<PAGE>
PROSPECTUS
$15,000,000
ARGO CAPITAL TRUST CO.
[LOGO]
11.0% CAPITAL SECURITIES
(LIQUIDATION AMOUNT OF $10.00 PER CAPITAL SECURITY)
FULLY AND UNCONDITIONALLY GUARANTEED, AS DESCRIBED HEREIN, BY
ARGO BANCORP, INC.
The 11.0% Capital Securities, liquidation amount $10.00 per security (the
"Capital Securities" or the "Securities") offered hereby represent undivided
beneficial interests in the assets of Argo Capital Trust Co., a statutory
business trust formed under the laws of the State of Delaware (the "Trust"). The
Capital Securities will be fully and unconditionally guaranteed, as described
herein, by Argo Bancorp, Inc. (the "Company"). (The offering of the Capital
Securities may hereinafter be referred to as the "Offering.") The Wilmington
Trust Co. will act as Property Trustee (as defined herein) for the Trust.
The Capital Securities have been approved for listing on the American Stock
Exchange under the symbol "ATP."
-------------------
THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" BEGINNING ON PAGE 17 FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE
CONSIDERED BY EACH PROSPECTIVE INVESTOR.
-------------------
THE SECURITIES OFFERED HEREBY ARE NOT SAVINGS ACCOUNTS OR
DEPOSITS AND ARE NOT FEDERALLY INSURED OR GUARANTEED.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION, OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE UNDERWRITING PROCEEDS TO
TO PUBLIC DISCOUNTS (1) THE TRUST (2)
<S> <C> <C> <C>
Per Capital Security.............................. $10.00 (2) $10.00
Total Offering (3)................................ $15,000,000 (2) $15,000,000
</TABLE>
(1) The Company and the Trust have agreed to indemnify the Underwriters against
certain liabilities, including certain liabilities under the Securities Act
of 1933, as amended. See "Underwriting."
(2) The Company has agreed to pay expenses of the Offering estimated to be
$700,000. Additionally, in view of the fact that the proceeds of the sale of
the Capital Securities will be invested in the Junior Subordinated
Debentures, the Company, as issuer of the Junior Subordinated Debentures,
has agreed to pay the Underwriters, as compensation, $0.60 per Capital
Security or $900,000 in the aggregate ($1,035,000 in the aggregate if the
over-allotment option is exercised in full). See "Underwriting."
(3) The Company and Trust have granted the Underwriters a 30-day option to
purchase up to $2,250,000 of Capital Securities, solely to cover
overallotments, if any. To the extent that the option is exercised, the
Underwriters will offer the additional Capital Securities at the Price to
Public shown above. If the option is exercised in full, the total Price to
Public and Proceeds to the Trust will each be $17,250,000. See
"Underwriting."
The Capital Securities are being offered by the Underwriters, subject to
prior sale, when, as and if delivered to and accepted by the Underwriters and
subject to their right to reject orders in whole or in part. It is expected that
delivery of the Capital Securities will be made on or about November 10, 1998.
-------------------
TUCKER ANTHONY
INCORPORATED
THE DATE OF THIS PROSPECTUS IS NOVEMBER 6, 1998
<PAGE>
The Capital Securities offered by the Underwriters in the Offering are
subject to prior sale, when, as and if delivered to and accepted by the
Underwriters, and subject to their right to withdraw, modify, correct and reject
orders in whole or in part. It is expected that delivery of the certificates
representing such shares of Capital Securities will be made against payment
therefore at the offices of Tucker Anthony Incorporated, in book entry form, or
through the facilities of the Depository Trust Company ("DTC") on or about
November 10, 1998.
Except as provided below, the Capital Securities will be represented by
certificates in fully registered form deposited with a custodian for and
registered in the name of a nominee of DTC. Beneficial interests in the Capital
Securities will be shown on, and transfers thereof will be effected through,
records maintained by DTC and its participants. Beneficial interests in such
Capital Securities will trade in DTC's Same-Day Funds Settlement System and
secondary market trading activity in such interests will therefore settle in
immediately available funds.
The Capital Securities offered hereby will represent beneficial interests in
the Trust. The Company will be the owner of all of the beneficial interests
represented by common securities of the Trust (the "Common Securities" and,
together with the Capital Securities, the "Trust Securities"). The Trust exists
for the exclusive purpose of issuing the Trust Securities and investing the
proceeds thereof in the 11.0% Junior Subordinated Deferrable Interest Debentures
(the "Junior Subordinated Debentures") to be issued by the Company, and certain
other limited activities described herein. The Junior Subordinated Debentures
are scheduled to mature on November 6, 2028 (the "Stated Maturity Date"). See
"Description of Junior Subordinated Debentures--General." The Capital Securities
will have a preference over the Common Securities under certain circumstances
with respect to cash distributions and amounts payable on liquidation,
redemption or otherwise. See "Description of the Capital
Securities--Subordination of Common Securities."
Holders of the Trust Securities will be entitled to receive cumulative cash
distributions arising from the payment of interest on the Junior Subordinated
Debentures, accruing from the date of original issuance and payable quarterly in
arrears on April 15th, July 15th, October 15th and January 15th of each year
(subject to possible deferral as described below), commencing January 15, 1999
at the annual rate of 11.0% of the Liquidation Amount (as defined herein) per
Trust Security ("Distributions"). So long as no Debenture Event of Default (as
defined herein) has occurred and is continuing, the Company will have the right
to defer payments of interest on the Junior Subordinated Debentures at any time
or from time to time for a period not exceeding twenty (20) consecutive
quarterly periods with respect to each deferral period (each, an "Extension
Period"), provided that no Extension Period may extend beyond the Stated
Maturity Date (as defined herein). Upon the termination of any such Extension
Period and the payment of all amounts then due, the Company may elect to begin a
new Extension Period subject to the requirements set forth herein. If and for so
long as interest payments on the Junior Subordinated Debentures are so deferred,
Distributions on the Trust Securities also will be deferred and the Company will
not be permitted, subject to certain exceptions described herein, to declare or
pay any cash distributions with respect to its capital stock, or to make any
payment with respect to debt securities of the Company that rank PARI PASSU with
or junior to the Junior Subordinated Debentures. DURING THE EXTENSION PERIOD,
INTEREST ON THE JUNIOR SUBORDINATED DEBENTURES WILL CONTINUE TO ACCRUE (AND THE
AMOUNT OF DISTRIBUTIONS TO WHICH HOLDERS OF THE TRUST SECURITIES ARE ENTITLED
WILL CONTINUE TO ACCUMULATE) AT THE RATE OF 11.0% PER ANNUM, COMPOUNDED
QUARTERLY AND HOLDERS OF THE TRUST SECURITIES WILL BE REQUIRED TO INCLUDE
DEFERRED INTEREST INCOME FOR UNITED STATES FEDERAL INCOME TAX PURPOSES PRIOR TO
THE RECEIPT OF THE CASH ATTRIBUTABLE TO SUCH INCOME ON THAT INCOME. See
"Description of Junior Subordinated Debentures--Option to Extend Interest
Payment Date" and "Certain Federal Income Tax Consequences with Respect to the
Issuance of the Capital Securities--Interest Income and Original Issue
Discount."
The Company will, through the Guarantee, the Common Guarantee, the Trust
Agreement, the Junior Subordinated Debentures, and the Indenture (each as
defined herein) taken together, fully, irrevocably and unconditionally,
guarantee all of the Trust's obligations under the Trust Securities. See
"Relationship
2
<PAGE>
Among the Capital Securities, the Junior Subordinated Debentures and the
Guarantee--Full and Unconditional Guarantee." The Guarantee and the Common
Guarantee will guarantee payments of Distributions and payments upon liquidation
of the Trust or redemption of the Trust Securities, but in each case only to the
extent that the Trust has funds legally available therefore and has failed to
make such payments, as described herein. See "Description of Guarantee." If the
Company fails to make a required payment on the Junior Subordinated Debentures,
the Trust will not have sufficient funds to make the related payments, including
Distributions, on the Trust Securities. The Guarantee and the Common Guarantee
will not cover any such payment when the Trust does not have sufficient funds
legally available therefore. In such event, a holder of Capital Securities may
institute a legal proceeding directly against the Company to enforce its rights
in respect of such payment. See "Distribution of Junior Subordinated
Debentures--Enforcement of Certain Rights by the Company of Capital Securities."
The obligations of the Company under the Guarantee, the Common Guarantee and the
Junior Subordinated Debentures will be unsecured and will rank subordinate and
junior in right of payment to all Senior Indebtedness (as defined in
"Description of Junior Subordinated Debentures--Subordination"). The ability of
the Company to make required payments on the Junior Subordinated Debentures will
depend, in large part, on its receipt of dividends from the subsidiaries of the
Company. See "Use of Proceeds" and "Risk Factors--Ranking of Subordinated
Obligations Under the Guarantee and the Junior Subordinated Debentures;
Limitations on Sources of Funds."
The Trust Securities will be subject to mandatory redemption in a Like
Amount (as defined herein): (i) in whole but not in part, on the Stated Maturity
Date upon repayment of the Junior Subordinated Debentures at a redemption price
equal to the principal amount of, plus accrued and unpaid interest on, the
Junior Subordinated Debentures (the "Maturity Redemption Price"); (ii) in whole
but not in part, at any time prior to November 6, 2003 (the "Initial Optional
Prepayment Date"), contemporaneously with the optional prepayment of the Junior
Subordinated Debentures by the Company, upon the occurrence and continuation of
a Special Event (as defined herein) at a redemption price equal to, for each
Capital Security, the Special Event Prepayment Price (as defined herein) for a
corresponding $10.00 principal amount of Junior Subordinated Debenture (the
"Special Event Redemption Price"); and (iii) in whole or in part, on or after
the Initial Optional Prepayment Date, contemporaneously with the optional
prepayment by the Company of all or part of the Junior Subordinated Debentures,
at a redemption price equal to, for each Capital Security to be redeemed, the
Optional Prepayment Price (as defined herein) for a corresponding $10.00
principal amount of Junior Subordinated Debentures (the "Optional Redemption
Price"). Any of the Maturity Redemption Price, the Special Event Redemption
Price and the Optional Redemption Price may be referred to herein as the
"Redemption Price." See "Description of Capital Securities--Redemption."
Subject to the Company having received any required regulatory approval, the
Junior Subordinated Debentures will be prepayable prior to the Stated Maturity
Date at the option of the Company; (i) on or after the Initial Optional
Prepayment Date, in whole or in part, at 100% of the principal amount thereof,
plus accrued and unpaid interest thereon to the date of prepayment (the
"Optional Prepayment Price"); or (ii) at any time prior to the Initial Optional
Prepayment Date, in whole but not in part, upon the occurrence and continuation
of a Special Event, at a prepayment price (the "Special Event Prepayment Price")
equal to the Make-Whole Amount (as defined below). The "Make-Whole Amount" shall
be equal to the greater of (a) 100% of the principal amount of the Junior
Subordinated Debentures or (b) the sum, as determined by a Quotation Agent (as
defined herein), of the present values of the scheduled payments of principal
and interest on the Junior Subordinated Debentures from the date of prepayment
to the Initial Optional Prepayment Date, discounted to the prepayment date on a
quarterly basis (assuming a 360-day year consisting of twelve 30-day months) at
the Adjusted Treasury Rate (as defined herein) plus, in the case of each of
clauses (a) and (b), accrued and unpaid interest thereon to the date of
prepayment. Either of the Optional Prepayment Price or the Special Event
Prepayment Price may be referred to herein as the "Prepayment Price." See
"Description of Junior Subordinated Debentures--Optional Prepayment" and
"--Special Event Prepayment."
3
<PAGE>
The Company will have the right at any time, including without limitation
upon the occurrence of a Tax Event (as defined herein) to terminate the Trust
and, after satisfaction of liabilities of creditors of the Trust as required by
applicable law, to cause a Like Amount of the Junior Subordinated Debentures to
be distributed to the holders of the Trust Securities in liquidation of the
Trust, subject to (i) the Company having received an opinion of counsel to the
effect that such distribution will not be a taxable event to holders of Capital
Securities and (ii) the receipt of any required regulatory approvals. Unless the
Junior Subordinated Debentures are distributed to the holders of the Trust
Securities, in the event of a liquidation of the Trust as described herein,
after satisfaction of liabilities to creditors of the Trust as required by
applicable law, the holders of the Trust Securities generally will be entitled
to receive $10.00 per Trust Security plus accumulated and unpaid Distributions
thereon to the date of payment. See "Description of Capital
Securities--Liquidation of the Trust and Distribution of Junior Subordinated
Debentures."
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE CAPITAL
SECURITIES, INCLUDING OVER-ALLOTMENT, STABILIZING AND SYNDICATE SHORT-COVERING
TRANSACTIONS IN SUCH SECURITIES, AND THE IMPOSITION OF PENALTY BIDS, IN
CONNECTION WITH THE OFFERING. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE
"UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, CERTAIN PERSONS MAY ENGAGE IN PASSIVE
MARKET MAKING TRANSACTIONS IN THE SECURITIES OFFERED HEREBY ON THE AMERICAN
STOCK EXCHANGE IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE "UNDERWRITING."
4
<PAGE>
SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION, INCLUDING "RISK FACTORS," AND CONSOLIDATED FINANCIAL STATEMENTS AND
NOTES THERETO APPEARING ELSEWHERE IN THIS PROSPECTUS. UNLESS OTHERWISE
INDICATED, ALL INFORMATION IN THIS PROSPECTUS ASSUMES THAT THE UNDERWRITER'S
OVER-ALLOTMENT OPTIONS WILL NOT BE EXERCISED, AND GIVES EFFECT TO THE ISSUANCE
BY THE COMPANY OF A FOUR-TO-ONE STOCK SPLIT IN THE FORM OF A STOCK DIVIDEND OF
THREE SHARES OF COMMON STOCK FOR EACH SHARE OF COMMON STOCK ISSUED AND
OUTSTANDING (THE "STOCK SPLIT"), WHICH WILL TAKE PLACE PRIOR TO THE DATE OF THIS
OFFERING. UNLESS OTHERWISE INDICATED ALL REFERENCES TO THE COMPANY SHALL BE
DEEMED TO INCLUDE THE COMPANY AND ITS SUBSIDIARIES.
THIS PROSPECTUS CONTAINS CERTAIN STATEMENTS OF A FORWARD-LOOKING NATURE
RELATING TO FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF THE COMPANY.
PROSPECTIVE PURCHASERS OF THE CAPITAL SECURITIES OFFERED HEREBY ARE CAUTIONED
THAT SUCH STATEMENTS ARE ONLY PREDICTIONS AND THAT ACTUAL EVENTS OR RESULTS MAY
DIFFER MATERIALLY. IN EVALUATING SUCH STATEMENTS, PROSPECTIVE PURCHASERS OF THE
CAPITAL SECURITIES SHOULD SPECIFICALLY CONSIDER THE VARIOUS FACTORS IDENTIFIED
IN THIS PROSPECTUS, INCLUDING THE MATTERS SET FORTH UNDER "RISK FACTORS," WHICH
WOULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH
FORWARD-LOOKING STATEMENTS.
THE COMPANY
The Company was incorporated in Delaware in 1987 primarily for the purpose
of acquiring all of the issued and outstanding stock of Argo Federal Savings
Bank, F.S.B. (the "Bank"). Unlike many savings and loan holding companies, the
Company is an active holding company with only a portion of its future
anticipated operating income dependent upon the Bank. On a consolidated basis at
June 30, 1998, the Company's total assets were $259.8 million, total liabilities
were $241.0 million and stockholders' equity was $18.7 million. At June 30,
1998, on an unconsolidated basis, the Company's assets included a $14.6 million
investment in the Bank, a $5.7 million investment in On-Line Financial Services,
Inc. ("On-Line"), and a $1.1 million investment in Empire/Argo, LLC ("Empire").
As the Company's primary subsidiary, the Bank's principal business is
attracting deposits from the general public and originating or purchasing loans
primarily secured by one- to four- family residential real estate. To a much
lesser extent, the Bank also originates multi-family and commercial real estate
mortgage loans, home equity loans, deposit account loans and other consumer
loans. Historically, the Bank's lending portfolio primarily consisted of one- to
four-family residential mortgage loans. Since 1992, the Bank has acquired
portfolios of loans consisting primarily of performing seasoned one- to
four-family residential mortgage loans. The Bank has also originated loans
through its branch network. From time to time and in limited amounts, the Bank
has purchased, through Argo Mortgage Corp., a wholly-owned subsidiary of the
Bank ("Argo Mortgage"), and through Empire, which is 98.4% owned by the Company,
discounted mortgage loans, generally for less than 90% of their principal
balance, most of which were non-performing when acquired ("Discounted Loans").
Discounted Loans are purchased with a view toward either bringing such loans
current for the Bank's portfolio, for resale in the secondary market or
foreclosure and liquidation. Since mid-1997, the Company has significantly
reduced its emphasis on the purchase of Discounted Loans. At June 30, 1998, the
Company had $17.0 million of loans classified as Discounted Loans, or 8.46% of
total loans compared to $37.3 million or 21.47% at June 30, 1997. Primarily as a
result of higher levels of real estate acquired through foreclosure or deed in
lieu of foreclosure or in judgment ("REO") resulting from its Discounted Loan
activities, the Bank's level of non-performing assets has been historically
higher than that of its peers. At June 30, 1998, non-performing loans to total
loans, exclusive of Discounted Loans, were 2.78% and non-performing assets to
total assets, exclusive of Discounted Loans, totaled 3.58%. The Bank has also
originated loans through its branch network.
In order to expand its level of loan originations and purchases, in 1996 the
Bank established a 50.1% ownership interest in Margo Financial Services, LLC
("MARGO"), a mortgage banking subsidiary. Since August 1996, the Bank has
engaged in both wholesale and retail lending activities primarily through MARGO.
MARGO focuses on the origination, purchase and sale of mortgage loans generally
on a "servicing released" basis into the secondary market. Through MARGO, the
Bank has originated loans
5
<PAGE>
through a network of brokers and correspondents (the "Correspondents") located
in various states throughout the country. These loans generally fall into three
categories: (1) Conventional Loans--loans which conform to all of the
underwriting guidelines of FannieMae and FreddieMac ("Agency Qualified"); (2)
Expanded Criteria Loans--loans which are (a) not Agency Qualified, generally due
to the borrowers credit profile, (b) are not as readily saleable in the
secondary market as Conventional Loans or Portfolio Loans and (c) are generally
fixed-rate loans which are originated at interest rates higher than those of
fixed-rate Conventional Loans; and (3) Portfolio Loans--adjustable-rate mortgage
("ARM") loans which (a) are not Agency Qualified but are readily saleable in the
secondary market, (b) are originated under specific criteria set forth by the
Bank, and (c) are not Conventional or Expanded Criteria Loans. ARM loans
originated by MARGO are generally retained by the Bank for its portfolio, while
fixed-rate loans originated by MARGO are generally not retained in the Bank's
portfolio but are immediately sold in the secondary market.
The primary sources of revenue to the Bank are interest and fee income
derived from lending and mortgage activities and, to a lesser extent, income
generated from investments in purchased mortgage servicing rights ("PMSRs").
Additionally, the Bank invests in United States Government and federal agency
obligations, mortgage-backed securities, time deposits, federal funds and other
types of liquid investments as permitted by federal law. More recently, the Bank
has also generated revenue from automatic teller machine ("ATM") and service
fees.
The overall strategy of the Bank is to increase stockholder value.
Specifically the Bank intends to focus on traditional banking activities while
non-traditional functions, such as activities related to Discounted Loan
purchases, will be maintained at the Company level. Management expects to meet
its goals by:
- DEVELOPING A STRONG BRANCH NETWORK. Management intends to prudently expand
the operations of the Bank by strategically opening economically efficient
branches which become available due to consolidation in the financial
institution industry, while streamlining its existing branch network as
necessary.
- EXPANDING ONE- TO FOUR-FAMILY LENDING. The Bank will continue to expand
the origination of one-to four-family loans through MARGO primarily on a
wholesale basis through its network of Correspondents. To a lesser extent,
the Bank also plans to expand its origination of one-to four-family loans
on a retail basis through its branch network.
- CONTINUING STRATEGIC PURCHASES AND SALES OF LOANS. The Bank will continue
to actively seek to purchase loans which the Bank believes to be
undervalued relative to the market and which the Bank believes can be
later resold at a profit.
- MAINTAINING COMMUNITY ORIENTATION. Management intends to maintain the
Bank's community orientation by continuing to emphasize traditional
deposit products, loan products consisting of primarily one- to
four-family residential mortgages, and active community lending and
development activities such as affordable housing.
- REDUCING NON-PERFORMING ASSETS. The Bank intends to reduce non-performing
assets by continuing to decrease its emphasis on the purchase of
Discounted Loans and reduce its REO by moving the responsibility to
service REO in-house from a third party servicer and hiring experienced
staff to manage such processes.
- INCREASING FEE INCOME. Management plans to increase fee income through the
expansion of its ATM network, both in the Greater Chicago Metro area
(hereinafter referred to as its "Primary Market Area") and outside the
Primary Market Area.
- INCREASING THE BANK'S CORE DEPOSIT BASE. The Bank intends to develop its
core deposit base through the use of specific marketing relationships.
6
<PAGE>
The Company also operates through its wholly-owned subsidiary, On-Line,
which was purchased by the Company in October 1995. On-Line is a third-party
provider of electronic data processing services to primarily financial
institution clients located throughout the Midwest. Since On-Line's acquisition,
the Company has promoted a corporate commitment to implementation of advanced
technologies sufficient to remain competitive in the rapidly changing financial
services marketplace. The Company's business plan has been to enhance On-Line's
foundation as a data processing and communications network provider by
implementing tools to continue supporting existing services, as well as evolve
into a provider of electronic commerce, intranet and Internet services,
technical training services, and document management and imaging services. Since
its acquisition, management has streamlined and restructured On-Line's
organization to deploy and implement its business strategies. Currently, On-Line
maintains two fully-integrated application software systems for its clients.
On-Line has targeted new potential sales markets both within and outside the
financial services industry, in order to expand and diversify its revenues.
On-Line's services also include computer output laser disc storage technology
utilizing a high-speed document storage and retrieval system, integrated check
and document imaging systems, as well as the planning and deployment of local
and wide area network architectural design and implementation services, the sale
of all related hardware and software, consultation, and training.
BUSINESS STRATEGY OF ON-LINE. The primary objectives of On-Line's strategic
planning have been to increase the Company's shareholder value by implementing
data processing platforms capable of continuously evolving to meet the needs of
the rapidly changing financial services industry and to attract and develop
skilled management and technical personnel. Principal steps taken include:
- DEVELOPING MANAGEMENT AND PERSONNEL. Since its acquisition in 1995,
On-Line has streamlined and re-structured its entire organization to
deploy and implement its revised business strategies.
- IMPLEMENTATION OF ADVANCED TECHNOLOGIES. Since On-Line's acquisition, the
Company has promoted a corporate commitment to implementation of advanced
technologies sufficient to remain competitive in the future marketplace.
On-Line's open system architecture allows the Company to take advantage of
rapidly changing technologies and gain certain operating efficiencies. As
a result of this architecture, On-Line has gained available capacity in
its hardware system and intends to use the increased capacity as an
additional avenue of generating income.
- NEW PRODUCT LINES. In order to become a full service out-sourcing business
partner to its clients, On-Line has upgraded and increased its product and
service offerings. On-Line is now actively offering the
BANKFORCE-Registered Trademark- system, an integrated application system
developed by Information Technology Incorporated ("ITI"), and On-Line
introduced and implemented a Computer Output Information Server ("COINS")
product, which is a high-speed optical storage and retrieval system.
- RELATIONSHIP DEVELOPMENT. On-Line seeks to initiate, develop and
strengthen its business relationships with its clients by offering new
products and services designed to provide technologically advanced
solutions for improving client profitability, performance, growth, and
competitive position in the marketplace.
- INTERNAL GROWTH AND SALES. On-Line seeks to grow internally by selling
services and products to new clients and cross-selling additional services
to existing clients. On-Line also seeks to develop and sell new services
to clients to help them retain existing customers and attract additional
customers from new markets.
7
<PAGE>
STRUCTURE OF THE COMPANY
[LOGO]
- ------------------------
* Denotes inactive subsidiary.
The Company's principal executive office and home office are located at 7600
West 63rd Street, Summit, Illinois and its telephone number is (708) 496-6010.
8
<PAGE>
THE TRUST
The Trust is a statutory business trust formed under Delaware law upon the
filing of a Certificate of Trust with the Delaware Secretary of State. The
Trust's business and affairs are conducted by the Issuer Trustees: the Property
Trustee, the Delaware Trustee and individual Administrative Trustees who are
officers of either the Bank or the Company. The Trust exists for the exclusive
purpose of (i) issuing and selling the Trust Securities, (ii) using the proceeds
from the sale of the Trust Securities to acquire the Junior Subordinated
Debentures issued by the Company, and (iii) engaging in only those other
activities necessary, advisable or incidental thereto. Accordingly, the Junior
Subordinated Debentures will be the sole assets of the Trust, and payments by
the Company under the Junior Subordinated Debentures will be the sole revenues
of the Trust. All of the Common Securities will be owned by the Company.
The Trust's principal offices are located at 7600 West 63rd Street, Summit,
Illinois and its telephone number is (708) 496-6010.
9
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Securities Offered.............. $15.0 million aggregate liquidation amount of Capital
Securities.
Participation by Management..... Management intends to purchase an aggregate of $150,000 of
Capital Securities in the Offering.
Price to Public................. $10.00 per Capital Security.
Distribution Dates.............. April 15th, July 15th, October 15th and January 15th of
each year, commencing on January 15, 1999.
Extension Periods............... So long as no Debenture Event of Default (as defined
herein) has occurred and is continuing, Distributions on
Capital Securities will be deferred for the duration of
any Extension Period elected by the Company with respect
to the payment of interest on the Junior Subordinated
Debentures. No Extension Period will exceed twenty (20)
consecutive quarterly periods, end on a date other than an
Interest Payment Date or extend beyond the Stated Maturity
Date. During an Extension Period, the holders of Capital
Securities will be required to include deferred interest
income in their gross income for United States federal
income tax purposes in advance of any corresponding cash
distributions. See; "Description, of Junior Subordinated
Debentures--Option to Extend Interest Payment Date" and
"Certain Federal Income Tax Consequences with Respect to
the Issuance of the Capital Securities--Interest Income
and Original Issue Discount."
Redemption...................... The Trust Securities will be subject to mandatory
redemption in a Like Amount: (i) in whole but not in part,
on the Stated Maturity Date upon repayment of the Junior
Subordinated Debentures; (ii) in whole but not in part, at
any time prior to November 6, 2003, contemporaneously with
the optional prepayment of the Junior Subordinated
Debentures by the Company upon the occurrence and
continuation of a Special Event (as defined herein); and
(iii) in whole or in part, on or after November 6, 2003,
contemporaneously with the optional prepayment by the
Company of all or part of the Junior Subordinated
Debentures, at the Optional Redemption Price . See
"Description of Capital Securities--Redemption" and
"Description of Junior Subordinated Debentures--Special
Event Prepayment."
Ranking and Subordination....... The Capital Securities will rank PARI PASSU, and payments
thereon will be made pro rata, with the Common Securities,
except as described under "Description of Capital
Securities--Subordination of Common Securities." The
Junior Subordinated Debentures will rank PARI PASSU with
all other junior subordinated debentures, if any issued by
the Company (the "Other Debentures"), which are issued and
sold, if at all, to other trusts established by the
Company if any, in each case similar to the Trust ("Other
Trusts"), and will constitute unsecured obligations of the
Company and will rank subordinate and junior in right of
payment to all Senior Indebtedness (as defined herein) to
the extent and in the manner
</TABLE>
10
<PAGE>
<TABLE>
<S> <C>
set forth in the Indenture. The Guarantee will rank PARI
PASSU with all other guarantees, if any, issued by the
Company with respect to Capital Securities, if any, issued
by Other Trusts ("Other Guarantees") and will constitute
an unsecured obligation of the Company and will rank
subordinate and junior in right of payment to all Senior
Indebtedness to the extent and in the manner set forth in
the Guarantee, including the Bank's deposit liabilities.
See "Description of Guarantee." In addition, because the
Company is a holding company, the Junior Subordinated
Debentures and the Guarantee will be effectively
subordinated to all existing and future liabilities of the
Company's subsidiaries, including the Bank's deposit
liabilities. See "Description of Junior Subordinated
Debentures--Subordination."
Guarantee....................... Taken together, the Company's obligations under various
documents described herein, including the Guarantee
Agreement, provide a full guarantee of payments by the
Trust of Distributions and other amounts due on the
Capital Securities. Under the Guarantee Agreement, the
Company guarantees the payment of Distributions by the
Trust and payments on liquidation of or redemption of the
Capital Securities (subordinate to the right to payment of
Senior Indebtedness of the Company), in each case to the
extent of funds legally available and held by the Trust.
If the Trust has insufficient funds to pay Distributions
on the Capital Securities (i.e., if the Company has failed
to make required payments under the Junior Subordinated
Debentures), a holder of the Capital Securities would have
the right to institute a legal proceeding directly against
the Company to enforce payment of such Distributions to
such holder. See "Description of Junior Subordinated
Debentures--Enforcement of Certain Rights by Holders of
the Capital Securities," "--Debenture Events of Default"
and "Description of Guarantee."
Voting Rights................... The holders of the Capital Securities will generally have
limited voting rights relating only to the modification of
the Capital Securities, the dissolution, wind-up or
liquidation of the Trust and certain other matters
described herein. See "Description of Capital
Securities--Voting Rights; Amendment of the Trust
Agreement."
ERISA Considerations............ For a discussion of certain restrictions on purchases, see
"ERISA Considerations."
Use of Proceeds................. All of the proceeds from the sale of the Capital
Securities will be used by the Trust to purchase Junior
Subordinated Debentures. Proceeds from the sale of such
Junior Subordinated Debentures will be used (a) by the
Bank for general lending purposes and enhancements of
operational capabilities and (b) by the Company for
general corporate purposes, the enhancement of operational
capabilities and the potential purchase of loans.
Absence of Market for the
Capital Securities............ The Capital Securities will be a new issue of securities
for which
</TABLE>
11
<PAGE>
<TABLE>
<S> <C>
there is no market. Accordingly, there can be no assurance
as to the development or liquidity of any market for the
Capital Securities.
American Stock Exchange Symbol
for the Capital Securities.... The Capital Securities have been approved for listing on
the American Stock Exchange under the symbol "ATP".
Risk Factors.................... Prospective investors are urged to carefully review the
matters discussed under "Risk Factors."
</TABLE>
AVAILABLE INFORMATION
No separate financial statements of the Trust have been included herein. The
Company and the Trust do not consider that such financial statements would be
material to holders of the Trust Securities because the Trust is a newly-formed
special purpose entity, has no operating history or independent operations and
is not engaged in and does not propose to engage in any activity other than
holding as trust assets the Junior Subordinated Debentures and issuing the Trust
Securities.
12
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA
The following tables set forth summary consolidated historical financial
data for the Company during the periods ended and at the dates indicated. The
selected consolidated historical financial data gives effect to a four-to-one
stock split in the form of a stock dividend which will take place prior to the
date of the Offering. This information should be read in conjunction with the
Consolidated Financial Statements of the Company and Notes thereto presented
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AT AT
JUNE 30, DECEMBER 31,
----------- ----------------------------------------------------------
1998 1997 1996 1995 1994 1993
----------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
(UNAUDITED) (DOLLARS IN THOUSANDS)
FINANCIAL CONDITION DATA:
Loans receivable, net......................... $ 200,879 $ 184,358 $ 173,429 $ 142,380 $ 118,063 $ 90,139
FHLB of Chicago Stock, at cost................ 1,847 3,271 3,428 2,669 2,576 2,576
Securities.................................... 4,993 4,974 5,788 7,573 12,491 15,009
Cash and cash equivalents..................... 18,626 8,677 13,276 11,061 9,286 6,905
Mortgage loan servicing rights................ 6,349 6,706 5,264 4,033 3,641 2,508
Foreclosed real estate, net................... 4,179 4,251 3,913 2,234 359 554
Other assets.................................. 22,885 24,061 24,186 16,518 9,601 8,038
----------- ---------- ---------- ---------- ---------- ----------
Total assets.............................. $ 259,758 $ 236,298 $ 229,284 $ 186,468 $ 156,017 $ 125,729
----------- ---------- ---------- ---------- ---------- ----------
----------- ---------- ---------- ---------- ---------- ----------
Deposits...................................... $ 201,463 $ 172,469 $ 150,627 $ 123,484 $ 100,697 $ 88,220
Borrowed money................................ 28,388 34,156 50,879 38,181 30,820 9,064
Custodial escrow balances for loans
serviced.................................... 5,891 6,400 5,782 9,696 14,691 20,031
Other liabilities............................. 5,291 5,169 5,436 4,228 835 619
----------- ---------- ---------- ---------- ---------- ----------
Total liabilities......................... 241,033 218,194 212,724 175,589 147,043 117,934
Stockholders' equity.......................... 18,725 18,104 16,560 10,879 8,974 7,795
----------- ---------- ---------- ---------- ---------- ----------
Total liabilities and stockholders'
equity.................................. $ 259,758 $ 236,298 $ 229,284 $ 186,468 $ 156,017 $ 125,729
----------- ---------- ---------- ---------- ---------- ----------
----------- ---------- ---------- ---------- ---------- ----------
</TABLE>
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30, YEAR ENDED DECEMBER 31,
-------------------- -----------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
(UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
SELECTED OPERATING DATA:
Interest income............................... $ 8,561 $ 10,090 $ 18,266 $ 16,074 $ 13,987 $ 10,282 $ 9,477
Interest expense.............................. 5,651 5,824 11,286 9,083 8,341 5,012 3,822
--------- --------- --------- --------- --------- --------- ---------
Net interest income....................... 2,910 4,266 6,980 6,991 5,646 5,270 5,655
Provision for loan losses..................... 235 60 210 248 55 48 270
--------- --------- --------- --------- --------- --------- ---------
Net interest income after provision for
loan losses............................. 2,675 4,206 6,770 6,743 5,591 5,222 5,385
Non-interest income........................... 8,817 6,658 15,585 14,194 4,479 1,838 1,738
Non-interest expense.......................... 10,865 10,083 21,409 19,260 7,662 5,383 4,587
--------- --------- --------- --------- --------- --------- ---------
Income before income taxes and cumulative
effect of change in accounting
principle............................... 627 781 946 1,677 2,408 1,677 2,536
Income tax expense (benefit).................. (40) 157 123 343 667 281 952
--------- --------- --------- --------- --------- --------- ---------
Income before cumulative effect of change
in accounting principle (1)............. 667 624 823 1,334 1,741 1,396 1,584
Cumulative effect of change in accounting for
income taxes (1)............................ -- -- -- -- -- -- 460
--------- --------- --------- --------- --------- --------- ---------
Net income................................ $ 667 $ 624 $ 823 $ 1,334 $ 1,741 $ 1,396 $ 2,044
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Basic earnings per share........................ $ .34 $ .33 $ .43 $ 1.07 $ 1.47 $ 1.16 $ 1.70
Diluted earnings per share...................... $ .32 $ .31 $ .39 $ .90 $ 1.24 $ 1.02 $ 1.55
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
AT OR FOR THE SIX
MONTHS
ENDED JUNE 30, YEAR ENDED DECEMBER 31,
-------------------- ------------------------------------------
1998 1997 1997 1996 1995 1994
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
SELECTED FINANCIAL RATIOS AND OTHER DATA:(2)
Return on average assets.............................. .55% .52% .35% .68% 1.00% 1.00%
Return on average equity.............................. 7.21 7.06 4.62 10.89 17.09 16.17
Average equity to average assets...................... 7.69 7.29 7.53 6.26 5.85 6.14
Stockholders' equity to total assets.................. 7.21 7.92 7.66 7.22 5.83 5.75
Interest rate spread during period.................... 3.07 4.38 3.80 4.62 3.69 4.25
Net interest margin................................... 2.87 4.17 3.54 4.29 3.65 4.24
Non-interest expense to average assets................ 9.03 8.32 9.05 9.83 4.40 3.83
Non-interest expense (exclusive of On-Line) to average
assets.............................................. 3.98 3.97 4.28 4.99 3.61 --
Non-performing loans to net loans receivable (3)...... 2.78 3.81 3.57 3.12 1.54 1.93
Non-performing assets to total assets (4)............. 3.58 4.00 4.14 3.43 2.26 1.72
Allowance for loan losses to non-performing loans
(3)................................................. 17.19 15.10 14.73 16.87 29.54 26.38
Allowances for loan losses to net loans receivable
(3)................................................. .48 .47 .53 .53 .45 .52
Ratio of net charge-offs during the period to average
loans outstanding, excluding Discounted Loans....... .01 -- .01 .08 .03 --
Average interest-earning assets to average
interest-bearing liabilities........................ .96x .96x .95x .94x .99x 1.00x
Book value per share.................................. $ 9.41 $ 9.30 $ 9.25 $ 9.28 $ 8.82 $ 7.73
Full-service customer service branches................ 5 5 5 5 5 4
<CAPTION>
1993
---------
<S> <C>
SELECTED FINANCIAL RATIOS AND OTHER DATA:(2)
Return on average assets.............................. 1.59%
Return on average equity.............................. 27.88
Average equity to average assets...................... 5.71
Stockholders' equity to total assets.................. 6.20
Interest rate spread during period.................... 4.82
Net interest margin................................... 4.93
Non-interest expense to average assets................ 3.58
Non-interest expense (exclusive of On-Line) to average
assets.............................................. --
Non-performing loans to net loans receivable (3)...... 1.19
Non-performing assets to total assets (4)............. 1.31
Allowance for loan losses to non-performing loans
(3)................................................. 55.88
Allowances for loan losses to net loans receivable
(3)................................................. .68
Ratio of net charge-offs during the period to average
loans outstanding, excluding Discounted Loans....... .01
Average interest-earning assets to average
interest-bearing liabilities........................ 1.03x
Book value per share.................................. $ 6.85
Full-service customer service branches................ 3
</TABLE>
- ------------------------
(1) On January 1, 1993 the Company adopted Statement of Financial Accounting
Standard No. 109 "Accounting for Income Taxes," (Statement 109) on a
prospective basis which changed the Company's method of accounting for
income taxes from the deferred method required under APB No. 11 to the asset
and liability method. The cumulative effect of this change in accounting of
$460,000 was reported in the 1993 consolidated statement of operations.
(2) Average balances are derived from month end balances. Performance ratios at
and for the six months ended June 30, 1998 and 1997 are annualized, where
appropriate.
(3) The formula used to calculate the ratios excludes balances related to the
portfolio of Discounted Loans receivable from both the numerator and the
denominator.
(4) The formula used to calculate the ratios excludes from the numerator the
balances related to the portfolio of Discounted Loans receivable.
14
<PAGE>
RECENT DEVELOPMENTS
BRANCH SALE
On May 4, 1998, the Bank entered into an agreement to sell its Gurnee branch
to CIB Bank. The transaction consisted of the sale of $13.2 million in deposits
and also included furniture, fixtures, and equipment with a net book value of
$149,000. The sale closed on July 16, 1998, and resulted in a pre-tax gain of
approximately $995,000, which will be recorded by the Bank in the third quarter
of 1998.
GOODWILL CONVERTIBLE PREFERRED STOCK
On July 28, 1998, the Company declared a stock dividend of $0.005 Goodwill
Convertible Preferred Stock ("Goodwill Preferred Stock") to all holders of
common stock of the Company, par value $0.01 ("Common Stock") as of August 24,
1998 on a share for share basis. As a result, 592,681 shares of Goodwill
Preferred Stock were issued to holders of Common Stock on August 31, 1998. The
Goodwill Preferred Stock entitles the holders thereof to 75% of any settlement
damages awarded upon a final judgment to the Bank, net of expenses and certain
other items, as a result of the Bank's lawsuit against the United States seeking
damages for breach of contract related to the limitation and exclusion of
supervisory goodwill in the computation of the Bank's regulatory capital in
connection with the Company's acquisition of the Bank in November 1987
("Goodwill Litigation"). At the time of the final judgment and award of damages,
if any, the Goodwill Preferred Stock will either be (i) redeemed by the Company
for cash or (ii) become convertible into Common Stock. The Company will be
entitled to retain the remaining 25% of any damages awarded to the Bank, net of
expenses and certain other items, in the Goodwill Litigation. See "Description
of Capital Stock of the Company--Goodwill Convertible Preferred Stock."
BRANCH OPENING
On September 1, 1998, the Bank opened a new branch at Dearborn Station
located in the south Loop business district of downtown Chicago. The branch was
opened as a DE NOVO and currently includes 3 ATMs. The Bank entered into a
5-year lease on the Dearborn Station property which will expire in June 2003.
PURCHASED MORTGAGE SERVICING RIGHTS
At June 30, 1998, the Bank owned, directly and indirectly, $6.3 million in
Purchased Mortgage Servicing Rights ("PMSRs"). The Bank's principal investment
in PMSRs is through a $5.7 million equity investment in three limited
partnerships. The three limited partnerships were established for the sole
purpose of purchasing mortgage servicing rights. The Bank's ownership of PMSRs
carries interest rate risk because the total amount of servicing fees earned, as
well as the amortization of the investment in the servicing rights, fluctuates
based on loan prepayments (affecting the expected average life of a portfolio of
PMSRs). The rate of prepayment of mortgage loans may be influenced by changing
national and regional economic trends, prevailing mortgage rates and the housing
market in general. During periods of declining interest rates, as currently
exists, many borrowers refinance their mortgage loans. Accordingly, prepayments
of mortgage loans increase and the loan administration income related to the
mortgage loan servicing rights corresponding to a mortgage loan ceases as
underlying loans are prepaid. Consequently, the market value of PMSRs tends to
decrease during periods of declining interest rates, since greater prepayments
can be expected. The income derived from and the market value of the Bank's
PMSRs, therefore, may be adversely affected during periods of declining interest
rates. The Bank accounts for its investment in the three limited partnerships
using the equity method. Income or loss is recorded based upon information
received from Dovenmuehle Mortgage, Inc. ("DMI"), which is a Delaware
corporation engaged principally in mortgage servicing activities. DMI obtains
quarterly valuations from an independent appraiser for each limited partnership.
At June 30, 1998, the valuation of one of the Bank's three limited partnerships
had a market value lower than the current book value. The general partner
recorded a
15
<PAGE>
valuation allowance during the quarter. The Bank's proportionate share of the
valuation allowance of $392,000 was recorded by the Bank as part of their
partnership loss for the quarter.
There can be no assurances that such reserve is adequate or that additional
reserves will not be required in the future. Given the current interest rate
environment and prepayment activity within the industry, Bank management expects
the valuation allowance in this partnership to increase during the quarter ended
September 30, 1998. Although management is unable to determine the amount of any
such increase at this time, the amount will likely equal or exceed the valuation
allowance of $392,000 recorded in the quarter ended June 30, 1998. Furthermore,
valuation allowances may also be required for the Bank's investments in the
other two partnerships. Such additional valuation reserves could be material to
the results of operations during the third and fourth quarters of 1998 and in
future periods. See "Business of the Bank-Purchased Mortgage Servicing Rights."
16
<PAGE>
RISK FACTORS
THE FOLLOWING RISK FACTORS, IN ADDITION TO THOSE DISCUSSED ELSEWHERE IN THIS
PROSPECTUS, SHOULD BE CONSIDERED BY INVESTORS IN DECIDING WHETHER TO PURCHASE
THE SECURITIES OFFERED HEREBY.
PROSPECTIVE INVESTORS SHOULD CAREFULLY REVIEW THE INFORMATION CONTAINED
ELSEWHERE IN THIS PROSPECTUS AND SHOULD PARTICULARLY CONSIDER THE FOLLOWING
MATTERS. INFORMATION CONTAINED IN THIS PROSPECTUS CONTAINS "FORWARD-LOOKING
STATEMENTS" WHICH CAN BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY
SUCH AS "BELIEVES," "EXPECTS," "MAY," "WILL," "SHOULD," "PROJECTED,"
"CONTEMPLATES" OR "ANTICIPATES" OR THE NEGATIVE THEREOF OR OTHER VARIATIONS
THEREON OR COMPARABLE TERMINOLOGY. NO ASSURANCE CAN BE GIVEN THAT THE FUTURE
RESULTS COVERED BY THE FORWARD-LOOKING STATEMENTS WILL BE ACHIEVED. THE
FOLLOWING MATTERS CONSTITUTE CAUTIONARY STATEMENTS IDENTIFYING IMPORTANT FACTORS
WITH RESPECT TO SUCH FORWARD-LOOKING STATEMENTS, INCLUDING CERTAIN RISKS AND
UNCERTAINTIES, THAT COULD CAUSE ACTUAL RESULTS TO VARY MATERIALLY FROM THE
FUTURE RESULTS COVERED IN SUCH FORWARD-LOOKING STATEMENTS. OTHER FACTORS, SUCH
AS THE GENERAL STATE OF THE ECONOMY, COULD ALSO CAUSE ACTUAL RESULTS TO VARY
MATERIALLY FROM THE FUTURE RESULTS COVERED IN SUCH FORWARD-LOOKING STATEMENTS.
RISKS RELATED TO THE CAPITAL SECURITIES
RANKING OF SUBORDINATED OBLIGATIONS UNDER THE GUARANTEE AND THE JUNIOR
SUBORDINATED DEBENTURES; LIMITATIONS ON SOURCES OF FUNDS. The obligations of
the Company under the Guarantee issued by it for the benefit of the holders of
Capital Securities, as well as under the Junior Subordinated Debentures will be
unsecured and will rank subordinate and junior in right of payment to all Senior
Indebtedness to the extent and in the manner set forth in the Guarantee and the
Indenture, respectively. No payment may be made of the principal or premium, if
any, or interest on the Junior Subordinated Debentures, or in respect of any
redemption, retirement, purchase or other acquisition of any of the Junior
Subordinated Debentures, at any time when (i) there shall have occurred and be
continuing a default in any payment in respect of any Senior Indebtedness, or
there has been an acceleration of the maturity thereof because of a default, or
(ii) in the event of the acceleration of the maturity of the Junior Subordinated
Debentures, until payment has been made on all Senior Indebtedness. Because the
Company is a holding company, the right of the Company to participate in any
distribution of assets of any subsidiary upon such subsidiary's liquidation or
reorganization or otherwise (and thus the ability of holders of the Capital
Securities to benefit indirectly from such distribution) is subject to the prior
claims of creditors of that subsidiary (including depositors, in the case of the
Bank), except to the extent that the Company may itself be recognized as a
creditor of that subsidiary. At June 30, 1998, the subsidiaries of the Company
had total liabilities (excluding liabilities owed to the Company) of $234.8
million. Accordingly, the Junior Subordinated Debentures effectively will be
subordinated to all existing and future liabilities of the Company's
subsidiaries (including the Bank's deposit liabilities, which aggregated $201.7
million at June 30, 1998) and holders of Junior Subordinated Debentures should
look only to the assets of the Company for payments on the Junior Subordinated
Debentures. The Guarantee will constitute an unsecured obligation of the Company
and will rank subordinate and junior in right of payment to all Senior
Indebtedness in the same manner as the Junior Subordinated Debentures. None of
the Indenture, the Guarantee or the Trust Agreement places any limitation on the
amount of secured or unsecured debt, including Senior Indebtedness, that may be
incurred by the Company or any of its subsidiaries. See "Description of
Guarantee-- Status of the Guarantee" and "Description of Junior Subordinated
Debentures--General" and "--Subordination."
The ability of the Trust to pay amounts due on the Capital Securities is
solely dependent upon the Company making payments on the Junior Subordinated
Debentures as and when required.
The Company is a holding company and almost all of the operating assets of
the Company are owned by the Company's subsidiaries. There are regulatory
limitations on the payment of dividends directly or indirectly to the Company
from the Bank. As of June 30, 1998, under regulations of the OTS, the total
capital available for payment of dividends by the Bank to the Company was
approximately $2.7 million. In addition to restrictions on the payment of
dividends, the Bank is subject to certain restrictions imposed by
17
<PAGE>
federal law on any extensions of credit to, and certain other transactions with,
the Company and certain other affiliates, and on investments in stock or other
securities thereof. Such restrictions prevent the Company and such other
affiliates from borrowing from the Bank unless the loans are secured by various
types of collateral. Further, such secured loans, other transactions and
investments by the Bank are generally limited in amount as to the Company and as
to each of such other affiliates to 10% of the Bank's capital and surplus and as
to the Company and all of such other affiliates to an aggregate of 20% of the
Bank's capital and surplus.
OPTION TO EXTEND INTEREST PAYMENT PERIOD. So long as no Debenture Event of
Default (as defined herein) shall have occurred and be continuing, the Company
will have the right under the Indenture to defer payments of interest on the
Junior Subordinated Debentures at any time or from time to time for a period not
exceeding twenty (20) consecutive quarterly periods with respect to each
Extension Period, provided that no Extension Period shall end on a date other
than an Interest Payment Date or extend beyond the Stated Maturity Date. As a
consequence of any such deferral, quarterly Distributions on the Trust
Securities by the Trust will be deferred (and the amount of Distributions to
which holders of the Trust Securities are entitled will accumulate additional
Distributions thereon at the rate of 11.0% per annum, compounded quarterly, but
not exceeding the interest rate then accruing on the Junior Subordinated
Debentures) from the relevant payment date for such Distributions during any
such Extension Period. During the pendency of any Extension Period, the Company
generally will be prohibited from declaring or paying dividends on the Company's
capital stock, including the Common Stock. See "Description of Capital
Securities--Distributions."
Prior to the termination of any such Extension Period, the Company may
further extend such Extension Period, provided that such extension does not
cause such Extension Period to exceed twenty (20) consecutive quarterly periods,
end on a date other than an Interest Payment Date or to extend beyond the Stated
Maturity Date. Upon the termination of any Extension Period and the payment of
all interest then accrued and unpaid on the Junior Subordinated Debentures
(together with interest thereon at the annual rate of 11.0%, compounded
quarterly, to the extent permitted by applicable law), the Company may elect to
begin a new Extension Period, subject to the above requirements. There is no
limitation on the number of times that the Company may elect to begin an
Extension Period. See "Description of Capital Securities--Distributions" and
"Description of Junior Subordinated Debentures--Option to Extend Interest
Payment Date."
TAX CONSEQUENCES. The Company has no current plan to exercise its right to
defer payments of interest on the Junior Subordinated Debentures. However,
should the Company exercise its right to defer payments of interest on the
Junior Subordinated Debentures, each holder of Trust Securities will be required
to accrue income (as original issue discount ("OID")) in respect of the deferred
stated interest allocable to its Trust Securities for United States federal
income tax purposes, which will be allocated but not distributed to holders of
Trust Securities. As a result, each holder of Capital Securities will recognize
income for United States federal income tax purposes in advance of the receipt
of cash and will not receive the cash related to such income from the Trust if
the holder disposes of the Capital Securities prior to the record date for the
payment of Distributions thereafter. See "Certain Federal Income Tax
Consequences with Respect to the Issuance of the Capital Securities--Interest
Income and Original Issue Discount" and "--Sales of Capital Securities."
MARKET PRICE CONSEQUENCES. Should the Company elect to exercise its right
to defer payments of interest on the Junior Subordinated Debentures in the
future, the market price of the Capital Securities is likely to be affected. A
holder that disposes of its Capital Securities during an Extension Period,
therefore, might not receive the same return on its investment as a holder that
continues to hold its Capital Securities. In addition, the Company's right to
defer payments of interest on the Junior Subordinated Debentures may cause the
market price of the Capital Securities to be more volatile than the market
prices of other securities on which OID accrues and that are not subject to such
deferrals.
18
<PAGE>
SPECIAL EVENT REDEMPTION. Upon the occurrence and continuation of a Special
Event, including a Tax Event or a Regulatory Capital Event (in each case as
defined under "Description of Junior Subordinated Debentures--Special Event
Prepayment" and when referred to together (the "Special Event")), prior to the
Initial Optional Prepayment Date, the Company will have the right to prepay the
Junior Subordinated Debentures in whole (but not in part) at the Special Event
Prepayment Price within 90 days following the occurrence of such Special Event
and therefore cause a mandatory redemption of the Trust Securities at the
Special Event Redemption Price. The exercise of such right is subject to the
Company having received any required regulatory approval. See "Description of
Capital Securities--Redemption."
LIQUIDATION DISTRIBUTION OF JUNIOR SUBORDINATED DEBENTURES. The Company
will have the right at any time to terminate the Trust and, after satisfaction
of liabilities to creditors of the Trust as required by applicable law, to cause
the Junior Subordinated Debentures to be distributed to the holders of the Trust
Securities in liquidation of the Trust. The exercise of such right is subject
to: (i) the Company having received an opinion of counsel to the effect that
such distribution will not be a taxable event to the holders of Capital
Securities; and (ii) receipt of any required regulatory approval. Under current
United States federal income tax law, a distribution of Junior Subordinated
Debentures upon the dissolution of the Trust would not be a taxable event to
holders of the Capital Securities. Upon the occurrence of a Special Event, a
dissolution of the Trust in which holders of the Capital Securities receive cash
would be a taxable event to such holders. See "Certain Federal Income Tax
Consequences with Respect to the Issuance of the Capital Securities--Receipt of
Junior Subordinated Debentures or Cash Upon Liquidation of the Trust."
Under current United States federal income tax law and interpretations, and
assuming that the Trust is classified as a grantor trust for such purposes, a
distribution of the Junior Subordinated Debentures upon a liquidation of the
Trust should not be a taxable event to holders of the Capital Securities.
However, if a Special Event were to occur which would cause the Trust to be
subject to United States federal income tax with respect to income received or
accrued on the Junior Subordinated Debentures, a distribution of the Junior
Subordinated Debentures by the Trust could be a taxable event to the Trust and
the holders of the Capital Securities. See "Certain Federal Income Tax
Consequences with Respect to the Issuance of the Capital Securities--Receipt of
Junior Subordinated Debentures or Cash Upon Liquidation of the Trust."
SHORTENING OF STATED MATURITY OF JUNIOR SUBORDINATED DEBENTURES. The
Company will have the right at any time to shorten the maturity of the Junior
Subordinated Debentures to a date not earlier than November 6, 2003, and thereby
cause the Capital Securities to be redeemed on such earlier date. The exercise
of such right is subject to the Company having received prior regulatory
approval if then required under applicable capital guidelines or policies. See
"Description of Junior Subordinated Debentures-- Redemption."
UNDER THE GUARANTEE. The Guarantee will provide assurances to the holders
of the Capital Securities for the following payments, to the extent not paid by
or on behalf of the Trust: (i) any accumulated and unpaid Distributions required
to be paid on the Capital Securities, to the extent that the Trust has funds
legally available therefore at such time, (ii) the applicable Redemption Price
with respect to the Capital Securities called for redemption, to the extent that
the Trust has funds legally available therefore at any such time, and (iii) upon
a voluntary or involuntary dissolution, winding-up or liquidation of the Trust
(unless the Junior Subordinated Debentures are distributed to holders of the
Capital Securities), the lesser of (a) the aggregate of the Liquidation Amount
and all accumulated and unpaid Distributions to the date of payment, to the
extent that the Trust has funds on hand available therefore at such time and (b)
the amount of assets of the Trust remaining available for distribution to
holders of the Capital Securities after satisfaction of liabilities to creditors
of the Trust as required by applicable law.
The holders of not less than a majority in aggregate Liquidation Amount of
the Capital Securities will have the right to direct the time, method and place
of conducting any proceeding for any remedy available to the Guarantee Trustee
in respect of the Guarantee or to direct the exercise of any trust power
conferred
19
<PAGE>
upon the Guarantee Trustee under the Guarantee. Any holder of the Capital
Securities may institute a legal proceeding directly against the Company to
enforce its rights under the Guarantee without first instituting a legal
proceeding against the Trust, the Guarantee Trustee or any other person or
entity. If the Company were to default on its obligation to remit amounts
payable under the Junior Subordinated Debentures, the Trust would not have
sufficient funds for the payment of Distributions or amounts payable on
redemption of the Capital Securities or otherwise, and, in such event, holders
of the Capital Securities would not be able to rely upon the Guarantee for
payment of such amounts. Instead, in the event a Debenture Event of Default
shall have occurred and be continuing and such event is attributable to the
failure of the Company to pay principal (or premium, if any) or interest
(including Additional Sums (as defined below) and Compounded Interest (as
defined below), if any) on the Junior Subordinated Debentures on the payment
date on which such payment is due and payable, then a holder of Capital
Securities may institute a legal proceeding directly against the Company for
enforcement of payment to such holder of the principal (or premium, if any) or
interest (including Additional Sums and Compounded Interest, if any) on such
Junior Subordinated Debentures having a principal amount equal to the aggregate
Liquidation Amount of the Capital Securities of such holder (a "Direct Action").
Notwithstanding any payments made to a holder of Capital Securities by the
Company in connection with a Direct Action, the Company shall remain obligated
to pay the principal (and premium, if any) and interest (including Additional
Sums and Compounded Interest, if any) on the Junior Subordinated Debentures, and
the Company shall be subrogated to the rights of the holder of such Capital
Securities with respect to payments on the Capital Securities to the extent of
any payments made by the Company to such holder in any Direct Action. Except as
described herein, holders of Capital Securities will not be able to exercise
directly any other remedy available to the holders of the Junior Subordinated
Debentures or to assert directly any other rights in respect of the Junior
Subordinated Debentures. See "Description of Junior Subordinated
Debentures--Enforcement of Certain Rights by Holders of Capital Securities,"
"--Debenture Events of Default" and "Description of Guarantee." The Trust
Agreement will provide that each holder of Capital Securities by acceptance
thereof agrees to the provisions of the Indenture. Wilmington Trust Company will
act as Guarantee Trustee and will hold the Guarantee for the benefit of the
holders of the Capital Securities. Wilmington Trust Company will also act as
Property Trustee and as Debenture Trustee under the Indenture. Wilmington Trust
Company will act as Delaware Trustee under the Trust Agreement.
LIMITED VOTING RIGHTS. Holders of Capital Securities will generally have
limited voting rights relating only to the modification of the Capital
Securities, the dissolution, winding-up or liquidation of the Trust, and the
exercise of the Trust's rights as holder of Junior Subordinated Debentures.
Holders of Capital Securities will not be entitled to vote to appoint, remove or
replace the Property Trustee or the Delaware Trustee, and such voting rights are
vested exclusively in the holder of the Common Securities except upon the
occurrence of certain events described herein. In no event will the holders of
the Capital Securities have the right to vote to appoint, remove or replace the
Administrative Trustees; such voting rights are vested exclusively in the holder
of the Common Securities. The Property Trustee, the Administrative Trustees and
the Company may amend the Trust Agreement without the consent of holders of
Capital Securities to ensure that the Trust will be classified for United States
federal income tax purposes as a grantor trust, even if such action adversely
affects the interests of such holders. See "Description of Capital
Securities-Voting Rights; Amendment of the Trust Agreement" and "--Removal of
Issuer Trustees."
TRADING CHARACTERISTICS OF THE CAPITAL SECURITIES. The Capital Securities
may trade at a price that does not fully reflect the value of accrued but unpaid
interest with respect to the underlying Junior Subordinated Debentures. A holder
who uses the accrual method of accounting for tax purposes (and a cash method
holder, if the Junior Subordinated Debentures are deemed to have been issued
with OID) and who disposes of its Capital Securities between record dates for
payments of distributions thereon will be required to include accrued but unpaid
interest on the Junior Subordinated Debentures through the date of disposition
in income as ordinary income (i.e., interest or, possible, OID), and to add such
amount to its adjusted tax basis in its share of the underlying Junior
Subordinated Debentures deemed disposed of. To
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the extent the selling price is less than the holder's adjusted tax basis (which
will include all accrued but unpaid interest), a holder will recognize a capital
loss. Subject to certain limited exceptions, capital losses cannot be applied to
offset ordinary income for United States federal income tax purposes. See
"Certain Federal Income Tax Consequences with Respect to the Issuance of the
Capital Securities--Interest Income and Original Issue Discount" and "--Sales of
Capital Securities."
MARKET PRICE OF CAPITAL SECURITIES. There can be no assurance as to the
market prices for the Capital Securities or Junior Subordinated Debentures that
may be distributed in exchange for Capital Securities if a liquidation of the
Trust occurs. Accordingly, the Capital Securities that a purchaser may purchase,
whether pursuant to this Offering or in the secondary market, or the Junior
Subordinated Debentures that a holder of the Capital Securities may receive on
liquidation of the Trust, may trade at a discount to the price that the
purchaser paid to purchase the Capital Securities offered hereby.
Future trading prices of the Capital Securities will depend on many factors
including, among other things, prevailing interest rates, the operating results
and financial condition of the Company, and the market for similar securities.
As a result of the existence of the Company's right to defer interest payments
on or, subject to any prior regulatory approval then required under applicable
capital guidelines or policies, shorten the Stated Maturity Date of the Junior
Subordinated Debentures, the market price of the Capital Securities may be more
volatile than the market prices of debt securities that are not subject to such
optional deferrals or reduction in maturity. There can be no assurance as to the
market prices for the Capital Securities, or the Junior Subordinated Debentures
that may be distributed in exchange for the Capital Securities, if the Company
exercises its right to terminate the Trust. Accordingly, the Capital Securities
that an investor may purchase, or the Junior Subordinated Debentures that a
holder of the Capital Securities may receive in liquidation of the Trust, may
trade at a discount from the price that the investor paid to purchase the
Capital Securities offered hereby.
ABSENCE OF PUBLIC MARKET AND RATINGS. The Capital Securities have not been
rated by any rating agency. In addition, there is no existing market for the
Capital Securities. Consequently, there can be no assurance as to the liquidity
of any markets that may develop for the Capital Securities, the ability of the
holders to sell their Capital Securities or at what price holders of the Capital
Securities will be able to sell their Capital Securities, as the case may be.
Future trading prices of the Capital Securities will depend on many factors
including, among other things, prevailing interest rates, the Company's
operating results, and the market for similar securities. Although the Capital
Securities have been approved for listing on the American Stock Exchange, there
can be no assurance that an active trading market for the Capital Securities
will develop or, if one does develop, that it will be maintained.
POTENTIAL IMPACT OF CHANGES IN INTEREST RATES
Like most banks, the Bank realizes income primarily from the spread between
interest earned on loans and investments and the interest paid on deposits and
borrowings. It is expected that the Bank, from time to time, will experience
"gaps" in the interest rate sensitivities of its assets and liabilities, meaning
that either its interest-bearing liabilities will be more sensitive to changes
in market interest rates than its interest-earning assets, or vice versa. In
either event, if market interest rates should move contrary to the Bank's
position, the "gap" will adversely affect the Bank's earnings and the Net
Present Value ("NPV") of the Bank's interest sensitive assets and liabilities.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Management of Interest Rate Risk."
NO ASSURANCE AS TO THE ADEQUACY OF ALLOWANCES FOR LOAN LOSSES AND REO
At June 30, 1998, the Company's allowance for loan losses amounted to
$880,000 or 17.19% of total non-performing loans (excluding Discounted Loans)
and .48% of net loans receivable (excluding Discounted Loans). The Company's
allowance for loan losses is maintained at a level considered adequate by
management to absorb inherent losses in its loan portfolio. The amount of
inherent loan losses which could be ultimately realized is susceptible to
changes in economic, operating, and other conditions,
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including changes in interest rates, that could be beyond the Company's control.
Such losses could exceed current estimates. In addition, the Company maintains a
separate allowance for losses on REO which amounted to $272,000 or 6.51% of REO
at June 30, 1998. Although management believes that the Company's allowances are
adequate, there can be no assurance that the allowances will prove sufficient to
cover actual losses should such losses be realized or that the Company will not
have to increase its allowances in the future.
NON-PERFORMING ASSETS
As of June 30, 1998, total non-performing assets (excluding Discounted
Loans) were $9.3 million or 3.58% of total assets as of that date. As of June
30, 1998, the Company had $5.1 million of loans and $4.2 million of REO
classified as Substandard or Doubtful.
The level of non-performing assets (excluding Discounted Loans) may remain
high in the future and the levels of nonaccrual loans and REO may fluctuate from
period to period as problem loans are worked out and/or properties are taken
into REO. Further, depending on real estate values, the overall economy and
other circumstances, the resolution of problem loans and liquidation of REO may
be more costly than presently anticipated, and may require the Company to
increase its allowances and incur additional REO-related expenses.
The Company believes that its policies and procedures related to its
monitoring and resolution of problem assets are adequate. In this regard, the
Company monitors its problem assets, and based on information known to
management at such time, establishes allowances against foreseeable losses
related to such assets. While the Company believes it has established adequate
reserves against such loans or written down the value of the properties in REO
to reflect the current estimated fair values of such properties, no assurances
can be provided that the properties in REO will not further decrease in value or
can be sold for their estimated fair values.
RISKS ASSOCIATED WITH MORTGAGE ORIGINATION, PURCHASE AND SALE ACTIVITIES
The Bank is actively involved in the origination, purchase and sale of real
estate secured loans. Generally, the profitability of such mortgage banking
operations depends on maintaining a sufficient volume of loans for sale and the
availability of loan purchasers. Changes in the level of interest rates and
economic factors may affect the amount of loans originated or available for
purchase by the Bank, and thus the availability of net gains from mortgage
banking operations. Changes in the purchasing policies of loan purchasers or
increases in defaults after funding could substantially reduce the amount of
loans sold to such loan purchasers. Any such changes could have a material
adverse effect on the Bank's results of operations and financial condition.
Therefore, between the time the Bank originates loans and purchase commitments
are issued, the Bank is exposed to downward movements in the market price of
such loans due to upward movements in interest rates or default by the borrower.
Management believes that this risk is mitigated to a certain extent as ARM loans
are generally originated for the portfolio while fixed-rate loans, excluding
Expanded Criteria Loans, are generally originated after receipt of a firm
commitment from a buyer to acquire such loans from the Bank. Fixed-rate Expanded
Criteria Loans are generally retained for portfolio due to their higher yielding
interest rates. See "Business of the Bank--Lending Activities--Loan Originations
and Purchases."
In addition to its lending activity in Illinois, the Bank has originated or
purchased a number of one- to four-family residential mortgage loans on a
nationwide basis through its network of Correspondents. At June 30, 1998, $123.5
million, or 70.3%, of the Bank's one- to four-family loan portfolio was secured
by property located outside of Illinois. Management believes that originating
and purchasing loans secured by properties located across the country results in
a geographically diversified lending operation which reduces certain risks
associated with loan concentrations in a single area. However, there are certain
other risks involved in nationwide lending. The Bank may not have the same depth
of experience or knowledge about particular markets in which it lends as other
lenders with staff physically located in such market areas. Additionally, the
Bank has historically experienced a greater level of non-performing loans with
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respect to loans purchased rather than originated through its Correspondents.
Some of the properties may be located in states which are experiencing adverse
economic conditions, including a general softening in real estate markets and
the local economies, which may result in increased loan delinquencies and loan
losses. Further, regulations and practices regarding the liquidation of
properties (e.g., foreclosure) and the rights of mortgagors in default vary
greatly from state to state, and these restrictions may impact the Bank's
ability to foreclose on a property or seek other recovery. See "Business of the
Bank--Lending Activities--Use and Qualifications of Correspondents."
RISKS ASSOCIATED WITH PORTFOLIO AND EXPANDED CRITERIA LENDING
The Bank actively originates Portfolio and Expanded Criteria Loans on one-
to four-family residential properties. These loans are originated, in many
instances, when the borrower's credit profile, or some aspect of the loan, does
not meet Agency criteria. Since the Bank retains in its portfolio a portion of
these Portfolio and Expanded Criteria Loans that it originates, such loans may
expose the Bank to additional risk of default by the borrower because the Bank
cannot as readily transfer the credit risk to a third party by sale of the loan.
To offset the possible additional risks of Portfolio and Expanded Criteria
Loans, the Bank may require a lower loan-to-value ratio, a co-signer, mortgage
insurance and/or other compensating factors. However, these loans provide the
Bank with higher yields and prepayment penalty fees. See "Business of the
Bank--Lending Activities -- Loan Approval and Underwriting."
