<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 December 31, 1998
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
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
225 South Main Avenue, Sioux Falls, SD 57104
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(Address of principal executive office) (ZIP Code)
(605) 333-7556
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(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 February 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 December 31, 1998 and June 30, 1998 1
Consolidated Statements of Income for the Three and
Six months ended December 31, 1998 and 1997 2
Consolidated Statement of Stockholders' Equity
for the Six months ended December 31, 1998 3
Consolidated Statements of Cash Flows for the Six
months ended December 31, 1998 and 1997 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 December 31, June 30,
1998 1998
------------ ------------
<S> <C> <C>
Cash and cash equivalents $ 18,412 $ 25,458
Securities available for sale 41,494 44,232
Mortgage-backed securities available for sale 49,180 39,647
Loans receivable 450,053 426,522
Loans held for sale 14,666 9,616
Accrued interest receivable 4,268 4,338
Foreclosed real estate and other properties 244 229
Office properties and equipment, at cost, net of
accumulated depreciation 14,259 14,317
Prepaid expenses and other assets 4,416 1,999
Mortgage servicing rights 1,592 1,423
Deferred income taxes 4,017 3,198
------------ ------------
$ 602,601 $ 570,979
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Deposits $ 440,844 $ 446,424
Advances from Federal Home Loan Bank
and other borrowings 89,154 50,635
Advances by borrowers for taxes and insurance 5,040 4,792
Accrued interest payable 5,519 5,898
Other liabilities 8,903 6,629
------------ ------------
Total liabilities 549,460 514,378
------------ ------------
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 December 31,
1998 and June 30, 1998 48 47
Additional paid-in capital 15,106 14,863
Retained earnings, substantially restricted 48,167 46,561
Unearned compensation (340) (340)
Accumulated other comprehensive income 114 (9)
Less cost of treasury stock, December 31, 1998 604,772 shares,
June 30, 1998 334,222 shares (9,954) (4,521)
------------ ------------
53,141 56,601
------------ ------------
$ 602,601 $ 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 Ended December 31, Six Months Ended December 31,
------------------------------ ------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Interest and dividend income:
Loans receivable $ 10,261 $ 10,069 $ 20,145 $ 20,247
Mortgage-backed securities 689 458 1,286 935
Investment securities and interest-bearing deposits 622 1,093 1,307 2,145
------------ ------------ ------------ ------------
11,572 11,620 22,738 23,327
------------ ------------ ------------ ------------
Interest expense:
Deposits 5,085 5,508 10,300 11,172
Advances from Federal Home Loan Bank
and other borrowings 1,072 972 1,856 1,968
------------ ------------ ------------ ------------
6,157 6,480 12,156 13,140
------------ ------------ ------------ ------------
Net interest income 5,415 5,140 10,582 10,187
Provision for losses on loans 1,696 804 3,258 1,330
------------ ------------ ------------ ------------
Net interest income after provision
for losses on loans 3,719 4,336 7,324 8,857
------------ ------------ ------------ ------------
Noninterest income:
Credit card fee income 2,099 1,163 5,161 1,984
Fees on deposits 564 570 1,164 1,105
Loan servicing income 308 288 618 554
Loan fees and service charges 366 350 606 677
Gain on sale of loans 103 71 300 584
Other 884 372 1,241 736
------------ ------------ ------------ ------------
4,324 2,814 9,090 5,640
------------ ------------ ------------ ------------
Noninterest expense:
Compensation and employee benefits 2,607 2,451 5,240 4,932
Credit card processing expense 1,913 511 3,862 856
Other general and administrative expenses 1,034 981 2,078 2,062
Occupancy and equipment 694 648 1,384 1,301
Federal insurance premiums 76 69 151 137
Other 54 70 98 223
------------ ------------ ------------ ------------
6,378 4,730 12,813 9,511
------------ ------------ ------------ ------------
Income before income taxes 1,665 2,420 3,601 4,986
Income tax expense 578 798 1,221 1,680
------------ ------------ ------------ ------------
Net income $ 1,087 $ 1,622 $ 2,380 $ 3,306
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Earnings per share:
Basic $0.25 $0.36 $0.55 $0.74
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Diluted $0.25 $0.35 $0.54 $0.72
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
See Notes to Consolidated Financial Statements
Page 2
<PAGE>
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Six Months Ended December 31, 1998
(Dollars In Thousands, Except Per Share Data)
(Unaudited)
<TABLE>
<CAPTION>
Accumulated
Additional Other Total
Common Paid-In Retained Unearned Treasury Comprehensive Stockholders'
Stock Capital Earnings Compensation Stock Income Equity
---------- ---------- ---------- -------------- ----------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, June 30, 1998 $ 47 $ 14,863 $ 46,561 $ (340) $ (4,521) $ (9) $ 56,601
