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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED December 31, 1997
Commission File Number: 0-18609
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CFSB BANCORP, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 38-2920051
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
112 EAST ALLEGAN STREET, LANSING, MICHIGAN 48933
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (517) 371-2911
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
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(Title of Class)
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 for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO .
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K 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-K or any amendment to this
Form 10-K. [ ]
As of March 10, 1998, the aggregate market value of the voting stock held by
non-affiliates of the registrant, computed by reference to the last price at
which the stock was sold ($29.44 per share), was approximately $199,172,490 (for
purposes of this calculation, directors and executive officers are treated as
affiliates).
As of March 10, 1998, there were issued and outstanding 7,518,972 shares of the
registrant's common stock, of which 753,602 shares were held by affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Annual Report to Stockholders for the Fiscal Year Ended
December 31, 1997 (the "Annual Report") (Parts I and II)
2. Portions of Proxy Statement for the 1998 Annual Meeting of Stockholders
(the "Proxy Statement") (Part III)
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CFSB BANCORP, INC.
INDEX TO FORM 10-K
FISCAL YEAR ENDED DECEMBER 31, 1997
PART I
Item 1 Business
Item 2 Properties
Item 3 Legal Proceedings
Item 4 Submission of Matters to a Vote of Security Holders
PART II
Item 5 Market for the Registrant's Common Equity and
Related Stockholder Matters
Item 6 Selected Financial Data
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 7a. Quantitative and Qualitative Disclosures About
Market Risk
Item 8 Financial Statements and Supplementary Data
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
PART III
Item 10 Directors and Executive Officers of the Registrant
Item 11 Executive Compensation
Item 12 Security Ownership of Certain Beneficial Owners
and Management
Item 13 Certain Relationships and Related Transactions
PART IV
Item 14 Exhibits, Financial Statement Schedules and
Reports on Form 8-K
SIGNATURES
EXHIBITS
Included or incorporated by reference in this Form 10-K are certain forward-
looking statements within the meaning of Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. Such forward-looking statements are based upon the beliefs of the
Registrant's management as well as on assumptions made by and information
currently available to the Registrant at the time such statements were made.
Readers are cautioned that various factors, including regional and national
economic conditions, substantial changes in levels of market interest rates,
credit and other risks of lending and investment activities and competitive and
regulatory factors, could affect CFSB Bancorp, Inc.'s financial performance and
could cause actual results for future periods to differ materially from those
anticipated. Investors are cautioned that all forward-looking statements
involve risks and uncertainty.
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PART I
ITEM 1. BUSINESS
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GENERAL
CFSB Bancorp, Inc. CFSB Bancorp, Inc. (the "Corporation") was incorporated
under the laws of the State of Delaware on November 28, 1989. The historical
information in this report, and the financial statements filed as exhibits,
principally address the financial condition and results of operations of the
Corporation's savings institution subsidiary, Community First Bank ("Community
First" or the "Bank"), through December 31, 1997, with disclosure as appropriate
to reflect the consolidated financial condition and results of operations of the
Corporation.
The Corporation is classified as a unitary savings and loan holding company
subject to regulation by the Office of Thrift Supervision ("OTS") of the
Department of the Treasury. The Corporation's principal business is the
business of Community First and its subsidiary. The holding company structure
permits the Corporation to expand the financial services currently offered
through Community First and its subsidiary. As a holding company, the
Corporation has greater flexibility than Community First to diversify its
business activities, through existing or newly formed subsidiaries, or through
acquisition or merger. So long as the Corporation remains a unitary savings and
loan holding company and Community First satisfies the Qualified Thrift Lender
Test, the Corporation may diversify its activities in such a manner as to
include any activities allowed by regulation to a unitary savings and loan
holding company. See "Item 1. Business -- Regulation of the Corporation."
The Corporation's main office is located at 112 East Allegan Street,
Lansing, Michigan, 48933, and the telephone number is (517) 371-2911. At
December 31, 1997, the Corporation had total assets of $852.9 million and
stockholders' equity of $67.5 million.
Community First Bank. Community First is a Michigan chartered stock savings
bank which commenced operations in 1890 as Capitol Investment Building and Loan
Association, a Michigan-chartered mutual savings and loan association, and in
1923 became Capitol Savings & Loan Association. The Bank changed its name to
Capitol Federal Savings & Loan Association upon its conversion from a state to a
federal charter in January 1982. In April 1986, the Bank became a federal
mutual savings bank known as Capitol Federal Savings Bank. In June 1990, the
Bank became a federal stock savings bank, and in December 1991 the Bank merged
with Union Federal Savings ("Union Federal") and adopted the name, Community
First Bank, A Federal Savings Bank. On December 9, 1996 the Bank converted to a
Michigan chartered state savings bank under its current name, Community First
Bank.
As a Michigan chartered savings bank, Community First is subject to
extensive regulation and examination by the Financial Institutions Bureau of the
Michigan Department of Consumer and Industry Services (the "Financial
Institutions Bureau") and the Federal Deposit Insurance Corporation ("FDIC"), as
the administrator of the Savings Association Insurance Fund ("SAIF") which
insures Community First's deposits up to applicable limits.
Community First conducts its operations through its main office located in
Lansing, Michigan and through 16 branch offices serving the Greater Lansing
area. The Bank is principally engaged in the business of accepting deposits from
the general public and using such deposits, together with Federal Home Loan Bank
("FHLB") advances, to make loans for the purchase and construction of
residential properties. To a lesser extent, the Bank also makes income-producing
property loans, commercial business loans, home equity loans, and various types
of consumer loans. The Bank also invests in government, federal agency and
corporate obligations and mortgage-backed securities.
As a federally insured savings bank, the Bank's deposit accounts are insured
by the FDIC to a maximum of $100,000. The Bank is a member of the FHLB of
Indianapolis, which is one of the 12 regional banks constituting the FHLB
System. The Bank is subject to comprehensive examination, supervision and
regulation by the Financial Institutions Bureau and the FDIC. This regulation is
intended primarily for the protection of depositors.
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The executive offices of the Bank are located at 112 East Allegan Street,
Lansing, Michigan 48933, and the telephone number is (517) 371-2911.
MARKET AREA
The Bank is a community-oriented financial institution offering a variety of
financial services to meet the needs of the communities it serves. The Bank's
primary market area is the greater Lansing, Michigan area, which is composed of
the tri-county area of Clinton, Eaton and Ingham Counties, the western townships
of Shiawassee County and Ionia County. Lansing is the capital of Michigan and
the fifth largest city in Michigan. The greater Lansing area is a diversified
market with a strong service sector, and, to a lesser extent, trade and
manufacturing sectors. Since 1984 growth in employment in the greater Lansing
area has occurred primarily in the service sector, and such trends are expected
to continue. The largest employers in the Bank's market area are the State of
Michigan, General Motors and Michigan State University. Based on total deposits
at December 31, 1997, Community First was the largest financial institution
headquartered in the greater Lansing area and historically, has been among the
three largest financial institutions serving the greater Lansing area.
LENDING ACTIVITIES
GENERAL. The principal lending activity of the Bank is the origination of
conventional residential mortgage loans (i.e., loans that are neither insured
nor partially guaranteed by government agencies) for the purpose of financing,
refinancing or constructing one-to four-family residential properties and
income-producing properties, which includes multi-family (over four-family) and
commercial properties. As of December 31, 1997, $627.7 million, or 80.99%, of
the Bank's loan portfolio (before the deduction of undistributed funds, unearned
fees, unearned income and discounts, and loan loss allowance) consisted of loans
secured by one-to four-family residential properties, of which $498.5 million
were loans originated by the Bank. Substantially all loans originated by the
Bank are on properties located in its primary market area. Of the purchased
loans which are serviced by other institutions, $40.4 million, $83.7 million and
$5.1 million represented loans on properties located in Michigan, Texas and
Florida, respectively. The Bank also originates second mortgage loans,
commercial business loans, consumer loans (including home equity loans,
educational loans, automobile loans, loans secured by savings accounts and
personal loans) and land contracts. Substantially all of the Corporation's
income-producing property and consumer loans are based in Michigan.
In recent years, in order to reduce the Bank's vulnerability to volatile
interest rate changes, the Bank has implemented a number of measures designed to
make the yield on its loan portfolio more interest rate sensitive. These
measures include: (i) emphasizing the origination and purchase of adjustable-
rate mortgage loans and loans with call or balloon payment provisions, (ii)
originating construction and consumer loans, which typically have shorter terms
to maturity or repricing than fixed-rate residential mortgage loans, (iii)
maintaining liquidity levels adequate to allow flexibility in reacting to the
interest rate environment, and (iv) selling upon origination certain long-term,
fixed-rate, residential mortgages in the secondary mortgage market. The level of
loan sales is partially a function of the interest rate environment. At December
31, 1997, 63.77% of the Bank's total loans receivable consisted of loans that
provided for periodic interest rate adjustments or had terms to repricing, call
provisions or balloon payment provisions of seven years or less.
As noted above, in an effort to maintain a closer match between the interest
rate sensitivity of its assets and liabilities, the Bank has been active in the
origination of loans on income-producing properties (consisting of commercial
and multi-family real estate loans) in its primary market area and in the
origination of consumer loans. Although income-producing property loans and
consumer loans provide for higher interest rates and shorter terms, these loans
have higher credit risks than one-to four-family residential loans. While the
Bank has been relatively successful in its origination of income-producing
property loans, and the real estate market in the greater Lansing area has
remained fairly stable, numerous financial institutions throughout the United
States have incurred significant losses due to delinquencies and foreclosures
resulting from a decline in the value of properties securing income-producing
property loans. At December 31, 1997, the Bank had income-producing property
loans of $77.2 million and consumer loans of
2
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$64.5 million. This compares to $84.0 million in income-producing property loans
and $54.6 million in consumer loans, at December 31, 1996. The decline in the
Bank's income-producing property loans is attributable to strong competition
from insurance companies offering lower interest rates for fixed-rate financing.
Consumer loan growth is a direct result of home equity loan promotions and
expanding the Bank's consumer lending to include indirect automobile lending
through local automobile dealerships. Any decline in the economy or real estate
market in the greater Lansing area could have a negative effect on the Bank's
loan portfolio and on the Corporation's net interest income and net income. At
December 31, 1997, the Bank's loans contractually delinquent 90 days or more and
real estate owned totaled $1.1 million, or .12%, of total assets.
In 1994, the Bank formed a small business commercial loan department. The
business loan department was developed to serve the financial needs of small
businesses in the Bank's tri-county market area. Small businesses are defined by
the Bank as companies with sales under $1.0 million and less than 20 employees.
The Bank believes it can satisfy the financial needs of small business owners by
assisting with both their credit and deposit needs. Also in 1994, a formal
credit department was formed and an active call program was initiated. During
1997, the commercial business loan department originated 68 loans for a total of
$4.0 million. Additional funds of $2.5 million were available for disbursement
at year-end 1997 on the Bank's commercial business loan portfolio. As of
December 31, 1997, commercial business loans totaled $5.1 million compared to
$4.6 million at December 31, 1996.
In March 1997, the Bank initiated a 24-hour consumer loan-by-phone program.
A consumer can telephone the Bank and electronically make a loan application for
consumer loan products such as auto, home equity, redicredit, marine or debt
consolidations. The Bank has averaged 100 calls to loan-by-phone a month with an
approximate 20% approval rate.
The Bank has implemented a preapproval mortgage loan program called Buyer's
Edge. This program allows a potential homeowner to identify, prior to finding a
home, the amount of financing the Bank will approve. A certificate is issued by
the Bank which is valid for three months for a purchase of a home, and five
months for construction of a home. The customer can then comfortably look for a
new home or construct a home knowing the financing has already been approved. In
1997, the Bank closed 184 loans amounting to $23.5 million under the Buyer's
Edge Program.
LOAN PORTFOLIO COMPOSITION. The first of the following two tables sets forth
information concerning the composition of the Bank's loan portfolio (separately
including mortgage-backed securities) in dollar amounts and percentages by
category and presents a reconciliation of total loans receivable before net
items. The second table sets forth information concerning the Bank's loan
portfolio (separately including mortgage-backed securities) in dollar amounts
and percentages by fixed and adjustable-rates at the dates indicated.
3
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<TABLE>
<CAPTION>
At December 31,
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1997 1996 1995 1994 1993
----------------- ----------------- ----------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
First mortgage loans:
One- to four-family
residential............. $585,267 75.51% $553,691 74.63% $469,820 74.46% $401,394 75.38% $267,481 69.13%
Income-producing property 44,580 5.75 52,584 7.09 57,952 9.19 55,178 10.36 49,435 12.78
FHA-insured and
VA-partially
guaranteed............ 7,607 0.98 6,404 0.86 7,458 1.18 3,629 .68 4,240 1.10
Construction and
development loans:
One- to four-family
residential........... 34,821 4.49 38,072 5.13 30,754 4.87 20,485 3.85 15,129 3.91
Income-producing
property.............. 32,649 4.21 31,428 4.24 17,060 2.70 11,677 2.19 14,292 3.69
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total first mortgage
loans................ 704,924 90.94 682,179 91.95 583,044 92.40 492,363 92.46 350,577 90.61
Second mortgage loans...... 549 0.07 510 0.07 571 .09 661 .12 750 .19
Commercial business loans.. 5,087 0.66 4,644 0.63 3,195 .51 706 .13 446 .12
Consumer loans:
Home equity.............. 42,281 5.46 36,275 4.89 28,126 4.46 26,048 4.89 22,569 5.83
Educational.............. 1,348 0.18 1,871 0.25 2,329 .37 2,967 .56 2,633 .68
Marine and recreational
vehicles................ 2,224 0.29 2,192 0.30 2,373 .38 2,420 .45 2,307 .60
Land contract............ 149 0.02 254 0.03 349 .05 409 .08 808 .21
Auto..................... 10,219 1.32 7,925 1.07 6,542 1.04 2,330 .44 1,842 .47
Savings.................. 578 0.07 452 0.06 338 .05 351 .07 458 .12
Mobile home.............. 1,099 0.14 1,519 0.20 1,735 .27 2,144 .40 2,087 .54
Other.................... 6,585 0.85 4,090 0.55 2,379 .38 2,090 .40 2,455 .63
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans.. 64,483 8.33 54,578 7.35 44,171 7.00 38,759 7.29 35,159 9.08
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans receivable 775,043 100.00% 741,911 100.00% 630,981 100.00% 532,489 100.00% 386,932 100.00%
====== ====== ====== ====== ======
Less:
Undistributed portion of
loans
in process............. (14,408) (18,147) (15,054) (8,578) (7,201)
Deferred origination fees (1,099) (1,485) (1,280) (1,196) (1,226)
Allowance for loan losses (4,730) (4,564) (4,363) (4,124) (3,847)
-------- -------- -------- -------- --------
Total loans
receivable, net...... 754,806 717,715 610,284 518,591 374,658
Mortgage-backed
securities, net........... 21,598 27,221 35,156 66,151 107,712
-------- -------- -------- -------- --------
Total loans
receivable and
mortgage- backed
securities, net...... $776,404 $744,936 $645,440 $584,742 $482,370
======== ======== ======== ======== ========
</TABLE>
4
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<TABLE>
<CAPTION>
At December 31,
---------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------------- ----------------- ----------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed-rate loans:
One- to four-family
residential............. $205,478 26.51% $192,972 26.01% $201,971 32.01% $211,445 39.71% $163,518 42.26%
Income-producing property 28,222 3.64 32,848 4.43 34,693 5.50 30,247 5.68 30,936 8.00
FHA-insured and
VA-partially
guaranteed............. 3,802 0.49 2,797 0.37 3,560 .56 3,629 .68 4,240 1.10
Construction and
development:
One- to four-family
residential........... 7,652 0.98 3,494 0.47 805 .13 2,691 .51 8,726 2.25
Income-producing
property.............. 4,553 0.59 4,878 0.66 7,591 1.20 5,557 1.04 7,395 1.91
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total first mortgage
loans................. 249,707 32.21 236,989 31.94 248,620 39.40 253,569 47.62 214,815 55.52
Second mortgage loans..... 311 0.04 399 0.06 456 .07 609 .11 750 .19
Commercial business loans. 927 0.12 836 0.11 585 .09 290 .05 145 .04
Other loans............... 29,926 3.86 24,274 3.27 20,097 3.18 16,687 3.14 14,959 3.86
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total fixed-rate loans. 280,871 36.23 262,498 35.38 269,758 42.74 271,155 50.92 230,669 59.61
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Adjustable-rate loans:
First mortgage loans:
One- to four-family
residential............. 379,789 49.00 360,719 48.62 267,849 42.45 189,949 35.67 103,963 26.87
Income-producing property 16,358 2.11 19,736 2.66 23,259 3.69 24,931 4.68 18,499 4.78
FHA-insured and
VA-partially guaranteed. 3,805 0.49 3,607 0.49 3,898 .62 -- -- -- --
Construction and
development:
One- to four-family
residential........... 27,169 3.51 34,578 4.66 29,949 4.74 17,794 3.34 6,403 1.66
Income-producing
property.............. 28,096 3.63 26,550 3.58 9,469 1.50 6,120 1.15 6,897 1.78
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total first mortgage
loans................. 455,217 58.74 445,190 60.01 334,424 53.00 238,794 44.84 135,762 35.09
Second mortgage loans..... 238 0.03 111 0.01 115 .02 52 .01 -- --
Commercial business loans. 4,160 0.54 3,808 0.52 2,610 .42 416 .08 301 .08
Other loans............... 34,557 4.46 30,304 4.08 24,074 3.82 22,072 4.15 20,200 5.22
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total adjustable-rate
loans................. 494,172 63.77 479,413 64.62 361,223 57.26 261,334 49.08 156,263 40.39
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans receivable. 775,043 100.00% 741,911 100.00% 630,981 100.00% 532,489 100.00% 386,932 100.00%
====== ====== ====== ====== ======
Less:
Undistributed portion of
loans in process........ (14,408) (18,147) (15,054) (8,578) (7,201)
Deferred origination fees (1,099) (1,485) (1,280) (1,196) (1,226)
Allowance for loan losses (4,730) (4,564) (4,363) (4,124) (3,847)
-------- -------- -------- -------- --------
Total loans
receivable, net...... 754,806 717,715 610,284 518,591 374,658
Mortgage-backed securities:
Fixed-rate
mortgage-backed
securities.............. 12,011 16,138 22,159 51,099 88,856
Adjustable-rate
mortgage-backed
securities............. 9,587 11,083 12,997 15,052 18,856
-------- -------- -------- -------- --------
Total mortgage-backed
securities, net.... 21,598 27,221 35,156 66,151 107,712
-------- -------- -------- -------- --------
Total loans
receivable and
mortgage-
backed securities,
net................ $776,404 $744,936 $645,440 $584,742 $482,370
======== ======== ======== ======== ========
</TABLE>
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The following table sets forth the contractual maturities of the Bank's loan
and mortgage-backed securities portfolios at December 31, 1997. The table does
not reflect the effects of prepayments or enforcement of due-on-sale clauses.
Loans with balloon or call provisions were assumed to contractually mature on
the call date or the date the balloon provision called for repayment.
<TABLE>
<CAPTION>
First Mortgage Loans
-------------------------------------------------------------------------------------------------------
Contruction
FHA- and development Total
Insured ----------------------- Second Loans and
Maturing During One-to Income- and VA- One- to Income- Mortgage Mortgage- Mortgage-
Year(s) Ended Four-Family Producing Partially Four-Family Producing and Other Total Backed Backed
December 31, Residential Property Guaranteed Residential Property Loans Loans Securities Securities
- -------------------------- ----------- --------- ---------- ----------- --------- --------- -------- ---------- ----------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1998...................... $ 25,816 $15,000 $ 140 $ 6,152 $17,377 $ 33,153 $ 97,638 $ 844 $ 98,482
1999...................... 24,817 6,455 151 794 8,127 15,011 55,355 914 56,269
2000...................... 23,584 2,797 164 529 1,663 8,936 37,673 990 38,663
2001-2002................. 44,336 3,490 344 1,178 2,234 6,524 58,106 2,189 60,295
2003-2007................. 105,900 6,711 1,070 3,434 1,885 5,502 124,502 4,929 129,431
2008-2012................. 85,410 6,401 1,525 4,262 1,164 911 99,673 5,152 104,825
2013 and following........ 275,404 3,726 4,213 18,472 199 82 302,096 6,580 308,676
-------- ------- ------- ------- ------- -------- -------- ------- --------
$585,267 $ 44,580 $ 7,607 $34,821 $32,649 $ 70,119 $775,043 $21,598 $796,641
======== ======== ======= ======= ======= ======== ======== ======= ========
Less:
Undistributed portion of
loans in process.................................................................................................... $(14,408)
Deferred origination fees............................................................................................ (1,099)
Allowance for loan losses............................................................................................ (4,730)
--------
Total loans receivable,
net............................................................................................................... $776,404
========
</TABLE>
At December 31, 1997, the total loans and mortgage-backed securities due
after December 31, 1998, which had fixed interest rates were $238.5 million and
$11.4 million, respectively, while the total loans and mortgage-backed
securities due after such date, which had adjustable interest rates were $438.9
million and $9.4 million, respectively.
6
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RESIDENTIAL REAL ESTATE LOANS. The Bank's primary lending activity is the
origination of mortgage loans secured by one-to four-family, owner-occupied
residential properties located in the Bank's primary market area, the majority
of which are owner-occupied, single-family residences. At December 31, 1997,
$592.9 million, or 76.49%, of the Bank's total loan portfolio consisted of loans
secured by one-to four-family residences. The Bank's loan portfolio also
includes $34.8 million of loans made for the development of unimproved real
estate located in the Bank's primary market area, to be used for residential
housing. At December 31, 1997, approximately 80.99% of the Bank's total loan
portfolio consisted of loans secured by residential real estate.
The Bank's residential mortgage loan originations historically were for
fixed-rate mortgage loans with terms of 15 to 30 years. The Bank has emphasized
the origination of adjustable-rate mortgage loans since 1983. All loans require
monthly payments sufficient to fully amortize principal over the life of the
loan. The Bank generally charges a higher interest rate on such loans if the
property is not owner-occupied. Residential real estate loans often remain
outstanding for significantly shorter periods than their contractual terms, and
borrowers may refinance or prepay loans at their option. Substantially all
fixed-rate mortgage loans are underwritten according to Federal Home Loan
Mortgage Corporation ("FHLMC") and Federal National Mortgage Association
("FNMA") guidelines, so the loans qualify for sale in the secondary market.
The Bank presently offers one-year, three-year and five-year adjustable-
rate residential loans with interest rates that adjust based upon the index of
the weekly average yield on United States Treasury securities adjusted to a
constant maturity of one year. In addition, the Bank offers three-year
adjustable-rate residential loans with interest rates that adjust based upon the
index of the weekly average yield on United States Treasury securities adjusted
to a constant maturity of three years. The Bank offers introductory interest
rates on adjustable-rate loans which are lower than the fully-indexed rate on
these loans. The interest rates on these mortgages generally include a cap of
2% per adjustment and 6% over the life of the loan. The Bank also provides a
conversion feature which allows borrowers to convert from an adjustable-rate to
a fixed-rate prior to the 60th payment. In recent years, the Bank has generally
sold longer-term, fixed-rate, residential mortgage loans in the secondary market
upon conversion from an adjustable-rate mortgage loan. Adjustable-rate
residential mortgage loans totaled $410.8 million, or 53.0%, of the Bank's total
loan portfolio at December 31, 1997.
In 1997, there was a decline in long-term rates during the first quarter
and a large amount of refinancing occurred. In the second and third quarter,
new home sales picked up and as interest rates stabilized, adjustable-rate
products were attractive. During the fourth quarter, the long-term rates began
to drop again; and refinancing into 30-year, fixed-rate mortgages was prevalent.
During 1997, the Bank originated $25.8 million in fixed-rate mortgage loans,
$18.4 million of which were sold in the secondary mortgage market, and $116.5
million in adjustable-rate and medium-term fixed-rate (15 years or less)
mortgage loans, of which none were sold in the secondary mortgage market.
The Bank also offers 7 year and 5 year loans which are convertible to 23
and 25 year amortized loans, respectively. The interest rates are based on the
FHLMC 30 year rates at the end of the respective 7th and 5th years.
Historically, the Bank sold substantially all 7 year and 5 year loans on the
secondary market. During recent years, the Bank has retained in portfolio newly
originated 7 year and 5 year loans.
The Bank's lending policies generally limit the maximum loan-to-value ratio
on residential mortgage loans to 95% of the lesser of the appraised value of the
property or the purchase price, with the condition private mortgage insurance is
required on loans with loan-to-value ratios in excess of 80%. For certain
adjustable-rate loans, loan-to-value ratios up to and including 85% are
permitted without requiring private mortgage insurance. The majority of the
Bank's residential loan portfolio has loan-to-value ratios of 80% or less.
In underwriting residential real estate loans, the Bank evaluates both the
borrower's ability to make monthly payments and the value of the property
securing the loan. Potential borrowers are qualified for adjustable-rate
mortgage loans based on the fully indexed rate of the loans. Upon receipt of a
completed loan application from a prospective borrower, credit reports are
ordered and income, employment and financial information is verified. An
appraisal of the real estate intended to secure the proposed loan is undertaken
by a Bank appraiser or an independent appraiser
7
<PAGE>
previously approved by the Bank. It is the Bank's policy to obtain title
insurance on all mortgage loans. Borrowers also must obtain hazard (including
fire) insurance prior to closing. Determination as to whether a property is
located in a flood zone is additionally required on new mortgage loan
originations. Borrowers are required to advance funds on a monthly basis
together with each payment of principal and interest through a mortgage escrow
account from which the Bank makes disbursements for items such as real estate
taxes and hazard insurance premiums as they become due. If a loan carries a
loan-to-value ratio of 75% or less, the borrower has the option of not having
real estate taxes and hazard insurance premiums placed in escrow as long as
proof of payment for these items is submitted to the Bank prior to their due
dates. These underwriting criteria are also applied to loans purchased giving
the Bank the right to reject any loans failing to meet underwriting standards.
The Bank began using automated loan underwriting utilizing Federal Home Loan
Mortgage Corporation Loan Prospector software in November 1996. The system was
fully implemented in January 1997 and is used to underwrite all residential loan
originations. Approximately 70% of mortgage applications are approved using
this software with the remaining 30% referred to traditional underwriting
methods. By using the automated underwriting procedures, the Bank is able to
approve loans faster and decrease the time to loan closing. Despite the
benefits of adjustable-rate mortgage loans to the Bank's asset/liability
management program, they do pose potential additional risks, primarily because
as interest rates rise, the underlying payment requirements of the borrower
rise, thereby increasing the potential for default.
Although interest rates charged by the Bank on mortgage loans are primarily
determined by competitive loan rates offered in its market area, interest rates
charged on fixed-rate mortgage loans fluctuate daily and are based on interest
rates offered by FHLMC and FNMA. Mortgage loan rates reflect factors such as
general 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 policies of the Federal government,
including the Federal Reserve Board, the general supply of money in the economy,
tax policies and governmental budget matters.
INCOME-PRODUCING PROPERTY LOANS (COMMERCIAL AND MULTI-FAMILY REAL ESTATE
LOANS). Income-producing property loans originated by the Bank are loans
secured by commercial and multi-family (five or more units) real estate
generally located in the Bank's primary market area. Permanent loans on income-
producing properties constituted approximately $44.6 million, or 5.7%, of the
Bank's total loans at December 31, 1997. The Bank originates both construction
loans and permanent loans on commercial and multi-family properties. The Bank
generally does not purchase commercial and multi-family real estate loans.
Permanent commercial and multi-family real estate loans are generally made in
amounts up to 75% of the lesser of the appraised value or the purchase price of
the property. Commercial and multi-family real estate loans have been made in
amounts up to $4.8 million, although the majority of the Bank's commercial and
multi-family real estate loans have been originated in amounts ranging from
$250,000 to $2.5 million.
The Bank's commercial real estate loans are secured by office buildings,
motels, medical facilities, retail centers, warehouses, apartment buildings,
condominiums, a country club, and other commercial buildings, principally all of
which are located in the Bank's primary market area. Adjustable-rate commercial
and multi-family real estate loans generally provide for interest rate
adjustments based upon the New York prime lending rate or every one to five
years at a rate indexed to the weekly average yield on United States Treasury
securities, adjusted to a constant maturity of one year or three years.
Additionally, the Bank's commercial and multi-family real estate loans generally
include balloon provisions or call options, which allow the Bank to call a loan
after one to ten years, with principal amortization generally of 20 to 25 years,
with a maximum 30-year period. These balloon provisions and call options
provide the Bank with flexibility to adjust the rates on loans to reflect then
current market conditions, allowing the Bank to better control interest rate
risk. Although adjustable-rate loans assist in managing interest rate risk,
they do increase the potential for default primarily because as interest rates
rise, the underlying payment requirements of the borrower increase.
Loans secured by commercial and multi-family properties are generally
larger and involve greater risks than residential mortgage loans. Because
payments on loans secured by commercial and multi-family residential properties
are often dependent on successful operation or management of the properties,
repayment of such loans may be subject to a greater extent to adverse conditions
in the real estate market or the economy. The Bank seeks to minimize these
8
<PAGE>
risks in a variety of ways, including limiting the size of its commercial and
multi-family real estate loans. In addition, the Bank requires a positive net
operating or rental income to debt service ratio for loans secured by commercial
and multi-family real estate. The Bank generally restricts these lending
activities to properties located in its primary market area. When considered
appropriate, the Bank requires borrowers to provide their personal guarantees on
commercial and multi-family real estate loans.
A loan with an outstanding balance of $3.8 million at December 31, 1997,
and secured by a motel, represents the Bank's largest single commercial real
estate loan to one borrower. At December 31, 1997, the Bank's 10 largest
commercial real estate loans, with balances outstanding ranging from $1.5
million to $3.8 million, totaled $33.0 million.
CONSTRUCTION AND LAND DEVELOPMENT LOANS. The Bank originates loans to
finance the construction of properties in its primary market area, including
one-to four-family dwellings, housing developments, multi-family apartments and
condominiums and commercial real estate. It also originates loans for the
acquisition and development of unimproved property to be used for residential
and commercial purposes. Construction and land development loans totaled $67.5
million, or 8.70%, of the Bank's total loan portfolio at December 31, 1997. Of
that total, $34.8 million were for the construction of one-to four-family
residential properties. Construction loans have been made in amounts up to $7.7
million. At December 31, 1997, the Bank had $10.2 million outstanding
commitments in construction and land development loans.
Construction loans generally have construction terms of up to 12 months.
Loan proceeds are disbursed in increments as construction progresses and as
inspections warrant. Inspections are carried out under the direction of the
Bank's Chief Lending Officer, although qualified architects are retained to
perform inspections on larger projects. The Bank also finances the construction
of individual owner-occupied residences. Construction loans are either
converted to permanent loans at the completion of construction or are paid off
upon receiving permanent financing from another financial institution.
Construction loans on residential properties are generally made in amounts up to
80% of the appraised value of the completed property, and construction loans on
commercial properties are generally made in amounts up to 75% of the appraised
value of the completed property.
The Bank's underwriting criteria are designed to evaluate and minimize the
risks of each construction loan. Among other things, the Bank considers the
reputation of the borrower and the contractor, the amount of the borrower's
equity in the project, independent valuations and reviews of cost estimates,
pre-construction sale and leasing information, and cash flow projections of the
borrower. Personal guarantees of the principals of each borrower are also
usually obtained. Generally, all construction loans made by the Bank are within
its primary market area.
Construction loans generally afford the Bank the opportunity to increase
the yield and interest rate sensitivity of its loan portfolio. These higher
yields correspond to the higher risks associated with construction lending. The
Bank's risk of loss on a construction loan is largely dependent upon the
accuracy of the initial estimate of the property's value at completion of
construction and the estimated cost (including interest) of completion. If the
estimate of the completed cost proves to be inaccurate, the Bank may be
confronted, at or prior to the maturity of the loan, with a property having a
value which is insufficient to assure full repayment of the loan. At December
31, 1997, the Bank had no construction loans outstanding which were non-
performing and $141,000 of construction loans classified as real estate owned.
CONSUMER LOANS. The Bank has offered consumer loans since 1983. As of
December 31, 1997, total consumer loans were $64.5 million, or 8.3%, of the
Bank's total loan portfolio. Consumer loans originated by the Bank include home
equity loans, educational loans, automobile loans, land contracts, personal
loans (secured and unsecured), marine and recreational vehicle loans, mobile
home loans, and loans secured by savings accounts.
The Bank believes the shorter terms and the normally higher interest rates
available on various types of consumer loans have been helpful in maintaining a
profitable spread between the Bank's average loan yield and its cost of funds.
Consumer loans do, however, pose additional risks of collectibility when
compared to traditional types of
9
<PAGE>
loans granted by thrift institutions such as residential mortgage loans. The
Bank has sought to reduce this risk by primarily granting secured consumer
loans.
LOAN SOLICITATION AND PROCESSING. Loan originations are derived from a
number of sources including "walk-in" customers at the Bank's offices, the
Bank's marketing efforts, the Bank's present customers, referrals from real
estate professionals, and building contractors. Loan applications are reviewed
in accordance with the underwriting standards approved by the Bank's Board of
Directors which generally conform to FHLMC and FNMA standards.
Upon receipt of a loan application, a credit report is ordered to verify
specific information relating to the loan applicant's employment, income and
credit standing. In the case of a real estate loan, an appraisal of the real
estate intended to secure the proposed loan is undertaken by the Bank's in-house
appraiser or by independent appraisers approved by the Bank. In the case of
commercial and multi-family properties only independent appraisers are used.
The loan application file is then reviewed, depending upon the dollar amount of
the loan, by either (i) the Bank's loan underwriters, (ii) the Chief Lending
Officer or the Bank's Senior Loan Committee approved by the Board of Directors,
or (iii) the Bank's Executive Loan Committee, consisting of the President and
other Directors of the Bank.
The Bank's Manager of Consumer Lending is authorized to approve unsecured
and secured consumer loans of up to $50,000 and $60,000, respectively. Other
consumer lending staff and branch managers are authorized to approve secured
consumer loans of up to $35,000, depending on individual lending authorities.
The Director of Lending Operations or the Residential Lending Manager is
authorized to approve residential mortgage loans of up to $227,150. Loans
between $227,150 and $500,000 require the approval of the Bank's President or
Chief Lending Officer. Loans in excess of $500,000 or multiple loans to the
same borrower in an aggregate amount exceeding $500,000 must be approved by the
Bank's Senior Loan Committee.
LOAN ORIGINATIONS, PURCHASES AND SALES. The Bank retains in its portfolio
substantially all adjustable-rate loans. All residential loans are originated
on documentation permitting their sale in the secondary market. The Bank
previously originated such loans with a forward commitment for their sale and
held these loans in portfolio at the lower of cost or market, as valued on an
aggregate basis, until their sale. During 1997, the Bank continued to sell
long-term, fixed-rate mortgage loan originations. Additionally, because of the
lower fixed rates available, the Bank began to experience conversions of
existing adjustable-rate mortgages to fixed-rate product. As the conversion
from an adjustable to a long-term, fixed-rate product (over 15 years) occurred,
the Bank sold the loans on the secondary market. This resulted in a reduction
in the loan portfolio with an increase in fixed-rate sales. The Bank retained
servicing rights on these residential loans sold.