COMPETITION
As a purchaser and originator of mortgage loans, the Bank faces intense
competition, primarily from mortgage banking companies, commercial banks, credit
unions, thrift institutions, credit card issuers and finance companies. Many of
these competitors in the financial services business are substantially larger
and have more capital and other resources than the Bank. Certain large national
finance companies and conforming mortgage originators have announced their
intention to revise their conforming origination programs and allocate resources
to the origination of loans similar to the Bank's Expanded Criteria Loans.
Certain of these larger mortgage companies and commercial banks have begun to
offer products similar to those offered by the Bank, targeting customers similar
to those of the Bank. In addition, it is anticipated that the participation of
government-sponsored entities with substantial capital resources in the
origination of loans similar to the Bank's Portfolio and Expanded Criteria Loans
will further intensify competition. FreddieMac recently announced its intention
to support such originations by purchasing, guaranteeing and securitizing loans
similar to the Bank's Portfolio and Expanded Criteria Loans originated by
qualified institutions. Other government-sponsored entities, such as the
FannieMae or Ginnie Mae may also enter into the market for loans similar to the
Bank's Portfolio and Expanded Criteria Loans. The offering by these competitors,
some of which are anticipated to receive support from government-sponsored
entities, of products similar to those of the Bank's, could have a material
adverse effect on the Bank's results of operations and financial condition. The
Bank depends largely on Correspondents with whom the Bank's competitors also
seek to establish relationships. The Bank's future results may become
increasingly sensitive to fluctuations in the volume and cost of its wholesale
loan purchases resulting from competition from other purchasers for such loans.
In addition, as the Bank expands into new geographic markets, it will face
competition from lenders with established positions in these locations. There
can be no assurance that the Bank will be able to continue to compete
successfully in the markets it serves.
AVAILABILITY OF FUNDING SOURCES
The Bank funds substantially all of the loans which it originates and
purchases through deposits, internally generated funds or Federal Home Loan Bank
("FHLB") advances. The Bank competes for deposits primarily on the basis of
rates, and as a consequence the Bank could experience difficulties in attracting
deposits to fund its operations if it does not continue to offer deposit rates
at levels that are competitive with other financial institutions. Certificate of
deposit accounts constituted $154.6 million, or 76.8% of total deposits at June
30, 1998, of which $71.0 million mature or reprice in one-year or less.
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Increases in short-term certificate accounts, which tend to be more sensitive to
movements in market interest rates than core deposits, may result in the Bank's
deposit base being less stable than if it had a large amount of core deposits
which, in turn, may result in increases in the Bank's cost of funds. The Bank
also uses the cash proceeds generated by the Bank in selling loans in the
secondary market to fund subsequent originations and purchases. On an ongoing
basis, the Company explores opportunities to access credit lines as an
additional source of funds. To the extent the Company is not able to maintain
its currently available funding sources or to access new funding sources, it may
have to curtail its loan investment activities. Any such event would have a
material adverse effect on the Bank's results of operations and financial
condition. See "Business of the Bank--Sources of Funds and Borrowings."
CONTINGENT RISKS
Substantially all of the mortgage loans sold by the Bank are sold without
recourse. In connection with its loan sales, the Bank enters agreements which
generally require the Bank to repurchase or substitute loans in the event of a
breach of a representation or warranty made by the Bank to the loan purchaser,
any misrepresentation during the mortgage loan origination process or, in some
cases, upon any fraud or early default on such mortgage loans. The remedies
available to a loan purchaser from the Bank are generally broader than those
available to the Bank against the sellers of such loans, and if a loan purchaser
enforces its remedies against the Bank, the Bank may not be able to enforce
whatever remedies the Bank may have against such sellers. If the loans were
originated directly by the Bank, the Bank would be solely responsible for any
breaches of representations or warranties. For loans originated through its
network of Correspondents, the Bank utilizes contract underwriters who provide
the Company with certain representations and warranties that such loans meet the
Bank's underwriting guidelines. For loans retained by the Bank in its portfolio,
credit risk may be incurred with respect to Expanded Criteria Loans in which the
borrower may have an impaired credit profile. The rates of delinquencies,
foreclosures and losses on Expanded Criteria Loans could be higher under adverse
economic conditions than on Agency Qualified loans. In addition, during the
period of time that the loans are held for sale, the Bank is subject to various
business risks associated with the lending business, including borrower default,
foreclosure and the risk that a rapid increase in interest rates would result in
a decline of the value of loans held for sale to potential purchasers. See
"Business of the Bank--Lending Activities--Loan Approval and Underwriting."
RISKS RELATING TO GOODWILL LITIGATION
From the commencement of the Goodwill Litigation to June 30, 1998, the
Company has incurred legal, accounting, consulting and other fees of $210,000.
To the extent the Company continues to engage in such litigation, the Company
will continue to incur legal, accounting, consulting and other expenses in the
future. There can be no assurances as to whether the legal, accounting,
consulting and other fees and expenses related to the Goodwill Litigation may
become substantial. There can also be no assurance as to whether there will be a
recovery in the Goodwill Litigation or whether the recovery will be sufficient
to offset the fees and expenses for which the Company will be liable. The
dilutive effect of this transaction cannot be determined until the final outcome
of the litigation.
RISKS ASSOCIATED WITH PURCHASED MORTGAGE SERVICING RIGHTS
At June 30, 1998, the Bank owned, directly and indirectly, $6.3 million in
PMSRs. The Bank's principal investment in PMSRs is through a $5.7 million equity
investment in three limited partnerships. The Bank's ownership of PMSRs carries
interest rate risk because the total amount of servicing fees earned, as well as
the amortization of the investment in the servicing rights, fluctuates based on
loan prepayments (affecting the expected average life of a portfolio of PMSRs).
The rate of prepayment of mortgage loans may be influenced by changing national
and regional economic trends, prevailing mortgage rates and the housing market
in general. During periods of declining interest rates, as currently exists,
many borrowers refinance their mortgage loans. Accordingly, prepayments of
mortgage loans increase and
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the loan administration income related to the mortgage loan servicing rights
corresponding to a mortgage loan ceases as underlying loans are prepaid.
Consequently, the market value of PMSRs tends to decrease during periods of
declining interest rates, since greater prepayments can be expected. The income
derived from and the market value of the Bank's PMSRs, therefore, may be
adversely affected during periods of declining interest rates. The Bank accounts
for its investment in the three limited partnerships using the equity method.
Income or loss is recorded based upon information received from DMI. DMI obtains
quarterly valuations from an independent appraiser for each limited partnership.
At June 30, 1998, the valuation of one of the Bank's three limited partnerships
had a market value lower than the current book value. The general partner
recorded a valuation allowance during the quarter. The Bank's proportionate
share of the valuation allowance of $392,000 was recorded by the Bank as part of
their partnership loss for the quarter.
There can be no assurances that such reserve is adequate or that additional
reserves will not be required in the future. Given the current interest rate
environment and prepayment activity within the industry, Bank management expects
the valuation allowance in this partnership to increase during the quarter ended
September 30, 1998. Although management is unable to determine the amount of any
such increase at this time, the amount will likely equal or exceed the valuation
allowance of $392,000 recorded in the quarter ended June 30, 1998. Furthermore,
valuation allowances may also be required for the Bank's investments in the
other two partnerships. Such additional valuation reserves could be material to
the results of operations during the third and fourth quarters of 1998 and in
future periods.
DEPENDENCE ON KEY PERSONNEL
The Company depends to a considerable degree on the contributions of a
limited number of key management personnel who have had, and will continue to
have, a significant role in the development and management of the Company. The
continued development of the Company's business strategy depends to a large
extent upon the continued employment of Mr. John Yedinak, President and Chief
Executive Officer of both the Company and the Bank. Additionally, the Company
maintains lines of credit with various lending institutions, some of which are
personally guaranteed by Mr. Yedinak. Mr. Yedinak receives no additional
compensation for his guarantee. Should Mr. Yedinak no longer be employed by the
Company, there is no assurance such lines of credit would continue to be
available. However, it is anticipated that following the Offering such lines of
credit will no longer require a personal guarantee. The Company and Bank have
entered into renewable employment agreements, providing for five and three year
terms, respectively, with Mr. Yedinak, effective November 1, 1996. The Company
and the Bank also maintain a total of $2.5 million in key-man life insurance
policies with respect to Mr. Yedinak. See "The Board of Directors and Management
of the Bank--Executive Compensation--Employment Agreements."
SHARES AVAILABLE FOR FUTURE SALE
The Company, the Trust, and the Company's directors and executive officers
have agreed that, for a period of 90 days from the closing of the Offering, such
person or entity will not offer for sale, sell or grant any options, rights or
warrants with respect to any capital securities of the Company or the Trust,
securities convertible into Common Stock or any other capital stock or other
security of the Company or the Trust, or otherwise dispose of, directly or
indirectly, any securities of the Company or the Trust, other securities or
capital stock of the Company or the Trust, without the prior consent of the
underwriter. See "Underwriting."
CERTAIN ANTI-TAKEOVER PROVISIONS
PROVISIONS IN THE COMPANY'S GOVERNING INSTRUMENTS. Certain provisions of
the Company's Certificate of Incorporation and Bylaws as well as certain federal
regulations, assist the Company in maintaining its status as an independent
publicly owned corporation. These provisions provide for, among other things,
supermajority voting on certain matters, staggered elections of the boards of
directors, non-cumulative voting for directors, and limits on the calling of
special meetings. These provisions in the Company's
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governing instruments may discourage potential proxy contests and other
potential takeover attempts, particularly those which have not been negotiated
with the Board of Directors, and thus, generally may serve to perpetuate current
management. See "Restrictions on Acquisition of the Company."
VOTING CONTROL OF OFFICERS AND DIRECTORS. Directors and executive officers
of the Company and Bank own approximately 84.5% of the shares of common stock at
June 30, 1998. An additional 349,584 shares may be attributable to directors and
officers of the Company and Bank through the exercise of options to purchase
shares of Common Stock held by such directors and officers pursuant to the
Company's stock option plans at June 30, 1998. Accordingly, management's voting
control will continue to have a significant influence over the affairs of the
Company and the Bank. Such concentration of ownership may have the effect of
delaying, deferring or preventing takeover attempts that certain stockholders
deem to be in their best interest and may tend to perpetuate existing
management. Additionally, pursuant to a stockholder agreement (the "Stockholder
Agreement") with Deltec, a banking corporation organized under the laws of the
Commonwealth of the Bahamas, for so long as Deltec, holds at least 15% of the
Company's Common Stock, Deltec has the right to nominate one director to the
Company's Board of Directors. Additionally, Mr. Yedinak has agreed that during
this time period he will vote all shares of the Company's Common Stock owned by
him for the nominee designated by Deltec. See "Restrictions on Acquisition of
the Company and the Bank--Restrictions in the Company's Certificate of
Incorporation and Bylaws," "The Board of Directors and Management of the
Bank--Stock Option Plans" and "Stockholder Agreement."
FINANCIAL INSTITUTION REGULATION AND POSSIBLE LEGISLATION
The Company, as a savings association holding company, and the Bank, as a
federal savings bank, are subject to extensive federal law, regulations and
supervision. Such law and regulations, which affect the Bank on a daily basis,
may be changed at any time, and the interpretation of the relevant law and
regulations is also subject to change by the federal regulatory authorities. Any
change in the regulatory structure or the applicable statutes or regulations,
whether by the OTS, the Federal Deposit Insurance Corporation ("FDIC") or the
Congress, could have a material impact on the Company, the Bank and their
respective operations. See "Regulation."
RECHARTERING LEGISLATION. The Deposit Insurance Funds Act of 1996 ("the
Funds Act"), enacted in September 1996, provides that the Bank Insurance Fund
("BIF"), the fund which insures most commercial bank deposits, and the Savings
Association Insurance Fund ("SAIF") will merge on January 1, 1999, if there are
no savings associations, as defined, in existence on that date. Pursuant to that
legislation, the Department of Treasury in May 1997 recommended in a report to
Congress that the separate charters for thrifts and banks be abolished. Various
proposals to eliminate the federal thrift charter, create a uniform financial
institutions charter, conform holding company regulation and abolish the OTS
have been introduced in Congress. The House Committee on Banking and Financial
Services has reported a bill that will require federal savings associations to
convert to national banks or some type of state charter within two years of
enactment or they would automatically become national banks. The bill would also
merge the BIF and the SAIF, repeal the Home Owners' Loan Act ("HOLA"), abolish
the OTS and transfer the regulation of savings associations to the federal bank
regulators and the Federal Reserve Board. Federal thrifts converted to national
banks generally will be permitted to continue to engage in any activity,
including the holding of any asset, lawfully conducted on the date prior to the
enactment. A federal savings association converted to a national bank may retain
all branches established or proposed in a pending application as of enactment
and establish new branches in any state in which it has a branch. Otherwise it
may establish new branches only under national bank rules. In addition,
beginning two years after enactment, national banks will be authorized to
exercise all powers formerly authorized for federal savings associations.
Under the proposal, holding companies for savings associations converted to
national banks generally will become subject to the same regulation as holding
companies that control commercial banks, with a
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grandfather provision for former unitary savings and loan holding companies.
Such grandfathered companies will be permitted to maintain and establish
affiliations with any type of company and to acquire additional depository
institutions, as long as any acquired depository institution is merged into its
converted savings association and such institution continues to comply with both
the qualified thrift lender test and certain asset and investment limitations to
which it was subject as a federal savings association.
The Financial Services Act of 1998, introduced in March 1998, would allow
securities firms, insurance companies and commercial banks to merge under a
holding company structure. Among other things, the bill would expand the Federal
Reserve's regulatory authority over these financial institutions. The Company is
unable to predict whether this bill or any other such legislation will be
enacted, what the provisions of such final legislation may be, or the extent to
which the legislation would restrict, disrupt or otherwise have a material
effect on its operations.
YEAR 2000 READINESS
As the Year 2000 approaches, a critical business issue has emerged regarding
how existing application software programs and operating systems can accommodate
this date value. In brief, many existing application software products in the
marketplace were designed to only accommodate a two digit date position which
represents the year (E.G., the year 1995 is stored on the system as "95"). The
Company has implemented a program designed to ensure that all software used in
connection with the Company's business will manage and manipulate data involving
the transition with data from 1999 to 2000 without functional or data
abnormality and without inaccurate results related to such data. However, there
can be no assurances that such program will be effective as to the results of
any potential failure of computer programs and/or systems. To the extent the
Company's systems or the systems of its vendors are not fully Year 2000 Ready,
there can be no assurance that potential systems interruptions or the cost
necessary to update software would not have a material adverse effect on the
Company's business, financial condition, results of operations or business
prospects. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Year 2000 Discussions."
ENVIRONMENTAL RISKS
In the course of its business, the Company has acquired, and may acquire in
the future, properties securing loans that are in default. There is a risk that
hazardous substances or waste, contaminants, pollutants or sources thereof could
be discovered on such properties after acquisition by the Company. In such
event, the Company may be required by law to remove such substances from the
affected properties at its sole cost and expense. There can be no assurance that
(i) the cost of such removal would not substantially exceed the value of the
affected properties or the loans secured by the properties, (ii) the Company
would have adequate remedies against the prior owner or other responsible
parties or (iii) the Company would not find it difficult or impossible to sell
the affected properties either prior to or following such removal.
RISK FACTORS RELATED TO ON-LINE
COMPETITION. On-Line competes with a number of other companies that provide
electronic data processing and other related services primarily to financial
institutions. The market for electronic data processing services within the
financial services industry is intensely competitive and rapidly changing and
there can be no assurance that On-Line will be able to compete successfully in
the future. In addition to direct competition, On-Line may also face indirect
competition from its existing and potential customers, many of which internally
design, integrate and deploy their own technologies for their particular needs,
and therefore may be reluctant to use services offered by independent providers
such as On-Line. This indirect risk is generally dependent on the size and
technological sophistication of the existing or potential customer, both of
which impact the cost versus benefit analysis for deciding whether to use an
independent provider or manage processing needs internally.
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<PAGE>
On-Line believes that its ability to compete successfully depends upon a
number of factors both within and beyond its control, including system
performance, price, market perception, level of customer support, quality and
breadth of services, and industry and general economic trends. As a result,
On-Line must educate existing and prospective customers as to the advantages and
differentiating factors of On-Line's services, which include offering advanced
technologies that compliment core application system products. In addition,
since mid-1997 On-Line began marketing its optical report retrieval and document
management and imaging systems, as well as local and wide area network
architectural design and implementation services, to companies outside the
financial services industry in order to expand and diversify its revenues. There
can be no assurance that On-Line will be able to compete effectively with its
direct competitors or to adequately educate potential customers as to the
benefits provided by On-Line's services, or effectively continue to increase
sales to companies outside of the financial services industry. See "Business of
On-Line Financial Services, Inc."
CONSOLIDATION IN BANKING AND FINANCIAL SERVICES INDUSTRY. There has been
and continues to be merger, acquisition and consolidation activity in the
banking and financial services industry. Mergers or consolidations of banks and
financial institutions in the future could reduce the number of On-Line's
clients or potential clients. A smaller market for On-Line's services could have
a material adverse impact on On-Line's business and results of operations. Also,
it is possible that larger banks or financial institutions resulting from
mergers or consolidations would consider the possibility of performing some or
all of the services which On-Line currently provides or could provide. Should
such events occur, it could have a material adverse impact on On-Line's business
and results of operations.
HIGH OPERATING EXPENSES. As a result of its acquisition in 1995, On-Line's
expenditures have increased the overall operating expenses of the Company.
During 1996 and 1997, On-Line implemented a restructuring program whereby it has
invested in highly skilled technical personnel and focused its resources on
advanced technologies in order to stay competitive in its industry, which is an
innovative and frequently changing market. On-Line incurred significant costs to
upgrade and increase the products and services it offers its customers, which
resulted in a period of rising operating expenses as such upgrades and increased
products and services were being implemented. Management believes that such
expenses have stabilized at the current level of recurring costs. Although
management believes that its capital expenditures are unlikely to continue to
escalate at the same rate, there can be no assurances that On-Line will not
continue to experience high operating costs or that it will obtain an adequate
revenue base or sustain future profitability.
DEPENDENCE ON SKILLED PERSONNEL. On-Line's success will depend on its
ability to attract and retain highly skilled personnel in all areas of its
business, as the demand for these individuals is high in all industry markets.
In addition, On-Line is dependent upon many skilled and highly specialized
technical personnel, none of whom are parties to employment agreements. The loss
or unavailability of one or more of certain of these individuals could have a
material adverse effect on On-Line's business prospects and existing clients. As
the Year 2000 approaches, key individuals knowledgeable in certain areas of
mainframe programming languages will also become more and more valuable to
companies faced with Year 2000 issues. On-Line will be competing for these
individuals with larger companies that may be offering better compensation
packages. As a result, On-Line may need to rely on the use of outside consulting
services and there can be no assurance that such consulting services will be
available. Although management believes it has good relations with its personnel
and currently has several Year 2000 incentive plans in place, no assurance can
be given that On-Line will be able to attract and retain personnel in the
future.
YEAR 2000 READINESS. On-Line has implemented several Year 2000 programs
designed to facilitate meeting Year 2000 criteria. However, there can be no
assurance that such programs will be effective as to the results of any
potential failure of the various computer systems and application programs in
place at On-Line. To the extent that On-Line's systems are not fully Year 2000
Ready, there can be no assurance that potential systems interruptions or the
cost necessary to update systems would not have a material adverse effect on
On-Line's financial condition, results of operations or business prospects.
Although Year 2000 planning initiatives are currently in place, there can be no
assurances that third parties will not commence litigation against On-Line
concerning Year 2000 Readiness. Any of the foregoing could result in a material
adverse effect on On-Line's business, financial condition or results of
operations.
28
<PAGE>
USE OF PROCEEDS
The Trust will use the gross proceeds from the sale of the Capital
Securities to purchase Junior Subordinated Debentures of the Company.
Approximately one-half of the net proceeds from the sale of the Junior
Subordinated Debentures will be contributed to the Bank and one-half will be
used by the Company. The net proceeds at the Bank level will be used for general
lending purposes, including the funding of new loans, as well as the enhancement
of operational capabilities. At the Company level, the net proceeds will be used
for general corporate purposes, the enhancement of operational capabilities and
for the potential purchase of loans.
MARKET FOR THE CAPITAL SECURITIES
The Capital Securities will be a new issue of securities for which there is
no current market. The Capital Securities have been approved for listing on the
American Stock Exchange under the trading symbol "ATP". Nevertheless there is no
assurance that an active and liquid trading market will develop or, if
developed, that such a market will be sustained. The offering price and
distribution rate have been determined by negotiations among representatives of
the Company and the Underwriters, and the offering price of the Capital
Securities may not be indicative of the market price following the Offering. See
"Underwriting."
RATIOS OF EARNINGS TO COMBINED FIXED CHARGES
The following table sets forth the ratios of earnings to combined fixed
charges of the Company on a consolidated basis for the respective periods
indicated.
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30, FOR THE YEAR ENDED DECEMBER 31,
-------------------- --------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1998 1997 1997 1996 1996(1) 1995
--------- --------- --------- --------- ----------- ---------
Ratios of Earnings to Combined Fixed Charges:
Excluding interest on deposits........................ 1.59x 1.46x 1.35x 1.63x 1.93x 1.88x
Including interest on deposits........................ 1.11x 1.13x 1.08x 1.18x 1.27x 1.29x
<CAPTION>
<S> <C> <C>
1994 1993
--------- ---------
Ratios of Earnings to Combined Fixed Charges:
Excluding interest on deposits........................ 2.11x 3.76x
Including interest on deposits........................ 1.33x 1.66x
</TABLE>
- ------------------------
(1) Represents the respective fixed charge ratios excluding the SAIF
recapitalization assessment.
For purposes of computing the ratios of earnings to combined fixed charges,
earnings represent net income plus applicable income taxes and fixed charges.
Fixed charges, excluding interest on deposits, include gross interest expense
other than on deposits. Fixed charges, including gross interest on deposits,
include all interest expense.
ACCOUNTING TREATMENT
For financial reporting purposes, the Trust will be treated as a subsidiary
of the Company and, accordingly, the accounts of the Trust will be included in
the Consolidated Financial Statements of the Company. The Capital Securities
will be presented as a separate line item in the consolidated balance sheet of
the Company under the caption "Guaranteed preferred beneficial interests in the
Company's Junior Subordinated Debentures," and appropriate disclosures about the
Capital Securities, the Guarantee and the Junior Subordinated Debentures will be
included in the notes to Consolidated Financial Statements. For financial
reporting purposes, the Company will record Distributions payable on the Capital
Securities as interest expense in the consolidated statements of operations.
Future audited Consolidated Financial Statements of the Company will include
a footnote to the financial statements stating that (i) the Trust is
wholly-owned, (ii) the sole assets of the Trust are the Junior Subordinated
Debentures (specifying the principal amount, interest rate and maturity date of
such Junior Subordinated Debentures), and (iii) the full and unconditional
guarantee by the Company of the obligations of the Trust under the Capital
Securities in the event of the occurrence of an Event of Default. The Trust will
not obtain separate audited financial statements.
29
<PAGE>
CAPITALIZATION
The following table sets forth (i) the consolidated capitalization of the
Company at June 30, 1998 and (ii) the consolidated capitalization of the Company
giving effect to the issuance of the Capital Securities hereby offered by the
Trust and receipt by the Company of the net proceeds from the corresponding sale
of the Junior Subordinated Debentures to the Trust, as if the sale of the
Capital Securities had been consummated on June 30, 1998 and assuming the
Underwriters over-allotment option was not exercised. The information below
should be read in conjunction with the Consolidated Financial Statements of the
Company and the Notes thereto which are included elsewhere herein. See "Use of
Proceeds."
<TABLE>
<CAPTION>
AT JUNE 30, 1998
----------------------
<S> <C> <C>
ACTUAL AS ADJUSTED
--------- -----------
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Guaranteed preferred beneficial interests in the Company's Junior Subordinated
Debentures.............................................................................. $ -- $ 15,000(1)
Stockholders' Equity:
Preferred stock of the Company, $0.01 par value (1,000,000 shares authorized, none issued
or outstanding)(2)...................................................................... $ -- $ --
Common stock of the Company, $0.01 par value (9,000,000 shares authorized, 1,990,576
shares issued and outstanding).......................................................... 20 20
Additional paid-in capital................................................................ 8,735 8,735
Retained earnings......................................................................... 10,414 10,414
Accumulated other comprehensive income.................................................... (127) (127)
Common stock acquired by:
Employee Stock Ownership Plan........................................................... (27) (27)
Management Recognition Plan............................................................. (290) (290)
--------- -----------
Total stockholders' equity................................................................ $ 18,725 $ 33,725
--------- -----------
--------- -----------
Book value per share...................................................................... $ 9.41 $ 16.94
--------- -----------
--------- -----------
Bank regulatory capital ratios(3):
Tangible Capital........................................................................ 5.68% 8.47%
Core (leverage) capital................................................................. 5.68% 8.47%
Total risk-based capital................................................................ 11.05% 16.64%
Stockholders' equity to total assets...................................................... 7.21% 12.27%
</TABLE>
- ------------------------
(1) In connection with the issuance of the guaranteed preferred beneficial
interests in the Company's Junior Subordinated Debentures, the Company
estimates it will incur expenses of $1,600,000 (including Underwriters'
compensation of $900,000). The Junior Subordinated Debentures will mature on
November 6, 2028, which date may be shortened to a date not earlier than
November 6, 2003 if certain conditions are met.
(2) On August 31, 1998 the Company issued 592,681 shares of Goodwill Convertible
Preferred Stock. See "Recent Developments" and "Description of Capital Stock
of the Company--Goodwill Convertible Preferred Stock."
(3) Pursuant to the OTS regulations, savings institutions must meet three
separate minimum capital-to-assets requirements: (1) a risk-based capital
requirement of 8.0% for risk-weighted assets, (2) a leverage or core ratio
of 3.0% core capital to total adjusted assets, and (3) a tangible capital
requirement of 1.5% tangible core capital to total assets. Although the
minimum capital requirement is 3.0%, the OTS Regulations provide that an
institution with less than 4.0% core capital is deemed to be
"undercapitalized."
30
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
The operating data presented below is derived in part from and should be
read in conjunction with the audited Consolidated Financial Statements of the
Company and Notes thereto of the Company, presented elsewhere in the Prospectus.
The operating data for the six month periods ended June 30, 1998 and 1997 is
derived from unaudited financial data, but, in the opinion of management,
reflects all adjustments (consisting of only normal recurring adjustments) which
are necessary to present fairly the results for such interim periods. The
results of operations for the six months ended June 30, 1998 are not necessarily
indicative of the results of operations that may be expected for the year ending
December 31, 1998.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED
JUNE 30, DECEMBER 31,
-------------------- -------------------------------
<S> <C> <C> <C> <C> <C>
1998 1997 1997 1996 1995
--------- --------- --------- --------- ---------
<CAPTION>
(UNAUDITED) (DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Interest income:
Loans receivable................................................... $ 6,829 $ 6,438 $ 12,072 $ 11,370 $ 11,836
Discounted loans receivable........................................ 1,215 3,210 5,249 3,687 1,174
Securities available-for-sale...................................... 204 301 581 596 910
Interest-earning deposits.......................................... 313 141 364 421 67
--------- --------- --------- --------- ---------
Total interest income.......................................... 8,561 10,090 18,266 16,074 13,987
--------- --------- --------- --------- ---------
Interest expense:
Deposits........................................................... 4,583 4,124 8,580 6,433 5,610
Custodial escrows.................................................. -- 5 1 78 224
Borrowed money..................................................... 1,068 1,695 2,705 2,572 2,507
--------- --------- --------- --------- ---------
Total interest expense......................................... 5,651 5,824 11,286 9,083 8,341
--------- --------- --------- --------- ---------
Net interest income before provision for loan losses................. 2,910 4,266 6,980 6,991 5,646
Provision for loan losses............................................ 235 60 210 248 55
--------- --------- --------- --------- ---------
Net interest income after provision for loan losses................ 2,675 4,206 6,770 6,743 5,591
--------- --------- --------- --------- ---------
Noninterest income:
Purchased mortgage servicing income (loss), net.................... (278) 169 426 352 361
Net gain (loss) on sale:
Loans held for sale.............................................. 384 31 217 246 226
Discounted loans receivable...................................... 715 23 279 1,843 1,062
Foreclosed real estate........................................... (91) 81 19 (366) (2)
Securities available-for-sale.................................... 318 207 710 235 219
Fees and service charges........................................... 1,020 572 1,451 520 450
Data processing income............................................. 6,020 5,509 11,528 11,111 1,836
Other.............................................................. 729 66 955 253 327
--------- --------- --------- --------- ---------
Total noninterest income....................................... 8,817 6,658 15,585 14,194 4,479
--------- --------- --------- --------- ---------
Noninterest expense:
Compensation and benefits.......................................... 4,345 4,529 8,799 8,731 3,648
Occupancy and equipment............................................ 2,709 2,353 4,930 4,260 1,471
Federal deposit insurance premiums................................. 56 47 102 1,072 268
Loan servicing expense............................................. 286 272 550 268 251
Professional fees.................................................. 354 428 1,261 788 431
Advertising and promotion.......................................... 189 156 382 305 104
Goodwill amortization.............................................. 51 53 104 108 102
Data processing cost of services................................... 1,721 946 2,806 1,542 231
Computer services.................................................. -- -- -- -- 181
Software expense................................................... 590 337 865 705 119
Other.............................................................. 564 962 1,610 1,481 856
--------- --------- --------- --------- ---------
Total noninterest expense...................................... 10,865 10,083 21,409 19,260 7,662
--------- --------- --------- --------- ---------
Income before income tax expense............................... 627 781 946 1,677 2,408
Income tax (benefit) expense....................................... (40) 157 123 343 667
--------- --------- --------- --------- ---------
Net income..................................................... $ 667 $ 624 $ 823 $ 1,334 $ 1,741
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Per share amounts(1):
Basic.............................................................. $ .34 $ .33 $ .43 $ 1.07 $ 1.47
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Diluted............................................................ $ .32 $ .31 $ .39 $ .90 $ 1.24
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
- ------------------------
(1) Adjusted to give effect to a four-to-one stock split in the form of a stock
dividend which will take place prior to the date of the Offering.
31
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MANAGEMENT OF INTEREST RATE RISK
Generally, the Bank's financial objective is to manage the sensitivity of
its earnings to interest rate fluctuations by altering the match between the
interest rate sensitivity of its assets and liabilities. The major strategies
the Bank has implemented are (i) the origination and purchase of ARMs; (ii) the
origination of balloon mortgages; (iii) the origination of adjustable rate home
equity lines of credit; (iv) the sale of newly originated long-term fixed-rate
mortgages; (v) the purchase of seasoned fixed-rate and adjustable rate mortgage
loans at a discount; (vi) from time to time, in appropriate interest rate
environments, the investment in PMSRs, which provide a source of noninterest
income and also act as a hedge against the decline in the value of fixed-rate
mortgages in a rising interest rate environment; (vii) the maintenance of
noninterest-bearing custodial accounts related to loans and PMSRs; and (viii)
the control of deposit growth and maintenance of long-term deposits. In addition
to the foregoing, the Bank has recently implemented a pre-payment penalty on
ARMs and management looks for and continues to seek low cost liabilities in the
public and private sectors. The strategies listed have been implemented by the
Bank and are monitored on a quarterly basis by management. The Bank does not use
any derivatives to reduce its exposure to interest rate risk. See "Business of
Bank--Lending Activities."
NET PORTFOLIO VALUE. As part of its normal operations, the Bank is subject
to interest-rate risk on the interest-sensitive assets it invests in and the
interest-sensitive liabilities it borrows. The Bank's Investment Committee which
includes members of senior management and directors, monitors and determines the
strategy of managing the rate and sensitivity repricing characteristics of the
individual asset and liability portfolios the Bank maintains. The overall goal
is to manage this interest rate risk to most efficiently utilize the Bank's
capital, as well as to maintain an acceptable level of change to its NPV and net
interest income. The Bank strategy is to minimize the impact of sudden and
sustained changes in interest rates on NPV and its net interest margin.
Interest rate risk exposure is measured using interest rate sensitivity
analysis to determine the Bank change in NPV in the event of hypothetical
changes in interest rates, as well as interest rate sensitivity gap analysis,
which monitors the repricing characteristics of the Bank's interest-earning
assets and interest-bearing liabilities. The Board of Directors has established
limits to changes in NPV and net interest income across a range of hypothetical
interest rate changes. If estimated changes to NPV and net interest income are
not within these limits, the Board may direct management to adjust its
asset/liability mix to bring its interest rate risk within Board limits.
Interest rate sensitivity analysis is used to measure the Bank's interest
rate risk by calculating the estimated change in the NPV of its interest
sensitive assets and liabilities, as well as certain off- balance sheet items,
in the event of a series of sudden and sustained changes in interest rates
ranging from 100 to 400 basis points. Management assumes that a 200 basis point
movement up or down is considered reasonable and plausible for purposes of
managing its interest-rate risk on a day-to-day basis. NPV is computed as the
difference between the estimated market value of assets and the estimated market
value of liabilities, adjusted for the value of off-balance sheet items. The
following table presents the Bank's projected change in NPV for the various rate
movements as of June 30, 1998.
32
<PAGE>
INTEREST RATE SENSITIVITY OF NET PORTFOLIO VALUE (NPV)
<TABLE>
<CAPTION>
NPV AS % OF PORTFOLIO
ESTIMATED INCREASE
(DECREASE) IN NPV VALUE OF ASSETS
------------------------------------ ------------------------
ESTIMATED PERCENT PERCENT
CHANGE IN INTEREST RATE NPV CHANGE CHANGE NPV RATIO CHANGE
- ----------------------------------------------------------- ----------- ---------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
400 basis point increase................................... $ 16,614 $ (12,325) (43.0)% 6.88% (4.27)%
300 basis point increase................................... 20,851 (8,088) (28.0) 8.44 (2.71)
200 basis point increase................................... 24,707 (4,233) (15.0) 9.79 (1.36)
100 basis point increase................................... 27,689 (1,251) (4.0) 10.79 (.37)
Base scenario.............................................. 28,939 -- -- 11.15 --
100 basis point decline.................................... 28,941 2 -- 11.08 (.07)
200 basis point decline.................................... 28,287 (653) (2.0) 10.77 (.38)
300 basis point decline.................................... 27,900 (1,040) (4.0) 10.56 (.59)
400 basis point decline.................................... 27,752 (1,187) (4.0) 10.53 (.73)
</TABLE>
The NPV is calculated by the OTS using guidelines related to interest rates,
loan prepayment rates, deposit decay rates and market values of certain assets
under the various interest rate scenarios. These assumptions should not be
relied upon as indicative of actual results due to the inherent shortcomings of
the NPV analysis. These shortcomings include (i) the possibility that actual
market conditions could vary from the assumptions used in the computation of
NPV, (ii) certain assets, including adjustable-rate loans, have features which
affect the potential repricing of such instruments, which may vary from the
assumptions used, (iii) that the discount rates used by the OTS in its
computation may not accurately reflect the credit risks inherent in the Bank's
loan portfolio and (iv) the likelihood that as interest rates are changing, the
Investment Committee would likely be changing strategies to limit the indicated
changes in NPV as part of its management process. See "Regulation--Federal
Savings Institution Regulation--Capital Requirements."
The Bank does not currently engage in trading activities or use derivative
instruments to control interest rate risk. Other types of market risk, such as
foreign currency exchange risk and commodity price risk, do not arise in the
normal course of the Company's business activities and operations.
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 also depends on the relative amounts of interest-earning assets
and interest-bearing liabilities and the interest rate earned or paid on them.
AVERAGE BALANCE SHEET
The following tables set forth certain information relating to the Company's
consolidated average balance sheets and reflects the average yield on assets and
average cost of liabilities for the period indicated. Such yields and costs are
derived by dividing income or expense by the average balance of assets or
liabilities, respectively, for the periods presented. Average balances are
derived from month-end
33
<PAGE>
balances. Management believes that the use of month-end balances instead of
daily average balances has not caused a material difference in the information
presented.
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
------------------------------------------------------------------------
1998 1997
------------------------------------ ----------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST
---------- --------- ------------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Loans receivable(1)......................... $ 183,564 $ 8,044 8.76% $ 189,602 $ 9,648 10.18%
Securities available-for-sale............... 7,829 204 5.21 9,750 301 6.17
Interest-earning deposits................... 11,604 313 5.40 5,270 141 5.35
---------- --------- ---------- ---------
Total interest-earning assets............. 202,997 8,561 8.44 204,622 10,090 9.86
Noninterest-earning assets.................... 37,752 37,703
---------- ----------
Total assets.............................. $ 240,749 $ 242,325
---------- ----------
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Deposits.................................... $ 180,857 $ 4,583 5.07% $ 161,902 $ 4,124 5.09%
Custodial escrows........................... 1 -- -- 28 5 35.71
Borrowed money.............................. 29,633 1,068 7.21 50,720 1,695 6.68
---------- --------- ---------- ---------
Total interest-bearing liabilities........ 210,491 5,651 5.37 212,650 5,824 5.48
Noninterest-bearing liabilities............... 11,747 12,000
---------- ----------
Total liabilities......................... 222,238 224,650
Stockholders' equity.......................... 18,511 17,675
---------- ----------
Total liabilities and stockholders'
equity.................................. $ 240,749 $ 242,325
---------- ----------
---------- ----------
Net interest income/interest rate spread(2)... $ 2,910 3.07% $ 4,266 4.38%
--------- --- --------- -----
--------- --- --------- -----
Net interest-earning assets(liabilities)/net
interest margin(3).......................... $ (7,494) 2.87% $ (8,028) 4.17%
---------- --- ---------- -----
---------- --- ---------- -----
Ratio of average interest-earning assets to
average interest-bearing liabilities........ .96x .96x
---------- ----------
---------- ----------
</TABLE>
- ------------------------
(1) Loans receivable include loans held for sale, Portfolio Loans receivable and
Discounted Loans receivable.
(2) Interest rate spread represents the difference between the average yield on
total interest-earning assets and the average cost of total interest-bearing
liabilities.
(3) Net interest margin represents net interest income divided by average
interest-earning assets.
34
<PAGE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------
1997 1996
----------------------------------- -----------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST BALANCE INTEREST YIELD/COST
--------- --------- ------------- --------- --------- -------------
<S> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
ASSETS:
Interest-earning assets:
Loans receivable(1)............................ $ 180,964 $ 17,321 9.57% $ 151,384 $ 15,057 9.95%
Securities available-for-sale.................. 9,670 581 6.01 9,470 596 6.29
Interest-earning deposits...................... 6,573 364 5.54 2,103 421 4.84
--------- --------- --------- ---------
Total interest-earning assets................ 197,207 18,266 9.26 162,957 16,074 9.86
Noninterest-earning assets....................... 39,260 32,927
--------- ---------
Total assets................................. $ 236,467 $ 195,884
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Deposits....................................... $ 165,669 $ 8,580 5.18% $ 130,163 $ 6,433 4.94%
Custodial escrows.............................. 21 1 4.76 1,209 78 6.45
Borrowed money................................. 41,140 2,705 6.58 41,909 2,572 6.14
--------- --------- --------- ---------
Total interest-bearing liabilities........... 206,830 11,286 5.46 173,281 9,083 5.24
Noninterest-bearing liabilities.................. 11,827 10,340
--------- ---------
Total liabilities............................ 218,657 183,621
Stockholders' equity............................. 17,810 12,263
--------- ---------
Total liabilities and stockholders' equity... $ 236,467 $ 195,884
--------- ---------
--------- ---------
Net interest income/interest rate spread(2)...... $ 6,980 3.80% $ 6,991 4.62%
--------- --- --------- ---
--------- --- --------- ---
Net interest-earning assets(liabilities)/net
interest margin(3)............................. $ (9,623) 3.54% $ (10,324) 4.29%
--------- --- --------- ---
--------- --- --------- ---
Ratio of average interest-earning assets to
average interest-bearing liabilities........... .95x .94x
--------- ---------
--------- ---------
<CAPTION>
1995
-----------------------------------
AVERAGE AVERAGE
BALANCE INTEREST YIELD/COST
--------- --------- -------------
<S> <C> <C> <C>
ASSETS:
Interest-earning assets:
Loans receivable(1)............................ $ 139,194 $ 13,010 9.35%
Securities available-for-sale.................. 13,945 910 6.53
Interest-earning deposits...................... 1,459 67 4.59
--------- ---------
Total interest-earning assets................ 154,598 13,987 9.05
Noninterest-earning assets....................... 19,444
---------
Total assets................................. $ 174,042
---------
---------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Interest-bearing liabilities:
Deposits....................................... $ 113,857 $ 5,610 4.93%
Custodial escrows.............................. 3,126 224 7.17
Borrowed money................................. 38,768 2,507 6.47
--------- ---------
Total interest-bearing liabilities........... 155,751 8,341 5.36
Noninterest-bearing liabilities.................. 8,103
---------
Total liabilities............................ 163,854
Stockholders' equity............................. 10,188
---------
Total liabilities and stockholders' equity... $ 174,042
---------
---------
Net interest income/interest rate spread(2)...... $ 5,646 3.69%
--------- ---
--------- ---
Net interest-earning assets(liabilities)/net
interest margin(3)............................. $ (1,153) 3.65%
--------- ---
--------- ---
Ratio of average interest-earning assets to
average interest-bearing liabilities........... .99x
---------
---------
</TABLE>
- ------------------------
(1) Loans receivable include loans held for sale, Portfolio Loans receivable and
Discounted Loans receivable.
(2) Interest rate spread represents the difference between the average yield on
total interest-earning assets and the average cost of total interest-bearing
liabilities.
(3) Net interest margin represents net interest income divided by average
interest-earning assets.
35
<PAGE>
RATE VOLUME ANALYSIS
The following table sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (1) changes in volume
(changes in volume multiplied by prior rate); (2) changes in rate (changes in
rate multiplied by prior volume); and (3) net changes in rate-volume. The
changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.
<TABLE>
<CAPTION>
SIX MONTHS ENDED 1996
JUNE 30, 1998 COMPARED
COMPARED TO TO 1995
SIX MONTHS ENDED INCREASE
JUNE 30, 1997 1997 COMPARED TO 1996 (DECREASE)
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO DUE TO
--------------------------------- ------------------------------- ---------
VOLUME RATE NET VOLUME RATE NET VOLUME
----------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
INTEREST-EARNING ASSETS:
Loans receivable, net..................... $ (307) $ (1,297) $ (1,604) $ 2,934 $ (670) $ 2,264 $ 1,146
Securities-available-for-sale............. (64) (33) (97) 4 (19) (15) (290)
Interest-earning deposits................. 169 3 172 894 (951) (57) 30
----- --------- --------- --------- --------- --------- ---------
Total interest-earning assets........... $ (202) $ (1,327) $ (1,529) $ 3,832 $ (1,640) $ 2,192 $ 886
----- --------- --------- --------- --------- --------- ---------
----- --------- --------- --------- --------- --------- ---------
INTEREST-BEARING LIABILITIES:
Deposits.................................. $ 482 $ (23) $ 459 $ 1,757 $ 390 $ 2,147 $ 799
Custodial escrows......................... (5) -- (5) (77) -- (77) (137)
Borrowed money............................ (705) 78 (627) (47) 180 133 203
----- --------- --------- --------- --------- --------- ---------
Total interest-bearing liabilities...... $ (228) $ 55 $ (173) $ 1,633 $ 570 $ 2,203 $ 865
----- --------- --------- --------- --------- --------- ---------
----- --------- --------- --------- --------- --------- ---------
Net change in interest income............... $ 26 $ (1,382) $ (1,356) $ 2,199 $ (2,210) $ (11) $ 21
----- --------- --------- --------- --------- --------- ---------
----- --------- --------- --------- --------- --------- ---------
<CAPTION>
RATE NET
--------- ---------
<S> <C> <C>
INTEREST-EARNING ASSETS:
Loans receivable, net..................... $ 901 $ 2,047
Securities-available-for-sale............. (24) (314)
Interest-earning deposits................. 324 354
--------- ---------
Total interest-earning assets........... $ 1,201 $ 2,087
--------- ---------
--------- ---------
INTEREST-BEARING LIABILITIES:
Deposits.................................. $ 24 $ 823
Custodial escrows......................... (9) (146)
Borrowed money............................ (138) 65
--------- ---------
Total interest-bearing liabilities...... $ (123) $ 742
--------- ---------
--------- ---------
Net change in interest income............... $ 1,324 $ 1,345
--------- ---------
--------- ---------
</TABLE>
RESULTS OF OPERATIONS
GENERAL. The Company's results of operations are dependent primarily on net
interest income, representing the difference between the interest income earned
on its loans, mortgage-backed securities, investment securities and
interest-earning deposits, and its cost of funds, consisting of the interest
paid on its deposits, escrows, and borrowings, and the fees generated by ATMs,
and the Bank's investment in PMSRs. The Company's operating results are also
affected by the profit recognized on the sale of mortgage loans and equity
securities, customer service charges, data processing and other income. The
Company's operating expenses consist of employee compensation, occupancy
expenses, federal deposit insurance premiums, amortization of goodwill, and
other general and administrative expenses.
Results of operations are also significantly affected by general economic
and competitive conditions, particularly changes in market interest rates,
government policies, and actions of regulatory authorities.
DISCOUNTED LOANS RECEIVABLE. In recent years the Company has acquired,
through public sales and auctions, mortgage loans at a discount for which the
borrowers may not be current as to principal and interest payments. Acquired
loans are valued based upon an analysis of the underlying collateral of the
loans being purchased. The Company estimates the amounts it will realize through
foreclosure, collection efforts or other resolution of each loan and the length
of time required to complete the collection process in determining the amounts
it will bid to acquire such loans. Investment in these assets has generally
resulted in higher than market interest yields and gains as a result of the
ultimate sale of properties acquired through these purchases. Losses have also
been incurred from the sales of certain REO properties. The Bank also incurs
higher operating expenses associated with administering these loans.
Beginning in the fourth quarter of 1996, the Company began to focus its
resources on Conventional Loans receivable originated through MARGO and in mid
1997 began to reduce its portfolio of Discounted
36
<PAGE>
Loans receivable. Sales of Discounted Loans receivable totaled $6.9 million for
the six month period ended June 30, 1998, $20.7 million for the year ended
December 31, 1997, and $7.5 million for the year ended December 31, 1996. As a
result of the Company's business strategy, the balance of the Discounted Loans
receivable portfolio decreased from $47.7 million or 20.8% of total assets at
December 31, 1996, to $30.6 million or 12.9% of total assets at December 31,
1997, to $17.0 million or 6.5% of total assets at June 30, 1998. Gains on these
sales were $715,000 and $23,000 for the six month periods ended June 30, 1998
and 1997, and were $279,000 and $1.8 million for the years ended December 31,
1997 and 1996, respectively.
ON-LINE FINANCIAL SERVICES, INC. On October 31, 1995, the Company acquired
On-Line, an Oak Brook, Illinois based computer services bureau.
The original transaction value, including asset notes and contingent
payments (based on future defined net revenues of On-Line over a seven year
period ending October 2002), was not to exceed $10.0 million. During 1997, the
Company asserted claims that the selling shareholders of On-Line had breached
certain representations and warranties in the purchase contract. Following a
series of negotiations, the selling shareholders agreed to reduce the purchase
price by $1,098,000. As a result, at December 31, 1997, the amount paid or
payable, exclusive of the future contingent payments for On-Line, was $836,000
less than the fair value of the net assets acquired. Any future contingent
payments will reduce this difference. In December 1997, the Company purchased
from certain of the former shareholders their rights to 25.45% of the future
contingent payments. The Company paid $172,000 for these future contingent
payments. Additionally, a payment of $479,000 was made in April 1998, further
reducing the remaining contingent payments to former stockholders to an amount
not to exceed $3.5 million. Management anticipates funding any required future
payments with borrowed funds and excess funds generated from operations and, to
the extent necessary, earnings and assets of the Company.
On-Line is a third party provider of electronic data processing services,
primarily to financial institutions. On-Line currently provides data processing
services to thrifts, community banks, savings banks, and mortgage bankers
throughout the Midwest. In addition, On-Line provides data report retrieval
services to an insurance company with offices located throughout the United
States. Management believes that On-Line's orientation toward superior customer
service and specialized products allows it to effectively compete in these
markets. The acquisition by the Company has promoted the development and sale of
technological advances in the systems, programs, and services offered by
On-Line, which includes resale of software produced by ITI, integrated check and
document imaging systems, computer output laser disc storage technology and high
speed communication technology. These services are in addition to new offerings
by On-Line in the planning and deployment of wide area and local area network
systems, the sale of all related hardware and services, expanded technical and
communications support, consultation, and training.
COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 1998 AND DECEMBER 31, 1997.
Total assets increased $23.5 million to $259.8 million at June 30, 1998,
from $236.3 million at December 31, 1997.
Cash and interest-earning deposits increased $9.9 million to $18.6 million
at June 30, 1998, primarily due to cash received from a sale of loans at the end
of June 1998.
Loans receivable and Discounted Loans receivable increased $16.5 million to
$200.9 million at June 30, 1998, due to the origination and purchase of $78.0
million of loans, and discount accretion of $302,000, partially offset by
principal repayments of $35.0 million, the sale of $24.9 million of loans
receivable and Discounted Loans receivable, and the transfer of $1.9 million of
loans and Discounted Loans receivable to REO.
Securities, which totaled $5.0 million at June 30, 1998 are carried at fair
value and include $2.3 million of mortgage-backed securities, $2.3 million of
marketable equity securities, and $379,000 of municipal securities.
37
<PAGE>
Deposits increased $29.0 million to $201.5 million at June 30, 1998, from
$172.5 million at December 31, 1997. The increase was attributed to an
aggressive marketing effort during the first six months of 1998, aimed at
attracting a larger customer base, and interest credited of $4.6 million for the
six months ended June 30, 1998. Brokered deposits at June 30, 1998, totaled
$16.5 million and had a weighted average maturity of one (1) year.
Borrowings decreased $5.8 million to $28.4 million at June 30, 1998, from
$34.2 million at December 31, 1997. The decrease in advances was due to the
increase in deposits during the six months ended June 30, 1998. At June 30,
1998, borrowings consisted of FHLB advances totaling $18.1 million, two lines of
credit totaling $6.6 million, capital lease obligations in the amount of $3.2
million and other borrowings of $387,000.
Custodial escrow balances for loans serviced decreased $509,000 to $5.9
million at June 30, 1998, from $6.4 million at December 31, 1997. This decrease
reflects normal fluctuations within these accounts. The custodial accounts
pertain to escrowed payments of taxes and insurance and the float on principal
and interest payments on loans serviced either for the Bank or on behalf of
others by an independent mortgage servicing operation. The custodial accounts
related to loans serviced by others are maintained at the Bank in both
interest-bearing and non-interest bearing accounts. The custodial accounts
associated with loans or PMSRs serviced for the Bank are maintained in
non-interest bearing accounts. At June 30, 1998, the entire escrow balance
pertains to loans subserviced on behalf of the Bank for Portfolio Loans,
servicing retained loans and PMSRs.
Stockholders' equity increased $621,000 to $18.7 million at June 30, 1998,
from $18.1 million at December 31, 1997. The increase was caused by the exercise
of stock options for $116,000, a $39,000 tax benefit related to the exercise of
the options and net income of $667,000, partially offset by dividends paid of
$168,000, and other comprehensive loss of $94,000.
COMPARISON OF OPERATING RESULTS FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997.
GENERAL. Net income for the six months-ended June 30, 1998, was $667,000 or
$0.32 per diluted share compared to net income of $624,000 or $0.31 per diluted
share for the six months ended June 30, 1997. The $0.01 increase in diluted
earnings per share during the six month period ending June 30, 1998, was due to
the $43,000 increase in net income during the period partially off-set by an
increase in weighted average common shares and equivalents of 15,007.
INTEREST INCOME. Interest income for the six months-ended June 30, 1998,
totaled $8.6 million, as compared to $10.1 million for the comparable 1997
period. The $1.5 million decrease was the result of a one hundred forty-two
(142) basis point decrease in the weighted average yield on interest earning
assets to 8.44% for the six months ended June 30, 1998. The decrease in yield
was primarily attributable to the decreased investment in Discounted Loans
receivable, which typically have higher yields. Loan sales of Discounted Loans
receivable amounted to $6.9 million for the period, while mortgage loan sales
were $17.9 million. Also contributing to the decrease in interest income for the
period was the $1.6 million decrease in average interest-earning assets.
INTEREST EXPENSE. Interest expense for the six months ended June 30, 1998,
totaled $5.7 million as compared to $5.8 million for the comparable 1997 period.
The $173,000 decrease was the result of a $2.2 million decrease in average
interest-bearing liabilities to $210.5 million for the six months ended June 30,
1998, and an eleven (11) basis point decrease in the weighted average costs of
interest-bearing liabilities to 5.37% for the six months ended June 30, 1998.
NET INTEREST INCOME. Net interest income totaled $2.9 million for the six
months ended June 30, 1998, reflecting a decrease of $1.4 million from the
amount recorded in the comparable 1997 period. The decrease in net interest
income for the six months ended June 30, 1998, resulted from a one hundred
thirty-one (131) basis point decrease in the effective net spread to 3.07% from
4.38% for the comparable
38
<PAGE>
1997 period. Also contributing to the decrease was the $1.6 million decrease in
average interest-earning assets which contributed to the one hundred thirty-one
(131) basis point decline in net interest margin. Partially offsetting this
decrease was the $2.2 million decrease in the average dollar amount of interest-
bearing liabilities.
PROVISION FOR LOAN LOSSES. A provision for loan losses of $235,000 was
recorded during the six month period ended June 30, 1998, as compared to $60,000
for the six months ended June 30, 1997. At June 30, 1998, the allowance for loan
losses amounted to $880,000 or 17.19% of total non-performing loans (excluding
Discounted Loans) and .48% of net loans (excluding Discounted Loans). In the
determination of the provision for loan losses and adequacy of the corresponding
allowance for loan losses, management considers changes in the asset quality,
charge-off experience, and economic conditions. Management currently believes
that its allowance for loan losses is adequate. However, additions to such
allowance may be necessary in future periods.
NON-INTEREST INCOME. Noninterest income increased $2.2 million for the six
month period ended June 30, 1998 from the amount recorded in the comparable 1997
period. The increase was primarily the result of a $984,000 increase in gains on
sale of loans receivable, Discounted Loans receivable, securities
available-for-sale, mortgage backed securities, and REO, for the six month
period ended June 30, 1998. Also data processing income increased $511,000 for
the six month period ended June 30, 1998. Lastly, other income also increased
$663,000. The increase in other income was primarily attributable to significant
increases in gains on sale of hardware and increases in other ancillary services
at On-Line. Partially offsetting these increases was a $447,000 decrease in
servicing income from the PMSRs for the six month period ended June 30, 1998, as
a result of a $392,000 valuation reserve being recorded on the Company's
investment in three limited partnerships which invest in PMSRs. At June 30,
1998, the Company had $5.7 million invested in such limited partnership
investments.
NONINTEREST EXPENSE. Noninterest expense increased $782,000 for the six
month period ended June 30, 1998. This increase was primarily due to increases
in occupancy and data processing costs of services. Occupancy expense increased
$356,000 for the six month period ended June 30, 1998, primarily due to facility
improvements and equipment upgrades at both the Bank and On-Line. Also
contributing to the increase was the opening of the Bank's permanent branch
location on the Westside of Chicago, Illinois during May 1997. The $775,000
increase in data processing cost of services was due to hardware and software
upgrades and increased hardware and software costs of $319,000 as a result of
the increased hardware and software sales activity at On-Line during the six
month period ended June 30, 1998. See "Business of On-Line Financial Services,
Inc." Partially offsetting these increases were decreases in compensation
expense and other general and administrative expenses during the six month
period. Compensation expense decreased $184,000 for the six month period. Other
general and administrative expenses reflected a decrease of $172,000 for the six
month period ended June 30, 1998. These decreases were due to Company-wide cost
reduction measures.
INCOME TAX EXPENSE. For the six month period ended June 30, 1998, the
Company recorded a net income tax benefit of $40,000. The provision for income
tax decreased $197,000 compared to the six month period ended June 30, 1997. The
decline in the provision was primarily due to the recognition of tax benefits
during the period.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1997 AND DECEMBER 31, 1996
Total assets increased $7.0 million to $236.3 million at December 31, 1997
from $229.3 million at December 31, 1996. The increase in total assets was
funded primarily by an increase of $21.8 million in deposits, partially offset
by a $16.7 million decrease in borrowed money.
Loans receivable, which include loans held for sale and Discounted Loans
receivable, increased $10.9 million or 6.28% in 1997 to $184.4 million at
December 31, 1997. The increase in loans receivable for 1997
39
<PAGE>
was due to the origination of ARMs and the purchase of seasoned fixed-rate loans
secured by single-family residences. New originations and purchases contributed
$115.2 million in loans receivable and purchases contributed $8.9 million in
Discounted Loans receivable. These purchases and originations were primarily
funded by principal repayments of $49.1 million on loans receivable, Discounted
Loans receivable and mortgage-backed securities, proceeds from the sale of loans
receivable, Discounted Loans receivable and REO of $65.8 million and an increase
in deposits of $21.8 million, partially offset by a $16.7 million decrease in
borrowings. The 1996 originations and purchases, excluding Discounted Loan
purchases of $41.1 million, were $83.2 million primarily funded by a $27.1
million increase in deposits, a $12.7 million increase in borrowings, principal
repayments of $47.0 million and proceeds from the sale of loans receivable and
Discounted Loans receivable of $45.4 million.
Securities available-for-sale, which totaled $5.0 million at December 31,
1997, are carried at fair value and include $2.9 million of mortgage-backed
securities, $1.7 million of marketable equity securities, and $380,000 of
municipal securities. The balance of mortgage-backed securities decreased during
1997 by $2.0 million due to the sale of $1.2 million and principal repayments of
$855,000. Partially offsetting these decreases was a $1.4 million increase in
marketable equity securities.
Deposits increased $21.9 million to $172.5 at December 31, 1997, from $150.6
million at December 31, 1996. The increase is attributable to increased focus on
attracting retail core deposits.
Borrowings decreased $16.7 million to $34.2 million at December 31, 1997. At
December 31, 1997, borrowings consisted of FHLB advances totaling $23.8 million,
two lines of credit totaling $6.1 million, and capital lease obligations in the
amount of $3.8 million and other borrowings of $386,000. The decrease was
primarily due to the increase in deposits and decreased funding needs for the
purchase of seasoned loan packages.
Custodial escrow balances for loans serviced increased $618,000 to $6.4
million at December 31, 1997. The custodial accounts relate to escrowed payments
of taxes and insurance and the float on principal and interest payments on loans
serviced either for the Bank or on behalf of others by an independent mortgage
servicing operation. The custodial accounts related to loans serviced by others
are maintained at the Bank in interest-bearing accounts. The custodial accounts
associated with loans or PMSRs serviced for the Bank are maintained in
noninterest-bearing accounts. Due to the nature of custodial escrow deposits,
balances may fluctuate widely on a day-to-day basis.
Common shares outstanding increased 173,320 shares to 1,958,336 at December
31, 1997. The increase was due to the exercise of 129,988 stock options and the
issuance of 43,332 shares under the Stock Purchase Agreement with Deltec. The
shares were issued from authorized but unissued common stock.
COMPARISON OF OPERATING RESULTS FOR THE YEAR ENDED DECEMBER 31, 1997 TO THE YEAR
ENDED
DECEMBER 31, 1996
GENERAL. Net income for the year ended December 31, 1997 was $823,000 or
$.39 per diluted share, compared to net income of $1.3 million, or $.90 per
diluted share, in 1996. The $511,000 decrease in net income was attributable
primarily to an increase in noninterest expense.
INTEREST INCOME. Interest income increased $2.2 million or 13.6% to $18.3
million in 1997 from $16.1 million in 1996. The increase was primarily due to
the increase of $34.2 million in the average balance of interest-earning assets
to $197.2 million in 1997 from $163.0 million in 1996. Loans receivable
accounted for $29.6 million of the increase. Partially offsetting this increase
was a 60 basis point decrease in the weighted average yield on interest-earning
assets to 9.26% in 1997 from 9.86% in 1996.
INTEREST EXPENSE. Interest expense increased $2.2 million or 24.3% to $11.3
million in 1997 from $9.1 million in 1996, primarily as a result of a higher
average balance of interest-bearing liabilities. The average balance of
interest-bearing liabilities increased $33.5 million to $206.8 million from
$173.3 million in 1996. Deposits accounted for $35.5 million of the increase,
while other borrowings decreased $769,000. Also
40
<PAGE>
contributing to the increase in interest expense was a 22 basis point increase
in the weighted average cost of funds from 5.24% in 1996 to 5.46% in 1997.
NET INTEREST INCOME. Net interest income for the year remained relatively
unchanged from 1996 at $7.0 million. The net interest margin decreased from
4.29% in 1996 to 3.54% in 1997. The interest rate spread decreased to 3.80% in
1997 from 4.62% in 1996.
PROVISION FOR LOAN LOSSES. A provision for loan losses of $210,000 was
recorded during 1997, resulting in an allowance for loan losses of $814,000 or
.53% of total loans receivable, excluding Discounted Loans receivable, and
14.73% of total nonperforming loans, excluding Discounted Loans receivable, at
December 31, 1997. The loan loss provision in 1996 was $248,000 and the
allowance for loan losses at December 31, 1996 amounted to $665,000 or .53% of
total loans receivable, excluding Discounted Loans receivable. In the
determination of the provision for loan losses and adequacy of the corresponding
allowance for loan losses, management considers changes in the asset quality,
charge off experience and economic conditions.
NONINTEREST INCOME. Noninterest income increased $1.4 million to $15.6
million in 1997 from $14.2 million in 1996. The increase was primarily due to a
$931,000 increase in fees attributable to MARGO's operations; a $475,000
increase in gains on sale of securities; a $417,000 increase in data processing
income;, a $702,000 increase in other income primarily attributable to other
ancillary income at On-Line; and a $385,000 increase in gains on sale of REO.
Offsetting these increases was a $1.6 million decrease in gains on sale of
Discounted Loans receivable.
NONINTEREST EXPENSE. Noninterest expense increased $2.1 million to $21.4
million in 1997 from $19.3 million in 1996. This increase was primarily due to
increases in occupancy, professional fees, data processing cost of services, and
other expenses. Occupancy and computer equipment and software expense increased
$670,000 primarily due to significant leasehold improvements, hardware
purchases, and software upgrades at On-Line, as well as the opening of the
Bank's permanent branch location on the West Side of Chicago, Illinois. The
$473,000 increase in professional fees was caused by increases in legal and
accounting fees. Data processing cost of services increased $1.3 million
primarily due to significant increases in hardware and software cost of sales by
On-Line as a result of growth in the hardware and software sales division. Also
contributing to the increase in data processing cost of services were increases
in various third party data communication charges. See "Business of On-Line
Financial Services, Inc." The $129,000 increase in other expenses was partially
due to MARGO being fully operational in 1997 as well as increases at other
subsidiaries. Offsetting these increases in noninterest expenses was the
decrease in federal deposit insurance premiums as a result of the one time SAIF
assessment of $789,000 which was recognized during the year ended December 31,
1996.
INCOME TAX EXPENSE. The provision for income tax expense decreased $220,000
to $123,000 for the year ended December 31, 1997. The decrease was primarily due
to a decrease of pretax income of $731,000 and the utilization of approximately
$202,000 in available tax credits primarily attributable to the Company's
investment in low-income housing partnerships. The Company has low-income
housing tax credit carryforwards in the amount of $212,000 expiring in 2011 and
2012. In addition, the Company has net operating loss carryforwards of
approximately $267,000 expiring in 2004.
COMPARISON OF OPERATING RESULTS FOR THE YEAR ENDED DECEMBER 31, 1996 TO THE YEAR
ENDED
DECEMBER 31, 1995
GENERAL. Net income for the year ended December 31, 1996 was $1.3 million
or $.90 per diluted share, compared to net income of $1.7 million, or $1.24 per
diluted share, in 1995.
INTEREST INCOME. Interest income increased $2.1 million or 14.9% to $16.1
million in 1996 from $14.0 million in 1995. The increase was primarily due to
the increase of $8.4 million in the average balance of interest-earning assets
to $163.0 million in 1996 from $154.6 million in 1995, and an increase in the
41
<PAGE>
weighted average yield on interest-earning assets to 9.86% in 1996 from 9.05% in
1995. This increase in average yield was primarily due to the growth in the
higher yielding Discounted Loans receivable portfolio during 1996.
INTEREST EXPENSE. Interest expense increased $800,000 or 9.64% to $9.1
million in 1996 from $8.3 million in 1995, primarily as a result of a higher
average balance of interest bearing liabilities. The average balance of
interest-bearing liabilities increased $17.5 million to $173.3 million in 1996
from $155.8 million in 1995. Partially offsetting this increase was a 12 basis
point decrease in the weighted average cost of funds from 5.36% in 1995 to 5.24%
in 1996.
NET INTEREST INCOME. Net interest income totaled $7.0 million for the year
ended December 31, 1996, reflecting an increase of $1.4 million from the $5.6
million recorded in 1995. The net interest margin increased from 3.65% in 1995
to 4.29% in 1996. The interest rate spread increased to 4.62% in 1996 compared
to 3.69% in 1995, primarily as a result of the purchase of higher yielding
Discounted Loans.
PROVISION FOR LOAN LOSSES. A provision for loan losses of $248,000 was
recorded during 1996, bringing the allowance for loan losses to $665,000 or .53%
of total loans receivable, excluding Discounted Loans receivable, and 16.87% of
total nonperforming loans, excluding Discounted Loans receivable, at December
31, 1996. The loan loss provision in 1995 was $55,000 and the allowance for loan
losses at December 31, 1995 amounted to $587,000 or .45% of total loans
receivable, excluding Discounted Loans receivable. In the determination of the
provision for loan losses and adequacy of the corresponding allowance for loan
losses, management considers changes in the asset quality, charge off
experience, and economic conditions.
NONINTEREST INCOME. Noninterest income increased $9.7 million during 1996
to $14.2 million in 1996 from $4.5 million in 1995. The increase is primarily
due to On-Line, which generated $11.1 million in data processing revenue for the
year ended December 31, 1996 as compared to the $1.8 million generated for the
two months ending December 31, 1995. See "Business of On-Line Financial
Services, Inc." Also contributing to the increase in noninterest income was a
$781,000 increase in gains on sale of Discounted Loans receivable. This increase
was due to increased loan sale activity at Argo Mortgage. Offsetting these
increases was a $364,000 increase in losses realized on the sale of REO.
NONINTEREST EXPENSE. Noninterest expense increased $11.6 million to $19.3
million in 1996 from $7.7 million in 1995. This increase was primarily due to
the acquisition of On-Line in the fourth quarter of 1995. The full year of
operations of On-Line resulted in increases of $3.8 million in compensation and
benefits, $658,000 in occupancy and equipment expense, $1.4 million in data
processing servicing costs, $715,000 in other general and administrative costs,
$1.7 million in software and equipment expenses, and $154,000 in legal and
professional fees. Also contributing to the increase in noninterest expense in
1996 was the $804,000 increase in FDIC insurance premiums. This was primarily
the result of the special SAIF recapitalization assessment of $789,000 which was
paid on September 30, 1996.
INCOME TAX EXPENSE. The provision for income tax expense decreased $324,000
to $343,000 for the year ended December 31, 1996. The decrease was primarily due
to a decrease of pretax income of $731,000 and the utilization of approximately
$179,000 in available tax credits primarily attributable to the Company's
investment in low-income housing partnerships. The Company had low-income
housing tax credit carryforwards in the amount of $358,000 expiring in 2011 and
2012. In addition, the Company had net operating loss carryforwards available of
approximately $323,000 expiring in 2004.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of funds include deposits, proceeds from principal and
interest payments on the loan and mortgage-backed securities portfolio,
custodial deposit accounts related to loans serviced for others, maturing
investments, borrowed money and loan sales. The most liquid assets are cash and
short-term investments. The levels of these assets are dependent on operating,
financing, and investing activities
42
<PAGE>
during any given period. Cash and interest-earning deposits totaled $18.6
million at June 30, 1998. The Company has adequate alternative funding sources
if short-term liquidity needs arise.
