UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(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, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from __________________ to ___________________
Commission file number: 0-24848
EAST TEXAS FINANCIAL SERVICES, INC.
- --------------------------------------------------------------------------------
(Name of small business issuer as specified in its charter)
Delaware 75-2559089
- --------------------------------------------------------------------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.
1200 South Beckham Avenue, Tyler, Texas 75701
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (903) 593-1767
--------------
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 $.01 per share
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the issuer was required to file such reports), and (2) has
been subject to such requirements for the past 90 days. YES [ X ] NO [ ]
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained herein, and no disclosure will be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. (X)
State the issuer's revenues for its most recent fiscal year:
$8,624,000.
<PAGE>
The aggregate market value of the voting stock held by non-affiliates
of the Registrant, computed by reference to the average of the closing bid and
ask prices of such stock on the OTC Electronic Bulletin Board as of December 9,
1998 was $9.4 million. (The exclusion from such amount of the market value of
the shares owned by any person shall not be deemed an admission by the
Registrant that such person is an affiliate of the Registrant.)
As of December 9, 1998, there were issued and outstanding 1,464,056
shares of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Part II of Form 10-KSB - Portions of Annual Report to Stockholders for
the fiscal year ended September 30, 1998.
Part III of Form 10-KSB - Portions of Proxy Statement for 1999 Annual
Meeting of Stockholders.
Transitional Small Business Disclosure Format: YES [ ] NO [ X ]
<PAGE>
PART I
Item 1. Description of Business
General
East Texas Financial Services, Inc. (the "Company") is a Delaware
corporation organized in 1994 to be the savings and loan holding company of
First Federal Savings and Loan Association of Tyler ("First Federal" or the
"Association"). First Federal was founded in 1923 as a Texas chartered
institution and converted in 1939 to a federally chartered mutual savings and
loan association. The Company owns all of the outstanding stock of the
Association issued on January 10, 1995, in connection with the completion of its
conversion from the mutual to the stock form of organization (the "Conversion").
All references to the Company, unless the context otherwise requires, all
references herein to the Association or the Company include the Company and
Association on a consolidated basis. The Company's common Stock is traded on the
OTC Electronic Bulletin Board under the symbol "ETFS."
The Company and the Association are subject to comprehensive
regulation, examination and supervision by the Office of Thrift Supervision,
Department of the Treasury ("OTS") and by the Federal Deposit Insurance
Corporation ("FDIC"). The Association is a member of the Federal Home Loan Bank
("FHLB") System and its deposits are insured by the Savings Association
Insurance Fund ("SAIF") to the maximum extent permitted by the FDIC.
The Company serves its primary market area, East Texas with a
concentration in Smith County, through its main office and loan production
office, which are located in Tyler, Texas, a loan production office located in
Lindale, Texas and a full service branch located in Whitehouse, Texas. At
September 30, 1998, the Company had total assets of $124.0 million, deposits of
$86.6 million, borrowings from the FHLB of Dallas of $14.9 million, and
stockholders' equity of $20.4 million.
The principal business of the Company consists of attracting retail
deposits from the general public and investing those funds primarily in one- to
four-family residential mortgage loans. To a lesser extent, the Company also
originated commercial real estate, one- to four-family construction,
multi-family and consumer loans. The Company also purchases mortgage-backed
securities and invests in U.S. Government and agency obligations and other
permissible investments. At September 30, 1998, substantially all of the
Company's real estate mortgage loans (excluding mortgage-backed securities) were
secured by properties located in Texas, with most of them located in the
Company's primary market area. See "--Originations, Purchases and Sales of
Loans."
The Company has initiated an expansion into full-service commercial
banking products and services. In January 1999, the Company will begin offering
new products and services, including but not limited to commercial and consumer
loans, debit and credit cards, an ATM machine and cards, safe deposit boxes and
investment brokerage services. The goal of the expansion is to better serve the
Company's existing customers, to attract new customers to diversify into lending
products with higher yields and shorter terms, and to increase non-interest
income. The Company has established a new branch office location in its primary
market and has hired additional personnel to develop commercial and consumer
products and services.
<PAGE>
The Company's revenues are derived primarily from interest earned on
loans, mortgage-backed securities and investments and, to a lesser extent, from
service charges and loan originations, gains on sales of loans and
mortgage-backed securities, and loan servicing fee income. The Company does not
originate loans to fund leveraged buyouts, and has no loans to foreign
corporations or governments.
The Company currently offers a variety of deposit accounts having a
wide range of interest rates and terms. The Company's deposits include passbook
and money market accounts, NOW checking accounts, and certificate accounts with
terms ranging from one month to five years. The Company solicits deposits in its
primary market area and does not accept brokered deposits.
The Company has recently begun utilizing its borrowing privileges as a
member of the FHLB of Dallas. The Company borrows funds from the FHLB of Dallas
to fund long term loans and to invest in mortgage-backed securities. "See
Mortgage-Backed Securities, Sources of Funds, and Borrowings."
The executive offices of the Company are located at 1200 South Beckham
Avenue, Tyler, Texas 75701. The telephone number at that address is (903)
593-1767.
Forward-Looking Statements
When used in this Form 10-KSB or future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases or other
public or shareholder communications, or in oral statements made with the
approval of an authorized executive officer, the words or phrases "will likely
result", "are expected to", "will continue", "is anticipated", "estimate",
"project", "believe" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The Company wishes to caution readers not to
place undue reliance on any such forward-looking statements, which speak only as
of the date made, and to advise readers that various factors, including regional
and national economic conditions, changes in levels of market interest rates,
credit risks of lending activities, and competitive and regulatory factors,
could affect the Company's financial performance and could cause the Company's
actual results for future periods to differ materially from those anticipated or
projected.
The Company does not undertake, and specifically disclaims any
obligation, to publicly release the results of any revisions which may be made
to any forward-looking statements to reflect the occurrence of anticipated or
unanticipated events or circumstances after the date of such statements.
Lending Activities
General. Historically, the Company originated fixed-rate one- to four-
family mortgage loans. In the early 1980's, the Company began the origination of
adjustable-rate mortgage ("ARM") loans for retention in its portfolio, in order
to increase the percentage of loans in its portfolio with more frequent
repricing or shorter maturities than fixed-rate mortgage loans. The Company has
continued to originate fixed-rate residential mortgage loans, however, in
response to consumer demand. The Company underwrites the majority of its
fixed-rate residential mortgage loans under secondary market guidelines allowing
them to be saleable primarily to the Federal National Mortgage Association
("FNMA") with the servicing retained, without recourse, in order to generate fee
income and reduce the company's exposure to changes in interest rates.
See"--Loan Portfolio Composition" and "--One- to Four-Family Residential
Mortgage Lending."
<PAGE>
The Company's primary focus in lending activities is on the origination
of loans secured by first mortgages on owner-occupied one- to four-family
residences. To a lesser extent, the Company originates loans secured by
commercial real estate, one- to four-family construction, multi-family and
consumer loans. At September 30, 1998, the Company's net loans held in portfolio
totaled $61.1 million, which constituted 49.3% of the Company's total assets. At
that date, the Company had no loans held for sale.
The Loan Committee, comprised of Director L. Lee Kidd (Chairman),
President Gerald W. Free, Senior Vice President-Lending Joe C. Hobson, Chief
Financial Officer Derrell W. Chapman, Treasurer William L. Wilson and Vice
President-Compliance/Marketing M. Earl Davis, has the responsibility for the
supervision of the Company's loan portfolio with an overview by the full Board
of Directors. Loans may be approved by the Loan Committee, depending on the size
of the loan, with all loans subject to ratification by the full Board of
Directors. Loans in excess of $500,000 require full board approval. In addition,
foreclosure actions or the taking of deeds-in-lieu of foreclosure are subject to
oversight by the Board of Directors.
The aggregate amount of loans that the Company is permitted to make
under applicable federal regulations to any one borrower, including related
entities, or the aggregate amount that the Company could have invested in any
one real estate project, is generally the greater of 15% of unimpaired capital
and surplus or $500,000. See "Regulation--Federal Regulation of Savings
Associations." At September 30, 1998, the maximum amount that the Company could
have lent to any one borrower and the borrower's related entities was
approximately $2.8 million. At September 30, 1998, the Company had no loans or
lending relationships with an outstanding balance in excess of this amount. The
largest amount outstanding to any one borrower, or group of related borrowers,
was approximately $1.4 million at September 30, 1998, and was secured by a lien
on a commercial real estate property in Tyler being operated as a retail
furniture store. The next largest lending relationship outstanding at September
30, 1998 was for $600,000 and was secured by a commercial real estate property
operating as a manufacturing firm in Tyler, Texas. At September 30, 1998, the
next three largest lending relationships totaled $556,000, $484,000, and
$461,000 respectively. The $556,000 loan was secured by a country club located
in Tyler, Texas, and the $484,000 loan was secured by a restaurant located in
the Tyler, Texas. The $461,000 loan was secured by several duplex rental
properties located in the Tyler area. At September 30, 1998, all of these loans
were performing in accordance with their respective repayment terms. The Company
had no other lending relationships in excess of $450,000 at September 30, 1998.
<PAGE>
Loan Portfolio Composition. The following information sets forth the
composition of the Company's loan portfolios in dollar amounts and in
percentages (before deductions for loans in process, deferred fees and
discounts, allowances for losses and loans held for sale) as of the dates
indicated.
<TABLE>
<CAPTION>
September 30,
---------------------------------------------------------------------------------------------
1998 1997 1996 1995
Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family
residential ........... $52,298 83.34 % $49,412 83.88 % $42,773 85.98 % $34,947 81.55 %
Other residential property 551 0.88 569 0.97 701 1.41 724 1.69
Nonresidential property .. 4,106 6.54 4,023 6.83 3,458 6.95 4,387 10.24
Construction loans ....... 2,256 3.60 3,600 6.11 1,806 3.63 1,879 4.38
------- ----- ------- ----- ------- ----- ------- -----
Total real estate loans 59,211 94.36 57,604 97.79 48,738 97.97 41,937 97.86
------- ------ ------- ------ ------- ------ ------- ------
Other loans:
Loans secured by deposits 403 0.64 488 0.83 500 1.00 404 0.94
Home improvement ......... 517 0.82 563 0.96 455 0.92 451 1.05
Home Equity .............. 2,454 3.91 0 0.00 0 0.00 0 0.00
Commercial ............... 168 0.27 252 0.42 54 0.11 63 0.15
------- ----- ------- ----- ------- ----- ------- -----
Total other loans ...... 3,542 5.64 1,303 2.21 1,009 2.03 918 2.14
------- ----- ------- ----- ------- ----- ------- -----
Total loans .............. $62,753 100.00 % 58,907 100.00 % 49,747 100.00 % 42,855 100.00 %
------- ----- ------- ----- ------- ----- ------- -----
Less:
Loans in process 1373 1,506 1,514 777
Deferred fees and discounts 28 18 19 22
Allowance for loan losses 233 273 289 296
------- ------ ------ -------
Total loans receivable, 61,119 57,110 47,925 41,760
net
Less:
Loans held for sale 0 0 0 0
-------- -------- --------- --------
Net portfolio loans $ 61,119 $ 57,110 $ 47,925 $ 41,760
======== ======== ========= ========
</TABLE>
<PAGE>
The following table shows the composition of the Company's loan
portfolio by fixed and adjustable rate at the dates indicated.
<TABLE>
<CAPTION>
September 30,
-----------------------------------------------------------------------------------------
1998 1997 1996 1995
------------------- -------------------- ----------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent
-------- -------- -------- -------- -------- -------- ------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed-Rate Loans
Real estate loans:
One- to four-family
residences $ 41,730 66.50 % $ 36,708 62.32 % $ 29,635 59.57 % $ 24,313 56.73 %
Other residential property 551 0.88 569 0.97 701 1.41 724 1.69
Nonresidential property 3,838 6.12 3,595 6.10 2,610 5.25 2,739 6.39
Construction loans 2,256 3.60 3,600 6.11 1,806 3.63 295 0.69
-------- -------- -------- -------- -------- -------- ------- --------
Total fixed-rate real
estate loans 48,375 77.09 44,472 75.50 34,752 69.86 28,071 65.50
-------- -------- -------- -------- -------- -------- ------- --------
Other Loans:
Loans secured by deposits 403 0.64 488 0.83 500 1.00 404 0.94
Home improvement 517 0.82 563 0.96 455 0.92 451 1.05
Home Equity 2,454 3.91 0 0.00 0 0.00 0 0.00
Commercial 168 0.27 252 0.42 54 0.11 63 0.15
-------- -------- -------- -------- -------- -------- ------- --------
Total other fixed-rate
loans 3,542 5.64 1,303 2.21 1,009 2.03 918 2.14
-------- -------- -------- -------- -------- -------- ------- --------
Total fixed-rate loans 51,917 82.73 45,775 77.71 35,761 71.89 28,989 67.64
-------- -------- -------- -------- -------- -------- ------- --------
Adjustable-Rate Loans
Real estate loans:
One- to four-family 10,568 16.84 12,704 21.56 13,138 26.41 10,634 24.81
residences
Other residential property 0 0.00 0 0.00 0 0.00 0 0.00
Nonresidential property 268 0.43 428 0.73 848 1.70 1,648 3.85
Construction loans 0 0.00 0 0.00 0 0.00 1,584 3.70
-------- -------- -------- -------- -------- -------- ------- --------
Total adjustable-rate
real estate loans 10,836 17.27 13,132 22.29 13,986 28.11 13,866 32.36
-------- -------- -------- -------- -------- -------- ------- --------
Total loans 62,753 100.00 % 58,907 100.00 % 49,747 100.00 % 42,855 100.00 %
====== ====== ====== ======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Less:
Loans in process 1,373 1,506 1,514 777
Deferred fees and discounts 28 18 19 22
Allowance for loan losses 233 273 289 296
-------- -------- ------- --------
Total loans receivable, net 61,119 57,110 47,925 41,760
-------- -------- ------- --------
Less:
Loans Held For Sale 0 0 0 0
-------- -------- ------- --------
Net Portfolio Loans $ 61,119 $ 57,110 $ 47,925 $ 41,760
======== ======== ======= ========
</TABLE>
<PAGE>
The following schedule illustrates the interest rate sensitivity of the
Company's loan portfolio at September 30, 1998. Mortgages which have adjustable
or renegotiable interest rates are shown as maturing in the period during which
the contract is due. The schedule does not reflect the effects of possible
prepayments or enforcement of due-on-sale clauses.
<TABLE>
<CAPTION>
Real Estate
-----------------------------------------------------------------------------------------------------------------------
One- to Other
Four-Family Residential Nonresidential Construction Other Loans Total Loans
----------------- ---------------- ------------------ ----------------- --------------- ----------------
Weighted Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average Average
Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ---- ------ ---- ------ ---- ------ ----
Due During (Dollars in Thousands)
Periods
Ending
September
30,
- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1999 $ 1,242 8.06 % $ 0 0.00 % $ 311 8.33 % $ 883 8.63 % $ 236 7.41 % $ 2,672 8.22 %
2000 3,603 7.69 0 0.00 0 0.00 0 0.00 162 7.58 3,765 7.69
2001 3,303 7.25 0 0.00 181 7.89 0 0.00 159 7.78 3,643 7.31
2002 2,419 7.94 314 7.62 15 9.00 0 0.00 616 7.44 3,364 7.82
2003 1,204 7.44 0 0.00 101 9.50 0 0.00 433 7.69 1,738 7.62
2004 638 8.40 0 0.00 0 0.00 0 0.00 174 8.08 812 8.33
2005 to 4,988 7.86 142 8.79 267 8.20 0 0.00 1,200 8.18 6,597 7.95
2008
2009 to 32,215 7.37 95 7.75 3,231 8.32 0 0.00 562 8.33 36,103 7.47
2018
2019 and 2,425 9.34 0 0.00 0 0.00 0 0.00 0 0.00 2,425 9.34
------- ------- ------- ------ -------- --------
Total $52,037 $ 551 $ 4,106 $ 883 $ 3,542 $ 61,119
======= ======= ======= ====== ======== ========
</TABLE>
The total amount of loans due after September 30, 1999 which have
predetermined interest rates is $49.1 million while the total amount of loans
due after such date which have floating or adjustable interest rates is $9.3
million.
One- to Four-Family Residential Mortgage Lending. The Company focuses
its lending efforts primarily on the origination of conventional loans for the
acquisition of owner-occupied, one- to four-family residences. At September 30,
1998, the Company's one- to four-family residential mortgage loans totaled $52.4
million, or 83.6% of the Company's gross loan portfolio. The Company originates
these loans primarily from referrals from real estate agents, existing
customers, walk-in customers, builders and from responses to the Company's
marketing campaign, directed primarily to individuals in its market area.
The Company currently originates fixed-rate and ARM loans. During the
year ended September 30, 1998, the Company originated $30.4 million and $861,000
of fixed-rate mortgage and adjustable rate mortgage loans, respectively, which
were secured by one- to four-family residences. During the same period, the
Company sold $10.0 million of fixed-rate real estate loans which were secured by
one- to four-family residences.
<PAGE>
The Company currently originates one- to four-family residential
mortgage loans in amounts up to 95% of the appraised value of the security
property and generally requires that private mortgage insurance be obtained in
an amount sufficient to reduce the Company's exposure to or below 80% of such
value. The terms of such loans are generally for up to a maximum term of 30
years. Interest charged on these mortgage loans is competitively prived
according to local market conditions.