Comprehensive income:
Net income - - 2,380 - - - 2,380
Change in unrealized gain (loss),
available for sale, net of
related deferred taxes of $63 - - - - - 123 123
-------- -------- -------- -------- -------- -------- --------
Total comprehensive income - - 2,380 - - 123 2,503
Exercise of stock options for
22,942 shares 1 243 - - - - 244
Cash dividends paid ($0.18 per share)
on common stock - - (774) - - - (774)
Purchase of treasury stock - - - - (5,433) - (5,433)
-------- -------- -------- -------- -------- -------- --------
Balance, December 31, 1998 $ 48 $ 15,106 $ 48,167 $ (340) $ (9,954) $ 114 $ 53,141
-------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- --------
</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>
SIX MONTHS ENDED DECEMBER 31,
-----------------------------
1998 1997
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,380 $ 3,306
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for losses on loans 3,258 1,330
Depreciation 777 727
Amortization of premiums and discounts, net:
Securities available for sale (10) (6)
Mortgage-backed securities available for sale 12 (144)
Reduction in cost of intangible assets - 3
Reduction in mortgage servicing rights 132 101
Increase (decrease) in deferred loan fees 364 (371)
Loans originated for resale (34,483) (40,953)
Proceeds from the sale of loans 34,783 41,240
(Gain) on sale of loans (300) (584)
Mortgage servicing rights capitalized (104) (77)
(Gain) on sale of securities, net (3) (10)
Losses and provision for losses on sales of
foreclosed real estate and other properties, net 28 152
(Gain) loss on disposal of office properties and equipment, net 29 (5)
(Increase) decrease in accrued interest receivable 70 (219)
(Increase) decrease in prepaid expenses and other assets (2,417) 124
(Increase) decrease in deferred income taxes (882) 167
Increase (decrease) in accrued interest payable and other
liabilities 1,895 (1,872)
------------ ------------
Net cash provided by operating activities $ 5,529 $ 2,909
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Loans purchased (20,342) (7,506)
Loans made to customers (109,898) (99,213)
Principal collected on loans 95,232 94,502
Sale of participation interests in loans 2,500 16,550
Mortgage-backed securities available for sale:
Sales 4,489 -
Purchases (21,430) -
Repayments 7,435 2,632
Securities available for sale:
Sales and maturities 24,005 14,054
Purchases (21,106) (33,058)
Proceeds from sale of office properties and equipment 44 49
Purchase of office properties and equipment (792) (490)
Purchase of mortgage servicing rights (197) (123)
Proceeds from sale of foreclosed real estate
and other properties, net 262 571
------------ ------------
Net cash (used in) investing activities $ (39,798) $ (12,032)
------------ ------------
</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>
SIX MONTHS ENDED DECEMBER 31,
-----------------------------
1998 1997
------------ ------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposits $ (5,580) $ 26,427
Proceeds of advances from Federal Home Loan Bank
and other borrowings 59,600 25,000
Payments on advances from Federal Home Loan Bank
and other borrowings (21,081) (34,049)
Increase in advances by borrowers for
taxes and insurance 248 414
Purchase of treasury stock (5,433) (488)
Proceeds from issuance of common stock 243 140
Cash dividends paid (774) (666)
------------ ------------
Net cash provided by financing activities $ 27,223 $ 16,778
------------ ------------
Increase (decrease) in cash and cash equivalents $ (7,046) $ 7,655
Cash and Cash Equivalents
Beginning 25,458 17,957
------------ ------------
Ending $ 18,412 $ 25,612
------------ ------------
------------ ------------
</TABLE>
See Notes to Consolidated Financial Statements
Page 5
<PAGE>
HF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For The Six months ended December 31, 1998 and 1997
(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 December 31, 1998:
AMOUNT PERCENT
------ -------
Tier I (Core) capital:
Required . . . . . . . . . . . . . . . . . $18,018 3.00%
Actual . . . . . . . . . . . . . . . . . . 44,764 7.45
Excess . . . . . . . . . . . . . . . . . . 26,746 4.45
Risk-based capital:
Required. . . . . . . . . . . . . . . . . . $32,618 8.00%
Actual . . . . . . . . . . . . . . . . . . 49,896 12.24
Excess . . . . . . . . . . . . . . . . . . 17,278 4.24
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 December 31,
1998 and 1997 as adjusted was 4,284,121 and 4,461,514 respectively. The
weighted average number of common shares outstanding for the six month period
ended December 31, 1998 and 1997 as adjusted was 4,302,085 and 4,467,028
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 December 31, 1998 and 1997 as adjusted was 4,356,389 and
4,585,575 respectively. The weighted average number of common and dilutive
potential common shares outstanding for the six month period ended December
31, 1998 and 1997 as adjusted was 4,411,153 and 4,585,083 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 December 31, 1998, 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 December 31,
1998.