Effective January 1, 1997, the Bank adopted the provisions of SFAS No. 125,
which proscribes the accounting for transfers and servicing of financial assets
and extinguishments of liabilities. The Bank has engaged, from time to time, in
the sale of participation interests in residential, commercial and multi-family
real estate loans in the secondary mortgage market. Such participation
interests are sold in an effort to reduce the Bank's amount loaned to one
borrower. The Bank's decision on whether to sell loans or participation
interests, and on which loans to sell, are generally based upon the size of the
project and amount loaned for a commercial or multi-family real estate loan, the
Bank's need for funds, and market opportunities that permit loan sales on terms
favorable to the Bank. The Bank also sells loans or loan participations in
private sales to savings institutions. In recent years such sales have been
without recourse. The Bank generally retains the servicing on the loans sold,
for which it receives a servicing fee of .25%. No participation interests have
been sold since December 31, 1996.
Effective January 1, 1996, the Bank adopted the provisions of SFAS No. 122,
as superseded by SFAS No. 125. This statement, as superseded, requires the Bank
to recognize as separate assets rights to service mortgage loans for others,
however those servicing rights are acquired. Prior to adoption of SFAS No. 122,
the Bank had no assets capitalized for originated or purchased servicing rights.
The fair value of capitalized originated mortgage servicing rights is determined
based on the estimated discounted net cash flows to be received. In applying
this valuation method, the Bank uses assumptions market participants would use
in estimating future net servicing income, which includes estimates of the cost
of servicing per loan, the discount rate, float value, an inflation rate,
ancillary income per loan,
10
<PAGE>
prepayment speeds, and default rates. Originated mortgage servicing rights are
amortized in proportion to and over the period of estimated net loan servicing
income. These capitalized mortgage servicing rights are periodically reviewed
for impairment based on the fair value of those rights.
The ongoing impact of SFAS No. 125 will depend upon demand in the Bank's
lending market for fixed-rate residential mortgage loans salable in the
secondary mortgage market. The balance of loans serviced for others at December
31, 1997 with capitalized originated mortgage servicing rights approximated
$73.3 million. The Bank capitalized $346,000 of originated mortgage servicing
rights during 1997, of which $25,000 has been amortized. Capitalized originated
mortgage servicing rights at December 31, 1997 approximated $402,000. No
valuation allowances for capitalized originated mortgage servicing rights were
considered necessary as of December 31, 1997.
In addition to originating loans, the Bank also purchases loans and
mortgage-backed securities in the secondary market. The Bank's purchases in the
secondary market are made on the same criteria and must satisfy the same
underwriting procedures as loans directly originated by the Bank. The Bank's
secondary market purchases are dependent upon the demand for mortgage credit in
the Bank's market area and the inflow of funds from traditional sources. During
1997, the Bank, to supplement and complement its own mortgage loan production,
purchased from an unaffiliated financial institution $27.4 million of loans
consisting principally of one-to four-family residential, fixed-and adjustable-
rate, medium-term mortgages. These loans are purchased without recourse with
servicing retained by the seller.
11
<PAGE>
The following table sets forth information concerning the loan origination,
purchase, sale and repayment activity of the Bank's portfolio of loans and
mortgage-backed securities:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(In Thousands)
<S> <C> <C> <C>
Originations:
Fixed-rate loans:
First mortgage loans:
One-to four-family residential............ $ 38,595 $ 36,990 $ 18,507
Income-producing property................. 729 758 337
FHA-insured and VA-partially
guaranteed............................. 329 217 141
Construction and development:
One-to four-family residential.......... 9,728 8,456 856
Income-producing property............... -- -- 314
Commercial business loans.................. 847 634 568
Other loans................................ 23,664 18,706 12,788
-------- -------- --------
Total fixed-rate loans................... 73,892 65,761 33,511
-------- -------- --------
Adjustable-rate loans:
First mortgage loans:
One-to four-family residential............ 50,859 68,063 40,183
Income-producing property................. 424 610 4,380
Construction and development:
One-to four-family residential.......... 45,628 50,889 47,784
Income-producing property............... 10,734 18,630 9,052
Second mortgage loans...................... 100 -- 60
Commercial business loans.................. 3,102 3,049 2,566
Other loans................................ 21,307 19,600 14,015
-------- -------- --------
Total adjustable-rate loans.............. 132,154 160,841 118,040
-------- -------- --------
Total loans originated................... 206,046 226,602 151,551
-------- -------- --------
Purchases:
Loans:
Fixed-rate................................. 9,559 2,905 4,860
Adjustable-rate............................ 18,288 28,829 38,732
-------- -------- --------
Total purchased.......................... 27,847 31,734 43,592
-------- -------- --------
Sales:
Fixed-rate:
Mortgage loans............................. 46,194 31,246 13,515
Student loans.............................. 634 739 1,293
Mortgage-backed securities................. -- -- 19,587
-------- -------- --------
Total sales.............................. 46,828 31,985 34,395
-------- -------- --------
Principal repayments:
Loans...................................... 153,259 115,079 84,278
Mortgage-backed securities................. 5,571 7,935 11,408
-------- -------- --------
Total principal repayments............... 158,830 123,014 95,686
-------- -------- --------
Transfers to real estate owned............... (672) (342) (265)
Transfers from real estate owned............. -- -- 2,700
Increase (decrease) due to other items, net.. 3,906 (3,499) (6,799)
-------- -------- --------
Net increases................................ $ 31,469 $ 99,496 $ 60,698
======== ======== ========
</TABLE>
12
<PAGE>
LOAN SERVICING AND LOAN FEES. As of December 31, 1997, Community First was
servicing approximately $180.2 million of loans for others. The Bank generally
receives a servicing fee ranging from .25% to .50% for these loans, with average
servicing fees of approximately .27%. In addition to interest earned on loans
and income from servicing of loans, the Bank receives fees in connection with
loan commitments and originations, loan modifications, late payments, changes of
property ownership and for miscellaneous services related to its loans. Income
from these activities varies from period to period with the volume and type of
loans originated, sold and purchased, which in turn is dependent on prevailing
mortgage interest rates and their effect on the demand for loans in the markets
served by the Bank.
To the extent loans are originated or acquired for the portfolio, the Bank
limits immediate recognition of loan origination or acquisition fees as revenues
and recognizes such income, net of certain loan origination or acquisition
costs, over the estimated lives of such loans as an adjustment to yield.
LOAN COMMITMENTS. Applicants for adjustable-rate one-to four-family
residential loans may lock in an interest rate for 50 days at any time prior to
the issuance of a loan commitment. The period between the applicant locking a
rate and the Bank's issuance of a commitment may be up to 21 days. The period
of time between issuance of a commitment to a borrower by the Bank through
closing of a loan generally ranges from 30 to 45 days. When selling loans to
the secondary market, the Bank protects itself from rising interest rates
through the purchase of mandatory commitments at the time a loan rate is locked
or a loan commitment is made. Funding generally occurs at or shortly after the
time the interest rate is locked. The Bank does not use financial futures or
options to protect against rising interest rates. Historically, less than 5% of
the Bank's commitments expire before being funded. At December 31, 1997, the
Bank's outstanding mortgage commitments totaled approximately $26.9 million.
NON-PERFORMING LOANS. Residential and commercial mortgage loans are
reviewed on a regular basis and are placed on nonaccrual status when either
principal or interest is more than 90 days past due. Consumer loans are
generally charged off when or before the loan becomes 120 days delinquent. The
Asset Control and Recovery Department reviews with the Chief Lending Officer all
consumer loans presented for chargeoff. On a quarterly basis, the Chief Lending
Officer submits a list of loan chargeoffs to the Executive Loan Committee for
review. Interest accrued and unpaid at the time a loan is placed on nonaccrual
status is charged against interest income. Subsequent payments are either
applied to the outstanding principal balance or recorded as interest income,
depending on the assessment of the ultimate collectibility of the loan.
When a loan becomes 15 days delinquent, the Bank institutes internal
collection procedures and will contact the customer directly. As to residential
and commercial real estate loans, if a borrower has not made payment within 15
days of the due date, a past due notice is mailed and a late charge of 5% is
generally assessed as permitted by the Bank's mortgage documentation. The Bank
seeks to determine the reason for the delinquency and attempts to effect a cure
for the delinquency on any loan which becomes more than 60 days past due. The
Bank will then regularly review the loan status, the condition of the property
and circumstances of the borrower. Based upon the results of its review, the
Bank may negotiate and accept a repayment program with the borrower, accept a
voluntary deed in lieu of foreclosure or, when deemed necessary, initiate
foreclosure proceedings. The decision on whether to initiate foreclosure
proceedings is based upon the amount of the loan outstanding in relation to the
original indebtedness, the extent of the delinquency and the borrower's ability
and willingness to cooperate in curing the default or delinquency.
Real estate acquired by the Bank as a result of foreclosure or by deed in
lieu of foreclosure is classified as real estate owned until such time as it is
sold. At the time title is received and in certain cases prior to title
transfer, the Bank will transfer the former loan to real estate owned. When
such property is acquired, it is recorded at the lower of the unpaid principal
balance of the related loan or its estimated fair market value less estimated
costs to sell. Any subsequent write-down of the property is charged directly to
income or against the appropriate allowance account.
13
<PAGE>
As of December 31, 1997, there were no loans which are not included in the
tables below or described thereafter where known information about the possible
credit problems of borrowers caused management to have serious doubts as to the
ability of the borrower to comply with present loan repayment terms and which
may result in classification of such loans in the future. As of December 31,
1997, there were no concentrations of loans in any type of industry which
exceeded 10% of the Bank's total loans that are not included as a loan category
in the table below.
Real estate loans originated by the Bank and delinquent loans are generally
collateralized by real estate in the Bank's primary market area.
The following table sets forth information concerning the Bank's delinquent
loans at December 31, 1997. Total remaining principal balances of the related
loans are shown rather than the actual payment amounts which are overdue:
<TABLE>
<CAPTION>
30-59 Days 60-89 Days 90 Days or Greater
------------------- --------------- -------------------
Number Amount Number Amount Number Amount
------ ----------- ------ ------- -------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
One-to four-family residential... 162 $7,051 29 $1,453 13 $ 697
Income-producing property........ -- -- -- -- -- --
FHA-insured and VA-partially
guaranteed..................... 5 256 1 109 2 109
Construction and development:
One-to four-family residential.. 1 199 -- -- -- --
Income-producing property....... -- -- -- -- -- --
Land development................ -- -- -- -- -- --
Commercial....................... 1 13 -- -- -- --
Other............................ 70 805 19 267 22 93
--- ------ ---- ------ ---- -----
Total.......................... 239 $8,324 49 $1,829 37 $ 899
=== ====== ==== ====== ==== =====
Percentage of total assets.... 0.98% 0.21% 0.10%
====== ====== =====
</TABLE>
14
<PAGE>
The following table sets forth information concerning the amounts of the
Bank's non-accruing loans and real estate owned by category.
<TABLE>
<CAPTION>
At December 31,
------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------ ------- -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Non-accruing loans:
One-to four-family residential
mortgages.......................... $ 697 $ 892 $ 68 $ 108 $ 571
Income-producing property............ -- 359 -- -- 1
FHA-insured and VA-partially
guaranteed......................... 109 183 253 192 140
Construction and development......... -- -- -- -- 182
Commercial........................... -- 195 -- -- --
Other................................ 93 158 28 93 160
------ ------ ----- ------ ------
Total.............................. $ 899 $1,787 $ 349 $ 393 $1,054
====== ====== ===== ====== ======
Percentage of total assets......... 0.10% 0.21% 0.05% 0.05% 0.16%
====== ====== ===== ====== ======
Real estate owned:....................
One-to four-family residential
mortgages.......................... $ 11 $ 205 $ 238 $ 139 $1,046
Income-producing property............ -- -- -- 1,700 2,380
Construction and development......... 141 7 7 981 1,060
------ ------ ----- ------ ------
Total.............................. $ 152 $ 212 $ 245 $2,820 $4,486
====== ====== ===== ====== ======
Percentage of total assets......... 0.02% 0.03% 0.03% 0.39% 0.67%
====== ====== ===== ====== ======
Total non-accruing loans and real
estate owned..................... $1,051 $1,999 $ 594 $3,213 $5,540
====== ====== ===== ====== ======
Percentage of total assets............ 0.12% 0.24% 0.08% 0.44% 0.83%
====== ====== ===== ====== ======
</TABLE>
Loans on which the accrual of interest was discontinued or reduced amounted
to $883,000 at December 31, 1997. For the year ended December 31, 1997, $32,000
of additional interest income would have been recorded if these non-accruing
loans were current in accordance with their original terms. Approximately
$46,000 of interest income relating to these loans was collected and included in
interest income for the year ended December 31, 1997.
Certain other income-producing property loans in the Bank's loan portfolio
are being closely monitored but are not included in non-performing loans above.
These loans cause management some concern as to the ability of such borrowers to
comply with the present loan repayment terms and which may result in their being
classified as non-accruing at some point in the future. These other loans
include a $161,000 loan secured by an apartment building, a loan totaling
$383,000 secured by an office building and a loan totaling $347,000 secured by a
townhouse complex. These loans were current as of December 31, 1997.
The Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 114, Accounting by Creditors for Impairment
of a Loan (SFAS No. 114), as amended by Statement of Financial Accounting
Standards No. 118, Accounting by Creditors for Impairment of a Loan - Income
Recognition and Disclosures (SFAS No. 118). The Bank adopted the provisions of
SFAS No. 114, as amended by SFAS No. 118, on
15
<PAGE>
a prospective basis as of January 1, 1995. Neither the initial adoption nor the
ongoing effect of SFAS No. 114 has had, or is expected to have, a material
impact on the financial condition or results of operations of the Bank.
Impaired loans as defined by SFAS No. 114 totaled $0 and $554,000 at
December 31, 1997 and 1996, respectively, and in 1996 included one income-
producing property loan and three commercial business loans. These loans are
included in nonaccrual loans at December 31, 1996. The Corporation's nonaccrual
loans include residential mortgage and consumer installment loans, for which
SFAS No. 114 does not apply. The Corporation's respective average investment in
impaired loans was $112,000 and $559,000 during 1997 and 1996, respectively.
Interest income recognized on impaired loans during 1997 and 1996, totaled
$1,000 and $27,000, respectively. Impaired loans had specific allocations of
the allowance for loan losses in accordance with SFAS No. 114 approximating $0
and $150,000 at December 31, 1997 and 1996, respectively.
CLASSIFICATION OF ASSETS. Under federal regulations, the Bank is required
to classify its own assets as to quality on a regular basis. In addition, in
connection with examinations of the Bank, FDIC and Michigan Financial
Institutions Bureau examiners have authority to identify problem assets and, if
appropriate, classify them. Assets are subject to evaluation under a
classification system with three categories: (i) Substandard, (ii) Doubtful and
(iii) Loss. An asset could fall within more than one category and a portion of
the asset could remain unclassified.
An asset is classified Substandard if it is determined to involve a
distinct possibility the Bank could sustain some loss if deficiencies associated
with the loan, such as inadequate documentation, were not corrected. 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. At December 31,
1997, the Bank classified $1.1 million of non-accruing loans and real estate
owned as Substandard. Included in the $11.0 million of loans classified as
Special Mention were $10.2 million of loans 30-89 days delinquent. The Bank had
no assets classified as Doubtful and no assets classified as Loss as of December
31, 1997.
ALLOWANCE FOR LOAN LOSSES. The Bank's management establishes allowances
for loan losses. On a quarterly basis, management evaluates the loan portfolio
and determines the amount that must be added to the allowance account. These
allowances are charged against income in the year they are established.
Additionally, accrual of interest on problem loans is discontinued when a loan
becomes ninety days past due as to principal or interest or when, in the opinion
of management, full collection of principal and interest is unlikely. At the
time a loan is placed on nonaccrual status, interest previously accrued but not
collected is charged against current income. Income on such loans is then
recognized only to the extent cash is received and where future collections of
principal are probable. A nonaccrual loan may be restored to accrual status
when interest and principal payments are current and the loan appears otherwise
collectible.
When establishing the appropriate levels for the provision and the
allowance for loan losses, management considers a variety of factors, in
addition to the fact an inherent risk of loss always exists in the lending
process. Consideration is given to the current and future impact of economic
conditions, the diversification of the loan portfolio, historical loss
experience, the review of loans by the loan review personnel, the individual
borrower's financial and managerial strengths, and the adequacy of underlying
collateral. Consideration is also given to examinations performed by regulatory
authorities.
Each quarter, the Bank determines the adequacy of the allowance for loan
losses based on factors such as the size and risk exposure of each portfolio,
current economic conditions, past loss experience, delinquency rates and current
collateral values, and other relevant factors. While available information is
used in evaluating the adequacy of the allowance for loan losses, future
additions to the allowance may be necessary if economic conditions change. In
addition, various regulatory agencies, as an integral part of their examination
process, periodically review the Bank's allowances for losses on loans and real
estate owned. Such agencies may require the Bank to recognize additions to the
allowances based on their judgments about information available to them at the
time of their examination.
16
<PAGE>
The following table provides a summary of the allowance for losses on loans
and real estate:
<TABLE>
<CAPTION>
Allowance for Losses on
--------------------------
Real
Loans Estate Total
-------- ------- -------
(In Thousands)
<S> <C> <C> <C>
BALANCE, DECEMBER 31, 1993................. $3,847 $ 167 $4,014
Provision for losses....................... 240 565 805
Charges against the allowance:
One-to four-family residential........... (21) (122) (143)
FHA-insured and VA partially guaranteed.. (62) -- (62)
Income-producing property................ (23) (590) (613)
Consumer................................. (47) -- (47)
Recoveries:
One-to four-family residential........... 80 55 135
FHA-insured and VA partially guaranteed.. 36 -- 36
Income-producing property................ -- 1 1
Consumer................................. 74 -- 74
------ ----- ------
BALANCE, DECEMBER 31, 1994................. $4,124 $ 76 $4,200
Provision for losses....................... 240 120 360
Charges against the allowance:
One-to four-family residential........... (10) (26) (36)
FHA-insured and VA partially guaranteed.. -- (2) (2)
Income-producing property................ -- (7) (7)
Consumer................................. (45) -- (45)
Recoveries:
One-to four-family residential........... 11 11 22
FHA-insured and VA partially guaranteed.. -- 1 1
Income-producing property................ -- 51 51
Consumer................................. 43 -- 43
------ ----- ------
BALANCE, DECEMBER 31, 1995................. $4,363 $ 224 $4,587
Provision for losses....................... 240 60 300
Charges against the allowance:
One-to four-family residential........... (9) (77) (86)
FHA-insured and VA partially guaranteed.. (10) (110) (120)
Consumer................................. (57) -- (57)
Recoveries:
One-to four-family residential........... 2 4 6
FHA-insured and VA partially guaranteed.. 7 102 109
Income-producing property................ -- 9 9
Consumer................................. 28 -- 28
------ ----- ------
BALANCE, DECEMBER 31, 1996................. $4,564 $ 212 $4,776
Provision for loan losses.................. 360 45 405
Charges against the allowance:
One-to four-family residential........... (3) (225) (228)
FHA-insured and VA partially guaranteed.. -- (7) (7)
Land..................................... -- (7) (7)
Income-producing property................ (134) (8) (142)
Consumer................................. (110) -- (110)
Recoveries:
One-to four-family residential........... 4 130 134
FHA-insured and VA partially guaranteed.. 1 3 4
Land..................................... -- 5 5
Income-producing property................ 18 5 23
Consumer................................. 30 -- 30
------ ----- ------
BALANCE, DECEMBER 31, 1997................. $4,730 $ 153 $4,883
====== ===== ======
</TABLE>
The ratio of net loan charge-offs (recoveries) to average loans outstanding
during the respective periods were .07% for 1993, (.01)% for 1994, .00% for
1995, .01% for 1996 and .03% for 1997.
17
<PAGE>
The following table represents the allocation of the allowance for loan
losses at the dates indicated:
<TABLE>
<CAPTION>
At December 31,
---------------------------------------------------------------------------------------------
1997 1996
--------------------------------------------- ----------------------------------------------
Percent Allowance Percent Allowance
of Total Allocation as % of Total Allocation as %
Balance Loan of of Loan Balance Loan of of Loan
of Loans Balance Allowance Balance of Loans Balance Allowance Balance
-------- -------- ----------- -------- --------- --------- ----------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
First mortgage loans:
One-to four-family
residential (including
construction and
development loans and
loans sold with
recourse)(1)............ $621,506 80.08% $ 1,775 .29% $593,163 79.80% $ 1,252 .21%
FHA-insured and
VA-partially
guaranteed............... 7,214 .93 49 .68 6,404 .86 47 .73
Income-producing property
(including
construction and
development loans)...... 77,229 9.95 1,468 1.90 84,012 11.30 2,100 2.50
-------- ------ ------- ------ -------- -------- ------- ------
Total first mortgage
loans................... 705,949 90.96 3,292 .47 683,579 91.96 3,399 .50
Second mortgage loans...... 549 .07 6 1.09 510 .07 5 .98
Commercial business loans.. 5,087 .66 138 2.71 4,644 .62 325 7.00
Other loans................ 64,483 8.31 1,294 2.01 54,578 7.35 835 1.53
-------- ------ ------- ------ -------- -------- ------- ------
Total.................... $776,068 100.00% $ 4,730 .61% $743,311 100.00% $ 4,564 .61%
======== ====== ======= ====== ======== ======== ======= ======
<CAPTION>
At December 31,
---------------------------------------------
1995
---------------------------------------------
Percent Allowance
of Total Allocation as %
Balance Loan of of Loan
of Loans Balance Allowance Balance
--------- -------- ---------- ---------
<S> <C> <C> <C> <C>
First mortgage loans:
One-to four-family
residential (including
construction and
development loans and
loans sold with
recourse)(1)............ $502,374 79.39% $1,401 .28%
FHA-insured and
VA-partially
guaranteed............... 7,458 1.18 319 4.28
Income-producing property
(including
construction and
development loans)...... 75,012 11.85 1,875 2.50
-------- ------- ---------- -------
Total first mortgage
loans................... 584,844 92.42 3,595 .61
Second mortgage loans...... 571 .09 4 .70
Commercial business loans.. 3,195 .51 96 3.00
Other loans................ 44,171 6.98 668 1.51
-------- ------- ---------- -------
Total.................... $632,781 100.00% $4,363 .69%
======== ======= ========== =======
<PAGE>
<CAPTION>
At December 31,
---------------------------------------------------------------------------------------------
1994 1993
--------------------------------------------- ----------------------------------------------
Percent Allowance Percent Allowance
of Total Allocation as % of Total Allocation as %
Balance Loan of of Loan Balance Loan of of Loan
of Loans Balance Allowance Balance of Loans Balance Allowance Balance
-------- -------- ----------- -------- --------- --------- ----------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
First mortgage loans:
One-to four-family
residential (including
construction and
development loans and
loans sold with
recourse)(1)............ $424,079 79.32% $1,296 .31% $285,610 73.25% $ 943 .33%
FHA-insured and
VA-partially
guaranteed............... 3,629 .68 421 11.60 4,240 1.09 582 13.73
Income-producing property
(including
construction and
development loans)...... 66,855 12.50 1,775 2.65 63,727 16.34 1,670 2.62
-------- ------ ------ ----- -------- ------ ------ -----
Total first mortgage
loans................... 494,563 92.50 3,492 .71 353,577 90.68 3,195 .90
Second mortgage loans...... 661 .12 5 .76 750 .19 7 .93
Commercial business loans.. 706 .13 21 2.97 446 .12 14 3.14
Other loans................ 38,759 7.25 606 1.56 35,159 9.01 631 1.79
-------- ------ ------ ----- -------- ------ ------ -----
Total.................... $534,689 100.00% $4,124 .77% $389,932 100.00% $3,847 .99%
======== ====== ====== ===== ======== ====== ====== =====
- --------------------------
</TABLE>
(1) Loans sold with recourse totaled $1.0 million, $1.4 million, $1.8 million,
$2.2 million and $3.0 million at December 31, 1997, 1996, 1995, 1994 and
1993, respectively.
18
<PAGE>
INVESTMENT ACTIVITIES
As a state chartered thrift, Community First is not subject to any
regulatory liquidity requirements. It has generally been Community First's
policy to maintain a liquidity portfolio in excess of OTS regulatory
requirements. Liquidity levels may be increased or decreased depending upon the
yields on investment alternatives, management's judgment as to the
attractiveness of the yields then available in relation to other opportunities,
its expectations of the level of yield that will be available in the future and
management's projections as to the short-term demand for funds to be used in the
Bank's loan origination and other activities. At December 31, 1997, Community
First had an investment portfolio of $26.0 million consisting of U.S. government
and federal agency obligations.
In July 1989, the Bank retained SS&H Financial Advisors, of Bingham Farms,
Michigan, to act as its investment advisor and to execute all related
transactions. In June 1988, the Bank's Board of Directors adopted an investment
policy which is annually reviewed by the Board. Pursuant to this policy, which
is binding upon the investment advisor, two of the four members of the Bank's
Investment Committee must approve all investment transactions. The policy also
outlines the approved investment securities in which the Bank may invest, within
each investment category.
As part of the Bank's asset/liability management program, the Bank had
previously entered into a series of interest rate exchange agreements in order
to lengthen the maturity of its liabilities by, in effect, converting variable-
rate liabilities to fixed-rate liabilities. In November 1994, the Bank
terminated, at a loss of $229,000, its one remaining interest rate exchange
agreement with an aggregate notional amount of $15.0 million and a maturity date
of December 23, 1996. The deferred loss from the termination of the interest
rate exchange agreement totaled $0 and $107,000 at December 31, 1996 and 1995,
respectively. Amortization of the loss as interest expense totaled $107,000 in
1996 and $109,000 in 1995.
During the years ended December 31, 1997, 1996 and 1995, the cost of the
Bank's interest rate exchange agreements was $0, $107,000 and $109,000,
respectively, and is included as interest expense on deposits.
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities ("SFAS No. 115") addresses the
accounting and reporting for equity securities having readily determinable fair
values and for all investments in debt securities. SFAS No. 115 requires
investment and mortgage-backed securities to be classified as follows:
. Debt securities the Bank has the positive intent and ability to hold
to maturity are classified as held-to-maturity securities and reported
at amortized cost.
. Debt and equity securities bought and held principally for the purpose
of selling them in the near term are classified as trading securities
and reported at fair value, with unrealized gains and losses included
in earnings.
. Debt and equity securities not classified as either held-to-maturity
securities or trading securities are classified as available-for-sale
securities and reported at fair value, with unrealized gains and
losses excluded from earnings and reported, net of tax, as a separate
component of stockholders' equity.
At December 31, 1996, investment and mortgage-backed securities available
for sale included unrealized net losses of $325,000 reported net of $110,000 of
federal income tax benefit. Throughout 1997, market interest rates generally
fell which favorably impacted the market value of the principally fixed-rate
investment and mortgage-backed securities available for sale. At December 31,
1997, the Bank reported $47.7 million in investment and mortgage-backed
securities available for sale at fair value, with unrealized net gains of
$474,000 reported net of $161,000 of federal income tax expense as a separate
component of stockholders' equity. The Bank had no investment or mortgage-
backed securities classified as held-to-maturity or trading securities as of
December 31, 1997.
19
<PAGE>
In November 1995, the FASB issued A Guide to Implementation of Statement
115 on Accounting for Certain Investments in Debt and Equity Securities (Guide).
The Guide permitted an institution to reassess the appropriateness of the
classifications of all securities held at the time and account for any resulting
reclassifications at fair value in accordance with Statement of Financial
Accounting Standards No. 115, Accounting for Certain Investments in Debt and
Equity Securities (SFAS No. 115). The Bank, in order to allow further
flexibility in future asset/liability management decisions relating to
securities, reclassified $18.1 million of corporate notes and U.S. Treasury
securities from a held-to-maturity classification to an available-for-sale
classification with unrealized pretax losses of $103,000 on these securities
recorded as a negative adjustment to stockholders' equity.
As of September 30, 1996, based upon liquidity and interest rate
considerations, management determined it could no longer assert its intention to
hold all mortgage-backed securities until maturity. Therefore, the entire
mortgage-backed securities portfolio totaling $28.6 million was reclassified to
an available-for-sale classification with unrealized pre-tax gains of $190,000
being recorded as a favorable adjustment to stockholders' equity. As a result,
the Bank intends to classify any investment or mortgage-backed securities
currently held or purchased in the subsequent two years as available for sale.
20
<PAGE>
The table below sets forth certain information regarding the amortized
cost, weighted average rates and maturities of the Bank's investment securities
available for sale at the date indicated. At December 31, 1997, the Bank did
not have any investment securities available for sale with maturities greater
than five years.
<TABLE>
<CAPTION>
At December 31, 1997
-----------------------------------------------------------------------------------------------
One Year or Less One to Five Years Five to Ten Years More than Ten Years
--------------------- --------------------- --------------------- ---------------------
Weighted Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average Amortized Average
Cost Rate Cost Rate Cost Rate Cost Rate
--------- -------- --------- -------- --------- -------- --------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
United States government
and agency obligations........ $24,000 5.99% $ -- --% $ -- --% $ -- --%
Federal agency obligations..... -- -- 2,000 6.41 -- -- -- --
------- ------ ---- ----
$24,000 5.99 $2,000 6.41 $ -- -- $ -- --
======= ====== ==== ====
<CAPTION>
At December 31, 1997
---------------------------------------------
Total Investment Securities
---------------------------------------------
Average Weighted
Life Amortized Market Average
in Years Cost Value Rate
-------- --------- -------- --------
<S> <C> <C> <C> <C>
United States government
and agency obligations........ 0.37 $24,000 $24,053 5.99%
Federal agency obligations..... 3.28 2,000 2,027 6.41
---- ------- ------- ----
0.60 $26,000 $26,080 6.02
==== ======= ======= ====
</TABLE>
At December 31, 1997, the Bank did not have any investment securities held
to maturity.
21
<PAGE>
During 1995, the Bank purchased a $5.1 million available-for-sale corporate
note with a maturity of 50 months and a weighted average yield of 7.08%.
Investment securities available for sale in the amount of $13.9 million were
sold during 1995, resulting in gross gains of $30,000 and gross losses of
$33,000. During 1996, the Bank purchased $20.1 million of available-for-sale
investment securities. These securities had a weighted average yield of 6.19%.
The available-for-sale investment securities purchased consisted of federal
agency obligations and U.S. Treasury securities with maturities of 11 to 61
months. Investment securities available for sale in the amount of $23.1 million
were sold during 1996, resulting in gross gains of $43,000 and gross losses of
$107,000. During 1997, the Bank purchased $24.0 million of available-for-sale
investment securities. These securities had a weighted average yield of 5.99%.
The available-for-sale investment securities purchased consisted of U.S.
Treasury securities with maturities of 12 to 16 months. Investment securities
available for sale in the amount of $20.0 million were sold during 1997,
resulting in gross gains of $20,000 and gross losses of $51,000.
At December 31, 1997, 1996 and 1995, the Bank's only held to maturity
investment securities were shares of Federal Home Loan Bank Stock, with an
amortized cost of $11,423,000, $10,632,000 and $8,537,000 at those dates,
respectively.
The following table sets forth certain information about the Bank's
available-for-sale investment securities and related fair values.
<TABLE>
<CAPTION>
At December 31,
-------------------------------------------------------------
1997 1996 1995
------- ------- -------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
---------- ------- ---------- ------- ---------- -------
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C>
United States government
and agency obligations:
Maturing within one year......... $24,000 $24,053 $20,097 $20,071 $15,139 $15,102
From one to five years........... -- -- -- -- 15,253 15,225
------- ------- ------- ------- ------- -------
24,000 24,053 20,097 20,071 30,392 30,327
Federal agency obligations:
Maturing from one to five years.. 2,000 2,027 7,000 7,015 -- --
Corporate bonds:
Maturing within one year......... -- -- 4,000 4,007 12,686 12,682
From one to five years........... -- -- -- -- 11,921 12,100
------- ------- ------- ------- ------- -------
-- -- 4,000 4,007 24,607 24,782
------- ------- ------- ------- ------- -------
$26,000 $26,080 $31,097 $31,093 $54,999 $55,109
======= ======= ======= ======= ======= =======
Weighted average interest rate.... 6.02% 5.89% 5.37%
======= ======= =======
</TABLE>
DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS
GENERAL. Retail customer deposits are the major source of the Bank's funds
for lending and other investment purposes. In addition to deposits, Community
First derives funds from loan and mortgage-backed securities principal
repayments, the sale of loans or participation interests therein and FHLB
borrowings. Loan repayments are a relatively stable source of funds while
deposit inflows and outflows and loan prepayments are significantly influenced
by general interest rates and money market conditions. Borrowings may be used
on a short-term basis to compensate for reductions in the availability of funds
from other sources. Available liquidity from net deposit inflows and the
proceeds from investment and mortgage-backed security repayments and maturities
were used by the Bank during 1995 to repay short-
22
<PAGE>
term adjustable-rate FHLB advances combined with holding in portfolio three-year
adjustable-rate mortgage loan originations and medium-term fixed- and
adjustable-rate mortgage loan purchases. Borrowings were also used on a longer-
term basis for general business purposes. FHLB advances were obtained, as needed
in 1996, to meet the Bank's operating needs which included the funding of three-
year adjustable-rate mortgage loan originations. Recognizing there is additional
interest rate risk associated with funding medium-term assets with shorter-term
liabilities in a rising or volatile interest rate environment, the Bank
emphasized increasing its deposit base by attracting new customers through
various promotional activities. In 1997, loan growth was funded by maturities of
investment and mortgage-backed securities, deposit growth (primarily in checking
and savings accounts) and long-term, fixed-rate FHLB advances.
DEPOSITS. Deposits are attracted primarily from within the Bank's primary
market area through the offering of a broad selection of deposit instruments
including checking accounts, money market accounts, savings accounts,
certificates of deposit, retirement savings plans and pension investment
accounts. Deposit account terms vary according to the minimum balance required,
the time period funds must remain on deposit and the interest rate, among other
factors. The Bank attempts to control its cost of funds by emphasizing
checking, savings and money market accounts. At December 31, 1997, such
accounts totaled $238.1 million, or 42.3%, of the Bank's total deposits.
While the deregulation of interest rates has allowed the Bank to be more
competitive in obtaining funds and given it more flexibility to meet the threat
of deposit outflows, it has also resulted in a higher and more volatile cost of
funds. During 1993 and early 1994, upon maturity of their certificates of
deposit, many customers chose to reinvest the proceeds into savings and money
market accounts possessing shorter terms and enhanced liquidity. As market
interest rates, however, climbed to a two-year high, some customers chose to
withdraw these short-term, liquid funds held in the Bank to seek higher returns
in non-bank financial products. Non-bank competition similarly affected the
level of certificates of deposit maintained in the Bank and, generally
consistent with an industry-wide trend, the Bank experienced declines in
certificates of deposit. Total deposits grew 1.6% from $553.6 million at
December 31, 1996, to $562.4 million at December 31, 1997. The $8.8 million
increase resulted from transaction account, savings account, and certificate of
deposit growth of $5.0 million, $3.7 million, and $100,000, respectively.
