SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
For Annual and Transition Reports Pursuant
to Sections 13 or 15(d) of the
Securities Exchange Act of 1934
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1997
--------------------------------
- or -
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period __________________ to ____________________
Commission Number: 0-24648
FSF FINANCIAL CORP.
(Exact name of Registrant as specified in its Charter)
Minnesota 41-1783064
(State or other jurisdiction of incorporation (I.R.S. Employer)
or organization) Identification No.)
201 Main Street South, Hutchinson, Minnesota 55350-2573
(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code: (320) 234-4500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.10 per share
---------------------------------------
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filling requirements for the past 90 days. YES X NO
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.[ X]
The aggregate market value of the voting stock held by non-affiliates
of the Registrant, based on the average bid and asked price of the Registrant's
Common Stock as quoted on the National Association of Securities Dealers, Inc.,
Automated Quotations National Market on December 1, 1997 was $
50,744,657 (2,585,715 shares at $ 19.625 per share).
- ---------- --------
As of December 1, 1997 there were issued and outstanding 3,009,715
shares of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Annual Report to Stockholders for the Fiscal Year Ended
September 30, 1997. (Parts I, II and IV)
2. Portions of the Proxy Statement for the Annual Meeting of Stockholders to
be held January 20, 1998. (Part III)
<PAGE>
INDEX
<TABLE>
<CAPTION>
PART I Page
----
<S> <C> <C>
Item 1. Business.....................................................................................1
Item 2. Properties..................................................................................18
Item 3. Legal Proceedings...........................................................................19
Item 4. Submission of Matters to a Vote of Security Holders.........................................19
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.......................19
Item 6. Selected Financial Data ....................................................................19
Item 7. Management's Discussion of Financial Condition and Results of Operations....................19
Item 7A. Quantitative and Qualitative Disclosure about Market Risk ..................................19
Item 8. Financial Statements and Supplementary Data.................................................19
Item 9. Change in and Disagreements with Accountants on Accounting and
Financial Disclosure......................................................................19
PART III
Item 10. Directors and Executive Officers of the Registrant..........................................19
Item 11. Executive Compensation......................................................................19
Item 12. Security Ownership of Certain Beneficial Owners and Management..............................20
Item 13. Certain Relationships and Related Transactions..............................................20
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............................20
</TABLE>
<PAGE>
PART I
ITEM 1. BUSINESS
General
FSF Financial Corp. (the "Company"), a Minnesota Corporation, was organized in
May, 1994, and as of October 6, 1994, became the holding company for First
Federal fsb ("First Federal" or the "Bank"). First Federal is the resulting
institution of the merger of First State Federal Savings and Loan Association,
Hutchinson, MN ("Hutchinson"), and First Federal Savings and Loan Association of
Hastings, Hastings, MN ("Hastings"). The merger of the two institutions was
completed in September, 1994 ("Merger"). Hutchinson was organized as a state
chartered mutual savings and loan association in 1933 and received a federal
charter in 1934. Hastings was initially chartered in 1881 as the "Dakota County
Building and Loan Association" and obtained a federal charter in 1968.
First Federal's business consists primarily of attracting deposits from the
general public and using such deposits, together with borrowings and other
funds, to make mortgage loans secured by residential real estate located in
Minnesota. At September 30, 1997, First Federal operated 11 retail banking
offices in Minnesota.
First Federal is regulated by the Office of Thrift Supervision ("OTS"), and by
the Federal Deposit Insurance Corporation ("FDIC") which, through the Savings
Association Insurance Fund ("SAIF"), insures, up to certain legal limits, the
deposit accounts of institutions such as First Federal. First Federal is also a
member of the Federal Home Loan Bank ("FHLB") of Des Moines, which is one of the
twelve regional banks for federally insured savings institutions and certain
other residential lending entities comprising the Federal Home Loan Bank System.
Market Area
The Bank is authorized to make real estate loans throughout the United States.
First Federal's primary market area consists of the ten Minnesota counties of
Benton, Carver, Dakota, McLeod, Meeker, Sherburne, Sibley, Stearns, Washington,
and Wright. The market area extends from the St. Cloud area northwest of the
Minneapolis/St Paul metropolitan area to the Mississippi River southeast of the
Minneapolis/St. Paul metropolitan area. The economic composition of the market
area is extremely diverse and contains agriculture, commercial, and
manufacturing enterprises. The market area is generally considered to be a
"bedroom" community for the Minneapolis/St. Paul metropolitan area.
<PAGE>
Lending Activities
General. The following table sets forth the composition of the Bank's loan
portfolio in dollars and in percentages of total loans at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
----------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------------------------------------------------------------------------------------------
Amount % Amount % Amount % Amount % Amount %
----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Residential real estate: (Dollars in Thousands)
One-to-four family (1) $170,422 60.3 $150,102 64.7 $121,034 64.6 $ 89,100 72.8 $ 92,088 73.1
Residential construction 20,796 7.4 19,676 8.5 20,366 10.9 4,474 3.7 6,328 5.1
Multi-family 3,370 1.2 3,753 1.6 3,708 2.0 3,209 2.6 4,680 3.7
----------------------------------------------------------------------------------------------
194,588 68.9 173,531 74.8 145,108 77.5 96,783 79.1 103,096 81.9
Land and commercial real estate 38,582 13.7 18,637 8.0 16,951 9.0 7,024 5.7 5,565 4.4
Commercial business 8,114 2.9 6,089 2.6 2,715 1.4 439 0.4 832 0.7
----------------------------------------------------------------------------------------------
241,284 85.5 198,257 85.4 164,774 87.9 104,246 85.2 109,493 87.0
----------------------------------------------------------------------------------------------
Consumer:
Savings accounts 977 0.3 563 0.2 516 0.3 437 0.4 537 0.4
Home equity and second mortgage 20,812 7.4 17,692 7.6 10,950 5.8 4,427 3.6 3,229 2.6
Automobile loans 11,596 4.1 10,080 4.3 8,399 4.5 6,950 5.7 6,753 5.4
Other 7,844 2.7 5,512 2.5 2,810 1.5 6,305 5.1 5,910 4.6
----------------------------------------------------------------------------------------------
Total loans 282,513 100.00 232,104 100.0 187,449 100.0 122,365 100.0 125,922 100.0
====== ===== ===== ===== ======= =====
Less:
Loans in process (20,364) (13,401) (15,010) (3,982) (3,973)
Deferred fees (703) (757) (613) (315) (282)
Allowance for loan losses (852) (776) (764) (748) (721)
--------- --------- --------------- --------- ---------
Total loans, net $ 260,594 $ 217,170 $ 171,062 $ 117,320 $ 120,946
========= ========= ========= ========= =========
</TABLE>
- ---------------------------------------------
(1) Includes loans held for sale in the amount of $204,000, $443,000, $230,000,
$729,000 and $21.6 million as of September 30, 1997, 1996, 1995, 1994, and
1993, respectively.
The following table sets forth the Bank's loan originations, loan purchases,
loan sales, and principal payments for the periods indicated:
<TABLE>
<CAPTION>
Years Ended September 30,
----------------------------------------------------------------
1997 1996 1995 1994 1993
----------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Total gross loans receivable at
end of period $ 282,513 $ 232,104 $ 187,449 $ 122,365 $ 125,922
Loans originated:
Residential real estate:
One-to-four family 55,144 53,801 45,988 42,462 49,999
Residential construction 12,968 12,975 21,996 5,064 7,164
Multi-family 190 - 437 - -
----------------------------------------------------------------
Total residential real estate 68,302 66,776 68,421 47,526 57,163
Land and commercial real estate 20,077 3,241 8,588 1,665 1,349
Commercial business 2,402 274 250 123 261
Consumer 28,465 27,270 17,465 13,438 12,019
----------------------------------------------------------------
Total loans orginated 119,246 97,561 94,724 62,752 70,792
Purchase of loans 8,528 17,447 20,993 - -
Sale of loans (6,661) (3,509) (810) (19,141) (22,685)
Principal repayments (72,035) (63,813) (49,651) (49,698) (45,386)
Other (net) 1,331 (3,031) (172) 2,530 (3,419)
----------------------------------------------------------------
Net loan activity $ 50,409 $ 44,655 $ 65,084 $ (3,557) $ (698)
================================================================
</TABLE>
2
<PAGE>
Maturity of Loans. The following table sets forth the maturity of the Bank's
loans at September 30, 1997. The table does not include prepayments or scheduled
principal repayments. Prepayments and scheduled principal repayments on loans
totaled $72.0 million, $63.8 million, $49.7 million, $49.7 million, and $45.4
million for the years ended September 30, 1997, 1996, 1995, 1994 and 1993,
respectively. Adjustable-rate mortgage loans are shown as maturing based on
contractual maturities.
<TABLE>
<CAPTION>
Family Multi-Family Commercial
Real Estate and Commercial Business and
Mortgages Real Estate Construction Consumer Total
-----------------------------------------------------------------------------
(In Thousands)
Amounts Due:
<S> <C> <C> <C> <C> <C>
Within 3 months $ 10,894 $ 2,955 $ 5,232 $ 23,429 $ 42,510
3 months to 1 year 19,716 6,365 15,564 2,248 43,893
-----------------------------------------------------------------------------
Total due before one year 30,610 9,320 20,796 25,677 86,403
-----------------------------------------------------------------------------
After 1 year:
1 to 3 years 23,324 14,450 - 10,655 48,429
3 to 5 years 22,688 17,249 - 10,093 50,030
5 to 10 years 42,359 486 - 2,857 45,702
10 to 20 years 41,143 447 - 61 41,651
Over 20 years 10,298 - - - 10,298
-----------------------------------------------------------------------------
Total due after one year
139,812 32,632 - 23,666 196,110
-----------------------------------------------------------------------------
Total amount due $ 170,422 $ 41,952 $ 20,796 $ 49,343 $ 282,513
=============================================================================
</TABLE>
The following table sets forth the dollar amount of all loans due after
September 30, 1998, which have predetermined interest rates and which have
floating or adjustable interest rates.
<TABLE>
<CAPTION>
Fixed- Balloon Adjustable
rates Rates Rates Total
-------------- ------------- --------------- -------------
(In Thousands)
<S> <C> <C> <C> <C>
One-to four-family real estate $ 46,166 $ 25,163 $ 68,483 $ 139,812
Land, multi-family and commercial real estate 24,624 2,394 5,614 32,632
Consumer and commercial business 14,178 - 9,488 23,666
-------------- ------------- --------------- -------------
Total $ 84,968 $ 27,557 83,585 $ 196,110
============== ============= =============== =============
</TABLE>
One- to Four-Family Mortgage Loans. The largest portion of the Bank's loans are
made for the purpose of enabling borrowers to purchase one- to four-family
residences secured by first liens on the properties. The Bank originates balloon
mortgage loans, ARM loans and fixed-rate mortgage loans secured by one- to
four-family residences with loan terms up to 30 years. The Bank also offers FHA
and VA loans that are originated and then sold, servicing released, in the
secondary market. Borrower demand for balloon and ARM loans versus fixed-rate
mortgage loans depends on various factors, including, but not limited to,
interest rates offered, the expectations of changes in the short- and long-term
levels of interest rates and loan fees charged. The relative amount of
fixed-rate mortgage loans, balloon loans and ARM loans that can be originated at
any time is largely determined by the demand for each in a competitive
environment. The Bank sells all fixed-rate loans with an original maturity of
greater than twenty years to the Federal Home Loan Mortgage Corporation
("FHLMC"), with servicing retained.
The Bank originates three-, five- and seven-year balloon mortgage loans, the
majority of which are three-year balloon mortgages. These mortgages contain no
contractual assurances that the loan will be renewed. At maturity the loan is
generally rewritten and re-recorded; however, if the borrower's loan payment
history is satisfactory, a new appraisal is not required. Management believes
that balloon loans have a pricing characteristic that helps offset the
detrimental effect that rising rates could have on net interest income because
the balloon loans do not contain interest rate adjustment caps. At September 30,
1997, balloon mortgages were $34.3 million, or 12.1% of the Bank's loan
portfolio.
The Bank offers ARM loans that adjust every year, with the initial adjustment
coming one, three, five, seven or ten years after origination. The loans have
terms from 10 to 30 years and the interest rates on these loans are generally
based on treasury bill indices. The annual interest rate cap (the maximum amount
by which the interest rate may be increased in a year) on the Bank's ARM loans
is generally 2.0% and the lifetime cap is generally 6.0% over the initial rate
of the loan. The Bank considers market factors and competitive rates on loans as
well as its own cost of funds when determining the rates on the loans it offers.
The Bank does not originate loans with negative amortization.
Residential Construction Lending. The Bank originates residential construction
loans to qualified borrowers for construction of one-to-four family residential
properties located in the Bank's market area. Construction loans are made to
builders on a pre-
3
<PAGE>
sold, speculative and model home basis and to owners for construction of their
primary residence on a construction/permanent basis. Such loans generally have
terms from six to nine months. Loans for speculative housing construction are
made to area builders only after a thorough background check has been made. The
background check includes an analysis of the builder's financial statements,
credit reports and reference checks with sub-contractors and suppliers. The Bank
usually will have no more than two speculative or model home construction loans
outstanding at any time to any single builder. Loan proceeds are disbursed in
increments as construction progresses and only after a physical inspection of
the project is made by a Bank representative. Accrued interest on loan
disbursements is paid monthly.
Loans involving construction financing present a greater level of risk than
loans for the purchase of existing homes because collateral value and
construction costs can only be estimated at the time the loan is approved. The
Bank has sought to minimize the risk by limiting construction lending to
qualified borrowers in the Bank's market area, by limiting the number of
construction loans for speculative purposes outstanding at any time, and by
installing a system to inspect the property and to monitor the loan
disbursements.
Land Acquisition and Development Loans, Commercial Real Estate and Multi-Family
Lending. The Bank originates land loans on residential properties located in the
Bank's primary market area. Land lending generally involves additional risks to
the lender as compared with residential mortgage lending. These risks are
attributable to the fact loan funds are advanced upon the security of land under
development, and predicated on the future value of the property upon completion
of development. Loans on undeveloped land may run the risk of adverse zoning
changes, environmental or other restrictions on future use. Because of these
factors, the analysis of land loans requires an expertise that is different in
significant respects from that which is required for residential lending.
Commercial real estate loans are permanent loans secured by improved property
such as office buildings, retail-wholesale facilities, industrial buildings and
other non-residential buildings. Commercial real estate loans may be originated
in amounts up to 80% of the appraised value of the mortgaged property as
determined by a certified or licensed independent appraiser.
Multi-family residential real estate loans are permanent loans secured by
apartment buildings. Of primary concern in multi-family residential real estate
lending is the borrower's creditworthiness, feasibility and cash flow potential
of the project. Loans secured by income properties generally are larger and
involve greater risks than residential mortgage loans because payments on loans
secured by income properties are often dependent on the successful operation or
management of the properties. As a result, repayment of such loans may be
subject to a greater extent than residential real estate loans to adverse
conditions in the real estate market or the economy. In order to monitor cash
flows on income properties, the Bank requires borrowers and loan guarantors, if
any, to provide annual financial statements and rent rolls on multi-family
loans. At September 30, 1997, the five largest land acquisition and development,
commercial real estate and multi-family loans ranged from $2.5 million to $7.9
million with an average outstanding balance of $3.9 million. All such loans were
current and have performed in accordance with their terms and the property
securing such loans is in the Bank's market area.
Commercial Business Lending. The Bank's commercial business loans are for a
variety of purposes including working capital, accounts receivable, inventory,
equipment and acquisitions. The Bank has no energy or foreign loans and expects
to commence Agricultural Lending in the first quarter of fiscal 1998.
Unlike residential mortgage loans, which generally are made on the basis of the
borrower's ability to make repayment from his or her employment and other income
and which are secured by real property with a value that tends to be more easily
ascertainable, commercial business loans typically are made on the basis of the
borrower's ability to make repayment from the cash flow of the borrower's
business. As a result, the availability of funds for the repayment of commercial
business loans may be substantially dependent on the success of the business
itself (which is likely to be dependent upon the general economic environment.)
The Bank's commercial business loans are sometimes, but not always, secured by
business assets, such as accounts receivable, equipment and inventory, as well
as real estate. However, the collateral securing the loans may depreciate over
time, may be difficult to appraise, and may fluctuate in value based on the
success of the business.
The Bank recognizes the generally increased risks associated with commercial
business lending. The Bank's commercial business lending policy emphasizes (1)
credit file documentation, (2) analysis of the borrower's character, (3)
analysis of the borrower's capacity to repay the loan, (4) adequacy of the
borrower's capital and collateral, and (5) evaluation of the industry conditions
affecting the borrower. Analysis of the borrower's past, present and future cash
flows is also an important aspect of the Bank's credit analysis. The Bank plans
to continue to expand its commercial business lending, subject to market
conditions.
The Bank generally obtains annual financial statements from borrowers for
commercial business loans. These statements are analyzed to monitor the quality
of the loan.
Consumer and Other Loans. The Bank offers consumer and other loans in the form
of home equity and second mortgage loans, automobile loans and loans for other
purposes. Federal regulations permit federally chartered thrift institutions to
make secured and unsecured consumer loans up to 35% of an institution's assets.
The Bank originates consumer loans in order to provide a
4
<PAGE>
wide range of financial services to its customers and because the shorter terms
and normally higher interest rates on such loans help maintain a profitable
spread between its average loan yield and the Bank's cost of funds.
In connection with consumer loan applications, the Bank verifies the borrower's
income and reviews a credit bureau report. In addition, the relationship of the
loan to the value of the collateral is considered. Consumer loans entail greater
risks than one-to- four family residential mortgage loans, particularly consumer
loans secured by rapidly depreciable assets such as automobiles or loans that
are unsecured. In such cases, any repossessed collateral for a defaulted loan
may not provide an adequate source of repayment of the outstanding loan balance,
since there is a greater likelihood of damage, loss or depreciation of the
underlying collateral. Further, consumer loan collections are dependent on the
borrower's continuing financial stability, and therefore are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Finally, the application of various federal and state laws, including federal
and state bankruptcy and insolvency laws, may limit the amount which can be
recovered on such loans in the event of a default. At September 30, 1997,
consumer loans 90 days or more delinquent totaled $82,000 or 0.19% of such
loans. Management believes that the Bank's level of consumer loan delinquencies
is relatively low in comparison to other financial institutions. No assurance
can be given, however, that the Bank's delinquency rate on consumer loans will
continue to remain low in the future.
Loan Approval Authority and Underwriting. First Federal's primary source of
mortgage loan applications is referrals from existing or past customers. The
Bank also solicits applications from real estate brokers, contractors, and
call-ins and walk-ins to its offices. First Federal advertises in local
newspapers for first mortgage and home equity loans.
Upon receipt of any loan application from a prospective borrower, a credit
report and verifications are ordered to confirm specific information relating to
the loan applicant's employment, income and credit standing. An appraisal or
valuation determination, subject to regulatory requirements, of the real estate
intended to secure the proposed loan is undertaken. First Federal utilizes the
services of Board approved appraisers and two authorized appraisers on staff at
the Bank. In connection with the loan approval process, First Federal's loan
officers analyze the loan applications and the property involved. All
residential, home equity, multi-family, construction and commercial real estate
loans are underwritten and processed at First Federal's main office by First
Federal's loan servicing department, subject to the loan underwriting policies
as approved by the Board of Directors. The Chief Executive Officer, President,
and the Directors of Lending are authorized to approve all one-to-four family
applications. Commercial real estate loans in excess of $1.0 million must be
approved by the Board of Directors.
Loan applicants are promptly notified of the decision of the Bank by a letter
setting forth the terms and conditions of the decision. If approved, these terms
and conditions include the amount of the loan, interest rate basis, amortization
term, a brief description of real estate to be mortgaged to First Federal, and
the notice of requirement of insurance coverage to be maintained to protect the
Bank's interest. First Federal requires title insurance or a title opinion on
first mortgage loans and fire and casualty insurance on all properties securing
loans, which insurance must be maintained during the entire term of the loan.
The Bank also requires flood insurance, if appropriate, in order to protect
First Federal's interest in the security property.
Loans-to-One Borrower. Under federal law, federally-chartered savings banks
have, subject to certain exemptions, aggregate lending limits to one borrower
equal to 15% of the institution's unimpaired capital and surplus. As of
September 30, 1997, First Federal's five largest lending relationships included
$7.9 million in land development loans to a local developer, a $3.0 million line
of credit to an unaffiliated mortgage-banking company, a $3.0 million
multi-family real estate loan, a $3.5 million commercial real estate loan, and a
$2.8 million commercial real estate loan. At September 30, 1997, all of these
loans were within the loans to one borrower limitations, performing in
accordance with their terms, and at market rates of interest.
Loan Servicing. The Bank generally retains the servicing on all loans sold to
others. In addition, the Bank services substantially all of the loans which it
retains in its portfolio. Loan servicing includes collecting and remitting loan
payments, accounting for principal and interest, making advances to cover
delinquent payments, making inspections as required of mortgaged premises,
contacting delinquent mortgagors, supervising foreclosures and property
dispositions in the event of unremedied defaults and generally administering the
loans. Funds that have been escrowed by borrowers for the payment of
mortgage-related expenses, such as property taxes and hazard and mortgage
insurance premiums, are maintained in noninterest-bearing accounts at the Bank.
At September 30, 1997, the Bank had $237,000 deposited in escrow accounts for
its loans serviced for others.
The following table presents information regarding the loans serviced by the
Bank for others at the dates indicated.
<TABLE>
<CAPTION>
September 30,
-------------------------------------
Mortgage loan portfolios serviced for: 1997 1996 1995
-------------------------------------
(In Thousands)
<S> <C> <C> <C>
FHLMC $ 38,137 $ 40,561 $ 43,481
Other Investors 4,597 572 971
-------------------------------------
$ 42,734 $ 41,133 $ 44,452
=====================================
</TABLE>
5
<PAGE>
The Bank receives fees for servicing mortgage loans, which generally amount to
0.25% per annum on the declining balance of mortgage loans. Such fees serve to
compensate the Bank for the costs of performing the servicing functions. Other
sources of loan servicing revenues include late charges. For the years ended
September 30, 1997, 1996 and 1995, the Bank earned gross fees of $204,000,
$194,000 and $186,000, respectively from loan servicing. The Bank retains a
portion of funds received from borrowers on the loans it services for others in
payment of its servicing fees received on loans serviced for others.
Non-Performing and Problem Assets
Loan Collections and Delinquent Loans. The Bank's collection procedures provide
that when a loan is 30 days or more delinquent, the borrower is contacted by
mail and telephone and payment is requested. If the delinquency continues,
subsequent efforts will be made to contact the delinquent borrower. In certain
instances, the Bank may modify the loan or grant a limited moratorium on loan
payments to enable the borrower to reorganize his financial affairs. Once a loan
delinquency exceeds 60 days it is classified as special mention and the Bank
attempts to work with the borrower to establish a repayment schedule to cure the
delinquency. If the borrower is unable to cure the delinquency, the Bank will
institute foreclosure actions. If a foreclosure action is taken and the loan is
not reinstated, paid in full or refinanced, the property is sold at a judicial
sale at which the Bank may be the buyer if there are no offers to satisfy the
debt. Any property acquired as the result of a foreclosure or by deed in lieu of
foreclosure is classified as foreclosed real estate until such time as it is
sold or otherwise disposed of by the Bank. At September 30, 1997, the Bank had
$72,000 of foreclosed real estate, consisting of a one-to-four family
residential loan. When foreclosed real estate is acquired, it is recorded at the
lower of the unpaid principal balance of the related loan or its fair market
value less related disposition costs. Any writedown of the property is charged
to the allowance for losses on real estate owned.