The primary investment activity of the Company is the origination and
purchase of mortgage loans. During the six months ended June 30, 1998 and years
ended December 31, 1997 and 1996, the Company originated and purchased $77.7
million, $115.2 million and $83.2 million of loans receivable, respectively, and
$296,000, $8.9 million and $41.1 million of Discounted Loans receivable,
respectively. Purchases of securities totaled $5.4 million, $8.1 million and
$152,000 for the six months ended June 30, 1998 and years ended December 31,
1997 and 1996, respectively. These investing activities were primarily funded by
principal repayments on loans and mortgage-backed securities of $35.2 million,
$49.1 million, and $47.0 million, respectively, and an increase in deposits of
$29.0 million, $21.8 million and $27.1 million for the six months ended June 30,
1998 and the years ended December 31, 1997 and 1996, respectively. Also
providing funding was the $32.9 million, $74.5 million and $48.1 million in
total proceeds that resulted from the sale of loans receivable, Discounted Loans
receivable, securities and REO for the six months ended June 30, 1998 and the
years ended December 31, 1997 and 1996.
The Bank is required to maintain minimum levels of liquid assets as defined
by OTS regulation. At June 30, 1998 liquid assets represented 6.7% of its
liquidity base as compared to the required level of 4.0%. The level of liquidity
maintained is believed by management to be adequate to meet the requirements of
normal operations, potential deposit outflows, and current loan demand. Cash
flow projections are updated regularly to assure necessary liquidity.
Liquidity management for the Company is both a daily and long-term function
of the Company's management. The Company's management meets on a daily basis and
monitors interest rates, current and projected commitments to purchase loans and
the likelihood of funding such commitments, and projected cash flows. Excess
funds are generally invested in short-term investments.
At June 30, 1998 the Bank's capital exceeded all capital requirements of the
OTS. The Bank's tangible, core, and risk-based capital ratios were 5.68%, 5.68%,
and 11.05%, respectively. The Bank is considered "well capitalized" under OTS
prompt corrective action regulations.
At June 30, 1998 , the Bank had outstanding loan commitments and unused
lines of credit of $11.3 million and $3.5 million, respectively. The Bank also
had Community Reinvestment Act investment commitments outstanding of $2.9
million. The Bank anticipates that it will have sufficient funds available to
meet its current commitments.
The OTS regulatory capital requirements also incorporate an interest rate
risk component. Savings institutions with "above normal" interest rate risk
exposure are subject to a deduction from total capital for purposes of
calculating their risk-based capital requirements. A savings institution's
interest rate risk is measured by the decline in the NPV of the estimated market
value of interest sensitive assets, liabilities, and off-balance sheet contracts
that would result from a hypothetical 200 basis point increase or decrease in
market interest rates divided by the estimated economic value of the
institution's assets. In calculating its total capital under the risk-based
capital rule, a savings institution whose measured interest rate risk exposure
exceeds 2.0% of the estimated market value of interest sensitive assets must
deduct an amount equal to one-half of the difference between the institution's
measured interest rate risk component on a case-by-case basis. A savings
institution with assets of less than $300.0 million and risk-based capital
ratios in excess of 12.0% is not subject to the interest rate risk component,
unless the OTS determines otherwise. For the present time, the OTS has deferred
implementation of the interest rate risk component. At June 30, 1998, the Bank
met each of its capital requirements, and it is anticipated that the Bank will
not be subject to the interest rate risk component.
43
<PAGE>
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
("GAAP"), which require the measurement of financial position and operating
results in terms of historical dollar amounts without considering the changes in
the relative purchasing power of money over time due to inflation. The impact of
inflation is reflected in the increased cost of the Company's operations. Unlike
industrial companies, nearly all of the assets and liabilities of the Company
are monetary in nature. As a result, interest rates have a greater impact on the
Company's performance than do the effects of general levels of inflation.
Interest rates do not necessarily move in the same direction or to the same
extent as the prices of goods and services. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Management of
Interest Rate Risk."
YEAR 2000
Many existing computer programs use only two digits to identify a year in a
date field. These programs were designed and developed without considering the
impact of a change in century. If not corrected, many computer programs could
fail, or create erroneous results that could affect a company's ability to do
business prior to, at, or after December 31, 1999.
Financial service organizations such as the Bank are heavily reliant upon
computer systems in processing and accounting for services provided to
customers. Substantially all of the Company's major computer processing is
contracted with third party providers. Although the contracted vendors bear the
responsibility of making their systems "Year 2000 Ready," assuming the costs
associated with necessary changes, keeping the Company apprised of their
progress in meeting established benchmarks, and certifying to the Company that
the systems are in fact "Year 2000 Ready," the Company bears ultimate
responsibility for testing, due diligence and assurance that its major vendors
will continue to provide service without interruption due to the change in
century at year-end 1999.
In 1996, the Company and the Bank established an internal Technology
Committee to identify and/or resolve issues related to the Year 2000 date
change. The Technology Committee has inventoried all of the systems used by the
Company and the Bank, and has identified those that are deemed "critical" to its
business. As a part of its responsibilities, the Committee maintains regular
communications with vendors providing critical systems to the Company and the
Bank to verify that 1) testing is performed regularly, and 2) necessary changes
are being identified and addressed. The Bank management estimates that its Year
2000 Readiness expenses will total approximately $100,000.
On-Line has initiated a company-wide business planning initiative to prepare
On-Line's multiple platform environment for the Year 2000, which includes due
diligence efforts, certain program remediation, and testing of all
date-sensitive hardware and operating systems, financial application system
product offerings, and other ancillary interface applications and systems.
On-Line has established four primary Year 2000 Committees: 1) a Thrift System
Committee to oversee, convert, implement and test Year 2000 renovation efforts
for the Thrift (COMMAND) proprietary application system product; 2) a Third
Party Software Committee to oversee due diligence efforts and test primarily the
BANKFORCE-Registered Trademark- application system product for Year 2000
Readiness, which is a third party system that On-Line licenses from ITI on
behalf of its clients; 3) a Network Communications Committee to test existing
hardware and software residing or running on On-Line's local and/or wide area
network; and 4) a Business Operations Committee to perform due diligence and
testing procedures on primary operational vendors such as telecommunication
carriers, disaster recovery providers, certain maintenance vendors, and other
software used for administrative functions.
On-Line expects to incur primarily internal staffing and consulting services
expenses related to internal Year 2000 efforts, as well as costs for software
tools and a dedicated testing platform. Such costs for testing and conversion of
On-Line's infrastructure and applications within its processing environment
44
<PAGE>
are estimated at $600,000 to $800,000 over the next three years. On-Line
estimates approximately $450,000 to $600,000 will be related to salaries and
benefits for additional personnel and Year 2000 incentive plans. The remaining
$150,000 to $200,000 is estimated for indirect costs related to depreciation and
amortization expense on equipment and software. Through June 30, 1998, On-Line
has incurred approximately $100,000 in direct costs and $7,000 in indirect costs
related to Year 2000 efforts. In addition to the direct and indirect costs
necessary for On-Line to meet its contractual and regulatory requirements for
its existing and future clients to ensure "Year 2000 Readiness", On-Line will
also incur certain costs related to optional subscription services for its
clients to perform their own Year 2000 testing both at On-Line's facility and
from their institution locations. Costs associated with these optional services
are expected to be offset by revenues earned from providing these testing
services.
IMPACT OF NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 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. SFAS No. 130 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. SFAS No. 130 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 net worth and additional paid-in capital in the equity section
of a statement of financial position. SFAS No. 130 is effective for fiscal years
beginning after December 15, 1997. Reclassification of financial statements for
earlier periods provided for comparative purposes are required. The Company
adopted SFAS No. 130 on January 1, 1998. The adoption of SFAS No. 130 did not
have an effect on the Consolidated Financial Statements of the Company.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 requires
disclosure for each segment that are similar to those required under current
standards with the addition of quarterly disclosure requirements and a finer
partitioning of geographic disclosures. It requires limited segment data on a
quarterly basis. It also requires geographic data by country, as opposed to
broader geographic regions as permitted under current standards. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997, with earlier
application permitted. Management of the Company does not expect that the
adoption of SFAS No. 131 will have a material effect on the Consolidated
Financial Statements of the Company.
The FASB has issued SFAS No. 132, "Employers' Disclosures about Pensions and
Other Post-Retirement Benefits," which is effective for fiscal years beginning
after December 15, 1997. This statement revises employers' disclosures about
pension and other post-retirement benefit plans. It does not change the
measurement of recognition of those plans. It standardizes the disclosure
requirements for pensions and other post-retirement benefits to the extent
practicable, requires additional information on changes in the benefit
obligations and fair values of plan assets that will facilitate financial
analysis, and eliminates certain disclosures that are no longer as useful. The
Company adopted SFAS No. 132 on January 1, 1998. The adoption did not have an
effect on the Consolidated Financial Statements of the Company.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," was issued by FASB in June 1998. SFAS No. 133 standardizes the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts. Under the standard, entities are required to carry
all derivative instruments at fair value. The accounting for changes in the fair
value (i.e., gains or losses) of a derivative instrument depends on whether it
has been designated and qualifies as part of a hedging relationship and, if so,
on the reason for holding it. If certain conditions are met, entities may elect
to designate a derivative instrument as a hedge of exposures to changes in fair
values, cash flows, or foreign currencies. If the hedged exposure is a fair
value exposure, the gain or loss on the derivative instrument is
45
<PAGE>
recognized in earnings in the period of change together with the offsetting loss
or gain on the hedged item attributable to the risk being hedged. If the hedged
exposure is a cash flow exposure, the effective portion of the gain or loss on
the derivative instruments is reported initially as a component of other
comprehensive income (outside earnings) and subsequently reclassified into
earnings when the forecasted transaction affects earnings. Any amounts excluded
from the assessment of hedge effectiveness as well as the ineffective portion of
the gain or loss is reported in earnings immediately. The Company anticipates
that the adoption of SFAS No. 133 will not have a material impact on the
Company's financial statements.
BUSINESS OF THE COMPANY
DEVELOPMENT OF THE COMPANY
The Company was incorporated in August 1987, for the purpose of acquiring
the Bank. On May 26, 1992, the Company acquired a neighboring savings and loan
association ("Dolton Riverdale") pursuant to a public supervisory merger
conversion (the "Merger-Conversion"). The transaction was accounted for under
the pooling of interests method of accounting. No goodwill or other intangible
assets were recorded as a result of the transaction. As part of the Merger
Conversion, the Company sold an additional 299,000 shares of Common Stock and
received net proceeds of $861,000. From December 31, 1987 to June 30, 1998, the
Bank's assets have increased from $25.6 million to $244.4 million.
On October 31, 1995, the Company acquired On-Line, an Oak Brook, Illinois
based computer services bureau which, at the time of the acquisition, served
only bank, thrift and mortgage banking clients throughout the Midwest. The
original transaction value, including asset notes and contingent payments (based
on future defined net revenues of On-Line over a seven year period ending
October 2002), was not to exceed $10.0 million. During 1997, the Company
asserted claims that the selling shareholders of On-Line had breached certain
representations and warranties in the purchase contract. Following a series of
negotiations, the selling shareholders agreed to reduce the purchase price by
$1.1 million. As a result, at December 31, 1997, the amount paid or payable,
exclusive of the future contingent payments for On-Line was $836,000 less than
the fair value of the net assets acquired. Any future contingent payments will
reduce this difference. In December 1997, the Company purchased from certain of
the former shareholders their rights to 25.45% of the future contingent
payments. The Company paid $172,000 for these future contingent payment rights.
Additionally, a payment of $479,000 was made in April 1998, further reducing the
remaining contingent payment to former stockholders to an amount not to exceed
$3.5 million. Management anticipates funding any required future payments with
borrowed funds and excess funds generated from operations and, to the extent
necessary, earnings and assets of the Company.
On December 31, 1996, the Company entered into the Stock Purchase Agreement
with Deltec. Under the terms of the Stock Purchase Agreement, the Company agreed
to issue and sell 446,256 shares of the Company's Common Stock to Deltec at a
purchase price of $9.50 per share. Total proceeds from this transaction were
approximately $4.2 million, and the net proceeds of the transaction were $4.0
million following payment of a 5% investment advisory fee. The Stock Purchase
Agreement also provides that Deltec may acquire additional shares of Common
Stock from the Company when the Company issues or sells additional shares to
third parties in order that Deltec can maintain a 25% ownership in the Company's
Common Stock.
Unlike many savings and loan holding companies, the Company is an active
holding company with only a portion of its future anticipated operating income
dependent upon the earnings of the Bank. As an operating company, the Company
has assets, liabilities and income that are unrelated to the operations of the
Bank. Among the assets of the Company is a 98.4% investment in Empire, which
engages in the purchase and disposition of Discounted Loans. See "Business of
Empire/Argo Mortgage, LLC." The Company's assets at June 30, 1998, on an
unconsolidated basis include its investment in the Bank of $14.6 million, its
investment in On-Line of $5.7 million, and its investment in the majority owned
Empire
46
<PAGE>
of $1.1 million. The Company also had outstanding borrowings on an
unconsolidated basis in the amount of $6.4 million at June 30, 1998, incurred in
connection with capital infusions to its subsidiaries.
At June 30, 1998, on a consolidated basis, the Company had assets totaling
$259.8 million, liabilities totaling $241.0 million and total stockholders'
equity of $18.7 million. The Company is a unitary savings and loan holding
company and is registered as such with the OTS. The Company is a FHA approved
originator and servicer, a licensed Illinois mortgage broker and an approved
FannieMae servicer. The principal executive offices of the Company are located
at 7600 West 63rd Street, Summit, Illinois and its telephone number is (708)
496-6010.
[LOGO]
- ------------------------
* Denotes inactive subsidiary.
COMPANY PERSONNEL
As of June 30, 1998, the Bank including its subsidiaries, had sixty-one (61)
full-time employees (including twelve (12) MARGO full-time employees
consolidated into the Bank's payroll) and fifteen (15) part-time employees.
On-Line had eighty-nine (89) full-time employees. The Company's employees are
not represented by a collective bargaining agreement. The Company believes its
relationship with its employees is good.
COMPANY PROPERTIES
The executive offices of the Company and the home office of the Bank are
located at 7600 West 63rd Street, Summit, Illinois 60501. On-Line's offices are
located at 900 Commerce Drive, Oak Brook, Illinois 60523.
47
<PAGE>
The following table sets forth the location of and certain additional
information regarding the offices of the Company and its subsidiaries at June
30, 1998.
<TABLE>
<CAPTION>
NET BOOK VALUE
OF PROPERTY OR
ORIGINAL LEASEHOLD
YEAR IMPROVEMENTS AT
LEASED LEASED DATE OF JUNE 30, 1998
OR OR LEASE (DOLLARS IN
LOCATION OWNED ACQUIRED EXPIRATION THOUSANDS)
- ----------------------------- --------- ----------- ------------ ---------------------
<S> <C> <C> <C> <C>
14076 Lincoln Avenue Owned 1992 -- $ 451
Dolton, IL 60419
7600 W. 63 Street Owned 1987 -- 882
Summit, IL 60501
8267 S. Roberts Road Owned 1987 -- 360
Bridgeview, IL 60455
2154 W. Madison Street Owned 1994 -- 914
Chicago, IL 60612
5818 S. Archer Owned 1988 -- 441
Summit, IL 60501
6121 Washington Street Leased 1995 Sept. 1999 48
Gurnee, IL 60031(1)
7604-06 W. 63rd Street Leased 1992 Mar. 2002 154
Summit, IL 60501
900 Commerce Drive Leased 1988 Oct. 2006 1,027
Oakbrook, IL 60523
------
$ 4,277
------
------
</TABLE>
- ------------------------
(1) On July 16, 1998 the sale of the Gurnee branch was completed. On September
1, 1998, the Bank opened a new branch at Dearborn Station. See "Recent
Developments."
COMPANY LEGAL PROCEEDINGS
The Company is not involved in any pending legal proceedings other than
legal proceedings occurring in the ordinary course of business. Management
believes that none of these legal proceedings, individually or in the aggregate,
will have a material adverse impact on the results of operations or financial
condition of the Company.
48
<PAGE>
BUSINESS OF THE BANK
BACKGROUND OF THE BANK
The Bank was originally chartered in 1908 as a mutual savings and loan
association in the State of Illinois. The Bank converted to a federal stock
charter in 1982 and was determined to be insolvent by the Federal Savings and
Loan Insurance Corporation ("FSLIC") in 1987. The Company acquired the Bank on
November 17, 1987. The Bank is a member of the FHLB System and its deposits are
insured by the FDIC under the SAIF. As of June 30, 1998, the Bank had five
branch offices, located in Cook and Lake County, Illinois. The home office of
the Bank is located at 7600 West 63rd Street, Summit, Illinois, and its
telephone number is (708) 496-6010.
On May 29, 1996, the Bank incorporated a majority-owned subsidiary, MARGO.
MARGO is an Illinois chartered limited liability corporation whose members are
the Bank and Nip'n Tuck, Inc., an Illinois corporation. MARGO's primary
objectives are to increase loan origination volume and to serve as a wholesale
mortgage banking operation using a network of brokers, Correspondents and
conduits. The Bank has a 50.1% interest in MARGO.
The Bank's primary business is the solicitation of savings deposits from the
general public and the purchase or origination of both Conventional and
Portfolio Loans secured by one- to four-family residential real estate. Through
its majority-owned subsidiary, MARGO, and its wholly-owned subsidiary, Argo
Mortgage, the Bank has engaged in mortgage banking activities that focus on the
origination, purchase and sale of mortgage loans in the secondary market. The
Bank, through MARGO, also offers, to a much lesser extent, Expanded Criteria
Loans. These one-to four-family loans are generally not Agency Qualified, due to
the borrower's credit profile, and are not as readily saleable in the secondary
market as Conventional Loans. The Expanded Criteria Loans also include home
equity lines of credit. See "Risk Factors--Risks Associated with Portfolio and
Expanded Criteria Lending." The Bank generates income by the sale of mortgage
loans generally on a "servicing released" basis, into the secondary market and
through investment in partnerships in PMSRs. More recently, the Bank also
generates fee income from an expanding network of ATMs in the Chicago area and
service fees.
Through Argo Mortgage, the Bank also has acquired Discounted Loans for which
the borrowers may not be current as to principal and interest payments. In
determining the amount it will bid to acquire such loans at public sales and
auctions, the Bank estimates the amounts it will realize through foreclosure,
collection efforts, or other resolution of each loan and the length of time
required to complete the collection process. Investment in these assets has
often resulted in higher yields and gains. However, the Bank has also incurred
losses on certain properties which have become real estate owned. See "Business
of Empire/Argo Mortgage LLC" for discussion of Discounted Loans purchased by
Empire.
The Bank continues to expand its operations to include additional ATMs, and
real estate secured consumer lending. The Bank also plans to expand, on a
limited basis, its commercial real estate lending and commercial checking. The
Bank also invests funds in securities approved for investment by federal
regulations, including obligations of the United States Government and its
agencies.
Beginning in the fourth quarter of 1996, the Bank began to focus its
resources on Conventional Loans receivable originated through its majority owned
subsidiary MARGO and began to reduce its position in Discounted Loans
receivable. As a result of the Bank's business strategy, the balance of the
Discounted Loans receivable portfolio decreased from $47.7 million or 20.8% of
total assets at December 31, 1996, to $30.6 million or 12.9% of total assets at
December 31, 1997, to $17.0 million or 6.5% of total assets at June 30, 1998.
GENERAL
The discussion that follows relates primarily to the business of the Bank, a
federally-chartered depository institution. The primary lending activities of
the Company are undertaken by the Bank,
49
<PAGE>
accordingly, the discussion under the caption "Lending Activities" materially
relates only to the Bank. The Company does, however, have certain investments in
loans on an unconsolidated basis at the holding company level, as well as
certain borrowings unrelated to the activities of the Bank. Accordingly, there
are certain references to the Company's separate activities in this section. See
also "Business of Empire/Argo LLC" for a discussion of Discounted Loans
purchased by Empire.
BUSINESS STRATEGY OF THE BANK
The overall strategy of the Bank is to increase stockholder value by
acquiring low cost liabilities, generating traditional and electronic fee
income, investing in assets providing consistent returns and reducing
non-performing assets. Specifically, the Bank intends to focus on traditional
banking activities and move the non-traditional functions, such as Discounted
Loan activities, to the Company level. Management expects to meet its goals by:
GROWING THE BANK IN THE LOCAL MARKET. From December 31, 1987 to June 30,
1998, the Bank has grown in asset size from $25.6 million to $244.4 million.
This growth has been achieved through (1) an increase in loan purchases and
originations funded through an increase in deposits, (2) the acquisition of
Dolton Riverdale, (3) the opening of new branches and (4) a marketing strategy
aimed at niche markets, including senior citizens and affordable housing
opportunities. Management intends to prudently expand the operations of the Bank
by strategically opening efficient branches within its Primary Market Area which
become available due to consolidation in the financial institution industry,
while streamlining its existing branch network as necessary.
EXPANDING OF ONE- TO FOUR-FAMILY LENDING. The Bank will continue to expand
the origination of one-to four-family loans through MARGO primarily on a
wholesale basis through its network of Correspondents. To a lesser extent, the
Bank also plans to expand its origination of one-to four-family loans on a
retail basis, through its branch network. In particular, the Bank intends to
increase ARM product lending which is retained for portfolio through geographic
expansion of its network of Correspondents and increased penetration in existing
markets. Implementation of new electronic access and delivery systems and
technology upgrades to MARGO's underwriting system will support this expansion
effort. Additionally, the Bank intends to initiate a warehouse lending program
whereby the Bank would extend funding to qualified mortgage brokers and bankers
for the origination of single-family mortgage loans to be held by the Bank for
resale in the secondary market. Such loans would not be originated, however,
until such time as the Bank and the mortgage broker had received a firm
commitment for the purchase of such loan in the secondary market. There can be
no assurances as to when or if the Bank will begin such warehouse lending
activities.
CONTINUING STRATEGIC PURCHASES AND SALES OF LOANS. The Bank will continue
to actively seek to purchase loans which the Bank believes to be undervalued
relative to the market and which the Bank believes can be later resold at a
profit.
MAINTAINING COMMUNITY ORIENTATION. Management is seeking to maintain the
value of the Bank's existing franchises in its Primary Market Area, which is
based in large part upon its long-standing reputation for a high level of
customer service in the delivery of traditional thrift products and services and
active community involvement. Management intends to maintain the Bank's
community orientation by continuing to emphasize traditional deposit products
and loan products consisting of primarily one- to four-family residential
mortgages. The Bank has been and intends to continue to be actively engaged in
community lending and development activities such as affordable housing. See
"Business of the Bank-- Lending Activities--General."
NON-PERFORMING ASSETS. The Bank intends to reduce non-performing assets by
continuing to decrease its emphasis on the purchase of Discounted Loans, and
reducing its REO. In May 1998, the Bank hired a full time asset manager with 16
years of experience. Prior to such time, most of the Bank's asset
50
<PAGE>
management function was outsourced. Additionally, the Bank has been and intends
to take additional steps to work out its existing non-performing loans by
bringing such loans current or foreclosing on such loans and selling the
underlying properties.
INCREASING FEE INCOME. Management plans to increase fee income through the
expansion of its ATM network both in its Primary Market Area and outside its
Primary Market Area. At June 30, 1998, the Bank has 21 ATMs strategically
located in such high traffic urban areas as retail food stores, gas stations,
hotels and other high volume areas. A number of these ATMs are located in low
income neighborhoods where there is little competition. Management is in the
process of installing several additional ATMs and plans to expand its ATM cash
withdrawal network throughout the Chicago area and, in the near future, to
additional states. Fee income from ATMs for the six months ended June 30, 1998,
totaled $171,000 compared to $102,000 for the six months ended June 30, 1997.
INCREASE IN CORE DEPOSIT BASE. The Bank has developed certain marketing
relationships in an effort to increase its core deposit base. For instance, the
Bank holds exclusive rights to use the Chicago Bull's logo on ATM cards and
offers such a card to its customers in connection with the opening of a new
savings or checking account. The Bank has also created a GOLDTIMER'S CLUB with
specific marketing efforts aimed at senior citizens. The Bank maintains and
services this customer base through seminars, travel events and special events
such as polka parties. The Bank plans to further develop and implement such
sector driven programs.
MARKET AREA
The Bank considers its Primary Market Area to be the greater Chicago
metropolitan area. The Bank maintains its headquarters and a branch in Summit,
Illinois. It also has branch offices in Bridgeview, the West Side of Chicago and
Dolton, Illinois. See "Recent Developments." The areas surrounding Summit,
Bridgeview, and Dolton are urban and are comprised of high density residential
neighborhoods interspersed with mixed-use and heavily industrialized areas. This
area is fully developed with a relatively large number of generally older homes.
Median household income levels are average, and a large portion of household
earnings are derived from traditional "blue collar" local manufacturing
facilities. All branch locations have excellent access to major transportation
routes, including Interstates 290, 294, 94 and 55, as well as public
transportation, both rail and bus.
In recent periods, the Bank, has expanded the origination of loans outside
of its Primary Market Area through its network of MARGO Correspondents. As of
June 30, 1998, the Bank was originating loans in numerous states, with a primary
focus in Illinois. See "--Lending Activities--Loan Originations and Purchases."
LENDING ACTIVITIES
GENERAL. The Company's net loans receivable, which includes loans held for
sale, Portfolio Loans receivable and Discounted Loans receivable, totaled $200.9
million, excluding accrued interest, at June 30, 1998, representing 77.3% of the
Company's total assets. On that date, $191.7 million of total loans outstanding
or 92.8% of the Bank's total gross loan portfolio, consisted of loans secured by
first mortgages on one-to four-family residential properties, $3.1 million, or
1.52%, consisted of loans secured by multi-family properties, and $1.4 million,
or .68%, consisted of loans that are secured by commercial buildings primarily
in suburban Cook and Lake County. In addition, at June 30, 1998, $10.4 million,
or 5.04% of the Bank's loan portfolio consisted of other loans, primarily
comprised of home equity and construction loans.
The Bank has focused its lending activities on the generation of gains from
the sale of loans, as well as increasing the interest-rate sensitivity of its
loan portfolio. The Bank originates long-term, fixed-rate mortgage loans with 15
and 30 year maturities generally for immediate sale in the secondary mortgage
market. Such loans are originated, in most instances, through its mortgage
brokerage subsidiary, MARGO,
51
<PAGE>
through the Bank's branch network and through MARGO's national network of
Correspondents. Historically, the Bank's lending activity has also included the
origination and purchase of ARMs. The majority of the growth in the Bank's loan
balances in the current year is due to the purchase and origination of
adjustable-rate loans and seasoned fixed-rate loans secured by single-family
residences located throughout the country. The Bank's policy of purchasing ARM
loans and seasoned higher yielding fixed-rate loans is intended to increase the
interest rate sensitivity of its assets without decreasing the yield on its
interest-earning assets. The Company originated and purchased approximately
$77.7 million of loans for portfolio and purchased $296,000 of Discounted Loans
receivable during the first six months of 1998.
ANALYSIS OF LOAN PORTFOLIO. The following table sets forth the composition
of the Company's loan portfolio, including loans held for sale, in dollar
amounts and in percentages of the respective portfolios at the dates indicated.
<TABLE>
<CAPTION>
AT JUNE 30, AT DECEMBER 31,
-------------------- ---------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------------- -------------------- -------------------- -------------------- ---------
% OF % OF % OF % OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT
--------- --------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Mortgage Loans:
One- to four-family......... $ 191,684 92.76% $ 177,521 92.20% $ 177,345 92.50% $ 143,931 93.47% $ 112,393
Multi-family................ 3,139 1.52 1,252 .65 1,468 .77 1,180 .77 1,177
Commercial.................. 1,412 .68 1,951 1.01 4,523 2.36 2,379 1.55 1,684
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Total mortgage loans.... 196,235 94.96 180,724 93.86 183,336 95.63 147,490 95.89 115,254
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Other loans:
Automobile.................. -- -- 4 -- 4 -- 5 -- 28
Mobile home................. 198 .10 208 .11 248 .13 379 .25 472
Other (1)................... 10,215 4.94 11,597 6.03 8,142 4.24 5,941 3.86 4,364
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Total other loans....... 10,413 5.04 11,809 6.14 8,394 4.37 6,325 4.11 4,864
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Total loans
receivable(2)......... 206,648 100.00% 192,533 100.00% 191,730 100.00% 153,815 100.00% 120,118
--------- --------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- ---------
Less:
Unearned discounts, premiums
and deferred loans, net... 4,889 7,361 17,636 10,848 1,442
Allowance for loan losses... 880 814 665 587 613
--------- --------- --------- --------- ---------
Loans receivable, net....... $ 200,879 $ 184,358 $ 173,429 $ 142,380 $ 118,063
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
<CAPTION>
1993
----------------------
% OF % OF
TOTAL AMOUNT TOTAL
--------- ----------- ---------
<S> <C> <C> <C>
Mortgage Loans:
One- to four-family......... 93.57% $ 80,059 86.92%
Multi-family................ .98 1,799 1.95
Commercial.................. 1.40 1,454 1.59
--------- ----------- ---------
Total mortgage loans.... 95.95 $ 83,312 90.46
--------- ----------- ---------
Other loans:
Automobile.................. .02 102 .11
Mobile home................. .39 636 .69
Other (1)................... 3.64 8,052 8.74
--------- ----------- ---------
Total other loans....... 4.05 8,790 9.54
--------- ----------- ---------
Total loans
receivable(2)......... 100.00% 92,102 100.00%
--------- ----------- ---------
--------- ---------
Less:
Unearned discounts, premiums
and deferred loans, net... 1,350
Allowance for loan losses... 613
-----------
Loans receivable, net....... $ 90,139
-----------
-----------
</TABLE>
- ------------------------
(1) Consists primarily of $5.7 million of home equity loans secured by one-to
four-family properties, and $3.6 million of construction loans at June 30,
1998.
(2) Includes loans receivable and Discounted Loans receivable.
52
<PAGE>
LOAN ORIGINATIONS, PURCHASES AND SALES. Set forth below is a table showing
the Company's loan originations, purchases and sales for the periods indicated:
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
-------------------- ----------------------------------
1998 1997 1997 1996 1995
--------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Loans originated:
One- to four-family (1).............................. $ 31,724 $ 29,939 $ 56,318 $ 12,904 $ 10,292
Multi-family and commercial.......................... -- 333 333 1,895 890
--------- --------- ---------- ---------- ----------
Total mortgage loans originated.................. 31,724 30,272 56,651 14,799 11,182
Other loans 7,645 8,892 18,137 20,914 15,504
--------- --------- ---------- ---------- ----------
Total loans originated........................... 39,369 39,164 74,788 35,713 26,686
Loans purchased:
Mortgage loans....................................... 38,217 19,770 39,521 58,722 75,371
Discounted loans..................................... 296 8,731 8,858 41,061 19,904
Other loans.......................................... 628 -- -- -- --
--------- --------- ---------- ---------- ----------
Total loans purchased............................ 39,141 28,501 48,379 99,783 95,275
--------- --------- ---------- ---------- ----------
Total loans originated and purchased............. $ 78,510 $ 67,665 $ 123,167 $ 135,496 $ 121,961
--------- --------- ---------- ---------- ----------
--------- --------- ---------- ---------- ----------
Loans Sold:
Mortgage loans receivable (2)........................ $ 17,530 $ 26,945 $ 48,466 $ 39,550 $ 45,084
Discounted loans..................................... 8,639 21,310 20,711 7,515 5,432
Other loans.......................................... 1,067 -- -- -- --
--------- --------- ---------- ---------- ----------
Total loans sold................................. $ 27,236 $ 48,255 $ 69,177 $ 47,065 $ 50,516
--------- --------- ---------- ---------- ----------
--------- --------- ---------- ---------- ----------
</TABLE>
- ------------------------
(1) Originations and sales exclude $38.0 million for the six months ended June
30, 1998 and $38.0 million and $3.5 million for the years ended December 31,
1997 and 1996, respectively of loans originated and immediately sold
directly to third party investors.
(2) Gains related to these sales were $715,000 and $23,000 for the six month
periods ended June 30, 1998 and 1997 and were $279,000, $1,843,000 and
$1,062,000 for the years ended December 31, 1997, 1996 and 1995,
respectively.
LOAN MATURITY AND REPRICING. The following table shows the maturity or
period to repricing of the Company's loan portfolio at June 30, 1998. Loans that
have adjustable rates are shown as being due in the period during which the
interest rates are next subject to change. The table does not include
prepayments or scheduled principal amortization. Prepayments and scheduled
principal amortization on mortgage loans
53
<PAGE>
totaled $35.0 million, $48.2 million, $46.2 million, and $35.9 million for the
six months ended June 30, 1998 and the years ended December 31, 1997, 1996, and
1995, respectively.
<TABLE>
<CAPTION>
LOANS
---------------------------------------------------------------
ONE- TO COMMERCIAL
FOUR- FAMILY MULTI-FAMILY REAL ESTATE OTHER(1) TOTAL
------------ ------------- ----------- --------- ----------
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Amounts Due:
Within one year................................ $ 66,770 $ 1,716 $ 184 $ 9,683 $ 78,353
------------ ------ ----------- --------- ----------
After one year:
One to three years........................... 10,580 524 660 180 11,944
Three to five years.......................... 1,824 898 568 53 3,343
Five to 10 years............................. 15,605 -- -- 228 15,833
10 to 20 years............................... 10,911 -- -- 265 11,176
Over 20 years................................ 85,999 -- -- -- 85,999
------------ ------ ----------- --------- ----------
Total due after one year......................... 124,919 1,422 1,228 726 128,295
------------ ------ ----------- --------- ----------
Total amounts due................................ 191,689 3,138 1,412 10,409 206,648
Less:
Unearned discounts, premiums and deferred loans
fees, net.................................... 4,926 -- -- (37) 4,889
Allowance for loan losses.................... 646 14 216 4 880
------------ ------ ----------- --------- ----------
Loans receivable, net........................ $ 186,117 $ 3,124 $ 1,196 $ 10,442 $ 200,879
------------ ------ ----------- --------- ----------
------------ ------ ----------- --------- ----------
</TABLE>
- ------------------------
(1) Consists primarily of home equity loans secured by one-to four-family
properties in the amount of $5.7 million and $3.6 million of construction
loans.
The following table sets forth at June 30, 1998, the dollar amount of all
loans due after June 30, 1999, and whether such loans have fixed or adjustable
interest rates.
<TABLE>
<CAPTION>
AT JUNE 30, 1998
-----------------------------------
FIXED ADJUSTABLE
RATES RATES TOTAL
---------- ----------- ----------
<S> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Due after June 30, 1999:
Mortgage Loans:
One- to four-family...................................................... $ 113,051 $ 11,868 $ 124,919
Multi-family............................................................. 1,422 -- 1,422
Commercial............................................................... 1,228 -- 1,228
Other loans.............................................................. 726 -- 726
---------- ----------- ----------
Total loans receivable....................................................... $ 116,427 $ 11,868 $ 128,295
---------- ----------- ----------
---------- ----------- ----------
</TABLE>
LOAN ORIGINATIONS AND PURCHASES. The Bank's principal business is
attracting deposits from the general public and originating or purchasing loans
primarily secured by one- to four-family residential real estate. To a much
lesser extent, the Bank also originates multi-family and commercial real estate
mortgage loans, home equity loans, construction loans, deposit account loans and
other consumer loans. Historically, the Bank's lending portfolio consisted of
those loans in existence in 1992 when the Company acquired Dolton Riverdale,
which primarily consisted of one- to four-family residential mortgage loans.
Since 1992, the Bank has acquired portfolios of loans consisting primarily of
performing seasoned one- to four-family residential mortgage loans. From time to
time and in limited amounts, the Bank has purchased, through Argo Mortgage and
through Empire, Discounted Loans. Discounted Loans are purchased by the Bank
54
<PAGE>
with a view toward bringing such loans current for the Bank's portfolio, for
resale in the secondary market or foreclosure and liquidation. Primarily as a
result of its Discounted Loan activities, the Bank's level of non-performing
loans to total loans has been historically higher than that of its peers.
In order to expand its level of loan originations and purchases, in 1996 the
Bank established MARGO as a majority-owned subsidiary. Since August 1996, the
Bank has engaged in both wholesale and retail lending activities primarily
through MARGO. MARGO focuses on the origination, purchase, and sale of mortgage
loans generally on a "servicing released" basis into the secondary market.
Through MARGO, the Bank has originated loans through Correspondents located in
various states throughout the country. ARM loans originated by MARGO are
generally retained by the Bank for its portfolio, while fixed-rate loans
originated by MARGO are generally not retained in the Bank's portfolio but are
immediately sold in the secondary market. From time to time, the Bank will
selectively sell ARM loans.
Through its network of Correspondents, the Bank is able to originate one- to
four-family residential mortgage loans throughout the United States. Since
August 1996, 100% of the loans originated by the Bank have been through MARGO
Correspondents.
The Bank continues to purchase performing seasoned one- to four-family
mortgage loans. For the six month period ended June 30, 1998, $38.2 million of
such loans were purchased by the Bank. In addition, Argo Mortgage purchases
Discounted Loans for which the borrowers may not be current as to principal and
interest payments. For the six months ended June 30, 1998, and the years ended
December 31, 1997 and December 31, 1996, Argo Mortgage purchased $296,000, $8.9
million and $41.1 million of Discounted Loans, respectively. From time to time,
Discounted Loans are also purchased by the Company through Empire, although the
Company is reducing its emphasis on the purchase of Discounted Loans. See
"Business of Empire/Argo Mortgage, LLC."
USE AND QUALIFICATIONS OF CORRESPONDENTS. The core of MARGO's
Correspondents consist of a nationwide network of third party loan originators.
Additional Correspondents are regularly added to MARGO's list of third party
originators through referrals (primarily from one of the six mortgage insurance
companies utilized by MARGO) and from contacts made at trade shows, conferences,
and over the Internet. At June 30, 1998, MARGO accepted applications from
approximately 100 Correspondents.
In order to be approved as a Correspondent for MARGO, an applicant must meet
certain defined criteria. In evaluating potential Correspondents, MARGO looks at
a number of criteria including, but not limited to, the financial statements of
the potential Correspondent, participation in trade associations, and continuing
education. Quality control measures and historical performance with respect to
originations and volume selling are also significant in selecting and continuing
relationships with Correspondents. MARGO seeks to enter into relationships with
Correspondents who are experienced, educated and financially secure and who do
not require day to day contact with MARGO staff. In addition, management will
maintain a relationship with a Correspondent only if that Correspondent brings
an established level of loans to MARGO on a monthly basis. Management believes
that it will be able to sustain relationships with Correspondents meeting the
foregoing criteria as it offers Correspondents what it believes to be very
competitive rates. In addition, as an additional incentive to Correspondents to
bring loans to MARGO, Correspondents originating an average of $250,000 per
month for MARGO are paid a servicing premium of 0.0625 basis points on
outstanding principal balance on such loans per year, up to a maximum of seven
years. In the event loans are sold, Correspondents are paid a fee equal to the
present value of the remaining service fee premiums less the amounts paid to
date.
ONE-TO FOUR-FAMILY RESIDENTIAL LOANS. The Bank, through MARGO, originates,
purchases and sells primarily fixed-rate and adjustable-rate mortgage loans
secured by one- to four-family residences. At June 30, 1998, the Bank's one- to
four-family loan portfolio totaled $191.7 million, or 92.8% of the Bank's total
loan portfolio. The loans generally fall into three categories: (1) Conventional
Loans--loans which conform to all of the underwriting guidelines of FannieMae
and FreddieMac ("Agency Qualified"); (2) Expanded Criteria Loans--loans which
are (a) not Agency Qualified, generally due to the borrowers
55
<PAGE>
credit profile, (b) are not as readily saleable in the secondary market as
Conventional Loans and (c) are generally fixed-rate loans which are originated
at interest rates higher than those of fixed-rate Conventional Loans; and (3)
Portfolio Loans--adjustable-rate mortgage ("ARM") loans which (a) are not Agency
Qualified, (b) are originated under specific criteria set forth by the Bank and
(c) are not Conventional or Expanded Criteria Loans.
The Bank, through MARGO, originates loans which it classifies as either
Conventional, Portfolio Loans or Expanded Criteria Loans. The bulk of the loan
originations by MARGO have been sold by the Bank. See "--Loan Originations and
Purchases." The Conventional Loans are either fixed-rate or adjustable-rate
mortgage loans ranging from $10,000 up to a maximum of $227,150. These loans are
then sold into the secondary market through one of eight third-party wholesale
conduits with servicing released. In the future, as the Company's cash flow and
volume of Agency Qualified loans increases, MARGO may sell such loans directly
to the Agencies.
The Portfolio Loans are adjustable-rate and, to a lesser extent, fixed-rate
mortgage loans originated by the Bank, through MARGO, with principal balances
that range from $10,000 to $2.0 million and which are not necessarily Agency
Qualified. The yield on these loans is generally 100 basis points higher than
the yield on Agency Qualified loans. Portfolio Loans are generally retained by
the Bank. From time to time, the Bank has made strategic sales of such loans.
The Bank, through MARGO, also originates Portfolio Loans which are jumbo
residential mortgage loans. Jumbo loans are loans with principal balances that
generally range between $300,000 and $2.0 million. Adjustable-rate jumbo
mortgage loans under $600,000 are generally held in the Bank's loan portfolio,
while other jumbo mortgage loans are originated for sale. The yield on jumbo
loans is generally between 125 and 375 basis points higher than the yield on
Agency Qualified loans.
Since September 1996, the Bank, through MARGO, has enlarged its product
offerings to include the origination of Expanded Criteria Loans, loans secured
by one- to four-family residences that are not Agency Qualified and may not be
as readily saleable in the secondary market as Conventional Loans. Since
December 31, 1997, 3.6% of the loans originated by MARGO were Expanded Criteria
Loans. These loans are originated, in many instances, when the borrower's credit
profile, or some aspect of the loan, does not adhere to the Agency underwriting
guidelines. Expanded Criteria Loans are perceived by management as being
advantageous to the Bank because they generally have higher interest rates and
origination and servicing fees and generally lower loan-to-value ratios than
loans that conform to Agency guidelines. In addition, management believes that
the resources are available through its third party servicers to adequately
service Expanded Criteria Loans as well as the experience to resolve loans that
may become non-performing.
As of June 30, 1998, the amount of Portfolio Loans originated by MARGO which
are non-performing is $337,000. The Bank intends to continue to expand the
volume of Portfolio and Expanded Criteria Loans throughout the country through
its nationwide network of Correspondents. See "Risk Factors--Risks Associated
With Portfolio and Expanded Criteria Lending" and "--Discounted Loans."
The Bank requires title insurance to insure the priority of its lien on all
of its mortgage loans. It also requires fire, flood, and casualty insurance on
all its properties securing loans provided by the Bank and mortgage insurance on
all loans with a loan-to-value of 80% or greater.
MULTI-FAMILY RESIDENTIAL REAL ESTATE LENDING. The Bank also originates
loans for the acquisition of existing multi-family residences or for the
refinancing of such properties, such as five to twelve unit apartment buildings
located in the greater Chicago metropolitan area. At June 30, 1998, the Bank had
gross loans secured by multi-family properties in the amount of $3.1 million, or
1.52% of the total loan portfolio. Loans originated on multi-family dwellings
are generally 5-year fixed-rate balloon mortgages amortized over thirty (30)
years. An origination fee is generally charged on such loans. Multi-family
residential real estate lending entails additional risk as compared with one-to
four-family residential property lending. Multi-family real estate loans
typically involve larger loan balances to a single borrower
56
<PAGE>
or groups of affiliated borrowers. The payment experience on such loans is
typically dependent on the successful operation of the real estate project. The
Bank evaluates all aspects of multi-family real estate loan transactions in
order to mitigate risk to the greatest extent possible. To minimize these risks,
the Bank generally limits its multi-family lending to properties used solely for
residential purposes. The Bank seeks to ensure that the property securing the
loan will generate cash flow to adequately cover operating expenses and debt
service payments. To this end, multi-family real estate loans generally are made
at a loan-to-value ratio no greater than 75.0%.
COMMERCIAL REAL ESTATE LENDING. The commercial real estate loan portfolio
originated or purchased is primarily secured by office buildings and other
income producing commercial properties and amounted to $1.4 million or .68% of
the total gross loan portfolio at June 30, 1998.
The Bank will continue on a limited basis to originate loans secured by
commercial real estate. In underwriting these loans, consideration is given to
the property's operating history, future operating projections, current and
projected occupancy, position in the local and regional market, location and
physical condition. The underwriting analysis also includes credit checks and a
review of the financial condition of the borrower. An appraisal report is
prepared in accordance with OTS regulations by an outside appraiser qualified by
federal and state law to substantiate property values for every multi-family and
commercial real estate loan. These appraisal reports are reviewed by the Bank
prior to the closing of the loan to assure compliance with OTS appraisal
standards and policies and the adequacy of the value of the security property.
The Bank also typically obtains full personal loan guarantees from the
borrowers. The Bank validates such personal loan guarantees through an
investigation of the borrower's personal finances.
Commercial real estate lending entails significant additional risks compared
to one- to four-family residential property lending. Commercial real estate
loans typically involve larger loan balances to a single borrower or groups of
affiliated borrowers. The payment experience on such loans is typically
dependent on the successful operation of the real estate project. These risks
can be significantly impacted by supply and demand conditions in the market for
office and retail space, and as such may be subject to a greater extent to
adverse conditions in the economy generally.
CONSUMER LENDING. The Bank makes various types of secured consumer loans,
primarily home equity loans and mobile home loans. The home equity loans are
made for terms of up to ten years, while mobile home loans have terms of up to
15 years. At June 30, 1998, the Bank's consumer loan portfolio totaled $10.4
million, or 5.0%, of the Bank's total loan portfolio, which included $3.6
million in construction loans.
Management considers consumer loans to involve more credit risk than secured
single family residential mortgage loans and, therefore, consumer loans
generally yield a higher return to the Bank and generally provide the Bank with
shorter maturities than single-family residential mortgage loans.
LOAN APPROVAL AND UNDERWRITING. Loan applications are accepted by both
MARGO personnel and employees of the Bank. Upon receipt of a loan application,
credit reports are ordered to verify specific information relating to a loan
applicant's employment, income, assets and credit standing, and for independent
verification of all credit, income and liability information provided by the
applicant. In the case of a real estate loan originated by the Bank, or by MARGO
for the Bank, an appraisal of the real estate intended to secure the proposed
loan is undertaken by an independent appraiser approved by the Bank's Board of
Directors. For loans originated for MARGO by third parties, an independent
appraiser approved by MARGO is used.
MARGO uses six major mortgage insurance companies, any of which may act as a
contract underwriter on all loans originated through its network of
Correspondents. All loans originated for the Bank's portfolio are also
underwritten by MARGO in order to ensure such loans conform to the specific loan
program under which they are being originated. These insurance companies are
provided with the Bank's underwriting manuals and guidelines and all loans are
underwritten to conform with the Bank's guidelines.
57
<PAGE>
Written assurances that the manuals and guidelines have been adhered to, in the
form of representations and warranties, are provided to MARGO by the insurance
company.
Upon completion of the loan application processing activities, all other
loan files are presented to the Bank's loan underwriters if the loan is
originated on behalf of the Bank, or to third party investors if the loan is
originated for immediate sale. In the case of the Bank, certain senior officers
have lending authority and may approve loans of up to $350,000 in the case of
commercial loans and $450,000 in the case of one-to four-family loans, after
completion of the underwriting process. Loans in excess of $350,000 but less
than $500,000, in the case of commercial loans, and in excess of $450,000 and
less than $600,000, in the case of one- to four-family loans, must be submitted
to the Bank's Lending Committee for approval. Loans in excess of $500,000, in
the case of commercial loans, and $600,000, in the case of one- to four-family
loans, are subject to approval by the Board of Directors of the Bank.
Loan applicants are promptly notified in writing of the final determination
of the loan request by either the Bank or MARGO. If approved, the terms and
conditions of the loan decision including the amount of the loan, interest rate,
amortization term, brief description of the real estate securing the mortgage as
well as all conditions to final closing of the transaction are provided in
writing to the loan applicant. The loan applicant is required to pay all costs
incurred by MARGO, as well as their own costs in connection with the loan
closing. If denied, disclosure of the factors resulting in the denial is made
pursuant to the requirements of applicable federal and state law.
The loan documentation and processing activities utilized by the Bank/MARGO
in connection with the origination of real estate loans conforms to standards
imposed by the Agencies, as well as third party investor guidelines. Loan
documentation and processing activities utilized by the Bank/MARGO also conforms
to both requirements of the Agencies, as well as to the standards promulgated by
the Federal Housing Authority ("FHA"), the Department of Housing and Urban
Development ("HUD") and the Veterans Administration ("VA"). Additionally,
written policies and procedures governing the origination of mortgage and other
loans conforming to regulatory guidelines promulgated by the OTS are in place
and utilized by the Bank.
Statistics regarding all loan applications, including those both denied and
approved, are retained by the Bank and MARGO, and reported annually under the
Home Mortgage Disclosure Act. Quality control procedures verifying data obtained
through loan processing activities are in place at the Bank and MARGO.
LOAN ORIGINATION AND OTHER FEES. In addition to interest earned on loans
and commitments for making loans, the Bank and MARGO earn fees in connection
with the origination of loans. Origination fees are a percentage of the
principal amount of the mortgage loan charged to the borrower for the granting
of the loan. Loan fees are accounted for by deferring all loan origination fees
and certain direct costs associated with originations. Net deferred fees or
costs are amortized as yield adjustments over the custodial life of the related
loans using the interest method, adjusted for estimated prepayment based on the
Bank's historical prepayment experience. At June 30, 1998, the Bank had $842,000
in net deferred loan costs that will be recognized in future periods.
Loan origination and commitment fee income vary with the volume and type of
loans and commitments made and purchased and with competitive conditions in
mortgage markets, which in turn tend to vary in response to the demand and
availability of money.
The Bank also receives other fees and charges relating to existing loans,
which include late charges, and fees collected in connection with a change in
borrower or other loan modifications.
PROBLEM ASSETS AND ASSET CLASSIFICATION. In accordance with Federal
regulations, loans and other assets are reviewed by the Bank on a regular basis
for a determination of need to classify such assets as "Substandard," "Doubtful"
or "Loss" assets. An asset is considered "Substandard" if it is inadequately
protected by the current net worth and paying capacity of the obligor, or of the
current realizable value of
58
<PAGE>
the collateral pledged. "Substandard" assets include those characterized by the
"distinct possibility" that the Bank will sustain "some loss" if the
deficiencies noted are not corrected. Assets classified as "Doubtful" have all
the weaknesses inherent in those classified as "Substandard," with the added
characteristic that the weaknesses present make "collection or liquidation in
full," on the basis of currently existing facts, conditions and values, "highly
questionable and improbable." Assets classified as "Loss" are those considered
"uncorrectable" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted. An
allowance for losses is established in amounts deemed prudent by management.
General allowances represent loss allowances which have been established by the
Bank to recognize the inherent risk associated with lending activities but,
which, unlike specific allowances, have not been allocated to a particular
problem asset. When an asset is classified as "Loss," the Bank is required to
establish a specific allowance for such losses equal to 100% of the amount of
the asset so classified, or to charge-off such amount. Recently, the OTS
discontinued classifying Assets as "special mention" if such assets possessed
weakness but did not expose the institution to sufficient risk to warrant
classification in the Substandard category.
At June 30, 1998, the Bank had $5.1 million of loans and $4.2 million of REO
classified as Substandard or Doubtful, respectively. Excluded from this total is
the $3.6 million of Discounted Loans ninety (90) days or more past due.
Management does not consider these loans non-performing and thus excludes them
from all non-performing loan analyses and from all general valuation allowance
analyses. If an asset or portion thereof is classified as Loss, the Bank must
either establish a specific allowance for loan losses in the amount of 100
percent of the portion of the asset classified as Loss, or charge off such
amount. At June 30, 1998, the Bank had no assets classified as Loss. Management
evaluates collectibility of the Discounted Loans receivable on an aggregate pool
basis.
As a general rule, the Bank has entered into contractual arrangements with
third parties ("Sub-servicers") who collect principal and interest payments from
obligors on loans owned by the Bank, pay real estate property taxes and ensure
collateral securing loans remains insured for the benefit of the Bank, in
accordance with generally recognized servicing standards and practices.
Sub-servicers remit payments received from loan obligors and submit monthly
reports detailing delinquencies and other matters to the Bank. The Bank may
handle managing the process of collection and liquidation of loan assets,
however, in some instances, Sub-servicers are charged with such responsibility.
Generally, when a loan becomes 15 days or more past due, the Sub-servicer
submits a reminder notice to the loan obligor. For loans 30-89 days delinquent,
additional notices are submitted to the borrower, and the Sub-servicer attempts
telephonic contact. After principal and interest are 90 days or more past due,
and the loan obligor has failed to respond to the Sub-servicer and no
forbearance or other repayment plan has been agreed to, the Sub-servicer
generally initiates foreclosure action. The Bank's policy is to stop accruing
interest for any loan in excess of 90 days delinquent separate from management's
analysis as to the future collectibility of interest.
Real estate acquired through foreclosure or deed in lieu of foreclosure or
in judgment is carried at the lower of the fair market value less cost to
dispose or the related loan balance at the date of foreclosure. An allowance for
loss is established by a charge to operations or a transfer from the allowance
for loan losses if the carrying value of REO exceeds its fair value less cost to
dispose. Sub-servicers generally manage the disposition process for the Bank,
contracting for security and maintenance of REO, listing REO with real estate
brokers for sale, submitting offers to purchase to the Bank for review and
approval, and arranging for final sale of REO utilizing attorneys and title
companies licensed in the jurisdiction where REO is located. The disposition of
REO related to Discounted Loans is now managed by the Bank through its in-house
personnel.
59
<PAGE>
The following table sets forth information with respect to the Bank's
non-performing assets as of the dates indicated. For the six months ended June
30, 1998, the amount of interest income that would have been recognized on
non-performing loans if such loans had continued to perform in accordance with
their contractual terms was $456,000, none of which was recognized. As of the
dates shown, the Bank had no restructured loans.
<TABLE>
<CAPTION>
AT JUNE 30, AT DECEMBER 31,
----------- -----------------------------------------------------
1998 1997 1996 1995 1994 1993
----------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Non-performing loans (1)(2)......................... $ 5,120 $ 5,525 $ 3,942 $ 1,987 $ 2,324 $ 1,097
Foreclosed real estate, net (3)..................... 4,179 4,251 3,913 1,473 359 554
----------- --------- --------- --------- --------- ---------
Total non-performing assets......................... $ 9,299 $ 9,776 $ 7,855 $ 3,460 $ 2,683 $ 1,651
----------- --------- --------- --------- --------- ---------
----------- --------- --------- --------- --------- ---------
Allowance for estimated loan losses as a percentage
of net loans receivable (1)....................... .48% .53% .53% .45% .52% .68%
----------- --------- --------- --------- --------- ---------
----------- --------- --------- --------- --------- ---------
Allowance for loan losses to non-performing loans... 17.19% 14.73% 16.87% 29.54% 26.38% 55.88%
----------- --------- --------- --------- --------- ---------
----------- --------- --------- --------- --------- ---------
Non-performing loans as a percentage of loans
receivable (1).................................... 2.78% 3.57% 3.12% 1.54% 1.93% 1.19%
----------- --------- --------- --------- --------- ---------
----------- --------- --------- --------- --------- ---------
Non-performing assets as a percentage of total
assets (1)........................................ 3.58% 4.14% 3.43% 2.26% 1.72% 1.31%
----------- --------- --------- --------- --------- ---------
----------- --------- --------- --------- --------- ---------
</TABLE>
- ------------------------
(1) All non-performing loan totals exclude Discounted Loans receivable ninety
(90) days or more past due which at June 30, 1998 amounted to $3.6 million.
(2) At June 30, 1998, $710,000 or 13.9% of the $5.1 million in non-performing
loans represent loans originated by the Bank. The remaining loans represent
loans purchased by the Bank.
(3) Includes $3.0 million of foreclosed real estate related to the Discounted
Loans receivable portfolio at June 30, 1998.
At June 30, 1998, the Bank had $5.1 million of Portfolio Loans receivable
and loans held for sale and $3.6 million of Discounted Loans receivable 90 days
or more delinquent. At both June 30, 1998 and December 31, 1997, the Bank had
approximately $4.2 million of REO. This stabilization is the result of the
Bank's reduction in its position in Discounted Loans receivable as the Company
focuses its resources on conventional lending.
60
<PAGE>
The following table sets forth delinquencies in the Company's loan portfolio
as of the dates indicated:
<TABLE>
<CAPTION>
AT JUNE 30, 1998 AT DECEMBER 31, 1997
----------------------------------------------- -----------------------------------------------
30-89 DAYS 90 DAYS OR MORE 30-89 DAYS 90 DAYS OR MORE
---------------------- ---------------------- ---------------------- ----------------------
LOANS LOANS LOANS LOANS
NUMBER RECEIVABLE, NUMBER RECEIVABLE, NUMBER RECEIVABLE, NUMBER RECEIVABLE,
OF LOANS NET OF LOANS NET OF LOANS NET OF LOANS NET
-------- ----------- -------- ----------- -------- ----------- -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Mortgage loans:
One- to four-family......... 86 $6,133 101 $4,958 107 $4,862 95 $5,474
Multi-family................ 1 2 2 127 -- -- -- --
Commercial.................. -- -- -- -- -- -- -- --
--- ----------- --- ----------- --- ----------- --- -----------
Total mortgage loans.... 87 6,135 103 5,085 107 4,862 95 5,474
Other loans................... 4 114 1 35 -- -- 9 51
--- ----------- --- ----------- --- ----------- --- -----------
Total................... 91 $6,249 104 $5,120 107 $4,862 104 $5,525
--- ----------- --- ----------- --- ----------- --- -----------
--- ----------- --- ----------- --- ----------- --- -----------
Delinquent loans to total
loans receivable(1)......... 3.40% 2.78% 3.16% 3.57%
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31, 1996 AT DECEMBER 31, 1995
----------------------------------------------- -----------------------------------------------
30-89 DAYS 90 DAYS OR MORE 30-89 DAYS 90 DAYS OR MORE
---------------------- ---------------------- ---------------------- ----------------------
LOANS LOANS LOANS LOANS
NUMBER RECEIVABLE, NUMBER RECEIVABLE, NUMBER RECEIVABLE, NUMBER RECEIVABLE,
OF LOANS NET OF LOANS NET OF LOANS NET OF LOANS NET
-------- ----------- -------- ----------- -------- ----------- -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Mortgage loans:
One- to four-family......... 115 $4,055 65 $3,908 38 $1,109 44 $1,918
Multi-family................ -- -- -- -- -- -- -- --
Commercial.................. -- -- -- -- -- -- -- --
-- -- --
--- ----------- ----------- ----------- -----------
Total mortgage loans.... 115 4,055 65 3,908 38 1,109 44 1,918
Other loans................... 1 1 13 19 2 1 13 69
-- -- --
--- ----------- ----------- ----------- -----------
Total................... 116 $4,056 78 $3,942 40 $1,110 57 $1,987
-- -- --
-- -- --
--- ----------- ----------- ----------- -----------
--- ----------- ----------- ----------- -----------
Delinquent loans to total
loans receivable(1)......... 3.21% 3.12% 1.10% 1.54%
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
- ------------------------
(1) Excludes balances related to portfolio of Discounted Loans receivable.
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is
maintained at a level determined to be adequate by management to absorb future
charge-offs of loans deemed uncollectible. At June 30, 1998, the Company
experienced a decrease in the percentage of net loans 90 days or more delinquent
from 3.57% of total loans receivable and loans held for sale (excluding
Discounted Loans) at December 31, 1997 to 2.78% of total loans receivable and
loans held for sale (excluding Discounted Loans) at June 30, 1998. In addition
to the allowance for loan losses, the Bank maintains an allowance for losses on
REO. At June 30, 1998, the Bank s allowance for losses on REO amounted to
$272,000, which represents specific reserves currently in place on REO. As of
June 30, 1998, all of the allowance for loan losses pertains to a general
allowance. The Bank had no specific reserves established at June 30, 1998, other
than the reserves against REO. The allowance is increased by provisions charged
to operating expense and by recoveries on loans previously charged off.
Determination of an appropriate level of allowance for loan losses
necessarily involves a high degree of judgment. Primary considerations in this
evaluation are prior loan loss experience, the character and mix
61
<PAGE>
of the loan portfolio, adverse situations which may affect a borrower s ability
to repay, size of the loan portfolio, business and economic conditions and
management s estimate of potential losses. Management believes that the
allowance for loan losses is currently adequate. However, there can be no
assurances as to whether such allowance may be increased in future periods.
While management uses all available information, including the monitoring of the
economic conditions in the geographic regions in which the loan portfolio is
located, future additions to the allowance may be necessary based on estimates
that are susceptible to significant revision as a result of changes in economic
conditions and other factors. Additionally, various regulatory agencies, as an
integral part of their examination process, periodically review the Bank s
allowance for loan losses. Such agencies may require the Bank to recognize
additions to the allowance based on their judgment of information available to
them at the time of their examination.
The following table sets forth information with respect to the Company's
allowance for loan losses by loan category for the periods and at the dates
indicated.
<TABLE>
<CAPTION>
AT OR FOR
THE SIX
MONTHS ENDED
JUNE 30, AT OR FOR THE YEAR ENDED DECEMBER 31,
------------ ----------------------------------------
1998 1997 1997 1996 1995 1994 1993
---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Balance as beginning of period:
Mortgage loans (gross):
One- to-four-family........................... $561 $412 $412 $330 $315 $313 $138
Multi-family.................................. 14 14 14 14 14 14 14
Commercial loans.............................. 216 216 216 216 216 216 216
Other loans................................... 23 23 23 27 68 70 13
---- ---- ---- ---- ---- ---- ----
Total......................................... 814 665 665 587 613 613 381
Provision for loan losses:
Mortgage loans (gross):
One- to-four-family........................... 235 60 210 248 96 45 200
Multi-family.................................. -- -- -- -- -- -- --
Commercial loans.............................. -- -- -- -- -- -- --
Other loans................................... -- -- -- -- (41) 3 70
---- ---- ---- ---- ---- ---- ----
Total......................................... 235 60 210 248 55 48 270
Purchased allowance one- to-four-family loans..... 30 -- -- -- -- -- --
Transfer to allowance for losses on foreclosed
real estate..................................... (180) -- (50) (77) (45) (43) (25)
Charge-offs:
Mortgage loans (gross):
One- to-four-family........................... -- -- (11) (89) (36) -- --
Multi-family.................................. -- -- -- -- -- -- --
Commercial loans.............................. -- -- -- -- -- -- --
Other loans................................... (19) -- -- (4) -- (5) (13)
---- ---- ---- ---- ---- ---- ----
Total......................................... (19) -- (11) (93) (36) (5) (13)
Balance at end of period:
Mortgage loans (gross):
One- to-four-family........................... 646 472 561 412 330 315 313
Multi-family.................................. 14 14 14 14 14 14 14
Commercial loans.............................. 216 216 216 216 216 216 216
Other loans................................... 4 23 23 23 27 68 70
---- ---- ---- ---- ---- ---- ----
Total......................................... $880 $725 $814 $665 $587 $613 $613
---- ---- ---- ---- ---- ---- ----
---- ---- ---- ---- ---- ---- ----
Ratio of net charge-offs during the period to
average loans outstanding, excluding Discounted
loans........................................... .01% --% .01% .08% .03% --% .01%
---- ---- ---- ---- ---- ---- ----
---- ---- ---- ---- ---- ---- ----
Ratio of allowance for loan losses to net loans
receivable, excluding Discounted Loans.......... .48% .53% .53% .53% .45% .52% .68%
---- ---- ---- ---- ---- ---- ----
---- ---- ---- ---- ---- ---- ----
</TABLE>
62
<PAGE>
PURCHASED MORTGAGE SERVICING RIGHTS
PMSRs represent the right to receive a fee for the collection and
administration of the mortgage payments on the loans being serviced for others.
The cost of acquiring the right to service the mortgage loans is carried as a
capitalized asset and amortized proportionately over the estimated remaining
lives of the loans serviced. The servicing of mortgages primarily consists of
the collection of monthly principal and interest payments, collection, and
disbursement of escrow funds for taxes and insurance, providing various customer
services and account maintenance, reporting, foreclosure processing, and
investor notification. For performing these administrative tasks, the servicer
retains a monthly servicing fee generally calculated as a percentage of the
outstanding loan balance, and holds the escrowed payments for taxes and
insurance in non-interest-bearing custodial accounts. The servicing fee is
intended to cover anticipated operating expenses incurred in servicing the loans
and to provide for an adequate profit margin. The Company uses Sub-servicers to
perform the administrative activities discussed above under sub-servicing
agreements. The Company's primary administrative task associated with PMSRs is
to review monthly analysis of all servicing and accounting reports prepared by
each Sub-servicer and to perform periodic on-site inspections and reviews of the
Sub-servicers' operations.
Prior to completing any acquisition of servicing rights, the Company
analyzes a wide range of parameters with respect to each portfolio under
consideration. This review includes the projected revenues and expenses,
maturity dates, geographic distribution, interest rate distribution,
loan-to-value ratios, outstanding balances, delinquency history, and other
statistics. Due diligence is either performed by the Bank's employees or a
designated independent contractor on a representative sample of the mortgages
involved. The purchase price is based on the present value of the expected
future stream of cash flows, computed by using a discount rate that management
considers to approximately reflect the risk associated with the investment, and
using a loan prepayment assumption that management considers to be conservative
relative to the characteristics of the serviced loans. Management does not
purchase PMSRs with recourse servicing, thus the Company is not subject to the
risk of and costs (including foreclosure costs) associated with borrower default
on the underlying loans.
Mortgage servicing activities carry interest rate risk since the total
amount of servicing fees earned, as well as the amortization of the investment
in the servicing rights, fluctuate based on loan prepayments which generally are
results of changes in market interest rates and the effect of these changes on
the average life of the underlying residential mortgage loans. Prepayment of the
mortgage loans may be influenced by a variety of economic, geographic, social,
and other factors and, most importantly, the difference between interest rates
on the mortgage loans underlying the PMSRs and prevailing mortgage rates
available for comparable mortgages.
The value of PMSRs generally decrease in a declining interest rate
environment and increase in a rising interest rate environment due to the actual
or anticipated fluctuation in the prepayment speeds of the underlying mortgage
loans. The value of the PMSRs reacts inversely with the other interest-earning
assets of the Bank. The value of mortgage loans, comprising the majority of the
Bank's assets, decreases in a rising interest rate environment and increases in
a declining interest rate environment. Thus, the PMSRs act as a natural hedge
against the mortgage loans in the Bank's portfolio in a changing interest rate
environment.