The Company currently offers ARMs with one, three and five year initial
terms with adjustments occurring annually thereafter as well as loans that
adjust once after five or seven years. All of the annually adjusting ARM loans
currently adjust at a margin over the yield on the one year Constant Maturity
Treasury Securities Rate. Initial rates on the three and five year ARMs and
adjusted rates on the five and seven year ARM products are currently based upon
the rate of a United States Treasury Note with a comparable term. ARM loans
offered by the Company generally provided for up to a 200 basis point annual cap
and a lifetime cap of 500 or 600 basis points greater than the initial rate. ARM
loans may not adjust below the initial rate. As a consequence of using caps, the
interest rates on the ARMs may not be as rate sensitive as the Company's cost of
funds. Borrowers of adjustable rate loans are qualified at the fully indexed
rate of interest. The Company has not experienced difficulty with the payment
history for these loans.
In underwriting one- to four-family residential real estate loans, the
Company evaluates both the borrower's ability to make monthly payments and the
value of the property securing the loan. Properties securing real estate loans
made by the Company are appraised by independent fee appraisers approved and
qualified by the Board of Directors. The Company generally requires borrowers to
obtain title insurance and fire, property and flood insurance (if required) in
an amount not less than the amount of the loan. Real estate loans originated by
the Companygenerally contain a "due on sale" clause allowing the Company to
declare the unpaid principal balance due and payable upon the sale of the
security property.
Commercial Real Estate and Multi-Family Residential Lending. The
Company engages in multi-family and commercial real estate lending, including
permanent loans secured primarily by apartment buildings, office buildings, and
retail establishments in the Company's primary market area. At September 30,
1998, the Company had $4.1 million and $551,000, respectively, of commercial
real estate and multi-family loans, which represented 6.5% and .9% respectively,
of the Company's gross loan portfolio.
Generally, commercial and multi-family real estate loans originated by
the Company are fixed-rate loans. To a lesser extent, the Company originates
adjustable-rate loans, with annual adjustments based upon either the one year
Constant Maturity Treasury Securities Rate or the Chase Manhattan Prime Rate,
subject to limitations on the maximum annual and total interest rate increase or
decrease over the life of the loan. Commercial real estate loans typically do
not exceed 80% of the appraised value of the property securing the loan. The
Company analyzes the financial condition of the borrower, the borrower's credit
history, the reliability and predictability of the net income generated by the
property securing the loan and the value of the property itself. The Company
generally requires personal guaranties of the borrowers in addition to the
security property as collateral for such loans and personal financial statements
on an annual basis. Appraisals on properties securing commercial and
multi-family real estate loans originated by the Company are generally performed
by independent fee appraisers approved by the Board of Directors.
<PAGE>
Loans secured by multi-family and commercial real estate are generally
larger and involve a greater degree of credit risk than one- to four-family
residential mortgage loans. Commercial real estate and multi-family loans
typically involve large balances to single borrowers or groups of related
borrowers. Because payments on loans secured by commercial real estate and
multi-family properties are often dependent on the successful operation or
management of the properties, repayment of such loans may be subject to adverse
conditions in the real estate market or the economy. If the cash flow from the
project is reduced (for example, if leases are not obtained or renewed), the
borrower's ability to repay the loan may be impaired.
Construction Lending. The Company engages in residential construction
lending, with $2.3 million, or 3.6% or its gross loan portfolio in construction
loans as of September 30, 1998. The Company offers loans to owner-occupants and
builders for the construction of one- to four-family residences. Currently, such
loans are offered with terms to maturity of up to nine months and in amounts
generally up to 80% of the appraised value of the security property.
The Company's construction loans require the payment of interest only
on a quarterly basis. The Company generally makes permanent loans on the
underlying property consistent with its underwriting standards for one- to
four-family residences. The Company also offers loans to a few selected builders
in its primary market area to build residential properties in anticipation of
the sale of the house or where the house has been presold. Such loans are made
for a term of nine months. The Company usually disburses funds on construction
loans directly to the builder at certain intervals based upon the completed
percentage of the project and inspections of the loans in process are performed
by the Company's staff. At September 30, 1998, $2.3 million, or 100% of the
Company's gross construction loans, were to builders for the construction of
residences which had not been pre-sold.
Construction lending generally affords the Company an opportunity to
receive interest at rates higher than those obtainable from residential lending.
Nevertheless, construction lending is generally considered to involve a higher
level of credit risk than one- to four-family residential lending since the risk
of loss on construction loans is dependent largely, upon the accuracy of the
initial estimate of the individual property's value upon completion of the
project and the estimated cost (including interest) of the project. If the cost
estimate proves to be inaccurate, the Company may be required to advance funds
beyond the amount originally committed to permit completion of the project. In
addition, to the extent the borrower is unable to obtain a permanent loan on the
underlying property, the Company may be required to modify or extend the terms
of the loan. In an effort to reduce these risks, the application process
includes a submission to the Company of accurate plans, specifications and costs
of the project to be constructed. These items are also used as a basis to
determine the appraised value of the subject property. Loans are based on a
lesser of current appraised value and/or the cost of construction (land plus
building).
Construction loans to borrowers other than owner-occupants also involve
many of the same risks discussed above regarding multi-family and commercial
real estate loans and tend to be more sensitive to general economic conditions
than many other types of loans.
Consumer Loans. The Company offers loans secured by savings deposits,
home equity and home improvement loans. Substantially all of the Company's
consumer loans are originated in its primary market area. These loans are
originated on a direct basis.
<PAGE>
At September 30, 1998, the Company's consumer loan portfolio totaled
$3.5 million, or 5.50% of its total gross loan portfolio. Home equity loans
accounted for $2.5 million of the total. All consumer loans are currently
originated with fixed rates of interest.
The Company made the decision to begin offering home equity loans
during the fiscal year ended September 30, 1998. Home equity lending was
approved by Texas voters in an amendment to the Texas Constitution in November
of 1997. Financial institutions were able to begin making loans on January 1,
1998.
The Company currently offers home equity loans for up to 80% of the
borrower's equity in the property, the maximum allowed by Texas law. Loan terms
of up to 15 years are offered at interest rates that are fixed for the term of
the loan.
Consumer loan terms vary according to the type and value of collateral,
length of contract and creditworthiness of the borrower. The underwriting
standards employed by the Company for consumer loans include an application, a
determination of the applicant's payment history on other debts, employment
stability and an assessment of ability to meet existing obligations and payments
on the proposed loan. Although creditworthiness of the applicant is a primary
consideration, the underwriting process also includes a comparison of the value
of the security, if any, in relation to the proposed loan amount.
Consumer loans may entail greater credit risk than do residential
mortgage loans. In addition, consumer loan collections are dependent on the
borrower's continuing financial stability, and thus are more likely to be
affected by adverse personal circumstances. Furthermore, the application of
various federal and state laws, including bankruptcy and insolvency laws, may
limit the amount which can be recovered on such loans. Although the level of
delinquencies in the Company's consumer loan portfolio has historically been
low, at September 30, 1998, four loans, totaling $4,600, or approximately .12%
of the consumer loan portfolio, was 60 days or more delinquent. There can be no
assurance that delinquencies will not increase in the future.
Commercial Business Loans. At September 30, 1998, the Company also had
$168,000 in commercial business loans outstanding, or .27 percent of the
Company's total loan portfolio. The Company's commercial business lending
activities have encompassed loans with a variety of purposes and security,
including loans to finance inventory and equipment. Generally, the Company's
commercial business lending has been limited to borrowers headquartered, or
doing business, in the Company's market area.
The Company anticipates significantly increasing its commercial
business lending activity during the next fiscal year. Management believes that
a sufficient demand for small to medium size commercial business loans exists in
the Tyler market to warrant expanding its efforts in commercial lending. In
conjunction with a new full-service office to be located in South Tyler, the
predominant area of growth in the city, the Company anticipates adding one
full-time commercial lending officer and one full-time loan processor to begin
its commercial lending program.
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 whose value tends to be
more easily ascertainable, commercial business loans are of higher risk and
<PAGE>
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. Further, 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 itself.
Originations, Purchases, Sales and Servicing of Loans and Mortgage-Backed
Securities
Real estate loans are generally originated by the Company's staff of
salaried loan officers. Loan applications are taken and processed at its main
office and its loan production offices.
In fiscal 1998, the Company originated $31.3 million of loans, compared
to $24.7 million and $25.2 million in fiscal 1997 and 1996, respectively.
Management attributes the sustained lending activity to continued lower interest
rates and economic conditions in the Tyler area. In fiscal 1998, $27.5 million
of loans and mortgage-backed securities were repaid, compared to $18.2 million
and $21.1 million in fiscal 1997 and 1996, respectively.
The Company currently sells its fixed-rate one- to four-family
residential mortgage loans with maturities of greater than 15 years, without
recourse, to FNMA, generally on a servicing retained basis. Sales of whole loans
generally are beneficial to the Company since these sales may generate income at
the time of sale, produce future servicing income, provide funds for additional
lending and other investments and increase liquidity. The Company sold whole
loans in aggregate amounts of $10.0 million, $4.7 million and $7.7 million
during the years ended September 30, 1998, 1997, and 1996, respectively. The
Company sells loans pursuant to forward sales commitments and, therefore, an
increase in interest rates after loan origination and prior to sale should not
adversely affect the Company's income at the time of sale.
In periods of economic uncertainty, the Company's ability to originate
large dollar volumes of real estate loans may be substantially reduced or
restricted with a resultant decrease in related loan origination fees, other fee
income and operating earnings. In addition, the Company's ability to sell loans
may substantially decrease as potential buyers (principally government agencies)
reduce their purchasing activities.
When loans are sold, the Company typically retains the responsibility
for servicing the loans. The Company receives a fee for performing these
services. The Company serviced for others mortgage loans amounting to $42.6
million, $39.4 million and $40.1 million at September 30, 1998, 1997, and 1996,
respectively.
From time to time, the Company has purchased whole loans or loan
participations consistent with its loan origination underwriting standards. The
company does not currently purchase loans because there is sufficient product
available for origination but will consider favorable purchase opportunities as
they arise.
In addition, the Company purchases mortgage-backed securities,
consistent with its asset/liability management objectives to complement its
mortgage lending activities. The Board believes that the slightly lower yield
carried by mortgage-backed securities is somewhat offset by the lower level of
credit risk and the lower level of overhead required in connection with these
assets, as compared to one- to four-family, non-residential, multi-family and
other types of loans. See "--Mortgaged-Backed Securities."
<PAGE>
The following table shows the loan and mortgage backed and related
securities originations, purchase, sale and repayment activities of the Company
for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------------
1998 1997 1996 1995
-------- -------- -------- --------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Originations by type:
Adjustable rate:
Real estate - one- to four-family ..... $ 861 $ 1,874 $ 4,841 $ 9,923
- multi-family ...... 0 0 0 0
- commercial ........ 0 0 0 0
Non-real estate - consumer ............ 0 0 0 0
- commercial business 0 0 0 0
-------- -------- -------- --------
Total adjustable-rate ............... 861 1,874 4,841 9,923
-------- -------- -------- --------
Fixed rate:
Real estate - one- to four-family ..... 27,740 21,170 20,208 9,736
- multi-family ...... 0 0 0 0
- commercial ........ 2,506 1,592 170 0
Non-real estate - consumer ............ 52 54 4 3
- commercial business 140 0 0 138
-------- -------- -------- --------
Total fixed-rate .................... 30,438 22,816 20,382 9,877
-------- -------- -------- --------
Total loans originated .............. 31,299 24,690 25,223 19,800
-------- -------- -------- --------
Purchases:
Real estate - one- to four-family ....... 0 0 0 0
- multi-family ...... 0 0 0 0
- commercial ........ 0 0 0 0
Non-real estate - consumer .............. 0 0 0 0
- commercial business 0 0 0 0
-------- -------- -------- --------
Total loans purchased ............... 0 0 0 0
Mortgage-backed securities (excluding
REMICs and CMOs) .................... 2,482 4,982 913 38,172
REMICs and CMOs ......................... 9,031 0 0 0
-------- -------- -------- --------
Total purchases ............... 11,513 4,982 913 38,172
-------- -------- -------- --------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Sales and Repayments:
Real estate - one- to four-family ....... 10,032 4,740 7,718 5,191
- multi-family ...... 0 0 0 0
- commercial ........ 0 0 0 0
Non-real estate - consumer .............. 0 0 0 0
- commercial business 0 0 0 0
-------- -------- -------- --------
Total loans sold .................... 10,032 4,740 7,718 5,191
Mortgage-backed securities .............. 0 0 0 0
-------- -------- -------- --------
Total sales ........................ 10,032 4,740 7,718 5,191
Principal repayments - Loans ............ 17,421 10,742 11,434 8,087
Principal repayments - mortgage-backed
securities ............................ 10,069 7,416 9,648 4,371
-------- -------- -------- --------
Total reductions .............. 37,522 22,898 28,800 17,649
-------- -------- -------- --------
Increase (decrease) in other items, net . (38) (30) 37 (159)
-------- -------- -------- --------
Net increase (decrease) ............. $ 5,252 $ 6,744 $ (2,627) $ 40,164
======== ======== ======== ========
</TABLE>
Asset Quality
Generally, when a borrower fails to make a required payment on real
estate secured loans and other loans by the 17th day after such payment is due,
the Company institutes collection procedures by mailing a delinquency notice.
The customer is contacted again by telephone or letter when the delinquency is
not promptly cured. In most cases delinquencies are cured promptly; however, if
a loan secured by real estate or other collateral has been delinquent for more
than 80 days, a final letter is sent or a telephone call is made demanding
payment and the customer is requested to make arrangements to bring the loan
current or, if the situation merits, a 30 day foreclosure notice is sent to the
borrower. Once a payment is 90 days past due, a 30 day foreclosure notice is
sent (if not previously sent) and, unless satisfactory arrangements have been
made, immediate repossession or foreclosure procedures will commence.
Generally, when a loan becomes delinquent 90 days or more, or when the
collection of principal or interest becomes doubtful, the Company will place the
loan on a non-accrual status and, as a result, previously accrued by unpaid
interest income on the loan is taken out of current income. Each account is
handled on an individual basis. The loan will be transferred back to an accrual
status if the borrower brings the loan current.
<PAGE>
The following table sets forth the Company's loan delinquencies by
number, amount and percentage of loan category at September 30, 1998.
<TABLE>
<CAPTION>
Loans Delinquent for:
----------------------------------------------------------------
60 - 89 Days 90 Days and Over Total Delinquent Loans
------------------------------- ------------------------------ ---------------------------------
Percent Percent Percent
of Loan of Loan of Loan
Number Amount Category Number Amount Category Number Amount Category
------ ------ -------- ------ ------ -------- ------ ------ --------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate:
One- to four-family 27 $423 0.69 % 12 $217 0.36 % 39 $640 1.05 %
Multi-family ...... 1 65 0.11 0 0 0.00 1 65 0.11
Commercial ........ 0 0 0.00 0 0 0.00 0 0 0.00
Construction or
development ..... 0 0 0.00 0 0 0.00 0 0 0.00
Consumer .......... 0 0 0.00 4 5 0.00 4 5 0.00
Commercial business 0 0 0.00 0 0 0.00 0 0 0.00
-- ---- ---- -- ---- ---- -- ---- ----
Total ........ 28 $488 0.80 % 16 $222 0.36 % 44 $710 1.16 %
</TABLE>
<PAGE>
Non-Performing Assets. The table below sets forth the amounts and
categories of non-performing assets in the Company's loan portfolio. At all
dates presented, the Company had no troubled debt restructurings (which involve
forgiving a portion of interest or principal on any loans or making loans at a
rate materially less than that of market rates). Foreclosed assets include
assets acquired in settlement of loans.
<TABLE>
<CAPTION>
September 30,
---------------------------------------
1998 1997 1996 1995
---- ---- ---- ----
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Non-accruing loans:
One- to four-family ..................... $187 $306 $449 $294
Other loans ............................. 0 4 1 0
---- ---- ---- ----
Total ............................... 187 310 450 294
---- ---- ---- ----
Accruing loans delinquent more than 90 days:
One- to four-family ..................... 6 0 0 12
---- ---- ---- ----
Total ............................... 6 0 0 12
---- ---- ---- ----
Foreclosed assets:
One- to four-family ..................... 35 0 0 90
---- ---- ---- ----
Total ............................... 35 0 0 90
---- ---- ---- ----
Total non-performing assets ................ $228 $310 $450 $396
==== ==== ==== ====
Total as a percentage of total assets ...... 0.18% 0.27% 0.39% 0.34%
==== ==== ==== ====
</TABLE>
For the year ended September 30, 1998, gross interest income which
would have been recorded had the non-accruing loans been current in accordance
with their original terms amounted to $17,000. The amount was included in
interest income on such loans was $13,000 for the year ended September 30, 1998.
Other Assets of Concern. As of September 30, 1998, there were no assets
classified by the Company because of known information about the possible credit
problems of the borrowers or the cash flows of the security property have caused
management to have some doubts as to the ability of the borrowers to comply with
present loan repayment terms and which could result in the future inclusion of
such item in the non-performing asset categories.
Classified Assets. Federal regulations provide for the classification
of loans and other assets such as debt and equity securities considered by the
OTS to be of lesser quality as "substandard," "doubtful" or "loss." An asset is
considered "substandard" if it is inadequately protected by the current net
worth and paying capacity of the obligor or of the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
<PAGE>
that the savings association 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," on the basis of
currently existing facts, conditions, and values, "highly questionable and
improbable." 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.
When a savings association classifies problem assets as either
substandard or doubtful, it may establish general allowances for loan losses in
an amount deemed prudent by management. General allowances represent loss
allowances which have been established to recognize the inherent risk associated
with lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets. When a savings association classified
problem assets as "loss," it is required either to establish a specific
allowance for losses equal to 100% of that portion of the asset so classified or
to charge-off such amount. An association's determination as to the
classification of its assets and the amount of its valuation allowances is
subject to review by the association's Regional Director at the regional OTS
office, who may order the establishment of additional general or specific loss
allowances.
