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 [FEE REQUIRED]
For the fiscal year ended September 30, 1999
---------------------------
- or -
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
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 November 30, 1999 was $ 25,729,056
(2,144,088 shares at $ 12.00 per share).
As of November 30, 1999 there were issued and outstanding 2,795,887 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, 1999. (Parts I, II and IV)
2. Portions of the Proxy Statement for the Annual Meeting of Stockholders to
be held January 19, 2000. (Part III)
<PAGE>
INDEX
PART I Page
----
Item 1. Business....................................................1
Item 2. Properties.................................................20
Item 3. Legal Proceedings..........................................21
Item 4. Submission of Matters to a Vote of Security Holders........21
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters.......................................21
Item 6. Selected Financial Data ...................................21
Item 7. Management's Discussion of Financial Condition and
Results of Operations.....................................21
Item 7A. Quantitative and Qualitative Disclosure about Market
Risk .....................................................21
Item 8. Financial Statements and Supplementary Data................21
Item 9. Change in and Disagreements with Accountants on
Accounting and Financial Disclosure.......................21
PART III
Item 10. Directors and Executive Officers of the Registrant.........22
Item 11. Executive Compensation.....................................22
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................22
Item 13. Certain Relationships and Related Transactions.............22
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K.................................................22
<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. The
Company operates three wholly owned subsidiaries, Insurance Planners, Homeowners
Mortgage Corporation ("HMC") and the Bank. Insurance Planners (the "Agency") is
an independent property and casualty insurance agency located in Hutchinson, MN.
HMC is a mortgage banking company located in Vadnais Heights, MN. The Agency was
acquired by the Company on June 1, 1998. HMC is the result of an acquisition on
November 17, 1998.
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, 1999, 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 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 loan portfolio in
dollars and in percentages of total loans at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
-------------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
-------------------------------------------------------------------------------------------------
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)......... $120,884 38.8 $157,340 52.2 $170,422 60.3 $150,102 64.7 $121,034 64.6
Residential construction ...... 42,937 13.8 21,960 7.3 20,796 7.4 19,676 8.5 20,366 10.9
Multi-family .................. 5,635 1.8 2,975 1.0 3,370 1.2 3,753 1.6 3,708 2.0
------------------------------------------------------------------------------------------------
169,456 54.4 182,275 60.4 194,588 68.9 173,531 74.8 145,108 77.4
Agricultural loans ............... 33,384 10.7 22,959 7.6 -- -- -- -- -- --
Land and commercial real estate .. 36,429 11.7 34,399 11.4 38,582 13.7 18,637 8.0 16,951 9.0
Commercial business .............. 29,767 9.6 21,095 7.0 8,114 2.9 6,089 2.6 2,715 1
269,036 86.3 260,728 86.4 241,284 85.4 198,257 85.4 164,774 87.9
------------------------------------------------------------------------------------------------
Consumer:
Home equity and second mortgage 24,312 7.8 23,606 7.8 20,812 7.4 17,692 7.6 10,950 5.8
Automobile loans .............. 7,428 2.4 9,670 3.2 11,596 4.1 10,080 4.3 8,399 4.5
Other ......................... 10,898 3.5 7,605 2.5 8,821 3.1 6,075 2.6 3,326 1.8
------------------------------------------------------------------------------------------------
Total loans 311,674 100.0 301,609 100.0 282,513 100.0 232,104 100.0 187,449 100.0
===== ===== ===== ===== =====
Less:
Loans in process .............. (26,156) (16,658) (20,364) (13,401) (15,010)
Deferred fees ................. (507) (641) (703) (757) (613)
Allowance for loan losses ..... (1,387) (1,035) (852) (776) (764)
--------- --------- --------- --------- ---------
Total loans, net ....... $283,624 $283,275 $260,594 $217,170 $171,062
========= ========= ========= ========= =========
</TABLE>
- --------------------------------------
(1) Includes loans held for sale in the amount of $5.3 million, $2.7 million,
$204,000, $443,000 and $230,000 as of September 30, 1999, 1998, 1997, 1996,
and 1995, respectively.
The following table sets forth the loan originations, loan purchases, loan
sales, and principal payments for the periods indicated:
<TABLE>
<CAPTION>
Years Ended September 30,
------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Total gross loans receivable at
end of period $ 311,674 $ 301,609 $ 282,513 $ 232,104 $ 187,449
Loans originated:
Residential real estate:
One-to-four family 130,461 56,768 55,144 53,801 45,988
Residential construction 55,700 23,007 12,968 12,975 21,996
Multi-family - 240 190 - 437
------------------------------------------------------------------------
Total residential real estate 186,161 80,015 68,302 66,776 68,421
Land and commercial real estate 5,900 4,960 20,077 3,241 8,588
Commercial business 13,033 9,801 2,402 274 250
Agricultural 28,081 27,049 - - -
Consumer 27,503 25,740 28,465 27,270 17,465
------------------------------------------------------------------------
Total loans originated 260,678 147,565 119,246 97,561 94,724
Purchase of loans 40,883 10,832 8,528 17,447 20,993
Sale of loan participation (3,000)
Sale of loans (128,925) (24,953) (6,661) (3,509) (810)
Principal repayments (169,131) (112,284) (72,035) (63,813) (49,651)
Other (net) 9,560 (2,064) 1,331 (3,031) (172)
------------------------------------------------------------------------
Net loan activity $ 10,065 $ 19,096 $ 50,409 $ 44,655 $ 65,084
========================================================================
</TABLE>
2
<PAGE>
Maturity of Loans. The following table sets forth the maturity of the Bank's
loans at September 30, 1999. The table does not include prepayments or scheduled
principal repayments. Prepayments and scheduled principal repayments on loans
totaled $136.0 million, $112.0 million, $72.0 million, $63.8 million, and $49.7
million for the years ended September 30, 1999, 1998, 1997, 1996 and 1995,
respectively. Adjustable-rate mortgage loans are shown as maturing based on
contractual maturities.
<TABLE>
<CAPTION>
One-to-Four Land, Commercial
Family Multi-Family Business,
Real Estate and Commercial Agriculture and
Mortgages Real Estate Construction Consumer Total
-------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Amounts Due:
Within 3 months $ 16,294 $ 4,689 $ 9,637 $ 46,196 $ 76,816
3 months to 1 year 20,151 9,439 33,300 18,469 81,359
-------------------------------------------------------------------------
Total due before one year 36,445 14,128 42,937 64,665 158,175
-------------------------------------------------------------------------
After 1 year:
1 to 3 years 19,518 12,490 - 15,307 47,315
3 to 5 years 17,518 13,385 - 19,227 50,130
5 to 10 years 19,495 480 - 4,591 24,566
10 to 20 years 19,129 1,581 - 1,999 22,709
Over 20 years 8,779 - - 8,779
-------------------------------------------------------------------------
Total due after one year 84,439 27,936 - 41,124 153,499
-------------------------------------------------------------------------
Total amount due $ 120,884 $ 42,064 $ 42,937 $ 105,789 $ 311,674
=========================================================================
</TABLE>
The following table sets forth the dollar amount of all loans due after
September 30, 2000, 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 and construction $ 42,323 $ 9,354 $ 34,762 $ 86,439
Land, multi-family and commercial real estate 9,414 9,715 8,807 27,936
Commercial business, agricultural and consumer 20,056 - 19,068 39,124
--------------- ------------ --------------- -------------
Total $ 71,793 $ 19,069 $ 62,637 $153,499
=============== ============ =============== =============
</TABLE>
One- to Four-Family Mortgage Loans. The largest portion of mortgage 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 and HMC originate
balloon mortgage loans, ARM loans and fixed-rate mortgage loans secured by one-
to four-family residences with loan terms up to 30 years. FHA and VA loans are
also offered and then sold, servicing released, in the secondary market.
Borrower demand for 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. All fixed-rate loans are sold
to the secondary market, some with servicing released and the bank retains
servicing on some loans sold to the Federal Home Loan Mortgage Corporation
("FHLMC").
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,
1999, balloon mortgages were $29.8 million, or 9.6% 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.
3
<PAGE>
Residential Construction Lending. The Bank and HMC originate residential
construction loans to qualified borrowers for construction of one-to-four family
residential properties primarily located in the Bank's market area. Construction
loans are made to builders on a pre-sold, speculative and model home basis and
primarily 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. 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 and HMC has sought to minimize the risk by limiting construction lending to
qualified borrowers primarily 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, 1999, the five largest land acquisition and development,
commercial real estate and multi-family loans ranged from $3.2 million to $5.0
million with an average committed outstanding balance of $3.9 million. All such
loans were current and have performed in accordance with their terms.
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.
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. As of September 30, 1999, the five largest commercial business
loans ranged from $2.5 million to $5.0 million, with an average committed
balance outstanding of $3.2 million. All such loans are current and have
performed in accordance with their terms.
4
<PAGE>
Agricultural Lending. The Bank originates loans to finance the purchase of
farmland, livestock, farm machinery and equipment, seed, fertilizer and for
other farm related products. Agricultural operating loans are originated at
either an adjustable or fixed rate of interest for up to a one year term or, in
the case of livestock, upon sale. Most agricultural operating loans have terms
of one year or less. Such loans provide for payments of principal and interest
at least annually, or a lump sum payment upon maturity in the original term is
less than one year. Loans secured by agricultural machinery are generally
originated as fixed-rate loans with terms of up to five years.
Agricultural real estate loans are frequently originated with adjustable rates
of interest. Generally, such loans provide for a fixed rate of interest for the
first three years, adjusting annually thereafter. In addition, such loans
generally provide for a ten year term based on a 20 year amortization schedule.
Adjustable-rate agricultural real estate loans are generally limited to 80% of
the value of the property securing the loan.
Agricultural lending affords the Bank the opportunity to earn yields higher than
those obtainable on one- to four-family residential lending. Nevertheless,
agricultural lending involves a greater degree of risk than one- to four-family
residential mortgage loans because of the typically larger loan amount. In
addition, payments on loans are dependent on the successful operation or
management of the farm property securing the loans or for which an operating
loan is utilized. The success of the loan may also be affected by many factors
outside the control of the farm borrower.
Weather presents one of the greatest risks as hail, drought, floods, or other
conditions, can severely limit crop yields and thus impair loan repayments and
the value of the underlying collateral. This risk can be reduced by the farmer
with multi-peril crop insurance which can guarantee set yields to provide
certainty of repayment. Unless the circumstances of the borrower merit
otherwise, the Bank generally does not require its borrowers to procure
multi-peril crop or hail insurance. However, recent changes in government
support programs generally require that farmers procure multi-peril crop
insurance to be eligible to participate in such programs.
Grain and livestock prices also present a risk as prices may decline prior to
sale resulting in a failure to cover production costs. These risks may be
reduced by the farmer with the use of futures contracts or options to provide a
"floor" below which prices will not fall. The Bank does not monitor or require
the use by borrowers of future contracts or options.
Another risk is the uncertainty of government programs and other regulations.
Some farmers rely on the income from government programs to make loan payments
and if these programs are discontinued or significantly changed, cash flow
problems or defaults could result.
Finally, many farms are dependent on a limited number of key individuals whose
injury or death may result in an inability to successfully operate the farm. At
September 30, 1999, the five largest agricultural loans ranged from $947,000 to
$1.5 million, with an average committed outstanding balance of $1.2 million. All
such loans are in the Bank's market area, are current and have performed in
accordance with their terms.
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 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 credit bureau reports. 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.
Loan Approval Authority and Underwriting. The primary source of mortgage loan
applications is referrals from existing or past customers. Applications are also
solicited from real estate brokers, contractors, call-ins and walk-ins to its
offices.
Upon receipt of any loan application from a prospective borrower, a credit
report is ordered and verifications of specific information relating to the loan
applicant's employment, income and credit standing are requested. An appraisal
or valuation determination, subject to regulatory requirements, of the real
estate intended to secure the proposed loan is undertaken. Licensed appraisers
and two authorized appraisers on staff at the Bank are utilized in determining
the value of property. In connection with the loan approval process,
underwriters analyze the loan applications and the property involved. All
residential, home equity, multi-family, construction and commercial real estate
loans are underwritten, subject to the loan underwriting policies as approved by
the Board of Directors. In general, loans in excess of $1.0 million must be
approved by the Board of Directors.
5
<PAGE>
Loan applicants are promptly notified of the decision 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, and the notice of
requirement of insurance coverage to be maintained. Title insurance or a title
opinion are required 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. Flood insurance is also required, if appropriate.
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, 1999, First Federal's five largest lending relationships included
$4.3 million in construction loans to a local developer, a $5.0 million line of
credit to an unaffiliated mortgage-banking company, a $3.3 million commercial
real estate loan, a $5.0 million commercial real estate loan and $3.8 million in
land development loans to a local developer, which is approximately 6.9% of the
total loans. At September 30, 1999, 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 services substantially all of the loans which it
retains in its portfolio. However, HMC does not engage in any loan servicing.
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, 1999, the Bank had
$296,000 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: 1999 1998 1997
--------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
FHLMC $ 48,219 $ 42,038 $ 38,137
Other Investors 7,269 4,418 4,597
--------------------------------------------------
$ 55,488 $ 46,456 $ 42,734
==================================================
</TABLE>
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, 1999, 1998 and 1997, the Bank earned gross fees of $236,000,
$234,000 and $204,000, 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, 1999, the Bank had
$323,000 of foreclosed real estate, consisting of three one-to-four family
residential loans and a commercial real estate 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
write-down of the property is charged to the allowance for losses.
Non-performing Assets. Loans are reviewed on a regular basis and are placed on
non-accrual status when, in the opinion of management, the collection of
additional interest is doubtful. Residential mortgage loans are placed on
non-accrual status when either principal or interest is 90 days or more past
due. Consumer loans are generally 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, 1999, the Bank had
approximately $289,000 of loans that were more than 60 days delinquent.
6
<PAGE>
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,
-----------------------------------------------------------------------
1999 1998 1997 1996 1995
-----------------------------------------------------------------------
(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 205 240 25 129 138
Permanent loans secured by non-
residential real estate - - - - -
Other -
Non-mortgage loans:
Commercial and agricultural - - - - -
Consumer 22 69 82 90 33
-----------------------------------------------------------------------
Total non-accrual loans 227 309 500 219 380
Foreclosed real estate and real estate
held for investment 323 502 72 - -
-----------------------------------------------------------------------
Total non-performing assets $ 550 $ 811 $ 572 $ 219 $ 380
=======================================================================
Total non-performing loans to net loans 0.08% 0.11% 0.19% 0.10% 0.22%
=======================================================================
Total non-performing loans to total assets 0.05% 0.07% 0.13% 0.06% 0.12%
=======================================================================
Total non-performing assets to total assets 0.13% 0.19% 0.15% 0.06% 0.12%
=======================================================================
</TABLE>
During the years ended September 30, 1999, 1998, 1997, 1996 and 1995,
approximately $22,403, $35,317, $22,833 $11,812, and $11,593, 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.
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, 1999, First Federal had total classified
assets of $1.0 million of which $477,000 were considered substandard, and no
assets were classified as doubtful or loss. Special mention assets totaled
$562,000 at September 30, 1999.
7
<PAGE>
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.