During 1995, the Bank introduced Really Free Checking and five other highly
competitive checking account programs. To support these checking account
programs, the Bank continued comprehensive marketing campaigns during 1996 and
1997. The continued promotion of Really Free Checking in 1996 and 1997 has
resulted in an expansion of the Bank's deposit base through attracting new
customers and cross-selling other Bank products to existing customers. With a
certificate of deposit campaign, coinciding with the checking campaign, the Bank
promoted the competitive rates offered on fourteen-month certificates, also
attracting new customers. The Bank continued to promote during 1997 a high
yield money market savings product, which was originally introduced during late
1996. Although the majority of the growth in certificates of deposit and the
money market savings products was obtained from external sources, many accounts
were also opened by existing customers with transfers of funds from their
checking, savings and money market checking accounts.
Bank management meets weekly to evaluate the internal cost of funds, review
a survey of rates offered by major competitors in the market, review the Bank's
cash flow requirements for lending and liquidity and execute rate changes when
deemed appropriate. At the present time, the Bank's primary strategy for
attracting and retaining deposits is to emphasize competitive rates which are
generally comparable to those offered by other market leaders. This pricing
strategy is complemented by the introduction of new deposit products designed to
differentiate the Bank from its competition, such as the offering of "Really
Free Checking." The Bank does not actively solicit brokered deposits, but does
accept brokered deposits at rates appropriate for institutional investors, which
are less than the amount paid for retail deposits. At December 31, 1997, the
Bank had a total of $100,000 in brokered deposits, or .02% of total deposits.
23
<PAGE>
The following table sets forth the change in dollar amount of deposits in
the various types of accounts offered by the Bank between the dates indicated.
<TABLE>
<CAPTION>
At December 31,
----------------------------------------------------------------------------------------------------
1997 1996 1995
-------------------------------- -------------------------------- --------------------------------
Percent of Increase Percent of Increase Percent of Increase
Amount Portfolio (Decrease) Amount Portfolio (Decrease) Amount Portfolio (Decrease)
-------- ---------- ---------- -------- ---------- ---------- -------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Regular savings........... $ 63,069 11.21% $ (2,145) $ 65,214 11.78% $ (2,376) $ 67,590 12.80% $ (4,104)
Money market savings...... 21,944 3.90 5,808 16,136 2.91 16,136 -- -- --
Consumer checking......... 93,340 16.60 6,617 86,723 15.67 7,092 79,631 15.09 11,269
Commercial checking....... 9,616 1.71 292 9,324 1.68 1,666 7,658 1.45 (1,553)
Money market checking..... 50,099 8.91 (1,864) 51,963 9.39 (2,561) 54,524 10.33 (9,884)
-------- ------ -------- -------- ------ -------- -------- ------ ---------
238,068 42.33 8,708 229,360 41.43 19,957 209,403 39.67 (4,272)
Certificates of deposit:
0.00 - 4.99%............ 20,758 3.69 (17,065) 37,823 6.83 13,333 24,490 4.64 (100,297)
5.00 - 5.99%............ 164,405 29.23 6,652 157,753 28.50 9,970 147,783 28.00 72,103
6.00 - 6.99%............ 137,225 24.40 11,128 126,097 22.78 (2,469) 128,566 24.36 86,363
7.00 - 7.99%............ 749 .13 (404) 1,153 .21 (14,849) 16,002 3.03 (7,704)
8.00 - 8.99%............ 656 .12 (170) 826 .15 (197) 1,023 .19 (11,599)
9.00 - 9.99%............ 551 .10 (11) 562 .10 13 549 .11 (5,781)
10.00 - 10.99%........... -- -- -- -- -- -- -- -- (2,687)
-------- ------ -------- -------- ------ -------- -------- ------ ---------
324,344 57.67 130 324,214 58.57 5,801 318,413 60.33 30,398
-------- ------ -------- -------- ------ -------- -------- ------ ---------
Totals.................... $562,412 100.00% $ 8,838 $553,574 100.00% $ 25,758 $527,816 100.00% $ 26,126
======== ====== ======== ======== ====== ======== ======== ====== =========
</TABLE>
24
<PAGE>
The following table sets forth certain information regarding the Bank's
deposit flows for the periods indicated:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
(Dollars in Thousands)
<S> <C> <C> <C>
Beginning balance................... $ 553,574 $ 527,816 $ 501,690
Deposits, net of interest credited.. 2,068,592 1,889,523 1,392,217
Withdrawals......................... (2,078,598) (1,879,791) (1,381,961)
Interest credited................... 18,844 16,026 15,870
----------- ----------- -----------
Ending balance...................... $ 562,412 $ 553,574 $ 527,816
=========== =========== ===========
Net increase........................ $ 8,838 $ 25,758 $ 26,126
=========== =========== ===========
Percentage increase................. 1.60% 4.88% 5.21%
=========== =========== ===========
</TABLE>
The following table sets forth the average balances (based on daily
balances) and interest rates for demand deposits and time deposits for the
periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------------------
1997 1996 1995
--------------------------- --------------------------- ----------------------------
Savings, Savings, Savings,
Checking and Certificates Checking and Certificates Checking and Certificates
Money Market of Money Market of Money Market of
Accounts Deposit Accounts Deposit Accounts Deposit
------------- ------------- ------------- ------------- ------------- -------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Average balance.... $235,475 $322,998 $217,316 $319,491 $207,635 $310,253
======== ========= ============ ============ ============ ============
Average rate paid.. 2.52% 5.74% 2.50% 5.76% 2.79% 5.80%
======== ========= ============ ============ ============ ============
</TABLE>
The following table indicates the amount, at December 31, 1997, of the
Bank's certificates of deposit of $100,000 or more by the time period remaining
until maturity.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposit
--------------------------------------- -------------
(In Thousands)
<S> <C>
Three months or less................... $ 3,628
Over three months through six months... 8,216
Over six months through twelve months.. 11,563
Over twelve months..................... 10,603
-------
$34,010
=======
</TABLE>
25
<PAGE>
The following table presents, by various interest rate categories, the
amounts of certificate of deposit accounts at December 31, 1997, maturing during
the periods reflected below:
<TABLE>
<CAPTION>
0.00- 5.00- 6.00- 7.00- 9.00- Percent
4.99% 5.99% 6.99% 8.99% 10.99% Total of Total
------- -------- -------- ------ ------ -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Certificate accounts maturing
in the period ending:
June 30, 1998.................. $16,470 $ 86,102 $ 12,650 $ 462 $ 69 $115,753 35.69%
December 31, 1998.............. 880 36,702 74,252 169 81 112,084 34.56
June 30, 1999.................. 1,488 16,740 25,721 179 398 44,526 13.73
December 31, 1999.............. 95 7,553 8,224 43 -- 15,915 4.91
December 31, 2000.............. 770 8,487 10,017 526 -- 19,800 6.10
December 31, 2001.............. 969 5,365 1,050 16 3 7,403 2.28
Thereafter..................... 86 3,456 5,311 10 -- 8,863 2.73
------- -------- -------- ------ ------ -------- ------
$20,758 $164,405 $137,225 $1,405 $ 551 $324,344 100.00%
======= ======== ======== ====== ====== ======== ======
</TABLE>
At December 31, 1997, accounts having balances of $100,000 or more totaled
$66.0 million representing 11.7% of total deposits.
INDIVIDUAL RETIREMENT ACCOUNTS AND KEOGH/CORPORATE QUALIFIED PLAN FUNDS.
The Bank seeks to attract Individual Retirement Accounts ("IRAs"). In addition
to the establishment of an IRA department, the Bank has a Retirement Accounts
Product Manager with previous experience in insurance, pension plan design and
personal sales. The Bank has maintained its commitment to retirement accounts
by developing a professional IRA staff and an extensive record-keeping system to
supply necessary customer information as required under current IRA provisions.
As of December 31, 1997, the Bank administered 5,260 IRAs and 7 Tax Qualified
Retirement Plans totaling $48.8 million, or 8.7%, of all deposits.
BORROWINGS. Deposits are the primary source of funds for the Bank's
lending and investment activities and for its general business purposes. The
Bank does, however, rely upon advances from the FHLB of Indianapolis to
supplement its supply of lendable funds and to meet deposit withdrawal
requirements. Advances from the FHLB are typically secured by the Bank's stock
in the FHLB and substantially all of the Bank's residential mortgage loans.
Since mid-1993, borrowings from the FHLB have been an integral component of the
Bank's funding strategy. Borrowings replaced maturing certificates of deposit
and other deposit withdrawals, funded asset growth, and were used to manage
interest rate risk. FHLB advances grew from $202.6 million at December 31, 1996
to $212.7 million at year-end 1997. Of the outstanding FHLB advances at
December 31, 1997, $201.7 million carried a weighted average fixed-rate of
6.11%. Adjustable-rate advances at December 31, 1997 totaled $11.0 million, all
of which reprice based upon the FHLB overnight Basic Agency Discount Note rate
plus 30 basis points.
Since 1995, FHLB advances have been obtained to meet the Bank's operating
needs which included the funding of adjustable-rate mortgage loan originations
and purchases of medium-term fixed- and adjustable-rate residential mortgage
loans. Recognizing there is additional interest rate risk associated with
funding medium-term assets with shorter-term liabilities in a rising or volatile
interest rate environment, the Bank emphasized using more medium term fixed-rate
FHLB advances.
The FHLB of Indianapolis functions as a central reserve bank providing
credit for savings institutions and certain other member financial institutions.
As a member, Community First is required to own capital stock in the FHLB and is
authorized to apply for advances on the security of such stock and certain of
its home mortgages and other assets (principally, securities which are
obligations of, or guaranteed by, the United States), provided certain standards
related to creditworthiness have been met.
26
<PAGE>
The following tables set forth certain information regarding borrowings at
the dates and during the periods indicated.
<TABLE>
<CAPTION>
At December 31,
------------------------------
1997 1996 1995
-------- --------- ---------
(Dollars in Thousands)
<S> <C> <C> <C>
Amount of borrowings:
FHLB advances............................. $212,693 $202,639 $160,649
Weighted average rate on:
FHLB advances.............................. 6.09% 5.97% 6.02%
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------
1997 1996 1995
-------- --------- ---------
(Dollars in Thousands)
<S> <C> <C> <C>
Maximum amount of borrowings
outstanding at any month end:
FHLB advances.............................. $223,461 $203,330 $165,787
Approximate average borrowings
outstanding with respect to:
FHLB advances.............................. $207,871 $176,943 $150,998
Approximate weighted average rate paid on:
FHLB advances.............................. 6.12% 6.02% 6.21%
</TABLE>
SUBSIDIARY ACTIVITIES
Community First is permitted to invest an amount equal to 5% of its assets
in service entities where such entities are authorized to engage in those
activities incidental to the conduct of the Bank. As of December 31, 1997,
Community First's investment in its subsidiary was $342,000.
In October 1982, the Bank formed a wholly-owned subsidiary, Capitol
Consolidated Financial Corporation ("CCFC"), for the purpose of engaging in real
estate development activities. Subsequent to its organization CCFC was involved
in one real estate development project beginning in 1985 and concluding in 1986,
and also was engaged in limited securities investment activities in 1986. CCFC
has engaged in no significant activities since May 1986, although in 1986 it did
purchase approximately $26,000 of stock in an insurance company, of which it
held $16,000 at December 31, 1997. During 1993, the Bank entered into a lease
agreement with a third-provider of investment products. The Bank, in 1995 and
1994, respectively, recognized $15,000 and $150,000 of rental income in
conjunction with this agreement. In addition, CCFC entered into a brokerage
services agreement with the same third-party vendor whereby $15,000, $53,000 and
$29,000 of commissions were received and included in CCFC's income in 1995, 1994
and 1993, respectively. Both the lease and the brokerage services agreement
were terminated in 1995. CCFC entered into a brokerage services agreement with
another third-party vendor in late 1995. Through the Bank's branch offices,
this third-party provides customers seeking alternative non-FDIC insured
investment services the opportunity to invest in bonds, mutual funds, stocks,
annuities, and other investment products. The offices occupied by the third
party are separate and distinct from the Bank's offices, and Bank customers are
alerted to the fact that the third party is not affiliated with the Bank, and is
not offering deposit or savings accounts insured by the SAIF or the FDIC. In
conjunction with the brokerage service agreement, CCFC received $16,000 in
commissions in 1996. The Bank also
27
<PAGE>
received $27,000 in rental income in 1996 from the third-party. In early 1997,
the brokerage services agreement with the third-party vendor was terminated.
In late 1995, CCFC purchased the Allegan Insurance Agency. No activity was
conducted through this agency during 1995 or 1996. In early 1997, a licensed
agent was hired to operate the Allegan Insurance Agency. During 1997, the
Allegan Insurance Agency conducted business as Community First Insurance and
Investment Services and offered customers and non-customers the opportunity to
invest in non-FDIC-insurance products such as bonds, mutual funds, stocks,
annuities, and life insurance. CCFC received $138,000 in commission income
during 1997.
Also during 1997, CCFC invested $26,838 to become a member of Michigan
Bankers Title of Mid-Michigan, L.L.C., a Michigan limited liability company, for
the purpose of engaging in the title insurance agency business. As agent for
Investors Title Insurance Company, a North Carolina insurance corporation
headquartered in Chapel Hill, North Carolina, the L.L.C. underwrites and issues
title insurance policies in the name and on behalf of the title insurer. The
Michigan Bankers Title of Mid-Michigan, L.L.C. is comprised of fourteen owners;
subsidiaries of ten state banks, three national banks and one subsidiary of a
state savings bank. CCFC received a dividend distribution of $29,820 in
December 1997, based upon the operation of the L.L.C. during 1997.
SAIF-insured savings associations are required to give the FDIC 30 days'
prior notice before establishing or acquiring a new subsidiary, or commencing
any new activity through an existing subsidiary. The FDIC has the authority to
order termination of subsidiary activities determined to pose a risk to the
safety or soundness of the association. In addition, savings associations are
required to phase-out the amount of their investments in and extensions of
credit to subsidiaries engaged in activities not permissible to national banks
from capital in determining regulatory capital compliance. CCFC's investment
activities are not permissible to national banks, but the Bank does not
anticipate that any resulting deduction from capital will materially affect its
capital for regulatory compliance purposes. See "Item 1. Business -- Regulation
of the Bank -- Regulatory Capital Requirements."
28
<PAGE>
KEY OPERATING RATIOS
Set forth below are certain key operating ratios for the Corporation at the
dates and for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------
1997 1996 1995
-------- --------- ---------
<S> <C> <C> <C>
Interest rate spread................... 2.70% 2.63% 2.52%
Net yield on earning assets............ 3.06 2.98 2.85
Return on average equity (net income
as a percentage of average
stockholders' equity)................ 16.39 8.55 11.47
Return on average assets (net income
as a percentage of average assets).. 1.26 0.69 0.92
Dividend payout ratio.................. 31.71 41.28 28.38
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------
1997 1996 1995
-------- --------- ---------
<S> <C> <C> <C>
Equity to assets ratio (average stockholders'
equity as a percentage of average
total assets).................................. 7.70% 8.06% 8.00%
</TABLE>
Additional performance ratios are set forth in the "Five Year Summary of
Selected Consolidated Financial Data," incorporated herein by reference to the
Annual Report. Any significant changes in the current trend of the above ratios
are reviewed in "Management's Discussion and Analysis of Financial Condition and
Results of Operations," incorporated herein by reference to the Annual Report.
COMPETITION
Community First encounters strong competition both in the attraction of
deposits and in the origination of real estate and other loans. Its most direct
competition for deposits has historically come from commercial banks, other
savings institutions and credit unions in its market area. Community First has
the largest market share of deposits for financial institutions with corporate
headquarters in the greater Lansing area, and the third largest market share of
financial institutions with branches or subsidiaries in that market.
Legislation passed by the U.S. Congress since 1980 and an increasingly
sophisticated investing public have dramatically increased competition for
deposits between thrift institutions and other types of investments (such as
money market mutual funds, Treasury securities and municipal bonds) and
increased competition with commercial banks in regard to loans, checking
accounts and other types of financial services. In addition, large
conglomerates and securities firms have entered the market for financial
services.
Community First competes for loans primarily through the interest rates and
loan fees it charges and the efficiency and quality of services it provides
borrowers, real estate brokers and builders. Factors which affect competition
include general and local economic conditions, current interest rate levels and
volatility in the mortgage markets.
29
<PAGE>
REGULATION OF THE BANK
GENERAL. As a Michigan chartered state savings bank with deposits insured
by the SAIF, Community First is subject to extensive regulation by the Financial
Institutions Bureau and the FDIC. The lending activities and other investments
of the Bank must comply with various federal and state regulatory requirements.
The Financial Institutions Bureau periodically examines the Bank for compliance
with various regulatory requirements. The FDIC also has the authority to
conduct special examinations of SAIF members. The Bank must file reports with
the Financial Institutions Bureau and the FDIC describing its activities and
financial condition. Community First is also subject to certain reserve
requirements promulgated by the Board of Governors of the Federal Reserve System
(the "Federal Reserve Board"). This supervision and regulation is intended
primarily for the protection of depositors. As a savings and loan holding
company, the Corporation is subject to the OTS' regulation, examination,
supervision and reporting requirements. Certain of these regulatory
requirements are referred to below or appear elsewhere herein.
CAPITAL REQUIREMENTS. Under FDIC regulations, state-chartered banks that
are not members of the Federal Reserve System ("state nonmember banks") are
required to maintain a minimum leverage capital requirement consisting of a
ratio of Tier 1 capital to total assets of 3% if the FDIC determines that the
institution is not anticipating or experiencing significant growth and has well-
diversified risk, including no undue interest rate risk exposure, excellent
asset quality, high liquidity, good earnings and in general a strong banking
organization, rated composite 1 under the Uniform Financial Institutions Rating
System (the CAMEL rating system) established by the Federal Financial
Institutions Examination Council. For all but the most highly rated
institutions meeting the conditions set forth above, the minimum leverage
capital ratio is 3% plus an additional "cushion" amount of at least 100 to 200
basis points. Tier 1 capital is 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 certain purchased mortgage servicing rights and purchased credit
card relationships), minus identified losses and minus investments in securities
subsidiaries.
In addition to the leverage ratio, state nonmember banks must maintain a
minimum ratio of qualifying total capital to risk-weighted assets of at least
8.0% of which at least four percentage points must be Tier 1 capital.
Qualifying total capital consists of Tier 1 capital plus Tier 2 or supplementary
capital items, which include allowances for loan losses in an amount of up to
1.25% of risk-weighted assets, perpetual preferred stock that does not qualify
as Tier 1 capital and long-term preferred stock with an original maturity of at
least 20 years and certain other capital instruments. The includable amount of
Tier 2 capital cannot exceed the institution's Tier 1 capital. Qualifying total
capital is further reduced by the amount of the bank's investments in banking
and finance subsidiaries that are not consolidated for regulatory capital
purposes, reciprocal cross-holdings of capital securities issued by other banks
and certain other deductions. Under the FDIC risk-weighting system, all of a
bank's balance sheet assets and the credit equivalent amounts of certain off-
balance sheet items are assigned to one of four broad risk weight categories.
The aggregate dollar amount of each category is multiplied by the risk weight
assigned to that category. The sum of these weighted values equals the bank's
risk-weighted assets.
At December 31, 1997, the Bank's ratio of Tier 1 capital to total assets
was 7.63%, its ratio of Tier 1 capital to risk-weighted assets was 12.83% and
its ratio of total capital to risk-weighted assets was 13.77%.
DIVIDEND LIMITATIONS. 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 its conversion to stock form.
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 stockholders 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 "Federal and State Taxation." The Bank intends to make
full use of this favorable tax treatment and does not contemplate use of any
earnings in a manner which would create federal tax liabilities.
30
<PAGE>
Under FDIC regulation, the Bank is 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%.
SAFETY AND SOUNDNESS STANDARDS. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each Federal banking agency is required to establish safety and soundness
standards for institutions under its authority. On July 10, 1995, the federal
banking agencies, including the FDIC and the Federal Reserve Board, 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 depository 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 depository 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 appropriate federal banking agency determines
that a depository 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 depository institution must submit an
acceptable compliance plan to its primary federal regulator 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 operations of the Bank.
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 FDIC and the Federal Reserve Board,
issued proposed guidelines relating to asset quality and earnings. Under the
proposed guidelines, an FDIC insured depository 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 earnings are sufficient to maintain
adequate capital and reserves. Management believes the asset quality and
earnings standards, in the form proposed by the banking agencies, would not have
a material effect on the operations of the Bank.
FEDERAL HOME LOAN BANK SYSTEM. Community First is a member of the FHLB
System. The FHLB System consists of 12 regional FHLBs subject to supervision
and regulation by the Federal Housing Finance Board ("FHFB"), as successor in
this respect to the Federal Home Loan Bank Board. The Federal Home Loan Banks
provide a central credit facility primarily for member institutions. As a
member of the FHLB of Indianapolis, the Bank is required to acquire and hold
shares of capital stock in its FHLB in an amount at least equal to the greater
of 1% of the aggregate unpaid principal of its residential mortgage loans, home
purchase contracts and similar obligations at the beginning of each year, or 5%
of outstanding advances (borrowings) from the FHLBs. The Bank was in compliance
with this requirement at December 31, 1997, with investments in FHLB stock of
$11.4 million.
The FHLBs serve as reserve or central banks for their member institutions
within their assigned regions. They are funded primarily from proceeds derived
from the sale of consolidated obligations of the FHLB System. They make
advances to members in accordance with policies and procedures established by
the FHFB and their Boards of Directors. Long-term advances may be made only
for the purpose of providing funds for residential housing finance. As of
December 31, 1997, the Bank had $212.7 million in advances from its FHLB.
LIQUIDITY REQUIREMENTS. Although not required by regulation, Community
First maintains average daily balances of short-term liquid assets at a
specified percentage (currently 3%) of the total of its net withdrawable savings
31
<PAGE>
accounts and borrowings payable in one year or less. The short-term liquidity
ratio of the Bank at December 31, 1997 was 7.32%. A substantial sustained
decline in savings deposits could adversely affect the Bank's liquidity which
could result in restricted operations and additional borrowings from the FHLB.
DEPOSIT INSURANCE. The Bank is required to pay assessments to the FDIC
based on a percent of its insured deposits for insurance of its deposits by the
SAIF. Under the Federal Deposit Insurance Act, the FDIC is required to set
semi-annual assessments for SAIF-insured institutions to maintain the designated
reserve ratio of the SAIF at 1.25% of estimated deposits or at a higher
percentage of estimated insured deposits that the FDIC determines to be
justified for that year by circumstances raising a significant risk of
substantial future losses to the SAIF.
Under the risk-based deposit insurance system adopted by the FDIC, 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 used under the prompt
corrective action regulations. 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.
Before 1997, institutions with SAIF-assessable deposits, like the Bank,
have been required to pay higher deposit insurance premiums than institutions
with deposits insured by the BIF. In order to recapitalize the SAIF and address
the premium disparity, the recently-enacted Deposit Insurance Funds Act of 1996
authorized the FDIC to impose 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. As a result of the special assessment the Bank incurred an
after-tax expense of $2,214,000 during the quarter ended September 30, 1996.
The FDIC has proposed a new assessment schedule for SAIF deposit insurance
pursuant to which the assessment rate for well-capitalized institutions with the
highest supervisory ratings would be reduced to zero and institutions in the
lowest risk assessment classification will be assessed at the rate of 0.27% of
insured deposits. Until December 31, 1999, however, 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 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.
RESTRICTIONS ON CERTAIN ACTIVITIES. Under FDICIA, state-chartered banks
with deposits insured by the FDIC are generally prohibited from acquiring or
retaining any equity investment of a type or in an amount that is not
permissible for a national bank. The foregoing limitation, however, does not
prohibit FDIC-insured state banks from acquiring or retaining an equity
investment in a subsidiary in which the bank is a majority owner. State-
chartered banks are also prohibited from engaging as principal in any type of
activity that is not permissible for a national bank and subsidiaries of state-
chartered, FDIC-insured state banks may not engage as principal in any type of
activity that is not permissible for a subsidiary of a national bank unless in
either case the FDIC determines that the activity would pose no significant risk
to the appropriate deposit insurance fund and the bank is, and continues to be,
in compliance with applicable capital standards.
The FDIC has adopted regulations to clarify the foregoing restrictions on
activities of FDIC-insured state-chartered banks and their subsidiaries. Under
the regulations, the term activity refers to the authorized conduct of business
by an insured state bank and includes acquiring or retaining any investment
other than an equity investment.
32
<PAGE>
A bank or subsidiary is considered acting as principal when conducted other than
as an agent for a customer, as trustee, or in a brokerage, custodial, advisory
or administrative capacity. An activity permissible for a national bank includes
any activity expressly authorized for national banks by statute or recognized as
permissible in regulations, official circulars or bulletins or in any order or
written interpretation issued by the Office of the Comptroller of the Currency
("OCC"). In its regulations, the FDIC indicates that it will not permit state
banks to directly engage in commercial ventures or directly or indirectly engage
in any insurance underwriting activity other than to the extent such activities
are permissible for a national bank or a national bank subsidiary or except for
certain other limited forms of insurance underwriting permitted under the
regulations. Under the regulations, the FDIC permits state banks that meet
applicable minimum capital requirements to engage as principal in certain
activities that are not permissible to national banks including guaranteeing
obligations of others, activities which the Federal Reserve Board has found by
regulation or order to be closely related to banking and certain securities
activities conducted through subsidiaries.
PROMPT CORRECTIVE REGULATORY ACTION. FDICIA requires the federal banking
regulators to take prompt corrective action in the event an FDIC-insured
institution fails to meet certain minimum capital requirements. Under FDICIA,
as implemented by regulations adopted by the FDIC, an institution is assigned to
one of the following five capital categories:
. well-capitalized -- total risk-based capital ratio of 10% or greater,
Tier 1 risk-based capital ratio of 6% or greater, leverage ratio of 5%
or greater, and no written FDIC directive or order requiring the
maintenance of specific levels of capital;
. adequately capitalized -- total risk-based capital ratio of 8% or
greater, Tier 1 risk-based capital ratio of 4% or greater, and
leverage ratio of 4% or greater (or 3% or greater if the institution's
composite rating under the FDIC's supervisory rating system is 1);
. undercapitalized -- total risk-based capital ratio of less than 8%, or
Tier 1 risk-based capital ratio of less than 4%, or leverage ratio of
less than 4% (or less than 3% if the institution's composite rating
under the FDIC's supervisory rating system is 1);
. significantly undercapitalized -- total risk-based capital ratio of
less than 6%, or Tier 1 risk-based capital ratio of less than 3% or
leverage ratio of less than 3%; and
. critically undercapitalized -- ratio of tangible equity to total
assets of 2% or less.
Under FDICIA, an "undercapitalized institution" generally is: (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. A
significantly undercapitalized institution, as well as any undercapitalized
institution that does 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, restrictions on 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 may also be required to divest the institution. The
senior executive officers of such an 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, with certain exceptions. If an institution's ratio of tangible capital to
total assets falls below a level established by the appropriate federal banking
regulator, which may not be less than 2% of total assets nor more than 65% of
the minimum tangible capital level otherwise required (the "critical capital
level"), the institution is 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
33
<PAGE>
critically undercapitalized. At December 31, 1997, the Bank was classified as
"well capitalized" under the FDIC's regulations.
UNIFORM LENDING STANDARDS. As required by FDICIA, the federal banking
agencies adopted regulations effective March 19, 1993 that require banks to
adopt and maintain written policies establishing 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 bank's real estate lending policy must
reflect consideration of the Interagency Guidelines for Real Estate Lending
Policies (the "Interagency Guidelines") that have been adopted by the banking
agencies. 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 loan-to-value limits specified in the Guidelines
for the various types of real estate loans. The Interagency 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. The Bank does not believe that the Interagency Guidelines materially
affect its lending activities.
LIMITS ON LOANS TO ONE BORROWER. The Home Owners' Loan Act ("HOLA")
provides that the loans-to-one-borrower limits applicable to national banks
apply to savings associations in the same manner and to the same extent. Under
these rules, with certain limited exceptions, loans and extensions of credit to
a person outstanding at one time generally shall not exceed 15% of the
unimpaired capital and surplus of the savings association. Loans and extensions
of credit fully secured by readily marketable collateral may comprise an
additional 10% of unimpaired capital and surplus. HOLA additionally authorizes
savings associations 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: (i) the purchase price of each single-family dwelling in the
development does not exceed $500,000; (ii) the savings association is in
compliance with its fully phased-in capital requirements; (iii) the loans comply
with applicable loan-to-value requirements, and; (iv) the aggregate amount of
loans made under this authority does not exceed 150% of unimpaired capital and
surplus.
FEDERAL RESERVE SYSTEM. Pursuant to regulations of the Federal Reserve
Board, all FDIC-insured depository institutions must maintain average daily
reserves against their transaction accounts. No reserves are required on the
first $4.7 million of transaction accounts. Reserves equal to 3% must be
maintained on the next $43.1 million of transaction accounts and a reserve of
10% must be maintained against the remaining transaction accounts. These
reserve requirements are subject to adjustment by the Federal Reserve Board.
Because required reserves must be maintained in the form of vault cash or in a
noninterest 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. At December 31, 1997, Community First met its reserve requirements.
MICHIGAN STATE LAW. As a state-chartered savings bank, the Bank is subject
to the applicable provisions of Michigan law and the regulations of the
Financial Institutions Bureau adopted thereunder. The Bank derives its lending
and investment powers from these laws, and is subject to periodic examination
and reporting requirements by and of the Financial Institutions Bureau. In
addition, it is required to make periodic reports to the Financial Institutions
Bureau.
REGULATION OF THE CORPORATION
GENERAL. The Corporation is registered as a savings and loan holding
company with the OTS and subject to OTS regulations, examinations, 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
Corporation and affiliates thereof.
ACTIVITIES RESTRICTIONS. The Board of Directors of the Corporation
presently operates the Corporation as a unitary savings and loan holding
company. There are generally no restrictions on the activities of a unitary
savings and
34
<PAGE>
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 association, the
Director of the OTS may impose such restrictions as deemed necessary to address
such risk and limiting (i) payment of dividends by the savings association, (ii)
transactions between the savings association and its affiliates, and (iii) any
activities of the savings association that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings association. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
association 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 association requalifies as a Qualified Thrift Lender within one year
thereafter, register as, and become subject to, the restrictions applicable to a
bank holding company.
If the Corporation were to acquire control of another savings association,
other than through merger or other business combination with the Bank, the
Corporation 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 association meets the QTL
Test, the activities of the Corporation and any of its subsidiaries (other than
the Bank or other subsidiary savings institutions) would thereafter be subject
to further restrictions. The Home Owners' Loan Act, as amended by FIRREA,
provides that, among other things, no multiple savings and loan holding company
or subsidiary thereof which is not a savings association 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 association, (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 the FSLIC by regulation as of March 5, 1987 to be engaged
in by multiple holding companies or (vii) those activities authorized by the
Federal Reserve Board as permissible for bank holding companies, unless the
Director of the OTS by regulation prohibits or limits such activities for
savings and loan holding companies. Those activities described in (vii) above
must also be approved by the Director of the OTS prior to being engaged in by a
multiple holding company.
Legislation has been recently introduced into the U.S. Congress which would
subject all unitary holding companies to the same restrictions on activities as
are currently applied to multiple holding companies. If such legislation is
enacted in its current form, the ability of the Corporation to engage in certain
activities that are currently permitted to the Corporation may be restricted.
The Corporation, however, does not believe that it will be required to
discontinue any current activity. In addition, such legislation would preclude
companies that are engaged in activities not permitted to multiple holding
companies from acquiring control of the Corporation. No prediction can be made
at this time as to whether such legislation will be enacted or whether it will
be enacted in its current form.
TRANSACTIONS WITH AFFILIATES. Transactions between savings associations
and any affiliate are governed by Sections 23A and 23B of the Federal Reserve
Act. An affiliate of a savings association is any company or entity which
controls, is controlled by or is under common control with the savings
association. In a holding company context, the parent holding company of a
savings association (such as the Corporation) and any companies which are
controlled by such parent holding company are affiliates of the savings
association. Generally, Sections 23A and 23B (i) limit the extent to which the
savings institution or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10% of such institution's capital
stock and surplus, and contain an aggregate limit on all such transactions with
all affiliates to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable, to the institution or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings association may (i) 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,
35
<PAGE>
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings association.
Savings associations are also subject to the restrictions contained in
Section 22(h) of the Federal Reserve Act on loans to executive officers,
directors and principal stockholders. Under Section 22(h), loans to an
executive officer and to a greater than 10% stockholder of a savings association
(18% in the case of institutions located in an area with less than 30,000 in
population), and certain affiliated entities of either, may not exceed, together
with all other outstanding loans to such person and affiliated entities the
association's loan 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 certain 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 association, and their respective
affiliates, unless such loan is approved in advance by a majority of the board
of directors of the association 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, the Federal Reserve Board
pursuant to 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.
Savings associations are also subject to the requirements and restrictions
of Section 22(g) of the Federal Reserve Act on loans to executive officers and
the restrictions of 12 U.S.C. (S) 1972 on certain tying arrangements and
extensions of credit by correspondent banks. Section 22(g) of the Federal
Reserve Act requires that loans to executive officers of depository institutions
not be made on terms more favorable than those afforded to other borrowers,
requires approval for such extensions of credit by the board of directors of the
institution, and imposes reporting requirements for and additional restrictions
on the type, amount and terms of credits to such officers. Section 1972
prohibits (i) a depository institution from extending credit to or offering any
other services, or fixing or varying the consideration for such extension of
credit or service, on the condition that the customer obtain some additional
service from the institution or certain of its affiliates or not obtain services
of a competitor of the institution, subject to certain exceptions, and (ii)
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.
RESTRICTIONS ON ACQUISITIONS. Savings and loan holding companies are
generally prohibited from acquiring, without prior approval of the Director of
the OTS, (i) control of any other savings association or savings and loan
holding company or substantially all the assets thereof or (ii) more than 5% of
the voting shares of a savings association 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 association, other than a subsidiary savings
association, 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
associations 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 association to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
association pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes of the state in which the
association to be acquired is located specifically permit institutions to be
acquired by state-chartered associations 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).
Federal associations may 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
36
<PAGE>
association may only establish an out-of-state branch under such OTS regulation
if (i) the federal association qualifies as a "domestic building and loan
association" under (S)7701(a)(19) of the Internal Revenue Code and the total
assets attributable to all branches of the association in the state would
qualify such branches taken as a whole for treatment as a domestic building and
loan association and (ii) such branch would not result in (a) formation of a
prohibited multi-state multiple savings and loan holding company or (b) a
violation of certain statutory restrictions on branching by savings association
subsidiaries of banking holding companies. Federal associations generally may
not establish new branches unless the association meets or exceeds minimum
regulatory capital requirements. The OTS will also consider the association's
record of compliance with the Community Reinvestment Act of 1977 in connection
with any branch application.
The Bank Holding Company Act of 1956 specifically authorizes the Federal
Reserve Board to approve an application by a bank holding company to acquire
control of any savings association. Pursuant to rules promulgated by the
Federal Reserve Board, owning, controlling or operating a savings association is
a permissible activity for bank holding companies, if the savings association
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 association may merge or
consolidate the assets and liabilities of the savings association 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 association plus an annual growth increment.