In connection with the filing of its periodic reports with the OTS and
in accordance with its classification of assets policy, the Company regularly
reviews the loans in its portfolio to determine whether any loans require
classification in accordance with applicable regulations. On the basis of
management's review of its assets, at September 30, 1998, the Company had
classified $570,000 assets as substandard, none as doubtful, and none as loss.
Classified assets and nonperforming assets differ in that classified assets may
include loans less than 90 days delinquent. Also, assets guaranteed by
governmental agencies such as the Veterans Administration or the Federal Housing
Administration are not included in classified assets but are included in
nonperforming assets.
Allowance for Loan Losses. The allowance for loan losses is established
through a provision for loan losses based on management's evaluation of the risk
inherent in its loan portfolio and changes in the nature and volume of its loan
activity, including those loans which are being specifically monitored by
management. Such evaluation, which includes a review of loans for which full
collectibility may not be reasonably assured, considers among other matters, the
estimated fair value of the underlying collateral, economic conditions,
historical loan loss experience and other factors that warrant recognition in
providing for an adequate loan loss allowance.
Real estate properties acquired through foreclosure are recorded at the
lower of cost or fair market value, less estimated disposition costs. If fair
value at the date of foreclosure is lower than the balance of the related loan,
the difference will be charged-off to the allowance for loan losses at the time
of transfer. Valuations are periodically updated by management, and if the value
declines, a specific provision for losses on such property is established by a
charge to operations.
Although management believes that it uses the best information
available to determine the allowance, unforeseen market conditions could result
in adjustments, and net earnings could be significantly affected if
circumstances differ substantially from the assumptions used in making the final
determination. Future additions to the Company's allowance will be the result of
periodic loan, property and collateral reviews and thus cannot be predicted in
advance. At September 30, 1998, the Company had a total allowance for loan
losses of $233,000, which equaled 102.2% of nonperforming loans, .38% of total
loans and .19% of total assets. See Note 1 of the Notes to Consolidated
Financial Statements.
<PAGE>
The following table sets forth an analysis of the Company's allowance
for loan losses.
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------
1998 1997 1996 1995
----- ----- ----- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Balance at beginning of period ............... $ 273 $ 289 $ 296 $ 300
Charge-offs:
One- to four-family ....................... (40) (26) (7) (4)
Other loans ............................... 0 (1) 0 0
----- ----- ----- -----
Total charge-offs ..................... (40) (27) (7) (4)
----- ----- ----- -----
Recoveries:
One- to four-family ....................... 0 6 0 0
Other loans ............................... 0 0 0 0
----- ----- ----- -----
Total recoveries ...................... 0 6 0 0
----- ----- ----- -----
Net charge-offs .............................. (40) (21) (7) (4)
Additions charged to operations .............. 0 5 0 0
----- ----- ----- -----
Balance at end of period ..................... $ 233 $ 273 $ 289 $ 296
===== ===== ===== =====
Ratio of net charge-offs during the period to
average loans outstanding during the period 0.07 % 0.04 % 0.02 % 0.01 %
===== ===== ===== =====
Ratio of net charge-offs during the period to
average non-performing assets ............. 14.87 % 5.53 % 1.66 % 1.14 %
===== ===== ===== =====
</TABLE>
<PAGE>
The distribution of the Company's allowance for losses on loans at the
dates indicated is summarized as follows:
<TABLE>
<CAPTION>
September 30,
------------------------------------------------------------------------------------------------------------
1998 1997 1996
--------------------------------- --------------------------------- -----------------------------------
Percent Percent Percent
of Loans of Loans of Loans
Loan in Each Loan In Each Loan In Each
Amount of Amounts Category Amount Amounts Category Amount of Amounts Category
Loan Loss by to Total Loan Loss by to Total Loan by to Total
Allowance Category Loans Allowance Category Loans Allowance Category Loans
--------- -------- ----- --------- -------- ----- --------- -------- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family $ 52 $52,298 83.34 % $ 88 $49,412 83.88 % $ 102 $42,773 85.98 %
Multi-family ........ 0 551 0.88 0 569 0.97 0 701 1.41
Commercial real ..... 0 4,106 6.54 0 4,023 6.83 0 3,458 6.95
estate
Construction or ..... 0 2,256 3.60 0 3,600 6.11 0 1,806 3.63
development
Other loans ......... 0 3,542 5.64 0 1,303 2.21 0 1,009 2.03
Unallocated ......... 181 0 0.00 185 0 0.00 187 0 0.00
------- ------- ------ ------ ------- ------ ----- ------- ------
Total ............ $ 233 $62,753 100.00 % $ 273 $58,907 100.00 % $ 289 $49,747 100.00 %
======= ======= ====== ======= ======= ====== ===== ======= ======
</TABLE>
Investment Activities
Generally, the investment policy of the Company is to invest funds
among various categories of investments and maturities based upon the Company's
need for liquidity, asset/liability management policies, investment quality and
marketability, liquidity needs and performance objectives.
At September 30, 1998, the Company had two investment portfolios, one
consisting primarily of adjustable rate mortgage-backed securities and the other
consisting principally of fixed rate debentures. Both portfolios consisted
entirely of U.S. Government or U.S. Government Agency obligations. These
investments were made in order to generate income, and because these securities
carry a low risk weighting for OTS risk-based capital purposes, to satisfy OTS
liquid-asset requirements. See "Regulation - Capital Requirements" and
"--Liquidity."
At September 30, 1998, the Company's fixed rate investment securities
totaled $29.8 million or 24.0% of total assets and mortgage-backed securities
totaled $23.8 million or 19.2% of total assets. For information regarding the
amortized cost, market and accounting classification values of the Company's
investment securities portfolio, see Note 3 of the Notes to Consolidated
Financial Statements. At September 30, 1998, the weighted average term to
maturity or repricing of the investment securities portfolio, excluding FHLB
stock, was 2.6 years. For information regarding the amortized cost, market
values and accounting classification of the Company's mortgage-backed securities
portfolio, see Note 4 of the Notes to Consolidated Financial Statements.
<PAGE>
Mortgage-Backed Securities. The Company purchases mortgage-backed and
related securities to complement its mortgage lending activities. The Company
began making significant purchases of mortgage-backed and related securities in
1991 as an alternative to home mortgage originations for its portfolio.
Management determined that such investments would produce relatively higher
risk-adjusted yields for the Company when compared to other investment
securities and substituted for loan originations, in light of the competition
for home mortgages in the Company's market area. The Company has emphasized
mortgage-backed and related securities with high credit quality, high cash flow,
low interest-rate risk, high liquidity and acceptable prepayment risk.
The Company's mortgage-backed and related securities portfolio consists
primarily of securities issued under government-sponsored agency programs,
including those of GNMA, FNMA and FHLMC. The securities consist of modified
pass-through mortgage-backed securities that represent undivided interest in
underlying pools of fixed-rate, or certain types of adjustable rate,
single-family residential mortgages issued by these government-sponsored
entities and collateralized mortgage obligations (debt obligations of the issuer
backed by mortgage loans as mortgage-backed securities). The securities
generally provide the certificate holder a guarantee of timely payments of
interest, whether or not collected.
Mortgage-backed securities generally yield less than the loans that
underlie such securities, because of the cost of payment guarantees or credit
enhancements that reduce credit risk to holders. Mortgage-backed securities are
also more liquid than individual mortgage loans and may be used to collateralize
obligations of the Company. In general, mortgage-backed securities issued or
guaranteed by FNMA, FHLMC and certain AAA- or AA-rated mortgage-backed
pass-through securities are weighted at no more than 20% for risk-based capital
purposes, and mortgage-backed securities issued or guaranteed by GNMA are
weighted at 0% for risk-based capital purposes, compared to an assigned risk
weighting of 50% to 100% for whole residential mortgage loans. These types of
securities thus allow the Company to optimize regulatory capital to a greater
extent than non-securitized whole loans.
While mortgage-backed securities carry a reduced credit risk as
compared to whole loans, such securities remain subject to the risk that a
fluctuating interest rate environment, along with other factors such as the
geographic distribution of the underlying mortgage loans, may alter the
prepayment rate of such mortgage loans and so affect both the prepayment speed,
and value, of such securities.
<PAGE>
The following table sets forth the composition of the Company's
mortgage-backed securities at the dates indicated.
<TABLE>
<CAPTION>
September 30,
---------------------------------------------------------------------------------------
1998 1997 1996 1995
------------------ ----------------- ------------------ --------------
Book % of Book % of Book % of Book % of
Value Total Value Total Value Total Value Total
----- ----- ----- ----- ----- ----- ----- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities
available-for-sale
U.S. Government agency pass-
through mortgage-backed
securities ...................... $ 4,217 17.76 % $ 4,200 18.66 % 0 0.00 % $ 0 0.00 %
U.S. Government agency
collateralized mortgage
obligations ..................... 8,360 35.20 0 0.00 0 0.00 0 0.00
------- ------ ------- ------ ------- ------ -------- ------
Subtotal ................... 12,577 52.95 4,200 18.66 0 0.00 0 0.00
Mortgage-backed securities
held-to-maturity
U.S. Government agency pass-through
mortgage-backed securities ...... 10,878 45.80 18,085 80.35 24,858 99.64 33,588 99.55
------- ------ ------- ------ ------- ------ -------- ------
Subtotal ......................... 10,878 45.80 18,085 80.35 24,858 99.64 33,588 99.55
------- ------ ------- ------ ------- ------ -------- ------
Unamortized premium (discounts), net ... 296 1.25 223 0.99 91 0.36 153 0.45
------- ------ ------- ------ ------- ------ -------- ------
Total mortgage-backed securities $23,751 100.00 % $22,508 100.00 % $24,949 100.00 % $ 33,741 100.00
======= ====== ======= ====== ======= ====== ======== ======
</TABLE>
<PAGE>
The following table sets forth the contractual maturities of the
Company's mortgage-backed securities at September 30, 1998.
<TABLE>
<CAPTION>
Due In Total
Mortgage-Backed
Securities
------------------------------------------------- -----------------------
5 Years 5 to 10 10 to 20 Over 20 Amortized Market
or Less Years Years Years Cost Value
------- ----- ----- ----- ---- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Mortgage-backed securities available-for-sale
U.S. Government agency pass-through
mortgage-backed securities .......... $ 0 $ 0 $ 379 $ 4,151 $ 4,530 $ 4,450
U.S. Government agency collateralized
mortgage obligations ................ 0 0 0 8,379 0 8,360
------- ------- ------- ------- ------- -------
Total available-for-sale ........... 0 0 379 12,530 12,909 12,810
------- ------- ------- ------- ------- -------
Mortgage-backed securities held-to-maturity
U.S. Government agency pass-through
mortgage-backed securities .......... 1,900 0 0 9,040 10,940 11,089
------- ------- ------- ------- ------- -------
Total mortgage-backed securities .. $ 1,900 $ 0 $ 379 $21,570 $23,849 $23,899
======= ======= ======= ======= ======= =======
Weighted average yield ................. 6.20% 0.00% 5.44% 6.73% 6.67%
</TABLE>
<PAGE>
The following table sets forth the composition of the Company's
investment securities, excluding mortgage-backed securities, at the dates
indicated.
<TABLE>
<CAPTION>
September 30,
-----------------------------------------------------------------------------
1998 1997 1996
-----------------------------------------------------------------------------
Book % of Book % of Book % of
Value Total Value Total Value Total
-----------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
U.S. government securities $ 0 0.00 % $ 0 0.00 % 0 0.00 %
Federal agency obligations 0 0.00 0 0.00 0 0.00
Mutual funds 0 0.00 0 0.00 0 0.00
Other securities 0 0.00 0 0.00 0 0.00
--------- ------- -------- -------- --------- ---------
Subtotal 0 0.00 0 0.00 0 0.00
--------- ------- -------- -------- --------- ---------
Investment securities held-to-maturity
U.S. government securities 2,505 7.42 2,511 7.65 1,998 5.23
Federal agency obligations 27,262 80.78 20,547 62.64 28,141 73.61
Other securites(1) 0 0.00 0 0.00 0 0.00
--------- ------- -------- -------- --------- ---------
Subtotal 29,767 88.20 23,058 70.29 30,139 78.84
--------- ------- -------- -------- --------- ---------
Total investment securities 29,767 88.20 23,058 70.29 30,139 78.84
--------- ------- -------- -------- --------- ---------
Average remaining life of investment 2.6 yrs 1.4 yrs 1.4 yrs
securities
Other interest-earning assets:
FHLB stock 789 2.34 1,006 3.07 949 2.48
Interest-bearing deposits with banks(2) 3,064 9.08 7,988 24.35 6,658 17.42
Other overnight deposits(3) 129 0.38 754 2.29 480 1.26
--------- ------- -------- -------- --------- ---------
Total other interest-earning assets 3,982 11.80 9,748 29.71 8,087 21.16
--------- ------- -------- -------- --------- ---------
Total investment securities, FHLB stock
and other interest-earning assets $ 33,749 100.00 % $ 32,806 100.00 % 38,226 100.00 %
========= ======== ========= ======= ========= ========
</TABLE>
(1) Includes investments in adjustable rate mortgage-backed mutual funds.
(2) Includes investments in insured certificates of deposit.
(3) Includes securities purchased under agreement to resell and federal funds
sold.
<PAGE>
The following table sets forth the composition and maturities of the
Company's investment securities portfolio as of September 30, 1998.
<TABLE>
<CAPTION>
At September 30, 1998
------------------------------------------------------------------------------------------
No
Less Than 1 to 3 3 to 5 Over Stated Total Investment
1 Year Years Years 5 Years Maturity Securities
Amort Amort Amort Amort Amort Amort Market
Cost Cost Cost Cost Cost Cost Value
---- ---- ---- ---- ---- ---- -----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Investment securities available-for-sale
U.S. government securities .......... $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0
Federal agency obligations .......... 0 0 0 0 0 0 0
Mutual funds ........................ 0 0 0 0 0 0 0
Other securities .................... 0 0 0 0 0 0 0
Investment securities held-to-maturity
U.S. government securities .......... 2,505 0 0 0 0 2,505 2,534
Federal agency obligations .......... 5,509 8,019 13,009 725 0 27,262 27,582
Other securities .................... 0 0 0 0 0 0 0
------- ------- ------- ------- ------- ------- -------
Total investment securities....... $ 8,014 $ 8,019 $13,009 $ 725 $ 0 $29,767 $30,116
======= ======= ======= ======= ======= ======= =======
Weighted average yield ................. 5.91% 6.13% 6.04% 6.08% 0.00% 6.03%
</TABLE>
The OTS has issued guidelines regarding management oversight and
accounting treatment for securities, including investment securities, loans,
mortgage-backed securities and derivative securities. The guidelines require
thrift institutions to reduce the carrying value of securities to the lesser of
cost or market value unless it can be demonstrated that a class of securities is
intended to be held to maturity.
Sources of Funds
General. The Company's primary sources of funds are deposits,
amortization and prepayment of loan principal, borrowings, interest earned on,
maturation and sales of investment securities and short-term investments, and
net earnings.
Borrowings may be used on a short-term basis to compensate for seasonal
reductions in deposits or deposit inflows at less than projected levels, and may
be used on a longer-term basis to support expanded lending activities or to
increase the effectiveness of the Company's asset/liability management program.
In this regard, in order to enhance both the return on the capital raised in the
Conversion and its interest rate spread, the Company may utilize advances form
the FHLB of Dallas and attempt to match the maturities of such liabilities with
assets such as mortgage-backed securities having similar effective maturities
but higher yields compared to the rate paid on such advances.
<PAGE>
Deposits. The Company offers the following types of deposit accounts:
passbook savings, NOW checking accounts, money market deposit accounts and
certificates of deposit. The Company solicits deposits from its market area and
does not accept brokered deposits. The flow of deposits is influenced
significantly by general economic conditions, changes in money market and
prevailing interest rates, and competition. The Company relies primarily on
competitive pricing policies, advertising and customer service to attract and
retain these deposits.
The variety of deposit accounts offered by the Company has allowed it
to be competitive in obtaining funds and to respond with flexibility to changes
in consumer demand. The Company has become more susceptible to short-term
fluctuations in deposit flows, as customers have become more interest rate
conscious. In this regard, deposits decreased from $88.6 million at September
30, 1997 to $86.6 million at September 30, 1998. Management believes that the
decrease in deposits was due to its decision not to pay the highest rates in the
local market. Based on its experience, the Company believes that its deposits
are relatively stable sources of funds. However, the ability of the Company to
attract and maintain certificates of deposit, and the rates paid on these
deposits, has been and will continue to be significantly affected by market
conditions.
<PAGE>
The following table sets forth the dollar amount of savings deposits in
the various types of deposit programs offered by the Company for the periods
indicated.