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 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. The 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 is expected in the second half
of fiscal 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 near completion as planned. Currently, all mission
critical systems that are known to be noncompliant with Year 2000 have already
been renovated as of December 31, 1998. As of December 31, 1998, there were 3
non-mission critical systems that needed to be renovated and are scheduled for
renovation in the third quarter of fiscal 1999. In May 1996, the Bank installed
new hardware and operations systems software that the vendor has represented to
be Year 2000 compliant. All mission critical systems of the 1996 installation,
both hardware and software, are scheduled to be tested in the first half of
fiscal 1999. 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
scheduled for March of 1999. 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 being 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 $80,000. Approximately $20,000 was incurred in fiscal 1998 with an
additional $45,000 incurred in the six months ended December 31, 1998. The Bank
sees no 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.
Management expects these costs to be incurred in fiscal 1999. Such costs will be
charged against income as they are incurred.
FINANCIAL CONDITION DATA
At December 31, 1998, the Company had total assets of $602.6 million,
an increase of $31.6 million from the level at June 30, 1998. The increase in
assets was due primarily to an increase in loans receivable of $23.5 million,
mortgage-backed securities of $9.5 million and loans held for sale of $5.1
million. The increase in loans receivable, mortgage-backed securities and loans
held for sale was funded primarily by a decrease in cash and cash equivalents of
$7.0 million, a decrease in securities available for sale of $2.7 million and an
increase in advances from Federal Home Loan Bank ("FHLB") and other borrowings
of $38.5 million from the levels at June 30, 1998. The remaining excess funds
received from advances from FHLB and other borrowings were used to offset the
decrease in deposits of $5.6 million and the increase in prepaid expenses and
other assets of $2.4 million from the levels at June 30, 1998. In addition,
stockholders' equity decreased from $56.6 million at June 30, 1998 to $53.1
million at December 31, 1998, primarily due to the purchase of treasury stock of
$5.4 million and the payment of cash dividends of $774,000 which was partially
offset by net income of $2.4 million.
Page 9
<PAGE>
The increase in loan receivables of $23.5 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 $7.1 million to $19.4 million at December 31,
1998 as compared to $12.3 million at June 30, 1998.
The increase in mortgage-backed securities of $9.5 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 six months ended December 31, 1998. 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 decrease in securities of $2.7 million from the level at June 30,
1998 is primarily due to calls and maturities of securities available for sale
of $24.0 million exceeding purchases of $21.1 million during the six months
ended December 31, 1998. The Bank's purchases of securities available for sale
were comprised primarily of U.S. Government agency securities which have a
maturity of three years or less that have a call feature that varies from three
months to one year.
The $5.6 million decrease in deposits was primarily due to a decrease in
savings accounts of $10.6 million and a decrease in certificates of deposit of
$7.9 million which were partially offset by an increase in money market accounts
of $7.8 million and an increase in demand and now accounts of $5.1 million. As
of December 31, 1998, the Bank had total deposits from local governmental
entities of $52.1 million.
Advances from the FHLB and other borrowings increased $38.5 million for
the six month period ended December 31, 1998 primarily due to the Company
obtaining new advances in the amount of $59.6 million which were partially
offset by payments of $21.1 million on advances and other borrowings during the
six month period ended December 31, 1998.
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 six months ended December 31, 1998 and 1997 include fees which are
considered adjustments to yield.
<TABLE>
<CAPTION>
THREE MONTHS ENDED DECEMBER 31,
--------------------------------------------------------------------------
1998 1997
------------------------------------- -----------------------------------
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) $459,236 $ 10,261 8.94% $445,892 $ 10,069 9.03%
Mortgage-backed securities 47,066 689 5.86% 28,611 458 6.40%
Other investment securities (2) 38,720 557 5.75% 68,038 1,001 5.88%
FHLB stock 3,968 65 6.55% 5,222 92 7.05%
------------ ----------- ---------- ------------ ---------- --------
Total interest-earning assets $548,990 $ 11,572 8.43% $547,763 $ 11,620 8.49%
----------- ---------- ---------- --------
----------- ---------- ---------- --------
Noninterest-earning assets 31,472 31,081
------------ ------------
Total assets $580,462 $578,844
------------ ------------
------------ ------------