8
<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,
---------------------------------------------------------
1999 1998 1997 1996 1995
---------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Total loans outstanding $311,674 $301,609 $282,513 $232,104 $187,449
=========================================================
Average loans outstanding $274,676 $276,730 $237,475 $193,202 $142,711
=========================================================
Allowance balance (beginning of period) $ 1,035 $ 852 $ 776 $ 764 $ 748
---------------------------------------------------------
Provision (credit):
Residential -- -- -- -- --
Commercial real estate 20 2 40 -- --
Land and commercial/agricultural business 418 293 -- -- --
Consumer 18 7 80 42 24
---------------------------------------------------------
Total provision 456 302 120 42 24
Charge-off:
Residential -- 45 13 -- --
Commercial real estate -- -- -- -- --
Consumer 142 87 37 34 20
---------------------------------------------------------
Total charge-offs 142 132 50 34 20
Recoveries:
Residential --
Commercial real estate --
Consumer 38 13 6 4 12
----------------------------------------------------------
Total recoveries 38 13 6 4 12
----------------------------------------------------------
Net charge-offs 104 119 44 30 8
----------------------------------------------------------
Allowance balance (at end of period) $ 1,387 $ 1,035 $ 852 $ 776 $ 764
==========================================================
Allowance as percent of total loans 0.45% 0.34% 0.30% 0.33% 0.41%
Net loans charged off as a percent of
average loans 0.04% 0.04% 0.02% 0.01% 0.01%
</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, 1999, 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,
---------------------------------------------------------------------------------------------
1999 1998 1997 1996 1995
---------------------------------------------------------------------------------------------
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 $ 368 54.4% $ 368 60.4% $ 413 68.9% $ 426 74.8% $ 675 77.5%
Consumer and commercial business, land, 45.6% 39.6% 31.1% 25.2% 22.5%
commercial real estate and agricultural 1,019 667 439 350 89
---------------------------------------------------------------------------------------------
$ 1,387 100.0% $ 1,035 100.0% $ 852 100.0% $ 776 100.0% $ 764 100.0%
=============================================================================================
</TABLE>
9
<PAGE>
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.
Mortgage-backed and Related Securities. First Federal invests in residential
mortgage-backed securities guaranteed by participation certificates issues by
FHLMC, Federal National Mortgage Association ("FNMA") and Government National
Mortgage Association ("GNMA"). The mortgage-backed securities portfolio as of
September 30, 1999, consisted primarily of Real Estate Mortgage Investment
Conduits ("REMICs") ($43.4 million) and a FNMA certificate ($1.1 million).
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, 1999, 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.
10
<PAGE>
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. These securities
consisted mainly of U.S. Government Securities and U.S. government agency
obligations. The Bank also invests in debt and equity securities.
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 dates indicated. At September 30, 1999, 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 $51.1 and $42.3 million, respectively.
September 30,
--------------------------------
1999 1998 1997
-------- --------- --------
(In Thousands)
Investment securities:
Debt securities $ 19,937 $ 24,412 $ 37,876
Debt securities available for sale 12,794 3,010 1,000
FHLB Stock 7,363 7,363 6,692
Equity securities available for sale 11,921 12,096 12,619
-------- -------- --------
Total investment securities 52,015 46,881 58,187
Interest-bearing deposits 16,020 17,370 3,645
Federal funds sold -- -- --
Mortgage-backed and related securities:
Mortgage-backed and related securities 27,587 36,418 38,539
Mortgage-backed and related securities
available for sale 15,979 16,574 16,699
-------- -------- --------
Total mortgage-backed and related securities
43,566 52,992 55,238
-------- -------- --------
Total investments $111,601 $117,243 $117,070
======== ======== ========
11
<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, 1999.
<TABLE>
<CAPTION>
September
30, 1999
---------------------------------------------------------------------------------------------------------------------
More than Total
Adjustable One Year or Less One to Five Years Five to Ten Years Ten Years Investment Securities
----------------- ----------------- ----------------- ----------------- ----------------- ---------------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Market
Value Yield Value Yield Value Yield Value Yield Value Yield Value Yield Value
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U. S.
Government
and Federal
Agency
Obligations
held to
maturity $ - - % $ 1,570 6.07 % $ 5,067 3.62 % $ 7,087 3.78 % $ 6,213 7.47 % $ 19,937 5.07 % $ 18,999
Federal Agency
Obligations
available
for sale - - - - 12,794 6.27 - - - - 12,794 6.27 12,794
Equity
Securities
available
for sale 11,921 5.04 - - - - - - - - 11,921 5.04 11,921
FHLB Stock N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A 6.35
7,363 7,363
Mortgage-
backed and
related
securities
held to
maturity
26,415 5.58 - - 2 6.50 14 7.59 1,156 7.37 27,587 5.66 26,338
Mortgage-
backed and
related
securities
available
for sale 15,979 5.47 - - - - - - - - 15,979 5.47 15,979
Interest-
bearing
deposits 16,020 5.05 - - - - - - - - 16,020 5.05 16,020
------- --------- --------- --------- --------- -------- ---------
Total $70,335 5.26 % $ 1,570 6.07 % $17,863 5.52 % $ 7,101 3.79 % $ 7,369 7.45 % $111,601 5.49 % $109,414
======= ========= ========= ========= ========= ======== =========
</TABLE>
12
<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.
(In Thousands)
NOW Accounts $ 19,366 $ 22,136 $ 24,740
Commercial Demand 13,586 8,163 3,319
Savings Accounts 65,554 53,984 47,847
------------------------------
98,506 84,283 75,906
------------------------------
Certificates of Deposit:
3.00 to 4.00% 10,013 3,744 4,204
4.01 to 5.00% 17,520 17,925 14,796
5.01 to 6.00% 66,280 52,303 50,460
6.01 to 7.00% 37,739 62,462 56,604
7.01 to 8.00% 180 3,143
--
8.01% and over 1,413 2,682 6,276
------------------------------
133,145 142,259 132,340
------------------------------
Total deposits $231,651 $226,542 $208,246
==============================
13
<PAGE>
The following table sets forth the amount and maturities of time deposits at
September 30, 1999.
Amount Due
----------------------------------------------------------------
Less than 1 - 2 2 - 3 Greater than
One Year Years Years 3 years Total
----------------------------------------------------------------
Interest Rate (In Thousands)
2.01 - 4.00% $ 6,549 $ 3,464 $ - $ - $ 10,013
4.01 - 6.00% 74,230 3,620 2,434 3,516 83,800
6.01 - 8.00% 26,373 10,682 456 408 37,919
Over 8.00% 1,413 - - - 1,413
-------------------------------------------------------------
$ 108,565 $17,766 $ 2,890 $ 3,924 $133,145
=============================================================
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, 1999.
Certificates
of
Maturity Period Deposits
----------
(In
Thousands)
Within three months $ 7,348
Three through six months
3,133
Six through twelve months
7,911
Over twelve months
2,289
----------
$ 20,681
==========
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).
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,
------------------------------------------
1999 1998 1997
------------------------------------------
(Dollars in Thousands)
Maximum balance $ 144,177 $ 147,234 $ 113,839
Average balance 143,123 145,459 120,093
Balance at end of period 140,967 144,177 133,817
Weighted average rate:
at end of period 5.39% 5.42% 5.83%
during the period 5.47% 5.79% 5.83%
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.
14
<PAGE>
Subsidiary Activity
As of September 30, 1999, the Company had three directly owned subsidiaries: the
Bank, HMC and the Agency.
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 development purposes. Under such limitations,
as of September 30, 1999, First Federal was authorized to invest up to
approximately $8.4 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, 1999, the net book value of First Federal's investment in stock,
unsecured loans, and conforming loans in its subsidiary was $255,172. For the
fiscal year ended September 30, 1999, FSI had net income of $58,585.
Insurance Planners ("the Agency") was incorporated in the State of Minnesota in
August, 1983, and is engaged in the sale, on an agency basis, of property and
casualty insurance products. As of September 30, 1999, the net book value of the
Company's investment in stock , unsecured loans, and conforming loans in its
subsidiary was $702,150. For the fiscal year ended September 30, 1999 the Agency
had net income of $22,214.
On November 17, 1998, the Company acquired, in a transaction that was a
combination of stock and cash, all of the outstanding shares of Homeowners
Mortgage Corporation ("HMC"). HMC was incorporated in the State of Minnesota in
1988, and originates residential mortgage loans from two locations in Minnesota.
As of September 30, 1999, the net book value of the Company's investment in
stock, unsecured loans and conforming loans in its subsidiary was $3.2 million.
For the ten month period ended September 30, 1999, Homeowners had a net loss of
$63,918.
Personnel
As of September 30,1999, First Federal had 87 full-time employees and 48
part-time employees, representing a total of 115.8 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.
15
<PAGE>
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
$7.4 million in FHLB of Des Moines stock at September 30, 1999. 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 10% of
its annual net earnings to fund certain affordable housing programs. 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 1999, 1998, and 1997, First Federal recorded dividend income of
$466,665, $491,888, and $417,929, 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 "satisfactory" in its last
CRA examination in May, 1999.
Regulatory Capital Requirement. The following table reflects, in both dollars
and ratios, First Federal's regulatory capital position as of September 30,
1999, as well as the requirements at that date.
Required
First Federal fsb minimum Excess
regulatory capital regulatory regulatory
Amount Percent(1) capital capital
-------------------------------------------------
(Dollars in Thousands)
Tangible equity $37,246 9.0% $ 6,201 $31,045
Tier 1 (Core) capital 37,246 9.0% 16,536 $20,710
Tier 1 risk-based capital 37,246 14.2% 10,528 $26,718
Total risk-based capital 37,629 14.3% 21,057 $16,572
- -----------------------------------------
(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.
16
<PAGE>
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 liabilities comprising First Federal's
statement of financial condition as of September 30, 1999, 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 of 6.0% or more, has Tier
1 (core) 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 Tier 1
(core) 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 Tier 1 (core) 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 Tier 1
(core) 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,
1999 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. The OTS imposes various
restrictions or requirements on the ability of savings institutions to capital
distributions, including cash dividends.
A savings association that is a subsidiary of a savings and loan holding
company, such as the Association after the conversion, must file an application
or a notice with the OTS at least 30 days before making a capital distribution.
Savings associations are not required to file an application for permission to
make a capital distribution and need only file a notice if the following
conditions are met: (1) they are eligible for expedited treatment under OTS
regulations, (2) they would remain adequately capitalized after the
distribution, (3) the annual amount of capital distribution does not exceed net
income for that year to date added to retained net income for the two preceding
years, and (4) the capital distribution would not violate any agreements between
the OTS and the savings association or any OTS regulations. Any other situation
would require an application to the OTS.
In addition, the OTS could prohibit a proposed capital distribution by any
institution, which would otherwise be permitted by the regulation, if the OTS
determines that the distribution would constitute an unsafe or unsound practice.
A federal savings institution is prohibited from making a capital distribution
if, after making the distribution, the savings institution would be unable to
meet any one of its minimum regulatory capital requirements. Further, a federal
savings institution cannot distribute regulatory capital that is needed for its
liquidation account.
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, 1999, First Federal was in compliance with its QTL requirement
with 74.4% of assets invested in QTIs.
17
<PAGE>
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 Company, the
Agency, HMC 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, 1999, 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.
18
<PAGE>
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.
Recent Developments - Financial Modernization. On November 12, 1999, President
Clinton signed into law the Gramm-Leach-Bliley Act (the "Act") which will,
effective March 11, 2000, permit qualifying bank holding companies to become
financial holding companies and thereby affiliate with securities firms and
insurance companies and engage in other activities that are financial in nature.
The Act defines "financial in nature" to include securities underwriting,
dealing and market making; sponsoring mutual funds and investment companies;
insurance underwriting and agency; merchant banking activities; and activities
that the Board has determined to be closely related to banking. A qualifying
national bank also may engage, subject to limitations on investment, in
activities that are financial in nature, other than insurance underwriting,
insurance company portfolio investment, real estate development, and real estate
investment, through a financial subsidiary of the bank.
The Act also prohibits new unitary thrift holding companies from engaging in
nonfinancial activities or from affiliating with an nonfinancial entity. As a
grandfathered unitary thrift holding company, the Company will retain its
authority to engage in nonfinancial activities.
19
<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 $1.7 million at September 30, 1999.
Additional offices, either owned or leased by the Bank and HMC, are set forth
below with information regarding net book value of the premises and equipment at
such facilities at September 30, 1999.
Year
Acquired or Net Book
Date Lease Value at Square
Location Expires September 30, 1999 Footage
- ------------------------- --------------------------------------------
(Dollars in thousands)
14994 Glazier Avenue
Apple Valley, MN 55124 1989 $257 3,000
19 Central Avenue
Buffalo, MN 55313 1973 71 1,800
305 10th Avenue S
Buffalo, MN 55313 1999 1,188 5,620
1002 Greeley Avenue
Glencoe, MN 55336 2000(1) 57 1,100
1320 South Frontage Road
Hastings, MN 55033 1984 851 15,000
905 Highway 15 South,
Frontage Road
Hutchinson, MN 55350 1980 204 1,400
6505 Cahill Avenue
Inver Grove Heights, MN 55075 1979 329 3,000
501 North Sibley Avenue
Litchfield, MN 55355 1978 183 2,400
200 East Frontage Road,
Highway 5
Waconia, MN 55387 1985 339 2,400
122 East Second Street
Winthrop, MN 55396 2000 (2) 8 950
113 Waite Avenue South
Waite Park, MN 56387 2003 (3) 52 550
135 3rd Avenue SW
Hutchinson, MN 55350 2001 (4) 33 1,200
1001 Labore Industrial Court
Suite E
Vadnais Heights, MN 55110 2001 (5) 60 7,748
(1) One year lease expires in April, 2000 with option to renew for one year
terms thereafter. The Bank expects to renew the lease.
(2) Lease expires in July, 2000 with option to renew for one year terms. The
Bank expects to renew the lease.
(3) Lease expires in September, 2003 with an option to renew for an additional
five year term.
(4) Lease expires September, 2001 with an option to renew for one year terms.
(5) Lease expires January, 2001 with the option to renew for 2 additional
years.
20
<PAGE>
The Bank leases approximately 1,400 square feet of the property in Hastings,
Minnesota under a three year operating lease. This lease will expire April 14,
2000, with annual rents totaling $8,317 in addition to their proportionate share
of the operating expenses.
The Agency operates from its main office located at 135 3rd Avenue Southeast,
Hutchinson, Minnesota and also has an office within the Bank's building in
Buffalo, Minnesota. Those facilities are covered by a month to month lease under
the terms of an expense sharing agreement.
HMC operates from its main office located at 1001 Labore Industrial Court,
Vadnais Heights, Minnesota and also has an office within the Bank's building in
Hastings, Minnesota. These facilities are covered by a month to month lease
under the terms of an expense sharing agreement.
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
In connection with the acquisitions of the Agency and HMC, the Company issued an
additional 116,800 shares of common stock, and registered the shares with the
Securities and Exchange Commission on July 21, 1999.
For additional information relating to the market for Registrant's common equity
and related stockholder matters, see "Corporate Profile and Stock Market
Information" in the Registrant's 1999 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 1999 Annual Report to Stockholders on page 2 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
1999 Annual Report to Stockholders on Pages 4 through 14 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 1999 Annual
Report to Stockholders on pages 4 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 1999 Annual Report to Stockholders on pages 15 through 40 and are
incorporated herein by reference.
Quarterly Results of Operations on page 41 of the 1999 Annual Report to
Stockholders is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
21
<PAGE>
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 3 to 8 the Registrant's definitive proxy statement for the
Company's Annual Meeting of Stockholders to be held on January 18, 2000 (the
"Proxy Statement"), which was filed with the Commission on December 10, 1999,
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 8 through 14.