Non-performing Assets. Loans are reviewed on a regular basis and are placed on a
non-accrual status when, in the opinion of management, the collection of
additional interest is doubtful. Residential mortgage loans are placed on a
non-accrual status when either principal or interest is 90 days or more past
due. Consumer loans generally are charged off when the loan becomes over 90 days
delinquent. Commercial business and real estate loans are generally placed on
non-accrual status when the loan is 90 days or more past due. Interest accrued
and unpaid at the time a loan is placed on non-accrual status is charged against
interest income. Subsequent payments are either applied to the outstanding
principal balance or recorded as interest income, depending on the assessment of
the ultimate collectibility of the loan. At September 30, 1997, the Bank had
approximately $478,000 of loans that were more than 60 days delinquent.
The following table sets forth information with respect to the Bank's
non-performing assets for the periods indicated. During the periods indicated
the Bank had no restructured loans within the meaning of SFAS No. 15.
<TABLE>
<CAPTION>
At September 30,
----------------------------------------------------------------
1997 1996 1995 1994 1993
----------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Loans accounted for on a non-accrual basis:
Mortgage loans:
Residential construction loans $ 393 $ - $ 209 $ - $ -
Permanent loans secured by one-to
four-family units 25 129 138 26 244
Other - - - 293 347
Non-mortgage loans:
Commercial - - - - -
Consumer 82 90 33 21 12
----------------------------------------------------------------
Total non-accrual loans 500 219 380 340 603
Foreclosed real estate and real estate
held for investment 72 - - 247 215
----------------------------------------------------------------
Total non-performing assets $ 572 $ 219 $ 380 $ 587 $ 818
================================================================
Total non-performing loans to net loans 0.04% 0.10% 0.22% 0.27% 0.50%
================================================================
Total non-performing loans to total assets 0.02% 0.06% 0.12% 0.11% 0.28%
================================================================
Total non-performing assets to total assets 0.14% 0.06% 0.12% 0.20% 0.38%
================================================================
</TABLE>
During the years ended September 30, 1997, 1996, 1995, 1994 and 1993,
approximately $22,833, $11,812, $11,593, $6,109, and $38,271, respectively would
have been recorded on loans accounted for on a non-accrual basis if such loans
had been current according to the original loan agreements for the entire
period. These amounts were not included in the Bank's interest income for the
respective periods. No interest income on loans accounted for on a non-accrual
basis was included in income during any of these periods.
6
<PAGE>
Classified Assets. Management, in compliance with regulatory guidelines, has
instituted an internal loan review program, whereby loans are classified as
special mention, substandard, doubtful or loss. When a loan is classified as
substandard or doubtful, management is required to establish a general valuation
reserve for loan losses in an amount that is deemed prudent. General allowances
represent allowances which have been established to recognize inherent risk
associated with lending activities, but which, unlike specific allowances, have
not been allocated to particular problem assets. When management classifies a
loan as "loss", a reserve equal to 100% of the loan balance may be established
or the loan is charged-off.
An asset is considered "substandard" if it is inadequately protected by the
paying capacity and net worth of the obligor or the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
that the institution will sustain "some loss" if the deficiencies are not
corrected. Assets classified as "doubtful" have all of the weaknesses inherent
in those classified substandard, with the added characteristic that the
weaknesses present make "collection or liquidation in full," "highly
questionable and improbable," on the basis of currently existing facts,
conditions, and values. Assets classified as "loss" are those considered
"uncollectible" and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted. Assets
which do not currently expose the insured institution to a sufficient degree of
risk to warrant classification in one of the aforementioned categories but
possess credit deficiencies or potential weaknesses, including all loans over 60
days delinquent, are required to be designated "special mention" by management.
The OTS has promulgated regulations that discontinue the classification of
assets as special mention. However, the Bank continues to utilize this category.
Management's evaluation of the classification of assets and the adequacy of the
reserve for loan losses is reviewed by regulatory agencies as part of their
periodic examinations. At September 30, 1997, First Federal had total classified
assets of $587,000 of which $491,000 were considered substandard, and no assets
were classified as doubtful or loss. Special mention assets totaled $96,000 at
September 30, 1997.
Allowance for Loan and Lease Losses and Foreclosed Real Estate. In making loans,
First Federal recognizes that credit losses will be experienced and that the
risk of loss will vary with, among other things, the type of loan being made,
the creditworthiness of the borrower over the term of the loan, and in the case
of a secured loan, the quality of the collateral for the loan. First Federal's
management evaluates the need to establish reserves against losses on loans and
other assets each quarter based on estimated losses on specific loans and on any
real estate held for sale or investment when a finding is made that a loss is
estimable and probable. Such evaluation includes a review of all loans for which
full collectibility may not be reasonably assured and considers, among other
matters, the estimated market value of the underlying collateral of problem
loans, prior loss experience, economic conditions and overall portfolio quality.
While management recognizes and charges against the allowance for loan losses
accounts which are determined to be uncollectible, experience indicates that at
any point in time, possible losses may exist in the loan portfolio which are not
specifically identifiable. Therefore, based upon management's best estimate,
each year an amount may be charged to earnings to maintain the allowance for
loan losses at a level sufficient to recognize potential risk.
Impaired loans, including all loans that are restructured in a troubled debt
restructuring involving a modification of terms, are measured at the present
value of expected future cash flows discounted at the loan's initial effective
interest rate. The fair value of the collateral of an impaired
collateral-dependent loan or an observable market price, if one exists, may be
used as an alternative to discounting. If the measure of the impaired loan is
less than the recorded investment in the loan, impairment is recognized through
the allowance for loan losses. A loan is considered impaired when, based on
current information and events, it is probable that the Bank will be unable to
collect all amounts due according to the contractual terms of the loan
agreement.
First Federal believes it has established its existing allowance for loan losses
in accordance with GAAP. However, there can be no assurance that banking
regulators, in reviewing the Bank's loan portfolio, will not request First
Federal to significantly increase its allowance for loan losses, or that a
deteriorating real estate market or other unforeseen economic changes, may cause
First Federal to significantly increase its allowance for loan losses, therefore
negatively affecting First Federal's financial condition and earnings.
<PAGE>
The following table sets forth information with respect to the Bank's allowance
for loan losses at the dates indicated:
<TABLE>
<CAPTION>
At September 30,
----------------------------------------------------------------
1997 1996 1995 1994 1993
----------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Total loans outstanding $ 282,513 $ 232,104 $ 187,449 $ 122,365 $ 125,922
================================================================
Average loans outstanding $ 237,475 $ 193,202 $ 142,711 $ 119,133 $ 109,448
================================================================
Allowance balance (beginning of period) $ 776 $ 764 $ 748 $ 721 $ 730
----------------------------------------------------------------
Provision (credit):
Residential - - - 27 36
Commercial real estate 40 - - - -
Consumer 80 42 24 6 11
----------------------------------------------------------------
Total provision 120 42 24 33 47
Charge-off:
Residential 13 - - - 7
Commercial real estate - - - - 36
Consumer 37 34 20 6 18
----------------------------------------------------------------
Total charge-offs 50 34 20 6 61
Recoveries:
Residential - - - - -
Commercial real estate - - - - -
Consumer 6 4 12 - 5
----------------------------------------------------------------
Total recoveries 6 4 12 - 5
----------------------------------------------------------------
Net charge-offs 44 30 8 6 56
----------------------------------------------------------------
Allowance balance (at end of period) $ 852 $ 776 $ 764 $ 748 $ 721
================================================================
Allowance as percent of total loans 0.30% 0.33% 0.41% 0.61% 0.57%
Net loans charged off as a percent of
average loans 0.02% 0.02% 0.01% 0.01% 0.04%
</TABLE>
To further monitor and assess the risk characteristics of the loan portfolio,
loan delinquencies are reviewed to consider any developing loan problems. Based
upon the procedures in place, First Federal's experience regarding charge-offs
and recoveries and the current risk elements in the portfolio, management
believes the allowance for loan losses at September 30, 1997, is adequate.
However, assessment of the adequacy of the allowance for loan losses involves
subjective judgments regarding future events and thus there can be no assurance
that additional provisions for loan losses will not be required in future
periods.
The following table sets forth the breakdown by loan category of the allowance
for loan losses.
<TABLE>
<CAPTION>
September 30,
-------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
-------------------------------------------------------------------------------------------
Percent Percent Percent Percent Percent
of Total of Total of Total of Total of Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
-------------------------------------------------------------------------------------------
Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans $ 413 68.9% $ 426 74.8% $ 675 77.5% $ 675 79.1% $ 691 81.9%
Consumer and commercial
business, land and
commercial real estate 439 31.1% 350 25.2% 89 22.5% 73 20.9% 30 18.1%
-------------------------------------------------------------------------------------------
$ 852 100.0% $ 776 100.0% $ 764 100.0% $ 748 100.0% $ 721 100.0%
===========================================================================================
</TABLE>
Investment and Mortgage-backed Securities Activities
General. Federally-chartered thrift 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 loans on Federal Funds. To supplement lending activities,
subject to various restrictions, First Federal invests a portion of its assets
in commercial paper, corporate debt securities and asset-backed securities
(e.g., mortgage-backed securities). A significant portion of First Federal's
income during recent years has been attributable to interest income on such
securities. The Corporation does not have the same investment limitations as the
Bank.
8
<PAGE>
Mortgage-backed and Related Securities. First Federal invests in residential
mortgage-backed securities guaranteed by participation certificates issues by
FHLMC and Government National Mortgage Association ("GNMA"). The mortgage-backed
securities portfolio as of September 30, 1997, consisted primarily of fixed-rate
certificates issued by the FHLMC ($7,000), GNMA ($63,000) and Real Estate
Mortgage Investment Conduits ("REMICs") ($55.4 million).
At September 30, 1997, the carrying value of mortgage-backed and related
securities held to maturity totaled $38.5 million, or 9.9% of total assets. The
market value of such securities totaled approximately $37.5 million at September
30, 1997. First Federal also held $16.7 million of mortgage-backed and related
securities that were classified available for sale.
Mortgage-backed securities represent a participation interest in a pool of
single-family or multi-family mortgages, the principal and interest payments on
which are passed from the mortgage originators, through intermediaries
(generally quasi-governmental agencies) that pool and repackage the
participation interest in the form of securities to investors such as the Bank.
Such quasi-governmental agencies, which guarantee the payment of principal and
interest to investors, primarily include FHLMC, FNMA, and GNMA.
Mortgage-backed securities typically are issued with stated principal amounts,
and the securities are backed by pools of mortgages that have loans with
interest rates that are within a range and have varying maturities. The
underlying pool of mortgages is primarily composed of either fixed-rate
mortgages or ARM loans. Mortgage-backed securities are generally referred to as
mortgage participation certificates or pass-through certificates. As a result,
the interest rate risk characteristics of the underlying pool of mortgages,
(i.e. fixed rate or adjustable-rate) as well as prepayment risk, are passed on
to the certificate holder. The life of a mortgage-backed pass-through security
is equal to the life of the underlying mortgages. Mortgage-backed securities
issued by FHLMC, FNMA, and GNMA make up a majority of the pass-through market.
Mortgage-backed securities provide for monthly payments of principal and
interest and generally have contractual maturities ranging from five to thirty
years. In periods of declining interest rates, payments on many mortgages is
received faster than the contractual amount required, causing the estimated
lives of mortgage-related securities to be significantly shorter than expected.
REMICs are typically issued by a special-purpose entity (the "issuer"), which
may be organized in a variety of legal forms, such as a trust, a corporation, or
a partnership. The entity aggregates pools of pass-through securities, which are
used to collateralize the mortgage related securities. Once combined, the cash
flows can be divided into "tranches" or "classes" of individual securities,
thereby creating more predictable average duration for each security than the
underlying pass-through pools. Accordingly, under this security structure all
principal pay downs from the various mortgage pools are allocated to a
mortgage-related class or classes structured to have priority until it has been
paid off. Thus, these securities are intended to address the reinvestment
concerns associated with mortgage-backed securities pass-through, namely that
(i) they tend to pay off when interest rates fall, thereby taking their
relatively high coupon with them, and (ii) their expected average life may vary
significantly among the different tranches.
Some REMIC instruments are more like traditional debt instruments because they
have stated principal amounts and traditionally defined interest rate terms.
Purchasers of certain other REMIC securities are entitled to the excess, if any,
of the issuer's cash inflows, including reinvestment earnings, over the cash
outflows for debt service and administrative expenses. These mortgage related
instruments may include instruments designated as residual interests, and are
riskier in that they could result in the loss of a portion of the original
investment. Cash flows from residual interests are very sensitive to prepayments
and, thus, contain a high degree of interest-rate risk. Residual interests
represent an ownership interest in the underlying collateral, subject to the
first lien of the REMICs investors.
The REMICs held by First Federal at September 30, 1997, consisted of
floating-rate tranches. The interest rate of all of the Bank's floating-rate
securities adjusts monthly and provides the institution with net interest margin
protection in an increasing market rate environment. The securities are backed
by mortgages on one- to four-family residential real estate and have contractual
maturities up to 30 years. None of the securities are deemed to be "High Risk"
according to OTS guidelines. The securities are primarily companion tranches to
"PACs" and "TACs". PACs and TACs (Planned and Targeted Amortization Classes) are
designed to provide a specific principal and interest cash-flow. Principal
payments that are received in excess of the amount needed for the PACs and TACs
are allocated to the companion tranches. When the PACs and TACs are repaid in
full, all principal is then used to pay the companion tranches. Although the
timing of principal payments may be impacted by the amount of prepayments (the
higher the level of prepayments, the sooner the principal will be received), all
of the principal and interest payments are guaranteed.
Investment Securities. First Federal is required under federal regulations to
maintain a minimum amount of liquid assets which may be invested in specified
short-term securities and certain other investments. Liquidity levels may be
increased or decreased depending upon the yields on investment alternatives and
upon management's judgment as to the attractiveness of the yields then available
in relation to other opportunities and its expectations of future yield levels,
as well as management's projections as to the short-term demand for funds to be
used in First Federal's loan origination and other activities. At
9
<PAGE>
September 30, 1997, the carrying value of debt securities held to maturity
totaled $37.9 million, or 9.8% of total assets. The market value of such
securities totaled $37.1 million at September 30, 1997. These securities
consisted mainly of U.S. Government Securities and U.S. government agency
obligations. The Bank also held available for sale debt and equity securities
with a market value of $1.0 million and $19.3 million respectively, at September
30, 1997.
The Investment Policy of First Federal, which is established by the Board of
Directors, is designed to provide and maintain liquidity, to generate favorable
return on investments without incurring undue interest rate and credit risk, and
to compliment First Federal's lending activity. The policy currently provides
for investments held to maturity and investments available for sale.
The amount of short-term securities in excess of regulatory requirements
reflects management's strategy to provide interest rate adjustments for
securities that are shorter than their maturity. It is the intention of
management to maintain a repricing structure in the Bank's investment portfolio
that better matches the interest rate sensitivities of its assets and
liabilities. However, during periods of rapidly declining interest rates, such
investments also decline at a faster rate than the yields on fixed-rate
investments. Investment decisions are made within policy guidelines established
by the Board of Directors. Unless loan demand increases, the Bank intends to
maintain its investments at current levels.
Investment and Mortgage-backed Securities Portfolio. The following table sets
forth the carrying value of First Federal's investment securities portfolio,
short-term investments, FHLB stock, and mortgage-backed and related securities
at the dated indicated. At September 30, 1997, the market value of the debt and
equity securities portfolio (including securities available for sale) and
mortgage-backed and related securities portfolio (including mortgage-backed
securities available for sale) was $57.4 and $54.2 million, respectively.
<TABLE>
<CAPTION>
September 30,
-------------------------------------------------
1997 1996 1995
------------ ------------ -----------
(In Thousands)
<S> <C> <C> <C>
Investment securities:
Debt securities $ 37,876 $ 44,349 $ 40,914
Debt securities available for sale 1,000 - -
Corporate Notes and Bonds - - 1,000
FHLB Stock 6,692 5,736 3,692
Equity securities available for sale (1) 12,619 12,495 12,473
---------- ----------- ----------
Total investment securities 58,187 62,580 58,079
Interest-bearing deposits 3,645 9,392 12,448
Federal funds sold - - -
Mortgage-backed and related securities:
Mortgage-backed and related securities (2) 38,539 38,557 37,110
Mortgage-backed and related securities
available for sale 16,699 16,336 16,141
---------- ----------- ----------
Total mortgage-backed and related securities 55,238 54,893 53,251
---------- ----------- ----------
Total investments $ 117,070 $ 126,865 $ 123,778
========== =========== ==========
</TABLE>
- -------------------------------------------------------
(1) Consists of Federated ARMS Fund and preferred stock
(2) Includes $38.5 million, $38.4 million and $37.0 million of REMICs as of
September 30, 1997, 1996, and 1995, respectively.
<PAGE>
The following table sets forth certain information regarding the carrying
values, weighted average yields and maturities of the Bank's investment
portfolio at September 30, 1997.
<TABLE>
<CAPTION>
September 30, 1997
--------------------------------------------------------------------
Adjustable One Year or Less One to Five Years
--------------------- -------------------- --------------------
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
----- ----- ----- ----- ----- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
U. S. Government
and Federal Agency
Obligations held to
maturity $ - - % $ 2,500 6.59 % $ 11,071 5.54 %
Federal Agency
Obligations
available for sale - - - - 1,000 6.56
Equity Securities
available for sale 12,619 5.87 - - - -
FHLB Stock N/A N/A N/A N/A N/A N/A
Mortgage-backed
and related
securities
held to maturity 38,539 5.99 - - - -
Mortgage-backed and
related securities
available for sale 16,699 6.03 - - - -
Interest-bearing deposits 3,645 5.31 - - - -
----------- ---------- ----------
Total $ 71,502 5.94 % $ 2,500 6.59 % $ 12,071 5.54
=========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
September 30, 1997
-----------------------------------------------------------------------------------
Five to Ten Years More than Ten Years Total Investment Securities
-------------------- -------------------- -------------------------------------
Carrying Average Carrying Average Carrying Average Market
Value Yield Value Yield Value Yield Value
----- ----- ----- ----- ----- ----- -----
Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
U. S. Government
and Federal Agency
Obligations held to
maturity $ 13,095 5.34 % $ 11,210 6.59 % $ 37,876 5.87 % $ 37,065
Federal Agency
Obligations
available for sale - - - - 1,000 6.56 1,000
Equity Securities
available for sale - - - - 12,619 5.87 12,619
FHLB Stock N/A N/A N/A N/A 6,692 7.00 6,692
Mortgage-backed
and related
securities
held to maturity - - - - 38,539 5.99 37,535
Mortgage-backed and
related securities
available for sale - - - - 16,699 6.03 16,699
Interest-bearing deposits - - - - 3,645 5.31 3,645
---------- ---------- ------------ ---------------
Total $ 13,095 5.34 % $ 11,210 6.59 % $ 117,070 5.98 % $ 115,255
========== ========== ============ ===========
</TABLE>
<PAGE>
Deposits and Other Sources of Funds
General. Deposits are the major source of First Federal's funds for lending and
other investment purposes. In addition to deposits, the Bank derives funds from
loan and mortgage-backed securities principal payments, interest on investment
securities, proceeds from the maturity of mortgage-backed securities and
investment securities and borrowings. Loan and mortgage-backed securities
payments are a relatively stable source of funds, while deposit inflows are
significantly influenced by general interest rates and money market conditions.
Borrowings may be used on a short-term basis to compensate for reductions in the
availability of funds from other sources. They also may be used on a longer-term
basis for general business purposes.
Deposits. First Federal offers a wide variety of deposit accounts. It constantly
strives to meet consumers' needs by offering new products. This, in addition to
interest rate risk management and asset/liability ratios, is taken into
consideration prior to offering new products. Deposit account terms vary,
primarily as to the required minimum balance amount, the amount of time that the
funds must remain on deposit and the applicable interest rate.
First Federal's current deposit products include regular savings, demand
deposits, NOW, money market and certificates of deposit accounts ranging in
terms from ninety-one days to five years including certificates of deposit with
negotiable interest rates and balances in excess of $100,000 (jumbo
certificates), and Individual Retirement Accounts (IRAs). All checking and
savings accounts are eligible for an Express Teller ATM card. This card can be
used at any Express Teller, Fastbank, or Instant Cash ATM in Minnesota and
surrounding states. With the addition of the Plus and Cirrus network automated
banking system, First Federal's Express Teller ATM card can be used at thousands
of ATM locations throughout the United States and the world.
Deposits are obtained primarily from residents in the Minnesota counties of
McLeod, Dakota, Meeker, Sibley, Carver, Wright, Benton, Sherburne, Stearns and
Washington. First Federal attracts deposit accounts by offering a wide variety
of products, competitive interest rates, and convenient locations and service
hours. The Bank uses traditional methods of advertising to attract new customers
and deposits, including radio and print media advertising.
First Federal pays interest on its deposits which are competitive in its market.
Interest rates on deposits are set weekly, based on a number of factors,
including: (1) the previous week's deposit flow; (2) a current survey of a
selected group of competitors' rates for similar products; (3) external data
which may influence interest rates; (4) investment opportunities and loan
demand; and (5) scheduled maturities.
The following table shows the amounts of First Federal's deposits by type of
account at the dates indicated.
<TABLE>
<CAPTION>
September 30,
--------------------------------------
1997 1996 1995
--------------------------------------
(In Thousands)
<S> <C> <C> <C>
NOW Accounts $ 24,740 $ 22,416 $ 23,892
Commercial Demand 3,319 5,185 3,446
Savings Accounts 47,847 48,334 48,027
--------------------------------------
75,906 75,935 75,365
--------------------------------------
Certificates of Deposit:
Under 3.00%
- - 477
3.00 to 4.00% 4,204 422 2,406
4.01 to 5.00% 14,796 28,155 23,061
5.01 to 6.00% 50,460 64,367 26,109
6.01 to 7.00% 56,604 13,693 37,079
7.01 to 8.00% - 6,502 1,978
8.01% and over 6,276 - 5,041
--------------------------------------
132,340 113,139 96,151
--------------------------------------
Total deposits $ 208,246 $ 189,074 $ 171,516
======================================
</TABLE>
<PAGE>
The following table sets forth the amount and maturities of time deposits at
September 30, 1997.
<TABLE>
<CAPTION>
Amount Due
----------------------------------------------------------------
Less than 1 - 2 2 - 3 Greater than
One Year Years Years 3 years Total
----------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Interest Rate
2.01 - 4.00% $ 3,831 $ 373 $ - $ - $ 4,204
4.01 - 6.00% 44,851 15,002 4,504 899 65,256
6.01 - 8.00% 23,273 21,850 10,935 546 56,604
Over 8.00% 3,684 1,468 969 155 6,276
----------------------------------------------------------------
$ 75,639 $ 38,693 $ 16,408 $ 1,600 $ 132,340
================================================================
</TABLE>
The following table indicates the amount of the Bank's certificates of deposit
of $100,000 or more by time remaining until maturity as of September 30, 1997.