The Bank's principal investment in PMSRs is through a $5.7 million equity
investment in three limited partnerships whose business activities are to
purchase mortgage servicing rights. There are several unaffiliated equity
investors in each limited partnership. The purchase of the servicing rights is
then leveraged, allowing the limited partnerships to purchase rights equaling
one to three times the equity investment by its partners. The cost of the
borrowings, as well as the service income and expense and related amortization,
is recorded at the limited partnership level. Each quarter, financial statements
are issued to the limited partnerships by DMI, the general partner of each
limited partnership and the pro-rata share of the income for each investor is
calculated by DMI. The Bank records its share of income or loss
63
<PAGE>
on the equity method for each partnership investment. At the end of five years,
or at such time as the investors may agree, the servicing rights will be sold
and the proceeds divided pro-rata among the investors. As with a direct
investment in PMSRs, the collateral behind the equity investment is the
servicing rights. All limited partnership purchases of servicing rights must be
approved by all equity investors and undergo the same guidelines outlined
previously for direct purchases of servicing. The task of finding and acquiring
the servicing rights controlled by the limited partnerships as well as all
associated administrative duties, is assigned to DMI. DMI also Sub-services the
PMSRs in each partnership. Each limited partnership is audited annually by an
independent auditor and an independent third party valuation of the
partnership's PMSRs is performed quarterly. In addition, unaudited financial
statements of each limited partnership are distributed quarterly by DMI to each
investor. The audited financial statements, the unaudited quarterly financial
statements and the quarterly valuations are sent directly to each equity
investor. The risks associated with PMSRs are somewhat mitigated in the case of
PMSRs managed by DMI. As a result of the current decline in the interest rate
market, DMI has actively moved to retain servicing rights on refinancings. The
loans may be refinanced at lower rates, for longer terms, and, from time to
time, with higher balances with the servicing on such loans retained by the
limited partnerships.
The Bank accounts for the investment in the three limited partnerships using
the equity method. Income or loss is recorded based upon information received
from DMI. DMI obtains quarterly valuations from an independent appraiser for
each limited partnership. At June 30, 1998, the valuation of one of the Bank's
three limited partnerships had a market value lower than the current book value.
The general partner recorded a valuation allowance. The Bank's proportionate
share of the writedown was $392,000, which the Bank has recorded based upon
information received from DMI.
In addition to its investment in the limited partnerships, at June 30, 1998,
the Bank had a $676,000 investment in a PMSR portfolio that it owns directly. At
June 30, 1998, this directly owned PMSR portfolio consisted of 1,344 mortgage
loans having an outstanding principal balance of $53.1 million.
At June 30, 1998, the Bank's investment in PMSRs, including the limited
partnerships, was $6.3 million. Of this amount, $635,000 exceeded the amount of
PMSRs allowable in regulatory capital. The remaining $5.7 million investment in
PMSRs constituted 40.9% of the Bank's core capital at June 30, 1998.
A secondary benefit derived from the PMSRs is the interest free custodial
accounts comprised of the borrowers' taxes and insurance escrows and, for a
short time period, the float on their principal and interest payments. The
custodial balances are maintained in noninterest-bearing accounts and are not
affected by changes in interest rates. The custodial balances relating to the
servicing owned at June 30, 1998, amounted to $5.9 million.
INVESTMENT ACTIVITIES
The Bank must maintain minimum levels of investments that qualify as liquid
assets under OTS regulations. Liquidity may increase or decrease depending upon
the availability of funds and comparative yields on investments in relation to
the return on loans. Historically, the Bank has maintained liquid assets at
levels above the minimum requirements imposed by the OTS regulations and at
levels believed adequate to meet the requirements of normal operations,
including potential deposit outflows. Cash flow projections are regularly
reviewed and updated to assure that adequate liquidity is maintained. At June
30, 1998, the Bank's liquidity ratio (liquid assets as a percentage of deposits
and borrowings payable in one year or less) was 6.7%. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
Federally chartered savings institutions have the authority to invest in
various types of liquid assets, including United States Treasury obligations,
securities of various federal agencies, certain certificates of deposit of
insured banks and savings institutions, certain bankers' acceptances, repurchase
agreements and federal funds. Subject to various restrictions, federally
chartered savings institutions may also invest their
64
<PAGE>
assets in commercial paper, investment grade corporate debt securities and
mutual funds whose assets conform to the investments that a federally chartered
savings institution is otherwise authorized to make directly.
Generally, the investment policy of the Bank is to invest funds among
various categories of investments and maturities based upon the Bank's
asset/liability management policies, investment quality and marketability,
liquidity needs and performance objectives. It is the Bank's general policy to
invest in certificates of deposit, overnight funds, and securities which are
securities of government sponsored entities and federal agency obligations, and
other fixed-issues that are rated investment grade. The policy also permits the
Bank to invest in the equity securities of government sponsored entities. All
mortgage-backed securities in the Bank's portfolio at June 30, 1998 were
acquired in the Merger Conversion. The Bank has not purchased mortgage-backed
securities since that time. All of the mortgaged-backed securities are insured
or guaranteed by the Agencies.
The Company also maintains a portfolio of readily marketable equity
securities, generally comprised of the equity securities of government sponsored
entities and the holding companies for local, regional and national banks,
savings banks and savings and loan associations. Generally, the Company has
acquired non-control positions in financial institution equities which
management believes, after analysis of market pricing, business practices, and
earnings potential, are under-valued and represent an opportunity for profit
from sales of such securities. At June 30, 1998, the Company and the Bank had
$5.0 million in securities.
The following table sets forth the composition of the Company's debt and
equity and mortgage-backed securities portfolios in dollar amounts and
percentages at the dates indicated.
<TABLE>
<CAPTION>
AT JUNE 30, AT DECEMBER 31,
-------------------- ----------------------------------------------------------------
1998 1997 1996 1995
-------------------- -------------------- -------------------- --------------------
FAIR % OF FAIR % OF FAIR % OF FAIR % OF
VALUE TOTAL VALUE TOTAL VALUE TOTAL VALUE TOTAL
--------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Debt securities:
U.S. Government obligations.............. $ -- --% $ -- --% $ -- --% $ 603 7.96%
Municipal bonds.......................... 379 7.59 380 7.64 602 10.40 619 8.17
--------- --------- --------- --------- --------- --------- --------- ---------
Total debt securities.................. $ 379 7.59% $ 380 7.64% $ 602 10.40% $ 1,222 16.13%
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
Equity securities.......................... $ 2,275 45.56% $ 1,667 33.51% $ 282 4.87% $ 639 8.44%
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
Mortgage-backed securities:
FreddieMac............................... $ 118 2.37% $ 124 2.51% $ 826 14.27% $ 1,164 15.37%
FannieMae................................ 2,198 44.02 2,799 56.26 3,949 68.23 4,339 57.30
GinnieMae................................ -- -- -- -- 152 2.62 158 2.09
--------- --------- --------- --------- --------- --------- --------- ---------
Total mortgage-backed securities....... 2,316 46.39 2,923 58.77 4,927 85.12 5,661 74.76
Net premium (discount)................... 35 .70 39 .78 60 1.04 78 1.03
Unrealized (loss) on securities
available-for-sale..................... (12) (.24) (35) (.70) (83) (1.43) (27) (.36)
--------- --------- --------- --------- --------- --------- --------- ---------
Net mortgage-backed securities........... $ 2,339 46.85% $ 2,927 58.85% $ 4,904 84.73% $ 5,712 75.43%
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
Total securities available-for-sale.... $ 4,993 100% $ 4,974 100% $ 5,788 100% $ 7,573 100%
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
FHLB of Chicago stock...................... $ 1,847 100% $ 3,271 100% $ 3,428 100% $ 2,669 100%
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------
</TABLE>
65
<PAGE>
The following table sets forth the amortized cost and fair values of the
Company's securities at the dates indicated.
<TABLE>
<CAPTION>
AT JUNE 30, AT DECEMBER 31,
---------------------- -----------------------------------------------------------
1998 1997 1996 1995
---------------------- ---------------------- ---------------------- -----------
AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR AMORTIZED
COST VALUE COST VALUE COST VALUE COST
----------- --------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Securities available-for-sale:
U.S. Government obligations............ $ -- $ -- $ -- $ -- $ -- $ -- $ 601
Municipal bonds........................ 370 379 370 380 557 602 558
Equity securities...................... 2,480 2,275 1,695 1,667 226 282 607
Mortgage-backed securities:
FreddieMac........................... 120 119 125 124 826 834 1,162
FannieMae............................ 2,232 2,220 2,837 2,803 4,009 3,910 4,419
GinnieMae............................ -- -- -- -- 152 160 158
----------- --------- ----------- --------- ----------- --------- -----------
Total mortgage-backed securities... 2,352 2,339 2,962 2,927 4,987 4,904 5,739
----------- --------- ----------- --------- ----------- --------- -----------
Total investment securities
available-for-sale................... $ 5,202 $ 4,993 $ 5,027 $ 4,974 $ 5,770 $ 5,788 $ 7,505
----------- --------- ----------- --------- ----------- --------- -----------
----------- --------- ----------- --------- ----------- --------- -----------
FHLB-Chicago stock..................... $ 1,847 $ 1,847 $ 3,271 $ 3,271 $ 3,428 $ 3,428 $ 2,669
----------- --------- ----------- --------- ----------- --------- -----------
----------- --------- ----------- --------- ----------- --------- -----------
<CAPTION>
FAIR
VALUE
---------
<S> <C>
Securities available-for-sale:
U.S. Government obligations............ $ 603
Municipal bonds........................ 619
Equity securities...................... 639
Mortgage-backed securities:
FreddieMac........................... 1,183
FannieMae............................ 4,364
GinnieMae............................ 165
---------
Total mortgage-backed securities... 5,712
---------
Total investment securities
available-for-sale................... $ 7,573
---------
---------
FHLB-Chicago stock..................... $ 2,669
---------
---------
</TABLE>
The table below sets forth certain information regarding the amortized cost,
weighted average yields and contractual maturities of investment securities as
of June 30, 1998.
<TABLE>
<CAPTION>
AT JUNE 30, 1998
--------------------------------------------------------------------------------------------------------------
MORE THAN ONE MORE THAN FIVE MORE THAN TEN YEARS
ONE YEAR OR LESS YEAR TO FIVE YEARS YEARS TO TEN YEARS
-------------------------- ------------------------ ---------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE AMORTIZED AVERAGE
COST YIELD COST YIELD COST YIELD COST YIELD
----------- ------------- ----------- ----------- ------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Investment
securities
available-for-sale:
Municipal Bonds... $ -- -- % $ -- -- % $ 50 9.50% $ 320 9.50%
Equity
Securities(1)... 2,480 -- -- -- -- -- -- --
Mortgage-backed
securities:
FreddieMac...... -- -- -- -- -- 120 6.07
FannieMae....... 558 6.22 -- -- -- -- 1,674 6.46
----------- --- ----------- ----- --- --- ----------- ---
Total
mortgage-
backed
securities... 558 6.22 -- -- -- -- 1,794 6.43
----------- --- ----------- ----- --- --- ----------- ---
Total
investment
securities
available-for-
sale........ $ 3,038 6.22% $ -- -- % $ 50 9.50% $ 2,114 6.90%
----------- --- ----------- ----- --- --- ----------- ---
----------- --- ----------- ----- --- --- ----------- ---
FHLB-Chicago
stock(1).......... $ 1,847 -- % $ -- -- % $ -- -- % $ -- -- %
----------- --- ----------- ----- --- --- ----------- ---
----------- --- ----------- ----- --- --- ----------- ---
<CAPTION>
TOTAL
--------------------------
WEIGHTED
AMORTIZED AVERAGE
COST YIELD
----------- -------------
<S> <C> <C>
Investment
securities
available-for-sale:
Municipal Bonds... $ 370 9.50%
Equity
Securities(1)... 2,480 --
Mortgage-backed
securities:
FreddieMac...... 120 6.07
FannieMae....... 2,232 6.40
----------- ---
Total
mortgage-
backed
securities... 2,352 6.38
----------- ---
Total
investment
securities
available-for-
sale........ $ 5,202 6.81%
----------- ---
----------- ---
FHLB-Chicago
stock(1).......... $ 1,847 -- %
----------- ---
----------- ---
</TABLE>
- ------------------------
(1) Weighted average yield does not include equity securities.
66
<PAGE>
SOURCES OF FUNDS AND BORROWINGS
GENERAL. Deposits are the major source of the Bank's funds for lending and
other investment purposes. In addition to deposits, the Bank derives funds from
loan principal repayments, proceeds from sales of loans, borrowings, and the
custodial balances on loans serviced for others. Loan repayments are a
relatively stable source of funds, while deposit inflows and outflows are
significantly influenced by general interest rates and money market conditions.
Borrowings may be used to compensate for reductions in the availability of other
sources of funds. They may also be used on a longer term basis for general
business purposes. In addition, the Company's sources of funds include two notes
payable. See "--Borrowings."
DEPOSITS. The Bank offers a number of deposit accounts, including tiered
passbook, NOW accounts, money market accounts and certificate accounts currently
ranging in maturity from seven days to ten years. Deposit accounts vary as to
terms, with the principal differences being the minimum balance required, the
period the funds must remain on deposit and the interest rate. The Bank in the
past has utilized brokered deposits, and will continue to use this source of
funds as needed in the future. The Bank had $16.5 million in brokered deposits
at June 30, 1998. The Bank has traditionally priced its deposit products at or
near market rates in its primary market.
DEPOSIT FLOW. The following table sets forth the change in dollar amount of
savings accounts offered by the Bank between the dates indicated.
<TABLE>
<CAPTION>
AT JUNE 30, AT DECEMBER 31,
----------------------------------- -----------------------------------------------------------
1998 1997 1996
----------------------------------- ----------------------------------- ----------------------
PERCENT PERCENT PERCENT
OF TOTAL INCREASE OF TOTAL INCREASE OF TOTAL
AMOUNT DEPOSITS (DECREASE) AMOUNT DEPOSITS (DECREASE) AMOUNT DEPOSITS
--------- ----------- ----------- --------- ----------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Passbook accounts...... $ 19,900 9.9% $ 2,293 $ 17,607 10.2% $ (742) $ 18,349 12.2%
NOW accounts........... 20,615 10.2 7,390 13,225 7.7 799 12,426 8.3
Money market accounts.. 6,308 3.1 85 6,223 3.6 1,266 4,957 3.3
--------- ----------- ----------- --------- ----------- ----------- --------- -----------
Total................ 46,823 23.2 9,768 37,055 21.5 1,323 35,732 23.8
--------- ----------- ----------- --------- ----------- ----------- --------- -----------
Certificate accounts:
3.99% or less........ -- -- (10) 10 -- (42) 52 --
4.00% to 4.99%....... 1,047 .5 173 874 .5 105 769 .5
5.00% to 5.99%....... 120,256 59.7 57,321 62,935 36.5 (8,234) 71,169 47.2
6.00% to 6.99%....... 32,560 16.2 (37,402) 69,962 40.5 30,768 39,194 26.0
7.00% to 7.99%....... 769 .4 (744) 1,513 .9 (2,099) 3,612 2.4
8.00% to 8.99%....... 8 -- (112) 120 .1 21 99 .1
--------- ----------- ----------- --------- ----------- ----------- --------- -----------
Total.............. 154,640 76.8 19,226 135,414 78.5 20,519 114,895 76.2
--------- ----------- ----------- --------- ----------- ----------- --------- -----------
--------- ----------- ----------- --------- ----------- ----------- --------- -----------
Total deposits......... $ 201,463 100.00% $ 28,994 $ 172,469 100.00% $ 21,842 $ 150,627 100.00%
--------- ----------- ----------- --------- ----------- ----------- --------- -----------
--------- ----------- ----------- --------- ----------- ----------- --------- -----------
Weighted average
rate................. 5.07% 5.18% 5.17%
----------- ----------- -----------
----------- ----------- -----------
<CAPTION>
1995
-----------------------------------
PERCENT
INCREASE OF TOTAL INCREASE
(DECREASE) AMOUNT DEPOSITS (DECREASE)
----------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Passbook accounts...... $ (167) $ 18,516 15.0% $ (2,680)
NOW accounts........... (404) 12,830 10.4 (225)
Money market accounts.. 474 4,483 3.6 400
----------- --------- ----------- -----------
Total................ (97) 35,829 29.0 (2,505)
----------- --------- ----------- -----------
Certificate accounts:
3.99% or less........ 34 18 -- (5,993)
4.00% to 4.99%....... (4,688) 5,457 4.4 (11,733)
5.00% to 5.99%....... 34,232 36,937 30.0 13,828
6.00% to 6.99%....... 8,634 30,560 24.7 17,785
7.00% to 7.99%....... (10,938) 14,550 11.8 12,298
8.00% to 8.99%....... (34) 133 .1 (167)
----------- --------- ----------- -----------
Total.............. 27,240 87,655 71.0 26,018
----------- --------- ----------- -----------
----------- --------- ----------- -----------
Total deposits......... $ 27,143 $ 123,484 100.00% $ 23,513
----------- --------- ----------- -----------
----------- --------- ----------- -----------
Weighted average
rate................. 5.17%
-----------
-----------
</TABLE>
CERTIFICATE ACCOUNTS. At June 30, 1998, the Bank had outstanding $53.3
million of certificate of deposit accounts in amounts of $100,000 or more
maturing or repricing as follows:
<TABLE>
<CAPTION>
AMOUNT
--------------------
<S> <C>
(DOLLARS IN
THOUSANDS)
Three months or less........................................................................ $ 22,060
Over three through six months............................................................... 9,894
Over six through 12 months.................................................................. 11,420
Over 12 months.............................................................................. 9,926
-------
Total................................................................................... $ 53,300
-------
-------
</TABLE>
The Bank had pledged investment securities with principal balances totaling
approximately $2.7 million at June 30, 1998, as collateral to secure certain
public deposits. At June 30, 1998, the Bank also had letters of credit totaling
$15.4 million, as collateral to secure several government certificates of
deposit totaling approximately $15.4 million which mature or reprice in the
three months or less time period.
67
<PAGE>
The following table presents the amount of certificate accounts outstanding
at June 30, 1998, and the periods to maturity or repricing.
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
AMOUNT RATE
---------- -----------
<S> <C> <C>
(DOLLARS IN THOUSANDS)
Within one year............................................................................ $ 70,958 5.55%
One to three years......................................................................... 76,297 5.89
Thereafter................................................................................. 7,385 6.25
---------- ---
Total...................................................................................... $ 154,640 5.74%
---------- ---
---------- ---
</TABLE>
CERTIFICATE ACCOUNTS CLASSIFIED BY RATES. The following table sets forth
the certificate accounts of the Bank classified by rates as of the dates
indicated.
<TABLE>
<CAPTION>
AT JUNE 30, AT DECEMBER 31,
----------- ---------------------------------
<S> <C> <C> <C> <C>
RATE 1998 1997 1996 1995
- ------------------------------------------------------------------ ----------- ---------- ---------- ---------
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
3.99% or less..................................................... $ -- $ 10 $ 52 $ 18
4.00% to 4.99%.................................................... 1,047 874 769 5,457
5.00% to 5.99%.................................................... 120,256 62,935 71,169 36,937
6.00% to 6.99%.................................................... 32,560 69,962 39,194 30,560
7.00% to 7.99%.................................................... 769 1,513 3,612 14,550
8.00% to 8.99%.................................................... 8 120 99 133
----------- ---------- ---------- ---------
Total......................................................... $ 154,640 $ 135,414 $ 114,895 $ 87,655
----------- ---------- ---------- ---------
----------- ---------- ---------- ---------
</TABLE>
DEPOSIT ACTIVITY. The following table sets forth the deposit activities of
the Bank for the periods indicated.
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
-------------------- -------------------------------
1998 1997 1997 1996 1995
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Deposits in excess of withdrawals.......................... $ 24,411 $ 15,629 $ 13,262 $ 20,710 $ 17,177
Interest credited.......................................... 4,583 4,124 8,580 6,433 5,610
--------- --------- --------- --------- ---------
Net increase in savings deposit accounts............... $ 28,994 $ 19,753 $ 21,842 $ 27,143 $ 22,787
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
Substantially all of the Bank's depositors are residents of the States of
Illinois and Indiana.
BORROWINGS. The Company's borrowings at June 30, 1998 include three notes
payable, a margin account, capital lease obligations, and FHLB advances.
Although savings deposits are the primary source of funds of the Bank's
lending and investment activities and for its general business purposes, the
Bank can also borrow funds from the FHLB of Chicago to supplement its supply of
lendable funds and to meet deposit withdrawal requirements. The FHLB has served
as the Bank's primary borrowing source. Advances from the FHLB are secured by
the Bank's stock in the FHLB and a portion of the Bank's portfolio of first
mortgage loans. The rates on these advances vary from time to time in response
to general economic conditions. At June 30, 1998, the Bank had $17.8 million of
fixed-rate advances and $309,000 of adjustable-rate advances from the FHLB with
interest rates ranging from 5.48% to 8.43%. The FHLB functions as a central
reserve bank providing credit for savings and loan associations and certain
other member financial institutions. As a member, the Bank is required to own
capital stock in the FHLB and is authorized to apply for advances on the
security of such stock and
68
<PAGE>
certain of its home mortgages and other assets (principally, securities that are
obligations of, or guaranteed by, the United States Government or its agencies)
provided certain standards related to creditworthiness have been met. Advances
are made pursuant to several different programs. Each credit program has its own
interest rate and the amount of advances is based either on a fixed percentage
of an institution's net worth or on the FHLB's assessment of an association's
creditworthiness.
One of the notes is payable for an amount of $6.0 million and is drawn on a
$6.0 million revolving line of credit with a third party financial institution
and is collateralized by the Bank's Common Stock. Additionally, this line of
credit is personally guaranteed by Mr. Yedinak, President and Chief Executive
Officer of the Company and the Bank. However, the Company believes such
guarantee will not be required should the line of credit be accessed following
the Offering. The interest rate on this note adjusts monthly at the lower of
LIBOR plus 250 basis points or the current designated prime rate. The second
note is payable by On-Line for $635,000 drawn on a $1.0 million open line of
credit with a third party financial institution. This note is also
collateralized by accounts receivable of On-Line and the line of credit is
guaranteed by the Company. Both lines of credit are due to mature on August 17,
1999. The third note is payable by the Company's ESOP, with a remaining balance
of $27,000. Finally, the balance outstanding under a third party securities
brokerage firm margin account agreement was in the amount of $360,000 at June
30, 1998.
Included in other borrowings at June 30, 1998, is $3.2 million in capital
lease obligations for premises and equipment related to On-Line.
The following table sets forth certain information regarding borrowings by
the Company on a consolidated basis at the end of and during the periods
indicated. The borrowings at and during the periods consisted of FHLB advances,
and promissory notes. The weighted average was computed on a monthly average
basis.
<TABLE>
<CAPTION>
AT JUNE 30, AT DECEMBER 31,
------------- -------------------------------
1998 1997 1996 1995
------------- --------- --------- ---------
<S> <C> <C> <C> <C>
Weighted average interest rate at end of period paid on:
FHLB advances.................................................................. 6.20% 6.22% 5.80% 5.85%
Other borrowings............................................................... 8.55 8.63 8.48 8.91
</TABLE>
<TABLE>
<CAPTION>
FOR THE SIX MONTH
PERIOD FOR THE YEAR ENDED
ENDED JUNE 30, DECEMBER 31,
-------------------- -------------------------------
1998 1997 1997 1996 1995
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Maximum amount of borrowings outstanding at any month end:
FHLB advances.............................................. $ 20,332 $ 49,587 $ 49,587 $ 45,257 $ 38,416
Other borrowings........................................... 10,678 11,411 11,542 8,760 8,121
</TABLE>
<TABLE>
<CAPTION>
FOR THE SIX MONTH
PERIOD FOR THE YEAR ENDED
ENDED JUNE 30, DECEMBER 31,
-------------------- -------------------------------
1998 1997 1997 1996 1995
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Average borrowings outstanding with respect to:
FHLB advances.............................................. $ 19,362 $ 41,225 $ 30,191 $ 34,608 $ 32,852
Other borrowings........................................... 10,271 9,495 10,621 7,669 6,166
--------- --------- --------- --------- ---------
Total.................................................. $ 29,633 $ 50,720 $ 40,812 $ 42,277 $ 39,018
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Weighted average interest rate during the period paid on:
FHLB advances.............................................. 6.20% 5.88% 5.98% 5.69% 6.06%
Other borrowings........................................... 9.11 10.21 8.43 8.60 7.86
--------- --------- --------- --------- ---------
Total weighted average................................. 7.21% 6.69% 6.60% 6.20% 6.34%
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
69
<PAGE>
BANK SUBSIDIARIES
The Bank has two wholly-owned subsidiaries, Argo Mortgage and Dolton
Riverdale Savings Services, Inc. ("Dolton Services"). Argo Mortgage engages in
mortgage brokerage activities that focus on the purchase and sale of Discounted
Loans into the secondary market. Dolton Services is an inactive subsidiary. In
May 1996, the Bank incorporated a 50.1% owned operating subsidiary, MARGO. MARGO
is an Illinois chartered limited liability corporation whose members are the
Bank and Nip'n Tuck, Inc., an unaffiliated Illinois corporation. MARGO's primary
objectives are to increase loan origination volume within the Bank's branch
network and to serve as a mortgage banking operation using a network of
Correspondents. At June 30, 1998, the Bank had an equity investment in Argo
Mortgage, Dolton Services, and MARGO of $18.0 million, $161,000 and $(4,000),
respectively.
COMPETITION
The Bank faces strong competition in attracting deposits and in originating
real estate loans. Its most direct competition for deposits has historically
come from other savings institutions, credit unions, savings banks and from
commercial banks located in its Primary Market Area. The Bank also faces
additional significant competition for investor funds from short-term money
market securities and other corporate and government securities. The Bank's
competition for real estate loans comes principally from mortgage banking and
brokerage companies and, to a lesser extent, other thrift institutions,
commercial banks and credit unions. Competition may also increase as a result of
the lifting of restrictions on the interstate operations of financial
institutions.
The Bank competes for loans principally through the interest rates and loan
fees it charges and the efficiency and quality of the services it provides
borrowers, real estate brokers and home builders. It competes for deposits by
offering depositors a wide variety of savings accounts, checking accounts, and
convenient office locations.
The Bank is a community oriented savings institution and competes with many
financial institutions in its Primary Market Area, most of which have assets
which are significantly larger than the assets of the Bank. Management considers
the Bank's reputation for financial strength and customer service as its major
competitive advantage in attracting and retaining customers in its market area.
The Bank also believes it benefits from its community bank orientation as well
as its core deposit base.
70
<PAGE>
BUSINESS OF ON-LINE FINANCIAL SERVICES, INC.
HISTORY
On October 31, 1995 the Company acquired On-Line, an Oak Brook, Illinois
based computer services bureau. The purchase transaction was consummated through
the use of a wholly-owned subsidiary, OLF Acquisition Corporation, which
acquired shares of three separate state chartered savings and loan service
corporations which owned, in the aggregate, 98.9% of the outstanding shares of
On-Line. Sale of the remaining 1.1% of On-Line shares was made by a single
institutional stockholder which held shares in On-Line directly. The intervening
acquisition subsidiary and state chartered savings and loan service corporation
shells were liquidated and merged by the Company in June 1996. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--On-Line Financial Services, Inc." for the financial terms of the
transaction.
GENERAL
On-Line is a third party provider of electronic data processing services
primarily to financial institutions located throughout the Midwest. On-Line
provides data processing services to thrifts, community banks, savings banks,
and mortgage brokers. Prior to the Company's acquisition, On-Line's business
focus was primarily on data processing only, utilizing the existing applications
in place at the time, and On-Line generally did not have the personnel or
technological infrastructure to meet the future technological needs of its
clients, nor was there an active pursuit to solicit new clients outside or
within the financial institution arena. Company management believed that it had
acquired a mature, but limited, technology company that required a new strategic
vision and enhanced technological capabilities to meet the needs of its evolving
marketplace. The Company's primary strategy during its 1996 and 1997 period of
transition was to evaluate the existing technological and operational
environment, including the internal business processes, existing products and
services, and technical viability of the equipment and resources.
BUSINESS STRATEGY OF ON-LINE
The Company's strategy since the acquisition has been to enhance On-Line's
strong foundation as a data processing and data communications network provider
by implementing tools to continue supporting existing services, as well as
evolve into a provider of electronic commerce, Intranet and Internet services,
technical training services, and document management and imaging services. The
primary objectives of On-Line's strategic planning have been to increase the
Company's shareholder value by implementing data processing platforms capable of
continuously evolving to meet the needs of the rapidly changing financial
services industry and to attract and develop skilled management and technical
personnel. Principal steps taken include:
- DEVELOPING MANAGEMENT AND PERSONNEL. Since its acquisition in 1995,
management has streamlined and re-structured On-Line's entire organization
to deploy and implement its revised business strategies. This process
included taking steps to create a team with complementary skills through
extensive internal training, re-engineering, recruiting, and the
elimination of certain technical positions which were no longer viable.
While key management personnel were retained following the acquisition,
many new management, supervisory and staff personnel were hired with
complementary advanced financial services, electronic commerce, local and
wide area networking, programming and systems software experience.
Management believes that it has assembled a technical staff capable of
implementing its future strategic objectives.
- IMPLEMENTATION OF ADVANCED TECHNOLOGIES. Since the acquisition of On-Line,
the Company has promoted a corporate commitment to implementation of
advanced technologies sufficient to remain competitive in the future
marketplace. On-Line's open system architecture allows the Company to take
advantage of rapidly changing technologies and gain certain operating
efficiencies. As a result of implementation of this architecture, On-Line
has gained available capacity in its
71
<PAGE>
hardware system and intends to use such excess capacity as an additional
avenue for generating income. From January 1996 through June 1998, On-Line
successfully upgraded its Unisys mainframe systems which include
Microsoft-C- NT client/server based services, faster response time, faster
disaster recovery capability, and increased memory and capacity for new
and/or upgraded product volumes, and also purchased and implemented Unisys
UNIX-based file servers to run its optical report retrieval system. In
addition, On-Line has implemented a local and wide area networking
infrastructure that includes an upgraded data communications front-end
processor with improved monitoring and diagnostic tools, frame relay
services, a redundant fiber optical ring, and enough capacity to sustain
On-Line's foreseeable business objectives for continued network growth in
router technology, ATM processing, running voice over the network, video
conferencing capabilities, and the potential for performing smaller scale
processing services within a Microsoft-C- NT file server environment.
On-Line's enhanced network has also resulted in improved internal workflow
processes such as the enterprise-wide automated help desk solution and
phone system implemented by On-Line during 1997, to improve client service
tracking and monitoring within all functional departments.
- NEW PRODUCT LINES. In order to become a full service out-sourcing business
partner to its clients, On-Line has upgraded and increased its product and
service offerings. On-Line is now actively offering the
BANKFORCE-Registered Trademark- system, an integrated application system
developed by ITI, capable of meeting customer requirements relating to
daily operations, account management reporting, and product distribution
functions which can be utilized by both banking and non-banking clients of
On-Line. In addition, On-Line introduced a Computer Output Information
Server ("COINS") product, which is a high-speed optical storage and
retrieval system developed by INSCI Corporation. On-Line has also
established its CyberDoc division, which distributes a non-proprietary,
sophisticated document imaging and management process.
- RELATIONSHIP DEVELOPMENT. On-Line seeks to initiate, develop and
strengthen its business relationships with its clients by offering new
products and services designed to provide technologically advanced
solutions for improving client profitability, performance, growth, and
competitive position in the marketplace. On-Line's client services team
approach focuses on a partnership with each individual client and to
tailoring products and services to meet their needs.
- INTERNAL GROWTH AND SALES. On-Line seeks to grow internally by selling
services and products to new clients and cross-selling additional services
to existing clients. On-Line also seeks to develop and sell new services
to clients to help them retain existing customers and attract additional
customers from new markets. The acquisition by the Company has resulted in
new potential targeted sales markets for On-Line that focus on educating
existing clients on necessary technological advances in order to remain
competitive in today's financial services industry, as well opening new
opportunities to offer servicing solutions to financial services
companies. Such sales include the resale of software developed by ITI,
integrated check and document imaging systems, and computer output laser
disc storage technology. These services are in addition to new offerings
by On-Line in the planning and deployment of wide area and local area
network design and implementation, the sale of all related hardware and
services, expanded technical and communications support, consultation, and
training.
- UPGRADED PLANT AND LIFE SAFETY. Since On-Line's acquisition, the Company
has significantly upgraded the physical plant where On-Line is located,
including the creation of a viewing area for visitors to monitor computer
processing activities, reconstruction of departmental office space,
improvement of workflow processes, and installation of numerous life
safety features within the facility such as improved lighting and fire
sprinkler systems. In addition, during July 1997, On-Line completed
construction of the APEX Training & Conference Solution Center, an
on-site, computer-based training and conference facility for use by its
staff, clients, and outside service providers.
72
<PAGE>
CLIENT BASE
On-Line's data processing clients are currently located primarily in the
Midwest. Historically, On-Line's clients have consisted primarily of financial
institutions. Since mid-1997, On-Line has expanded its client base to include
optical report processing services for an insurance company with offices
throughout the United States; document management and imaging services to
financial institution clients, a payroll processor, and manufacturing companies;
and network services to existing and new financial institutions, restaurants,
manufacturing firms, and out-sourcing services for other hardware providers and
technology servicing companies.
COMPETITION
The market for On-Line's services is highly competitive. On-Line seeks to
compete based upon several factors, including product quality, technical
management and staff, leveraging of current advanced technologies capabilities
to existing and prospective clients, introduction of new products and services,
competitive pricing and its relationship strategy. On-Line competes with
independent vendors who offer a full range of products and services to financial
institutions which have assets significantly larger than those of the Company,
as well as certain existing and prospective clients' in-house technical
departments.
SALES, MARKETING AND CLIENT SUPPORT
Sales and Marketing representatives are responsible for sales of On-Line
services to existing clients and the development of new business, including
COINS, document imaging, and data processing. Collectively with On-Line's Client
Services department, such representatives are also responsible for communication
between On-Line and its clients and coordination of On-Line resources to provide
conversion and consultative services. Account Managers manage client
relationships, communicate On-Line's activities and strategic plans, and serve
as a liaison with various On-Line servicing groups. On-Line's collective client
servicing team consists of professional staff members who generally have data
processing experience and/ or experience in the financial services industries.
During 1997, On-Line also began to leverage its enhanced network to improve
internal workflow processes and implement productivity tools. On-Line's
enterprise network provides for a company-wide electronic communications system,
access to all host based applications from multiple platforms, an electronic
application product documentation library, and complete and timely access to all
client reports via the COINS optical viewing system. In addition, On-Line has
implemented an enterprise-wide automated help desk solution and a new phone
system to improve client service tracking and monitoring within all functional
departments. The automated help desk solution provides for call tracking by
client, time, and type of problem, includes a problem solutions database for
reference and ease of problem solving, maintains a client call history, and
provides statistical analysis capabilities for management reporting and
performance measurement. The help desk system allows for call problem escalation
within and between departments and allows for information sharing among
departments to improve customer problem resolution response time.
On-Line's strategy to implement and offer local and wide area networking
services, computer output laser disc storage, optical report retrieval, i.e.
COINS technology, and a full line of document management services has been
realized. Additionally, certain products and services are now being marketed to
a wide array of users in various paper intensive industries. Together with
aggressive marketing to small and mid-size commercial and community banks,
On-Line's business plan to expand its traditional financial institution client
base and enter into other industries is also being implemented. See
"--Description of Business--Interface and/or Stand Alone Systems" and
"--Ancillary Services"
73
<PAGE>
FINANCIAL RESULTS
A summary of the financial results of On-Line is presented below.
ON-LINE FINANCIAL SERVICES, INC.
STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
AT
AT DECEMBER 31,
JUNE 30, ---------------------------------
1998 1997 1996 1995
----------- --------- --------- -----------
<S> <C> <C> <C> <C>
(UNAUDITED) (UNAUDITED)
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents...................................... $ 142 $ 98 $ 36 $ 1,171
Trade accounts receivable, net................................. 1,892 2,244 2,023 1,374
Property and equipment, net.................................... 5,984 6,445 5,719 2,897
Other.......................................................... 2,966 2,302 2,445 1,043
----------- --------- --------- -----------
Total assets..................................................... $ 10,984 $ 11,089 $ 10,223 $ 6,485
----------- --------- --------- -----------
----------- --------- --------- -----------
Liabilities and stockholder's equity:
Capital lease obligations...................................... $ 3,224 $ 3,829 $ 4,338 $ 2,288
Note payable................................................... 635 830 975 --
Other liabilities.............................................. 1,379 1,316 1,364 2,795
Total stockholder's equity..................................... 5,746 5,114 3,546 1,402
----------- --------- --------- -----------
Total liabilities and stockholder's equity....................... $ 10,984 $ 11,089 $ 10,223 $ 6,485
----------- --------- --------- -----------
----------- --------- --------- -----------
</TABLE>
ON-LINE FINANCIAL SERVICES, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE TWO
FOR THE SIX MONTHS
MONTHS ENDED YEARS ENDED DECEMBER ENDED
JUNE 30, 31, DECEMBER 31,
---------------------- -------------------- -------------
1998 1997 1997 1996 1995
----------- --------- --------- --------- -------------
<S> <C> <C> <C> <C> <C>
(UNAUDITED) (UNAUDITED)
<CAPTION>
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Revenue:
Processing revenue.................................. $ 6,154 $ 5,415 $ 11,690 $ 10,956 $ 1,758
Other income........................................ 670 221 1,063 590 256
----------- --------- --------- --------- ------
Total Revenue..................................... 6,824 5,636 12,753 11,546 2,014
Expense:
Processing costs.................................... 1,721 1,017 2,806 1,665 232
Personnel costs..................................... 2,363 2,280 4,499 4,618 784
Computer equipment and software expenses............ 1,489 1,193 2,642 2,033 380
Other expense....................................... 874 1,350 2,610 2,103 260
----------- --------- --------- --------- ------
Total Expense..................................... 6,627 5,840 12,557 10,419 1,656
----------- --------- --------- --------- ------
Income (loss) before income taxes..................... 197 (204) 196 1,127 358
Income tax expense (benefit).......................... 75 (80) 71 391 136
----------- --------- --------- --------- ------
Net Income (loss)..................................... $ 122 $ (124) $ 125 $ 736 $ 222
----------- --------- --------- --------- ------
----------- --------- --------- --------- ------
</TABLE>
74
<PAGE>
DESCRIPTION OF BUSINESS--CORE APPLICATION SYSTEMS
On-Line maintains two fully-integrated application software systems for its
clients. The COMMAND. System is a proprietary application system primarily used
by thrift institutions. BANKFORCE-Registered Trademark- is a third-party banking
electronic commerce solution developed by ITI that can be used by a variety of
financial services clients. In addition to security controls in place within
On-Line's facility, logical security for both application systems resides at the
mainframe, network, terminal, and application levels.
The COMMAND. System, On-Line's proprietary product offering, provides user
institutions with an on-line real-time system for maintaining savings,
IRA/KEOGH, DDA accounts (including line of credit), mortgage loans,
loans-in-process, mortgage banking, installment loans, and general ledger-type
accounts, and supports a batch commercial loan system. The COMMAND.Teller system
serves as an interface with the COMMAND.System applications and allows the
teller to enter transactions using menu screens. The COMMAND.System core
application system includes a mix of integrated value added systems, which
include full ATM processing, support for electronic funds transfer ("EFT") /
automated clearing house ("ACH") transactions, over-the-counter transaction
system capabilities, personal computer ("PC")-based teller and platform systems,
and a telephone banking system.
BANKFORCE-Registered Trademark- is On-Line's electronic commerce solution
developed by ITI. BANKFORCE-Registered Trademark- performs account processing
services for all types of financial institutions and may also be used in any
business utilizing electronic commerce technology. The
BANKFORCE-Registered Trademark- product is capable of meeting customer
requirements relating to daily operations, account management, regulatory
reporting and product distribution functions. All facets of electronic banking
are available with BANKFORCE-Registered Trademark-, as well as detailed customer
information files and expansive capabilities on loan and deposit requirements
allowing customization by users. All modules available with the
BANKFORCE-Registered Trademark- product interface with the general ledger module
to provide a totally integrated product meeting customer needs.
The BANKFORCE-Registered Trademark- application system also includes several
"value added" systems including real-time ATM processing and support for EFT/ACH
transactions. During 1997, On-Line also introduced and implemented the telephone
banking option for its BANKFORCE-Registered Trademark- clients. The
BANKFORCE-Registered Trademark- version of telephone banking allows customers of
On-Line's clients to access account information and transfer funds between
accounts. During the first quarter of 1998, On-Line also introduced home banking
into its BANKFORCE-Registered Trademark- client base, which allows the customers
of On-Line's clients to access account information via PC. Allowable
transactions are determined by the On-Line client, and can include viewing
statements, histories, and transferring funds.
During the first quarter of 1998, On-Line entered into a joint marketing
agreement with a leading provider of remote financial servicing options such as
full-service banking through home computers, an Internet web browser solution,
and another type of voice response ("IVR" or telephone banking) system. These
remote financial services are available to both COMMAND.System and
BANKFORCE-Registered Trademark- clients. On-Line also has a joint marketing
agreement with a Chicago, Illinois ATM supplier and servicer. Both joint
marketing agreements include certain referral fees for On-Line, and may assist
with the renewal of existing client contracts by offering a wider breath of
servicing options to the client.
On-Line's conversion services include product file specification training,
application functionality training, and pre- and post-conversion support at the
client location with the goal for client institutions to become self-sufficient
in managing their new system. On-Line is responsible for providing the training
and guidance necessary to complete the required COMMAND.System or
BANKFORCE-Registered Trademark- system specifications. Each client is ultimately
responsible, however, for reviewing and making decisions regarding the
specifications, based on the institution's products and services. On-Line client
services personnel work with user institutions to set-up institutional
parameters such as interest rates, loan payment schedules, loan classification
codes, etc. Client services professionals then develop the specifications
necessary for converting each existing application field to a corresponding
COMMAND.System or BANKFORCE-Registered Trademark- field. Conversion programming
for the COMMAND. System is performed by On-Line's in-house programming and
client
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services departments. Conversion programming for the
BANKFORCE-Registered Trademark- system is out-sourced to ITI's programming staff
and performed in conjunction with On-Line's Client Services department.
After conversion and on an on-going basis, BANKFORCE-Registered Trademark-
allows for customization of products and services through modification of
appropriate specifications within the system. As such, it is each institution's
responsibility to modify application file specifications, implement segregation
of duties and application-level security through the mechanisms within the
BANKFORCE-Registered Trademark- security control module, and ensure that local
area network ("LAN") security is adequately controlled and administered. After
conversion and on an on-going basis, COMMAND.System users are also responsible
for implementing application level security and determining specifications, but
certain specifications must be made with the assistance of On-Line staff after
receiving written authorization from the client.
Once a client has entered into a COMMAND.System or
BANKFORCE-Registered Trademark- processing contract, On-Line's monthly recurring
fees are generated from processing charges primarily based on the number of
accounts and number of transactions, plus communications charges, disaster
recovery fees and any recurring or one-time special services. In addition,
conversion services generally include a one-time conversion fee, re-sale of
certain software licensing fees, the sale of teller terminals and computer
hardware and/or software.
DESCRIPTION OF BUSINESS--INTERFACE AND/OR STAND ALONE SYSTEMS
COINS. In 1996, On-Line completed the acquisition, development and testing
of its Computer Output Information Server product ("COINS"), which is a
high-speed, optical computer storage and retrieval system that replaces computer
paper and/or microfiche output. Any mainframe-based output can be transferred to
On-Line's COINS server for on-line viewing via a PC and can be distributed and
viewed by multiple concurrent users on a local or wide area network.
Since late 1996, On-Line has been actively marketing COINS to existing
clients, as well as potential clients both within, and outside, the financial
services industry. As of June 30, 1998, most existing On-Line data processing
clients utilize, or have contracted for, the COINS system as their microfiche
replacement, as well as an insurance company with offices throughout the United
States. With over 500 installations worldwide, the COINS solution is based on
client server technology and is one of the market leaders. While the COINS
application can operate on various client/server platforms, the On-Line COINS
application currently resides on a Unisys UNIX-based server within the On-Line
climate controlled computer room. After the nightly update, all existing client
files (I.E., reports, notices, statements ) are transferred from the On-Line
mainframe to the UNIX-based server. Through the existing communications network,
multiple concurrent users at client locations can then access and retrieve
stored data via terminals/PCs, and can distribute the data electronically.
Reports, statements, checks and notices may also be printed if hard copy is
required. Non-data processing client files are transferred from the client's
location to On-Line, and can then be viewed at the clients' sites via dedicated
communication links to On-Line. Access to COINS is controlled by user ID and
password to ensure that only authorized users receive these images.
On-Line obtains recurring revenue from COINS by charging monthly licensing
and account fees. Annual software maintenance fees are also assessed to each
client. On-Line has competitive advantages related to offering an out-sourcing
solution for COINS, as opposed to running the COINS system in-house because,
generally, it is more cost beneficial for clients. There are substantial
hardware investment costs and software licensing fees for running the system
in-house. Currently, On-Line has a site-license for the COINS application and,
thus, can add an unlimited number of file servers and individual users to the
system without incurring additional licensing upgrades.
CYBERDOC. On-Line has entered into several re-selling agreements with third
parties for the resale of two primary imaging solutions and various different
hardware components. During third quarter 1997, On-Line officially introduced
document management and imaging to its line of products and services under
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the marketing label "CyberDoc", thereby enhancing the scope of services
available to its clients. CyberDoc is also being aggressively marketed to
attract new clients. The sales and implementation cycle for CyberDoc clients
includes On-Line's use of high-speed scanners to scan backlogged client records,
such as personnel records or mortgage files, save scanned documents to CD-ROM,
and then code and index the documents for retrieval according to client
specifications. Clients are then able to manipulate the data and access
information meeting specific parameters, i.e., mortgages meeting specific
requirements for sale in the secondary market or a specified customer base for
cross-selling products. Clients have the option of having On-Line continue to
scan new documents on an on-going basis or On-Line will train the client to scan
and code new documents in-house.
Typically, CyberDoc sales consist of one-time, high-margin revenues
associated with backlog conversion of client documents, the sale of complete
imaging capture and retrieval systems, and associated scanners. Image capturing
and scanners may not be sold if the client decides to have On-Line scan and code
new documents; in this case, On-Line benefits from the recurring conversion
work. A licensing fee is also charged to the customer, as well as maintenance
fees for software systems.
DESCRIPTION OF BUSINESS--ANCILLARY SERVICES
Since the Company's acquisition, On-Line has expanded its existing client
services by creating a Network Services department in order to re-sell hardware
and software to existing clients and provide local and wide area network
architectural design and implementation services. Since mid-1997, On-Line's
Network Services have also been targeted to companies both within and outside
the financial services industry. See also "Business of On-Line Financial
Services, Inc.--Client Base"
In addition, in July 1997, On-Line completed construction of its APEX
Training and Conference Solution Center ("APEX"). APEX has a dedicated local
area network and is designed to provide computer based training services.
On-Line utilizes APEX to conduct application and conversion training services to
existing clients, and also generates one-time revenues from rental of the center
to third parities, primarily training companies that provide instruction on
PC-based application software.
CONTRACTS
On-Line has contracts with its financial institution data processing clients
that generally have an initial term of three to seven years and automatically
renew for successive terms unless terminated by either party. In addition, based
on the average contract length, approximately 20% of On-Line's recurring data
processing revenues are at risk each year. On-Line's fee structure is primarily
based on the number of accounts and transactions processed, plus additional
charges for special services. All data processing contracts are in compliance
with OTS Thrift Bulletin 46 (TB-46): "Contracting for Data Processing Services
or Systems" and also address certain other Federal Financial Institutions
Examination Council (FFIEC) requirements for information systems servicing
providers. It is On-Line's policy that legal counsel review data processing
contracts for compliance with applicable regulations and soundness to help
eliminate potential risk exposures to On-Line. In addition, On-Line's data
processing contracts generally include penalties and/or recovery of servicing
discounts received over the life of the contract, in the event a client
terminates its agreement prior to the expiration date, as well as de-conversion
fees.
During October 1997, On-Line began entering into processing contracts with
non-financial institution clients. Such contracts are similar to those for
financial institutions and have specified terms, but may differ slightly based
on the nature of the client's business.
In addition, On-Line may enter into agreements to provide "one-time"
services to existing and new clients, in all industries, in the areas of local
and wide area networking, hardware and software sales and services, document
management and retrieval systems, or specialized consulting services. As a
result of these "one-time" agreements, On-Line may from time to time also enter
into a relationship to provide
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ongoing maintenance services which include network support, network
administration or certain other software maintenance services that result in a
recurring revenue stream for On-Line.
DISASTER RECOVERY / BUSINESS RESUMPTION SYSTEMS
On-Line has comprehensive disaster recovery and business resumption systems.
The key restoration services include daily off-site storage and rotation of
critical files, and the availability of a third-party "hot site". On-Line's
hot-site is a fully operational off-site processing facility equipped with
hardware and system software consistent with On-Line's facility, and is ready to
operate within several hours in the event of a disaster. The hot-site is also
equipped with certain communications equipment as well as On-Line owned
equipment to provide full network recovery capabilities. In order to manage its
recovery systems, On-Line utilizes a disaster recovery planning product that is
specifically designed to meet the compliance needs of its financial institution
clients. All components of On-Line's multiple platform environment and product
offerings are considered in its recovery systems.
REGULATION
On-Line is not directly subject to federal or state banking regulations.
However, as a provider of services to banking institutions, On-Line is subject
to review from time to time by the FDIC, the OTS, the Federal Reserve Board, the
Office of the Comptroller of the Currency, and various state regulatory
authorities. These regulators make certain recommendations to On-Line regarding
various aspects of its operations. In addition, On-Line processing operations
are reviewed annually by an independent auditing firm during a third-party
service center review. Internal auditing procedures are also performed
periodically throughout the year by an independent auditing firm. Such
regulatory reviews and independent audits are intended to review compliance with
FFIEC guidelines, primarily as related to information systems internal controls,
in order to better protect client data from potential security, data integrity,
or confidentiality risks.
BUSINESS OF EMPIRE/ARGO, LLC
In recent years, the Company has acquired Discounted Loans through Empire.
The Company estimates the amounts it will realize through foreclosure,
collection efforts or other resolution of each loan and the length of time
required to complete the collection process in determining the amounts it will
bid to acquire such loans. Investments in these assets has generally resulted in
higher yields and gains. Losses have also been incurred from certain properties
through REO activity. Discounted Loans receivable have also been acquired
through Argo Mortgage. See "Business of the Bank--Bank Subsidiaries."
FEDERAL AND STATE TAXATION
FEDERAL TAXATION
GENERAL. The Company and the Bank report their income on a consolidated
basis and the accrual method of accounting, and are subject to federal income
taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company. For its 1998 taxable year, the Bank is subject to a maximum
federal income tax rate of 35%.
BAD DEBT RESERVES. For fiscal years beginning prior to December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986 (the "Code") were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans (generally secured
by interests in real property improved or to be improved)
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under (i) the Percentage of Taxable Income Method (the "PTI Method") or (ii) the
Experience Method. The reserve for nonqualifying loans was computed using the
Experience Method.
The Small Business Job Protection Act of 1996 (the "1996 Act"), which was
enacted on August 20, 1996, requires savings institutions to recapture (I.E.,
take into income) certain portions of their accumulated bad debt reserves. The
1996 Act repeals the reserve method of accounting for bad debts effective for
tax years beginning after 1995. However, thrift institutions that would be
treated as small banks are allowed to utilize the Experience Method applicable
to such institutions, while thrift institutions that are treated as large banks
(those generally exceeding $500 million in assets) are required to use only the
specific charge-off method. Thus, the PTI Method of accounting for bad debts is
no longer available for any financial institution.
A thrift institution required to change its method of computing reserves for
bad debts will treat such change as a change in method of accounting, initiated
by the taxpayer, and having been made with the consent of the IRS. Any Section
481(a) adjustment required to be taken into income with respect to such change
generally will be taken into income ratably over a six-taxable year period,
beginning with the first taxable year beginning after 1995, subject to the
residential loan requirement.
Under the residential loan requirement provision, the recapture required by
the 1996 Act was suspended for the 1996 and 1997 taxable years because the Bank
met the residential loan requirement test for both years.
Under the 1996 Act, for its current and future taxable years, as a small
bank, the Bank is permitted to make additions to its tax bad debt reserves. In
addition, the Bank is required to recapture (I.E., take into income) over a six
year period the excess of the balance of its tax bad debt reserves as of
December 31, 1995 other than its supplemental reserve for losses on loans, if
any over the balance of such reserves as of December 31, 1987 or a recomputed
December 31, 1987 reserves if the Bank's loan portfolio decreased since December
31, 1987. As a result of such recapture, the Bank will incur additional taxable
income of approximately $80,000 which will be taken into income beginning in
1998 over a six year period.
DISTRIBUTIONS. Under the 1996 Act, if the Bank makes "non-dividend
distributions" to the Company, as a small bank such distributions will be
considered to have been made from the greater of the Bank's tax bad debt
reserves computed under the experience method on the Bank's tax bad debt
reserves as of December 31, 1987 to the extent thereof, and then from the Bank's
supplemental reserve for losses on loans, to the extent thereof, and an amount
based on the amount distributed (but not in excess of the amount of such
reserves) will be included in the Bank's income. Non-dividend distributions
include distributions in excess of the Bank's current and accumulated earnings
and profits, as calculated for federal income tax purposes, distributions in
redemption of stock, and distributions in partial or complete liquidation.
Dividends paid out of the Bank's current or accumulated earnings and profits
will not be so included in the Bank's income.
The amount of additional taxable income triggered by a non-dividend
distribution is the lesser of the Bank's tax bad debt reserves and supplemental
reserves as determined above as of December 31, 1987 or an amount that, when
reduced by the tax attributable to the income, is equal to the amount of the
distribution. Thus, if the Bank makes a non-dividend distribution to the
Company, in some instances approximately one and one-half times the amount of
such distribution (but not in excess of the amount of such reserves) would be
includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. The Bank does not intend to pay dividends that would
result in a recapture of any portion of its bad debt reserves.
SAIF RECAPITALIZATION ASSESSMENT. The Funds Act levied a $.657-cent fee on
every $100 of thrift deposits held on March 31, 1995. For financial statement
purposes, this assessment was reported as an expense for the quarter ended
September 30, 1996. The Funds Act includes a provision which states that
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the amount of any special assessment paid to capitalize SAIF under this
legislation is deductible under Section 162 of the Code in the year of payment.
STATE AND LOCAL TAXATION
STATE OF ILLINOIS. The Company files Illinois income tax returns. For
Illinois income tax purposes, savings institutions are presently taxed at a rate
equal to 7.18% of taxable income. For these purposes, "taxable income" generally
means federal taxable income, subject to certain adjustments (including the
addition of interest income on State and municipal obligations and the exclusion
of interest income on United States Treasury obligations). The exclusion of
income on United States Treasury obligations has the effect of reducing
significantly the Illinois taxable income of savings institutions. The Company
is not currently under audit with respect to its Illinois income tax returns.
STATE OF DELAWARE TAXATION. As a Delaware holding company not earning
income in Delaware, the Company is exempt from Delaware corporate income tax but
is required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
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REGULATION
GENERAL
The Bank is subject to extensive regulation, examination and supervision by
the OTS, as its chartering agency, and the FDIC, as the deposit insurer. The
Bank is a member of the FHLB System. The Bank's deposit accounts are insured up
to applicable limits by the SAIF managed by the FDIC. The Bank must file reports
with the OTS and the FDIC concerning its activities and financial condition in
addition to obtaining regulatory approvals prior to entering into certain
transactions such as mergers with, or acquisitions of, other financial
institutions. There are periodic examinations by the OTS and the FDIC to test
the Bank's compliance with various regulatory requirements. This regulation and
supervision establishes a comprehensive framework of activities in which an
institution can engage and is intended primarily for the protection of the
insurance fund and depositors. The regulatory structure also gives the
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in such policies, whether by
the OTS, the FDIC or the Congress, could have a material adverse impact on the
Company, the Bank or their operations. The Company, as a savings and loan
holding company, will also be required to file certain reports with, and
otherwise comply with the rules and regulations of, the OTS and the Commission
under the federal securities laws.
Any change in the regulatory structure or the applicable statutes or
regulations, whether by the OTS, the FDIC or the Congress, could have a material
impact on the Company, the Bank, their operations, or the Reorganization.
Congress is expected to consider in 1998 the elimination of the federal thrift
charter and the abolishment of the OTS. The results of such consideration,
including possible enactment of legislation, is uncertain. Therefore, the
Company is unable to determine the extent to which the results of such
consideration or possible legislation, if enacted, would affect its business.
See "Risk Factors-- Financial Institution Regulation and Possible Legislation."
Certain of the regulatory requirements applicable to the Bank and to the
Company are referred to below or elsewhere herein. The description of statutory
provisions and regulations applicable to savings associations set forth in this
Prospectus do not purport to be complete descriptions of such statutes and
regulations and their effects on the Bank and the Company and is qualified in
its entirety by reference to such statutes and regulations.
FEDERAL SAVINGS INSTITUTION REGULATION
BUSINESS ACTIVITIES. The activities of federal savings institutions are
governed by the HOLA and, in certain respects, the Federal Deposit Insurance Act
("FDI Act") and the regulations issued by the agencies to implement these
statutes. These laws and regulations delineate the nature and extent of the
activities in which federal associations may engage. In particular, many types
of lending authority for federal associations, E.G., commercial, non-residential
real property loans and consumer loans, are limited to a specified percentage of
the institutions' capital or assets.
LOANS-TO-ONE BORROWER. Under the HOLA, savings institutions are generally
subject to the national bank limit on loans-to-one borrower. Generally, this
limit is 15% of the Bank's unimpaired capital and surplus, plus an additional
10% of unimpaired capital and surplus, if such loan is secured by readily-
marketable collateral, which is defined to include certain financial instruments
and bullion. At June 30, 1998, the Bank's general limit on loans-to-one borrower
was $2.1 million. At June 30, 1998, the Bank's largest aggregate amount of
loans-to-one borrower consisted of $3.2 million. The OTS has allowed the Bank to
lend an amount not to exceed $4.0 million to this customer based on regulatory
exceptions to the loan to-one-borrower limitation.
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QTL TEST. The HOLA requires savings institutions to meet a QTL test. Under
the QTL test, a savings association is required to maintain at least 65% of its
"portfolio assets" (total assets less: (i) specified liquid assets up to 20% of
total assets; (ii) intangibles, including goodwill; and (iii) the value of
property used to conduct business) in certain "qualified thrift investments"
(primarily residential mortgages and related investments, including certain
mortgage-backed and related securities) in at least 9 months out of each 12
month period. A savings association that fails the QTL test must either convert
to a bank charter or operate under certain restrictions. As of June 30, 1998,
the Bank maintained 93% of its portfolio assets in qualified thrift investments
and, therefore, met the QTL test. Recent legislation has expanded the extent to
which education loans, credit card loans and small business loans may be
considered as "qualified thrift investments."
LIMITATION ON CAPITAL DISTRIBUTIONS. OTS regulations impose limitations
upon all capital distributions by savings institutions, such as cash dividends,
payments to repurchase or otherwise acquire its shares, payments to stockholders
of another institution in a cash-out merger and other distributions charged
against capital. The rule establishes three tiers of institutions, which are
based primarily on an institution's capital level. An institution that exceeds
all fully phased-in regulatory capital requirements before and after a proposed
capital distribution ("Tier 1 Bank") and has not been advised by the OTS that it
is in need of more than normal supervision, could, after prior notice to, but
without the approval of the OTS, make capital distributions during a calendar
year equal to the greater of: (i) 100% of its net earnings to date during the
calendar year plus the amount that would reduce by one-half its "surplus capital
ratio" (the excess capital over its fully phased-in capital requirements) at the
beginning of the calendar year; or (ii) 75% of its net earnings for the previous
four quarters. Any additional capital distributions would require prior OTS
approval. At June 30, 1998, the Bank was classified as a Tier 1 Bank. In the
event the Bank's capital fell below its capital requirements or the OTS notified
it that it was in need of more than normal supervision, the Bank's ability to
make capital distributions could be restricted. In addition, the OTS could
prohibit a proposed capital distribution by any institution, which would
otherwise be permitted by the regulation, if the OTS determines that such
distribution would constitute an unsafe or unsound practice.
LIQUIDITY. The Bank is required to maintain an average daily balance of
specified liquid assets equal to a monthly average of not less than a specified
percentage (currently 4%) of its net withdrawable deposit accounts plus
short-term borrowings. Monetary penalties may be imposed for failure to meet
these liquidity requirements. The Bank's average liquidity ratio for the quarter
ended June 30, 1998 was 6.66% and for the year ended December 31, 1997 was
5.91%, which exceeded the applicable requirements. The Bank has never been
subject to monetary penalties for failure to meet its liquidity requirements.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
ASSESSMENTS. Savings institutions are required by regulation to pay
assessments to the OTS to fund the agency's operations. The general assessment,
paid on a semi-annual basis, is based upon the savings institution's total
assets, including consolidated subsidiaries, as reported in the Bank's latest
quarterly Thrift Financial Report. The assessments paid by the Bank for the six
months ended June 30, 1998 totaled $56,000 and for the year ended December 31,
1997 totaled $102,000.
BRANCHING. OTS regulations permit federally chartered savings associations
to branch nationwide under certain conditions. Generally, federal savings
associations may establish interstate networks and geographically diversify
their loan portfolios and lines of business. The OTS authority preempts any
state law purporting to regulate branching by federal savings associations. For
a discussion of the impact of proposed legislation, see "Risk Factors--Financial
Institution Regulation and Possible Legislation."
TRANSACTIONS WITH RELATED PARTIES. The Bank's authority to engage in
transactions with related parties or "affiliates" (I.E., any company that
controls or is under common control with an institution, including the Company
and any non-savings institution subsidiaries that the Company may establish) is
limited by
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Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section 23A restricts
the aggregate amount of covered transactions with any individual affiliate to
10% of the capital and surplus of the savings institution and also limits the
aggregate amount of transactions with all affiliates to 20% of the savings
institution's capital and surplus. Certain transactions with affiliates are
required to be secured by collateral in an amount and of a type described in
Section 23A and the purchase of low quality assets from affiliates is generally
prohibited. Section 23B generally requires that certain transactions with
affiliates, including loans and asset purchases, must be on terms and under
circumstances, including credit standards, that are substantially the same or at
least as favorable to the institution as those prevailing at the time for
comparable transactions with non-affiliated companies.
ENFORCEMENT. Under the FDI Act, the OTS has primary enforcement
responsibility over savings institutions and has the authority to bring action
against all "institution-affiliated parties," including stockholders, and any
attorneys, appraisers and accountants who knowingly or recklessly participate in
wrongful action likely to have an adverse effect on an insured institution.
Formal enforcement action may range from the issuance of a capital directive or
cease and desist order to removal of officers or directors, receivership,
conservatorship or termination of deposit insurance. Civil penalties cover a
wide range of violations and can amount to $25,000 per day, or $1 million per
day in especially egregious cases. Under the FDI Act, the FDIC has the authority
to recommend to the Director of the OTS that enforcement action be taken with
respect to a particular savings institution. If action is not taken by the
Director, the FDIC has authority to take such action under certain
circumstances. Federal and state law also establishes criminal penalties for
certain violations.
STANDARDS FOR SAFETY AND SOUNDNESS. The FDI Act requires each federal
banking agency to prescribe for all insured depository institutions standards
relating to, among other things, internal controls, Information systems and
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, and compensation, fees and benefits and such other
operational and managerial standards as the agency deems appropriate. The
federal banking agencies have adopted final regulations and Interagency
Guidelines Establishing Standards for Safety and Soundness ("Guidelines") to
implement these safety and soundness standards. The Guidelines set forth the
safety and soundness standards that the federal banking agencies use to identify
and address problems at insured depository institutions before capital becomes
impaired. The Guidelines address internal controls and information systems;
internal audit systems; credit underwriting; loan documentation; interest rate
risk exposure; asset growth; asset quality; earnings; and compensation, fees and
benefits. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the Guidelines, the agency
may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard, as required by the FDI Act. The final
regulations establish deadlines for the submission and review of such safety and
soundness compliance plans.
CAPITAL REQUIREMENTS. The OTS capital regulations require savings
institutions to meet three capital standards: a 1.5% tangible capital standard,
a 3% leverage (core capital) ratio and an 8% risk based capital standard. Core
capital is defined as common stockholders' equity (including retained earnings),
certain non-cumulative perpetual preferred stock and related surplus, minority
interests in equity accounts of consolidated subsidiaries less intangibles other
than certain mortgage servicing rights and credit card relationships. The OTS
regulations require that, in meeting the leverage ratio, tangible and risk-based
capital standards, institutions generally must deduct investments in and loans
to subsidiaries engaged in activities not permissible for a national bank. In
addition, the OTS prompt corrective action regulation provides that a savings
institution that has a leverage capital ratio of less than 4% (3% for
institutions receiving the highest CAMEL examination rating) will be deemed to
be "undercapitalized" and may be subject to certain restrictions. See
"Regulation--Prompt Corrective Regulatory Action."
The risk-based capital standard for savings institutions requires the
maintenance of total capital (which is defined as core capital and supplementary
capital) to risk-weighted assets of 8%. In determining
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the amount of risk-weighted assets, all assets, including certain off-balance
sheet assets, are multiplied by a risk-weight of 0% to 100%, as assigned by the
OTS capital regulation based on the risks the OTS believes are inherent in the
type of asset. The components of core capital are equivalent to those discussed
earlier under the 3% leverage standard. The components of supplementary capital
currently include cumulative preferred stock, long-term perpetual preferred
stock, mandatory convertible securities, subordinated debt and intermediate
preferred stock and, within specified limits, the allowance for loan and lease
losses. Overall, the amount of supplementary capital included as part of total
capital cannot exceed 100% of core capital.
The OTS has incorporated an interest rate risk component into its regulatory
capital rule. The final interest rate risk rule also adjusts the risk-weighting
for certain mortgage derivative securities. Under the rule, savings associations
with "above normal" interest rate risk exposure would be subject to a deduction
from total capital for purposes of calculating their risk-based capital
requirements. A savings association's interest rate risk is measured by the
decline in the NPV of its assets (I.E., the difference between incoming and
outgoing discounted cash flows from assets, liabilities and off-balance sheet
contracts) that would result from a hypothetical 200-basis point increase or
decrease in market interest rates divided by the estimated economic value of the
association's assets, as calculated in accordance with guidelines set forth by
the OTS. A savings association whose measured interest rate risk exposure
exceeds 2% must deduct an interest rate component in calculating its total
capital under the risk-based capital rule. The interest rate risk component is
an amount equal to one-half of the difference between the institution's measured
interest rate risk and 2%, multiplied by the estimated economic value of the
association's assets. That dollar amount is deducted from an association's total
capital in calculating compliance with its risk-based capital requirement. Under
the rule, there is a two quarter lag between the reporting date of an
institution's financial data and the effective date for the new capital
requirement based on that data. A savings association with assets of less than
$300 million and risk-based capital ratios in excess of 12% is not subject to
the interest rate risk component, unless the OTS determines otherwise. The rule
also provides that the Director of the OTS may waive or defer an association's
interest rate risk component on a case-by-case basis. The OTS has postponed the
date that the component will first be deducted from an institution's total
capital to provide it with an opportunity to review the interest rate risk
approaches taken by the other federal banking agencies.
At both June 30, 1998 and December 31, 1997, the Bank met each of its
capital requirements.
PROMPT CORRECTIVE REGULATORY ACTION
Under the OTS prompt corrective action regulations, the OTS is required to
take certain supervisory actions against undercapitalized institutions, the
severity of which depends upon the institution's degree of capitalization.
Generally, a savings institution that has a total risk-based capital of less
than 8.0% or a leverage ratio or a Tier 1 capital ratio that is less than 4.0%
is considered to be undercapitalized. A savings institution that has a total
risk-based capital less than 6.0%, a Tier 1 risk-based capital ratio of less
than 3.0% or a leverage ratio that is less than 3.0% is considered to be
"significantly undercapitalized" and a savings institution that has a tangible
capital to assets ratio equal to or less than 2.0% is deemed to be "critically
undercapitalized." Subject to a narrow exception, the banking regulator is
required to appoint a receiver or conservator for an institution that is
critically undercapitalized. The regulation also provides that a capital
restoration plan must be filed with the OTS within 45 days of the date an
association receives notice that it is "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." Compliance with the plan
must be guaranteed by any parent holding company. In addition, numerous
mandatory supervisory actions may become immediately applicable to the
institution depending upon its category, including, but not limited to,
increased monitoring by regulators, restrictions on growth, and capital
distributions and limitations on expansion. The OTS could also take any one of a
number of discretionary supervisory actions, including the issuance of a capital
directive and the replacement of senior executive officers and directors.