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 2 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 1999 Annual Report to
Stockholders. PAGE
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . 15
Consolidated Statements of Financial Condition as of
September 30, 1999 and 1998 . . . . . . . . . . . . . . . . . . . 16
Consolidated Statements of Income for the Years
Ended September 30, 1999, 1998 and 1997 . . . . . . . . . . . . . 17
Consolidated Statements of Changes in Stockholders' Equity for the
Years Ended September 30, 1999, 1998 and 1997 . . . . . . . . . .
Consolidated Statements of Cash Flows for the Years Ended
September 30, 1999, 1998 and 1997 . . . . . . . . . . . . . . . . 19
Notes to Consolidated Financial Statements . . . . . . . . . . . . 21
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. 1996 Stock Option Plan**
10.4 FSF Financial Corp. 1998 Stock Compensation Plan***
13.0 1999 Annual Report to Stockholders
21.0 Subsidiary Information
22
<PAGE>
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,
1996, and filed with the Commission on December 13, 1995.
*** Incorporated herein by reference into this document from the Registrant's
proxy statement for the Annual Meeting of Stockholders held on January 20,
1998, and filed with the Commission on December 10, 1997.
**** Included with electronic filing only.
23
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 of 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 10, 1999 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,
By: /s/ Donald A. Glas By: /s/ Richard H. Burgart
------------------ ----------------------
Donald A. Glas Richard H. Burgart
Co-Chair of the Board Chief Financial Officer
and Chief Executive Officer and Treasurer
(Principal Executive Officer) (Principal Financial and
Accounting Officer)
Director
Date: December 10, 1999 Date: December 10, 1999
By: /s/ George B. Loban By: /s/ Sever B. Knutson
------------------- --------------------
George B. Loban Sever B. Knutson
Co-Chair of the Board and President Director
Date: December 10, 1999 Date: December 10, 1999
By: /s/ Roger R. Stearns By: /s/ James J. Caturia
-------------------- --------------------
Roger R. Stearns James J. Caturia
Director Director
Date: December 10, 1999 Date: December 10, 1999
By: /s/ Jerome R. Dempsey
---------------------
Jerome R. Dempsey
Director
Date: December 10, 1999
EXHIBIT 13
<PAGE>
FSF
[LOGO] FINANCIAL
CORPORATION
---------------------------------------------------------------
Financial Services Holding Company
ANNUAL REPORT
1999
<PAGE>
FSF FINANCIAL CORP.
1999 ANNUAL REPORT
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Corporate Profile and Stock Market Information...............................1
Selected Financial and Other Data............................................2
Letter to Stockholders.......................................................3
Management's Discussion and Analysis of
Financial Condition and Results of Operations..............................4
Independent Auditors' Report................................................15
Consolidated Statements of Financial Condition..............................16
Consolidated Statements of Income...........................................17
Consolidated Statements of Changes in Stockholders' Equity..................18
Consolidated Statements of Cash Flows.......................................19
Notes to Consolidated Financial Statements..................................21
Selected Quarterly Financial Data...........................................41
Office Locations............................................................42
Corporate Information.......................................................43
<PAGE>
FSF FINANCIAL CORPORATION
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 Company operates three wholly owned subsidiaries, Insurance Planners,
Homeowners Mortgage Corporation and the Bank. Insurance Planners (the "Agency")
is an independent property and casualty insurance agency located in Hutchinson,
MN. The Agency was acquired by the Company on June 1, 1998. Furthermore, on
November 17, 1998, the Company acquired Homeowners Mortgage Corporation ("HMC"),
Vadnais Heights, MN. on November 17, 1998. HMC is a mortgage banking company.
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 law as administered 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
residential real estate, commercial real estate, multi-family loans,
construction loans, agricultural loans, commercial business loans, 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
November 30, 1999, was approximately 511. This does not reflect the number of
persons or entities who held stock in nominee or "street" name through various
brokerage firms. At November 30, 1999, there were 2,805,887 shares issued and
outstanding.
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.
1
<PAGE>
<TABLE>
<CAPTION>
FSF FINANCIAL CORPORATION
- ----------------------------------------------------------------------------------------------------------------------
SELECTED FINANCIAL AND OTHER DATA
Financial Condition (Dollars in Thousands)
- ----------------------------------------------------------------------------------------------------------------------
September 30, 1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total assets $418,094 $416,232 $388,135 $354,636 $304,605
Loans held for sale 5,334 2,672 204 443 230
Loans receivable, net 278,290 280,603 260,390 216,727 170,921
Mortgage-backed securities 27,587 36,418 38,539 38,557 37,110
Mortgage-backed securities available for sale 15,979 16,574 16,699 16,336 16,141
Debt securities 19,937 24,412 37,876 44,349 41,914
Debt securities available for sale 12,794 3,010 1,000 - -
Equity securities available for sale 19,284 19,459 19,311 18,231 16,165
Cash and cash equivalents (1) 19,265 22,597 6,135 11,756 14,855
Savings deposits 231,651 226,542 208,246 189,074 171,516
Other borrowings 140,967 144,177 133,817 114,693 73,807
Stockholders' equity 42,325 42,518 43,362 47,649 57,351
Summary of Operations (Dollars in Thousands)
- ----------------------------------------------------------------------------------------------------------------------
Year Ended September 30, 1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------
Interest income $ 29,420 $ 29,981 $ 27,315 $ 23,244 $ 19,079
Interest expense 18,198 18,499 16,346 13,609 9,472
Net interest income 11,222 11,482 10,969 9,635 9,607
Provision for loan losses 456 302 120 42 24
Non-interest income 5,259 2,269 1,510 1,354 1,127
Non-interest expense (2) 11,826 8,395 7,130 8,178 6,966
Income before cummulative effect
of change in accounting principle 2,505 3,030 3,124 1,668 2,243
Net income (2) 2,505 3,030 3,124 1,668 2,625
Other Selected Data
- ----------------------------------------------------------------------------------------------------------------------
Year Ended September 30, 1999 1998 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------
Return on average assets before cum. eff. 0.59% 0.74% 0.84% 0.69% 0.82%
Return on average assets after cum. eff. 0.59% 0.74% 0.84% 0.69% 0.95%
Return on average equity before cum. eff. 5.74% 6.94% 6.87% 4.25% 3.83%
Return on average equity after cum. eff. 5.74% 6.94% 6.87% 4.25% 4.48%
Average equity to average assets 10.26% 10.70% 12.25% 15.93% 21.31%
Net interest rate spread (3) 2.39% 2.44% 2.54% 2.36% 2.78%
Non-performing assets to total assets 0.13% 0.19% 0.15% 0.06% 0.12%
Allowance for loan losses to total loans 0.45% 0.34% 0.30% 0.33% 0.41%
Basic earnings per share before cum eff. (2) $ 0.94 $ 1.14 $ 1.13 $ 0.49 $ 0.57
Diluted earnings per share before cum eff. (2) $ 0.90 $ 1.05 $ 1.04 $ 0.47 $ 0.55
Basic earnings per share (2) $ 0.94 $ 1.14 $ 1.13 $ 0.49 $ 0.67
Diluted earnings per share (2) $ 0.90 $ 1.05 $ 1.04 $ 0.47 $ 0.65
Cash dividends declared per share $ 0.50 $ 0.50 $ 0.50 $ 0.50 $ 0.375
</TABLE>
- -------------------------------------------------
(1) Consists of cash due from banks, interest-bearing deposits, and other
investments with original maturities of less than three months.
(2) Includes a one-time special assessment of $1,030,000 to recapitalize the
SAIF for the year ended September 30, 1996.
(3) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities
2
<PAGE>
[LOGO] FSF
FINANCIAL
CORP.
-----------------------------------------------------------------
201 Main Street South Hutchinson, MN 55350-2573 Tele.320-234-4500
Fax 320-234-4542
- --------------------------------------------------------------------------------
To Our Stockholders:
Fiscal 1999 provided us with a variety of challenges and opportunities.
Refinance activity continued at a record pace and principal repayments exceeded
$136 million during the year, an increase of almost 18% over the previous year's
level. Loan production totaled more than $254 million, with slightly more than
50% of the production in one-to-four family residential mortgages. We continued
to decrease our reliance on residential lending and continue to seek a
reasonable balance between residential mortgages, construction lending,
commercial business loans, agricultural loans and consumer loans. Single family
residential loans comprised 38.8% of our loan portfolio at September 30, 1999,
compared to 64.7% of all loans at September 30, 1996.
The change in composition of our loan portfolio required an increase in our loan
loss provision. Even though we increased the loan loss provision, there was not
an increase in problem assets or non-performing assets. Non-performing assets
were 0.13% of total assets at the end of the fiscal year and all construction,
agricultural and commercial loans were performing.
During the majority of the year, liquidity continued to increase as a result of
the refinance activity. Due to the uncertainty of the interest rate environment
we were unwilling to accept the interest rate risk associated with redeploying
the funds throughout most of the year. As a result, we accepted lower interest
earnings but as rates began to move upward, primarily during the fourth quarter,
we utilized alternative investments and began decreasing our liquidity position.
The complete integration of Insurance Planners and Homeowners Mortgage
Corporation continues. With more than 150 employees in 14 locations, working for
four different companies, we implemented a comprehensive communications
solution. Due to the magnitude of the project there was some duplication of
costs, however the operational efficiencies and on-going cost savings will
provide us with the foundation necessary to continue to provide additional
electronic services to our mortgage, insurance, investment and banking
customers.
We have dedicated resources to the implementation of a sales culture - formal
service and sales training, hiring a retail sales manager, implementation of
profitability based incentive programs and marketing software introducing
customer relationship profitability. During the past year we opened a new office
in Buffalo that allowed us to expand our drive-up needs, and implement a "sales
relationship" office. However, the sales culture journey is far from over.
Our ability to maximize the potential within our family of companies will
continue to provide challenges. From the traditional banking products offered by
the Bank, to investment and estate planning provided by Firstate Investments, to
residential mortgage services of HMC, to the full line of insurance services
provided by Insurance Planners, we can meet the financial needs of our customers
but we must leverage our strengths.
Enhancing shareholder value is the number one objective of the Board of
Directors. Plateaus develop in earnings due to the absorption of businesses,
communications and technology upgrades, Y2K issues, loan loss reserve increases
due to business diversification and internet development. However we feel these
items are necessary in order to insure future growth in earnings.
Thank you for your confidence and investment in FSF Financial Corp. We hope that
you are using some of our many products and services. If not, please consider
doing so. Our best sales people are our satisfied customers.
Sincerely,
/s/Donald A. Glas /s/George B. Loban
- ----------------- ------------------
Donald A. Glas George B. Loban
Co-Chair/Chief Executive Officer Co-Chair/President
3
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
The Private Securities Litigation Reform Act of 1995 contains safe harbor
provisions regarding forward-looking statements. When used in this discussion,
the words "believes", "anticipates", "contemplates", "expects", and similar
expressions are intended to identify forward-looking statements. Such statements
are subject to certain risks and uncertainties which could cause actual results
to differ materially from those projected. Those risks and uncertainties include
changes in interest rates, risks associated with the effect of integrating newly
acquired businesses, the ability to control costs and expenses, and general
economic conditions. FSF Financial Corp. undertakes no obligation to publicly
release the results of any revisions to those forward looking statements which
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
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. The Corporation also receives
interest income on its investments.
The earnings of the Corporation depend primarily on the Bank's net interest
income and to a lesser extent, income from its recently acquired wholly owned
subsidiaries: Insurance Planners (June 1998) and Homeowners Mortgage (November
1998). 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 on deposit accounts,
other service charges and fees, commission income and income from the sale of
loans to the secondary market. 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 loans, 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 of various interest rate scenarios on the
Bank's capital.
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 rather than 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 residential
mortgages and retains for its portfolio residential mortgages 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 1999 fiscal year, the Bank originated $2.6 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 $3.3 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 $55.7 million. At September 30, 1999, $130.2
4
<PAGE>
million of real estate mortgages were adjustable rate mortgages, balloon
mortgages, or construction and land development loans, representing 41.8% of
total loans and 31.1% of total assets.
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 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, 1999, which are expected to
reprice or mature in each of the future time periods shown.
<TABLE>
<CAPTION>
Analysis of Repricing Mechanisms
Over One Over Five
Within to Five to Ten Over Ten
One Year Years Years Years Total
------------- ------------- ------------- ------------- -------------
Interest-earning assets: (Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Mortgage loans $ 93,510 $ 62,911 $ 21,556 $ 27,908 $205,885
Other loans 64,665 34,534 4,591 1,999 105,789
Investment securities 79,268 17,863 7,101 7,369 111,601
------------- ------------- ------------- ------------- -------------
Total interest-earning assets 237,443 115,308 33,248 37,276 423,275
------------- ------------- ------------- ------------- -------------
Interest-bearing liabilities:
Noninterest bearing deposits - - - - -
NOW and Super now accounts 15,140 3,449 - - 18,589
Savings accounts 58,350 7,204 - - 65,554
Money market deposit accounts 1,732 214 - - 1,946
Certificates 108,565 21,983 2,597 - 133,145
Other borrowed money 24,467 106,000 10,500 - 140,967
------------- ------------- ------------- ------------- -------------
Total interest-bearing liabilities 208,254 138,850 13,097 - 360,201
------------- ------------- ------------- ------------- -------------
Interest sensitivity gap $ 29,189 $(23,542) $ 20,151 $ 37,276 $ 63,074
============= ============= ============= ============= =============
Cumulative interest sensitivity gap $ 29,189 $ 5,647 $ 25,798 $ 63,074
============= ============= ============= =============
Cumulative ratio of interest-earning assets
to interest-bearing liabilities 1.14% 1.02% 1.07% 1.18%
============= ============= ============= =============
Cumulative ratio of cumulative interest
sensitivity gap to total assets. 6.98% 1.35% 6.17% 15.09%
============= ============= ============= =============
</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 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.
5
<PAGE>
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 1999 have changed when compared to fiscal 1998.
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, 1999, 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 $ 29,145 (8,913) (23.42) % 7.29 (194) bp
+300 bp 31,217 (6,841) (17.98) 7.75 (148) bp
+200 bp 33,385 (4,673) (12.28) 8.22 (101) bp
+100 bp 35,661 (2,397) (6.30) 8.72 (51) bp
0 bp 38,058 - - 9.23 -
-100 bp 40,591 2,533 6.66 9.76 53 bp
-200 bp 43,278 5,220 13.72 10.31 108 bp
-300 bp 46,142 8,084 21.24 10.90 167 bp
-400 bp 49,208 11,150 29.30 11.51 228 bp
</TABLE>
This table shows that the Bank's economic value of equity would decrease with
rising interest rates while increasing with falling interest rates. However,
computations of prospective effects of hypothetical interest rate changes are
based on numerous assumptions, including relative levels of market interest
rates, loan repayments and deposit runoffs, and may not be indicative of actual
results. The computations do not reflect any actions the Bank may undertake in
response to changes in interest rates although management cannot always predict
future interest rates or their effect on the Bank. Certain shortcomings are
inherent in the method of analysis presented in the computation of NPV. For
example, although certain assets and liabilities may have
6
<PAGE>
similar maturities or periods to repricing, they may react in differing degrees
to changes in market area interest rates. Additionally, certain assets, such as
adjustable rate loans, have features that restrict changes in interest rates
during the initial term and over the remaining life of the asset. Further, in
the event of a change in interest rates, prepayment and early withdrawal levels
could deviate significantly from those assumed in the table. Finally, the
ability of many borrowers to service their adjustable rate debt may decrease in
the event of an interest rate increase.
