<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended ....................................JUNE 30, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from.....................to...........................
Commission file number...................................................0-18046
FIRST FEDERAL CAPITAL CORP
(Exact name of Registrant as specified in its charter)
WISCONSIN 39-1651288
(State or other jurisdiction of (IRS employer
incorporation or organization) identification)
605 STATE STREET
LA CROSSE, WISCONSIN 54601
(Address of principal executive office) (Zip code)
Registrant's telephone number, including area code: (608) 784-8000
NOT APPLICABLE
(Former name, former address, and former fiscal year,
if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or such shorter period as the Registrant has
been subject to such requirements), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class: COMMON STOCK--$.10 PAR VALUE Outstanding as of August 1, 1998: 18,533,182
(EXCLUDES 1,408,448 SHARES HELD AS TREASURY STOCK)
<PAGE> 2
FORM 10-Q TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
PART I-FINANCIAL INFORMATION
Item 1--Financial Statements .........................................................2
Item 2--Management's Discussion and Analysis of Financial Condition and Results of
Operations...................................................................11
PART II-OTHER INFORMATION
Item 1--Legal Proceedings............................................................22
Item 2--Changes in Securities........................................................22
Item 3--Defaults Upon Senior Securites...............................................22
Item 4--Submission of Matters to Vote of Security Holders............................22
Item 5--Other Information............................................................22
Item 6--Exhibits and Reports on Form 8-K.............................................22
SIGNATURES........................................................................................23
</TABLE>
1
<PAGE> 3
PART I-FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, 1998, and December 31, 1997
<TABLE>
<CAPTION>
JUNE 30 DECEMBER 31
1998 1997
ASSETS (UNAUDITED)
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash and due from banks $33,653,302 $29,939,484
Interest-bearing deposits with banks 82,952,592 7,113,756
Investment securities available for sale, at fair value 5,879,885 21,376,678
Mortgage-backed and related securities:
Available for sale, at fair value 265,996,042 47,895,297
Held for investment, at cost (fair value of $107,622,246 and $123,613,629,
respectively) 107,725,332 124,335,969
Loans held for sale 36,124,948 45,576,945
Loans held for investment, net 973,289,313 1,193,893,087
Federal Home Loan Bank stock 12,138,700 13,811,300
Accrued interest receivable, net 13,510,774 11,547,757
Office properties and equipment 24,677,380 24,243,132
Mortgage servicing rights, net 20,889,625 16,290,903
Intangible assets 5,679,960 5,921,443
Other assets 1,887,033 2,348,647
- -------------------------------------------------------------------------------------------------------------------
Total assets $1,584,404,886 $1,544,294,398
- -------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
- -------------------------------------------------------------------------------------------------------------------
Deposit liabilities $1,279,588,325 $1,146,533,896
Federal Home Loan Bank advances and other borrowings 166,395,440 275,778,770
Advance payments by borrowers for taxes and insurance 5,473,644 3,872,764
Accrued interest payable 1,465,828 2,030,153
Other liabilities 12,661,807 6,717,469
- -------------------------------------------------------------------------------------------------------------------
Total liabilities 1,465,585,044 1,434,933,052
- -------------------------------------------------------------------------------------------------------------------
Preferred stock, $.10 par value, 5,000,000 shares authorized, none outstanding - -
Common stock, $.10 par value, 20,000,000 shares authorized, 19,941,630 shares
issued and outstanding, including 1,422,716 and 1,560,570 shares of treasury stock,
respectively 1,994,163 997,082
Additional paid-in capital 34,540,065 35,537,146
Retained earnings 91,886,232 84,548,291
Treasury stock, at cost (10,155,071) (10,845,168)
Unearned restricted stock (1,600,340) (211,006)
Non-owner asjustments to equity, net 2,154,793 (664,999)
- -------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 118,819,842 109,361,346
- -------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $1,584,404,886 $1,544,294,398
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
Refer to accompanying Notes to Consolidated Financial Statements.
2
<PAGE> 4
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended June 30, 1998 and 1997
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30
-------------------------------------
1998 1997
(UNAUDITED) (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest on loans $23,251,584 $24,153,490
Interest on mortgage-backed and related securities 3,846,266 3,128,424
Interest and dividends on investments 1,586,874 1,335,240
- ------------------------------------------------------------------------------------------------------------------
Total interest income 28,684,723 28,617,154
- ------------------------------------------------------------------------------------------------------------------
Interest on deposit liabilities 14,472,820 12,376,766
Interest on FHLB advances and other borrowings 2,734,017 5,090,163
- ------------------------------------------------------------------------------------------------------------------
Total interest expense 17,206,837 17,466,929
- ------------------------------------------------------------------------------------------------------------------
Net interest income 11,477,886 11,150,225
Provision for loan losses 88,734 131,581
- ------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 11,389,152 11,018,644
- ------------------------------------------------------------------------------------------------------------------
Retail banking fees and service charges 3,635,739 3,111,367
Commissions on annuity and insurance sales 435,141 503,659
Loan servicing fees (1,504,941) 597,718
Gain on sales of loans 3,760,722 991,798
Loss on sales of investment securities - (42,860)
Other income 1,165,252 463,758
- ------------------------------------------------------------------------------------------------------------------
Total non-interest income 7,491,914 5,625,440
- ------------------------------------------------------------------------------------------------------------------
Compensation and employee benefits 6,437,939 5,309,649
Occupancy and equipment 1,734,563 1,450,635
Advertising and marketing 556,566 699,909
Federal deposit insurance premiums 174,715 164,058
Other expenses 2,443,717 2,122,475
- ------------------------------------------------------------------------------------------------------------------
Total non-interest expense 11,347,500 9,746,726
- ------------------------------------------------------------------------------------------------------------------
Income before income taxes 7,533,566 6,897,358
Income tax expense 2,835,715 2,688,442
- ------------------------------------------------------------------------------------------------------------------
Net income $4,697,851 $4,208,916
- ------------------------------------------------------------------------------------------------------------------
PER SHARE INFORMATION
- ------------------------------------------------------------------------------------------------------------------
Diluted earnings per share $0.24 $0.22
Basic earnings per share 0.25 0.23
Dividends paid per share 0.07 0.06
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
Refer to accompanying Notes to Consolidated Financial Statements.
3
<PAGE> 5
CONSOLIDATED STATEMENTS OF OPERATIONS
Six Months Ended June 30, 1998 and 1997
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30
------------------------------------
1998 1997
(UNAUDITED) (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest on loans $49,034,804 $47,454,992
Interest on mortgage-backed and related securities 6,463,076 6,343,364
Interest and dividends on investments 2,818,487 2,775,118
- ------------------------------------------------------------------------------------------------------------------
Total interest income 58,316,367 56,573,474
- ------------------------------------------------------------------------------------------------------------------
Interest on deposit liabilities 28,241,334 24,355,127
Interest on FHLB advances and other borrowings 6,683,717 10,262,288
- ------------------------------------------------------------------------------------------------------------------
Total interest expense 34,925,051 34,617,415
- ------------------------------------------------------------------------------------------------------------------
Net interest income 23,391,316 21,956,059
Provision for loan losses 141,922 252,421
- ------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 23,249,394 21,703,638
- ------------------------------------------------------------------------------------------------------------------
Retail banking fees and service charges 6,888,079 5,917,579
Commissions on annuity and insurance sales 788,357 1,119,529
Loan servicing fees (2,670,443) 1,176,482
Gain on sales of loans 7,580,744 1,780,828
Loss on sales of investment securities - (97,415)
Other income 1,720,868 881,150
- ------------------------------------------------------------------------------------------------------------------
Total non-interest income 14,307,606 10,778,153
- ------------------------------------------------------------------------------------------------------------------
Compensation and employee benefits 12,127,437 10,460,037
Occupancy and equipment 3,438,681 3,268,325
Advertising and marketing 1,045,905 1,185,523
Federal deposit insurance premiums 351,388 326,152
Other expenses 5,286,254 4,219,185
- ------------------------------------------------------------------------------------------------------------------
Total non-interest expense 22,249,665 19,459,222
- ------------------------------------------------------------------------------------------------------------------
Income before income taxes 15,307,335 13,022,569
Income tax expense 5,810,591 5,055,888
- ------------------------------------------------------------------------------------------------------------------
Net income $9,496,744 $7,966,681
- ------------------------------------------------------------------------------------------------------------------
PER SHARE INFORMATION
- ------------------------------------------------------------------------------------------------------------------
Diluted earnings per share $0.48 $0.41
Basic earnings per share 0.51 0.44
Dividends paid per share 0.130 0.113
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
Refer to accompanying Notes to Consolidated Financial Statements.