In addition, the transaction must comply with the restrictions on interstate
acquisitions of commercial banks under the Bank Holding Company Act.
TAXATION
GENERAL. The Corporation and the Bank currently file a consolidated
federal income tax return on a calendar year basis. Consolidated returns have
the effect of eliminating intercompany distributions, including dividends, from
the computation of consolidated taxable income for the taxable year in which the
distributions occur.
FEDERAL INCOME TAXATION. Thrift institutions are subject to the provisions
of the Internal Revenue Code of 1986, as amended ("Code") in the same general
manner as other corporations. Prior to recent legislation, institutions such as
the Bank which met certain definitional tests and other conditions prescribed by
the Code benefitted from certain favorable provisions regarding their deductions
from taxable income for annual additions to their bad debt reserve. For
purposes of the bad debt reserve deduction, loans were separated into
"qualifying real property loans," which generally are loans secured by interests
in certain real property, and nonqualifying loans, which are all other loans.
The bad debt reserve deduction with respect to nonqualifying loans was based on
actual loss experience, however, the amount of the bad debt reserve deduction
with respect to qualifying real property loans could be based upon actual loss
experience (the "experience method") or a percentage of taxable income
determined without regard to such deduction (the "percentage of taxable income
method"). The thrift bad debt reserve method was repealed for taxable years
beginning after December 31, 1995. For taxable years beginning on or after
January 1, 1996, savings institutions will be treated the same as commercial
banks. Institutions such as the Bank that are part of a consolidated group with
$500 million or more in assets will only be able to take a tax deduction when a
loan is actually charged off. Institutions in groups with less than $500
million in assets will still be permitted to make deductible bad debt additions
to reserves, but only using the experience method.
The legislation also requires savings institutions to recapture the excess
of their tax bad debt reserves for the last taxable year beginning before
January 1, 1996, over their tax bad debt reserves for the last taxable year
beginning before January 1, 1988 ("base year"), adjusted downward for any
decline in outstanding loans from the base year. This excess will be taken into
income over six years, generally for taxable years beginning in 1996, but
subject to potential deferral up to two years.
37
<PAGE>
The base year tax bad debt reserves are generally not subject to recapture,
but they are frozen, not forgiven. Earnings that represent amounts appropriated
to an institution's bad debt reserves 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
amounts are included in taxable income, along with the amount deemed necessary
to pay the resulting federal income tax.
The Corporation's federal income tax returns were audited through December
1992 by the IRS, without material adjustments.
STATE TAXATION. Under Michigan law, Community First is subject to a
"Single Business Tax," a value-added tax for the privilege of doing business in
the state of Michigan. The major components of the tax base are: compensation,
federal taxable income and depreciation, less the cost of acquisition of
tangible assets during the year. The tax rate is 2.30% of the Michigan adjusted
tax base for 1997. Community First is also subject to an "Intangibles Tax" of
$.05 on each $1,000 of savings deposits for 1997. The Intangibles Tax has been
repealed beginning in 1998.
The Bank's state tax returns have been audited through December 1991 by the
Michigan Department of Treasury.
For additional information regarding federal taxes, see Notes 1 and 13 of
the Notes to Consolidated Financial Statements in the Annual Report.
PERSONNEL
As of December 31, 1997, the Bank, including its subsidiaries, had 195
full-time employees and 68 part-time employees. The employees are not
represented by a collective bargaining unit. The Bank believes its relationship
with its employees to be good.
EXECUTIVE OFFICERS
The following table sets forth information regarding the Corporation's
and/or the Bank's executive officers.
<TABLE>
<CAPTION>
Name Age(1) Position
- --------------------------- ------ -------------------------------------------------------------------------
<S> <C> <C>
Robert H. Becker 62 President and Chief Executive Officer of the Corporation and the Bank
John W. Abbott 50 Executive Vice President, Chief Operating Officer, and Secretary of the
Corporation and the Bank
Carl C. Farrar 48 Senior Vice President -- Chief Lending Officer of the Bank
Jane M. Judge McMillian 36 Vice President -- Director of Human Resources of the Bank
Rick L. Laber 40 Vice President, Chief Financial Officer, and Treasurer of the Corporation
and the Bank
Jack G. Nimphie 48 Senior Vice President -- Director of Operations of the Bank
Sally A. Peters 45 Vice President -- Director of Marketing of the Bank
C. Wayne Weaver 44 Senior Vice President -- Director of Retail Banking of the Bank
- -------------------------
</TABLE>
(1) At December 31, 1997
38
<PAGE>
The principal occupation of each executive officer of the Corporation
and/or the Bank is set forth below.
ROBERT H. BECKER joined Community First in November 1987 as the President
and Chief Executive Officer. Mr. Becker also serves as the Corporation's
President and Chief Executive Officer. Mr. Becker began his banking career in
1957, and from 1976 to 1987, Mr. Becker served as President and Chief Executive
Officer of MetroBanc located in Grand Rapids, Michigan. Mr. Becker is a past
Director of the Federal Home Loan Bank of Indianapolis and a past Chairman of
the Michigan League of Savings Institutions. He is also a director of the
Lansing Community College Foundation, a Board member of the Rotary Club of
Lansing, and a member of the Finance Committee of the Capital Region Community
Foundation.
JOHN W. ABBOTT joined Community First in February 1989 as the Executive
Vice President and Chief Operating Officer. Mr. Abbott also serves as the
Corporation's Executive Vice President and Chief Operating Officer. In October
1993, Mr. Abbott also began serving as the Corporation's Secretary. From 1985
until January 1989, Mr. Abbott was Vice President -- Finance of Union Bancorp,
Inc., located in Grand Rapids, Michigan, a subsidiary of NBD Bancorp, Inc., and
prior to August 1985 he was a C.P.A. with a national accounting firm.
CARL C. FARRAR joined Community First in March 1994 as Senior Vice
President -- Chief Lending Officer. Mr. Farrar began his career in banking in
1965 and from 1991 until joining Community First in March 1994, he worked as a
Vice President in Corporate Lending at Huntington National Bank in Columbus,
Ohio. From 1988 to 1991, Mr. Farrar served as Senior Vice President -- Chief
Lending Officer at Central Trust Company in Columbus, Ohio.
JANE M. JUDGE MCMILLIAN joined Community First in May 1995 as Vice
President -- Director of Human Resources. Ms. Judge McMillian holds a Masters
Degree in Labor and Industrial Relations and prior to May 1995 served as manager
of human resources for a clinical reference laboratory headquartered in
Southfield, Michigan.
RICK L. LABER joined Community First in August 1997 as Vice President,
Chief Financial Officer and Treasurer. Mr. Laber also serves as the
Corporation's Vice President, Chief Financial Officer and Treasurer. From 1996
until July 1997, Mr. Laber was Vice President -- Branch Coordinator of Flagstar
Bank in Jackson, Michigan. From 1992 to 1996, Mr. Laber was Senior Vice
President, Chief Financial Officer and Treasurer of Security Savings Bank
located in Jackson, Michigan. Prior to August 1992, Mr. Laber was a C.P.A. with
a national accounting firm.
JACK G. NIMPHIE joined Community First in 1971 as a management trainee and
became Senior Vice President -- Director of Retail Banking in 1986. In February
1989 he became Senior Vice President -- Director of Banking Operations, and in
December 1991 he became Senior Vice President -- Director of Operations and
Retail Banking. In October 1996, Mr. Nimphie became Senior Vice President --
Director of Operations of the Bank.
SALLY A. PETERS joined Community First in February 1994 as Vice President
- -- Director of Marketing. Prior to February 1994, Ms. Peters, for fifteen years,
was responsible for marketing and communications at an insurance company in
Lansing, Michigan.
C. WAYNE WEAVER joined Community First in 1975 as a management trainee and
became Senior Vice President -- Director of Corporate Planning in 1986. In
December 1989 he became Senior Vice President -- Director of Retail Banking and
Investments, and in December 1991 he became Senior Vice President -- Director of
Finance. In October 1993, Mr. Weaver became Treasurer of the Corporation and
Senior Vice President -- Director of Corporate Planning and Treasurer of the
Bank. In October 1996, Mr. Weaver became Senior Vice President -- Director of
Retail Banking of the Bank.
39
<PAGE>
ITEM 2. PROPERTIES
- -------------------
Community First owns all of its offices, except as noted. The following
table sets forth the location of the Bank's offices, as well as certain
additional information relating to those offices as of December 31, 1997.
<TABLE>
<CAPTION>
Net Book
Year Approximate Value at
Facility Office Area December 31,
Opened (Square Feet) 1997 (1)
-------- ------------- -------------
<S> <C> <C> <C>
Community First Main Office:
112 East Allegan Street
Lansing, Michigan (2) 1922 46,368 $3,718,490
Branch Offices:
101 East Lawrence Street
Charlotte, Michigan 1981 1,700 191,109
6333 West St. Joseph Street
Delta Township, Michigan 1986 1,200 374,328
250 East Saginaw Street
East Lansing, Michigan 1977 2,100 418,161
401 South Bridge Street
Grand Ledge, Michigan 1966 1,700 321,228
4440 West Saginaw Street
Lansing, Michigan 1977 2,100 442,257
6510 South Cedar Street
Lansing, Michigan (3) 1974 3,000 525,738
606 West Columbia Street
Mason, Michigan 1971 1,700 326,326
2119 Hamilton Road
Okemos, Michigan (4) 1961 2,500
301 North Clinton Avenue
St. Johns, Michigan 1978 2,700 385,768
225 West Grand River Avenue
Williamston, Michigan 1978 1,500 248,454
121 West Allegan Street
Lansing, Michigan (5) 1922 16,800 417,905
5620 Pennsylvania Avenue
Lansing, Michigan 1970 1,250 117,482
</TABLE>
40
<PAGE>
<TABLE>
<CAPTION>
Net Book
Year Approximate Value at
Facility Office Area December 31,
Opened (Square Feet) 1997 (1)
-------- ------------- -------------
<S> <C> <C> <C>
100 North Dexter Street
Ionia, Michigan 1975 1,248 87,229
709 S. U.S. 27
St. Johns, Michigan 1981 1,454 220,871
2285 W. Grand River
Okemos, Michigan (4) 1976 1,200
2801 E. Grand River
Lansing, Michigan 1978 1,454 170,214
5610 W. Saginaw Street
Lansing, Michigan (6) 1991 4,158
13007 S. U.S. 27
DeWitt, Michigan 1994 2,420 1,127,795
515 E. Grand River Avenue, Suite E
East Lansing, Michigan (7) 1996 2,500 99,536
4815 Okemos Road
Okemos, Michigan (8) 1997 2,635 958,655
Ledges Commerce Park, Unit 2A
Grand Ledge, Michigan (9) 1996 198,635
</TABLE>
_______________
(1) Represents the book value of land, building, fixtures, equipment and
furniture at the premises and owned or leased by the Bank.
(2) This location has attached buildings with an additional 2,444 square feet
rented as retail space.
(3) Building has a second floor with an additional 2,200 square feet rented as
office space.
(4) These two locations were sold in 1997. The offices were relocated and
consolidated into the purchased location at 4815 Okemos Road described in
(8) below; 2119 Hamilton Road, sold April 18, 1997; and 2285 W. Grand River
Avenue, sold July 11, 1997.
(5) This office was closed effective May 1, 1992, and is currently held for
future expansion and offers for interim rental are considered.
(6) Branch office was closed effective December 1, 1996, and was sold April 17,
1997.
(7) Branch office was opened April 29, 1996. Property is leased and net book
value at December 31, 1997 represents building improvements and furniture
and equipment.
(8) Net book value at December 31, 1997 represents the purchase price of branch
office at this location. Building was purchased March 21, 1997 and
occupied March 24, 1997.
(9) Net book value at December 31, 1997 represents the purchase price of land
which is held for future development of a branch office.
41
<PAGE>
The net book value of the Bank's investment in premises and equipment
totaled $10.5 million at December 31, 1997. For additional information
regarding the Bank's premises and equipment, see Note 9 of the Notes to
Consolidated Financial Statements in the Annual Report.
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
There are various claims and lawsuits in which the Bank is periodically
involved, such as claims to enforce liens, condemnation proceedings on
properties in which the Bank holds security interests, claims involving the
making and servicing of real property loans and other issues incident to the
Bank's business. Management of the Corporation and the Bank does not consider
any of these legal proceedings material to the Corporation's or the Bank's
financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of 1997.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
- --------------------------------------------------------------------------
MATTERS
-------
The information contained in this Section captioned "Market Information" in
the Annual Report is hereby incorporated by reference.
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
The information contained in the section "Selected Consolidated Financial
and Other Data" in the Annual Report is hereby incorporated by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
-------------
The information contained in the section "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in the Annual Report
is hereby incorporated by reference.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARK RISK
- ------------------------------------------------------------------
The information contained in the section "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in the Annual Report
is hereby incorporated by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------
The financial statements contained in the Annual Report which are listed in
Item 14 herein are incorporated herein by reference.
42
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
Information concerning the Directors of the Corporation and compliance with
Section 16(a) of the Securities Exchange Act of 1934 is set forth under the
section captioned "Proposal 1 -- Election of Directors" in the Proxy Statement,
which is incorporated herein by reference.
Information concerning the Executive Officers of the Corporation is set
forth under "Item 1. Business ---Executive Officers" which is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
- --------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Proposal 1 -- Election of Directors -- Executive
Compensation" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
The information required by this item is incorporated herein by reference
to the sections captioned "Voting Securities and Principal Holders Thereof" and
"Proposal 1 -- Election of Directors" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Proposal 1 -- Election of Directors -- Transactions
with Management" in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
- --------------------------------------------------------------------------
(a)(1) Financial Statements - The following financial statements are
--------------------
incorporated by reference to Item 8 of this Annual Report on Form 10-K:
1. Consolidated Statements of Financial Condition at December 31, 1997
and 1996
2. Consolidated Statements of Operations for the Years Ended December 31,
1997, 1996 and 1995
3. Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1997, 1996 and 1995
4. Consolidated Statements of Cash Flows for the Years Ended December 31,
1997, 1996 and 1995
5. Notes to Consolidated Financial Statements
6. Independent Auditors' Report
43
<PAGE>
(a)(2) Financial Statement Schedules - All financial statement schedules
-----------------------------
have been omitted as the required information is either inapplicable or included
in the Consolidated Financial Statements or related notes.
(a)(3) Exhibits - The following exhibits are either filed as part of this
--------
report or are incorporated herein by reference:
3.1 Certificate of Incorporation of CFSB Bancorp, Inc. (incorporated by
reference to Exhibit 3.1 to the Corporation's registration statement
on Form S-1 filed with the SEC on January 9, 1990)
3.2 Bylaws of CFSB Bancorp, Inc. (incorporated by reference to Exhibit
3.2 to the Corporation's registration statement on Form S-1 filed
with the SEC on January 9, 1990)
10.1 Stock Option Plan of CFSB Bancorp, Inc. (incorporated by reference to
Exhibit 10.3 to the Corporation's registration statement on Form S-1
filed with the SEC on January 9, 1990)
10.2 Employment Agreements between Community First, A Federal Savings Bank
and Robert H. Becker and John W. Abbott (incorporated by reference to
Exhibit 10.2 to Post-Effective Amendment No. 2 to the Corporation's
registration statement on Form S-4 filed with the SEC on May 21,
1990)
10.3 Merger Conversion Agreement with Union Federal Savings dated June 12,
1991 (incorporated by reference to Exhibit 28.2 to the Corporation's
current report on Form 8-K filed with the SEC on June 14, 1992)
13 1997 Annual Report to Stockholders
21 Subsidiaries
23 Consent of KPMG Peat Marwick LLP
27 Financial Data Schedule
(b) Reports on Form 8-K. On November 21, 1997, the registrant filed a
-------------------
Current Report on Form 8-K regarding the registrant's Board of
Directors approval of a 3-for-2 common stock split on November 18,
1997.
(c) Exhibits - All exhibits to this report are attached or incorporated
--------
by reference as stated above.
(d) Financial Statement Schedules - None.
-----------------------------
44
<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, as of March 17, 1998.
CFSB BANCORP, INC.
By: /s/ Robert H. Becker
--------------------
Robert H. Becker
President and Chief Executive Officer
(Duly Authorized Representative)
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 indicated as of March 17, 1998.
/s/ Robert H. Becker /s/ John W. Abbott
- -------------------- ------------------
Robert H. Becker John W. Abbott
President and Executive Vice President, Chief
Chief Executive Officer Operating Officer and Secretary
(Principal Executive Officer (Duly Authorized Representative)
and a Director)
/s/ James L. Reutter /s/ Rick L. Laber
- -------------------- ---------------------
James L. Reutter Rick L. Laber
Chairman of the Board Vice President, Chief Financial Officer
(Director) and Treasurer
(Principal Financial and Accounting Officer)
/s/ Cecil Mackey
- ------------------- -------------------
Cecil Mackey David H. Brogan
(Director) (Director)
/s/ William C. Hollister
- ------------------------- ------------------------
J. Paul Thompson, Jr. William C. Hollister
(Director) (Director)
/s/ Henry W. Wolcott, IV /s/ Donald F. Wall
- ------------------------ ------------------
Henry W. Wolcott, IV Donald F. Wall
(Director) (Director)
45
<PAGE>
INDEX TO EXHIBITS
Exhibit
-------
3.1 * Certificate of Incorporation of CFSB Bancorp, Inc.
3.2 * Bylaws of CFSB Bancorp, Inc.
10.1 * Stock Option Plan of CFSB Bancorp, Inc.
10.2 ** Employment Agreements between Community First, A Federal Savings
Bank and Robert H. Becker and John W. Abbott.
10.3 *** Merger Conversion Agreement with Union Federal Savings dated
June 12, 1991.
13 1997 Annual Report to Stockholders
21 Subsidiaries
23 Consent of KPMG Peat Marwick LLP
27 Financial Data Schedule
_____________
* Incorporated by reference to the Corporation's registration statement on
Form S-1 filed with the SEC on January 9, 1990.
** Incorporated by reference to Exhibit 10.2 to Post-Effective Amendment No. 2
to the Corporation's registration statement on Form S-1 filed with the SEC
on May 21, 1990.
*** Incorporated by reference to Exhibit 28.2 to the Corporation's current
report on Form 8-K filed with the SEC on June 14, 1992.
46
<PAGE>
GROWING OUR COMMUNITIES
[GRAPHICS APPEARS HERE]
[LOGO OF CFSB BANCORP APPEARS HERE]
1997 Annual Report
[PHOTO OF BUILDING APPEARS HERE]
[PHOTO OF SALE SIGNS APPEARS HERE]
[PHOTO OF MOTHER AND CHILD APPEARS HERE]
[PHOTO OF GRADUATE APPEARS HERE]
[PHOTO OF COUPLE APPEARS HERE]
[GRAPHIC OF VINE APPEARS HERE]
<PAGE>
Fulfilling Our Mission
CFSB Bancorp, Inc., through Community First Bank, is a financial services
organization of dedicated people serving the needs of our customers. We provide
competitive products and services with a continuous emphasis on quality. We will
achieve superior returns for our stockholders by placing the interests of our
customers and our communities first.
- ---------------------------
Business of the Corporation
- ---------------------------
CFSB Bancorp, Inc. is the parent company of Community First Bank, an $851
million state-chartered savings bank headquartered in Lansing, Michigan. CFSB
Bancorp, Inc. was organized as a Delaware Corporation in November 1989.
The reorganization of the Bank into the holding company form of ownership and
the commencement of operations by the Corporation occurred in June 1990.
Since the reorganization, the Corporation's activities have principally been
limited to holding the stock of the Bank. The Bank originates and invests in
single family mortgage loans. The Bank also offers retail banking services to
the mid-Michigan marketplace.
In addition, the Bank offers a variety of complementary services such as
commercial business loans, consumer loans, and home equity loans. The Bank's
full line of retail deposit services includes checking and savings accounts, and
certificates of deposit.
The Bank's deposits are insured by the Federal Deposit Insurance Corporation
up to the applicable limits.
[GRAPHIC OF VINE APPEARS HERE BEHIND TEXT]
Stock Market Highlights
- --------------------------------------------------------------------------------
Year End Closing Stock Price
[BAR GRAPH APPEARS HERE]
1994 1995 1996 1997
---- ---- ---- ----
$8.515 $11.845 $11.818 $26.250
Performance Highlights
- --------------------------------------------------------------------------------
[BAR GRAPH APPEARS HERE]
Net Income Return on Average
(In Thousands) Assets
1994 1995 1996* 1997 1994 1995 1996* 1997
---- ---- ----- ---- ---- ---- ----- ----
$5,589 $6,803 $7,661 $10,673 .80% .92% .97% 1.26%
*Excludes FDIC special assessment *Excludes FDIC special assessment
Return on Average
Equity
1994 1995 1996* 1997
---- ---- ----- ----
10.18% 11.47% 11.89% 16.39%
*Excludes FDIC special assessment
<PAGE>
Four Year Summary Of Selected Consolidated Financial Data
<TABLE>
<CAPTION>
At and for the Years Ended December 31, 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
<S> <C> <C> <C> <C>
Summary of Financial Condition:
Total assets $852,888 $829,800 $761,418 $727,243
Interest-earning deposits 13,301 15,270 22,654 10,524
Investment securities, net 26,080 31,093 55,109 88,712
Mortgage-backed securities, net 21,598 27,221 35,156 66,151
Loans receivable, net 754,806 717,715 610,284 518,591
Deposits 562,412 553,574 527,816 501,690
FHLB advances 212,693 202,639 160,649 160,351
Stockholders' equity 67,535 62,470 62,743 55,607
- ----------------------------------------------------------------------------------------------------
Summary of Operations:
Interest income $ 62,501 $ 57,402 $ 53,621 $ 47,080
Interest expense 37,131 34,498 33,188 26,978
- ----------------------------------------------------------------------------------------------------
Net interest income before provision for loan losses 25,370 22,904 20,433 20,102
Provision for loan losses 360 240 240 240
- ----------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 25,010 22,664 20,193 19,862
Other income 6,401 4,242 3,966 2,349
General and administrative expenses 15,762 15,669 14,427 14,473
FDIC special assessment -- 3,355 -- --
- ----------------------------------------------------------------------------------------------------
Income before federal income tax expense 15,649 7,882 9,732 7,738
Federal income tax expense 4,976 2,435 2,929 2,149
- ----------------------------------------------------------------------------------------------------
Net income $ 10,673 $ 5,447 $ 6,803 $ 5,589
- ----------------------------------------------------------------------------------------------------
Per Share Data: (1)
Basic earnings $ 1.39 $ 0.68 $ 0.84 $ 0.69
Diluted earnings 1.34 0.66 0.82 0.67
Stockholders' equity (book value) 8.88 8.04 7.76 6.91
- ----------------------------------------------------------------------------------------------------
Ratios and Other Data:
Interest rate spread 2.70% 2.63% 2.52% 2.69%
Net yield on average earning assets 3.06 2.98 2.85 2.98
Return on average assets 1.26 0.69 0.92 0.80
Return on average stockholders' equity 16.39 8.55 11.47 10.18
Average earning assets to average
interest-bearing liabilities 108.18 107.78 107.23 107.41
Efficiency ratio 51.42 58.13 60.73 64.51
General and administrative expenses
to average assets 1.87 1.98 1.95 2.08
Stockholders' equity to total assets 7.92 7.53 8.24 7.65
Nonaccruing loans and real estate
owned to total assets 0.12 0.24 0.08 0.44
Dividend payout ratio 31.71 41.28 28.38 30.14
Number of full-service offices 17 18 18 18
- ----------------------------------------------------------------------------------------------------
</TABLE>
(1) The financial information for per share amounts has been restated to reflect
the ten percent stock dividend declared May 20, 1997 and a 3-for-2 stock
split declared on November 18, 1997, as well as previous stock dividends
paid in 1996, 1995, and 1994 and a stock split distributed in 1993.
1
<PAGE>
Exceeding
Expectations
Our goal is to continuously exceed the expectations of our stockholders and our
customers in order to continually add value to our Bank and meet the financial
needs of our communities. Only by setting the highest standards of performance
in everything we do, and then achieving even greater results, can we expect to
remain the leading financial institution in mid-Michigan.
[PHOTOGRAPH OF ROBERT H. BECKER APPEARS HERE]
Robert H. Becker
President and
Chief Executive Officer
- -------------------
To Our Stockholders
- -------------------
GROWTH IN EARNING ASSETS, PROPER MANAGEMENT OF OUR COST OF FUNDS, NEW SOURCES OF
NON-INTEREST INCOME, AND CONTROLLED NON-INTEREST EXPENSE COMBINED TO MAKE 1997
ANOTHER VERY SUCCESSFUL YEAR FOR CFSB BANCORP, INC.
Managing a strong community bank in a changing and competitive industry is a
welcome challenge for all of us at Community First Bank. In 1997 the dedicated
teamwork of our employees and board of directors resulted in exceptional results
for our shareholders while delivering convenient products and services to our
growing customer base.
Net income for 1997 was $10.7 million, or $1.34 per share, compared to $5.4
million, or $0.66 per share, for 1996. Federal legislation to recapitalize the
Federal Deposit Insurance Corporation's (FDIC) Savings Association Insurance
Fund significantly impacted 1996 earnings. As a result, earnings were reduced
$2.2 million, or $0.27 per share. In addition, pre-tax earnings were favorably
impacted by net gains on asset sales of $1.1 million and $192,000 in 1997 and
1996, respectively.
Pre-tax core earnings for 1997, which exclude net gains on asset sales,
increased 32 percent over 1996 pre-tax core earnings, which exclude the 1996
special FDIC deposit premium assessment and net gains on asset sales. Total
assets climbed to $852.9 million at year-end 1997, an increase of $23.1 million
from $829.8 million at year-end 1996.
[GRAPHIC OF VINE APPEARS HERE BEHIND TEXT]
The Corporation's strong financial performance enabled us to declare a 10
percent stock dividend in May, announce a 3-for-2 stock split in November, and
increase our cash dividend during the year, concluding 1997 with the declaration
of our 28th consecutive quarterly cash dividend at an annualized rate of $0.48
per share.
On January 1, 1998, the Detroit News reported CFSB Bancorp, Inc. was one of
Michigan's Top Ten performers in stock price appreciation, with 121 percent
growth in 1997.
At December 31, 1997, our common stock closed at $26.25 per share. The average
annual return for the last three years was 87.51 percent.
To assist in our capital management, we continue our stock repurchase
programs. In our current program, we repurchased 141,035 shares of the 387,750
authorized shares at an average cost of $16.23 per share. We believe this
represents a very prudent investment and use of our capital.
A vigorous Michigan business climate has contributed to our growth. New and
existing businesses combined with mid-Michigan's three major employers--the
State of Michigan, General Motors, and Michigan State University--to produce a
growing and robust economy. Unemployment in Greater Lansing stood at 2.7 percent
in December 1997--the second lowest metropolitan rate in Michigan. All
indicators point to continued growth of business, jobs, and the diverse economic
strength of the region we serve.
Our success has been achieved, in part, from listening to our growing
community and responding with service options that fit its banking needs and
lifestyles. Our response has included continued investment in technology to
build relationships--making us more convenient and more accessible to our
customers.
There has been a significant amount of publicity recently about the Year 2000
and the problems that may
2
<PAGE>
be encountered with computers and computer software. At CFSB Bancorp, Inc. we
are taking appropriate actions to ensure the new millennium does not disrupt the
delivery of products and services to our customers.
OUR GOAL IS TO BUILD A LONG-LASTING RELATIONSHIP WITH EVERY CUSTOMER. Through
our branch office network we provide face-to-face service, a practice some other
financial institutions discourage. Customers can also speak to specialists over
the telephone through our Customer Service Center, which currently serves more
than 180,000 callers annually.
In 1997 we consolidated our two Okemos offices into a more modern and
convenient branch facility. We also expanded the capacity of our Mason office.
In 1998 we are improving other facilities and services, as well as building a
new Williamston office on its existing location.
For those customers who prefer to access our services where they live, work or
shop, we continue to place new 24-Hour ATM Banking Centers in convenient
locations. In addition, customers can access information and services on demand
anywhere, anytime, using our FirstLine Telephone Banking, Loan by Phone, and
Internet Web site, http://www.communityfirst.com.
Our rapidly growing ATM network is now processing over 1.2 million
transactions annually. To complement this service, last year we introduced our
new MoneyCard which combines ATM and debit card access and can be used directly
with merchants, eliminating the need for writing checks. These cards generated
over 800,000 transactions in 1997.
WE CONTINUE TO HOLD A STRONG MARKET SHARE IN BOTH DEPOSITS AND LOANS, AND WE
ARE, BY FAR, THE LARGEST LOCALLY OWNED AND CONTROLLED FINANCIAL INSTITUTION IN
OUR AREA. We are proud to report that 28 percent of the households in the
Greater Lansing area are customers of our Bank.
Community First is consistently the number one home mortgage lender in mid-
Michigan and the leading construction lender. We have built valuable
relationships with nearly 300 realtors in our communities. We continue to
finance newly constructed homes, serving over 200 approved builders. In 1997 we
helped more than 1,200 families purchase or build new homes, many who were
first-time home owners.
In the first quarter of 1997, we entered into a partnership with 14 mid-
Michigan banks to form a title insurance agency. We can now provide this service
to all of our loan customers.
Also during 1997, we formed a new subsidiary of Community First Bank--
Community First Insurance and Investment Services--to market annuities and
uninsured mutual funds to our customers. Currently 30 of our employees are
licensed to sell these products.
In 1995 we introduced Really Free Checking to our market. This account is
heavily promoted and continues to be very well received, leading to a 70 percent
increase in checking accounts since 1994.
THE "COMMUNITY" IN OUR NAME STANDS FOR OUR LEADERSHIP IN GIVING BACK TO THE
COMMUNITIES THAT SUPPORT OUR SUCCESS. Our employees are in the forefront of this
effort, serving as ambassadors for Community First Bank in charitable and civic
organizations throughout our communities. We are especially proud to support
housing initiatives that assist lower income families through activities related
to the Community Reinvestment Act.
For 1998 the pace of product introduction, service enhancement, and business
development will only accelerate. We pledge to continually evaluate and evolve
our entire product line and delivery system to ensure we are operating with the
most efficient and cost-effective methods. We also pledge to continue our market
leadership by providing a total banking solution to a growing family of
customers.
We are pleased with the recent U.S. Supreme Court decision regarding the
curtailment of the tax-exempt credit union growth. In concurring with this
ruling, we believe the large non-traditional credit unions should be taxed as
the full service financial institutions they have become, while leaving the
small traditional credit unions with their current tax-exempt status.
I would like to personally thank our retiring director, Donald F. Wall, for
his outstanding service to both CFSB Bancorp, Inc. and Community First Bank.
We are very pleased with CFSB Bancorp, Inc.'s strong financial performance for
1997. On the following pages you will find details of other priorities, products
and services we have in place to continue our profitability and value. As an
investor, your interest and support are very much a part of our success. Thank
you.
[GRAPHIC OF VINE APPEARS HERE BEHIND TEXT]
Sincerely yours,
/s/ Robert H. Becker
Robert H. Becker
President and
Chief Executive Officer
3
<PAGE>
[GRAPHIC OF VINE APPEARS HERE BEHIND TEXT]
- --------------------------------------------------------------------------------
FORMING LASTING
RELATIONSHIPS
By virtue of the superior banking products we offer and the unmatched quality of
our service, we expect to continue helping people achieve their financial goals.
From an individual's first checking account to their preparations for
retirement, Community First Bank plans to be there.
- --------------------------------------------------------------------------------
=================
MAKING BANKING
ACCESSIBLE
=================
AT COMMUNITY FIRST BANK, A WHOLLY-OWNED SUBSIDIARY OF CFSB BANCORP, INC., WE
WANT OUR CUSTOMERS TO BE ABLE TO BANK ANYWHERE, ANYTIME.
And we continually look for better delivery channels for customers to access our
bank at their convenience. At the same time, as the largest, independent
community bank in mid-Michigan, we aim to meet the needs of our customers who
prefer dealing with a familiar person in a branch office.
During 1997 our customers had more ways to bank with us than ever before.
They responded by using all delivery channels available to them and at record
levels.
Leading the growth of "on-demand" automated banking services is our
FirstLine Telephone Banking. Calls into this automated voice response system
rose dramatically in 1997, offering customers immediate access to their accounts
24 hours a day, seven days a week to transfer funds, check account balances,
calculate loan payments and much more.
In 1997, we expanded our telephone banking by adding Loan by Phone, a fully
automated, 24-hour, loan qualification program that allows customers to complete
a brief touch-tone questionnaire to initiate the loan process. We then follow up
the process with a personal call the next business day.
Our customers also embraced our MoneyCard, a combination ATM and debit card
introduced in 1996. With MoneyCard, customers can access their checking account
at over 12 million merchants nationwide, anywhere MasterCard is accepted. In
1997, debit card purchase transactions exceeded 800,000.
For many customers, the ATM is their 24-hour banking center of choice,
exceeding 1.2 million transactions in 1997. We continue to install ATMs in new
and current markets including high-traffic locations like the Meridian Mall in
Okemos. In 1998 our initial plans include installing several ATMs in grocery
stores in our DeWitt market, and at the downtown Lansing Center, the hub of
mid-Michigan's convention and trade show business.
[_] Use of our new MoneyCard quickly accelerated to 800,000 debit card
transactions per year.
[BAR GRAPH APPEARS HERE]
CUSTOMER SERVICE CENTER
1995 39,000
1996 114,000
1997 180,000
FIRSTLINE TELEPHONE
BANKING SERVICE
1995 71,000
1996 365,000
1997 664,000
DRIVE-UP TRANSACTIONS
1995 782,000
1996 1,045,000
1997 1,045,000
[_] Community First Bank served more customers, through more delivery channels,
than ever before--by phone, in person, and at the drive-up windows.
When customers need more one-on-one banking assistance with the convenience
of a telephone call, our Customer Service Center stands ready to assist them.
Staffed six days a week, our specialists answer questions, provide account
information, open new accounts and schedule sales appointments. Last year we
helped over 180,000 callers take care of their banking from the convenience of
their homes, cars, offices, hotel rooms and anywhere else they chose to make
their calls.
4
<PAGE>
[GRAPHIC OF VINE BEHIND TEXT APPEARS HERE]
[GRAPHIC OF CFSB WEB PAGE APPEARS HERE]
[_] Community First Bank's Web site provides product and service information 24
hours a day.
New and potential customers can now surf the 'Net to find complete
product and service information, rates, hours, and branch office locations at
http://www.communityfirst.com. Additional plans include adding functioning loan
applications and calculators to our site. Customers will be able to calculate
their payments and apply for a consumer or home mortgage loan at their
convenience. Community First Bank's home page is already linked to many
businesses in mid-Michigan including real estate companies and the residential
listing site hosted by the Lansing State Journal.
While advanced technologies produced dramatic increases in transactions and
income, many customers still prefer a traditional approach to banking. A warm
smile and a personal touch continue to be our most popular method of banking at
Community First. Our customers also visited our drive-through windows in record
numbers, topping the million mark for the second straight year.