Rate/Volume Analysis
The table below sets forth certain information regarding changes in interest
income and interest expense of the Corporation 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
-------------- -------------- ------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
Year Ended September 30, 1999 vs 1998:
Interest income:
Loans Receivable $ (488) $ (165) $ 2 $ (651)
Mortgage-backed securities (279) (454) 45 (688)
Investment securities (319) 1,210 (113) 778
-------------- -------------- -------------- --------------
Total change in interest income (1,086) 591 (66) (561)
Interest expense:
Savings accounts (611) 796 (34) 151
FHLB Borrowings (460) 18 (10) (452)
-------------- -------------- -------------- --------------
Total change in interest expense (1,071) 814 (44) (301)
--------------------------------------------------------------
Net change in net interest income $ (15) $ (223) $ (22) $ (260)
============== ============== ============== ==============
Year Ended September 30, 1998 vs 1997:
Interest income:
Loans Receivable $ 109 $ 3,317 $ 20 $ 3,446
Mortgage-backed securities (350) (25) (3) (378)
Investment securities (308) (87) (7) (402)
-------------- -------------- -------------- --------------
Total change in interest income (549) 3,205 10 2,666
Interest expense:
Savings accounts 151 583 9 743
FHLB Borrowings (59) 1,479 (10) 1,410
-------------- -------------- -------------- --------------
Total change in interest expense 92 2,062 (1) 2,153
-------------- -------------- -------------- --------------
Net change in net interest income $ (641) $ 1,143 $ 11 $ 513
============== ============== ============== ==============
</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,
-----------------------------------------------------------------------------------------
1999 1998 1997
-----------------------------------------------------------------------------------------
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) $ 274,676 $22,861 8.32% $ 276,730 $ 23,512 8.50% $ 237,475 $20,066 8.45%
Mortgage-backed securities 46,398 2,318 5.00% 54,657 3,006 5.50% 55,062 3,384 6.15%
Investment securities (2) 87,987 4,241 4.82% 65,238 3,463 5.31% 66,734 3,865 5.79%
---------------------- ------------------------ -------------------
Total interest-earning assets 409,061 29,420 7.19% 396,625 29,981 7.56% 359,271 27,315 7.60%
---------------------- ------------------------ -------------------
Interest-Bearing Liabilities
NOW and money market accounts $ 31,670 289 0.91% $ 28,626 407 1.42% $ 27,463 389 1.42%
Passbook savings 3.24% 3.33% 3.15%
58,463 1,896 5.64% 50,699 1,690 3.33% 48,381 1,524 3.15%
Certificates of deposit 142,811 8,048 5.64% 136,407 7,985 5.85% 127,211 7,426 5.84%
---------------------- ------------------------ -------------------
Total deposits 232,944 10,233 4.39% 215,732 10,082 4.67% 203,055 9,339 4.60%
FHLB advances and other borrowed funds 145,690 7,965 5.47% 145,459 8,417 5.79% 120,093 7,007 5.83%
---------------------- ------------------------ -------------------
Total interest-bearing liabilities 378,634 18,198 4.81% 361,191 18,499 5.12% 323,148 16,346 5.06%
---------------------- ------------------------ -------------------
Net Interest Income $11,222 $ 11,482 $10,969
========== ============= =========
Net Interest Rate Spread (3) 2.39% 2.44% 2.54%
Net Interest Rate Margin (4) 2.74% 2.89% 3.05%
Ratio of average interest-earning assets
to average interest-bearing liabilities 1.08x 1.10x 1.11x
============ =========== ==========
</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-
<PAGE>
Changes in Financial Condition
General. Total assets increased from $416.2 million at September
30, 1998, to $418.1 million at September 30, 1999, an increase of $1.9 million
or 0.5%. The Bank and HMC continued to experience good demand for loans and
supplemented the internal loan originations ($255.7 million) with purchases of
other loans ($45.9 million) that met the interest rate risk and credit risk
criteria established by management.
Securities Available for Sale. Equity securities and
mortgage-backed and related securities available for sale decreased by $175,000
and $595,000 respectively during the 1999 fiscal year as a result of a reduction
in market value. The net unrealized losses on securities available for sale
increased from $661,000 at September 30, 1998 to $1.3 million at September 30,
1999. This increase was primarily due to the market rate of interest increasing
compared to the contractual rate. Debt securities available for sale increased
$9.8 million due to the purchase of such securities for liquidity purposes.
Securities Held to Maturity. Debt securities held to maturity
decreased from $24.4 million to $19.9 million due to maturities and the exercise
of call options by issuers. Mortgage-backed securities held to maturity
decreased from $36.4 million to $27.6 million during fiscal 1999, due to
principal repayments. The net unrealized losses on securities held to maturity
increased from $1.5 million at September 30, 1998 to $2.2 million at September
30, 1999. These increases were primarily due to the market rate of interest
increasing compared to the contractual rate.
Loans Held for Sale. Net loans held for sale increased from $2.7
million at September 30, 1998, to $5.3 million at September 30, 1999. The Bank
and HMC had firm commitments to sell $5.2 million of the loans held for sale
that were closed by September, 1999.
Loans Receivable. Net Loans receivable decreased due to the
continued sale of long term fixed-rate loans, from $280.6 million at September
30, 1998, to $278.3 million at September 30, 1999, a decrease of $2.3 million or
0.8%. The decrease was comprised of a decline in one-to-four family loans of
$39.1 million, which was partially offset by increases in other real estate
mortgages ($3.6 million), net construction loans ($12.6 million) , commercial
business loans ($8.7 million) and agricultural loans ($10.4 million).
Deposits. Total deposits increased by $5.1 million, or 2.3% during
the 1999 fiscal year. The increase in deposits can be attributed to an increase
in savings accounts ($11.6 million), an increase in demand deposits ($2.7
million) and a decrease in certificates of deposit ($9.1 million). The increase
in total deposits was accompanied by a decrease in the weighted average cost of
funds from 4.67% to 4.39% for the years ended September 30, 1998 and 1999,
respectively. The decrease in cost is primarily attributable to the change in
the composition of deposits.
Borrowings. In addition to growth in deposits, borrowings may be
utilized to fund the growth in assets. Management utilizes a least cost, at the
margin, approach to fund assets. As a result, borrowings are 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. Borrowings decreased by $3.2
million dollars during fiscal 1999 due to principal payments. The Bank was able
to fund lending and investments with loan repayments and deposit growth.
Stockholders' Equity. Stockholders' equity decreased from $42.5
million at September 30, 1998, to $42.3 million at September 30, 1999, a
decrease of $0.2 million. The Corporation repurchased 204,754 shares of its
common stock during the year at an average price of $14.53, thereby reducing
stockholders' equity and the total number of shareholders. Furthermore,
unrealized losses on securities available for sale further decreased
stockholders' equity. Book value per share increased from $16.22 at September
30, 1998, to $16.32 at September 30, 1999.
Comparison of Years Ended September 30, 1999 and 1998
Net Income. Net income decreased to $2.5 million for the year ended
September 30, 1999, from $3.0 million for the year ended September 30, 1998. The
decrease was primarily due to an increase in non-interest expense and
non-interest income, the majority of which was attributable to the acquisition
of the Agency and HMC.
Interest Income. Total interest income decreased $561,000 to $29.4
million for the year ended September 30, 1999, from $30.0 million for the year
ended September 30, 1998. Interest income on loans decreased by $651,000 from
$23.5 million for the year ended September 30, 1998, to $22.9 million for the
year ended September 30, 1999, as a result of a $2.0 million decrease in the
average balance of loans receivable from $276.7 million at September 30, 1998,
to $274.7 million at September 30, 1999. Furthermore, the average yield
decreased from 8.50% at September 30, 1998, to 8.32% at September 30, 1999.
Interest income on mortgage-backed securities decreased from $3.0 million for
the year ended September 30, 1998, to $2.3 million for the year ended September
30, 1999. The decrease was primarily the result of a decrease in average rate
from 5.50% for the 1998 fiscal year to 5.00% for the 1999 fiscal year and a
decrease in the average balance of $8.3 million. The average balance of
investment securities increased by $22.7 million during the fiscal year and the
yield decreased from 5.31% to 4.82%.
-9-
<PAGE>
The decrease in yield for investment securities was primarily impacted by
maturities and the exercise of call options by issuers. The yield on
interest-earning assets decreased from 7.56% for the year ended September 30,
1998, to 7.19% for the year ended September 30, 1999. Interest income increased
by $591,000 as a result of increased volume during the year while the changes in
rates caused interest income to decrease by $1.1 million and the rate/volume
change decreased interest income by $66,000.
Interest Expense. Total interest expense decreased to $18.2 million
for 1999 from $18.5 million for 1998 as the average balance of total interest
bearing liabilities increased but the average cost of funds decreased. The
increased cost of deposits attendant to the growth of balances was approximately
$796,000 while the decrease associated with a change in interest rates was
approximately $611,000. The cost associated with interest bearing deposits
decreased from 4.67% for the year ended September 30, 1998, to 4.39% for the
same period ended September 30, 1999. The cost associated with borrowed funds
decreased to 5.47% for fiscal 1999 compared to 5.79% for fiscal 1998. $460,000
of the decrease in the cost of borrowed funds was a result of decreases in
rates, while increased volumes added $18,000 in interest expense and $10,000 of
the decrease was rate/volume related.
Net Interest Income. Net interest income decreased $260,000.
Changes in interest rates caused a decrease in net interest income of $15,000,
volumes accounted for a decrease in net interest income of $223,000 and
rate/volume differences decreased $22,000.
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 $302,000 for the year ended
September 30, 1998, to $456,000 for the year ended September 30, 1999, due to
the change in composition of the loan portfolio. The Bank's allowance for loan
losses was $1,387,000 at September 30, 1999. The allowance for loan losses
represents .45% of total loans outstanding and 252.2% 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. Non-interest income and non-interest expense
were impacted by acquisitions in two ways: (1) only 4 months of income and
expense for the Agency were included in fiscal 1998 and (2) 11 months of income
and expense for HMC are included in fiscal 1999, that were not present in 1998.
Total non-interest income increased by $3.0 million to $5.3 million for the year
ended September 30, 1999, from $2.3 million for the year ended September 30,
1998. The Agency and HMC accounted for approximately $2.7 million of the
increase. Gains on loans sold increased from $360,000 in the 1998 fiscal year to
$2.3 million in the 1999 fiscal year. The gains are a result of fixed-rate
mortgages that were sold in the secondary market because they do not fit the
interest rate risk profile of the Bank and also the addition of HMC. Other
service charges and fees increased from $457,000 for the year ended September
30, 1998 to $801,000 for the year ended September 30, 1999. Service charges on
deposit accounts increased $146,000 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. Commission income
increased from $543,000 for the year ended September 30, 1998 to $946,000 for
the year ended September 30, 1999. $381,000 of the increase was a result of
having the Agency for a full year.
Non-interest Expense. Total non-interest expense increased to $11.8
million for the year ended September 30, 1999, from $8.4 million for the year
ended September 30, 1998, or 40.5%. The Agency and HMC accounted for
approximately $2.6 million of the increase. Compensation and benefits increased
from $5.4 million to $7.4 million or 37.0%, due to the acquisition of HMC ($1.6
million), a full year's expense for the Agency ($278,000) and merit increases,
which averaged 4.5%. Occupancy and equipment expense increased $467,000. Deposit
insurance premiums increased $3,000. Professional fees increased from $258,000
for fiscal year 1998 to $276,000 for fiscal year 1999. Data processing increased
$152,000 to $644,000 for the period ended September 30, 1999, due to processing
expense associated with increased delivery of electronic services to customers,
the introduction of agricultural lending and the expansion of commercial lending
and to a lesser extent, as a result of the costs associated with the
Corporation's Year 2000 compliance program. Goodwill amortization during the
year was $79,000 for HMC and $26,000 for the Agency.
Income Tax Expense. Income tax expense decreased to $1.7 million
for the year ended September 30, 1999, from $2.0 million for the year ended
September 30, 1998. The decrease was primarily due to a decrease in pre-tax
income of $855,000.
-10-
<PAGE>
Comparison of Years Ended September 30, 1998 and 1997
Net Income. Net income decreased to $3.0 million for the year ended
September 30, 1998, from $3.1 million for the year ended September 30, 1997. The
decrease was primarily due to an increase in non-interest expense.
Interest Income. Total interest income increased $2.7 million to
$30.0 million for the year ended September 30, 1998, from $27.3 million for the
year ended September 30, 1997. Interest income on loans increased by $3.4
million from $20.1 million for the year ended September 30, 1997, to $23.5
million for the year ended September 30, 1998, as a result of a $39.3 million
increase in the average balance of loans receivable from $237.5 million at
September 30, 1997, to $276.7 million at September 30, 1998. Furthermore, the
average yield increased from 8.45% at September 30, 1997, to 8.50% at September
30, 1998. Interest income on mortgage-backed securities decreased from $3.4
million for the year ended September 30, 1997, to $3.0 million for the year
ended September 30, 1998. The decrease was primarily the result of a decrease in
average rate from 6.15% for the 1997 fiscal year to 5.50% for the 1998 fiscal
year. The average balance of investment securities decreased by $1.5 million
during the fiscal year and the yield decreased from 5.79% to 5.31%. The decrease
in yield for investment securities was primarily impacted by maturities and the
exercise of call options by issuers. The yield on interest-earning assets
decreased from 7.60% for the year ended September 30, 1997, to 7.56% for the
year ended September 30, 1998. Interest income increased by $3.2 million as a
result of increased volume during the year while the changes in rates caused
interest income to decrease by $549,000 and the rate/volume change increased
interest income by $10,000.
Interest Expense. Total interest expense increased to $18.5 million
for 1998 from $16.3 million for 1997 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
$583,000 while the increase associated with a change in interest rates was
approximately $151,000. The cost associated with interest bearing deposits
increased from 4.60% for the year ended September 30, 1997, to 4.67% for the
same period ended September 30, 1998. The cost associated with borrowed funds
decreased to 5.79% for fiscal 1998 compared to 5.83% for fiscal 1997. $59,000 of
the decrease in the cost of borrowed funds was a result of increases in rates,
$1.5 million of the increase was attributable to the increased volumes and
$10,000 of the decrease was rate/volume related.
Net Interest Income. Net interest income increased $513,000.
Changes in interest rates caused a decrease in net interest income of $641,000,
volumes accounted for an increase in net interest income of $1.1 million and
rate/volume differences increased $11,000.
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 $120,000 for the year ended
September 30, 1997, to $302,000 for the year ended September 30, 1998, due to
the change in composition of the loan portfolio. The Bank's allowance for loan
losses was $1,035,000 at September 30, 1998. The allowance for loan losses
represents .34% of total loans outstanding and 127.6% 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
$759,000 to $2.3 million for the year ended September 30, 1998, from $1.5
million for the year ended September 30, 1997. Gains on loans sold increased
from $48,000 in the 1997 fiscal year to $360,000 in the 1998 fiscal year. The
gains are a result of fixed-rate mortgages 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 increased from $422,000 for the year ended September
30, 1997 to $457,000 for the year ended September 30, 1998. Service charges on
deposit accounts increased $105,000 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.
Commission income increased from $227,000 for the year ended September 30, 1997
to $543,000 for the year ended September 30, 1998. $214,000 of the increase was
a result of the acquisition of Insurance Planners, $50,000 was a result of
increased investment sales and $45,000 was due to the sale of federal crop
insurance (an ancillary activity to our agricultural lending).