Interest-bearing liabilities:
Checking and money market $107,262 $ 670 2.50% $ 88,354 $ 567 2.57%
Savings 43,269 311 2.88% 49,992 445 3.56%
Certificates of deposit 281,160 4,104 5.84% 299,702 4,496 6.00%
------------ ----------- ---------- ------------ ---------- --------
Total deposits $431,691 $ 5,085 4.71% $438,048 $ 5,508 5.03%
FHLB advances and other borrowings 77,210 1,072 5.55% 66,960 972 5.81%
------------ ----------- ---------- ------------ ---------- --------
Total interest-bearing liabilities $508,901 $ 6,157 4.84% $505,008 $ 6,480 5.13%
----------- ---------- ---------- --------
----------- ---------- ---------- --------
Other liabilities 17,125 18,760
------------ ------------
Total liabilities $526,026 $523,768
54,436 55,076
------------ ------------
Total liabilities and equity $580,462 $578,844
------------ ------------
------------ ------------
Net interest income; interest rate spread $ 5,415 3.59% $ 5,140 3.36%
----------- ---------- ---------- --------
----------- ---------- ---------- --------
Net interest margin (3) 3.95% 3.75%
---------- --------
---------- --------
</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>
SIX MONTHS ENDED DECEMBER 31,
--------------------------------------------------------------------------
1998 1997
------------------------------------- -----------------------------------
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) $450,009 $ 20,145 8.95% $450,008 $ 20,247 9.00%
Mortgage-backed securities 5.89% 6.39%
43,670 1,286 29,256 935
Other investment securities (2) 5.90% 5.85%
39,985 1,180 67,039 1,961
FHLB stock 6.66% 7.05%
3,813 127 5,222 184
------------ ------------ ----------- ------------ ------------ ---------
------------ ------------ ----------- ------------ ------------ ---------
Total interest-earning assets $537,477 $ 22,738 8.46% $551,525 $ 23,327 8.46%
------------ ----------- ------------ ---------
------------ ----------- ------------ ---------
Noninterest-earning assets
29,796 30,139
------------ ------------
------------ ------------
Total assets $567,273 $581,664
------------ ------------
------------ ------------
Interest-bearing liabilities:
Checking and money market $103,438 $ 1,326 2.56% $ 84,648 $ 1,074 2.54%
Savings 3.17% 3.70%
46,059 731 55,393 1,024
Certificates of deposit 279,915 5.89% 300,952 6.03%
8,243 9,074
------------ ------------ ----------- ------------ ------------ ---------
------------ ------------ ----------- ------------ ------------ ---------
Total deposits $429,412 $ 10,300 4.80% $440,993 $ 11,172 5.07%
FHLB advances and other 5.63% 5.81%
borrowings 65,919 1,856 67,714 1,968
------------ ------------ ----------- ------------ ------------ ---------
------------ ------------ ----------- ------------ ------------ ---------
Total interest-bearing liabilities $495,331 $ 12,156 4.91% $508,707 $ 13,140 5.17%
------------ ----------- ------------ ---------
------------ ----------- ------------ ---------
Other liabilities
17,361 18,589
------------ ------------
------------ ------------
Total liabilities $512,692 $527,296
Equity
54,581 54,368
------------ ------------
------------ ------------
Total liabilities and equity $567,273 $581,664
------------ ------------
------------ ------------
Net interest income; interest rate
spread $ 10,582 3.55% $ 10,187 3.29%
------------ ----------- ------------ ---------
------------ ----------- ------------ ---------
Net interest margin (3) 3.94% 3.69%
----------- ---------
----------- ---------
</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 December 31, Six Months Ended December 31,
---------------------------------------------- ----------------------------------------------
1998 vs. 1997 1998 vs. 1997
---------------------------------------------- ----------------------------------------------
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) $ 300 $ (108) $ 192 $ -- $ (102) $ (102)
Mortgage-backed securities 283 (52) 231 443 (92) 351
Other investment securities (2) (426) (18) (444) (795) 14 (781)
FHLB stock (21) (6) (27) (48) (9) (57)
------------- ------------- ------------- ------------- ------------- -------------
Total interest-earning assets $ 136 $ (184) $ (48) $ (400) $ (189) $ (589)
------------- ------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- ------------- -------------
Interest-bearing liabilities:
Checking and money market $ 120 $ (17) $ 103 $ 239 $ 13 $ 252
Savings (54) (80) (134) (160) (133) (293)
Certificates of deposit (274) (118) (392) (627) (204) (831)
------------- ------------- ------------- ------------- ------------- -------------
Total deposits (208) (215) (423) (548) (324) (872)
FHLB advances and other borrowings 146 (46) 100 (52) (60) (112)
------------- ------------- ------------- ------------- ------------- -------------
Total interest-bearing liabilities $ (62) $ (261) $ (323) $ (600) $ (384) $ (984)
------------- ------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- ------------- -------------
Net interest income increase $ 275 $ 395
------------- -------------
------------- -------------
</TABLE>
- --------------------------------------------------------------------------------
(1) Includes interest on loans past due 90 days or more.
(2) Includes primarily U. S. Government securities.