Certificates
of
Maturity Period Deposits
-------------
(In Thousands)
Within three months $ 3,234
Three through six months 5,687
Six through twelve months 15,109
Over twelve months 6,908
-------------
$ 30,938
=============
Borrowings. Savings deposits are the primary source of funds for First Federal's
lending and investment activities and for its general business purposes. The
Bank, if the need arises, may rely upon advances from the FHLB of Des Moines to
supplement its supply of lendable funds and to meet deposit withdrawal
requirements. Advances from the FHLB of Des Moines are typically secured by
First Federal's stock in the FHLB and a portion of First Federal's residential
mortgage loans and other assets (principally securities which are obligations of
or guaranteed by the U.S. Government). First Federal has an Open Line of Credit
("LOC") in the amount of $25.0 million with the FHLB, which had an outstanding
balance of $8.0 million. The LOC requires an annual review and a commitment fee
of 0.05%. The LOC is reviewed for renewal annually. The LOC is maintained in
order to help meet on-going liquidity and cash flow needs of First Federal.
Advances have been utilized when adequate spreads can be obtained and the risk
(credit risk, interest rate risk, and market risk) in the transaction minimized.
Advances have been used to purchased mortgage-backed and related securities and
to purchase single family residential mortgages originated by other financial
institutions within the state of Minnesota.
The following table sets forth certain information as to the Bank's FHLB
advances at the date indicated.
As of and for the Years Ended
September 30,
--------------------------------------
1997 1996 1995
--------------------------------------
(Dollars in Thousands)
Maximum balance $ 133,839 $ 114,693 $ 73,807
Average balance 120,093 90,408 52,688
Balance at end of period 133,817 114,693 73,807
Weighted average rate:
at end of period 5.83% 5.88% 5.82%
during the period 5.83% 5.91% 5.16%
It is First Federal's policy to fund loan demand and investment opportunities
out of current loan and mortgage-backed securities repayments, investment
maturities and new deposits. However, the Bank has utilized FHLB advances to
supplement these sources. This policy may change in the future as investment
opportunities are presented or loan demand increases.
Subsidiary Activity
First Federal is permitted to invest up to 2% of its assets in the capital stock
of, in secured or unsecured loans to, subsidiary corporations, with an
additional investment of 1% of assets when such additional investment is
utilized primarily for community
13
<PAGE>
development purposes. Under such limitations, as of September 30, 1997, First
Federal was authorized to invest up to approximately $7.7 million in the stock
of service corporations (based upon the 2% limitation). First Federal has one
wholly-owned subsidiary, Firstate Services, Inc. ("FSI"). FSI was incorporated
in the State of Minnesota in August, 1983, and is engaged in the sale, on an
agency basis, of mutual funds, annuities and life, credit life and disability
insurance products. As of September 30, 1997, the net book value of First
Federal's investment in stock, unsecured loans, and conforming loans in its
subsidiary was $151,977. For the fiscal year ended September 30, 1997, FSI had
net income of $22,081.
Personnel
As of September 30,1997, First Federal had 70 full-time employees and 42
part-time employees, representing a total of 90.0 full-time equivalents. The
employees are not represented by a collective bargaining agreement. First
Federal believes its relationship with its employees is satisfactory.
Competition
First Federal faces strong competition in its attraction of savings deposits,
which are its primary source of funding for lending, and in the origination of
real estate loans. The Bank's competition for savings deposits and loans
historically has come from other savings institutions and commercial banks
located in First Federal's market area. However, in recent years, mortgage
bankers have captured a larger share of the mortgage market. The size and number
of mortgage bankers, as well as their decreased costs due to less regulatory
oversight, has contributed to their growth. First Federal also faces competition
for investor funds from credit unions, investment firms and insurance companies.
First Federal competes for loans and deposits by charging competitive interest
rates and loan fees, remaining efficient, marketing aggressively and providing a
wide range of services to its customers. First Federal offers all consumer
banking services such as checking accounts, certificates of deposits, retirement
accounts, consumer and mortgage loans and ancillary services such as convenient
offices and drive-up facilities, automated teller machines and overdraft
protection.
Bank Regulation
General
First Federal is a federally chartered savings bank and a member of the FHLB of
Des Moines. First Federal's deposits are insured by the FDIC through the SAIF.
First Federal is subject to examination and regulation by the OTS and the FDIC
with respect to most of its business activities, including, among others,
lending activities, capital standards, general investment authority, deposit
taking and borrowing authority, mergers and other business combinations,
establishment of branch offices, and permitted subsidiary investments and
activities. The OTS's operations, including examination activities, are funded
by assessments levied on its regulated institutions.
First Federal is further subject to regulations of the Board of Governors of the
Federal Reserve System (the "Federal Reserve Board") concerning reserves
required to be maintained against deposits and certain other matters. Financial
institutions, including the Bank, may also be subject, under certain
circumstances, to potential liability under various statutes and regulations
applicable to property owners generally, including statutes and regulations
relating to the environmental condition of real property and the remediation
thereof.
The descriptions of the statutes and regulations applicable to the Company and
First Federal set forth below and elsewhere herein do not purport to be complete
descriptions of such statutes and regulations and their effects on the Company
and First Federal. Such descriptions also do not purport to identify every
statute and regulation that may apply to the Company or the Bank.
The FDIC may terminate the deposit insurance of any insured depository
institution if the FDIC determines, after a hearing, that the institution has
engaged or is engaging in unsafe or unsound practices, is in an unsafe or
unsound condition to continue operations or has violated any applicable law,
regulation or order or any condition imposed in writing by the FDIC. In
addition, FDIC regulations provide that any insured institution that falls below
a 2% minimum leverage ratio will be subject to FDIC deposit insurance
termination proceedings unless it has submitted, and is in compliance with, a
capital plan with its primary federal regulator and the FDIC. The FDIC may also
suspend deposit insurance temporarily during the hearing process if the
institution has no tangible capital.
Federal Home Loan Bank System
As a member of the FHLB System, First Federal is required to own capital stock
in its regional FHLB, the FHLB of Des Moines, in an amount at least equal to the
greater of 1% of the aggregate principal amount of its unpaid residential
mortgage loans, home purchase contracts and similar obligations at the end of
each year, or 5% of its outstanding borrowings from the FHLB of Des Moines.
First Federal was in compliance with this requirement, with an investment of
$6.7 million in FHLB of Des Moines stock at September 30, 1997.
14
<PAGE>
The FHLB of Des Moines serves as a reserve or central bank for the member
institutions within its assigned region, the Eighth FHLB District. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes advances to members in accordance with policies and
procedures established by the Federal Housing Finance Board and the Board of
Directors of the FHLB of Des Moines.
Current law requires each FHLB to transfer a certain portion of its reserves and
undivided profits to the Resolution Funding Corporation ("REFCORP"), the entity
established to raise funds to resolve troubled thrift cases, to fund the
principal and a portion of the interest on bonds issued by the REFCORP and
certain other obligations. In addition, each FHLB is required to transfer 5% of
its annual net earnings to fund certain affordable housing programs. That amount
is scheduled to increase to at least 10% of its annual net income in 1996 and
subsequent years. As a result of these requirements and other factors, the FHLB
of Des Moines has experienced reduced earnings since these provisions became
effective in 1989. It is anticipated that this may continue and that First
Federal will continue to receive a reduced level of dividends on its FHLB of Des
Moines stock in future periods. During 1997, 1996, and 1995, First Federal
recorded dividend income of $417,929, $328,853, and $177,660, respectively, on
its FHLB of Des Moines stock.
Insurance of Accounts
The FDIC administers two separate deposit insurance funds. Generally, the Bank
Insurance Fund (the "BIF") insures the deposits of commercial banks and the SAIF
insures the deposits of savings institutions. The FDIC is authorized to increase
deposit insurance premiums if it determines such increases are appropriate to
maintain the reserves of either the SAIF or BIF or to fund the administration of
the FDIC. In addition, the FDIC is authorized to levy emergency special
assessments on BIF and SAIF members.
Community Reinvestment Act. The Community Reinvestment Act ("CRA") requires each
savings institution, as well as commercial banks and certain other lenders, to
identify the communities served by the institution and assess the credit needs
of those communities. The CRA also requires the OTS to assess an institution's
performance in meeting the credit needs of its identified communities as part of
its examination of the institution, and to take such assessments into
consideration in reviewing applications with respect to branches, mergers and
other business combinations, and savings and loan holding company acquisitions.
An unsatisfactory CRA rating may be the basis for denying such an application
and community groups have successfully protested applications on CRA grounds.
The OTS assigns CRA ratings of "outstanding, satisfactory, need to improve, or
substantial noncompliance". First Federal was rated "outstanding" in its last
CRA examination in May, 1996.
Regulatory Capital Requirement. The following table reflects, in both dollars
and ratios, First Federal's regulatory capital position as of September 30,
1997, as well as the requirements at that date.
<TABLE>
<CAPTION>
First Federal fsb Required
regulatory capital minimum Excess
--------------------------------- regulatory regulatory
Amount Percent (1) capital capital
---------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Tangible capital $ 38,608 10.06% $ 5,754 $ 32,854
Core capital 38,608 10.06% 11,509 27,099
Risk-based capital 39,460 19.20% 16,523 22,937
</TABLE>
- ---------------------------------------
(1) Based upon a percentage of adjusted total assets for tangible and core
capital and a percentage of risk-adjusted assets for risk-based capital.
Beginning July 1, 1994, OTS regulated institutions are required to maintain
additional risk-based capital equal to one-half of the amount by which the
decline in its "net portfolio value" that would result from a hypothetical 200
basis point change (up or down, depending on which would result in the greater
reduction in net portfolio value) in interest rates on its assets and
liabilities exceeds 2% of the estimated "economic value" of its assets. The one
exception to this general rule is that if the three month Treasury bond
equivalent yield falls below 4%, an institution would measure the hypothetical
downward change at one-half of that Treasury yield. An institution's "net
portfolio value" is defined for this purpose as the difference between the
aggregate expected future cash inflows from an institution's assets and the
aggregate expected cash outflows on its liabilities, plus the net expected cash
flows from existing off-balance sheet contract, each discounted to present
value. The estimated "economic value" of an institution's assets is defined as
the discounted present value of the estimated future cash flows from its assets.
Both the "net portfolio value" and the "economic value" include, as specified in
the regulation, the book value of assets and liabilities that are not interest
rate sensitive. The OTS has stated that implementation of this amendment to its
regulations will require additional capital to be maintained only by
institutions having "above normal" interest rate risk. Based on the assets and
15
<PAGE>
liabilities comprising First Federal's statement of financial condition as of
September 30, 1997, there was no additional increase required in First Federal's
minimum capital requirement.
Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement
Act of 1989 ("FDICIA"), among other things, established a system of prompt
corrective action to resolve problems of undercapitalized institutions. Under
this system, the banking regulators are required to take certain supervisory
actions against undercapitalized institutions, the severity of which depends
upon the institution's degree of capitalization. Under the OTS final rule
implementing the prompt corrective action provisions, an institution shall be
deemed to be (i) "well capitalized" if it has total risk-based capital of 10.0%
or more, has a Tier I risk-based capital ratio (core or leverage capital to
risk-weighted assets) of 6.0% or more, has a leverage capital of 5.0% or more
and is not subject to any order or final capital directive to meet and maintain
a specific capital level for any capital measure, (ii) "adequately capitalized"
if it has a total risk-based capital ratio of 8.0% or more, Tier I risk-based
ratio of 4.0% or more and a leverage capital ratio of 4.0% or more (3.0% under
certain circumstances) and does not meet the definition of well capitalized,
(iii) "undercapitalized" if it has a total risk-based capital ratio that is less
than 6.0%, a Tier I risk-based capital ratio that is less than 4.0% or a
leverage capital ratio that is less than 4.0% (3.0% in certain circumstances),
(iv) "significantly undercapitalized" if it has a total risk-based capital ratio
that is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0%
or a leverage capital ratio that is less than 3.0% and (v) "critically
undercapitalized" if it has a ratio of tangible equity to total assets that is
equal to or less than 2.0%. In addition, under certain circumstances, a federal
banking agency may reclassify a well capitalized institution as adequately
capitalized and may require an adequately capitalized institution or an
undercapitalized institution to comply with supervisory actions as if it were in
the next lower category (except that the OTS may not reclassify a significantly
undercapitalized institution as critically undercapitalized). At September 30,
1997 First Federal was a "well capitalized institution" as defined in the prompt
corrective action regulations and as such is not subject to any prompt
corrective action measures.
Dividend and Other Capital Distribution Limitations. OTS regulations require the
Bank to give the OTS 30 days advance notice of any proposed declaration of
dividends to the Holding Company, and the OTS has the authority under its
supervisory powers to prohibit the payment of dividends to the Holding Company.
In addition, the Bank may not declare or pay a cash dividend on its capital
stock if the effect thereof would be to reduce the regulatory capital of the
Bank below the amount required for the liquidation account established in
connection with its Conversion.
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 shareholders of another institution in a
cash-out merger and other distributions charged against capital. The rule
establishes three tiers of institutions, based primarily on an institution's
capital level. An institution that exceeds all fully phased-in capital
requirements before and after a proposed capital distribution ("Tier 1
institution") and has not been advised by the OTS that it is in need of more
than the normal supervision can, after prior notice but without approval of the
OTS, make capital distributions during a calendar year equal to the greater 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 require prior regulatory approval. An
institution is further limited in its ability to pay dividends as its capital
levels decrease below its regulatory requirement. As of September 30, 1997,
First Federal was a Tier 1 institution.
The OTS retains the authority to prohibit any capital distribution otherwise
authorized under the regulation if the OTS determines that the capital
distribution would constitute an unsafe or unsound practice. The regulation also
states that the capital distribution limitations apply to direct and indirect
distributions to affiliates, including those occurring in connection with
corporate reorganizations.
Qualified Thrift Lender Test. The Home Owners' Loan Act, as amended ("HOLA"),
requires savings institutions to meet a Qualified Thrift Lender ("QTL") test. If
an institution maintains an appropriate level of Qualified Thrift Investments
(primarily residential mortgages and related investments, including
mortgage-backed securities) ("QTIs") on a monthly basis in nine out of every 12
months and otherwise qualifies as a QTL, it will continue to enjoy full
borrowing privileges from the FHLB of Des Moines. The required percentage of
QTIs is 65% of portfolio assets (defined as all assets minus intangible assets,
property used by the institution in conducting its business and liquid assets
equal to 10% of total assets). Certain assets are subject to a percentage
limitation of 20% of portfolio assets. In addition, savings associations may
include shares of stock of the FHLBs, FNMA and FHLMC as qualifying QTIs. As of
September 30, 1997, First Federal was in compliance with its QTL requirement
with 90.9% of assets invested in QTIs.
Loans-to-One Borrower. See "Lending Activities -- Loans-to-One Borrower."
Transactions with Affiliates. Generally, restrictions on transactions with
affiliates require that transactions between a savings association or its
subsidiaries and its affiliates be on terms as favorable to the Bank as
comparable transactions with non-affiliates. In addition, certain of these
transactions are restricted to an aggregate percentage of the Bank's capital;
collateral in specified amounts must usually be provided by affiliates to
receive loans from the Bank. Affiliates of the Bank include the
16
<PAGE>
Company and any company which would be under common control with the Bank. In
addition, a savings association may not lend to any affiliate engaged in
activities not permissible for a bank holding company or acquire the securities
of any affiliate which is not a subsidiary. The OTS has the discretion to treat
subsidiaries of savings associations as affiliates on a case-by-case basis.
Branching by Federal Associations. Effective May 11, 1992, the OTS amended its
Policy Statement on Branching by Federal Savings Associations to permit
interstate branching to the full extent permitted by statute (which is
essentially unlimited). This permits savings associations with interstate
networks to diversify their loan portfolios and lines of business. The OTS
authority preempts any state law purporting to regulate branching by federal
associations. However, the OTS will evaluate a branch's record of compliance
with the CRA. A poor CRA record may be the basis for denial of a branching
application.
Federal Reserve System. The Federal Reserve Board requires all depository
institutions to maintain non-interest bearing reserves at specified levels
against their transaction accounts (primarily checking, NOW and Super NOW
checking accounts) and non-personal time deposits. The balances maintained to
meet the reserve requirements imposed by the Federal Reserve Board may be used
to satisfy the liquidity requirements that are imposed by the OTS. At September
30, 1997, the Bank was in compliance with all applicable requirements.
Savings associations have authority to borrow from the Federal Reserve Bank
"discount window," but Federal Reserve policy generally requires savings
associations to exhaust all other sources before borrowing from the Federal
Reserve System.
Holding Company Regulation
General. The Company is registered with the OTS as a unitary savings and loan
holding company. As such, the Company is required to register and file reports
with the OTS and is subject to regulation and examination by the OTS. In
addition, the OTS has enforcement authority over the Company and its non-savings
association subsidiaries, should such subsidiaries be formed, which also permits
the OTS to restrict or prohibit activities that are determined to be a serious
risk to the subsidiary savings association. This regulation and oversight is
intended primarily for the protection of the depositors of the Bank and not for
the benefit of stockholders of the Company. The Company also is required to file
certain reports with, and otherwise comply with, the rules and regulations of
the Securities and Exchange Commission ("SEC").
QTL Test. As a unitary savings and loan holding company, the Company generally
is not subject to activity restrictions, provided the Bank satisfies the QTL
test. If the Company acquires control of another savings association as a
separate subsidiary, it would become a multiple savings and loan holding
company, and the activities of the Company and any subsidiaries (other than the
Bank or any other SAIF-insured savings association) would become subject to
restrictions applicable to bank holding companies unless such other associations
each also qualify as a QTL and were acquired in a supervisory acquisition.
Restrictions on Acquisitions. The Company must obtain approval from the OTS
before acquiring control of any SAIF-insured association. Such acquisitions are
generally prohibited if they result in a multiple savings and loan holding
company controlling savings associations in more than one state. However, such
interstate acquisitions are permitted based on specific state authorization or
in a supervisory acquisition of a failing savings association.
Federal law generally provides that no "person," acting directly or indirectly
or through or in concert with one or more other persons, may acquire "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 (a) the acquisition would substantially lessen competition; (b) the
financial condition of the acquiring person might jeopardize the financial
stability of the savings institution or prejudice the interest of its
depositors; or (c) 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 acquisitions of
control by such person.
Subject to appropriate regulatory approvals, a bank holding company can acquire
control of a savings association, and it controls a savings association, merge
or consolidate the assets and liabilities of the savings association with, or
transfer assets and liabilities to, any subsidiary bank which is a member of the
BIF with the approval of the appropriate federal banking agency and the Federal
Reserve Board. Generally, federal savings associations can acquire or be
acquired by any insured depository institution.
Federal Securities Law. The Company's stock held by persons who are affiliates
(generally officers, directors, and principal shareholders) of the Company may
not be resold without registration or unless sold in accordance with certain
sale restrictions. If the Company meets specified current public information
requirements, each affiliate of the Company is able to sell in the public
market, without registration, a limited number of shares in any three-month
period.
17
<PAGE>
ITEM 2. PROPERTIES
The Bank operates from its main office located at 201 Main Street South,
Hutchinson, Minnesota. The Bank owns this 20,000 square feet office facility
which it built in 1985/86. The total investment in property and equipment at 201
Main Street South had a net book value of $1.4 million at September 30, 1997.
Additional offices, either owned or leased by the Bank, are set forth below with
information regarding net book value of the premises and equipment at such
facilities at September 30, 1997.
<TABLE>
<CAPTION>
Year
Acquired or Net Book
Date Lease Value at Square
Location Expires September 30, 1997 Footage
- -------------------------- -----------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
14994 Glazier Avenue
Apple Valley, MN 55124 1989 $290 3,000
19 Central Avenue
Buffalo, MN 55313 1973 88 1,800
1002 Greeley Avenue
Glencoe, MN 55336 1998 (1) 22 1,100
1320 South Frontage Road
Hastings, MN 55033 1984 664 15,000
905 Highway 15 South,
Frontage Road
Hutchinson, MN 55350 1980 162 1,400
6505 Cahill Avenue
Inver Grove Heights, MN 55075 1979 217 3,000
501 North Sibley Avenue
Litchfield, MN 55355 1978 180 2,400
200 East Frontage Road,
Highway 5
Waconia, MN 55387 1985 225 2,400
122 East Second Street
Winthrop, MN 55396 1998 (2) 12 950
113 Waite Avenue South
Waite Park, MN 56387 1998 (3) 46 550
</TABLE>
(1) One year lease expires in April, 1998 with option to renew for one year
terms thereafter. The Bank expects to renew the lease.
(2) Lease expires in July, 1998 with option to renew for one year terms. The
Bank expects to renew the lease.
(3) Lease expires in September, 1998 with options to renew for five year terms
The Bank leases approximately 5,713 square feet of the property in Hastings,
Minnesota to various tenants under three year operating leases. These leases
expire April 14, 2000 and April 30, 1999. The annual rents total $39,698 in
addition to each tenant's proportionate share of the operating expenses.
18
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
First Federal, from time to time, is a party to legal proceedings in the
ordinary course of business when it enforces security interests in loans made by
it. The Bank is not engaged in any legal proceedings of a material nature at the
present time.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS
Information relating to the market for Registrant's common equity and related
stockholder matters appears under "Corporate Profile and Stock Market
Information" in the Registrant's 1997 Annual Report to Stockholders on page 1,
and is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The above-captioned information appears under "Selected Financial Data" in the
Registrant's 1997 Annual Report to Stockholders on page 3 and is incorporated
herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The above-captioned information appears under Management's Discussion and
Analysis of Financial Condition and Results of Operations in the Registrant's
1997 Annual Report to Stockholders on Pages 5 through 15 and is incorporated
herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The above information appears under Management's Discussion and Analysis of
Financial Condition and Results of Operations in the Registrant's 1997 Annual
Report to Stockholders on pages 5 through 7 and is incorporated herein by
reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Company and its subsidiary,
together with the report thereon by Bertram Cooper & Co., LLP appears in the
Bank's 1997 Annual Report to Stockholders on pages 16 through 37 and are
incorporated herein by reference.
Quarterly Results of Operations on page 38 of the 1997 Annual Report to
Stockholders is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
PART III
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
The information contained under the section captioned "Information with Respect
to Nominees for Director, Directors Continuing in Office, and Executive
Officers" at pages 4 to 13 the Registrant's definitive proxy statement for the
Company's Annual Meeting of Stockholders to be held on January 20, 1998 (the
"Proxy Statement"), which was filed with the Commission on December 8, 1997, and
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information relating to executive compensation is incorporated herein by
reference to the Registrant's Proxy Statement at pages 9 through 13.
19
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information relating to security ownership of certain beneficial owners and
management is incorporated herein by reference to the Registrant's Proxy
Statement at pages 3 through 5.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information relating to certain relationships and related transactions is
incorporated herein by reference to the Registrant's Proxy Statement at page 15.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
- -------------------------------------------------------------------------
(a) The following documents are filed as a part of this report:
(1) Consolidated Financial Statements of the Bank are incorporated by
reference to the following indicated pages of the 1997 Annual Report to
Stockholders.