<TABLE>
<CAPTION>
September 30,
-----------------------------------------------------------------------------------------------
1998 1997 1996 1995
-----------------------------------------------------------------------------------------------
Percent Percent Percent Percent
Amount of Total Amount Of Total Amount of Total Amount of Total
------ -------- ------ -------- ------ -------- ------ --------
Transactions and (Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Savings Deposits:
Non-interest
checking $ 1,528 1.76 % $ 1,882 2.13 % $ 1,997 2.20 % $ 2,692 2.91 %
NOW accounts 1,312 1.51 1,279 1.44 1,514 1.67 1,467 1.59
Passbook accounts 3,032 3.50 5,681 3.03 3,010 3.32 2,906 3.14
Money market
accounts 6,162 7.11 5,812 6.56 6,575 7.24 6,140 6.64
--------- ------ --------- ------ --------- ------ ----------- ------
Total Non-
certificates 12,034 13.89 11,654 13.16 13,096 14.43 13,205 14.28
--------- ------ --------- ------ --------- ------ ----------- ------
Certificates:
0.00 - 3.99% 434 0.50 383 0.43 0 0.00 222 0.24
4.00 - 4.99% 14,753 17.03 15,163 17.12 18,669 20.57 21,570 23.32
5.00 - 5.99% 53,641 61.91 54,522 61.57 52,775 58.14 46,612 50.40
6.00 - 6.99% 3,857 4.45 4,756 5.37 4,147 4.57 8,605 9.31
7.00 - 7.99% 1,914 2.21 2,073 2.35 2,081 2.29 2,245 2.43
8.00 - 8.99% 11 0.01 0 0.00 0 0.00 15 0.02
--------- ------ --------- ------ --------- ------ ----------- ------
Total Certificates 74,610 86.11 76,897 86.84 77,672 85.57 79,269 85.72
--------- ------ --------- ------ --------- ------ ----------- ------
Total Deposits $ 86,644 100.00 % $ 88,551 100.00 % $ 90,768 100.00 % $ 92,474 100.00 %
========= ====== ========= ====== ========= ====== =========== ======
</TABLE>
<PAGE>
The following table sets forth the savings flows at the Company during
the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------------------------
1998 1997 1996 1995
--------- --------- --------- ---------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Opening balance ........... $ 88,551 $ 90,768 $ 92,474 $ 102,200
Deposits .................. 25,131 14,394 16,039 16,264
Withdrawals ............... 29,302 18,823 19,902 26,951
Interest credited ......... 2,264 2,212 2,157 961
--------- --------- --------- ---------
Ending balance ............ $ 86,644 $ 88,551 $ 90,768 $ 92,474
========= ========= ========= =========
Net increase (decrease) ... $ (1,907) $ (2,217) $ (1,706) $ (9,726)
========= ========= ========= =========
Percent increase (decrease) (2.15)% (2.44)% (1.84)% (9.52)%
========= ========= ========= =========
</TABLE>
The following table shows rate and maturity information for the
Company's certificates of deposit as of September 30, 1998.
<TABLE>
<CAPTION>
8.00%
0.00- 4.00- 5.00- 6.00- 7.00- or Percent
3.99% 4.99% 5.99% 6.99% 7.99% Greater Total of Total
---------- ----------- ----------- --------- --------- ---------- --------------------
(Dollars in Thousands)
Certificate accounts maturing in quarter ending:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
December 31, 1998 $ 434 $ 6,941 $ 13,494 $ 151 $ 15 $ 0 $ 21,035 28.19%
March 31, 1999 0 3,095 8,683 208 6 0 11,992 16.07%
June 30, 1999 0 1,293 9,051 469 0 0 10,813 14.49%
September 30,1999 0 1,346 7,096 125 0 0 8,567 11.48%
December 31, 1999 0 885 2,796 344 156 0 4,181 5.60%
March 31, 2000 0 643 2,477 268 1,634 0 5,022 6.73%
June 30, 2000 0 275 2,474 394 0 0 3,143 4.21%
September 30, 2000 0 275 2,302 668 0 0 3,245 4.35%
December 31, 2000 0 0 1,738 730 1 0 2,469 3.31%
March 31, 2001 0 0 1,228 500 0 0 1,728 2.32%
June 30, 2001 0 0 777 0 0 0 777 1.04%
September 30, 2001 0 0 408 0 0 0 408 0.55%
Thereafter 0 0 1,117 0 102 11 1,230 1.65%
-------- --------- --------- ------- ------- -------- ------- ---------
Total $ 434 $ 14,753 $ 53,641 $ 3,857 $ 1,914 $ 11 $ 74,610 100.00%
======== ========= ========= ======= ======= ======== ======= =========
Percent of total 0.50% 19.72% 70.90% 6.18% 2.70% 0.00%
======== ========= ========= ======= ======= ========
</TABLE>
<PAGE>
The following table indicates the amount of the Company's certificates
of deposit and other deposits by time remaining until maturity as of September
30, 1998.
<TABLE>
<CAPTION>
Maturity
-----------------------------------------------------------------------
Over Over
3 Months 3 to 6 6 to 12 Over
or Less Months Months 12 Months Total
-----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Certificates of deposit less than $100,000 $ 7,086 $ 8,838 $ 12,715 $ 17,258 $ 45,897
Certificates of deposit of $100,000 or more 9,470 6,067 7,873 5,303 28,713
-------- ----------- ---------- ---------- ----------
Total certificates of deposit $ 16,556 $ 14,905 $ 20,588 $ 22,561 $ 74,610
======== =========== ========== ========== ==========
</TABLE>
Borrowings. The Company has the ability to use advances for the FHLB of
Dallas to supplement its deposits when the rates are favorable. As a member of
the FHLB of Dallas, the Company is required to own capital stock and is
authorized to apply for advances. Each FHLB credit program has its own interest
rate, which may be fixed or variable, and includes a range of maturities. The
FHLB of Dallas may prescribe the acceptable uses to which these advances may be
put, as well as limitations on the size of the advances and repayment
provisions.
During the fiscal year ended September 30, 1998, the Company continued
borrowing funds through the FHLB of Dallas advance program. The Company used the
proceeds to invest in adjustable rate mortgage-backed securities with yields
greater than the cost of the advance. The intent of the program was to make
better use of the Company's excess capital by increasing the overall size of the
Company's balance sheet.
The advances used in the program are short-term, usually 30-35 days.
The rates of the advances, which are established by the FHLB of Dallas,
generally are linked to comparable short term U.S. Treasury interest rates or a
short term index such as the 30 day London Interbank Offering Rate (LIBOR). The
Company invests the advance proceeds in a dollar-for-dollar matching program in
adjustable mortgage-backed pass-through securities and collateralized mortgage
obligations. The program is designed to achieve a positive spread between the
cost of the advances and the investment yield. The mortgage-backed securities
are held in an "available-for-sale" accounting classification. See
"Mortgage-Backed Securities" and "Sources of Funds."
<PAGE>
The following table sets forth the maximum month-end balance of FHLB
Advances, securities sold under agreements to repurchase and other borrowings
for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------
1998 1997 1996 1995
------------------------------------------------------
(Dollars In Thousands)
<S> <C> <C> <C> <C>
Maximum Balance:
FHLB Advances $ 14,946 $ 4,195 $ 0 $ 0
Securities sold under agreements to 0 0 0 0
repurchase
Other borrowings 0 0 0 0
Average Balance:
FHLB Advances $ 9,724 $ 2,621 $ 0 $ 0
Securities sold under agreements to 0 0 0 0
repurchase
Other borrowings 0 0 0 0
</TABLE>
The following table sets forth certain information as to the
Association's borrowings at the dates indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------------------
1998 1997 1996 1995
--------- --------- -------- -------
(Dollars In Thousands)
<S> <C> <C> <C> <C>
FHLB Advances $ 14,946 $ 4,195 $ 0 $ 0
Securities sold under agreements to repurchase 0 0 0 0
Other borrowings 0 0 0 0
--------- --------- -------- -------
Total Borrowings $ 14,946 $ 4,195 $ 0 $ 0
========= ========= ======== =======
Weighted average interest rate of FHLB
advances 5.55 % 5.54 % 0.00 % 0.00 %
Weighted average interest rate of securities sold
under agreements to repurchase 0.00 % 0.00 % 0.00 % 0.00 %
Weighted average interest rate of other
borrowings 0.00 % 0.00 % 0.00 % 0.00 %
</TABLE>
<PAGE>
Subsidiary Activities
As a federal savings and loan association, First Federal is permitted
by OTS regulations to invest up to 2% of its assets or approximately $2.5
million at September 30, 1998, in the stock of, or unsecured loans to, service
corporation subsidiaries. First Federal may invest an additional 1% of its
assets in service corporations where such additional funds are used for
inner-city or community development purposes. At September 30, 1998, the
Association did not have any subsidiaries.
REGULATION
General
First Federal is a federally chartered savings and loan association,
the deposits of which are federally insured and backed by the full faith and
credit of the United States Government. Accordingly, the Association is subject
to broad federal regulation and oversight extending to all its operations. First
Federal is a member of the FHLB of Dallas and is subject to certain limited
regulation by the Board of Governors of the Federal Reserve System ("Federal
Reserve Board"). As the savings and loan holding company of First Federal, the
Company also is subject to federal regulation and oversight. The purpose of the
regulation of the Company and other holding companies is to protect subsidiary
savings associations. The Association is a member of the Savings Association
Insurance Fund ("SAIF"), which together with the Bank Insurance Fund (the "BIF")
are the two deposit insurance funds administered by the FDIC, and the deposits
of First Federal are insured by the FDIC. As a result, the FDIC has certain
regulatory and examination authority over the Association.
Certain of these regulatory requirements and restrictions affecting
First Federal and the Company are discussed below or elsewhere in this document.
Federal Regulation of Savings Associations
The OTS has extensive authority over the operations of savings
associations. As part of this authority, First Federal is required to file
periodic reports with the OTS and is subject to periodic examinations by the OTS
and the FDIC. The last regular OTS and FDIC examinations of First Federal were
as of April 27, 1998 and August 17, 1990, respectively. Under agency scheduling
guidelines, another examination will be initiated within the next 12-18 months.
When these examinations are conducted by the OTS and FDIC, the examiners may
require the Association to provide for higher general or specific loan loss
reserves. All savings associations are subject to a semi-annual assessment,
based upon the savings association's total assets, to fund the operations of the
OTS. The Association's OTS assessment for the fiscal year ended September 30,
1998 was $28,000.
The OTS also has extensive enforcement authority over all savings
institutions and their holding companies, including the Association and the
Company. This enforcement authority includes, among other things, the ability to
assess civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions. In general, these enforcement actions may be
initiated for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement
action, including misleading or untimely reports filed with the OTS. Except
under certain circumstances, public disclosure of final enforcement actions by
the OTS is required.
<PAGE>
In addition, the investment, lending and branching authority of First
Federal is prescribed by federal laws and it is prohibited form engaging in any
activities not permitted by such laws. For instance, no savings institution may
invest in non-investment grade corporate debt securities. In addition, the
permissible level of investment by federal associations in loans secured by
nonresidential real property may not exceed 400% of total capital, except with
approval of the OTS. Federal savings associations are also generally authorized
to branch nationwide. The Association is in compliance with the noted
restrictions.
The Association's general permissible lending limit for
loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired
capital and surplus (except for loans fully secured by certain readily
marketable collateral, in which case this limit is increased to 25% of
unimpaired capital and surplus). At September 30, 1998, the Association's
lending limit under this restriction was $2.8 million. First Federal is in
compliance with the loans-to-one-borrower limitation.
The OTS, as well as the other federal banking agencies, has adopted
guidelines establishing safety and soundness standards on such matters as loan
underwriting and documentation, asset quality, earnings standards, internal
controls and audit systems, interest rate risk exposure and compensation and
other employee benefits. Any institution that fails to comply with these
standards must submit a compliance plan.
Insurance of Accounts and Regulation by the FDIC
First Federal is a member of the SAIF, which is administered by the
FDIC. Deposits are insured up to applicable limits by the FDIC and such
insurance is backed by the full faith and credit of the United States
Government. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious risk
to the SAIF or the BIF. The FDIC also has the authority to initiate enforcement
actions against savings associations, after giving the OTS an opportunity to
take such action, and may terminate the deposit insurance if it determines that
the institution has engaged in unsafe or unsound practices or is in an unsafe or
unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums, based upon their level of
capital and supervisory evaluation. Under the system, institutions classified as
well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1
of core capital to risk-weighted assets ("Tier 1 risk-based capital") of at
least 6% and a risk-based capital ratio of at least 10%) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a
risk-based capital ratio of less than 8%) and considered of substantial
supervisory concern pay the highest premium. Risk classification of all insured
institutions is made by the FDIC for each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semiannual
basis, if it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of 1.25% of SAIF insured deposits. In setting these
increased assessments, the FDIC must seek to restore the reserve ratio to that
designated reserve level, or such higher reserve ratio as established by the
FDIC. The FDIC may also impose special assessments on SAIF members to repay
amounts borrowed from the United States Treasury or for any other reason deemed
necessary by the FDIC.
<PAGE>
Effective January 1, 1997, the premium schedule for BIF and SAIF
insured institutions ranged from 0 to 27 basis points. However, SAIF-insured
institutions are required to pay a Financing Corporation (FICO) assessment, in
order to fund the interest on bonds issued to resolve thrift failures in the
1980s, equal to approximately 6.48 basis points for each $400 in domestic
deposits, while BIF-insured institutions pay an assessment equal to
approximately 1.52 basis points for each $100 in domestic deposits. The
assessment is expected to be reduced to 2.43 basis points no later than January
1, 2000, when BIF-insured institutions fully participate in the assessment.
These assessments, which may be revised based upon the level of BIF and SAIF
deposits will continue until the bonds mature in the year 2017.
Regulatory Capital Requirements
Federally insured savings associations, such as First Federal, are
required to maintain a minimum level of regulatory capital. The OTS has
established capital standards, including a tangible capital requirement, a
leverage ratio (or core capital) requirement and a risk-based capital
requirement applicable to such savings associations. These capital requirements
must be generally as stringent as the comparable capital requirements for
national banks. The OTS is also authorized to impose capital requirements in
excess of these standards on individual associations on a case-by-case basis.
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity and retained income, and certain
noncumulative perpetual preferred stock and related income. In addition, all
intangible assets, other than a limited amount of purchased mortgage servicing
rights, must be deducted from tangible capital for calculating compliance with
this requirement. At September 30, 1998, the Association had no intangible
assets that were required to be deducted from tangible capital.
The OTS regulations establish special capitalization requirements for
savings associations that own subsidiaries. In determining compliance with the
capital requirements, all subsidiaries engaged solely in activities permissible
for national banks or engaged in certain other activities solely as agent for
its customers are "includable" subsidiaries that are consolidated for capital
purposes in proportion to the association's level of ownership. For excludable
subsidiaries the debt and equity investments in such subsidiaries are deducted
from assets and capital. The Association currently has no subsidiaries.
At September 30, 1998, the Association had tangible capital of $18.6
million, or 14.9% of adjusted total assets, which is approximately $16.7 million
above the minimum requirement of 1.5% of adjusted total assets in effect on that
date.
The capital standards also require core capital equal to at least 3% of
adjusted total assets. Core capital generally consists of tangible capital plus
certain intangible assets, including a limited amount of purchased credit card
relationships. As a result of the prompt corrective action provisions discussed
below, however, a savings association must maintain a core capital ratio of at
least 4% to be considered adequately capitalized unless its supervisory
condition is such to allow it to maintain a 3% ratio.
At September 30, 1998, the Association had core capital equal to $18.6
million, or 14.9% of adjusted total assets, which is $13.6 million above the
minimum leverage ratio requirement of 4% as in effect on that date.
<PAGE>
The OTS risk-based requirement requires savings associations to have
total capital of at least 8% of risk-weighted assets. Total capital consists of
core capital, as defined above, and supplementary capital. Supplementary capital
consists of certain permanent and maturing capital instruments that do not
qualify as core capital and general valuation loan and lease loss allowances up
to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used
to satisfy the risk-based requirement only to the extent of core capital. The
OTS is also authorized to require a savings association to maintain an
additional amount of total capital to account for concentration of credit risk
and the risk of non-traditional activities. At September 30, 1998, the
Association had no capital instruments that qualify as supplementary capital and
$233,000 of general loss reserves, which was less than 1.25% of risk-weighted
assets.
Certain exclusions from capital and assets are required to be made for
the purpose of calculating total capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
nonresidential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments. First Federal had
exclusions from capital and assets totaling $4,000 at September 30, 1998.
In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet items, will be multiplied by a risk weight,
ranging from 0% to 100%, based on the risk inherent in the type of asset. For
example, the OTS has assigned a risk of 50% for prudently underwritten permanent
one- to four-family first lien mortgage loans not more than 90 days delinquent
and having a loan to value ratio of not more than 80% at origination unless
insured to such ratio by a insurer approved by the FNMA or FHLMC.
OTS regulations also require that every savings association with more
than normal interest rate risk exposure to deduct from its total capital, for
purposes of determining compliance with such requirement, an amount equal to 50%
of its interest-rate risk exposure multiplied by the present value of its
assets. This exposure is a measure of the potential decline in the net portfolio
value of a savings association, greater than 2% of the present value of its
assets, based upon a hypothetical 200 basis point increase or decrease in
interest rates (whichever results in a greater decline). Net portfolio value is
the present value of expected cash flows from assets, liabilities and
off-balance sheet contracts. The rule will not become effective until the OTS
evaluates the process by which savings associations may appeal an interest rate
risk deduction determination. It is uncertain as to when this evaluation may be
completed. Any savings association with less than $300 million in assets and a
total capital ratio in excess of 12% is exempt from this requirement unless the
OTS determines otherwise.
On September 30, 1998, First Federal had total risk based capital of
$18.8 million (including $18.5 million in core capital and no qualifying
supplementary capital) and risk-weighted assets of $49.1 million (including no
converted off-balance sheet assets); or total risk based capital of 38.3% of
risk-weighted assets. This amount was $14.8 million above the 8% requirement in
effect on that date.