Non-interest Expense. Total non-interest expense increased to $8.4
million for the year ended September 30, 1998, from $7.1 million for the year
ended September 30, 1997, or 18.3%. Compensation and benefits increased from
$4.5 million to $5.4 million or 20.2%, due to the acquisition of Insurance
Planners ($122,000), the hiring of critical management and
-11-
<PAGE>
related support positions, including Agricultural Lending, Marketing, Community
Banking, internal audit ($400,000) and merit increases, which averaged 4.5%.
Occupancy and equipment expense increased $46,000. The Company expects increased
compensation and property costs in fiscal 1999, due to the acquisition of
Homeowners Mortgage in November, 1998. Deposit insurance premiums decreased
$36,000. Professional fees increased from $235,000 for fiscal year 1997 to
$258,000 for fiscal year 1998. Data processing increased $99,000 to $492,000 for
the period ended September 30, 1998, due to processing expense associated with
increased delivery of electronic services to customers, the introduction of
agricultural lending and the expansion of commercial lending and to a lesser
extent, as a result of the costs associated with the Corporation's Year 2000
compliance program.
Furthermore, due to the acquisitions of Insurance Planners and Homeowners
Mortgage, the Company will experience approximately $115,000 in annual expense
due to the amortization, over a 25 year period, of goodwill associated with such
acquisitions.
Income Tax Expense. Income tax expense decreased to $2.0 million
for the year ended September 30, 1998, from $2.1 million for the year ended
September 30, 1997. The decrease was primarily due to a decrease in pre-tax
income of $175,000.
Liquidity and Capital Resources
The liquidity of a Corporation 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 Corporation'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 $7.0 million, $1.3 million and $3.8
million during the years ended September 30, 1999, 1998, and 1997, respectively.
In fiscal 1998 and 1997, 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 1997, which was paid out in fiscal 1998.
In fiscal 1999, the cash flow in operating activities was influenced primarily
by the change in loans held for sale and other liabilities.
Investing activities used $2.4 million, $8.0 million, and $39.5 million during
the years ended September 30, 1999, 1998, and 1997, respectively. The primary
activity of the Bank is originating and purchasing loans and purchasing
investment and mortgage-backed securities. The primary activity of HMC is
originating and selling loans in the secondary mortgage market. During the years
ended September 30, 1999, 1998 and 1997, the Corporation originated loans in the
amount of $260.7 million ($104.8 million were originated by HMC), $147.6 million
and $119.2 million, respectively. The net loan origination's and principal
payments on loans provided $40.0 million in 1999 and used $9.9 million and $41.2
million in 1998 and 1997 respectively. The increase in 1999 was a result of
prepayment on mortgage loans refinancing elsewhere. The purchase of loans used
$40.9 million, $10.8 million and $2.4 million in fiscal 1999, 1998 and 1997
respectively and were largely comprised of commercial business loans that
represented participation interest with other financial institutions. The Bank
also sold a participation in a non-residential loan in fiscal year 1999 for $3.0
million. Purchase of investment and mortgage-backed securities held to maturity
used $1.2 million, $0 and $3.0 million and maturities, principal payments or the
exercise of call provisions by the issuers of such securities provided $14.5
million, $15.6 million and $9.5 million for the years ended September 30, 1999,
1998 and 1997 respectively. Purchase of investment securities available for sale
used $13.0 million, $3.7 million and $2.0 million and maturities or the exercise
of call provision by the issuers of such securities provided $3.0 million, $1.0
million and $0 for the years ended September 30, 1999, 1998 and 1997
respectively. Other investment activities included sale of REO property,
purchase of equipment and property improvements and the net cash acquisition of
HMC. For the fiscal year 1999, the Bank acquired corporate owned insurance
policies in the amount of $5.5 million.
For the year ended September 30, 1999, $5.1 million in cash was provided as a
result of an increase in deposits and $3.2 million in cash was paid on FHLB
advances. The purchase of treasury stock and dividends on common stock used $2.9
million and $1.3 million, respectively. During the fiscal year ended September
30, 1998, $18.3 million in cash was provided as a result of an increase in
deposits and $10.4 million was provided as a result of an increase in
borrowings. The purchase of treasury stock used $5.5 million and dividends on
common stock used $1.4 million during the 1998 fiscal year. Basic and diluted
earnings per share for the year ended September 30, 1999, were $0.94 and $0.90,
respectively. A portion of the earnings per share was a result of the purchase
of treasury stock during the fiscal year. Financing activities used $7.9 million
during the year ended September 30, 1999 and provided $23.2 million, and $30.0
million in cash during the years ended September 30, 1998 and 1997,
respectively. Financing activities in the foreseeable future are expected to
primarily include changes in deposits and advances from FHLB of Des Moines, and
to a lesser extent, the repurchase of treasury shares and the payment of
dividends. See Consolidated Statements of Cash Flow for FSF Financial Corp. and
Subsidiary.
12
<PAGE>
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, 1999, such
borrowed funds totaled $141.0 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. In December of 1997, the OTS reduced
the requirement for banks to maintain liquid assets from 5% to not less than 4%
of its net withdrawable accounts plus short term borrowings. The Bank's
regulatory liquidity was 13.3%, 6.05%, and 5.12% at September 30, 1999, 1998,
and 1997, respectively. The options from the previous method were used in the
current period, which are more restrictive.
The amount of certificate accounts which are scheduled to mature during the
twelve months ending September 30, 2000, is approximately $108.6 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, 1999, the Bank and HMC had commitments to extend credit of
$39.3 million. Funds required to fill these commitments are derived primarily
from FHLB borrowings, current excess liquidity, deposit inflows, loan sales or
loan and security repayments.
OTS regulations require the Bank to maintain core capital of 4% of assets, of
which 2.0% must be tangible equity capital, excluding goodwill. The Bank is also
required to maintain risk-based capital equal to 8% of total risk-based assets.
The Bank's regulatory capital exceeded its tangible equity, tier 1 (risk based),
tier 1 (core) and risk-based capital requirements by 7.5%, 5.0%, 10.2% and 6.3%,
respectively.
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.
Year 2000
The Year 2000 problem exists because many computer programs use only the last
two digits to refer to a year. This convention could affect date-sensitive
calculations that treat "00" as the year 1900, rather than 2000. An additional
issue is that 1900 was not a leap year, whereas the year 2000 is. Therefore,
some programs may not properly provide for February 29, 2000. This anomaly could
result in miscalculations when processing critical date-sensitive information
after December 31, 1999.
The following discussion of the implications of the Year 2000 problem for the
Bank, contains numerous forward looking statements based on inherently uncertain
information. The cost of the project and the date on which the Bank plans to
complete the internal Year 2000 modifications are based on management's best
estimates, which are derived utilizing a number of assumptions of future events
including the continued availability of internal and external resources, third
party modifications and other factors. However, there can be no guarantee that
these statements will be achieved and actual results could differ. Moreover,
although management believes it will be able to make the necessary modifications
in advance, there can be no guarantee that failure to modify the systems would
not have a material adverse effect on the Bank.
Year 2000 issues expose the Company to a number of risks, any one of which, if
realized, could have a material adverse effect on the Company's business,
results of operations or financial condition. These risks include the
possibility that, to the extent certain vendors fail to adequately address Year
2000 issues, the Company may suffer disruptions in important services on which
the Company depends, such as telecommunications, electrical power and data
processing. Year 2000 issues could affect the Company's liquidity if customer
withdrawals in anticipation of the Year 2000 are greater than expected or if the
Company's lenders are unable to provide the Company with funds when and as
needed by the Company. Year 2000 issues also create additional credit risk to
the Company insofar as the failure of the Company's customers and counterparties
to adequately address Year 2000 issues could increase the likelihood that these
customers and counterparties become delinquent or default on the obligations to
the Company. In addition to increasing the Company's risk exposure to problem
loans, credit losses and liquidity problems, Year 2000 issues expose the Company
to increased risk of litigation losses and expenses relating to the foregoing.
There are other Year 2000 risks besides those described above that may impact
the Company's business, results of operations and financial condition.
13
<PAGE>
The Bank places a high degree of reliance on computer systems of third parties,
such as customers, suppliers, and other financial and governmental institutions.
Although the Bank is assessing the readiness of these third parties and
preparing contingency plans, there can be no guarantee that the failure of these
third parties to modify their systems in advance of December 31, 1999 would not
have a material adverse affect on the Bank.
During fiscal 1998, the Bank adopted a Year 2000 Compliance Plan (the "Plan")
and established a Year 2000 Compliance Committee (the "Committee"). The
objectives of the Plan and the Committee are to prepare the Bank for the new
millennium. As recommended by the Office of Thrift Supervision, the Plan
encompasses the following phases: Awareness, Assessment, Renovation, Validation
and Implementation. These phases will enable the Bank to identify risks, develop
an action plan, perform adequate testing and complete affirmation that its
processing systems will be Year 2000 ready. Execution of the Plan is currently
on target. The Bank has completed Phase 4, Validation, which involved testing of
changes to hardware and software, accompanied by monitoring and testing with
vendors. The Bank is currently in Phase 5, Implementation, which will continue
into calendar year 2000. Systems have been certified and customer and public
education efforts continue.
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.
Total direct costs are estimated not to exceed $50,000. Actual costs will be
charged to earnings over the next five quarters, as incurred.
The Bank has developed business resumption contingency plans specific to the
Year 2000. Business resumption contingency plans address the actions that would
be taken if critical business functions can not be carried out in the normal
manner upon entering the next century due to system or supplier failure.
Despite the best efforts of management to address this issue, the vast number of
external entities that have direct and indirect business relationships with the
Bank, such as customers, vendors, payment system providers and other financial
institutions, makes it impossible to assure that a failure to achieve compliance
by one or more of these entities would not have material adverse impact on the
operations of the Bank.
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.
14
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
FSF Financial Corp. and Subsidiaries
Hutchinson, MN 55350
We have audited the accompanying consolidated statements of financial condition
of FSF Financial Corp. and Subsidiaries (the Corporation) as of September 30,
1999, and 1998, 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, 1999. 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 Subsidiaries as of September 30, 1999, and 1998, and the consolidated
results of their operations and their cash flows for each of the fiscal years in
the three-year period ended September 30, 1999, in conformity with generally
accepted accounting principles.
Bertram Cooper & Co., LLP
Waseca, Minnesota
October 25, 1999
15
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
September 30,
------------------------
1999 1998
------------------------
(In thousands)
ASSETS
------
<S> <C> <C>
Cash and cash equivalents $ 19,265 $ 22,597
Securities available for sale, at fair value:
Equity securities 19,284 19,459
Mortgage-backed and related securities 15,979 16,574
Debt securities 12,794 3,010
Securities held to maturity, at amortized cost:
Debt securities (Fair value of $18,999 and $23,953) 19,937 24,412
Mortgage-backed and related securities (Fair value of $26,338 and $35,369) 27,587 36,418
Loans held for sale 5,334 2,672
Loan receivable, net 278,290 280,603
Foreclosed real estate
323 502
Accrued interest receivable 3,328 3,089
Premises and equipment 5,314 4,111
Other assets 10,659 2,785
-------------------------------
Total Assets $ 418,094 $ 416,232
===============================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Liabilities:
Demand deposits $ 32,952 $ 30,299
Savings accounts 65,554 53,984
Certificates of deposit 133,145 142,259
-------------------------------
Total deposits 231,651 226,542
Federal Home Loan Bank borrowings 140,967 144,177
Advances from borrowers for taxes and insurance 669 819
Other liabilities 2,482 2,176
-------------------------------
Total liabilities 375,769 373,714
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 43,292 43,382
Retained earnings, substantially restricted 26,627 25,451
Treasury stock at cost (1,695,390 and 1,603,663 shares) (24,575) (23,298)
Unearned ESOP shares at cost (162,798 and 198,773 shares) (1,628) (1,988)
Unearned MSP stock grants at cost (49,825 and 77,214 shares) (528) (818)
Accumulated other comprehensive income (loss) (1,313) (661)
-------------------------------
Total stockholders' equity 42,325 42,518
-------------------------------
Total Liabilities and Stockholders' Equity $ 418,094 $ 416,232
===============================
</TABLE>
The accompanying notes are an integral part of these statements
16
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended September 30,
---------------------------------------
1999 1998 1997
---------------------------------------
(In thousands)
<S> <C> <C> <C>
Interest income:
Loans receivable $ 22,861 $ 23,512 $ 20,066
Mortgage-backed and related securities 2,318 3,006 3,384
Investment securities 4,241 3,463 3,865
---------------------------------------
Total interest income 29,420 29,981 27,315
---------------------------------------
Interest expense:
Deposits 10,233 10,082 9,339
Borrowed funds 7,965 8,417 7,007
---------------------------------------
Total interest expense 18,198 18,499 16,346
---------------------------------------
Net interest income 11,222 11,482 10,969
Provision for loan losses 456 302 120
---------------------------------------
Net interest income after provision for loan losses 10,766 11,180 10,849
---------------------------------------
Non-interest income:
Gain (loss) on loans - net 2,341 360
48
Other service charges and fees 801 457 422
Service charges on deposit accounts 968 822 717
Commission income 946 543 227
Other 203 87 96
---------------------------------------
Total non-interest income 5,259 2,269 1,510
---------------------------------------
Non-interest expense:
Compensation and benefits 7,390 5,393 4,487
Occupancy and equipment 1,313 846 800
Deposit insurance premiums 134 131 167
Data processing 644 492 393
Professional fees 276 258 235
Other 2,069 1,275 1,048
---------------------------------------
Total non-interest expense 11,826 8,395 7,130
---------------------------------------
Income before provision for income taxes 4,199 5,054 5,229
Income tax expense 1,694 2,024 2,105
---------------------------------------
Net income 2,505 3,030 3,124
=======================================
Basic earnings per share $ 0.94 $ 1.14 $ 1.13
Diluted earnings per share $ 0.90 $ 1.05 $ 1.04
</TABLE>
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Net Income $ 2,505 $ 3,030 $ 3,124
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities - - -
Unrealized holding gains (losses) arising during period (652) (182) 328
Less: reclassification adjustment
for gains included in net income - (11) -
-------------------------------------
Other comprehensive income (loss) (652) (193) 328
-------------------------------------
Comprehensive income $ 1,853 $ 2,837 $ 3,452
=====================================
</TABLE>
The accompanying notes are an integral part of these statements
17
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Unallocated Accumulated
Retained Common Unearned Other
Additional Earnings Stock Stock Comprehensive
Common Paid-in Substantially Held by Acquired by Treasury Income
Stock Capital Restricted ESOP MSP Stock (Loss) Total
----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
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)
Stock issued for stock options -- (12) -- -- -- 73 61
Amortization of MSP shares -- 40 -- -- 290 -- -- 330
Common stock dividends
($0.50 per share) -- -- (1,413) -- -- -- -- (1,413)
Allocated ESOP shares -- 156 -- 372 -- -- -- 528
Other comprehensive income -- -- -- -- -- -- 328 328
---------------------------------------------------------------------------------------------
Balance September 30, 1997 450 43,334 23,779 (2,347) (1,108) (20,267) (479) 43,362
Net earnings -- -- 3,030 -- -- -- -- 3,030
Treasury stock acquired -- -- -- -- -- (5,492) -- (5,492)
Stock issued for stock options -- (341) -- -- -- 1,911 -- 1,570
Common stock dividends
($0.50 per share) -- -- (1,358) -- -- -- -- (1,358)
Purchase of subsidiary -- 106 -- -- -- 550 -- 656