PAGE
----
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . 16
Consolidated Statements of Financial Condition as of
September 30, 1997 and 1996 . . . . . . . . . . . . . . . . . 17
Consolidated Statements of Income for the Years
Ended September 30, 1997, 1996 and 1995 . . . . . . . . . . . 18
Consolidated Statements of Changes in Stockholders' Equity for the
Years Ended September 30, 1997, 1996 and 1995 . . . . . . . . 19
Consolidated Statements of Cash Flows for the Years Ended
September 30, 1997, 1996 and 1995 . . . . . . . . . . . . . . 20
Notes to Consolidated Financial Statements . . . . . . . . . . . . 22
The remaining information appearing in the Annual Report to
Stockholders is not deemed to be filed as part of this report, except as
expressly provided herein.
(2) All schedules are omitted because they are not required or
applicable, or the required information is shown in the consolidated
financial statements or the notes thereto.
(3) Exhibits
(a) The following exhibits are filed as part of this report.
2.1 Plan of Conversion Merger of Hutchinson and Hastings *
2.2 Agreement of Merger *
3.1 Articles of Incorporation of FSF Financial Corp. *
3.2 Bylaws of FSF Financial Corp. *
4.0 Stock Certificate of FSF Financial Corp. *
10.1 Form of Employment Agreement with Donald A. Glas, George B.
Loban and Richard H. Burgart *
10.2 First Federal fsb Management Stock Plan**
10.3 FSF Financial Corp. 1995 Stock Option Plan**
11.0 Statement regarding computation of earnings per share ***
13.0 1997 Annual Report to Stockholders
21.0 Subsidiary Information
23.0 Consent of Accountant
27.0 Financial Data Schedule ****
- ---------------------
* Incorporated herein by reference into this document from the Exhibits
to Form S-1, Registration Statement, initially filed with the
Commission, on June 1, 1994, Registration No. 33-79570.
** Incorporated herein by reference into this document from the Registrant's
proxy statement for the Annual Meeting of Stockholders held on January
17, 1995, and filed with the Commission on December 13, 1994.
*** See the consolidated financial statements of the registrant in 1997
Report to Stockholders.
**** Included with electronic filing only.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 o4 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FSF Financial Corp.
Dated: December 12, 1997 By: /s/ Donald A. Glas
------------------
Donald A. Glas
Co-Chair of the Board and Chief
Executive Officer
(Duly Authorized Representative)
Pursuant to the requirement of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated,
<TABLE>
<CAPTION>
<S> <C> <C> <C>
By: /s/ Donald A. Glas By: /s/ Richard H. Burgart
------------------ ----------------------
Donald A. Glas Richard H. Burgart
Co-Chair of the Board and Chief Executive Officer Chief Financial Officer and Treasurer
(Principal Executive Officer) (Principal Financial and Accounting Officer)
Director
Date: December 12, 1997 Date: December 12, 1997
By: /s/ George B. Loban By: /s/ Carl O. Bretzke
------------------ ----------------------
George B. Loban Carl O. Bretzke
Co-Chair of the Board and President Director
Date: December 12, 1997 Date: December 12, 1997
By: /s/ Sever B. Knutson By: /s/ Roger R. Stearns
------------------ ----------------------
Sever B. Knutson Roger R. Stearns
Director Director
Date: December 12, 1997 Date: December 12, 1997
By: /s/ James J. Caturia By: /s/ Jerome R. Dempsey
------------------ ----------------------
James J. Caturia Jerome R. Dempsey
Director Director
Date: December 12, 1997 Date: December 12, 1997
</TABLE>
21
EXHIBIT 13
<PAGE>
FSF FINANCIAL CORP.
1997 ANNUAL REPORT
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Corporate Profile and Stock Market Information..............................1
Selected Financial and Other Data...........................................3
Letter to Stockholders......................................................4
Management's Discussion and Analysis of
Financial Condition and Results of Operations.............................5
Independent Auditors' Report...............................................16
Consolidated Statements of Financial Condition.............................17
Consolidated Statements of Income..........................................18
Consolidated Statements of Changes in Stockholders' Equity.................19
Consolidated Statements of Cash Flows......................................20
Notes to Consolidated Financial Statements.................................22
Selected Quarterly Financial Data..........................................38
Office Locations...........................................................39
Corporate Information......................................................40
<PAGE>
FSF FINANCIAL CORP.
Corporate Profile and Related Information
FSF Financial Corp. (the "Corporation") is a Minnesota corporation organized in
1994 at the direction of First Federal fsb (the "Bank") to acquire all of the
capital stock of the Bank upon its conversion from the mutual to stock form of
ownership. The Bank resulted from the merger of First Federal Savings and Loan
Association of Hastings, Hastings, Minnesota, with and into First State Federal
Savings and Loan Association, Hutchinson, Minnesota, on September 30, 1994. On
October 6, 1994, the Bank completed its mutual-to-stock conversion
("Conversion") and is currently chartered by the Office of Thrift Supervision
("OTS") as a federally-chartered stock savings bank. The Corporation is a
unitary savings and loan holding company which, under existing laws, generally
is not restricted in the types of business activities in which it may engage
provided that the Bank retains a specified amount of its assets in
housing-related investments.
The Corporation purchased all of the capital stock of the Bank with one-half of
the net proceeds from the Conversion. The Corporation also provided a loan to
the Bank's Employee Stock Ownership Plan ("ESOP") to enable the ESOP to purchase
shares of the Corporation's common stock in the initial public offering. The
note bears an interest rate and has terms and conditions which prevailed in the
marketplace at the time it was originated. The Corporation has not engaged in
any business activities to date other than the loan to the ESOP.
The Bank conducts its business from its main office in Hutchinson, Minnesota,
and ten additional full service offices located in the Minnesota counties of
McLeod, Dakota, Meeker, Sibley, Carver, Stearns and Wright. The Bank also
operates ten automated teller machines ("ATMs"). The Bank's deposits have been
federally insured since 1934 and are currently insured up to the maximum
allowable by the Federal Deposit Insurance Corporation (the "FDIC"). The Bank is
a community oriented savings institution offering a variety of financial
services to meet the needs of the communities it serves.
The Bank attracts deposits from the general public and uses such deposits,
together with borrowings and other funds, primarily to originate and purchase
loans secured by first mortgages on owner-occupied, one-to-four family
residences located in its market area and to invest in mortgage-backed and
investment securities. The Bank also originates commercial real estate and
multi-family loans, construction loans, and commercial business and consumer
loans.
Stock Market Information
Since its issuance in October 1994, the Corporation's common stock has been
traded on the Nasdaq National Market. The daily stock quotation for FSF
Financial Corp. is listed in the Nasdaq National Market published in The Wall
Street Journal, the St Paul Pioneer Press and Dispatch, and other leading
newspapers under the trading symbol of "FFHH". For a listing of the stock price
as published by the Nasdaq statistical report, see "Selected Quarterly Financial
Data."
The number of stockholders of record of common stock as of the record date of
December 1, 1997, was approximately 533. This does not reflect the number of
persons or entities who held stock in nominee or "street" name through various
brokerage firms. At December 1, 1997, there were 3,009,715 shares issued and
outstanding.
1
<PAGE>
The following table sets forth the Corporation's net income and the dividends
declared on the common stock:
Net Dividends
Income Declared
---------------- ---------------
(Dollars in thousands,
except per share amounts)
Quarter ended December 31, 1994
Total $ 1,069
Per common share outstanding 0.26 None
Quarter ended March 31, 1995
Total 565
Per common share outstanding 0.14 0.125
Quarter ended June 30, 1995
Total 531
Per common share outstanding 0.14 0.125
Quarter ended September 30, 1995
Total 460
Per common share outstanding 0.12 0.125
Quarter ended December 31, 1995
Total 421
Per common share outstanding 0.11 0.125
Quarter ended March 31, 1996
Total 460
Per common share outstanding 0.13 0.125
Quarter ended June 30, 1996
Total 684
Per common share outstanding 0.21 0.125
Quarter ended September 30, 1996
Total 103
Per common share outstanding 0.03 0.125
Quarter ended December 31, 1996
Total 722
Per common share outstanding 0.24 0.125
Quarter ended March 31, 1997
Total 725
Per common share outstanding 0.25 0.125
Quarter ended June 30, 1997
Total 823
Per common share outstanding 0.29 0.125
Quarter ended September 30, 1997
Total 854
Per common share outstanding 0.30 0.125
The Corporation's ability to pay dividends to stockholders is dependent upon the
dividends it receives from the Bank. The Bank may not declare or pay a cash
dividend on any of its stock if the effect thereof would cause the Bank's
regulatory capital to be reduced below (1) the amount required for the
liquidation account established in connection with the Bank's conversion from
mutual to stock form, or (2) the regulatory capital requirements imposed by the
OTS.
2
<PAGE>
FSF FINANCIAL CORP.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
SELECTED FINANCIAL AND OTHER DATA (1)
Financial Condition (Dollars in Thousands)
- ------------------------------------------------------------------------------------------------------------------------------------
September 30, 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total assets $ 388,135 $ 354,636 $ 304,605 $ 281,467 $ 217,672
Loans held for sale 204 443 230 729 21,576
Loans receivable, net 260,390 216,727 170,921 116,591 99,370
Mortgage-backed securities 38,539 38,557 37,110 33,267 30,702
Mortgage-backed securities available for sale 16,699 16,336 16,141 16,338 16,979
Debt securities 37,876 44,349 41,914 22,897 28,175
Debt securities available for sale 1,000 - - - -
Equity securities available for sale 19,311 18,231 16,165 14,172 -
Cash and cash equivalents (2) 6,135 11,756 14,855 69,991 14,666
Savings deposits 208,246 189,074 171,516 156,479 164,827
Other borrowings 133,817 114,693 73,807 37,688 30,472
Stockholders' equity 43,362 47,649 57,351 20,508 19,873
Summary of Operations (Dollars in Thousands) (3)
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended September 30, 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
Interest income $ 27,315 $ 23,244 $ 19,079 $ 15,320 $ 14,728
Interest expense 16,346 13,609 9,472 7,544 7,282
Net interest income 10,969 9,635 9,607 7,776 7,446
Provision for loan losses 120 42 24 33 47
Non-interest income 1,510 1,354 1,127 184 1,684
Non-interest expense (4) 7,130 8,178 6,966 5,964 5,339
Income before cummulative effect
of change in accounting principle 3,124 1,668 2,243 1,135 2,464
Net income 3,124 1,668 2,625 1,135 2,464
Other Selected Data
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended September 30, 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
Return on average assets before cum. eff. 0.84% 0.69% 0.82% 0.50% 1.27%
Return on average assets after cum. eff. 0.84% 0.69% 0.95% 0.50% 1.27%
Return on average equity before cum. eff. 6.87% 4.25% 3.83% 5.58% 14.78%
Return on average equity after cum. eff. 6.87% 4.25% 4.48% 5.58% 14.78%
Average equity to average assets 12.25% 15.93% 21.31% 8.96% 8.57%
Net interest rate spread (5) 2.54% 2.36% 2.78% 3.41% 3.73%
Non-performing assets to total assets 0.14% 0.06% 0.12% 0.20% 0.38%
Allowance for loan losses to total loans 0.30% 0.33% 0.41% 0.61% 0.57%
Earnings per share before cum. eff. $ 1.06 $ 0.48 $ 0.57 N/A N/A
Earnings per share after cum. eff. $ 1.06 $ 0.48 $ 0.67 N/A N/A
Cash dividends declared per share $ 0.50 $ 0.50 $ 0.375 N/A N/A
</TABLE>
- ---------------------------------------------------
(1) The financial statements and other selected data as of and for the period
ended September 30, 1993 have been restated to reflect First State
Federal's merger with First Federal of Hastings, which was accounted for
as a pooling-of-interests.
(2) Consists of cash due from banks, interest-bearing deposits, and other
investments with original maturities of less than three months.
(3) The cumulative effect of the change in accounting for debt securities as a
pro-forma adjustment to prior years operations would result in an increase
in non-interest income for fiscal 1994 by $681 and net income would
increase by $382.
(4) Includes a one-time special assessment of $1,030,000 to recapitalize the
SAIF for the year ended September 30, 1996.
(5) Interest rate spread represents the difference between the average yield
on interest-earning assets and the average cost of interest-bearing
liabilities
3
<PAGE>
To Our Stockholders:
The year ended September 30, 1997, provided many challenges, which were met, and
many opportunities, which were capitalized on. For our stockholders, this year
also marked a significant achievement for FSF Financial Corp. stock. Our stock
price has approximately doubled since our conversion three years ago.
Earnings per share were $1.06 for the fiscal year compared with $0.48 for the
1996 fiscal year. Stockholders' equity, as a percentage of total assets,
decreased to 11.2% at September 30, 1997, from 13.4% at September 30, 1996. This
was accomplished by a combination of internal growth and stock repurchases
completed during the year that totaled 473,884 shares. These repurchases have
the effect of decreasing stockholders' equity while increasing earnings per
share for you, our stockholders.
Fiscal year 1997 saw mortgage originations and purchases exceed $70.7 million,
land and commercial real estate originations and purchases were $25.4 million,
and consumer originations and purchases totaled more than $31.6 million. This
activity led to an increase in our loan portfolio of more than $50.4 million and
an increase in total assets of more than 9.4%. Lending will continue to be an
important part of our asset generation, with a greater emphasis on
adjustable-rate and "prime-based" products, while not compromising our risk
standards. Our private banking department will continue to grow and we recently
hired a veteran agricultural lender.
Our emphasis continues to be customer service and increased customer
relationships. The success of our "Master Money" check card and "Telephone
Banking" has provided customers with increased access to funds, while still
continuing to provide excellent face-to-face customer service at no charge.
FSF Financial Corp. is positioned to meet tomorrow's challenges and
opportunities. Quality financial services and products, along with dedicated
staff, management, and directors who recognize the importance of customer and
stockholder satisfaction, will be the key ingredients to our growth and
profitability.
Thank you for your confidence and support in our future success.
Sincerely,
Donald A. Glas George B. Loban
Co-Chair/Chief Executive Officer Co-Chair/President
4
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
General
The Corporation does not engage in any active business. In connection with the
conversion from the mutual to stock form of ownership, the Corporation made a
loan to the Bank's employee stock ownership plan, from which it receives
interest income. The Corporation also receives interest income on its
investments.
The earnings of the Corporation depend primarily on the Bank's net interest
income. Net interest income is affected by the interest rates that the Bank
receives from its loans and investments and by the interest rates that the Bank
must pay for its sources of funds. The difference between average rates of
interest earned on earning assets and the average rates paid on interest bearing
liabilities is the "interest rate spread". When interest earning assets equal or
exceed interest bearing liabilities, any positive interest rate spread will
produce net interest income.
In addition, the Bank receives income from service charges and other fees and
occasionally from sales of loans and real estate owned. The Bank incurs expenses
in addition to interest expense in the form of salaries and benefits, deposit
insurance, property operations and maintenance, advertising and other related
business expenses.
Earnings of the Bank are significantly affected by economic and competitive
conditions, particularly changes in interest rates, government policies and
regulations of various regulatory authorities.
Asset/Liability Management
The Bank, like other financial institutions, is vulnerable to changes in
interest rates to the extent that interest-bearing liabilities mature
differently than interest-earning assets. The lending activities of the Bank
have emphasized the origination of long-term loans secured by one- to
four-family residences, the majority of which have a repricing term which is
substantially shorter than their amortization term, and the source of funds has
been deposits and borrowings. Having interest-earning assets that reprice more
frequently than interest-bearing liabilities is generally beneficial to net
interest income during periods of increasing interest rates, such an
asset/liability mismatch is generally detrimental during periods of declining
interest rates.
In an attempt to manage its exposure to changes in interest rates, management
closely monitors interest rate risk. Management meets at least quarterly to
review the interest rate risk position and projected profitability of the Bank.
In addition, management reviews the Bank's portfolio, formulates investment
strategies and oversees the timing and implementation of transactions to assure
attainment of the Bank's objectives in the most effective manner. The Board of
Directors reviews on a quarterly basis the Bank's asset/liability position,
including simulations of the effect on the Bank's capital of various interest
rate scenarios.
Depending on the relationship between long-term and short-term interest rates,
market conditions and consumer preferences, the Bank, at times, may place more
emphasis on managing net interest margin than on better matching the interest
rate sensitivity of its assets and liabilities in an effort to enhance net
interest income. Management believes that the increased net interest income
resulting from a mismatch in the maturity of its assets and liability portfolios
can provide high enough returns to justify the increased exposure to sudden and
unexpected changes in interest rates.
Management attempts to reduce the Bank's interest rate risk by the way it
structures its assets and liabilities. The Bank sells all fixed rate mortgages
with contractual terms of greater than 20 years and has primarily focused its
residential lending programs on loans with either adjustable interest rates or
balloon provisions. These loans provide the Bank with a repricing time frame
which is substantially shorter than the contractual term. During the 1997 fiscal
year, the Bank originated $24.9 million of single family mortgage loans which
have initial fixed rates for terms of one to ten years and then adjust annually
off a treasury index thereafter. The Bank also originated $14.3 million of
single family mortgage loans that have a balloon payment due in three to seven
years. Originations of construction and land development loans, which generally
have a contractual maturity of two years or less, totaled $22.0 million. At
September 30, 1997, $147.3 million of real estate mortgages were adjustable rate
mortgages, balloon mortgages, or construction and land development loans,
representing 63% of total mortgages and 38% of total assets.
5
<PAGE>
Interest rate sensitivity is the result of differences in the amounts and
repricing dates of rate-sensitive assets and rate-sensitive liabilities. These
differences, or interest rate repricing "GAP," provide an indication of the
extent to which the Bank's net interest income is affected by future changes in
interest rates. A GAP is considered positive when the amount of interest rate
sensitive assets exceeds the amount of interest rate sensitive liabilities. A
GAP is considered negative when the amount of interest rate sensitive
liabilities exceeds interest rate sensitive assets. During a period of falling
interest rates, a negative GAP would tend to result in an increase in net
interest income, while a positive GAP would tend to affect net interest income
adversely. Conversely, during a period of rising interest rates, a negative GAP
would tend to result in a decrease in net interest income, while a positive GAP
would tend to result in an increase in net interest income.
The table that follows sets forth the amounts of interest-earning assets and
interest-bearing liabilities at September 30, 1997, which are expected to
reprice or mature in each of the future time periods shown.
Analysis of Repricing Mechanisms
<TABLE>
<CAPTION>
Over One Over Five
Within to Five to Ten Over Ten
One Year Years Years Years Total
---------------- ------------ ------------------ -------------- ------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Interest-earning assets:
Mortgage loans $ 64,896 $ 86,305 $ 51,950 $ 8,767 $ 211,918
Other loans 37,287 9,892 2,349 - 49,528
Investment securities 76,058 12,071 13,095 15,846 117,070
---------------- ------------ ------------------ -------------- ------------
Total interest-earning assets 178,241 108,268 67,394 24,613 378,516
---------------- ------------ ------------------ -------------- ------------
Interest-bearing liabilities:
Noninterest bearing deposits - - - - -
NOW and Super now accounts 25,351 - - - 25,351
Savings accounts 47,847 - - - 47,847
Money market deposit accounts 2,708 - - - 2,708
Certificates 75,639 55,601 1,100 - 132,340
Other borrowed money 98,400 35,417 - - 133,817
---------------- ------------ ------------------ -------------- ------------
Total interest-bearing liabilities 249,945 91,018 1,100 - 342,063
---------------- ------------ ------------------ -------------- ------------
Interest sensitivity gap $ (71,704) $ 17,250 $ 66,294 $ 24,613 $ 36,453
================ ============ ================== ============== ============
Cumulative interest sensitivity gap $ (71,704) $ (54,454) $ 11,840 $ 36,453
================ ============ ================== ==============
Cumulative ratio of interest-earning assets
to interest-bearing liabilities 0.71% 0.84% 1.03% 1.11%
================ ============ ================== ==============
Cumulative ratio of cumulative interest
sensitivity gap to total assets. -18.47% -14.03% 3.05% 9.39%
================ ============ ================== ==============
</TABLE>
The table above indicates the time periods in which interest-earning assets and
interest-bearing liabilities will mature or reprice in accordance with their
contractual terms. The following assumptions have been used in calculating the
values in the table: Adjustable-rate and balloon loans have a constant
prepayment rate of 6%; mortgages held for sale are all set to reprice in three
years or less; remaining mortgages have prepayment rates ranging from 4% to 10%;
consumer loans have a prepayment rate that is constant over time at 19%; NOW
checking, core savings deposits, and money market deposits have an increasing
decay ranging from 6.0% to 30.0%. Management utilizes its own assumptions, and
feels that these assumptions provide a reasonable estimate of actual experience.
Certain shortcomings are inherent in the method of analysis presented in the
previous table. For example, although certain assets and liabilities may have
similar maturities or periods of repricing, they may react in different degrees
to changes in market interest rates. Also, the interest rates on certain types
of assets and liabilities may fluctuate in advance
6
<PAGE>
of changes in market interest rates, while interest rates on other types may lag
behind changes in market rates. Additionally, certain assets, such as
adjustable-rate mortgage loans, have features which restrict changes in interest
rates on a short-term basis over the life of the assets. Further, in the event
of a change in interest rate, prepayment levels and decay rates on core deposits
may deviate significantly from those assumed in calculating the table.
Market Risk Management
Market risk is the risk of loss arising from adverse changes in market prices
and rates. The Bank's market risk is comprised primarily of interest rate risk
resulting from its core banking activities of lending and deposit taking.
Interest rate risk is the risk that changes in market interest rates might
adversely affect the Bank's net interest income or the economic value of its
portfolio of assets, liabilities and off-balance sheet contracts. Management
continually develops and applies strategies to mitigate this risk. Management
does not believe that the Bank's primary market risk exposures and how those
exposures are managed in Fiscal 1997 have changed when compared to Fiscal 1996.
Market risk limits have been established by the Board of Directors based on the
Bank's tolerance for risk.
The Bank primarily relies on its Net Portfolio Value Model (the Model) to
measure its susceptibility to interest rate changes. Net portfolio value (NPV)
is defined as the present value of expected cash flows from existing assets
minus the present value of expected net cash flows from existing liabilities
plus or minus the present value of net expected cash flows from existing
off-balance sheet contracts. The Bank does not currently own any derivative
financial instruments whose values are determined from underlying instruments or
market indices, and whose notional or contractual amounts would not be
recognized in the financial statements. The Model estimates the current economic
value of each type of asset, liability, and off-balance sheet contract after
various assumed instantaneous, parallel shifts in the Treasury yield curve both
upward and downward.
The NPV Model uses an option-based pricing approach to value one to four family
mortgages, mortgages serviced by others, and firm commitments to buy, sell, or
originate mortgages. This approach makes use of an interest rate simulation
program to generate numerous random interest rate paths that, in conjunction
with a prepayment model, are used to estimate mortgage cash flows. Prepayment
options and interest rate caps and floors contained in mortgages and
mortgage-related securities introduce significant uncertainty in estimating the
timing of cash flows for these instruments that warrants the use of this
sophisticated methodology. All other financial instruments are valued using a
static discounted cash flow method. Under this approach, the present value is
determined by discounting the cash flows the instrument is expected to generate
by the yields currently available to investors from an instrument of comparable
risk and duration.