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INSURANCE OF DEPOSIT ACCOUNTS
Deposits of the Bank are presently insured by the SAIF. Both the SAIF and
the BIF (the deposit insurance fund that covers most commercial bank deposits)
are statutorily required to be recapitalized to a 1.25% of insured reserve
deposits ratio. Until recently, members of the SAIF and BIF were paying average
deposit insurance premiums of between 24 and 25 basis points. The BIF met the
required reserve in 1995, whereas the SAIF was not expected to meet or exceed
the required level until 2002 at the earliest. This situation was primarily due
to the statutory requirement that SAIF members make payments on bonds issued in
the late 1980s by the FICO to recapitalize the predecessor to the SAIF.
In view of the BIF's achieving the 1.25% ratio, the FDIC ultimately adopted
a new assessment rate schedule of from 0 to 27 basis points under which 92% of
BIF members paid an annual premium of only $2,000. With respect to SAIF member
institutions, the FDIC adopted a final rule retaining the previously existing
assessment rate schedule applicable to SAIF member institutions of 23 to 31
basis points. As long as the premium differential continued, it may have had
adverse consequences for SAIF members, including reduced earnings and an
impaired ability to raise funds in the capital markets. In addition, SAIF
members, such as the Bank could have been placed at a substantial competitive
disadvantage to BIF members with respect to pricing of loans and deposits and
the ability to achieve lower operating costs.
On September 30, 1996, the President signed into law the the Funds Act
which, among other things, imposed a special one-time assessment on SAIF member
institutions, including the Bank, to recapitalize the SAIF. As required by the
Funds Act, the FDIC imposed a special assessment of 65.7 basis points on SAIF
assessable deposits held as of March 31, 1995, payable November 27, 1996 (the
"SAIF Special Assessment"). The SAIF Special Assessment was recognized by the
Bank as an expense in the quarter ended September 30, 1996 and was tax
deductible. The SAIF Special Assessment recorded by the Bank amounted to
$789,000 on a pre-tax basis and $489,000 on an after-tax basis.
The Funds Act also spreads the obligations for payment of the FICO bonds
across all SAIF and BIF members. Beginning on January 1, 1997, BIF deposits will
be assessed for FICO payment of 1.3 basis points, while SAIF deposits will pay
6.48 basis points. Full pro rata sharing of the FICO payments between BIF and
SAIF members will occur on the earlier of January 1, 2000 or the date the BIF
and SAIF are merged. The Funds Act specifies that the BIF and SAIF will be
merged on January 1, 1999, provided no savings associations remain as of that
time.
As a result of the Funds Act, the FDIC recently voted to effectively lower
SAIF assessments to 0 to 27 basis points as of January 1, 1997, a range
comparable to that of BIF members. However, SAIF members will continue to make
the FICO payments described above. Management cannot predict the level of FDIC
insurance assessments on an on-going basis, whether the savings association
charter will be eliminated or whether the BIF and SAIF will eventually be
merged.
The Bank's assessment rate for the six months ended June 30, 1998 and the
year ended December 31, 1997 was 6 basis points and the premiums paid for these
periods were $56,000 and $102,000, respectively. A significant increase in SAIF
insurance premiums would likely have an adverse effect on the operating expenses
and results of operations of the Bank.
Under the FDI Act, insurance of deposits may be terminated by the FDIC upon
a finding that the institution has engaged in unsafe or unsound practices, is in
an unsafe or unsound condition to continue operations or has violated any
applicable law, regulation, rule, order or condition imposed by the FDIC or the
OTS. The management of the Bank does not know of any practice, condition or
violation that might lead to termination of deposit insurance.
THRIFT RECHARTERING LEGISLATION
The Funds Act, enacted in September 1996, provides that the BIF, the fund
which insures most commercial bank deposits, and the SAIF will merge on January
1, 1999, if there are no savings associations,
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as defined, in existence on that date. Pursuant to that legislation, the
Department of Treasury in May, 1997 recommended in a report to Congress that the
separate charters for thrifts and banks be abolished. Various proposals to
eliminate the federal thrift charter, create a uniform financial institutions
charter, conform holding company regulation and abolish the OTS have been
introduced in Congress. The House Committee on Banking and Financial Services
has reported a bill that will require federal savings associations to convert to
national banks or some type of state charter within two years of enactment or
they would automatically become national banks. The bill would also merge the
BIF and the SAIF, repeal the HOLA, abolish the OTS and transfer the regulation
of savings associations to the federal bank regulators and the Federal Reserve
Board. Federal thrifts converted to national banks generally will be permitted
to continue to engage in any activity, including the holding of any asset,
lawfully conducted on the date prior to the enactment. A federal savings
association converted to a national bank may retain all branches established or
proposed in a pending application as of enactment and establish new branches in
any state in which it has a branch. Otherwise, it may establish new branches
only under national bank rules. In addition, beginning two years after
enactment, national banks will be authorized to exercise all powers formerly
authorized for federal savings associations.
Under the proposal, holding companies for savings associations converted to
national banks generally will become subject to the same regulation as holding
companies that control commercial banks, with a grandfather provision for former
unitary savings and loan holding companies. Such grandfathered companies will be
permitted to maintain and establish affiliations with any type of company and to
acquire additional depository institutions, as long as any acquired depository
institution is merged into its converted savings association and such
institution continues to comply with both the qualified thrift lender test and
certain asset and investment limitations to which it was subject as a federal
savings association.
TRUTH IN LENDING
The Truth in Lending Act ("TILA") and Regulation Z promulgated thereunder
requires lenders, such as the Bank, to provide a disclosure statement to
borrowers which explains the terms and cost of credit, including, but not
limited to, the amount financed, finance charges, other charges, and prepayment
terms. Regulation Z applies to a wide variety of lending transactions, including
mortgage loans and credit cards. The TILA provides borrowers with a three day
right to cancel certain credit transactions, including residential mortgage
loans and other loans where a customer pledges his or her principal dwelling as
security for the loan. Failure to comply with the provisions of the TILA could
subject a lender to criminal and civil sanctions.
The TILA was amended effective October 1, 1995 to impose new disclosure
requirements and substantive limitations on closed-end home equity mortgage
loans bearing rates or fees above a certain percentage or amount ("TILA
Amendments"). Specifically, the TILA Amendments applies to loans secured by a
customer's principal dwelling (other than a residential mortgage loan to acquire
or construct a borrower's principal dwelling, a reverse mortgage transaction or
home equity lines of credit) with (i) an annual percentage rate which exceeds by
more than ten percentage points the yield on U.S. Treasury securities having
comparable periods of maturity; or (ii) total loan origination fees and other
fees payable by the customer will exceed the greater of 8% of the loan amount or
$400 ("Covered Loans"). Additional disclosures are required to be provided to
the customer under the TILA Amendments for all Covered Loans not less than three
business days prior to the consummation of the transaction.
OTHER LENDING LAWS
The Bank is also required to comply with the Equal Credit Opportunity Act of
1974, as amended ("ECOA"), which prohibits creditors from discriminating against
applicants on certain prohibited bases, including race, color, religion,
national origin, sex, age or marital status. Regulation B promulgated under ECOA
restricts creditors from obtaining certain types of information from loan
applicants. Among other things, it also requires certain disclosures by the
lender regarding consumer rights and requires lenders to
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advise applicants of the reasons for any credit denial. In instances where the
applicant is denied credit or the rate or charge for loans increases as a result
of information obtained from a consumer credit agency, another statute, the Fair
Credit Reporting Act of 1970, as amended, requires lenders to supply the
applicant with the name and address of the reporting agency. In addition, the
Bank is subject to the Fair Housing Act and regulations thereunder, which
broadly prohibit certain discriminatory practices in connection with the Bank's
business. The Bank is also subject to the Real Estate Settlement Procedures Act
of 1974, as amended, and the Home Mortgage Disclosure Act.
In addition, the Bank is subject to various other Federal and state laws,
rules and regulations governing, among things, the licensing of, and procedures
which must be followed by, mortgage lenders and services, and disclosures which
must be made to consumer borrowers. Failure to comply with such laws, as well as
with the laws described above, may result in civil and criminal liability.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the FHLB System, which consists of 12 regional
FHLBs. The FHLB provides a central credit facility primarily for member
institutions. The Bank, as a member of the FHLB, is required to acquire and hold
shares of capital stock in the FHLB in an amount at least equal to 1% of the
aggregate principal amount of its unpaid residential mortgage loans and similar
obligations at the beginning of each year, or 1/20 of its advances (borrowings)
from the FHLB, whichever is greater. The Bank was in compliance with this
requirement with an investment in FHLB stock at June 30, 1998, of $1.8 million.
FHLB advances must be secured by specified types of collateral and all long-term
advances may only be obtained for the purpose of providing funds for residential
housing finance. At June 30, 1998, the Bank had outstanding FHLB advances of
$18.1 million.
The FHLBs are required to provide funds for the resolution of insolvent
thrifts and to contribute funds for affordable housing programs. These
requirements could reduce the amount of dividends that the FHLBs pay to their
members and could also result in the FHLBs imposing a higher rate of interest on
advances to their members. For the six months ended June 30, 1998 and 1997 and
the years ended December 31, 1997, 1996 and 1995, dividends from the FHLB to the
Bank amounted to $89,000, $112,000, $226,000, $188,000, and $175,000
respectively. If dividends were reduced, the Bank's net interest income would
likely also be reduced. Further, there can be no assurance that the impact of
recent or future legislation on the FHLBs will not also cause a decrease in the
value of the FHLB stock the Bank is required to hold.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board regulations require savings institutions to
maintain non-interest-earning reserves against their transaction accounts. The
Federal Reserve Board regulations generally require that reserves be maintained
against aggregate transaction accounts as follows: for accounts aggregating
$47.8 million or less (subject to adjustment by the Federal Reserve Board) the
reserve requirement is 3%; and for accounts greater than $47.8 million, the
reserve requirement is $1.4 million plus 10% (subject to adjustment by the
Federal Reserve Board between 8% and 14%) against that portion of total
transaction accounts in excess of $47.8 million. The first $4.7 million of
otherwise reservable balances (subject to adjustment by the Federal Reserve
Board) are exempted from the reserve requirements. The Bank is in compliance
with the foregoing requirements. Because required reserves must be maintained in
the form of either vault cash, a non-interest-bearing account at a Federal
Reserve Bank or a pass-through account as defined by the Federal Reserve Board,
the effect of this reserve requirement is to reduce the Bank's interest-earning
assets. FHLB System members are also authorized to borrow from the Federal
Reserve "discount window," but Federal Reserve Board regulations require
institutions to exhaust all FHLB sources before borrowing from a Federal Reserve
Bank.
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HOLDING COMPANY REGULATION
The Company is a non-diversified unitary savings and loan holding company
within the meaning of the HOLA. As such, the Company is registered with the OTS
and is subject to OTS regulations, examinations, supervision and reporting
requirements. In addition, the OTS has enforcement authority over the Company
and its non-savings institution subsidiaries. Among other things, this authority
permits the OTS to restrict or prohibit activities that are determined to be a
serious risk to the subsidiary savings institution. The Bank must notify the OTS
30 days before declaring any dividend to the Company.
As a unitary savings and loan holding company, the Company generally is not
restricted under existing laws as to the types of business activities in which
it may engage, provided that the Bank continues to be a QTL. See
"Regulation--Federal Savings Institution Regulation--QTL Test" for a discussion
of the QTL requirements. Upon any non-supervisory acquisition by the Company of
another savings association, the Company would become a multiple savings and
loan holding company (if the acquired institution is held as a separate
subsidiary) and would be subject to extensive limitations on the types of
business activities in which it could engage. The HOLA limits the activities of
a multiple savings and loan holding company and its non-insured institution
subsidiaries primarily to activities permissible for bank holding companies
under Section 4(c)(8) of the BHC Act, subject to the prior approval of the OTS,
and to other activities authorized by OTS regulation. Previously proposed
legislation would have treated all savings and loan holding companies as bank
holding companies and limit the activities of such companies to those
permissible for bank holding companies. See "Risk Factors--Financial Institution
Regulation and Possible Legislation."
The HOLA prohibits a savings and loan holding company, directly or
indirectly, or through one or more subsidiaries, from acquiring more than 5% of
the voting stock of another savings institution, or holding company thereof,
without prior written approval of the OTS; and from acquiring or retaining, with
certain exceptions, more than 5% of a non-subsidiary holding company or savings
association. The HOLA also prohibits a savings and loan holding company from
acquiring more than 5% of a company engaged in activities other than those
authorized for savings and loan holding companies by the HOLA; or acquiring or
retaining control of a depository institution that is not insured by the FDIC.
In evaluating applications by holding companies to acquire savings institutions,
the OTS must consider the financial and managerial resources and future
prospects of the company and institution involved, the effect of the acquisition
on the risk to the insurance funds, the convenience and needs of the community
and competitive factors.
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, except: (i) the approval of interstate supervisory
acquisitions by savings and loan holding companies, and (ii) the acquisition of
a savings institution in another state if the laws of the state of the target
savings institution specifically permit such acquisitions. The states vary in
the extent to which they permit interstate savings and loan holding company
acquisitions.
FEDERAL SECURITIES LAWS
The Company has filed with the Commission a registration statement on Form
S-1 under the Securities Act for the registration of the Common Stock and the
Capital Securities to be issued in the Offering. Upon the effectiveness of the
Offering, the Company's Common Stock and Capital Securities will be registered
with the Commission under the Securities Exchange Act of 1934 (the "Exchange
Act"). The Company will then be subject to the information, proxy solicitation,
insider trading restrictions and other requirements under the Exchange Act.
The registration under the Securities Act of 1933 (the "Securities Act") of
shares of the Common Stock and the Capital Securities to be issued in the
Offering does not cover the resale of such shares. Shares of the Common Stock
and/or Capital Securities purchased by persons who are not affiliates of the
Company may be resold without registration. Shares purchased by 144 under the
Securities Act. If the Company meets the current public information requirements
of Rule 144 under the Securities Act, each
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affiliate of the Company who complies with the other conditions of Rule 144
(including those that require the affiliate's sale to be aggregated with those
of certain other persons) would be able to sell in the public market, without
registration, a number of shares not to exceed, in any three-month period, the
greater of (i) 1% of the outstanding shares of the Company or (ii) the average
weekly volume of trading in such shares during the preceding four calendar weeks
revision may be made in the future by the Company to permit affiliates to have
their shares registered for sale under the Securities Act under certain
circumstances.
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THE BOARD OF DIRECTORS AND
MANAGEMENT OF THE COMPANY
The following table sets forth certain information regarding executive
officers and directors of the Company.
<TABLE>
<CAPTION>
NAME AGE(1) POSITION(S) HELD WITH COMPANY
- ---------------------------------------------------- ----------- ----------------------------------------------------
<S> <C> <C>
John G. Yedinak..................................... 49 Director, Chairman of the Board, President and Chief
Executive Officer
Sergio Martinucci................................... 63 Director, Vice President
Frances M. Pitts.................................... 39 Director, Executive Vice President and Secretary
Donald G. Wittmer................................... 62 Director
Arthur E. Byrnes.................................... 53 Director
George L. Koehm..................................... 36 Interim Chief Financial Officer
</TABLE>
- ------------------------
(1) As of June 30, 1998
The Board of Directors of the Company is divided into three classes, each of
which contains approximately one-third of the Board. The directors shall be
elected by the stockholders of the Company for staggered three year terms, or
until their successors are elected and qualified. One class of directors,
consisting of Mr. Wittmer, has a term of office expiring at the 1999 annual
meeting of stockholders; a second class, consisting of Ms. Pitts and Mr. Byrnes,
has a term of office expiring at the 2000 annual meeting of stockholders; and a
third class consisting of Messrs. Martinucci and Yedinak, has a term of office
expiring at the 2001 annual meeting of stockholders.
During the term of the Stockholder Agreement with Deltec, and for so long as
Deltec holds at least 15% of the Company's Common Stock, Deltec has the right to
nominate one director to the Company's Board of Directors. The Stockholder
Agreement also grants Deltec registration rights in respect of any shares of
Common Stock that Deltec decides to sell. Furthermore, John G. Yedinak, the
President and Chief Executive Officer of the Company has agreed that, during
this time period, he will vote all shares of the Company's Common Stock owned by
him for the nominee designated by Deltec. Finally, during the term of the
Stockholder Agreement, Deltec has agreed to remain in compliance with the
Rebuttal Agreement between Deltec and the OTS. See "Stockholder Agreement."
COMMITTEES AND MEETINGS OF THE BOARD OF DIRECTORS OF THE COMPANY
The Board of Directors of the Company met on a monthly basis during the year
ended December 31, 1997. No directors attended fewer than 75% of the total
number of Board and Committee meetings held during this period. The Board of
Directors of the Company maintains committees, the nature and composition of
which are described below:
EXECUTIVE COMMITTEE. The Executive Committee of the Company consists of
Messrs. Yedinak, Wittmer and Martinucci. This committee exercises the authority
of the Board of Directors with respect to matters requiring action between
meetings of the Board of Directors. Any actions by this committee require
subsequent ratification by the Board of Directors at the next regular meeting.
This committee meets as needed between regular meetings of the Board. The
Executive Committee met 12 times in 1997.
AUDIT COMMITTEE. The Audit Committee of the Company consists of Messrs.
Wittmer, Byrnes and Yedinak. The Audit Committee met 12 times in 1997.
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NOMINATING COMMITTEE. The Company's Nominating Committee for the 1998
Annual Meeting of Stockholders consisted of the entire Board of Directors. The
Nominating Committee considers and recommends the nominees for director to stand
for election at the Company's annual meeting of stockholders. The Company's
Bylaws provide for stockholder nominations of directors. These provisions
require such nominations to be made pursuant to timely notice in writing to the
Secretary of the Company. The stockholder's notice of nomination must contain
all information relating to the nominee which is required to be disclosed by the
Company's bylaws and by the Exchange Act. The Nominating Committee last met on
February 11, 1998.
DIRECTORS' COMPENSATION
DIRECTORS' FEES. Directors of the Company are paid $700 monthly for
attendance at meetings and for services rendered to the Company. Directors of
the Bank are paid $700 for attendance at monthly meetings of the Board, and are
also compensated for service to and attendance at meetings of the committees of
the Board on which they serve at the rate of $400 ($450 for the Chairman) for
each committee meeting. The Chairman of each Board and each committee is
compensated at a higher rate for attendance at monthly meetings and for duties
performed during the month and the Secretary of the Board and of each committee
also receives compensation for services, at the rate of $400 each meeting.
Directors of On-Line are paid $700 for attendance at meetings of the Board.
1998 INCENTIVE STOCK OPTION PLAN. Each member of the Board of Directors who
is not an officer or employee of the Bank or the Company, is eligible to receive
non-statutory stock options to purchase shares of Common Stock under the
Company's 1998 Incentive Stock Option Plan ("Incentive Stock Option Plan"). As
of June 30, 1998 no options had been granted under the Incentive Stock Option
Plan.
THE BOARD OF DIRECTORS AND MANAGEMENT OF THE BANK
DIRECTORS
The following table sets forth certain information regarding the Board of
Directors of the Bank.
<TABLE>
<CAPTION>
POSITIONS HELD WITH THE DIRECTOR TERM
NAME AGE(1) BANK SINCE EXPIRES
- --------------------------------------------------------- ----------- --------------------------- ----------- -----------
<S> <C> <C> <C> <C>
Sergio Martinucci........................................ 63 Chairman of the Board 1987 1999
John G. Yedinak.......................................... 49 Director, President and 1987 1999
Chief Executive Officer
Richard B. Duffner....................................... 63 Director 1987 2001
Emil T. Sergo............................................ 72 Director 1988 2001
Dennis G. Carroll........................................ 48 Director 1990 1999
Raymond E. Froula........................................ 72 Director 1991 2000
Mary Ann Gearhart........................................ 47 Director 1991 2000
</TABLE>
- ------------------------
(1) As of June 30, 1998.
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EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
The following table sets forth certain information regarding the executive
officers of the Bank who are not also directors.
<TABLE>
<CAPTION>
NAME AGE(1) POSITION HELD WITH THE BANK
- ---------------------------------------------------- ----------- ----------------------------------------------------
<S> <C> <C>
Frances M. Pitts.................................... 39 Senior Vice President, General Counsel and Secretary
George L. Koehm..................................... 36 Senior Vice President and Chief Operating Officer
</TABLE>
- ------------------------
(1) As of June 30, 1998.
BIOGRAPHICAL INFORMATION
Presented below is biographical information regarding directors and
executive officers of the Company and directors and executive officers of the
Bank who are not also directors and executive officers of the Company.
JOHN G. YEDINAK has served as the Chairman of the Board, President and Chief
Executive Officer of the Company. Mr. Yedinak also serves as the President and
Chief Executive Officer and Director of the Bank and the Chairman of the Board
and Chief Executive Officer of On-Line. He received a B.S. from Northern
Illinois University and his Master of Business from Governor's State University.
Mr. Yedinak was previously President of Summit Financial Services, Inc.,
City-Wide Collection Company, Inc., and Assistant Secretary and Systems Manager
of Talman Federal Savings and Loan Association.
SERGIO MARTINUCCI has served as a Director and Vice President of the Company
since 1987. Mr. Martinucci also serves as the Chairman of the Board of the Bank
and is a Director of On-Line. Mr. Martinucci is President of Coldwell
Banker-Stanmeyer Realtors. He received his B.A. and Masters in Education from
Roosevelt University, Chicago, Illinois. Previously, Mr. Martinucci was a
college professor.
FRANCES M. PITTS has served as a Director of the Company since 1992 and as
Executive Vice President and Secretary of the Company since 1994. Ms. Pitts also
serves as Senior Vice President, General Counsel and Secretary of the Bank and
Senior Vice President and Secretary of On-Line. She received her B.A. from
Marquette University and her J.D. from Valparaiso University School of Law. Ms.
Pitts was previously in private practice representing financial institutions.
RICHARD B. DUFFNER has served as a Director of the Bank since 1987. He
received his B.S.C. in accounting and M.B.A. from Loyola University. Mr. Duffner
has served as Assistant Treasurer and Director of Cash Management at Commerce
Clearing House, Inc. and also served as Vice President, Branch Operations of
Talman Federal Savings. Mr. Duffner is also President of R.B.D. & Associates,
Ltd, a real estate appraisal firm.
DONALD G. WITTMER has served as Director of the Company since 1992 and also
serves as a Director of On-Line. He received his B.S. in Accounting from
Fairleigh Dickinson University and his MBA in Finance from Loyola University in
Chicago. Previously he served as Vice President, Controller for Quaker Oats
Company. Currently, Mr. Wittmer is an owner and President of Wittmer Management
Corporation and Wittmer Financial Services, Ltd. Mr. Wittmer is a Certified
Public Accountant.
ARTHUR E. BYRNES has served as a Director of the Company since 1997. Mr.
Byrnes is Chairman of the Deltec Asset Management Corporation, a wholly owned
subsidiary of Deltec, and a Director of Deltec International S.A., the parent
holding company of Deltec. He received his B.A. from Harvard University
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and his M.B.A. from Stanford University. Mr. Byrnes is also a Director at Dravo
Corporation and Home Federal Financial Corporation.
EMIL T. SERGO has served as a Director of the Bank since 1988. He is the
Mayor of McCook, Illinois. Currently, Mr. Sergo is a member and past President
of the Lyons Township Democratic Organization.
DENNIS G. CARROLL has served as a Director of the Bank since 1990. He is a
detective with the City of Chicago Police Department. He received his B.S. from
St. Joseph College and his Masters in Public Administration from Illinois
Institute of Technology. Mr. Carroll was previously associated with the Chicago
City Bank. He is a Certified Residential Appraiser. Currently, he also is a
consultant for Midwest Appraisals, Ltd.
RAYMOND E. FROULA has served as a Director of the Bank since 1991. He is
currently retired, but was previously a Senior Vice President in charge of
appraisal services for Bell Federal Savings in Chicago, Illinois. Mr. Froula was
a past President of Illinois Chapter #6 of the American Institute of Real Estate
Appraisers and of the Society of Real Estate Appraisers Market Data Center.
MARY ANN GEARHART has served as a Director of the Bank since 1991. Ms.
Gearhart received her B.S. and M.A. in Education from Illinois State University.
Previously, she was an owner of Deer Creek Cooperative Preschool and was a
special education teacher. Currently, she also serves as Executive Chairperson
of the Will County Board of Commissioners and a Supervisor in Crete Township.
GEORGE L. KOEHM joined the Bank in October 1997 as Senior Vice President and
Chief Operating Officer and was appointed Interim Chief Financial Officer of the
Company in July 1998. From August 1989 until August 1997, Mr. Koehm was Vice
President and Treasurer of Community Bank, a Federal Savings Bank located in
Michigan City, Indiana and served as Vice President and Chief Financial Officer
of its parent company, CB Bancorp, Inc.
Presented below is biographical information regarding certain executive
officers of the Company's subsidiaries other than the Bank.
COLLEEN A. KITCH joined On-Line in May 1996 as Director of Information
Systems Integration and was promoted to Senior Vice President and Chief
Operating Officer in October 1996. Prior to joining On-Line, Ms. Kitch worked
for KPMG Peat Marwick LLP's financial audit division and Information Risk
Management/Information Systems consulting division. Ms. Kitch graduated from the
University of Notre Dame with a BAA in Accountancy and a BA in Computer
Applications. Ms. Kitch is also a Certified Public Accountant and Certified
Systems Auditor.
JOSEPH C. ("TUCK") MARSHALL, has served as the President for MARGO since its
inception in May 1996. Mr. Marshall has an extensive background in mortgage
brokerage and mortgage financing. He is responsible for the marketing direction
and efforts of MARGO. In addition, Mr. Marshall is the current President of the
National Association of Mortgage Brokers, which represents approximately 8,000
mortgage brokers across the country.
RALPH E. ROSYNEK, JR., has served as the Executive Vice President and Chief
Operating Officer of MARGO since its inception in May, 1996. From 1993-1996, Mr.
Rosynek was President of Shoreline Bancorp, Inc., a privately held mortgage
banking firm. Mr. Rosynek is responsible for all operations of MARGO, assisted
by a staff of 12 and has a 22 year background in banking, mortgage banking and
mortgage brokerage. In addition, Mr. Rosynek is currently the Treasurer of the
National Association of Mortgage Brokers Educational Foundation and holds the
national designation of Senior Mortgage Consultant.
COMMITTEES AND MEETINGS OF THE BOARD OF DIRECTORS OF THE BANK
The Board of Directors meets on a monthly basis and may have additional
special meetings upon the request of the Chairman of the Board. During the year
ended December 31, 1997, the Board of Directors
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met 12 times. No director attended fewer than 75% of the total number of Board
and committee meetings held during this period.
The Board of Directors of the Bank has established the following Board and
management committees:
The Audit Committee consists of Messrs. Carroll and Duffner and Mmes.
Gearhart and Pitts. The Bank's outsourced internal audit function reports to
this Committee. The purpose of this Committee is to review the audit report and
to suggest management actions regarding the implementation of audit findings.
The Committee also maintains a liaison with the outside auditors and reviews the
adequacy of internal controls. The Committee meets monthly.
The Loan Committee consists of Messrs. Yedinak, Carroll, Duffner, Froula,
Koehm, Rosynek and Ms. Pitts. This Committee exercises the authority of the
Board pertaining to loan matters and approves or rejects all loans presented by
management. This Committee also reviews the workout solutions of problem loans,
and approves the classification of assets and the establishment of adequate
valuation allowances. The Committee meets monthly.
The Executive Committee consists of Messrs. Yedinak, Martinucci, Carroll and
Duffner. This committee exercises the authority of the Board of Directors with
respect to matters requiring action between meetings of the Board of Directors.
Any actions by this committee require subsequent ratification by the Board of
Directors at the next regular meeting. The Executive Committee meets as needed;
in the year ended December 31, 1997 it met 12 times.
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE. The following table shows for the fiscal years
ending December 31, 1997, 1996 and 1995, the cash compensation paid by the
Company and its subsidiaries, the Bank and On-Line, as well as certain other
compensation paid or accrued for those years, to the Chief Executive Officer and
to the other executive officers of the Company who received total salary and
bonus in excess of $100,000 in 1997 (the "Named Executive Officers").
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
----------------------------
<S> <C> <C> <C> <C> <C> <C>
ANNUAL COMPENSATION AWARDS
------------------------------------- ----------------------------
OTHER RESTRICTED SECURITIES
ANNUAL STOCK UNDERLYING
NAME AND SALARY BONUS COMPEN- SATION AWARD(S) OPTIONS/
PRINCIPAL OFFICE YEAR ($)(1)(2) ($)(3) ($)(4) ($) SARS(#)
- ---------------------------------------- --------- ----------- --------- ------------- ----------- ---------------
John G. Yedinak......................... 1997 $ 359,804 $ 176,000 $ -- $ -- --
President and Chief 1996 320,336 200,998 -- -- --
Executive Officer of the 1995 299,149 125,434 -- 13,755 --
Company and President
and Chief Executive
Officer of the Savings
Bank
Frances M. Pitts........................ 1997 $ 144,615 $ 70,500 $ -- $ -- --
Executive Vice President 1996 126,368 82,989 -- -- --
and Secretary of the 1995 117,034 46,201 -- 5,000 --
Company and Senior
Vice President, General
Counsel and Secretary of
the Saving Bank
<CAPTION>
<S> <C> <C>
PAYOUTS
----------- ALL OTHER
LTIP COMPEN-
NAME AND PAYOUTS SATION
PRINCIPAL OFFICE ($)(5) ($)
- ---------------------------------------- ----------- -----------
John G. Yedinak......................... None $ 24,816(6)
President and Chief None 58,451
Executive Officer of the None 23,369
Company and President
and Chief Executive
Officer of the Savings
Bank
Frances M. Pitts........................ None $ 23,482(6)
Executive Vice President None 21,453
and Secretary of the None 9,945
Company and Senior
Vice President, General
Counsel and Secretary of
the Saving Bank
</TABLE>
- ------------------------
(1) Includes amounts of salary deferred pursuant to the Bank's 401(k) Plan.
Under the plan, participants may elect to have up to the lesser of 12% or
$9,500 of annual compensation deferred for the plan year.
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(2) Includes directors' fees received from the Company, the Bank and On-Line
with respect to Mr. Yedinak and directors' fees and Secretary's fees
received from the Company and the Bank with respect to Ms. Pitts.
(3) Includes deferred bonus amounts as described under "--Employment Agreements"
with respect to Mr. Yedinak and Ms. Pitts. Such bonuses were based upon the
financial results of the Company for 1996 and 1995. No bonuses were paid in
1997.
(4) For 1997, 1996 and 1995, there were no (a) perquisites over the lesser of
$50,000 or 10% of the individual's total salary and bonus for the years; (b)
payments of above market preferential earnings on deferred compensation; (c)
payments of earnings with respect to long term incentive plans prior to
settlement or maturation; (d) tax payment reimbursements; or (e)
preferential discounts on stock.
(5) The Company does not maintain a long-term incentive plan and therefore,
there were no payouts or awards under such plan.
(6) Includes $4,750 contributed by the Bank pursuant to the 401(k) Plan for the
account of each of Mr. Yedinak and Ms. Pitts, for the year ended December
31, 1997. Excludes $82,219, and $10,797 which represents the market value of
premiums paid on supplemental policies covering life (with proceeds to be
paid to the Company and the Bank) and long-term disability for Mr. Yedinak
and Ms. Pitts for the year ended December 31, 1997. Includes $20,066 and
$18,632, the market value of the allocations of shares made under the
Employee Stock Ownership Plan for 1997.
EMPLOYMENT AGREEMENTS. The Company and the Bank (collectively the
"Employer") entered into employment agreements ("Agreements") with each of Mr.
Yedinak and Ms. Pitts (the "Executives"), effective November 1, 1996. The Bank
Agreements provide for a three year term and, commencing on the first
anniversary date and continuing each anniversary date thereafter, the Board of
Directors may extend the Agreements for an additional year so that the remaining
term shall be three years, unless written notice of non-renewal is given by the
Board of Directors after conducting a performance evaluation of the Executives.
The Company Agreements provide for a five year term and shall be extended on a
daily basis unless written notice of non-renewal is given by the Board of the
Company. Under the Agreements with each of the Executives, base compensation of
$150,000 and $173,800 with respect to Mr. Yedinak and $98,000 and $33,415 with
respect to Ms. Pitts, will be paid by each of the Bank and the Company,
respectively. The salary amounts under the Agreements may be increased at the
discretion of the Board of Directors, or authorized committee of the Board, of
each of the Company and the Bank. The salary may not be decreased during the
term of the Agreements without the prior written consent of the executive
officer.
Pursuant to the Agreements, in addition to the Executive's base
compensation, an amount equal to 2.0% for Mr. Yedinak and 1.0% for Ms. Pitts of
gross profits of each of the Company and Bank shall be credited as additional
compensation to the executive to be paid on the earlier of termination for other
than cause, death or disability, the expiration of the Agreements, or annually
on the anniversary date of the Agreements. The deferred amounts will be
forfeited if the Executive is terminated prior to the anniversary date of the
Agreements for any reason other than death or disability. The Agreements also
provide for, among other things, participation in stock benefits plans and other
fringe benefits applicable to executive personnel. The Agreements provide for
termination by the Bank or the Company for cause as defined in the Agreements at
any time.
In the event the Bank or the Company chooses to terminate the Executive's
employment for reasons other than for cause, or in the event of the Executive's
resignation from the Bank and the Company upon: (i) termination of employment
other than for disability, retirement or cause or (ii) the Executive's
resignation upon: (a) a failure to re-elect the Executive or his current offices
or failure to nominate or renominate the Executive to the board; (b) a material
demotive change in the Executive's functions, duties or responsibilities; (c) a
relocation of the Executive's principal place of employment by more than 30
miles; (d) a material reduction in benefits or perquisites being provided to the
Executive under the Agreements; (e) liquidation or dissolution of the Bank or
the Company; or (f) a breach of the Agreements by the Bank
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<PAGE>
or the Company, the Executive or, in the event of death, his beneficiary would
be entitled to receive an amount equal to the base salary increased annually by
four percent (4.0%) due to the Executive for the remaining term of the
Agreements and the contributions that would have been made on the Executive's
behalf to any employee benefit plans of the Bank or the Company during the
remaining term of the Agreements. The Bank and the Company would also continue
and pay for the Executive's life, health and disability coverage for the
remaining term of the Agreements.
Under the Agreements, if voluntary or involuntary termination follows a
change in control of the Bank or the Company (as defined in the Agreements), the
Executive or, in the event of the Executive's death, his beneficiary, would be
entitled under the Company Agreements to a severance payment equal to five times
the average of the three preceding taxable years' annual compensation. Under the
Bank Agreements, the Executive would be entitled to a severance payment equal to
three times the Executive's average annual compensation for the five most recent
taxable years. The Bank and the Company would also continue the Executive's
life, health, and disability coverage for sixty months. Notwithstanding that
both the Bank and the Company Agreements provide for a severance payment in the
event of a change in control, the Executive would only be entitled to receive a
severance payment under one agreement. Any excise taxes due as a result of an
"excess parachute payment" under the Company Agreements will be reimbursed under
the Agreements. Based solely on the compensation reported in the Summary
Compensation Table for 1997 and excluding any benefits under any employee plan
which may be payable, following a change in control and termination of
employment, Mr. Yedinak and Ms. Pitts would be entitled to severance payments of
approximately $2,469,535 and $980,035, respectively.
Payments to the Executives under the Bank Agreements will be guaranteed by
the Company in the event that payments or benefits are not paid by the Bank.
Payment under the Company Agreements would be made by the Company. The
Agreements also provide that the Bank and Company shall indemnify the Executive
to the fullest extent allowable under federal and Delaware law, respectively.
MANAGEMENT RECOGNITION PLAN AND TRUST. The Management Recognition and
Retention Plan (the "MRP") provides stock awards to officers and key employees.
Awards made after June 1, 1995 are subject to performance goals and vest at a
rate of 16.66% on the last day of each six month period following the date of
grant. Awards made prior to June 1, 1995 are not subject to performance goals
and vest at a rate of 33.33% per year commencing on the date of grant. As of
June 30, 1998, 3,250 shares have been granted pursuant to the MRP and remain
unvested and 24,212 shares remain available for grant.
STOCK OPTION PLANS. On May 20, 1998 the Stockholders of the Company
approved the Incentive Stock Option Plan. The Incentive Stock Option Plan
provides for discretionary awards of options to purchase Common Stock to
officers and key employees as determined by a committee of disinterested
directors. As of June 30, 1998 no options had been granted under the Incentive
Stock Option Plan. All outstanding options to purchase common stock held by
employees were granted under the Argo Bancorp, Inc. 1991 Employee Stock Option
and Incentive Plan (the "1991 Stock Option Plan"). The following table provides
certain information with respect to option exercises in the previous fiscal year
by Named Executive Officers and the number of shares of Common Stock represented
by outstanding stock options held by the Named Executive Officers as of December
31, 1997. Also reported are the values for "in-the-money" options which
represent the positive spread between the exercise price of any such existing
stock options and the year-end price of the Common Stock. As of June 30, 1998,
400,000 options to purchase shares of Common Stock are available for grant (all
under the Incentive Stock Option Plan) and 381,808 options to purchase Common
Stock have been granted under predecessor plans and are currently outstanding.
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<PAGE>
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR END OPTION/SAR VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF
UNDERLYING UNEXERCISED IN-THE-MONEY
UNEXERCISED OPTIONS OPTIONS/SARS
AT FISCAL YEAR END AT FISCAL YEAR END
(#)(1)(2)(3)(4) ($)(5)
------------------------------ ------------------------------
<S> <C> <C> <C> <C> <C> <C>
SHARES
ACQUIRED ON VALUE
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- -------------------------------------- ----------- ------------- ----------- ----------------- ----------- -----------------
John G. Yedinak....................... 95,984 $ 271,365 95,984(6) -- $ 449,325 --
Frances M. Pitts...................... -- -- 54,000(7) -- $ 265,687 --
</TABLE>
- ------------------------
(1) All options become 100% exercisable upon death, disability, retirement or a
change in control, as defined generally under the 1991 Stock Option Plan. In
addition, vesting of non-statutory options may be accelerated by a committee
consisting of outside directors.
(2) The purchase price may be made in whole or in part through the surrender of
previously held shares of Common Stock.
(3) Under limited circumstances, such as death, disability or normal retirement
of an employee, the employee (or his beneficiary) may request that the
Company, in exchange for the employee's surrender of an option, pay to the
employee (or beneficiary) the amount by which the fair market value of the
Common Stock exceeds the exercise price of the option on the date of the
employee's termination of employment. It is within the Company's discretion
to accept or reject such as request.
(4) Options are subject to limited (SAR) rights pursuant to which the options,
to the extent outstanding for at least six months, may be exercised in the
event of a change in control of the Company. Upon the exercise of a limited
right, the option holder would receive a cash payment equal to the
difference between the exercise price of the related option on the date of
grant and the fair market value of the underlying shares of Common stock on
the date the limited right is exercised.
(5) The price of the Common Stock on December 31, 1997 was $8.53.
(6) The exercise price for 95,984 options is $3.85.
(7) The exercise price for 50,000 options is $3.50 and the exercise price for
4,000 options is $5.00.
INDEBTEDNESS OF MANAGEMENT AND TRANSACTIONS WITH CERTAIN RELATED PERSONS
The Bank has adopted a policy which requires that all loans or extensions of
credit to executive officers and directors must be made on substantially the
same terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with the general public and must not involve
more than the normal risk of repayment or present other unfavorable features.
BENEFICIAL OWNERSHIP
At June 30, 1998, the Company had 1,990,576 shares of Common Stock
outstanding. The following table sets forth, as of June 30, 1998 on an
historical and on a pro forma basis, certain information as to those persons who
were known by management to be beneficial owners of more than 5% of the
Company's
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<PAGE>
outstanding shares of Common Stock, each director, each Named Executive Officer
and the shares of Common Stock beneficially owned by all directors and executive
officers of the Company as a group.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP
-----------------------
<S> <C> <C>
NAME AND ADDRESS OF BENEFICIAL OWNER(1) SHARES PERCENT
- ----------------------------------------------------------------------------------------- ---------- -----------
The Deltec Banking Corporation, Limited.................................................. 497,644 25.00%
Deltec House
Lyford Cay
Nassau, Bahamas
John G. Yedinak.......................................................................... 979,048(2) 46.92%
Sergio Martinucci........................................................................ 275,676(3) 13.50%
Frances M. Pitts......................................................................... 107,352(2) 5.25%
Donald G. Wittmer........................................................................ 28,004(3) 1.39%
Arthur E. Byrnes......................................................................... 497,644(4) 25.00%
All executive officers and directors as a group (9 persons).............................. 1,894,028(5) 85.99%
</TABLE>
- ------------------------
(1) Each person or relative of such person whose shares are included herein,
exercises sole (or shared with spouse, relative or affiliate) voting or
dispositive power as to the shares reported.
(2) Includes 95,984 and 54,000 shares subject to options which are currently
exercisable and which may be acquired by Mr. Yedinak and Ms. Pitts,
respectively.
(3) Includes 38,000 and 24,000 shares subject to options which are currently
exercisable and may be acquired by Mr. Martinucci and Mr. Wittmer,
respectively.
(4) Shares owned by Deltec attributable to Mr. Byrnes.
(5) Includes 381,808 shares subject to options which are currently exercisable
and 3,120 shares allocated to executive officers but not yet vested under
the Company's MRP.
ARGO CAPITAL TRUST CO.
The Trust is a statutory business trust formed under Delaware law upon the
filing of a certificate of trust with the Delaware Secretary of State. The Trust
exists for the exclusive purposes of: (i) issuing and selling the Trust
Securities; (ii) using the proceeds from the sale of Trust Securities to acquire
the Junior Subordinated Debentures; and (iii) engaging in only those other
activities necessary, advisable or incidental thereto. The Junior Subordinated
Debentures will be the sole assets of the Trust, and accordingly, payments under
the Junior Subordinated Debentures will be the sole revenues of the Trust. All
of the Common Securities will be owned by the Company. The Common Securities
will rank PARI PASSU, and payments will be made thereon PRO RATA, with the
Capital Securities, except that upon the occurrence and continuance of an event
of default under the Trust Agreement resulting from a Debenture Event of
Default, the rights of the Company as holder of the Common Securities to
payments in respect of Distributions and payments upon liquidation, redemption
or otherwise will be subordinated to the rights of the holders of the Capital
Securities. See "Description of Capital Securities--Subordination of Common
Securities." The Company will acquire Common Securities in a Liquidation Amount
equal to at least 3% of the total capital of the Trust. The Trust has a term of
31 years, but may be dissolved earlier as provided in the Trust Agreement. The
Trust's business and affairs are conducted by the Issuer Trustees, each
appointed by the Company as holder of the Common Securities. The Issuer Trustee
for the Trust will be Wilmington Trust Company as the Property Trustee,
Wilmington Trust Company, as Delaware Trustee, and 3 Administrative Trustees who
are officers of the Company. Wilmington Trust Company, as Property Trustee, will
act as sole indenture trustee under the Trust Agreement. See "Description of
Guarantee" and "Description of Junior Subordinated Debentures." The holder of
the Common Securities of the Trust or, if an Event of Default under the Trust
Agreement has occurred and is continuing, the holders of a majority in
Liquidation Amount of the Capital Securities will be entitled to appoint, remove
or replace the Property
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<PAGE>
Trustee and/or the Delaware Trustee. In no event will the holders of the Capital
Securities have the right to vote to appoint, remove or replace the
Administrative Trustees; such voting rights will be vested exclusively in the
holder of the Common Securities. The duties and obligations of each Issuer
Trustee are governed by the Trust Agreement. The Company, as issuer of the
Junior Subordinated Debentures, will pay all fees, expenses, debts and
obligations (other than the payment of principal, interest and premium, if any,
on the Trust Securities) related to the Trust and the offering of the Capital
Securities and will pay, directly or indirectly, all ongoing costs, expenses and
liabilities of the Trust. The principal executive office of the Trust is 7600
West 63rd Street, Summit, Illinois 60501.
DESCRIPTION OF CAPITAL SECURITIES
DESCRIPTION OF CAPITAL SECURITIES
The Capital Securities will represent beneficial interests in the Trust and
the holders thereof will be entitled to a preference over the Common Securities
in certain circumstances with respect to Distributions and amounts payable on
redemption of the Trust Securities or liquidation of the Trust. See
"--Subordination of Common Securities." The Trust Agreement will be qualified
under the Trust Indenture Act of 1939, as amended (the "Trust Indenture Act").
This summary of certain provisions of the Capital Securities, the Common
Securities and the Trust Agreement does not purport to be complete and is
subject to, and is qualified in its entirety by reference to, all the provisions
of the Trust Agreement, including the definitions therein of certain terms.
GENERAL
The aggregate Liquidation Amount of Capital Securities at any one time
outstanding shall be limited to the aggregate Liquidation Amount of Capital
Securities issued in the Offering. The Capital Securities will rank PARI PASSU,
and payments will be made thereon PRO RATA, with the Common Securities except as
described under "--Subordination of Common Securities." Legal title to the
Junior Subordinated Debentures will be held by the Property Trustee in trust for
the benefit of the holders of the Trust Securities. The Guarantee will not
guarantee payment of Distributions or amounts payable on redemption of the
Capital Securities or liquidation of the Trust when the Trust does not have
funds on hand legally available for such payments. See "Description of
Guarantee."
DISTRIBUTIONS
Distributions on the Capital Securities will be cumulative, will accumulate
from the Issue Date, and will be payable quarterly in arrears on April 15th,
July 15th, October 15th and January 15th of each year, commencing on January 15,
1999 at the annual rate of 11.0% of the Liquidation Amount to the holders of the
Capital Securities on the relevant record dates. The record dates will be the
15th day of the month in which the relevant Distribution Date (as defined
herein) falls. The amount of Distributions payable for any period will be
computed on the basis of a 360-day year of twelve 30-day months and, for any
period of less than a full calendar month, the number of days elapsed in such
month. In the event that any date on which Distributions are payable on the
Capital Securities is not a Business Day (as defined below), payment of the
Distribution payable on such date will be made on the next succeeding day that
is a Business Day (and without any interest or other payment in respect to any
such delay), except that if such next succeeding Business Day falls in the next
succeeding calendar year, such payment shall be made on the immediately
preceding Business Day, in each case with the same force and effect as if made
on such date (each date on which Distributions are payable in accordance with
the foregoing, a "Distribution Date"). A "Business Day" shall mean any day other
than a Saturday or a Sunday, or a day on which banking institutions in the State
of Delaware or Illinois are authorized or required by law or executive order to
remain closed.
So long as no Debenture Event of Default shall have occurred and be
continuing, the Company will have the right under the Indenture to elect to
defer the payment of interest on the Junior Subordinated Debentures at any time
or from time to time for a period not exceeding 20 consecutive quarterly periods
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<PAGE>
with respect to each Extension Period, provided that no Extension Period shall
end on a date other than an Interest Payment Date or extend beyond the Stated
Maturity Date. Upon any such election, quarterly Distributions on the Capital
Securities will be deferred by the Trust during such Extension Period.
Distributions to which holders of the Capital Securities are entitled during any
such Extension Period will accumulate additional Distributions thereon at the
rate per annum of 11.0% thereof, compounded quarterly from the relevant
Distribution Date, but not exceeding the interest rate then accruing on the
Junior Subordinated Debentures. The term "Distributions," as used herein, shall
include any such additional Distributions.
Prior to the termination of any such Extension Period, the Company may
further extend such Extension Period, provided that such extension does not
cause such Extension Period to exceed 20 consecutive quarterly periods, to end
on a date other than an Interest Payment Date or to extend beyond the Stated
Maturity Date. Upon the termination of any such Extension Period and the payment
of all amounts then due on any Interest Payment Date, the Company may elect to
begin a new Extension Period, subject to the above requirements. No interest
shall be due and payable during an Extension Period, except at the end thereof.
The Company must give the Property Trustee, the Administrative Trustees and the
Debenture Trustee notice of its election of any such Extension Period (or an
extension thereof) at least five Business Days prior to the earlier of (i) the
date the Distributions on the Capital Securities would have been payable except
for the election to begin such Extension Period and (ii) the date the
Administrative Trustees are required to give notice to any securities exchange
or automated quotation system or to holders of such Capital Securities of the
record date or the date such Distributions are payable, but in any event not
less than five Business Days prior to such record date. There is no limitation
on the number of times that the Company may elect to begin an Extension Period.
See "Description of Junior Subordinated Debentures--Option to Extend Interest
Payment Date" and "Certain Federal Income Tax Consequences with Respect to the
Capital Securities--Interest Income and Original Issue Discount."
During any such Extension Period, the Company may not: (i) declare or pay
any dividends or distributions on, or redeem, purchase, acquire, or make a
liquidation payment with respect to, any of the Company's capital stock; (ii)
make any payment of principal of or premium, if any, on or repay, repurchase or
redeem any debt securities of the Company (including any Other Debentures) that
rank PARI PASSU with or junior in right of payment to the Junior Subordinated
Debentures; or (iii) make any guarantee payments with respect to any guarantee
by the Company of the debt securities of any subsidiary of the Company
(including Other Guarantees) if such guarantee ranks PARI PASSU with or junior
in right of payment to the Junior Subordinated Debentures (other than (a)
dividends or distributions in shares of, or options, warrants or rights to
subscribe for or purchase shares of, the Common Stock of the Company, (b) any
declaration of a dividend in connection with the implementation of a
stockholders' rights plan, or the issuance of stock under any such plan in the
future, or the redemption or repurchase of any such rights pursuant thereto, (c)
payments under the Guarantee, (d) as a result of a reclassification of the
Company's capital stock or the exchange or conversion of one class or series of
the Company's capital stock for another class or series of the Company's capital
stock, (e) the purchase of fractional interests in shares of the Company's
capital stock pursuant to the conversion or exchange provisions of such capital
stock or the security being converted or exchanged and (f) purchases of Common
Stock related to the issuance of Common Stock or rights under any of the
Company's benefit plans for its directors, officers or employees or any of the
Company's dividend reinvestment plans). The Company has no current intention to
exercise its option to defer payments of interest on the Junior Subordinated
Debentures.
The revenue of the Trust available for distribution to holders of the
Capital Securities will be limited to payments under the Junior Subordinated
Debentures in which the Trust will invest the proceeds from the issuance and
sale of the Trust Securities. See "Description of Junior Subordinated
Debentures-- General." If the Company does not make interest payments on the
Junior Subordinated Debentures, the Property Trustee will not have funds
available to pay Distributions on the Capital Securities. The payment of
Distributions (if and to the extent the Trust has funds on hand legally
available for the payment of such
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Distributions) will be guaranteed by the Company on a limited basis as set forth
herein under "Description of Guarantee."
REDEMPTION
Upon the repayment on the Stated Maturity Date or prepayment in whole or in
part prior to the Stated Maturity Date of the Junior Subordinated Debentures
(other than following the distribution of the Junior Subordinated Debentures to
the holders of the Trust Securities), the proceeds from such repayment or
prepayment shall be applied by the Property Trustee to redeem a Like Amount (as
defined below) of the Trust Securities, upon not less than 30 nor more than 60
days' notice of a date of redemption (the "Redemption Date"), at the applicable
Redemption Price, which shall be equal to (i) in the case of the repayment of
the Junior Subordinated Debentures on the Stated Maturity Date, the Maturity
Redemption Price (equal to the principal of, and accrued and unpaid interest on,
the Junior Subordinated Debentures), (ii) in the case of the optional prepayment
of the Junior Subordinated Debentures before the Initial Optional Prepayment
Dates upon the occurrence and continuation of a Special Event, the Special Event
Redemption Price (equal to the Special Event Prepayment Price in respect of the
Junior Subordinated Debentures) and (iii) in the case of the optional prepayment
of the Junior Subordinated Debentures on or after the Initial Optional
Prepayment Date, the Optional Redemption Price (equal to the principal of, and
accrued and unpaid interest on, the Junior Subordinated Debentures). See
"Description of Junior Subordinated Debentures--Optional Prepayment" and
"--Special Event Prepayment." If less than all of the Junior Subordinated
Debentures are to be prepaid on a Redemption Date, then the proceeds of such
prepayment shall be allocated PRO RATA to the Trust Securities.
"Like Amount" means (i) with respect to a redemption of the Trust
Securities, Trust Securities having a Liquidation Amount equal to the principal
amount of Junior Subordinated Debentures to be paid in accordance with their
terms and (ii) with respect to a distribution of Junior Subordinated Debentures
upon the liquidation of the Trust, Junior Subordinated Debentures having a
principal amount equal to the Liquidation Amount of the Trust Securities of the
holder to whom such Junior Subordinated Debentures are distributed.
The Company will have the option to prepay the Junior Subordinated
Debentures, (i) in whole or in part, on or after the Initial Optional Prepayment
Date, at the Optional Prepayment Price and (ii) in whole but not in part, at any
time prior to the Initial Optional Prepayment Date, upon the occurrence of a
Special Event, at the Special Event Prepayment Price, in each case subject to
the receipt of any required regulatory approval. See "Description of Junior
Subordinated Debentures--Optional Prepayment" and "--Special Event Prepayment."
LIQUIDATION OF THE TRUST AND DISTRIBUTION OF JUNIOR SUBORDINATED DEBENTURES
The Company will have the right at any time to terminate the Trust and,
after satisfaction of liabilities to creditors of the Trust as required by
applicable law, to cause the Junior Subordinated Debentures to be distributed to
the holders of the Trust Securities in liquidation of the Trust. Such right is
subject to: (i) the Company having received an opinion of counsel to the effect
that such distribution will not be a taxable event to holders of Capital
Securities; and (ii) the receipt of any required regulatory approval.
The Trust shall automatically terminate upon the first to occur of: (i)
certain events of bankruptcy, dissolution or liquidation of the Company; (ii)
the distribution of a Like Amount of the Junior Subordinated Debentures to the
holders of the Trust Securities, if the Company, as Sponsor, has given written
direction to the Property Trustee to terminate the Trust (which direction is
optional and, except as described above, wholly within the discretion of the
Company, as Sponsor); (iii) redemption of all of the Trust Securities as
described under "--Redemption;" (iv) expiration of the term of the Trust; and
(v) the entry of an order for the dissolution of the Trust by a court of
competent jurisdiction.
If a termination occurs as described in clause (i), (ii), (iv), or (v)
above, the Trust shall be liquidated by the Issuer Trustees as expeditiously as
the Issuer Trustees determine to be possible by distributing, after
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satisfaction of liabilities to creditors of the Trust as provided by applicable
law, to the holders of the Trust Securities a Like Amount of the Junior
Subordinated Debentures, unless such distribution is determined by the Property
Trustee not to be practicable, in which event such holders will be entitled to
receive out of the assets of the Trust legally available for distribution to
holders, after satisfaction of liabilities to creditors of the Trust as provided
by applicable law, an amount equal to the aggregate of the Liquidation Amount
plus accumulated and unpaid Distributions thereon to the date of payment (such
amount being the "Liquidation Distribution"). If such Liquidation Distribution
can be paid only in part because the Trust has insufficient assets on hand
legally available to pay in full the aggregate Liquidation Distribution, then
the amounts payable directly by the Trust on the Trust Securities shall be paid
on a PRO RATA basis, except that if a Debenture Event of Default has occurred
and is continuing, the Capital Securities shall have a priority over the Common
Securities. See "--Subordination of Common Securities."
If the Company elects not to prepay the Junior Subordinated Debentures prior
to maturity in accordance with their terms and either elects not to or is unable
to liquidate the Trust and distribute the Junior Subordinated Debentures to
holders of the Trust Securities, the Trust Securities will remain outstanding
until the repayment of the Junior Subordinated Debentures on the Stated Maturity
Date.
After the liquidation date is fixed for any distribution of Junior
Subordinated Debentures to holders of the Trust Securities, (i) the Trust
Securities will no longer be deemed to be outstanding, (ii) DTC or its nominee
will receive, in respect of each registered global certificate, if any,
representing Trust Securities and held by it, a registered global certificate or
certificates representing the Junior Subordinated Debentures to be delivered
upon such distribution and (iii) any certificates representing Trust Securities
not held by DTC or its nominee will be deemed to represent Junior Subordinated
Debentures having a principal amount equal to the Liquidation Amount of such
Trust Securities, and bearing accrued and unpaid interest in an amount equal to
the accumulated and unpaid Distributions on such Trust Securities until such
certificates are presented to the Administrative Trustees or their agent for
cancellation, whereupon the Company will issue to such holder, and the Debenture
Trustee will authenticate, a certificate representing such Junior Subordinated
Debentures.
There can be no assurance as to the market prices for the Capital Securities
or the Junior Subordinated Debentures that may be distributed in exchange for
the Trust Securities if a dissolution and liquidation of the Trust were to
occur. Accordingly, the Capital Securities that an investor may purchase, or the
Junior Subordinated Debentures that the investor may receive on dissolution and
liquidation of the Trust, may trade at a discount to the price that the investor
paid to purchase the Capital Securities offered hereby.
REDEMPTION PROCEDURES
If applicable, Trust Securities shall be redeemed at the applicable
Redemption Price with the proceeds from the contemporaneous repayment or
prepayment of the Junior Subordinated Debentures. Any redemption of Trust
Securities shall be made and the applicable Redemption Price shall be payable on
the Redemption Date only to the extent that the Trust has funds legally
available for the payment of such applicable Redemption Price. See also
"--Subordination of Common Securities."
If the Trust gives a notice of redemption in respect of the Capital
Securities, then, by 12:00 noon, New York City time, on the Redemption Date, to
the extent funds are legally available, with respect to the Capital Securities
held by DTC or its nominees, the Property Trustee will deposit or cause the
Paying Agent (as defined herein) to deposit irrevocably with DTC funds
sufficient to pay the applicable Redemption Price. See "--Form, Denomination,
Book-Entry Procedures and Transfer." With respect to the Capital Securities held
in certificated form, the Property Trustee, to the extent funds are legally
available, will irrevocably deposit with the paying agent for the Capital
Securities funds sufficient to pay the applicable Redemption Price and will give
such paying agent irrevocable instructions and authority to pay the applicable
Redemption Price to the holders thereof upon surrender of their certificates
evidencing the Capital Securities. See "--Payment and Paying Agency."
Notwithstanding the foregoing, Distributions
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payable on or prior to the Redemption Date shall be payable to the holders of
such Capital Securities on the relevant record dates for the related
Distribution Dates. If notice of redemption shall have been given and funds
deposited as required, then upon the date of such deposit, all rights of the
holders of the Capital Securities called for redemption will cease, except the
right of the holders of such Capital Securities to receive the applicable
Redemption Price, but without interest on such Redemption Price, and such
Capital Securities will cease to be outstanding. In the event that any
Redemption Date of Capital Securities is not a Business Day, then the applicable
Redemption Price payable on such date will be paid on the next succeeding day
that is a Business Day (and without any interest or other payment in respect of
any such delay), except that, if such next succeeding Business Day falls in the
next calendar year, such payment shall be made on the immediately preceding
Business Day. In the event that payment of the applicable Redemption Price is
improperly withheld or refused and not paid either by the Trust or by the
Company pursuant to the Guarantee as described under "Description of Guarantee,"
(i) Distributions on Capital Securities will continue to accumulate at the then
applicable rate, from the Redemption Date originally established by the Trust to
the date such applicable Redemption Price is actually paid and (ii) the actual
payment date will be the Redemption Date for purposes of calculating the
applicable Redemption Price.
Subject to applicable law (including, without limitation, United States
federal securities law), the Company or its subsidiaries may at any time and
from time to time purchase outstanding Capital Securities by tender, in the open
market or by private agreement.
Notice of any redemption will be mailed at least 30 days but not more than
60 days prior to the Redemption Date to each holder of Trust Securities at its
registered address. Unless the Company defaults in payment of the applicable
Redemption Price on, or in the repayment of, the Junior Subordinated Debentures,
on and after the Redemption Date, Distributions will cease to accrue on the
Trust Securities called for redemption.
SUBORDINATION OF COMMON SECURITIES
Payment of Distributions on, and the Redemption Price of, the Trust
Securities, as applicable, shall be made PRO RATA based on the Liquidation
Amount of the Trust Securities; provided, however, that if on any Distribution
Date or Redemption Date a Debenture Event of Default shall have occurred and be
continuing, no payment of any Distribution on, or applicable Redemption Price
of, any of the Common Securities, and no other payment on account of the
redemption, liquidation or other acquisition of the Common Securities, shall be
made unless payment in full in cash of all accumulated and unpaid Distributions
on all of the outstanding Capital Securities for all Distribution periods
terminating on or prior thereto, or in the case of payment of the applicable
Redemption Price the full amount of such Redemption Price, shall have been made
or provided for, and all funds available to the Property Trustee shall first be
applied to the payment in full in cash of all Distributions on, or Redemption
Price of, the Capital Securities then due and payable.
In the case of any Event of Default, the Company as holder of the Common
Securities will be deemed to have waived any right to act with respect to such
Event of Default until the effect of such Event of Default shall have been
cured, waived or otherwise eliminated. Until any such Event of Default has been
so cured, waived or otherwise eliminated, the Property Trustee shall act solely
on behalf of the holders of the Capital Securities and not on behalf of the
Company as holder of the Common Securities, and only the holders of the Capital
Securities will have the right to direct the Property Trustee to act on their
behalf.
EVENTS OF DEFAULT; NOTICE
The occurrence of a Debenture Event of Default (see "Description of Junior
Subordinated Debentures--Debenture Events of Default") constitutes an "Event of
Default" under the Trust Agreement.
Within ten Business Days after the occurrence of any Event of Default
actually known to the Property Trustee, the Property Trustee shall transmit
notice of such Event of Default to the holders of the Capital Securities, the
Administrative Trustees and the Company, as Sponsor, unless such Event of
Default shall
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have been cured or waived. The Company, as Sponsor, and the Administrative
Trustees are required to file annually with the Property Trustee a certificate
as to whether or not they are in compliance with all the conditions and
covenants applicable to them under the Trust Agreement.
If a Debenture Event of Default has occurred and is continuing, the Capital
Securities shall have a preference over the Common Securities as described under
"--Liquidation of the Trust and Distribution of Junior Subordinated Debentures"
and "--Subordination of Common Securities."
REMOVAL OF ISSUER TRUSTEES
Unless a Debenture Event of Default shall have occurred and be continuing,
any Issuer Trustee may be removed at any time by the holder of the Common
Securities. If a Debenture Event of Default has occurred and is continuing, the
Property Trustee and the Delaware Trustee may be removed at such time by the
holders of a majority in Liquidation Amount of the outstanding Capital
Securities. In no event will the holders of the Capital Securities have the
right to vote to appoint, remove or replace the Administrative Trustees, which
voting rights are vested exclusively in the Company as the holder of the Common
Securities. No resignation or removal of an Issuer Trustee and no appointment of
a successor trustee shall be effective until the acceptance of appointment by
the successor trustee in accordance with the provisions of the Trust Agreement.
MERGER OR CONSOLIDATION OF ISSUER TRUSTEES
Any Person into which the Property Trustee, the Delaware Trustee or any
Administrative Trustee that is not a natural person may be merged or converted
or with which it may be consolidated, or any Person resulting from any merger,
conversion or consolidation to which such Issuer Trustee shall be a party, or
any Person succeeding to all or substantially all the corporate trust business
of such Issuer Trustee, shall be the successor of such Issuer Trustee under the
Trust Agreement, provided such Person shall be otherwise qualified and eligible.
MERGERS, CONSOLIDATIONS, AMALGAMATIONS OR REPLACEMENTS OF THE TRUST
The Trust may not merge with or into, consolidate, amalgamate, or be
replaced by, or convey, transfer or lease its properties and assets as an
entirety or substantially as an entirety to any corporation or other Person,
except as described below or as otherwise described under "--Liquidation of the
Trust and Distribution of Junior Subordinated Debentures." The Trust may, at the
request of the Company, as Sponsor, with the consent of the Administrative
Trustees but without the consent of the holders of the Capital Securities, merge
with or into, consolidate, amalgamate, or be replaced by or convey, transfer or
lease its properties and assets as an entirety or substantially as an entirety
to a trust organized as such under the laws of any State; provided, that: (i)
such successor entity either (a) expressly assumes all of the obligations of the
Trust with respect to the Trust Securities or (b) substitutes for the Trust
Securities other securities having substantially the same terms as the Trust
Securities (the "Successor Securities") so long as the Successor Securities rank
the same as the Trust Securities rank in priority with respect to distributions
and payments upon liquidation, redemption and otherwise; (ii) the Company
expressly appoints a trustee of such successor entity possessing the same powers
and duties as the Property Trustee with respect to the Junior Subordinated
Debentures; (iii) the Successor Securities are listed, or any Successor
Securities will be listed upon notification of issuance, on any national
securities exchange or other organization on which the Trust Securities are then
listed or quoted, if any; (iv) if the Capital Securities (including any
Successor Securities) are rated by any nationally recognized statistical rating
organization prior to such transaction, such merger, consolidation,
amalgamation, replacement, conveyance, transfer or lease does not cause the
Capital Securities (including any Successor Securities) or, if the Junior
Subordinated Debentures are so rated, the Junior Subordinated Debentures, to be
downgraded by any such nationally recognized statistical rating organization;
(v) such merger, consolidation, amalgamation, replacement, conveyance, transfer
or lease does not adversely affect the rights, preferences and privileges of the
holders of the Trust Securities (including any Successor Securities) in any
material respect; (vi) such successor entity has a purpose
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identical to that of the Trust; (vii) prior to such merger, consolidation,
amalgamation, replacement, conveyance, transfer or lease, the Company has
received an opinion from independent counsel to the Trust experienced in such
matters to the effect that (a) such merger, consolidation, amalgamation,
replacement, conveyance, transfer or lease does not adversely affect the rights,
preferences and privileges of the holders of the Trust Securities (including any
Successor Securities) in any material respect (other than any dilution of such
holders' interests in the new entity), and (b) following such merger,
consolidation, amalgamation, replacement, conveyance, transfer or lease, neither
the Trust nor such successor entity will be required to register as an
investment company under the Investment Company Act of 1940, as amended (the
"Investment Company Act"); and (viii) the Company or any permitted successor or
assignee owns all of the common securities of such successor entity and
guarantees the obligations of such successor entity under the Successor
Securities at least to the extent provided by the Guarantee and the Common
Guarantee. Notwithstanding the foregoing, the Trust shall not, except with the
consent of holders of 100% in Liquidation Amount of the Trust Securities,
consolidate, amalgamate, merge with or into, or be replaced by or convey,
transfer or lease its properties and assets as an entirety or substantially as
an entirety to, any other entity or permit any other entity to consolidate,
amalgamate, merge with or into, or replace it if such consolidation,
amalgamation, merger, replacement, conveyance, transfer or lease would cause the
Trust or the successor entity not to be classified as a grantor trust for United
States federal income tax purposes.
VOTING RIGHTS; AMENDMENT OF THE TRUST AGREEMENT
Except as provided below and under "--Mergers, Consolidations, Amalgamations
or Replacements of the Trust" and "Description of Guarantee--Amendments and
Assignment" and as otherwise required by law and the Trust Agreement, the
holders of the Capital Securities will have no voting rights.