The OTS and FDIC are authorized and, under certain circumstances
required, to take certain actions against savings associations that fail to meet
their capital requirements. The OTS is generally required to take action to
restrict the activities of an "undercapitalized association" (generally defined
<PAGE>
to be one with less than either a 4% core capital ratio, a 4% Tier 1 risk-based
capital ratio or an 8% risk-based capital ratio). Any such association must
submit a capital restoration plan and until such plan is approved by the OTS may
not increase its assets, acquire another institution, establish a branch or
engage in any new activities, and generally may not make capital distributions.
The OTS is authorized to impose the additional restrictions that are applicable
to significantly undercapitalized associations.
As a condition to the approval of the capital restoration plan, any
company controlling an undercapitalized association must agree that it will
enter into a limited capital maintenance guarantee with respect to the
institution's achievement of its capital requirements.
Any savings association that fails to comply with its capital plan or
is "significantly undercapitalized" (i.e., Tier 1 risk-based or core capital
ratios of less than 3% or a risk-based capital ratio of less than 6%) must be
made subject to one or more of additional specified actions and operating
restrictions which may cover all aspects of its operations and include a forced
merger or acquisition of the association. An association that becomes
"critically undercapitalized" (i.e., a tangible capital ratio of 2% or less) is
subject to further mandatory restrictions on its activities in addition to those
applicable to significantly undercapitalized associations. In addition, the OTS
must appoint a receiver (or conservator with the concurrence of the FDIC) for a
savings association, with certain limited exceptions, within 90 days after it
becomes critically undercapitalized. Any undercapitalized association is also
subject to the general enforcement authority of the OTS and the FDIC, including
the appointment of a conservator or receiver.
The OTS is also generally authorized to reclassify an association into
a lower capital category and impose the restrictions applicable to such category
if the institution is engaged in unsafe or unsound practices or is in an unsafe
or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on First
Federal may have a substantial adverse effect on the Association's operations
and profitability and the value of the common stock of the Company. Company
stockholders do not have preemptive rights, and therefore, if the Company is
directed by the OTS or the FDIC to issue additional shares of Common Stock, such
issuance may result in the dilution in the percentage of ownership of the
Company held by the existing stockholders of the Company.
Limitations on Dividends and Other Capital Distributions
OTS regulations impose various restrictions on savings associations
with respect to their ability to make distributions of capital, which include
dividends, stock redemptions or repurchases, cash-out mergers and other
transactions charged to the capital account. OTS regulations also prohibit a
savings association from declaring or paying any dividends or from repurchasing
any of its stock if, as a result, the regulatory capital of the association
would be reduced below the amount required to be maintained for the liquidation
account established in connection with its mutual to stock conversion.
Generally, savings associations, such as First Federal, that before and
after the proposed distribution meet their capital requirements, may make
capital distributions during any calendar year equal to the greater of 100% of
net income for the year-to-date plus 50% of the amount by which the lesser of
the association's tangible, core or risk-based capital exceeds its capital
<PAGE>
requirement for such capital component, as measured at the beginning of the
calendar year, or 75% of its net income for the most recent four quarter period.
However, an association deemed to be in need of more than normal supervision by
the OTS may have its dividend authority restricted by the OTS. First Federal may
pay dividends in accordance with this general authority.
Savings associations proposing to make any capital distribution need
only submit written notice to the OTS 30 days prior to such distribution.
Savings associations that do not, or would not meet their current minimum
capital requirements following a proposed capital distribution, however, must
obtain OTS approval prior to making such distribution. The OTS may object to the
distribution during that 30-day period notice based on safety and soundness
concerns. See "--Regulatory Capital Requirements."
The OTS has proposed regulations that would revise the current capital
distribution restrictions. Under the proposal a savings association may make a
capital distribution without notice to the OTS (unless it is a subsidiary of a
holding company) provided that it has a CAMEL 1 or 2 rating, is not of
supervisory concern, and would remain adequately capitalized (as defined in the
OTS prompt corrective action regulations) following the proposed distribution.
Savings associations that would remain adequately capitalized following the
proposed distribution but do not meet the other noted requirements must notify
the OTS 30 days prior to declaring a capital distribution. The OTS stated it
will generally regard as permissible that amount of capital distributions that
do not exceed 50% of the institution's excess regulatory capital plus net income
to date during the calendar year. A savings association may not make a capital
distribution without prior approval of the OTS and the FDIC if it is
undercapitalized before, or as a result of, such a distribution. As under the
current rule, the OTS may object to a capital distribution if it would
constitute an unsafe or unsound practice. No assurance may be given as to
whether or in what form the regulations may be adopted.
Liquidity
All savings associations, including First Federal, are required to
maintain an average daily balance of liquid assets equal to a certain percentage
of the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. For a discussion of what First Federal
includes in liquid assets, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital Resources,"
contained in the Annual Report to Shareholders. This liquid asset ratio
requirement may vary from time to time (between 4% and 10%) depending upon
economic conditions and savings flows of all savings associations. As of
September 30, 1998, the minimum liquid asset ratio was 4%. The Association was
in compliance with an overall liquid asset ratio of 40.1%.
Qualified Thrift Lender Test
All savings associations, including First Federal, are required to meet
a qualified thrift lender ("QTL") test to avoid certain restrictions on their
operations. This test requires a savings association to have at least 65% of its
portfolio assets (as defined by regulation) in qualified thrift investments on a
monthly average for nine out of every 12 months on a rolling basis. As an
alternate, the savings association may maintain 60% of its assets in those
assets specified in Section 7701(a)(19) of the Internal Revenue Code. Under
either test, such assets primarily consist of residential housing related loans
and investments. At September 30, 1998, the Association met the test and has
always met the test since its effectiveness.
<PAGE>
Any savings association that fails to meet the QTL test must convert to
a national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If such an association has not yet requalified or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
association is immediately ineligible to receive any new FHLB borrowings and is
subject to national bank limits for payment of dividends. If such association
has not requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
association that fails the QTL test is controlled by a holding company, then
within one year after the failure, the holding company must register as a bank
holding company and become subject to all restrictions on bank holding
companies. See "--Holding Company Regulation."
Community Reinvestment Act
Under the Community Reinvestment Act ("CRA"), every FDIC insured
institution has a continuing and affirmative obligation consistent with safe and
sound banking practices to help meet the credit needs of its entire community,
including low and moderate income neighborhoods. The CRA does not establish
specific lending requirements or programs for financial institutions nor does it
limit an institution's discretion to develop the types of products and services
that it believes are best suited to its particular community, consistent with
the CRA. The CRA requires the OTS, in connection with the examination of the
Association, to assess the institution's record of meeting the credit needs of
its community and to take such record into account in its evaluation of certain
applications, such as a merger or the establishment of a branch by First
Federal. An unsatisfactory rating may be used as the basis for the denial of an
application by the OTS.
The federal banking agencies, including the OTS, have recently revised
the CRA regulations and the methodology for determining an institution's
compliance with the CRA. Due to the heightened attention being given to the CRA
in the past few years, the Association may be required to devote additional
funds for investment and lending in its local community. The Association was
examined for CRA compliance in February 1997 and received a rating of "Needs
Improvement."
As a result of the February 1997 CRA examination, the Association's
Board of Directors implemented a loan program designed to lend money to low to
moderate income borrowers and targeted to specific census tract locations that
were considered low to moderate income areas. The program, entitled Housing
Assistance Program (HAP) initially set aside $500,000 to reach low to moderate
income borrowers. The Association significantly relaxed its normal loan
underwriting guidelines in order to qualify the applicants. The HAP program was
successful and the Association was able to loan all of the designated funds in
approximately six months.
In 1998, the Board set aside $350,000 to lend to low to moderate income
borrowers. The Company was able to loan all of the designated amount. As a
result of the Association's lending efforts to low to moderate income areas and
borrowers, the Association received a "satisfactory" rating on its April 6, 1998
CRA examination.
<PAGE>
Transactions with Affiliates
Generally, transactions between a savings association or its
subsidiaries and its affiliates are required to be on terms as favorable to the
association as transactions with non-affiliates. In addition, certain of these
transactions, such as loans to an affiliate, are restricted to a percentage of
the association's capital. Affiliates of the Association include the Company and
any company, which is under common control with the Association. 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 most
affiliates. First Federal's Subsidiaries are not deemed affiliates, however; the
OTS has the discretion to treat subsidiaries of savings associations as
affiliates on a case by case basis.
Certain transactions with directors, officers or controlling persons
are also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such
loans must be made on terms substantially the same as for loans to unaffiliated
individuals.
Holding Company Regulation
The Company is a unitary savings and loan holding company subject to
regulatory oversight by the OTS. 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 which also permits the OTS to restrict or
prohibit activities that are determined to be a serious risk to the subsidiary
savings association.
As a unitary savings and loan holding company, the Company generally is
not subject to activity restrictions. If the holding company acquired 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 of
its subsidiaries (other than First Federal or any other SAIF-insured savings
association) would become subject to such restrictions unless such other
associations each qualify as a QTL and were acquired in a supervisory
acquisition.
If the Association fails the QTL test, the Company must obtain the
approval of the OTS prior to continuing after such failure, directly or through
its other subsidiaries, any business activity other than those approved for
multiple savings and loan holding companies or their subsidiaries. In addition,
within one year of such failure the Company must register as, and will become
subject to, the restrictions applicable to bank holding companies. The
activities authorized for a bank holding company are more limited than are the
activities authorized for a unitary or multiple savings and loan holding
company. See "--Qualified Thrift Lender Test."
The Company must obtain approval from the OTS before acquiring control
of any other SAIF-insured association. Such acquisitions are generally
prohibited if they result in 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.
<PAGE>
Federal Securities Law
The stock of the Company is registered with the SEC under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Accordingly,
the Company is subject to the information, proxy solicitation, insider trading
restrictions and other requirements of the SEC under the Exchange Act.
Company stock held by persons who are affiliates (generally officers,
directors, and principal stockholders) of the Company may not be resold without
registration or unless sold in accordance with certain resale 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.
Federal Reserve System
The Federal Reserve Board requires all depository institutions to
maintain noninterest bearing reserves at specified levels against their
transaction accounts (primarily checking, NOW and Super NOW checking accounts).
At September 30, 1998, First Federal was in compliance with these reserve
requirements. The balances maintained to meet the reserve requirements imposed
by the Federal Reserve Board may be used to satisfy liquidity requirements that
may be imposed by the OTS. See "--Liquidity."
Savings associations are authorized to borrow from the Federal Reserve
Bank "discount window," but Federal Reserve Board regulations require
associations to exhaust other reasonable alternative sources of funds, including
FHLB borrowings, before borrowing from the Federal Reserve Bank.
Federal Home Loan Bank System
First Federal is a member of the FHLB of Dallas, which is one of 12
regional FHLBs, that administers the home financing credit function of savings
associations. Each FHLB serves as a reserve or central bank for its members
within its assigned region. It is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB System. It makes loans to
members (i.e., advances) in accordance with policies and procedures, established
by the board of directors of the FHLB, which are subject to the regulation and
oversight of the Federal Housing Finance Board. All advances from the FHLB are
required to be fully secured by sufficient collateral as determined by the FHLB.
In addition, all long-term advances are required to provide funds for
residential home financing.
As a member, First Federal is required to purchase and maintain stock
in the FHLB of Dallas. At September 30, 1998, First Federal had $789,000 in FHLB
stock, which was in compliance with this requirement. In past years, first
Federal has received substantial dividends on its FHLB stock. Over the past five
calendar years such dividends have averaged 5.80% and were 6.00% for fiscal year
1998.
Under federal law the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to low and
moderately priced housing programs through direct loans or interest subsidies on
advances targeted for community investment and low- and moderate-income housing
projects. These contributions have affected adversely the level of FHLB
dividends paid and could continue to do so in the future. These contributions
could also have an adverse effect on the value of FHLB stock in the future. A
reduction in value of First Federal's FHLB stock may result in a corresponding
reduction in First Federal's capital.
<PAGE>
For the fiscal year ended September 30, 1998, dividends paid by the
FHLB of Dallas to First Federal totaled $54,000, which constitutes a $3,000
decrease over the amount of dividends received in fiscal year 1997. The $12,000
dividend received for the quarter ended September 30, 1998 reflects an
annualized rate of 6.02%, or ten basis points above the rate for fiscal 1998.
Federal and State Taxation
Savings associations such as the Association that meet certain
conditions prescribed by the Internal Revenue Code of 1986, as amended (the
"Code"), are permitted to establish reserves for bad debts and to make annual
additions thereto which may, within specified formula limits, be taken as a
deduction in computing taxable income for federal income tax purposes. The
amount of the bad debt reserve deduction is computed under the experience
method. Under the experience method, the bad debt reserve deduction is an amount
determined under a formula based generally upon the bad debts actually sustained
by the savings association over a period of years.
In August 1996, legislation was enacted that repealed the percentage of
taxable income method of accounting used by many thrifts, including the
Association, to calculate their bad debt reserve for federal income tax
purposes. As a result, large thrifts such as the Association must recapture that
portion of the reserve that exceeds the amount that could have been taken under
the experience method for post-1987 tax years. The recapture may be deferred
over a six-year period, the commencement of which will be delayed until the
first taxable year beginning after December 31, 1997, provided the institution
meets certain residential lending requirements. The Company elected to recapture
the total amount of its excess reserves of approximately $7,000 in the fiscal
year ended September 30, 1997.
In addition to the regular income tax, corporations, including savings
associations such as the Association, generally are subject to a minimum tax. An
alternative minimum tax is imposed at a minimum tax rate of 20% on alternative
minimum taxable income, which is the sum of a corporation's regular taxable
income (with certain adjustments) and tax preference items, less any available
exemption. The alternative minimum tax is imposed to the extent it exceeds the
corporation's regular income tax and net operating losses can offset no more
than 90% of alternative minimum taxable income.
To the extent earnings appropriated to a savings association's bad debt
reserves for "qualifying real property loans" and deducted for federal income
tax purposes exceed the allowable amount of such reserves computed under the
experience method and to the extent of the association's supplemental reserves
for loan losses on loans ("Excess"), such Excess may not, without adverse tax
consequences, be utilized for the payment of cash dividends or other
distributions to a shareholder (including distributions on redemption,
dissolution or liquidation) or for any other purpose (except to absorb bad debt
losses). As of September 30, 1998, the Association's Excess for tax purposes
totaled approximately $2.7 million.
The Association files federal income tax returns on a fiscal year basis
using the accrual method of accounting. The Company files a consolidated federal
income tax returns with the Association. The Association has been audited by the
IRS with respect to federal income tax returns for the tax years through
December 31, 1988. With respect to years examined by the IRS, any deficiencies
have been satisfied. In the opinion of management, any examination of still open
returns would not result in a deficiency which could have a material adverse
effect on the financial condition of the Bank.
<PAGE>
Texas Taxation. The State of Texas does not have a corporate income
tax, but it does have a corporate franchise tax. Prior to January 1, 1992
savings and loan associations had been exempt from the corporate franchise tax.
The tax for the year 1998 is the higher of 0.25% of taxable capital
(usually the amount of paid in capital plus retained earnings) or 4.5% of "net
taxable earned surplus." "Net taxable earned surplus" is net income for federal
income tax purposes increased by the compensation of directors and executive
officers and decreased by interest on obligations guaranteed by the U.S.
government. Net income cannot be reduced by net operating loss carryforwards
form years prior to 1991, and operating loss carryovers are limited to five
years.
Delaware Taxation. As a Delaware Company, the Company is exempted from
Delaware corporate income tax but is required to file an annual report with and
pay an annual fee to the State of Delaware. The Company is also subject to an
annual franchise tax imposed by the State of Delaware.
Competition
The Company faces strong competition, both in originating loans and in
attracting deposits. Competition in originating loans comes primarily from other
commercial banks, savings associations, credit unions and mortgage bankers
making loans secured by real estate located in the Company's market area. The
Company competes for loans principally on the basis of the quality of services
it provides to borrowers, interest rates and loan fees it charges, and the types
of loans it originates.
The Company attracts all of its deposits through its retail banking
offices, primarily from the communities it serves. Therefore, competition for
those deposits is principally from other commercial banks, savings associations
and brokerage houses located in the same communities. The Company competes for
these deposits by offering deposit accounts at competitive rates and convenient
business hours.
The Company's primary market area covers Smith County, Texas. There are
14 commercial banks, one savings association and 13 credit unions which compete
for deposits and loans in the Company's primary market area. The Company
estimates its share of the residential mortgage loan market and savings deposit
base to be not more than 15% and 5%, respectively.
Employees
The Company had 28 full-time employees and one part-time employee as of
September 30, 1998, none of whom was represented by a collective bargaining
agreement. The Company believes that its relations with its personnel have been
good.
Executive Officers Who Are Not Directors
The following is a description of the Company's and the Association's
executive officers who were not also directors as of September 30, 1998.
<PAGE>
Derrell W. Chapman, age 40, is Vice President, Chief Operating Officer
and Chief Financial Officer of the Company and the Association. He has held such
positions with the Company since its formation and the Association since 1989.
Mr. Chapman was appointed an Advisory Director in 1998. Prior to his employment
with the Association, Mr. Chapman was Vice President and Controller of Jasper
Federal Savings and Loan Association, located in Jasper, Texas. Mr. Chapman is a
certified public accountant.
Joe C. Hobson, age 45, is Senior Vice President--Lending of the
Association, a position he has held since 1992. Mr. Hobson has served the
Association in various capacities since 1975.
Item 2. Description of Property
The Company conducts its business at its main office and a
drive-through facility located in Tyler, Texas, a full service branch office
located in Whitehouse, Texas and loan production offices located in Tyler and
Lindale, Texas. The following table sets forth information relating to each of
the Company's properties as of September 30, 1998.