[PHOTO APPEARS HERE]
[_] Six days a week, Customer Service Center banking specialists like Anna
Shipman, left, and Dawn Cutler provide friendly, one-on-one assistance over
the telephone.
By telephone, in person, at an automated teller machine (ATM), or on the
Web, Community First Bank serves more customers through more delivery channels
than ever before. We know today's customers demand service that is better,
faster and cheaper. They want the conveniences of automated services, and at the
same time they want "one-stop shopping" -- one place where they can buy mutual
funds, make deposits, and set up savings accounts for their children and
grandchildren.
In 1997 we formed our own insurance agency-- Community First Insurance and
Investment Services. We provide full service, on-line trading access to products
like individual securities, bonds, mutual funds, fixed and variable annuities,
and life insurance. We launched a direct marketing campaign to present our term
life insurance products to a wide customer audience.
[PHOTO APPEARS HERE]
[_] Sherrie Cooper, right, customer service specialist, Okemos office, is one of
a growing number of trained professionals advising customers about annuities
to help plan their financial futures.
Beyond products and services, we are dedicated to giving our customers the
information they need to make smart investment decisions. We regularly conduct
seminars on estate planning, pension distribution, and asset allocation. A new
seminar, "Women and Wealth," empowers women to understand and take charge of
their financial futures.
We are building a bank of the future by listening to our customers and
refining the way we deliver our products and services to them. At the same time,
we are constantly exploring new market opportunities to grow our customer base.
5
<PAGE>
[GRAPHIC OF VINE BEHIND TEXT APPEARS HERE]
[_] In 1997, more mid-Michigan families realized their dream of home ownership
with Community First Bank than any other financial institution.
[PHOTO APPEARS HERE]
COMMUNITY FIRST BANK CONTINUES TO BE MID-MICHIGAN'S #1 HOME MORTGAGE LENDER AND
THE RECOGNIZED LEADER IN CONSTRUCTION LOANS. It's a record we are proud of
because it means that every year we continue to help more families realize their
home ownership dreams than any other financial institution in mid-Michigan. Many
of these homebuyers begin their house shopping with new confidence thanks to our
Buyer's Edge mortgage pre-approval program. Buyer's Edge gives the customer an
advantage with the real estate community as well as sellers because they know up
front what they can afford, and they are already approved for that amount.
Buyer's Edge also gives us the opportunity to start a relationship with many
homebuyers just when they need it--at the beginning of the home-buying process.
In 1997 we helped over 1,200 families purchase homes.
Right from the start, we are building relationships with our mortgage
customers as they automatically qualify for a Homeowners' Checking account. And
we take every opportunity to provide them with other products such as our home
equity line of credit, mortgage life insurance, and investment services.
Also in 1997, we joined with 14 other mid-Michigan banks to form a title
insurance agency--Michigan Bankers Title of Mid-Michigan. The agency allows us
to provide competitive title insurance rates and more complete service to our
loan customers.
In our quest to build long-term relationships with consumers, builders and
realtors, we also took action to make sure we were operating as cost effectively
and as efficiently as possible. In 1997 we installed Loan Prospector, an
automated underwriting system that allows us to process loans quicker, and with
less paperwork. This technology enables us to increase our volume, and at the
same time, speed the approval process.
New products, combined with product enhancements, all helped to strengthen
our position. Auto financing and related secured loans increased in 1997 as we
continued to be a major full-service lender to mid-Michigan families and
businesses.
Home equity loans and lines of credit continued to grow in 1997, as
customers view equity in their homes as a means of buying autos, making home
repairs, consolidating debt, and financing college educations.
STEADY GROWTH IS COMMUNITY FIRST BANK'S HALLMARK. OUR DEPOSIT BASE CONTINUES TO
GROW, particularly since we introduced Really Free Checking to our market in
1995. Since that time, our checking accounts have increased by 70 percent as we
continue to be the leader in our market offering free checking. This product has
introduced us to thousands of new checking account customers. Now we are helping
them discover all of the other products and services Community First Bank can
provide them, from savings and investment services to home mortgages. It's our
way of building long-term customers.
Really Free Checking also helps to increase our relationships with local
college and university students. Each summer we direct mail to incoming Michigan
State University students before they arrive on campus. Then in the fall, we
launch an aggressive one-week campaign targeted to all students. With a major
university, two law schools, a community college and a business college, this
provides a tremendous opportunity for Community First Bank to expand our deposit
market share in mid-Michigan.
Our Power Rate Money Market account continues to be a successful product
attracting over $20 million since its introduction in the fourth
6
<PAGE>
[GRAPHIC OF VINE BEHIND TEXT APPEARS HERE]
[PHOTO OF MULTI-MEDIA CAMPAIGN APPEARS HERE]
[_] A multi-media campaign, including the billboard above, invites customers to
"Do the Math" and open a Really Free Checking account. Thousands have
accepted the invitation.
quarter of 1996. Power Rate offers customers a high yielding, liquid account
with a $25,000 minimum deposit. We continue to offer certificates of deposit
including a special 14-Month Bump CD, which features a competitive rate, and the
opportunity to move into a two-year product and increase the rate.
Equally important to competitive products and services is our evolving
sales culture. We expect more of our growth to come from existing markets
through business development. In 1998 our external sales force will focus on
prospecting new business as well as enhancing current relationships, both at the
consumer and small-business level.
Also recognizing the busy lifestyles of our customers today, and their
demand for convenience and immediate access to banking services, we constantly
analyze our delivery channels including our branch office network. In 1997 we
consolidated our two Okemos branch offices into one more convenient and modern
facility, and expanded our Mason branch office. Both of these offices now offer
enhanced drive-up window and ATM services to accommodate a growing customer
base. In 1998 we will also improve our Williamston branch office by rebuilding
this office on its current location. We continue to move toward full-service
financial centers.
AS THE LARGEST, INDEPENDENT LOCAL BANK IN MID-MICHIGAN, WE HAVE A STRONG
COMMUNITY ORIENTATION. At Community First Bank, we have always taken pride in
our relationships within the communities where we live and work. All our
decisions are made locally which means fast, efficient, personal service for our
customers. Our employees are at the forefront of our commitment to community
matters, taking great pride in their leadership roles with the Capital Area
United Way, American Cancer Society, the Children's Miracle Network, and dozens
of other giving organizations throughout mid-Michigan.
Employees who deserve a round of applause are Ellen Messer, the 1997 winner
of the President's Excellence Award, and the members of the Volunteer Activities
Group, winners of the 1997 Volunteer of the Year Award. These individuals are
wonderful examples of the way employees of Community First Bank grow special
relationships with our customers, with people in need, with the community we
serve. We are honored, every day, to work side by side with them.
Community banking is thriving in mid-Michigan, and will continue to prosper
within Community First Bank as long as customers prefer local decision making,
personal service, competitive products and the caring employees that make it all
happen.
[PHOTO APPEARS HERE]
[_] Ellen Messer, St. Johns office, received the 1997 President's Excellence
Award for outstanding customer service.
[PHOTO APPEARS HERE]
[_] The Volunteer Activities Group (some members not shown), 1997 Volunteer of
the Year Award winners, exemplify the commitment to community at Community
First Bank.
7
<PAGE>
[GRAPHIC OF VINE BEHIND TEXT APPEARS HERE]
CFSB BANCORP, INC., AND SUBSIDIARY
December 31, 1997
TABLE OF CONTENTS
Statement of Management's Responsibility....................................9
Five Year Summary of Consolidated Financial Data...........................10
Management's Discussion and Analysis of
Financial Condition and Results of Operations.........................11
Independent Auditors' Report...............................................23
Consolidated Statements of Financial Condition.............................24
Consolidated Statements of Operations......................................25
Consolidated Statements of Stockholders' Equity............................26
Consolidated Statements of Cash Flows......................................27
Notes to Consolidated Financial Statements.................................29
Stockholder Information....................................................54
8
<PAGE>
STATEMENT OF MANAGEMENT'S RESPONSIBILITY
The management of CFSB Bancorp, Inc. (the Corporation), and its wholly-owned
subsidiary Community First Bank, is responsible for the preparation of the
consolidated financial statements and other related financial information
included in the annual report. The consolidated financial statements have been
prepared in accordance with generally accepted accounting principles and include
amounts based on management's estimates and judgments where applicable. The
financial statements of the Bank, as filed with the Federal Deposit Insurance
Corporation (FDIC), have been prepared in accordance with the FDIC instructions
for Call Reports.
The Corporation maintains a system of internal controls to provide reasonable
assurance that assets are safeguarded and that transactions are executed in
accordance with management's authorization and are recorded properly to permit
the preparation of financial statements in accordance with generally accepted
accounting principles. Management continually monitors the internal control
structure for compliance with established policies and procedures. As an
integral part of the internal control system, the Corporation maintains a staff
of internal auditors who monitor compliance with internal controls and
coordinate audit coverage with the independent public accountants.
The Audit Committee of the board of directors, composed entirely of outside
directors, oversees the Corporation's financial reporting process and has
responsibility for recommending the independent public accountants who are
appointed by the board of directors to audit the Corporation's annual financial
statements.
The financial statements in this annual report have been audited by KMPG Peat
Marwick LLP.
The Audit Committee of the board of directors meets regularly with management,
internal auditors, independent public accountants and regulatory examiners to
review matters relating to financial reporting and internal controls. The
internal auditors, independent public accountants and regulatory examiners have
direct access to the Audit Committee.
The Corporation assesses its internal control structure over financial reporting
in relation to the criteria described in the "Internal Control--Integrated
Framework" issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on this assessment, management of the Corporation believes
that as of December 31, 1997, in all material respects, the Corporation
maintained an effective internal control structure over financial reporting.
/s/ Robert H. Becker
Robert H. Becker
President & Chief Executive Officer
/s/ John W. Abbott
John W. Abbott
Executive Vice President, Chief Operating Officer & Secretary
/s/ Rick L. Laber
Rick L. Laber
Vice President, Chief Financial Officer & Treasurer
9
<PAGE>
FIVE YEAR SUMMARY OF CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
At and for the Years Ended December 31, 1997 1996 1995 1994 1993
(Dollars in Thousands, Except Per Share Data)
====================================================================================================================
<S> <C> <C> <C> <C> <C>
Summary of Financial Condition:
Total assets $ 852,888 $ 829,800 $ 761,418 $ 727,243 $ 669,910
Interest-earning deposits 13,301 15,270 22,654 10,524 11,639
Investment securities, net 26,080 31,093 55,109 88,712 142,736
Mortgage-backed securities, net 21,598 27,221 35,156 66,151 107,712
Loans receivable, net 754,806 717,715 610,284 518,591 374,658
Deposits 562,412 553,574 527,816 501,690 526,218
FHLB advances 212,693 202,639 160,649 160,351 77,830
Stockholders' equity 67,535 62,470 62,743 55,607 54,835
====================================================================================================================
Summary of Operations:
Interest income $ 62,501 $ 57,402 $ 53,621 $ 47,080 $ 44,644
Interest expense 37,131 34,498 33,188 26,978 25,771
- --------------------------------------------------------------------------------------------------------------------
Net interest income before provision for loan losses 25,370 22,904 20,433 20,102 18,873
Provision for loan losses 360 240 240 240 240
- --------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 25,010 22,664 20,193 19,862 18,633
Other income 6,401 4,242 3,966 2,349 5,678
General and administrative expenses 15,762 15,669 14,427 14,473 14,672
FDIC special assessment -- 3,355 -- -- --
- --------------------------------------------------------------------------------------------------------------------
Income before federal income tax expense
and cumulative effect of accounting change 15,649 7,882 9,732 7,738 9,639
Federal income tax expense 4,976 2,435 2,929 2,149 2,947
- --------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of
accounting change 10,673 5,447 6,803 5,589 6,692
Cumulative effect of change in accounting
for postretirement benefits -- -- -- -- (436)
- --------------------------------------------------------------------------------------------------------------------
Net income $ 10,673 $ 5,447 $ 6,803 $ 5,589 $ 6,256
====================================================================================================================
Per Share Data: (1)
Basic earnings:
Before cumulative effect of accounting change $ 1.39 $ 0.68 $ 0.84 $ 0.69 $ 0.82
Net income 1.39 0.68 0.84 0.69 0.77
Diluted earnings:
Before cumulative effect of accounting change 1.34 0.66 0.82 0.67 0.79
Net income 1.34 0.66 0.82 0.67 0.74
Stockholders' equity (book value) 8.88 8.04 7.76 6.91 6.74
====================================================================================================================
Ratios and Other Data:
Interest rate spread 2.70% 2.63% 2.52% 2.69% 2.71%
Net yield on average earning assets 3.06 2.98 2.85 2.98 3.04
Return on average assets 1.26 0.69 0.92 0.80 0.96
Return on average stockholders' equity 16.39 8.55 11.47 10.18 12.02
Average earning assets to average
interest-bearing liabilities 108.18 107.78 107.23 107.41 107.92
Efficiency ratio 51.42 58.13 60.73 64.51 66.33
General and administrative expenses
to average assets 1.87 1.98 1.95 2.08 2.25
Stockholders' equity to total assets 7.92 7.53 8.24 7.65 8.19
Nonaccruing loans and real estate
owned to total assets 0.12 0.24 0.08 0.44 0.83
Dividend payout ratio 31.71 41.28 28.38 30.14 21.43
Number of full-service offices 17 18 18 18 18
====================================================================================================================
</TABLE>
(1) The financial information for per share amounts has been restated to reflect
the ten percent stock dividend declared May 20, 1997 and a 3-for-2 stock
split declared on November 18, 1997, as well as previous stock dividends
paid in 1996, 1995, and 1994 and a stock split distributed in 1993.
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following sections are designed to provide a more thorough discussion of the
Corporation's financial condition and results of operations as well as to
provide additional information on the Corporation's asset/liability management
strategies, sources of liquidity, and capital resources. Management's discussion
and analysis should be read in conjunction with the consolidated financial
statements and supplemental data contained elsewhere in this report.
General
CFSB Bancorp, Inc. (Corporation) is the holding company for Community First Bank
(Bank). Substantially all of the Corporation's assets are currently held in, and
operations conducted through its sole subsidiary, Community First Bank. The Bank
is a community-oriented financial institution offering a variety of financial
services to meet the needs of the communities it serves. The Bank's primary
market area is the Greater Lansing, Michigan area, which is comprised of the
tri-county area of Clinton, Eaton, and Ingham counties, the western townships of
Shiawassee County, and Ionia County. The Bank's business consists primarily of
attracting deposits from the general public and using such deposits, together
with Federal Home Loan Bank (FHLB) advances, to originate loans for the purchase
and construction of residential properties. To a lesser extent, the Bank also
makes income-producing property loans, commercial business loans, home equity
loans, and various types of consumer loans. The Bank's revenues are derived
principally from interest income on mortgage and other loans, mortgage-backed
securities, investment securities, and to a lesser extent, from fees and
commissions. The operations of the Bank, and the financial services industry
generally, are significantly influenced by general economic conditions and
related monetary and fiscal policies of financial institution regulatory
agencies. Deposit flows and cost of funds are impacted by interest rates on
competing investments and market rates of interest. Lending activities are
affected by the demand for financing of real estate and other types of loans,
which in turn is affected by the interest rates at which such financing is
offered.
Financial Condition
The Corporation's total assets increased to $852.9 million at December 31, 1997
from $829.8 million at December 31, 1996. Most of the growth occurred in loans,
which was funded by an increase in deposits and FHLB advances, as well as
repayments on mortgage-backed securities and maturities of investments.
Net loans receivable increased to $754.8 million at December 31, 1997 from
$717.7 million at December 31, 1996. This net growth of $37.1 million occurred
primarily through growth in mortgages of $28.7 million, consumer loans of $9.7
million, and commercial loans of $0.5 million, partially offset by a decrease in
income-producing property loans of $1.8 million. The Corporation originated
$206.0 million of loans in 1997, compared to $226.6 million in 1996. Single
family mortgage loan originations in 1997 were $142.3 million, compared to
$164.6 million for 1996. During 1997 and 1996, the Corporation sold primarily
fixed-rate loans aggregating $46.8 million and $32.0 million, respectively. The
Corporation purchased loans consisting of one-to-four family residential, fixed-
and adjustable-rate loans from an unaffiliated financial institution. These
purchases, totalling $27.8 million and $31.7 million in 1997 and 1996,
respectively, are used to supplement and complement the Corporation's own
mortgage loan production.
Deposits increased $8.8 million to $562.4 million at December 31, 1997 from
$553.6 million at December 31, 1996. This growth occurred through an increase in
savings accounts of $3.7 million, an increase in checking accounts of $5.0
million, and an increase in certificates of deposit of $0.1 million.
FHLB advances increased $10.1 million to $212.7 million at December 31,
1997 from $202.6 million at December 31, 1996. The net increase was composed of
an increase in fixed-rate advances of $50.8 million, partially offset by a
decline in adjustable-rate advances of $40.7 million. The use of fixed-rate
advances increased as management continues to take steps to reduce interest rate
risk.
Total stockholders' equity was $67.5 million at December 31, 1997, a $5.0
million increase, compared to the 1996 year end total of $62.5 million. The
increase was primarily the result of net income for 1997, offset in part by
dividend declarations and treasury stock purchases.
11
<PAGE>
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997,
COMPARED TO THE YEAR ENDED DECEMBER 31, 1996
Net income for the year ended December 31, 1997 was $10.7 million, or $1.34 per
diluted share, compared to $5.4 million, or $0.66 per diluted share for 1996, a
net increase of $5.3 million. Earnings for 1996 were significantly impacted by a
nonrecurring, pre-tax charge of $3.4 million resulting from federal legislation
to recapitalize the Federal Deposit Insurance Corporation's (FDIC) Savings
Association Insurance Fund (SAIF). As a result of this charge, 1996 after-tax
earnings were reduced $2.2 million, or $0.27 per diluted share.
Pre-tax core earnings for 1997 increased 32 percent over 1996 pre-tax core
earnings. Principally accounting for the increase in pre-tax core earnings
between years was significant growth in the Corporation's net interest margin
and improved fee income.
The following table reconciles net income to pre-tax core earnings:
<TABLE>
<CAPTION>
1997 1996
(Dollars in Thousands)
================================================================================
<S> <C> <C>
Net income $ 10,673 $ 5,447
Federal income tax expense 4,976 2,435
Net gains on loan and security sales (614) (192)
Net gains on sales of branches (506) --
FDIC special assessment -- 3,355
- -------------------------------------------------------------------------------
Pre-tax core earnings $ 14,529 $ 11,045
================================================================================
</TABLE>
Net income for 1997 represents a return on average assets of 1.26 percent,
an increase from 0.69 percent for 1996 and a return on average stockholders'
equity of 16.39 percent compared to 8.55 percent for 1996. The Corporation's
efficiency ratio, or recurring operating expenses over recurring operating
revenues, was 51.4 percent for the year ended December 31, 1997, an improvement
from 58.1 percent for the year ended December 31, 1996.
Net Interest Income
The most significant component of the Corporation's earnings is net interest
income, which is the difference between interest earned on loans,
mortgage-backed securities, investment securities and other earning assets, and
interest paid on deposits and FHLB advances. This amount, when divided by
average earning assets, is referred to as the net yield on average earning
assets. Net interest income and net yield on average earning assets are directly
impacted by changes in volume and composition of earning assets and
interest-bearing liabilities, market rates of interest, the level of
nonperforming assets, demand for loans, and other market forces.
12
<PAGE>
Analysis of Net Interest Income
The following table sets forth, for the periods indicated, information
regarding: (i) the total dollar amount of interest income from average earning
assets and the resultant average yields; (ii) the total dollar amount of
interest expense on average interest-bearing liabilities and the resultant
average cost; (iii) net interest income; (iv) interest rate spread; and (v) net
yield on average earning assets. Average balances are based on daily average
balances.
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------
Interest Interest Interest
Average Earned/ Yield/ Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
(Dollars in Thousands)
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Earning Assets:
Loans receivable (1) $747,060 $ 57,570 7.71% $674,437 $ 51,612 7.65% $566,249 $ 44,449 7.85%
Mortgage-backed securities 24,144 1,769 7.32 30,714 2,342 7.62 60,789 4,188 6.89
Investment securities 28,452 1,689 5.94 38,848 2,189 5.63 71,191 3,862 5.43
Interest-earning deposits
with FHLB and other
depository institutions 15,836 523 3.30 14,598 465 3.18 9,122 374 4.10
Other 12,433 950 7.64 10,680 794 7.44 9,918 748 7.55
- ------------------------------------------------------------------------------------------------------------------------------
Total earning assets 827,925 62,501 7.55 769,277 57,402 7.46 717,269 53,621 7.48
- ------------------------------------------------------------------------------------------------------------------------------
Interest-bearing Liabilities:
Savings, checking, and money
market accounts (2) 235,475 5,930 2.52 217,316 5,435 2.50 207,635 5,802 2.79
Certificates of deposit (2) 322,998 18,547 5.74 319,491 18,403 5.76 310,253 18,008 5.80
FHLB advances 206,826 12,654 6.12 176,943 10,660 6.02 150,998 9,378 6.21
- ------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 765,299 37,131 4.85 713,750 34,498 4.83 668,886 33,188 4.96
- ------------------------------------------------------------------------------------------------------------------------------
Excess earning assets $ 62,626 $ 55,527 $ 48,383
- ------------------------------------------------------------------------------------------------------------------------------
Net interest income $ 25,370 $ 22,904 $ 20,433
- ------------------------------------------------------------------------------------------------------------------------------
Interest rate spread (3) 2.70% 2.63% 2.52%
- ------------------------------------------------------------------------------------------------------------------------------
Net yield on average
earning assets (4) 3.06% 2.98% 2.85%
- ------------------------------------------------------------------------------------------------------------------------------
Average earning assets to average
interest-bearing liabilities 108.18% 107.78% 107.23%
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) The average balance for loans receivable includes average balances for
nonaccrual loans. The amortization of loan fees, net of capitalized costs,
is included as an adjustment to yield but does not significantly affect the
yield calculation.
(2) Interest expense includes the cost of the Bank's interest rate exchange
agreements in 1996 and 1995.
(3) Represents the weighted average yield on earning assets for the year less
the weighted average cost of interest-bearing liabilities for the year.
(4) Net interest income divided by average outstanding balances of earning
assets.
13
<PAGE>
The following table presents information concerning yields on the
Corporation's earning assets and costs of the Corporation's interest-bearing
liabilities, the interest rate spread, and the net yield on earning assets at
the dates and for the periods indicated. Yields and costs for the periods were
computed using daily average balances.
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------
For the Year End of Year For the Year End of Year For the Year End of Year
==========================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Weighted Average Yield:
Loans receivable (1) 7.71% 7.71% 7.65% 7.60% 7.85% 7.75%
Mortgage-backed securities 7.32 8.00 7.62 7.82 6.89 7.86
Investment securities 5.94 6.02 5.63 5.89 5.43 5.37
Interest-earning deposits with
FHLB and other depository
institutions 3.30 3.31 3.18 4.93 4.10 4.92
Other 7.64 7.90 7.44 7.55 7.55 7.61
- --------------------------------------------------------------------------------------------------------------------------
Total earning assets 7.55 7.57 7.46 7.47 7.48 7.49
==========================================================================================================================
Weighted Average Cost:
Savings, checking, and money
market accounts (2) 2.52 2.60 2.50 2.65 2.79 2.76
Certificates of deposit (2) 5.74 5.83 5.76 5.73 5.80 5.97
FHLB advances 6.12 6.09 6.02 5.97 6.21 6.02
- --------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 4.85 4.91 4.83 4.86 4.96 5.00
==========================================================================================================================
Interest rate spread (3) 2.70% 2.66% 2.63% 2.61% 2.52% 2.49%
==========================================================================================================================
Net yield on earning assets (4) 3.06% 3.02% 2.98% 2.95% 2.85% 2.81%
==========================================================================================================================
</TABLE>
(1) The amortization of loan fees, net of capitalized costs, is included as an
adjustment to yield but does not significantly affect the yield calculation.
(2) Includes the effect of the applicable interest rate exchange agreements.
(3) Represents the weighted average yield on earning assets less the weighted
average cost of interest-bearing liabilities.
(4) Net yield on earning assets for the period represents net interest income
divided by average earning assets. Net yield on earning assets at the period
represents net interest income computed using the end of period balance and
rate, divided by earning assets at the end of the period.
Net interest income before provision for loan losses was $25.4 million
during 1997, a $2.5 million increase from $22.9 million during 1996. Net
interest income was positively affected by higher loan rates in 1997 and strong
growth in earning assets. The Corporation's net yield on average earning assets
was 3.06 percent for 1997, an improvement from 2.98 percent for 1996. A shift in
the composition of average earning assets from lower yielding, more liquid
assets toward higher earning, longer term assets also contributed to an improved
net interest margin. Average loans receivable were $747.1 million in 1997,
representing growth of 10.8 percent over average loans receivable of $674.4
million in 1996. The increased level of loans outstanding resulted from
originations of adjustable-rate mortgage loans and purchases of adjustable- and
fixed-rate, medium-term mortgage loans, all of which are held in the
Corporation's portfolio. Because the Corporation is liability sensitive,
pressure may be felt on the Corporation's net interest margin if short-term
market interest rates rise or if long-term mortgage rates fall.
The future trend of the Corporation's net interest margin and net interest
income may further be impacted by the level of mortgage loan originations,
purchases, repayments, refinancings, and sales, and a resulting change in the
composition of the Corporation's earning assets. The relatively flat yield curve
during late 1997 resulted in a shift toward more customers exhibiting a
preference for fixed-rate mortgage loans, many of which were originated for sale
in the secondary market. In late 1997, customers began converting adjustable
rate mortgage loans to 30-year fixed-rate loans, which are sold in the secondary
market. The average net interest margin for 1997 was 3.06 percent. The net
interest margin at December 31, 1997 was 3.02 percent. A continued high level of
refinancings and conversions of adjustable-rate mortgage loans to 30-year
fixed-rate loans could have a negative impact on future net interest income.
Additional factors affecting the Corporation's net interest income will continue
to be the volatility of interest rates, slope of the yield curve, asset size,
maturity/repricing activity, and competition.
14
<PAGE>
Rate/Volume Analysis of Net Interest Income
The following table presents the dollar amount of changes in interest income and
interest expense for major components of earning assets and interest-bearing
liabilities, distinguishing between changes related to outstanding balances and
changes due to interest rates. For each category of earning assets and
interest-bearing liabilities, information is provided on changes attributable
to: (i) changes in rate (i.e., changes in rate multiplied by prior volume); and
(ii) changes in volume (i.e., changes in volume multiplied by prior rate). 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 the change due to rate.
<TABLE>
<CAPTION>
Years Ended December 31, 1997 vs 1996 1996 vs 1995
- -------------------------------------------------------------------------------------------------------------
Increase (Decrease) Due to Increase (Decrease) Due to
Volume Rate Total Volume Rate Total
(Dollars in Thousands) (Dollars in Thousands)
=============================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Interest Income
Loans receivable $ 5,554 $ 404 $ 5,958 $ 8,319 $(1,156) $ 7,163
Mortgage-backed securities (484) (89) (573) (2,251) 405 (1,846)
Investment securities (614) 114 (500) (1,811) 138 (1,673)
Interest-earning deposits with FHLB
and other depository institutions 40 18 58 188 (97) 91
Other 134 22 156 57 (11) 46
- -------------------------------------------------------------------------------------------------------------
Total interest income 4,630 469 5,099 4,502 (721) 3,781
=============================================================================================================
Interest Expense
Savings, NOW, and money
market accounts 452 43 495 259 (626) (367)
Certificates of deposit 207 (63) 144 522 (127) 395
FHLB advances 1,815 179 1,994 1,575 (293) 1,282
- -------------------------------------------------------------------------------------------------------------
Total interest expense 2,474 159 2,633 2,356 (1,046) 1,310
=============================================================================================================
Net interest income $ 2,156 $ 310 $ 2,466 $ 2,146 $ 325 $ 2,471
=============================================================================================================
</TABLE>
Provision for Loan Losses
The allowance for loan losses, established through provisions for losses charged
to expense, is increased by recoveries of loans previously charged off and
reduced by charge-offs of loans. The provision for loan losses was $360,000 and
$240,000 during 1997 and 1996, respectively.
The Corporation maintains the allowance for loan losses at a level
determined to be adequate by management based on a review of the loan portfolio.
While management uses available information to determine the allowance for
losses on loans, future additions to the allowance may be necessary based on
changes in economic conditions and borrower circumstances. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Corporation's allowance for losses on loans. Such
agencies may require the Corporation to record additions to the allowance based
on their judgments about information available to them at the time of their
examination.
For more information on the Corporation's allowance for loan losses and
activity therein, reference is made to "Asset Quality."
15
<PAGE>
Other Income
Other income, a significant component of the Corporation's earnings, was $6.4
million for the year ended December 31, 1997, an increase of $2.2 million
compared to $4.2 million for the year ended December 31, 1996. The increase in
other income resulted primarily from an increase in service charges and other
fees of $847,000. The increase in service charges and fees results from higher
fees assessed on a higher level of accounts and transaction account activity.
Net gains on sales of loans and securities increased $421,000 compared to 1996.
During 1997, other income included nonrecurring net gains on the sales of three
branches totalling $506,000. Debit cards were introduced in April 1996 and
income from debit cards increased $199,000 in 1997.
General and Administrative Expenses
Earnings for 1996 were significantly impacted by a nonrecurring, pre-tax charge
of $3.4 million to recapitalize the FDIC's SAIF. General and administrative
expenses in 1997 were $15.8 million, compared to $15.7 million in 1996,
excluding the FDIC special assessment of $3.4 million. Compensation and fringe
benefits expense rose $416,000 between periods as a result of merit-based salary
adjustments, an increased provision for the management incentive program,
employee bonuses paid in 1997, and unallocated ESOP dividends used to reduce
1996 ESOP expense. Furniture and equipment depreciation decreased $288,000
compared to 1996 primarily as a result of certain computer equipment becoming
fully depreciated in 1997. FDIC insurance, $796,000 lower in 1997, reflects the
lower premium of 6.3 cents per $100 of domestic deposits versus 23 cents per
$100 of domestic deposits in 1996. Michigan single business tax was $214,000
higher in 1997 due to higher taxable income and higher compensation. Various
other costs were higher in 1997 due to a larger customer base and higher
transaction volumes.
Federal Income Tax Expense
Federal income tax expense was $5.0 million for the year ended December 31,
1997, compared to $2.4 million for 1996. The Corporation's federal income tax
expense is, for the most part, recorded at the federal statutory rate less a pro
rata portion of the anticipated low-income housing tax credits expected to be
available based upon the Corporation's limited partnership investments.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1996,
COMPARED TO THE YEAR ENDED DECEMBER 31, 1995
Net income for the year ended December 31, 1996 was $5.4 million, or $0.66 per
diluted share, compared to $6.8 million, or $0.82 per diluted share for 1995, a
net decrease of $1.4 million. Earnings were significantly impacted by a
nonrecurring, pre-tax charge of $3.4 million resulting from federal legislation
to recapitalize the FDIC's SAIF. As a result of this charge, 1996 after-tax
earnings were reduced $2.2 million, or $0.27 per diluted share. Other components
of income also varied significantly from year to year.
Net Interest Income
Net interest income for 1996 was $22.9 million, compared to $20.4 million for
1995. Interest rate spread increased to 2.63 percent in 1996 from 2.52 percent
in 1995 and net yield on average earning assets was 2.98 percent, compared to
2.85 percent for 1995. Net interest income for 1996 increased due to 1) a $52.0
million increase in average earning assets, partially offset by a $44.9 million
increase in average interest bearing liabilities and 2) a 13 basis point
decrease in cost of funds, partially offset by a 2 basis point decrease in yield
on funds. The $2.5 million increase in net interest income is summarized as
follows: net volume increases contributed $2.2 million and net rate increases
contributed $0.3 million to the net interest income increase over 1995.
16
<PAGE>
Provision for Loan Losses
The provision for loan losses was $240,000 during both 1996 and 1995. The
Corporation maintains the allowance for loan losses at a level determined to be
adequate by management based on a review of the loan portfolio. Factors
considered in this review include the historical loss experience, recovery
levels of loans previously charged off, the financial condition of the
borrowers, the perceived risk exposure among loan types, delinquency rates, and
present and projected economic conditions, as well as other relevant factors.
While the allowance for loan losses increased to $4.6 million at December
31, 1996, compared to $4.4 million at December 31, 1995, the Corporation's level
of nonperforming assets as a percentage of total assets increased from 0.08
percent at December 31, 1995 to 0.24 percent at December 31, 1996, and the
allowance for loan losses as a percentage of total loans as of December 31, 1996
declined to 0.62 percent compared to 0.69 percent at December 31, 1995. The
ratio of net loan charge-offs to average loans outstanding during the years
ended December 31, 1996 and 1995 was 0.01 percent and 0.00 percent,
respectively.
Other Income
Other income, a significant component of the Corporation's earnings, was $4.2
million for the year ended December 31, 1996, an increase of $0.2 million
compared to $4.0 million for the year ended December 31, 1995. Growth in other
income resulted principally from $769,000 more in deposit fees assessed on a
higher level of transaction account activity. Although offset in part by
lower-of-cost or market adjustments on loans intended for sale in the secondary
market, increased gains on loan sales, including the impact of adopting
Statement of Financial Accounting Standards No. 122, Accounting for Mortgage
Servicing Rights, an amendment of FASB Statement No. 65 (SFAS 122), also
contributed to the higher level of other income. Partially offsetting these
increases in other income were decreased servicing income resulting from lower
balances of loans serviced for other parties and the amortization of capitalized
mortgage servicing costs. In addition, a $587,000 nonrecurring gain on the sale
of real estate owned was recognized in 1995.
General and Administrative Expenses
Earnings in 1996 were significantly impacted by a nonrecurring, pre-tax charge
of $3.4 million to recapitalize the FDIC's SAIF. Excluding the FDIC special
assessment of $3.4 million, general and administrative expenses were $15.7
million for 1996, up $1.3 million compared to $14.4 million for 1995.
Compensation and fringe benefits expense rose $204,000 between periods as a
result of merit-based salary increases, an increased provision for the
management incentive program, and increased employment taxes on a higher
compensation base partly offset by the effect of fewer full-time equivalent
employees. Furniture and equipment depreciation increased $374,000, or 48
percent, over 1995 primarily as a result of accelerating the depreciation on
computer equipment to more closely reflect the estimated remaining lives of this
equipment. Marketing expense also increased over 1995 as the result of the
continued promotion of the Corporation's checking account products. In addition,
the expanded account base resulted in more operating losses than in the prior
year.
Federal Income Tax Expense
Federal income tax expense was $2.4 million for the year ended December 31,
1996, compared to $2.9 million for 1995. The reduction reflects the tax benefit
of the FDIC special assessment. The Corporation's federal income tax expense is,
for the most part, recorded at the federal statutory rate of 34 percent less a
pro rata portion of the anticipated low-income housing tax credits expected to
be available based upon the Corporation's limited partnership investments.
Asset Quality
The following table presents the Corporation's nonperforming assets. Management
normally considers loans to be nonperforming when payments are 90 days or more
past due, when credit terms are renegotiated below market levels, or when an
analysis of an individual loan indicates that repossession of the collateral may
be necessary to satisfy the loan.
