<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-19772
HF FINANCIAL CORP.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 46-0418532
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
225 South Main Avenue, Sioux Falls, SD 57104
- --------------------------------------------------------------------------------
(Address of principal executive office) (ZIP Code)
(605) 333-7556
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities
Exchange Act of 1934 during the preceding 12 months(or 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
--- ---
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
As of May 10, 1999 there were 4,753,218 issued and outstanding
shares of the Registrant's Common Stock, with $.01 par value.
<PAGE>
HF FINANCIAL CORP.
FORM 10-Q
INDEX
Page
PART I. Financial Information
- ----------------------------------------
Item 1. Financial Statements (Unaudited):
Consolidated Statements of Financial Condition
As of March 31, 1999 and June 30, 1998 1
Consolidated Statements of Income for the Three and
Nine months ended March 31, 1999 and 1998 2
Consolidated Statement of Stockholders' Equity
for the Nine months ended March 31, 1999 3
Consolidated Statements of Cash Flows for the Nine
months ended March 31, 1999 and 1998 4-5
Notes to Consolidated Financial Statements 6-7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8-21
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 22
PART II. Other Information
- ------------------------------------
Item 1. Legal Proceedings 23
Item 2. Changes in Securities 23
Item 3. Default upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
<PAGE>
Item 1.
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
ASSETS March 31, June 30,
1999 1998
---------------------
<S> <C> <C>
Cash and cash equivalents $ 15,686 $ 25,458
Securities available for sale 49,642 44,232
Mortgage-backed securities available for sale 45,211 39,647
Loans receivable 454,789 426,522
Loans held for sale 11,073 9,616
Accrued interest receivable 4,035 4,338
Foreclosed real estate and other properties 207 229
Office properties and equipment, at cost, net of
accumulated depreciation 14,154 14,317
Prepaid expenses and other assets 3,658 1,999
Mortgage servicing rights 1,685 1,423
Deferred income taxes 4,045 3,198
---------------------
$604,185 $570,979
---------------------
---------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits $443,545 $446,424
Advances from Federal Home Loan Bank
and other borrowings 88,876 50,635
Advances by borrowers for taxes and insurance 8,806 4,792
Accrued interest payable 6,002 5,898
Other liabilities 5,488 6,629
---------------------
Total liabilities
552,717 514,378
---------------------
Stockholders' Equity
Preferred stock, $.01 par value, 500,000
shares authorized, none outstanding ---- ----
Series A Junior Participating Preferred Stock,
$1.00 stated value, 50,000 shares authorized,
none outstanding ---- ----
Common stock, $.01 par value, 10,000,000 shares
authorized, 4,753,218 and 4,730,276 shares
outstanding at March 31,1999 and June 30, 1998 48 47
Additional paid-in capital 15,106 14,863
Retained earnings, substantially restricted 47,844 46,561
Unearned compensation (340) (340)
Accumulated other comprehensive income (235) (9)
Less cost of treasury stock, March 31, 1999
663,992 shares, June 30, 1998 334,222 shares (10,955) (4,521)
---------------------
51,468 56,601
---------------------
$604,185 $570,979
---------------------
---------------------
</TABLE>
See Notes to Consolidated Financial Statements
Page 1
<PAGE>
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Thousands, Except Per Share Data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended March 31, Ended March 31,
--------------------- --------------------
1999 1998 1999 1998
-------- -------- --------- -------
<S> <C> <C> <C> <C>
Interest and dividend income:
Loans receivable $ 9,973 $ 9,855 $ 30,118 $ 30,102
Mortgage-backed securities 710 468 1,996 1,403
Investment securities and interest-bearing deposits 714 1,079 2,021 3,224
-------- ------- -------- --------
11,397 11,402 34,135 34,729
-------- ------- -------- --------
Interest expense:
Deposits 4,933 5,296 15,233 16,468
Advances from Federal Home Loan Bank
and other borrowings 1,207 899 3,063 2,867
-------- ------- -------- --------
6,140 6,195 18,296 19,335
-------- ------- -------- --------
Net interest income 5,257 5,207 15,839 15,394
Provision for losses on loans 2,041 898 5,299 2,228
-------- ------- -------- --------
Net interest income after provision
for losses on loans 3,216 4,309 10,540 13,166
-------- ------- -------- --------
Noninterest income:
Credit card fee income 2,647 1,533 7,808 3,517
Fees on deposits 557 518 1,721 1,623
Loan servicing income 329 309 947 863
Loan fees and service charges 234 253 840 930
Gain on sale of loans 184 193 484 777
Other (90) 249 1,151 985
-------- ------- -------- --------
3,861 3,055 12,951 8,695
-------- ------- -------- --------
Noninterest expense:
Compensation and employee benefits 2,770 2,590 8,010 7,522
Credit card processing expense 2,195 799 6,057 1,655
Other general and administrative expenses 1,109 1,064 3,187 3,126
Occupancy and equipment 719 689 2,103 1,990
Federal insurance premiums 75 68 226 205
Other 31 42 129 265
-------- ------- -------- --------
6,899 5,252 19,712 14,763
-------- ------- -------- --------
Income before income taxes 178 2,112 3,779 7,098
Income tax expense 131 696 1,352 2,376
-------- ------- -------- --------
Net income $ 47 $ 1,416 $ 2,427 $ 4,722
-------- ------- -------- --------
-------- ------- -------- --------
Earnings per share:
Basic $0.01 $0.32 $0.57 $1.06
-------- ------- -------- --------
-------- ------- -------- --------
Diluted $0.01 $0.31 $0.56 $1.03
-------- ------- -------- --------
-------- ------- -------- --------
</TABLE>
See Notes to Consolidated Financial Statements
Page 2
<PAGE>
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Nine Months Ended March 31, 1999
(Dollars In Thousands, Except Per Share Data)
(Unaudited)
<TABLE>
<CAPTION>
Accumulated
Additional Other Total
Common Paid-In Retained Unearned Comprehensive Treasury Stockholders'
Stock Capital Earnings Compensation Income Stock Equity
------- ---------- -------- ------------ ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1998 $ 47 $ 14,863 $46,561 $ (340) $ (9) $ (4,521) $ 56,601
Comprehensive income:
Net income - - - - - - - - 2,427 - - - - - - - - - - - - 2,427
Change in unrealized gain (loss),
Securities available for sale, net
Of related deferred taxes of ($118) - - - - - - - - - - - - - - - - (226) - - - - (226)
------- ---------- -------- ----------- ------------- ------------ -------------
Total comprehensive income - - - - - - - - 2,427 - - - - (226) - - - - 2,201
Exercise of stock options for 22,942 - - - -
shares 1 243 - - - - - - - - - - - - - - - - 244
Cash dividends paid ($0.27 per share)
on common stock - - - - - - - - (1,144) - - - - - - - - - - - - (1,144)
Purchase of treasury stock - - - - - - - - - - - - - - - - - - - - (6,434) (6,434)
------- ---------- -------- ------------ ------------- ------------ -------------
Balance, March 31, 1999 $ 48 $ 15,106 $47,844 $ (340) $ (235) $ (10,955) $ 51,468
------- ---------- -------- ------------ ------------- ------------ -------------
------- ---------- -------- ------------ ------------- ------------ -------------
</TABLE>
See Notes to Consolidated Financial Statements
Page 3
<PAGE>
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended March 31,
------------------------------------
1999 1998
---------------- ----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,427 $ 4,722
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for losses on loans 5,299 2,228
Depreciation 1,181 1,127
Amortization of premiums and discounts, net:
Securities available for sale (15) (10)
Mortgage-backed securities available for sale 17 (101)
Reduction in cost of intangible assets - - - - 3
Reduction in mortgage servicing rights 202 155
Increase (decrease) in deferred loan fees 254 (93)
Loans originated for resale (60,901) (62,080)
Proceeds from the sale of loans 61,385 62,560
(Gain) on sale of loans (484) (777)
Mortgage servicing rights capitalized (296) (145)
(Gain) on sale of securities, net (3) (10)
Losses and provision for losses on sales of
foreclosed real estate and other properties, net 25 156
(Gain) loss on disposal of office properties and equipment, net 29 (9)
Decrease in accrued interest receivable 303 122
(Increase) decrease in prepaid expenses and other assets (1,659) 227
(Increase) decrease in deferred income taxes (729) 142
(Decrease) in accrued interest payable and other liabilities (1,037) (1,570)
----------- ----------
Net cash provided by operating activities $ 5,998 $ 6,647