4
<PAGE> 6
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Three Months Ended June 30, 1998 and 1997
<TABLE>
<CAPTION>
COMMON
STOCK AND
ADDITIONAL UNEARNED NON-OWNER
PAID-IN RETAINED TREASURY RESTRICTED ADJUSTMENTS
UNAUDITED CAPITAL EARNINGS STOCK STOCK TO EQUITY TOTAL
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at March 31, 1997 $36,459,636 $75,347,331 ($11,740,063) ($321,049) ($2,487,404) $97,258,451
-----------
Net income 4,208,916 4,208,916
Securities valuation
adjustment, net of income taxes 799,797 799,797
-----------
Net income and non-owner
adjustments to equity 5,008,713
-----------
Dividends paid (1,101,555) (1,101,555)
Exercise of stock options 147,931 (164,557) 192,000 175,374
Purchase of treasury stock (135,000) (135,000)
Amortization of restricted stock 36,681 36,681
- -----------------------------------------------------------------------------------------------------------------
Balance at June 30, 1997 $36,607,567 $78,290,135 ($11,683,063) ($284,368) ($1,687,607) $101,242,664
- -----------------------------------------------------------------------------------------------------------------
UNAUDITED
- -----------------------------------------------------------------------------------------------------------------
Balance at March 31, 1998 $36,534,228 $88,100,961 ($9,745,333) ($1,051,113) ($522,022) $113,316,721
-----------
Net income 4,697,851 4,697,851
Securities valuation
adjustment, net of income taxes 2,676,815 2,676,815
-----------
Net income and non-owner
adjustments to equity 7,374,666
----------
Dividends paid (1,296,604) (1,296,604)
Exercise of stock options 4,964 823,663 828,627
Restricted stock award 379,060 342,848 (721,908) -
Purchase of treasury stock (1,576,249) (1,576,249)
Amortization of restricted stock 172,681 172,681
- -----------------------------------------------------------------------------------------------------------------
Balance at June 30, 1998 $36,534,228 $91,886,232 ($10,155,071) ($1,600,340) $2,154,793 118,819,842
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
Refer to accompanying Notes to Consolidated Financial Statements.
5
<PAGE> 7
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Six Months Ended June 30, 1998 and 1997
<TABLE>
<CAPTION>
COMMON
STOCK AND
ADDITIONAL UNEARNED NON-OWNER
PAID-IN RETAINED TREASURY RESTRICTED ADJUSTMENTS
UNAUDITED CAPITAL EARNINGS STOCK STOCK TO EQUITY TOTAL
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 $36,244,047 $72,569,092 ($10,533,625) ($414,392) ($2,450,764) $95,414,358
-----------
Net income 7,966,681 7,966,681
Securities valuation
adjustment, net of income taxes 763,157 763,157
-----------
Net income and non-owner
adjustments to equity 8,729,838
-----------
Dividends paid (2,081,082) (2,081,082)
Exercise of stock options 363,520 (164,556) 192,000 390,964
Purchase of treasury stock (1,341,438) (1,341,438)
Amortization of restricted
stock 130,024 130,024
- ----------------------------------------------------------------------------------------------------------------
Balance at June 30, 1997 $36,607,567 $78,290,135 ($11,683,063) ($284,368) ($1,687,607) $101,242,664
- ----------------------------------------------------------------------------------------------------------------
UNAUDITED
- ----------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 $36,534,228 $84,548,291 ($10,845,168) ($211,006) ($664,999) $109,361,346
------------
Net income 9,496,744 9,496,744
Securities valuation
adjustment, net of income taxes 2,819,792 2,819,792
-----------
Net income and non-owner
adjustments to equity 12,316,536
-----------
Dividends paid (2,404,676) (2,404,676)
Exercise of stock options (518,223) 1,457,034 938,811
Restricted stock award 764,096 969,312 (1,733,408) -
Purchase of treasury stock (1,736,249) (1,736,249)
Amortization of restricted
stock 344,074 344,074
- ----------------------------------------------------------------------------------------------------------------
Balance at June 30, 1998 $36,534,228 $91,886,232 ($10,155,071) ($1,600,340) $2,154,793 118,819,842
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
Refer to accompanying Notes to Consolidated Financial Statements.
6
<PAGE> 8
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended June 30, 1998 and 1997
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30
-------------------------------------
1998 1997
(UNAUDITED) (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $4,697,851 $4,208,916
Adjustments to reconcile net income to net cash provided (used) by
operations:
Provision for loan and real estate losses, net 103,899 108,431
Net loan costs deferred (182,528) (180,726)
Depreciation and amortization 4,037,280 1,516,771
Gains on sales of loans, and other investments (3,760,722) (948,938)
Increase in accrued interest receivable (1,568,813) (230,907)
Decrease in accrued interest payable (597,286) (67,747)
Decrease in current and deferred income taxes (399,886) (1,509,171)
Other accruals and prepaids, net 339,042 (45,362)
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by operations before loan originations and sales 2,668,837 2,851,267
Loans originated for sale (152,088,439) (43,564,700)
Sales of loans originated for sale 191,259,750 43,123,536
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by operations 41,840,148 2,410,103
- -----------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Increase in interest-bearing deposits with banks (23,844,209) (4,607,319)
Sales of investment securities - 1,772,050
Maturities of investment securities 4,578,484 8,221,497
Principal payments on mortgage-backed and related securities held for
investment 10,006,440 5,159,698
Principal payments on mortgage-backed and related securities available
for sale 3,387,384 3,376,158
Loans originated for investment (148,312,974) (151,242,354)
Loans purchased for investment - (2,021,991)
Loan principal repayments 104,112,179 95,764,817
Sales of loans originated for investment 13,495,563 5,609,453
Sales of real estate 739,571 564,623
Additions to office properties and equipment (715,066) (451,792)
Purchases of mortgage servicing rights - (711,440)
Other, net 4,432,699 1,486,684
- -----------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (32,119,929) (37,079,916)
- -----------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase in deposit liabilities 72,623,168 26,199,399
Repayment of long-term Federal Home Loan Bank advances - (50,000,000)
Net increase (decrease) in short-term Federal Home Loan Bank borrowings (75,000,000) 59,355,000
Decrease in other borrowings (501,427) (1,001,298)
Increase in advance payments by borrowers for taxes and insurance 240,653 3,929,146
Proceeds from sale of common stock 85,207 91,514
Purchase of treasury stock (1,576,249) (135,000)
Dividends paid (1,296,604) (1,101,555)
Other, net 1,231,644 590,208
- -----------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities (4,193,608) 37,927,414
- -----------------------------------------------------------------------------------------------------------------
Net increase in cash and due from banks 5,526,611 3,257,601
Cash and due from banks at beginning of period 28,126,691 26,262,826
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
Cash and due from banks at end of period $33,653,302 $29,520,427
- -----------------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Interest and dividends received on loans and investments $27,097,697 $28,386,247
Interest paid on deposits and borrowings 17,804,124 17,534,676
Income taxes paid 1,213,000 4,331,000
Income taxes refunded 385,879 97,545
Mortgage-backed security swaps 222,259,809 -
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
Refer to accompanying Notes to Consolidated Financial Statements.
