level of interest
rate risk under the rule and believes that it will not be required to increase
its total capital as a result of the rule.
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
28
<PAGE>
institution. Such circumstances would include a high degree of exposure to
interest rate risk, prepayment risk, credit risk, concentration of credit risk
and certain risks arising from non-traditional activities. 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, 1997, 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. 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.
Under regulations jointly adopted by the federal banking regulators,
including the OTS, a depository institution's capital adequacy for purposes of
the prompt corrective action rules is determined 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 will be 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 CAMELS rating). An "undercapitalized" depository instituion is an 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 CAMELS rating). A
"significantly undercapitalized" institution is defined
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<PAGE>
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 CAMELS rating category. As of September 30, 1997, 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 FDIC through the SAIF. Under the Federal Deposit Insurance Act, the FDIC is
required to set semi-annual assessments for SAIF-insured institutions at a level
necessary to maintain the designated reserve ratio of the SAIF at 1.25% of
estimated insured deposits, or at a higher percentage of estimated insured
deposits that the FDIC determines to be justified for that year by circumstances
indicating a significant risk of substantial future losses to 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 under 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.
Over the past years, institutions with SAIF-assessable deposits, like the
Bank, were required to pay higher deposit insurance premiums than institutions
with deposits insured by the Bank Insurance Fund ("BIF"). In order to
recapitalize the SAIF and address the premium disparity, in November 1996 the
FDIC imposed a one-time special assessment on institutions with SAIF-assessable
deposits based on the amount determined by the FDIC to be necessary to increase
the reserve levels of the SAIF to the designated reserve ratio of 1.25% of
insured deposits. Institutions were assessed at the rate of 65.7 basis points
based on the amount of their SAIF-assessable deposits as of March 31, 1995.
The special assessment recapitalized the SAIF, and as a result, the FDIC
lowered the SAIF deposit insurance assessment rates through the end of 1997 to
zero for "well capitalized" institutions with the highest supervisory ratings
and 0.27% of insured deposits for institutions in the highest risk-based premium
category. Since the BIF is above its designated reserve ratio of 1.25% of
insured deposits, "well-capitalized" institutions in Subgroup A, numbering 95%
of BIF-insured institutions, pay no federal deposit insurance premiums, with the
remaining 5% of BIF institutions paying a graduated range of rates up to 0.27%
of insured deposits for the highest risk-based premium category. Until December
31, 1999, SAIF-insured institutions will be required to pay assessments to the
FDIC at the rate of 6.5 basis points to help fund interest payments on certain
bonds issued by the Financing Corporation ("FICO") an agency of the federal
government established to finance takeovers of insolvent thrifts. During this
period, BIF members will be assessed for
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<PAGE>
these obligations at the rate of 1.3 basis points. After December 31, 1999, both
BIF and SAIF members will be assessed at the same rate for FICO payments, or
sooner if the two funds are merged.
Substantial entrance and exit fees apply to conversions from SAIF to BIF
insurance and such fees may make a SAIF to BIF conversion prohibitively
expensive. In the past the substantial disparity existing between deposit
insurance premiums paid by BIF and SAIF members gave BIF-insured institutions a
competitive advantage over SAIF-insured institutions like the Bank. The
reduction of SAIF deposit insurance premiums effectively eliminated this
disparity and could have the effect of increasing the net earnings of the Bank
and restoring the competitive equality between BIF-insured and SAIF-insured
institutions.
The FDIC has adopted a regulation which provides that any insured
depository institution with a ratio of Tier 1 capital to total assets of less
than 2% will be deemed to be operating in an unsafe or unsound condition, which
would constitute grounds for the initiation of termination of deposit insurance
proceedings. The FDIC, however, would not initiate termination of insurance
proceedings if the depository institution has entered into and is in compliance
with a written agreement with its primary regulator, and the FDIC is a party to
the agreement, to increase its Tier 1 capital to such level as the FDIC deems
appropriate. Tier 1 capital is defined as the sum of common stockholders'
equity, noncumulative perpetual preferred stock (including any related surplus)
and minority interests in consolidated subsidiaries, minus all intangible assets
other than mortgage servicing rights and qualifying supervisory goodwill
eligible for inclusion in core capital under OTS regulations and minus
identified losses and investments in certain securities subsidiaries. Insured
depository institutions with Tier 1 capital equal to or greater than 2% of total
assets may also be deemed to be operating in an unsafe or unsound condition
notwithstanding such capital level. The regulation further provides that in
considering applications that must be submitted to it by savings institutions,
the FDIC will take into account whether the savings institution is meeting with
the Tier 1 capital requirement for state non-member banks of 4% of total assets
for all but the most highly rated state non-member banks.
Federal Reserve System. Pursuant to regulations of the Federal Reserve
Board, a thrift institution must maintain average daily reserves equal to 3% on
the first $49.3 million of transaction accounts plus 10% on the remainder.
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, 1997, 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 give the OTS 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 its fully phased-in capital requirement to assets ratio at the
beginning of the calendar year. A savings institution with total capital in
excess of current minimum capital ratio requirements but not in excess of fully
phased-in 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
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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 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 and
deducted 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,
OTS regulations provide that 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. Section 106 of the BHCA which applies to the Bank,
prohibits the Bank 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.
Loans to Directors, Executive Officers and Principal Stockholders. Savings
institutions are also subject to the restrictions contained in Section 22(h) and
Section 22(g) of the Federal Reserve Act 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 entities of such persons, may not exceed, together with
all other outstanding loans to such person and affiliated entities, the
institution's loans-to-one-borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus and an additional 10% of such
capital and surplus for loans fully secured by readily marketable collateral).
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. The
Federal Reserve Board has prescribed 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.
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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 the depository institution for such extensions 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. In addition, Section 106 of the BHCA 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 depository 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.
Under federal banking regulations, savings institutions must also 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. A savings institution's real estate lending policy
must reflect consideration of the Interagency Guidelines for Real Estate Lending
Policies (the "Real Estate Lending Guidelines") that have been adopted by the
federal banking regulators. The Real Estate Lending Guidelines, among other
things, call upon savings institutions to establish internal loan-to-value
limits for real estate loans that are not in excess of the specified loan-to-
value limits for the various types of real estate loans. The Real Estate
Lending Guidelines state, however, 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.
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.
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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 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
previously directly 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 savings and loan holding company.
Restrictions on Acquisitions. The HOLA generally prohibits savings and
loan holding companies 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. 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
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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 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).
OTS regulations 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 QTL or as
a "domestic building and loan institution" under (S)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 QTL or for 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.
Under the BHCA, bank holding companies are specifically authorized 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. 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 BHCA.
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.
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<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, 1997.
<TABLE>
<CAPTION>
Year Owned or Book Value at Approximate Deposits at
Opened Leased September 30, 1997 Square Footage September 30, 1997
------ -------- ------------------ -------------- ------------------
(In thousands)
<S> <C> <C> <C> <C> <C>
MAIN OFFICE:
214 5th Street 1910 Owned $1.07 million 10,990 $48,338
Bemidji, Minnesota 56601
BRANCH OFFICES:
22 First Street, NE 1977 Owned 158,000 1,789 16,960
Bagley, Minnesota 56621
109 Main Street West 1983 Owned 303,000 3,083 10,498
Baudette, Minnesota 56623
527 Minnesota Avenue 1987 Owned 107,000 1,700 6,000
Walker, Minnesota 56484
550 Paul Bunyan Drive, N.W. 1995 Leased 260,000 2,158 1,207
Bemidji, Minnesota 56601
</TABLE>
The book value of the Company's investment in premises and equipment
totaled $1.89 million at September 30, 1997. See Note 9 of Notes to
Consolidated Financial Statements.
ITEM 3. LEGAL PROCEEDINGS.
- - -------------------------
At September 30, 1997, there were no 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 loss to the
Company or the Bank.
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, 1997.
36
<PAGE>
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, 1997 (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
- - --------------------
On January 21, 1997 the Company filed a Current Report on Form 8-K
announcing the change in Registrant's Certifying Accountants. However, as
disclosed in the Form 8-K, previously filed, there were no disagreements with
the previous accountants on accounting or financial disclosures in the two most
recent fiscal years, or any interim period.
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 1998 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.
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.
37
<PAGE>
(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,
1997 and 1996
Consolidated Statements of Earnings - Years ended September 30,
1997, 1996 and 1995
Consolidated Statements of Stockholders' Equity - Years ended
September 30, 1997, 1996 and 1995
Consolidated Statements of Cash Flows - Years ended September 30,
1997, 1996 and 1995
Notes to Consolidated Financial Statements
(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.
No. Description
--- -----------
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 **
38
<PAGE>
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 McGladrey & Pullen LLP
27 Financial Data Schedule
___________
(*) 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,
-------------------
1997, 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.
39
<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 23, 1997
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 23, 1997
- - -------------------------------------
William R. Belford
President, Chief Executive Officer
and Director
(Principal Executive Officer)
December 23, 1997
/s/ Dennis M. Vorgert
- - -------------------------------------
Dennis M. Vorgert
Vice President and Treasurer
(Principal Financial and Accounting Officer)
/s/ Ralph T. Smith December 23, 1997
- - -------------------------------------
Ralph T. Smith
Chairman of the Board
/s/ Martin R. Sathre December 23, 1997
- - -------------------------------------
Martin R. Sathre
Vice Chairman of the Board
/s/ Walter R. Fankhanel December 23, 1997
- - -------------------------------------
Walter R. Frankhanel
Director
/s/ James R. Sharp December 23, 1997
- - -------------------------------------
James R. Sharp
Director
/s/ Dean J. Thompson December 23, 1997
- - ------------------------------------
Dean J. Thompson
Director
<PAGE>
EXHIBIT 13
[ L O G O ]
ANNUAL REPORT FOR
THE YEAR ENDED
SEPTEMBER 30, 1997
<PAGE>
[FIRST FEDERAL BANCORPORATION LETTERHEAD]
December 19, 1997
To Our Stockholders:
It gives me great please to give you our progress and profitability report
for First Federal Bancorporation and its principal subsidiary, First Federal
Bank. This report represents an exciting and productive year at First Federal
detailing our second full year as a public company.