Allocated ESOP shares -- 183 -- 359 -- -- -- 542
Other comprehensive (loss) -- -- -- -- (182) (182)
---------------------------------------------------------------------------------------------
Balance September 30, 1998 450 43,382 25,451 (1,988) (818) (23,298) (661) 42,518
Net earnings -- -- 2,505 -- -- -- -- 2,505
Treasury stock acquired -- -- -- -- -- (2,912) -- (2,912)
Stock issued for stock options -- (145) -- -- -- 509 -- 364
Amortization of and tax on MSP shares -- 54 -- -- 290 -- -- 344
Common stock dividends
($0.50 per share) -- -- (1,329) -- -- -- -- (1,329)
Purchase of subsidiary -- (109) -- -- -- 1,126 -- 1,017
Allocated ESOP shares -- 110 -- 360 -- -- -- 470
Other comprehensive (loss) -- -- -- -- -- -- (652) (652)
---------------------------------------------------------------------------------------------
Balance September 30, 1999 $ 450 $ 43,292 $ 26,627 $ (1,628) $ (528) $(24,575) $ (1,313) $ 42,325
---------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these statements
18
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended September 30,
---------------------------------------------
1999 1998 1997
---------------------------------------------
In thousands)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,505 $ 3,030 $ 3,124
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 490 359 329
Net amortization of discounts and premiums on
securities held to maturity (37) (42) (31)
Provision for loan losses 456 302 120
Net market value adjustment on ESOP shares 104 185 141
Tax benefit on stock options 24 254 10
Amortization of ESOP and MRP stock compensation 656 650 669
Amortization of intangibles 105 10 --
Net gain on sale of assets (11) (18) --
Net loan fees deferred and amortized (134) (194) 214
Loans originated for sale (131,586) (27,625) (2,263)
Loans sold 134,539 25,156 2,103
(Increase) decrease in:
Accrued interest receivable (234) (653) (111)
Other assets (95) (142) 132
Increase (decrease) other liabilities 216 67 (589)
----------------------------------------------
Net cash provided by operating activities 6,998 1,339 3,848
Cash flows from investing activities:
Loan originations and principal payments on loans, net 40,038 (9,928) (41,245)
Purchase of loans (40,883) (10,832) (2,445)
Loan participations sold 3,000 -- --
Principal payments on securities held to maturity 10,002 2,125 19
Purchase of mortgage-related securities held to maturity (1,161) -- --
Purchase of securities available for sale (12,987) (3,671) (1,956)
Purchase of securities held to maturity -- -- (3,000)
Proceeds from securities available for sale -- 411 --
Proceeds from maturities of securities available for sale 3,000 1,000 --
Proceeds from maturities of securities held to maturity 4,500 13,500 9,500
Investment in foreclosed real estate (38) (12) (2)
Proceeds from sale of REO 500 24 22
Purchase paid up life insurance policies (5,495)
Proceeds from sale of fixed assets -- -- 5
Acquisition of Homeowners, net of cash acquired (1,245) -- --
Purchase of equipment and property improvements (1,677) (666) (373)
----------------------------------------------
Net cash (used in) investing activities $ (2,446) $ (8,044) $ (39,480)
</TABLE>
The accompanying notes are an integral part of these statements
19
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
<TABLE>
<CAPTION>
Years Ended September 30,
---------------------------------
1999 1998 1997
---------------------------------
(In thousands)
<S> <C> <C> <C>
Cash flows from financing activities:
Net increase in deposits, $ 5,109 $ 18,297 $ 19,171
FHLB Advances -- 10,500 19,250
Payments on FHLB Advances (3,210) (141) (126)
Net short term borrowings (5,726) -- --
Net increase (decrease) in mortgage escrow funds (152) 46 305
Treasury stock purchased (2,912) (5,492) (7,245)
Dividends on common stock (1,329) (1,358) (1,413)
Proceeds from exercise of stock options 336 1,315 69
----------------------------------------
Net cash provided by financing activities (7,884) 23,167 30,011
----------------------------------------
Net increase in cash and cash equivalents (3,332) 16,462 (5,621)
Cash and cash equivalents:
Beginning of year 22,597 6,135 11,756
----------------------------------------
End of period $ 19,265 $ 22,597 $ 6,135
========================================
Supplemental disclosures of cash flow information: Cash payments for:
Interest on advances and other borrowed money $ 7,980 $ 8,464 $ 6,976
Interest on deposits 9,588 10,220 9,188
Income taxes 1,443 1,850 1,999
Supplemental schedule of noncash investing and financing activities:
Reinvested amounts of capital gains and dividends
from mutual fund investments $ 80 $ 121 $ 22
Foreclosed real estate 197 449
20
Stock acquisition of Insurance Planners -- 656
Acquisition of Homeowners Mortgage Corporation non-cash
asset, net of assumed liabilities 1,037 -- --
</TABLE>
The accompanying notes are an integral part of these statements
20
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999, 1998 AND 1997
(1) Description of Business and Summary of Significant Accounting Policies
The consolidated financial statements include the accounts of FSF Financial
Corp. ("the Corporation") and its wholly owned subsidiaries, Homeowners Mortgage
Corporation ("HMC"), Insurance Planners of Hutchinson, Inc. ("the Agency"),
First Federal fsb ("the Bank") and Firstate Services, a wholly owned subsidiary
of the Bank. All significant inter-company accounts and transactions have been
eliminated in consolidated financial statements which have been prepared in
conformity with generally accepted accounting principles.
Nature of Business
The Corporation is a holding company whose subsidiaries provide financial
services. The Bank is a community financial institution attracting deposits from
the general public and using such deposits, together with borrowings and other
funds, to make mortgage, consumer, commercial and agricultural loans. At
September 30, 1999, 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. The Agency is a
property and casualty insurance company. HMC is a mortgage banking entity
located in Vadnais Heights, MN., that originates and sells residential mortgage
loans.
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 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 $16,020 and $15,299 at
September 30, 1999, and 1998, 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
during the three fiscal years ended September 30, 1999.
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,
21
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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.
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
foreseeable future or until maturity or payoff are reported at their outstanding
principal adjusted by 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 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 an 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
The Corporation calculates income taxes on the liability method, under which the
net deferred tax asset or liability is determined based on the tax effects of
the differences between the book and tax bases of the various assets and
liabilities of the Corporation giving current recognition to changes in tax
rates and laws.
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.
22
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Mortgage Loan-Servicing Rights
The Bank has 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 Bank, and the derecognition of financial assets and
liabilities when control is extinguished. Liabilities and derivatives incurred
or obtained 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.
Mortgage servicing rights are amortized in proportion to, and over the period
of, estimated net servicing revenues. Impairment of mortgage servicing rights 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 rights for a stratum exceed their fair value.
Earnings Per Share
Basic income per share amounts are computed by dividing the net income by the
weighted average number of common shares outstanding. Diluted income per share
amounts were computed by dividing net income, adjusted for the effect of assumed
conversions, by the weighted average number of common shares outstanding plus
dilutive potential common shares calculated for stock options outstanding using
the treasury stock method.
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
Effective for the year ended September 30, 1998, the Corporation has adopted
SFAS No. 123, "Accounting for Stock-Based Compensation." As allowed by SFAS No.
123, the Corporation has elected to continue using the accounting methods
prescribed by Accounting Principles Board (APB) Opinion No. 25 and related
interpretations, which measure compensation cost using the intrinsic value
method. See Note 10 for the impact of the fair value of employee stock-based
compensation plans on net income and earnings per share on a pro forma basis for
awards granted after October 1, 1995.
Comprehensive Income
Effective October 1, 1998, the Corporation adopted SFAS No. 130, Reporting
Comprehensive Income. The statement establishes standards for reporting and
display of comprehensive income and its components in a full set of
general-purpose financial statements. The statement requires that all items that
are required to be recognized under accounting standards as components of
comprehensive income to be disclosed in the financial statements. Comprehensive
income is defined as the change in equity during a period from transactions and
other events from non-owner sources. Comprehensive income is the total of net
income and other comprehensive income, which for the Corporation is comprised
entirely of unrealized gains and losses on securities available for sale.
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
Life Insurance Policies - Cash value of the policies approximates fair
value.
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
23
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
offered on certificates to a schedule of aggregated expected
monthly maturities on time deposits.
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 considered material for disclosure.
(2) Business Combination
On June 1, 1998, the Corporation acquired 100% of the outstanding common stock
of the Agency. The business combination was accounted for by the purchase method
and the financial statements reflect the operating results of the Agency for the
four month period ended September 30, 1998. The Corporation issued 38,961 shares
of common stock held as treasury shares to complete the acquisition. The
acquisition price of $750,000, resulted in an acquired identifiable customer
based intangible asset of $674,628, which will be amortized using the straight
line method over twenty five years. The acquisition did not have a material
pro-forma effect on the results of operations for the twelve month periods
ending September 30, 1998, 1997 and 1996.
On November 17, 1998, the Corporation acquired 100% of the outstanding common
stock of HMC, an originator and seller of residential mortgage loans. The
business combination was accounted for by the purchase method and the financial
statements reflect the operating results of HMC for the ten and a half months
ended September 30, 1999. The Corporation issued 77,839 shares of common stock
held as treasury shares and $1.25 million in cash to complete the transaction.
In addition, options for 50,000 common stock shares, at an exercise price of
$15.00, were also issued. The acquisition price of $2.5 million resulted in
goodwill of approximately $2.3 million, which will be amortized using the
straight line method over twenty-five years.
The following unaudited pro forma supplemental information is presented based on
historical financial statements of the Corporation and HMC. The unaudited pro
forma supplemental information for the three years ended September 30, 1999,
were prepared as if the acquisition had occurred as of the beginning of the
respective periods.
<TABLE>
<CAPTION>
For the Three Years Ended
September 30,
----------------------------------------------
1999 1998 1997
----------------------------------------------
(In thousands)
<S> <C> <C> <C>
Interest income $ 29,434 $ 30,208 $ 27,565
Interest Expense 18,230 18,611 16,384
----------------------------------------------
Net interest income 11,204 11,597 11,181
Provision for loan losses 456 302 120
----------------------------------------------
Net interest income after provision
for loan losses 10,748 11,295 11,061
----------------------------------------------
Non-interest income 6,173 5,831 3,619
Non-interest expense 12,470 11,198 9,296
----------------------------------------------
Income before provision for income taxes 4,451 5,928 5,384
Income tax expense 1,796 2,378 2,168
----------------------------------------------
Net income $ 2,655 $ 3,550 $ 3,216
==============================================
Basic earnings per share $ 0.99 $ 1.30 $ 1.14
Diluted earnings per share $ 0.95 $ 1.20 $ 1.06
</TABLE>
24
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(3) 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>
September 30, 1999
---------------------------------------------------------
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 $ - $ 601 $ 11,921
Stock in FHLB 7,363 - - 7,363
------------- --------- ------------- -------------
Total $ 19,885 $ - $ 601 $ 19,284
============= ========= ============= =============
Mortgage backed securities:
REMICs $ 16,981 $ - $ 1,002 $ 15,979
============= ========= ============= =============
Debt Securities: $ 12,988 $ 22 $ 216 $ 12,794
============= ========= ============= =============
Held to maturity securities:
Debt securities:
U.S. Government and Agency $ 18,367 $ 92 $ 1,037 $ 17,422
Other Debt Securities $ 1,570 $ 7 $ - $ 1,577
----------------------------------------------------------
Total $ 19,937 $ 99 $ 1,037 $ 18,999
==========================================================
Mortgage backed securities:
REMICs $ 26,415 $ 162 $ 1,414 $ 25,163
FNMA certificates 1,142 $ 1,144
2 -
Other certificates 30 2 - $ 31
------------- --------- ------------- -------------
Total $ 27,587 $ 165 $ 1,414 $ 26,338
============= ========= ============= =============
</TABLE>
The amortized cost of debt and mortgage-backed securities at September 30, 1999
included unamortized premiums of $214 and unaccreted discounts of $337,
respectively.
25
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
<TABLE>
<CAPTION>
September 30, 1998
----------------------------------------------------------------------------
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 7,363 - - 7,363
Total $ 19,885 $ - $ 426 $19,459
================= ================== ================== =============
Mortgage backed securities:
REMICs $ 16,980 $ - $ 406 $16,574
================= ================== ================== =============
Debt Securities: $ 3,000 $ 10 $ - $ 3,010
================= ================== ================== =============
Held to maturity securities:
Debt securities:
U.S. Government and Agency $ 22,844 $ 613 $ 1,105 $22,352
Other Debt Securities $ 1,568 $ 33 - $ 1,601
----------------------------------------------------------------------------
Total $ 24,412 $ 646 $ 1,105 $23,953
============================================================================
Mortgage backed securities:
REMICs $ 36,363 $ 65 $ 1,120 $35,308
GNMA certificates 49 6 - 55
FHLMC certifiactes 6 - - 6
----------------- ------------------ ------------------ -------------
Total $ 36,418 $ 71 $ 1,120 $35,369
================= ================== ================== =============
</TABLE>
The amortized cost of debt and mortgage backed securities at September 30, 1998,
includes unamortized premiums of $232 and unaccreted discounts of $392,
respectively.
Gross realized gains on sales of available for sale securities was $11 for the
year ended September 30, 1998 There were no sales of securities during the two
years ended September 30, 1999 and 1997.
The scheduled maturities of securities held-to-maturity and securities (other
than equity securities) available-for-sale at September 30, 1999, 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 $ 570 $ 570 $ - $ -
Due from one to five years 6,069 5,815 12,988 12,794
Due from five to ten years 7,103 6,327
- -
Due after ten years 33,782 32,625 16,981 15,979
------------ ------------ --------------- ----------
Total $ 47,524 $ 45,337 $ 29,969 $28,773
============ ============ =============== ==========
</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 $20.0 million at September
30, 1999 and $26.7 million at September 30, 1998, were pledged to secure public
deposits and for other purposes required or permitted by law.
26
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(4) Loans Receivable (in thousands)
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
September 30,
----------------------------
1999 1998
-------------- ----------
<S> <C> <C>
First mortgage loans:
Secured by one-to-four family residences $ 115,550 $ 154,668
Secured by other properties 28,824 25,235
Construction and land development loans 56,177 34,098
-------------- ------------
200,551 214,001
Less:
Undisbursed portion of construction
and land development loans (26,156) (16,658)
Net deferred loan origination fees (744) (850)
-------------- ------------
Sub-total first mortgage loans 173,651 196,493
Consumer and other loans:
Consumer loans 18,326 17,275
Home equity and second mortgages 24,312 23,606
Commercial 29,767 21,095
Agricultural loans 33,384 22,960
-------------- ------------
105,789 84,936
Add: net deferred loan origination costs 237 209
-------------- ------------
Sub-total consumer and other loans 106,026 85,145
-------------- ------------
Sub-total all loans 279,677 281,638
Less: allowance for loan losses (1,387) (1,035)
-------------- ------------
Total $ 278,290 $ 280,603
============== ============
</TABLE>
A summary of the activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
Years Ended September 30,
-----------------------------------------------
1999 1998 1997
------------ ------------ -----------
<S> <C> <C> <C>
Balance, beginning of period $ 1,035 $ 852 $ 776
Provision for losses 456 302 120
Charge-offs (142) (132) (50)
Recoveries 38 13 6
------------ ------------ -----------
Balance, end of period $ 1,387 $ 1,035 $ 852
============ ============ ==========
</TABLE>
The Bank had no loans classified as impaired at September 30, 1999, and 1998.