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Loans purchased (27,114) (11,535)
Loans made to customers (140,855) (122,888)
Principal collected on loans 129,767 125,422
Sale of participation interests in loans 2,500 16,550
Mortgage-backed securities available for sale:
Sales 4,489 - - - -
Purchases (21,430) (12,507)
Repayments 11,210 4,051
Securities available for sale:
Sales and maturities 29,590 39,975
Purchases (35,176) (46,117)
Proceeds from sale of office properties and equipment 44 55
Purchase of office properties and equipment (1,091) (742)
Purchase of mortgage servicing rights (168) (220)
Proceeds from sale of foreclosed real estate
and other properties, net 423 734
----------- ----------
Net cash (used in) investing activities $ (47,811) $ (7,222)
----------- ----------
</TABLE>
See Notes to Consolidated Financial Statements
Page 4
<PAGE>
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Dollars in Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended March 31,
---------------------------------------
1999 1998
---------------- ----------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits $ (2,879) $ 18,051
Proceeds of advances from Federal Home Loan Bank
and other borrowings 62,600 25,000
Payments on advances from Federal Home Loan Bank
and other borrowings (24,359) (39,136)
Increase in advances by borrowers for
taxes and insurance 4,014 3,483
Purchase of treasury stock (6,434) (1,736)
Proceeds from issuance of common stock 243 140
Cash dividends paid (1,144) (939)
---------------- ----------------
Net cash provided by financing activities $ 32,041 $ 4,863
---------------- ----------------
Increase (decrease) in cash and cash equivalents $ (9,772) $ 4,288
Cash and Cash Equivalents
Beginning 25,458 17,957
---------------- ----------------
Ending $ 15,686 $ 22,245
---------------- ----------------
---------------- ----------------
</TABLE>
See Notes to Consolidated Financial Statements
Page 5
<PAGE>
HF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Nine months ended March 31, 1999 and 1998
(Dollars in Thousands)
(unaudited)
NOTE 1. SELECTED ACCOUNTING POLICIES
BASIS OF PRESENTATION:
The foregoing consolidated financial statements are unaudited. However,
in the opinion of management, all adjustments (which consist of normal recurring
accruals) necessary for a fair presentation of the consolidated financial
statements have been included. Results for any interim period are not
necessarily indicative of results to be expected for the year. The interim
consolidated financial statements include the accounts of HF Financial Corp.
(the "Company"), its subsidiaries, HomeFirst Mortgage Corp. (formerly known as
HF Mortgage Corp.), HF Card Services L.L.C. and Home Federal Savings Bank, (the
"Bank") and the Bank's subsidiaries.
NOTE 2. REGULATORY CAPITAL
The following table sets forth the Bank's compliance with its capital
requirements at March 31, 1999:
<TABLE>
<CAPTION>
AMOUNT PERCENT
------- -------
<S> <C> <C>
Tier I (Core) capital:
Required . . . . . . . . . . . . . $18,090 3.00%
Actual . . . . . . . . . . . . . . . 44,774 7.43
Excess . . . . . . . . . . . . . . . 26,684 4.43
Risk-based capital:
Required. . . . . . . . . . . . . . $33,080 8.00%
Actual . . . . . . . . . . . . . . . 49,981 12.09
Excess . . . . . . . . . . . . . . . 16,901 4.09
</TABLE>
NOTE 3. EARNINGS PER SHARE
Earnings (loss) per share are calculated in accordance with the
provisions of Financial Accounting Standards Board ("FASB") Statement No. 128,
"Earnings Per Share", which was effective for fiscal year 1998. This Statement
establishes standards for computing and presenting earnings (loss) per share
("EPS"). It replaces the presentation of primary EPS with a presentation of
basic EPS. It also requires dual presentation of basic and diluted EPS on the
face of the income statement for all entities with complex capital structures.
Basic earnings per share is computed by dividing income available to
common stockholders (the numerator) by the weighted-average number of common
shares outstanding (the denominator) during the period. Shares issued during the
period and shares reacquired during the period are weighted for the portion of
the period that they were outstanding. The weighted average number of common
shares outstanding for the three month period ended March 31, 1999 and 1998 as
adjusted was 4,114,774 and 4,462,689 respectively. The weighted average number
of common shares outstanding for the nine month period ended March 31, 1999 and
1998 as adjusted was 4,239,648 and 4,459,295 respectively.
Dilutive earnings per share is similar to the computation of basic
earnings per share except that the denominator is increased to include the
number of additional common shares that would have been outstanding if the
dilutive options outstanding had been exercised. The weighted average number of
common and dilutive potential common shares outstanding for the three month
period ended March 31, 1999 and 1998 as adjusted was 4,276,486 and 4,598,439
respectively. The weighted average number of common and dilutive potential
common shares outstanding for the nine month period ended March 31, 1999 and
1998 as adjusted was 4,343,678 and 4,587,918 respectively.
Page 6
<PAGE>
NOTE 4. NEW STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS ("SFAS")
The FASB issued SFAS No. 130, " Reporting Comprehensive Income". This
Statement establishes standards for reporting and display of comprehensive
income and its components (revenues, expenses, gains, and losses) in a full set
of general-purpose financial statements. This Statement requires that all items
that are required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. This Statement requires that
an enterprise (a) classify items of other comprehensive income by their nature
in a financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of a statement of financial position. This
Statement was adopted July 1, 1998 and is reflected in the accompanying
consolidated financial statements.
The FASB issued SFAS No. 131, "Disclosures about Segments of Enterprise
and Related Information". This Statement establishes standards for the way that
public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. This Statement is
effective for financial statements for periods beginning after December 15,
1997. Management anticipates providing the required disclosures in its June 30,
1999 consolidated financial statements.
The FASB issued SFAS No. 132, "Employers' Disclosures about Pensions
and Other Postretirement Benefits". This Statement standardizes the disclosure
requirements for pensions and other postretirement benefits, requires additional
information on changes in the benefit obligations and fair values of plan
assets, and eliminates certain disclosures that are no longer useful. This
Statement also permits reduced disclosures for nonpublic entities. This
Statement supersedes the disclosure requirements in FASB Statements No. 87,
"Employers' Accounting for Pensions", No. 88, "Employers' Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits", and No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions". This Statement is effective for financial
statements for periods beginning after December 15, 1997. Management anticipates
providing the required disclosures in its June 30, 1999 consolidated financial
statements.
The FASB issued SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities". This Statement establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives) and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. If certain conditions are met, a derivative may
be specifically designated as (a) a hedge of the exposure to changes in the fair
value of a recognized asset liability or an unrecognized firm commitment, (b) a
hedge of the exposure to variable cash flows of a forecasted transaction, or (c)
a hedge of the foreign currency exposure of a net investment in a foreign
operation, an unrecognized firm commitment, an available-for-sale security, or a
foreign-currency-denominated forecasted transaction. This Statement is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. Initial
application of this Statement should be as of the beginning of an entity's
fiscal quarter; on that date, hedging relationships must be designated anew and
documented pursuant to the provisions of this Statement. Earlier application of
all of the provisions of this Statement is encouraged, but it is permitted only
as of the beginning of any fiscal quarter that begins after issuance of this
Statement. This Statement should not be applied retroactively to financial
statements of prior periods. Management is evaluating the impact of this
Statement on the Company's consolidated financial statements.