Total consolidated net earnings for the year ended September 30, 1997 was
$708,413. Net income increased 123.83% over 1996 levels primarily due to
reduced operating expenses over 1996 levels and increased reliance on fee
income. Consolidated stockholders' equity was $11,941,026 at September 30,
1997, \ which represents 10.71% of total assets.
We are pleased to report the following positive changes during 1997:
. Our banking subsidiary, First Federal Banking and Savings, FSB, changed
its name to First Federal Bank reflecting our continuing effort to provide high
quality banking services.
. As of November 18, 1997, First Federal Bancorporation had completed the
repurchase of 22.84% of the original 862,500 shares of common stock. As of
November 18, 1997, First Federal Bancorporation had 665,538 shares of common
stock outstanding.
. In addition, on November 18, 1997, First Federal Bancorporation declared
a three for two stock split in the form of a 50% stock dividend payable December
18, 1997 to stockholders of record as of December 5, 1997.
We thank you for your support and pledge our continuing time and energy
toward enhancing shareholder value.
Sincerely,
/s/ William R. Belford
William R. Belford
President
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
AT SEPTEMBER 30, CHANGE
---------------------- -------------------
1997 1996 AMOUNT PERCENT
---------- ---------- --------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
FINANCIAL POSITION:
Total assets............................. $ 111,492 $ 107,256 $ 4,236 3.95%
Loans receivable, net.................... 53,589 51,003 2,586 5.07
Mortgage-backed and related securities... 19,364 20,749 (1,385) (6.68)
Investment securities.................... 28,757 25,750 3,007 11.68
Deposits................................. 83,003 81,047 1,956 2.41
Stockholders' equity..................... 11,941 12,323 (382) (3.10)
Number of common shares outstanding (1).. 1,008,849 1,050,849 (42,000) (4.00)
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
SEPTEMBER 30, CHANGE
---------------------- ------------------
1997 1996 AMOUNT PERCENT
---------- ---------- -------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
RESULTS OF OPERATIONS:
Interest income.......................... $ 7,891 $ 7,429 $ 462 6.22%
Interest expense......................... 4,457 4,016 441 10.98
Net interest income...................... 3,434 3,413 21 0.62
Provision for loan losses................ -- -- -- --
Net interest income after provision
for loan losses......................... 3,434 3,413 21 0.62
Non-interest income...................... 571 533 38 7.13
Non-interest expense..................... 2,805 3,414 (609) (17.84)
Earnings before cumulative effect
of accounting change.................... 1,200 532 668 125.56
Net earnings............................. 708 316 392 124.05
</TABLE>
_______________________________
(1) Adjusted to retroactively give effect to a 3-for-2 stock split on December
18, 1997.
1
<PAGE>
SELECTED FINANCIAL INFORMATION
SUMMARY OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
AT SEPTEMBER 30,
-----------------------------------------------
1997 1996 1995 1994 1993
-------- -------- ------- ------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Total amount of:
Assets.................................. $111,492 $107,256 $99,507 $87,256 $85,075
Loans receivable, net................... 53,589 51,003 48,044 46,381 48,947
Investment securities:
Available for sale...................... 28,757 25,750 15,632 13,231 --
Held to maturity........................ -- -- -- 1,669 15,477
Mortgage-backed and related securities:
Available for sale...................... 18,834 19,903 20,417 13,230 --
Held to maturity........................ 530 846 1,106 1,435 11,500
Deposit accounts......................... 83,003 81,047 82,060 79,626 77,513
Advances from FHLB....................... 9,534 6,943 -- -- --
Other borrowings......................... 4,697 4,955 1,000 -- --
Stockholders' equity..................... 11,941 12,323 15,091 6,566 6,553
</TABLE>
<TABLE>
<CAPTION>
SUMMARY OF OPERATIONS
YEAR ENDED SEPTEMBER 30,
-----------------------------------------------
1997 1996 1995 1994 1993
-------- -------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Interest income.......................... $ 7,891 $ 7,429 $ 6,732 $ 5,613 $ 6,001
Interest expense......................... 4,457 4,016 3,547 2,841 3,206
-------- -------- ------- ------- -------
Net interest income before
provision for loan losses............... 3,434 3,413 3,185 2,772 2,795
Provision for loan losses................ -- -- 4 16 12
Non-interest income...................... 571 533 361 354 358
Non-interest expense..................... 2,805 3,414 2,387 2,163 2,090
-------- -------- ------- ------- -------
Earnings before income tax expense and
cumulative effect of accounting change.. 1,200 532 1,155 947 1,051
Income tax expense....................... 492 216 473 410 391
-------- -------- ------- ------- -------
Earnings before cumulative effect
of accounting change.................... 708 316 682 537 660
Cumulative effect of accounting change... -- -- -- 120 --
-------- -------- ------- ------- -------
Net earnings............................. $ 708 $ 316 $ 682 $ 657 $ 660
======== ======== ======= ======= =======
- - --------------------------------------------------------------------------------------------------
Per Share Data:
Net earnings (1)....................... $ .81 $ .28 .33 -- --
Pro forma net earnings (1)............. -- -- .57 -- --
Book value (1)......................... 11.83 11.73 11.67 -- --
</TABLE>
______________________
(1) Adjusted to retroactively give effect to a 3-for-2 stock split on December
18, 1997.
2
<PAGE>
<TABLE>
<CAPTION>
KEY OPERATING RATIOS
YEAR ENDED SEPTEMBER 30,
-------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Return on assets (net earnings divided
by average total assets)................. 0.65% 0.31% 0.73% 0.77% 0.77%
Return on equity (net earnings
divided by average equity)............... 5.87 2.31 6.45 9.52 10.61
Tangible-equity-to-assets ratio
(average equity divided by
average total assets).................... 11.10 13.25 11.40 8.10 7.21
Interest rate spread....................... 2.94 3.02 3.29 3.26 3.29
Net interest margin (1).................... 3.32 3.51 3.63 3.42 3.41
Non-performing loans to total loans (2).... 0.17 0.41 0.18 0.19 0.83
Non-performing assets to total assets (3).. 0.32 0.38 0.24 0.22 0.52
Allowance for loan losses to total loans... 0.78 0.87 0.99 1.11 1.10
Allowance for loan losses to
non-performing loans..................... 464.13 214.93 564.37 594.38 135.80
Net charge-offs to average loans........... 0.05 0.08 0.09 0.08 0.15
Non-interest expense to average assets..... 2.58 3.30 2.57 2.54 2.42
Average interest-earning assets to
average interest-bearing
liabilities.............................. 108.73 111.96 108.27 104.52 103.20
</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
1,293,750 shares (as adjusted for a 3-for-2 stock split) of Common Stock at a
price of $6.67 per share (as adjusted for a 3-for-2 stock split), realizing
gross proceeds of $8.63 million and net proceeds of $7.96 million. Since the
Conversion, the Company has repurchased 284,901 shares (as adjusted for a 3-for-
2 stock split) of its Common Stock, and as of September 30, 1997, there were
1,008,849 shares (as adjusted for a 3-for-2 stock split) of Common Stock issued
and outstanding. 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, $433,000 of cash and cash equivalents and
$260,000 in securities available for sale, and $603,000 in other assets.
FIRST FEDERAL BANK
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. In August 1997, the Bank changed its name to
"First Federal Bank." 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, 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 1997 continued to be active in
originating and purchasing participation interests in commercial real estate
loans, and development of consumer loans in the local markets.
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.
4
<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 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, 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 Company's Year 2000 Action Plan was presented to the Board of Directors
on September 24, 1997. The Year 2000 Plan includes the following phases:
awareness, assessment, upgrading, implementation and testing. The Year 2000
Project Team, currently in the assessment phase, has determined that the main
operating system and the teller system must be upgraded or replaced. The Year
2000 Team is evaluating new systems which are Year 2000 compliant. Based upon
current findings, the Company has estimated $300,000 for capital expenditures in
Fiscal 1998 relating to Year 2000 software and hardware issues. The Year 2000
Plan is scheduled for completion by December 31, 1998 with progress reported to
the Board of Directors.
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.
5
<PAGE>
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
long-term 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, 1997, $20.6 million, or 78.89% 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, 1997, $16.71 million, or
57.90% of the Company's loans 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, 1997, the Company had $32.66 million of investment securities and interest
bearing deposits in other banks, with a weighted average remaining maturity of
less than four 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, 1997, the Company had $10.80 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, 1997, the Company had $2.44 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 $4.23
million, or 3.95%, from $107.26 million at September 30, 1996 to $111.49 million
at September 30, 1997. The increase in total assets resulted primarily from an
increase in investment securities of $3.01 million, an increase in loans
receivable, net of $2.59 million, offset by a decrease in mortgage-backed and
related securities of $1.38 million.
Investment securities and mortgage-backed and related securities totaling
$48.12 million at September 30, 1997, consisted of $47.59 million in securities
classified as available for sale and $530,000 in securities classified as held
to maturity. Loans receivable, net increased $2.59 million as a result of an
excess of new loan originations and purchases over repayments and refinances.
The Company experienced an increase in deposits during fiscal 1997 of $1.96
million, or 2.41%. Repurchase agreements decreased $258,000, or 5.20%, from
$4.95 million at September 30, 1996 to $4.70 million at September 30, 1997.