The Trust Agreement may be amended from time to time by the Company, the
Property Trustee and the Administrative Trustees, without the consent of the
holders of the Trust Securities (i) to cure any ambiguity, correct or supplement
any provisions in the Trust Agreement that may be inconsistent with any other
provision, or to make any other provisions with respect to matters or questions
arising under the Trust Agreement, which shall not be inconsistent with the
other provisions of the Trust Agreement, or (ii) to modify, eliminate or add to
any provisions of the Trust Agreement to such extent as shall be necessary to
ensure that the Trust will be classified for United States federal income tax
purposes as a grantor trust at all times that any Trust Securities are
outstanding or to ensure that the Trust will not be required to register as an
"investment company" under the Investment Company Act; provided, however, that
in each such case such action shall not adversely affect in any material respect
the interests of the holders of the Trust Securities. Any amendments of the
Trust Agreement pursuant to the foregoing shall become effective when notice
thereof is given to the holders of the Trust Securities. The Trust Agreement may
be amended by the Issuer Trustees and the Company (i) with the consent of
holders representing a majority (based upon Liquidation Amount) of the
outstanding Trust Securities and (ii) upon receipt by the Issuer Trustees of an
opinion of counsel experienced in such matters to the effect that such amendment
or the exercise of any power granted to the Issuer Trustees in accordance with
such amendment will not affect the Trust's status as a grantor trust for United
States federal income tax purposes or the Trust's exemption from status as an
"investment company" under the Investment Company Act, provided that, without
the consent of each holder of Trust Securities, the Trust Agreement may not be
amended to (i) change the amount or timing of any Distribution on the Trust
Securities or otherwise adversely affect the amount of any Distribution required
to be made in respect of the Trust Securities as of a specified date or (ii)
restrict the right of a holder of Trust Securities to institute suit for the
enforcement of any such payment on or after such date.
So long as any Junior Subordinated Debentures are held by the Property
Trustee, the Issuer Trustees shall not (i) direct the time, method and place of
conducting any proceeding for any remedy available to the Debenture Trustee, or
execute any trust or power conferred on the Debenture Trustee with respect to
the Junior Subordinated Debentures, (ii) waive certain past defaults under the
Indenture, (iii) exercise any right to rescind or annul a declaration of
acceleration of the maturity of the principal of the Junior
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Subordinated Debentures or (iv) consent to any amendment, modification or
termination of the Indenture or the Junior Subordinated Debentures, where such
consent shall be required, without, in each case, obtaining the prior approval
of the holders of a majority in Liquidation Amount of all outstanding Capital
Securities; provided, however, that where a consent under the Indenture would
require the consent of each holder of Junior Subordinated Debentures affected
thereby, no such consent shall be given by the Property Trustee without the
prior approval of each holder of the Capital Securities. The Issuer Trustees
shall not revoke any action previously authorized or approved by a vote of the
holders of the Capital Securities except by subsequent vote of such holders. The
Property Trustee shall notify each holder of Capital Securities of any notice of
default with respect to the Junior Subordinated Debentures. In addition to
obtaining the foregoing approvals of such holders of the Capital Securities,
prior to taking any of the foregoing actions, the Issuer Trustees shall obtain
an opinion of counsel experienced in such matters to the effect that the Trust
will not be classified as an association taxable as a corporation for United
States federal income tax purposes on account of such action.
Any required approval of holders of Capital Securities may be given at a
meeting of such holders convened for such purpose or pursuant to written
consent. The Property Trustee will cause a notice of any meeting at which
holders of Capital Securities are entitled to vote, or of any matter upon which
action by written consent of such holders is to be taken, to be given to each
holder of record of Capital Securities in the manner set forth in the Trust
Agreement.
No vote or consent of the holders of Capital Securities will be required for
the Trust to redeem and cancel the Capital Securities in accordance with the
Trust Agreement.
Notwithstanding that holders of the Capital Securities are entitled to vote
or consent under any of the circumstances described above, any of the Capital
Securities that are owned by the Company, the Issuer Trustees or any affiliate
of the Company or any Issuer Trustees, shall, for purposes of such vote or
consent, be treated as if they were not outstanding.
FORM, DENOMINATIONS, BOOK-ENTRY PROCEDURES AND TRANSFER
The Capital Securities initially will be represented by one or more Capital
Securities in registered, global form (collectively, the "Global Capital
Securities"). The Global Capital Securities will be deposited upon issuance with
the Property Trustee as custodian for DTC, in New York, New York, and registered
in the name of DTC or its nominee, in each case for credit to an account of a
direct or indirect participant in DTC as described below.
Except as set forth below, the Global Capital Securities may be transferred,
in whole and not in part, only to another nominee of DTC or to a successor of
DTC or its nominee. Beneficial interests in the Global Capital Securities may
not be exchanged for Capital Securities in certificated form, except in the
limited circumstances described below. See "--Exchange of Book-Entry Capital
Securities for Certificated Capital Securities."
DEPOSITORY PROCEDURES
DTC has advised the Trust and the Company that DTC is a limited-purpose
trust company organized under the laws of the State of New York, a member of the
Federal Reserve System, a "clearing corporation" within the meaning of the
Uniform Commercial Code and a "clearing agency" registered pursuant to the
provisions of Section 17A of the Exchange Act. DTC was created to hold
securities for its participating organizations (collectively, the
"Participants") and to facilitate the clearance and settlement of transactions
in those securities between Participants through electronic book-entry changes
in accounts of its Participants, thereby eliminating the need for physical
movement of certificates. Participants include securities brokers and dealers,
banks, trust companies, clearing corporations and certain other organizations.
Indirect access to DTC's system is also available to other entities such as
banks, brokers, dealers and trust companies that clear through or maintain a
custodial relationship with a Participant, either directly or indirectly
(collectively, the "Indirect Participants"). Persons who are not Participants
may beneficially own
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securities held by or on behalf of DTC only through the Participants or the
Indirect Participants. The ownership interest and transfer of ownership interest
of each actual purchaser of each security held by or on behalf of DTC are
recorded on the records of the Participants and Indirect Participants.
DTC has also advised the Trust and the Company that, pursuant to procedures
established by it, (i) upon deposit of the Global Capital Securities, DTC will
credit the accounts of Participants with portions of the Liquidation Amount of
the Global Capital Securities and (ii) ownership of such interests in the Global
Capital Securities will be shown on, and the transfer of ownership thereof will
be effected only through, records maintained by DTC (with respect to the
Participants) or by the Participants and the Indirect Participants (with respect
to other owners of beneficial interests in the Global Capital Securities).
Investors in the Global Capital Securities may hold their interests therein
directly through DTC if they are Participants in such system, or indirectly
through organizations (including Euroclear and Cedel) which are Participants in
such system. All interest in a Global Capital Security will be subject to the
procedures and requirements of DTC. The laws of some states require that certain
persons take physical delivery in certified form of securities that they own.
Consequently, the ability to transfer beneficial interests in a Global Capital
Security to such persons will be limited to that extent. Because DTC can act
only on behalf of Participants, which in turn act on behalf of Indirect
Participants and certain banks, the ability of a person having beneficial
interests in a Global Capital Security to pledge such interests to persons or
entities that do not participate in the DTC system, or otherwise take actions in
respect of such interests, may be affected by the lack of a physical certificate
evidencing such interests. For certain other restrictions on the transferability
of the Capital Securities, see "--Exchange of Book-Entry Capital Securities for
Certificated Capital Securities"
EXCEPT AS DESCRIBED BELOW, OWNERS OF INTERESTS IN THE GLOBAL CAPITAL
SECURITIES WILL NOT HAVE CAPITAL SECURITIES REGISTERED IN THEIR NAME, WILL NOT
RECEIVE PHYSICAL DELIVERY OF CAPITAL SECURITIES IN CERTIFICATED FORM AND WILL
NOT BE CONSIDERED THE REGISTERED OWNERS OR HOLDERS THEREOF UNDER THE TRUST
AGREEMENT FOR ANY PURPOSE.
Payments in respect of the Global Capital Security registered in the name of
DTC or its nominee will be payable by the Property Trustee to DTC in its
capacity as the registered holder under the Trust Agreement. Under the terms of
the Trust Agreement, the Property Trustee will treat the persons in whose names
the Capital Securities, including the Global Capital Securities, are registered
as the owners thereof for the purpose of receiving such payments and for any and
all other purposes whatsoever. Consequently, neither the Property Trustee nor
any agent thereof has or will have any responsibility or liability for (i) any
aspect of DTC's records or any Participant's or Indirect Participant's records
relating to or payments made on account of beneficial ownership interests in the
Global Capital Securities, or for maintaining, supervising or reviewing any of
DTC's records or any Participant's or Indirect Participant's records relating to
the beneficial ownership interests in the Global Capital Securities or (ii) any
other matter relating to the actions and practices of DTC or any of its
Participants or Indirect Participants. DTC has advised the Trust and the Company
that its current practice, upon receipt of any payment in respect of securities
such as the Capital Securities, is to credit the accounts of the relevant
Participants with the payment on the payment date, in amounts proportionate to
their respective holdings in Liquidation Amount of beneficial interests in the
relevant security as shown on the records of DTC unless DTC has reason to
believe it will not receive payment on such payment date. Payments by the
Participants and the Indirect Participants to the beneficial owners of Capital
Securities will be governed by standing instructions and customary practices and
will be the responsibility of the Participants or the Indirect Participants and
will not be the responsibility of DTC, the Property Trustee, the Trust or the
Company. None of the Trust, the Company or the Property Trustee will be liable
for any delay by DTC or any of its Participants in identifying the beneficial
owners of the Capital Securities, and the Trust or the Company and the Property
Trustee may conclusively rely on and will be protected in relying on
instructions from DTC or its nominee for all purposes.
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Secondary market trading activity in interests in the Global Capital
Securities will settle in immediately available funds, subject in all cases to
the rules and procedures of DTC and its participants. Transfers between
Participants in DTC will be effected in accordance with DTC's procedures, and
will settle in same-day funds.
DTC has advised the Trust and the Company that it will take any action
permitted to be taken by a holder of Capital Securities (including, without
limitation, the presentation of Capital Securities for exchange as described
below) only at the direction of one or more Participants to whose account with
DTC interests in the Global Capital Securities are credited and only in respect
of such portion of the Liquidation Amount of the Capital Securities as to which
such Participant or Participants has or have given such direction. However, if
there is an Event of Default under the Trust Agreement, DTC reserves the right
to exchange the Global Capital Securities for legended Capital Securities in
certificated form and to distribute such Capital Securities to its Participants.
The information in this section concerning DTC and its book-entry system has
been obtained from sources that the Trust and the Company believe to be
reliable, but neither the Trust nor the Company takes responsibility for the
accuracy thereof.
Although DTC has agreed to the foregoing procedures to facilitate transfers
of interest in the Global Capital Securities among Participants in DTC, they are
under no obligation to perform or to continue to perform such procedures, and
such procedures may be discontinued at any time. None of the Trust, the Company
or the Property Trustee will have any responsibility for the performance by DTC,
or its Participants or Indirect Participants of its obligations under the rules
and procedures governing its operations.
EXCHANGE OF BOOK-ENTRY CAPITAL SECURITIES FOR CERTIFICATED CAPITAL SECURITIES
A Global Capital Security is exchangeable for Capital Securities in
registered certificated form if (i) DTC (x) notifies the Trust that it is
unwilling or unable to continue as Depository for the Global Capital Security
and the Trust thereupon fails to appoint a successor Depository within 90 days
or (y) has ceased to be a clearing agency registered under the Exchange Act,
(ii) the Company in its sole discretion elects to cause the issuance of the
Capital Securities in certificated form or (iii) there shall have occurred and
be continuing an Event of Default or any event which after notice or lapse of
time or both would be an Event of Default under the Trust Agreement. In
addition, beneficial interests in a Global Capital Security may be exchanged by
or on behalf of DTC for certificated Capital Securities upon request by DTC, but
only upon at least 20 days' prior written notice given to the Property Trustee
in accordance with DTC's customary procedures. In all cases, certificated
Capital Securities delivered in exchange for any Global Capital Security or
beneficial interests therein will be registered in the names, and issued in any
approved denominations, requested by or on behalf of the depository (in
accordance with its customary procedures).
PAYMENT AND PAYING AGENCY
Payments in respect of the Capital Securities held in global form shall be
made to the Depository, which shall credit the relevant accounts at the
Depository on the applicable Distribution Dates, or in respect of the Capital
Securities that are not held by the Depository, such payments shall be made by
check mailed to the address of the holder entitled thereto as such address shall
appear on the register. The paying agent (the "Paying Agent") shall initially be
the Property Trustee and any co-paying agent chosen by the Property Trustee and
acceptable to the Administrative Trustees and the Company. The Paying Agent
shall be permitted to resign as Paying Agent upon 30 days' written notice to the
Property Trustee, the Administrative Trustees and the Company. In the event that
the Property Trustee shall no longer be the Paying Agent, the Administrative
Trustees shall appoint a successor (which shall be a bank or trust company
acceptable to the Administrative Trustees and the Company) to act as Paying
Agent.
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REGISTRAR AND TRANSFER AGENT
The Property Trustee will act as registrar and transfer agent for the
Capital Securities.
Registration of transfers of the Capital Securities will be effected without
charge by or on behalf of the Trust, but upon payment of any tax or other
governmental charges that may be imposed in connection with any transfer or
exchange. The Trust will not be required to register or cause to be registered
the transfer of the Capital Securities after they have been called for
redemption.
INFORMATION CONCERNING THE PROPERTY TRUSTEE
The Property Trustee, other than during the occurrence and continuance of an
Event of Default, undertakes to perform only such duties as are specifically set
forth in the Trust Agreement and, during the existence of an Event of Default,
must exercise the same degree of care and skill as a prudent person would
exercise or use in the conduct of his or her own affairs. Subject to this
provision, the Property Trustee is under no obligation to exercise any of the
powers vested in it by the Trust Agreement at the request of any holder of Trust
Securities unless it is offered reasonable indemnity against the costs, expenses
and liabilities that might be incurred thereby. If no Event of Default has
occurred and is continuing and the Property Trustee is required to decide
between alternative causes of action, construe ambiguous provisions in the Trust
Agreement or is unsure of the application of any provision of the Trust
Agreement, and the matter is not one on which holders of the Capital Securities
or the Common Securities are entitled under the Trust Agreement to vote, then
the Property Trustee shall take such action as is directed by the Company and,
if not so directed, shall take such action as it deems advisable and in the best
interests of the holders of the Trust Securities and will have no liability
except for its own bad faith, negligence or willful misconduct.
MISCELLANEOUS
The Administrative Trustees are authorized and directed to conduct the
affairs of and to operate the Trust in such a way that the Trust will not be
deemed to be an "investment company" required to be registered under the
Investment Company Act or classified as an association taxable as a corporation
for United States federal income tax purposes and so that the Junior
Subordinated Debentures will be treated as indebtedness of the Company for
United States federal income tax purposes. In this connection, the Company and
the Administrative Trustees are authorized to take any action, not inconsistent
with applicable law, the certificate of trust of the Trust or the Trust
Agreement, that the Company and the Administrative Trustees determine in their
discretion to be necessary or desirable for such purposes, as long as such
action does not materially adversely affect the interests of the holders of the
Trust Securities.
Holders of the Trust Securities have no preemptive or similar rights.
The Trust may not borrow money, issue debt, execute mortgages or pledge any
of its assets.
DESCRIPTION OF JUNIOR SUBORDINATED DEBENTURES
The Junior Subordinated Debentures are to be issued under an Indenture, as
supplemented from time to time (as so supplemented, the "Indenture"), between
the Company and Wilmington Trust Company, as trustee (the "Debenture Trustee").
The Indenture has been qualified under the Trust Indenture Act of 1939, as
amended (the "Trust Indenture Act"). This summary of certain terms and
provisions of the Junior Subordinated Debentures and the Indenture does not
purport to be complete, and where reference is made to particular provisions of
the Indenture, such provisions, including the definitions of certain terms, some
of which are not otherwise defined herein, are qualified in their entirety by
reference to all of the provisions of the Indenture and the Trust Indenture Act.
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GENERAL
Concurrently with the issuance of the Capital Securities, the Trust will
invest the proceeds thereof, together with the consideration paid by the Company
for the Common Securities, in Junior Subordinated Debentures issued by the
Company. The Junior Subordinated Debentures will bear interest from the Issue
Date at the annual rate of 11.0% of the principal amount thereof, payable
quarterly in arrears on April 15th, July 15th, October 15th, and January 15th of
each year (each, an "Interest Payment Date"), commencing January 15, 1999, to
the person in whose name each Junior Subordinated Debenture is registered,
subject to certain exceptions, at the close of business on the 15th day of the
month in which the relevant payment date falls. It is anticipated that, until
the liquidation, if any, of the Trust, each Junior Subordinated Debenture will
be held in the name of the Property Trustee in trust for the benefit of the
holders of the Trust Securities. The amount of interest payable for any period
will be computed on the basis of a 360-day year of twelve 30-day months and, for
any period of less than a full calendar month, the number of days elapsed in
such month. In the event that any date on which interest is payable on the
Junior Subordinated Debentures is not a Business Day, then payment of the
interest payable on such date will be made on the next succeeding day that is a
Business Day (and without any interest or other payment in respect of any such
delay), except that if such next succeeding Business Day falls in the next
succeeding calendar year, then such payment shall be made on the immediately
preceding Business Day, in each case with the same force and effect as if made
on such date. Accrued interest that is not paid on the applicable Interest
Payment Date will bear additional interest on the amount thereof (to the extent
permitted by law) at the rate per annum of 11.0% thereof, compounded quarterly.
The term "interest," as used herein, shall include quarterly interest payments,
interest on quarterly interest payments not paid on the applicable Interest
Payment Date and Additional Sums (as defined below), as applicable. The Junior
Subordinated Debentures will mature on November 6, 2028 (the "Stated Maturity
Date").
The Junior Subordinated Debentures will rank PARI PASSU with all Other
Debentures and will be unsecured and will rank subordinate and junior in right
of payment to all Senior Indebtedness to the extent and in the manner set forth
in the Indenture. See "--Subordination."
The Company is a holding company and almost all of the operating assets of
the Company are owned by the Company's subsidiaries. The Company is a legal
entity separate and distinct from its subsidiaries. Holders of Junior
Subordinated Debentures should look only to the Company for payments on the
Junior Subordinated Debentures. The principal sources of the Company's income
are dividends, interest and fees from its subsidiaries. The Company relies
primarily on dividends from its subsidiaries to meet its obligations for payment
of principal and interest on its outstanding debt obligations and corporate
expenses. There are regulatory limitations on the payment of dividends directly
or indirectly to the Company from the Bank. As of June 30, 1998, under OTS
regulations, the total capital available for payment of dividends by the Bank to
the Company was approximately $1.5 million. However, the OTS has the power to
prohibit any act, including the payment of dividends, if such act would reduce
bank capital to a point that, in its opinion, would render the Bank
undercapitalized and thus constitute an unsafe or unsound banking practice. In
addition, the Bank is subject to certain restrictions imposed by federal law on
any extensions of credit to, and certain other transactions with, the Company
and certain other affiliates, and on investments in stock or other securities
thereof. Such restrictions prevent the Company and such other affiliates from
borrowing from the Bank unless the loans are secured by various types of
collateral. Further, such secured loans, other transactions and investments by
the Bank are generally limited in amount as to the Company and as to each of
such other affiliates to 10% of the Bank's capital and surplus and as to the
Company and all of such other affiliates to an aggregate of 20% of the Bank's
capital and surplus.
Because the Company is a holding company, the right of the Company to
participate in any distribution of assets of any subsidiary upon such
subsidiary's liquidation or reorganization or otherwise (and thus the ability of
holders of the Capital Securities to benefit indirectly from such distribution),
is subject to the prior claims of creditors of that subsidiary (including
depositors, in the case of the Bank),
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except to the extent the Company may itself be recognized as a creditor of that
subsidiary. At June 30, 1998, the subsidiaries of the Company had total
liabilities (excluding liabilities owed to the Company) of $234.5 million.
Accordingly, the Junior Subordinated Debentures will be effectively subordinated
to all existing and future liabilities of the Company's subsidiaries (including
the Bank's deposit liabilities) and all liabilities of any future subsidiaries
of the Company. The Indenture does not limit the incurrence or issuance of other
secured or unsecured debt of the Company or any subsidiary, including Senior
Indebtedness. See "--Subordination."
FORM, REGISTRATION AND TRANSFER
If the Junior Subordinated Debentures are distributed to the holders of the
Trust Securities, the Junior Subordinated Debentures may be represented by one
or more global certificates registered in the name of Cede & Co. as the nominee
of DTC. The depository arrangements for such Junior Subordinated Debentures are
expected to be substantially similar to those in effect for the Capital
Securities. For a description of DTC and the terms of the depository
arrangements relating to payments, transfers, voting rights, redemptions and
other notices and other matters, see "Description of Capital Securities--Form,
Denomination, Book-Entry Procedures and Transfer."
PAYMENT AND PAYING AGENTS
Payment of principal of (and premium, if any) and interest on Junior
Subordinated Debentures will be made at the office of the Debenture Trustee in
Wilmington, Delaware or at the office of such Paying Agent or Paying Agents as
the Company may designate from time to time, except that at the option of the
Company payment of any interest may be made, except in the case of Junior
Subordinated Debentures in global form, (i) by check mailed to the address of
the Person entitled thereto as such address shall appear in the register for
Junior Subordinated Debentures or (ii) by transfer to an account maintained by
the Person entitled thereto as specified in such register, provided that proper
transfer instructions have been received by the relevant Record Date. Payment of
any interest on any Junior Subordinated Debenture will be made to the Person in
whose name such Junior Subordinated Debenture is registered at the close of
business on the Record Date for such interest, except in the case of defaulted
interest. The Company may at any time designate additional Paying Agents or
rescind the designation of any Paying Agent; however, the Company will at all
times be required to maintain a Paying Agent in each place of payment for the
Junior Subordinated Debentures.
Any moneys deposited with the Debenture Trustee or any Paying Agent, or then
held by the Company in trust, for the payment of the principal of (and premium,
if any) or interest on any Junior Subordinated Debenture and remaining unclaimed
for two years after such principal (and premium, if any) or interest has become
due and payable shall, at the request of the Company, be repaid to the Company
and the holder of such Junior Subordinated Debenture shall thereafter look, as a
general unsecured creditor, only to the Company for payment thereof.
OPTION TO EXTEND INTEREST PAYMENT DATE
So long as no Debenture Event of Default has occurred and is continuing, the
Company will have the right under the Indenture to defer the payment of interest
on the Junior Subordinated Debentures at any time and from time to time for a
period not exceeding 20 consecutive quarterly periods with respect to each
Extension Period, provided that no Extension Period shall end on a date other
than an Interest Payment Date or extend beyond the Stated Maturity Date. At the
end of such Extension Period, the Company must pay all interest then accrued and
unpaid (together with interest thereon at the annual rate of 11.0%, compounded
quarterly to the extent permitted by applicable law ("Compounded Interest")).
During an Extension Period, interest will continue to accrue and, if the Junior
Subordinated Debentures have been distributed to holders of the Trust
Securities, holders of Junior Subordinated Debentures (or holders of the Trust
Securities while Trust Securities are outstanding) will be required to accrue
such
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deferred interest income for United States federal income tax purposes prior to
the receipt of cash attributable to such income. See "Certain Federal Income Tax
Consequences with Respect to the Capital Securities--Interest Income and
Original Issue Discount."
During any such Extension Period, the Company may not (i) declare or pay any
dividends or distributions on, or redeem, purchase, acquire, or make a
liquidation payment with respect to, any of the Company's capital stock, (ii)
make any payment of principal, interest or premium, if any, on or repay,
repurchase or redeem any debt securities of the Company (including any Other
Debentures) that rank PARI PASSU with or junior in right of payment to the
Junior Subordinated Debentures or (iii) make any guarantee payments with respect
to any guarantee by the Company of the debt securities of any subsidiary of the
Company (including any Other Guarantees) if such guarantee ranks PARI PASSU with
or junior in right of payment to the Junior Subordinated Debentures (other than
(a) dividends or distributions in shares of, or options, warrants or rights to
subscribe for or purchase shares of, the Common Stock of the Company, (b) any
declaration of a dividend in connection with the implementation of a
stockholders' rights plan, or the issuance of stock under any such plan in the
future, or the redemption or repurchase of any such rights pursuant thereto, (c)
payments under the Guarantee, (d) as a result of a reclassification of the
Company's capital stock or the exchange or conversion of one class or series of
the Company's capital stock for another class or series of the Company's capital
stock, (e) the purchase of fractional interests in shares of the Company's
capital stock pursuant to the conversion or exchange provisions of such capital
stock or the security being converted or exchanged, and (f) purchases of Common
Stock related to the issuance of Common Stock or rights under any of the
Company's benefit plans for its directors, officers or employees or any of the
Company's dividend reinvestment plans).
Prior to the termination of any such Extension Period, the Company may
further extend such Extension Period, provided that such extension does not
cause such Extension Period to exceed 20 consecutive quarterly periods, end on a
date other than an Interest Payment Date or extend beyond the Stated Maturity
Date. Upon the termination of any such Extension Period and the payment of all
amounts then due on any Interest Payment Date, the Company may elect to begin a
new Extension Period, subject to the above requirements. No interest shall be
due and payable during an Extension Period, except at the end thereof. The
Company must give the Property Trustee, the Administrative Trustees and the
Debenture Trustee notice of its election of any Extension Period (or an
extension thereof) at least five Business Days prior to the earlier of (i) the
date the Distributions on the Trust Securities would have been payable except
for the election to begin or extend such Extension Period or (ii) the date the
Administrative Trustees are required to give notice to any securities exchange
or to holders of Capital Securities of the Record Date or the date such
Distributions are payable, but in any event not less than five Business Days
prior to such Record Date. The Debenture Trustee shall give notice of the
Company's election to begin or extend a new Extension Period to the holders of
the Capital Securities. There is no limitation on the number of times that the
Company may elect to begin an Extension Period.
OPTIONAL PREPAYMENT
The Junior Subordinated Debentures will be prepayable, in whole or in part,
at the option of the Company on or after the Initial Optional Prepayment Date,
subject to the Company having received any required regulatory approval, at 100%
of the principal amount thereon plus accrued and unpaid interest thereon to the
date of prepayment (the "Optional Prepayment Price").
SPECIAL EVENT PREPAYMENT
If a Special Event shall occur and be continuing prior to the Initial
Optional Prepayment Date, the Company may, at its option and subject to receipt
of any required regulatory approval, prepay the Junior Subordinated Debentures
in whole (but not in part) at any time (i) within 90 days of the occurrence of
such Special Event and (ii) prior to November 6, 2003 at a prepayment price (the
"Special Event Prepayment Price") equal to the Make-Whole Amount (as defined
below). The "Make-Whole Amount" shall be equal
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to the greater of (x) 100% of the principal amount of the Junior Subordinated
Debentures to be prepaid or (y) the sum, as determined by a Quotation Agent (as
defined herein), of the present values of the scheduled payments of principal
and interest on the Junior Subordinated Debentures from the prepayment date to
the Initial Optional Prepayment Date discounted to the prepayment date on a
quarterly basis (assuming a 360-day year consisting of twelve 30-day months) at
the Adjusted Treasury Rate, plus, in the case of each of clauses (x) and (y),
accrued and unpaid interest thereon to the date of prepayment. If, following the
occurrence of a Special Event, the Company exercises its option to prepay the
Junior Subordinated Debentures, then the proceeds of that prepayment must be
applied to redeem a Like Amount of Trust Securities at the Special Event
Redemption Price (equal to the Special Event Prepayment Price in respect of the
Junior Subordinated Debentures). See "Description of Capital Securities--
Redemption."
A "Special Event" means a Tax Event or a Regulatory Capital Event, as the
case may be.
A "Tax Event" means the receipt by the Company and the Trust of an opinion
of counsel experienced in such matters to the effect that, as a result of any
amendment to, or change (including any announced prospective change) in, the
laws or any regulations thereunder of the United States or any political
subdivision or taxing authority thereof or therein, or as a result of any
official administrative pronouncement or judicial decision interpreting or
applying such laws or regulations, which amendment or change is effective or
such pronouncement or decision is announced on or after the Issue Date, there is
more than an insubstantial risk that: (i) the Trust is, or will be within 90
days of the date of such opinion, subject to United States federal income tax
with respect to income received or accrued on the Junior Subordinated
Debentures; (ii) interest payable by the Company on the Junior Subordinated
Debentures is not, or within 90 days of the date of such opinion will not be,
deductible by the Company, in whole or in part, for United States federal income
tax purposes; or (iii) the Trust is, or will be within 90 days of the date of
such opinion, subject to more than a de minimis amount of other taxes, duties or
other governmental charges.
A "Regulatory Capital Event" means that the Company shall have become, or
pursuant to law or regulation will become within 180 days, subject to capital
requirements under which, in the written opinion of counsel experienced in such
matters, the Capital Securities would not constitute Tier 1 Capital (as that
concept is used in the guidelines or regulations issued by the OTS as of the
date of this Prospectus) , or the then-equivalent of such Tier 1 Capital
(provided, however, that the distribution of the Junior Subordinated Debentures
in connection with the liquidation of the Trust by the Corporation shall not in
and of itself constitute a Regulatory Capital Event unless such liquidation
shall have occurred in connection with a Tax Event).
"Adjusted Treasury Rate" means, with respect to any prepayment date, the
rate per annum equal to the quarterly equivalent yield to maturity of the
Comparable Treasury Issue, assuming a price for the Comparable Treasury Issue
(expressed as a percentage of its principal amount) equal to the Comparable
Treasury Price for such prepayment date plus (i) five basis points less than the
difference between the coupon of the Capital Securities at pricing and the yield
on the thirty (30) year U.S. Treasury Bond due November 6, 2028, if such
prepayment date occurs prior to January 15, 2000 and (ii) 55 basis points less
than the difference between the coupon of the Capital Securities at pricing and
the yield on the thirty (30) year U.S. Treasury Bond due November 6, 2028, in
all other cases.
"Comparable Treasury Issue" means the United States Treasury security
selected by the Quotation Agent as having a maturity comparable to the Remaining
Life of the Junior Subordinated Debentures to be prepaid that would be utilized,
at the time of selection and in accordance with customary financial practice, in
pricing new issues of corporate debt securities of comparable maturity to the
Remaining Life. If no United States Treasury security has a maturity which is
within a period from three months before to three months after the Remaining
Life, the two most closely corresponding United States Treasury securities as
selected by the Quotation Agent shall be used as the Comparable Treasury Issue,
and the Treasury Rate shall be interpolated or extrapolated on a straight-line
basis, rounding to the nearest month.
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"Treasury Rate" means (i) the yield, under the heading which represents the
average for the immediately prior week, appearing in the most recently published
statistical release designated "H.15(519)" or any successor publication which is
published weekly by the Federal Reserve Board and which establishes yields on
actively traded United States Treasury securities adjusted to constant maturity
under the caption "Treasury Constant Maturities" for the maturity corresponding
to the Remaining Life (if no maturity is within three months before or after the
Remaining Life, yields for the two published maturities most closely
corresponding to the Remaining Life shall be determined and the Treasury Rate
shall be interpolated or extrapolated from such yields on a straight-line basis,
rounding to the nearest month), or (ii) if such release (or any successor
release) is not published during the week preceding the calculation date or does
not contain such yields, the rate per annum equal to the quarterly equivalent
yield to maturity of the Comparable Treasury Issue, calculated equal to the
Comparable Treasury Price for such prepayment date. The Treasury Rate shall be
calculated on the third Business Day preceding the prepayment date.
"Remaining Life" means the term of the Junior Subordinated Debenture from
the Prepayment Date to the Stated Maturity Date.
"Quotation Agent" means the Reference Treasury Dealer appointed by the
Company. "Reference Treasury Dealer" means a nationally-recognized U.S.
Government securities dealer in New York City selected by the Company.
"Comparable Treasury Price" means, with respect to any prepayment date, (i)
the average of the bid and asked prices for the Comparable Treasury Issue
(expressed in each case as a percentage of its principal amount) on the third
Business Day preceding such prepayment date, as set forth in the daily
statistical release (or any successor release) published by the Federal Reserve
Bank of New York and designated "Composite 3:30 p.m. Quotations for U.S.
Government Securities" or (ii) if such release (or any successor release) is not
published or does not contain such prices on such Business Day, (A) the average
of the Reference Treasury Dealer Quotations for such prepayment date, after
excluding the highest and lowest such Reference Treasury Dealer Quotations, or
(B) if the Debenture Trustee obtains fewer than three such Reference Treasury
Dealer Quotations, the average of all such Quotations.
"Reference Treasury Dealer Quotations" means, with respect to each Reference
Treasury Dealer and any prepayment date, the average, as determined by the
Debenture Trustee, of the bid and asked prices for the Comparable Treasury Issue
(expressed in each case as a percentage of its principal amount) quoted in
writing to the Debenture Trustee by such Reference Treasury Dealer at 5:00 p.m.,
New York City time, on the third Business Day preceding such prepayment date.
Notice of any prepayment will be mailed at least 30 days but not more than
60 days before the redemption date to each holder of Junior Subordinated
Debentures to be prepaid at its registered address. Unless the Company defaults
in payment of the prepayment price, on and after the prepayment date interest
ceases to accrue on such Junior Subordinated Debentures called for prepayment.
If the Trust is required to pay any additional taxes, duties or other
governmental charges as a result of a Tax Event, the Company will pay as
additional amounts on the Junior Subordinated Debentures such amounts as shall
be necessary in order that the amount of Distributions then due and payable by
the Trust on the outstanding Trust Securities shall not be reduced as a result
of any additional taxes, duties and other governmental charges to which the
Trust has become subject as a result of a Tax Event ("Additional Sums").
CERTAIN COVENANTS OF THE COMPANY
The Company will also covenant that it will not, (i) declare or pay any
dividends or distributions on, or redeem, purchase, acquire or make a
liquidation payment with respect to, any of the Company's capital stock, (ii)
make any payment of principal, interest or premium, if any, on or repay or
repurchase or redeem
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any debt securities of the Company (including Other Debentures) that rank PARI
PASSU with or junior in right of payment to the Junior Subordinated Debentures
or (iii) make any guarantee payments with respect to any guarantee by the
Company of the debt securities of any subsidiary of the Company (including under
Other Guarantees) if such guarantee ranks PARI PASSU or junior in right of
payment to the Junior Subordinated Debentures (other than (a) dividends or
distributions in shares of, or options, warrants or rights to subscribe for or
purchase shares of, Common Stock of the Company, (b) any declaration of a
dividend in connection with the implementation of a stockholders' rights plan,
or the issuance of stock under any such plan in the future, or the redemption or
repurchase of any such rights pursuant thereto, (c) payments under the
Guarantee, (d) as a result of a reclassification of the Company's capital stock
or the exchange or conversion of one class or series of the Company's capital
stock for another class or series of the Company's capital stock, (e) the
purchase of fractional interests in shares of the Company's capital stock
pursuant to the conversion or exchange provisions of such capital stock or the
security being converted or exchanged, and (f) purchases of Common Stock related
to the issuance of Common Stock or rights under any of the Company's benefit
plans for its directors, officers or employees or any of the Company's dividend
reinvestment plans) if at such time (1) there shall have occurred any event of
which the Company has actual knowledge that (a) is, or with the giving of notice
or the lapse of time, or both, would be, a Debenture Event of Default and (b) in
respect of which the Company shall not have taken reasonable steps to cure, (2)
the Company shall be in default with respect to its payment of any obligations
under the Guarantee or (3) the Company shall have given notice of its election
of an Extension Period as provided in the Indenture and shall not have rescinded
such notice, and such Extension Period, or any extension thereof, shall have
commenced and be continuing.
So long as the Trust Securities remain outstanding, the Company also will
covenant: (i) to directly or indirectly maintain 100% direct or indirect
ownership of the Common Securities, provided, however, that any permitted
successor of the Company under the Indenture may succeed to the Company's
ownership of such Common Securities; (ii) to use its reasonable efforts to cause
the Trust (a) to remain a business trust, except in connection with the
distribution of Junior Subordinated Debentures to the holders of Trust
Securities in liquidation of the Trust, the redemption of all of the Trust
Securities of the Trust, or certain mergers, consolidations or amalgamations,
each as permitted by the Trust Agreement, and (b) to otherwise continue to be
classified as a grantor trust for United States federal income tax purposes; and
(iii) to use its reasonable efforts to cause each holder of Trust Securities to
be treated as owning an undivided beneficial interest in the Junior Subordinated
Debentures.
MODIFICATION OF INDENTURE
From time to time the Company and the Debenture Trustee may, without the
consent of the holders of Junior Subordinated Debentures, amend, waive or
supplement the Indenture for specified purposes, including, among other things,
curing ambiguities, defects or inconsistencies provided that any such action
does not materially adversely affect the interest of the holders of Junior
Subordinated Debentures), and maintaining the qualification of the Indenture
under the Trust Indenture Act. The Indenture contains provisions permitting the
Company and the Debenture Trustee, with the consent of the holders of a majority
in principal amount of Junior Subordinated Debentures, to modify the Indenture
in a manner affecting the rights of the holders of Junior Subordinated
Debentures; provided that no such modification may, without the consent of the
holders of each outstanding Junior Subordinated Debenture so affected, (i)
change the Stated Maturity Date, or reduce the principal amount of the Junior
Subordinated Debentures or reduce the amount payable on redemption thereof or
reduce the rate or extend the time of payment of interest thereon except
pursuant to the Company's right under the Indenture to defer the payment of
interest as provided therein (see "--Option to Extend Interest Payment Date") or
make the principal of, or interest or premium on, the Junior Subordinated
Debentures payable in any coin or currency other than that provided in the
Junior Subordinated Debentures, or impair or affect the right of any holder of
Junior Subordinated Debentures to institute suit for the payment thereof, or
(ii) reduce the
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percentage of principal amount of Junior Subordinated Debentures, the holders of
which are required to consent to any such modification of the Indenture.
DEBENTURE EVENTS OF DEFAULT
The Indenture provides that any one or more of the following described
events with respect to the Junior Subordinated Debentures constitutes a
"Debenture Event of Default" (whatever the reason for such Debenture Event of
Default and whether it shall be voluntary or involuntary or be effected by
operation of law or pursuant to any judgment, decree or order of any court or
any order, rule or regulation of any administrative or governmental body):
(i) failure for 30 days to pay any interest (including Compounded
Interest and Additional Sums, if any) on the Junior Subordinated Debentures
or any Other Debentures, when due (subject to the deferral of any due date
in the case of an Extension Period); or
(ii) failure to pay any principal or premium, if any, on the Junior
Subordinated Debentures or any Other Debentures when due whether at
maturity, upon redemption, by declaration of acceleration of maturity or
otherwise; or
(iii) failure to observe or perform in any material respect certain other
covenants contained in the Indenture for 90 days after written notice to the
Company from the Debenture Trustee or the holders of at least 25% in
aggregate outstanding principal amount of Junior Subordinated Debentures; or
(iv) certain events in bankruptcy, insolvency or reorganization of the
Company.
The holders of a majority in aggregate outstanding principal amount of the
Junior Subordinated Debentures have, subject to certain exceptions, the right to
direct the time, method and place of conducting any proceeding for any remedy
available to the Debenture Trustee. The Debenture Trustee or the holders of not
less than 25% in aggregate outstanding principal amount of the Junior
Subordinated Debentures may declare the principal due and payable immediately
upon a Debenture Event of Default. The holders of a majority in aggregate
outstanding principal amount of the Junior Subordinated Debentures may annul
such declaration and waive the default if the default (other than the
non-payment of the principal of the Junior Subordinated Debentures which has
become due solely by such acceleration) has been cured and a sum sufficient to
pay all matured installments of interest and principal due otherwise than by
acceleration has been deposited with the Debenture Trustee.
The holders of a majority in aggregate outstanding principal amount of the
Junior Subordinated Debentures affected thereby may, on behalf of the holders of
all the Junior Subordinated Debentures, waive any past default, except a default
in the payment of principal (or premium, if any) on or interest (unless such
default has been cured and a sum sufficient to pay all matured installments of
interest (and premium, if any) and principal due otherwise than by acceleration
has been deposited with the Debenture Trustee) or a default in respect of a
covenant or provision which under the Indenture cannot be modified or amended
without the consent of the holder of each outstanding Junior Subordinated
Debenture.
The Indenture requires the annual filing by the Company with the Debenture
Trustee of a certificate as to the absence of certain defaults under the
Indenture.
The Indenture provides that the Debenture Trustee may withhold notice of a
Debenture Event of Default from the holders of the Junior Subordinated
Debentures if the Debenture Trustee considers it in the interest of such holders
to do so.
ENFORCEMENT OF CERTAIN RIGHTS BY HOLDERS OF CAPITAL SECURITIES
If a Debenture Event of Default shall have occurred and be continuing and
shall be attributable to the failure of the Company to pay the principal of (or
premium, if any), or interest (including Compounded
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Interest and Additional Sums, if any) on the Junior Subordinated Debentures on
the due date, a holder of Capital Securities may institute a Direct Action. The
Company may not amend the Indenture to remove the foregoing right to bring a
Direct Action without the prior written consent of the holders of all of the
Capital Securities. Notwithstanding any payments made to a holder of Capital
Securities by the Company in connection with a Direct Action, the Company shall
remain obligated to pay the principal of (or premium, if any) or interest
(including Compounded Interest and Additional Sums, if any) on the Junior
Subordinated Debentures, and the Company shall be subrogated to the rights of
the holder of such Capital Securities with respect to payments on the Capital
Securities to the extent of any payments made by the Company to such holder in
any Direct Action.
The holders of the Capital Securities will not be able to exercise directly
any remedies, other than those set forth in the preceding paragraph, available
to the holders of the Junior Subordinated Debentures unless there shall have
been an Event of Default under the Trust Agreement. See "Description of Capital
Securities--Events of Default; Notice."
CONSOLIDATION, MERGER, SALE OF ASSETS AND OTHER TRANSACTIONS
The Indenture provides that the Company shall not consolidate with or merge
into any other Person or convey, transfer or lease its properties as an entirety
or substantially as an entirety to any Person, and no Person shall consolidate
with or merge into the Company or convey, transfer or lease its properties as an
entirety or substantially as an entirety to the Company, unless: (i) in case the
Company consolidates with or merges into another Person or conveys or transfers
its properties substantially as an entirety to any Person, the successor Person
is organized under the laws of the United States or any State or the District of
Columbia, and such successor Person expressly assumes the Company's obligations
on the Junior Subordinated Debentures; (ii) immediately after giving effect
thereto, no Debenture Event of Default, and no event which, after notice or
lapse of time or both, would become a Debenture Event of Default, shall have
occurred and be continuing; and (iii) certain other conditions as prescribed in
the Indenture are met.
The general provisions of the Indenture do not afford holders of the Junior
Subordinated Debentures protection in the event of a highly leveraged or other
transaction involving the Company that may adversely affect holders of the
Junior Subordinated Debentures.
SATISFACTION AND DISCHARGE
The Indenture provides that when, among other things, all Junior
Subordinated Debentures not previously delivered to the Debenture Trustee for
cancellation (i) have become due and payable or (ii) will become due and payable
at maturity or called for redemption within one year, and the Company deposits
or causes to be deposited with the Debenture Trustee funds, in trust, for the
purpose and in an amount sufficient to pay and discharge the entire indebtedness
on the Junior Subordinated Debentures not previously delivered to the Debenture
Trustee for cancellation, for the principal (and premium, if any) and interest
to the date of the deposit or to the Stated Maturity Date, as the case may be,
then the Indenture will cease to be of further effect (except as to the
Company's obligations to pay all other sums due pursuant to the Indenture and to
provide the officers' certificates and opinions of counsel described therein),
and the Company will be deemed to have satisfied and discharged the Indenture.
SUBORDINATION
In the Indenture, the Company has covenanted and agreed that any Junior
Subordinated Debentures issued thereunder will be subordinate and junior in
right of payment to all Senior Indebtedness to the extent provided in the
Indenture. Upon any payment or distribution of assets to creditors upon any
liquidation, dissolution, winding up, reorganization, assignment for the benefit
of creditors, marshaling of assets or any bankruptcy, insolvency, debt
restructuring or similar proceedings in connection with any insolvency or
bankruptcy proceeding of the Company, all Senior Indebtedness must be paid in
full before
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the holders of Junior Subordinated Debentures will be entitled to receive or
retain any payment in respect thereof.
In the event of the acceleration of the maturity of Junior Subordinated
Debentures, the holders of all Senior Indebtedness outstanding at the time of
such acceleration will first be entitled to receive payment in full of such
Senior Indebtedness before the holders of Junior Subordinated Debentures will be
entitled to receive or retain any payment in respect of the Junior Subordinated
Debentures.
No payments on account of principal, or premium, if any, or interest, if
any, in respect of the Junior Subordinated Debentures may be made if there shall
have occurred and be continuing a default in any payment with respect to Senior
Indebtedness, or an event of default with respect to any Senior Indebtedness
resulting in the acceleration of the maturity thereof, or if any judicial
proceeding shall be pending with respect to any such default.
"Indebtedness" shall mean (i) every obligation of the Company for money
borrowed; (ii) every obligation of the Company evidenced by bonds, debentures,
notes or other similar instruments, including obligations incurred in connection
with the acquisition of property, assets or businesses; (iii) every
reimbursement obligation of the Company with respect to letters of credit,
banker's acceptances or similar facilities issued for the account of the
Company; (iv) every obligation of the Company issued or assumed as the deferred
purchase price of property or services (but excluding trade accounts payable or
accrued liabilities arising in the ordinary course of business); (v) every
capital lease obligation of the Company; (vi) all indebtedness of the Company
whether incurred on or prior to the date of the Indenture or thereafter
incurred, for claims in respect of derivative products, including interest rate,
foreign exchange rate and commodity forward contracts, options and swaps and
similar arrangements; and (vii) every obligation of the type referred to in
clauses (i) through (vi) of another Person and all dividends of another Person
the payment of which, in either case, the Company has guaranteed or is
responsible or liable, directly or indirectly, as obligor or otherwise.
"Indebtedness Ranking on a Parity with the Junior Subordinated Debentures"
shall mean (i) Indebtedness, whether outstanding on the date of execution of the
Indenture or thereafter created, assumed or incurred, to the extent such
indebtedness by its terms ranks equally with and not prior to the Junior
Subordinated Debentures in the right of payment upon the happening of the
dissolution or winding-up or liquidation or reorganization of the Company and
(ii) all other debt securities, and guarantees in respect of those debt
securities, issued to any other trust, or a trustee of such trust, partnership
or other entity affiliated with the Company that is a financing vehicle of the
Company (a "financing entity") in connection with the issuance by such financing
entity of equity securities or other securities guaranteed by the Company
pursuant to an instrument that ranks PARI PASSU with or junior in right of
payment to the Guarantee. The securing of any Indebtedness, otherwise
constituting Indebtedness Ranking on a Parity with the Junior Subordinated
Debentures, shall not be deemed to prevent such Indebtedness from constituting
Indebtedness Ranking on a Parity with the Junior Subordinated Debentures.
"Indebtedness Ranking Junior to the Junior Subordinated Debentures" shall
mean any Indebtedness, whether outstanding on the date of execution of the
Indenture or thereafter created, assumed or incurred, to the extent such
indebtedness by its terms ranks junior to and not equally with or prior to the
Junior Subordinated Debentures (and any other Indebtedness Ranking on a Parity
with the Junior Subordinated Debentures) in right of payment upon the happening
of the dissolution or winding-up or liquidation or reorganization of the
Company. The securing of any Indebtedness, otherwise constituting Indebtedness
Ranking Junior to the Junior Subordinated Debentures, shall not be deemed to
prevent such Indebtedness from constituting Indebtedness Ranking Junior to the
Junior Subordinated Debentures.
"Senior Indebtedness" shall mean all Indebtedness, whether outstanding on
the date of execution of the Indenture or thereafter created, assumed or
incurred, except Indebtedness Ranking on a Parity with the Junior Subordinated
Debentures or Indebtedness Ranking Junior to the Junior Subordinated Debentures,
and any deferrals, renewals or extensions of such Senior Indebtedness.
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The Company is a holding company and the majority of the operating assets of
the Company are owned by the Company's subsidiaries. The Company relies
primarily on dividends from its subsidiaries to meet its obligations for payment
of principal and interest on its outstanding debt obligations and corporate
expenses. The Company is a legal entity separate and distinct from its
subsidiaries. Holders of Junior Subordinated Debentures should look only to the
Company for payments on the Junior Subordinated Debentures. There are regulatory
limitations on the payment of dividends directly or indirectly to the Company
from the Bank. See "--General." In addition, the Bank is subject to certain
restrictions imposed by federal law on any extensions of credit to, and certain
other transactions with, the Company and certain other affiliates, and on
investments in stock or other securities thereof. Such restrictions prevent the
Company and such other affiliates from borrowing from the Bank unless the loans
are secured by various types of collateral. Further, such secured loans, other
transactions and investments by the Bank are generally limited in amount as to
the Company and as to each of such other affiliates to 10% of the Bank's capital
and surplus and as to the Company and all of such other affiliates to an
aggregate of 20% of the Bank's capital and surplus. Accordingly, the Junior
Subordinated Debentures will be effectively subordinated to all existing and
future liabilities of the Company's subsidiaries.
Because the Company is a holding company, the right of the Company to
participate in any distribution of assets of any subsidiary upon such
subsidiary's liquidation or reorganization or otherwise (and thus the ability of
holders of the Capital Securities to benefit indirectly from such distribution),
is subject to the prior claims of creditors of that subsidiary (including
depositors, in the case of the Bank), except to the extent the Company may
itself be recognized as a creditor of that subsidiary. At June 30, 1998, the
subsidiaries of the Company had total liabilities (excluding liabilities owed to
the Company) of $234.5 million. Accordingly, the Junior Subordinated Debentures
will be effectively subordinated to all existing and future liabilities of the
Company's subsidiaries (including the deposit liabilities of the Bank) and all
liabilities of any future subsidiaries of the Company. The Indenture does not
limit the incurrence or issuance of other secured or unsecured debt of the
Company or any subsidiary, including Senior Indebtedness. See "--Subordination."
GOVERNING LAW
The Indenture and the Junior Subordinated Debentures will be governed by and
construed in accordance with the laws of the State of Delaware.
INFORMATION CONCERNING THE DEBENTURE TRUSTEE
The Debenture Trustee is subject to all the duties and responsibilities
specified with respect to an indenture trustee under the Trust Indenture Act.
Subject to such provisions, the Debenture Trustee is under no obligation to
exercise any of the powers vested in it by the Indenture at the request of any
holder of Junior Subordinated Debentures, unless offered reasonable indemnity by
such holder against the costs, expenses and liabilities which might be incurred
thereby. The Debenture Trustee is not required to expend or risk its own funds
or otherwise incur personal financial liability in the performance of its duties
if the Debenture Trustee reasonably believes that repayment or adequate
indemnity is not reasonably assured to it.
DESCRIPTION OF GUARANTEE
The Guarantee will be executed and delivered by the Company concurrently
with the issuance by the Trust of the Capital Securities for the benefit of the
holders from time to time of the Capital Securities. Wilmington Trust Company
will act as Guarantee Trustee under the Guarantee. The Guarantee has been
qualified under the Trust Indenture Act. This summary of certain provisions of
the Guarantee does not purport to be complete and is subject to, and qualified
in its entirety by reference to, all of the provisions of the Guarantee,
including the definitions therein of certain terms, and the Trust Indenture Act.
The Guarantee Trustee will hold the Guarantee for the benefit of the holders of
the Capital Securities.
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GENERAL
The Company will irrevocably agree to pay in full on a subordinated basis,
to the extent set forth herein, the Guarantee Payments (as defined below) to the
holders of the Capital Securities, as and when due, regardless of any defense,
right of set-off or counterclaim that the Trust may have or assert other than
the defense of payment. The following payments with respect to the Capital
Securities, to the extent not paid by or on behalf of the Trust (the "Guarantee
Payments"), will be subject to the Guarantee: (i) any accumulated and unpaid
Distributions required to be paid on the Capital Securities, to the extent that
the Trust has funds on hand legally available therefore at such time, (ii) the
applicable Redemption Price with respect to the Capital Securities called for
redemption, to the extent that the Trust has funds on hand legally available
therefore at such time, and (iii) upon a voluntary or involuntary dissolution,
winding-up or liquidation of the Trust (other than in connection with the
distribution of the Junior Subordinated Debentures to holders of the Capital
Securities or the redemption of all Capital Securities), the lesser of (a) the
Liquidation Distribution, to the extent the Trust has funds legally available
therefore at the time, and (b) the amount of assets of the Trust remaining
available for distribution to holders of Capital Securities after satisfaction
of liabilities to creditors of the Trust as required by applicable law. The
Company's obligation to make a Guarantee Payment may be satisfied by direct
payment of the required amounts by the Company to the holders of the Capital
Securities or by causing the Trust to pay such amounts to such holders.
The Guarantee will rank subordinate and junior in right of payment to all
Senior Indebtedness to the extent provided therein. See "--Status of the
Guarantee." Because the Company is a holding company, the right of the Company
to participate in any distribution of assets of any subsidiary upon such
subsidiary's liquidation or reorganization or otherwise is subject to the prior
claims of creditors of that subsidiary, except to the extent the Company may
itself be recognized as a creditor of that subsidiary. Accordingly, the
Company's obligations under the Guarantee effectively will be subordinated to
all existing and future liabilities of the Company's subsidiaries (including the
Bank's deposit liabilities), and all liabilities of any future subsidiaries of
the Company. Claimants should look only to the assets of the Company for
payments under the Guarantee. See "Description of the Junior Subordinated
Debentures--General." The Guarantee does not limit the incurrence or issuance of
other secured or unsecured debt of the Company, including Senior Indebtedness,
whether under the Indenture, any other indenture that the Company may enter into
in the future or otherwise.
The Company will, through the Guarantee, the Trust Agreement, the Junior
Subordinated Debentures and the Indenture, taken together, fully, irrevocably
and unconditionally guarantee all of the Trust's obligations under the Capital
Securities. No single document standing alone or operating in conjunction with
fewer than all of the other documents constitutes such guarantee. It is only the
combined operation of these documents that has the effect of providing a full,
irrevocable and unconditional Guarantee of the Trust's obligations under the
Capital Securities. See "Relationship Among the Capital Securities, the Junior
Subordinated Debentures and the Guarantee."
STATUS OF THE GUARANTEE
The Guarantee will constitute an unsecured obligation of the Company and
will rank subordinate and junior in right of payment to all Senior Indebtedness
in the same manner as the Junior Subordinated Debentures.
The Guarantee will rank PARI PASSU with all Other Guarantees issued by the
Company after the Issue Date with respect to capital securities (if any) issued
by Other Trusts. The Guarantee will constitute a guarantee of payment and not of
collection (i.e., the guaranteed party may institute a legal proceeding directly
against the Company to enforce its rights under the Guarantee without first
instituting a legal proceeding against any other person or entity). The
Guarantee will be held for the benefit of the holders of the Capital Securities.
The Guarantee will not be discharged except by payment of the Guarantee
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Payments in full to the extent not paid by the Trust or upon distribution to the
holders of the Capital Securities of the Junior Subordinated Debentures. The
Guarantee does not place a limitation on the amount of additional Senior
Indebtedness that may be incurred by the Company.
EVENTS OF DEFAULT
An event of default under the Guarantee will occur upon the failure of the
Company to perform any of its payment or other obligations thereunder, provided,
however, that except with respect to a default in payment of any Guarantee
Payment, the Company shall have received notice of default and shall not have
cured such default within 60 days after receipt of such notice. The holders of
not less than a majority in Liquidation Amount of the Capital Securities will
have the right to direct the time, method and place of conducting any proceeding
for any remedy available to the Guarantee Trustee in respect of the Guarantee or
to direct the exercise of any trust or power conferred upon the Guarantee
Trustee under the Guarantee.
Any holder of the Capital Securities may institute a legal proceeding
directly against the Company to enforce its rights under the Guarantee without
first instituting a legal proceeding against the Trust, the Guarantee Trustee or
any other person or entity.
The Company, as guarantor, will be required to file annually with the
Guarantee Trustee a certificate as to whether or not the Company is in
compliance with all the conditions and covenants applicable to it under the
Guarantee.
AMENDMENTS AND ASSIGNMENT
Except with respect to any changes that do not materially adversely affect
the rights of holders of the Capital Securities (in which case no vote will be
required), the Guarantee may not be amended without the prior approval of the
holders of a majority of the Liquidation Amount of such outstanding Capital
Securities. The manner of obtaining any such approval will be as set forth under
"Description of Capital Securities--Voting Rights; Amendment of the Trust
Agreement." All guarantees and agreements contained in the Guarantee Agreement
shall bind the successors, assigns, receivers, trustees and representatives of
the Company and shall inure to the benefit of the holders of the Capital
Securities then outstanding.
TERMINATION OF THE GUARANTEE
The Guarantee will terminate and be of no further force and effect upon full
payment of the applicable Redemption Price of the Capital Securities, upon full
payment of the Liquidation Amount payable upon liquidation of the Trust or upon
distribution of Junior Subordinated Debentures to the holders of the Capital
Securities. The Guarantee will continue to be effective or will be reinstated,
as the case may be, if at any time any holder of the Capital Securities must
restore payment of any sums paid under the Capital Securities or the Guarantee.
INFORMATION CONCERNING THE GUARANTEE TRUSTEE
The Guarantee Trustee, other than during the occurrence and continuance of a
default by the Company in performance of the Guarantee, will undertake to
perform only such duties as are specifically set forth in the Guarantee and, in
case a default with respect to the Guarantee has occurred, must exercise the
same degree of care and skill as a prudent person would exercise or use in the
conduct of his or her own affairs. Subject to this provision, the Guarantee
Trustee will be under no obligation to exercise any of the powers vested in it
by the Guarantee at the request of any holder of the Capital Securities unless
it is offered reasonable indemnity against the costs, expenses and liabilities
that might be incurred thereby.
GOVERNING LAW
The Guarantee will be governed by and construed in accordance with the laws
of the State of Delaware.
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RELATIONSHIP AMONG THE CAPITAL SECURITIES, THE JUNIOR SUBORDINATED
DEBENTURES AND THE GUARANTEE
FULL AND UNCONDITIONAL GUARANTEE
Payments of Distributions and other amounts due on the Capital Securities
(to the extent the Trust has funds on hand legally available for the payment of
such Distributions) will be irrevocably guaranteed by the Company as and to the
extent set forth under "Description of Guarantee." Taken together, the Company's
obligations under the Junior Subordinated Debentures, the Indenture, the Trust
Agreement and the Guarantee will provide, in the aggregate, a full, irrevocable
and unconditional guarantee of payments of Distributions and other amounts due
on the Capital Securities. No single document standing alone or operating in
conjunction with fewer than all of the other documents constitutes such
guarantee. It is only the combined operation of these documents that has the
effect of providing a full, irrevocable and unconditional guarantee of the
Trust's obligations under the Capital Securities. If and to the extent that the
Company does not make the required payments on the Junior Subordinated
Debentures, the Trust will not have sufficient funds to make the related
payments, including Distributions, on the Capital Securities. The Guarantee will
not cover any such payment when the Trust does not have sufficient funds on hand
legally available therefore. In such event, the remedy of a holder of Capital
Securities is to institute a Direct Action. The obligations of the Company under
the Guarantee will be subordinate and junior in right of payment to all Senior
Indebtedness.
SUFFICIENCY OF PAYMENTS
As long as payments of interest and other payments are made when due on the
Junior Subordinated Debentures, such payments will be sufficient to cover
Distributions and other payments due on the Capital Securities, primarily
because: (i) the aggregate principal amount or Prepayment Price of the Junior
Subordinated Debentures will be equal to the sum of the Liquidation Amount or
Redemption Price, as applicable, of the Trust Securities; (ii) the interest rate
and interest and other payment dates on the Junior Subordinated Debentures will
match the Distribution rate and Distribution and other payment dates for the
Trust Securities; (iii) the Company, as Sponsor, shall pay for all and any
costs, expenses and liabilities of the Trust except the Trust's obligations to
holders of Trust Securities under such Trust Securities; and (iv) the Trust
Agreement will provide that the Trust is not authorized to engage in any
activity that is not consistent with the limited purposes thereof.
ENFORCEMENT RIGHTS OF HOLDERS OF CAPITAL SECURITIES
A holder of any Capital Security may institute a legal proceeding directly
against the Company to enforce its rights under the Guarantee without first
instituting a legal proceeding against the Guarantee Trustee, the Trust or any
other person or entity.
A default or event of default under any Senior Indebtedness would not
constitute a default or Event of Default under the Trust Agreement. However, in
the event of payment defaults under, or acceleration of, Senior Indebtedness,
the subordination provisions of the Indenture will provide that no payments may
be made in respect of the Junior Subordinated Debentures until such Senior
Indebtedness has been paid in full or any payment default thereunder has been
cured or waived. Failure to make required payments on Junior Subordinated
Debentures would constitute an Event of Default under the Trust Agreement.
LIMITED PURPOSE OF THE TRUST
The Capital Securities will represent beneficial interests in the Trust, and
the Trust exists for the sole purpose of issuing and selling the Trust
Securities, using the proceeds from the sale of the Trust Securities to acquire
the Junior Subordinated Debentures and engaging in only those other activities
necessary, advisable or incidental thereto. A principal difference between the
rights of a holder of a Capital Security and a holder of a Junior Subordinated
Debenture is that a holder of a Junior Subordinated Debenture will
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be entitled to receive from the Company the principal amount of (and premium, if
any) and interest on Junior Subordinated Debentures held, while a holder of
Capital Securities is entitled to receive Distributions from the Trust (or, in
certain circumstances, from the Company under the Guarantee) if and to the
extent the Trust has funds on hand legally available for the payment of such
Distributions.
RIGHTS UPON TERMINATION
Unless the Junior Subordinated Debentures are distributed to holders of the
Capital Securities, upon any voluntary or involuntary termination, winding-up or
liquidation of the Trust, after satisfaction of the liabilities of creditors of
the Trust as required by applicable law, the holders of the Trust Securities
will be entitled to receive, out of assets held by the Trust, the Liquidation
Distribution in cash. See "Description of Capital Securities--Liquidation of the
Trust and Distribution of Junior Subordinated Debentures." Upon any voluntary or
involuntary liquidation or bankruptcy of the Company, the Property Trustee, as
holder of the Junior Subordinated Debentures, would be a subordinated creditor
of the Company, subordinated in right of payment to all Senior Indebtedness as
set forth in the Indenture, but entitled to receive payment in full of principal
(and premium, if any) and interest, before any stockholders of the Company
receive payments or distributions. Since the Company will be the guarantor under
the Guarantee and will agree to pay for all costs, expenses and liabilities of
the Trust (other than the Trust's obligations to the holders of its Capital
Securities), the positions of a holder of Capital Securities and a holder of
Junior Subordinated Debentures relative to other creditors and to stockholders
of the Company in the event of liquidation or bankruptcy of the Company are
expected to be substantially the same.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
WITH RESPECT TO THE ISSUANCE OF THE CAPITAL SECURITIES
GENERAL
In the opinion of Patton Boggs LLP, special federal income tax counsel to
the Company and the Trust ("Tax Counsel"), the following constitutes, in all
material respects, a fair and accurate summary of certain of the principal
United States federal income tax consequences under current law of the purchase,
ownership and disposition of Capital Securities held as capital assets by a
holder who purchases such Capital Securities upon initial issuance. It does not
deal with special classes of holders such as banks, thrifts, real estate
investment trusts, regulated investment companies, insurance companies, dealers
in securities or currencies, tax-exempt investors, United States Alien Holders
(as defined below) engaged in a U.S. trade or business or persons that will hold
the Capital Securities as a position in a "straddle," as part of a "synthetic
security" or "hedge," as part of a "conversion transaction" or other integrated
investment, or as other than a capital asset. This summary also does not address
the tax consequences to persons that have a functional currency other than the
U.S. dollar or the tax consequences to shareholders, partners or beneficiaries
of a holder of Capital Securities. Further, it does not include any description
of any alternative minimum tax consequences or the tax laws of any state or
local government or of any foreign government that may be applicable to the
Capital Securities. This summary is based on the Code, Treasury regulations
thereunder and the administrative and judicial interpretations thereof, as of
the date hereof, all of which are subject to change, possibly on a retroactive
basis. An opinion of Tax Counsel is not binding on the IRS or the courts. No
rulings have been or are expected to be sought from the IRS with respect to any
of the transactions described herein and no assurance can be given that the IRS
will not take contrary positions. Moreover, no assurance can be given that the
opinions expressed herein will not be challenged by the IRS or, if challenged,
that such a challenge would not be successful.
CLASSIFICATION OF THE JUNIOR SUBORDINATED DEBENTURES
In connection with the issuance of the Junior Subordinated Debentures, Tax
Counsel will render its opinion generally to the effect that, under then current
law and assuming full compliance with the terms of the Indenture (and certain
other documents), and based on certain facts and assumptions contained in
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such opinion, the Junior Subordinated Debentures will be classified for United
States federal income tax purposes as indebtedness of the Company. The Company,
the Trust and the holders of the Capital Securities (by acceptance of a
beneficial interest in a Capital Security) will agree to treat the Junior
Subordinated Debentures as indebtedness of the Company for all United States
federal income tax purposes.
CLASSIFICATION OF THE TRUST
In connection with the issuance of the Capital Securities, Tax Counsel will
render its opinion generally to the effect that, under then current law and
assuming full compliance with the terms of the Trust Agreement and the Indenture
(and certain other documents), and based on certain facts and assumptions
contained in such opinion, the Trust will be classified for United States
federal income tax purposes as a grantor trust and not as an association taxable
as a corporation. Accordingly, for United States federal income tax purposes,
each holder of Capital Securities generally will be considered the owner of an
undivided interest in the Junior Subordinated Debentures, and each holder will
be required to include in its gross income any interest (or OID accrued) with
respect to its allocable share of those Junior Subordinated Debentures.
INTEREST INCOME AND ORIGINAL ISSUE DISCOUNT
Under new Treasury regulations (the "Regulations") applicable to debt
instruments issued on or after August 13, 1996, a "remote" contingency that
stated interest will not be timely paid will be ignored in determining whether a
debt instrument is issued with OID. The Company believes that the likelihood of
its exercising its option to defer payments of interest is "remote" since
exercising that option would, among other things, prevent the Company from
declaring dividends on any class of its equity securities. Accordingly, the
Company intends to take the position based on the advice of Tax Counsel that the
Junior Subordinated Debentures will not be considered to be issued with OID and,
accordingly, stated interest on the Junior Subordinated Debentures generally
will be taxable to a holder as ordinary income at the time it is paid or accrued
in accordance with such holder's method of tax accounting.
Under the Regulations, if the Company were to exercise its option to defer
payments of interest, the Junior Subordinated Debentures would at that time be
treated as issued with OID, and all stated interest on the Junior Subordinated
Debentures would thereafter be treated as OID as long as the Junior Subordinated
Debentures remain outstanding. In such event, all of a holder's taxable interest
income with respect to the Junior Subordinated Debentures would thereafter be
accounted for on an economic accrual basis regardless of such holder's method of
tax accounting, and actual distributions of stated interest would not be
reported as taxable income. Consequently, a holder of Capital Securities would
be required to include in gross income OID even though the Company would not
make actual cash payments during an Extension Period. Moreover, under the
Regulations, if the option to defer the payment of interest was determined not
to be "remote," the Junior Subordinated Debentures would be treated as having
been originally issued with OID. In such event, all of a holder's taxable
interest income with respect to the Junior Subordinated Debentures would be
accounted for on an economic accrual basis regardless of such holder's method of
tax accounting, and actual distributions of stated interest would not be
reported as taxable income.
The new Regulations have not yet been addressed in any rulings or other
interpretations by the IRS. Because of the lack of regulatory guidance in
respect to the application of such Regulations and the factual nature of
determining the likelihood of exercise of the option to defer payments of
interest, it is possible that the IRS could take a position contrary to the
Company's position that the Junior Subordinated Debentures will not be
considered to be issued with OID.
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Because income on the Capital Securities will constitute interest or OID,
corporate holders of the Capital Securities will not be entitled to a
dividends-received deduction with respect to any income recognized with respect
to the Capital Securities.