Page 13
<PAGE>
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
--------------------------------------------
December 31, June 30,
------------------ ------------------
1998 1998
------------------ ------------------
(Dollars in Thousands)
<S> <C> <C>
Nonaccruing loans:
One- to four-family $ 365 $ 623
Commercial real estate 415 719
Multi-family -- --
Mobile homes 55 31
Credit cards -- --
Consumer 531 482
Agriculture 225 --
Commercial business 159 396
------------------ ------------------
Total $ 1,750 $ 2,251
------------------ ------------------
Accruing loans delinquent more than 90 days:
One- to four-family $ -- $ --
Commercial real estate -- --
Multi-family -- --
Mobile homes -- --
Credit cards 1,601 530
Consumer -- --
Agriculture -- --
Commercial business -- --
------------------ ------------------
Total $ 1,601 $ 530
------------------ ------------------
Foreclosed assets:
One- to four-family $ 123 $ 22
Commercial real estate -- --
Multi-family -- --
Mobile homes 55 67
Credit cards -- --
Consumer 66 140
Agriculture -- --
Commercial business -- --
------------------ ------------------
Total $ 244 $ 229
------------------ ------------------
Total nonperforming assets $ 3,595 $ 3,010
------------------ ------------------
------------------ ------------------
Ratio of nonperforming assets to total assets 0.60% 0.53%
------------------ ------------------
------------------ ------------------
Ratio of nonperforming loans to total loans 0.71% 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 $3.6 million at December 31, 1998
from $3.0 million at June 30, 1998, an increase of $585,000. In addition, the
ratio of nonperforming assets to total assets, which is one indicator of
credit risk exposure, increased to 0.60% at December 31, 1998 as compared to
0.53% at June 30, 1998.
Nonaccruing loans decreased from $2.3 million at June 30, 1998 to
$1.8 million at December 31, 1998, a decrease of $501,000. Included in
nonaccruing loans at December 31, 1998 were twelve loans totaling $365,000
secured by one-to four-family real estate, two loans totaling $415,000
secured by commercial real estate, six mobile home loans totaling $55,000,
thirty-five consumer loans totaling $531,000, two agriculture loans totaling
$225,000 and five commercial business loans totaling $159,000. For the six
months ended December 31, 1998, gross interest income of $30,000 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 $40,000 was recognized as income on loans accounted for on a nonaccrual
basis.
Accruing credit card loans delinquent more than 90 days increased to
$1.6 million at December 31, 1998 from $530,000 at June 30, 1998.
Additionally, $4.8 million of credit card loans are delinquent 30 days at
December 31, 1998 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 six
months of fiscal 1999. Management is reviewing the increased level of credit
card delinquencies, and the loan underwriting criteria and collection
procedures in the credit card portfolio and will cease processing credit card
applications under the current underwriting criteria by March 5, 1999, the
earliest contractual date possible. Net charge-offs for the six months ended
December 31, 1998 were $1.6 million as compared to $189,000 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 $9.7
million in the next six months. Of this amount, about 31% will be a
charge-off against allowance for loan losses, of which the Company currently
provides a loan loss reserve of 22% of credit card loans in the allowance.
The remaining 69% will be charged against deferred credit card fee income,
interest income and credit card fee income in future periods. The Company is
discussing the ramifications of the above projections with its 49% partner in
HF Card Services to institute changes in loan underwriting criteria and
collection procedures which should enhance the profitability of any future
credit card products.
Foreclosed assets increased to $244,000 at December 31, 1998 from
$229,000 at June 30, 1998, an increase of $15,000.
At December 31, 1998, the Bank had approximately $8.0 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 December 31, 1998 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 December 31,
1998 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>
Six Months Ended
-------------------------------
12/31/98 12/31/97
------------- ------------
(Dollars in Thousands)
<S> <C> <C>
Balance at beginning of period $ 7,199 $ 4,526
CHARGE-OFFS:
One- to four-family (20) (77)
Commercial -- --
Commercial business (61) --
Consumer (507) (541)
Agriculture (446) --
Credit cards (1,643) (330)
Mobile homes (35) (117)
------------- ------------
Total charge-offs $ (2,712) $ (1,065)
------------- ------------
RECOVERIES:
One- to four-family $ 11 $ 10
Commercial -- --
Multi-family -- --
Commercial business 53 --
Consumer 98 87
Agriculture -- --
Credit cards 79 141
Mobile homes 18 15
------------- ------------
Total recoveries $ 259 $ 253
------------- ------------
Net (charge-offs) $ (2,453) $ (812)
Additions charged to operations 3,258 1,330
------------- ------------
Balance at end of period $ 8,004 $ 5,044
------------- ------------
------------- ------------
Ratio of net (charge-offs) recoveries
during the period to average loans outstanding
during the period (0.55)% (0.18)%
------------- ------------
------------- ------------
Ratio of allowance for loan losses to total
loans at end of period 1.69% 1.14%
------------- ------------
------------- ------------
Ratio of allowance for loan losses to
nonperforming loans at end of period (1) 238.85% 290.89%
------------- ------------
------------- ------------
</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 December 31, 1998 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 $ 1,159 29.85% $ 1,203 29.12%
Commercial and multi-family real estate (1) 888 22.90% 967 23.41%
Commercial business 385 9.92% 377 9.13%
Consumer 1,076 27.74% 1,219 29.49%
Agricultural 145 3.74% 150 3.63%
Credit cards 4,274 3.85% 3,181 2.74%
Mobile homes 77 2.00% 102 2.48%
------------- ------------ ------------- ------------
Total $ 8,004 100.00% $ 7,199 100.00%
------------- ------------ ------------- ------------
------------- ------------ ------------- ------------
</TABLE>
(1) Includes construction loans.