Total September 30,
Owned Approximate 1998
Year or square Book
Location Acquired Leased Footage Value
- -------- -------- ------ ------- -----
(In Thousands)
Main Office:
1200 South Beckham 1962 Owned 10,000 $415
Tyler, Texas
Full-Service Branch:
107 Highway 110 North 1984 Owned 2,500 $275
Whitehouse, Texas
7205 South Broadway 1998 Owned n/a $1,241*
Loan Agencies:
4550 Kinsey Drive 1994 Owned 2,200 $148
Tyler, Texas
904 South Main 1997 Leased 1,200 $11**
Lindale, Texas
* The amount shown is for land only. The building located at 7205 South
Broadway is leased.
** Leasehold improvements.
The Company believes that its current facilities are adequate to meet
the present and foreseeable needs of the Association and the Company, subject to
possible future expansion.
The Company maintains an on-line database with a service bureau
servicing financial institutions. The net book value of the data processing and
computer equipment utilized by the Company at September 30, 1998 was $130,000.
<PAGE>
Item 3. Legal Proceedings
The Company is involved form time to time as plaintiff or defendant in
various legal actions arising in the normal course of business. While the
ultimate outcome of these proceedings cannot be predicted with certainty, it is
the opinion of management, after consultation with counsel representing the
Company in the proceedings, that the resolution of these proceedings should not
have a material effect on the Company's results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year, through the solicitation of proxies or otherwise
during the year ended September 30, 1998.
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters
Pages 30 through 31 of the Company's 1998 Annual Report to Stockholders
is incorporated herein by reference.
Item 6. Management's Discussion and Analysis or Plan of Operation
Pages 6 through 31 of the Company's 1998 Annual Report to Stockholders
is incorporated herein by reference.
Item 7. Financial Statements
Pages 33 through 37 of the Company's 1998 Annual Report to Stockholders
is incorporated herein by reference.
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
There has been no Current Report on Form 8-K filed within 24 months
prior to the date of the most recent financial statements reporting a change of
accountants and/or reporting disagreements on any matter of accounting principle
or financial statement disclosure.
Part III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
Directors
Information concerning Directors of the Company is incorporated herein
by reference from the definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on January 20, 1999, a copy of which will be filed not
later than 120 days after the close of the fiscal year.
Executive Officers
Information regarding the business experience of the executive officers
of the Company and the Association who are not also directors contained in Part
I of this Form 10-KSB is incorporated herein by reference.
<PAGE>
Compliance with Section 16(a)
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's directors and executive officers, and persons who own more than 10% of
a registered class of the Bank's equity securities, to file with the SEC initial
reports of ownership and reports of changes in ownership of Common Stock and
other equity securities of the Company. Officers, directors and greater than 10%
stockholders are required by SEC regulation to furnish the Company with copies
of all Section 16(a) forms they file.
To the Company's knowledge, based solely on a review of the copies of
such reports furnished to the Company and written representations that no other
reports are required, during the fiscal year ended September 30, 1998, all
Section 16(a) filing requirements applicable to its officers, directors and
greater than 10 percent beneficial owners were complied with.
Item 10. Executive Compensation
Information concerning executive compensation is incorporated herein by
reference from the definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on January 20, 1999, a copy of which will be filed not
later than 120 days after the close of the fiscal year.
Item 11. Security Ownership of Certain Beneficial Owner and Management
Information concerning security ownership of certain beneficial owners
and management is incorporated herein by reference from the definitive Proxy
Statement for the Annual Meeting of Stockholders to be held on January 20, 1999,
a copy of which will be filed not later than 120 days after the close of the
fiscal year.
Item 12. Certain Relationships and Related Transactions
Information concerning certain relationships and related transactions
is incorporated herein by reference from the definitive Proxy Statement for the
Annual Meeting of Stockholders to be held on January 20, 1999, a copy of which
will be filed not later than 120 days after the close of the fiscal year.
<PAGE>
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits
Reference to Prior
Filing or Exhibit
Number Attached
Regulation Document Hereto
- ---------- -------- ------
3(a) Articles of Incorporation *
3(b) Amended and Restated By-Laws **
4 Instruments defining the rights of security *
holders, including debentures
10 Material contracts
(a) Employment Contract between Gerald W. *
Free and the Association
(b) Employment Contract between Derrell W. *
Chapman and the Association
(c) 1995 Stock Option and Incentive Plan **
(d) Recognition and Retention Plan **
11 Statement re: computation of per share earnings 11
13 Annual Report to Security Holders 13
21 Subsidiaries of Registrant 21
23 Consents of Experts and Counsel 23
27 Financial Data Schedule 27
99 Additional Exhibits None
* Filed as exhibits to the Company's Form S-1 registration statement
(File No. 33-83758) filed on September 6, 1994 pursuant to Section
5 of the Securities Act of 1933. All of such previously filed
documents are hereby incorporated herein by reference in accordance
with Item 601 of Regulation S-B.
** Filed as exhibits to the Company's Quarterly Report on Form 10-QSB
for the quarter ended December 31, 1996 (File No. 0-24848). These
previously filed documents are hereby incorporated herein by
reference in accordance with item 601 of Regulation S-B.
(b) Reports on Form 8-K
A Form 8-K, dated July 22, 1998, was filed during the quarter ended
September 30, 1998 to report the issuance of a press release by the
Company announcing a cash dividend and earnings for the quarter ended
June 30, 1998.
<PAGE>
A Form 8-K, dated July 30, 1998, was filed during the quarter ended
September 30, 1998, to announce a 5% stock repurchase program.
A Form 8-K, dated August 19, 1998, was filed during the quarter ended
September 30, 1998, to announce the completion of the Company's stock
repurchase program.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 15(d) of the Securities Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
EAST TEXAS FINANCIAL
SERVICES, INC.
Date: December 23, 1998 By: /s/Gerald W. Free
-------------------
Gerald W. Free, President, Chief
Executive Officer and Director
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons in the capacities and
on the dates indicated.
/s/Gerald W. Free /s/Jack W. Flock
- ----------------- ----------------
Gerald W. Free, President, Chief Jack W. Flock,
Executive Officer and Director Chairman of the Board
(Principal Executive Officer)
Date: December 23, 1998 Date: December 23, 1998
/s/Derrell W. Chapman /s/M. Earl Davis
- --------------------- ----------------
Derrell W. Chapman, Vice President, M. Earl Davis, Director
Chief Operating Officer and Chief
Financial Officer (Principal Financial
And Accounting Officer)
Date: December 23, 1998 Date: December 23, 1998
/s/James W. Fair /s/Charles R. Halstead
- ---------------- ----------------------
James W. Fair, Director Charles R. Halstead, Director
Date: December 23, 1998 Date: December 23, 1998
/s/L. Lee Kidd /s/H. H. Richardson, Jr.
- -------------- ------------------------
L. Lee Kidd, Director H. H. Richardson, Jr., Director
Date: December 23, 1998 Date: December 23, 1998
/s/Jim M. Vaughn, M.D.
- ----------------------
Jim M. Vaughn, M.D., Director
Date: December 23, 1998
EXHIBIT 11
Statement re: Computation of Per Share Earnings
<PAGE>
<TABLE>
<CAPTION>
EAST TEXAS FINANCIAL SERVICES, INC.
Statement re: Computation of Per Share Earnings
Fiscal Year Ended September 30, 1998
Total Shares Unallocated Total Shares
Outstanding ESOP Shares* For EPS Calculation
----------- ------------ -------------------
<S> <C> <C> <C>
September 30, 1997 1,539,461 97,593 1,441,868
October 31, 1997 1,539,461 97,593 1,441,868
November 30, 1997 1,539,461 97,593 1,441,868
December 31, 1997 1,539,461 97,593 1,441,868
January 31, 1998 1,539,461 97,593 1,441,868
February 28, 1998 1,539,461 97,593 1,441,868
March 31, 1998 1,539,461 97,593 1,441,868
April 30, 1998 1,539,461 97,593 1,441,868
May 31, 1998 1,539,461 97,593 1,441,868
June 30, 1998 1,539,461 97,593 1,441,868
July 31, 1998 1,541,029 97,593 1,443,436
August 31, 1998 1,464,056 97,593 1,366,463
September 30, 1998 1,464,056 81,536 1,382,520
<CAPTION>
<S> <C>
Weighted average number of shares outstanding
for the year ended September 30, 1998, for earnings
per share calculation 1,431,623
Stock options outstanding at September 30, 1998: 148,843
-------
Exercise price of stock options: $9.42 per share
---------------
Average stock price for the 12 month period ended
September 30, 1998 $14.3109
-----------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
12 Months Ended
Basic Earnings Per Share September 30,
- ------------------------ -------------
1998 1997
---- ----
<S> <C> <C>
Income available to common stockholders $560,946 $766,775
======== ========
Weighted average number of common shares
outstanding for basic EPS calculation 1,431,623 1,470,358
========= =========
Basic Earnings Per Share $.39 $.52
==== ====
Diluted Earnings Per Share
Income available to common stockholders $560,946 $766,775
======== ========
Weighted average number of common shares
outstanding for basic EPS calculation 1,431,623 1,470,358
========= =========
Weighted average common shares issued under
stock options plans 150,019 151,587
Less weighted average shares assumed
repurchased with proceeds (98,755) (122,466)
Weighted average number of common shares
outstanding for diluted EPS calculation 1,482,887 1,499,479
Basic Earnings Per Share $.38 $.51
==== ====
</TABLE>
EXHIBIT 13
Annual Report
to
Security Holders
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Table of Contents
Selected Financial Data 2
Letter to Shareholders 3
Glossary 5
Management's Discussion and Analysis of
Financial Condition and Operating Results 6
Forward Looking Information 6
General 6
Results of Operations
Net Income 6
Interest Income 9
Interest Expense 12
Net Interest Income 13
Provisions for Loan Losses 14
Other Operating Income 14
Operating Expense 16
Income Tax Expense 18
Financial Condition
Balance Sheet Summary 18
Loans 19
Mortgage-Backed Securities 21
Investment Securities 22
Deposits and Borrowings 22
Interest Rate Sensitivity 22
Asset Quality 25
Liquidity and Capital Position 26
Impact of Accounting Pronouncements 27
Year 2000 Compliance Assessment 29
Impact of Inflation and Changing Prices 30
Market Price of Common Stock 30
Report of Independent Accountants 32
Consolidated Financial Statements 33
Notes To Consolidated Financial Statements 38
Corporate Directory 62
Shareholder Reference 63
<PAGE>
<TABLE>
<CAPTION>
Selected Financial Data
(Dollars in Thousands, except share data) 1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
At September 30,
Total assets $ 124,017 $ 115,949 $ 114,373 $ 117,077 $ 114,935
Loans receivable, net
Held for sale 0 0 0 0 0
Held in portfolio 61,119 57,110 47,925 41,760 35,337
Investment securities - held-to-maturity 29,767 23,058 30,139 30,263 0
Mortgage-backed securities -
available-for-sale 12,810 4,356 0 0 0
Mortgage-backed securities --
held-to-maturity 10,941 18,152 24,949 33,741 0
Deposits 86,644 88,551 90,768 92,474 102,200
FHLB Advances 14,946 4,195 0 0 0
Stockholders' equity 20,384 20,879 20,931 23,146 11,458
Common shares outstanding 1,464,056 1,026,366 1,079,285 1,256,387 N.A.
Book value per share 13.92 20.34 19.39 18.42 N.A.
For The Year Ended September 30,
Net interest income $ 3,298 $ 3,419 $ 3,552 $ 3,658 $ 3,040
Provision for loan losses 0 5 0 0 121
Other operating income 361 302 371 299 (2,118)
Operating expenses 2,768 2,523 3,200 2,335 1,981
Net income 561 767 458 1,071 (759)
Selected Financial Ratios
Return on average assets 0.46 % 0.67 % 0.40 % 0.92 % (0.66) %
Return on average equity 2.72 3.67 2.08 5.47 (6.41)
Interest rate spread (average) 2.00 2.21 2.27 2.49 2.33
Net interest margin 2.83 3.12 3.16 3.21 2.67
Ratio of interest-earning assets to
interest-
bearing liabilities 119.58 122.29 122.23 119.13 110.08
Operating expenses to average assets 2.31 2.19 2.77 2.01 1.72
Efficiency ratio 78.96 69.24 84.10 59.70 61.70
Net interest income to operating expenses 1.20 x 1.35 x 1.11 x 1.57 x 1.47 x
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Asset Quality Ratios
Non-performing assets to total assets 0.18 % 0.27 % 0.39 % 0.34 % 0.27 %
Non-performing loans to total loans 0.37 0.54 0.94 0.95 0.87
receivable
Allowance for loan losses to non-performing 102.19 88.06 64.22 74.75 97.72
loans
Allowance for loan losses to total loans 0.38 0.48 0.60 0.71 0.85
Allowance for loan losses to total assets 0.18 0.24 0.25 0.25 0.26
Regulatory Capital Ratios (Association only)
Total capital to total assets 14.91 % 15.21 % 15.39 % 14.40 % 9.97 %
Tangible capital ratio 14.95 15.20 15.30 14.40 9.97
Core capital ratio 14.95 15.20 15.30 14.40 9.97
Risk-based capital ratio 38.29 40.22 44.23 43.44 31.06
</TABLE>
2
<PAGE>
To Our Shareholders:
The past twelve months have been challenging for the traditional thrift
institution relying primarily on interest income on mortgage related products as
its primary source of income. Continued lower interest rates and a narrowing of
the difference in shorter and longer-term interest rates caused a decrease in
our net interest margin during the fiscal year. Competition for single-family
lending in the Tyler market and the propensity for a borrower to refinance a
mortgage at the slightest decline in interest rates has caused a decrease in the
overall yield on interest earning assets. Further, our reliance on certificates
of deposit as our primary funding source and demands from certificate holders
for the highest interest rates have contributed to the decline in our net
interest margin as well. We believe that this trend is unlikely to reverse at
any time in the foreseeable future and in fact may never return to levels that
will allow for long term profitability in the traditional mortgage lending
business.
As a result, and after substantial research and planning, we made the decision
in 1998 to expand our lines of business. The need for higher yielding assets
with less likelihood to refinance, less reliance on certificates of deposit as
our primary source of funds, and a greater reliance on income from sources other
than net interest income are the principal objectives of our decision to
introduce additional business lines.
By the time you receive this annual report, we will be well on our way to
opening a new office location in the rapidly growing area of south Tyler. The
new office will focus primarily on commercial and consumer lending with a
reliance on transaction accounts as its primary funding source. We will offer
all of the products usually associated with a commercial banking organization,
such as credit and debit cards, an ATM machine and cards, safe deposit boxes,
investment brokerage services, and both commercial and personal transaction
accounts. We will also expand all of these services to each of our existing full
service locations.
The initial costs associated with adding these new lines of business will be
extensive and we do not expect them to be profitable immediately. However, we
believe that this is the direction we should be moving and that the long term
future of the Company is dependent upon our success in doing so.
The past twelve months have also been a challenge for bank stock values. We have
seen the per share price of our stock decline from approximately $13.67 per
share on September 30, 1997, as adjusted for a three for two stock split in
1998, to its closing price of $13.25 per share on September 30, 1998. Our stock
price further declined to approximately $9.85 by December 9, 1998, the record
date for our upcoming annual meeting. The decrease in price through December 9,
1998 is approximately 28% and while we are disappointed, we believe that the
decline in the price of our stock is somewhat indicative of the overall decline
in small bank stocks during the year.
3
<PAGE>
We continued to repurchase stock during the year, acquiring 76,973 shares of
stock at an average price of approximately $14.04 per share. At year-end, we
held 420,436 shares of treasury stock at an average purchase price of
approximately $11.40 per share. We expect, from time-to-time as market
conditions warrant, to continue to repurchase shares of treasury stock. We ended
the year with 1,464,056 outstanding shares of stock, an increase of 438,000
shares over the 1,026,366 outstanding as of September 30, 1997. The increase was
primarily due to the three for two stock split completed in 1998. After the
split, we continued our policy of paying a quarterly cash dividend of $.05 per
share in fiscal 1998. Based on the September 30, 1998 ending stock price, our
dividend yield is approximately 1.51%.
We expanded our wholesale funded arbitrage program in 1998. At year end, we had
borrowed approximately $14.9 million in short term advances from the Federal
Home Loan Bank of Dallas and invested the proceeds in primarily adjustable rate
mortgage related securities. Our margin on the difference in the yield on the
securities and the cost of the advance was approximately .42%, an after tax
basis at year end. Subsequent to year end, after the Federal Reserve lowered
short term interest rates, the cost of the borrowings in the program decreased
substantially. As of December 9, 1998, the after tax margin on the program was
approximately .82%. We expect to expand this program as market conditions
warrant during the upcoming fiscal year.
We invite you to attend our annual meeting of stockholders. The meeting will be
held at 2:00 p.m. on January 20, 1999 at the offices of the Company, 1200 South
Beckham, Tyler, Texas. Once again, we remain confident about the future of the
Company. Our goal is to continue to try and maximize the long-term value of your
investment.
Sincerely,
/s/Jack W. Flock /s/Gerald W. Free
---------------- -----------------
Jack W. Flock Gerald W. Free
Chairman of the Board Vice Chairman, President and
Chief Executive Officer
4
<PAGE>
G l o s s a r y
Book Value Per Share
Indicates the amount of stockholders' equity attributable to each outstanding
share of common stock. It is determined by dividing total stockholders' equity
by the total number of common shares outstanding at the end of a period.
Earnings Per Share
Indicates the amount of net income attributable to each share of common stock.
It is determined by dividing net income for the period by the weighted average
number of common shares outstanding during the same period.