The following table sets forth the present value estimates of the Bank at
September 30, 1997, as calculated by its NPV Model. The table shows the NPV of
the Bank under rate shock scenarios of -400 basis points to +400 basis points in
increments of 100 basis points. As market rates increase, the market value of
the Bank's large portfolio of mortgage loans and securities declines
significantly and prepayments are slow. As rates decrease, the market value of
mortgage loans and securities increase only modestly due to prepayment risk,
periodic rate caps, and other embedded options. Actual changes in market value
will differ from estimated changes set forth in this table due to various risks
and uncertainties. <TABLE> <CAPTION>
Changes in Interest
Rates in Basis Net Portfolio Change NPV as % of Assets
------------------------------------------------------------- ---------------------------------------
Points (Rate Shock) $ Amount $ Change Change % NPV Ratio Change
--------------- ------------------ -------------------- ------------------ -----------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
+400 bp $ 30,276 (13,518) (30.87) % 8.42 (280) bp
+300 bp 33,191 (10,603) (24.21) 9.06 (217) bp
+200 bp 36,390 (7,404) (16.91) 9.73 (149) bp
+100 bp 39,911 (3,883) (8.87) 10.45 (77) bp
0 bp 43,794 - - 11.22 -
-100 bp 48,091 4,297 9.81 12.05 82 bp
-200 bp 52,858 9,064 20.70 12.93 171 bp
-300 bp 58,163 14,369 32.81 13.87 265 bp
-400 bp 64,087 20,293 46.34 14.89 366 bp
</TABLE>
7
<PAGE>
Average Balances
The following table sets forth information relating to the Corporation's average
yield on assets and average cost of liabilities for the periods indicated. The
yields and costs are computed by dividing income or expense by the average
balance of interest-earning assets and interest-bearing liabilities,
respectively, for the periods indicated. Average balances are derived from
month-end balances. Management does not believe that the use of month-end
balances has caused any material difference in the information presented.
<TABLE>
<CAPTION>
Years Ended September 30,
-------------------------------------------------------------------------------------------
1997 1996 1995
-------------------------------------------------------------------------------------------
Average Average Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Cost Balance Expense Cost Balance Expense Cost
-------------------------------------------------------------------------------------------
(in thousands) (in thousands) (In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets
Loans receivable (1) $237,475 $20,066 8.45% $ 193,202 $16,077 8.32% $ 142,711 $ 11,221 7.86%
Mortgage-backed securities 55,062 3,384 6.15% 54,208 3,270 6.03% 51,984 3,504 6.74%
Investment securities (2) 66,734 3,865 5.79% 69,676 3,897 5.59% 70,762 4,354 6.15%
------------------------ ---------------------- ----------------------
Total interest-earning assets $359,271 27,315 7.60% $ 317,086 23,244 7.33% $ 265,457 19,079 7.19%
------------------------ ---------------------- ----------------------
Interest-Bearing Liabilities
NOW and money market accounts $ 27,463 389 1.42% $ 25,697 443 2.41% $ 27,923 673 2.41%
Passbook savings 48,381 1,524 3.15% 49,120 1,576 3.52% 47,519 1,669 3.51%
Certificates of deposit 127,211 7,426 5.84% 108,665 6,243 5.75% 86,518 4,411 5.10%
------------------------ ---------------------- ----------------------
Total deposits 203,055 9,339 4.60% 183,482 8,262 4.50% 161,960 6,753 4.17%
FHLB advances 120,093 7,007 5.83% 90,408 5,347 5.91% 52,688 2,719 5.16%
------------------------ ---------------------- ----------------------
Total interest-bearing liabilities 323,148 16,346 5.06% 273,890 13,609 4.97% 214,648 9,472 4.41%
------------------------ ---------------------- ----------------------
Net Interest Income $10,969 $ 9,635 $ 9,607
========== ========== ===========
Net Interest Rate Spread (3) 2.54% 2.36% 2.78%
Net Interest Rate Margin (4) 3.05% 3.04% 3.62%
Ratio of average interest-earning assets
to average interest-bearing liabilities 1.11x 1.16x 1.24x
============== ============ ===========
</TABLE>
(1) Average balances include non-accrual loans and loans held for sale. (2)
Includes interest-bearing deposits in other financial institutions. (3) Net
interest rate spread represents the difference between the average
yield on interest-earning assets and the average cost of interest-bearing
liabilities.
(4) Net interest rate margin represents net interest income as a percentage of
average interest-earning assets
8
The accompanying notes are an integral part of these statements.
<PAGE>
Rate/Volume Analysis
The table below sets forth certain information regarding changes in interest
income and interest expense of the Bank 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 average volume multiplied by old rate); (2) changes in rates
(changes in rate multiplied by old average volume); (3) total changes in
rate-volume. The combined effects of changes in both volume and rate which
cannot be separately identified, have been allocated proportionately to the
change due to volume and the change due to rate.
<TABLE>
<CAPTION>
Increase (Decrease) Due To
-------------------------------------------------------------------------------
Rate Volume Rate/Volume Total
--------------- --------------- ------------------ ---------------
Year Ended September 30, 1997 vs 1996: (In Thousands)
<S> <C> <C> <C> <C>
Interest income:
Loans Receivable $ 247 $ 3,684 $ 58 $ 3,989
Mortgage-backed securities 55 51 8 114
Investment securities 117 (164) 15 (32)
--------------- --------------- ------------------ ---------------
Total change in interest income 419 3,571 81 4,071
Interest expense:
Savings accounts (813) 1,849 41 1,077
FHLB Borrowings (70) 1,754 (24) 1,660
--------------- --------------- ------------------ ---------------
Total change in interest expense (883) 3,603 17 2,737
--------------- --------------- ------------------ ---------------
Net change in net interest income $ 1,302 $ (32) $ 64 1,334
=============== =============== ================== ===============
Year Ended September 30, 1996 vs 1995:
Interest income:
Loans Receivable $ 656 $ 3,968 $ 232 $ 4,856
Mortgage-backed securities (369) 150 (15) (234)
Investment securities (396) (67) 5 (458)
--------------- --------------- ------------------ ---------------
Total change in interest income (109) 4,051 222 4,164
Interest expense:
Savings accounts 534 897 78 1,509
Other liabilities 395 1,947 286 2,628
--------------- --------------- ------------------ ---------------
Total change in interest expense 929 2,844 364 4,137
--------------- --------------- ------------------ ---------------
Net change in net interest income $ (1,038) $ 1,207 $ (142) $ 27
=============== =============== ================== ===============
</TABLE>
9
<PAGE>
Changes in Financial Condition
General. Total assets increased from $354.6 million at September
30, 1996, to $388.1 million at September 30, 1997, an increase of $33.5 million
or 9.4%. The Bank continues to experience good demand for loans and supplemented
the internal loan originations ($119.2 million) with purchases of other loans
($8.5 million) that meet the interest rate risk and credit risk criteria
established by management.
Securities Available for Sale. Equity securities available for
sale increased by $1.1 million during the 1997 fiscal year as a result of the
purchase of additional stock in the Federal Home Loan Bank of Des Moines
("FHLB"). The additional stock purchase was required as FHLB borrowings
increased. The net unrealized losses on securities available for sale decreased
from $1.1 million at September 30, 1996 to $0.6 million at September 30, 1997.
This decrease was primarily due to the market rate of interest decreasing
compared to the contractual rate.
Securities Held to Maturity. Debt securities held to maturity
decreased from $44.3 million to $37.9 million due to maturities and the exercise
of call options by issuers. Mortgage-backed securities held to maturity
decreased from $38.6 million to $38.5 million during fiscal 1997. The net
unrealized losses on securities held to maturity decreased from $4.3 million at
September 30, 1996 to $1.8 million at September 30, 1997. These decreases were
primarily due to the market rate of interest decreasing compared to the
contractual rate.
Loans Held for Sale. Loans held for sale decreased from $443,000
at September 30, 1996, to $204,000 at September 30, 1997. The Bank had no firm
commitments to sell loans held for sale that were closed at September, 1997.
Loans Receivable. Loans receivable increased from $216.7 million
at September 30, 1996, to $260.4 million at September 30, 1997, an increase of
$43.7 million or 20.2%. The increase was primarily comprised of increases in
adjustable rate mortgages (ARMs), balloon mortgages, loans with short
contractual maturities (i.e., consumer, construction and land development loans)
and Home Equity Lines of Credit (HELOCs) that have an interest rate that adjusts
to the prime rate as published in the Wall Street Journal.
Deposits. Total deposits increased by $19.2 million, or 10.2%
during the 1997 fiscal year. The increase in deposits can be primarily
attributed to an increase in certificates of deposit. The increase in total
deposits was accompanied by an increase in the weighted average cost of funds
from 4.50% to 4.60% for the years ended September 30, 1996 and 1997,
respectively. The increase in cost is primarily attributable to the change in
the composition of deposits.
Borrowings. In addition to the growth in deposits, additional
borrowings of $19.1 million were needed in order to fund the growth in assets.
Management utilizes a least cost, at the margin, approach to fund assets. As a
result, borrowings will be utilized as a funding source when it provides the
least cost, at the margin. FHLB advances are used to fund lending and investment
activities, withdrawals from deposit accounts and other ordinary business
activity.
Stockholders' Equity. Stockholders' equity decreased from $47.6
million at September 30, 1996, to $43.4 million at September 30, 1996, a
decrease of $4.2 million. The Corporation repurchased 473,884 shares of its
common stock during the year at an average price of $15.29, thereby reducing
stockholders' equity. The repurchase of shares also reduced the total number of
shareholders. Despite the decrease in stockholders' equity, book value per share
increased from $15.50 at September 30, 1996, to $16.24 at September 30, 1997.
Comparison of Years Ended September 30, 1997 and 1996
Net Income. Net income increased by $1.4 million to $3.1 million
for the year ended September 30, 1997, from $1.7 million for the year ended
September 30, 1996. The increase was primarily due to an increase in net
interest income and non-interest income and the decrease of non-interest
expense.
Interest Income. Total interest income increased $4.1 million to
$27.3 million for the year ended September 30, 1997, from $23.2 million for the
year ended September 30, 1996. Interest income on loans increased by $4.0
million from $16.1 million for the year ended September 30, 1996, to $20.1
million for the year ended September 30, 1997, as a result of a $44.3 million
increase in the average balance of loans receivable from $193.2 million at
September 30, 1996, to $237.5 million at September 30, 1997. Furthermore, the
average yield increased from 8.32% at September 30, 1996, to 8.45% at September
30, 1997. Interest income on mortgage-backed securities increased from $3.3
million for the year ended September 30, 1996, to $3.4 million for the year
ended September 30, 1997. The increase was primarily the result
10
<PAGE>
of an increase in average rate from 6.03% for the 1996 fiscal year to 6.15% for
the 1997 fiscal year. The average balance of investment securities decreased by
$3.0 million during the fiscal year and the yield increased from 5.59% to 5.79%.
The increase in yield for investment securities was primarily impacted by
maturities and the exercise of call options by issuers. The yield on
interest-earning assets increased from 7.33% for the year ended September 30,
1996, to 7.60% for the year ended September 30, 1997. Interest income increased
by $3.6 million as a result of increased volume during the year while the
changes in rates caused interest income to increase by $419,000 and the
rate/volume change increased interest income by $81,000.
Interest Expense. Total interest expense increased to $16.3
million for 1997 from $13.6 million for 1996 as both the average balance of
total interest bearing liabilities and the average cost of funds increased. The
increased cost of deposits attendant to the growth of balances was approximately
$1.8 million while the increase associated with a change in interest rates was
approximately $813,000. The cost associated with interest bearing deposits
increased from 4.50% for the year ended September 30, 1996, to 4.60% for the
same period ended September 30, 1997. The cost associated with borrowed funds
decreased to 5.83% for fiscal 1997 compared to 5.91% for fiscal 1996. $70,000 of
the decrease in the cost of borrowed funds was a result of increases in rates,
$1.8 million of the increase was attributable to the increased volumes and
$24,000 of the decrease was rate/volume related.
Net Interest Income. Net interest income increased $1.3 million.
Changes in interest rates caused an increase in net interest income of $1.3
million, volumes accounted for a decrease in net interest income of $32,000 and
rate/volume differences increased $64,000.
Provision For Loan Losses. The allowance for losses on loans is
maintained at a level which is considered by management to be adequate to absorb
probable losses on existing loans that may become uncollectible based on an
evaluation of the collectibility, prior loss experience and market conditions.
The evaluation takes into consideration such factors as changes in the nature
and volume of the loan portfolio, overall portfolio quality, review of specific
problem loans, and current economic conditions that may affect the borrower's
ability to pay. The allowance for loan losses is established through a provision
for loan losses charged to expense.
The Bank's loan loss provision increased from $42,000 for the year ended
September 30, 1996, to $120,000 for the year ended September 30, 1997, due to
the change in composition of the loan portfolio. The Bank's allowance for loan
losses was $852,000 at September 30, 1997. The allowance for loan losses
represents .30% of total loans outstanding and 149% of total non-performing
assets. While the Bank maintains its allowance for loan losses at a level which
it considers to be adequate, there can be no assurance that further additions
will not be made to the loss allowances or that such losses will not exceed the
estimated amounts.
Non-interest Income. Total non-interest income increased by
$156,000 to $1.5 million for the year ended September 30, 1997, from $1.4
million for the year ended September 30, 1996. Gains on loans sold increased
from $38,000 in the 1996 fiscal year to $48,000 in the 1997 fiscal year. The
gains are a result of long-term fixed-rate mortgages (with an amortization of
greater than 20 years) that were sold in the secondary market because they do
not fit the interest rate risk profile of the Bank. Other service charges and
fees decreased from $430,000 for the year ended September 30, 1996 to $422,000
for the year ended September 30, 1997. Service charges on deposit accounts
increased $177,000 during the periods compared as a result of an increase in the
number of accounts affected and to a lesser degree by an increase in the fees
associated with deposit accounts.
Non-interest Expense. Total non-interest expense decreased to
$7.1 million for the year ended September 30, 1997, from $8.2 million for the
year ended September 30, 1996, or 13.4%. Compensation and benefits increased
from $4.4 million to $4.5 million or 1.9%, primarily due to merit increases.
Occupancy and equipment expense remained unchanged. Deposit insurance premiums
decreased 58.9%, as a result of the reduction in the SAIF premium and the
absence of a one-time $1.0 million charge to recapitalize the SAIF in fiscal
1996. Professional fees decreased from $249,000 for fiscal year 1996 to $235,000
for fiscal year 1997.
Historically, date fields in computer software programs were programmed using
two digit characters to represent the year. Due to this practice, these software
applications, if not corrected prior to the year 2000, will interpret the year
as 1900 and not 2000. As a result, many calculations which rely on the date
field information, such as interest, payment or due dates and other operating
functions, will generate results which will be significantly misstated.
To prepare for this event and to minimize its potential adverse impact,
management has begun a process to identify areas that will be affected by this
issue, assess their potential impact on the operations of the Bank, monitor the
progress of third
11
<PAGE>
party software vendors in addressing this matter, testing changes provided by
these vendors, and developing contingency plans for any critical systems which
are not effectively reprogrammed.
The Bank's material data processing functions are performed using software
provided by a third party vendor. This company has advised its users that it
expects to resolve any potential problems prior to the year 2000. In addition,
this company will provide ongoing communication to its users to assist them in
implementing tests of the vendor's software. If this company is unable to
correct potential problems in time, or if tests should prove the proposed
corrections to be insufficient, it is likely that the Bank would experience
significant data processing delays, errors or failures. Such delays, errors or
failures could have a significant adverse impact on the financial condition and
results of operations of the Bank. In addition, monitoring and managing the year
2000 project will result in additional direct and indirect costs to the Bank.
Direct costs include potential charges by third party software vendors for
product enhancements, costs involved in testing software products for year 2000
compliance, and any resulting costs for developing and implementing contingency
plans for critical software products which are not enhanced. Indirect costs will
principally consist of the time devoted by existing employees in managing
software vendor progress, testing enhanced software products and implementing
any necessary contingency plans. While such direct costs cannot yet be
reasonably estimated, these expenditures will be charged to expense as incurred.
Income Tax Expense. Income tax expense increased to $2.1 million
for the year ended September 30, 1997, from $1.1 million for the year ended
September 30, 1996. The increase was primarily due to an increase in pre-tax
income of $2.5 million.
Comparison of Years Ended September 30, 1996 and 1995
Net Income. Net income decreased by $957,000 to $1.7 million for
the year ended September 30, 1996, from $2.6 million for the year ended
September 30, 1995. The decrease was primarily due to the Savings Association
Insurance Fund (SAIF) special assessment of $1,030,000 which was accrued for as
of September 30, 1996. Without the special assessment, net income for the year
ended September 30, 1996, would have been $2.3 million, a decrease of $344,000
compared to the year ended September 30, 1995.
Interest Income. Total interest income increased $4.1 million to
$23.2 million for the year ended September 30, 1996, from $19.1 million for the
year ended September 30, 1995. Interest income on loans increased by $4.9
million from $11.2 million for the year ended September 30, 1995, to $16.1
million for the year ended September 30, 1996, as a result of a $50.5 million
increase in the average balance of loans receivable from $142.7 million at
September 30, 1995, to $193.2 million at September 30, 1996. Furthermore, the
average yield increased from 7.86% at September 30, 1995, to 8.32% at September
30, 1996. Interest income on mortgage-backed securities decreased from $3.5
million for the year ended September 30, 1995, to $3.3 million for the year
ended September 30, 1996. The income decrease was the result of a decrease in
average rate from 6.74% for the 1995 fiscal year to 6.03% for the 1996 fiscal
year. The average balance of investment securities decreased by $1.1 million
during the fiscal year and the yield decreased from 6.15% to 5.59%. The decline
in yields for both mortgage backed securities and investment securities was
primarily impacted by the relatively low interest rate environment and the flat
yield curve that existed during the first six months of the fiscal year. The
yield on interest-earning assets increased from 7.19% for the year ended
September 30, 1995, to 7.33% for the year ended September 30, 1996. Interest
income increased by $4.1 million as a result of increased volume during the year
while the changes in rates caused interest income to decrease by $109,000 and
the rate/volume change increased interest income by $222,000.
Interest Expense. Total interest expense increased to $13.6
million for 1996 from $9.5 million for 1995 as both the average balance of total
interest bearing liabilities and the average cost of funds increased. The
increased cost of deposits attendant to the growth of balances was approximately
$897,000 while the increase associated with a change in interest rates was
approximately $534,000. The cost associated with interest bearing deposits
increased from 4.17% for the year ended September 30, 1995, to 4.50% for the
same period ended September 30, 1996. The cost associated with borrowed funds
increased to 5.91% for fiscal 1996 compared to 5.16% for fiscal 1995. $395,000
of the increase in the cost of borrowed funds was a result of increases in
rates, $1.9 million of the increase was attributable to the increased volumes
and $286,000 was rate/volume related.
Net Interest Income. Net interest income remained unchanged at
$9.6 million. Changes in interest rates caused a decrease in net interest income
of $1.0 million, volumes accounted for an increase in net interest income of
$1.2 million and rate/volume differences were slightly less than $200,000.
12
<PAGE>
Provision For Loan Losses. The allowance for losses on loans is
maintained at a level which is considered by management to be adequate to absorb
probable losses on existing loans that may become uncollectible based on an
evaluation of the collectibility, prior loss experience and market conditions.
The evaluation takes into consideration such factors as changes in the nature
and volume of the loan portfolio, overall portfolio quality, review of specific
problem loans, and current economic conditions that may affect the borrower's
ability to pay. The allowance for loan losses is established through a provision
for loan losses charged to expense.
The Bank's loan loss provision increased from $24,000 for the year ended
September 30, 1995, to $42,000 for the year ended September 30, 1996. The Bank's
allowance for loan losses was $776,000 at September 30, 1996. The allowance for
loan losses represents .36% of total loans outstanding and 354.3% of total
non-performing assets. While the Bank maintains its allowance for loan losses at
a level which it considers to be adequate, there can be no assurance that
further additions will not be made to the loss allowances or that such losses
will not exceed the estimated amounts.
Non-interest Income. Total non-interest income increased by
$227,000 to $1.4 million for the year ended September 30, 1996, from $1.1
million for the year ended September 30, 1995. Gains on loans sold increased
from $6,000 in the 1995 fiscal year to $38,000 in the 1996 fiscal year. The
gains are a result of long-term fixed-rate mortgages (with an amortization of
greater than 20 years) that are sold in the secondary market because they do not
fit the interest rate risk profile of the Bank. Other service charges and fees
increased from $329,000 for the year ended September 30, 1995 to $430,000 for
the year ended September 30, 1996. Service charges on deposit accounts increased
$95,000 during the periods compared as a result of an increase in the number of
accounts affected and to a lesser degree by an increase in the fees associated
with deposit accounts.
Non-interest Expense. Total non-interest expense increased to
$8.2 million for the year ended September 30, 1996, from $7.0 million for the
year ended September 30, 1995, or 17.4%. Without the impact of the SAIF special
assessment, non-interest expense increased by $181,000 or 2.6% during the
period. Compensation and benefits increased from $4.2 million to $4.4 million or
4.8%, primarily due to merit increases. Occupancy and equipment expense
increased 11.3% between September 30, 1995, and September 30, 1996, with the
majority of the increase due to the opening of the Bank's eleventh location in
Waite Park, Minnesota. Data processing decreased from $567,000 for the year
ended September 30, 1995, to $379,000 for the year ended September 30, 1996, as
a result of cost savings realized through the integration of processing systems
subsequent to the merger.
Income Tax Expense. Income tax expense decreased to $1.1 million
for the year ended September 30, 1996, from $1.5 million for the year ended
September 30, 1995, or 26.6%. The decrease was primarily due to a decrease in
pre-tax income of slightly less than $1 million.
Liquidity and Capital Resources
The liquidity of a banking institution reflects its ability to provide funds to
meet loan requests, accommodate possible outflows in deposits, and take
advantage of interest rate market opportunities. Funding of loan requests,
providing for liability outflows, and management of interest rate fluctuations
require a continuous analysis in order to match the maturities of specific
categories of short-term loans and investments with specific types of deposits
and borrowings. The Bank's liquidity, represented by cash and cash equivalents,
is a product of its operating, investing and financing activities. The primary
sources of cash were net income and cash derived from investing activities.
Operating activities provided cash of $3.8 million, $3.0 million and $3.6
million during the years ended September 30, 1997, 1996, and 1995, respectively.
In fiscal 1997 and 1996, the cash flow in operating activities was primarily
influenced by the changes in accrued liabilities associated with the accrual of
the SAIF special assessment in fiscal 1996, which was paid out in fiscal 1997.
Investing activities used $39.5 million, $52.2 million, and $79.5 million during
the years ended September 30, 1997, 1996, and 1995, respectively. During fiscal
1997 and fiscal 1996, the cash used in investing activities was primarily due to
the origination and purchase of loans and to a less extent was the result of the
purchase of securities held to maturity and mortgage-backed securities held to
maturity. During fiscal 1995, the cash used in investing activities was the
result of the purchase of securities held to maturity and mortgage-backed
securities held to maturity. The use of cash in all periods was offset in part
by maturities or the exercise of call options by the issuer of investments.