The FASB issued SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise". This statement further amends SFAS No. 65, "Accounting for
Certain Mortgage Banking Activities" to require that after the securitization of
mortgage loans held for sale, an entity engaged in mortgage Banking activities
classify the resulting mortgage-backed securities or other retained interests
based on its ability and intent to sell or hold those investments. This
Statement conforms the subsequent accounting for securities retained after the
securitization of mortgage loans by a mortgage Banking enterprise with the
subsequent accounting for securities retained after the securitization of other
types of assets by a nonmortgage Banking enterprise. This Statement is effective
for the first fiscal quarter beginning after December 15, 1998. As of March 31,
1999, the Company has no securitized mortgage loans held for sale. There is no
impact from this Statement on the Company's consolidated financial statements at
March 31, 1999.
Page 7
<PAGE>
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
HF Financial Corp. ("Company") was incorporated under the laws of the
State of Delaware in November 1991 for the purpose of owning all of the
outstanding stock of Home Federal Savings Bank ("Bank") issued in the mutual to
stock conversion of the Bank. The Company acquired all of the stock of the Bank
on April 8, 1992. In October 1994, the Company acquired and began operating a
new mortgage subsidiary as HomeFirst Mortgage Corp. ("Mortgage Corp."). The
Company ceased operation of the Mortgage Corp. during fiscal 1998. In May, 1996
the Company formed a Limited Liability Company named HF Card Services L.L.C.
("HF Card Services") and became the owner of 51% of this entity. The Company
became the owner of 100% of HF Card Services in February 1999. The activities of
the Company itself have no significant impact on the results of operations on a
consolidated basis. Unless otherwise indicated, all activities discussed herein
relate to the Company, and its direct and indirect subsidiaries, including
without limitation, the Bank, HF Card Services and the Mortgage Corp.
HomeFirst Mortgage Corp. is a South Dakota Corporation which had an
office in Omaha, Nebraska. Mortgage Corp. was a mortgage Banking operation that
originated one- to four-family residential loans which were sold into the
secondary market and to the Bank. The Company ceased operation of HomeFirst
Mortgage Corp. during the first quarter of fiscal 1998.
HF Card Services was established to provide secured, partially secured
and unsecured credit cards nationwide. The target market for HF Card Services is
sub-prime credit customers who have either an insufficient credit history or a
negative credit history and are unable to obtain a credit card from more
traditional card issuers.
The Company's net income is primarily dependent upon the difference (or
"spread") between the average yield earned on loans, mortgage-backed securities
and investments and the average rate paid on deposits and borrowings, as well as
the relative amounts of such assets and liabilities. The interest rate spread is
affected by regulatory, economic and competitive factors that influence interest
rates, loan demand and deposit flows. The Company, like other financial
institutions, is subject to interest rate risk to the degree that its
interest-bearing liabilities mature or reprice at different times, or on a
different basis, than its interest-earning assets. To better insulate itself
from such risk, the Company has, over the last few years, attempted to increase
both numerically and on a percentage basis its holding of consumer and
commercial loans. The Company's net income is also affected by, among other
things, gains and losses on sales of foreclosed property, loans, mortgage-backed
securities and securities available for sale, provisions for loan losses,
service charge fees, subsidiary activities, operating expenses and income taxes.
THIS DISCUSSION AND ANALYSIS CONTAINS CERTAIN FORWARD-LOOKING
TERMINOLOGY SUCH AS "BELIEVES," "ANTICIPATES," "WILL," AND "INTENDS," OR
COMPARABLE TERMINOLOGY. SUCH STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND
UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
PROJECTED. POTENTIAL PURCHASERS OF THE COMPANY'S SECURITIES ARE CAUTIONED NOT TO
PLACE UNDUE RELIANCE ON SUCH FORWARD-LOOKING STATEMENTS WHICH ARE QUALIFIED IN
THEIR ENTIRETY BY THE CAUTIONS AND RISKS DESCRIBED HEREIN AND IN OTHER REPORTS
FILED BY THE COMPANY WITH THE SECURITIES AND EXCHANGE COMMISSION.
ACQUISITION OF DAKOTA STATE BANK
On December 15, 1998 the Bank and Dakota State Bank ("DSB") jointly
announced the signing of a definitive Stock Purchase Agreement whereby the Bank
will acquire 100% of the outstanding capital stock of DSB for cash
consideration. With the acquisition, the Company's assets will increase to
approximately $650.0 million. Regulatory approval was obtained on May 10, 1999
with anticipated date of legal closing to be in late May 1999. The new locations
along the Interstate 29 highway corridor between Sioux Falls and Brookings
support the Company's expansion into commercial and agricultural markets. The
Company will operate 25 branches in 18 South Dakota communities and will
continue to offer Internet Banking which serves customers nationwide.
Page 8
<PAGE>
YEAR 2000
The Year 2000 issue is whether computer systems will properly recognize
date-sensitive information when the year changes to 2000. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. The Bank is heavily dependent on computer processing in its
business activities and the Year 2000 issue creates risk for the Bank from
unforeseen problems in the Bank's computer system and from third parties with
whom the Bank processes financial information. Such failures of the Bank's
computer system and/or third parties computer systems could have a material
impact on the Bank's ability to conduct its business.
In May 1997, the Company developed a five-step plan that follows the
guidelines as specified by the Federal Financial Institutions Examination
Councils. As this council provides new requirements, the plan is modified to
reflect the new requirements. Management of the Company is updated at least
monthly on the status of the plan and the Bank's Information Systems Steering
Committee has changed from a quarterly meeting to a bi-monthly meeting to be
more proactive on Year 2000. In addition, the Board of Directors of the Company
is updated on the status of the Year 2000 project on a quarterly basis at its
regularly scheduled meetings or as circumstances may change requiring new
information to be shared with the Board of Directors. The five stages of the
plan are as follows: awareness, assessment, renovation, validation and
implementation. The awareness and assessment phases were completed by December
31, 1997. The assessment phase included hardware, software and third party
vendors that provide a service to the Company (i.e. utility companies, alarm
companies, payroll providers, electronic funds transfer providers, insurance
providers, loan participation companies, mortgage loan secondary market
agencies, and governmental agencies). The renovation, validation and
implementation phases are completed as planned. All mission critical systems
known to be non-compliant with Year 2000 have been renovated as of March 31,
1999. In May 1996, the Bank installed new hardware and operations systems
software that the vendor has represented to be Year 2000 compliant. Testing has
been completed and verified for the Bank's core processing system for the dates
of September 9,1999, December 31, 1999, January 2, 2000, February 29, 2000, and
March 31, 2000. Testing for December 31, 2000 is currently being performed. All
mission critical PC software applications have been tested for all specific
dates as determined by the Federal Financial Institution Examination Council's
guidelines. In addition, testing will be performed with service providers that
are providing the capability to test with the Bank. The Company will continue
its Year 2000 plan in 1999 by continually monitoring updates as provided by
vendors.
The Bank has written contingency plans for all software and hardware
providers. In addition, contingency plans are also written for all outside
service providers. These contingency plans are now under review for adequacy and
if applicable, will be tested. The Bank is also involved in a customer awareness
and employee education program regarding the year 2000.
Based on the Bank's review of its computer systems, management
believes the cost of the corrections to make the systems Year 2000 compliant
to be less than $65,000. Approximately $20,000 was incurred in fiscal 1998
with an additional $45,000 incurred in the nine months ended March 31, 1999.
The Bank does not anticipate further major expenditures that are Year 2000
related. In addition, approximately 2,000 to 2,500 man hours are expected to
be incurred by Bank personnel related to Year 2000 issues which have an
estimated cost of $70,000. Such costs will be charged against income as they
are incurred.