RECEIPT OF JUNIOR SUBORDINATED DEBENTURES OR CASH UPON LIQUIDATION OF THE TRUST
The Company will have the right at any time to liquidate the Trust and cause
the Junior Subordinated Debentures to be distributed to the holders of the Trust
Securities. Under current law, such a distribution, for United States federal
income tax purposes, would be treated as a nontaxable event to each holder, and
each holder would receive an aggregate tax basis in the Junior Subordinated
Debentures equal to such holder's aggregate tax basis in its Capital Securities.
A holder's holding period in the Junior Subordinated Debentures so received in
liquidation of the Trust would include the period during which the Capital
Securities were held by such holder.
Under certain circumstances described herein (see "Description of Capital
Securities"), the Junior Subordinated Debentures may be redeemed for cash and
the proceeds of such redemption distributed to holders in redemption of their
Capital Securities. Under current law, such a redemption would, for United
States federal income tax purposes, constitute a taxable disposition of the
redeemed Capital Securities, and a holder could recognize gain or loss as if it
sold such redeemed Capital Securities for cash. See "--Sales of Capital
Securities."
SALES OF CAPITAL SECURITIES
A holder that sells Capital Securities (including a redemption of the
Capital Securities by the Company) will recognize gain or loss equal to the
difference between its adjusted tax basis in the Capital Securities and the
amount realized on the sale of such Capital Securities (other than with respect
to accrued and unpaid interest which has not yet been included in income, which
will be treated as ordinary income). A holder's adjusted tax basis in the
Capital Securities generally will be its initial purchase price increased by OID
(if any) previously includable in such holder's gross income to the date of
disposition and decreased by payments (if any) received on the Capital
Securities in respect of OID. Such gain or loss generally will be a capital gain
or loss and generally will be a long-term capital gain or loss if the Capital
Securities have been held for more than one year.
The Capital Securities may trade at a price that does not accurately reflect
the value of accrued but unpaid interest with respect to the underlying Junior
Subordinated Debentures. A holder who uses the accrual method of accounting for
tax purposes (and a cash method holder, if the Junior Subordinated Debenture are
deemed to have been issued with OID) who disposes of his Capital Securities
between record dates for payments of distributions thereon will be required to
include accrued but unpaid interest on the Junior Subordinated Debentures
through the date of disposition in income as ordinary income (i.e., interest or,
if applicable, OID), and to add such amount to his adjusted tax basis in his PRO
RATA share of the underlying Junior Subordinated Debentures deemed disposed of.
To the extent the selling price is less than the holder's adjusted tax basis
(which will include all accrued but unpaid interest) a holder will recognize a
capital loss. Subject to certain limited exceptions, capital losses cannot be
applied to offset ordinary income for United States federal income tax purposes.
UNITED STATES ALIEN HOLDERS
For purposes of this discussion, a "United States Alien Holder" is any
corporation, individual, partnership, estate or trust that is not a U.S. holder
for United States federal income tax purposes.
A "U.S. Holder" is a holder of Capital Securities who or which is (i) a
citizen or individual resident (or is treated as a citizen or individual
resident) of the United States for United States federal income tax purposes,
(ii) a corporation or partnership created or organized in or under the laws of
the United States or any political subdivision thereof, (iii) an estate the
income of which is includable in its gross income for
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United States federal income tax purposes without regard to its source or (iv) a
trust over which (A) a court within the United States is able to exercise
primary supervision over the administration of the trust and (B) one or more
United States trustees have the authority to control all substantial decisions
of the trust.
Under present United States federal income tax laws: (i) payments by the
Trust or any of its paying agents to any holder of a Capital Security who or
which is a United States Alien Holder will not be subject to United States
federal withholding tax; provided that, (a) the beneficial owner of the Capital
Security does not actually or constructively own 10 percent or more of the total
combined voting power of all classes of stock of the Company entitled to vote,
(b) the beneficial owner of the Capital Security is not a controlled foreign
corporation that is related to the Company through stock ownership, and (c)
either (A) the beneficial owner of the Capital Security certifies to the Trust
or its agent, under penalties of perjury, that it is not a United States holder
and provides its name and address or (B) a securities clearing organization,
bank or other financial institution that holds customers' securities in the
ordinary course of its trade or business (a "Financial Institution"), and holds
the Capital Security in such capacity, certifies to the Trust or its agent,
under penalties of perjury, that such statement has been received from the
beneficial owner by it or by a Financial Institution between it and the
beneficial owner and furnishes the Trust or its agent with a copy thereof; and
(ii) a United States Alien Holder of a Capital Security will not be subject to
United States federal withholding tax on any gain realized upon the sale or
other disposition of a Capital Security.
As discussed above, changes in legislation affecting the United States
federal income tax treatment of the Junior Subordinated Debentures are possible,
and could adversely affect the ability of the Company to deduct the interest
payable on the Junior Subordinated Debentures. Moreover, any such legislation
could adversely affect United States Alien Holders by characterizing income
derived from the Junior Subordinated Debentures as dividends, generally subject
to a 30% income tax (on a withholding basis) when paid to a United States Alien
Holder, rather than as interest which, as discussed above, is generally exempt
from income tax in the hands of a United States Alien Holder.
A United States Alien Holder that holds Capital Securities in connection
with the active conduct of a United States trade or business will be subject to
income tax on all income and gains recognized with respect to its proportionate
share of the Junior Subordinated Debentures.
INFORMATION REPORTING TO HOLDERS
Generally, income on the Capital Securities will be reported to holders on
Forms 1099, which forms should be mailed to holders of Capital Securities by
January 31 following each calendar year.
BACKUP WITHHOLDING
Payments made on, and proceeds from the sale of, the Capital Securities may
be subject to a "backup" withholding tax of 31 percent unless the holder
complies with certain identification requirements. Any withheld amounts will be
allowed as a credit against the holder's United States federal income tax,
provided the required information is provided to the IRS.
THE UNITED STATES FEDERAL INCOME TAX DISCUSSION SET FORTH ABOVE IS INCLUDED
FOR GENERAL INFORMATION ONLY AND MAY NOT BE APPLICABLE DEPENDING UPON A HOLDER'S
PARTICULAR SITUATION. HOLDERS SHOULD CONSULT THEIR TAX ADVISORS WITH RESPECT TO
THE TAX CONSEQUENCES TO THEM OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF THE
CAPITAL SECURITIES, INCLUDING THE TAX CONSEQUENCES UNDER STATE, LOCAL, FOREIGN
AND OTHER TAX LAWS AND THE POSSIBLE EFFECTS OF CHANGES IN UNITED STATES FEDERAL
OR OTHER TAX LAWS.
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ERISA CONSIDERATIONS
Each of the Company (the obligor with respect to the Junior Subordinated
Debentures held by the Trust), and its affiliates and the Property Trustee may
be considered a "party in interest" (within the meaning of ERISA) or a
"disqualified person" (within the meaning of Section 4975 of the Code) with
respect to many Plans that are subject to ERISA and certain employee
benefit-related provisions of the Code. The purchase and/or holding of Capital
Securities by a Plan that is subject to the fiduciary responsibility provisions
of ERISA or the prohibited transaction provisions of Section 4975 of the Code
(including individual retirement arrangements and other plans described in
Section 4975(e)(1) of the Code) and with respect to which the Company, the
Property Trustee or any affiliate is a service provider (or otherwise is a party
in interest or a disqualified person) may constitute or result in a prohibited
transaction under ERISA or Section 4975 of the Code, unless such Capital
Securities are acquired pursuant to and in accordance with an applicable
exemption, such as Prohibited Transaction Class Exemption ("PTCE") 84-14 (an
exemption for certain transactions determined by an independent qualified
professional asset manager), PTCE 91-38 (an exemption for certain transactions
involving bank collective investment funds), PTCE 90-1 (an exemption for certain
transactions involving insurance company pooled separate accounts), PTCE 95-60
(an exemption for transactions involving certain insurance company general
accounts) or PTCE 96-23 (an exemption for certain transactions determined by an
in-house asset manager). In addition, a Plan fiduciary considering the purchase
of Capital Securities should be aware that the assets of the Trust may be
considered "plan assets" for ERISA purposes. In such event, any persons
exercising discretion with respect to the Junior Subordinated Debentures may
become fiduciary parties in interest or disqualified persons with respect to
investing Plans. In order to avoid certain prohibited transactions under ERISA
and the Code that could thereby result, each investing Plan, by purchasing the
Capital Securities, will be deemed to have directed the Trust to invest in the
Junior Subordinated Debentures and to have consented to the appointment of the
Property Trustee. In this regard, it should be noted that, in an Event of
Default, the Company may not remove the Property Trustee without the approval of
a majority of the holders of the Capital Securities.
A Plan fiduciary should consider whether the purchase of Capital Securities
could result in a delegation of fiduciary authority to the Property Trustee,
and, if so, whether such a delegation of authority is permissible under the
Plan's governing instrument or any investment management agreement with the
Plan. In making such determination, a Plan fiduciary should note that the
Property Trustee is a U.S. bank qualified to be an investment manager (within
the meaning of Section 3(38) of ERISA) to which such a delegation of authority
generally would be permissible under ERISA. Further, prior to an Event of
Default with respect to the Junior Subordinated Debentures, the Property Trustee
will have only limited custodial and ministerial authority with respect to Trust
assets.
THE SALE OF INVESTMENTS TO PLANS IS IN NO RESPECT A REPRESENTATION BY THE
TRUST, THE COMPANY, THE PROPERTY TRUSTEE, THE UNDERWRITERS OR ANY OTHER PERSON
ASSOCIATED WITH THE SALE OF THE CAPITAL SECURITIES THAT SUCH SECURITIES MEET ALL
RELEVANT LEGAL REQUIREMENTS WITH RESPECT TO INVESTMENTS BY PLANS GENERALLY OR
ANY PARTICULAR PLAN, OR THAT SUCH SECURITIES ARE OTHERWISE APPROPRIATE FOR PLANS
GENERALLY OR ANY PARTICULAR PLAN. ANY PURCHASER PROPOSING TO ACQUIRE CAPITAL
SECURITIES WITH ASSETS OF ANY PLAN SHOULD CONSULT WITH ITS COUNSEL.
STOCKHOLDER AGREEMENT
On December 31, 1996, the Company entered into the Stock Purchase Agreement
with Deltec, whereby Deltec acquired 446,256 of the issued and outstanding
shares of Common Stock of the Company as of that date for an aggregate purchase
price of $4.2 million. The shares of Common Stock acquired by Deltec were not
registered with the Securities and Exchange Commission, however, the Stock
Purchase Agreement grants Deltec registration rights in respect of any shares of
Common Stock that Deltec decides
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to sell. The Stock Purchase Agreement was entered into following the submission
by Deltec of a Rebuttal of Control to the OTS and the execution by Deltec
International, S.A., the parent of Deltec, of a Rebuttal Agreement with the OTS.
Pursuant to the Stock Purchase Agreement, the Company and Deltec also
entered into a stockholder agreement (the "Stockholder Agreement"). The
principal provision of the Stockholder Agreement stipulates that at any time
that the Company proposes to issue and sell any additional shares of its Common
Stock, it shall notify Deltec and shall offer to sell to Deltec concurrently
with the issuance and sale of the additional shares such number of additional
shares (including fractional shares) so that Deltec will continue to own 25% of
the outstanding shares of the Company's Common Stock. Generally, the additional
shares offered and sold to Deltec pursuant to the Stockholders Agreement will be
at a similar price and upon substantially the same terms and conditions as the
other additional shares sold. In the event that the Company purchases or
otherwise acquires any of its outstanding shares of Common Stock, it shall offer
to purchase from Deltec such number of shares that, after the purchase, Deltec
will continue to own 25% of the outstanding shares of the Company's Common
Stock. During the term of the Stockholder Agreement, and for so long as Deltec
holds at least 15% of the Company's Common Stock, Deltec has the right to
nominate one director to the Company's Board of Directors. John G. Yedinak, the
President and Chief Executive Officer of the Company, has agreed that, during
this time period, he will vote all shares of the Company's Common Stock owned by
him for the nominee designated by Deltec. During the term of the Stockholder
Agreement, Deltec has agreed to remain in compliance with the Rebuttal Agreement
between Deltec and the OTS.
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RESTRICTIONS ON ACQUISITION OF THE COMPANY
GENERAL
Certain provisions in the Company's Certificate of Incorporation and Bylaws
and in its management remuneration together with provisions of Delaware
corporate law, may have anti-takeover effects. In addition, regulatory
restrictions may make it difficult for persons or companies to acquire control
of the Company.
RESTRICTIONS IN THE COMPANY'S CERTIFICATE OF INCORPORATION AND BYLAWS
A number of provisions of the Company's Certificate of Incorporation and
Bylaws deal with matters of corporate governance and certain rights of
stockholders. The following discussion is a general summary of the provisions of
the Company's Certificate of Incorporation and Bylaws which might be deemed to
have a potential "anti-takeover" effect. These provisions may have the effect of
discouraging a future takeover attempt which is not approved by the Board of
Directors but which individual Company stockholders may deem to be in their best
interests or in which stockholders may receive a substantial premium for their
shares over then current market prices. As a result, stockholders who might
desire to participate in such a transaction may not have an opportunity to do
so. Such provisions will also render the removal of the current Board of
Directors or management of the Company more difficult. The following description
of certain of the provisions of the Certificate of Incorporation and Bylaws of
the Company is necessarily general and reference should be made in each case to
such Certificate of Incorporation and Bylaws, which are incorporated herein by
reference. See "Additional Information" as to how to obtain a copy of these
documents.
BOARD OF DIRECTORS. The Board of Directors of the Company is divided into
three classes, each of which shall contain approximately one-third of the whole
number of members of the Board. Each class shall serve a staggered term, with
approximately one-third of the total number of directors being elected each
year. The Company's Certificate of Incorporation and Bylaws provide that the
size of the Board shall be determined by a majority of the directors. The
Certificate of Incorporation and the Bylaws provide that any vacancy occurring
in the Board, including a vacancy created by an increase in the number of
directors or resulting from death, resignation, retirement, disqualification,
removal from office or other cause, may be filled for the remainder of the
unexpired term exclusively by a two-thirds vote of the directors then in office.
The classified Board is intended to provide for continuity of the Board of
Directors and to make it more difficult and time consuming for a stockholder
group to fully use its voting power to gain control of the Board of Directors
without the consent of the incumbent Board of Directors of the Company. The
Certificate of Incorporation of the Company provides that a director may be
removed from the Board of Directors prior to the expiration of his term only for
cause, upon the vote of 70% of the outstanding shares of voting stock. In the
absence of these provisions, the vote of the holders of a majority of the shares
could remove the entire Board, with or without cause, and replace it with
persons of such holders' choice.
CUMULATIVE VOTING, SPECIAL MEETINGS AND ACTION BY WRITTEN CONSENT. The
Certificate of Incorporation does not provide for cumulative voting for any
purpose. Moreover, special meetings of stockholders of the Company may be called
only by the Board of Directors of the Company or an appropriate committee
designated by the Board of Directors. The Certificate of Incorporation also
provides that any action required or permitted to be taken by the stockholders
of the Company may be taken only at an annual or special meeting and prohibits
stockholder action by written consent in lieu of a meeting.
AUTHORIZED SHARES. The Certificate of Incorporation authorizes the issuance
of 9,000,000 shares of Common Stock and 1,000,000 shares of Preferred Stock. The
authorized shares of Common Stock and Preferred Stock provide the Company's
Board of Directors with as much flexibility as possible to effect, among other
transactions, financings, acquisitions, stock dividends, stock splits and
employee stock options. However, these additional authorized shares may also be
used by the Board of Directors
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consistent with its fiduciary duty to deter future attempts to gain control of
the Company. The Board of Directors also has sole authority to determine the
terms of any one or more series of Preferred Stock, including voting rights,
conversion rates, and liquidation preferences. As a result of the ability to fix
voting rights for a series of Preferred Stock, the Board has the power, to the
extent consistent with its fiduciary duty, to issue a series of Preferred Stock
to persons friendly to management in order to attempt to block a post-tender
offer merger or other transaction by which a third party seeks control, and
thereby assist management to retain its position. The Company's Board of
Directors currently has no plans for the issuance of additional shares. --See
"Recent Developments--Issuance of $0.005 Goodwill Convertible Preferred."
STOCKHOLDER VOTE REQUIRED TO APPROVE BUSINESS COMBINATIONS WITH INTERESTED
STOCKHOLDERS. The Certificate of Incorporation requires the approval of the
holders of at least 70% of the Company's outstanding shares of voting stock
entitled to vote thereon to approve certain "Business Combinations" by an
"Interested Stockholder," each as defined therein, and related transactions.
Under Delaware law, absent this provision, business combinations, including
mergers, consolidations and sales of all or substantially all of the assets of a
corporation must, subject to certain exceptions, be approved by the vote of the
holders of only a majority of the outstanding shares of Common Stock of the
Company and any other affected class of stock. Under the Certificate of
Incorporation, the approval of the holders of at least 70% of the shares of
capital stock entitled to vote thereon is required for any business combination
involving an Interested Stockholders except (i) in cases where the proposed
transaction has been approved by a majority of those members of the Company's
Board of Directors who are unaffiliated with the Interested Stockholder and were
Directors prior to the time when the Interested Stockholder became an Interested
Stockholder or (ii) if the proposed transaction meets certain conditions set
forth therein which are designed to afford the stockholders a fair price in
consideration for their shares. In each such case, where stockholder approval is
required, the approval of only a majority of the outstanding shares of voting
stock is sufficient. The term "Interested Stockholder" is defined to include,
among others, any individual, a group acting in concert, corporation,
partnership, association or other entity (other than the Company or its
subsidiary) who or which is the beneficial owner, directly or indirectly, of 10%
or more of the outstanding shares of voting stock of the Company. A "Business
Combination," is defined to include: (i) any merger or consolidation of the
Company or any of its subsidiaries with any Interested Stockholder or Affiliate
(as defined in the Certificate of Incorporation) of an Interested Stockholder or
any corporation which is, or after such merger or consolidation would be, an
Affiliate of an Interested Stockholder; (ii) any sale, lease, exchange,
mortgage, pledge, transfer, or other disposition to or with any Interested
Stockholder or Affiliate of 25% or more of the assets of the Company or combined
assets of the Company and its subsidiary; (iii) the issuance or transfer to any
Interested Stockholder or its Affiliate by the Company (or any subsidiary) of
any securities of the Company (or any subsidiary) in exchange for any cash,
securities or other property the value of which equals or exceeds 25% of the
fair market value of the Common Stock of the Company; (iv) the adoption of any
plan for the liquidation or dissolution of the Company proposed by or on behalf
of any Interested Stockholder or Affiliate there; and (v) any reclassification
of securities, recapitalization, merger or consolidation of the Company with any
of its subsidiaries which has the effect of increasing the proportionate share
of Common Stock or any class of equity or convertible securities of the Company
or subsidiary owned directly or indirectly, by an Interested stockholder or
Affiliate thereof.
EVALUATION OF OFFERS. The Certificate of Incorporation of the Company
further provides that the Board of Directors of the Company, when evaluating any
offer of another "Person" (as defined therein), to (i) make a tender or exchange
offer for any equity security of the Company, (ii) merge or consolidate the
Company with another corporation or entity or (iii) purchase or otherwise
acquire all or substantially all of the properties and assets of the Company,
may, in connection with the exercise of its judgment in determining what is in
the best interest of the Company and the stockholders of the Company, give due
consideration to all relevant factors, including, without limitation, those
factors that directors of any subsidiary (including the Bank) may consider in
evaluating any action that may result in a change or potential change of control
of such subsidiary, and the social and economic effects of acceptance of such
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offer on: the Company's present and future customers and employees and those of
its subsidiaries (including the Bank); the communities in which the Company and
the Bank operate or are located; the ability of the Company to fulfill its
corporate objectives as a savings and loan holding company; and the ability of
the Bank to fulfill the objectives of a stock savings bank under applicable
statutes and regulations. By having these standards in the Certificate of
Incorporation of the Company, the Board of Directors may be in a stronger
position to oppose such a transaction if the Board concludes that the
transaction would not be in the best interest of the Company, even if the price
offered is significantly greater than the then market price of any equity
security of the Company.
SUPERMAJORITY VOTING REQUIREMENT FOR AMENDMENT OF CERTAIN PROVISIONS OF THE
CERTIFICATE OF INCORPORATION. The Certificate of Incorporation provides that
specified provisions contained in the Certificate of Incorporation may not be
repealed or amended except upon the affirmative vote of the holders of not less
than 70% of the outstanding shares of the Company stock entitled to vote
generally in the election of directors. This requirement exceeds the majority
vote of the outstanding stock that would otherwise be required by Delaware law
for the repeal or amendment of the Certificate of Incorporation provision. The
specific provisions covered by such supermajority voting requirement include the
following: (i) the calling of special meetings of stockholders, the absence of
cumulative voting rights and the requirement that stockholder action be taken
only at annual meetings; (ii) the number and classification of the Company's
Board of Directors; (iii) removing directors; (iv) the requirement for the
approval of certain Business Combinations involving "Interested Stockholders";
(v) the indemnification of directors, officers, employees and agents of the
Company; (vi) the limitation of voting rights; and (vii) the required
stockholder vote for amending the Certificate of Incorporation or Bylaws of the
Company. This provision is intended to prevent the holders of less than 70% of
the outstanding stock of the Company from circumventing any of the foregoing
provisions by amending the Certificate of Incorporation to delete or modify one
of such provisions. This provision would enable the holders of more than 70% of
the Company's voting stock to prevent amendments to the Company's Certificate of
Incorporation or Bylaws even if they were favored by the holders of a majority
of the voting stock.
CERTAIN BYLAW PROVISIONS. The Bylaws of the Company also require a
stockholder who intends to nominate a candidate for election to the Board of
Directors, or to raise new business at a stockholder meeting to give at least 90
days advance notice to the Secretary of the Company. The notice provision
requires a stockholder who desires to raise new business to provide certain
information to the Company concerning the nature of the new business, the
stockholder and the stockholder's interest in the business matter. Similarly, a
stockholder wishing to nominate any person for election as a director must
provide the Company with certain information concerning the nominee and the
proposing stockholder.
ANTI-TAKEOVER EFFECTS OF THE COMPANY'S CERTIFICATE OF INCORPORATION AND BYLAWS
AND MANAGEMENT REMUNERATION
The provisions described above are intended to reduce the Company's
vulnerability to takeover attempts and certain other transactions which have not
been negotiated with and approved by members of its Board of Directors. The
provisions of the employment Agreements with Mr. Yedinak and Ms. Pitts and the
1998 Incentive Stock Option Plan may also discourage takeover attempts by
increasing the costs to be incurred by the Bank and the Company in the event of
a takeover. See "The Board of Directors and Management of the Bank--Executive
Compensation--Employment Agreements" and "--Benefits--Stock Option Plans."
The Company's Board of Directors believes that the provisions of the
Certificate of Incorporation, Bylaws and management remuneration plans are in
the best interest of the Company and its stockholders. An unsolicited
non-negotiated proposal can seriously disrupt the business and management of a
corporation and cause it great expense. Accordingly, the Board of Directors
believes it is in the best interests of the Company and its stockholders to
encourage potential acquirors to negotiate directly with management and that
these provisions will encourage such negotiations and discourage non-negotiated
takeover attempts. It
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is also the Board of Directors' view that these provisions should not discourage
persons from proposing a merger or other transaction at a price that reflects
the true value of the Company and that otherwise is in the best interest of all
stockholders.
DELAWARE CORPORATE LAW
The State of Delaware has a statute designed to provide Delaware
corporations with additional protection against hostile takeovers. The takeover
statute, which is codified in Section 203 of the Delaware General Corporate Law
("Section 203"), is intended to discourage certain takeover practices by
impeding the ability of a hostile acquiror to engage in certain transactions
with the target company.
In general, Section 203 provides that a "Person" (as defined therein) who
owns 15% or more of the outstanding voting stock of a Delaware corporation (an
"Interested Stockholder") may not consummate a merger or other business
combination transaction with such corporation at any time during the three-year
period following the date such "Person" became an Interested Stockholder. The
term "business combination" is defined broadly to cover a wide range of
corporate transactions including mergers, sales of assets, issuances of stock,
transactions with subsidiaries and the receipt of disproportionate financial
benefits.
The statute exempts the following transactions from the requirements of
Section 203: (i) any business combination if, prior to the date a person became
an Interested Stockholder, the Board of Directors approved either the business
combination or the transaction which resulted in the stockholder becoming an
Interested Stockholder; (ii) any business combination involving a person who
acquired at least 85% of the outstanding voting stock in the transaction in
which he became an Interested Stockholder, with the number of shares outstanding
calculated without regard to those shares owned by the corporation's directors
who are also officers and by certain employee stock plans; (iii) any business
combination with an Interested Stockholder that is approved by the Board of
Directors and by a two-thirds vote of the outstanding voting stock not owned by
the Interested Stockholder; and (iv) certain business combinations that are
proposed after the corporation had received other acquisition proposals and
which are approved or not opposed by a majority of certain continuing members of
the Board of Directors. A corporation may exempt itself from the requirements of
the statute by adopting an amendment to its Certificate of Incorporation or
Bylaws electing not to be governed by Section 203. At the present time, the
Board of Directors does not intend to propose any such amendment.
Any proposal to acquire 10% of any class of equity security of the Company
generally would be subject to approval by the OTS under the Change in Bank
Control Act. The OTS requires all persons seeking control of a savings
institution, and, therefore, indirectly its holding company, to obtain
regulatory approval prior to offering to obtain control. Federal law generally
provides that no "person," acting directly or indirectly or through or in
concert with one or more other persons, may acquire directly or indirectly
"control," as that term is defined in OTS regulations, of a federally-insured
savings institution without giving at least 60 days" written notice to the OTS
and providing the OTS an opportunity to disapprove the proposed acquisition.
Such acquisitions of control may be disapproved if it is determined, among other
things, that: (i) the acquisition would substantially lessen competition; (ii)
the financial condition of the acquiring person might jeopardize the financial
stability of the savings institution or prejudice the interests of its
depositors; or (iii) the competency, experience or integrity of the acquiring
person or the proposed management personnel indicates that it would not be in
the interest of the depositors or the public to permit the acquisition of
control by such person. Such change in control restrictions on the acquisition
of holding company stock are not limited to three years after conversion but
will apply for as long as the regulations are in effect. Persons holding
revocable or irrevocable proxies may be deemed to be beneficial owners of such
securities under OTS regulations and therefore prohibited from voting all or the
portion of such proxies in excess of the 10% aggregate beneficial ownership
limit. Such regulatory restrictions may prevent or inhibit proxy contests for
control of the Company or the Bank which have not received prior regulatory
approval.
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DESCRIPTION OF CAPITAL STOCK OF THE COMPANY
The Company is authorized to issue 9,000,000 shares of Common Stock, and
1,000,000 shares of Preferred Stock. As of June 30, 1998, there were 1,990,576
shares of Common Stock issued and outstanding and no shares of Preferred Stock
are issued or outstanding. --See "Recent Developments-- Issuance of $0.005
Goodwill Convertible Preferred." or reference discussion below
COMMON STOCK
VOTING RIGHTS. The holders of Common Stock possess exclusive voting rights
in the Company, except to the extent that shares of Preferred Stock issued in
the future may have voting rights, if any. Each holder of Common Stock will be
entitled to one vote for each share held of record on all matters submitted to a
vote of holders of the Common Stock.
DIVIDENDS. Subject to such preferences as may be applicable to any shares
of Preferred Stock which may be issued in the future, the holders of Common
Stock are entitled to such dividends as the Board of Directors may declare from
time to time out of funds legally available therefore and are entitled to share
pro rata in liquidating and other distributions to shareholders. For information
pertaining to cash dividends, see "Dividend Policy." Failure to pay dividends by
the Trust on the Capital Securities issued hereunder would restrict the
Company's ability to pay dividends. See "Description of Capital Securities--
Distributions."
OTHER CHARACTERISTICS. Holders of the Common Stock will not have preemptive
rights with respect to any additional shares of Common Stock which may be
issued. Therefore, the Board of Directors may sell shares of capital stock of
the Company without first offering it to existing stockholders. The Common Stock
is not subject to call for redemption and the outstanding shares of Common Stock
when issued and upon receipt by the Company of the offering price will be fully
paid and non-assessable.
PREFERRED STOCK
The Company has designated as Goodwill Convertible Preferred Stock 592,681
shares of the Preferred Stock which are all outstanding. None of the remaining
authorized shares of Preferred Stock of the Company will be issued in the
Offering. The Board of Directors without shareholders approval can issue
Preferred Stock with voting and conversion rights which could adversely affect
the voting power of the common shareholders. If and when issued, the Preferred
Stock is likely to rank prior to the Common Stock as to dividend rights,
liquidation preferences, or both, and may have full or limited voting rights.
The Board of Directors has no present intention to issue any additional shares
of Preferred Stock.
GOODWILL CONVERTIBLE PREFERRED STOCK
On July 28, 1998, the Company declared a stock dividend of $0.005 Goodwill
Convertible Preferred Stock ("Goodwill Preferred Stock") to all holders of
Common Stock as of August 24, 1998 on a share for share basis. As a result,
592,681 shares of Goodwill Preferred Stock were issued to holders of Common
Stock on August 31, 1998. The Goodwill Preferred Stock entitles the holders
thereof to 75% of any damages awarded upon a final judgment to the Bank, net of
expenses and certain other items as a result of the Bank's lawsuit against the
United States seeking damages for breach of contract related to the limitation
and exclusion of supervisory goodwill in the computation of the Bank's
regulatory capital in connection with the Company's acquisition of the Bank in
November, 1987 ("Goodwill Litigation"). At the time of the final judgment and
award of damages, if any, the Goodwill Preferred Stock will either be (i)
redeemed by the Company for cash or (ii) become convertible into Common Stock.
The Company will be entitled to retain the remaining 25% of any damages awarded
to the Bank, net of expenses, in the Goodwill Litigation.
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LITIGATION BACKGROUND. The Goodwill Litigation was filed on July 31, 1995
by the Bank and certain of its shareholders ("Plaintiffs") at such time. The
Plaintiffs' claims arise from changes in regulatory capital regulations mandated
by the Financial Institutions Reform Recovery and Enforcement Act of 1989 ("
FIRREA"). The Plaintiffs allege that the enactment of FIRREA constituted a
breach by the U.S. Government of its contractual commitment regarding the
treatment of supervisory goodwill which arose out of the Company's acquisition
of a failed thrift and unlawful taking of the Bank's property rights with
respect to such supervisory goodwill. The Plaintiffs seek damages for breach of
contract and for deprivation of property without just compensation and without
due process of law.
The Goodwill Litigation was stayed pending the resolution on appeal of
related cases, which present issues similar to those presented by the Goodwill
Litigation. The Goodwill Litigation is one of a number of cases filed against
the U.S. Government in the U.S. Federal Claims Court ("Claims Court") involving
agreements to acquire and operate failed thrift institutions and alleging that
the changes in regulatory capital calculation brought about by FIRREA constitute
a breach of contract between the acquiring institution and the U.S. Government.
On July 1, 1996, the U.S. Supreme Court issued its opinion for U.S. V.
WINSTAR CORPORATION, ET AL., No. 95-865, which affirmed the decisions of the
U.S. Court of Appeals for the Fourth Circuit and the Claims Court in various
consolidated cases (the "Winstar cases") granting summary judgment to the
plaintiff thrift institutions on the liability portion of their breach of
contract claims against the U.S. Government. The Supreme Court held that the
U.S. Government breached certain express contracts when Congress enacted FIRREA,
and the Supreme Court remanded the proceedings for a determination of the
appropriate measure and amount of damages.
The first trial of the related Winstar cases on the issue of damages,
GLENDALE FEDERAL BANK V. U.S., No. 90-772C (the "Glendale Case"), is currently
underway and there has been no final ruling to date with respect to the amount
or scope of damages. In an attempt to manage the numerous cases against the U.S.
Government involving the calculation of regulatory capital as a result of the
adoption of FIRREA, the Claims Court issued a Case Management Order in all of
the Winstar cases and determined that no other case will go to trial until the
damages trials in both the Glendale case and another related Winstar case,
STATESMAN SAVINGS HOLDING CORP., ET AL. V. U.S., No. 90-773C (the "Statesman
Case") have been completed. In addition, the Claims Court has designated twelve
cases as priority cases that will be the first cases to go to trial following
the trials on damages in the Glendale case and the Statesman case.
The first of the priority cases is expected to begin trial in late 1998 or
early 1999. Another group of thirty cases is scheduled for trial following
completion of the priority cases. The Goodwill Litigation is not included among
the twelve priority cases or in the next thirty lawsuits. Assuming a settlement
is not reached and based upon the status of the proceedings in the Winstar case
and the Case Management Order, the Goodwill Litigation is not expected to
commence trial proceedings for at least three years.
The plaintiffs in the Goodwill Litigation have not specified conclusively
the type of damages sought, nor have they quantified definitively the amount of
damages they will claim. In addition, there has been no final ruling in the
Glendale case or any other related Winstar case with respect to the amount or
appropriate measure of damages. The extent and amount of damages awarded to each
such institution that has brought an action against the U.S. Government is
expected to be fact specific. Even if the plaintiffs in other related Winstar
cases are successful in securing damage awards, there is no assurance that the
plaintiffs in the Goodwill Litigation will obtain a damage award.
TERMS OF THE GOODWILL PREFERRED STOCK. At such time the plaintiffs receive
a final judgment and related damages ("the Litigation Award") of the Goodwill
Litigation, the Company will have 90 days, at its option, to redeem the Goodwill
Preferred Stock. The Redemption price shall be determined by a set formula,
which deducts expenses, fees and net taxes related to the Goodwill Litigation
and issuance of the Goodwill Preferred Stock from the Litigation Award and
distributes 75% of such amount among all Goodwill Preferred Stockholders on a
pro rata basis.
134
<PAGE>
To the extent that all or a portion of the Litigation Award is non-cash, the
Company will receive an independent appraisal to determine the fair market value
of the non-cash portion. If the Litigation Award is solely for non-cash and
valued at $250,000 or less, the Company will redeem the shares for its par
value.
In the event the Company chooses not to redeem to Goodwill Preferred Stock
within the 90 day window, the Goodwill Preferred Stock shall become convertible
into Common Stock based on the current market value of the Common Stock divided
into a pro rata share of 75% of the Litigation Award less expenses, fees and net
taxes. The shares shall be convertible until 90 days from the beginning of the
first day of the fiscal quarter following the time the shares first become
convertible.
The terms of the Goodwill Preferred Stock provide that a committee approved
by the Board of Directors of the Company will supervise the Goodwill Litigation.
The Goodwill Preferred Stock contains no voting rights, except with respect
to issues concerning the Goodwill Preferred Stock.
The Goodwill Preferred Stock maintains a preference over the Common Stock in
the event of any dissolution, liquidation, winding-up of the affairs of the
Company in the amount of the applicable redemption price of the Goodwill
Preferred Stock.
The Goodwill Preferred Stock is not registered with the Commission or any
other state or regulatory agency.
TAX TREATMENT. The Company received an opinion from KPMG Peat Marwick LLP
("KPMG") that the distribution of the Goodwill Preferred Stock constitutes a
tax-free stock distribution under Sections 305(a) and 311(a) of the Internal
Revenue Code.
ACCOUNTING TREATMENT. For accounting purposes the Goodwill Preferred Stock
will not be considered an equity security of the Company.
135
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the underwriting agreement (the
"Underwriting Agreement"), the underwriters named below (the "Underwriters"),
for whom Tucker Anthony Incorporated is acting as representative (the
"Representative"), has severally agreed to purchase from the Company the
aggregate number of shares of Capital Securities set forth opposite its name
below.
<TABLE>
<CAPTION>
CAPITAL
UNDERWRITER SECURITIES
- --------------------------------------------------------------------------------- ----------
<S> <C>
Tucker Anthony Incorporated...................................................... 1,500,000
----------
Total........................................................................ 1,500,000
----------
----------
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent, and that the Underwriters will
purchase all of the Capital Securities offered hereby if any such Capital
Securities are not purchased.
The Company has been advised by the Representative that the Underwriters
propose initially to offer the Capital Securities at a Price to Public of $10.00
per Capital Security. The Underwriters may allow, and such dealer may re-allow,
a discount not in excess of $0.40 per share with respect to the Capital
Securities to certain other dealers. The offering of the Capital Securities is
made for delivery when, as and if accepted by the Underwriters and is subject to
prior sale and to the Underwriters' right to reject any order in whole or in
part and to withdraw, cancel, or modify the offer without notice. After the
initial public offering of the Securities, the offering price and other selling
terms may be changed by the Underwriters.
The Company has granted the Underwriters an option, exercisable not later
than 30 days after the date of this Prospectus, to purchase up to an aggregate
of $2,250,000 of additional Capital Securities, in each case at the applicable
Price to the Public set forth on the cover page of this prospectus less the
applicable underwriting discount,. The Underwriters may exercise such option and
only to cover over-allotments, if any, made in connection with the sale of
shares of Capital Securities offered hereby. If purchased, the Underwriters will
offer such additional shares of Capital Securities on the same terms as the
$15,000,000 of Capital Securities being offered. To the extent that the
Underwriters exercise such options, each of the Underwriters will be obligated,
subject to certain conditions, to purchase approximately the same percentage
thereof that the number of shares of Capital Securities to be purchased by it
shown in the above table bears to the total of such respective Capital
Securities and the Company will be obligated, pursuant to the option, to sell
such shares of Capital Securities to the Underwriters.
The Company and the Trust have agreed not to, and the Company's directors
and executive officers have agreed that, for a period of 90 days from the
closing of the Offering, such person or entity will not offer for sale, sell or
grant any options, rights or warrants with respect to any Capital Securities of
the Trust without the prior consent of the Representative.
The Company has agreed to indemnify the Underwriters against certain
liabilities including liabilities under the federal securities laws, or to
contribute to payments the Underwriter may be required to make in respect
thereof.
The Underwriters do not intend to confirm sales to any accounts over which
they exercise discretionary authority to exceed 5% of the number of shares
offered.
136
<PAGE>
Prior to the Offering, there has not been any public market for the Capital
Securities. The Price to the Public for the Capital Securities included in the
offering was determined by negotiations between the Company and Representatives.
Among the factors considered in determining that price were the history of and
prospects for the Company's business and the industry in which it competes, an
assessment of the Company's management and the present state of the Company's
development, the past and present revenues and earnings of the Company, the
prospects for growth of the Company's revenues and earnings, the current state
of the economy in the United States and the current level of economic activity
in the industry in which the Company competes and in related or comparable
industries, and currently prevailing conditions in the securities markets,
including current market valuations of publicly traded companies that are
comparable to the Company.
ADDITIONAL INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith, files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Reports, proxy statements
and other information concerning the Company can be inspected and copied at
prescribed rates at the Commission's Public Reference Room, Judiciary Plaza, 450
Fifth Street, N.W., Washington, D.C. 20549, as well as the following Regional
Offices of the Commission: 7 World Trade Center, 13th Floor, New York, New York
10048; and Citicorp Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661. Copies of such material may be obtained by mail from the
Commission's Public Reference Section, 450 Fifth Street, N.W.,Washington, D.C.
20549, at prescribed rates. If available, such reports and other information may
also be accessed through the Commission's electronic data gathering, analysis
and retrieval system ("EDGAR") via electronic means, including the Commission's
web site on the Internet (http://www.sec.gov).
This Prospectus constitutes a part of a Registration Statement on Form S-1
(the "Registration Statement") filed by the Company with the Commission under
the Securities Act with respect to the Securities offered hereby. This
Prospectus does not contain all the information set forth in the Registration
Statement, certain parts of which are omitted in accordance with the rules and
regulations of the Commission, and reference is hereby made to the Registration
Statement and to the exhibits relating thereto for further information with
respect to the Company and the Securities offered hereby. Any statements
contained herein concerning the provisions of any document are not necessarily
complete, and, in each instance, reference is made to the copy of such document
filed as an exhibit to the Registration Statement or otherwise filed with the
Commission. Each such statement is qualified in its entirety by such reference.
EXPERTS
The Consolidated Financial Statements of the Company and its subsidiaries as
of December 31, 1997 and 1996 and for each of the years in the three-year period
ended December 31, 1997, have been included in reliance upon the report of KPMG
Peat Marwick LLP, independent certified public accountants, and upon the
authority of said firm as experts in accounting and auditing.
LEGAL MATTERS
Certain matters of Delaware law relating to the validity of the Capital
Securities, the enforceability of the Trust Agreement and the formation of the
Trust will be passed upon by Richards, Layton and Finger, P.A., special counsel
to the Company and to the Trust. The validity under Delaware Law of the Junior
Subordinated Debentures and the Guarantee will be passed upon for the Company
and the Trust by Patton Boggs LLP. Certain legal matters will be passed upon for
Tucker Anthony Incorporated by Elias, Matz, Tiernan & Herrick L.L.P.,
Washington, D.C.
137
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Consolidated Statements of Financial Condition at June 30, 1998 (Unaudited) and
December 31, 1997.............................................................. F-2
Consolidated Statements of Income for the Six Months ended June 30, 1998 and 1997
(Unaudited).................................................................... F-3
Consolidated Statements of Comprehensive Income for the Six Months ended June 30,
1998 and 1997 (Unaudited)...................................................... F-4
Consolidated Statements of Shareholders' Equity for the Six Months ended June 30,
1998 and 1997 (Unaudited)...................................................... F-5
Consolidated Statements of Cash Flows for the Six Months ended June 30, 1998 and
1997 (Unaudited)............................................................... F-6
Notes to Consolidated (Unaudited) Financial Statements........................... F-7-F-10
Independent Auditors' Report..................................................... F-11
Consolidated Statements of Financial Condition at December 31, 1997 and 1996..... F-12
Consolidated Statements of Operations for the Years Ended December 31, 1997, 1996
and 1995....................................................................... F-13
Consolidated Statements of Stockholders' Equity for the Years ended December 31,
1997, 1996 and 1995............................................................ F-14
Consolidated Statements of Cash Flows for the Years ended December 31, 1997, 1996
and 1995....................................................................... F-15
Notes to Consolidated Financial Statements....................................... F-17-F-40
</TABLE>
F-1
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS)
6/30/98 12/31/97
----------- ---------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Cash................................................................... $ 8,703 $ 6,211
Interest-earning deposits.............................................. 9,923 2,466
FHLB of Chicago Stock.................................................. 1,847 3,271
Securities available-for-sale.......................................... 4,993 4,974
Loans receivable, net.................................................. 183,878 153,808
Discounted loans receivable............................................ 17,001 30,550
Accrued interest receivable............................................ 1,743 1,725
Foreclosed real estate, net............................................ 4,179 4,251
Premises and equipment, net............................................ 10,712 11,235
Mortgage loan servicing rights, net.................................... 6,349 6,706
Prepaid expenses and other assets...................................... 10,430 11,101
----------- ---------
$ 259,758 $ 236,298
----------- ---------
----------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities:
Deposits............................................................. $ 201,463 $ 172,469
Borrowed money....................................................... 28,388 34,156
Interest-bearing custodial escrow balances for loans serviced........ -- 1
Custodial escrow balances for loans serviced......................... 5,891 6,399
Advance payments by borrowers for taxes and insurance................ 746 741
Other liabilities.................................................... 4,545 4,428
----------- ---------
Total liabilities.................................................. $ 241,033 $ 218,194
----------- ---------
Stockholders' Equity:
Preferred stock, $0.01 par value; Authorized 1,000,000 shares; none
issued or outstanding.............................................. -- --
Common Stock, $0.01 par value; Authorized 9,000,000 shares; issued
and outstanding 497,644 shares..................................... 5 5
Additional paid-in capital........................................... 8,750 8,570
Retained earnings--substantially restricted.......................... 10,414 9,915
Accumulated other comprehensive income............................... (127) (33)
Common stock acquired by:
Employee Stock Ownership Plan...................................... (27) (57)
Management Recognition Plan........................................ (290) (296)
----------- ---------
Total stockholders' equity....................................... $ 18,725 $ 18,104
----------- ---------
Commitments and contingencies
Total Liabilities and Stockholders' Equity............................. $ 259,758 $ 236,298
----------- ---------
----------- ---------
</TABLE>
See notes to accompanying unaudited consolidated financial statements
F-2
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(DOLLARS IN
THOUSANDS, EXCEPT
PER SHARE DATA)
--------------------
<S> <C> <C>
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------------
<CAPTION>
1998 1997
--------- ---------
(UNAUDITED)
<S> <C> <C>
Interest income:
Loans receivable............................................................................... $ 6,829 $ 6,438
Discounted loans receivable.................................................................... 1,215 3,210
Mortgage-backed securities..................................................................... 82 156
Interest-earning deposits...................................................................... 435 286
--------- ---------
Total interest income........................................................................ 8,561 10,090
--------- ---------
Interest expense:
Deposits....................................................................................... 4,583 4,124
Custodial escrow balances for loans serviced................................................... -- 5
Borrowed money................................................................................. 1,068 1,695
--------- ---------
Total interest expense....................................................................... 5,651 5,824
--------- ---------
Net interest income before provision for loan losses............................................. 2,910 4,266
Provision for loan losses........................................................................ 235 60
--------- ---------
Net interest income after provision for loan losses.......................................... 2,675 4,206
--------- ---------
Noninterest income:
Purchased mortgage servicing income (loss), net................................................ (278) 169
Mortgage banking............................................................................... 661 350
Net gain (loss) on sale:
Loans held for sale.......................................................................... 384 31
Discounted loans receivable.................................................................. 715 23
Foreclosed real estate....................................................................... (91) 81
Securities available-for-sale................................................................ 318 207
Fees for other customer services............................................................... 359 222
Data processing income......................................................................... 6,020 5,509
Other.......................................................................................... 729 66
--------- ---------
Total noninterest income..................................................................... 8,817 6,658
--------- ---------
Noninterest expense:
Compensation and benefits...................................................................... 4,345 4,529
Occupancy and equipment........................................................................ 2,709 2,353
Federal deposit insurance premiums............................................................. 56 47
Goodwill amortization.......................................................................... 51 53
Data processing cost of services............................................................... 1721 946
Other general and administrative fees.......................................................... 1,983 2,155
--------- ---------
Total noninterest expense.................................................................... 10,865 10,083
--------- ---------
Income before income tax expense................................................................. 627 781
Income tax expense (benefit)..................................................................... (40) 157
--------- ---------
Net income................................................................................... 667 624
--------- ---------
--------- ---------
Per share amounts:
Basic.......................................................................................... $ 1.35 $ 1.31
--------- ---------
--------- ---------
Diluted........................................................................................ $ 1.26 $ 1.22
--------- ---------
--------- ---------
</TABLE>
See notes to accompanying unaudited consolidated financial statements
F-3
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
(DOLLARS IN
THOUSANDS)
--------------------
<S> <C> <C>
FOR THE SIX MONTHS
ENDED
JUNE 30,
--------------------
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Net Income........................................................................................ $ 667 $ 624
Other Comprehensive Income:
Unrealized gains on available-for sale securities:
Unrealized holding gains (losses) arising during period, net of tax............................. 103 92
Less reclassification adjustment for gains included in net income net of tax...................... (197) (128)
--------- ---------
Other comprehensive income(loss).................................................................. (94) (36)
--------- ---------
Comprehensive income.............................................................................. $ 573 $ 588
--------- ---------
--------- ---------
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
F-4
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
ACCUMULATED COMMON COMMON
COMMON ADDITIONAL OTHER STOCK STOCK
STOCK PAID-IN RETAINED COMPREHENSIVE ACQUIRED ACQUIRED
CLASS A CAPITAL EARNINGS INCOME (LOSS) BY ESOP BY MRP
------------- ------------- ----------- ----------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
SIX MONTHS ENDED JUNE 30, 1997
- --------------------------------------
Balance at December 31, 1996.......... $ 4 7,382 9,444 12 (117) (165)
Net income............................ -- -- 624 -- -- --
Proceeds from issuance of stock....... 1 411 -- -- -- --
Other comprehensive income (loss), net
of tax.............................. -- -- -- (36) -- --
Principal payments on ESOP loan....... -- -- -- -- 30 --
Amortization of purchase price of MRP
stock............................... -- -- -- -- -- 55
Proceeds from exercise of stock
options............................. -- 525 -- -- -- --
Tax benefits of stock options......... -- 193 -- -- -- --
Fair value adjustment for committed
ESOP shares......................... -- 23 -- -- -- --
Cash dividends........................ -- -- (175) -- -- --
--
----- ----------- --- --- ---
Balance at June 30, 1997.............. $ 5 8,534 9,893 (24) (87) (110)
--
--
----- ----------- --- --- ---
----- ----------- --- --- ---
SIX MONTHS ENDED JUNE 30, 1998
- --------------------------------------
Balance at December 31, 1997.......... $ 5 8,570 9,915 (33) (57) (296)
Net income............................ -- -- 667 -- -- --
Other comprehensive income (loss), net
of tax.............................. -- -- -- (94) -- --
Principal payments on ESOP loan....... -- -- -- -- 30 --
Amortization of purchase price of MRP
stock............................... -- -- -- -- -- 6
Proceeds from exercise of stock
options............................. -- 116 -- -- -- --
Tax benefits of stock options......... -- 39 -- -- -- --
Fair value adjustment for committed
ESOP shares......................... -- 25 -- -- -- --
Cash dividends........................ -- -- (168) -- -- --
--
----- ----------- --- --- ---
Balance at June 30, 1998.............. $ 5 8,750 10,414 (127) (27) (290)
--
--
----- ----------- --- --- ---
----- ----------- --- --- ---
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
---------------
<S> <C>
SIX MONTHS ENDED JUNE 30, 1997
- --------------------------------------
Balance at December 31, 1996.......... 16,560
Net income............................ 624
Proceeds from issuance of stock....... 412
Other comprehensive income (loss), net
of tax.............................. (36)
Principal payments on ESOP loan....... 30
Amortization of purchase price of MRP
stock............................... 55
Proceeds from exercise of stock
options............................. 525
Tax benefits of stock options......... 193
Fair value adjustment for committed
ESOP shares......................... 23
Cash dividends........................ (175)
------
Balance at June 30, 1997.............. 18,211
------
------
SIX MONTHS ENDED JUNE 30, 1998
- --------------------------------------
Balance at December 31, 1997.......... 18,104
Net income............................ 667
Other comprehensive income (loss), net
of tax.............................. (94)
Principal payments on ESOP loan....... 30
Amortization of purchase price of MRP
stock............................... 6
Proceeds from exercise of stock
options............................. 116
Tax benefits of stock options......... 39
Fair value adjustment for committed
ESOP shares......................... 25
Cash dividends........................ (168)
------
Balance at June 30, 1998.............. 18,725
------
------
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
F-5
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(DOLLARS IN
THOUSANDS)
SIX MONTHS ENDED
JUNE 30,
--------------------
1998 1997
--------- ---------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net income.................................................................................. $ 667 $ 624
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation.............................................................................. 1,145 1,020
Accretion of discounts and deferred loan fees............................................. (302) (731)
Provision for losses on loans receivable and foreclosed real estate....................... 265 98
(Gain) loss on sale of:
Securities available-for-sale........................................................... (318) (207)
Loans receivable........................................................................ (384) (31)
Discounted loans receivable............................................................. (715) (23)
Foreclosed real estate.................................................................. 91 (81)
Loans originated and purchased for sale..................................................... -- (12,998)
Proceeds from sale of loans receivable...................................................... 18,335 27,092
Proceeds from sale of discounted loans receivable........................................... 7,635 14,125
Amortization of goodwill.................................................................... 51 53
(Increase) decrease in purchased mortgage servicing rights.................................. 356 (1,476)
Amortization of purchase price of MRP and ESOP stock........................................ 36 85
Recognition of fair value of ESOP shares scheduled to be released........................... 25 23
FHLB stock redemption....................................................................... 1,424 157
(Increase) decrease in accrued interest receivable, prepaid expenses, and other assets...... 1,185 893
Increase (decrease) in accrued interest payable and other liabilities....................... 118 (675)
--------- ---------
Net cash provided by (used in) operating activities....................................... 29,614 27,948
--------- ---------
Cash flows from investing activities:
Loans originated and purchased for portfolio.............................................. (77,738) (45,718)
Discounted loans receivable purchased..................................................... (296) (8,731)
Principal repayments on:
Loans receivable and discounted loans receivable.......................................... 34,994 24,644
Mortgage-backed securities................................................................ 235 333
Proceeds from sale of:
Foreclosed real estate.................................................................... 1,671 1,698
Securities available for sale............................................................. 5,271 2,079
Purchase of:
Securities available for sale............................................................. (5,365) (2,113)
Premises and equipment.................................................................... (622) (2,519)
Net cash (paid) in purchase of subsidiary................................................. (485) --
--------- ---------
Net cash provided by (used in) investing activities........................................... (42,335) (30,327)
--------- ---------
Cash flows from financing activities:
Net increase (decrease) in deposits....................................................... 28,994 19,753
Proceeds from borrowed funds.............................................................. 13,345 66,919
Repayment of borrowed funds............................................................... (19,113) (87,650)
Proceeds from exercise of stock options................................................... 116 937
Dividends paid............................................................................ (168) (175)
Net increase (decrease) in advance payments by borrowers for taxes and insurance.......... 5 857
Net increase (decrease) in custodial escrow balances for loans serviced................... (509) (283)
--------- ---------
Net cash provided by financing activities............................................... 22,670 358
--------- ---------
Net increase (decrease) in cash and cash equivalents...................................... 9,949 (2,021)
Cash and cash equivalents at beginning of period............................................ 8,677 13,276
--------- ---------
Cash and cash equivalents at end of period.................................................. $ 18,626 $ 11,255
--------- ---------
--------- ---------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest expense............................................................................ $ 5,405 $ 5,268
Income taxes................................................................................ $ 225 $ 70
Non-cash investing activity--transfer of loans to foreclosed real estate.................... $ 1,869 $ 2,130
See accompanying notes to unaudited consolidated financial statements.
</TABLE>
F-6
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A--BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles ("GAAP")
for interim financial information and with the instructions to Form 10-Q and
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments including
normal recurring accruals, considered necessary for fair presentation have been
included. The results of operations for the six months ended June 30, 1998, are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1998.
The unaudited consolidated financial statements include the accounts of Argo
Bancorp, Inc. ("Argo Bancorp," the "Corporation" or "Holding Company") and its
wholly owned subsidiaries, On-Line Financial Services, Inc. ("On-Line"), Argo
Federal Savings Bank, FSB ("Argo Savings" or "Savings Bank") and Argo Savings'
wholly owned subsidiaries, Argo Mortgage Corporation, Dolton-Riverdale Savings
Service Corporation, and Argo Savings' majority owned subsidiary Margo Financial
Services LLC ("MARGO"). The statements also include Argo Bancorp's majority
owned limited liability corporation, Argo / Empire Mortgage LLC. Significant
intercompany accounts and transactions have been eliminated in consolidation.
NOTE B--STOCK BENEFIT PLANS
The Savings Bank adopted the Argo Federal Savings 401(k) Plan ("Plan")
effective October 1, 1988, for the exclusive benefit of eligible employees of
the Savings Bank. The Plan is a qualified plan covering all employees of the
Savings Bank who have completed at least 1,000 hours of service within a twelve
(12) consecutive month period and are age twenty-one (21) or older. Participants
may make contributions to the Plan from 1.0% to 12.0% of their earnings, subject
to Internal Revenue Service limitations. Matching contributions of 50.0% of each
participant's contribution up to 12.0% are made at the Savings Bank's discretion
each Plan year. The Savings Bank made contributions of $35,000 and $41,000, to
the Plan for the six months ended June 30, 1998, and 1997. The Plan also
provides benefits in the event of death, disability, or other termination of
employment.
On-Line has a 401(k) Plan covering all employees who have completed one or
more years of service. Participants may make contributions to the Plan from 1.0%
to 12.0% of their earnings, subject to Internal Revenue Service limitations.
Matching contributions of 50.0% of each participant's contribution up to 6.0% of
participant contributions are made at On-Line's discretion each year. On-Line
contributions totaled $29,000 and $28,000 for the six-month periods ended June
30, 1998, and 1997, respectively.
In conformity with Internal Revenue Service (IRS) rules governing separate
lines of business, the 401(k) Plan for On-Line will continue to be operated
separately from the 401(k) Plan for the Savings Bank.
In connection with the Merger Conversion, Argo Savings formed an Employee
Stock Ownership Plan ("ESOP") for eligible employees. The ESOP borrowed funds
from an unrelated third party lender in the amount of $60,180 in order to
purchase 7.0% of the Common Stock to be issued in the Merger Conversion (5,233
shares at $11.50 per share). The ESOP has subsequently borrowed additional funds
from the same third party lender in the amount of $245,000 in order to purchase
additional shares as of June 30, 1998, the unpaid principal balance of the ESOP
note was $27,000. The note has an interest rate of 8.25% and matures on May 27,
1999. The ESOP has purchased an additional 13,020 shares at an average price of
$18.79 per share. Argo Savings will make scheduled discretionary cash
contributions to the ESOP sufficient to service the amounts borrowed. The unpaid
balance of the ESOP loan has been included in borrowed funds on the unaudited
consolidated statement of condition and stockholders' equity has been reduced by
F-7
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B--STOCK BENEFIT PLANS (CONTINUED)
a similar amount. Contributions of $32,000 and $34,000 were made to the ESOP to
fund principal and interest for the three months ended June 30, 1998, and 1997,
respectively.
The Savings Bank records the difference between the fair value of the shares
committed to be released and the cost of those shares to the ESOP as a charge to
additional paid-in-capital with the corresponding increase or decrease to
compensation expense. Additional paid in capital increased by $25,000 and
$23,000 for the six months ended June 30, 1998 and 1997, respectively.
On-Line does not offer an ESOP for On-Line employees. On-Line employees are
not eligible for participation under the Savings Bank's ESOP.
The Board of Directors of Argo Bancorp formed a new MRP effective September
1, 1996, which purchased 12,500 shares of Argo Bancorp stock on September 24,
1996, for $115,000. During the year ended December 31, 1997, the Company sold
4,652 shares held by the Argo Bancorp MRP for $181,000 reducing the total shares
held by the plan to 7,848. Under this plan, employees in key management
positions with Argo Bancorp and all its subsidiaries are eligible for
participation. No shares were awarded during the six months ended June 30, 1998.
During the six months ended June 30, 1997, 1,575 shares were awarded to certain
key On-Line employees. Amortization expense totaled $6000 for each the six month
period ended June 30, 1998.
The Board of Directors of Argo Savings formed a Management Recognition Plan
and Trust ("MRP") effective October 31, 1991, which purchased 6.8% or 15,400
shares, of the Corporation's authorized but unissued common stock in December
1991. In addition, Argo Savings contributed $34,385 to allow the MRP to purchase
2,990 shares in the merger conversion or on the open market. All initial MRP
shares have been awarded to employees in key management positions with the
Savings Bank and are fully vested.
On April 26, 1995, an amendment to the MRP was approved, which increased the
amount of shares available to be awarded under the MRP to 24,498. An additional
3,797 and 1,907 shares were purchased in 1996 and 1995, respectively, under the
MRP. During the year ended December 31, 1997, the Company sold 5,604 shares held
by the plan for $219,000, reducing the total shares held by the plan to one
hundred (100). Employees earn the awards over a three-year period. Once awarded
the aggregate purchase price of the shares will be amortized to expense as a
portion of annual compensation as the employees become vested in their stock
awards and the amortized cost is reflected as a reduction of stockholders'
equity. No shares were awarded or vested during the six-months ended June 30,
1998. Amortization expense totaled $55,000 for the six months ended June 30,
1997.
Argo Bancorp's Board of Directors adopted the 1991 Stock Option and
Incentive Plan (the 1991 Stock Option Plan), which was approved by its
shareholders effective December 23, 1991, under which up to 107,450 shares of
Argo Bancorp's common stock were reserved for issuance by Argo Bancorp upon
exercise of incentive stock options to be granted to full-time employees of Argo
Bancorp and its subsidiaries from time to time. Argo Bancorp awarded all 107,450
options under the 1991 Stock Option Plan. The exercise price for the options
awarded was equal to the fair market value of the common stock at the date of
grant. To date there have been 61,898 options exercised and 8,060 options of
which were exercised during the six months ended June 30, 1998. At June 30,
1998, options to purchase 45,552 shares were outstanding.
F-8
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B--STOCK BENEFIT PLANS (CONTINUED)
Argo Bancorp's Board of Directors adopted the Non-Qualified Stock Option
Plan for Non-Employee Directors (Non-Qualified Stock Option Plan), which was
approved by its shareholders effective December 23, 1991, under which up to
107,450 shares of Argo Bancorp's common stock were reserved for issuance by Argo
Bancorp upon exercise of non-incentive stock options to be granted to
non-employee directors of the Corporation and its subsidiaries from time to
time. At June 30, 1998, Argo Bancorp has awarded 63,100 options for shares under
the Non-Qualified Stock Option Plan. To date, options to acquire 13,200 shares
have been exercised. No options were exercised during the six months ended June
30, 1998. The exercise price for the options awarded was equal to the fair
market value of the common stock at the date of grant. At June 30, 1998, options
to purchase 49,900 shares were outstanding under the Non-Qualified Stock Option
Plan.
On-Line does not offer a stock option plan for On-Line employees. On-Line
employees are not eligible for participation under Argo Bancorp's Stock Option
Plan.
NOTE C--REGULATORY CAPITAL
Pursuant to the Office of Thrift Supervision ("OTS") regulations, savings
institutions must meet three separate minimum capital-to-assets requirements:
(1) a risk-based capital requirement of 8.0% of risk-weighted assets, (2) a
leverage ratio of 3.0% core capital to total adjusted assets, and (3) a tangible
capital requirement of 1.5% tangible core capital to total assets. Although the
minimum capital requirement is 3.0%, the OTS Regulations provide that an
institution with less than 4.0% core capital is deemed to be
"under-capitalized." The following table summarizes, as of June 30, 1998, Argo
Savings' capital requirements under OTS regulations and its actual capital
ratios at that date:
<TABLE>
<CAPTION>
REQUIRED ACTUAL REQUIRED ACTUAL EXCESS
CAPITAL CAPITAL CAPITAL CAPITAL CAPITAL
PERCENTAGE PERCENTAGE BALANCE BALANCE BALANCE
--------------- ----------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Risk-based.............................................. 8.0% 11.05% $ 10,741 $ 14,838 $ 4,097
Core.................................................... 3.0 5.68 7,374 13,958 6,584
Tangible................................................ 1.5 5.68 3,687 13,958 10,271
</TABLE>
NOTE D--EARNINGS PER SHARE
Basic earnings per share is based on a weighted average number of shares
outstanding of 494,293 and 497,644 for the six months ended June 30, 1998, and
1997, respectively. Diluted earnings per share for the
F-9
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE D--EARNINGS PER SHARE (CONTINUED)
six months ended June 30, 1998, and 1997, is based upon a weighted average
number of shares outstanding of 527,517 and 530,868, respectively.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------
1998 1997
---------- ----------
<S> <C> <C>
Net Income................................................................................ $ 667,000 $ 624,000
---------- ----------
---------- ----------
Weighted average common shares outstanding................................................ 494,293 477,449
Basic earnings per shares................................................................. $ 1.35 $ 1.31
---------- ----------
---------- ----------
Total weighted average common shares outstanding.......................................... 494,293 477,449
Additional dilutive shares of stock options outstanding................................... 33,224 35,061
---------- ----------
Total weighted average common shares and Equivalents outstanding for diluted
computation............................................................................. 527,517 512,510
---------- ----------
---------- ----------
Diluted earnings per share................................................................ $ 1.26 $ 1.22
---------- ----------
---------- ----------
</TABLE>
NOTE E--COMMITMENTS AND CONTINGENCIES
At June 30, 1998, the Bank had loan commitments totaling $11.3 million and
$3.5 million in unused lines of credit. Commitments to fund loans have credit
risk essentially the same as that involved in extending loans to customers and
are subject to the Bank's normal credit policies. the Bank also had community
reinvestment act ("CRA") investment commitments outstanding of $2.9 million.
NOTE F--SUBSEQUENT EVENTS
On May 4, 1998, the Bank entered into an agreement to sell its Gurnee branch
to CIB Bank. The transaction included the sale of $13.2 million in deposits and
$149,000 in furniture, fixtures, and equipment. The sale closed on July 16,
1998, and resulted in a pre-tax gain of approximately $995,000, which will be
recorded by the Bank in the third quarter of 1998.
F-10
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Argo Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial
condition of Argo Bancorp, Inc. and subsidiaries (the Company) as of December
31, 1997 and 1996, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Argo
Bancorp, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1997 in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Chicago, Illinois
March 24, 1998
F-11
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
---------- ---------
<S> <C> <C>
(IN THOUSANDS)
ASSETS
Cash....................................................................................... $ 6,211 12,518
Interest-earning deposits.................................................................. 2,466 758
Stock in Federal Home Loan Bank of Chicago, at cost........................................ 3,271 3,428
Securities available-for-sale, at fair value............................................... 4,974 5,788
Loans receivable, net of allowance for loan losses of $814 and $665 in 1997 and 1996,
respectively............................................................................. 153,808 125,704
Discounted loans receivable................................................................ 30,550 47,725
Accrued interest receivable................................................................ 1,725 2,089
Foreclosed real estate, net of allowance for losses of $92 and $189 in 1997 and 1996,
respectively............................................................................. 4,251 3,913
Premises and equipment, net................................................................ 11,235 9,856
Mortgage loan servicing rights............................................................. 794 1,089
Investment in limited partnerships......................................................... 5,912 4,175
Software licensing rights.................................................................. 1,338 1,663
Prepaid expenses and other assets.......................................................... 9,763 10,578
---------- ---------
$ 236,298 229,284
---------- ---------
---------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits................................................................................... 172,469 150,627
Borrowed money............................................................................. 34,156 50,879
Advance payments by borrowers for taxes and insurance...................................... 741 24
Accrued interest payable................................................................... 264 267
Interest-bearing custodial escrow balances for loans serviced for others................... 1 76
Custodial escrow balances for loans serviced for others.................................... 6,399 5,706
Other liabilities.......................................................................... 4,164 5,145
---------- ---------
Total liabilities.......................................................................... 218,194 212,724
---------- ---------
Stockholders' equity:
Preferred stock, $0.01 par value. Authorized 500,000 shares; none issued or
outstanding............................................................................ -- --
Common stock:
Class A, $0.01 par value. Authorized 3,020,000 shares; issued and outstanding 489,584
shares in 1997 and 446,254 shares in 1996............................................ 5 4
Class B and C, $0.01 par value. Authorized 340,000 shares each; none issued or
outstanding.......................................................................... -- --
Class D, $0.01 par value. Authorized 800,000 shares; none issued or outstanding........ -- --
Additional paid-in capital............................................................... 8,570 7,382
Retained earnings--substantially restricted.............................................. 9,915 9,444
Common stock acquired by:
Employee Stock Ownership Plan.......................................................... (57) (117)
Management Recognition Plan............................................................ (296) (165)
Net unrealized gain (loss) on securities available-for-sale, net of income taxes......... (33) 12
---------- ---------
Total stockholders' equity................................................................. 18,104 16,560
Commitments and contingencies..............................................................