The Company has made extensive use of the Federal Home Loan Bank Advance
program during the twelve months ended September 30, 1997. Federal Home Loan
Bank advances have increased from $6.94 million at September 30, 1996 to $9.53
million at September 30, 1997.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 1997 AND
SEPTEMBER 30, 1996
Net Earnings. The Company had net earnings of $708,000 for the year ended
September 30, 1997, as compared to $316,000 for the year ended September 30,
1996. As discussed below, the increase in net earnings of $392,000 was
primarily the result of a $588,000 charge in the year ended September 30, 1996
for assessments imposed under the Deposit Insurance Fund Act of 1996. Other
changes affecting net earnings include an increase in net interest income of
$22,000 an increase in non-interest income of $37,000, and a decrease in other
non-interest expense of $21,000, offset by an increase in income tax expense of
$276,000.
6
<PAGE>
Net Interest Income. Net interest income remained relatively unchanged,
increasing only $22,000, or 0.64%, from $3.41 million for the year ended
September 30, 1996 to $3.43 million for the year ended September 30, 1997.
Average interest-earning assets increased $6.36 million, or 6.55%, while average
interest-bearing liabilities increased $8.43 million, or 9.72%. During this same
period, the interest rate spread decreased from 3.02% for the year ended
September 30, 1996 to 2.94% for the year ended September 30, 1997.
Interest Income. Interest income increased by $462,000, or 6.23%, from
$7.43 million for the year ended September 30, 1996 to $7.89 million for the
year ended September 30, 1997. This increase was due primarily to an increase
in the average outstanding balance of interest-earning assets. Total average
interest-earning assets increased 6.55% during the year ended September 30,
1997. At the same time the overall yield on interest-earning assets remained
relatively unchanged for the same period.
Interest Expense. Interest expense increased by $441,000, or 10.97%, from
$4.02 million for the year ended September 30, 1996 to $4.46 million for the
year ended September 30, 1997. This increase was primarily the result of an
increase in the average outstanding balances of Federal Home Loan Bank advances
and repurchase agreements.
Provision for Losses on Loans. There were no provisions for losses on
loans during either of the past two fiscal years. 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 $37,000, or
7.00%, from $533,000 for the year ended September 30, 1996 to $571,000 for the
year ended September 30, 1997. This increase was related to a $62,000 increase
in fees and service charges, a $30,000 increase in gains on sales of securities
and foreclosed real estate, and a $55,000 decrease in other income.
Non-interest Expense. Non-interest expense decreased by $609,000, or
17.84%, from $3.41 million for the year ended September 30, 1996 to $2.80
million for the year ended September 30, 1997. This decrease was primarily the
result of a $588,000 charge in the year ended September 30, 1996 for assessments
imposed under the Deposit Insurance Fund Act of 1996. This decrease was also
due to a $134,000 decrease in federal deposit insurance premiums and an $89,000
decrease in legal and professional fees. These decreases were offset by a
$103,000 increase in compensation and employee benefits expense, a $20,000
increase in occupancy expense, a $45,000 increase in advertising expense and a
$34,000 increase in other non-interest expenses.
Income Tax Expense. Income tax expense increased from $216,000 for the
year ended September 30, 1996 to $492,000 for the year ended September 30, 1997
due to increased income before income tax expense.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED SEPTEMBER 30, 1996 AND
SEPTEMBER 30, 1995
Net Earnings. The Company had net earnings of $316,000 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 $366,000 was due to
an increase in net interest income of $228,000, an increase in non-interest
income of $173,000, 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 $228,000, 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 an
7
<PAGE>
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.
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.
8
<PAGE>
The following table reflects the activity in the allowance for loan losses.
<TABLE>
<CAPTION>
At or for the
Year Ended September 30,
----------------------------
1997 1994 1995
-------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C>
Balance at the beginning of the year....... $ 454 $ 491 $ 529
Provision for losses....................... -- -- 4
Charge-offs................................ (38) (49) (49)
Recoveries................................. 11 12 7
----- ----- -----
Net charge-offs........................ (27) (37) (38)
----- ----- -----
Balance at end of the year................. $ 427 $ 454 $ 491
===== ===== =====
Ratio of net charge-offs to average loans
outstanding during the period............ 0.05% 0.08% 0.09%
===== ===== =====
Ratio of allowance for loan losses
to total loans........................... 0.78% 0.87% 0.99%
===== ===== =====
</TABLE>
NON-PERFORMING ASSETS
Non-performing assets totaled $355,000 at September 30, 1997 compared to
$405,000 at September 30, 1996 and $239,000 at September 30, 1995.
Non-performing assets are summarized in the following table.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------
1997 1996 1995
-------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C>
Non-performing loans............................... $ 92 $ 211 $ 87
Foreclosed assets.................................. 263 194 152
------- ------- -------
Total non-performing assets.................... $ 355 $ 405 $ 239
======= ======= =======
Non-performing assets to total assets.............. 0.32% 0.38% 0.24%
======= ======= =======
Non-performing assets to total loans............... 0.65% 0.78% 0.18%
======= ======= =======
Allowance for loan losses to non-performing loans.. 464.13% 214.93% 564.37%
======= ======= =======
</TABLE>
The non-performing loans reflected above consist of non-accruing loans and
accruing loans 90 days or more past due.
9
<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.
10
<PAGE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED SEPTEMBER 30,
-------------------------------------------------------------------------
AT SEPTEMBER 30,1997 1997 1996
-------------------- --------------------------------- ------------------------------------
AVERAGE AVERAGE AVERAGE
YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE COST BALANCE INTEREST COST BALANCE INTEREST COST
---------- -------- --------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable......... $ 53,589 9.05% $ 51,810 $ 4,694 9.06% $ 48,954 $4,471 9.13%
Other marketable
securities.............. 28,757 6.68 27,511 1,815 6.60 20,763 1,339 6.45
Mortgage-backed and
related securities...... 19,364 6.20 19,820 1,278 6.45 21,676 1,407 6.49
Short-term investment
and other interest-
earning assets......... 3,676 5.75 4,361 104 2.38 5,745 212 3.69
-------- -------- ------- -------- -----
Total interest-earning
assets................ 105,386 7.77 103,502 7,891 7.62 97,138 7,429 7.65
------- -------
Non-interest-earning assets 6,106 5,187 5,287
-------- -------- --------
Total assets........... 111,492 108,689 102,425
======== ======== ========
Interest-bearing
liabilities:
Deposits:
NOW accounts........... $ 10,823 1.59 $ 10,707 168 1.57 $ 9,945 157 1.58
Passbook accounts...... 8,061 2.00 8,266 165 2.00 8,903 186 2.09
Money market deposits.. 8,955 3.00 9,051 269 2.97 8,782 260 2.96
Certificate accounts... 55,164 5.82 54,406 3,129 5.75 54,101 3,133 5.79
Borrowings:
FHLB advances............ 9,534 5.75 8,302 480 5.78 2,654 151 5.69
Repurchase agreements.... 4,697 5.59 4,460 246 5.52 2,374 129 5.43
-------- -------- ------- -------- -------
Total interest-bearing
liabilities........... 97,234 4.75 95,192 4,457 4.68 86,759 4,016 4.63
------- -------
Non interest-bearing
liabilities............... 2,317 1,436 1,235
-------- -------- --------
Total liabilities...... 99,551 96,628 87,994
Stockholders' equity....... 11,941 12,061 14,431
-------- -------- --------
Total liabilities and
retained earnings..... $111,492 $108,689 $102,425
======== ======== ========
Net interest income........ $ 3,434 $3,413
======= =======
Interest rate spread....... 3.02% 2.94% 3.02%
==== ==== =====
Net interest margin........ 3.39% 3.32% 3.51%
==== ==== =====
Ratio of average
interest-earning
assets to average
interest-
bearing liabilities...... 108.38% 108.73% 111.96%
====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
------------------------------------
1995
------------------------------------
AVERAGE
AVERAGE YIELD/
BALANCE INTEREST COST
---------- -------- ---------
<S> <C> <C> <C>
Interest-earning assets:
Loans receivable......... $ 47,485 4,274 9.00%
Other marketable
securities.............. 16,222 1,021 6.29
Mortgage-backed and
related securities...... 17,581 1,156 6.59
Short-term investment
and other
interest-earning assets 6,572 281 4.28
--------- -------
Total interest-earning
assets................ 87,860 6,732 7.66
-------
Non-interest-earning assets 4,965
---------
Total assets........... $ 92,825
=========
Interest-bearing liabilities:
Deposits:
NOW accounts........... $ 9,633 158 1.64
Passbook accounts...... 9,542 234 2.46
Money market deposits.. 8,869 263 2.97
Certificate accounts... 52,452 2,867 5.47
Borrowings:
FHLB advances.......... 656 25 3.76
Repurchase agreements.. -- -- --
--------- -------
Total interest-bearing
liabilities......... 81,152 3,547 4.37
--------- -------
Non-interest-bearing
liabilities............... 1,094
---------
Total liabilities...... 82,246
Stockholders' equity....... 10,579
---------
Total liabilities and
retained
earnings............. $ 92,825
=========
Net interest income........ $ 3,185
=======
Interest rate spread....... 3.29%
======
Net interest margin........ 3.63%
======
Ratio of average
interest-earning
assets to average
interest-
bearing liabilities...... 108.27%
=======
</TABLE>
11
<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,
-----------------------------------------------------------------------------------------
1997 VS. 1996 1996 VS. 1995
-------------------------------------- --------------------------------------------
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..................... $ 257 $(34) $ 223 $ 134 $ 63 $ 197
Mortgage-backed and related
securities......................... (120) (9) (129) 292 26 318
Other marketable securities.......... 444 32 476 269 (18) 251
Other interest-earning assets........ (44) (64) (108) (33) (36) (69)
----- ---- ----- ----- ----- -----
Total interest-earning assets..... 537 (75) 462 662 35 697
Interest expense:
Deposits:
NOW accounts....................... 12 (1) 11 5 (6) (1)
Passbook accounts.................. (13) (8) (21) (15) (33) (48)
Money market accounts.............. 8 1 9 (2) (1) (3)
Certificates....................... 18 (22) (4) 93 173 266
Borrowings:
FHLB advances...................... 327 2 329 107 19 126
Repurchase agreements.............. 115 2 117 129 -- 129
----- ---- ----- ----- ----- -----
Total interest-bearing
liabilities..................... 467 (26) 441 317 152 469
----- ---- ----- ----- ----- -----
Change in net interest income.......... $ 70 $(49) $ 21 $ 345 $(117) $ 228
===== ==== ===== ===== ===== =====
</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, 1997, 1996 and 1995, the
Bank's loan originations totaled $15.26 million, $14.47 million and $9.13
million, respectively. The Company purchased investment securities and mortgage
backed and related securities during the years ended September 30, 1997, 1996
and 1995 of $23.14 million, $23.05 million and $20.18 million, respectively.