Loans having carrying values of $197 and $449 were transferred to foreclosed
real estate in 1999 and 1998, 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 $366, and $489 at September 30, 1999, and 1998, respectively.
During 1999 repayments on loans to executive officers and directors aggregated
$259 and $136 was advanced.
27
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(5) 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 $55,488 and $46,456 at September 30, 1999
and 1998, respectively.
Custodial escrow balances maintained in connection with the foregoing loan
servicing, and included in demand deposits, were $296 and $274 at September 30,
1999 and 1998, respectively.
Capitalized mortgage servicing rights and excess servicing receivables are
summarized as follows:
<TABLE>
<CAPTION>
Years Ended September 30,
--------------------------------
1999 1998 1997
-------- ---------- ----------
<S> C> <C> <C>
Beginning balance, net of accumulated amortization $ 201 $ 148 $ 157
Amounts capitalized 132 98 20
Amortization (80) (42) (30)
Valuation adjustments - (3) 1
-------- ---------- ----------
Balance, end of period $ 253 $ 201 $ 148
======== ========== ==========
</TABLE>
6) 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, 1999. The Bank held foreclosed
real estate at September 30, 1999 and 1998 amounting to $323 and $502,
respectively.
(7) Premises and Equipment (in thousands)
Premises and equipment are summarized as follows:
September 30,
-----------------------
1999 1998
----------- ---------
Land $ 669 $ 685
Buildings and improvements 4,597 3,787
Furniture, equipment and automobiles 3,582 2,818
Leasehold improvements 40 40
----------- ----------
Total costs 8,888 7,330
Less accumulated depreciation 3,574 3,219
----------- ----------
Total $ 5,314 $ 4,111
=========== ==========
At September 30, 1999, the Corporation was obligated under non-cancelable
operating leases for office space and equipment. Net rental expense under
operating leases, included in occupancy and equipment, was $275, $51, and $58
for the years ended September 30, 1999, 1998, and 1997, respectively. The
projected minimum lease commitments under the terms of the leases at September
30, 1999, are as follows:
Rental Income Rental Expense
Fiscal as Lessor as Lessee
------------ ---------------
2000 19 435
2001 7 341
2002 - 289
2003 - 147
--------- --------------
$ 26 $ 1,212
========= ==============
28
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(8) Deposits (in thousands)
The aggregate amount of short-term jumbo CDs, each with a minimum denomination
of $100,000, was $20,681 and $24,311 in 1999 and 1998 respectively.
September 30, 1999
-------------------------------------
1999 1998 1997
------- ------- -------
Savings accounts $ 1,896 $ 1,690 $ 1,548
Demand deposits 289 407 389
Certificates of deposit 8,048 7,985 7,402
------- ------- -------
$10,233 $10,082 $ 9,339
======= ======= =======
Interest expense on deposits is summarized as follows:
At September 30, 1999, the scheduled maturities of certificates of deposit are
as follows:
Years Ending September 30,
- --------------------------
2000 108,565
2001 17,766
2002 2,890
2003 1,327
2004 and thereafter 2,597
--------
$133,145
========
(9) 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,
----------------------------------------------------------------
1999 1998
------------------------------ ------------------------------
Fiscal Year of Maturity - Advances Weighted Weighted
Amount Rate Amount Rate
----------------------------------------------------------------
<S> <C> <C> <C> <C>
1999 $ - % $ 3,000 6.55 %
2000 24,467 5.89 24,677 5.89
2001 24,000 5.80 24,000 5.80
2002 - - - -
2003 and thereafter 92,500 5.15 92,500 5.15
-------------- ------------ -------------- -----------
Total $140,967 5.39 % $ 144,177 5.42 %
============== ============ ============== ===========
</TABLE>
At September 30, 1999, borrowed funds are collateralized by stock in the FHLB,
first mortgage loans with carrying value of $119,262 and debt and
mortgage-backed securities with carrying values of $49,722 under a collateral
agreement.
29
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(10) 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
$119, $151, and $142 for the three years ended September 30, 1999, respectively.
Deferred Compensation 401(k) Plans
The Corporation provides 401(k) plans which cover substantially all employees
meeting age and length of service requirements. The plan maintained by the Bank
covers employees of both the Bank and the Agency. Employees participating in
this plan are eligible to contribute up to 15% of their annual compensation. The
plan maintained by HMC for the benefit of its employees provides for employee
contribution up to 15% of annual compensation. Both plans provide for
discretionary contributions by the employers which are allocated to the
participants' accounts in proportion to employee contributions. Company
contributions to these plans for the three years ended September 30, 1999 were
$0, $601 and $0, respectively.
Supplemental Life Insurance
In addition to group term insurance benefits provided to substantially all
employees, the Bank maintains investments in insurance policies that provide
either split-dollar or survivor benefits for certain key employees.
Employee Stock Ownership Plan
The Corporation 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. Employer
contributions, 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, 1999, 1998 and 1997 was $442,
$668 and $549, respectively.
A summary of the ESOP share allocation is as follows:
September 30,
------------------------------
1999 1998 1997
--------- --------- --------
Shares allocated beginning of year 160,947 124,975 87,870
Shares allocated during year 35,975 35,972 37,105
Unreleased shares 162,798 198,773 234,745
--------- ---------- --------
Total ESOP 359,720 359,720 359,720
========= ========== ========
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 in
January 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 is recorded as unearned compensation, a contra equity account, and
is recognized as an expense in accordance with the vesting requirements defined
by the MSP. For each of the three fiscal years ended September 30, 1999, the
amount included in compensation expense related to the MSP was $290. The
following summarizes the activity in the MSP for the three years ended September
30, 1999.
30
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Unawarded Awarded
Shares Shares
--------- ---------
At September 30, 1996 42,964 109,517
Vested - (27,379)
--------- ---------
At September 30, 1997 42,964 82,138
Vested - (27,379)
--------- ---------
At September 30, 1998 42,964 54,759
Vested - (27,379)
--------- ---------
At September 30, 1999 42,964 27,380
========= =========
Director's Stock Compensation Plan
In January 1998, the shareholders of the Corporation approved a stock
compensation plan for its non-employee directors. The plan granted 6,000 shares
of common stock issued from treasury that vests over a four year period, with
1,200 shares awarded in January 1998. The compensation cost associated with this
plan is the fair value of the stock ($19.42/share) on the date the plan was
approved by shareholders. Compensation cost included in the accompanying
financial statements for the year ended September 30, 1999 and 1998 were $23,292
and $40,814 respectively. During the year ended September 30, 1999, 1,200 shares
of the total grant were vested to the plan recipients.
Stock Option Plans
The Corporation maintains the 1994 stock option plan, approved by the
Corporation's stockholders on January 17, 1995 (the 1994 Plan); and the 1998
stock option plan, approved by the Corporation's stockholders on January 20,
1998 (the 1998 Plan). These plans permit the granting of stock options, with an
exercise price equal to the fair value of the Corporation's stock on the date of
the option grant. All options granted under these plans may be exercised over a
ten-year period beginning on the date the option is granted. Awards made under
the Plans may be incentive stock plans (ISO's) as defined by Section 422 of the
Internal Revenue Code or options that do not qualify. Those options granted that
qualify as ISO's are generally exercisable on the date of the grant while those
not qualifying (non-incentive stock options granted to executives and directors
of the Corporation) vest over 3-5 years. The following summarizes the activity
in the two Plans for the three years ended September 30, 1999: [OBJECT OMITTED]
The following table summarizes information about stock options outstanding at
September 30, 1999:
<TABLE>
<CAPTION>
Shares Available Options Shares Weighted Average
for Grant Outstanding Exercise Price
------------------ ------------------ ------------------
<S> <C> <C> <C>
At September 30, 1996 7,488 433,158 $
Exercised - (5,405) 9.50
Cancelled 1,500 (1,500) 9.50
------------------ ------------------ ------------------
At September 30, 1997 8,988 426,253 -
1998 Plan Created 300,000 - -
Granted (145,601) 145,601 19.18
Exercised - (135,957) 9.50
------------------ ------------------ ------------------
At September 30, 1998 163,387 435,897 12.73
Granted (90,074) 90,074 14.34
Exercised - (33,988) 9.50
Cancelled 6,582 (6,582) 19.13
------------------ ------------------ ------------------
At September 30, 1999 79,895 485,401 $ 13.40
================== ================== ==================
Shares available for future grants
1994 Plan 7,988
1998 Plan 71,907
</TABLE>
31
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
- --------------------------------------------------------------------------------------------------
Weighted average
Exercise Number remaining contractual
Price Outstanding life in years Number Price
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 9.500 256,308 5.3 190,861 $ 9.500
20.000 1,000 8.3 400 20.000
19.125 96,019 8.3 50,457 19.125
19.416 12,000 8.3 4,800 19.416
19.250 30,000 8.7 15,000 19.250
15.000 50,000 9.2 10,000 15.000
14.750 19,387 9.2 19,387 14.750
12.375 20,687 10.0 20,687 12.375
------------
485,401
============
</TABLE>
The Corporation elected to follow APB 25 and related interpretations in
accounting for its employee stock options. The exercise price of the employee
stock options equal the market price of the underlying stock on the date of
grant and, therefore, no compensation expense is recognized, under APB 25.
Proforma information regarding net income and earnings per share is required by
SFAS No. 123, and has been determined as if the Corporation had accounted for
its employee stock option under the fair value method of that statement.
Proforma net income and earnings per share for fiscal years 1999 and 1998
follow:
1999 1998
------------------ ------------------
Net Income
As reported $ 2,505 $ 3,030
Pro forma 2,322 2,943
Earnings per common share
As reported
Basic $ 0.94 $ 1.14
Diluted 0.90 1.05
Pro forma
Basic $ 0.87 $ 1.10
Diluted 0.83 1.02
The above disclosed pro forma effects of applying SFAS No. 123 to compensation
costs may not be representative of the effects on reported pro forma net income
for future years.
The fair value for each option grant is estimated on the date of the grant using
the Black Scholes Model. The Model incorporates the following assumptions for
the grants:
1999 1998
-----------------------
Risk free interest rate 5.22% 5.32%
Expected life 10 years 10 years
Expected volatility 27.00% 62.65%
Expected dividends - -
The weighted average fair value of the options granted in fiscal 1999 and 1998
were $8.64 and $11.33 per option, respectively.
32
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(11) Income Taxes (in thousands)
The Corporation files a consolidated federal income tax return. The Corporation
and its subsidiaries entered into a tax-sharing agreement that provides for the
allocation and payment of federal and state income taxes. The provision for
income taxes of each corporation is computed on a separate company basis,
subject to certain adjustments. Income tax expense (benefit) is summarized as
follows:
<TABLE>
<CAPTION>
September 30,
---------------------------------------------
1999 1998 1997
------------- ------------- -------------
Current
<S> <C> <C> <C>
Federal $ 936 $ 1,650 $ 1,494
State 308 534 498
------------- ------------- -------------
Subtotal 1,244 2,184 1,992
Deferred
Federal 338 (120) 85
State 112 (40) 28
------------- ------------- -------------
Subtotal 450 (160) 113
------------- ------------- -------------
Total income tax provision $ 1,694 $ 2,024 $ 2,105
============= ============= =============
</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. 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:
September 30,
----------------------
1999 1998
--------- ---------
Deferred tax assets:
Deferred compensation $ 693 $ 866
Deferred net loan fees 205 265
Securities unrealized loss 719 324
Allowance for loan losses 562 419
----------- ----------
Subtotal 2,179 1,874
Less: Valuation allowance 243 172
----------- ----------
Total 1,936 1,702
Deferred tax liabilities:
FHLB Stock 241 241
Tax bad debt reserve 213 256
Premises and equipment 375 337
Installment obligation sale of former building 28 29
Mortgage servicing rights 74 43
Discount on loans 6
7
Section 475 "For Sale Assets" 484 161
----------- ----------
Total 1,421 1,074
----------- ----------
Net deferred tax asset $ 515 $ 628
=========== ==========
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 Corporation 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, 1999 and 1998.
33
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
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,
1999 1998 1997
------------- ------------ ----------
<S> <C> <C> <C>
Computed "expected" tax expense $ 1,333 $ 1,718 $ 1,778
Exempt dividends - (5) (8)
State income taxes, net of federal tax benefit 278 322 336
Other, net 83 (11) (1)
------------- ------------ ----------
Total income tax provision $ 1,694 $ 2,024 $ 2,105
============= ============ ==========
</TABLE>
Retained earnings at September 30, 1999, 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, 1999.
(12) Earnings per Share
The following table sets forth the computation of basic and diluted earnings per
share:
<TABLE>
<CAPTION>
For the Years ended
September 30,
------------------------------------------
1999 1998 1997
------------------------------------------
<S> <C> <C> <C>
Numerator:
Net income - Numerator for basic earnings
per share and diluted earnings per share--
income available to common stockholders $ 2,505,000 $ 3,030,000 $ 3,124,000
===========================================
Denominator:
Denominator for basic earnings per share--
weighted-average shares 2,663,691 2,669,586 2,763,481
Effect of dilutive securities:
Stock - based compensation plans 108,713 222,598 230,656
-------------------------------------------
Denominator for diluted earnings per share--
adjusted weighted-average shares and
assumed conversions 2,772,404 2,892,184 2,994,137
===========================================
Basic earnings per share $ 0.94 $ 1.14 $ 1.13
Diluted earnings per share $ 0.90 $ 1.05 $ 1.04
</TABLE>
(13) Contingencies (in thousands)
Loans Sold During 1982, the Bank sold loans subject to recourse provisions. The
balance of these loans at September 30, 1999, and 1998 was $208 and $238,
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.
34
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(14) 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. 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, 1999, that the Bank meets all capital adequacy requirements to
which it is subject.
As of September 30, 1999, and 1998, 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
table 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 capital, September 30, 1999 $ 36,534
Add: Unrealized losses on debt
securities held for sale 712
-----------
Tangible equity capital and ratio to
adjusted total assets $ 37,246 9.0% $ 6,201 1.5% $ 8,268 2.0%
-------------------- -------------------- --------------------
Tier 1 (Core) capital and ratio to
adjusted total assets $ 37,246 9.0% $ 16,536 4.0% $ 20,670 5.0%
-------------------- -------------------- --------------------
Total risk-based capital and ratio to
risk-weighted assets $ 37,246 14.2% $ 10,528 4.0% $ 15,793 6.0%
--------- -------------------- --------------------
Tier 2 risk-based capital, net adjustment 383
-----------
Total risk-based capital and ratio to
risk-weighted assets, September 30 , 1999 $ 37,629 14.3% $ 21,057 8.0% $ 26,321 10.0%
==================== ==================== ====================
</TABLE>
35
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
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 capital, September 30, 1998 $ 37,220
Add: Unrealized losses on debt
securities held for sale 236
-----------
Tangible equity capital and ratio to
adjusted total assets $ 37,456 9.1% $ 6,168 1.5% $ 8,229 2.0%
-------------------- -------------------- --------------------
Tier 1 (Core) capital and ratio to
adjusted total assets $ 37,456 9.1% $ 16,457 3.0% $ 20,560 5.0%
-------------------- -------------------- --------------------
Tier 1 capital and ratio to
risk-weighted assets $ 37,456 15.5% $ 9,645 4.0% $ 14,467 6.0%
--------- -------------------- --------------------
Tier 2 capital, allowance for loan losses 1,035
-----------
Total risk-based capital and ratio to
risk-weighted assets, September 30 , 1998 $ 38,491 16.0% $ 1,920 8.0% $ 24,112 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.