7
<PAGE> 9
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 1998 and 1997
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30
----------------------------------
1998 1997
(UNAUDITED) (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $9,496,744 $7,966,681
Adjustments to reconcile net income to net cash provided (used) by
operations:
Provision for loan and real estate losses, net 356,340 227,825
Net loan costs deferred (530,506) (384,609)
Depreciation and amortization 7,457,736 3,099,084
Gains on sales of loans, and other investments (7,580,744) (1,683,413)
Increase in accrued interest receivable (1,963,017) (933,122)
Increase (decrease) in accrued interest payable (564,325) 22,390
Increase in current and deferred income taxes 2,120,869 462,775
Other accruals and prepaids, net (207,893) (478,381)
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by operations before loan originations and sales 8,585,204 8,299,230
Loans originated for sale (367,119,122) (84,197,169)
Sales of loans originated for sale 365,852,539 86,444,507
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by operations 7,318,621 10,546,568
- -----------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Increase in interest-bearing deposits with banks (75,838,836) (9,111,387)
Sales of investment securities - 4,773,621
Maturities of investment securities 15,442,923 11,710,379
Principal payments on mortgage-backed and related securities held for
investment 16,601,385 9,622,683
Principal payments on mortgage-backed and related securities available
for sale 6,522,100 7,066,722
Loans originated for investment (260,991,142) (244,629,638)
Loans purchased for investment - (2,021,991)
Loan principal repayments 209,520,184 160,866,667
Sales of loans originated for investment 56,553,153 8,879,751
Sales of real estate 3,764,554 619,823
Additions to office properties and equipment (1,689,585) (1,364,569)
Purchases of mortgage servicing rights (454,774) (857,004)
Other, net 2,319,249 1,271,795
- -----------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (28,250,789) (53,173,148)
- -----------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase in deposit liabilities 133,054,429 55,829,754
Long-term advances from Federal Home Loan Bank 75,000,000 25,000,000
Repayment of long-term Federal Home Loan Bank advances (16,580,000) (177,776,000)
Net increase (decrease) in short-term Federal Home Loan Bank borrowings (156,300,000) 143,688,000
Decrease in other borrowings (11,503,330) (1,002,984)
Increase in advance payments by borrowers for taxes and insurance 1,600,880 5,118,690
Proceeds from sale of common stock 195,391 148,343
Purchase of treasury stock (1,736,249) (1,341,437)
Dividends paid (2,404,676) (2,081,082)
Other, net 3,319,541 (80,531)
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 24,645,986 47,502,753
- -----------------------------------------------------------------------------------------------------------------
Net increase in cash and due from banks 3,713,818 4,876,173
Cash and due from banks at beginning of period 29,939,484 24,644,254
- -----------------------------------------------------------------------------------------------------------------
Cash and due from banks at end of period $33,653,302 $29,520,427
- -----------------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Interest and dividends received on loans and investments $56,353,350 $55,640,352
Interest paid on deposits and borrowings 35,489,376 34,595,025
Income taxes paid 3,659,000 4,729,000
Income taxes refunded 389,875 97,545
Mortgage-backed security swaps 222,259,809 -
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
Refer to accompanying Notes to Consolidated Financial Statements.
8
<PAGE> 10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts and balances
of First Federal Capital Corp (the "Corporation"), First Federal Savings Bank La
Crosse-Madison (the "Bank"), and the Bank's wholly-owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
NOTE 2--BASIS OF PRESENTATION
The accompanying interim consolidated financial statements are
unaudited and do not include information or footnotes necessary for a complete
presentation of financial condition, results of operations, or cash flows in
accordance with generally accepted accounting principles. However, in the
opinion of management, all adjustments (consisting of normal recurring accruals)
necessary for a fair presentation of the consolidated financial statements have
been included. Operating results for the three and six month periods ended June
30, 1998, may not necessarily be indicative of the results which may be expected
for the entire year ending December 31, 1998.
Certain 1997 balances have been reclassified to conform with the 1998
presentation.
NOTE 3--CONTINGENCIES
First Enterprises, Inc. ("FEI"), a wholly-owned subsidiary of the Bank
that was formerly involved in the acquisition and development of hotels,
received a favorable judgement in a United States District Court in 1996
awarding it $1.1 million in compensatory damages, plus post-judgement interest
on the damages, as well as filing fees and other court costs. The defendant in
the action is a well-capitalized money-center bank that provided certain trust
services relating to one of FEI's hotel joint ventures in the 1980s.
In addition to compensatory damages, FEI also has a pending claim
against the defendant for punitive damages, which could substantially increase
the final award, if any. A hearing on this claim was conducted in 1997. On June
22, 1998, a United States Magistrate Judge submitted a written report to the
United States District Court recommending total punitive damages of $5.9
million. FEI's share of these damages would be $4.5 million if the United States
District Court adopts the recommendation.
Oral arguments on the issue of punitive damages were held in the United
States District Court on July 29, 1998. The Corporation is not certain when the
District Court will render a final judgement on the matter of punitive damages.
The defendant may appeal these judgements and/or oppose any award of damages. As
a result, management of the Corporation is unable to determine the likelihood of
a favorable outcome or reliably estimate the amount of the final judgement, if
any. Accordingly, the Corporation has not recognized any portion of the
compensatory damages or possible future punitive damages in its results of
operations.
The Corporation and its subsidiaries are also engaged in various
routine legal proceedings occurring in the ordinary course of business, which in
the aggregate are believed by management to be immaterial to the consolidated
financial condition of the Corporation.
NOTE 4--PENDING ACCOUNTING CHANGE
In June 1998 the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and for Hedging Activities" ("SFAS 133"). This standard establishes
new rules for the recognition and measurement of derivatives and hedging
activities. It requires all derivatives to be recorded on the balance sheet at
fair value, although the timing of recognition in earnings will depend on the
classification of the hedge according to criteria established by SFAS 133.
Changes in
9
<PAGE> 11
the fair value of derivatives that do not meet these criteria are required to be
included in earnings in the period of the change. The new standard is effective
for years beginning after June 15, 1999, although earlier adoption is permitted.
The Corporation does not intend to adopt SFAS 133 until January 1, 2000.
The Corporation does not use derivative financial instruments such as
futures, swaps, caps, floors, options, interest- or principle-only strips, or
similar financial instruments to manage its operations. However, the Corporation
does use forward sales of mortgage-backed securities to manage exposure to
market risk in its "pipeline" of single-family residential loans intended for
sale. Forward sales are derivative securities and are subject to the rules
established by SFAS 133. The Corporation has not completed the complex analysis
necessary to determine the impact SFAS 133 will have on its statements of
financial condition or operations. However, such impact is not expected to be
material, although there can be no assurances.
NOTE 5--STOCK SPLIT
Earnings per share and dividends paid per share, as presented in the
Corporation's Consolidated Statements of Operations, have been adjusted to
recognize a two-for-one stock split on June 11, 1998. Common shares issued and
outstanding, as presented in the Corporation's Consolidated Statements of
Financial Condition, have also been adjusted for such stock split.
10
<PAGE> 12
ITEM 2--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The discussion in this report includes certain forward-looking
statements based on current management's expectations. Examples of factors which
could cause future results to differ from management's expectations include, but
are not limited to, the following: general economic and competitive conditions;
legislative and regulatory initiatives; monetary and fiscal policies of the
federal government; general market rates of interest; interest rates on
competing investments; interest rates on funding sources; consumer demand for
deposit and loan products and services; consumer demand for other financial
services; changes in accounting policies or guidelines; and changes in the
quality or composition of the Corporation's loan and investment portfolios.
Readers are cautioned that forward-looking statements are not guarantees of
future performance and that actual results may differ materially from
management's current expectations.
RESULTS OF OPERATIONS
QUARTER OVERVIEW The Corporation's net income for the three months
ended June 30, 1998 and 1997, was $4.7 million or $0.24 per diluted share and
$4.2 million or $0.22 per diluted share, respectively. These amounts represented
a return on average assets of 1.19% and 1.10%, respectively, and a return on
average equity of 16.50% and 16.88%, respectively.