12
<PAGE>
The primary financing activity of the Company is the attraction of
deposits. During the year ended September 30, 1997, the Bank experienced a net
increase in deposits of $1.96 million. 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, 1997, the Bank has become actively
involved in the area of repurchase agreements. Repurchase agreements at
September 30, 1997 totaled $4.70 million compared to a total of $4.45 million at
September 30, 1996.
The Bank has the ability to borrow additional funds from the FHLB of Des
Moines by pledging additional securities. At September 30, 1997, the Bank had
an undrawn borrowing capacity with the FHLB for $16.63 million. At September
30, 1997 the Bank had $9.53 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 1997 was 14.97% and its short-
term liquidity for the same month was 4.01%.
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, 1997, 1996 and 1995, cash and cash equivalents totaled $4.60
million, $4.69 million and $10.19 million, respectively.
The Bank anticipates that it will have sufficient funds available to meet
its current commitments. At September 30, 1997, the Bank had commitments to
originate/purchase loans of $1.43 million. Certificates of deposit which are
scheduled to mature in one year or less at September 30, 1997, totaled $31.40
million. Management believes that a significant portion of such deposits will
remain with the Bank.
At September 30, 1997, 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.
13
<PAGE>
CONSOLIDATED FINANCIAL STATEMENTS
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE
<S> <C>
Independent Auditors' Report 15
Consolidated Statements of Financial Condition 16
September 30, 1997 and 1996
Consolidated Statements of Income for the years ended 17
September 30, 1997, 1996, and 1995
Consolidated Statements of Stockholders' Equity for the years ended 18
September 30, 1997, 1996, and 1995
Consolidated Statements of Cash Flows for the years ended 20
September 30, 1997, 1996, and 1995
Notes to Consolidated Financial Statements 22
</TABLE>
14
<PAGE>
[LETTERHEAD OF MCGLADREY & PULLEN, LLP]
INDEPENDENT AUDITORS' REPORT
The Board of Directors
First Federal Bancorporation
Bemidji, Minnesota
We have audited the accompanying consolidated statement of financial condition
of First Federal Bancorporation and subsidiaries (the Company) as of September
30, 1997, and the related consolidated statements of income, stockholders'
equity, and cash flows for the year then ended. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit. The consolidated financial statements of First
Federal Bancorporation and subsidiaries for the year ended September 30, 1996
were audited by other auditors whose report, dated October 25, 1996, expressed
an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 1997 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of First
Federal Bancorporation and subsidiaries as of September 30, 1997, and the
results of their operations and their cash flows for the year then ended in
conformity with generally accepted accounting principles.
/s/ McGladery & Pullen, LLP
Duluth, Minnesota
October 24, 1997
15
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
SEPTEMBER 30, 1997 AND 1996
<TABLE>
<CAPTION>
ASSETS 1997 1996
- - ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash $ 1,623,991 $ 1,376,853
Interest-bearing deposits with banks 2,975,412 3,308,983
-------------------------------
CASH AND CASH EQUIVALENTS 4,599,403 4,685,836
Available-for-sale securities 47,591,284 45,653,160
Held-to-maturity securities 529,964 845,605
Loans receivable, less allowance for loan losses
$427,255 in 1997 and $453,460 in 1996 53,588,542 51,003,105
Federal Home Loan Bank stock, at cost 700,500 700,500
Foreclosed real estate, net 263,186 193,823
Accrued Interest receivable 886,263 862,732
Premises and equipment, net 1,894,958 1,944,754
Other assets 1,437,938 1,366,586
-------------------------------
$ 111,492,038 $ 107,256,101
===============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 83,003,312 $ 81,046,519
Repurchase agreements 4,696,904 4,954,620
Federal Home Loan Bank advances 9,534,298 6,943,258
Advance payments by borrowers for taxes and insurance 163,876 156,730
Accrued interest payable 594,920 587,779
Accrued expenses and other liabilities 1,557,702 1,244,497
-------------------------------
TOTAL LIABILITIES 99,551,012 94,933,403
-------------------------------
Commitments and Contingencies
Stockholders' Equity
Serial preferred stock ($.01 par value); authorized
1,000,000 shares; issued and outstanding none - -
Common stock ($.01 par value); authorized 4,000,000 shares;
issued 1,008,849 and 1,050,849 shares in 1997 and 1996 6,726 7,006
Additional paid-in capital 6,109,390 6,372,253
Retained earnings, subject to certain restrictions 8,015,142 7,558,604
Unrealized loss on securities available for sale, net (14,515) (150,979)
Unearned employee stock ownership plan shares (483,000) (552,000)
Unearned management recognition plan shares (283,331) (377,775)
Treasury stock, at cost, 129,117 and 54,845 shares in 1997
and 1996 (1,409,386) (534,411)
-------------------------------
TOTAL STOCKHOLDERS' EQUITY 11,941,026 12,322,698
-------------------------------
$ 111,492,038 $ 107,256,101
===============================
</TABLE>
See Notes to Consolidated Financial Statements.
16
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED SEPTEMBER 30, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
- - ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest Income
Loans receivable $ 4,694,386 $ 4,470,858
Mortgage-backed and related securities 1,277,792 1,406,698
Other marketable securities 1,814,440 1,339,367
Interest-bearing deposits with banks 55,399 161,052
Dividends 49,001 50,561
--------------------------
7,891,018 7,428,536
--------------------------
Interest Expense
Deposits 3,731,004 3,736,423
Borrowings 725,840 279,768
--------------------------
4,456,844 4,016,191
--------------------------
NET INTEREST INCOME 3,434,174 3,412,345
Provision for Loan Losses - -
--------------------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 3,434,174 3,412,345
--------------------------
Noninterest Income
Fees and service charges 471,979 409,631
Gain on sales of securities 27,095 5,350
Gain on sales of foreclosed real estate 13,485 5,643
Other income 58,122 112,722
--------------------------
570,681 533,346
--------------------------
Noninterest Expense
Compensation and employee benefits 1,526,983 1,423,486
Occupancy 517,737 498,075
Federal deposit insurance premiums 85,256 220,710
SAIF assessment - 588,444
Data processing 74,823 70,161
Advertising 138,221 93,535
Other expenses 461,529 519,133
--------------------------
2,804,549 3,413,544
--------------------------
INCOME BEFORE INCOME TAX EXPENSE 1,200,306 532,147
Income Tax Expense 491,893 215,647
--------------------------
NET INCOME $ 708,413 $ 316,500
==========================
Earnings per Common Share $ 0.81 $ 0.28
==========================
Weighted Average Number of Shares Outstanding 875,925 1,119,029
==========================
</TABLE>
See Notes to Consolidated Financial Statements.