The primary activity of the Bank is originating and purchasing loans, and
purchasing investment and mortgage-backed securities. During the years ended
September 30, 1997, 1996, and 1995, the Bank originated loans in the amounts of
13
<PAGE>
$119.2 million, $97.6 million and $94.7 million, respectively. The Bank also
purchases loans, investment and mortgage-backed securities to manage liquidity
and interest rate risk, to supplement local loan demand and to diversify its
loan portfolio. Funding of loans purchased was $2.4 million, $17.4 million and
$21.0 million for the 1997, 1996 and 1995 fiscal years, respectively. Purchases
of investment and mortgage-backed securities held to maturity totaled $3.0
million, $21.0 million, and $26.0 million, and securities available for sale
totaled $2.0 million, $2.0 million and $1.9 million during the years ended
September 30, 1997, 1996, and 1995, respectively. Other investment activities
included investments in U. S. Government and federal agency obligations, and
FHLB of Des Moines stock.
Changes in cash flows from financing activities covered by the Consolidated
Statements of Cash Flows in fiscal 1995 were primarily the result of increases
in short-term borrowings of $36.1 million. In addition, increases in deposits
provided $15.0 million in cash during fiscal 1995. For the year ended September
30, 1996, $17.6 million in cash was provided as a result of an increase in
deposits and $40.9 million in cash was provided as a result of an increase in
borrowings. The purchase of treasury stock, and dividends on common stock used
$10.6 million, and $1.8 million, respectively. During the fiscal year ended
September 30, 1997, $19.2 million in cash was provided as a result of an
increase in deposits and $19.1 million was provided as a result of an increase
in borrowings. The purchase of treasury stock used $7.2 million and dividends on
common stock used $1.4 million during the 1997 fiscal year. Earnings per share
for the year ended September 30, 1997, were $1.06. A portion of the earnings per
share was a result of the purchase of treasury stock during the fiscal year.
Earnings per share on a pro forma basis for the fiscal year would have been
$0.95, if the funds used to purchase treasury stock would have been used to
reduce borrowed funds. Financing activities provided $30.0 million, $46.2
million, and $20.7 million in cash during the years ended September 30, 1997,
1996 and 1995, respectively. Financing activities in the foreseeable future are
expected to primarily include changes in deposits and advances from FHLB of Des
Moines. See Consolidated Statements of Cash Flow for FSF Financial Corp. and
Subsidiary.
The Bank's liquidity is a measure of its ability to fund loans, pay withdrawals
of deposits, and other cash outflows in an efficient, cost effective manner. The
Bank's primary source of funds are deposits and scheduled amortization and
prepayments of loan and mortgage-backed security principal. During the past
several years, the Bank has used such funds primarily to fund maturing time
deposits, pay savings withdrawals, fund lending commitments, purchase new
investments, and increase liquidity. The Bank funds its operations internally
and as needed with borrowed funds from the FHLB. As of September 30, 1997, such
borrowed funds totaled $133.8 million. While loan repayments and maturing
investments and mortgage-backed securities are relatively predictable sources of
funds, deposit flows and loan and mortgage-backed security prepayments are
greatly influenced by general interest rates, economic conditions and
competition.
The Bank is required under federal regulations to maintain certain specified
levels of "liquid investments," which include certain United States government
obligations and other approved investments. Current regulations require the Bank
to maintain liquid assets of not less than 5% of its net withdrawable accounts
plus short term borrowings. Short term liquid assets must consist of not less
than 1% of such accounts and borrowings, which amount is also included within
the 5% requirement. These levels may change from time to time by the regulators
to reflect the current economic conditions. The Bank's regulatory liquidity was
5.12%, 6.08% and 11.05% at September 30, 1997, 1996, and 1995, respectively and
its short-term liquidity was 5.12%, 6.08%, and 11.05%, at such dates,
respectively.
The amount of certificate accounts which are scheduled to mature during the
twelve months ending September 30, 1998, is approximately $75.6 million. To the
extent that these deposits do not remain at the Bank upon maturity, the Bank
believes that it can replace these funds with deposits, current excess
liquidity, FHLB advances or outside borrowings. It has been the Bank's
experience that a substantial portion of such maturing deposits remain at the
Bank.
At September 30, 1997, the Bank had commitments to extend credit of $18.3
million and forward commitments to purchase mortgages of $80,000. Funds required
to fill these commitments are derived primarily from FHLB borrowings, current
excess liquidity, deposit inflows, or loan and security repayments.
OTS regulations require the Bank to maintain core capital of 3% of assets, of
which 1.5% must be tangible capital, excluding goodwill. The Bank is also
required to maintain risk-based capital equal to 8% of total risk-based assets.
The OTS has proposed amending its regulations in a manner that would increase
the core capital requirements for most thrifts from 3% to 4% or 5%, depending
upon the institution's financial condition and other factors. Although the final
form of the regulation cannot be foreseen, if adopted as proposed, the Bank
would expect its core capital requirement to remain at 3%. The Bank's regulatory
capital exceeded its tangible, core and risk-based capital requirements by
8.56%, 7.06% and 11.20%, respectively.
14
<PAGE>
Management believes that under current regulations, the Bank will continue to
meet its minimum capital requirements in the foreseeable future. Events beyond
the control of the Bank, such as increased interest rates or a downturn in the
economy in areas in which the Bank operates, could adversely affect future
earnings and as a result, the ability of the Bank to meet its future minimum
capital requirements.
Impact of Inflation and Changing Prices
The financial statements and related data have been prepared in accordance with
generally accepted accounting principles which require the measurement of
financial position and operating results in terms of historical dollars, without
consideration for changes in the relative purchasing power of money over time
caused by inflation.
Unlike industrial companies, nearly all of the assets and liabilities of a
financial institution are monetary in nature. As a result, interest rates have a
more significant impact of a financial institution's performance than general
levels of inflation. Interest rates do not necessarily move in the same
direction or in the same magnitude as the price of goods and services, since
goods and services are affected by inflation. In the current interest rate
environment, liquidity and the maturity structure of the Bank's assets and
liabilities are critical to the maintenance of acceptable performance levels.
15
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
FSF Financial Corp. and Subsidiary
Hutchinson, MN 55350
We have audited the accompanying consolidated statements of financial condition
of FSF Financial Corp. and Subsidiary (the Corporation) as of September 30,
1997, and 1996, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the three fiscal years in the
period ended September 30, 1997. These financial statements are the
responsibility of the Corporation's management. Our responsibility is to express
an opinion on these 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of FSF Financial
Corp. and Subsidiary as of September 30, 1997, and 1996, and the consolidated
results of their operations and their cash flows for each of the three fiscal
years in the period ended September 30, 1997, in conformity with generally
accepted accounting principles.
As discussed in Note 1 to the financial statements, the Corporation changed its
method of accounting for certain investments in debt and equity securities as of
October 1, 1994.
Bertram Cooper & Co., LLP
Waseca, Minnesota
October 24, 1997
16
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
September 30,
--------------------------------------
1997 1996
--------------------------------------
(In thousands)
ASSETS
------
<S> <C> <C>
Cash and cash equivalents $ 6,135 $ 11,756
Securities available for sale, at fair value:
Equity securities 19,311 18,231
Mortgage-backed and related securities 16,699 16,336
Debt securities 1,000 -
Securities held to maturity, at amortized cost:
Debt securities (Fair value of $37,065 and $41,626) 37,876 44,349
Mortgage-backed and related securities (Fair value of $37,535 and $36,915) 38,539 38,557
Loans held for sale 204 443
Loan receivable, net 260,390 216,727
Accrued interest receivable 2,436 2,325
Premises and equipment 3,772 3,728
Other assets 1,773 2,184
--------------------------------------
Total Assets $ 388,135 $ 354,636
======================================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Demand deposits $ 28,059 $ 27,601
Savings accounts 47,847 48,334
Certificates of deposit 132,340 113,139
--------------------------------------
Total deposits 208,246 189,074
Federal Home Loan Bank borrowings 133,817 114,693
Other liabilities 2,710 3,220
--------------------------------------
Total liabilities 344,773 306,987
--------------------------------------
Stockholders' equity:
Serial preferred stock, no par value 5,000,000 shares
authorized, no shares issued - -
Common stock, $.10 par value 10,000,000 shares authorized,
4,501,277 and 4,501,277 shares issued 450 450
Additional paid in capital 43,334 43,150
Retained earnings, substantially restricted 23,779 22,068
Treasury stock at cost (1,491,562 and 1,023,083 shares) (20,267) (13,095)
Unearned ESOP shares at cost (234,745 and 271,850 shares) (2,347) (2,719)
Unearned MSP stock grants at cost (104,604 and 131,946 shares)
(1,108) (1,398)
Unrealized (loss) on securities available for sale (479) (807)
--------------------------------------
Total stockholders' equity 43,362 47,649
--------------------------------------
Total Liabilities and Stockholders' Equity $ 388,135 $ 354,636
======================================
</TABLE>
The accompanying notes are an integral part of these statements.
17
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended September 30,
----------------------------------------
1997 1996 1995
----------------------------------------
(In thousands)
<S> <C> <C> <C>
Interest income:
Loans receivable $ 20,066 $ 16,077 $ 11,221
Mortgage-backed and related securities 3,384 3,270 3,504
Investment securities 3,865 3,897 4,354
----------------------------------------
Total interest income 27,315 23,244 19,079
----------------------------------------
Interest expense:
Deposits 9,339 8,262 6,753
Borrowed funds 7,007 5,347 2,719
----------------------------------------
Total interest expense 16,346 13,609 9,472
----------------------------------------
Net interest income 10,969 9,635 9,607
Provision for loan losses 120 42 24
----------------------------------------
Net interest income after provision for loan losses 10,849 9,593 9,583
----------------------------------------
Non-interest income:
Gain (loss) on loans - net 48 38 6
Other service charges and fees 422 430 329
Service charges on deposit accounts 717 540 445
Commission income 227 231 161
Other 96 115 186
----------------------------------------
Total non-interest income 1,510 1,354 1,127
----------------------------------------
Non-interest expense:
Compensation and benefits 4,487 4,404 4,212
Occupancy and equipment 800 797 716
Deposit insurance premiums 167 406 357
SAIF special assessment - 1,030 -
Data processing 393 379 567
Professional fees 235 249 242
Other 1,048 913 872
----------------------------------------
Total non-interest expense 7,130 8,178 6,966
----------------------------------------
Income before provision for income taxes and cumulative effect
of change in accounting principle 5,229 2,769 3,744
Income tax expense 2,105 1,101 1,501
----------------------------------------
Income before cumulative effect of change in accounting principle 3,124 1,668 2,243
Cumulative effect of change in accounting for securities
available for sale - - 382
----------------------------------------
Net income $ 3,124 $ 1,668 $ 2,625
========================================
Earnings per common and common equivalent shares:
Income before cumulative effect of change in accounting principle $1.06 $0.48 $0.57
Cumulative effect of change in accounting principle - - $0.10
Net income $1.06 $0.48 $0.67
========================================
Weighted average common shares outstanding (000's) 2,945 3,470 3,931
========================================
</TABLE>
The accompanying notes are an integral part of these statements.
18
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Unallocated Unrealized
Retained Common Unearned (Loss) on
Additional Earnings Stock Stock Securities
Common Paid-in Substantially Held by Acquired by Treasury Available
Stock Capital Restricted ESOP MSP Stock For Sale Total
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, September 30, 1994 $ -- $ -- $ 21,046 $ -- $ -- $ -- $ (538) $ 20,508
Net earnings -- -- 2,625 -- -- -- -- 2,625
Issuance of common stock net
of stock acquired by the ESOP
and MSP 450 43,020 -- (3,597) (1,905) -- -- 37,968
Treasury stock acquired -- -- -- -- -- (2,589) -- (2,589)
Common stock dividends
($0.375 per share) -- -- (1,513) -- -- -- -- (1,513)
Allocated ESOP & MSP Shares -- 17 -- 494 217 -- -- 728
Common stock issued for options
exercised -- 32 -- -- -- -- -- 32
Cumulative effect of change in
accounting for securities -- -- -- -- -- -- (382) (382)
Adjust valuation allowance for
securities available for sale -- -- -- -- -- -- (26) (26)
------------------------------------------------------------------------------------------------
Balance September 30, 1995 450 43,069 22,158 (3,103) (1,688) (2,589) (946) 57,351
Net earnings -- -- 1,668 -- -- -- -- 1,668
Treasury stock acquired -- -- -- -- -- (10,560) -- (10,560)
Treasury stock issued for
stock options -- (7) -- -- -- 54 -- 47
Common stock dividends
($0.50 per share) -- -- (1,758) -- -- -- -- (1,758)
Allocated ESOP & MSP Shares -- 75 -- 384 290 -- -- 749
Common stock issued for options
exercised -- 13 -- -- -- -- -- 13
Adjust valuation allowance for
securities available for sale -- -- -- -- -- -- 139 139
------------------------------------------------------------------------------------------------
Balance September 30, 1996 450 43,150 22,068 (2,719) (1,398) (13,095) (807) 47,649
Net earnings -- -- 3,124 -- -- -- -- 3,124
Treasury stock acquired -- -- -- -- -- (7,245) -- (7,245)
Treasury stock issued for
stock options -- (12) -- -- -- 73 -- 61
Common stock dividends
($0.50 per share) -- -- (1,413) -- -- -- -- (1,413)
Allocated ESOP & MSP Shares -- 196 -- 372 290 -- -- 858
Adjust valuation allowance for
securities available for sale -- -- -- -- -- -- 328 328
------------------------------------------------------------------------------------------------
Balance September 30, 1997 $ 450 $ 43,334 $ 23,779 $ (2,347) $ (1,108) $(20,267) $ (479) $ 43,362
================================================================================================
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended September 30,
------------------------------------
1997 1996 1995
------------------------------------
(In thousands)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 3,124 $ 1,668 $ 2,625
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation 329 340 330
Net amortization of discounts and premiums on
securities held to maturity (31) (36) (55)
Provision for loan losses 120 42 24
Net market value adjustment on ESOP shares 208 89 18
Amortization of ESOP and MRP stock compensation 612 674 712
Net gain on sale of fixed assets -- (2) (12)
Net gain on real estate sold -- (3) (44)
Federal Home Loan Bank stock dividends -- (81) --
Change in accounting for securities available for sale -- -- (382)
Net loan fees deferred and amortized 214 283 225
(Increase) decrease in:
Loans held for sale (160) (213) 499
Accrued interest receivable (111) (228) (741)
Other assets 132 (72) 547
Increase (decrease) in:
Net deferred taxes 234 (676) (237)
Accrued interest payable 182 (16) (87)
Accrued income tax (78) (26) 411
Accrued liabilities (1,043) 1,111 (416)
Deferred compensation payable 116 106 203
--------------------------------
Net cash provided by operating activities 3,848 2,960 3,620
--------------------------------
Cash flows from investing activities:
Loan originations and principal payments on loans, net (41,245) (28,770) (33,767)
Purchase of loans (2,445) (17,447) (20,993)
Principal payments on securities held to maturity 19 49 84
Purchase of mortgage-related securities held to maturity -- (1,494) (3,924)
Purchase of securities available for sale (1,956) (1,963) (1,900)
Purchase of securities held to maturity (3,000) (19,552) (22,063)
Proceeds from maturities of securities held to maturity 9,500 17,150 3,100
Investment in foreclosed real estate (2) (21) (35)
Proceeds from sale of foreclosed real estate 22 112 502
Proceeds from sale of fixed assets -- 2 16
Purchase of equipment and property improvements (373) (311) (481)
-------------------------------
Net cash (used in) investing activities $(39,480) $(52,245) $(79,461)
-------------------------------
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
<TABLE>
<CAPTION>
Years Ended September 30,
----------------------------------
1997 1996 1995
----------------------------------
(In thousands)
<S> <C> <C> <C>
Cash flows from financing activities:
Net increase in deposits, $ 19,171 $ 17,558 $ 15,036
Net increase in short-term borrowings 19,124 40,886 36,119
Net increase in mortgage escrow funds 305 6 53
Expenses related to stock offering -- -- (1,496)
Treasury stock purchased (7,245) (10,559) (2,589)
Refund of proceeds from stock offering -- -- (23,032)
Dividends on common stock (1,413) (1,758) (1,513)
Purchase of stock for MSP
-- -- (1,905)
Proceeds from exercise of stock options 69 53 32
----------------------------------
Net cash provided by financing activities 30,011 46,186 20,705
----------------------------------
Net increase in cash and cash equivalents (5,621) (3,099) (55,136)
Cash and cash equivalents:
Beginning of year 11,756 14,855 69,991
----------------------------------
End of year $ 6,135 $ 11,756 $ 14,855
======== ======== ========
Supplemental disclosures of cash flow information: Cash payments for:
Interest on advances and other borrowed money $ 6,976 $ 5,368 $ 2,834
Interest on deposits 9,188 8,258 6,725
Income taxes 1,999 1,656 1,338
Supplemental schedule of noncash investing and financing activities:
Federal Home Loan Bank stock dividends $ -- $ 81 $ --
Reinvested amounts of capital gains and dividends
from mutual fund investments 22 163 607
Refinancings of sales of real estate owned -- -- 436
</TABLE>
The accompanying notes are an integral part of these statements.
21
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997, 1996 AND 1995
(1) Summary of Significant Accounting Policies
The following comprise the significant accounting policies FSF Financial Corp.
(the Corporation) follows in preparing and presenting its consolidated financial
statements:
Principles of Consolidation
The consolidated financial statements include the accounts of FSF Financial
Corp. and its wholly owned subsidiary, First Federal fsb (the Bank), and its
wholly owned subsidiary, Firstate Services Inc., which markets insurance and
investment products. Significant intercompany accounts and transactions are
eliminated in consolidation. Certain amounts in the financial statements for the
prior years have been reclassified to conform to current financial statement
presentation.
Nature of Business
The Corporation is a unitary thrift holding company whose subsidiary provides
financial services. The Bank's business is that of a financial intermediary and
consists primarily of attracting deposits from the general public and using such
deposits, together with borrowings and other funds, to make mortgage loans
secured by residential real estate located primarily in Minnesota. At September
30, 1997, the Bank operated 11 retail banking offices in Minnesota. The Bank is
subject to significant competition from other financial institutions, and is
also subject to regulation by certain federal agencies and undergoes periodic
examinations by those regulatory authorities.
Use of Estimates
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the consolidated statements of financial
condition, and income and expenses for the period. Actual results could differ
from those estimates. Material estimates that are particularly susceptible to
significant change relate to the determination of the allowance for losses on
loans and the valuation of real estate acquired in connection with foreclosures
or in satisfaction of loans. In connection with the determination of the
allowances for losses on loans and foreclosed real estate, management obtains
independent appraisals for significant properties. While management uses
available information to recognize losses on loans and foreclosed real estate,
future additions to the allowances may be necessary based on changes in local
economic conditions. In addition, regulatory agencies, as an integral part of
their examination process, periodically review the Bank's allowance for losses
on loans and foreclosed real estate. Such agencies may require the Bank to
recognize additions to the allowance based on their judgments about information
available to them at the time of their examination.
Cash and Cash Equivalents (In thousands)
For purposes of the consolidated statements of cash flows, the Corporation
considers all highly liquid debt instruments with original maturities of three
months or less and money market funds to be cash equivalents. Cash and cash
equivalents include interest bearing deposits of $3,645 and $9,392 at September
30, 1997, and 1996, respectively.
Debt and Equity Securities
The Corporation classifies its investments, including marketable equity
securities, mortgage-backed securities, and mortgage-related securities,
in one of three categories: Trading Account Securities Securities held
principally for resale in the near term, are classified as trading
account securities and recorded at their fair values. Unrealized gains
and losses on trading account securities are included in other income.
The Corporation did not hold any trading securities at September 30, 1997
or 1996.
Securities Held to Maturity
Debt securities which the Corporation has the positive intent and ability
to hold to maturity are reported at cost, adjusted for premiums and
discounts that are recognized in interest income using the interest
method over the period to maturity. Unrealized losses on held to maturity
securities reflecting a decline in value judged to be other than
temporary are charged to income.
Securities Available for Sale
Available for sale securities consist of equity securities and certain
debt securities not classified as trading securities nor as held to
maturity securities. Unrealized holding gains and losses, net of income
taxes, on available for sale securities are reported as a net amount in a
separate component of shareholders' equity until realized. Gains and
losses on the sale of available for sale securities are determined using
the specific identification method. Any decision to sell available for
sale securities would be based on various factors, including movements in
interest rates, changes in the maturity mix of the Corporation's assets
and liabilities, liquidity demands, regulatory capital considerations,
and other similar factors. Premiums and discounts are recognized in
interest income using the interest method over the period to maturity.
Unrealized losses on available for sale securities reflecting a decline
in value judged to be other than temporary are charged to income.
22
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The Corporation adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" as of October 1, 1994. Prior to the adoption of SFAS No. 115, the
Corporation classified and accounted for its held to maturity debt securities
using the same criteria required by SFAS No. 115. Held for sale debt securities
were carried at the lower of cost or market with unrealized losses thereon
included in the determination of net income. Marketable equity securities were
recorded at the lower of cost or market with unrealized losses recorded as a
reduction in retained earnings. Upon adoption of SFAS No. 115, held for sale
debt securities were reclassified as available for sale. The cumulative effect
of the change in accounting method for debt securities is reported, net of
income tax, in the consolidated statements of income and the consolidated
statements of changes in stockholders' equity.
The Bank, as a member of the Federal Home Loan Bank System, is required to
maintain an investment in capital stock of the Federal Home Loan Bank of Des
Moines (FHLB) in varying amounts based on balances of outstanding home loans and
on amounts borrowed from the FHLB. Because no ready market exists for this
stock, and it has no quoted market value, the Bank's investment in this stock is
carried at cost.
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. Net
unrealized losses are recognized through a valuation allowance by charges to
income.
Loans Receivable
Loans receivable that management has the intent and ability to hold for the
forseeable future or until maturity or pay-off are reported at their outstanding
principal adjusted for any charge-offs, the allowance for loan losses, and any
deferred fees or costs on originated loans and unamortized premiums or discounts
on purchased loans. Discounts and premiums on purchased residential real estate
loans are amortized to income using the interest method over the remaining
period to contractual maturity, adjusted for anticipated prepayments. Discounts
and premiums on purchased consumer loans are recognized over the expected lives
of the loans using the level yield method.
The allowance for loan losses is increased by charges to income and decreased by
charge-offs (net of recoveries). Management's periodic evaluation of the
adequacy of the allowance is based on the Bank'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 economic conditions. Loans are considered impaired if full principal
or interest payments are not anticipated in accordance with the contractual loan
terms. Impaired loans are carried at the present value of expected future cash
flows discounted at the loan's effective interest rate or at the fair value of
the collateral if the loan is collateral dependent. A portion of the allowance
for loan losses is allocated to impaired loans if the value of such loans is
deemed to be less than the unpaid balance. If these allocations cause the
allowance for loan losses to require an increase, such increase is reported as a
component of the provision for loan losses.
Uncollectible interest on loans that are contractually past due for three months
is charged off or an allowance is established, based on management's periodic
evaluation. The allowance is established by a charge to interest income equal to
all interest previously accrued, and income is subsequently recognized only to
the extent cash payments are received until, in management's judgment, the
borrower's ability to make periodic interest and principal payments returns to
normal, in which case the loan is returned to accrual status.