---------- ---------
$ 236,298 229,284
---------- ---------
---------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
F-12
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
Interest income:
Loans receivable............................................................ $ 12,072 11,370 11,836
Discounted loans receivable................................................. 5,249 3,687 1,174
Mortgage-backed securities available-for-sale............................... 293 354 405
Interest-earning deposits................................................... 364 421 67
Securities available-for-sale............................................... 288 242 505
--------- --------- ---------
Total interest income......................................................... 18,266 16,074 13,987
--------- --------- ---------
Interest expense:
Deposits.................................................................... 8,580 6,433 5,610
Custodial escrows........................................................... 1 78 224
Borrowed money.............................................................. 2,705 2,572 2,507
--------- --------- ---------
Total interest expense........................................................ 11,286 9,083 8,341
--------- --------- ---------
Net interest income before provision for loan losses.......................... 6,980 6,991 5,646
Provision for loan losses..................................................... 210 248 55
--------- --------- ---------
Net interest income after provision for loan losses........................... 6,770 6,743 5,591
--------- --------- ---------
Noninterest income:
Loan servicing income, net.................................................. 426 352 361
Net gain (loss) on sale of:
Loans held for sale....................................................... 217 246 226
Discounted loans receivable............................................... 279 1,843 1,062
Foreclosed real estate.................................................... 19 (366) (2)
Securities available-for-sale............................................. 710 235 219
Fees and service charges.................................................... 1,451 520 450
Data processing income...................................................... 11,528 11,111 1,836
Other....................................................................... 955 253 327
--------- --------- ---------
Total noninterest income...................................................... 15,585 14,194 4,479
--------- --------- ---------
Noninterest expense:
Compensation and benefits................................................... $ 8,799 8,731 3,648
Occupancy and equipment..................................................... 4,930 4,260 1,471
Federal deposit insurance premiums.......................................... 102 1,072 268
Loan servicing expense...................................................... 550 268 251
Professional fees........................................................... 1,261 788 431
Advertising and promotion................................................... 382 305 104
Goodwill amortization....................................................... 104 108 102
Data processing cost of services............................................ 2,806 1,542 231
Computer services........................................................... -- -- 181
Software expense............................................................ 865 705 119
Other....................................................................... 1,610 1,481 856
--------- --------- ---------
Total noninterest expense..................................................... 21,409 19,260 7,662
--------- --------- ---------
Income before income taxes.................................................... 946 1,677 2,408
Income tax expense............................................................ 123 343 667
--------- --------- ---------
Net income.................................................................... $ 823 1,334 1,741
--------- --------- ---------
--------- --------- ---------
Per share amounts:
Basic....................................................................... $ 1.70 4.26 5.88
Diluted..................................................................... 1.56 3.60 4.96
--------- --------- ---------
--------- --------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
F-13
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
NET UNREALIZED
COMMON COMMON GAIN (LOSS)
COMMON ADDITIONAL STOCK STOCK ON SECURITIES
STOCK PAID-IN RETAINED ACQUIRED ACQUIRED AVAILABLE-
CLASS A CAPITAL EARNINGS BY ESOP BY MRP FOR-SALE
----------- ------------- ----------- ------------- ------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Balance at December 31, 1994........... $ 3 2,664 6,789 (237) (21) (224)
Net income............................. -- -- 1,741 -- -- --
Principal payments on ESOP loan........ -- -- -- 60 -- --
Amortization of purchase price of MRP
stock................................ -- -- -- -- 21 --
Proceeds from exercise of stock
options.............................. -- 49 -- -- -- --
Fair value adjustment for committed
ESOP shares.......................... -- 26 -- -- -- --
Cash dividends ($.68 per share)........ -- -- (208) -- -- --
Purchase of additional MRP shares...... -- -- -- -- (50) --
Change in unrealized gain (loss) on
securities available-for-sale, net of
income taxes......................... -- -- -- -- -- 266
----- ----- ----- --- --- ---
Balance at December 31, 1995........... 3 2,739 8,322 (177) (50) 42
Net income............................. -- -- 1,334 -- -- --
Proceeds from issuance of stock........ 1 4,026 -- -- -- --
Principal payments on ESOP loan........ -- -- -- 60 -- --
Proceeds from exercise of stock
options.............................. -- 430 -- -- -- --
Tax benefits of stock options
exercised............................ -- 149 -- -- -- --
Fair value adjustment for committed
ESOP shares.......................... -- 38 -- -- -- --
Cash dividends ($.68 per share)........ -- -- (212) -- -- --
Purchase of additional MRP shares...... -- -- -- -- (115) --
Change in unrealized gain (loss) on
securities available-for-sale, net of
income taxes......................... -- -- -- -- -- (30)
----- ----- ----- --- --- ---
Balance at December 31, 1996........... 4 7,382 9,444 (117) (165) 12
Net income............................. -- -- 823 -- -- --
Proceeds from issuance of stock........ 1 411 -- -- -- --
Principal payments on ESOP loan........ -- -- -- 60 -- --
Amortization of purchase price of MRP
stock................................ -- -- -- -- 12 --
Proceeds from exercise of stock
options.............................. -- 525 -- -- -- --
Tax benefits of stock options
exercised............................ -- 145 -- -- -- --
Fair value adjustment for committed
ESOP shares.......................... -- 50 -- -- -- --
Cash dividends ($.68 per share)........ -- -- (352) -- -- --
Purchase of additional MRP shares...... -- -- -- -- (486) --
Proceeds from sale of MRP stock........ -- 57 -- -- 343 --
Change in unrealized gain (loss) on
securities available-for-sale, net of
income taxes......................... -- -- -- -- -- (45)
----- ----- ----- --- --- ---
Balance at December 31, 1997........... $ 5 8,570 9,915 (57) (296) (33)
----- ----- ----- --- --- ---
----- ----- ----- --- --- ---
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
-------------
<S> <C>
Balance at December 31, 1994........... 8,974
Net income............................. 1,741
Principal payments on ESOP loan........ 60
Amortization of purchase price of MRP
stock................................ 21
Proceeds from exercise of stock
options.............................. 49
Fair value adjustment for committed
ESOP shares.......................... 26
Cash dividends ($.68 per share)........ (208)
Purchase of additional MRP shares...... (50)
Change in unrealized gain (loss) on
securities available-for-sale, net of
income taxes......................... 266
------
Balance at December 31, 1995........... 10,879
Net income............................. 1,334
Proceeds from issuance of stock........ 4,027
Principal payments on ESOP loan........ 60
Proceeds from exercise of stock
options.............................. 430
Tax benefits of stock options
exercised............................ 149
Fair value adjustment for committed
ESOP shares.......................... 38
Cash dividends ($.68 per share)........ (212)
Purchase of additional MRP shares...... (115)
Change in unrealized gain (loss) on
securities available-for-sale, net of
income taxes......................... (30)
------
Balance at December 31, 1996........... 16,560
Net income............................. 823
Proceeds from issuance of stock........ 412
Principal payments on ESOP loan........ 60
Amortization of purchase price of MRP
stock................................ 12
Proceeds from exercise of stock
options.............................. 525
Tax benefits of stock options
exercised............................ 145
Fair value adjustment for committed
ESOP shares.......................... 50
Cash dividends ($.68 per share)........ (352)
Purchase of additional MRP shares...... (486)
Proceeds from sale of MRP stock........ 400
Change in unrealized gain (loss) on
securities available-for-sale, net of
income taxes......................... (45)
------
Balance at December 31, 1997........... 18,104
------
------
</TABLE>
See accompanying notes to consolidated financial statements.
F-14
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
(IN THOUSANDS)
Cash flows from operating activities:
Net income.................................................................. $ 823 1,334 1,741
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization........................................... 2,176 1,435 708
Accretion of discounts and deferred loan fees........................... (1,032) (774) (1,440)
Deferred income tax expense (benefit)................................... (37) 261 545
Provision for losses on loans receivable and foreclosed
real estate........................................................... 248 487 114
Loss (gain) on sale of:
Loans held for sale................................................... (217) (246) (226)
Discounted loans receivable........................................... (279) (1,843) (1,062)
Securities available-for-sale......................................... (710) (235) (219)
Foreclosed real estate................................................ (19) 366 2
Loans originated and purchased for sale................................. (14,428) (23,681) (57,769)
Proceeds from sale of loans held for sale............................... 40,312 36,040 45,850
Proceeds from sale of discounted loans receivable....................... 20,990 9,358 6,494
Goodwill amortization................................................... 104 108 102
Amortization of purchased loan servicing rights......................... 169 -- --
Amortization of purchase price of MRP and ESOP stock.................... 72 60 81
Recognition of fair value of ESOP shares committed to be released....... 50 38 26
FHLB stock dividends.................................................... -- -- (40)
Decrease (increase) in accrued interest receivable and prepaid expenses
and other assets...................................................... 1,571 (3,689) (3,985)
Increase in accrued interest payable and other liabilities.............. (948) 1,500 2,865
---------- ---------- ----------
Net cash provided by (used in) operating activities........................... 48,845 20,519 (6,213)
---------- ---------- ----------
Cash flows from investing activities:
Loans originated and purchased for portfolio................................ (100,742) (59,552) (35,633)
Discounted loans receivable purchased....................................... (8,858) (41,061) (19,904)
Principal repayments on:
Loans receivable and discounted loans receivable.......................... 48,232 46,231 35,928
Mortgage-backed securities available-for-sale............................. 855 735 936
Proceeds from maturities of investment securities........................... -- 625 4,100
Proceeds from sale of:
Securities available-for-sale............................................. 8,668 742 1,448
FHLB stock................................................................ 157 -- --
Foreclosed real estate.................................................... 4,543 1,968 600
Purchased loan servicing rights........................................... 120 -- --
Premises and equipment.................................................... -- 19 14
Purchase of:
Securities available-for-sale............................................. (8,088) (152) (830)
Premises and equipment.................................................... (3,553) (5,849) (3,691)
(CONTINUED)
</TABLE>
F-15
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Stock in Federal Home Loan Bank of Chicago................................ $ -- (759) (53)
Loan servicing rights..................................................... (1,731) (1,231) --
Net cash (paid) received in purchase of subsidiary.......................... -- 67 (629)
---------- ---------- ----------
Net cash used in investing activities......................................... (60,397) (58,217) (17,714)
---------- ---------- ----------
Cash flows from financing activities:
Net increase in deposits.................................................... 21,842 27,143 22,787
Proceeds from borrowed money................................................ 88,433 118,671 145,718
Repayment of borrowed money................................................. (105,156) (105,974) (137,482)
Purchase of MRP shares...................................................... (486) (115) (50)
Proceeds from stock issuance................................................ 412 4,027 --
Proceeds from sale of MRP stock............................................. 400 -- --
Proceeds from exercise of stock options..................................... 525 430 49
Dividends paid.............................................................. (352) (212) (208)
Net increase (decrease) in advance payments by borrowers for taxes and
insurance................................................................. 717 (143) (17)
Net increase (decrease) in custodial escrow balances for loans serviced..... 618 (3,914) (4,995)
---------- ---------- ----------
Net cash provided by financing activities..................................... 6,953 39,913 25,802
---------- ---------- ----------
Net increase in cash and cash equivalents..................................... (4,599) 2,215 1,875
Cash and cash equivalents at beginning of year................................ 13,276 11,061 9,186
---------- ---------- ----------
Cash and cash equivalents at end of year...................................... $ 8,677 13,276 11,061
---------- ---------- ----------
---------- ---------- ----------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest.................................................................. $ 11,196 8,980 7,983
Income taxes.............................................................. 76 400 190
Noncash investing activity -
transfer of loans to foreclosed real estate............................... 4,955 4,285 1,820
Decrease in taxes payable from exercise of stock options.................... 145 149 --
On-Line acquisition:
Fair value of assets acquired, including cash and cash equivalents........ -- -- 5,344
Value assigned to intangibles............................................. -- -- 154
Liabilities assumed....................................................... -- -- 5,190
</TABLE>
See accompanying notes to consolidated financial statements.
F-16
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996, AND 1995
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting policies of Argo Bancorp, Inc. (Argo Bancorp or the Company)
and subsidiaries conform to generally accepted accounting principles and to
prevailing industry practices. The following is a description of the more
significant of those policies.
(A) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements are comprised of the accounts of Argo
Bancorp; its wholly-owned subsidiaries, On-Line Financial Services, Inc. and the
Savings Bank; the Savings Bank's wholly-owned subsidiaries, Argo Mortgage
Corporation and Dolton-Riverdale Savings Service Corporation and its majority
owned subsidiary, Margo Financial Services LLC; and Argo Bancorp's consolidated
joint venture, Empire/Argo Mortgage LLC. All significant intercompany balances
and transactions have been eliminated in consolidation. Certain amounts in the
1996 and 1995 consolidated financial statements have been reclassified to
conform with the 1997 presentation.
(B) INVESTMENT SECURITIES AND MORTGAGE-BACKED SECURITIES
Investments for which the Company has the positive intent and ability to
hold to maturity are classified as "held-to-maturity" and measured at amortized
cost, adjusted for amortization of premiums and accretion of discounts.
Investments purchased and held principally for the purpose of selling them in
the near term are classified as "trading securities" and measured at fair value,
with any changes in fair value included in earnings. All other investments that
are not classified as "held-to-maturity" or "trading securities" are classified
as "available-for-sale." Investments available-for-sale are measured at fair
value with any unrealized gains or losses reflected as a separate component of
stockholders' equity, net of income taxes.
Mortgage-backed securities represent participating interests in pools of
long-term first mortgage loans originated and serviced by the issuers of the
securities.
Amortization of premiums and accretion of discounts are recognized in
interest income over the estimated life of the related securities using the
interest method. Gains or losses on the sale of investment and mortgage-backed
securities are determined using the specific identification method.
(C) LOANS RECEIVABLE
Loans receivable are stated at unpaid principal balances less unearned
discounts, deferred loan fees (costs), and allowance for loan losses. Discounts
on loans are amortized to interest income over the contractual life of the
related loans using the interest method. Interest income is not recognized on
loans which are 90 days or greater delinquent or on loans which management
believes are uncollectible.
All loan origination fees and certain direct costs associated with loan
originations are deferred. Net deferred fees and costs are amortized as yield
adjustments over the contractual life of the related loans using a method which
approximates the interest method, adjusted for estimated prepayments based on
the Savings Bank's historical prepayment experience.
The allowance for loan losses is increased by charges to income and
decreased by charge-offs (net of recoveries). Allowances for estimated losses on
loans receivable are established when any permanent decline in value occurs.
Additions to allowances for losses are provided based on a periodic evaluation
by
F-17
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
management. Management's periodic evaluation of the adequacy of the allowance is
based on the Company's past loan loss experience, known and inherent risks in
the portfolio, adverse situations that may affect the borrower's ability to
repay, estimated value of any underlying collateral, and current and prospective
economic conditions. In addition, various regulatory agencies, as an integral
part of their examination process, periodically review the Savings Bank's
allowance for losses. Such agencies may require the Savings Bank to recognize
additions to the allowance for loan losses based on their judgments or
information available to them at the time of their examination. In the opinion
of management, the allowance, when taken as a whole, is adequate to absorb
losses in the current loan portfolio.
(D) ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN
Impaired loans are measured at the present value of expected future cash
flows discounted at the loan's effective interest rate, or, as a practical
expedient, at the loan's observable market price or the fair value of the
collateral if the loan is collateral-dependent. Homogeneous loans that are
collectively evaluated for impairment, including first mortgage loans, consumer
loans, and the portfolio of discounted loans receivable are excluded from the
impairment provisions. At December 31, 1997 and 1996, the Company identified no
loans that were considered impaired as defined.
(E) DISCOUNTED LOANS RECEIVABLE
The Company purchases loans, predominately secured by single family homes,
at moderate to deep discounts. The moderate discount loans have been
historically performing loans whereas the deep discount loans have been
nonperforming. These loans receivable are stated at unpaid principal balance
less unearned discount. Discounts on the performing loans are accreted to
interest income over the contractual life of the related loans using the
interest method. Discounts on purchased loans for which the collection of
principal and interest is not probable are only recognized in income when the
loan is sold or paid in full. Management evaluates collectibility of the
portfolio of discounted loans receivable on an aggregate pool basis. Any excess
of estimated fair value over the net loan balance, in the aggregate, is charged
to income. There was no impairment expense recorded in 1997, 1996, or 1995.
(F) MORTGAGE LOANS HELD FOR SALE
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated market value in the aggregate.
(G) FORECLOSED REAL ESTATE
Real estate acquired through foreclosure or deed in lieu of foreclosure or
in judgment is carried at the lower of fair value less costs to dispose or the
related loan balance at the date of foreclosure. Valuations are periodically
performed by management and an allowance for loss is established by a charge to
operations if the carrying value of a property exceeds its fair value less costs
to dispose.
F-18
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Activity in the allowance for losses on foreclosed real estate is summarized
as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
--------- --------- -----
<S> <C> <C> <C>
Balance at beginning of year............................................................... $ 189 412 399
Provision for losses....................................................................... 38 238 59
Transfer from allowance for loan losses.................................................... 50 77 45
Charge-offs................................................................................ (185) (538) (91)
--------- --- ---
Balance at end of year..................................................................... $ 92 189 412
--------- --- ---
--------- --- ---
</TABLE>
(H) PREMISES AND EQUIPMENT
Premises and equipment are carried at cost less accumulated depreciation and
amortization. Depreciation and amortization are computed on the straight-line
method over the estimated useful lives of the assets. Useful lives are 25 to 50
years for building and additions, 7 to 10 years for building and parking lot
improvements, and 3 to 10 years for furniture, fixtures, equipment, and computer
software.
(I) PURCHASED LOAN SERVICING RIGHTS
The investment in purchased loan servicing rights represents equity
investments in limited partnerships carried at the lower of fair value or the
equity investment. The cost of acquiring the rights to service mortgage loans is
capitalized at the partnership level as are other loan servicing costs.
Valuations are performed by management of the Company on a quarterly basis, and
an independent valuation is performed annually by the partnerships.
(J) SOFTWARE LICENSING RIGHTS
The cost of certain software licensing rights acquired and other product
conversion costs at On-Line Financial Services, Inc. are capitalized and
amortized to expense on a straight-line basis over periods of 5 to 7 years.
(K) EXCESS COST OVER FAIR VALUE OF NET ASSETS ACQUIRED
The cost in excess of fair value of net assets acquired (goodwill) in
business combinations is amortized to expense over 15 years for banking
acquisitions and 20 years (straight-line method) for the On-Line acquisition
using the straight line method.
(L) INCOME TAXES
Argo Bancorp and its subsidiaries file a consolidated Federal income tax
return. The provision for Federal and state income taxes is based upon earnings
reported in the consolidated financial statements.
Under the asset and liability method, deferred tax assets and liabilities
are recognized for the tax consequences attributable to differences between the
financial statement existing assets and liabilities and their respective tax
bases (temporary differences). Deferred tax assets and liabilities are measured
using
F-19
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
enacted tax rates expected to apply to taxable income in the years in which the
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
(M) CASH AND CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, cash and
interest-earning deposits with banks with original maturities less than 90 days
are considered to be cash and cash equivalents.
The Savings Bank is required by federal regulations to maintain a minimum
level of liquid assets of 4%. The Savings Bank exceeded the federal requirement
at December 31, 1997 and 1996.
(N) EARNINGS PER SHARE
The Company adopted SFAS No. 128, "Earnings Per Share," in the fourth
quarter of 1997. All prior periods presented have been restated under the
provisions of SFAS No. 128. Under the provisions of SFAS No. 128, primary and
fully diluted earnings per share were replaced with basic and diluted earnings
per share. Basic earnings per share is calculated by dividing net income by the
weighted average number of common shares outstanding. Diluted earnings per share
is calculated by dividing net income by the weighted average number of shares
adjusted for the diluted effect of outstanding stock options.
The following table sets forth the components of basic and diluted earnings
per share:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
----------------------------------
1997 1996 1995
---------- ---------- ----------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Numerator:
Net income................................................................. $ 823 1,334 1,741
---------- ---------- ----------
---------- ---------- ----------
Denominator:
Basic earnings per share--weighted average shares outstanding.............. 482,893 313,256 295,978
Effect of dilutive stock options outstanding............................... 43,798 57,523 55,186
---------- ---------- ----------
Diluted earnings per share--weighted average shares outstanding.............. 526,691 370,779 351,164
---------- ---------- ----------
Basic earnings per share..................................................... $ 1.70 4.26 5.88
Diluted earnings per share................................................... 1.56 3.60 4.96
---------- ---------- ----------
</TABLE>
(O) MANAGEMENT ESTIMATES
In order to prepare the consolidated financial statements in conformity with
generally accepted accounting principles, management is required to make certain
estimates that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. These estimates may differ from actual results.
F-20
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(2) ACQUISITION OF ON-LINE FINANCIAL SERVICES, INC.
On October 31, 1995 Argo Bancorp acquired On-Line Financial Services, Inc.
(On-Line), an Oak Brook, Illinois based computer service bureau, servicing bank
and thrift clients throughout the Midwest. The acquisition was accounted for
using the purchase method. The consolidated financial statements include the
results of operations since the acquisition date.
The purchase transaction was consummated through the use of a wholly owned
subsidiary of the Company, OLF Acquisition Corporation, which acquired shares of
three separate state chartered savings and loan service corporations which
owned, in the aggregate, 98.9% of the outstanding shares of On-Line. Sale of the
remaining 1.1% of On-Line shares was made by a single institutional stockholder
which held shares in On-Line directly. The intervening acquisition subsidiary
and state chartered savings and loan service corporation shells were liquidated
and merged by Argo Bancorp in 1996.
Financial terms of the transaction included a cash sweep to shareholders of
On-Line funds on hand on the closing date, less amounts necessary to establish
certain agreed-upon escrow balances; a two-year asset note of approximately
$1,026,000, representing the closing date net book value of On-Line; a 26-month
escrow note in the amount of $460,000, which was paid in 1997, representing
funds held for future performance under a third-party computer lease; and a
structured schedule of contingent payments based on future revenues of On-Line
over the next seven years. The total transaction value, including asset notes
and contingent payments, will not exceed $8.9 million. During 1997, the Company
asserted claims that the selling shareholders of On-Line had breached certain
representations and warranties in the purchase contract. Following a series of
negotiations, the selling shareholders agreed to reduce the purchase price by
$1,098,000. As a result, at December 31, 1997, the amounts paid or payable,
exclusive of the future contingent payments, for On-Line were $836,000 less than
the fair value of the net assets acquired. Any future contingent payments will
reduce this shortgage. In December, 1997, the Company purchased from certain of
the former shareholders their rights to 25.45% of the future contingent payment.
The Company paid $172,000 for these future contingent payments. Management
anticipates funding any required future payments with borrowed funds and excess
funds generated from operations and, to the extent necessary, earnings and
assets of the Company. The structured payment schedule is as follows:
<TABLE>
<CAPTION>
PERCENTAGE OF
NET REVENUES
---------------
<S> <C>
Year 1.............................................................................................. 10.5%
Year 2.............................................................................................. 15.5
Year 3.............................................................................................. 15.5
Year 4.............................................................................................. 11.0
Year 5.............................................................................................. 11.0
Year 6.............................................................................................. 11.0
Year 7.............................................................................................. 11.0
</TABLE>
F-21
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(3) SECURITIES AVAILABLE-FOR-SALE
Securities available-for-sale are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
----------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
DESCRIPTION COST GAINS LOSSES VALUE
- ----------------------------------------------------- ----------- ------------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Municipal Securities................................. $ 370 10 -- 380
Mortgage-backed securities:
Federal Home Loan Mortgage Corporation............. 125 -- (1) 124
Federal National Mortgage Association.............. 2,837 -- (34) 2,803
Marketable equity securities......................... 1,695 7 (35) 1,667
----------- --- --- -----
$ 5,027 17 (70) 4,974
----------- --- --- -----
----------- --- --- -----
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1996
------------------------------------------------------
<S> <C> <C> <C> <C>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
DESCRIPTION COST GAINS LOSSES VALUE
- ------------------------------------------------------------------- ----------- ------------- ------------- -----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Municipal securities............................................... $ 557 45 -- 602
Mortgage-backed securities:
Federal Home Loan Mortgage Corporation........................... 826 12 (4) 834
Federal National Mortgage Association............................ 4,009 4 (103) 3,910
Government National Mortgage Association........................... 152 8 -- 160
Marketable equity securities....................................... 226 56 -- 282
----------- --- --- -----
$ 5,770 125 (107) 5,788
----------- --- --- -----
----------- --- --- -----
</TABLE>
The amortized cost and estimated fair value of securities
available-for-sale, by contractual maturity, at December 31, 1997, are shown
below. Mortgage-backed securities, although not due at a single maturity date,
are allocated among the maturity groupings based on contractual maturity.
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations.
<TABLE>
<CAPTION>
AMORTIZED ESTIMATED
COST FAIR VALUE
----------- -----------
<S> <C> <C>
(IN THOUSANDS)
Due in one year or less.................................................................... $ 234 234
Due after one year through five years...................................................... 565 560
Due after five years through ten years..................................................... 50 52
Due after ten years........................................................................ 2,483 2,461
----------- -----
3,332 3,307
Marketable equity securities............................................................... 1,695 1,667
----------- -----
$ 5,027 4,974
----------- -----
----------- -----
</TABLE>
F-22
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(3) SECURITIES AVAILABLE-FOR-SALE (CONTINUED)
Proceeds from sales of securities available-for-sale for the years ended
December 31, 1997, 1996, and 1995 were $8,668,000, $742,000, and $1,448,000,
respectively. Gross gains of $710,000, $235,000, and $219,000, respectively
during 1997, 1996, and 1995 were recorded. There were no realized losses on
security sales during these years.
(4) LOANS RECEIVABLE
Loans receivable and loans held for sale, net are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
<S> <C> <C>
1997 1996
---------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
First mortgage loans....................................................................... $ 111,404 81,050
Participating investment in first mortgage loans........................................... 31,059 37,487
Commercial real estate loans............................................................... 1,951 4,019
Equity line of credit loans................................................................ 7,700 6,035
Other loans................................................................................ 3,649 1,297
---------- ---------
Total gross loans receivable............................................................... 155,763 129,888
Add (deduct):
Allowance for loan losses...................................................... (814) (665)
Deferred loan costs............................................................ 681 93
Unearned discounts............................................................. (1,822) (3,612)
---------- ---------
$ 153,808 125,704
---------- ---------
---------- ---------
Weighted-average interest rate............................................................. 9.57% 9.95%
---------- ---------
---------- ---------
</TABLE>
Included in first mortgage loans are loans held for sale totaling
approximately $6.5 million and $6.2 million at December 31, 1997 and 1996,
respectively.
The following is a summary of the changes in the allowance for loan losses:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-----------------------------------
<S> <C> <C> <C>
1997 1996 1995
--------- ----- -----
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Balance at beginning of year................................................................ $ 665 587 613
Provision for loan losses................................................................... 210 248 55
Transfer to allowance for losses on foreclosed real estate.................................. (50) (77) (45)
Charge-offs................................................................................. (11) (93) (36)
--------- --- ---
Balance at end of year...................................................................... $ 814 665 587
--------- --- ---
--------- --- ---
</TABLE>
F-23
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(4) LOANS RECEIVABLE (CONTINUED)
Loans receivable delinquent three months or more are as follows:
<TABLE>
<CAPTION>
PERCENTAGE OF
NUMBER LOANS RECEIVABLE
OF LOANS AMOUNT NET OF DISCOUNT
----------- --------- -----------------
<S> <C> <C> <C>
(IN THOUSANDS)
December 31, 1997............................................................. 104 $ 5,525 3.57%
December 31, 1996............................................................. 78 3,942 3.12
December 31, 1995............................................................. 57 1,987 1.54
--- --------- ---
--- --------- ---
</TABLE>
First mortgage loans at December 31, 1997 include approximately $90.9
million in out-of-area purchased participation and whole loans, which are
secured by single-family homes, with approximately 13% in California, 13% in New
York, and 74% spread throughout the remainder of the country. There is no
geographic concentration of nonperforming loans.
(5) DISCOUNTED LOANS RECEIVABLE
Discounted loans receivable, net are as follows:
<TABLE>
<CAPTION>
DECEMBER 31
--------------------
<S> <C> <C>
1997 1996
--------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
First mortgage loans......................................................................... $ 36,310 60,276
Commercial real estate loans................................................................. -- 504
Other loans.................................................................................. 460 1,062
--------- ---------
Total discounted loans receivable............................................................ 36,770 61,842
Less unearned discount....................................................................... (6,220) (14,117)
--------- ---------
$ 30,550 47,725
--------- ---------
--------- ---------
</TABLE>
Discounted loans receivable delinquent three months or more are as follows:
<TABLE>
<CAPTION>
PERCENTAGE
OF DISCOUNT LOANS
AMOUNT RECEIVABLE, NET
------------- -----------------
<S> <C> <C>
(IN
THOUSANDS)
December 31, 1997................................................................ $ 6,220 20.36%
December 31, 1996................................................................ 15,454 32.38
------ -----
------ -----
</TABLE>
F-24
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(6) ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31
--------------------
<S> <C> <C>
1997 1996
--------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
Investment securities........................................................................... $ 61 58
Mortgage-backed securities...................................................................... 18 27
Loans receivable and discounted loans receivable................................................ 1,646 2,004
--------- ---------
$ 1,725 2,089
--------- ---------
--------- ---------
</TABLE>
(7) PREMISES AND EQUIPMENT
Premises and equipment, at cost, less accumulated depreciation and
amortization are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31
--------------------
<S> <C> <C>
1997 1996
--------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
Land......................................................................................... $ 537 537
Office buildings and improvements............................................................ 4,075 3,776
Leasehold improvements....................................................................... 1,994 1,293
Furniture, fixtures, and equipment........................................................... 17,082 15,331
Capital leases............................................................................... 6,593 5,811
--------- ---------
30,281 26,748
Less accumulated depreciation and amortization............................................... (19,046) (16,892)
--------- ---------
$ 11,235 9,856
--------- ---------
--------- ---------
</TABLE>
Included in occupancy and equipment expense is depreciation and amortization
expense of office properties and equipment of approximately $2,176,000,
$1,435,000, and $708,000 for the years ended December 31, 1997, 1996, and 1995,
respectively.
The Company leases certain equipment under capital lease agreements. The
cost of these assets is amortized on the straight-line basis with the charge
included in depreciation expense.
At December 31, 1997 the Company had capital lease obligations of $6.6
million relating to lease agreements for equipment and other space in connection
with On-Line. Interest expense with respect to these capital leases totaled
$402,000, $207,000, and $42,000 in 1997, 1996, and 1995, respectively.
The Company leases office space and computer equipment under noncancelable
operating leases. Rent expense for the years ended December 31, 1997, 1996, and
1995 totaled $503,000, $574,000, and $149,000, respectively.
F-25
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(7) PREMISES AND EQUIPMENT (CONTINUED)
At December 31, 1997, minimum future rental payments due under capital and
noncancelable operating leases having an initial or remaining term of one year
or more consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31 OPERATING CAPITAL
- --------------------------------------------------------------------------------------------- ----------- -----------
<S> <C> <C>
(IN THOUSANDS)
1998......................................................................................... $ 343 1,296
1999......................................................................................... 359 986
2000......................................................................................... 344 802
2001......................................................................................... 359 777
2002......................................................................................... 372 496
Thereafter................................................................................... 1,520 310
----------- -----
Total minimum lease payments................................................................. $ 3,297 4,667
-----------
-----------
Amount representing interest--capital leases................................................. 838
-----
Present value of minimum capital lease payments.............................................. 3,829
-----
-----
</TABLE>
(8) LOAN SERVICING AND PURCHASED MORTGAGE SERVICING RIGHTS
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid principal balances of
these loans totaled approximately $9.1 million, $8.9 million, and $10.3 million
at December 31, 1997, 1996, and 1995, respectively.
For independently acquired servicing rights, the cost of acquiring the
rights to service mortgage loans is capitalized and amortized in proportion to
and over the period of the estimated net servicing income. On December 31, 1997
and 1996, Argo Savings held $794,000 and $1.1 million, respectively, in
purchased mortgage servicing rights (PMSR's) with an underlying principal
balance of approximately $62.2 million and $83.2 million, respectively. Service
fee income for the year ended December 31, 1997 totaled $84,000 net of
amortization of purchased mortgage servicing rights of $2,000. No income was
recorded in 1996. In 1995, Argo Bancorp had no independently purchased servicing
rights.
During the year ended December 31, 1997, PMSR's totaling $120,000 with an
underlying principal balance of $9.2 million were sold at cost from the Savings
Bank. There were no other sales of purchased mortgage servicing rights for the
years ended December 31, 1997, 1996, and 1995.
The custodial accounts which relate to loans subserviced on behalf of the
Savings Bank and Argo Bancorp for portfolio loans, servicing retained loans, and
purchased mortgage servicing rights are maintained at the Savings Bank in
noninterest-bearing accounts. The custodial accounts are used for escrowed
payments of taxes and insurance and the float on principal and interest
payments. At December 31, 1997, the entire balance of the custodial accounts of
$6,399,000 relates to loans serviced on behalf of the Savings Bank and Argo
Bancorp.
The balance of investment in limited partnerships of $5.9 million and $4.2
million at December 31, 1997 and 1996, respectively, represents Argo Savings'
investment in three divisions of a single limited partnerships. The single
business activity of this limited partnership is the purchase of current
mortgage servicing rights. There are several equity investors in each division
of the partnership. The purchase of the servicing rights is then leveraged
allowing the partnership to purchase additional servicing rights. At the
F-26
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(8) LOAN SERVICING AND PURCHASED MORTGAGE SERVICING RIGHTS (CONTINUED)
end of five years, or at such time as the investors agree, the servicing rights
will be sold and the proceeds divided pro rata among the investors. As with
typical investments in PMSR's, the collateral underlying the equity investment
is the servicing rights. All purchases of servicing rights must be approved by
all equity investors and undergo stringent guidelines outlined previously for a
purchase of servicing. The administration and servicing of the purchased
portfolios in each division is performed by the general partner. Argo Savings'
recorded income related to this partnership on the equity method of $341,000,
$352,000, and $360,000 during 1997, 1996, and 1995, respectively, is included in
servicing fee income, net of amortization of PMSR's, in the consolidated
statements of operations.
(9) DEPOSITS
Deposits at December 31 are summarized as follows:
<TABLE>
<CAPTION>
1997 1996
------------------------------------ -----------------------
AMOUNT WEIGHTED AMOUNT
IN AVERAGE IN
THOUSANDS PERCENT RATE THOUSANDS PERCENT
---------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Passbook accounts......................................... $ 17,607 10.2% 2.63% $ 18,349 12.2%
NOW accounts.............................................. 13,225 7.7 2.48 12,426 8.3
Money market accounts..................................... 6,223 3.6 3.50 4,957 3.3
---------- ----- --- ---------- -----
37,055 21.5 2.72 35,732 23.8
---------- ----- --- ---------- -----
---------- ----- --- ---------- -----
Certificate accounts:
3.99% or less........................................... 10 -- 2.50 52 --
4.00 - 4.99%............................................ 874 .5 4.85 769 .5
5.00 - 5.99%............................................ 62,935 36.5 5.55 71,169 47.2
6.00 - 6.99%............................................ 69,962 40.5 6.11 39,194 26.0
7.00 - 7.99%............................................ 1,513 .9 7.09 3,612 2.4
8.00 - 8.99%............................................ 120 .1 8.44 99 .1
---------- ----- --- ---------- -----
135,414 78.5 5.85 114,895 76.2
---------- ----- --- ---------- -----
$ 172,469 100.0% 5.18% $ 150,627 100.0%
---------- ----- --- ---------- -----
---------- ----- --- ---------- -----
<CAPTION>
WEIGHTED
AVERAGE
RATE
-----------
<S> <C>
Passbook accounts......................................... 2.76%
NOW accounts.............................................. 3.05
Money market accounts..................................... 4.30
---
3.07
---
---
Certificate accounts:
3.99% or less........................................... 2.50
4.00 - 4.99%............................................ 4.84
5.00 - 5.99%............................................ 5.50
6.00 - 6.99%............................................ 6.17
7.00 - 7.99%............................................ 7.05
8.00 - 8.99%............................................ 8.44
---
5.77
---
5.13%
---
---
</TABLE>
Contractual maturities of certificate accounts at December 31 are as
follows:
<TABLE>
<CAPTION>
1997 1996
---------- ---------
<S> <C> <C>
(IN THOUSANDS)
Under 12 months............................................................................ $ 116,154 48,570
12 months to 36 months..................................................................... 13,313 57,111
Over 36 months............................................................................. 5,947 9,214
---------- ---------
$ 135,414 114,895
---------- ---------
---------- ---------
</TABLE>
The Savings Bank has pledged investment securities of approximately
$3,022,000 and $4,160,000 at December 31, 1997 and 1996, respectively, as
collateral to secure certain public deposits. At December 31, 1997 and 1996,
respectively, the Savings Bank also had letters of credit totaling $15,402,000
and
F-27
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(9) DEPOSITS (CONTINUED)
$14,523,000, respectively, as collateral to secure several State of Illinois
certificates of deposit totaling approximately $14,100,000. The aggregate amount
of deposit accounts with a balance greater than $100,000 was $40,607,000 and
$36,487,000 at December 31, 1997 and 1996, respectively.
Interest expense on deposit accounts is summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-------------------------------
<S> <C> <C> <C>
1997 1996 1995
--------- --------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Passbook and certificate accounts...................................................... $ 8,064 5,934 5,162
NOW accounts........................................................................... 270 282 333
Money market accounts.................................................................. 246 217 115
--------- --------- ---------
$ 8,580 6,433 5,610
--------- --------- ---------
--------- --------- ---------
</TABLE>
(10) BORROWED MONEY
Borrowed money at December 31 is summarized as follows:
<TABLE>
<CAPTION>
WEIGHTED INTEREST
RATE BALANCE
DECEMBER 31 DECEMBER 31
-------------------- --------------------
MATURITY 1997 1996 1997 1996
----------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Advances from the Federal
Home Loan Bank of Chicago:
Open line.. 6.24% 5.59 $ 6,000 25,650
1/02/97 -- 6.14 -- 297
2/11/97 -- 4.80 -- 2,000
2/10/97 -- 4.80 -- 1,409
12/17/97 -- 6.30 -- 55
2/21/00 5.48 -- 5,000 --
6/03/01 8.43 8.43 72 72
4/20/03 6.13 6.13 2,760 2,760
11/25/06 6.58 6.58 10,000 10,000
--- --------- --------- ---------
6.22 5.80 23,832 42,243
--- --------- --------- ---------
Other borrowings:
ESOP note payable............................................. 4/27/99 8.08 8.02 57 117
Note payable.................................................. Open line 8.44 8.25 5,279 2,227
Note payable.................................................. 10/31/97 -- 5.90 -- 1,026
Note payable.................................................. Open line 8.44 8.25 830 975
Margin account................................................ Open line 8.49 -- 329 --
Capital lease obligations
(see note 7)................................................ various 8.96 9.28 3,829 4,291
--- --------- --------- ---------
8.63 8.48 10,324 8,636
--- --------- --------- ---------
6.95% 6.25 $ 34,156 50,879
--- --------- --------- ---------
</TABLE>
F-28
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(10) BORROWED MONEY (CONTINUED)
The Savings Bank adopted a collateral pledge agreement whereby the Savings
Bank has agreed to at all times keep on hand, free of all other pledges, liens,
and encumbrances, first mortgages with unpaid principal balances aggregating no
less than 167% of the outstanding secured advances and letters of credit from
the Federal Home Loan Bank of Chicago. All stock in the Federal Home Loan Bank
of Chicago is pledged as additional collateral for these advances.
The 18,253 shares of common stock of Argo Bancorp held by the ESOP are
pledged as collateral for the ESOP note. The other borrowings at December 31,
1997 consist of two notes payable and an open line margin account. The note
payable of $5,279,000 is drawn on an open line of credit totaling $6,000,000
with a third-party financial institution, and is collateralized by the Company's
stock in Argo Federal Savings Bank. The rate of interest adjusts monthly at
prime (8.50% at December 31, 1997). The note payable of $830,000 is drawn on
On-Line's $1,000,000 line of credit with a third-party financial institution,
and is collateralized by accounts receivable of On-Line. The rate of interest
adjusts monthly at prime (8.50% at December 31, 1997).
The margin account loan is from a third party securities broker. The rate of
interest on the loan adjusts daily at prime less .50% (8.00% at December 31,
1997). The margin account loan was secured at December 31, 1997 by securities
held by the broker having a market value of $1.1 million.
(11) INCOME TAXES
The provision for Federal and state income tax expense consists of the
following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
--------- ----- -----
(IN THOUSANDS)
<S> <C> <C> <C>
Federal:
Current................................................................................... $ 496 82 122
Deferred.................................................................................. (242) 261 545
--------- --- ---
254 343 667
State:
Current................................................................................... (124) -- --
Deferred.................................................................................. (7) -- --
--------- --- ---
Total income tax expense.................................................................... $ 123 343 667
--------- --- ---
--------- --- ---
</TABLE>
F-29
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(11) INCOME TAXES (CONTINUED)
The tax effects of existing temporary differences that give rise to
significant portions of the deferred tax assets and liabilities at December 31,
1997 and 1996 are summarized as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards........................................................... $ 91 111
Unused tax credit.......................................................................... 212 --
Allowance for loan losses.................................................................. 374 259
Depreciation............................................................................... 215 159
Unrealized loss on securities available-for-sale........................................... 20 --
Other...................................................................................... 20 40
--------- ---------
Gross deferred tax assets.................................................................... 932 569
--------- ---------
Deferred tax liabilities:
Excess tax bad debt deduction.............................................................. (31) (31)
Limited partnership interest............................................................... (1,116) (988)
Unrealized gain on securities available-for-sale........................................... -- (7)
Other...................................................................................... (75) (108)
--------- ---------
Gross deferred tax liabilities............................................................... (1,222) (1,134)
--------- ---------
Net deferred tax liabilities................................................................. $ (290) (565)
--------- ---------
--------- ---------
</TABLE>
The effective income tax rate differs from the statutory federal tax rate of
34%. The major reasons for this difference for the years ended December 31
follow:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Federal income tax at statutory rate....................................................... $ 321 570 819
Increase (decrease) in tax resulting from:
Amortization of discounts and goodwill, net.............................................. 35 37 35
Net operating loss carryforwards utilized................................................ (124) (18) (19)
Net decrease in valuation allowance...................................................... -- (62) --
Municipal interest, net.................................................................. (14) (14) (13)
Tax credits.............................................................................. (208) (179) (306)
Other.................................................................................... 113 9 151
--------- --- ---
Income tax expense......................................................................... $ 123 343 667
--------- --- ---
--------- --- ---
</TABLE>
At December 31, 1997 Argo Bancorp has net operating loss carryforwards
available of approximately $267,000 expiring in 2004. Utilization of these net
operating losses is limited to approximately $55,000 per year.
At December 31, 1997, Argo Bancorp has low income housing tax credit
carryforwards in the amount of $212,000 expiring in 2011 and 2012.
Retained earnings at December 31, 1997 include $1,349,000 for which no
provision for Federal income tax has been made. These amounts represent
allocations of income to bad debt deductions for tax purposes only. Reduction of
amounts so allocated for purposes other than tax bad debt losses will create
income, which will be subject to the then-current corporate income tax rate.
F-30
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(12) EMPLOYEE BENEFIT PLANS
401(K) PLAN AND TRUST The Argo Federal Savings 401(k) Plan (Plan) is an
ERISA-qualified plan covering all employees of the Savings Bank who have
completed at least 1,000 hours of service within a 12 consecutive month period
and are age 21 or older. Participants may make contributions to the Plan from 1%
to 12% of their earnings, subject to Internal Revenue Service limitations.
Matching contributions of 50% of each participant's contribution up to 12% are
made at the Savings Bank's discretion each Plan year. The Savings Bank made
contributions of $82,000, $73,000, and $64,000 to the Plan for the years ended
December 31, 1997, 1996, and 1995, respectively. The Plan also provides benefits
in the event of death, disability, or other termination of employment.
On-Line has a qualified 401(k) Plan covering all employees who have
completed one or more years of service. Participants may make contributions to
the Plan from 1% to 12% of their earnings, subject to Internal Revenue Service
limitations. Matching contributions of 50% of each participant's contribution up
to 6% of participant contributions are made at On-Line's discretion each year.
On-Line made contributions of $49,000, $81,000, and $10,800 to the Plan for the
years ended December 31, 1997, 1996, and 1995, respectively.
In conformity with Internal Revenue Service (IRS) rules governing separate
lines of business, the 401(k) Plan for On-Line will continue to be operated
separately from the 401(k) Plan for the Savings Bank.
EMPLOYEE STOCK OWNERSHIP PLAN
In connection with the Dolton Riverdale merger conversion, the Savings Bank
formed an Employee Stock Ownership Plan (ESOP) for eligible employees. The ESOP
borrowed funds from an unrelated third-party lender in the amount of $60,180 in
order to purchase 7% of the common stock to be issued in the merger conversion
(5,233 shares at $11.50 per share). The ESOP has subsequently borrowed
additional funds from the same third-party lender in the amount of $245,000 in
order to purchase an additional 13,020 shares at an average price of $18.79 per
share. The Savings Bank will make scheduled discretionary cash contributions to
the ESOP sufficient to service the amounts borrowed. The unpaid balance of the
ESOP loan has been included in borrowed funds on the consolidated statements of
financial condition, and stockholders' equity has been reduced by a similar
amount. Contributions of $67,000, $72,000, and $78,000 were made to the ESOP to
fund principal and interest payments for the years ended December 31, 1997,
1996, and 1995, respectively. At December 31, 1997, 18,253 shares were
allocated, 15,856 shares were committed to be released, and 2,397 shares were in
suspense. The fair value of unearned shares at December 31, 1997 was $93,483.
In accordance with Statement of Position 93-6, (SOP 93-6), "Employers'
Accounting for Employee Stock Ownership Plans," Argo Bancorp considers
outstanding only those shares of the ESOP that are committed to be released when
calculating both basic and diluted earnings per share. The Savings Bank records
the difference between the fair value of the shares committed to be released and
the cost of those shares to the ESOP as a charge to additional paid-in capital
with the corresponding increase or decrease to compensation expense. Additional
paid-in capital was increased by $50,000, $38,000, and $26,000 for the years
ended December 31, 1997, 1996, and 1995, respectively.
On-Line does not offer an ESOP for its employees. On-Line employees are not
eligible for participation under the Savings Bank's ESOP.
F-31
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(12) EMPLOYEE BENEFIT PLANS (CONTINUED)
MANAGEMENT RECOGNITION PLAN
The Board of Directors of the Savings Bank formed a Management Recognition
Plan and Trust (MRP) effective October 31, 1991, which purchased 6.8%, or 15,400
shares, of Argo Bancorp's authorized but unissued common stock in December 1991.
In addition, Argo Bancorp contributed $34,385 to allow the MRP to purchase 2,990
shares in the merger conversion or on the open market. All MRP shares have been
awarded to employees in key management positions with the Savings Bank. The
awards vested over a three-year period. The aggregate purchase price of the
shares awarded is being amortized to expense as a portion of annual
compensation, and the unamortized cost is reflected as a reduction of
stockholders' equity. No MRP shares were awarded or expensed during the years
ended December 31, 1997 and 1996. For the year ended December 31, 1995, the
Savings Bank expensed $21,000 of the funds relating to the MRP awards.
On April 26, 1995, an amendment to the MRP was approved, which increased the
amount of shares available to be awarded under the MRP to 24,498. An additional
3,797 and 1,907 shares were purchased in 1996 and 1995, respectively, under the
MRP. During the year ended December 31, 1997, the Company sold 5,604 shares held
by the Savings Bank MRP for $219,000, reducing the total shares held by the plan
to one hundred (100). The proceeds from this transaction were recorded as an
increase in capital at December 31, 1997. None of the remaining shares have been
awarded.
The Board of Directors of Argo Bancorp formed a new MRP effective September
1, 1996, which purchased 12,500 shares of Argo Bancorp stock on September 24,
1996 for $115,000. Under this plan, employees in key management positions with
Argo Bancorp and all its subsidiaries are eligible for participation. During the
year ended December 31, 1997, 1,575 shares were awarded to certain key On-Line
employees. Amortization expense totaled $12,000 for the year ended December 31,
1997. No MRP shares were awarded or expensed during the year ended December 31,
1996. Also during the year ended December 31, 1997, the Company sold 4,652
shares held by the Argo Bancorp MRP plan for $181,000, reducing the total shares
held by the plan to 7,848. The proceeds from this transaction were recorded as
an increase in capital at December 31, 1997.
STOCK OPTION PLANS
Argo Bancorp's Board of Directors adopted the 1991 Stock Option and
Incentive Plan (the 1991 Stock Option Plan), under which up to 107,450 shares of
Argo Bancorp's common stock were reserved for issuance by Argo Bancorp upon
exercise of incentive stock options to be granted to full-time employees of Argo
Bancorp and its subsidiaries from time to time. All 107,450 options were awarded
during 1993. The exercise price for the options awarded was equal to or greater
than the fair market value of the common stock on the date of grant. During
1997, 1996, and 1995, 23,997, 22,972, and 3,762 of the options were exercised,
respectively. The weighted average exercise price for the options exercised in
1997, 1996, and 1995 was $15.40, $16.76, and $14.21, respectively. At December
31, 1997, options to purchase 53,612 shares were outstanding.
Argo Bancorp's Board of Directors adopted the Non-Qualified Stock Option
Plan for Non-Employee Directors (Non-Qualified Stock Option Plan) in 1991, under
which up to 107,450 shares of Argo Bancorp's common stock were reserved for
issuance by Argo Bancorp upon exercise of nonincentive stock options to be
granted to nonemployee directors of the Savings Bank subsidiary from time to
time. At December 31,
F-32
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(12) EMPLOYEE BENEFIT PLANS (CONTINUED)
1997, 62,100 options for shares have been awarded by Argo Bancorp under the
Non-Qualified Stock Option Plan. The exercise price for the options awarded was
equal to the fair market value of the common stock on the date of grant. During
1997, 1996, and 1995, 8,500, 3,200, and 500 of the options were exercised,
respectively. The weighted average exercise price for options exercised in 1997,
1996, and 1995 was $18.24, $14.31, and $11.50, respectively. At December 31,
1997, options to purchase 48,900 shares were outstanding.
On-Line does not offer a stock option plan for its employees. On-Line
employees and directors are not eligible for participation under Argo Bancorp's
Stock Option Plans.
The Company applies ABP Opinion No. 25 in accounting for the Stock Option
Plan and, accordingly, compensation cost based on the fair value at grant date
has not been recognized for its stock options in the consolidated financial
statements during the years ended December 31, 1997 and 1996. Had the Company
determined compensation cost based on the fair value at the grant date for its
stock options under SFAS No. 123, "Accounting for Stock-Based Compensation," the
Company's net income would have been reduced to the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
(IN THOUSANDS)
Net income:
As reported........................................................ $ 823 1,334 1,741
Pro forma.......................................................... 583 1,115 1,375
Earnings per share:
Basic:
As reported...................................................... 1.70 4.26 5.88
Pro forma........................................................ 1.21 3.56 4.63
Diluted:
As reported...................................................... 1.56 3.60 4.96
Pro forma........................................................ 1.10 3.01 3.92
</TABLE>
Pro forma net income reflects only options granted in 1997, 1996, and 1995.
Therefore, the full impact of calculating compensation cost for stock options
under SFAS No. 123 is not reflected in the pro forma net income amounts
presented above, because compensation cost is reflected over the options' graded
vesting period of three years for the 1991 Stock Option Plan and immediately for
the Non Qualified Stock Option Plan. Compensation cost for options granted prior
to January 1, 1995, is not considered. However, the annual expense allocation
methodology prescribed by SFAS No. 123 attributes a higher percentage of the
reported expense to earlier years than to later years, resulting in an
accelerated expense recognition.
The fair value of each option granted is estimated on the grant date using
the Black-Scholes option pricing model. The following assumptions were used in
estimated the fair value for options granted in 1997, 1996, and 1995:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Dividend yield................................................... 2.13% 2.37% 2.37%
Risk-free interest rate.......................................... 6.11% 6.10% 6.64%
Weighted average expected life................................... 8 yrs. 8 yrs. 8 yrs.
Expected volatility.............................................. 8.70% 6.95% 6.95%
</TABLE>
F-33
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(12) EMPLOYEE BENEFIT PLANS (CONTINUED)
The weighted average per share fair values of options granted during 1997,
1996, and 1995 were $10.72, $9.99, and $8.49, respectively.
(13) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Savings Bank is a party to financial instruments with off-balance sheet
risk in the normal course of its business. These instruments represent
commitments to originate and sell first mortgage loans and letters of credit,
and involve credit and interest rate risk in excess of the amount recognized in
the consolidated statements of financial condition.
Commitments to originate fixed and adjustable rate mortgage loans amounted
to approximately $5.8 million at December 31, 1997, at rates ranging from 6.25%
to 9.38%. These commitments represent amounts which the Savings Bank plans to
fund in its normal commitment period. The Savings Bank evaluates each customer's
creditworthiness on a case-by-case basis.
Unused lines of credit amounted to approximately $7.8 million as of December
31, 1997. The Savings Bank also had Community Reinvestment Act (CRA) investment
commitments outstanding of $3.2 million. These commitments include $977,000 to
be funded over ten years for investment in the Chicago Equity Fund, $317,000 to
be funded over thirteen years for investment in the Community Investment
Corporation.
(14) CAPITAL CONTRIBUTIONS
Argo Bancorp contributed $2.4 million and $1.5 million to On-Line during the
years ended December 31, 1997 and 1996, respectively. These capital
contributions were used to fund software license purchases, leasehold
improvements, and to improve the cash flow position. Argo Bancorp contributed
$1.3 million and $2.3 million to the Savings Bank in December of 1997 and 1996,
respectively. Both contributions were made with the intent of increasing
regulatory capital levels and thereby allowing future growth. Argo Bancorp also
contributed $2.5 million to Empire Mortgage LLC during the year ended December
31, 1995 to fund loan purchases.
(15) REGULATION AND SUPERVISION
The Savings Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Savings Bank's financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Savings Bank must meet specific capital guidelines that involve quantitative
measures of the Savings Bank assets, liabilities, and certain off-balance sheet
items as calculated under regulatory accounting practices. The Savings Bank
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Savings Bank to maintain minimum amounts and ratios (set forth in
the table below) of total and Tier I capital (as defined) to risk-weighted
assets (as defined), Tier I capital (as defined) to assets (as defined), and
tangible capital (as defined). Management believes, as of December 31, 1997 and
1996, that the Savings Bank meets all capital adequacy requirements to which it
is subject.
F-34
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(15) REGULATION AND SUPERVISION (CONTINUED)
As of December 31, 1997 and 1996, the most recent notification from the
Office of the Thrift Supervision categorized the Savings Bank as
well-capitalized under the regulatory framework for prompt corrective action. To
be categorized as well-capitalized, the Savings Bank must maintain minimum total
risk-based, Tier I risk-based, Tier I leverage, and tangible capital ratios as
set forth in the following table. There are no conditions or events since that
notification that management believes have changed the institution's category.
The Savings Bank's actual capital amounts (in thousands) and ratios are as
follows as of December 31, 1997 and 1996:
<TABLE>
<CAPTION>
TO BE WELL-
FOR CAPITAL CAPITALIZED UNDER
ADEQUACY PROMPT CORRECTIVE
ACTUAL PURPOSES ACTION
-------------------- ------------------------ ------------------------
DECEMBER 31, 1997 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- --------------------------------------------- --------- --------- ----------- ----- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Total capital (to risk-weighted assets)...... $ 13,849 11.10% $ 9,981 8.00% $ 12,476 10.00%
Tier I capital (to risk-weighted assets)..... 13,035 10.45 N/A N/A 7,486 6.00
Tier I capital (core leverage) (to assets)... 13,035 5.93 6,592 3.00 10,986 5.00
Tangible capital (to assets)................. 13,035 5.93 3,296 1.50 N/A N/A
</TABLE>
<TABLE>
<CAPTION>
TO BE WELL-
FOR CAPITAL CAPITALIZED UNDER
ADEQUACY PROMPT CORRECTIVE
ACTUAL PURPOSES ACTION
-------------------- ------------------------ ------------------------
DECEMBER 31, 1996 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- --------------------------------------------- --------- --------- ----------- ----- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Total capital (to risk-weighted assets)...... $ 13,212 10.84% $ 9,749 8.00% $ 12,186 10.00%
Tier I capital (to risk-weighted assets)..... 12,547 10.30 N/A N/A 7,311 6.00
Tier I capital (core leverage) (to assets)... 12,547 5.82 6,464 3.00 10,774 5.00
Tangible capital (to assets)................. 12,547 5.82 3,232 1.50 N/A N/A
</TABLE>
(16) DIVIDEND RESTRICTIONS
The OTS imposes limitations upon all capital distributions by savings
institutions, including cash dividends. An institution that exceeds all fully
phased-in capital requirements before and after a proposed capital distribution
(Tier I Savings Bank) and has not been advised by the OTS that it is in need of
more than normal supervision, could, after prior notice but without the approval
of the OTS, make capital distributions during a calendar year up to the higher
of (i) 100% of its net income to date during the calendar year plus the amount
that would reduce by one-half its "surplus capital ratio" (the excess capital
over its fully phased-in capital requirements) at the beginning of the calendar
year; or (ii) 75% of its net income over the most recent four-quarter period.
Any additional capital distributions would require prior regulatory approval. As
of December 31, 1997 and 1996, the Savings Bank was a Tier I Savings Bank.
(17) SEGMENT FINANCIAL INFORMATION
Argo Bancorp operates in two primary business segments, banking and data
processing, through its two operating subsidiaries. The Savings Bank provides a
wide array of diversified financial services including mortgage, commercial, and
consumer banking services to individuals as well as small and midsize
businesses. On-Line Financial provides data processing services to financial
institutions.
F-35
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(17) SEGMENT FINANCIAL INFORMATION (CONTINUED)
The following table highlights Argo Bancorp's organizational revenues,
earnings, and assets by business segment. Organizational revenues, earnings, and
assets by business segment are impacted by Argo Bancorp intercompany
allocations. The allocations are based upon various management estimates. The
data processing 1995 amounts represent a stub period of two months from the
acquisition date of On-Line.
<TABLE>
<CAPTION>
DATA CONSOLIDATED
BANKING PROCESSING TOTAL
---------- ----------- ------------
<S> <C> <C> <C>
(IN THOUSANDS)
1997:
Revenues.................................................................. $ 21,101 12,750 33,851
Earnings.................................................................. 698 125 823
Assets.................................................................... 225,129 11,169 236,298
---------- ----------- ------------
1996:
Revenues.................................................................. $ 18,722 11,546 30,268
Earnings.................................................................. 598 736 1,334
Assets.................................................................... 218,972 10,312 229,284
---------- ----------- ------------
1995:
Revenues.................................................................. $ 16,630 1,836 18,466
Earnings.................................................................. 1,519 222 1,741
Assets.................................................................... 179,983 6,485 186,468
---------- ----------- ------------
</TABLE>
(18) PARENT COMPANY FINANCIAL INFORMATION
Condensed statements of financial condition, operations, and cash flows of
Argo Bancorp, Inc. are presented on the following pages, and should be read
in connection with the consolidated financial statements and notes thereto.
STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
DECEMBER 31
--------------------
<S> <C> <C>
1997 1996
--------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
Assets:
Cash....................................................................................... $ 146 538
Interest-bearing deposits.................................................................. 520 316
Securities available-for-sale.............................................................. 1,333 282
Loans receivable........................................................................... 62 5
Investment in subsidiaries................................................................. 20,185 18,583
Other assets............................................................................... 1,760 813
--------- ---------
Total assets................................................................................. $ 24,006 20,537
--------- ---------
--------- ---------
Liabilities and stockholders' equity:
Borrowed money............................................................................. 5,608 3,540
Other liabilities.......................................................................... 294 437
Total stockholders' equity................................................................... 18,104 16,560
--------- ---------
Total liabilities and stockholders' equity................................................. $ 24,006 20,537
--------- ---------
--------- ---------
</TABLE>
F-36
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(18) PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-------------------------------
<S> <C> <C> <C>
1997 1996 1995
--------- --------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Interest income......................................................................... $ 23 9 23
Interest expense........................................................................ (335) (341) (286)
--------- --------- ---------
Net interest expense.................................................................... (312) (332) (263)
Dividends from subsidiaries............................................................. 2,242 1,818 973
Equity in undistributed earnings of subsidiaries........................................ (1,144) 148 1,097
Other noninterest income................................................................ 618 235 206
Noninterest expense..................................................................... (789) (683) (399)
--------- --------- ---------
Net income before income taxes.......................................................... 615 1,186 1,614
Income tax benefit...................................................................... (208) (148) (127)
--------- --------- ---------
Net income.............................................................................. $ 823 1,334 1,741
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-37
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(18) PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-------------------------------
<S> <C> <C> <C>
1997 1996 1995
--------- --------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income......................................................................... $ 823 1,334 1,741
Adjustments to reconcile net income to net cash provided by operating activities:
Proceeds from sale of loans...................................................... -- -- 137
(Gain) loss on the sale of:
Loans.......................................................................... -- -- (2)
Investment securities.......................................................... (618) (235) (204)
Equity in undistributed earnings of subsidiaries................................. 1,144 (148) (1,097)
Amortization of purchase price of ESOP and MRP................................... 72 60 81
Recognition of fair value of ESOP shares scheduled to be released................ 50 38 26
Increase in other assets......................................................... (729) (586) (139)
Increase (decrease) in other liabilities......................................... (143) 370 (499)
--------- --------- ---------
Net cash provided by operating activities............................................ 599 833 44
--------- --------- ---------
Cash flows from investing activities:
Loans originated................................................................... (63) -- (135)
Principal repayments on loans receivable........................................... 6 3 3
Proceeds from the sale of investment securities.................................... 5,790 742 1,314
Purchase of investment securities.................................................. (6,306) (127) (760)
Net cash (paid) received in purchase of subsidiary................................. 916 -- (629)
Contribution to MRP and ESOP....................................................... (486) (115) (50)
--------- --------- ---------
Net cash provided by (used in) investing activities.................................. (143) 503 (257)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from stock issuance....................................................... 412 4,027 --
Proceeds from borrowed money....................................................... 11,108 1,943 5,173
Repayment of borrowed money........................................................ (9,040) (3,120) (2,573)
Capital contributions to subsidiaries.............................................. (3,698) (3,775) (2,517)
Proceeds from exercise of stock options............................................ 525 430 49
Proceeds from sale of MRP stock.................................................... 400 -- --
Dividends paid..................................................................... (351) (212) (208)
--------- --------- ---------
Net cash used in financing activities................................................ (644) (707) (76)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents................................. (188) 629 (289)
Cash and cash equivalents at beginning of year....................................... 854 225 514
--------- --------- ---------
Cash and cash equivalents at end of year............................................. $ 666 854 225
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-38
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(19) FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires the disclosure of estimated fair values for all asset, liability,
and off-balance sheet financial instruments. The estimated fair value
amounts under SFAS No. 107 have been determined as of a specific point in
time utilizing various available market information, assumptions, and
appropriate valuation methodologies. Accordingly, the estimated fair values
presented herein are not necessarily representative of the underlying value
of Argo Bancorp. Rather, the disclosures are limited to reasonable estimates
of the fair value of only Argo Bancorp's financial instruments. The use of
assumptions and various valuation techniques, as well as the absence of
secondary markets for certain financial instruments, will likely reduce the
comparability of fair value disclosures between financial institutions. Argo
Bancorp does not plan to sell most of its assets or settle most of its
liabilities at these fair values. The estimated fair values of Argo
Bancorp's financial instruments as of December 31, 1997 and 1996 are set
forth in the following table, followed by the methods and assumptions used.
<TABLE>
<CAPTION>
1997 1996
-------------------- --------------------
<S> <C> <C> <C> <C>
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
--------- --------- --------- ---------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Financial assets:
Cash................................................................ $ 6,211 6,211 12,518 12,518
Interest-bearing deposits........................................... 2,466 2,466 758 758
FHLB of Chicago stock............................................... 3,271 3,271 3,428 3,428
Securities available-for-sale....................................... 4,974 4,974 5,788 5,788
Loans receivable.................................................... 184,358 201,466 173,429 190,655
Accrued interest receivable......................................... 1,725 1,725 2,089 2,089
--------- --------- --------- ---------
--------- --------- --------- ---------
Financial liabilities:
Deposits without stated maturities.................................. $ 37,055 37,055 35,732 35,732
Deposits with stated maturities..................................... 135,414 135,582 114,895 115,184
Borrowed money...................................................... 34,156 34,205 50,879 50,018
Interest-bearing custodial escrow balances.......................... 1 1 76 76
Custodial escrow balances........................................... 6,399 6,399 5,706 5,706
Accrued interest payable............................................ 264 264 267 267
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
The following methods and assumptions are used by Argo Bancorp in estimating
the fair value amounts for its financial instruments.
(A) CASH AND INTEREST-BEARING DEPOSITS
The carrying value of cash and interest-bearing deposits approximates fair
value due to the short period of time between origination of the instruments and
their expected realization.
(B) SECURITIES AVAILABLE-FOR-SALE AND FHLB OF CHICAGO STOCK
The fair value of these securities available-for-sale were estimated using
quoted market prices. The fair value of FHLB stock is based on its redemption
value.
F-39
<PAGE>
ARGO BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1996, AND 1995
(19) FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
(C) LOANS RECEIVABLE AND ACCRUED INTEREST RECEIVABLE
The fair value of loans receivable is based on values obtained in the
secondary market. The loan portfolio is segmented into fixed and adjustable
interest rate categories. For fixed rate loans, fair value is estimated based on
quoted market prices of similar loans sold in conjunction with securitization
transactions, adjusted for differences in loan characteristics. For adjustable
rate loans that reprice frequently and with no significant change in credit
risk, fair values are based on carrying values. The carrying amount of accrued
interest receivable approximates its fair value due to the relatively short
period of time between accrual and expected realization.
(D) DEPOSITS, CUSTODIAL ESCROWS, AND INTEREST PAYABLE
The fair value of deposits with no stated maturity, such as passbook
savings, NOW, and money market accounts and custodial escrows are disclosed as
the amount payable on demand.
The fair value of fixed-maturity deposits is the present value of the
contractual cash flow discounted using interest rates currently being offered
for deposits with similar remaining terms to maturity.
The carrying amount of interest payable approximates its fair value due to
the relatively short period of time between accrual and expected realization.
(E) BORROWED FUNDS
The fair value of borrowed funds is the present value of the contractual
cash flows, discounted by the current rate offered for similar remaining
maturities.
F-40
<PAGE>
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Summary........................................ 5
Available Information.......................... 12
Summary Consolidated Financial and Other
Data......................................... 13
Recent Developments............................ 15
Risk Factors................................... 17
Use of Proceeds................................ 29
Market for the Capital Securities.............. 29
Ratios of Earnings to Combined Fixed Charges... 29
Accounting Treatment........................... 29
Capitalization................................. 30
Consolidated Statements of Income.............. 31
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 32
Business of the Company........................ 46
Business of the Bank........................... 49
Business of On-Line Financial Services, Inc.... 71
Business of Empire/Argo, LLC................... 78
Federal and State Taxation..................... 78
Regulation..................................... 81
The Board of Directors and Management of the
Company...................................... 90
The Board of Directors and Management of the
Bank......................................... 91
Description of Capital Securities.............. 99
Description of Junior Subordinated
Debentures................................... 109
Description of Guarantee....................... 119
Relationship among the Capital Securities, the
Junior Subordinated Debentures and the
Guarantee.................................... 122
Certain Federal Income Tax Consequences with
Respect to the Issuance of the Capital
Securities................................... 123
ERISA Considerations........................... 127
Stockholder Agreement.......................... 127
Restrictions on Acquisition of the Company..... 129
Description of Capital Stock of the Company.... 133
Underwriting................................... 136
Additional Information......................... 137
Experts........................................ 137
Legal Matters.................................. 137
Financial Statements........................... F-1
</TABLE>
---------------------
NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN AS CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFERING MADE HEREBY, AND, IF GIVEN OR MADE,
SUCH OTHER INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY, THE BANK OR THE UNDERWRITERS. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE
SECURITIES OFFERED HEREBY TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER
OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL
TO MAKE SUCH OFFER OR SOLICITATION IN SUCH JURISDICTION. NEITHER THE DELIVERY OF
THIS PROSPECTUS NOR ANY SALE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY
IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY OR THE
BANK SINCE ANY OF THE DATES AS OF WHICH INFORMATION IS FURNISHED HEREIN OR SINCE
THE DATE HEREOF.
[LOGO]
$15,000,000
ARGO CAPITAL TRUST CO.
11.0% CAPITAL SECURITIES
ARGO BANCORP, INC.
----------------
PROSPECTUS
----------------
NOVEMBER 6, 1998
TUCKER ANTHONY
INCORPORATED
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