FINANCIAL CONDITION DATA
At March 31, 1999, the Company had total assets of $604.2 million, an
increase of $33.2 million from the level at June 30, 1998. The increase in
assets was due primarily to an increase in loans receivable of $28.3 million,
mortgage-backed securities of $5.6 million and securities available for sale of
$5.4 million. The increase in loans receivable, mortgage-backed securities and
securities available for sale was funded primarily by a decrease in cash and
cash equivalents of $9.8 million, an increase in advances from Federal Home Loan
Bank ("FHLB") and other borrowings of $38.2 million and an increase in advances
by borrowers for taxes and insurance of $4.0 million from the levels at June 30,
1998. The remaining excess funds received from advances from FHLB and other
borrowings and advances by borrowers for taxes and insurance were used to offset
the decrease in deposits of $2.9 million and the increase in prepaid expenses
and other assets of $1.7 million from the levels at June 30, 1998. In addition,
stockholders' equity decreased from $56.6 million at June 30, 1998 to $51.5
million at March 31, 1999, primarily due to the purchase of treasury stock of
$6.4 million and the payment of cash dividends of $1.1 million which was
partially offset by net income of $2.4 million.
Page 9
<PAGE>
The increase in loan receivables of $28.3 million was primarily the
result of originations exceeding amortizations, sales and prepayments of
principal. The increase in loan receivables resulted partially from growth in
the credit card loan portfolio of $7.7 million to $20.0 million at March 31,
1999 as compared to $12.3 million at June 30, 1998.
The increase in mortgage-backed securities of $5.6 million was
primarily the result of purchases exceeding sales, amortizations and prepayments
of principal. The Bank purchased mortgage-backed securities in the amount of
$21.4 million and sold mortgage-backed securities in the amount of $4.5 million
during the nine months ended March 31, 1999. The Bank's purchases of
mortgage-backed securities included $14.9 million of thirty year, fixed-rate,
mortgage-backed securities and $6.5 million of thirty year, fixed-rate,
mortgage-backed securities that have a principal payment balloon in the seventh
year.
The increase in securities of $5.4 million from the level at June 30,
1998 is primarily due to purchases of securities available for sale of $35.2
million exceeding calls and maturities of $30.0 million during the nine months
ended March 31, 1999. The Bank's purchases of securities available for sale were
comprised primarily of U.S. Government agency securities which have a maturity
of five years or less that have a call feature that varies from three months to
two years.
The $2.9 million decrease in deposits was primarily due to a decrease
in savings accounts of $14.0 million and a decrease in certificates of deposit
of $10.4 million which were substantially offset by an increase in money market
accounts of $19.0 million and an increase in demand and now accounts of $2.4
million. As of March 31, 1999, the Bank had total deposits from local
governmental entities of $54.8 million compared to $51.6 million at June 30,
1998.
Advances from the FHLB and other borrowings increased $38.2 million for
the nine month period ended March 31, 1999 primarily due to the Company
obtaining new advances in the amount of $62.6 million which were partially
offset by payments of $24.4 million on advances and other borrowings during the
nine month period ended March 31, 1999.
The $4.0 million increase in advances by borrowers for taxes and
insurance was due primarily to the receipt of escrow payments in excess of
amounts paid out. The major escrow payments are primarily paid semiannually in
April and October.
Page 10
<PAGE>
ANALYSIS OF NET INTEREST INCOME
Net interest income represents the difference between income on
interest-earning assets and expense on interest-bearing liabilities. Net
interest income depends upon the volume of interest-earning assets and
interest-bearing liabilities and the interest rate earned or paid on them.
AVERAGE BALANCES, INTEREST RATES AND YIELDS. The following table
presents for the periods indicated the total dollar amount of interest income
from average interest-earning assets and the resulting yields, as well as the
interest expense on average interest-bearing liabilities, expressed both in
dollars and rates, and the net interest margin. The table does not reflect any
effect of income taxes. All average balances are monthly average balances and
include the balances of nonaccruing loans. The yields and costs for the three
and nine months ended March 31, 1999 and 1998 include fees which are considered
adjustments to yield.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------------------------------------------------
1999 1998
------------------------------------- ----------------------------------
AVERAGE INTEREST AVERAGE INTEREST
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
--------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1) $470,401 $ 9,973 8.48% $440,438 $ 9,855 8.95%
Mortgage-backed securities 47,448 710 5.99% 29,598 468 6.32%
Other investment securities (2) 44,817 645 5.76% 69,203 995 5.75%
FHLB stock 4,433 69 6.23% 5,222 84 6.43%
------------ ---------- ---------- ------------- ---------- ---------
Total interest-earning assets $567,099 $ 11,397 8.04% $544,461 $ 11,402 8.38%
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Noninterest-earning assets 30,623 28,783
------------ ------------
Total assets $597,722 $573,244
------------ ------------
------------ ------------
Interest-bearing liabilities:
Deposits:
Checking and money market $112,987 $ 723 2.56% $91,174 $ 567 2.49%
Savings 49,961 381 3.05% 53,510 468 3.50%
Certificates of deposit 274,878 3,829 5.57% 291,067 4,261 5.86%
------------ ---------- ---------- ------------- ---------- ---------
Total deposits $437,826 $ 4,933 4.51% $435,751 $ 5,296 4.86%
FHLB advances and other borrowings 89,394 1,207 5.40% 63,276 899 5.68%
------------ ---------- ---------- ------------- ---------- ---------
Total interest-bearing liabilities $527,220 $ 6,140 4.66% $499,027 $ 6,195 4.97%
---------- ---------- ---------- --------
---------- ---------- ---------- --------
Other liabilities 18,614 18,296
------------ ------------
Total liabilities $545,834 $517,323
51,888 55,921
------------ ------------
Total liabilities and equity $597,722 $573,244
------------ ------------
------------ ------------
Net interest income; interest rate
spread $ 5,257 3.38% $ 5,207 3.41%
------------ ------------ --------- --------
------------ ------------ --------- --------
Net interest margin (3) 3.71% 3.83%
------------ --------
------------ --------
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes interest on accruing loans past due 90 days or more.
(2) Includes primarily U.S. Government securities.
(3) Net interest margin is net interest income divided by average
interest-earning assets.
Page 11
<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED MARCH 31,
---------------------------------------------------------------------------
1999 1998
------------------------------------- -------------------------------------
AVERAGE INTEREST AVERAGE INTEREST
OUTSTANDING EARNED/ YIELD/ OUTSTANDING EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE
------------- ----------- ---------- ------------- ---------- -----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1) $456,806 $ 30,118 8.79% $446,817 $ 30,102 8.98%
Mortgage-backed securities 44,929 1,996 5.92% 29,370 1,403 6.37%
Other investment securities (2) 41,597 1,825 5.85% 67,761 2,956 5.82%
FHLB stock 4,019 196 6.50% 5,222 268 6.84%
------------ ---------- ---------- ------------ ---------- -----------
Total interest-earning assets $547,351 $ 34,135 8.32% $549,170 $ 34,729 8.43%
---------- ---------- ---------- -----------
Noninterest-earning assets 30,072 29,753
------------ ------------
Total assets $577,423 $578,923
------------ ------------
------------ ------------
Interest-bearing liabilities:
Deposits:
Checking and money market $106,621 $ 2,049 2.56% $86,890 $ 1,641 2.52%
Savings 47,360 1,112 3.13% 54,765 1,492 3.63%
Certificates of deposit 278,236 12,072 5.79% 297,657 13,335 5.97%
------------ ---------- ---------- ------------ ---------- -----------
Total deposits $432,217 $ 15,233 4.70% $439,312 $ 16,468 5.00%
FHLB advances and other borrowings 73,744 3,063 5.54% 66,234 2,867 5.77%
------------ ---------- ---------- ------------ ---------- -----------
Total interest-bearing liabilities $505,961 $ 18,296 4.82% $505,546 $ 19,335 5.10%
---------- ---------- ---------- -----------
Other liabilities 17,779 18,491
------------ ------------
Total liabilities $523,740 $524,037
Equity 53,683 54,886
------------ ------------
Total liabilities and equity $577,423 $578,923
------------ ------------
------------ ------------
Net interest income; interest rate
spread $ 15,839 3.50% $ 15,394 3.33%
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net interest margin (3) 3.86% 3.74%
---------- ----------
---------- ----------
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes interest on accruing loans past due 90 days or more.