(15) Concentration of Credit Risk (in thousands)
The Corporation is primarily engaged in originating mortgage, consumer, and
business 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.
The Corporation had cash on deposit in a financial institution in excess of
Federal deposit insurance limits of approximately $15,841 at September 30, 1999.
(16) 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. Each customer's creditworthiness
is evaluated on a case-by-case basis. The amount of collateral obtained, if it
is deemed necessary, upon extension of credit, is based on management's credit
evaluation of the counter-party. 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.
36
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
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
and/or HMC 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 Corporation's financial instruments at
September 30, 1999 follows:
Commitments to extend credit $ 39,263
Standby letters of credit 17
Commitments to sell loans 5,238
The carrying value and fair value of the Corporation's financial assets and
financial liabilities are as follows:
<TABLE>
<CAPTION>
September 30,
---------------------------------------------------
1999 1998
--------------------------- -------------------
Carrying Fair Carrying Fair
Value Value Value Value
--------------------------- -------------------
Financial assets:
<S> <C> <C> <C> <C>
Cash & cash equivalents $ 19,265 $ 19,265 $ 22,597 22,597
Investment securities 52,015 51,077 46,881 46,422
Mortgage-backed and related securities 43,566 42,315 52,992 51,943
Loans held for sale 5,334 5,334 2,672 2,672
Loans receivable, net 278,290 278,977 280,603 282,857
Accrued interest receivable 3,328 3,328 3,089 3,089
Life Insurance Policies 6,835 6,835 1,178 1,178
Financial liabilities:
Deposits 231,651 232,608 226,542 226,909
Borrowings 140,967 138,239 144,177 146,042
</TABLE>
(17) Effects of New Financial Accounting Standards
SFAS No. 133, "Accounting For Derivative Instruments and Hedging Activities" -
issued June 1998, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. SFAS No. 137 issued on July 7, 1999, deferred Statement 133's
effective date until the fiscal year beginning October 1, 2000. On the date of
adoption, the Corporation may transfer any held to maturity security into the
available for sale category and then be able to designate the transferred
security as a hedge item. Any unrealized holding gain or loss on transferred
securities will be reported in net income or accumulated other comprehensive
income. Management has not determined its strategy for the adoption of Statement
No. 133 or its effect on the financial statements. If the Corporation elects to
apply hedge accounting, it is required to establish, at the inception of the
hedge, the method it will use for assessing the effectiveness of the hedging
activities and the measurement approach for determining the ineffective aspect
of the hedge.
37
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(18) 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 and MSP adjustments.
The investment in the Bank subsidiary is carried net of the Banks' unrealized
loss on securities available for sale.
<TABLE>
<CAPTION>
STATEMENT OF FINANCIAL CONDITION
September 30,
---------------------
ASSETS 1999 1998
--------- --------
<S> <C> <C>
Cash and cash equivalents $ 278 $ 2,809
Investment securities held to maturity 1,570 1,568
Investment in subsidiaries 40,461 37,904
Loan to Bank ESOP 1,628 1,988
Other assets 282 67
-------- --------
$ 44,004 $ 44,551
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 51 $ 45
Stockholders' equity:
Common stock 450 450
Additional paid-in capital 43,292 43,382
Treasury stock (24,575) (23,298)
Unearned MSP stock (528) (818)
Retained earnings 25,314 24,790
-------- --------
Total stockholders' equity 43,953 44,506
-------- --------
$ 44,004 $ 44,551
======== ========
</TABLE>
STATEMENT OF INCOME
<TABLE>
<CAPTION>
Years Ended September 30,
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Income:
Dividends from Bank Subsidiary $ 3,000 $ 4,500 $ 4,202
Interest From:
Bank's ESOP Plan 159 193 222
Investments 180 309 343
-------- -------- --------
3,339 5,002 4,767
Expense:
Non-Interest Expense 462 615 566
-------- -------- --------
Income before income taxes and equity in undistributed
net income of subsidiaries 2,877 4,387 4,201
Income tax (benefit) expense (48) (54) (1)
-------- -------- --------
2,925 4,441 4,202
Subsidiaries dividends received in excess of subsidiaries net income (420) (1,423) (1,078)
-------- -------- --------
Net income $ 2,505 $ 3,018 $ 3,124
======== ======== ========
</TABLE>
38
<PAGE>
FSF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(18) Parent Only Condensed Financial Information - Continued (in thousands)
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended September 30,
1999 1998 1997
--------------- ---------- ------------
Cash flows from operating activities:
<S> <C> <C> <C>
Net Income $ 2,505 $ 3,030 $ 3,124
Adjustments:
Subsidiaries dividends received in excess
of subsidiaries net income 420 1,423 1,078
(Increase) decrease in other assets 215 (123) 10
Increase in other liabilities 6 82 27
Other 80 356 115
------------ ----------- -----------
Net cash provided by operations 3,226 4,768 4,354
Cash flows from investing activities:
Proceeds from maturities of investments - 1,500 1,500
Investment in Homeowners (2,267) - -
Proceeds from securities available for sale - 411 -
------------ ----------- -----------
Net cash provided by investing activities (2,267) 1,911 1,500
Cash flows from financing activities:
Payments received on ESOP bank loan 360 360 371
Purchases of treasury stock (2,912) (5,492) (7,245)
Proceeds from exercise of stock options 336 1,315 73
Payments of cash dividends (1,381) (1,358) (1,413)
------------ ----------- -----------
Net cash used in financing activities (3,597) (5,175) (8,214)
------------ ----------- -----------
Increase (decrease) in cash and cash equivalents (2,638) 1,504 (2,360)
Cash and cash equivalents:
Beginning of year 2,916 1,412 3,772
------------ ----------- -----------
End of year $ 278 $ 2,916 $ 1,412
============ =========== ===========
</TABLE>
(19) Business Segments
The Corporation's reportable business segments are business units that offer
different products and services that are marketed through different channels.
In accordance with SFAS No. 131, "Disclosure about Segments of an Enterprise
and Related Information". The Corporation has identified its wholly-owned
subsidiaries First Federal, fsb, (the Bank) and Homeowners Mortgage Corporation
(HMC) as reportable business segments. Both segments operate and are managed
independently. Additionally, HMC is not regulated by the Office of Thrift
Supervision.
The accounting policies and the nature of business of these segments are
described in the summary of significant accounting policies (Note 1).
Management evaluates segment performance based on segment profit or loss before
income taxes and nonrecurring gains and losses, and returns on average assets
and average equity. Transfers between segments are accounted for at market
value.
Firstate Services, the Agency and FSF Financial Corporation (the holding
company), did not meet the quantitative thresholds for determining reportable
segments and therefore are included in the "Other" category.
39
<PAGE>
<TABLE>
<CAPTION>
First Homeowners Consolidated
Federal fsb Mortgage Corp. Other Eliminations Total
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
As of and for the year ended September 30, 1999
From Operations
Interest income from external sources $ 29,061 $ 171 $ 8 $ - $ 29,240
Non-interest income from external sources 2,189 2,180 890 - 5,259
Inter-segment interest income 183 - 3,152 (3,335) -
Interest expense 18,079 301 - (182) 18,198
Provision for loan loss 456 - - - 456
Depreciation and Amortization 454 99 42 - 595
Other non-interest expense 8,683 2,333 1,214 (404) 11,826
Net Income $ 2,563 $ (64) $ 3,006 $ (3,000) $ 2,505
=============================================================================
Total Assets $ 413,391 $ 6,210 $ 43,058 $ (44,565) $ 418,094
=============================================================================
As of and for the year ended September 30, 1998
From Operations
Interest income from external sources $ 29,667 - $ 314 $ - $ 29,981
Non-interest income from external sources 1,758 - 511 - 2,269
Inter-segment interest income 5 - 4,692 (4,697) -
Provision for loan loss 302 - - - 302
Depreciation and Amortization 355 - 14 - 369
Other non-interest expense 7,574 - 1,014 (193) 8,395
Income tax expense (benefit) 2,036 - (12) - 2,024
Net Income $ 3,013 - $ 4,517 $ (4,500) $ 3,030
=============================================================================
Total Assets $ 411,753 - $ 42,614 $ (38,135) $ 416,232
=============================================================================
As of and for the year ended September 30, 1997
From Operations
Interest income from external sources $ 26,969 - $ 346 $ - $ 27,315
Non-interest income from external sources 1,284 - 226 - 1,510
Inter-segment interest income 4 - 4,426 (4,430) -
Interest expense 16,346 - - - 16,346
Provision for loan loss 120 - - - 120
Depreciation and Amortization 329 - - - 329
Other non-interest expense 6,594 - 759 (223) 7,130
Income tax expense (benefit) 2,091 - 14 - 2,105
Net Income $ 3,102 - $ 4,224 $ (4,202) $ 3,124
=============================================================================
Total Assets $ 384,390 - $ 26,916 $ (23,171) $ 388,135
=============================================================================
</TABLE>
40
<PAGE>
Selected Quarterly Financial Data (Unaudited)
For Three Years Ended September 30, 1999
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
-------------------------------------------------
Fiscal 1999
<S> <C> <C> <C> <C> <C>
Interest income $ 7,503 $ 7,242 $ 7,267 $ 7,408 $29,420
Interest expense 4,704 4,522 4,526 4,446 18,198
-------------------------------------------------
Net Interest Income 2,799 2,720 2,741 2,962 11,222
Provision for loan losses 114 114 114 114 456
Gain on sale of assets 700 573 624 444 2,341
Net income $ 842 $ 693 $ 525 $ 445 $ 2,505
Basic earnings per share 0.32 0.26 0.20 0.17 0.94
Diluted earnings per share 0.30 0.25 0.19 0.17 0.90
Cash dividends declared per share $ 0.125 $ 0.125 $ 0.125 $ 0.125 $ 0.50
Market range:
High bid (1) $ 15.75 $ 15.50 $ 14.44 $ 14.13 $ 15.75
Low bid (1) $ 14.25 $ 13.56 $ 13.50 $ 11.75 $ 11.75
Fiscal 1998
Interest income $ 7,364 $ 7,518 $ 7,554 $ 7,545 $29,981
Interest expense 4,548 4,591 4,657 4,703 18,499
-------------------------------------------------
Net Interest Income 2,816 2,927 2,897 2,842 11,482
Provision for loan losses 45 75 107 75 302
Gain on sale of assets 15 107 130 108 360
Net income $ 746 $ 810 $ 767 $ 707 $ 3,030
Basic earnings per share 0.28 0.30 0.29 0.27 $ 1.14
Diluted earnings per share 0.26 0.28 0.27 0.25 $ 1.05
Cash dividends declared per share $ 0.125 $ 0.125 $ 0.125 $ 0.125 $ 0.50
Market range:
High bid (1) $ 20.94 $ 20.88 $ 20.75 $ 18.50 $ 20.94
Low bid (1) $ 19.00 $ 19.50 $ 18.00 $ 13.38 $ 13.38
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
Basic earnings per share 0.25 0.26 0.31 0.32 $ 1.13
Diluted earnings per share 0.24 0.24 0.28 0.29 $ 1.04
Cash dividends declared per share $ 0.125 $ 0.125 $ 0.125 $ 0.125 $ 0.50
Market range:
High bid (1) $ 15.13 $ 18.25 $ 18.13 $ 21.00 $ 21.00
Low bid (1) $ 12.75 $ 14.75 $ 16.38 $ 17.25 $ 12.75
</TABLE>
- ------------------------
(1) As reported by the Nasdaq Stock Market. Such over-the-counter quotations do
not reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions.
41
<PAGE>
- --------------------------------------------------------------------------------
FSF Financial Corporation
-------------------------
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 (651) 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 (651) 432-6840
Buffalo Office Glencoe Office
305 10th Avenue S, 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
(651) 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 56387-0641
(612) 442-2141 (320) 656-1133
Winthrop Office
122 East Second Street, PO
Box 424 Winthrop, MN
55396-0424
(507) 647-5356
- --------------------------------------------------------------------------------
Insurance Planners
------------------
Hutchinson Office Buffalo Office
135 3rd Avenue Southeast 305 10th Avenue S, P.O. Box 338
Hutchinson, MN 55350 Buffalo, MN 55313
(320) 587-2299 (612) 682-3035
- --------------------------------------------------------------------------------
Homeowners Mortgage Corporation
-------------------------------
Vadnais Heights Office Hastings Office
1001 Labore Industrial Court, Suite E 1320 South Frontage Road
Vadnais Heights, MN 55110 Hastings, MN 55033
(651) 415-1020
- --------------------------------------------------------------------------------
</TABLE>
42
<PAGE>
Our Board of Directors and Management Team
Board of Directors of FSF Financial Corporation and First Federal fsb
<TABLE>
<CAPTION>
<S> <C>
Donald A. Glas, Co-Chair of the Board George B. Loban, Co-Chair of the Board
Richard H. Burgart James J. Caturia
Jerome R. Dempsey Sever B. Knutson
Roger R. Stearns
</TABLE>
Executive Officers of FSF Financial Corporation
and First Federal fsb
<TABLE>
<CAPTION>
<S> <C>
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 & 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>
<PAGE>
FSF
[LOGO] FINANCIAL
CORPORATION
---------------------------------------------------------------
Financial Services Holding Company
201 Main Street South, Hutchinson, MN 55350-2573 320-234-4500
EXHIBIT 21
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
Parent
- ------
FSF Financial Corp.
Percentage State of
Subsidiaries Owned Incorporation
- ------------ ----- -------------
First Federal fsb 100% United States
Insurance Planners (a) 100% Minnesota
Homeowners Mortgage Corporation (b) 100% Minnesota
- ---------------
(a) Insurance Planners became a wholly owned subsidiary of FSF Financial Corp.
on June 1, 1998.
(b) Homeowners Mortgage Corporation became a wholly owned subsidiary of FSF
Financial Corporation on November 17, 1998.
25
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ANNUAL
REPORT ON FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL INFORMATION.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-END> SEP-30-1999
<CASH> 19,265
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 48,057
<INVESTMENTS-CARRYING> 47,524
<INVESTMENTS-MARKET> 45,337
<LOANS> 285,011
<ALLOWANCE> (1,387)
<TOTAL-ASSETS> 418,094
<DEPOSITS> 231,651
<SHORT-TERM> 140,967
<LIABILITIES-OTHER> 3,151
<LONG-TERM> 0
0
0
<COMMON> 450
<OTHER-SE> 41,875
<TOTAL-LIABILITIES-AND-EQUITY> 418,094
<INTEREST-LOAN> 22,861
<INTEREST-INVEST> 6,559
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 29,420
<INTEREST-DEPOSIT> 10,233
<INTEREST-EXPENSE> 7,965
<INTEREST-INCOME-NET> 11,222
<LOAN-LOSSES> 456
<SECURITIES-GAINS> 2,341
<EXPENSE-OTHER> 11,826
<INCOME-PRETAX> 4,199
<INCOME-PRE-EXTRAORDINARY> 2,505
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,505
<EPS-BASIC> 0.94
<EPS-DILUTED> 0.90
<YIELD-ACTUAL> 2.74
<LOANS-NON> 550
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,035
<CHARGE-OFFS> 142
<RECOVERIES> 38
<ALLOWANCE-CLOSE> 1,387
<ALLOWANCE-DOMESTIC> 1,387
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