Loan origination fees and certain direct origination costs are capitalized with
the net fee or cost recognized as an adjustment to interest income using the
interest method.
Foreclosed Real Estate
Real estate properties acquired through, or in lieu of, loan foreclosure are
initially recorded at fair value at the date of foreclosure establishing a new
cost basis. After foreclosure, valuations are periodically performed by
management and the real estate is carried at the lower of carrying amount or
fair value minus estimated costs to sell. Revenue and expenses from operations
and changes to the valuation allowance are included in operations.
Income Taxes
Deferred tax assets and liabilities are reflected at currently enacted income
tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.
Premises and Equipment
Land is carried at cost. Buildings, leasehold improvements and equipment are
carried at cost, less accumulated depreciation and amortization. Buildings and
equipment are depreciated using the straight-line method over the estimated
useful lives of the assets. The cost of leasehold improvements is being
amortized using the straight-line method over the terms of the related leases.
Net gains and losses on disposal or retirement of premises and equipment are
included in other income.
23
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Mortgage Loan-Servicing Assets
The Bank adopted SFAS No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" for transactions entered
into after December 31, 1996. SFAS No. 125 established accounting and reporting
standards for transfers and servicing of financial assets and extinguishments of
liabilities based on the consistent application of the financial-components
approach. This approach requires the recognition of financial assets and
servicing assets that are controlled by the reporting entity, and the
derecognition of financial assets and liabilities when control is extinguished.
Liabilities and derivatives incurred or obtained by transferors in conjunction
with the transfer of financial assets are measured at fair value, if
practicable. Servicing assets and other retained interest in transferred assets
are measured by allocating the carrying amount between the assets sold and the
interest retained, based on their relative fair value. The adoption of SFAS No.
125 did not have a material effect on the Bank's operations for the year ended
September 30, 1997.
The cost of mortgage servicing assets is amortized in proportion to, and over
the period of, estimated net servicing revenues. Impairment of mortgage
servicing assets is assessed based on the fair value of those rights. Fair
values are estimated using discounted cash flows based on a current market
interest rate. The Bank evaluates the mortgage servicing rights strata for
impairment by estimating the fair value based on anticipated future net cash
flows, taking into consideration prepayment predictions. The predominant
characteristics used as the basis for stratifying are loan types, period of
origination, and interest rates. The amount of impairment recognized is the
amount by which the capitalized mortgage servicing assets for a stratum exceed
their fair value.
For servicing contracts in existence before January 1, 1997, previously
recognized servicing rights and "excess servicing" receivables not exceeding
contractually specified servicing fees were combined, net of any previously
recognized servicing obligations, as a servicing asset.
Earnings Per Share
Earnings per share of common stock has been determined by dividing the income
before cumulative effect of change in accounting principle and net income by the
weighted average number of shares of common stock and common stock equivalents
outstanding during the year. Stock options are regarded as common stock
equivalents computed using the treasury stock method. Shares acquired by the
employee stock benefit plans are not considered in the weighted average shares
outstanding until shares are committed to be released to an employee's
individual account or have been earned. The difference between primary and fully
diluted earnings per share is not material.
Treasury Stock
Treasury stock is recorded at cost. In the event of subsequent reissue, the
treasury stock account will be reduced by the cost of such stock on the average
cost basis with any excess proceeds credited to additional paid-in capital.
Treasury stock is available for general corporate purposes.
Stock-Based Compensation
SFAS No. 123, "Accounting for Stock-Based Compensation," establishes a new fair
value-based accounting method for stock-based compensation plans. As permitted
by SFAS No. 123, management has elected to continue measuring compensation costs
based on the intrinsic value method as prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees," by providing pro forma net income
and pro forma earnings per share disclosures for stock options granted after
October 1, 1995.
Fair Values of Financial Instruments
The following methods and assumptions were used by the Corporation in estimating
fair values of financial instruments as disclosed herein:
Cash and cash equivalents - The carrying value of cash and cash
equivalents approximate fair value. Debt and equity securities - Fair
values of debt and equity securities have been estimated using quoted
market prices. Loans receivable - For variable-rate loans, loans with
balloon
maturities, loans with relatively near-term maturities (such as
consumer installment loans) carrying values approximate fair
values. The fair value of long-term fixed rate loans has been
estimated using present value cash flows, discounted at a rate
approximating current market rates and giving consideration to
estimated prepayment risk and credit loss factors. The estimated
fair value of loans held for sale is based on quoted market prices
of similar instruments trading in the secondary market.
Originated mortgage servicing rights - The carrying amounts of originated
mortgage servicing rights approximate fair values. Accrued interest - The
carrying amounts of accrued interest receivable approximate their fair
values Deposit liabilities - The fair values of demand deposits are, by
definition, equal to the amount payable on demand at the reporting
date (that is, their carrying amounts). The carrying amounts of
variable-rate, fixed-term money market accounts and certificates of
deposits approximate their fair values at the reporting date. Fair
values for fixed-rate certificates of deposit are estimated using a
discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated
expected monthly maturities on time deposits.
24
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Short-term borrowings - The carrying amounts of advances from the Federal
Home Loan Bank (FHLB) of Des Moines maturing within 90 days approximate their
fair values.
Long-term borrowings - The carrying amounts of amounts of long-term
borrowings are estimated using discounted cash flow analyses based
on the Bank's current incremental borrowing rates for similar types
of borrowing arrangements.
Off-balance-sheet items - Fair value for off-balance-sheet lending
commitments are based on fees currently charged to enter into
similar agreements, taking into account the remaining terms of the
agreements and the counterparties' credit standings. The carrying
value and fair value of commitments to extend credit are not
material.
(2) Debt and Equity Securities (in thousands)
Debt and equity securities have been classified in the consolidated balance
sheets according to management's intent. The carrying amount of securities and
their approximate fair values at September 30 are presented as follows:
<TABLE>
<CAPTION>
eptember 30,
1997
------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Available for sale securities:
Equity securities
Fund Investments $ 12,522 $ - $ 325 $ 12,197
Stock in FHLB 6,692 - - 6,692
Preferred Stock 399 23 - 422
-------------- ----------------- ----------------- -----------------
Total $ 19,613 $ 23 $ 325 $ 19,311
============== ================= ================= =================
Mortgage backed securities:
REMICs $ 16,980 $ - $ 281 $ 16,699
============== ================= ================= =================
Debt Securities: $ 1,000 $ - $ - $ 1,000
============== ================= ================= =================
Held to maturity securities:
Debt securities:
U.S. Government and Agency $ 37,876 $ 372 $ 1,183 $ 37,065
============== ================= ================= =================
Mortgage backed securities:
REMICs $ 38,469 $ 90 $ 1,103 $ 37,456
GNMA certificates 63 8 - 71
FHLMC certifiactes 7 1 - 8
-------------- ----------------- ----------------- -----------------
Total $ 38,539 $ 99 $ 1,103 $ 37,535
============== ================= ================= =================
</TABLE>
25
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The amortized cost of debt and mortgage-backed securities at September 30, 1997,
included unamortized premiums of $241 and unaccreted discounts of $444,
respectively. <TABLE> <CAPTION>
September 30,
1996
--------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Available for sale securities:
Equity securities
Fund Investments $ 12,522 $ - $ 426 $ 12,096
Stock in FHLB 5,736 - - 5,736
Preferred Stock 398 1 - 399
---------------- ----------------- ----------------- -----------------
Total $ 18,656 $ 1 $ 426 $ 18,231
================ ================= ================= =================
Mortgage backed securities:
REMICs $ 16,980 $ - $ 644 $ 16,336
================ ================= ================= =================
Held to maturity securities:
Debt securities:
U.S. Government and Agency $ 44,349 $ 30 $ 2,753 $ 41,626
================ ================= ================= =================
Mortgage backed securities:
REMICs $ 38,468 $ 46 $ 1,693 $ 36,821
GNMA certificates 80 4 - 84
FHLMC certifiactes 9 1 - 10
---------------- ----------------- ----------------- -----------------
Total $ 38,557 $ 51 $ 1,693 $ 36,915
================ ================= ================= =================
</TABLE>
The amortized cost of debt and mortgage backed securities at September 30, 1996,
includes unamortized premiums of $255 and unaccreted discounts of $462,
respectively.
There were no sales of securities during the three years ended September 30,
1997.
The scheduled maturities of securities held-to-maturity and securities (other
than equity securities) available-for-sale at September 30, 1997, were as
follows: <TABLE> <CAPTION>
Held-to-Maturity Available-for-Sale
Securities Securities
------------------------------------ ------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Due in one year or less $ 2,500 $ 2,510 $ - $ -
Due from one to five years 11,070 11,012 1,000 1,000
Due from five to ten years 13,132 12,537 - -
Due after ten years 49,713 48,541 16,980 16,699
---------------- ----------------- ----------------- -----------------
Total $ 76,415 $ 74,600 $ 17,980 $ 17,699
================ ================= ================= =================
</TABLE>
For purposes of the maturity table, mortgage-backed securities, which are not
due at a single maturity date, have been allocated over maturity groupings based
on the weighted-average contractual maturities of underlying collateral. The
mortgage-backed securities may mature earlier than their weighted-average
contractual maturities because of principal prepayments.
Debt and mortgage-backed securities carried at approximately $27.5 million at
September 30, 1997 and $26.9 million at September 30, 1996, were pledged to
secure public deposits and for other purposes required or permitted by law.
26
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(3) Loans Receivable (in thousands)
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
September 30,
--------------------------------------
1997 1996
---------------- -------------------
<S> <C> <C>
First mortgage loans:
Secured by one-to-four family residences $ 170,218 $ 149,659
Secured by other properties 28,364 14,996
Construction and land development loans 34,384 27,070
---------------- -------------------
232,966 191,725
Less:
Undisbursed portion of construction and land development loans (20,364) (13,401)
Unearned discounts (22) (23)
Net deferred loan origination fees (866) (889)
---------------- -------------------
Sub-total first mortgage loans 211,714 177,412
Consumer and other loans:
Consumer loans 19,440 17,709
Home equity and second mortgages 20,812 15,430
Commercial 8,114 6,234
Secured by savings 977 563
---------------- -------------------
49,343 39,936
Add: net deferred loan origination costs 185 155
---------------- -------------------
Sub-total consumer and other loans 49,528 40,091
---------------- -------------------
Sub-total all loans 261,242 217,503
Less: allowance for loan losses (852) (776)
---------------- -------------------
Total $ 260,390 $ 216,727
================ ===================
</TABLE>
A summary of the activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
Years Ended September 30,
-------------------------------------------------------------
1997 1996 1995
------------------- ---------------- -------------------
<S> <C> <C> <C>
Balance, beginning of period $ 776 $ 764 $ 748
Provision for losses 120 42 24
Charge-offs (50) (34) (20)
Recoveries 6 4 12
------------------- ---------------- -------------------
Balance, end of period $ 852 $ 776 $ 764
=================== ================ ===================
</TABLE>
Recorded investments in impaired loans were $82 at September 30, 1997, and $145,
at September 30, 1996. The average recorded investment in impaired loans during
1997 and 1996 was $137 and $111, respectively. The total allowance for loan
losses related to these loans was $3 and $2, on September 30, 1997, and 1996,
respectively. No interest income on these loans was recognized or received in
1997 and 1996.
Loans having carrying values of $20 and $74 were transferred to foreclosed real
estate in 1997 and 1996, respectively.
The Bank is not committed to lend additional funds to debtors whose loans have
been modified.
The aggregate amount of loans to executive officers and directors of the
Corporation were $639, and $648 at September 30, 1997, and 1996, respectively.
During 1997 repayments on loans to executive officers and directors aggregated
$56 and loans originated aggregated $106.
27
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(4) Loan Servicing (in thousands)
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid principal balances of
these loans serviced for others was $42,734 and $41,133 at September 30, 1997
and 1996, respectively.
Custodial escrow balances maintained in connection with the foregoing loan
servicing, and included in demand deposits, were approximately, $237 and $235 at
September 30, 1997 and 1996, respectively.
Capitalized mortgage servicing assets are summarized as follows:
<TABLE>
<CAPTION>
Years Ended Spetember 30,
-------------------------------------------------------------
1997 1996 1995
------------------- ---------------- -------------------
<S> <C> <C> <C>
Beginning balance,net of accumulated amortization $ 157 $ 155 $ 163
Amounts capitalized 20 23 3
Amortization (30) (18) (9)
Valuation adjustments 1 (3) (2)
------------------- ---------------- -------------------
Balance, end of period $ 148 $ 157 $ 155
=================== ================ ===================
</TABLE>
(5) Foreclosed Real Estate (in thousands)
Gain on foreclosed real estate, including net revenues from operations, was not
material for the three years ended September 30, 1996. The Bank held foreclosed
real estate at September 30, 1997 amounting to $72, which is included in other
assets.
(6) Premises and Equipment (in thousands)
Premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
September 30,
--------------------------------------
1997 1996
---------------- -------------------
<S> <C> <C>
Land $ 490 $ 490
Buildings and improvements 3,693 3,552
Furniture, equipment and automobiles 2,685 2,740
Leasehold improvements 40 40
---------------- -------------------
Total costs 6,908 6,822
Less accumulated depreciation 3,136 3,094
---------------- -------------------
Total $ 3,772 $ 3,728
================ ===================
</TABLE>
At September 30, 1997, the Bank was obligated under noncancelable operating
leases for office space. Net rental expense under operating leases, included in
occupancy and equipment, was $58, $59, and $69 for the years ended September 30,
1997, 1996, and 1995, respectively.
The projected minimum rental commitments under the terms of the leases at
September 30, 1997, are as follows:
<TABLE>
<CAPTION>
Rental Income Rental Expense
Fiscal as Lessor as Lessee
------------------- -------------------
<S> <C> <C>
1998 $ 23 $ 31
1999 19 31
2000 5 -
------------------- -------------------
$ 47 $ 62
=================== ===================
</TABLE>
28
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(7) Deposits (in thousands)
The aggregate amount of short-term jumbo CDs, each with a minimum denomination
of $100,000, was approximately $30,938 and $16,008 in 1997 and 1996
respectively.
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
September 30,
-------------------------------------------------------------
1997 1996 1995
------------------- ---------------- -------------------
<S> <C> <C> <C>
Savings accounts $ 1,548 $ 1,576 $ 1,669
Demand deposits 389 443 673
Certificates of deposit 7,402 6,243 4,411
------------------- ---------------- -------------------
$ 9,339 $ 8,262 $ 6,753
=================== ================ ===================
</TABLE>
At September 30, 1997, the scheduled maturities of certificates of deposit are
as follows:
<TABLE>
<CAPTION>
<S> <C>
Years Ending September 30,
1998 $ 75,639
1999 38,693
2000 16,408
2001 578
2002 and thereafter 1,022
----------------
$ 132,340
================
</TABLE>
(8) Federal Home Loan Bank Borrowings (in thousands)
Borrowings by the Bank from the Federal Home Loan Bank of Des Moines (FHLB) are
summarized as follows:
<TABLE>
<CAPTION>
September 30,
--------------------------------------------------------------------------------
1997 1996
--------------------------------------- --------------------------------------
Fiscal Year of Maturity - Advances Weighted Weighted
- ----------------------------------
Amount Rate Amount Rate
------------------- ---------------- ------------------- ----------------
<S> <C> <C> <C> <C>
1997 $ - - % $ 22,100 5.74 %
1998 90,400 5.75 56,900 5.80
1999 13,000 6.03 3,000 6.55
2000 7,417 6.11 7,693 6.11
2001 15,000 6.00 15,000 6.00
------------------- -------------------
Total 125,817 104,693
Line of Credit from FHLB 8,000 variable 10,000 variable
------------------- ---------------- ------------------- ----------------
$ 133,817 5.83 $ 114,693 5.88
=================== ================ =================== ================
</TABLE>
At September 30, 1997, borrowed funds are collateralized by stock in the FHLB,
first mortgage loans with carrying value of $169,321 and debt and
mortgage-backed securities with carrying values of $50,869 under a collateral
agreement. The line of credit has a variable rate of interest that is adjusted
daily based on the FHLB's short-term investment return. The interest rate on the
line of credit was 5.75% and 6.18% at September 30, 1997, and 1996,
respectively. The total amount available to the Bank on its line of credit was
$17,000 and $15,000 at September 30, 1997 and 1996, respectively.
(9) Employee and Stock Benefit Plans (in thousands except shares)
Salary Continuation Plans
The Bank has adopted insured salary continuation plans for the benefit of
selected members of management by providing them with retirement and death
benefits. The estimated liability under the agreements is charged to income over
the expected remaining years of employment. The Bank's policy is to fund the
costs accrued with insurance contracts. Salary continuation expense amounted to
$142, $134, and $141 for the three years ended September 30, 1997, respectively.
29
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Employee Stock Ownership Plan
At the time of the stock conversion, the Bank established an Employee Stock
Ownership Plan (ESOP) covering all employees, over the age of 21, with at least
one year of service and who work at least 1,000 hours during a plan year. The
ESOP borrowed funds from the Corporation to purchase a total of 359,720 shares
of the Corporation's Common Stock, the loan being collateralized by the Common
Stock. Contributions by the Bank, along with dividends received on unallocated
shares, are being used to repay the loan with shares being released from the
Corporation's lien proportional to the loan repayments. Annually, on September
30, the released shares are allocated to the participants in the same proportion
that their wages bear to the total compensation of all of the participants.
Unreleased ESOP shares are not considered outstanding in calculating earnings
per share.
The Corporation presents these financial statements in accordance with the AICPA
Statement of Position (SOP) No. 93-6, "Employers' Accounting for Employee Stock
Ownership Plans." The price of the shares issued and unreleased are charged to
unearned compensation, a contra-equity account, and shares released are reported
as compensation expense equal to the current market value price of the released
shares. Dividends paid on allocated shares are charged to retained earnings and
those on unallocated shares are charged to expense. The total amount charged to
expense in the fiscal year ended September 30, 1997, 1996 and 1995 was $549,
$449 and $525, respectively.
A summary of the ESOP share allocation is as follows:
<TABLE>
<CAPTION>
September 30,
----------------------------------------------------------
1997 1996 1995
------------------- ------------------- --------------
<S> <C> <C> <C>
Shares allocated beginning of year 87,870 49,461 -
Shares allocated during year 37,105 38,409 49,461
Unreleased shares 234,745 271,850 310,259
------------------- ---------------- --------------
Total ESOP 359,720 359,720 359,720
=================== ================ ==============
Fair value of unreleased shares $ 4,607 $ 3,466 $ 4,074
=================== ================ ==============
</TABLE>
Management Stock Plan
The Bank established the Management Stock Plan (MSP) for key officers during the
year ended September 30, 1995. Following shareholder approval of the MSP on
January 17, 1995, the Bank purchased 179,860 shares of the Corporation's common
stock in the open market at $10.59 per share to be awarded to officers in
accordance with the provisions of the MSP. The cost of the shares awarded under
these plans are recorded as unearned compensation, a contra equity account, and
are recognized as an expense in accordance with the vesting requirements under
the plan. For the fiscal year ended September 30, 1997, 1996 and 1995, the
amount included in compensation expense was $290, $290 and $218, respectively.
<TABLE>
<CAPTION>
Unawarded Awarded
Shares Shares
------------------- ----------------
<S> <C> <C>
Purchased by Plan 179,890 -
Granted (136,896) 136,896
Vested - -
------------------- ----------------
At September 30, 1995 42,964 136,896
Granted - -
Vested - 27,379
------------------- ----------------
At September 30, 1996 42,964 109,517
------------------- ----------------
Granted - -
Vested - 27,379
------------------- ----------------
At September 30, 1997 42,964 82,138
=================== ================
</TABLE>
Stock Option Plan
The Corporation established a stock option plan for directors, officers and
employees. The stock option plan was approved by shareholders on January 17,
1995, and in accordance with the terms of the plan, the exercise price was
established at $9.50 per share, the fair market price on the date of shareholder
approval. Awards made under the plan may be incentive stock options as defined
by Section 422 of the Internal Revenue Code of 1986 or options that do not
qualify. All options expire on January 16, 2005.
30
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The following table summarizes the stock option transactions:
<TABLE>
<CAPTION>
Available Options
for Grant Outstanding
------------------- ----------------
<S> <C> <C>
At inception 449,650 -
Granted (442,163) 442,163
Exercised - (3,405)
------------------- ----------------
At September 30, 1995 7,487 438,758
Granted - -
Exercised - (6,000)
------------------- ----------------
At September 30, 1996 7,487 432,758
------------------- ----------------
Granted - -
Exercised - (5,405)
Cancelled - (1,500)
------------------- ----------------
At September 30, 1997 7,487 425,853
=================== ================
</TABLE>
(10) Income Taxes (in thousands)
The Corporation and its Subsidiary file consolidated income tax returns. Income
tax expense (benefit) is summarized as follows:
<TABLE>
<CAPTION>
September 30,
-------------------------------------------------------------
1997 1996 1995
------------------- ---------------- -------------------
<S> <C> <C> <C>
Current
Federal $ 1,533 $ 1,263 $ 1,274
State 498 403 424
------------------- ---------------- -------------------
Subtotal 2,031 1,666 1,698
------------------- ---------------- -------------------
Deferred
Federal 55 (423) (148)
State 19 (142) (49)
------------------- ---------------- -------------------
Subtotal 74 (565) (197)
------------------- ---------------- -------------------
Total income tax provision $ 2,105 $ 1,101 $ 1,501
=================== ================ ===================
</TABLE>
The State of Minnesota follows the Internal Revenue Code for the determination
of taxable income, in connection with temporary differences. The State portion
of deferred tax assets and liabilities is approximately 25 percent.
The Bank was allowed a bad debt deduction, in determining income tax for tax
purposes, based on specific formulas or a percentage of taxable income before
such deduction. On August 21, 1996 legislation was signed into law which
repealed the percentage of taxable income method for the tax bad debt deduction.
The repeal is effective for the Bank's taxable year beginning October 1, 1996.
In addition, the legislation requires the Bank to include in taxable income its
bad debt reserves in excess of its base year reserves (pre-1988 reserves) over a
six, seven, or eight year period depending upon the attainment of certain loan
origination levels. Since the percentage of taxable income method for the bad
debt tax deduction and the corresponding increase in the tax bad debt reserve in
excess of base year have been recorded as temporary differences, this change in
the tax law will not effect the Corporation's consolidated statement of income.
31
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Temporary differences between the financial statement carrying amounts and the
tax basis of assets and liabilities that can create deferred tax assets and
liabilities are as follows: <TABLE> <CAPTION>
September 30,
--------------------------------------
1997 1996
---------------- -------------------
<S> <C> <C>
Deferred tax assets:
Deferred compensation $ 530 $ 396
Deferred net loan fees 336 297
Deferred SAIF premium - 417
Securities unrealized loss 227 423
Allowance for loan losses 344 314
---------------- -------------------
Subtotal 1,437 1,847
Less: Valuation allowance 131 172
---------------- -------------------
Total 1,306 1,675
---------------- -------------------
Deferred tax liabilities:
FHLB Stock 241 241
Tax bad debt reserve 256 252
Premises and equipment 302 273
Installment obligation sale of former building 29 30
Mortgage servcing rights 14 8
Discount on loans 11 21
Section 475 "For Sale Assets" 105 273
---------------- -------------------
Total 958 1,098
---------------- -------------------
Net deferred tax asset $ 348 $ 577
================ ===================
</TABLE>
The valuation allowance was established to reduce the deferred tax asset related
to the unrealized loss on equity securities because management is uncertain that
more likely than not it will be realized. The Bank has paid sufficient taxes in
prior carryback years which will enable it to recover the balance of the net
deferred tax assets, and therefore, no additional valuation allowance was
required at September 30, 1997 and 1996.