The allowance for loan losses was $8.0 million at December 31, 1998
as compared to $7.2 million at June 30, 1998. The ratio of the allowance for
loan losses to total loans was 1.69% at December 31, 1998 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 is providing a reserve in a range of 22% to
30% of the loan balance until the credit card portfolio becomes seasoned. As
of December 31, 1998, $4.3 million of the $8.0 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 six months ended December 31, 1998 and the fiscal
year ended June 30, 1998.
Page 17
<PAGE>
COMPARISON OF THE SIX MONTHS ENDED DECEMBER 31, 1998 AND DECEMBER 31, 1997
GENERAL. The Company's net income decreased $926,000 to $2.4 million
for the six months ended December 31, 1998 as compared to $3.3 million for
the six months ended December 31, 1997. As discussed in more detail below,
this decrease was due primarily to an increase in noninterest expense of $3.3
million and an increase in provision for losses on loans of $1.9 million.
These increases were partially offset by an increase in noninterest income of
$3.5 million, an increase in net interest income of $395,000 and a reduction
in income tax expense of $459,000.
INTEREST INCOME. Interest income decreased $589,000 from $23.3
million for the six months ended December 31, 1997 to $22.7 million for the
six months ended December 31, 1998. This decrease was primarily due to a
decrease in the average balance of interest-earnings assets. The average
balance of interest-earning assets decreased $14.0 million when comparing the
six months ended December 31, 1998 to the same period in the prior fiscal
year.
INTEREST EXPENSE. Interest expense decreased $984,000 from $13.1
million for the six months ended December 31, 1997 to $12.2 million for the
six months ended December 31, 1998. This decrease was largely attributable to
a decrease in the average balance of interest-bearing liabilities and to a
decrease in the rates paid on interest-bearing liabilities. The average rates
paid on interest-bearing liabilities decreased from 5.17% to 4.91% for the
six months ended December 31, 1997 and December 31, 1998, respectively. The
average balance of interest-bearing liabilities decreased $13.4 million for
the six months ended December 31, 1998 as compared to the same period in the
prior fiscal year.
NET INTEREST INCOME. The Company's net interest income for the six
months ended December 31, 1998 increased $395,000, or 3.88%, to $10.6 million
as compared to $10.2 million for the same period ended December 31, 1997. The
increase in the net interest income reflects an overall increase in the net
interest spread on average interest-earning assets from 3.29% for the six
months ended December 31, 1997 to 3.55% for the six months ended December 31,
1998. The increase in the net interest spread was primarily due to a decrease
in the rates paid on interest-bearing liabilities from 5.17% for the six
months ended December 31, 1997 to 4.91% for the six months ended December 31,
1998.
During the six months ended December 31, 1998, 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. 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 six months ended December
31, 1998, the Company recorded a provision for losses on loans of $3.3
million as compared to $1.3 million for the six months ended December 31,
1997. The provision for losses on loans of $3.3 million for the six months
ended December 31, 1998 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 six months ended December 31, 1998, the Company had net
charge-offs of credit card loans of $1.6 million as compared to $189,000 for
the six months ended December 31, 1997. The net charge-offs for the six
months ended December 31, 1998 exceeded management's expectations.
Delinquencies on credit card loans increased from 19.66% at June 30, 1998 to
24.55% at December 31, 1998.
NONINTEREST INCOME. Noninterest income was $9.1 million for the six
months ended December 31, 1998 as compared to $5.6 million for the six months
ended December 31, 1997, an increase of $3.5 million.
Page 18
<PAGE>
The increase in credit card fee income of $3.2 million for the six
months ended December 31, 1998 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 $19.4 million at December 31, 1999. The credit
card loan portfolio had a balance of $4.8 million at December 31, 1997. 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. A reduction in future credit card applications 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 $3.3 million from
$9.5 million for the six months ended December 31, 1997 to $12.8 million for
the six months ended December 31, 1998.