17
<PAGE>
<TABLE>
<CAPTION>
Unrealized Unearned
Loss On Employee Unearned
Securities Stock Management
Retained Available Ownership Recognition Treasury
Earnings For Sale, Net Plan Shares Plan Shares Stock Total
- - ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 7,892,170 $ (154,087) $ (621,000) $ - $ - $ 15,090,602
316,500 - - - - 316,500
- 3,108 - - - 3,108
- - - - (1,008,341) (1,008,341)
(650,066) - - - - (2,269,406)
- - - (472,219) 473,930 -
- - - 94,444 - 94,444
- - 69,000 - - 95,791
- - ------------------------------------------------------------------------------------------------------------------------------------
7,558,604 (150,979) (552,000) (377,775) (534,411) 12,322,698
708,413 - - - - 708,413
- 136,464 - - - 136,464
- - - - (877,383) (877,383)
- - - - 2,408 2,354
(251,875) - - - - (531,875)
- - - 94,444 - 94,444
- - 69,000 - - 85,911
- - ------------------------------------------------------------------------------------------------------------------------------------
$ 8,015,142 $ (14,515) $ (483,000) $ (283,331) $ (1,409,386) $ 11,941,026
====================================================================================================================================
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
Unrealized Unearned
Loss On Employee Unearned
Securities Stock Management
Retained Available Ownership Recognition Treasury
Earnings For Sale, Net Plan Shares Plan Shares Stock Total
- - ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 7,892,170 $ (154,087) $ (621,000) $ - $ - $ 15,090,602
316,500 - - - - 316,500
- 3,108 - - - 3,108
- - - - (1,008,341) (1,008,341)
(650,066) - - - - (2,269,406)
- - - (472,219) 473,930 -
- - - 94,444 - 94,444
- - 69,000 - - 95,791
- - ------------------------------------------------------------------------------------------------------------------------------------
7,558,604 (150,979) (552,000) (377,775) (534,411) 12,322,698
708,413 - - - - 708,413
- 136,464 - - - 136,464
- - - - (877,383) (877,383)
- - - - 2,408 2,354
(251,875) - - - - (531,875)
- - - 94,444 - 94,444
- - 69,000 - - 85,911
- - ------------------------------------------------------------------------------------------------------------------------------------
$ 8,015,142 $ (14,515) $ (483,000) $ (283,331) $ (1,409,386) $ 11,941,026
====================================================================================================================================
</TABLE>
19
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
- - -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows from Operating Activities
Net income $ 708,413 $ 316,500
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 268,084 281,862
Amortization of premium and discount, net (10,004) 6,404
Increase in accrued interest receivable (23,531) (211,743)
Increase in accrued interest payable 7,141 62,715
Gain on sales of securities and foreclosed real estate (40,579) (10,993)
(Increase) decrease in other assets 60,025 (438,209)
Increase in accrued expenses and other liabilities 158,816 535,488
Earned ESOP shares priced above original cost 62,100 26,791
Decrease in unearned ESOP shares 69,000 69,000
Decrease in unamortized restricted stock 94,444 94,444
Other, net - (2,495)
----------------------------------
NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES 1,353,909 729,764
----------------------------------
Cash Flows from Investing Activities
Net increase in loans receivable (2,585,437) (2,959,480)
Purchase of securities available for sale (23,285,455) (23,046,489)
Purchase of premises and equipment (218,288) (109,759)
Proceeds from maturities and sale of securities 17,683,792 9,263,609
Principal payments on mortgage-backed
and related securities available for sale 4,038,810 3,761,386
Principal payments on mortgage-backed
and related securities held to maturity 105,240 261,908
Net increase in foreclosed real estate (69,363) (41,749)
----------------------------------
NET CASH FLOWS USED BY INVESTING ACTIVITIES (4,330,701) (12,870,574)
----------------------------------
Cash Flows from Financing Activities
Net increase (decrease) in deposits 1,956,793 (1,013,947)
Increase in advance payments by borrowers
for taxes and insurance 7,146 34,644
Net increase (decrease) in repurchase agreements (257,716) 3,954,620
Net increase in FHLB advances 2,591,040 6,943,258
Purchase of treasury stock (877,383) (1,008,341)
Proceeds from exercise of stock options 2,354 -
Purchase and retirement of common stock (531,875) (2,269,406)
----------------------------------
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES 2,890,359 6,640,828
----------------------------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (86,433) (5,499,982)
Cash and cash equivalents:
Beginning of year 4,685,836 10,185,818
----------------------------------
End of year $ 4,599,403 $ 4,685,836
----------------------------------
</TABLE>
(Continued)
20
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED SEPTEMBER 30, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
- - -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for:
Interest $ 4,449,702 $ 3,953,476
==================================
Income taxes $ 239,000 $ 487,076
==================================
Supplemental Schedule of Noncash Investing and
Financing Activities
Net change in unrealized gain (loss) on securities
available for sale $ 231,297 $ 4,902
==================================
Real estate acquired in settlement of loan $ 120,514 $ 50,756
==================================
</TABLE>
See Notes to Financial Statements.
21
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
NOTE 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 Bank (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.
NOTE 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 judgement
about information available to them at the time of their examination.
SECURITIES: The Company accounts for debt and marketable equity securities in
accordance with Financial Accounting Standards Board Statement No. 115. This
statement requires that management determine the appropriate classification of
securities at the date of adoption and thereafter as each individual security is
acquired. In addition, the appropriateness of such classification is reassessed
at each balance sheet date. The classifications and related accounting policies
are as follows:
AVAILABLE-FOR-SALE SECURITIES: Securities classified as available-for-sale
(AFS) are debt securities that the Company intends to hold for an indefinite
period of time, but not necessarily to maturity. Any decision to sell an AFS
security would be based on factors including movements in interest rates,
changes in the maturity mix of the Company's assets and liabilities, liquidity
needs, regulatory capital considerations, and similar factors. AFS Securities
are carried at fair value. Unrealized gains or losses, net of the related
deferred tax effect, are reported as increases or decreases in stockholders'
equity. Realized gains or losses, determined on the basis of the cost of
specific securities sold, are included in earnings.
22
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
HELD-TO-MATURITY SECURITIES: Securities classified as 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 stated at the amount of unpaid principal, reduced by
an allowance for loan losses.
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 against the allowance for loan losses when management believes
that collectibility of the principal is unlikely.
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.
The Company defines a loan as impaired when it is probable it will be unable to
collect principal and interest payments due in accordance with the terms of the
loan agreement. Impaired loans that have been separately identified for
evaluation are measured based on the present value of expected future cash flows
or, alternatively, the observable market price of the loans or the fair value of
the collateral. However, for those loans that are collateral dependent (that
is, if repayment of those loans is expected to be provided solely by the
underlying collateral) and for which management has determined foreclosure is
probable, the measure of impairment of those loans is to be based on the fair
value of the collateral.
Interest on loans is recognized over the terms of the loans and is calculated
using the simple interest method on principal amounts outstanding. Accrual of
interest is generally stopped when a loan is greater than three months past due.
Interest on these loans is recognized only when actually paid by the borrower if
collection of the principal is likely to occur. Accrual of interest is
generally resumed when the customer is current on all principal and interest
payments and has been paying on a timely basis for a period of time.
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.
23
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
INCOME TAXES: Deferred taxes are provided on an asset and liability method
whereby deferred tax assets are recognized for deductible temporary differences,
operating loss or tax credit carryforwards and deferred tax liabilities are
recognized for taxable temporary differences. Temporary differences are the
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. Deferred tax assets and liabilities are adjusted for the
effects of changes in tax rates on the date of enactment.
CASH EQUIVALENTS AND CASH FLOWS: 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. Cash
flows from loans, deposits, short-term borrowings and FHLB advances are reported
net.
EARNINGS PER SHARE: Earnings per share are based upon the weighted average
number of common shares and common stock equivalents, if dilutive, outstanding
during the period. The only common stock equivalents are stock options. The
weighted average number of common stock equivalents is calculated using the
treasury stock method. The weighted average number of common shares outstanding
during the years ended September 30, 1997 and 1996 have been retroactively
adjusted to give effect to a 3-for-2 stock split on December 18, 1997.
RECLASSIFICATIONS: Certain prior year amounts have been reclassified to conform
with the 1997 presentation. These reclassifications had no effect on net income
or stockholders' equity.
NEW ACCOUNTING STANDARDS: The Financial Accounting Standards Board (FASB) has
issued SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities and SFAS No. 127 Deferral of the Effective
Date of Certain Provisions of Statement No. 125. SFAS 125 provides accounting
and reporting standards for transfers and servicing of financial assets and
extinguishment of liabilities based on control of the underlying financial
assets. The provisions of SFAS 125 including those applicable to the servicing
of financial assets were effective as of January 1, 1997. The impact of these
provisions on the consolidated financial statements was not material. Other
provisions of SFAS 125, including those applicable to transfers of financial
assets and extinguishment of liabilities, are effective as of January 1, 1999.
The impact of these provisions on the consolidated financial statements is not
expected to be material.
SFAS No. 128, Earnings per Share was issued in February 1997. Effective for
First Federal Bancorporation and Subsidiaries as of December 31, 1997, SFAS 128
replaces the primary earnings per share (EPS) disclosures with basic and diluted
EPS disclosures to simplify the calculation and improve international
comparability. Statement 128 requires the presentation of earnings per share by
all entities that have common stock or potential common stock, such as options,
warrants, and convertible securities, outstanding that trade in a public market.
Those entities that have only common stock outstanding are required to present
basic EPS amounts. All other entities are required to present basic and diluted
EPS amounts. Diluted EPS amounts assume the conversion, exercise or issuance of
all potential common stock instruments unless the effect is to reduce a loss or
increase the income per common share from continuing operations. All entities
required to present per-share amounts must initially apply Statement 128 for
annual and interim periods ending after December 15, 1997. Earlier application
is not permitted. The adoption of this standard is not expected to affect the
historical trends in reported earnings per share.
24
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
In June 1997 the FASB issued Statement of Financial Accounting Standards No.
130, Reporting Comprehensive Income (SFAS 130). SFAS 130 requires that all
items that are components of comprehensive income (defined as "the change in
equity (net assets) of a business enterprise during a period from transactions
and other events and circumstances from nonowner sources. It includes all
changes in equity during a period except those resulting from investments by
owners and distributions to owners"), be reported in a financial statement that
is displayed with the same prominence as other financial statements. Companies
will be required to (a) classify items of other comprehensive income by its
nature in a financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of a statement of financial position. SFAS 130 is
effective for fiscal years beginning after December 13, 1997 and requires
reclassification of prior periods presented. SFAS 130's requirements are
disclosure-related and its implementation will have no impact on the Company's
financial condition or results of operations.
NOTE 3 SECURITIES AVAILABLE FOR SALE
Summaries of securities available for sale at September 30, 1997 and 1996 are
presented below:
<TABLE>
<CAPTION>
1997
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
- - ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 8,231,891 $ 63,058 $ 68,928 $ 8,226,021
Collateralized mortgage
obligations and REMICS 10,594,632 46,036 32,396 10,608,272
----------------------------------------------------------
Total mortgage-backed
and related securities 18,826,523 109,094 101,324 18,834,293
----------------------------------------------------------
Other Marketable Securities
U.S. government and agency
securities 21,642,268 40,886 24,203 21,658,951
Corporate bonds and notes 5,641,451 39,521 59,045 5,621,927
Municipal bonds 497,830 2,532 - 500,362
Mutual funds 1,007,812 2,689 34,750 975,751
----------------------------------------------------------
Total other marketable
securities 28,789,361 85,628 117,998 28,756,991
----------------------------------------------------------
$ 47,615,884 $ 194,722 $ 219,322 $ 47,591,284
==========================================================
</TABLE>
25
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1996
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
- - ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 9,151,506 $ 35,792 $ 183,120 $ 9,004,178
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 1,432,295 286,874 48,881 1,670,288
----------------------------------------------------------
Total other marketable
securities 25,780,689 331,503 362,415 25,749,777
----------------------------------------------------------
$ 45,909,057 $ 395,795 $ 651,692 $ 45,653,160
==========================================================
</TABLE>
The amortized cost and fair value of other marketable securities available for
sale at September 30, 1997 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 call or prepayment
penalties:
<TABLE>
<CAPTION>
1997
-----------------------------
Amortized
Cost Fair Value
- - ----------------------------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less $ 3,055,501 $ 3,051,781
Due after one year through five years 13,092,650 13,088,960
Due after five years through ten years 10,645,568 10,651,124
Due after ten years 987,830 989,375
Mutual funds with no stated maturity 1,007,812 975,751
-----------------------------
$ 28,789,361 $ 28,756,991
=============================
</TABLE>
Proceeds from maturities and sales of securities available for sale during 1997
were $16,079,246 and $1,394,679, respectively, resulting in gross gains of
$27,095. Proceeds from maturities and sales of securities available for sale
during 1996 were $6,828,824 and $2,434,785, respectively, resulting in gross
gains of $7,537 and gross losses of $2,187.