(2) Includes primarily U.S. Government securities.
(3) Net interest margin is net interest income divided by average
interest-earning assets.
Page 12
<PAGE>
RATE/VOLUME ANALYSIS OF NET INTEREST INCOME
The following schedule presents the dollar amount of changes in
interest income and interest expense for major components of interest-earning
assets and interest-bearing liabilities. It distinguishes between the increases
and decreases due to fluctuating outstanding balances that are due to the levels
and volatility of interest rates. For each category of interest-earning assets
and interest-bearing liabilities, information is provided on changes
attributable to (i) changes in volume (i.e., changes in volume multiplied by old
rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume).
For purposes of this table, changes attributable to both rate and volume, which
cannot be segregated, have been allocated proportionately to the change due to
volume and the change due to rate.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, NINE MONTHS ENDED MARCH 31,
------------------------------------ ------------------------------------
1999 vs 1998 1999 vs 1998
------------------------------------ ------------------------------------
INCREASE INCREASE INCREASE INCREASE
(DECREASE) (DECREASE) TOTAL (DECREASE) (DECREASE) TOTAL
DUE TO DUE TO INCREASE DUE TO DUE TO INCREASE
VOLUME RATE (DECREASE) VOLUME RATE (DECREASE)
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1) $ 653 $(535) $ 118 $ 666 $(650) $ 16
Mortgage-backed securities 275 (33) 242 717 (124) 593
Other investment securities (2) (351) 1 (350) (1,145) 14 (1,131)
FHLB stock (12) (3) (15) (60) (12) (72)
---------- ---------- ---------- ---------- ---------- ----------
Total interest-earning assets $ 565 $(570) $ (5) $ 178 $(772) $ (594)
---------- ---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ---------- ----------
Interest-bearing liabilities:
Deposits:
Checking and money market $ 138 $ 18 $ 156 $ 376 $ 32 $ 408
Savings (29) (58) (87) (188) (192) (380)
Certificates of deposit (231) (201) (432) (856) (407) (1,263)
---------- ---------- ---------- ---------- ---------- ----------
Total deposits (122) (241) (363) (668) (567) (1,235)
FHLB advances and other borrowings 362 (54) 308 319 (123) 196
---------- ---------- ---------- ---------- ---------- ----------
Total interest-bearing liabilities $ 240 $(295) $ (55) $ (349) $(690) $(1,039)
---------- ---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ---------- ----------
Net interest income increase $ 50 $ 445
---------- ---------
---------- ---------
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes interest on loans past due 90 days or more.
(2) Includes primarily U.S. Government securities.
Page 13
<PAGE>
[OBJECT OMITTED]
ASSET QUALITY
In accordance with the Bank's internal classification of assets policy,
management evaluates the loan portfolio on a monthly basis to identify loss
potential and determine the adequacy of the allowance for possible loan losses.
The following table sets forth the amounts and categories of the Bank's
nonperforming assets for the periods indicated.
<TABLE>
<CAPTION>
NONPERFORMING ASSETS AS OF
-------------------------------------------
MARCH 31, JUNE 30,
------------------ ------------------
1999 1998
------------------ ------------------
(Dollars in Thousands)
<S> <C> <C>
Nonaccruing loans:
One- to four-family $ 380 $ 623
Commercial real estate 420 719
Multi-family - - - - - - - -
Mobile homes 43 31
Credit cards - - - - - - - -
Consumer 342 482
Agriculture 666 - - - -
Commercial business 177 396
----------- ----------
Total $ 2,028 $ 2,251
----------- ----------
Accruing loans delinquent more than 90 days:
One- to four-family $ - - - - $ - - - -
Commercial real estate - - - - - - - -
Multi-family - - - - - - - -
Mobile homes - - - - - - - -
Credit cards 1,499 530
Consumer - - - - - - - -
Agriculture - - - - - - - -
Commercial business - - - - - - - -
----------- ----------
Total $ 1,499 $ 530
----------- ----------
Foreclosed assets:
One- to four-family $ 140 $ 22
Commercial real estate - - - - - - - -
Multi-family - - - - - - - -
Mobile homes 41 67
Credit cards - - - - - - - -
Consumer 26 140
Agriculture - - - - - - - -
Commercial business - - - - - - - -
----------- ----------
Total $ 207 $ 229
----------- ----------
Total nonperforming assets $ 3,734 $ 3,010
----------- ----------
----------- ----------
Ratio of nonperforming assets to total assets 0.62% 0.53%
----------- ----------
----------- ----------
Ratio of nonperforming loans to total loans 0.74% 0.63%
----------- ----------
----------- ----------
</TABLE>
When a loan becomes 90 days delinquent, except for credit card loans,
the Bank places the loan on a nonaccrual status and, as a result, accrued
interest income on the loan is taken out of income. Future interest income is
recognized on a cash basis. The loan will remain on a nonaccrual status until
the borrower has brought the loan current. Credit card loans remain in accrual
status until 120 days, when accrued interest income on the loan is taken out of
income.
Page 14
<PAGE>
Nonperforming assets increased to $3.7 million at March 31, 1999 from
$3.0 million at June 30, 1998, an increase of $724,000. In addition, the ratio
of nonperforming assets to total assets, which is one indicator of credit risk
exposure, increased to 0.62% at March 31, 1999 as compared to 0.53% at June 30,
1998.
Nonaccruing loans decreased from $2.3 million at June 30, 1998 to $2.0
million at March 31, 1999, a decrease of $223,000. Included in nonaccruing loans
at March 31, 1999 were nine loans totaling $380,000 secured by one- to
four-family real estate, three loans totaling $420,000 secured by commercial
real estate, four mobile home loans totaling $43,000, twenty-eight consumer
loans totaling $342,000, five agriculture loans totaling $666,000 and ten
commercial business loans totaling $177,000. For the nine months ended March 31,
1999, gross interest income of $90,000 would have been recognized on loans
accounted for on a nonaccrual basis had such loans been current in accordance
with their original terms. Gross interest income of $15,000 was recognized as
income on loans accounted for on a nonaccrual basis.
Accruing credit card loans delinquent more than 90 days increased to
$1.5 million at March 31, 1999 from $530,000 at June 30, 1998. Additionally,
$4.3 million of credit card loans are delinquent 30 days at March 31, 1999 as
compared to $2.4 million at June 30, 1998. Management has determined that
increased delinquencies were primarily due to a change in loan underwriting
criteria during the fourth quarter of fiscal 1998 that had the impact of
reducing the overall quality of credit card loans that were originated from the
fourth quarter of fiscal 1998 through the first nine months of fiscal 1999.
Management has reviewed the increased level of credit card delinquencies, and
the loan underwriting criteria and collection procedures in the credit card
portfolio and ceased processing credit card applications under the current
underwriting criteria in March 1999. Net charge-offs for the nine months ended
March 31, 1999 were $3.2 million as compared to $358,000 for the same period in
fiscal 1998. Using historical stratification data on the current product,
management expects credit card loan write-offs not to exceed $8.6 million in the
next six months. Of this amount, historically about 37% will be a charge-off
against allowance for credit card loan losses, of which the Company currently
maintains an allowance for credit card loan losses equal to 22% of the
outstanding credit card loan balance. Historically, the remaining 63% will be
charged against deferred credit card fee income, interest income and credit card
fee income in future periods. Based upon lack of performance, the Company will
be exiting the subprime credit card business.
Foreclosed assets decreased from $229,000 at June 30, 1998 to $207,000
at March 31, 1999, a decrease of $22,000.
At March 31, 1999, the Bank had approximately $7.3 million of other
loans of concern that management has determined need to be closely monitored
because of possible credit problems of the borrowers or the cash flows of the
secured properties. These loans were considered in determining the adequacy of
the allowance for possible loan losses. The allowance for possible loan losses
is established based on management's evaluation of the risks inherent in the
loan portfolio and changes in the nature and volume of loan activity. Such
evaluation, which includes a review of all loans for which full collectability
may not be reasonably assured, considers the estimated fair market value of the
underlying collateral, economic conditions, historical loan loss experience and
other factors that warrant recognition in providing for an adequate loan loss
allowance. Although the Bank's management believes that the March 31, 1999
recorded allowance for loan losses was adequate to provide for potential losses
on the related loans, there can be no assurance that the allowance existing at
March 31, 1999 will be adequate in the future.