The improvement in net income from 1997 to 1998 was primarily
attributable to a $2.8 million increase in gain on sales of loans. Also
contributing, was a $701,000 increase in other income, due in part to state
income tax refunds related to the Corporation's 1987-89 tax years, as well as a
$524,000 increase in retail banking fees and a $328,000 increase in net interest
income. These developments were partially offset by a $2.1 million decline in
loan servicing fees and a $1.6 million increase in non-interest expense--the
later due primarily to a $1.1 million increase in compensation and employee
benefits expense.
SIX MONTH OVERVIEW The Corporation's net income for the six months
ended June 30, 1998 and 1997, was $9.5 million or $0.48 per diluted share and
$8.0 million or $0.41 per diluted share, respectively. These amounts represented
a return on average assets of 1.20% and 1.05%, respectively, and a return on
average equity of 16.82% and 16.31%, respectively.
The improvement in net income from 1997 to 1998 was primarily
attributable to a $5.8 million increase in gain on sales of loans. Also
contributing, was a $1.4 million increase in net interest income, a $971,000
increase in retail banking fees, and an $840,000 increase in other income. These
developments were partially offset by a $3.8 million decline in loan servicing
fees and a $2.8 million increase in non-interest expense--the latter due
primarily to a $1.7 million increase in compensation and employee benefits
expense.
The following paragraphs discuss these changes in more detail along
with other changes in the components of net income during the three and six
month periods ended June 30, 1998 and 1997.
NET INTEREST INCOME Net interest income increased by $328,000 or 2.9%
and $1.4 million or 6.5% during the three and six month periods ended June 30,
1998, as compared to the same periods in the previous year. Net interest income
was favorably impacted in these periods by a $27.8 million or 1.9% increase and
a $48.6 million or 3.4% increase, respectively, in the Corporation's average
interest-earning assets. The primary source of this growth was consumer and
commercial real estate loans. This growth was principally funded by increases in
deposit liabilities, including non-interest-bearing checking deposits.
Also contributing to the increase in net interest income in both
periods was an increase in the Corporation's ratio of interest-earning assets to
interest-bearing liabilities. This increase occurred primarily as a result of
over 30% growth in the Corporation's average non-interest-bearing checking
accounts during each period. Approximately half of this growth was attributable
to increases in custodial deposit accounts. The Corporation maintains borrowers'
11
<PAGE> 13
principal and interest payments in these accounts on a temporary basis pending
their remittance to the third-party owners of the loans. Balances in these
accounts have increased in recent months because of increased loan prepayment
activity, which was brought about by a low interest rate environment.
The favorable impact of these developments on net interest income was
offset in part by a modest decline in the Corporation's interest rate spread
during the three and six month periods ended June 30, 1998, as compared to the
same periods in the previous year. Management attributes this decline to a flat
yield curve environment during 1998. This type of interest rate environment has
an unfavorable impact on the Corporation's interest rate spread because of the
tendency of the Corporation's assets to price off a longer end of the yield
curve than its liabilities. If this interest rate environment persists in the
future, management expects further decline in the Corporation's interest rate
spread.
The following tables set forth information regarding the average
balances of the Corporation's assets, liabilities, and equity, as well as the
interest earned or paid and the average yield or cost of each. The information
is based on daily average balances during the three and six months ended June
30, 1998 and 1997.
<TABLE>
<CAPTION>
Dollars in thousands THREE MONTHS ENDED JUNE 30, 1998 THREE MONTHS ENDED JUNE 30, 1997
- -------------------------------------------------------------------------------------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Single-family mortgage loans $476,995 $9,265 7.77% $604,596 $12,020 7.95%
Commercial real estate loans 286,421 6,148 8.59 241,079 5,269 8.74
Consumer loans 370,601 7,839 8.46 321,011 6,864 8.55
- -------------------------------------------------------------------------------------------------------------------
Total loans 1,134,017 23,252 8.20 1,166,686 24,153 8.28
Mortgage-backed and related
securities 230,965 3,846 6.66 198,402 3,128 6.31
Investment securities 7,390 112 6.06 63,361 967 6.10
Interest-bearing deposits with
banks 93,501 1,258 5.38 4,731 64 5.41
Other earning assets 13,215 217 6.57 18,118 305 6.73
- -------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 1,479,088 28,685 7.76 1,451,298 28,617 7.89
Non-interest-earning assets:
Office properties and equipment 24,677 25,525
Other assets 69,618 56,111
- -------------------------------------------------------------------------------------------------------------------
Total assets $1,573,383 $1,532,934
- -------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Regular savings accounts $94,537 $420 1.78% $89,620 $452 2.02%
Checking accounts 57,290 142 0.99 51,989 131 1.01
Money market accounts 147,025 1,512 4.11 143,424 1,595 4.45
Certificates of deposit 822,392 12,399 6.03 688,552 10,199 5.92
- -------------------------------------------------------------------------------------------------------------------
Total deposits 1,121,244 14,473 5.16 973,585 12,377 5.09
FHLB advances 202,251 2,691 5.32 346,313 4,935 5.70
Other borrowings 7,632 43 2.25 15,909 155 3.90
- -------------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 1,331,127 17,207 5.17 1,335,807 17,467 5.23
Non-interest-bearing liabilities:
Non-interest-bearing deposits 115,066 87,359
Other liabilities 13,270 10,031
- -------------------------------------------------------------------------------------------------------------------
Total liabilities 1,459,463 1,433,197
Stockholders' equity 113,920 99,737
- -------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $1,573,383 $1,532,934
- -------------------------------------------------------------------------------------------------------------------
Net interest income $11,478 $11,150
- -------------------------------------------------------------------------------------------------------------------
Interest rate spread 2.59% 2.66%
- -------------------------------------------------------------------------------------------------------------------
Net interest income as a percent
of average earning assets 3.10% 3.07%
- -------------------------------------------------------------------------------------------------------------------
Average interest-earning assets to
average interest-bearing liabilities 111.12% 108.65%
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
12
<PAGE> 14
<TABLE>
<CAPTION>
Dollars in thousands SIX MONTHS ENDED JUNE 30, 1998 SIX MONTHS ENDED JUNE 30, 1997
- -------------------------------------------------------------------------------------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Single-family mortgage loans $542,184 $21,212 7.82% $593,605 $23,595 7.95%
Commercial real estate loans 279,651 12,219 8.74 241,241 10,433 8.65
Consumer loans 369,464 15,604 8.45 314,862 13,427 8.53
- -------------------------------------------------------------------------------------------------------------------
Total loans 1,191,299 49,035 8.23 1,149,708 47,455 8.26
Mortgage-backed and related
securities 199,957 6,463 6.46 202,563 6,343 6.26
Investment securities 10,325 310 6.00 66,558 2,005 6.02
Interest-bearing deposits with
banks 75,426 2,030 5.38 5,433 145 5.34
Other earning assets 14,592 478 6.55 18,698 625 6.69
- -------------------------------------------------------------------------------------------------------------------
Total interest-earning assets 1,491,599 58,316 7.82 1,442,960 56,573 7.84
Non-interest-earning assets:
Office properties and equipment 24,532 25,932
Other assets 65,542 54,951
- -------------------------------------------------------------------------------------------------------------------
Total assets $1,581,673 $1,523,843
- -------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Regular savings accounts $91,995 $865 1.88% $88,244 $886 2.01%
Checking accounts 55,548 272 0.98 51,903 259 1.00
Money market accounts 145,436 3,063 4.21 141,500 3,111 4.40
Certificates of deposit 800,935 24,041 6.00 682,162 20,099 5.89
- -------------------------------------------------------------------------------------------------------------------
Total deposits 1,093,914 28,241 5.16 963,809 24,355 5.05
FHLB advances 243,140 6,568 5.40 355,390 9,946 5.60
Other borrowings 7,677 116 3.02 14,720 316 4.29
- -------------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 1,344,731 34,925 5.19 1,333,919 34,617 5.19
Non-interest-bearing liabilities:
Non-interest-bearing deposits 110,569 82,450
Other liabilities 13,443 9,807
- -------------------------------------------------------------------------------------------------------------------
Total liabilities 1,468,743 1,426,176
Stockholders' equity 112,930 97,667
- -------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $1,581,673 $1,523,843
- -------------------------------------------------------------------------------------------------------------------
Net interest income $23,391 $21,956
- -------------------------------------------------------------------------------------------------------------------
Interest rate spread 2.62% 2.65%
- -------------------------------------------------------------------------------------------------------------------
Net interest income as a percent
of average earning assets 3.14% 3.04%
- -------------------------------------------------------------------------------------------------------------------
Average interest-earning assets to
average interest-bearing liabilities 110.92% 108.17%
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
A low interest rate environment in 1998 has had a significant impact on
the ability of the Corporation to maintain growth in its interest-earning
assets. This situation has developed because a low interest rate environment
tends to increase customer preference for fixed-rate mortgage loans, as opposed
to adjustable-rate loans. In addition, a low interest rate environment
encourages borrowers to refinance their existing adjustable-rate residential
mortgage loans into fixed-rate loans to "lock-in" a lower long-term rate. Given
the Corporation's policy of selling these types of loans in the secondary
market, its portfolio of adjustable-rate residential loans has declined since
December 31, 1998. Although some of this decline has been replaced by growth in
consumer and commercial real estate loans, management believes it will be a
challenge for the Corporation to maintain its current level of earning assets if
this interest rate environment persists. Such could have an unfavorable impact
on growth in the Corporation's net interest income in the immediate future.