Efficiency Ratio
A measure of operating efficiency determined by dividing total operating
expenses by the sum of net interest income after provisions for loan losses and
non-interest income, excluding net gains or losses on sale of assets.
Interest Rate Sensitivity
A measure of the sensitivity of the Company's net interest income to changes in
market interest rates. It is determined by analyzing the difference between the
amount of interest-earning assets maturing or repricing within a given time
period and the amount of interest-bearing liabilities maturing or repricing
within that same time period.
Interest Rate Spread
The difference between the average yield earned on the Company's
interest-earning assets and the average rate paid on its interest-bearing
liabilities.
Net Interest Income
The dollar difference between the interest earned on the Company's
interest-earning assets and the interest paid on its interest-bearing
liabilities.
Net Interest Margin
Net interest income as a percentage of average interest-earning assets.
Net Portfolio Value
The present value of future expected cash flows on interest-earning assets less
the present value of future expected cash flows on interest-bearing liabilities.
Non-Performing Assets
Loans on which the Company has discontinued accruing interest or are delinquent
more than ninety days and still accruing interest and foreclosed real estate.
Return On Average Assets
A measure of profitability determined by dividing net income by average assets.
Return On Average Stockholders' Equity
A measure of profitability determined by dividing net income by average
stockholders' equity.
5
<PAGE>
Management's Discussion and Analysis
of Financial Condition and
Operating Results
Results of Operation
Forward-Looking Information
Except for the historical information contained herein, the matters discussed in
the Annual Report may be deemed to be forward-looking statements that involve
risks and uncertainties, including the acceptance of new products, the impact of
competitive products and pricing, and the other risks detailed from time to time
in the Company's SEC reports, including the report on Form 10-KSB, for the year
ended September 30, 1998. Actual strategies and results in future periods may
differ materially from those currently expected. These forward-looking
statements represent the Company's judgment as of the date of this Report. The
Company disclaims, however, any intent or obligation to update these
forward-looking statements.
General
The principal business of the Company consists of attracting retail deposits
from the general public and investing those funds primarily in one- to
four-family residential mortgage loans. To a lesser extent, the Company also
originates commercial real estate, one- to four-family construction,
multi-family and consumer loans. The Company also purchases mortgage-backed
securities and invests in U.S. Government and agency obligations and other
permissible investments.
The Company's revenues are derived primarily from interest earned on loans,
mortgage-backed securities and investments and, to a lesser extent, from service
charges and loan originations, gains on sales of loans and mortgage-backed
securities, and loan servicing fee income.
The Company currently offers a variety of deposit accounts having a wide range
of interest rates and terms. The Company's deposits include passbook and money
market accounts, NOW checking accounts, and certificate accounts with terms
ranging from one month to five years. The Company solicits deposits in its
primary market area and does not accept brokered deposits.
Net Income
1998 and 1997 Comparison
Net income was $561,000, or $.39 in basic earnings per share for the year ended
September 30, 1998, compared to $767,000, or $.52 in basic earnings per share
for the year ended September 30, 1997. On a diluted basis, earnings per share
was calculated at $.38 and $.51 for the years ended September 30, 1998 and 1997
respectively. Per share earnings for the year ended September 30, 1997 were
restated for comparative purposes as a result of the Company's three for two
stock split in the
6
<PAGE>
form of a 50% stock dividend completed in 1998. The decrease in net income was
primarily attributable to a $245,000 increase in non-interest expense to $2.8
million for the year ended September 30, 1998, compared to $2.5 million for the
year ended September 30, 1997. Additionally, a $117,000 decline in net interest
income after provision for loan losses from $3.4 million for the year ended
September 30, 1997 to $3.3 million for the year ended September 30, 1998
contributed to the overall decline in net income.
Partially offsetting the increase in non-interest expense and the decline in net
interest income after provision for loan losses was a $59,000 increase in
non-interest income from $302,000 for the year ended September 30 1997 to
$361,000 for the year ended September 30, 1998. In addition, a $97,000 decrease
in income tax expenses from $427,000 for the year ended September 30, 1997 to
$329,000 for the year ended September 30, 1998 offset the decline in net income.
For the year ended September 30, 1998, the Company reported a return on average
assets of approximately .46%, compared to .67% for the year ended September 30,
1997. Return on average stockholders' equity was reported as 2.72% for the year
ended September 30, 1998, compared to 3.67% for the year ended September 30,
1997.
1997 and 1996 Comparison
For the year ended September 30, 1997, net income was $767,000, or $.52 per
share, compared to $458,000, or $.28 per share, for the year ended September 30,
1996. Per share earnings for both years were restated due to the Company's three
for two stock split in 1998. Diluted earnings per share were $.51 and $.28 for
the years ended September 30, 1997 and 1996 respectively. The increase in net
income was primarily attributable to a $677,000 reduction in total non-interest
expenses to $2.5 million for the year ended September 30, 1997, compared to $3.2
million for the year ended September 30, 1996. Total non-interest expenses were
higher in 1996 due to the special one time assessment charged to all Savings
Association Insurance Fund ("SAIF") insured institutions to recapitalize the
SAIF insurance fund. The Company's portion of the one time assessment was
approximately $645,000, before the effects of income taxes were considered.
Partially offsetting the decrease in total non-interest expense was a $133,000
reduction in net interest income before provisions for loan losses from $3.6
million for the year ended September 30, 1996 to $3.4 million for the year ended
September 30, 1997. Also, total non-interest income declined during the year to
$302,000 for the year ended September 30, 1997 from $371,000 for the same period
in 1996 and income tax expense increased to $427,000 for the year ended
September 30, 1997 from $265,000 for the year ended September 30, 1996.
For the year ended September 30, 1997, return on average assets was .67%,
compared to .40% for the year ended September 30, 1996. Return on average
stockholders' equity equaled 3.67% for the year ended September 30, 1997,
compared to 2.08% for 1996.
7
<PAGE>
Net Interest Income Analysis
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------------------------------------------------
1998 1997 1996
Interest Interest Interest
Average Earned/ Yield/ Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate Balance Paid Rate
------------------------------ ---------------------------- ----------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable .................. $ 60,563 $ 4,771 7.88% $ 52,192 $ 4,191 8.03% $ 44,406 $ 3,641 8.20%
Mortgage-backed securities ........ 22,665 1,526 6.73 22,412 1,564 6.98 28,912 2,000 6.92
Investment securities ............. 32,249 1,913 5.93 34,165 2,080 6.09 38,155 2,368 6.21
FHLB stock ........................ 905 54 5.92 972 57 5.86 917 55 6.00
-------- -------- ---- -------- ------- ---- -------- ------- ----
Total interest-earning assets (1) $116,382 8,264 7.10 $109,741 $ 7,892 7.19% $112,390 $ 8,064 7.18%
======== ===== ==== ======== ======= ==== ======== ======= ====
Interest-bearing liabilities:
Demand accounts ................... $ 1,284 $ 0 0.00 $ 1,285 $ 0 0.00% $ 2,401 $ 0 0.00%
NOW accounts ...................... 1,427 29 2.03 1,448 29 2.00 1,468 30 2.04
Savings accounts .................. 2,852 86 3.02 2,913 87 2.99 2,948 88 2.99
Money market checking ............. 5,905 197 3.34 6,099 209 3.43 6,329 213 3.37
Certificate accounts .............. 76,138 4,114 5.40 77,146 4,101 5.32 78,807 4,181 5.31
Borrowings ........................ 9,724 540 5.55 850 47 5.53 0 0 0.00
-------- -------- ---- -------- ------- ---- -------- ------- ----
Total interest-bearing
liabilities ....................... 97,330 4,966 5.10 $ 89,741 $ 4,473 4.98% $ 91,953 $ 4,512 4.91%
-------- -------- ---- -------- ------- ---- -------- ------- ----
Net interest income................... $ 3,298 $ 3,419 $ 3,552
======== ======= =======
Net interest rate spread (2).......... 2.00% 2.21% 2.27%
==== ===== ====
Net earning assets ................... $ 19,052 $ 20,000 $ 20,437
======== ======== =========
Net yield on average
interest
earning assets (3) 2.83% 3.12% 3.16%
===== ==== =====
Average interest-earning assets to
average interest-bearing
liabilities ...................... 119.58% 122.29% 122.23%
====== ====== =======
</TABLE>
- --------------------------
(1) Calculated net of deferred loan fees, loan discounts, loans in process, loss
reserves and premiums or discounts.
(2) Net interest rate spread represents the difference between the average yield
on interest-earning assets and the average cost of interest-bearing liabilities.
(3) Net yield on interest-earning assets represents annualized net interest
income as a percentage of average interest-earning assets.
8
<PAGE>
Rate/Volume Analysis
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------------------------------------------------------------------------
1998 vs 1997 1997 vs 1996 1996 vs 1995
------------------------------ -------------------------------- ------------------------------
Increase Increase Increase
(Decrease) (Decrease) (Decrease) Total
Due to Total Due to Total Due to Increase
------------------- Increase ----------------- Increase ---------------- ----------
Volume Rate (Decrease) Volume Rate (Decrease) Volume Rate (Decrease)
------------------- ---------- ----------------- ---------- ---------------- ---------
(Dollars in Thousands) (Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable ......... $ 672 $ (92) $ 580 $ 638 $ (88) $ 550 $ 439 $(185) $ 254
Mortgage-backed securities 18 (56) (38) (450) 14 (436) (122) 414 292
Investment securities .... (117) (50) (167) (248) (40) (288) (296) (138) (434)
FHLB stock ............... (4) 1 (3) 3 (1) 2 4 (3) 1
----- ----- ----- ----- ----- ----- ----- ----- -----
Total interest-earning
assets ................ $ 569 $(197) $ 372 $ (57) $(115) $(172) $ 25 $ 88 $ 113
===== ===== ===== ===== ===== ===== ===== ===== =====
Interest-bearing liabilities:
NOW accounts ............. $ 0 $ 0 $ 0 $ 0 $ (1) $ (1) $ (2) $ 1 $ (1)
Savings deposits ......... (2) 1 (1) (1) 0 (1) 1 4 5
Money market checking
accounts ................ (7) (5) (12) (8) 4 (4) (16) 19 3
Certificate accounts ..... (54) 67 13 (88) 8 (80) (155) 367 212
Borrowings ............... 491 2 493 47 0 47 0 0 0
----- ----- ----- ----- ----- ----- ----- ----- -----
Total interest-bearing
liabilities ........... $ 428 $ 65 $ 493 $ (50) $ 11 $ (39) $(172) $ 391 $ 219
===== ===== ===== ===== ===== ===== ===== ===== =====
Net change in interest income $(121) $(133) $(106)
====== ===== =====
Net interest income $3,298 $3,419 $3,552
====== ====== ======
</TABLE>
Interest Income
Interest income is dependent upon the composition and dollar amounts of the
Company's interest-earning assets, the yield on those assets and the current
level of market interest rates.
<PAGE>
Interest income is generated by the earnings of the Company's loans receivable,
investment securities and mortgage-backed securities portfolios. The Company's
loans receivable portfolio is primarily comprised of fixed rate, single family
residential mortgages and, to a lesser extent, adjustable rate single family
mortgages and other real estate loans of both fixed and adjustable rates.
Generally, all fixed rate one- to four-family mortgage loans with final
maturities of more than fifteen years are sold into the secondary market upon
origination. Depending upon the mortgage rate, fixed rate loans with maturities
of fifteen years or less may be placed into portfolio or sold into the secondary
market. All adjustable rate loans are held in portfolio.
A significant portion of interest income is also derived from the Company's
investment and mortgage-backed securities portfolios. The investment securities
portfolio is comprised of U. S. Treasury and agency securities with a weighted
average maturity of approximately 2.6 years. With portions of the portfolio
scheduled to mature on a staggered basis, the portfolio provides liquidity for
the Company's operations and additional flexibility with regard to asset and
liability management. Additionally, 79.7% of the mortgage-backed securities
portfolio is comprised of securities that have interest rate adjustment
9
<PAGE>
frequencies of either six months or one year. The remainder of the portfolio is
comprised of fixed rate securities all having final maturities of less than five
years.
1998 and 1997 Comparison
The Company reported total interest income of $8.3 million for the year ended
September 30, 1998, an increase of $372,000 or 4.7% from the $7.9 million
reported for the year ended September 30, 1997. The increase in interest income
was a direct result of a $6.7 million increase in average interest earning
assets from $109.7 million for the year ended September 30, 1997 to $116.4
million for the year ended September 30, 1998 which was only partially offset by
a nine basis point decline in the average yield on interest earning assets from
7.19% for the year ended September 30, 1997 to 7.10% for the year ended
September 30, 1998.
The increase in average interest earning assets was primarily the result of an
$8.4 million increase in average loans receivable balances outstanding from
$52.2 million for the year ended September 30, 1997 to $60.6 million for the
year ended September 30, 1998. As a result, interest income on loans receivable
increased by $580,000 or 13.8% from $4.2 million for the year ended September
30, 1997 to $4.8 million for the year ended September 30, 1998. The increase in
average loans receivable balances was a direct result of the Company's decision
to continue placing into portfolio all fixed rate one- to four-family loans with
terms of 15 years or less and with interest rates of greater than 7.00%. For
most of the year ended September 30, 1998, interest rates on mortgage loans in
the Company's market allowed the Company to continue this policy. In addition,
the Company began making home equity loans in 1998, the first year allowed under
Texas law. All home equity loans currently meet the Company's criteria for
placing real estate related loans into portfolio. As a result of both
conditions, the Company was able to substantially increase its loans receivable
portfolio during 1998. As long term interest rates continued to decline during
1998 and mortgage rates on one- to four-family loans fell below 7.00%, the
Company elected, towards the end of the fiscal year, to begin selling its
15-year and shorter one- to four-family loans into the secondary market. The
Company continued to place all home equity loans into portfolio throughout the
year.
For the fiscal year ending September 30, 1999, the Company's ability to continue
to increase its one- to four-family loans receivable portfolio will be primarily
dependent upon the overall level of interest rates. Continued declines in
interest rates could have the effect of increasing prepayments on the Company's
existing mortgage portfolio if customers refinance their mortgages at lower
interest rates or refinance with other lenders. In addition, the Company's
ability to increase its one- to four-family loan portfolio will be dependent
upon the Company's ability to meet its loan production targets, which are in
turn primarily dependent upon the continued strong economic environment
experienced in the Company's market over the past several quarters. See
- --"Financial Condition - Loans"
Offsetting the increase in interest income on loans receivable was a $117,000
decline in interest on the Company's short term U.S. Treasury and agency
portfolio and a $38,000 decline in interest income on the Company's
mortgage-backed securities portfolio.
10
<PAGE>
During the fiscal year ended September 30, 1998, the Company elected to continue
to increase its wholesale arbitrage program, by borrowing funds from the Federal
Home Loan Bank of Dallas and investing in mortgage-backed securities. As a
result, despite increased prepayments on its mortgage-backed securities
portfolio as interest rates continued to decline, the Company was able to
increase its mortgage-backed securities portfolio to $23.8 million at September
30, 1998 from $22.5 million at September 30, 1997. In fact, the average balance
outstanding in the portfolio increased slightly to $22.7 million for the year
ended September 30, 1998 from $22.4 million for the year ended September 30,
1997. As interest rates continued to decline throughout the year and the loans
underlying the mortgage-backed securities refinanced into lower interest rates,
the overall yield on the Company's mortgage-backed securities portfolio declined
approximately 25 basis points from 6.98% for the year ended September 30, 1997
to 6.73% for the year ended September 30, 1998. The decline in average yield
accounted for the overall decline in interest income on mortgage-backed
securities for the year ended September 30, 1998. See -- "Financial Condition
- -Mortgage-backed securities.
The average balance in the Company's U.S. Treasury and agency portfolio declined
approximately $1.9 million from $34.2 million for the year ended September 30,
1997 to $32.2 million for the year ended September 30, 1998. In addition as the
overall level of interest rates decreased during the year and securities matured
and were replaced with lower yielding securities, the average yield on the
portfolio decreased to approximately 5.93% for the year ended September 30, 1998
from 6.09% for the year ended September 30, 1997. The result was an overall
decline in interest income from the portfolio of approximately $167,000.
1997 and 1996 Comparison
Interest income was reported as $7.9 million for the year ended September 30,
1997, a decrease of $172,000 or 2.1% from $8.1 million for the same period in
1996. The decrease in interest income was attributable to a $2.6 million
decrease in average interest-earning asset balances during the year to $109.7
million for the year ended September 30, 1997 from $112.4 million for the year
ended September 30, 1996. The decline in average total interest-earning assets
was attributable to the Company's decision to fund deposit withdrawals with
maturing investment and mortgage-backed securities. As a result and for a
portion of the year ended September 30, 1997, total interest-earning assets and
total assets of the Company declined. During the year, the Company began
replacing retail deposits with wholesale borrowings from the Federal Home Loan
Bank of Dallas. By September 30, 1997, total interest-earning assets increased
to a level greater than that at September 30, 1996; however, the average balance
for the year declined. The weighted average yield on average total
interest-earning assets was 7.19% for 1997, up one basis point from the 7.18%
reported for 1996.
During the year, the Company also elected to divert cash flow from maturing
investment securities and payments on mortgage-backed securities into the loans
receivable portfolio. In addition, the average yield on the investment security
portfolio declined from 6.21% for the fiscal year ended September 30, 1996 to
6.09% for the year ended September 30, 1997. As a result,
11
<PAGE>
interest income from the investment security and mortgage-backed security
portfolios declined to $3.4 million for the year ended September 30, 1997 from
$4.1 million for the year ended September 30, 1996.