26
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
NOTE 4. SECURITIES HELD TO MATURITY
Summaries of securities held to maturity at September 30, 1997 and 1996 are
presented below:
<TABLE>
<CAPTION>
1997
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
- - ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 337,697 $ 4,080 $ 961 $ 340,816
Collateralized mortgage
obligations and REMICS 192,267 5,371 2,941 194,697
----------------------------------------------------------
Total mortgage-backed
and related securities $ 529,964 $ 9,451 $ 3,902 $ 535,513
==========================================================
</TABLE>
<TABLE>
<CAPTION>
1996
----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
- - ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 635,388 $ 10,009 $ 2,722 $ 642,675
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
==========================================================
</TABLE>
NOTE 5. LOANS RECEIVABLE
Loans receivable consisted of the following:
<TABLE>
<CAPTION>
September 30,
-------------------------------
1997 1996
- - ----------------------------------------------------------------------------------------------
<S> <C> <C>
One-to-four family residential loans $ 26,110,935 $ 26,294,685
Commercial real estate and multifamily residential loans 14,205,942 12,904,658
Consumer loans 13,497,780 10,686,848
Commercial business loans 1,155,636 2,141,805
-------------------------------
54,970,293 52,027,996
Less:
Loans in process 1,024,505 627,273
Deferred fees and discounts (premiums) (70,009) (55,842)
Allowance for loan losses 427,255 453,460
-------------------------------
$ 53,588,542 $ 51,003,105
===============================
</TABLE>
27
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
The amount and the effect of impaired loans on the financial condition at
September 30, 1997 and 1996, or to the results of operations for the years then
ended was not significant.
The aggregate amount of loans to directors and executive officers was $185,344,
and $135,423 at September 30, 1997 and 1996, respectively. Activity with respect
to these loans during fiscal 1997 included net increases of $49,921. Activity
with respect to these loans during fiscal 1996 included net decreases of
$27,633. In the opinion of management, 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, 1997 and 1996 the Bank was servicing real estate loans for
others with aggregate unpaid principal balances of approximately $164,001 and
$192,474, respectively.
NOTE 6. ALLOWANCE FOR LOANS RECEIVABLE
<TABLE>
<CAPTION>
September 30,
--------------------------
1997 1996
- - ----------------------------------------------------------------------------
<S> <C> <C>
Balance, beginning $ 453,460 $ 491,382
Provision for losses - -
Charge-offs (37,952) (49,801)
Recoveries 11,747 11,879
--------------------------
Balance, ending $ 427,255 $ 453,460
==========================
</TABLE>
NOTE 7. FORECLOSED REAL ESTATE
Foreclosed real estate consisted of the following:
<TABLE>
<CAPTION>
September 30,
--------------------------
1997 1996
- - ----------------------------------------------------------------------------
<S> <C> <C>
Real estate acquired through foreclosure or deed
in lieu of foreclosure $ 173,500 $ 189,077
Real estate in judgement (subject to redemption) 89,836 38,950
--------------------------
263,336 228,027
Less allowance for losses 150 34,204
--------------------------
$ 263,186 $ 193,823
==========================
</TABLE>
28
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
NOTE 8. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows:
<TABLE>
<CAPTION>
September 30,
--------------------------
1997 1996
- - ------------------------------------------------------------------------------
<S> <C> <C>
Mortgage-backed and related securities $ 58,635 $ 59,218
Other marketable securities 450,840 453,891
Loans receivable 376,788 349,623
--------------------------
$ 886,263 $ 862,732
==========================
</TABLE>
NOTE 9. PREMISES AND EQUIPMENT
Premises and equipment consisted of the following:
<TABLE>
<CAPTION>
September 30,
---------------------------
1997 1996
- - ------------------------------------------------------------------------------
<S> <C> <C>
Land and improvements $ 222,667 $ 222,667
Office buildings 1,568,633 1,561,513
Furniture and equipment 1,498,920 1,752,722
Leasehold improvements 187,931 170,965
Automobile 27,519 27,519
------------------------------
3,505,670 3,735,386
Less accumulated depreciation and amortization 1,610,712 1,790,632
------------------------------
$ 1,894,958 $1,944,754
==============================
</TABLE>
29
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
NOTE 10. DEPOSITS
Deposits consisted of the following:
<TABLE>
<CAPTION>
1997 1996
------------------------------------------ --------------------------------------
Weighted Weighted
Average Percentage of Average Percent of
Rate Amount Total Rate Amount Total
- - -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Noninterest NOW - % $ 2,389,046 2.88 % - % $ 2,366,924 2.92 %
NOW 2.04 8,434,507 10.16 2.05 8,150,951 10.06
Passbook 2.00 8,060,598 9.71 2.00 8,539,868 10.54
Money Market 3.00 8,955,038 10.79 3.00 8,757,336 10.81
---------------------------------------- ------------------------------------
2.16 27,839,189 33.54 2.16 27,815,079 34.32
---------------------------------------- ------------------------------------
Certificates
2-2.99% 2.50 2,577 0.00 2.43 3,693 -
3-3.99% - - 0.00 3.90 1,603 -
4-4.99% 4.85 2,043,581 2.46 4.73 3,459,019 4.27
5-5.99% 5.50 32,902,086 39.64 5.44 31,198,668 38.49
6-6.99% 6.32 17,684,171 21.31 6.41 16,015,025 19.76
7-7.99% 7.18 2,531,708 3.05 7.19 2,553,432 3.15
---------------------------------------- ------------------------------------
5.82 55,164,123 66.46 5.77 53,231,440 65.68
---------------------------------------- ------------------------------------
4.59 % $ 83,003,312 100.00 % 4.53% $ 81,046,519 100.00 %
======================================== ====================================
</TABLE>
At September 30, 1997 and 1996 the Bank had $9,321,981 and $8,196,119,
respectively of deposit accounts with balances of $100,000 or more. The Bank did
not have any brokered deposits at September 30, 1997 or 1996.
Certificates had the following remaining maturities:
<TABLE>
<CAPTION>
September 30,
----------------------------------------------------------------
1997 1996
----------------------------------------------------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
- - -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
0-6 months $ 18,832,046 5.53% $ 19,776,416 5.46%
7-12 months 12,570,464 5.68 9,881,489 5.65
13-36 months 18,342,053 6.09 17,621,005 5.94
Over 36 months 5,419,560 6.19 5,952,530 6.49
----------------- ---------------
$ 55,164,123 5.82% $ 53,231,440 5.77%
================= ===============
</TABLE>
Mortgage backed securities with a fair value of $8,045,506 and $7,475,855 at
September 30, 1997 and 1996, respectively, were pledged as collateral for
certain deposits.
30
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
1997 1996
- - --------------------------------------------------------------------------------
<S> <C> <C>
NOW $ 168,280 $ 156,807
Passbook 164,632 186,057
Money Market 269,324 260,403
Certificates 3,128,768 3,133,156
-------------------------------
$ 3,731,004 $ 3,736,423
===============================
</TABLE>
NOTE 11. INCOME TAXES
Federal and state income tax expense (benefit) is as follows:
<TABLE>
<CAPTION>
1997 1996
- - --------------------------------------------------------------------------------
<S> <C> <C>
Current
Federal $ 273,361 $ 408,257
State 27,708 136,086
-----------------------------
301,069 544,343
-----------------------------
Deferred
Federal 143,118 (246,522)
State 47,706 (82,174)
-----------------------------
190,824 (328,696)
-----------------------------
$ 491,893 $ 215,647
=============================
</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,
----------------------------
1997 1996
- - --------------------------------------------------------------------------------
<S> <C> <C>
Statutory federal rate 34.0% 34.00%
State tax, net of federal benefit 6.3 6.7
Other 0.7 (0.2)
----------------------------
41.0% 40.5%
============================
</TABLE>
31
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
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>
1997 1996
- - ----------------------------------------------------------------------------------
<S> <C> <C>
Deferred Tax Assets
Allowance for loan losses $ 148,382 $ 172,768
Deferred compensation 265,313 207,810
Deferred loan fees 31,504 25,206
Unrealized loss on securities available for sale 11,043 102,639
SAIF assessment - 238,143
Other 12,407 8,651
-------------------------
Total gross deferred tax assets 468,649 755,217
-------------------------
Deferred Tax Liabilities
Premises and equipment 133,647 152,741
FHLB stock 102,632 102,632
Accrued real estate taxes 25,313 25,313
Prepaid insurance 5,278 19,471
-------------------------
Total deferred tax liabilities 266,870 300,157
-------------------------
Net deferred tax assets $ 201,779 $ 455,060
=========================
</TABLE>
No valuation allowance was required as of September 30, 1997 and 1996.
In prior years the Company was 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, 1997 include
approximately $2,860,000 for which no deferred taxes have been provided.
NOTE 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 5.6% and 5.5% at
September 30, 1997 and 1996, 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, 1997, the agreements were collateralized by securities
totaling approximately $7,544,732.