There was an increase of $3.0 million in the cost of third party
processors of credit cards. This 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 six
months ended December 31, 1998 was $1.2 million as compared to $1.7 million
for the six months ended December 31, 1997, a decrease of $459,000. This
decrease was primarily due to the decrease in the Company's income before
income tax
COMPARISON OF THE THREE MONTHS ENDED DECEMBER 31, 1998 AND DECEMBER 31, 1997
GENERAL. The Company's net income decreased $535,000 to $1.1 million
for the three months ended December 31, 1998 as compared to $1.6 million for
the three months ended December 31, 1997. 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 $892,000. These
increases were partially offset by an increase in noninterest income of $1.5
million, an increase in net interest income of $275,000 and a reduction in
income tax expense of $220,000.
INTEREST INCOME. Interest income decreased $48,000 when comparing the
three months ended December 31, 1998 to the three months ended December 31,
1997. This decrease was primarily due to a decrease in the average yield of
interest-earnings assets which was partially offset by an increase in the
average balance of interest-earning assets. The average yield on
interest-earning assets decreased from 8.49% to 8.43% for the three months
ended December 31, 1997 and December 31, 1998, respectively. The average
balance of interest-earning assets increased $1.2 million when comparing the
three months ended December 31, 1998 to the same period in the prior fiscal
year.
INTEREST EXPENSE. Interest expense decreased $323,000 from $6.5
million for the three months ended December 31, 1997 to $6.2 million for the
three months ended December 31, 1998. This decrease was largely attributable
to a decrease in the average rate paid on interest-bearing liabilities. The
average rates on interest-bearing liabilities decreased from 5.13% to 4.84%
for the three months ended December 31, 1997 and December 31, 1998,
respectively.
NET INTEREST INCOME. The Company's net interest income for the three
months ended December 31, 1998 increased $275,000, or 5.35%, to $5.4 million
as compared to $5.1 million for the same period ended December 31, 1997. The
increase in the net interest income reflects an overall increase in the net
interest spread on average interest-earning assets from 3.36% for the three
months ended December 31, 1997 to 3.59% for the three months ended December
31, 1998. The increase in the net interest spread was primarily due to a
decrease in the rates paid on interest-bearing liabilities from 5.13% for the
three months ended December 31, 1997 to 4.84% for the three months ended
December 31, 1998.
During the three months ended December 31, 1998, 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. 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 December
31, 1998, the Company recorded a provision for losses on loans of $1.7
million as compared to $804,000 for the three months ended December 31, 1997.
The
Page 19
<PAGE>
provision for losses on loans of $1.7 million for the three months ended
December 31, 1998 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.
NONINTEREST INCOME. Noninterest income was $4.3 million for the
three months ended December 31, 1998 as compared to $2.8 million for the
three months ended December 31, 1997, an increase of $1.5 million.
The increase in credit card fee income of $936,000 for the three
months ended December 31, 1998 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 $17.0
million at September 30, 1998 to $19.4 million at December 31, 1999. The
balance of the credit card loan portfolio at December 31, 1997 was $4.8
million. 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. A reduction in future credit card applications 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
$4.7 million for the three months ended December 31, 1997 to $6.4 million for
the three months ended December 31, 1998.
There was an increase of $1.4 million in the cost of third party
processors of credit cards. This 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 December 31, 1998 was $578,000 as compared to $798,000 for the
three months ended December 31, 1997, a decrease of $220,000. This decrease
was primarily due to the decrease in the Company's income before income tax.
This decrease was partially offset by the increase in the effective tax rate
from 32.98% for the three months ended December 31, 1997 to 34.71% for the
three months ended December 31, 1998.
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 December 31, 1998, the Bank's regulatory liquidity ratio was
8.17%.
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 six months ended December 31, 1998, 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 $38.5 million.
The Bank anticipates that it will have sufficient funds available to
meet current loan commitments. At December 31, 1998, the Bank had outstanding
commitments to originate or purchase loans of $41.3 million and to sell loans
of $18.9 million. The Bank had no commitments to purchase or sell
mortgage-backed securities or securities available for sale.
Page 20
<PAGE>
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 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 had purchased 285,550 shares of common stock as of
December 31, 1998.
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 December 31, 1998, 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 7.45% at December 31, 1998.
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 June 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 10.48%. The post-shock NPV ratio was
estimated to be 10.18%, a decline of 30bp. As of September 30, 1998, the most
recent report available, the Bank's sensitivity to interest rate changes
increased slightly. The post-shock ratio for a 200 bp increase in market
interest rates as of September 30, 1998 was estimated to be 10.11%, a
decrease of 53bp from the pre-shock NPV ratio estimate of 10.64%.
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
The following matters were submitted to a vote by the
stockholders of HF Financial Corp. at the Annual Meeting of
Stockholders on November 18, 1998:
a. Election of Board of Directors of the Company.
<TABLE>
<S> <C> <C> <C>
Robert L. Hanson* For: 3,991,929 Vote Withheld: 17,043 Non-Voters: 274,986
Kevin T. Kirby* For: 3,987,367 Vote Withheld: 21,605 Non-Voters: 274,986
</TABLE>
*Terms to expire 2001.