The Corporation is currently exploring other alternatives to increase
its level of earning assets in the near term. These alternatives include, but
are not limited to, the purchase of adjustable-rate residential mortgage loans
from third-party originators, the purchase of mortgage-backed and related
securities, and the retention of certain fixed-rate loans that are currently
sold by the Corporation in the secondary market. These assets are expected to be
funded by increased borrowings from the Federal Home Loan Bank of Chicago
("FHLB"). However, there are many considerations involved in this decision and
there can be no assurances that the Corporation will elect to adopt any of these
strategies to increase its level of earnings assets.
13
<PAGE> 15
PROVISION FOR LOAN LOSSES Due to growth in the Corporation's loan
portfolio in recent years, management of the Corporation elected to record
provisions for loan losses during the three and six month periods ended June 30,
1998 and 1997. In general, the provisions recorded during these periods
approximated the Corporation's actual charge-off activity during the periods.
Management of the Corporation expects the provision for the remainder of 1998 to
also approximate actual charge-off activity, although there can be no
assurances.
As of June 30, 1998 and December 31, 1997, the Corporation's allowance
for loan losses was $7.6 million or 0.78% and 0.64% of loans held for
investment, respectively. Although management believes that the Corporation's
present level of allowance for loan losses is adequate, there can be no
assurance that future adjustments to the allowance will not be necessary, which
could adversely affect the Corporation's results of operations. For additional
discussion, refer to "Financial Condition--Non-Performing Assets".
NON-INTEREST INCOME Non-interest income for the three months ended June
30, 1998 and 1997, was $7.5 million and $5.6 million, respectively. The
following paragraphs discuss the principal components of non-interest income and
the primary reasons for their changes from 1997 to 1998.
Retail banking fees and service charges increased by $524,000 or 16.9%
during the three months ended June 30, 1998, as compared to the same period in
the previous year. This increase in was due in part to growth of 13.3% since
December 31, 1996, in the number of checking accounts serviced by the
Corporation. Approximately 25% of this growth came from retail banking offices
opened in 1997 and 1998. Also contributing to the growth in retail banking fees
in the most recent period was a $114,000 or approximately 50% increase in fee
income from customers' use of debit cards and a $128,000 or approximately 25%
increase in fees from customers' use of ATMs. The Corporation introduced debit
cards to its checking account customers during the last quarter of 1996. The
Corporation increased the number of ATMs it operates in 1997 and 1998 as a
result of changes in the rules governing ATM surcharges, which permitted the
Corporation to increase fee revenue from ATMs. The Corporation intends to
increase the number of ATMs it operates by approximately 10 to 15% in 1998,
although there can be no assurances.
Commissions on annuity and insurance sales decreased by $69,000 or
13.6% during the three months ended June 30, 1998, as compared to the same
period in the previous year. The Corporation's current sources of commission
revenues are from sales of tax-deferred annuity contracts, credit life insurance
policies, and mortgage loan insurance policies. The decline in 1998 was
primarily attributable to lower commissions on sales of tax-deferred annuities.
This was principally due to a lower interest rate environment, which tends to
make tax-deferred annuities less attractive to customers.
Loan servicing fees declined by $2.1 million from $598,000 during the
three months ended June 30, 1997, to $(1.5) million during the same period in
1998. The decrease in 1998 was caused by a significant decline in the carrying
value of the Corporation's mortgage servicing rights. A declining interest rate
environment in 1998 resulted in an increase in mortgage refinance activity,
which translated into increased loan prepayments during the first six months of
1998. As a result of such prepayments, the Corporation recorded a $2.4 million
decline in the estimated carrying value of its mortgage servicing rights during
the first quarter of 1998. This compared to a decline of only $150,000 in the
second quarter of 1997. Subsequent to June 30, 1998, interest rates have
remained at low levels. If this environment persists, or if interest rates
decline further, the Corporation may be required to record additional losses on
the carrying value of its mortgage servicing rights.
Excluding the effects of the aforementioned declines in carrying value
of mortgage servicing rights, loan servicing fees would have increased by
$147,000 or 19.7% during the three months ended June 30, 1998, as compared to
the same period in the previous year. This increase was attributable to a $528.7
million or approximately 40% increase in mortgage loans serviced for others
since June 30, 1997. A large portion of this increase was caused by the
securitization during the most recent quarter of $222 million of the
Corporation's adjustable-rate residential mortgage loans into mortgage-backed
securities. The principal balance related to these securities is included in the
amount reported as loans serviced for others even though the securities were
retained by the Corporation (refer to "Financial Condition" for additional
discussion). The remaining increase in loans serviced
14
<PAGE> 16
for others was the result of increased sales of mortgage loans in the secondary
market, as described in the following paragraph.
Gains on sales of mortgage loans increased by $2.8 million from
$992,000 during the three months ended June 30, 1997, to $3.8 million during the
same period in 1998. This improvement was primarily attributable to a $156.0
million or approximately 320% increase in the Corporation's mortgage loan sales.
This increase was due to a declining interest rate environment that resulted in
increased originations of fixed-rate mortgage loans, as well as increased
conversions of adjustable-rate loans to fixed-rate, both of which are generally
sold in the secondary market. Subsequent to June 30, 1998, interest rates have
remained at low levels. If this environment persists, or if interest rates
decline further, the Corporation is likely to continue to experience high levels
of refinance activity, as well as conversions by borrowers of their
adjustable-rate loans into fixed-rate loans. Such activity is expected to result
in high levels of gains on sales of mortgage loans, although there can be no
assurances. To a certain extent, management expects such gains to be offset by
declines in the carrying value of the Corporation's mortgage servicing rights,
as previously described.
Other income increased by $701,000 from $464,000 during the three
months ended June 30, 1997, to $1.2 million during the current quarter. Most of
this increase was attributable to a $390,000 state income tax refund for the
Corporation's 1987-89 tax years. This refund was received a result of the thrift
industry's victory in the Lincoln tax case, which reinstated certain tax
deductions that had been denied by the State of Wisconsin. Also contributing to
the increase in other income was an increase in fees received on loans
originated as agent for the Wisconsin State Veterans Administration ("State VA")
and the Wisconsin Housing and Economic Development Authority ("WHEDA"), as well
as increased fee income from customers that converted their adjustable-rate
mortgage loans to fixed rate loans, as previously described.