32
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
Advances from the Federal Home Loan Bank (FHLB) of Des Moines as of September
30, 1997 are summarized as follows:
<TABLE>
<CAPTION>
Year Due Average Rate Amount
- - --------------------------------------------------------------------------------
<S> <C> <C>
1997 5.68 % $ 4,958,000
1998 5.81 2,500,000
1999 6.10 1,000,000
2000 5.51 1,000,000
2001 6.24 76,298
-----------------------------------
5.75 % $ 9,534,298
===================================
</TABLE>
At September 30, 1997, the FHLB advances are secured by the FHLB stock and a
blanket pledge of residential mortgage loans, and government agency securities.
Under the agreement, the Bank must maintain eligible collateral in amounts
exceeding 150 percent of the outstanding advances.
NOTE 13. CAPITAL STOCK
Common stock (as adjusted for a 3-for-2 stock split) was repurchased during the
years ended September 30, 1997 and 1996 as follows:
<TABLE>
<CAPTION>
1997 1996
---------------------- ----------------------
Average Average
Shares Price Shares Price
- - ----------------------------------------------------------------- ----------------------
<S> <C> <C> <C> <C>
Purchased for management recognition plan - $ - 51,750 $ 9.13
Purchased for stock option plan 74,531 11.77 54,845 9.74
Purchased and retired 42,000 12.67 242,901 9.34
</TABLE>
On December 18, 1997 the Company issued additional shares necessary to effect a
3-for-2 common stock split for shareholders of record on December 5, 1997. The
share and per share amounts, including shares held in treasury and shares to be
issued under the various stock-based compensation plans, have been retroactively
adjusted to give effect to the stock split as of October 1, 1995.
NOTE 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.
The Bank is subject to various regulatory capital requirements administered by
the Bank's primary federal regulatory agency. Failure to meet minimum capital
requirements can initiate certain mandatory
33
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
and possibly additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on the Company's consolidated 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 assets and certain off-balance sheet items as
calculated under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgements by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum 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, 1997, that
the Bank meets all capital adequacy requirements to which it is subject.
As of September 30, 1997, 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* Amount Assets* Amount Assets*
- - --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Bank's stockholders'
equity $ 10,727,404
Plus, net unrealized
loss on certain
securities
available for sale 17,381
--------------
Tangible capital 10,744,785 9.70% $ 1,661,430 1.50% $ 9,083,355 8.20%
--------------
Core capital 10,744,785 9.70% 3,322,860 3.00% 7,421,925 6.70%
--------------
Plus Allowable
Portion of General
Allowance for
Loan Losses 427,256
--------------
Risk-based
capital $ 11,172,041 19.20% 4,652,130 8.00% 6,519,911 11.20%
==============
</TABLE>
* 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.
34
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
NOTE 15. EMPLOYEE BENEFITS
EMPLOYEE STOCK OWNERSHIP PLAN: The Company adopted an Employee Stock Ownership
Plan (the ESOP), which meets 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 is 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 103,500 (adjusted for a 3-
for-2 stock split) 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 rateably 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 $131,100 and $95,791 for 1997 and 1996, 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 1997 and 1996, the Company committed to release 10,350 (adjusted
for a 3-for-2 stock split) shares of common stock each year which were allocated
to eligible participants subject to the restrictions of the ESOP.
<TABLE>
<CAPTION>
Amount
- - -------------------------------------------------------------------
<S> <C>
Shares Released and Allocated 31,050
Unreleased Shares 72,450
------------
Total ESOP shares 103,500
============
Fair Value of Unreleased Shares at September 30, 1997 $ 1,062,600
============
</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, 51,750
(adjusted for a 3-for-2 stock split) shares of restricted stock were granted.
MRP expense was $94,444 in both 1997 and 1996.
STOCK OPTION PLAN: The Company adopted a stock option plan in October 1995. The
plan provides for granting of 129,375 (adjusted for a 3-for-2 stock split)
options for the purpose of attracting and retaining key personnel and to
facilitate their purchase of a stock interest in the Company. The options
become exercisable over a five-year period at the rate of 20% per year. If
unused, the options expire in October 2005. A summary of the status of the
Company's stock option plan as of September 30, 1997 and 1996, and changes
during the years ending on those dates is presented below (adjusted for a 3-for-
2 stock split):
35
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
<TABLE>
<CAPTION>
1997 1996
------------------------------------ ---------------------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
- - ---------------------------------------------------------------- ---------------------------------
<S> <C> <C> <C> <C>
Outstanding at beginning
of year 91,866 $ 9.14 - $ -
Granted 15,750 11.67 93,161 9.14
Exercised (258) 9.13 - -
Forfeited (4,478) 9.97 (1,295) 9.13
------------------------------------ ---------------------------------
Outstanding at end of year 102,880 $ 9.49 91,866 $ 9.14
==================================== =================================
Exercisable at end of year 20,576 -
=================== =================
Weighted-average fair value
per option of options granted
during the year $ 5.83 $ 4.36
================= ===============
</TABLE>
As permitted under generally accepted accounting principles, grants under the
plan are accounted for following the provisions of APB Opinion No. 25 and its
related interpretations. Accordingly, no compensation cost has been recognized
for grants made to date. Had compensation cost been determined based on the
fair value method prescribed in the FASB Statement No. 123, reported net income
and earnings per share would have been reduced to:
<TABLE>
<CAPTION>
Year Ended September 30, Net Income Per Share
- - ----------------------------------------------------------------------
<S> <C> <C>
1997 $ 678,268 $ 0.77
1996 292,476 0.26
</TABLE>
In determining the pro forma amounts above, the value of each grant is estimated
at the grant date using the fair value method prescribed in Statement No. 123,
with the following weighted-average assumptions for grants in 1997 and 1996: No
dividends; risk-free interest rate of 6.0%, expected life of 10 years, and
expected price volatility of 22.28% and 18.59% for 1997 and 1996, respectively.
NOTE 16. RETIREMENT PLANS
The Company has a 401(k) plan that covers all full-time employees meeting
certain minimum employment service requirements. The Company's expense for the
years ended September 30, 1997 and 1996 was $48,116 and $48,072, respectively.
The Company has adopted a retirement plan for nonemployee directors. The Company
recorded expense of approximately $6,000 and $25,000, during the years ended
September 30, 1997, and 1996, respectively.
36
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
The Bank has individual deferred compensation and supplemental retirement
agreements with certain directors and officers. The cost of such individual
agreements is being accrued over the period of actual service from the date of
the respective agreement. The cost of such agreements was $78,468, and $42,000
for the years ended September 30, 1997 and 1996, respectively. The agreements
are funded through a grantor trust with assets which match the investment
options selected by the directors and officers.
NOTE 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.
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.
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.
NOTE 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.
37
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
The contractual amount of these financial instruments at September 30, 1997 and
1996 is as follows (in 000's):
<TABLE>
<CAPTION>
1997 1996
- - --------------------------------------------------------------------------------
<S> <C> <C>
Unused lines of credit $ 1,664 $ 425
Commitments to originate and purchase loans 1,434 -
------------------------
$ 3098 $ 425
========================
</TABLE>
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.
NOTE 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, 1997 and 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 judgements 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 judgement 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, 1997 and 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.
38
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30,
----------------------------------------------------------------------
1997 1996
----------------------------------------------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
- - -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial Assets
Cash and cash equivalents $ 4,599,403 $ 4,599,403 $ 4,685,836 $ 4,685,836
Securities available for sale 47,591,284 47,591,284 45,653,160 45,653,160
Securities held to maturity 529,964 535,513 845,605 852,112
Loans receivable 53,588,542 53,723,000 51,003,105 51,395,390
Federal Home Loan Bank stock 700,500 700,500 700,500 700,500
Accrued interest receivable 886,263 886,263 862,732 862,732
Financial Liabilities
Deposits 83,003,312 83,226,000 81,046,519 81,171,807
Borrowings 14,231,202 14,149,000 11,897,878 11,885,878
Accrued interest payable 594,920 594,920 587,779 587,779
</TABLE>
CASH AND CASH EQUIVALENTS: The carrying amount of cash and cash equivalents
approximates their fair value.
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, 1997 and 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.
39
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
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, 1997 and 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.