The actual income tax expense varied from the expected tax expense
(computed by applying the United States federal corporate income tax rate
of 34 percent to earnings before income taxes) as follows:
<TABLE>
<CAPTION>
Years Ended September 30,
---------------------------------------------------------
1997 1996 1995
---------------- ------------------- ----------------
<S> <C> <C> <C>
Computed "expected" tax expense $ 1,778 $ 941 $ 1,273
Exempt dividends (8) (20) (5)
State income taxes, net of federal tax benefit 341 173 247
Other, net (6) 7 (14)
---------------- ------------------- ----------------
Total income tax provision $ 2,105 $ 1,101 $ 1,501
================ =================== ================
</TABLE>
Retained earnings at September 30, 1997, includes $6,492 for which no deferred
federal income tax liability has been recognized. This amount represents an
allocation of income to bad-debt deductions for tax purposes only that arose in
tax years beginning before September 30, 1988, (that is, the base-year amount).
Reduction of the amount so allocated for purposes other than tax bad-debt losses
or adjustments arising from this carryback of net operating losses would create
income for tax purposes only, which would be subject to the then-current
corporate income-tax rate. The unrecorded deferred income-tax liability on the
above amount was approximately $2,600 at September 30, 1997.
(11) Contingencies (in thousands)
Loans Sold
During 1982, the Bank sold loans subject to recourse provisions. The balance of
these loans at September 30, 1997, and 1996 was $302 and $413, respectively. The
loans had interest rates ranging from 9.50% to 9.875% with an original balance
of $3,400 and were sold to FHLMC.
32
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(12) Stockholders' Equity and Regulatory Capital (in thousands)
On October 6, 1994, the Bank converted from a federally chartered mutual savings
and loan association to a federally chartered stock savings bank pursuant to a
Plan of Conversion (the Conversion) via the issuance of common stock. The Bank
received $64.4 million in subscriptions for common stock in the Corporation and
an order for 359,720 shares of common stock from the Employee Stock Ownership
Plan (the ESOP). In conjunction with the Conversion, the Corporation sold
4,496,500 shares of common stock which, after giving effect to offering expenses
of $1.5 million, resulted in net proceeds of $44.0 million and refunds of $23.0
million of the stock subscription proceeds held at September 30, 1994. Pursuant
to the Conversion, the Bank transferred all of its outstanding shares to a newly
organized holding company, FSF Financial Corp., in exchange for 50% of the net
proceeds.
Upon the Conversion, the preexisting liquidation rights of the depositors of the
Bank were unchanged. Such rights are accounted for by the Bank for the benefit
of such depositors in proportion to their liquidation interests as of the
Eligibility Record Date or the Supplemental Eligibility Record Date, as defined,
in the Conversion.
The Bank is subject to various regulatory capital requirements administered by
the Office of Thrift Supervision (OTS). 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 Bank's financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank's assets, liabilities and certain off-balance sheet items as calculated
under regulatory accounting practices. The Bank's 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 Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets (as defined), and of tangible and Tier 1 capital (as
defined) to adjusted total assets (as defined). Management believes, as of
September 30, 1997, that the Bank meets all capital adequacy requirements to
which it is subject.
As of September 30, 1997, and 1996, the most recent notification from the OTS
categorized the Bank as "well capitalized" under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Bank must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios
as set forth in the table below. There are no conditions or events since that
notification that management believes have changed the institution's category.
The Bank's actual regulatory capital amounts, with reconciliation to the
Corporation's investment in the Bank determined in accordance with Generally
Accepted Accounting Principles (GAAP), and ratios, are also presented in the
tables below. <TABLE> <CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------ ---------------------------- ------------------------
<S> <C> <C> <C> <C> <C> <C>
GAAP captial, September 30, 1997 $ 38,440
Add: Unrealized losses on debt
securities held for sale 168
----------
Tangible capital and ratio to
adjusted total assets $ 38,608 10.1% $ 5,754 1.5%
------------------------ ----------------------------
Tier 1 (Core) capital and ratio to
adjusted total assets $ 38,608 10.1% $ 11,509 3.0% $ 19,181 5.0%
------------------------ ---------------------------- ------------------------
Tier 1 capital and ratio to
risk-weighted assets $ 38,608 18.8% $ 8,221 4.0% $ 12,331 6.0%
-------------- ---------------------------- ------------------------
Tier 2 capital, allowance for loan losses 852
----------
Total risk-based capital and ratio to
risk-weighted assets, September 30, 1997 $ 39,460 19.2% $ 16,523 8.0% $ 20,654 10.0%
======================== ============================ ========================
</TABLE>
33
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------ ---------------------------- -----------------------
<S> <C> <C> <C> <C> <C> <C>
GAAP captial, September 30, 1996 $ 38,856
Add: Unrealized losses on debt
securities held for sale 383
----------
Tangible capital and ratio to
adjusted total assets $ 39,239 11.3% $ 5,218 1.5%
------------------------ ----------------------------
Tier 1 (Core) capital and ratio to
adjusted total assets $ 39,239 11.3% $ 10,436 3.0% $ 17,393 5.0%
------------------------ ---------------------------- -----------------------
Tier 1 capital and ratio to
risk-weighted assets $ 39,239 22.3% $ 7,023 4.0% $ 10,534 6.0%
-------------- ---------------------------- -----------------------
Tier 2 capital, allowance for loan losses 776
----------
Total risk-based capital and ratio to
risk-weighted assets, September 30, 1996 $ 40,015 22.8% $ 14,046 8.0% $ 17,557 10.0%
======================== ============================ =======================
</TABLE>
The Bank may not declare or pay cash dividends to the Corporation if the effect
would be to reduce GAAP capital below applicable regulatory capital requirements
or if such declaration and payment would otherwise violate regulatory
requirements.
(13) Concentration of Credit Risk (in thousands)
The Bank is primarily engaged in originating real estate loans in the Minnesota
counties of McLeod, Dakota, Meeker, Wright, Carver, Washington and Sibley. The
Bank offers fixed and adjustable rates of interest on these loans which have
amortization terms ranging up to thirty years. In addition, the Bank purchases
loans secured by one-to-four family residences located within Minnesota which
have been originated by other financial institutions. The loans are generally
originated on the basis of not more than an 80% loan-to-value ratio, which has
historically provided the Bank with more than adequate collateral coverage in
the event of default. Nevertheless, the Bank, as with any lending institution,
is subject to the risk that real estate values in the primary lending area will
deteriorate, thereby potentially impairing collateral values in the primary
lending area. However, management believes that real estate values are presently
stable in its primary lending area and that loan loss allowances have been
provided for in amounts commensurate with its current perception of the
foregoing risks in the portfolio.
The Corporation had cash on deposit in a financial institution in excess of
Federal deposit insurance limits of approximately $1,367 at September 30, 1997.
(14) Financial Instruments (in thousands)
The Corporation is party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit and forward commitments to
purchase securities. Those instruments involve, to varying degrees, elements of
credit and interest-rate risk in excess of the amount recognized in the
statement of financial position. The contract or notional amount of those
instruments reflect the extent of the Bank's involvement in particular classes
of financial instruments.
The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual notional amount of those
instruments. The Bank uses the same credit policies in making commitments and
conditional obligations as it does for on-balance sheet instruments.
Commitments to extend credit are unused lines of credit and loan commitments
which are agreements to lend to a customer as long as there is no violation of
any condition established in the contract. Since some of the commitments may be
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Bank evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if it is deemed necessary by the Bank upon extension of credit, is
based on management's credit evaluation of the counterparty. Collateral held
varies but may include accounts receivable, inventory, property, plant and
equipment, and income producing commercial properties. Standby letters of credit
are conditional commitments issued by the Bank to guarantee the performance of a
customer to a third party. The credit risk involved in issuing letters of credit
is essentially the same as that involved in extending loan facilities to
customers. Typically, the Bank issues letters of credit to municipalities and
generally does not require collateral for standby letters of credit.
34
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Forward commitments to purchase securities and mortgages involve an agreement
whereby the seller agrees to make delivery at a specified future date of a
specified instrument, at a specified price or yield. Risks arise from the
possible inability of counterparties to meet the terms of their contracts and
from movements in securities values and interest rates.
Forward commitments to sell mortgages involve an agreement whereby the bank
agrees to make delivery at a specified future date of a specified loan, at a
specified price or yield. Risks arise from the possible inability on
counterparties to meet the terms of their contracts and from movements in loan
values and interest rates.
A summary of the notional amounts of the Bank's financial instruments at
September 30, 1997 follows:
Commitments to extend credit $ 18,264
Standby letters of credit
118
Forward commitments to purchase loans
80
The carrying value and fair value of the Corporation's financial assets and
financial liabilities are as follows:
<TABLE>
<CAPTION>
September 30,
--------------------------------------------------------------------------------
1997 1996
--------------------------------------- --------------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial assets:
Cash & cash equivalents $ 6,135 $ 6,135 $ 11,756 $ 11,756
Investment securities 58,187 57,376 62,580 59,857
Mortgage-backed and related securities 55,238 54,234 54,893 53,251
Loans held for sale 204 220 443 453
Loans receivable, net 260,390 259,994 216,727 216,427
Accrued interest receivable 2,436 2,436 2,325 2,325
Financial liabilities:
Deposits 208,246 208,487 189,074 189,300
Borrowings 133,817 134,060 114,693 114,797
</TABLE>
(15) Effects of New Financial Accounting Standards
SFAS No. 128, "Earnings per Share" - issued February 1997, establishes standards
for computing and presenting earnings per share (EPS). It simplifies prior
standards by replacing primary earnings per share with basic earnings per share
and by altering the calculation of diluted EPS, which replaces fully diluted
EPS. SFAS No. 128 is effective for financial statements issued after December
15, 1997, including interim periods.
SFAS No. 130, "Reporting Comprehensive Income" - issued June 1997, establishes
standards for reporting and displaying comprehensive income and its components
in general-purpose financial statements. Comprehensive income includes net
income and several other items that current accounting standards require to be
recognized outside of net income. This statement requires entities to display
comprehensive income and its components in the financial statements, with
presentation of the accumulated balances of other comprehensive income reported
in stockholders' equity separately from retained earnings and additional paid-in
capital. SFAS No. 130 is effective for fiscal years beginning after December 15,
1997. Reclassification of financial statements for earlier periods that are
presented for comparative purposes is required.
SFAS No. 131, "Disclosures about Segments of and Enterprise and Related
Information" - issued June 1997, requires public business enterprises to report
information about their operating segments in a complete set of financial
statements to shareholders. This statement also requires entities to report
enterprise-wide information about their products and services, their activities
in different geographic areas, and their reliance on major customers. Certain
segment information is also to be reported in interim financial statements. The
basis for determining an enterprise's operating segments is the manner in which
management operates the business. Specifically, financial information is
required to be reported on the basis that it is used
35
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
internally by the
enterprise's chief operating decision maker in making decisions related to
resource allocation and segment performance. SFAS No. 131 is effective for
financial statements for years beginning after December 15, 1997.
Management believes adoption of the above-described Statements will not have a
material effect on financial position and the results of operations, nor will
adoption require additional capital resources.
(16) Parent Only Condensed Financial Information (in thousands)
This information should be read in conjunction with the other Notes to
Consolidated Financial Statements. Stockholders' equity differs from the
consolidated statements by the amount of consolidating ESOP adjustments. The
investment in the Bank subsidiary is carried net of the Banks' unrealized loss
on securities available for sale.
STATEMENT OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
September 30,
----------------------------------
ASSETS 1997 1996
--------------- ---------------
<S> <C> <C>
Cash and cash equivalents $ 1,412 $ 3,772
Investment securites available for sale 423 399
Investment securities held to maturity 3,062 4,560
Investment in Bank subsidiary 38,440 38,856
Loan to Bank ESOP 2,347 2,719
Other assets 66 76
--------------- ---------------
$ 45,750 $ 50,382
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 41 $ 14
Stockholders' equity:
Common stock 450 450
Additional paid-in capital 43,334 43,150
Unrealized gain on securities available for sale 14 1
Treasury stock (20,267) (13,095)
Unearned MSP stock (1,108) (1,398)
Retained earnings 23,286 21,260
--------------- ---------------
Total stockholders' equity 45,709 50,368
--------------- ---------------
$ 45,750 $ 50,382
=============== ===============
</TABLE>
STATEMENT OF INCOME
<TABLE>
<CAPTION>
Years Ended September 30,
-----------------------------------------------------
Income: 1997 1996 1995
--------------- --------------- ----------------
<S> <C> <C> <C>
Dividends from Bank subsidiary $ 4,202 $ 3,500 $ 1,686
Interest from
Bank's ESOP loan 222 254 306
Investments 343 641 1,072
--------------- --------------- ----------------
4,767 4,395 3,064
Expense:
Non-interest expense 566 474 430
--------------- --------------- ----------------
Income before income taxes and equity in undistributed
net income of Bank subsidiary 4,201 3,921 2,634
Income tax expense (1) 154 380
--------------- --------------- ----------------
4,202 3,767 2,254
Equity (loss) in undistributed net income of Bank subsidiary (1,078) (2,100) 371
--------------- --------------- ----------------
Net income $ 3,124 $ 1,667 $ 2,625
=============== =============== ================
</TABLE>
36
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(16) Parent Only Condensed Financial Information - Continued (In thousands)
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended September 30,
-----------------------------------------------------
1997 1996 1995
--------------- --------------- ----------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net Income $ 3,124 $ 1,667 $ 2,625
Adjustments:
(Equity) loss in undistributed net income of
Bank subsidiary 1,078 2,100 (371)
(Increase) decrease in other assets 10 97 (171)
Increase (decrease)in other liabilities 27 (7) 13
Others 115 85 -
--------------- --------------- ----------------
Net cash provided by operations 4,354 3,942 2,096
--------------- --------------- ----------------
Cash flows from investing activities:
Proceeds from maturities of investments 1,500 8,650 1,000
Purchase of investment securities - (2,559) (12,088)
Loan to ESOP - - (3,597)
Purchase of subsidiary stock
- - (21,735)
--------------- --------------- ----------------
Net cash provided by (used in) investing activities 1,500 6,091 (36,420)
--------------- --------------- ----------------
Cash flows from financing activities:
Net proceeds from sale of stock - - 43,519
Payments received on ESOP bank loan 371 385 494
Purchases of treasury stock (7,245) (10,559) (2,589)
Proceeds from sale of stock 73 52 32
Payments of cash dividends (1,413) (1,758) (1,513)
--------------- --------------- ----------------
Net cash provided by (used in) financing activities (8,214) (11,880) 39,943
--------------- --------------- ----------------
Increase (decrease) in cash and cash equivalents (2,360) (1,847) 5,619
Cash and cash equivalents:
Beginning of year 3,772 5,619 -
--------------- --------------- ----------------
End of year $ 1,412 $ 3,772 $ 5,619
=============== =============== ================
</TABLE>
37
<PAGE>
Selected Quarterly Financial Data (Unaudited)
For Three Years Ended September 30, 1997
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fiscal 1997
Interest income $ 6,564 $ 6,728 $ 6,933 $ 7,090 $ 27,315
Interest expense 3,886 4,011 4,104 4,345 16,346
------------------------------------------------------------------
Net Interest Income 2,678 2,717 2,829 2,745 10,969
Provision for loan losses 30 30 30 30 120
Gain on sale of assets 5 13 15 15 48
Net income $ 722 $ 725 $ 823 $ 854 $ 3,124
Primary earnings per share of common stock:
Net income 0.24 0.25 0.29 0.30 1.06
Cash dividends declared per share $ 0.125 $ 0.125 $ 0.125 0.125 $ 0.50
Market range:
High bid $ 15.13 $ 18.25 $ 18.13 $ 21.00 $ 21.00
Low bid $ 12.75 $ 14.75 $ 16.38 $ 17.25 $ 12.75
Fiscal 1996
Interest income $ 5,488 $ 5,583 $ 5,898 $ 6,275 $ 23,244
Interest expense 3,219 3,335 3,427 3,628 13,609
------------------------------------------------------------------
Net Interest Income 2,269 2,248 2,471 2,647 9,635
Provision for loan losses 6 6 15 15 42
Gain on sale of assets 5 9 3 21 38
Net income $ 421 $ 460 $ 684 $ 103 $ 1,668
Primary earnings per share of common stock:
Net income 0.11 0.13 0.21 0.03 0.48
Cash dividends declared per share $ 0.125 $ 0.125 $ 0.125 0.125 0.50
Market range:
High bid $ 13.50 $ 13.50 $ 13.00 13.25 13.50
Low bid $ 12.38 $ 12.38 $ 11.50 $ 11.38 $ 11.38
Fiscal 1995
Interest income $ 4,451 $ 4,604 $ 4,836 $ 5,188 $ 19,079
Interest expense 1,973 2,149 2,523 2,827 9,472
------------------------------------------------------------------
Net Interest Income 2,478 2,455 2,313 2,361 9,607
Provision for loan losses 6 6 6 6 24
Gain on sale of assets 4 - - 2 6
Net income before cumulative effect of change
in accounting principle 687 565 531 460 2,243
Net income $ 1,069 $ 565 $ 531 $ 460 $ 2,625
Primary earnings per share of common stock:
Net income before cumulative effect of
change in accounting for securities $ 0.17 $ 0.14 $ 0.14 $ 0.12 $ 0.57
Net income 0.26 0.14 0.14 0.12 0.67
Cash dividends declared per share N/A $ 0.125 $ 0.125 $ 0.125 $ 0.375
Market range:
High bid $ 10.50 $ 10.75 $ 12.00 $ 13.13 $ 13.13
Low bid $ 7.50 $ 9.00 $ 10.00 $ 11.13 $ 7.50
</TABLE>
38
<PAGE>
- --------------------------------------------------------------------------------
FSF Financial Corp.
-------------------
Corporate Office
201 Main Street South
Hutchinson, MN 55350-2573
(320) 234-4500
FIRST FEDERAL fsb
-----------------
Office Locations
<TABLE>
<CAPTION>
<S> <C>
Hutchinson Main Office Hastings Office
201 Main Street South 1320 South Frontage Road
Hutchinson, MN 55350-2573 Hastings, MN 55033-2426
(320) 234-4500 (612) 437-6169
Hutchinson South Office Apple Valley Office
905 Hwy. 15 South Frontage Road 14994 Glazier Avenue
Hutchinson, MN 55350 Apple Valley, MN 55124-7498
(320) 234-4563 (612) 432-6840
Buffalo Office Glencoe Office
19 Central Avenue, PO Box 338 1002 Greeley Avenue
Buffalo, MN 55313-0338 Glencoe, MN 55336-2128
(320) 682-3035 (320) 864-5541
Inver Grove Heights Office Litchfield Office
6505 Cahill Avenue East 501 North Sibley Avenue, PO Box 577
Inver Grove Heights, MN 55076-2022 Litchfield, MN 55355-0577
(612) 455-1553 (320) 693-2861
Waconia Office Waite Park Office
200 East Frontage Road, Hwy 5, PO Box 287 113 Waite Avenue South, PO Box 641
Waconia, MN 55387-0287 Waite Park, MN
(612) 442-2141 (320) 656-1133
</TABLE>
Winthrop Office
122 East Second Street, PO Box 424
Winthrop, MN 55396-0424
(507) 647-5356
- --------------------------------------------------------------------------------
39
<PAGE>
<TABLE>
<CAPTION>
Our Board of Directors and Management Team
Board of Directors of FSF Financial Corp.
<S> <C>
Donald A. Glas, Co-Chair of the Board George B. Loban, Co-Chair of the Board
Richard H. Burgart Carl O. Bretzke
James J. Caturia Jerome R. Dempsey
Sever B. Knutson Roger R. Stearns
Board of Directors of First Federal fsb
Donald A. Glas, Co-Chair of the Board George B. Loban, Co-Chair of the Board
Richard H. Burgart Carl O. Bretzke
James J. Caturia Jerome R. Dempsey
Sever B. Knutson Roger R. Stearns
Executive Officers of FSF Financial Corp.
and First Federal fsb
Donald A. Glas George B. Loban
Chief Executive Officer President
Richard H. Burgart
Chief Financial Officer & Corporate Secretary
- --------------------------------------------------------------------------------
Corporate Counsel Special Counsel
Mackall Crounse & Moore Malizia, Spidi, Sloane & Fisch, P.C.
1400 AT&T Tower One Franklin Square
901 Marquette Avenue 1301 K Street NW, Ste. 700 East
Minneapolis, MN 55402 Washington, DC 20005
Independent Auditors Transfer Agent and Registrar
Bertram Cooper & Co. LLP American Securities Transfer, Inc.
110 Second Avenue SE 1825 Lawrence
Waseca, MN 56093 Denver, CO 80202
</TABLE>
40
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
<PAGE>
Parent
FSF Financial Corp.
Percentage State of
Subsidiaries Owned Incorporation
- ------------ ----- -------------
First Federal fsb (a) 100% United States
- ---------------
(a) Because FSF Financial Corporation neither completed its initial public
offering nor conducted any operations prior to the year ended September 30,
1994, the operations of First Federal fsb are included in the consolidated
financial statements contained in the 1994 Annual Report to Stockholders
incorporated herein by reference. First Federal fsb became a wholly owned
subsidiary of FSF Financial Corp. on October 6, 1994.
22
EXHIBIT 23
<PAGE>
INDEPENDENT AUDITOR'S CONSENT
We consent to the incorporation by reference in Registration Statement No. 33-
93114 of FSF Financial Corp. on Form S-8 (filed with the Securities and Exchange
Commission on June 5, 1995) of our report dated October 24, 1997 included in
this Annual Report on Form 10-K of FSF Financial Corp. for the fiscal year ended
September 30, 1997.
/s/Bertram Cooper & Co., LLP
Bertram Cooper & Co., LLP
Waseca, Minnesota
December 16, 1997
<TABLE> <S> <C>
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<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-END> SEP-30-1997
<CASH> 6,135
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 37,010
<INVESTMENTS-CARRYING> 76,415
<INVESTMENTS-MARKET> 74,600
<LOANS> 261,446
<ALLOWANCE> (852)
<TOTAL-ASSETS> 388,135
<DEPOSITS> 208,246
<SHORT-TERM> 133,817
<LIABILITIES-OTHER> 2,710
<LONG-TERM> 0
0
0
<COMMON> 450
<OTHER-SE> 42,912
<TOTAL-LIABILITIES-AND-EQUITY> 388,135
<INTEREST-LOAN> 20,066
<INTEREST-INVEST> 7,249
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<INTEREST-TOTAL> 27,315
<INTEREST-DEPOSIT> 9,339
<INTEREST-EXPENSE> 7,007
<INTEREST-INCOME-NET> 10,969
<LOAN-LOSSES> 120
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<EXPENSE-OTHER> 7,130
<INCOME-PRETAX> 5,229
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