17
<PAGE>
December 31, 1997 1996
(Dollars in Thousands)
===============================================================================
=Nonaccruing Loans:
One-to-four family residential mortgages $ 697 $ 892
Income-producing property -- 359
FHA-partially insured and VA-partially guaranteed 109 183
Commercial -- 195
Consumer installment 93 158
- -------------------------------------------------------------------------------
Total $ 899 $1,787
===============================================================================
Percentage of total assets 0.10% 0.21%
===============================================================================
Real Estate Owned:(1)
One-to-four family residential $ 11 $ 205
Construction and development 141 7
- -------------------------------------------------------------------------------
Total $ 152 $ 212
===============================================================================
Percentage of total assets 0.02% 0.03%
===============================================================================
Total nonaccruing loans and real estate owned $1,051 $1,999
===============================================================================
Percentage of total assets 0.12% 0.24%
===============================================================================
(1) Real estate owned includes properties in redemption and acquired through
foreclosure.
The following is a summary of the Corporation's loan and real estate owned
loss experience from December 31, 1994 through December 31, 1997. The ratio of
net loan charge-offs to average loans outstanding during the years ended
December 31, 1997 and 1996, was 0.03 percent and 0.01 percent, respectively.
REAL
LOANS ESTATE TOTAL
================================================================================
Balance at December 31, 1994 $ 4,123,918 $ 75,973 $ 4,199,891
Provision for losses 240,000 120,000 360,000
Charges against the allowance (55,107) (34,614) (89,721)
Recoveries 54,328 62,218 116,546
- --------------------------------------------------------------------------------
Balance at December 31, 1995 4,363,139 223,577 4,586,716
Provision for losses 240,000 60,000 300,000
Charges against the allowance (76,528) (187,214) (263,742)
Recoveries 36,983 115,796 152,779
- --------------------------------------------------------------------------------
Balance at December 31, 1996 4,563,594 212,159 4,775,753
Provision for losses 360,000 45,000 405,000
Charges against the allowance (247,432) (247,080) (494,512)
Recoveries 54,245 142,548 196,793
- --------------------------------------------------------------------------------
Balance at December 31, 1997 $ 4,730,407 $ 152,627 $ 4,883,034
================================================================================
While the $4.7 million allowance for loan losses at December 31, 1997 grew
from $4.6 million at December 31, 1996, the allowance for loan losses as a
percentage of total loans as of December 31, 1997 declined slightly to 0.61
percent compared to 0.62 percent at December 31, 1996. Nonperforming assets as a
percentage of total assets were 0.24 percent at December 31, 1996, and decreased
to 0.12 percent at December 31, 1997. The ratio of net loan charge-offs to
average loans outstanding was 0.03 percent, and 77.4 percent of the growth in
loans receivable in 1997 was in mortgages, which tend to have a lower risk of
loss than other lending.
Management believes the current provisions and related allowances for loan
and real estate owned losses are adequate to meet current and potential credit
risks in the current loan and real estate owned portfolios, although there can
be no assurances the related allowances may not have to be increased in the
future.
18
<PAGE>
Market Risk
Derivative financial instruments include futures, forwards, interest rate swaps,
option contracts and other financial instruments with similar characteristics.
The Corporation currently does not enter into futures, forwards, swaps, or
options. However, the Corporation is party to financial instruments with
off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit and standby letters of credit. These instruments involve to
varying degrees elements of credit and interest rate risk in excess of the
amount recognized in the consolidated balance sheets. Commitments to extend
credit are agreements to lend to a customer as long as there is no violation of
any condition established in the contract. Commitments generally have fixed
expiration dates and may require collateral from the borrower if deemed
necessary by the Corporation. Standby letters of credit are conditional
commitments issued by the Corporation to guarantee the performance of a customer
to a third party up to a stipulated amount and with specified terms and
conditions.
Commitments to extend credit and standby letters of credit are not recorded
as an asset or liability by the Corporation until the instrument is exercised.
The Bank's exposure to market risk is reviewed on a regular basis by the
Asset/Liability Committee (See "Asset/Liability Management"). Interest rate risk
is the potential for economic losses due to future interest rate changes. These
economic losses can be reflected as a loss of future net interest income and/or
a loss of current fair market values. The objective is to measure the effect on
net interest income and to adjust the balance sheet to minimize the inherent
risk while at the same time maximize income. Management realizes certain risks
are inherent and the goal is to identify and minimize the risks. Tools used by
management include the standard GAP report and an interest rate shock simulation
report. The Bank has no market risk sensitive instruments held for trading
purposes. The condensed GAP report summarizing the Bank's interest rate
sensitivity is presented under "Asset/Liability Management."
Asset/Liability Management
The operating results of the Corporation are dependent, to a large extent, upon
its net interest income, which is the difference between its interest income
from interest-earning assets, such as loans, mortgage-backed securities and
investment securities, and interest expense on interest-bearing liabilities,
such as deposits and FHLB advances.
The Corporation's current asset/liability management objective is to
provide an acceptable balance between interest rate risk, credit risk, and
maintenance of yield. The principal operating strategy of the Corporation has
been to manage the repricing of its interest-sensitive assets and liabilities
and manage the sensitivity of the Corporation's earnings to changes in interest
rates. The Corporation generally implemented this strategy by: (i) originating
and retaining adjustable-rate mortgages; (ii) originating construction and
consumer loans which typically have shorter terms to maturity or repricing than
long-term, fixed-rate residential mortgages; (iii) maintaining liquidity levels
adequate to allow flexibility in reacting to the interest rate environment; and
(iv) selling upon origination certain long-term, fixed-rate residential
mortgages in the secondary mortgage market.
The following table sets forth the interest rate sensitivity of the
Corporation's interest-earning assets and interest-bearing liabilities at
December 31, 1997. One indicator used to measure interest rate risk is the
one-year gap which represents the difference between interest-earning assets
which mature or reprice within one year and interest-bearing liabilities which
mature or reprice within one year. The Corporation's one-year gap was a negative
10.4 percent at December 31, 1997, compared to a negative 9.3 percent at
December 31, 1996, and the Corporation's three-to-five-year gap was a negative
1.5 percent at December 31, 1997, compared to a negative 1.9 percent at December
31, 1996. Fixed-rate loans and mortgage-backed securities are shown on the basis
of contractual amortization adjusted for prepayments at rates estimated by
available industry sources. Adjustable-rate loans and investment and
mortgage-backed securities are determined to reprice at the earlier of maturity,
call date or the next contractual repricing date. The allocation of savings,
checking, and money market account balances between the various
maturity/repricing periods is based on anticipated withdrawals and/or repricing
practices. The assumptions used should not be regarded as indicative of the
actual prepayments and withdrawals which may be experienced by the Corporation.
FHLB advances that are putable by the FHLB are assumed to mature/reprice at the
first put date.
19
<PAGE>
The data presented in the table represent a static measure of assets and
liabilities maturing over various time periods. The table does not necessarily
indicate the impact of general interest rate movements on the Corporation's net
yield, because the repricing of certain categories of assets and liabilities is
subject to competitive and other pressures beyond the Corporation's control. As
a result, certain assets and liabilities indicated as maturing or otherwise
repricing within a stated period may, in fact, mature or reprice at different
times or at different volumes.
MATURITY/RATE SENSITIVITY
<TABLE>
<CAPTION>
At December 31, 1997
- -------------------------------------------------------------------------------------------------------------------------------
0-6 7-12 1-3 3-5 Over 5
Months Months Years Years Years Total
(Dollars in Thousands)
===============================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Assets:
First mortgage loans $ 116,924 $ 100,665 $ 246,544 $ 111,874 $ 114,059 $ 690,066
Second mortgage and other loans 43,286 7,353 9,222 5,263 4,346 69,470
Mortgage-backed securities 12,500 2,636 6,461 -- -- 21,597
Investment securities 9,998 14,055 -- 2,027 -- 26,080
Other 13,301 -- -- -- -- 13,301
- -------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets 196,009 124,709 262,227 119,164 118,405 820,514
Noninterest earning assets 32,374
- -------------------------------------------------------------------------------------------------------------------------------
Total assets $ 852,888
===============================================================================================================================
Liabilities and Stockholders' Equity:
Savings 6,452 5,676 9,712 7,706 33,520 $ 63,066
Checking 7,746 6,155 12,731 3,406 7,565 37,603
Money market 53,693 9,886 5,607 50,447 -- 119,633
Certificates of deposit 139,791 104,098 64,891 14,725 839 324,344
Advances from Federal
Home Loan Bank 16,144 56,209 98,246 40,874 1,220 212,693
- -------------------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities 223,826 182,024 191,187 117,158 43,144 757,339
Stockholders' equity and
noninterest bearing liabilities 95,549
- -------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $ 852,888
===============================================================================================================================
Rate Sensitivity GAP and Ratios:
GAP for period (interest-earning assets
less interest-bearing liabilities) $ (27,817) $ (57,315) $ 71,040 $ 2,006 $ 75,261 $ 63,175
- -------------------------------------------------------------------------------------------------------------------------------
Cumulative gap $ (27,817) $ (85,132) $ (14,092) $ (12,086) $ 63,175 --
===============================================================================================================================
GAP as a percentage of
interest-earning assets -3.39% -6.99% 8.66% 0.25% 9.17% 7.70%
- -------------------------------------------------------------------------------------------------------------------------------
Cumulative gap as a percentage of
interest-earning assets -3.39% -10.38% -1.72% -1.47% 7.70% --
===============================================================================================================================
Cumulative gap at December 31, 1996 -6.89% -9.29% -5.61% -1.92% 8.04% --
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Average Estimated
Total Interest Rate Fair Value
===============================================================================================================================
<S> <C> <C> <C>
Assets:
Loans $759,536 7.71% $771,000
Securities 47,677 6.91 48,000
Other 13,301 3.39 13,000
Liabilities:
Deposits 544,646 4.47 546,000
FHLB Advances 212,693 6.09 214,000
===============================================================================================================================
</TABLE>
20
<PAGE>
Liquidity
The Bank has no regulatory mandated minimum liquidity requirements. Management's
intention is to maintain average short-term liquid assets each quarter of 3.0
percent of net withdrawable deposit accounts plus borrowings payable in one year
or less. The Bank's short-term liquidity ratio was 7.32 percent and 4.01 percent
at December 31, 1997 and December 31, 1996, respectively. Although the liquidity
ratio fluctuates, the ratio has been consistently maintained above minimum
targeted levels.
The Bank's principal sources of funds are deposits, principal and
interest payments on loans, sale of loans, maturities of securities, securities
available for sale and FHLB advances. All of the securities held in portfolio
are available for sale, thereby increasing the Bank's flexibility with respect
to such securities. While scheduled loan repayments and maturing investments are
relatively predictable, deposit flows and early loan prepayments are more
influenced by interest rates, general economic conditions, and competition.
As of September 30, 1996, based upon liquidity and interest rate
considerations, management determined it could no longer assert its intention to
hold all mortgage-backed securities until maturity. Therefore, the entire
mortgage-backed securities portfolio totalling $28.6 million was reclassified to
an available-for-sale classification. As a result, the Corporation intends to
classify any investment or mortgage-backed securities currently held or
purchased in the two years subsequent to September 30, 1996 as available for
sale.
Capital Resources
The Bank is subject to capital asset requirements in accordance with Bank
regulations. Community First Bank's regulatory capital ratios are well in excess
of minimum capital requirements specified by federal banking regulations. The
Bank's tangible, core, and risk-based capital ratios were 7.63 percent, 7.63
percent, and 13.77 percent at December 31, 1997, respectively.
The Corporation's cash dividend policy is continually reviewed by
management and the board of directors. The Corporation currently intends to
continue its policy of paying quarterly dividends; however, such payments will
depend upon a number of factors, including capital requirements, regulatory
limitations, the Corporation's financial condition and results of operation, and
the Bank's ability to pay dividends to the Corporation. Presently, the
Corporation has no significant source of income other than dividends from the
Bank. Consequently, the Corporation depends upon dividends from the Bank to
accumulate earnings for payment of cash dividends to its stockholders.
The Corporation's board of directors declared a 10 percent stock dividend
on May 20, 1997. The additional shares as a result of the dividend were
distributed on June 16, 1997 to stockholders of record as of May 30, 1997.
Although the stock dividend represents a component of the Corporation's
established dividend practices and the Corporation intends to issue similar
dividends in the future, such declarations will depend on several factors
similar to cash dividends.
The Corporation's board of directors also declared a 3-for-2 stock split
on November 18, 1997. The additional shares were distributed on December 18,
1997 to stockholders of record as of December 1, 1997.
During April 1997, the Corporation's board of directors approved a stock
repurchase program pursuant to which the Corporation may repurchase up to 5
percent or 387,750 shares of CFSB Bancorp, Inc. common stock. Through December
31, 1997, the Corporation repurchased 141,035 shares of CFSB Bancorp, Inc.
common stock on the open market for $2.3 million for an average purchase price
of $16.23 per share. The program has a one-year term.
21
<PAGE>
Year 2000
The Corporation has an ongoing program to identify, correct and test any
processing systems that are date driven and are not Year 2000 compliant. The
Corporation's core data processing software is provided by an outside vendor.
The outside vendor projects the software they provide will be Year 2000
compliant, including testing, in 1998. The Corporation anticipates testing the
software and integration with other third party software in 1998. Management
also anticipates testing its remaining systems for Year 2000 compliance in 1998.
As of December 31, 1997, no identifiable costs have been incurred in
connection with ensuring the Corporation's systems and products are Year 2000
compliant. Management anticipates costs to complete Year 2000 implementation
will approximate $500,000 to $750,000. These costs will be primarily for the
replacement of depreciable assets.
Accounting Standards
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 128, Earnings Per Share (SFAS
128). The statement specifies the computation, presentation, and disclosure
requirements for earnings per share (EPS) for entities with publicly held common
stock. SFAS 128 was issued to simplify the computation of EPS and to make the
U.S. standard more compatible with the EPS standards of other countries and that
of the International Accounting Standards Committee. It replaces Primary EPS and
Fully Diluted EPS with Basic EPS and Diluted EPS, respectively. It also requires
dual presentation of Basic EPS and Diluted EPS on the face of the income
statement for all entities with complex capital structures and requires a
reconciliation of the numerator and denominator of the Basic EPS computation to
the numerator and denominator of the Diluted EPS computation. SFAS 128 was
effective for financial statements for both interim and annual periods ended
after December 15, 1997. Earlier application was not permitted. This standard
does not have a material impact on the Corporation's results of operations.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, Reporting Comprehensive Income (SFAS 130). SFAS 130 establishes
standards for reporting and displaying comprehensive income and its components,
including but not limited to unrealized gains or losses on securities available
for sale, in the financial statements. This statement is effective for both
interim and annual periods beginning after December 15, 1997 with earlier
application permitted. SFAS 130 will require reclassification of all prior
period amounts.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, Disclosures about Segments of an Enterprise and Related Information
(SFAS 131). SFAS 131 establishes standards for the way that public entities
report information about operating segments in financial statements. This
statement is effective for both interim and annual periods beginning after
December 31, 1997 with restatement of prior period information required.
22
<PAGE>
Independent Auditors' Report
[LOGO OF KPMG PEAT MARWICK LLP APPEARS HERE]
The Board of Directors and Stockholders
CFSB Bancorp, Inc.:
We have audited the consolidated statements of financial condition of CFSB
Bancorp, Inc., and subsidiary ("Corporation") as of December 31, 1997 and 1996,
and the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1997. These consolidated financial statements are the responsibility of the
Corporation's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of CFSB Bancorp, Inc.,
and subsidiary as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ KPMG Peat Marwick LLP
Lansing, Michigan
January 20, 1998
23
<PAGE>
<TABLE>
<CAPTION>
CFSB BANCORP, INC., AND SUBSIDIARY
Consolidated Statements of Financial Condition
December 31, 1997 1996
=============================================================================================================
<S> <C> <C>
Assets:
Cash and amounts due from depository institutions $ 5,188,951 $ 7,479,722
Interest-earning deposits with Federal Home Loan Bank and
other depository institutions, at cost, which approximates market 13,300,543 15,270,241
Investment securities available for sale, at fair value 26,079,688 31,093,494
Mortgage-backed securities available for sale, at fair value 21,597,690 27,220,567
Loans receivable, net 754,806,061 717,714,636
Accrued interest receivable, net 4,910,200 4,349,240
Premises and equipment, net 10,457,180 10,985,199
Stock in Federal Home Loan Bank of Indianapolis, at cost 11,423,100 10,632,000
Other assets 5,124,500 5,054,447
- -------------------------------------------------------------------------------------------------------------
Total assets $ 852,887,913 $ 829,799,546
=============================================================================================================
Liabilities and Stockholders' Equity:
Liabilities:
Deposits $ 562,412,067 $ 553,574,001
Advances from Federal Home Loan Bank 212,692,934 202,639,323
Advance payments by borrowers for taxes and insurance 1,454,316 1,356,507
Accrued interest payable 3,043,923 4,233,799
Federal income taxes payable 556,315 740,242
Other liabilities 5,193,568 4,785,647
- -------------------------------------------------------------------------------------------------------------
Total liabilities 785,353,123 767,329,519
- -------------------------------------------------------------------------------------------------------------
Stockholders' Equity:
Serial preferred stock, $0.01 par value; authorized 2,000,000 shares;
issued - none -- --
Common stock, $0.01 par value; authorized 10,000,000 shares;
issued 7,655,466 shares in 1997 and 7,274,416 shares in 1996 76,555 72,744
Additional paid-in capital 48,377,350 41,398,650
Retained income - substantially restricted 20,011,874 23,863,600
Net unrealized gains on available-for-sale securities,
net of tax of $161,035 - 1997 and $110,548 - 1996 312,597 214,594
Employee Stock Ownership Plan (227,522) (459,408)
Treasury stock, at cost; 47,988 shares - 1997 and 236,891 shares - 1996 (1,016,064) (2,620,153)
- -------------------------------------------------------------------------------------------------------------
Total stockholders' equity 67,534,790 62,470,027
- -------------------------------------------------------------------------------------------------------------
Commitments and contingent liabilities -- --
Total liabilities and stockholders' equity $ 852,887,913 $ 829,799,546
=============================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE>
<TABLE>
<CAPTION>
CFSB Bancorp, Inc., and Subsidiary
Consolidated Statements of Operations
Years Ended December 31, 1997 1996 1995
=========================================================================================================
<S> <C> <C> <C>
Interest Income:
Loans receivable $ 57,570,229 $ 51,612,087 $ 44,448,774
Mortgage-backed securities 1,768,498 2,341,727 4,187,867
Investment securities 1,688,983 2,188,967 3,862,157
Other 1,473,760 1,259,274 1,122,512
- ---------------------------------------------------------------------------------------------------------
Total interest income 62,501,470 57,402,055 53,621,310
- ---------------------------------------------------------------------------------------------------------
Interest Expense:
Deposits, net 24,477,571 23,837,494 23,810,254
Federal Home Loan Bank advances 12,654,049 10,660,383 9,377,784
- ---------------------------------------------------------------------------------------------------------
Total interest expense 37,131,620 34,497,877 33,188,038
- ---------------------------------------------------------------------------------------------------------
Net interest income before provision
for loan losses 25,369,850 22,904,178 20,433,272
Provision for loan losses 360,000 240,000 240,000
- ---------------------------------------------------------------------------------------------------------
Net interest income after provision
for loan losses 25,009,850 22,664,178 20,193,272
- ---------------------------------------------------------------------------------------------------------
Other Income (Loss):
Service charges and other fees 4,296,132 3,449,537 2,688,164
Loan servicing income 305,174 399,446 476,292
Losses on sales of investment securities
available for sale, net (31,372) (64,188) (2,975)
Gains (losses) on sales of mortgage-backed securities
available for sale, net 2,051 -- (42,056)
Gains on sales of loans, net 642,876 256,343 100,885
Real estate operations, net (50,121) (60,000) 467,478
Gains on sales of branches, net 505,698 -- --
Other, net 730,168 260,529 278,138
- ---------------------------------------------------------------------------------------------------------
Total other income 6,400,606 4,241,667 3,965,926
- ---------------------------------------------------------------------------------------------------------
General and Administrative Expenses:
Compensation, payroll taxes, and fringe benefits 8,426,696 8,010,714 7,807,029
Office occupancy and equipment 2,384,424 2,609,958 2,170,139
Federal insurance premiums 354,007 1,150,117 1,174,941
FDIC special assessment -- 3,355,000 --
Marketing 808,823 792,083 626,657
Data processing 454,099 365,704 316,188
Other, net 3,333,879 2,739,977 2,332,341
- ---------------------------------------------------------------------------------------------------------
Total general and administrative expenses 15,761,928 19,023,553 14,427,295
- ---------------------------------------------------------------------------------------------------------
Income before federal income tax expense 15,648,528 7,882,292 9,731,903
Federal income tax expense 4,976,000 2,435,000 2,929,000
- ---------------------------------------------------------------------------------------------------------
Net income $ 10,672,528 $ 5,447,292 $ 6,802,903
=========================================================================================================
Earnings Per Share:
Basic $ 1.39 $ 0.68 $ 0.84
Diluted 1.34 0.66 0.82
=========================================================================================================
Dividends per share 0.42 0.27 0.23
=========================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE>
CFSB Bancorp, Inc., and Subsidiary
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 1997, 1996, and 1995
<TABLE>
<CAPTION>
=================================================================================================
Net Unrealized
Gains (Losses) on
Common Additional Retained Available-for-
Stock Paid-in Capital Income Sale Securities
=================================================================================================
<S> <C> <C> <C> <C>
Balance at December 31, 1994 $ 61,622 $ 24,658,144 $ 34,774,725 $ (1,721,695)
Net income for the year 1995 -- -- 6,802,903 --
10% common stock dividend 6,155 9,636,500 (9,654,329) --
Stock options exercised -- -- (203,543) --
Repayment of ESOP debt -- -- -- --
Cash dividends on common
stock - $0.23 per share -- -- (1,866,776) --
Tax benefit of ESOP dividends -- 45,220 -- --
Tax benefit associated with exercise
of stock options -- 26,706 -- --
Change in market value of
available-for-sale securities,
net of tax of $923,851 -- -- -- 1,793,356
- -------------------------------------------------------------------------------------------------
Balance at December 31, 1995 67,777 34,366,570 29,852,980 71,661
Net income for the year 1996 -- -- 5,447,292 --
10% common stock dividend 4,967 6,969,800 (8,980,475) --
Treasury stock purchased -- -- -- --
Stock options exercised -- -- (283,171) --
Repayment of ESOP debt -- -- -- --
Cash dividends on common stock -
$0.27 per share -- -- (2,173,026) --
Tax benefit of ESOP dividends -- 28,730 -- --
Tax benefit associated with exercise
of stock options -- 33,550 -- --
Change in market value of
available-for-sale securities,
net of tax of $73,631 -- -- -- 142,933
- -------------------------------------------------------------------------------------------------
Balance at December 31, 1996 72,744 41,398,650 23,863,600 214,594
Net income for the year 1997 -- -- 10,672,528 --
10% common stock dividend 3,811 6,985,791 (11,063,418) --
Cash value of fractional shares
on stock split -- (7,091) -- --
Treasury stock purchased -- -- -- --
Stock options exercised -- -- (214,148) --
Repayment of ESOP debt -- -- -- --
Cash dividends on common
stock - $0.42 per share -- -- (3,246,688) --
Change in market value of
available-for-sale securities,
net of tax of $50,487 -- -- -- 98,003
- -------------------------------------------------------------------------------------------------
Balance at December 31, 1997 $ 76,555 $ 48,377,350 $ 20,011,874 $ 312,597
=================================================================================================
<CAPTION>
=================================================================================
Total
Commitment Treasury Stockholders'
for ESOP Debt Stock Equity
=================================================================================
<S> <C> <C> <C>
Balance at December 31, 1994 $ (923,180) $ (1,242,288) $ 55,607,328
Net income for the year 1995 -- -- 6,802,903
10% common stock dividend -- -- (11,674)
Stock options exercised -- 317,615 114,072
Repayment of ESOP debt 231,886 -- 231,886
Cash dividends on common
stock - $0.23 per share -- -- (1,866,776)
Tax benefit of ESOP dividends -- -- 45,220
Tax benefit associated with exercise
of stock options -- -- 26,706
Change in market value of
available-for-sale securities,
net of tax of $923,851 -- -- 1,793,356
- ---------------------------------------------------------------------------------
Balance at December 31, 1995 (691,294) (924,673) 62,743,021
Net income for the year 1996 -- -- 5,447,292
10% common stock dividend -- 1,995,912 (9,796)
Treasury stock purchased -- (4,089,237) (4,089,237)
Stock options exercised -- 397,845 114,674
Repayment of ESOP debt 231,886 -- 231,886
Cash dividends on common stock -
$0.27 per share -- -- (2,173,026)
Tax benefit of ESOP dividends -- -- 28,730
Tax benefit associated with exercise
of stock options -- -- 33,550
Change in market value of
available-for-sale securities,
net of tax of $73,631 -- -- 142,933
- ---------------------------------------------------------------------------------
Balance at December 31, 1996 (459,408) (2,620,153) 62,470,027
Net income for the year 1997 -- -- 10,672,528
10% common stock dividend -- 4,062,759 (11,057)
Cash value of fractional shares
on stock split -- -- (7,091)
Treasury stock purchased -- (2,777,983) (2,777,983)
Stock options exercised -- 319,313 105,165
Repayment of ESOP debt 231,886 -- 231,886
Cash dividends on common
stock - $0.42 per share -- -- (3,246,688)
Change in market value of
available-for-sale securities,
net of tax of $50,487 -- -- 98,003
- ---------------------------------------------------------------------------------
Balance at December 31, 1997 $ (227,522) $ (1,016,064) $ 67,534,790
=================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
26
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
<TABLE>
<CAPTION>
Consolidated Statements of Cash Flows
Years Ended December 31, 1997 1996 1995
=========================================================================================================================
<S> <C> <C> <C>
Cash Flows From Operating Activities:
Net income $ 10,672,528 $ 5,447,292 $ 6,802,903
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 1,347,691 1,605,669 1,217,594
Provision for loan losses 360,000 240,000 240,000
Provision for real estate losses 45,000 60,000 120,000
Net amortization of premiums and accretion
of discounts 165,158 370,832 1,178,859
Loans originated for sale (20,424,389) (25,856,898) (10,755,582)
Proceeds from sales of loans originated for sale 18,650,496 24,219,028 10,080,914
Net gains on sales of loans and securities (613,555) (192,155) (55,854)
Net gains on sales of real estate owned -- -- (587,478)
Net (gains) losses on sales and disposals of
premises and equipment (491,675) 83,101 (6,752)
Increase (decrease) in deferred loan fees (353,731) 198,518 89,768
Decrease (increase) in accrued interest receivable (560,960) 533,993 (399,843)
Increase (decrease) in accrued interest payable (1,189,876) 759,736 722,010
Increase (decrease) in federal income taxes payable (183,927) 273,902 506,999
Increase (decrease) in other liabilities 291,539 (192,161) 458,314
Decrease (increase) in other assets (66,566) 1,595,411 3,401,950
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 7,647,733 9,146,268 13,013,802
- -------------------------------------------------------------------------------------------------------------------------
Cash Flows From Investing Activities:
Purchases of investment securities available for sale (24,018,281) (20,060,266) (5,065,650)
Proceeds from sales of investment securities
available for sale 20,037,695 23,135,173 13,906,169
Principal repayments and maturities of investment
securities held to maturity -- -- 14,450,000
Principal repayments and maturities of investment
securities available for sale 9,000,000 20,420,000 11,000,000
Loan originations (net of undisbursed loans in process) (185,621,409) (200,744,785) (134,320,368)
Loans purchased (27,847,054) (31,733,987) (43,592,182)
Proceeds from sales of loans 28,439,980 7,853,490 4,822,738
Principal repayments on loans 149,524,869 118,078,242 84,224,676
Proceeds from sales of mortgage-backed securities
available for sale -- -- 19,545,420
Principal repayments and maturities on mortgage-
backed securities available for sale 5,571,279 2,271,581 4,035,345
Principal repayments and maturities on mortgage-
backed securities held to maturity -- 5,967,777 8,219,953
Proceeds from sales, redemptions, and settlements
of real estate owned, net 751,580 437,935 742,358
Capitalized additions to real estate owned,
net of recoveries (27,864) 59,702 11,884
Purchases of premises and equipment (1,706,796) (1,456,346) (463,318)
Proceeds from sales and disposals of premises
and equipment 1,378,799 5,524 13,455
Purchases of Federal Home Loan Bank stock (791,100) (2,095,200) (374,000)
- -------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (25,308,302) (77,861,160) (22,843,520)
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
27
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
<TABLE>
<CAPTION>
Consolidated Statements of Cash Flows, continued
Years Ended December 31, 1997 1996 1995
=================================================================================================================
<S> <C> <C> <C>
Cash Flows From Financing Activities:
Net increase in deposits $ 8,838,066 $ 25,757,823 $ 26,126,642
Stock options exercised 105,165 114,674 114,072
Purchases of treasury stock (2,777,983) (4,089,237) --
Net increase (decrease) in advance payments
by borrowers for taxes and insurance 97,809 75,464 (815,970)
Federal Home Loan Bank advance repayments (110,885,770) (98,262,720) (147,218,103)
Federal Home Loan Bank advances 120,939,381 140,252,667 147,516,795
Dividends paid on common stock (2,916,568) (2,107,991) (1,832,008)
- -----------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 13,400,100 61,740,680 23,891,428
- -----------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (4,260,469) (6,974,212) 14,061,710
Cash and cash equivalents at beginning of period 22,749,963 29,724,175 15,662,465
- -----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 18,489,494 $ 22,749,963 $ 29,724,175
=================================================================================================================
Supplemental Disclosures of Cash Flow Information:
Cash paid for:
Interest expense $ 38,321,496 $ 33,738,141 $ 32,466,028
Federal income taxes 5,170,000 2,450,000 2,285,000
Transfers of loans to real estate owned 672,078 342,408 264,637
Transfers of loans to repossessed property and
accounts receivable 150,611 69,673 53,600
Loans charged off 247,432 76,528 55,107
Loans to facilitate the sale of real estate owned -- 279,700 2,724,120
Transfers of securities to available-for-sale classification:
Investment securities -- -- 18,081,023
Mortgage-backed securities -- 28,553,035 --
=================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
28
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 1997
(1) SIGNIFICANT ACCOUNTING POLICIES
Business
CFSB Bancorp, Inc. is a unitary savings and loan holding company whose principal
business is conducted through its subsidiary Community First Bank. Community
First Bank (the Bank) is a community-oriented financial institution offering a
variety of financial services to meet the needs of the communities it serves.
The Bank's primary market area is the Greater Lansing, Michigan area, which is
comprised of the tri-county area of Clinton, Eaton, and Ingham counties, the
western townships of Shiawassee County, and Ionia County.
Principles of Consolidation
CFSB Bancorp, Inc. (the Corporation), is the holding company for Community First
Bank, a state chartered stock savings bank. Substantially all of the
Corporation's assets are currently held in, and operations conducted through its
sole subsidiary, Community First Bank.
The consolidated financial statements include the accounts and transactions
of CFSB Bancorp, Inc., and its wholly-owned subsidiary, Community First Bank,
and the Bank's wholly-owned subsidiary, Capitol Consolidated Financial
Corporation (Capitol Consolidated), and Capitol Consolidated's wholly-owned
subsidiary, Allegan Insurance Agency, doing business as Community First
Insurance and Investment Services. Intercompany transactions and account
balances are eliminated.
Basis of Financial Statement Presentation
The consolidated financial statements are prepared in conformity with generally
accepted accounting principles. In preparing the financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities as of the date of the balance sheet and the reported amounts of
income and expenses for the period. Actual results could differ from those
estimates.
Investment and Mortgage-Backed Securities
Investment and mortgage-backed securities available for sale represent those
securities not classified as held-to-maturity. Unrealized holding gains and
losses, net of tax, on available-for-sale securities are reported as a net
amount in a separate component of stockholders' equity until realized. Gains and
losses on the sale of securities are determined using the
specific-identification method and are recognized on a trade-date basis.
Premiums and discounts are recognized in interest income using the
effective-interest method over the period to maturity.
Loans Receivable
Loans receivable, which the Corporation has the intent and ability to hold for
the foreseeable future or until maturity or payoff, are reported at their
outstanding unpaid principal balances, net of any undistributed portion of loans
in process, net deferred origination fees, and the allowance for loan losses.
Loan Origination and Commitment Fees
Fees received in connection with loan commitments are deferred in other
liabilities until the loan is advanced, and are then recognized over the term of
the loan as an adjustment to the yield. Fees on commitments that expire unused
are recognized as fee income at expiration.
29
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(1) SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Loan origination fees, net of certain loan origination costs, are deferred
and recognized over the lives of the related loans as an adjustment to the
yield. When loans are sold, any remaining unamortized deferred fees are
recognized as an adjustment of gain (loss) on sale of loans.
Loan origination and commitment fees charged on adjustable-rate mortgages
are generally deemed to be adjustments to the first adjustment period yield of
the mortgage, to the extent the interest rate during the first adjustment period
on the mortgage is less than the index rate plus the contractual spread.
Nonaccrual Assets
Nonaccrual assets are comprised of loans where the accrual of interest has been
discontinued, loans which the terms have been renegotiated to less than market
rates as a result of a serious weakening of the borrower's financial condition,
and real estate which has been acquired primarily through foreclosure and is
awaiting disposition.
Loans are generally placed on a nonaccrual basis when principal or interest
is past due 90 days or more or when, in the opinion of management, full
collection of principal and interest is unlikely. At the time a loan is placed
on nonaccrual status, interest previously accrued but not collected is charged
against current income. Income on such loans is then recognized only to the
extent that cash is received and where future collections of principal are
probable. A nonaccrual loan may be restored to accrual status when interest and
principal payments are current and the loan appears otherwise collectible.
Allowance for Losses on Loans and Real Estate
Provisions for losses on loans and real estate are charged to operations based
upon management's evaluation of potential losses in the portfolio. In addition
to providing reserves on specific assets where a decline in value has been
identified, general provisions for losses are established based upon the overall
portfolio composition and general market conditions. In establishing both
specific and general valuation allowances, management reviews individual loans,
recent loss experience, current economic conditions, the overall balance and
composition of the portfolio, and such other factors which, in management's
judgment, deserve recognition in estimating possible losses.
Management believes the allowance for losses on loans and real estate is
adequate. While management uses available information to recognize losses on
loans and real estate, future additions to the allowance may be necessary based
on changes in economic conditions and borrower circumstances.
Impaired loans have been identified in accordance with provisions of SFAS
No. 114. The Corporation considers a loan to be impaired when it is probable
that it will be unable to collect all or part of amounts due according to the
contractual terms of the loan agreement. Impaired loans are measured based on
the present value of expected cash flows discounted at the loan's effective
interest rate or, as a practical expedient, at a loan's observable market price
or the fair value of the collateral if the loan is collateral dependent.
Real Estate
Real estate acquired through foreclosure is carried at the lower of estimated
fair value less costs to sell or cost. Such determination is made on an
individual-asset basis. At the time of acquisition, any excess of carrying
amount over estimated fair value is recorded as a reduction in the allowance for
loan losses. Subsequent declines in fair value less estimated costs to sell are
recognized as increases in the valuation allowance. If the estimated fair value
of the asset minus the estimated costs to sell the asset is more than its
carrying amount, the valuation allowance is reduced, but not below zero.