NOTE 20. FIRST FEDERAL BANCORPORATION FINANCIAL INFORMATION (PARENT COMPANY
ONLY)
The following are the condensed financial statements for the parent company only
as of September 30, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
- - -----------------------------------------------------------------------------------------
<S> <C> <C>
CONDENSED STATEMENTS OF FINANCIAL CONDITION
Assets
Cash and cash equivalents $ 432,555 $ 460,779
Securities available for sale 260,500 1,002,321
Investment in subsidiary 10,727,405 9,928,068
Other assets 603,231 948,101
------------------------------
Total assets $ 12,023,691 $ 12,339,269
==============================
Liabilities and Stockholders' Equity
Accrued expenses $ 82,665 $ 16,571
Stockholders' equity 11,941,026 12,322,698
------------------------------
Total liabilities and stockholders' equity $ 12,023,691 $ 12,339,269
==============================
CONDENSED STATEMENTS OF INCOME
Interest income $ 168,255 $ 239,078
Noninterest income 21,391 8,897
Equity in earnings of subsidiary 657,703 250,437
Noninterest expense (103,697) (136,524)
------------------------------
Income before income tax expense 743,652 361,888
Income tax expense 35,239 45,388
------------------------------
Net income $ 708,413 $ 316,500
==============================
</TABLE>
40
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1997 1996
- - --------------------------------------------------------------------------------------------------------
<S> <C> <C>
CONDENSED STATEMENTS OF CASH FLOWS
Operating Activities
Net income $ 708,413 $ 316,500
Decrease (increase) in other assets 344,870 (454,988)
Increase in accrued expenses 66,094 7,141
Equity in earnings of subsidiary (657,703) (250,437)
Cash dividend from subsidiary - 2,000,000
Earned ESOP shares priced above original cost 16,911 26,791
Decrease in unamortized restricted stock 94,444 94,444
Decrease in unearned ESOP shares 69,000 69,000
Other (5,170) (5,177)
--------------------------------
Net cash provided by operating activities 636,859 1,803,274
--------------------------------
Investing Activities
Purchase of securities available for sale - (738,651)
Proceeds from maturities of securities available for sale - 297,287
Proceeds from sales of securities available for sale 741,821 1,722,657
--------------------------------
Net cash provided by investing activities 741,821 1,281,293
--------------------------------
Financing Activities
Proceeds from exercise of stock options 2,354 -
Purchase and retirement of common stock (531,875) (2,269,406)
Purchase of treasury stock (877,383) (1,008,341)
--------------------------------
Net cash used in financing activities (1,406,904) (3,277,747)
--------------------------------
Decrease in cash and cash equivalents (28,224) (193,180)
Cash and cash equivalents:
Beginning of period 460,779 653,959
--------------------------------
End of period $ 432,555 $ 460,779
================================
</TABLE>
41
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
NOTE 21. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly selected operations data for fiscal 1997 and 1996 are as
follows:
<TABLE>
<CAPTION>
SELECTED OPERATIONS DATA
----------------------------------------------
Three Months Ended
---------------------------------------------------------------
September 30, June 30, March 31, December 31,
1997 1997 1997 1996
- - ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest Income $ 2,007,730 $ 1,984,145 $ 1,944,452 $ 1,954,692
Interest Expense 1,143,402 1,135,154 1,087,070 1,091,217
---------------------------------------------------------------
Net interest income 864,328 848,991 857,382 863,475
Provision for loan losses - - - -
Noninterest income 136,177 140,721 147,100 146,682
Noninterest expense 670,302 670,805 777,547 685,896
Income tax expense 136,066 129,970 92,997 132,860
---------------------------------------------------------------
Net income $ 194,137 $ 188,937 $ 133,938 $ 191,401
===============================================================
Earnings per common share (1) $ 0.23 $ 0.22 $ 0.15 $ 0.20
===============================================================
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended
--------------------------------------------------------------
September 30, June 30, March 31, December 31,
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 - - - -
Noninterest income 162,248 159,557 101,120 110,421
Noninterest expense 1,319,616 691,489 717,311 685,128
Income tax expense (benefit) (135,392) 142,227 91,907 116,905
--------------------------------------------------------------
Net income (loss) $ (194,501) $ 204,905 $ 132,488 $ 173,608
==============================================================
Earnings (loss) common share (1) $ (0.16) $ 0.18 $ 0.11 $ 0.15
==============================================================
</TABLE>
(1) Adjusted to retroactively give effect to a 3-for-2 stock split on
December 18, 1997.
42
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------------
SELECTED FINANCIAL CONDITION DATA
<TABLE>
<CAPTION>
September 30, June 30, March 31, December 31,
1997 1997 1997 1996
- - ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total Assets $ 111,492,038 $ 110,589,488 $ 107,716,418 $ 109,728,801
Securities 48,121,248 47,097,530 47,488,931 46,919,264
Net Loans 53,588,542 52,878,381 51,376,532 51,369,047
Deposits 83,003,312 82,346,810 81,666,754 83,750,133
Stockholders' Equity 11,941,038 12,019,204 12,036,205 12,467,041
</TABLE>
<TABLE>
<CAPTION>
September 30, June 30, March 31, December 31,
1996 1996 1996 1995
- - ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total Assets $ 107,256,101 $ 104,968,978 $ 100,533,100 $ 100,590,508
Securities 46,498,765 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
</TABLE>
43
<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 (as of September 30, 1997) 1,008,849 shares (as adjusted for
a 3-for-2 stock split) of the Common Stock outstanding and approximately 227
holders of record of the Common Stock (not including shares held in "street
name") as of December 5, 1997. The December 5, 1997 closing sale price of the
Common Stock as traded on the SmallCap Market was $18.00 per share (as adjusted
for a 3-for-2 stock split).
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) (2) LOW BID (1) (2) DIVIDENDS PAID
---------------- --------------- --------------
<S> <C> <C> <C>
FISCAL 1995:
Third Quarter $ 8 3/16 $ 7 $ --
Fourth Quarter 9 3/16 7 1/2 --
FISCAL 1996:
First Quarter 9 11/16 8 13/16 --
Second Quarter 9 13/16 8 13/16 --
Third Quarter 9 11/16 8 1/2 --
Fourth Quarter 10 13/16 8 13/16 --
FISCAL 1997:
First Quarter 12 5/16 10 1/2 --
Second Quarter 13 11 11/16 --
Third Quarter 13 1/2 11 13/16 --
Fourth Quarter 14 11/16 13 3/16 --
</TABLE>
_____________________
(1) Quotations reflect inter-dealer price, without retail mark-up, mark-down
or commissions, and may not represent actual transactions.
(2) Prices have been adjusted retroactively to give effect to a 3-for-2 stock
split on December 18, 1997/
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
44
<PAGE>
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 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.
45
<PAGE>
<TABLE>
<CAPTION>
BOARD OF DIRECTORS
<S> <C> <C>
RALPH T. SMITH WILLIAM R. BELFORD WALTER R. FANKHANEL
Chairman of the Board of the Company and President and Chief Executive Director of the Company and the
the Bank Officer Bank
of the Company and the Bank
MARTIN R. SATHRE JAMES R. SHARP DEAN J. THOMPSON
Vice Chairman and Director of the Company Director of Company and the Bank Director of the Company and the
and the Bank Bank
EXECUTIVE OFFICERS
RALPH T. SMITH MARTIN R. SATHRE WILLIAM R. BELFORD
Chairman of the Board of the Company and Vice Chairman and Director of the President and Chief Executive
the Bank Company and the Bank Officer of the Company and the
Bank
DENNIS M. VORGERT KAREN JACOBSON
Treasurer of the Company and the Bank Secretary of the Company 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
550 Paul Bunyan Drive, N.W. 527 Minnesota Avenue
Bemidji, Minnesota 56601 Walker, Minnesota 56484
GENERAL INFORMATION
INDEPENDENT PUBLIC ACCOUNTANTS ANNUAL MEETING ANNUAL REPORT ON FORM 10-KSB
McGladrey & Pullen LLP The 1998 Annual Meeting of A copy of the Company's Annual
Certified Public Accountants Stockholders will be held on January Report on Form 10-KSB for the
Duluth, Minnesota 20, 1998 at 2:30 p.m. at the main fiscal year ended September 30,
office, 214 5th Street, Bemidji, 1997 as filed with the Securities
GENERAL COUNSEL Minnesota 56601. and Exchange Commission will be
Smith Law Firm furnished without charge to
Bemidji, Minnesota 56601 TRANSFER AGENT AND REGISTRAR stockholders as of the record date
Stock Transfer Department for the 1998 Annual Meeting upon
SPECIAL COUNSEL Norwest Bank, N.A. written request to Karen Jacobson,
Housley Kantarian P.O. Box 119 214 5th Street, Bemidji, Minnesota
& Bronstein, P.C. So. St. Paul, Minnesota 55075-9988 56601.
1220 19th Street, N.W. Suite 700
Washington, D.C. 20036
</TABLE>
46
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
<TABLE>
<CAPTION>
State or Other
Jurisdiction of Percentage
Parent Incorporation Ownership
- - ------ ------------- ---------
<S> <C> <C>
First Federal Bancorporation Minnesota N/A
Subsidiary (1)
- - ----------
First Federal Bank United States 100%
Subsidiaries of First Federal Bank (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>
Exhibit 23
[LETTERHEAD OF MCGLADREY & PULLEN, LLP APPEARS HERE]
Independent Auditors' Consent
The Board of Directors
First Federal Bancorporation
Bemidji, Minnesota
We hereby consent to the incorporation by reference of this report
included in this Form 10-KSB in the previously filed Registration Statement of
First Federal Bancorporation on Form S-8 (No. 33-98242).
/s/ McGladrey & Pullen, LLP
Duluth, Minnesota
December 23, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-END> SEP-30-1997
<CASH> 1,623,991
<INT-BEARING-DEPOSITS> 2,975,412
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 47,591,284
<INVESTMENTS-CARRYING> 529,964
<INVESTMENTS-MARKET> 535,513
<LOANS> 54,015,797
<ALLOWANCE> 427,255
<TOTAL-ASSETS> 111,492,038
<DEPOSITS> 83,003,312
<SHORT-TERM> 14,231,202
<LIABILITIES-OTHER> 2,316,498
<LONG-TERM> 0
0
0
<COMMON> 6,726
<OTHER-SE> 11,934,300
<TOTAL-LIABILITIES-AND-EQUITY> 111,492,038
<INTEREST-LOAN> 4,694,386
<INTEREST-INVEST> 3,092,232
<INTEREST-OTHER> 104,400
<INTEREST-TOTAL> 7,891,018
<INTEREST-DEPOSIT> 3,731,004
<INTEREST-EXPENSE> 4,456,844
<INTEREST-INCOME-NET> 3,434,174
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 27,095
<EXPENSE-OTHER> 2,804,549
<INCOME-PRETAX> 1,200,306
<INCOME-PRE-EXTRAORDINARY> 1,200,306
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 708,413
<EPS-PRIMARY> .81
<EPS-DILUTED> .81
<YIELD-ACTUAL> 3.32
<LOANS-NON> 0
<LOANS-PAST> 92,000
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 453,460
<CHARGE-OFFS> 37,952
<RECOVERIES> 11,747
<ALLOWANCE-CLOSE> 427,255
<ALLOWANCE-DOMESTIC> 419,690
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 7,565
</TABLE>