Continuing Board of Directors - Curtis L. Hage, JoEllen G.
Koerner, Wm. G. Pederson, Paul J. Hallem, Jeffrey G. Parker
and Thomas L. Van Wyhe.
b. Amendment of the Company's Certificate of Incorporation to
increase the number of authorized shares of common stock from
5,000,000 to 10,000,000.
<TABLE>
<CAPTION>
NUMBER OF VOTES % VOTES CAST
<S> <C> <C>
For 3,221,108 75.19%
Against 762,181 17.79%
Abstain 25,683 0.60%
Non-Voters 274,986 6.42%
</TABLE>
c. Ratification of the re-appointment of McGladrey & Pullen, LLP
as the Company's auditors for fiscal year ending June 30, 1999.
<TABLE>
<CAPTION>
NUMBER OF VOTES % VOTES CAST
<S> <C> <C>
For 3,995,339 93.26%
Against 5,917 0.14%
Abstain 7,716 0.18%
Non-Voters 274,986 6.42%
</TABLE>
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. Report Form 8-K is not required to be filed at this time.
- --------------------------------------------------------------------------------
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.
<TABLE>
<CAPTION>
<S> <C>
HF Financial Corp.
----------------------------------------------
(Registrant)
Date: 2/10/99 by /S/ CURTIS L. HAGE
--------------------- -------------------------------------------
Curtis L. Hage, Chairman, President
And Chief Executive Officer
(Duly Authorized Officer)
Date: 2/10/99 by /S/ BRENT E. JOHNSON
--------------------- -------------------------------------------
Brent E. Johnson, Senior Vice President,
Chief Financial Officer And Treasurer
(Principal Financial and Accounting Officer)
</TABLE>
Page 24
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<RESTATED>
<CIK> 0000881790
<NAME> HF FINANCIAL CORP
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 14,412
<INT-BEARING-DEPOSITS> 4,000
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 90,674
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 472,723
<ALLOWANCE> 8,004
<TOTAL-ASSETS> 602,601
<DEPOSITS> 440,844
<SHORT-TERM> 0
<LIABILITIES-OTHER> 19,462
<LONG-TERM> 89,154
0
0
<COMMON> 15,154
<OTHER-SE> 37,987
<TOTAL-LIABILITIES-AND-EQUITY> 602,601
<INTEREST-LOAN> 20,145
<INTEREST-INVEST> 2,593
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 22,738
<INTEREST-DEPOSIT> 10,300
<INTEREST-EXPENSE> 12,156
<INTEREST-INCOME-NET> 10,582
<LOAN-LOSSES> 3,258
<SECURITIES-GAINS> 3
<EXPENSE-OTHER> 12,813
<INCOME-PRETAX> 3,601
<INCOME-PRE-EXTRAORDINARY> 3,601
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,380
<EPS-PRIMARY> 0.55
<EPS-DILUTED> 0.54
<YIELD-ACTUAL> 8.46
<LOANS-NON> 1,750
<LOANS-PAST> 1,601
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 7,199
<CHARGE-OFFS> 2,712
<RECOVERIES> 259
<ALLOWANCE-CLOSE> 8,004
<ALLOWANCE-DOMESTIC> 8,004
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<RESTATED>
<CIK> 0000881790
<NAME> HF FINANCIAL CORP
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 16,612
<INT-BEARING-DEPOSITS> 9,000
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 94,154
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 443,063
<ALLOWANCE> 5,044
<TOTAL-ASSETS> 580,668
<DEPOSITS> 444,613
<SHORT-TERM> 0
<LIABILITIES-OTHER> 14,753
<LONG-TERM> 65,694
0
0
<COMMON> 14,866
<OTHER-SE> 40,742
<TOTAL-LIABILITIES-AND-EQUITY> 580,668
<INTEREST-LOAN> 20,247
<INTEREST-INVEST> 3,080
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 23,327
<INTEREST-DEPOSIT> 11,172
<INTEREST-EXPENSE> 13,140
<INTEREST-INCOME-NET> 10,187
<LOAN-LOSSES> 1,330
<SECURITIES-GAINS> 10
<EXPENSE-OTHER> 9,511
<INCOME-PRETAX> 4,986
<INCOME-PRE-EXTRAORDINARY> 4,986
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,306
<EPS-PRIMARY> 0.74
<EPS-DILUTED> 0.72
<YIELD-ACTUAL> 8.46
<LOANS-NON> 1,555
<LOANS-PAST> 179
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 4,526
<CHARGE-OFFS> 1,065
<RECOVERIES> 253
<ALLOWANCE-CLOSE> 5,044
<ALLOWANCE-DOMESTIC> 5,044
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