Page 15
<PAGE>
The following table sets forth information with respect to activity in
the Bank's allowance for loan losses during the periods indicated.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
----------------------------
3/31/99 3/31/98
--------- ---------
(Dollars in Thousands)
<S> <C> <C>
Balance at beginning of period $ 7,199 $ 4,526
Charge-offs:
One- to four-family (48) (77)
Commercial - - - - - - -
Multi-family - - - - - - -
Commercial business (93) - - -
Consumer (700) (797)
Agriculture (487) - - -
Credit cards (3,356) (519)
Mobile homes (53) (154)
--------- --------
Total charge-offs $ (4,737) $(1,547)
--------- --------
Recoveries:
One- to four-family $ 13 $ 12
Commercial - - - - - -
Multi-family - - - - - -
Commercial business 72 - - -
Consumer 156 134
Agriculture - - - - - -
Credit cards 178 161
Mobile homes 41 25
--------- --------
Total recoveries $ 460 $ 332
--------- --------
Net (charge-offs) $ (4,277) $(1,215)
Additions charged to operations 5,299 2,228
--------- --------
Balance at end of period $ 8,221 $ 5,539
--------- --------
--------- --------
Ratio of net (charge-offs) recoveries during the period to
average loans outstanding during the period (0.94)% (0.27)%
--------- --------
--------- --------
Ratio of allowance for loan losses to total loans at end
of period 1.73% 1.26 %
--------- --------
--------- --------
Ratio of allowance for loan losses to nonperforming
loans at end of period (1) 233.09% 240.30 %
--------- --------
--------- --------
</TABLE>
(1) Nonperforming loans includes nonaccruing loans and accruing
loans delinquent more than 90 days.
Page 16
<PAGE>
The distribution of the Bank's allowance for loan losses at the dates indicated
is summarized as follows:
<TABLE>
<CAPTION>
AT MARCH 31, 1999 AT JUNE 30, 1998
------------------------------ ----------------------------
PERCENT OF PERCENT OF
LOANS IN LOANS IN
EACH EACH
CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
-------------- ------------- ------------ ------------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
One- to four-family $1,108 27.85% $ 1,203 29.12%
Commercial and multi-family real estate (1) 974 24.49% 967 23.41%
Commercial business 399 10.04% 377 9.13%
Consumer 1,104 27.75% 1,219 29.49%
Agricultural 161 4.04% 150 3.63%
Credit cards 4,401 3.98% 3,181 2.74%
Mobile homes 74 1.85% 102 2.48%
-------------- ------------- ------------ ------------
Total $ 8,221 100.00% $ 7,199 100.00%
-------------- ------------- ------------ ------------
-------------- ------------- ------------ ------------
</TABLE>
(1) Includes construction loans.
The allowance for loan losses was $8.2 million at March 31, 1999 as
compared to $7.2 million at June 30, 1998. The ratio of the allowance for loan
losses to total loans was 1.73% at March 31, 1999 and 1.62% at June 30, 1998.
The Bank's management has considered nonperforming assets and other assets of
concern in establishing the allowance for loan losses. The Bank continues to
monitor its allowance for possible loan losses and make future additions or
reductions in light of the level of loans in its portfolio, historical
experience and as economic conditions dictate.
The current level of the allowance for loan losses is a result of
management's assessment of the risks within the portfolio based on the
information revealed in credit reporting processes. The Company utilizes a
risk-rating system on all commercial business, agricultural, construction and
multi-family and commercial real estate loans, including purchased loans, that
exceed $250,000 and a monthly credit review and reporting process on all types
of loans that results in the calculation of the guidelines reserves based on the
risk within the portfolio. This assessment of risk takes into account the
composition of the loan portfolio, historical loss experience for each loan
category, previous loan experience, concentrations of credit and other factors
that in management's judgment deserve recognition. In regard to credit card
loans, the Company has been providing a reserve in a range of 22% to 30% of the
loan balance until the credit card portfolio becomes seasoned. As of March 31,
1999, $4.4 million of the $8.2 million allowance for loan losses was reserved
for the credit card loan portfolio. The Company has historically maintained a
positive variance from the minimum estimated allowance for loan losses based on
the analyses that are conducted by Bank management and corporate credit
personnel. This unallocated portion of the allowance is based upon assessment of
general economic conditions as well as specific economic factors in the
individual locations the Company serves. This determination inherently involves
a higher degree of uncertainty and considers current risk factors that may not
have yet manifested themselves in the Company's historical loss factors; and it
recognizes that knowledge of the portfolio may be incomplete. Management has
reviewed the allocations in the various classifications of loans and believes
the allowance was adequate at all times during the nine months ended March 31,
1999 and the fiscal year ended June 30, 1998.
Page 17
<PAGE>
COMPARISON OF THE NINE MONTHS ENDED MARCH 31, 1999 AND MARCH 31, 1998
GENERAL. The Company's net income decreased $2.3 million to $2.4
million for the nine months ended March 31, 1999 as compared to $4.7 million
for the nine months ended March 31, 1998. As discussed in more detail below,
this decrease was due primarily to an increase in noninterest expense of $4.9
million and an increase in provision for losses on loans of $3.1 million.
These increases were partially offset by an increase in noninterest income of
$4.3 million and a reduction in income tax expense of $1.0 million.
INTEREST INCOME. Interest income decreased $594,000 from $34.7
million for the nine months ended March 31, 1998 to $34.1 million for the
nine months ended March 31, 1999. This decrease was primarily due to a
decrease in the interest earned on interest-earning assets. The average
yields earned on interest-earning assets decreased from 8.43% for the nine
months ended March 31, 1998 to 8.32% for the nine months ended March 31, 1999.
INTEREST EXPENSE. Interest expense decreased $1.0 million from $19.3
million for the nine months ended March 31, 1998 to $18.3 million for the
nine months ended March 31, 1999. This decrease was largely attributable to a
decrease in the rates paid on interest-bearing liabilities. The average rates
paid on interest-bearing liabilities decreased from 5.10% to 4.82% for the
nine months ended March 31, 1998 and March 31, 1999, respectively.
NET INTEREST INCOME. The Company's net interest income for the nine
months ended March 31, 1999 increased $445,000, or 2.89%, to $15.8 million as
compared to $15.4 million for the same period ended March 31, 1998. The
increase in the net interest income reflects an overall increase in the net
interest spread on average interest-earning assets from 3.33% for the nine
months ended March 31, 1998 to 3.50% for the nine months ended March 31,
1999. The increase in the net interest spread was primarily due to a decrease
in the rates paid on interest-bearing liabilities from 5.10% for the nine
months ended March 31, 1998 to 4.82% for the nine months ended March 31, 1999.
During the nine months ended March 31, 1999, the Company increased
its average balances of commercial, agricultural and credit card loans. The
Company anticipates activity in this type of lending to continue in future
years subject to market demand except for subprime credit card loans fore
which the Company ceased processing applications in March 1999. In addition,
the Company sold the majority of conventional single-family residential real
estate loan originations into the secondary market. Net interest income is
expected to trend upward as a result of this lending activity as interest
rate yields are generally higher on these types of loans compared to the
yield provided by conventional single-family residential real estate loans.
However, lending activity will carry a higher level of risk due to the nature
of the collateral and the size of the individual loans. As such, the Company
anticipates continued increases in its allowance for loan losses.