Increases or decreases in the valuation allowance are charged or credited to
income. Generally, expenditures relating to the development and improvement of
real estate acquired through foreclosure are capitalized.
30
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(1) SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Loans Held for Sale
Additional funds for lending are periodically provided by selling mortgage
loans. Mortgage loans intended for sale in the secondary market are carried at
the lower-of-cost or estimated market value in the aggregate. These loans are
classified as held for sale and are included in loans receivable in the
consolidated statements of financial condition. Net unrealized losses are
recorded by charges to income.
Loan Servicing
The Corporation services for investors mortgage loans that are not included in
the consolidated statements of financial condition. Fees earned for servicing
loans owned by investors are reported as income when the related mortgage loan
payments are collected. Loan servicing costs are charged to expense as incurred.
The total cost of mortgage loans originated with the intent to sell is
allocated between the loan servicing right and the mortgage loan without
servicing, based on their relative fair value at the date of origination. The
capitalized cost of loan servicing rights is amortized in proportion to, and
over the period of, estimated net future servicing revenue.
Mortgage servicing rights are periodically evaluated for impairment. For
purposes of measuring impairment, mortgage servicing rights are stratified based
on predominant risk characteristics of the underlying serviced loans. These risk
characteristics include loan type, term, year originated, and note rate.
Impairment represents the excess of cost of an individual mortgage servicing
rights stratum over its fair value, and is recognized through a valuation
allowance.
Fair values for individual strata are based on quoted market prices for
comparable transactions if available or estimated fair value. Estimates of fair
value include assumptions about prepayment, default and interest rates, and
other factors which are subject to change over time. Changes in these underlying
assumptions could cause the fair value of mortgage servicing rights, and the
related valuation allowance, to change significantly in the future.
Federal Income Taxes
The Corporation and its subsidiary file a consolidated federal income tax
return. The provision for federal income taxes is based upon income for
financial statement purposes, rather than amounts reported on the Corporation's
income tax return.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to 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. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized as income or
expense in the period that includes the enactment date.
Premises and Equipment
Office property and equipment are carried at cost, less accumulated depreciation
and amortization. Depreciation and amortization of office properties and
equipment is charged to operations on a straight-line basis over the estimated
useful lives of the related assets.
Derivative Financial Instruments
Interest rate exchange agreements, designated as hedges against future
fluctuations in the interest rates of specifically identified assets or
liabilities, are not marked to market. Net interest income (expense) resulting
from the differential between exchanging floating and fixed-rate interest
payments is recorded as an addition to or reduction of the interest income
(expense) on the associated asset or liability. Gains and losses on terminated
interest rate exchange agreements are amortized over the remaining terms of the
agreements.
31
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(1) SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
Interest on Deposits
Penalty income on early withdrawal of certificates of deposit is recognized as a
reduction of interest expense on deposits.
Statement of Cash Flows
For the purpose of presentation in the consolidated statement of cash flows,
cash and cash equivalents include cash and amounts due from depository
institutions and interest-earning deposits with the Federal Home Loan Bank and
other depository institutions.
Stock-Based Compensation
FASB SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123) encourages
but does not require companies to record compensation cost for stock-based
employee compensation plans at fair value. The Bank has chosen to continue to
measure compensation cost for those plans using the intrinsic value based method
of accounting prescribed by Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (Opinion 25). Accordingly, compensation
cost for stock options is measured as the excess, if any, of the quoted market
price of the Corporation's stock at the date of the grant over the amount an
employee must pay to acquire the stock.
Stock Dividend and Split
The Corporation's board of directors declared a 10 percent stock dividend on May
20, 1997. The additional shares as a result of the dividend were distributed on
June 16, 1997 to stockholders of record as of May 30, 1997. The Corporation's
board of directors declared a 3-for-2 stock split on November 18, 1997. The
additional shares as a result of the split were distributed on December 18, 1997
to stockholders of record as of December 1, 1997. Common shares outstanding, per
common share amounts, and price per common share have been restated for all
periods presented to give retroactive effect to the stock dividend and the stock
split.
Reclassifications
Certain prior year's financial statement amounts have been reclassified to
conform to the current year financial statement presentation.
(2) Restrictions on Cash and Amounts Due from Depository Institutions
The Bank is required to maintain certain daily reserve balances in accordance
with Federal Reserve Board requirements. The reserve balances maintained in
accordance with such requirements were $1,754,000 and $5,684,000 at December 31,
1997 and 1996, respectively.
32
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(3) INVESTMENT SECURITIES
Investment securities available for sale consist of the following:
<TABLE>
<CAPTION>
December 31, 1997 1996
- -----------------------------------------------------------------------------------------------------------------------
Amortized Cost Fair Value Amortized Cost Fair Value
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
United States Government and Agency Obligations:
Maturing within one year $ 24,000,000 $ 24,053,125 $ 20,096,712 $ 20,071,094
Federal agency obligations:
Maturing from one to five years 2,000,000 2,026,563 -- --
Maturing from five to ten years -- -- 7,000,000 7,015,200
- -----------------------------------------------------------------------------------------------------------------------
2,000,000 2,026,563 7,000,000 7,015,200
Corporate bonds:
Maturing within one year -- -- 4,000,000 4,007,200
- -----------------------------------------------------------------------------------------------------------------------
$ 26,000,000 $ 26,079,688 $ 31,096,712 $ 31,093,494
=======================================================================================================================
Weighted average interest rate 6.02% 5.89%
=======================================================================================================================
</TABLE>
Unrealized gains and losses on investment securities available for sale are
summarized as follows:
<TABLE>
<CAPTION>
December 31, 1997 1996
- -----------------------------------------------------------------------------------------------------------------------
Gross Gross Gross Gross
Unrealized Gains Unrealized Losses Unrealized Gains Unrealized Losses
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
United States government and
agency obligations $ 54,688 $ 1,563 $ 21,205 $ 46,823
Federal agency obligations 26,563 -- 15,200 --
Corporate bonds -- -- 7,200 --
- -----------------------------------------------------------------------------------------------------------------------
$ 81,251 $ 1,563 $ 43,605 $ 46,823
=======================================================================================================================
</TABLE>
Proceeds from sales of investment securities available for sale during the
years ended December 31, 1997, 1996, and 1995 were $20,037,695, $23,135,173, and
$13,906,169, respectively. Gross gains of $19,659, $43,207, and $29,872, and
gross losses of $51,031, $107,395, and $32,847, were realized on those sales
during 1997, 1996, and 1995, respectively.
Expected maturities may differ from the contractual maturities above
because certain borrowers have the right to call or prepay obligations with or
without call or prepayment penalties. During the years ended December 31, 1997
and 1996, call provisions were exercised on $5,000,000 and $4,295,000,
respectively, of investment securities available for sale. No gains or losses
were recognized during the respective periods. There were no call provisions
exercised on investment securities available for sale during 1995.
In accordance with A Guide to Implementation of Statement 115 on Accounting
for Certain Investments in Debt and Equity Securities, the Corporation, in order
to allow further flexibility in future asset liability management decisions
relating to securities, in 1995 reclassified $18,081,023 of corporate notes and
U.S. Treasury securities from a held-to-maturity classification to an available-
for-sale classification. The unrealized pre-tax losses of $103,210 on these
securities were recorded as a negative adjustment to stockholders' equity.
Accrued interest receivable related to investment securities approximated
$627,000 and $293,000 at December 31, 1997 and 1996, respectively.
At December 31, 1997, the Bank had no commitments to purchase or sell
investment securities.
33
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(4) MORTGAGE-BACKED SECURITIES
Mortgage-backed securities available for sale consist of the following:
<TABLE>
<CAPTION>
December 31, 1997 1996
- -----------------------------------------------------------------------------------------------------------------------
Amortized Cost Fair Value Amortized Cost Fair Value
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Federal Home Loan Mortgage Corporation
participation certificates $ 15,711,732 $ 16,137,553 $ 19,438,088 $ 19,845,510
Fannie Mae guaranteed mortgage
pass-through certificates 2,308,037 2,275,221 2,547,019 2,468,209
Government National Mortgage Association
modified pass-through certificates 45,208 46,338 92,490 95,265
Conventional pass-through certificates 3,138,769 3,138,578 3,982,504 3,981,597
Collateralized mortgage obligations -- -- 832,106 829,986
- -----------------------------------------------------------------------------------------------------------------------
$ 21,203,746 $ 21,597,690 $ 26,892,207 $ 27,220,567
=======================================================================================================================
Weighted average interest rate 8.00% 7.82%
=======================================================================================================================
</TABLE>
Unrealized gains and losses on mortgage-backed securities available for sale are
summarized as follows:
<TABLE>
<CAPTION>
December 31, 1997 1996
- -------------------------------------------------------------------------------------------------------------------------------
Gross Gross Gross Gross
Unrealized Gains Unrealized Losses Unrealized Gains Unrealized Losses
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Federal Home Loan Mortgage Corporation
participation certificates $ 494,651 $ 68,830 $ 538,105 $ 130,683
Fannie Mae guaranteed mortgage
pass-through certificates 409 33,225 629 79,439
Government National Mortgage Association
modified pass-through certificates 1,130 -- 2,775 --
Conventional pass-through certificates -- 191 -- 907
Collateralized mortgage obligations -- -- -- 2,120
- -------------------------------------------------------------------------------------------------------------------------------
$ 496,190 $ 102,246 $ 541,509 $ 213,149
===============================================================================================================================
</TABLE>
Proceeds from the sales of mortgage-backed securities available for sale
during the year ended December 31, 1995 were $19,545,420. Gross gains of $8,889
and gross losses of $50,945 were realized on those 1995 sales. There were no
sales of mortgage-backed securities during the years ended December 31, 1997 and
1996.
During the year ended December 31, 1997 call provisions were exercised on
$380,544 of mortgage-backed securities available for sale. Gross gains of $2,051
were recognized during the respective period. There were no call provisions
exercised on mortgage-backed securities available for sale during 1996 and 1995.
As of September 30, 1996, based upon liquidity and interest rate
considerations, the Corporation determined it could no longer assert its
intention to hold all mortgage-backed securities until maturity. Therefore, the
entire mortgage-backed securities portfolio totaling $28,553,035 was
reclassified to an available-for-sale classification with unrealized pre-tax
gains of $190,368 being recorded as a favorable adjustment to stockholders'
equity. As a result, the Corporation intends to classify any investment or
mortgage-backed securities currently held or purchased in the subsequent two
years as available for sale.
Accrued interest receivable on mortgage-backed securities was approximately
$250,000 and $316,000 at December 31, 1997 and 1996, respectively.
The cost of mortgage-backed securities at December 31, 1997 and 1996
included net unamortized premiums of $0 and $119,000, respectively.
34
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(4) MORTGAGE-BACKED SECURITIES - CONTINUED
Variable-rate mortgage-backed securities approximated $9,681,000 and
$11,286,000, with weighted average rates of 7.29 percent and 6.95 percent, at
December 31, 1997 and 1996, respectively.
At December 31, 1997, the Bank had no commitments to buy or sell mortgage-
backed securities.
(5) LOANS RECEIVABLE
Loans receivable consist of the following:
December 31, 1997 1996
- --------------------------------------------------------------------------------
First mortgage:
One-to-four family residential $ 585,266,880 $ 553,690,395
Income-producing property 44,580,004 52,583,762
FHA-insured and VA-partially guaranteed 7,607,118 6,404,211
Construction and development:
One-to-four family residential 34,821,124 38,072,036
Income-producing property 32,648,987 31,428,040
- --------------------------------------------------------------------------------
704,924,113 682,178,444
Second mortgage 549,105 510,458
Other loans:
Land contract 149,095 254,068
Auto 10,218,761 7,925,413
Commercial 5,087,147 4,644,308
Educational 1,347,731 1,870,672
Marine 1,349,584 1,307,903
Home equity 42,281,117 36,275,330
Mobile home 1,099,038 1,518,817
Other 8,037,676 5,425,604
- --------------------------------------------------------------------------------
69,570,149 59,222,115
- --------------------------------------------------------------------------------
775,043,367 741,911,017
Less:
Undistributed portion of loans in process (14,408,253) (18,147,704)
Deferred origination fees (1,098,646) (1,485,083)
Allowance for losses on loans (4,730,407) (4,563,594)
- --------------------------------------------------------------------------------
$ 754,806,061 $ 717,714,636
================================================================================
Weighted average interest rate 7.71% 7.60%
================================================================================
Accrued interest receivable on loans receivable, net of the allowance for
uncollectible interest, approximated $3,986,000 and $3,703,000, at December 31,
1997 and 1996, respectively.
The Corporation had approximately $883,000 and $1,787,000 of nonaccruing
loans as of December 31, 1997 and 1996, respectively. Interest received and
included as income on these loans for the years ended December 31, 1997, 1996,
and 1995, was $46,000, $118,000, and $26,000, respectively. The Corporation
would have recorded $32,000, $46,000, and $39,000 of additional interest income
on these nonaccrual loans for the years ended December 31, 1997, 1996, and 1995,
respectively, if these loans had been current in accordance with their original
terms and had been outstanding throughout the periods or since origination.
35
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(5) LOANS RECEIVABLE - CONTINUED
There were no impaired loans as defined by SFAS 114 at December 31, 1997
and 1995. Impaired loans at December 31, 1996 totaled $554,000, and included one
income-producing property loan and three commercial business loans. The
Corporation's nonaccrual loans include residential mortgage and consumer
installment loans, for which SFAS 114 does not apply. The Corporation's
respective average investment in impaired loans was $112,000, $559,000, and $0
during 1997, 1996, and 1995, respectively. Interest income recognized on
impaired loans during 1997, 1996, and 1995 totaled $1,000, $27,000, and $0,
respectively. Impaired loans had specific allocations of the allowance for loan
losses in accordance with SFAS 114 approximating $0, $150,000, and $0 at
December 31, 1997, 1996, and 1995, respectively.
The Corporation had no troubled debt restructured loans at December 31,
1997 and 1996.
Included in one-to-four family residential, first-mortgage loans were
approximately $407,000,000 and $395,300,000 of adjustable-rate mortgages at
December 31, 1997 and 1996, respectively.
Included in income-producing property loans were approximately $44,500,000
and $46,300,000 of adjustable-rate mortgages at December 31, 1997 and 1996,
respectively.
The Corporation serviced loans for others of approximately $180,200,000,
$156,600,000, and $154,900,000 at December 31, 1997, 1996, and 1995,
respectively.
The balance of loans serviced for others at December 31, 1997 and 1996 with
capitalized originated mortgage servicing rights approximated $73,300,000 and
$30,100,000, respectively. Capitalized originated mortgage servicing rights at
December 31, 1997 and 1996 approximated $402,000 and $191,000, respectively. No
valuation allowances for capitalized originated mortgage servicing rights were
considered necessary as of December 31, 1997.
The Corporation had commitments to originate the following mortgage loans
at December 31, 1997:
<TABLE>
<CAPTION>
Amount Weighted Average Rate
==============================================================================================
<S> <C> <C>
One-to-four family residential:
Fixed-rate $ 12,415,000 7.59%
Adjustable-rate 13,397,000 7.21
Income-producing property, fixed-rate 1,050,000 8.23
- ----------------------------------------------------------------------------------------------
$ 26,862,000 7.43%
==============================================================================================
</TABLE>
The Corporation had commitments to sell one-to-four family residential,
fixed-rate mortgage loans of $7,685,000 at December 31, 1997. As of December 31,
1997, the Corporation had no commitments to buy mortgage loans. As of year-end
1997, $6,210,000 of one-to-four family residential, fixed-rate mortgage loans
were held for sale. Loans held for sale, after consideration of the
aforementioned commitments, were valued at the lower-of-cost or market, as
determined on an aggregate basis.
36
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(6) CONCENTRATION OF CREDIT RISK
The Corporation considers its primary market area for lending and savings
activities to be the Greater Lansing area in mid-Michigan. The Corporation's
one-to-four family residential real estate loans totaled $627,700,000 and
$598,200,000 at December 31, 1997 and 1996, respectively, and included
$498,500,000 and $474,900,000 of originated loans, respectively. Substantially
all of the originated loans were on properties located in Michigan. Of the
purchased loans which are serviced by other institutions at December 31, 1997,
$40,400,000, $83,700,000 and $5,100,000 represented loans on properties located
in Michigan, Texas, and Florida, respectively. Substantially all of the
Corporation's income-producing property and consumer loans are based in
Michigan. Although the Corporation has a diversified loan portfolio, a
substantial portion of its debtors' ability to honor their contractual
obligations is reliant upon the economic stability of the area. The Greater
Lansing area is a diversified market with a strong service sector and, to a
lesser extent, trade and manufacturing sectors. The three major employers in the
area are the State of Michigan, General Motors, and Michigan State University.
The Corporation is not dependent upon any single industry or business for its
banking opportunities.
Collateral securing the Corporation's income-producing loan portfolio
consists of the following property types:
<TABLE>
<CAPTION>
December 31, 1997 1996
================================================================================
<S> <C> <C>
Apartments $ 35,466,164 $ 35,340,019
Office buildings 16,068,170 22,242,915
Restaurants and motels 3,808,960 5,699,844
Retail centers 5,448,099 5,000,860
Residential land development 6,683,685 7,490,957
Residential and condominiums 5,309,418 3,552,506
Other 4,444,494 4,684,701
- --------------------------------------------------------------------------------
$ 77,228,990 $ 84,011,802
================================================================================
</TABLE>
(7) Real Estate
Real estate held by the Corporation is summarized as follows:
<TABLE>
<CAPTION>
December 31, 1997 1996
================================================================================
<S> <C> <C>
Real estate in judgment, subject to redemption $ 11,455 $ 189,990
Real estate acquired through foreclosure 141,172 22,169
- --------------------------------------------------------------------------------
152,627 212,159
Less: Allowance for losses (152,627) (212,159)
- --------------------------------------------------------------------------------
$ -- $ --
================================================================================
</TABLE>
The following is a summary of the results of real estate operations for
the years indicated:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
=======================================================================================
<S> <C> <C> <C>
Income from sales of real estate acquired
through foreclosure, net $ -- $ -- $ 587,478
Provision for losses on real estate (45,000) (60,000) (120,000)
Real estate expenses (5,121) -- --
- ---------------------------------------------------------------------------------------
$ (50,121) $ (60,000) $ 467,478
=======================================================================================
</TABLE>
37
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(8) ALLOWANCE FOR LOSSES ON LOANS AND REAL ESTATE
The following is a summary of the allowance for losses on loans and real estate:
<TABLE>
<CAPTION>
Loans Real Estate Total
========================================================================================
<S> <C> <C> <C>
Balance at December 31, 1994 $ 4,123,918 $ 75,973 $ 4,199,891
Provision for losses 240,000 120,000 360,000
Losses charged against the allowance (55,107) (34,614) (89,721)
Recoveries of losses 54,328 62,218 116,546
- ----------------------------------------------------------------------------------------
Balance at December 31, 1995 4,363,139 223,577 4,586,716
Provision for losses 240,000 60,000 300,000
Losses charged against the allowance (76,528) (187,214) (263,742)
Recoveries of losses 36,983 115,796 152,779
- ----------------------------------------------------------------------------------------
Balance at December 31, 1996 4,563,594 212,159 4,775,753
Provision for losses 360,000 45,000 405,000
Losses charged against the allowance (247,432) (247,080) (494,512)
Recoveries of losses 54,245 142,548 196,793
- ----------------------------------------------------------------------------------------
Balances at December 31, 1997 $ 4,730,407 $ 152,627 $ 4,883,034
========================================================================================
</TABLE>
(9) Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation and are
summarized by major classification as follows:
<TABLE>
<CAPTION>
December 31, 1997 1996
================================================================================
<S> <C> <C>
Land $ 2,873,424 $ 3,004,842
Office buildings and improvements 12,009,627 11,901,210
Furniture, fixtures, and equipment 9,155,258 9,205,565
- --------------------------------------------------------------------------------
24,038,309 24,111,617
Less: Accumulated depreciation (13,581,129) (13,126,418)
- --------------------------------------------------------------------------------
$ 10,457,180 $ 10,985,199
================================================================================
</TABLE>
(10) INVESTMENT IN FEDERAL HOME LOAN BANK STOCK
The Bank is required to maintain an investment in the stock of the Federal Home
Loan Bank of Indianapolis (FHLB) in an amount equal to at least 1.0 percent of
the unpaid principal balances of the Bank's residential mortgage loans, 0.3
percent of its total assets, or 5.0 percent of its outstanding advances from the
FHLB, whichever is greater. Purchases and sales of stock are made directly with
the FHLB at par value.
38
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(11) DEPOSITS
Deposits represented by various types of programs are presented below:
<TABLE>
<CAPTION>
December 31, 1997 1996
- -------------------------------------------------------------------------------------------
Weighted Weighted
Average Rate Amount Average Rate Amount
===========================================================================================
<S> <C> <C> <C> <C>
Regular savings 2.16% $ 63,069,112 2.14% $ 65,213,797
Money market savings 5.80 21,943,735 6.03 16,136,425
Consumer checking 1.77 93,339,386 1.85 86,722,533
Commercial checking -- 9,616,043 -- 9,324,314
Money market checking 3.81 50,099,329 4.07 51,962,675
- -------------------------------------------------------------------------------------------
2.60 238,067,605 2.65 229,359,744
Certificates of deposit 5.83 324,344,462 5.73 324,214,257
- -------------------------------------------------------------------------------------------
Total deposits 4.47% $ 562,412,067 4.46% $ 553,574,001
===========================================================================================
</TABLE>
Accrued interest payable on deposits approximated $2,434,000 and $3,678,000 at
December 31, 1997 and 1996, respectively. Contractual maturities of certificates
of deposit are as follows:
<TABLE>
<CAPTION>
December 31, 1997 1996
- -------------------------------------------------------------------------------------------
Weighted Weighted
Average Rate Amount Average Rate Amount
===========================================================================================
<S> <C> <C> <C> <C>
Maturing in
1997 5.62% $ 219,022,772
1998 5.76% $ 227,836,887 5.88 51,800,281
1999 5.97 60,441,070 5.96 30,414,437
2000 6.15 19,800,311 6.37 14,024,568
2001 5.68 7,403,257 5.63 7,821,907
2002 6.01 8,023,975 5.99 605,346
2003 and thereafter 5.95 838,962 5.94 524,946
- -------------------------------------------------------------------------------------------
5.83% $ 324,344,462 5.73% $ 324,214,257
===========================================================================================
</TABLE>
Included in total certificates of deposit as of December 31, 1997 and
1996 are approximately $34,000,000 and $32,800,000, respectively, in
certificates of deposit of $100,000 or more in amount, with weighted average
interest rates of 6.00 percent and 5.85 percent, respectively. Contractual
maturities of certificates of deposit of $100,000 or more in amount outstanding
at December 31, 1997 are $3,600,000 within 3 months or less; $8,200,000 within 3
months to 6 months; $11,600,000 within 6 months to 12 months; and $10,600,000
for over 12 months.
At December 31, 1997, the Corporation had $100,000 of brokered deposits,
representing 0.02 percent of total deposits.
39
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(11) DEPOSITS - CONTINUED
By regulation, certain penalties are assessed depositors exercising early
certificate withdrawal privileges. These penalties are accounted for as offsets
to interest expense on deposits in the year they are incurred. Listed below are
interest expense and penalties for the years indicated.
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
===================================================================================================
<S> <C> <C> <C>
Interest on deposits (net of penalties):
Savings $ 1,407,554 $ 1,592,132 $ 1,985,791
Checking 4,522,875 3,842,849 3,816,335
Certificates of deposit 18,547,142 18,402,513 18,008,128
- ---------------------------------------------------------------------------------------------------
$ 24,477,571 $ 23,837,494 $ 23,810,254
===================================================================================================
Penalties $ 121,000 $ 102,000 $ 117,000
===================================================================================================
</TABLE>
The Corporation's interest rate exchange agreements were terminated in
November 1994. The remainder of the deferred loss was amortized in 1996. The
cost of the Corporation's interest rate exchange agreements was $106,927 and
$109,018 during the years ended December 31, 1996, and 1995, respectively, and
is included above as interest expense on deposits. There were no costs
associated with interest rate exchange agreements in 1997.
(12) ADVANCES FROM FEDERAL HOME LOAN BANK
FHLB advances at December 31, 1997 and 1996 are secured by the Corporation's
investment in the stock of the Federal Home Loan Bank of Indianapolis, and
substantially all of its first mortgage loans are under a blanket collateral
agreement. Maturities and weighted average interest rates are as follows:
<TABLE>
<CAPTION>
December 31, 1997 1996
- ------------------------------------------------------------------------------------------------------------
Weighted Weighted
Average Rate Amount Average Rate Amount
============================================================================================================
<S> <C> <C> <C> <C>
Fixed-rate advances maturing in
1997 6.12% $ 26,746,389
1998 6.01% $ 61,357,552 6.01 61,357,552
1999 6.07 71,165,257 6.17 37,190,257
2000 5.85 27,086,995 5.66 13,586,995
2001 6.59 11,295,559 6.60 8,295,559
2002 6.46 29,567,059 6.42 2,567,059
2003 and thereafter 6.17 1,220,512 6.17 1,220,512
- ------------------------------------------------------------------------------------------------------------
Total fixed-rate advances 6.11 201,692,934 6.08 $150,964,323
Adjustable-rate advances maturing in
1997 -- -- 5.64 51,675,000
1998 5.70 11,000,000 -- --
- ------------------------------------------------------------------------------------------------------------
Total adjustable-rate advances 5.70 11,000,000 5.64 51,675,000
- ------------------------------------------------------------------------------------------------------------
6.09% $212,692,934 5.97% $202,639,323
============================================================================================================
</TABLE>
At December 31, 1997 and 1996, the portfolio of FHLB advances included
borrowings of $1,650,000, which contractually the Corporation may, at its option
and without prepayment penalty, repay such advances on the first anniversary
date of each borrowing or semiannually thereafter until maturity.
40
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(12) ADVANCES FROM FEDERAL HOME LOAN BANK - CONTINUED
At December 31, 1997, the portfolio of FHLB advances included borrowings
of $30,000,000, which contractually the FHLB may, at its option on the second
anniversary date and quarterly thereafter, convert such advances to a quarterly
adjustable interest rate indexed to the three month LIBOR rate. If the FHLB
exercises its option, the Corporation may, at its option and without prepayment
penalty, repay such advances on the second anniversary date or quarterly
thereafter. These advances are included in the fixed rate maturity year that
corresponds with their second anniversary date in the preceding schedule.
The Corporation had a $5,000,000 available but unused line of credit from
the FHLB at December 31, 1997 and 1996.
(13) FEDERAL INCOME TAXES
Federal income tax expense consists of:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
=============================================================================================================
<S> <C> <C> <C>
Current tax expense $ 4,976,000 $ 2,500,000 $ 2,792,000
Deferred tax expense (benefit) -- (65,000) 137,000
- -------------------------------------------------------------------------------------------------------------
Income tax expense in the statement of operations 4,976,000 2,435,000 2,929,000
Income tax expense (benefit) charged (credited)
directly to stockholders' equity:
Gains on securities available for sale 50,000 74,000 924,000
ESOP dividends -- (29,000) (45,000)
Exercise of stock options -- (34,000) (27,000)
- -------------------------------------------------------------------------------------------------------------
$ 5,026,000 $ 2,446,000 $ 3,781,000
=============================================================================================================
</TABLE>
The tax effects of temporary differences between the financial statement
carrying amounts and the tax bases of assets and liabilities that gave rise to
significant portions of the deferred tax assets and deferred tax liabilities are
summarized as follows:
<TABLE>
<CAPTION>
December 31, 1997 1996
==================================================================================================
<S> <C> <C>
Deferred tax assets:
Allowance for losses on loans and real estate $ 1,709,000 $ 1,657,000
Postretirement benefits 552,000 533,000
Compensation and benefits 289,000 261,000
Premises and equipment 371,000 53,000
Other 273,000 209,000
- --------------------------------------------------------------------------------------------------
Total gross deferred tax assets 3,194,000 2,713,000
Deferred tax liabilities:
Excess of tax bad debt reserves over base-year reserves (1,255,000) (1,255,000)
Unrealized gains on available-for-sale securities (161,000) (111,000)
Federal Home Loan Bank stock dividends (285,000) (285,000)
Deferred loan origination fees (648,000) (506,000)
Servicing rights (141,000) (65,000)
Other (437,000) (174,000)
- --------------------------------------------------------------------------------------------------
Total gross deferred tax liabilities (2,927,000) (2,396,000)
- --------------------------------------------------------------------------------------------------
Net deferred tax asset $ 267,000 $ 317,000
==================================================================================================
</TABLE>
41
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(13) FEDERAL INCOME TAXES - CONTINUED
The deferred tax asset is subject to certain asset realization tests.
Management believes no valuation allowance is required at December 31, 1997 and
1996, or at the end of any interim quarter during these years, due to the
combination of potential recovery of tax previously paid and the reversal of
certain deductible temporary differences.
Federal income tax expense differs from the amounts computed using the
statutory federal income tax rate. The reasons for the differences are
summarized as follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
==========================================================================================================
<S> <C> <C> <C>
Computed "expected" tax expense $ 5,477,000 $ 2,680,000 $ 3,309,000
Increase (reduction) resulting from:
Base-year tax bad debt reserves, net -- -- (174,000)
Low-income housing tax credits (360,000) (228,000) (228,000)
Other, net (141,000) (17,000) 22,000
- ----------------------------------------------------------------------------------------------------------
$ 4,976,000 $ 2,435,000 $ 2,929,000
==========================================================================================================
</TABLE>
As a result of legislation enacted in 1996, the Bank is not permitted to use the
reserve method previously available to thrift institutions to compute its tax
bad debt deduction for years ending after December 31, 1995. It is expected the
excess of the Bank's December 31, 1995 tax bad debt reserves over its reserves
as of December 31, 1987 will be taken into taxable income ratable over a
six-year period beginning in 1998, and a deferred tax liability has been
recognized related to this amount. No deferred tax liability has been recognized
for the Bank's December 31, 1987 tax bad debt reserves of $8,500,000 since these
reserves would only be taken into taxable income under circumstances the
Corporation is not likely to encounter. Therefore, this temporary difference is
not expected to reverse in the foreseeable future.
(14) STOCK OPTION PLANS
In October 1990, the Corporation adopted the 1990 Stock Option Plan (1990 Plan)
for the benefit of directors, selected officers, and other key employees. The
number of shares of common stock reserved for issuance under the 1990 Plan was
equal to 10 percent of the total number of common shares issued pursuant to the
Bank's conversion to capital stock form. The 1990 Plan provides for the granting
of options for up to 628,587 shares of the Corporation's common stock at the
fair market value at the time the options are granted. The 1990 Plan will remain
in effect until June 28, 2000. Each stock option granted under the 1990 Plan
must be exercised within ten years of the date the option was granted.
In April 1994, the Corporation adopted the 1994 Stock Option and
Incentive Plan (1994 Plan) to provide select employees and directors the
opportunity to acquire shares. The number of shares of common stock reserved for
issuance under the 1994 Plan was equal to 10 percent of the then-outstanding
shares. The 1994 Plan provides for the granting of options for up to 818,765
shares of the Corporation's common stock at the fair market value at the time
the options are granted. The 1994 Plan will remain in effect until April 19,
2004. Each stock option granted under the 1994 Plan must be exercised within ten
years of the date the option was granted. The 1994 Plan provides that the Stock
Option Committee (Committee), appointed by the Corporation's board of directors,
at its discretion, may award restricted shares of the Corporation's common stock
to employees. Shares of the Corporation's common stock issued pursuant to the
1994 Plan are restricted for a period of no less than six months and no greater
than five years. The Committee determines the restrictions applicable to the
award of restricted stock, including, but not limited to, requirements of
continuous service for a specified term or the attainment of specific corporate,
divisional, or individual performance standards or goals. As of December 31,
1997, no restricted stock has been awarded.
42
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(14) STOCK OPTION PLANS - CONTINUED
Both plans also provide for the granting of options with tandem stock
appreciation rights. Stock appreciation rights entitle the grantee to receive
cash equal to the excess of the market value of the shares at the date the right
is exercised over the exercised price. Upon exercise of a stock appreciation
right, the related option, or portion thereof, is canceled. An expense is
accrued for the amount by which the market value of the stock exceeds the option
price for each stock appreciation right outstanding. As of December 31, 1997, no
stock appreciation rights have been granted.
Financial Accounting Standard No. 123, which became effective for 1996,
requires pro forma disclosures for companies that do not adopt its fair value
accounting method for stock-based employee compensation. Accordingly, the
following pro forma information presents net income and earnings per share had
the Standard's fair value method been used to measure compensation cost for
stock option plans. There were no compensation costs recognized for stock
options during 1997 and 1996.
<TABLE>
<CAPTION>
1997 1996
================================================================================
<S> <C> <C>
Net income as reported $ 10,672,528 $ 5,447,292
Pro forma net income 10,569,927 5,349,009
Basic earnings per share as reported 1.39 0.68
Pro forma basic earnings per share 1.38 0.67
Diluted earnings per share as reported 1.34 0.66
Pro forma diluted earnings per share 1.33 0.65
================================================================================
</TABLE>
In future years, the pro forma effect of not applying this standard is
expected to increase as additional options are granted.
Options exercisable at December 31 are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
================================================================================
<S> <C> <C> <C>
Number of options 317,753 331,119 372,311
Weighted average exercise price $ 2.76 $ 2.65 $ 2.55
================================================================================
</TABLE>
For options granted during the years indicated, the weighted-average fair
values at grant date are as follows:
<TABLE>
<CAPTION>
1997 1996
================================================================================
<S> <C> <C>
Options granted at market price:
Exercise price $ 14.35 $ 11.59
Fair value 2.63 3.39
================================================================================
</TABLE>
The fair value of options granted during 1997 and 1996 is estimated using
the following weighted average information:
<TABLE>
<CAPTION>
1997 1996
================================================================================
<S> <C> <C>
Risk-free interest rate 5.78% 5.42%
Expected life 7 years 10 years
Expected volatility of stock price 18.97% 17.01%
Expected dividends 2.00% 2.00%
================================================================================
</TABLE>
43
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(14) STOCK OPTION PLANS - CONTINUED
At December 31, 1997, options outstanding were as follows:
<TABLE>
<CAPTION>
================================================================================
<S> <C>
Number of options 508,948
Range of exercise price $2.31 - $17.55
Weighted average exercise price $6.07
Weighted average remaining option life 4.78 years
For options now exercisable:
Number 317,753
Weighted-average exercise price $2.76
================================================================================
</TABLE>
The following table summarizes outstanding grants and stock option
transactions for the three years ended December 31, 1997:
<TABLE>
<CAPTION>
Number of Shares Average Exercise Price
=============================================================================================
<S> <C> <C>
Options outstanding at December 31, 1994 423,846 $ 2.71
Options exercised (39,494) 2.89
Options forfeited (1,864) 5.11
Options granted 188,942 11.42
- ---------------------------------------------------------------------------------------------
Options outstanding at December 31, 1995 571,430 5.58
Options exercised (46,299) 2.48
Options forfeited (655) 8.82
Options granted 17,810 11.59
- ---------------------------------------------------------------------------------------------
Options outstanding at December 31, 1996 542,286 6.03
Options exercised (23,249) 4.52
Options forfeited (21,986) 11.41
Options granted 11,897 14.35
- ---------------------------------------------------------------------------------------------
Options outstanding at December 31, 1997 508,948 $ 6.07
=============================================================================================
</TABLE>
At December 31, 1997, 627,819 shares were available for future grants.