Non-interest income for the six months ended June 30, 1998 and 1997,
was $14.3 million and $10.8 million, respectively. This increase was primarily
the result of a $5.8 million increase in gain on sales of loans from $1.8
million in 1997 to $7.6 million in 1998. Also contributing was a $971,000 or
16.4% increase in retail banking fees and an $840,000 or approximately 95%
increase in other income. These developments were partially offset by a $3.8
million decrease in loan servicing fees from $1.2 million in 1997 to $(2.7)
million in 1998, as well as a $331,000 or approximately 40% decrease in
commissions on annuity and insurance sales. Reasons for these changes are
substantially the same as those described in previous paragraphs for the three
month periods ended June 30, 1998 and 1997.
NON-INTEREST EXPENSE Non-interest expense for the three-month periods
ended June 30, 1998 and 1997, was $11.3 million and $9.7 million, respectively.
Non-interest expense as a percent of average assets during these periods was
2.88% and 2.55%, respectively. The following paragraphs discuss the principal
components of non-interest expense and the primary reasons for their changes
from 1997 to 1998.
Compensation and employee benefits increased by $1.1 million or
approximately 20% during the three months ended June 30, 1998, as compared to
the same period in the previous year. In general, this increase was due to
normal annual merit increases and to general growth in the number of banking
facilities operated by the Corporation. Since December 31, 1996, the Corporation
has opened ten retail banking facilities and one loan production facility. The
Corporation also closed one retail banking facility in 1997. During the
remainder of 1998, the Corporation intends to open or acquire two or three
additional retail banking facilities, although there can be no assurances.
Also contributing to the increase in compensation and employee
benefits, was an increase in commissions paid in the Corporation's Residential
Lending Division, due primarily to increased originations of mortgage loans, as
previously described.
As of June 30, 1998, the Corporation had 750 full-time equivalent
employees. This compares to 690 and 673 as of December 31, 1997, and June 30,
1997, respectively.
15
<PAGE> 17
Occupancy and equipment expense increased by $284,000 or 19.6% during
the three months ended June 30, 1998, as compared to the same period in the
previous year. This increase was principally due to general growth in the number
of banking facilities operated by the Corporation, as previously described. In
addition, the second quarter of 1997 contained a reversal of an over-accrual of
real estate and personal property taxes from earlier periods.
Advertising and marketing expense decreased by $143,000 or
approximately 20% during the three months ended June 30, 1998, as compared to
the same period in the previous year. This decrease was caused by an unusually
high level of activity during the second quarter of last year in areas such as
checking and savings promotions, consumer and mortgage loan promotions, and
office grand openings.
Other non-interest expenses increased by $321,000 or 15.1% during the
three months ended June 30, 1998, as compared to the same period in the previous
year. This increase was caused by a variety of factors, the most significant of
which were increased costs related to "loan-payoff interest" remitted to the
Federal National Mortgage Association ("FNMA"). Under the terms of its servicing
agreement with FNMA, the Corporation is required to pay a full month's interest
to FNMA when certain loans payoff, regardless of the actual date of the payoff.
A low interest rate environment and increased prepayment activity in recent
months has resulted in increased payment of loan-payoff interest to FNMA.
Also contributing to the increase in non-interest expense were
increased transaction charges related to customers' use of ATMs and debit cards
and increased expenditures related to the operation of a 248-unit apartment
complex located in Indianapolis, Indiana. Although this property was sold in the
first quarter at loss of approximately $203,000, the Corporation incurred
additional operating costs in the second quarter related to the wind-up of its
involvement in the property.
Non-interest expense for the six month periods ended June 30, 1998 and
1997, was $22.2 million and $19.5 million, respectively. Non-interest expense as
a percent of average assets during these periods was 2.79% and 2.56%,
respectively. This increase was primarily the result of a $1.7 million or 15.9%
increase in compensation and employee benefits. Also contributing was a $1.1
million or approximately 25% increase in other non-interest expenses and a
$170,000 or 5.2% increase in occupancy and equipment expenses. Reasons for these
changes are substantially the same as those described in previous paragraphs for
the three month periods ended June 30, 1998 and 1997.
INCOME TAX EXPENSE Income tax expense for the three months ended June
30, 1998 and 1997, was $2.8 million and $2.7 million, respectively, or 37.6% and
39.0% of pretax income, respectively. Income tax expense for the six months
ended June 30, 1998 and 1997, was $5.8 million and $5.1 million, respectively,
or 38.0% and 38.8% of pretax income, respectively. Although there can be no
assurances, management expects the Corporation's effective tax rate to decline
modestly in the immediate future. This is expected to occur because of the
aforementioned securitization of $222 million in adjustable-rate residential
mortgage loans and the subsequent transfer of the related mortgage-backed
securities to the Corporation's wholly-owned investment subsidiary in Nevada.
The State of Nevada does not currently impose a corporate income tax.
FINANCIAL CONDITION
OVERVIEW The Corporation's total assets increased by $40.1 million or
2.6% during the six months ended June 30, 1998. This increase was primarily the
result of a $75.8 million increase in overnight investments. Mortgage-backed and
related securities classified as available for sale also increased substantially
during the period, but this increase was attributable to the securitization of
$222 million in adjustable-rate residential mortgage loans, as more
fully-described in a subsequent paragraph. The increase in overnight investments
was partially offset by decreases in investment securities available for sale
and mortgage-backed and related securities classified as held for investment.
These decreases were the result of maturities and periodic amortization of the
underlying collateral.
16
<PAGE> 18
The increase in the Corporation's assets was funded by a $133.1 million
or 11.6% increase in deposit liabilities. Growth in deposits was also used to
pay down $109.4 million in FHLB advances and other borrowings during the period.
OVERNIGHT INVESTMENTS Interest-bearing deposits with banks, which
consist of overnight investments at the FHLB and fed funds sold, increased by
$75.8 million from $7.1 million at December 31, 1997, to $83.0 million at June
30, 1998. This increase was caused by the temporary investment of cash flows
from deposit liabilities, loans held for investment, and mortgage-backed and
investment securities. The Corporation fully expects to use most of its
overnight investments to repay short-term FHLB advances as they mature. However,
overnight investments may also be used to invest in longer-term, higher-yielding
assets if such opportunities present themselves.
INVESTMENT SECURITIES The Corporation's investment securities available
for sale decreased by $15.5 million or approximately 70% during the six months
ended June 30, 1998. This decrease was due to the maturity of a number of
investment securities during the period. The proceeds from such maturities were
generally reinvested in overnight investments, as previously described.
Historically, the primary purpose of the Corporation's investment
securities portfolio was to meet liquidity requirements imposed on the Bank by
the Office of Thrift Supervision ("OTS"). During the fourth quarter of 1997,
however, the OTS modified its regulatory liquidity requirements for thrift
institutions. As a result of such modifications, the investment securities the
Bank is required to hold for regulatory liquidity purposes were substantially
reduced. Accordingly, the Bank anticipates that it will not need to maintain a
portfolio of investment securities in the future that is as large as it has been
in the past, although there can be no assurances.
MORTGAGE-BACKED AND RELATED SECURITIES The Corporation's aggregate
investment in its mortgage-backed and related securities portfolios increased by
$201.5 million during the six months ended June 30, 1998. This increase was
caused by the securitization of $222 million of the Corporation's
adjustable-rate residential loans into mortgage-backed securities (MBSs) during
the period. These securities were classified as "available for sale" and were
transferred to the Corporation's wholly-owned investment subsidiary in Nevada.
The securitization of the Corporation's adjustable-rate residential
mortgage loans into MBSs improves the liquidity of the asset and increases the
Corporation's borrowing capacity by making such loans acceptable as collateral
for reverse-repurchase agreements. MBSs also receive more favorable treatment
under the FHLB's current collateralization guidelines. The Corporation has
retained the credit risk associated with the underlying loans, which has the
effect of reducing the guarantee fee that is normally paid to the Federal Home
Loan Mortgage Corporation ("FHLMC"), the issuer of the MBSs. This fact is not
expected to have any impact on the marketability of the securities, although
there can be no assurances. Furthermore, this action does not change the credit
risk profile of the Corporation's assets, as it was exposed to the credit risk
on the loans prior to their securitization.