PROVISION FOR LOSSES ON LOANS. During the nine months ended March 31,
1999, the Company recorded a provision for losses on loans of $5.3 million as
compared to $2.2 million for the nine months ended March 31, 1998 an increase
of $3.1 million. All of the increase is related to the growth of the subprime
credit card loan portfolio from $6.0 million at March 31, 1998 to $20.0
million at March 31, 1999. The provision for losses on loans of $5.3 million
for the nine months ended March 31, 1999 compared to the same period in
fiscal 1998 is primarily to provide for future expected write-offs on credit
card loans and reflects management's continued evaluation of the loan
portfolio in light of general economic conditions. See "Asset Quality" for
further discussion.
During the nine months ended March 31, 1999, the Company had net
charge-offs of credit card loans of $3.2 million as compared to $358,000 for
the nine months ended March 31, 1998. The net charge-offs for the nine months
ended March 31, 1999 exceeded management's expectations. Delinquencies on
credit card loans increased from 19.66% at June 30, 1998 to 21.39% at March
31, 1999.
NONINTEREST INCOME. Noninterest income was $13.0 million for the
nine months ended March 31, 1999 as compared to $8.7 million for the nine
months ended March 31, 1998, an increase of $4.3 million.
The increase in credit card fee income of $4.3 million for the nine
months ended March 31, 1999 as compared to the same period in fiscal 1998 is
primarily due to an increase in fees received on unsecured credit cards. This
is a result of the credit card loan portfolio increasing from $12.3 million
at June 30, 1998 to $20.0 million at March 31, 1999. The credit card loan
portfolio had a balance of $6.0 million at March 31, 1998. The fee income
represents processing fees, interchange fees, annual fees, late fees and
other miscellaneous fees. This credit card program was initiated in fiscal
1997. The Company ceased processing credit card applications in March 1999.
This will decrease the level of these fees. Interest income on credit card
loans is included in interest income on loans.
Page 18
<PAGE>
NONINTEREST EXPENSE. Noninterest expense increased $4.9 million from
$14.8 million for the nine months ended March 31, 1998 to $19.7 million for
the nine months ended March 31, 1999.
There was an increase of $4.4 million in the cost of third party
processors of credit cards. This included $1.1 million of nonrecurring
expenses associated with the decision to stop marketing subprime credit
cards. This expense represents costs for processing of applications,
collecting loans, and marketing costs for the acquisition of credit cards for
the increased amount of unsecured credit card loans. The Company began
processing credit cards in the second quarter of fiscal 1997.
INCOME TAX EXPENSE. The Company's income tax expense for the nine
months ended March 31, 1999 was $1.4 million as compared to $2.4 million for
the nine months ended March 31, 1998, a decrease of $1.0 million. This
decrease was primarily due to the decrease in the Company's income before
income tax.
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 1999 AND MARCH 31, 1998
GENERAL. The Company's net income decreased $1.4 million to $47,000
for the three months ended March 31, 1999 as compared to $1.4 million for the
three months ended March 31, 1998. As discussed in more detail below, this
decrease was due primarily to an increase in noninterest expense of $1.6
million and an increase in provision for losses on loans of $1.1 million.
These increases were partially offset by an increase in noninterest income of
$806,000 and a reduction in income tax expense of $565,000.
INTEREST INCOME. Interest income remained relatively stable at $11.4
million when comparing the three months ended March 31, 1999 to the three
months ended March 31, 1998, respectively. The decrease in the average yield
of interest-earnings assets was offset by an increase in the average balance
of interest-earning assets. The average yield on interest-earning assets
decreased from 8.38% to 8.04% for the three months ended March 31, 1998 and
March 31, 1999, respectively. The average balance of interest-earning assets
increased $22.6 million when comparing the three months ended March 31, 1999
to the same period in the prior fiscal year.
INTEREST EXPENSE. Interest expense decreased $55,000 from $6.2
million for the three months ended March 31, 1998 to $6.1 million for the
three months ended March 31, 1999. This decrease was largely attributable to
a decrease in the average rate paid on interest-bearing liabilities and was
partially offset by an increase in the average balance of interest-bearing
liabilities. The average rates on interest-bearing liabilities decreased from
4.97% to 4.66% for the three months ended March 31, 1998 and March 31, 1999,
respectively. The average balance of interest-bearing liabilities increased
$28.2 million when comparing the three months ended March 31, 1999 to the
same period in the prior fiscal year.
NET INTEREST INCOME. The Company's net interest income for the three
months ended March 31, 1999 increased $50,000 to $5.3 million as compared to
$5.2 million for the same period in fiscal 1998. The net interest spread on
average interest-earning assets remained relatively stable at 3.38% and 3.41%
for the three months ended March 31, 1999 and March 31, 1998, respectively.
The increase in the net interest income reflects a decrease in the rates paid
on interest-bearing liabilities from 4.97% for the three months ended March
31, 1998 to 4.66% for the three months ended March 31, 1999.
During the three months ended March 31, 1999, the Company increased
its average balances of commercial, agricultural and credit card loans. The
Company anticipates activity in this type of lending to continue in future
years, subject to market demand, except for subprime credit card loans fore
which the Company ceased processing applications in March 1999. In addition,
the Company sold the majority of conventional single-family residential real
estate loan originations into the secondary market. Net interest income is
expected to trend upward as a result of this lending activity as interest
rate yields are generally higher on these types of loans compared to the
yield provided by conventional single-family residential real estate loans.
However, lending activity will carry a higher level of risk due to the nature
of the collateral and the size of the individual loans. As such, the Company
anticipates continued increases in its allowance for loan losses.
PROVISION FOR LOSSES ON LOANS. During the three months ended March
31, 1999, the Company recorded a provision for losses on loans of $2.0
million as compared to $898,000 for the three months ended March 31, 1998.
The provision for losses on loans of $2.0 million for the three months ended
March 31, 1999 compared to the same period in fiscal 1998 is primarily to
provide for future expected write-offs on credit card loans and to
management's continued evaluation of the loan portfolio in light of general
economic conditions. See "Asset Quality" for further discussion.
Page 19
<PAGE>
NONINTEREST INCOME. Noninterest income was $3.9 million for the
three months ended March 31, 1999 as compared to $3.1 million for the three
months ended March 31, 1998, an increase of $806,000.
The increase in credit card fee income of $1.1 million for the three
months ended March 31, 1999 as compared to the same period in fiscal 1998 is
primarily due to an increase in fees received on unsecured credit cards. This
is the result of the balance of the credit card portfolio increasing to $20.0
million at March 31, 1999 as compared to $6.0 million at March 31, 1998. The
fee income represents processing fees, interchange fees, annual fees, late
fees and other miscellaneous fees. This credit card program was initiated in
fiscal 1997. The Company ceased processing credit card applications in March
1999. This will decrease the level of these fees. Interest income on credit
card loans is included in interest income on loans.
NONINTEREST EXPENSE. Noninterest expense increased $1.6 million from
$5.3 million for the three months ended March 31, 1998 to $6.9 million for
the three months ended March 31, 1999.
There was an increase of $1.4 million in the cost of third party
processors of credit cards. This included $1.1 million of nonrecurring
expenses associated with the decision to stop marketing subprime credit
cards. This expense represents costs for processing of applications,
collecting loans, and marketing costs for the acquisition of credit cards for
the increased amount of unsecured credit card loans. The Company began
processing credit cards in the second quarter of fiscal 1997.
INCOME TAX EXPENSE. The Company's income tax expense for the three
months ended March 31, 1999 was $131,000 as compared to $696,000 for the
three months ended March 31, 1998, a decrease of $565,000. This decrease was
primarily due to the decrease in the Company's income before income tax.
LIQUIDITY AND CAPITAL RESOURCES
The Bank's primary sources of funds are deposits, amortization and
prepayments of loan principal (including mortgage-backed securities),
advances from the FHLB and, to a lesser extent, sales of mortgage loans,
sales and/or maturities of securities, mortgage-backed securities, and
short-term investments. While scheduled loan payments and maturing securities
are relatively predictable, deposit flows and loan prepayments are more
influenced by interest rates, general economic conditions, and competition.