(15) EMPLOYEE STOCK OWNERSHIP PLAN
In conjunction with the plan of conversion, the Corporation's board of
directors approved a noncontributory Employee Stock Ownership Plan (ESOP) for
substantially all employees. The ESOP acquired 331,271 and 108,316 shares of
common stock in June 1990 and December 1991, respectively, for $1,260,000 and
$595,088, respectively, financed by loans payable to a nonaffiliated bank. The
loan agreements are secured by pledges of the Corporation's common stock owned
by the ESOP and purchased with the proceeds from these loans. The Corporation
does not guarantee the debt.
On April 25, 1994, the ESOP borrowed from the Corporation funds totaling
$1,097,095, which were used to repay debt outstanding to the nonaffiliated bank.
The repayment schedules for the new loans are the same as those contained in the
original loan agreements; however, the new agreements provide for the payment of
no interest on the unpaid principal balances. As of December 31, 1997, the
outstanding loan balances are reflected as a reduction in stockholders' equity.
44
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(15) EMPLOYEE STOCK OWNERSHIP PLAN - CONTINUED
The Corporation's contribution to the ESOP was approximately $232,000,
$147,000, and $99,000 for the years ended December 31, 1997, 1996, and 1995,
respectively. These amounts were charged to expense in the accompanying
consolidated statements of operations. Dividends on shares not allocated to
participants and held by the ESOP are utilized to service the ESOP debt and are
tax-deductible by the Corporation to the extent they are utilized to repay the
outstanding principal of the debt. Contributions from dividends on shares held
by the ESOP approximated $0, $85,000, and $133,000 for the years ended December
31, 1997, 1996, and 1995, respectively. The interest portion of the loan
payments was zero for the years ended December 31, 1997, 1996, and 1995,
respectively.
(16) PENSION PLAN AND OTHER RETIREMENT BENEFITS
Employees' Deferred Savings Plan and Deferred Savings Plan
The Bank's Employees' Deferred Savings Plan and Deferred Savings Plan (401(k)
plans) cover substantially all of its employees who have attained the age of 21,
have completed at least one year of service, and are a full-time or part-time
employee who has worked at least 1,000 hours during such plan year. Eligible
employees may contribute up to 18 percent of their annual compensation, subject
to certain maximums established by the Internal Revenue Service. The Corporation
will match up to 50 percent of the first 4 percent of the employees'
compensation deferred each year. In 1994, in addition to providing matching
funds under the 401(k) plans, the Bank established a discretionary
profit-sharing plan whereby eligible employees, regardless of their level of
participation in the 401(k) plans, received a contribution to their 401(k)
account in an amount equal to 2 percent of their compensation. The Corporation's
cost of these plans for the years ending December 31, 1997, 1996, and 1995, was
approximately $141,000, $176,000, and $132,000, respectively.
Financial Institutions Retirement Fund
The former Union Federal Savings (Union), which was merged into the Bank in
December 1991, was a participant in the multiple employer Financial Institutions
Retirement Fund (FIRF or the Fund), and substantially all of its officers and
employees were covered by the plan. FIRF provides benefits based on basic
compensation and years of service for employees age 21 and over after one year
of service. Union's contributions were determined by FIRF and generally
represented the normal cost of the Fund.
Union's participation in the FIRF was withdrawn effective February 29,
1992; therefore, no subsequent contributions have been required. Employee
participants were given the election to either choose continued participation
with the FIRF or to transfer the accrued benefit into the Bank's 401(k) plans.
Transfer of excess plan assets to the Bank's 401(k) plans occurred during 1993
and 1994 and are periodically allocated to remaining eligible participants as an
employer contribution.
Postretirement Benefits
The Bank's Employees' Retirement Health Care and Life Insurance Plan
(Postretirement Plan) is a contributory defined benefit postretirement health
care plan which covers substantially all employees of the Bank and their covered
dependents. Eligibility for benefits from the Postretirement Plan is age 60 with
at least 25 years of service with the Bank and active employment at retirement.
Retirees' contributions to the Postretirement Plan vary based upon the retiree's
age and election of coverage.
45
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(16) PENSION PLAN AND OTHER RETIREMENT BENEFITS - CONTINUED
Components of net periodic postretirement benefit cost for the years
indicated are as follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
=================================================================================
<S> <C> <C> <C>
Service cost $ 22,645 $ 21,209 $ 13,729
Interest cost 53,107 47,523 49,682
Amortization and deferral -- -- (3,470)
- ---------------------------------------------------------------------------------
Net periodic postretirement benefit cost $ 75,752 $ 68,732 $ 59,941
=================================================================================
</TABLE>
The weighted average discount rate used in determining the net periodic
postretirement benefit cost for 1997, 1996, and 1995 was 7.50 percent, 7.25
percent, and 8.75 percent, respectively. Additionally, in determining the net
periodic postretirement benefit cost, in 1997 there was a health care inflation
assumption of 10.41 percent, grading down uniformly to 5.50 percent in 2005 and
all years thereafter. A health care inflation assumption of 11.06 percent,
grading down uniformly to 5.25 percent in 2005 and all years thereafter, was
used in 1996. The dental inflation assumption was 5.00 percent in 1997 and 1996.
The Postretirement Plan's funded status, reconciled with amounts recognized
in the consolidated statements of financial condition, is as follows:
<TABLE>
<CAPTION>
December 31, 1997 1996
==========================================================================================
<S> <C> <C>
Accumulated postretirement benefit obligation for:
Retirees $ 427,568 $ 433,545
Other fully eligible plan participants 20,429 41,710
Other active plan participants 311,315 264,113
- ------------------------------------------------------------------------------------------
Total accumulated postretirement benefit obligation 759,312 739,368
Plan assets at fair value -- --
- ------------------------------------------------------------------------------------------
Accumulated postretirement benefit obligation in excess
of plan assets 759,312 739,368
Unrecognized net transition obligation -- --
Unrecognized net gains (losses) from experience different
from that assumed (15,609) (21,872)
Prior service cost not yet recognized in net periodic
postretirement benefit cost -- --
- ------------------------------------------------------------------------------------------
Accrued postretirement benefit cost $ 743,703 $ 717,496
==========================================================================================
</TABLE>
The weighted average discount rate used in determining the accumulated
postretirement benefit obligation at December 31, 1997 and 1996, was 7.00
percent and 7.50 percent, respectively.
For measurement purposes at December 31, 1997, the health care inflation
rate is assumed to decline uniformly from 9.80 percent per year presently to
5.00 percent per year in 2005 and all years thereafter. The dental inflation
assumption is 5.00 percent per year in all future years.
At December 31, 1996, for measurement purposes, the health care inflation
rate is assumed to decline uniformly from 10.41 percent per year to 5.50 percent
per year in 2005 and all years thereafter. The dental inflation assumption is
5.00 percent per year in all future years.
The effect of a one-percentage-point increase in the health care cost
trend rate assumptions on the service and interest components of net periodic
postretirement benefit cost for 1997, 1996, and 1995 and the accumulated
postretirement benefit obligation as of December 31, 1997 and 1996 would be
minimal because of the application of defined dollar caps on employer-provided
benefits.
46
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(17) REGULATORY MATTERS
The Bank is subject to regulatory capital requirements administered by federal
regulatory agencies. Capital adequacy guidelines and prompt corrective action
regulations involve quantitative measures of assets, liabilities, and certain
off-balance-sheet items calculated under regulatory accounting practices.
Capital amounts and classifications are also subject to qualitative judgments by
regulators about components, risk weightings, and other factors, and the
regulators can lower classifications in certain cases. Failure to meet various
capital requirements can initiate regulatory action that could have a direct
material effect on the consolidated financial statements.
The prompt corrective action regulations provide five classifications,
including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although these
terms are not used to represent overall financial condition. If adequately
capitalized, regulatory approval is required to accept brokered deposits. If
undercapitalized, capital distributions are limited, as is asset growth and
expansion, and plans for capital restoration are required. The minimum
requirements are:
<TABLE>
<CAPTION>
Capital to Risk- Tier 1 Capital
Weighted Assets to Adjusted
Total Tier 1 Total Assets
================================================================================
<S> <C> <C> <C>
Well capitalized 10% 6% 5%
Adequately capitalized 8 4 4
Undercapitalized 6 3 3
================================================================================
</TABLE>
At year-end, actual capital levels (in millions) and minimum required
levels were:
<TABLE>
<CAPTION>
Minimum Required
Minimum Required To Be Well Capitalized
for Capital Under Prompt-
Actual Adequacy Purposes Corrective-Action Regulations
- -------------------------------------------------------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
===============================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
1997
Total capital (to risk-weighted assets) $ 69.7 13.8% $ 40.5 8.0% $ 50.6 10.0%
Tier 1 (core) capital
(to risk-weighted assets) $ 65.0 12.8% $ 20.2 4.0% $ 30.4 6.0%
Tier 1 (core) capital
(to adjusted total assets) $ 65.0 7.6% $ 25.5 3.0% $ 42.6 5.0%
Tangible capital
(to adjusted total assets) $ 65.0 7.6% $ 12.8 1.5% N/A N/A
- -------------------------------------------------------------------------------------------------------------------------------
1996
Total capital (to risk-weighted assets) $ 64.1 13.2% $ 38.9 8.0% $ 48.6 10.0%
Tier 1 (core) capital
(to risk-weighted assets) $ 59.6 12.3% $ 19.4 4.0% $ 29.1 6.0%
Tier 1 (core) capital
(to adjusted total assets) $ 59.6 7.2% $ 24.9 3.0% $ 41.5 5.0%
Tangible capital
(to adjusted total assets) $ 59.6 7.2% $ 12.4 1.5% N/A N/A
===============================================================================================================================
</TABLE>
The Bank, at December 31, 1997 and 1996, was categorized as well
capitalized.
47
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(17) REGULATORY MATTERS - CONTINUED
The following is a reconciliation of the Corporation's consolidated
stockholders' equity for financial reporting purposes to the Bank's consolidated
tangible, core, and risk-based capital available to meet its regulatory
requirements:
<TABLE>
<CAPTION>
December 31, 1997 1996
======================================================================================================
<S> <C> <C>
Corporation's stockholders' equity as reported
in the accompanying consolidated financial statements $ 67,534,790 $ 62,470,027
Plus (less):
Capitalization of parent company (2,266,491) (2,683,442)
Unrealized gains on available-for-sale securities, net of tax (312,597) (214,594)
- ------------------------------------------------------------------------------------------------------
Tangible and core capital 64,955,702 59,571,991
Plus supplementary capital:
General loss reserves 4,730,407 4,563,594
- ------------------------------------------------------------------------------------------------------
Risk-based capital $ 69,686,109 $ 64,135,585
======================================================================================================
</TABLE>
The Bank may not declare or pay cash dividends on, or purchase, any of its
shares of common stock if the effect thereof would cause stockholders' equity to
be reduced below applicable regulatory capital maintenance requirements or if
such declaration and payment would otherwise violate regulatory requirements.
(18) EARNINGS PER SHARE
In February 1997 the FASB issued SFAS No. 128, Earnings Per Share (SFAS 128).
SFAS 128 specifies the computation, presentation, and disclosure requirements
for earnings per share. It replaces primary earnings per share and fully diluted
earnings per share with basic earnings per share and diluted earnings per share.
Effective December 31, 1997 the Corporation adopted SFAS 128. For the
Corporation, the computation for basic earnings per share is similar to primary
earnings per share except stock options are not considered when computing basic
earnings per share. For the Corporation, diluted earnings per share and fully
diluted earnings per share are similar. Diluted earnings per share of common
stock are based on the weighted average number of common shares and common share
equivalents outstanding during the year. The effect of common stock equivalent
shares applicable to employees' and directors' stock options has been included
in the calculation of diluted earnings per share for 1997, 1996, and 1995
because their impact was dilutive. The weighted average number of common and
common equivalent shares used in the calculation of diluted earnings per share
for 1996 and 1995 was restated to give retroactive effect to the 10 percent
stock dividend declared May 20, 1997 and the 3-for-2 stock split declared on
November 18, 1997.
A reconciliation of basic and diluted earnings per share for the years
ended December 31, follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
==================================================================================================
<S> <C> <C> <C>
Net earnings applicable to common stock and
common stock equivalents $10,672,528 $ 5,447,292 $ 6,802,903
==================================================================================================
Average number of shares outstanding 7,673,080 8,013,783 8,060,989
Effect of dilutive securities - stock options 304,212 234,648 259,796
- --------------------------------------------------------------------------------------------------
7,977,292 8,248,431 8,320,785
==================================================================================================
Diluted earnings per share $ 1.34 $ 0.66 $ 0.82
==================================================================================================
</TABLE>
48
<PAGE>
CFSB Bancorp, Inc., and Subsidiary
Notes to Consolidated Financial Statements, continued
(19) Financial Instruments with Off-Balance-Sheet Risk
In the normal course of business, to meet the financing needs of its customers
and to reduce its own exposure to fluctuations in interest rates, the
Corporation is a party to financial instruments with off-balance-sheet risk.
These financial instruments include commitments to extend credit and letters of
credit. Those instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the accompanying
consolidated statements of financial condition. The contract or notional amounts
of those instruments reflect the extent of involvement the Corporation has in
particular classes of financial instruments.
The Corporation's exposure to credit loss in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit and
letters of credit is represented by the contractual amount of that instrument.
The Corporation uses the same credit policies in making commitments as it does
for on-balance-sheet instruments.
Financial instruments whose contract amounts represent credit risk at
December 31, 1997 and 1996, are as follows:
<TABLE>
<CAPTION>
1997 1996
===========================================================================
<S> <C> <C>
Commitments to extend credit $82,305,000 $73,220,000
Letters of credit 440,000 283,000
===========================================================================
</TABLE>
There were no financial instruments whose notional amounts exceeded the
amount of credit risk at December 31, 1997.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Because many of the commitments are expected
to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Corporation applies the same
credit standards used in the lending process when extending these commitments
and evaluates each customer's creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Corporation upon
extension of credit, is based on management's credit evaluation of the
counterparty. Collateral held varies, but may include residential real estate
and income-producing commercial properties.
Letters of credit written are conditional commitments issued by the
Corporation to guarantee the performance of a customer to a third party. Most
guarantees extend for one year and expire in decreasing amounts through December
10, 1998. The extent of collateral held on those commitments at December 31,
1997 is equal to or in excess of the committed amount.
49
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(20) CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY
The statements of financial condition at December 31, 1997 and 1996, and
the statements of operations and cash flows for the years ended December 31,
1997, 1996, and 1995 of CFSB Bancorp, Inc., follow:
<TABLE>
<CAPTION>
Statements of Financial Condition
December 31, 1997 1996
======================================================================================
Assets:
Cash on deposit at subsidiary bank $ 77,505 $ 1,122,093
Investment in subsidiary bank 65,268,299 59,786,585
Dividends receivable from subsidiary bank 1,767,318 829,050
Other assets 1,884,227 1,825,052
- --------------------------------------------------------------------------------------
Total assets $ 68,997,349 $ 63,562,780
======================================================================================
Liabilities:
Dividends payable to stockholders $ 912,897 $ 564,629
Other liabilities 549,662 528,124
- --------------------------------------------------------------------------------------
Total liabilities 1,462,559 1,092,753
- --------------------------------------------------------------------------------------
Stockholders' Equity:
Common stock 76,555 72,744
Additional paid-in capital 48,377,350 41,398,650
Retained income 20,011,874 23,863,600
Net unrealized gains on available-for-sale
securities of subsidiary bank, net of tax 312,597 214,594
Employee Stock Ownership Plan (227,522) (459,408)
Treasury stock (1,016,064) (2,620,153)
- --------------------------------------------------------------------------------------
Total stockholders' equity 67,534,790 62,470,027
- --------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 68,997,349 $ 63,562,780
======================================================================================
<CAPTION>
Statements of Operations
Years Ended December 31, 1997 1996 1995
===============================================================================================================
<S> <C> <C> <C>
Income:
Dividends from subsidiary bank $ 5,141,733 $ 6,342,950 $ 3,022,000
Loss on equity investment (92,754) (108,153) (16,651)
- ---------------------------------------------------------------------------------------------------------------
Total operating income 5,048,979 6,234,797 3,005,349
Expenses:
Compensation, payroll taxes, and fringe benefits 401,105 312,954 333,072
Other operating expenses 297,325 208,621 222,142
- ---------------------------------------------------------------------------------------------------------------
Total operating expenses 698,430 521,575 555,214
- ---------------------------------------------------------------------------------------------------------------
Income before equity in undistributed net
income of subsidiary bank 4,350,549 5,713,222 2,450,135
Equity in undistributed net income of subsidiary bank 6,321,979 (265,930) 4,352,768
- ---------------------------------------------------------------------------------------------------------------
Net income $ 10,672,528 $ 5,447,292 $ 6,802,903
===============================================================================================================
</TABLE>
50
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(20) CONDENSED FINANCIAL INFORMATION -- PARENT COMPANY ONLY -- CONTINUED
<TABLE>
<CAPTION>
Statements of Cash Flows
Years Ended December 31, 1997 1996 1995
=======================================================================================================
<S> <C> <C> <C>
Cash Flows From Operating Activities:
Net income $ 10,672,528 $ 5,447,292 $ 6,802,903
Adjustments to reconcile net income:
Loss (equity) in undistributed net income
of subsidiary bank (6,321,979) 265,930 (4,352,768)
Decrease (increase) in other assets (59,175) 129,969 (634,019)
Increase in other liabilities 253,424 217,059 257,947
- -------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 4,544,798 6,060,250 2,074,063
- -------------------------------------------------------------------------------------------------------
Cash Flows From Financing Activities:
Proceeds from stock options exercised 105,165 114,674 114,072
Purchases of treasury stock (2,777,983) (4,089,237) --
Dividends paid on common stock (2,916,568) (2,107,991) (1,832,008)
- -------------------------------------------------------------------------------------------------------
Net cash used by financing activities (5,589,386) (6,082,554) (1,717,936)
- -------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash (1,044,588) (22,304) 356,127
Cash at beginning of period 1,122,093 1,144,397 788,270
- -------------------------------------------------------------------------------------------------------
Cash at end of period $ 77,505 $ 1,122,093 $ 1,144,397
=======================================================================================================
</TABLE>
(21) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, Disclosures About Fair
Value of Financial Instruments (SFAS 107), requires disclosures of fair-value
information about financial instruments, whether or not recognized in the
balance sheet, for which it is practicable to estimate that value. In cases
where quoted market prices are not available, fair values are based on estimates
using present value or other valuation techniques. Those techniques are
significantly affected by the assumptions used, including the discount rate and
estimates of future cash flows. In that regard, the derived fair-value estimates
cannot be substantiated by comparison to independent markets and, in many cases,
could not be realized in immediate settlement of the instrument.
Fair-value methods and assumptions for the Corporation's financial
instruments are as follows:
Cash and Cash Equivalents - The carrying amounts reported in the
consolidated statements of financial condition for cash and interest-earning
deposits with the Federal Home Loan Bank and other depository institutions
reasonably approximate those assets' fair values.
Investment and Mortgage-Backed Securities - Fair values for investment and
mortgage-backed securities are based on quoted market prices.
Loans Receivable - For adjustable-rate loans that reprice frequently and
with no significant change in credit risk, fair values are generally based on
carrying values. The fair values for fixed-rate one-to-four family residential
mortgage loans, income-producing property loans, and consumer loans are
estimated using discounted cash flow analyses, using interest rates currently
being offered for loans with similar terms and similar credit quality. The
carrying amount of accrued interest receivable approximates its fair value.
Deposit Liabilities - The fair value of deposits with no stated maturity,
such as savings, checking, and money market accounts, is equal to the amount
payable on demand as of December 31, 1997 and 1996. The fair value of
certificates of deposit is based on the discounted value of contractual cash
flows. The discount rate is estimated using the rates currently offered by the
Corporation for deposits of similar remaining maturities. The fair value of
accrued interest payable approximates its carrying value.
51
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(21) FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED
Deposit Liabilities, continued - The fair-value estimates of deposit
liabilities do not include the benefit that results from the low-cost funding
provided by the deposit liabilities compared to the cost of borrowing funds in
the market.
Federal Home Loan Bank Advances - The fair value of the Corporation's
borrowings from the Federal Home Loan Bank are estimated using discounted cash
flow analyses, based on the Corporation's current incremental borrowing rates
for similar types of borrowing arrangements.
Off-Balance-Sheet Instruments - The fair value of commitments to extend
credit is estimated using the fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
present creditworthiness of the counterparties. For fixed-rate loan commitments,
fair value also considers the difference between current levels of interest
rates and the committed rates.
The estimated fair value of the Corporation's financial instruments at
December 31, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
1997 1996
Carrying Value Estimated Fair Value Carrying Value Estimated Fair Value
===================================================================================================================================
<S> <C> <C> <C> <C>
Financial assets:
Cash and short-term interest-earning deposits $ 18,489,494 $ 18,500,000 $ 22,749,963 $ 22,700,000
Investment securities 26,079,688 26,100,000 31,093,494 31,100,000
Mortgage-backed securities 21,597,690 21,600,000 27,220,567 27,200,000
Loans receivable, net 754,806,061 765,900,000 717,714,636 717,900,000
Accrued interest receivable 4,910,200 4,900,000 4,349,240 4,300,000
- -----------------------------------------------------------------------------------------------------------------------------------
Financial liabilities:
Savings, checking, and money market accounts 238,067,605 238,100,000 229,359,744 229,400,000
Certificates of deposit 324,344,462 325,400,000 324,214,257 325,300,000
Advances from Federal Home Loan Bank 212,692,934 214,200,000 202,639,323 202,600,000
Accrued interest payable 3,043,923 3,000,000 4,233,799 4,200,000
- -----------------------------------------------------------------------------------------------------------------------------------
Off-balance-sheet items:
Commitments to extend credit -- -- -- --
===================================================================================================================================
</TABLE>
Limitations
Fair-value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These
estimates do not reflect any premium or discount that could result from offering
for sale at one time the Corporation's entire holding of a particular financial
instrument. Because no market exists for a significant portion of the
Corporation's financial instruments, fair-value estimates are based on judgments
regarding future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment, and therefore cannot be determined with precision. Changes
in assumptions could significantly affect the estimates.
Fair-value estimates are based on existing on- and off-balance-sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. Accordingly, the aggregate fair-value amounts presented
do not represent the underlying value of the Corporation.
52
<PAGE>
CFSB BANCORP, INC., AND SUBSIDIARY
Notes to Consolidated Financial Statements, continued
(22) QUARTERLY FINANCIAL INFORMATION
The following is a summary of quarterly financial information for the years
ended December 31, 1997 and 1996 (unaudited):
<TABLE>
<CAPTION>
March 31 June 30 September 30 December 31
(Dollars in Thousands, Except Per Share Data)
===============================================================================================================
<S> <C> <C> <C> <C>
1997
Interest income $ 15,171 $ 15,459 $ 15,879 $ 15,992
Net interest income 6,215 6,344 6,466 6,345
Provision for loan losses 90 90 90 90
Income before federal income tax expense 3,373 4,056 4,138 4,082
Net income 2,307 2,796 2,801 2,769
Earnings per share (1):
Basic .30 .36 .37 .36
Diluted .29 .35 .35 .35
Stock price range (1) $11.52-$13.48 $12.88-$16.50 $15.50-$20.67 $19.17-$26.25
- ---------------------------------------------------------------------------------------------------------------
1996
Interest income $ 13,786 $ 14,065 $ 14,549 $ 15,002
Net interest income 5,367 5,721 5,806 5,950
Provision for loan losses 60 60 60 60
Income (loss) before federal income tax expense 2,530 2,714 (530) 3,168
Net income (loss) 1,715 1,851 (293) 2,174
Earnings (loss) per share (1):
Basic .21 .23 (.04) .28
Diluted .21 .22 (.04) .27
Stock price range (1) $11.02-$13.22 $10.74-$12.12 $10.74-$12.12 $10.91-$12.58
===============================================================================================================
</TABLE>
(1) Per share data was restated to give retroactive effect to the 10 percent
stock dividend declared May 20, 1997 and the 3-for-2 stock split declared
November 18, 1997.
53
<PAGE>
=======================
STOCKHOLDER INFORMATION
=======================
Corporate Headquarters
CFSB Bancorp, Inc.
112 East Allegan Street
Lansing, MI 48933
(517) 374-3550
Fax (517) 374-3557
Wholly-Owned Subsidiary
Community First Bank
112 East Allegan Street
Lansing, Michigan 48933
(517) 371-2911
Stock Transfer Agent & Registrar
Registrar and Transfer Company
Investor Relations
10 Commerce Drive
Cranford, New Jersey 07016
(800) 368-5948
Dividend Reinvestment Plan
CFSB Bancorp, Inc. offers a Dividend Reinvestment and Stock Purchase Plan to
stockholders. The plan provides participating stockholders with a convenient way
to purchase additional shares of CFSB Bancorp common stock by reinvesting the
cash dividends paid on their shares. Participants may also purchase additional
shares by making an optional cash payment of $50 to $2,000. There are no fees or
commissions charged on shares purchased through the Plan. If you are interested
in learning more about the Dividend Reinvestment and Stock Purchase Plan, please
contact the Marketing Department at (517) 374-3569.
Annual Meeting
The annual meeting of stockholders for the year ended December 31, 1997 will be
held at the Sheraton Lansing Hotel, 925 South Creyts Road, Lansing, Michigan, on
Tuesday, April 21, 1998, at 11:00 a.m.
Form 10-K
The Corporation's 1997 Annual Report on Form 10-K as filed with the Securities
and Exchange Commission will be provided without charge to stockholders upon
request. Send requests to the Marketing Department at CFSB Bancorp, 112 East
Allegan Street, Lansing, Michigan 48933, or call (517) 374-3569.
54
<PAGE>
Quarterly Stock Price and Dividend Information
Quarterly stock prices and dividends declared are shown in the table below:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996
- ---------------------------------------------------------------------------------------------------------------
Dividends Dividends
High Low Close Declared High Low Close Declared
===============================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Quarter
First $ 13 1/2 $ 11 1/2 $ 12 7/8 $ 0.09 $13 1/4 $ 11 $ 11 7/8 $ 0.06
Second 16 1/2 12 7/8 15 1/2 0.10 12 1/8 10 3/4 11 7/16 0.07
Third 20 11/16 15 1/2 19 1/4 0.11 12 1/8 10 3/4 10 15/16 0.07
Fourth 26 1/4 19 3/16 26 1/4 0.12 12 9/16 10 15/16 11 13/16 0.07
- ---------------------------------------------------------------------------------------------------------------
Year $ 26 1/4 $ 11 1/2 $ 26 1/4 $ 0.42 $13 1/4 $ 10 3/4 $ 11 13/16 $ 0.27
===============================================================================================================
</TABLE>
On November 18, 1997, the Corporation's board of directors declared a
3-for-2 stock split payable on December 18, 1997 to stockholders of record on
December 1, 1997. On May 20, 1997 a 10 percent stock dividend payable on June
16, 1997 to stockholders of record on May 30, 1997 was declared. In addition, on
August 20, 1996 the Corporation's board of directors declared a 10 percent stock
dividend payable on September 12, 1996 to stockholders of record on August 30,
1996. As a result, per share amounts have been restated for all periods to
reflect the stock split and the stock dividends.
On June 29, 1990, the Corporation's common stock began trading on the
NASDAQ National Market System under the symbol CFSB.
As of December 31, 1997, there were 7,607,478 shares of common stock issued
and outstanding.
As of February 27, 1998, there were approximately 1,261 stockholders of
record which does not include stockholders holding their stock in street name or
nominee's name.
55
<PAGE>
==================
BOARD OF DIRECTORS
==================
[PHOTO APPEARS HERE] [PHOTO APPEARS HERE]
James L. Reutter Robert H. Becker
Chairman of the Board, President and
CFSB Bancorp, Inc. Chief Executive Officer,
President, Lansing Ice CFSB Bancorp, Inc.
and Fuel Company Lansing, Michigan
Lansing, Michigan
[PHOTO APPEARS HERE] [PHOTO APPEARS HERE]
David H. Brogan William C. Hollister
Agent, Ohio National Life President, Basic Insight
Insurance Company East Lansing, Michigan
Lansing, Michigan
[PHOTO APPEARS HERE] [PHOTO APPEARS HERE]
Cecil Mackey J. Paul Thompson, Jr.
Professor of Economics, President,
Michigan State University Computer Graphics, Inc.
East Lansing, Michigan DeWitt, Michigan
[PHOTO APPEARS HERE] [PHOTO APPEARS HERE]
Donald F. Wall Henry W. Wolcott, IV
President, Compass Shareholder,
Management, Inc. Public Accounting Firm
Williamston, Michigan of Kutas, Hawes, Wolcott &
Bergman, P.C.
Lansing, Michigan
[GRAPHIC OF VINE APPEARS HERE BEHIND TEXT]
========
OFFICERS
========
CFSB Bancorp, Inc.
Officers
James L. Reutter, Chairman
Robert H. Becker, President & Chief Executive Officer
John W. Abbott, Executive Vice President,
Chief Operating Officer & Secretary
Rick L. Laber, Vice President, Chief Financial Officer & Treasurer
Community First Bank
Executive Officers
Robert H. Becker, President & Chief Executive Officer
John W. Abbott, Executive Vice President,
Chief Operating Officer & Secretary
Carl C. Farrar, Senior Vice President & Chief Lending Officer
Jack G. Nimphie, Senior Vice President & Director of Operations
C. Wayne Weaver, Senior Vice President & Director of Retail Banking
JaneMarie Judge McMillian, Vice President &
Director of Human Resources
Rick L. Laber, Vice President, Chief Financial Officer & Treasurer
Sally A. Peters, Vice President & Director of Marketing
Other Officers
Vice Presidents
Richard J. Benson, Manager of Data Processing
S. Mark Guastella, Branch Administrator
David A. Huson, Manager of Central Operations
James S. Leenstra, Director of Lending Operations
Carole A. Rush-Witt, Manager of Residential Lending
Douglas W. Sutton, Manager of Consumer Lending
Rodney W. Weaver, Director of Corporate Services
Assistant Vice Presidents
Brenda G. Bartowiak, Williamston Branch Manager
Susan K. Bennett, Manager of Residential Lending Operations
Rhonda A. Curtis, Ionia Branch Manager
Kevin J. Fedewa, St. Johns Area Branch Manager
Michael C. Fildey, Operations Service Manager
Julie M. Goff, Manager of Construction Lending
JoAnn R. Isham, Okemos Area Branch Manager
Dan O. Kares, Manager of Commercial Lending
Paul L. Kelsey, East Lansing Area Branch Manager
R. Anthony Payne, West Saginaw Area Branch Manager
Joseph F. Szombati, Grand Ledge Area Branch Manager
Glenn R. Varlesi, South Cedar Area Branch Manager
Michelle L. Warfle, Mason Branch Manager
Robert D. Warnke, Metro Area Branch Manager &
Manager of Retirement Accounts
Gail L. Wilcox, Manager of Mortgage Loan Servicing
Gail M. Williams, Charlotte Branch Manager
Crystal D. Yaw, DeWitt Branch Manager
Managers
Stanley J. Gorecki, Controller
William E. Johnson, Data Processing Operations Manager
Ronald M. Pioch, Manager of Internal Control and Compliance
Lori A. Smith, Consumer Loan Officer
56
<PAGE>
[GRAPHIC OF VINE APPEARS HERE]
==============================
COMMUNITY FIRST BANK LOCATIONS
==============================
[MAP APPEARS HERE]
* Branch Office with Full-Service ATM Banking Center
[] Branch Office without ATM Banking Center
+ Full-Service ATM Banking Center
(Deposits and Withdrawals)
. ATM Banking Center (Withdrawals Only)
[MAP OF REGION APPEARS HERE]
<PAGE>
[GRAPHIC OF VINE APPEARS HERE]
[LOGO OF CFSB BANCORP APPEARS HERE]
<PAGE>
EXHIBIT 21
SUBSIDIARIES
CFSB Bancorp, Inc. (the "Corporation") owns 100% of the common stock of
Community First Bank ("Community First") and Community First owns 100% of the
common stock of Capitol Consolidated Financial Corporation, a Michigan
corporation. Capital Consolidated Financial Corporation owns 100% of the common
stock of Allegan Insurance Agency, Inc., a Michigan Corporation.
Community First also owns 100% of the common stock of Community First
Mortgage Corporation, a Michigan Corporation, which was formed on January 2,
1998.
<PAGE>
EXHIBIT 23
[LETTERHEAD OF KPMG PEAT MARWICK, LLP]
The Board of Directors
CFSB Bancorp, Inc.
We consent to incorporation by reference in the registration (Nos. 33-37440 and
33078164) on Form S-8s of CFSB Bancorp, Inc. of our report dated January 20,
1998, relating to the consolidated statements of financial condition of CFSB
Bancorp, Inc. and subsidiary as of December 31, 1997 and 1996, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the years in the three-year period ended December 31, 1997, which report
appears in the December 31, 1997, Annual Report on Form 10-K of CFSB Bancorp,
Inc.
/s/ KPMG Peat Marwick LLP
Lansing, Michigan
March 17, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> MAR-31-1998
<CASH> 5,188,951
<INT-BEARING-DEPOSITS> 13,300,543
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 47,677,378
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 754,806,061
<ALLOWANCE> 4,730,407
<TOTAL-ASSETS> 852,887,913
<DEPOSITS> 562,412,067
<SHORT-TERM> 72,357,552
<LIABILITIES-OTHER> 10,248,122
<LONG-TERM> 140,335,382
0
0
<COMMON> 48,453,905
<OTHER-SE> 19,080,885
<TOTAL-LIABILITIES-AND-EQUITY> 852,887,913
<INTEREST-LOAN> 57,570,229
<INTEREST-INVEST> 3,457,481
<INTEREST-OTHER> 1,473,760
<INTEREST-TOTAL> 62,501,470
<INTEREST-DEPOSIT> 24,477,571
<INTEREST-EXPENSE> 37,131,620
<INTEREST-INCOME-NET> 25,369,850
<LOAN-LOSSES> 360,000
<SECURITIES-GAINS> (29,321)
<EXPENSE-OTHER> 15,761,928
<INCOME-PRETAX> 15,648,528
<INCOME-PRE-EXTRAORDINARY> 15,648,528
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,672,528
<EPS-PRIMARY> 1.39
<EPS-DILUTED> 1.34
<YIELD-ACTUAL> 3.06
<LOANS-NON> 883,194
<LOANS-PAST> 15,622
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 24,345
<ALLOWANCE-OPEN> 4,563,594
<CHARGE-OFFS> 247,432
<RECOVERIES> 54,245
<ALLOWANCE-CLOSE> 4,730,407
<ALLOWANCE-DOMESTIC> 4,699,588
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 183,446
</TABLE>