LOANS HELD FOR SALE The Corporation's loans held for sale decreased by
$9.5 million or approximately 20% during the six months ended June 30, 1998.
Declining interest rates and high levels of refinance activity during the last
few months of 1997 and the first few months of 1998 resulted in high levels of
loans held for sale during such periods. Interest rates have stabilized in
recent months, however, resulting in a decline in refinance activity and a
corresponding decrease in loans held for sale.
LOANS HELD FOR INVESTMENT The Corporation's loans held for investment
decreased by $220.6 million or 18.5% during the six months ended June 30, 1998.
This decrease was caused by the aforementioned securitization of adjustable-rate
residential mortgage loans into MBSs. Excluding the effects of this transaction,
loans held for investment would have increased slightly during the six months
ended June 30, 1998.
A low interest rate environment in 1998 has had a significant impact on
the ability of the Corporation to maintain its portfolio of loans held for
investment. This situation has developed because a low interest rate environment
tends to increase customer preference for fixed-rate mortgage loans, as opposed
to adjustable-rate loans. In addition, a low interest rate environment
encourages borrowers to refinance their existing adjustable-rate residential
mortgage loans into fixed-rate loans to "lock-in" a lower long-term rate. Given
the Corporation's policy
17
<PAGE> 19
of selling these types of loans in the secondary market, its portfolio of
adjustable-rate residential loans has declined since December 31, 1998. Although
some of this decline has been replaced by growth in consumer and commercial real
estate loans, management believes it will be a challenge for the Corporation to
maintain its current portfolio of loans held for investment if this interest
rate environment persists.
The Corporation is currently exploring other alternatives to increase
its portfolio of loans held for investment and other earning assets in the near
term. These alternatives include, but are not limited to, the purchase of
adjustable-rate residential mortgage loans from third-party originators, the
retention of certain fixed-rate loans that are currently sold by the Corporation
in the secondary market, or the purchase of mortgage-backed and related
securities. Management expects to fund these assets through increased borrowings
from the FHLB. However, there are many considerations involved in this decision
and there can be no assurances that the Corporation will elect to adopt any of
these strategies to increase its portfolio of loans held for investment or other
earning assets.
DEPOSIT LIABILITIES The Corporation's deposit liabilities increased by
$133.1 million or 11.6% during the six months ended June 30, 1998. This growth
was due in part to a number of popular CD programs that were offered to
customers during the period. Management also attributes this to the combined
effects of the Corporation's competitive interest rate offerings, its expansion
efforts in recent years, its convenient banking locations, and the strong local
economies in its market areas. Management expects these trends to continue in
the immediate future, resulting in continued modest growth in the Corporation's
deposit liabilities, although there can be no assurances.
Also contributing to the increase in deposit liabilities was a $23.2
million increase in the amount the Corporation holds as custodian for
third-party investors in loans serviced by the Corporation. These deposits
increased as a result of significant loan prepayment activity, which was brought
about by a low interest rate environment, as previously described. Management
expects these deposits to return to more reasonable levels as prepayment
activity slows in the future. However, there can be no assurances.
FHLB ADVANCES AND OTHER BORROWINGS The Corporation's FHLB advances and
other borrowings decreased by $109.4 million or approximately 40% during the six
months ended June 30, 1998. This decrease was funded by growth in deposit
liabilities, as described in the previous paragraph. Management expects FHLB
advances to continue to decline in the immediate future as overnight investments
are used to repay maturing advances. Alternatively, FHLB advances may increase
if the Corporation executes any of the strategies described in previous
paragraphs to increase its level of loans held for investment or other earning
assets.
NON-PERFORMING ASSETS The Corporation's non-performing assets
(consisting of non-accrual loans, real estate acquired through foreclosure or
deed-in-lieu thereof, and real estate in judgement) amounted to $3.4 million or
0.22% of total assets at June 30, 1998, compared to $4.9 million or 0.32% of
total assets at December 31, 1997. The decrease in non-performing assets during
the period was principally due to the aforementioned apartment complex in
Indianapolis, Indiana. The loan on this property was classified as
non-performing as of December 31, 1997. However, it was classified as performing
as of June 30, 1998, because of the Corporation's acceptance of a deed-in-lieu
of foreclosure and subsequent sale to a new borrower in the first quarter.
In addition to non-performing assets, at June 30, 1998, management was
closely monitoring $7.7 million in assets which it had classified as doubtful,
substandard, or special mention, but which were performing in accordance with
their terms. This compares to $7.2 million in such assets at December 31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Bank is required under applicable federal regulations to maintain
specified levels of qualifying types of U.S government, federal agency, and
other mortgage-related and investment securities of not less than 4% of net
withdrawable accounts and short-term borrowings. The Bank was in full compliance
with these regulations during the six months ended June 30, 1998.
18
<PAGE> 20
The Bank is also required to maintain specified amounts of capital
pursuant to regulations promulgated by the OTS and the FDIC. The Bank's
objective is to maintain its regulatory capital in an amount sufficient to be
classified in the highest regulatory capital category (i.e., as a "well
capitalized" institution). At June 30, 1998, the Bank's regulatory capital
exceeded all regulatory minimum requirements as well as the minimum amount
required to be classified as a "well capitalized" institution.
The Corporation's stockholder's equity ratio as of June 30, 1998, was
7.50% of total assets. The Corporation's objective is to maintain its
stockholders' equity ratio in a range of approximately 6.5% to 7.0%, which is
consistent with return on asset and return on equity goals of at least 1% and
15%, respectively. The Corporation's equity ratio is above its target range as
of June 30, 1998, primarily because of slower growth in the Corporation's
earning assets, as previously described. Also contributing was $2.2 million in
"non-owner adjustments to equity", which represent a valuation allowance (net of
the related income tax effect) on the Corporation's securities classified as
"available for sale". This allowance increased during the six months ended June
30, 1998, because of the aforementioned securitization of adjustable-rate
residential mortgage loans into MBSs. Management expects the Corporation to
operate with a higher than normal equity ratio in the immediate future. Although
the aforementioned strategies to increase the Corporation's earning assets, if
implemented, may result in an equity ratio more in line with the Corporation's
target range.
The Corporation paid cash dividends of $2.4 million and $2.1 million
during the six months ended June 30, 1998 and 1997, respectively. These amounts
equated to dividend payout ratios of 25.3% and 26.1% of net income in such
periods, respectively. It is the Corporation's objective to maintain its
dividend payout ratio in a range of 25% to 35% of net income. However, the
Corporation's dividend policy and/or dividend payout ratio will be impacted by
considerations such as the level of stockholders' equity in relation to the
Corporation's stated goal, as previously described, regulatory capital
requirements for the Bank, as previously described, and certain dividend
restrictions in effect for the Bank. Furthermore, unanticipated or non-recurring
fluctuations in earnings may impact the Corporation's ability to pay dividends
and/or maintain a given dividend payout ratio.
On July 28, 1998, the Corporation's Board of Directors approved a
regular quarterly dividend of $0.07 per share payable on September 3, 1998, to
shareholders of record on August 13, 1998.
During the six months ended June 30, 1998, the Corporation repurchased
100,000 shares of common stock at a cost of $1.7 million under its 1996 and 1997
stock repurchase plans (the "1996 Plan" and "1997 Plan"). As of June 30, 1998,
no shares remain to be purchased under the 1996 Plan and 886,152 shares remain
to be purchased under the 1997 Plan.
During the six months ended June 30, 1998, the Corporation reissued
237,854 shares of common stock out of its inventory of treasury stock with a
cost basis of $2.4 million. In general, these shares were issued upon the
exercise of stock options by, or the issuance of restricted stock to, employees
and directors of the Corporation.