The Bank attempts to price its deposits to meet its asset/liability
objectives consistent with local market conditions. Excess balances are
invested in overnight funds.
Federal regulations have historically required the Bank to maintain
minimum levels of liquid assets. The required percentage has varied from time
to time based upon economic conditions and savings flows and is currently 4%
of net withdrawable savings deposits and current borrowings. Liquid assets
for purposes of this ratio include cash, certain time deposits, U. S.
Government and corporate securities and other obligations generally having
remaining maturities of less than five years. The Bank has historically
maintained its liquidity ratio at a level in excess of that required by these
regulations. At March 31, 1999, the Bank's regulatory liquidity ratio was
9.34%.
Liquidity management is both a daily and long-term responsibility of
management. The Bank adjusts its investments in liquid assets based upon
management's assessment of (i) expected loan demand, (ii) projected loan
sales, (iii) expected deposit flows, (iv) yields available on
interest-bearing deposits, and (v) the objectives of its asset/liability
management program. Excess liquidity is invested generally in
interest-bearing overnight deposits and other short-term government and
agency obligations. During the nine months ended March 31, 1999, the Bank
required funds beyond its ability to generate funds internally. Thus it used
its borrowing capacity with the FHLB by obtaining advances, which increased
its borrowings with the FHLB by $38.2 million.
The Bank anticipates that it will have sufficient funds available to
meet current loan commitments. At March 31, 1999, the Bank had outstanding
commitments to originate or purchase loans of $69.5 million and to sell loans
of $22.6 million. The Bank had commitments to purchase securities available
for sale of $260,000 and no commitments to sell securities available for
sale. The Bank had no commitments to purchase or sell mortgage-backed
securities.
Although deposits are the Bank's primary source of funds, the Bank's
policy has been to utilize borrowings where the funds can be invested in
either loans or securities at a positive rate of return or to use the funds
for short term liquidity purposes. See "Financial Condition Data" for further
analysis.
In April of 1997, the Company initiated a stock buy back program in
which up to 10% of the common stock of the Company could be acquired
beginning May 1, 1997 through April 30, 1998. A total of 111,750 shares of
common stock were purchased pursuant to this program. In April of 1998, the
Company initiated another stock buy back program in which up to
Page 20
<PAGE>
10% of the common stock of the Company may be acquired beginning May 1, 1998
through April 30, 1999. In accordance with the provisions of the current
stock buy back program, the Company purchased 364,350 shares of common stock
in this stock buy back program that expired April 30, 1999.
In May of 1999, the Company initiated another stock buy back program
in which up to 10% of the common stock of the Company may be acquired through
April 30, 2000. Purchases may be made periodically in either open market or
private transactions or both, in accordance with guidelines established by
the Securities and Exchange Commission, which includes volume restrictions
designed to minimize the impact of such repurchases. The number of shares of
common stock actually acquired by the Company will depend upon subsequent
developments and corporate needs, and such repurchases may be interrupted or
discontinued at any time.
Savings institutions insured by the Federal Deposit Insurance
Corporation are required by the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA") to meet three regulatory capital
requirements. If a requirement is not met, regulatory authorities may take
legal or administrative actions, including restrictions on growth or
operations or, in extreme cases, seizure. Institutions not in compliance may
apply for an exemption from the requirements and submit a recapitalization
plan. Under these capital requirements, at March 31, 1999, the Bank met all
current capital requirements.
The OTS has adopted a core capital requirement for savings
institutions comparable to the requirement for national Banks. The OTS core
capital requirement is 3% of total adjusted assets for thrifts that receive
the highest supervisory rating for safety and soundness. The Bank had core
capital of 7.43% at March 31, 1999.
Pursuant to FDICIA, the federal Banking agencies, including the OTS,
have also proposed regulations authorizing the agencies to require a
depository institution to maintain additional total capital to account for
concentration of credit risk and the risk of non-traditional activities. No
assurance can be given as to the final form of any such regulation.
During the first quarter of fiscal 1997, the Small Business Job
Protection Act of 1996 was signed into law which repealed the percentage of
taxable income method of computing the bad debt deduction for savings
institutions for tax years beginning after December 31, 1995. Beginning in
fiscal year 1997, the Bank is required to recapture into income the excess of
its June 30, 1996 loan loss reserves for "qualifying" and "nonqualifying"
loans over its June 30, 1988 loan loss reserves for "qualifying" and
"nonqualifying" loans. This excess which was $720,000 at June 30, 1998, is
required to be recaptured ratably over a six year period. The onset of
recapture was delayed in fiscal years 1998 and 1997 since the Bank met a
residential loan origination requirement which allowed for a two year delay
in recapture. At June 30, 1998, the Bank's recorded deferred tax liability of
$245,000 provides for the recapture of the loan loss reserves.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and Notes thereto presented
herein have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars without considering the change in the
relative purchasing power of money over time due to inflation. The impact of
inflation is reflected in the increased cost of the Bank's operations. Unlike
most industrial companies, nearly all the assets and liabilities of the Bank
are monetary in nature. As a result, interest rates have a greater impact on
the Bank's performance than do the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same
extent as the prices of goods and services.
Page 21
<PAGE>
Item 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The composition of the Bank's balance sheet results in maturity
mismatches between interest-earning assets and interest-bearing liabilities.
The scheduled maturities of the Bank's fixed rate interest-earning assets are
longer than the scheduled maturities of its fixed rate interest-bearing
liabilities. This mismatch exposes the Bank to interest rate risk. In a
rising rate scenario, as measured by the OTS interest rate risk exposure
simulation model, the estimated market or portfolio value ("PV") of the
Bank's assets would decline in value to a greater degree than the change in
the PV of the Bank's liabilities, thereby reducing net portfolio value
("NPV"), the estimated market value of its shareholders' equity.
As of September 30, 1998, under a rate shock scenario of plus 200
basis points ("bp"), the Bank's pre-shock NPV ratio (NPV as a % of PV of
assets) was estimated in the OTS model to be 10.64%. The post-shock NPV ratio
was estimated to be 10.11%, a decline of 53bp. As of December 31, 1998, the
most recent report available, the Bank's sensitivity to interest rate changes
decreased slightly. The post-shock ratio for a 200 bp decrease in market
interest rates as of December 31, 1998 was estimated to be 9.93%, a decrease
of 31bp from the pre-shock NPV ratio estimate of 10.24%.
In managing the asset/liability mix, the Bank has placed its emphasis
on developing a portfolio in which, to the extent practicable, assets and
liabilities reprice within similar periods. The effect of this policy will
generally be to reduce the Bank's sensitivity to interest rate changes. The
goal of this policy is to provide a relatively consistent level of net
interest income in varying interest rate cycles and to minimize the potential
for significant fluctuations from period to period.
Other types of market risk, such as foreign exchange rate risk and
commodity price risk, do not arise in the normal course of the Company's
business activities.
Page 22
<PAGE>
HF FINANCIAL CORP.
FORM 10-Q
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
None
Item 2. CHANGES IN SECURITIES
None
Item 3. DEFAULTS UPON SENIOR SECURITIES
None
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
Item 5. OTHER INFORMATION
None
Item 6. EXHIBITS AND REPORTS OF FORM 8-K
a. Exhibit 27.1 and Exhibit 27.2 are attached.
b. Refer to Form 8-K filed on May 13, 1999.
- -----------------------------------------------------------------------
No other information is required to be filed under Part II of the form.
Page 23
<PAGE>
HF FINANCIAL CORP.
FORM 10-Q
SIGNATURES
Pursuant to the requirements 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.
HF Financial Corp.
------------------------------------
(Registrant)
Date: 5/14/99 by /s/ Curtis L. Hage
------- ------------------------------------
Curtis L. Hage, Chairman, President
And Chief Executive Officer
(Duly Authorized Officer)
Date: 5/14/99 by /s/ Brent E. Johnson
------- ------------------------------------
Brent E. Johnson, Senior Vice
President, Chief Financial Officer
And Treasurer (Principal Financial
and Accounting Officer)
Page 24
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