ASSET/LIABILITY MANAGEMENT
The Corporation manages the exposure of its operations to changes in
interest rates ("interest rate risk") by monitoring its ratios of
interest-earning assets to interest-bearing liabilities within one- and
three-year maturities and/or repricing dates (i.e., its one- and three-year
"funding gaps"). Management has sought to control the Corporation's funding
gaps, thereby limiting the affects of changes in interest rates on its future
earnings, by selling substantially all of its long-term, fixed-rate,
single-family mortgage loan production, investing in adjustable-rate
single-family mortgage loans, investing in consumer and education loans, which
generally have shorter terms to maturity and/or floating rates of interest, and
investing in multi-family residential and commercial real estate loans, which
also tend to have shorter terms to maturity and/or floating rates of interest.
The Corporation also invests from time-to-time in short- and medium-term
fixed-rate CMOs and MBSs, as well as medium-term, fixed-rate, single-family
mortgage loans. As a result of this strategy, the Corporation's exposure to
interest rate risk is significantly impacted by its funding of the
aforementioned asset groups with deposit liabilities and FHLB advances that tend
to have average terms to maturity of less than one year or carry floating rates
of interest.
19
<PAGE> 21
In general, it is management's goal to maintain the Corporation's
one-year funding gap in a range between 0% and -25% and its three-year funding
gap in a range between +5% and -5%. Management believes this strategy takes
advantage of the fact that market yield curves tend to be upward sloping, which
increases the spread between the Corporation's earning assets and
interest-bearing liabilities. Furthermore, management of the Corporation does
not believe that this strategy exposes the Corporation to unacceptable levels of
interest rate risk as evidenced by the fact that the Corporation's three-year
funding gap is generally maintained in a narrow band around zero, which implies
that the Corporation is exposed to little interest rate risk over a three-year
horizon.
Although management believes that its asset/liability management
strategies reduce the potential effects of changes in interest rates on the
Corporation's operations, material and prolonged increases in interest rates may
adversely affect the Corporation's operations because the Corporation's
interest-bearing liabilities which mature or reprice within one year are greater
than the Corporation's interest-earning assets which mature or reprice within
the same period. Alternatively, material and prolonged decreases in interest
rates may benefit the Corporation's operations.
As of June 30, 1998, the Corporation was in compliance with its
internal polices with respect to exposure to interest rate risk. Furthermore,
there was no material change in its interest rate risk exposure since December
31, 1997. It should be noted, however, that the strategies intended to increase
the Corporation's earning assets, as discribed elsewhere in this report, if
implemented, are expected to modestly increase the Corporation's negative
funding gap. However, management expects that the Corporation will remain in
compliance with its internal interest rate risk policy should any of the
strategies be implemented.
OTHER MATTERS
FORMATION OF AN INSURANCE SUBSIDIARY The Corporation has sold credit
insurance policies (life and disability) to its consumer loan customers for a
number of years. The Corporation has earned commission revenue from the
third-party insurer in connection with such sales, but has not underwritten or
reinsured any of the associated risk. However, in the third quarter of 1998
management expects to complete the formation of a wholly-owned subsidiary of the
Bank, the purpose of which will be to reinsure credit insurance policies sold in
connection with its consumer loans. The third-party insurer will carry the first
level of risk and will be responsible for performing most of the administrative
tasks of the subsidiary on a contract basis. Based on the Corporation's past
claims experience, management does not believe this decision will expose the
Corporation to significant risk of loss, although there can be no assurances.
The Corporation will continue to earn commission revenue from the
third-party insurer. However, it will also earn reinsurance premiums, which net
of administrative costs and required insurance reserves, are expected to
increase revenue from this source by 15% to 20% from what would otherwise be
received (although there can be no assurances). During the six months ended June
30, 1998 and 1997, the Corporation earned commission revenue from sales of
credit insurance policies of $280,000 and $477,000, respectively. The decline in
1998 was primarily attributable to the receipt in the prior year of a larger
than normal annual commission bonus.
As a result of forming this subsidiary and assuming reinsurance risk on
all policies sold since October 1, 1995, the Corporation expects to receive a
"warehousing bonus" from the third-party insurer. This bonus is expected to be
approximately $300,000 and will be recorded as income during the period in which
the subsidiary is formed. However, there can be no assurances with respect to
this bonus. Furthermore, there can be no assurance that the Corporation will
complete the formation of the subsidiary or that it will be able to meet the
timeline specified herein.
LEGISLATION AFFECTING EDUCATION LOANS The Student Loan Reform Act of
1993 ("the Act") contains a provision that changes the rate received on
education loans originated after July 1, 1998, from the three-month U.S.
Treasury bill plus 310 basis points to the ten-year U.S. Treasury note plus 100
basis points. This provision of the Act is expected to substantially reduce the
profitability of education loans, which may have an adverse impact on the
Corporation's willingness to originate this type of loan in the future. During
the six months ended June 30, 1998 and 1997, the Corporation originated $13.9
million and $13.2 million of education loans, respectively.
20
<PAGE> 22
The banking and thrift industries, as well as other interested parties,
have been working with federal legislators to eliminate or modify this provision
of the Act. As a result these efforts, compromise legislation was signed into
law in June 1998, which delayed the effective date of the provision to October
1, 1998. The legislation also reduced the rate on education loans originated
between July 1, 1998, and October 1, 1998, by 30 basis points, which is expected
to have less of an impact on the profitability of education loans than the
original provision of the Act. The banking and thrift industries, as well as
other interest parties, are working with federal legislators to make the terms
of the compromise legislation permanent. However, there can be no assurances
that they will be successful or that additional compromises will not have to be
made, which may affect the Corporation's willingness to originate education
loans in the future.
21
<PAGE> 23
PART II-OTHER INFORMATION
ITEM 1--LEGAL PROCEEDINGS
Refer to Note 3 of the Corporation's Consolidated Financial Statements.
ITEM 2--CHANGES IN SECURITIES
None.
ITEM 3--DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4--SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
ITEM 5--OTHER INFORMATION
None.
ITEM 6--EXHIBITS AND REPORTS ON FORM 8-K
None.
22
<PAGE> 24
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FIRST FEDERAL CAPITAL CORP
/s/ Thomas W. Schini August 1, 1998
Thomas W. Schini
President, Chairman of the
Board and Chief Executive Officer
(duly authorized officer)
/s/ Jack C. Rusch August 1, 1998
Jack C. Rusch
Executive Vice President and
Chief Financial Officer
23
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
FOR THE 6-MONTH PERIOD ENDED JUNE 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FORM 10-Q.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 33,653,302
<INT-BEARING-DEPOSITS> 82,952,592
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 271,875,927
<INVESTMENTS-CARRYING> 107,725,332
<INVESTMENTS-MARKET> 107,622,246
<LOANS> 973,289,313
<ALLOWANCE> 7,623,526
<TOTAL-ASSETS> 1,584,404,886
<DEPOSITS> 1,279,588,325
<SHORT-TERM> 63,195,440
<LIABILITIES-OTHER> 19,601,279
<LONG-TERM> 103,200,000
0
0
<COMMON> 36,534,228
<OTHER-SE> 82,285,614
<TOTAL-LIABILITIES-AND-EQUITY> 1,584,404,886
<INTEREST-LOAN> 49,034,804
<INTEREST-INVEST> 9,281,563
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 58,316,367
<INTEREST-DEPOSIT> 28,241,334
<INTEREST-EXPENSE> 34,925,051
<INTEREST-INCOME-NET> 23,391,316
<LOAN-LOSSES> 141,922
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 22,249,665
<INCOME-PRETAX> 15,307,335
<INCOME-PRE-EXTRAORDINARY> 9,496,744
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,496,744
<EPS-PRIMARY> 0.51
<EPS-DILUTED> 0.48
<YIELD-ACTUAL> 7.82
<LOANS-NON> 1,856,000
<LOANS-PAST> 0
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