Partially offsetting the decline in interest income from investment and
mortgage-backed securities was an increase in interest income from loans
receivable to $4.1 million for the year ended September 30, 1997 from $3.6
million for the year ended September 30, 1996. The average loans receivable
balance increased to $52.1 million for 1997 from $44.4 million in 1996. The
increase in average loans receivable outstanding was partially offset by a
decline in the average yield on the portfolio from 8.20% for the year ended
September 30, 1996 to 8.03% for the year ended September 30, 1997.
Interest Expense
The Company's interest expense is dependent upon the pricing and volume of its
interest-bearing liabilities, comprised primarily of certificates of deposit
and, to a lesser extent, savings accounts, NOW accounts, money market accounts,
and borrowed funds. The level of interest expense depends upon the composition,
pricing and dollar amount of the Company's interest-bearing liabilities,
competition for deposits and the current level of market interest rates.
Competition for certificate of deposit accounts continues to have an impact on
the Company's ability to control interest expense.
1998 and 1997 Comparison
Total interest expense increased approximately $494,000 to $5.0 million for the
year ended September 30, 1998, compared to $4.5 million for the year ended
September 30, 1997. The increase was primarily attributable to an increase in
average interest-bearing liabilities from $89.7 million for the year ended
September 30, 1997 to $97.3 million for the year ended September 30, 1998. The
Company's overall cost of interest-bearing liabilities, despite a general
decline in the level of interest rates throughout the year, actually increased
by approximately 12 basis points from 4.98% for the year ended September 30,
1997 to 5.10% for the year ended September 30, 1998.
The increase in average interest-bearing liabilities was directly attributable
to the Company's decision to continue its wholesale funding arbitrage through
the Federal Home Loan Bank of Dallas. During the year ended September 30, 1998,
the Company increased its borrowings from the FHLB to $14.9 million at September
30, 1998 from $4.2 million at September 30, 1997. The Company's total deposit
accounts declined slightly from $88.6 million at September 30, 1997 to $86.6
million at September 30, 1998. The increase in average cost of funds was
primarily attributable to continued competitive pressure in the Company's local
market for certificate of deposit accounts and the cost of the FHLB borrowings.
1997 and 1996 Comparison
Total interest expense remained unchanged at $4.5 million for the year ended
September 30, 1997, compared to the year ended September 30, 1996. Average total
interest-bearing liabilities declined to $89.7 million for the year ended
September 30, 1997 from $92.0 million for the year ended September 30, 1996, a
$2.2 million decrease. The decline in average total interest-
12
<PAGE>
bearing liabilities was primarily the result of a $1.7 million decrease in
average balances outstanding in certificate of deposit accounts. Continued
competition in the Company's local market and the Company's decision not to pay
the highest rates in the market accounted for the decline in average certificate
of deposit balances.
The Company's average cost of interest-bearing liabilities increased 7 basis
points to 4.98% for the year ended September 30, 1997, compared to 4.91% for the
year ended September 30, 1996. The increase resulted partially from a 6 basis
point increase in the average cost of money market checking accounts from 3.37%
for 1996 to 3.43% for 1997. Also, the Company reported an average balance
outstanding of $850,000 for borrowed funds for the fiscal year ended September
30, 1997, compared to none for the fiscal year ended September 30, 1996. The
Company began a program of borrowing funds from the Federal Home Loan Bank of
Dallas and investing in various mortgage-backed securities in order to achieve a
positive margin on the transaction. The weighted-average cost of borrowings for
the year ended September 30, 1997 was 5.53%.
Net Interest Income
Net interest income is the Company's principal source of earnings, and is
directly affected by the relative level, composition and pricing of interest
sensitive assets and liabilities. These factors are, in turn, affected by
current economic conditions and the overall level of interest rates.
1998 and 1997 Comparison
Net interest income after provision for loan losses totaled $3.3 million for the
year ended September 30, 1998, a $117,000 or 3.4% decline from the $3.4 million
reported for the year ended September 30, 1997. During the year ended September
30, 1998, the Company's average net interest spread was approximately 2.00%,
compared to 2.21% for the year ended September 30, 1997. The Company's net
interest margin on average interest earning assets was approximately 2.83% for
the year ended September 30, 1998, compared to 3.12% for the year ended
September 30, 1997.
Continued competitive pressure for interest rates on certificates of deposit,
refinancing of mortgage loans, and a "flat" interest rate environment
contributed to the decline in the Company's net interest spread and net interest
margin for the year.
1997 and 1996 Comparison
Net interest income totaled $3.4 million for the year ended September 30, 1997,
a decrease of $133,000 or 3.7% from the $3.6 million reported for the year ended
September 30, 1996. The decline in net interest income was primarily the result
of the $172,000 decrease in total interest income.
For the year ended September 30, 1997, the Company reported an average net
interest spread of 2.21%, down 6 basis points from the 2.27% reported for the
year ended September 30, 1996. The Company's net interest margin on average
interest-earning assets was 3.12% for 1997, compared to 3.16% for 1996 while the
Company's ratio of average interest-earning assets to average interest-bearing
liabilities was 122.29% for 1997, compared to 122.23% for 1996.
13
<PAGE>
Provision for Loan Losses
The Company's provision for loan losses is determined by management's periodic
assessment of the adequacy of the allowance for loan losses. Management's
assessment of the desired level of the allowance for loan losses is affected by
factors such as the composition of the loan portfolio and the risk
characteristics of various classes of loans, the current level of non-performing
loans, economic conditions and real estate values, as well as current regulatory
trends.
1998 and 1997 Comparison
For the year ended September 30, 1998, the Company made no provision for loan
losses, compared to $5,000 for the year ended September 30, 1997. The continued
strength of the economy in the Company's market and the continued quality of its
loan portfolio contributed to the decision to make no additional provisions for
loan losses during the year ended September 30, 1998 and only $5,000 for the
year ended September 30, 1997. The Company anticipates adding to its allowance
for loan losses and thereby increasing its provision for loan losses as
commercial and consumer loans are introduced in 1999.
Non-performing assets to total assets were down to .18% of total assets at
September 30, 1998, compared to .27% at September 30, 1997. Non-performing loans
to total loans receivable totaled .37% at September 30,1998, compared to .54% at
September 30, 1997. The Company's allowance for loan losses as a percentage of
loans receivable equaled .38% at September 30, 1998, compared to .48% at
September 30, 1997 while the allowance for loan losses as a percentage of
non-performing loans increased to 102.19% at September 30, 1998 from 88.06% at
September 30, 1997.
1997 and 1996 Comparison
During the year ended September 30, 1997, the Company reported provisions for
loan losses of $5,000 compared to zero for the year ended September 30, 1996.
At September 30, 1997, non-performing assets to total assets were .27% compared
to .39% at September 30, 1996. Non-performing loans to total loans receivable
were .54% at September 30, 1997, compared to .94% at September 30, 1996.
Allowance for loans losses as a percentage of non-performing loans was 88.06% at
September 30, 1997, compared to 64.22% at September 30, 1996, while the
allowance for loan losses declined to .48% of loans receivable at September 30,
1997 from .60% of loans receivable at September 30, 1996, due to the increase in
the size of the loans receivable portfolio.
Other Operating Income
Other operating income consists primarily of fee income from service charges,
origination fees and servicing fees on the Company's loan portfolio, gains or
losses on the sale of loans and fees from transaction accounts.
14
<PAGE>
1998 and 1997 Comparison
Other operating income equaled $361,000 for the year ended September 30, 1998,
an increase of $58,000 from the $302,000 reported for the year ended September
30, 1997. The increase in other operating income was primarily the result of an
$81,000 increase in gains on sales of loans to $153,000 for the year ended
September 30, 1998, compared to $72,000 for the year ended September 30, 1997.
As interest rates on mortgage loans fell below the Company's threshold for
placing such loans into its loan portfolio in the fiscal year ended September
30, 1998, the Company began selling more loans into the secondary market. The
result was additional gains on the sale of such loans both on a cash basis and
under Statement of Financial Accounting Standards No. 122, Accounting For
Mortgage Servicing Rights. SFAS No. 122 requires that the present value of the
estimated servicing income from a loan sold be recorded as a gain on the sale of
the loan. The recorded gain on the sale of the loan is subsequently amortized
over the estimated life of the loan against loan servicing fee income. Proceeds
from the sale of mortgage loans totaled approximately $10.1 million during the
year ended September 30, 1998, compared to $4.8 million for the year ended
September 30, 1997. Gains on the sale of loans due to originated mortgage
servicing rights totaled $120,000 for the year ended September 30, 1998,
compared to $58,000 for the year ended September 30, 1997. Cash gains on the
sale of loans totaled $32,000 and $14,000 for the years ended September 30, 1998
and 1997 respectively.
Offsetting a portion of the additional gains on sales of loans into the
secondary market was a $25,000 decline in loan servicing fees to $70,000 for the
year ended September 30, 1998, compared to $95,000 for the year ended September
30, 1997. The decline in loan servicing fees resulted primarily from additional
amortization of originated mortgage servicing rights on previously recorded
loans that were paid off or refinanced during the year. Loans serviced for
others totaled $42.6 million at September 30, 1998, compared to $39.4 million at
September 30, 1997. Loan servicing fee income before the reduction for the
amortization of originated mortgage servicing rights totaled $123,000 for the
year ended September 30, 1998, compared to $124,000 for the year ended September
30, 1997. However, the amortization of previously recorded mortgage servicing
rights totaled $53,000 for the year ended September 30, 1998, compared to
$29,000 for the year ended September 30, 1997. The net result was a decline in
loan servicing fee income, despite the fact that loan balances serviced for
others increased during the year.
With the introduction of the consumer and commercial banking products associated
with its additional lines of business, the Company anticipates an increase in
other operating income for 1999.
1997 and 1996 Comparison
Other operating income totaled $302,000 for the year ended September 30, 1997, a
decrease of $69,000 from the $371,000 reported for the year ended September 30,
1996. The decrease in other operating income was attributable to the Company's
decision to continue to place loans into portfolio rather than sell loans into
the secondary market. For the year ended September 30, 1997, the Company
continued its policy of placing all single family real estate loans with a term
of less than or
15
<PAGE>
equal to 15 years and with an interest rate of greater than 7.00% into its loan
portfolio. Loans with longer terms or with lower interest rates were sold into
the secondary market. That policy, in conjunction with continued lower mortgage
rates and a preference of loan customers for shorter term fixed rate loans,
affected the Company's reported gains on sales of loans under the requirements
of SFAS No. 122. Net gains on the sale of loans totaled $72,000 for the year
ended September 30,1997, a $44,000 or 38.2% decrease from the $116,000 reported
for the year ended September 30, 1996 as more loans were placed into portfolio
and fewer gains on the sales of the loans were recorded under SFAS No. 122.
In addition, loan origination and commitment fees declined to $66,000 for the
year ended September 30, 1997 from $84,000 for 1996 as the borrowers for single
family real estate loans in the Company's market area continued to demand loans
with little or no initial fees. Loan servicing fees declined to $95,000 for the
year ended September 30, 1997 from $111,000 for the year ended September 30,
1996. The decline was the result, as borrowers paid off or refinanced their
mortgages, of a continued decrease in older loans in the Company's servicing
portfolio with higher servicing margins. Also, in order to remain competitive in
its local market on thirty year fixed rate loans and still be able to sell such
loans into the secondary market, the Company has been forced to minimize the
amount of servicing spread built into those transactions. In addition, the
Company's decision to retain its fifteen year loans in portfolio and a local
market preference for them, has resulted in fewer additions to the loan
servicing portfolio, and the continued amortization of originated mortgage
servicing assets recorded under SFAS No. 122 accounted for the decline in
servicing fees. At September 30, 1997, the Company serviced approximately $39.4
million in loans sold to other lenders, compared to $40.1 million at September
30, 1996.
Operating Expenses
Operating expenses are comprised of compensation and benefits, occupancy and
equipment and general and administrative expense, together with FDIC insurance
premiums.
1998 and 1997 Comparison
Operating expenses totaled $2.8 million for the year ended September 30, 1998, a
$245,000 or 9.7% increase from the $2.5 million reported for the year ended
September 30, 1997. The increase in total non-interest expense was primarily the
result of a $165,000 increase in compensation and benefits expense, a $34,000
increase in occupancy and equipment expenses and a $63,000 increase in
miscellaneous operating expenses.
The increase in compensation and benefits expense was the result of an $85,000
increase in salaries paid to employees, a $50,000 increase in funding costs on
the Company's defined benefit pension plan and a $20,000 increase in expenses
associated with the release of shares under the Company's ESOP. The increase in
salaries paid to employees was due to additional lending personnel added to the
Company's staff during 1997. Compensation expense for such employees were for a
twelve month period in fiscal 1998 compared to only a portion of fiscal 1997.
The additional pension expense was also the result of additions to the Company's
staff and increased funding requirements as participants in the plan receive
salary increases and increase their length of employment. The additional ESOP
expense was due to the accounting requirements of
16
<PAGE>
American Institute of Certified Public Accountants Statement of Operating
Procedures No. 93-6. Under this procedure, ESOP expense is determined by the
number of shares released during the year and the average fair market value of
the Company's stock. The average fair market value of the Company's stock
increased in 1998 as compared to 1997.
Occupancy and equipment expense totaled $192,000 for the year ended September
30, 1998, compared to $157,000 for the year ended September 30, 1997. The
increase was primarily due to additional depreciation expense associated with
the addition of computer and other equipment added to the Company's operations
in 1998. The Company anticipates significant increases in its operating expenses
in 1999 with the introduction of its commercial and consumer lines of business.
Total non-interest expense as a percentage of average total assets was 2.31% for
the year ended September 30, 1998, compared to 2.19% for the year ended
September 30, 1997. The Company's efficiency ratio was 78.96% for the year ended
September 30, 1998, compared to 69.24% for the year ended September 30, 1997.
1997 and 1996 Comparison
Operating expenses were reported as $2.5 million for the year ended September
30, 1997, a $677,000 decrease from the $3.2 million reported for the year ended
September 30, 1996. The decrease in total non-interest expense was primarily
attributable to the elimination of the one time special assessment, mandated by
the U.S. Congress, and charged to all SAIF insured institutions during the
fiscal year ended September 30, 1996. The Company's portion of the special
assessment was approximately $645,000. In addition, for the year ended September
30, 1997, SAIF deposit insurance premiums were $80,000, compared to $223,000 for
the fiscal year ended September 30, 1996, a $143,000 decrease. The decrease was
a result of reduced SAIF insurance premium rates once the fund attained its
minimum required level (after the special assessment.)
Partially offsetting the decline in SAIF insurance premiums was a $92,000
increase in compensation and benefits expense. The increase was partially the
result of additional personnel added during the year to staff the Company's new
loan agency offices. In addition, an increase in the funding requirements for
the Company's defined benefit pension plan and an increase in reported ESOP
expense accounted for the remainder of the increase in compensation and benefits
expense. The additional ESOP expense was the result of an increase, due to the
increase in the stock price, in the average value of the shares of Company stock
scheduled to be released to participants during the year.
Total non-interest expense as a percentage of average total assets was 2.19% for
the year ended September 30, 1997, compared to 2.77% for the year ended
September 30, 1996. The Company's efficiency ratio, which considers operating
expenses as a percentage of net interest income and other operating income
(excluding gains and losses on sales of assets), was 69.2% in 1997, compared to
84.1% in 1996.
17
<PAGE>
Income Tax Expense
Income tax expense is comprised of federal income tax. The Company does not
incur any state or local income tax liability.
1998 and 1997 Comparison
Income tax expense totaled $329,000 for the year ended September 30, 1998 or
37.0% of pre-tax income, compared to $427,000 or 35.8% of pre-tax income for the
year ended September 30, 1997. The decrease in income tax expense was
attributable to the reduction in pre-tax income from $1.2 million for the year
ended September 30, 1997 to $890,000 for the year ended September 30, 1998.
1997 and 1996 Comparison
Income tax expense was reported as $427,000 or 35.8% of pre-tax income for the
fiscal year ended September 30, 1997, compared to $265,000 or 36.7% of pre-tax
income in 1996. The increase in income tax expense was directly attributable to
the additional pre-tax income reported for the year ended September 30, 1997.
Financial Condition
Balance Sheet Summary
During the year ended September 30, 1998, management made a determined effort to
increase the total assets of the Company. A continued focus on one- to
four-family portfolio lending and a commitment to continue the wholesale
arbitrage program begun in 1997 allowed the Company to increase its total assets
from $115.9 million at September 30, 1997 to $124.0 million at September 30,
1998.
Based upon its ability to access the FHLB for short-term liquidity needs, the
Company elected to deploy more of its excess short-term overnight funds into
investment securities. The balance in total cash and cash equivalents equaled
$1.7 million at September 30, 1998, compared to $6.9 million at September 30,
1997. Consequently, the Company's investment securities portfolio of U.S.
Treasury securities and agency increased to $29.8 million at September 30, 1998
from $23.1 million at September 30, 1997.
Mortgage-backed securities available-for-sale increased as the Company expanded
its wholesale arbitrage program begun. However, lower interest rates had the
effect of decreasing the Company's held-to-maturity mortgage-backed securities
portfolio as borrowers on the adjustable rate loans underlying the securities
refinanced into fixed rate loans.
18
<PAGE>
Loans receivable increased as a result of the Company's policy of continuing to
place its fixed rate loans with original maturities of less than 15 years into
portfolio.
Premises and equipment increased substantially to $2.3 million at September 30,
1998 compared to $1.1 million at September 30, 1997. The increase was due to the
Company's acquisition of approximately 4.2 acres of land in south Tyler for its
new full service location.
Competition for certificates of deposit accounts and the Company's decision not
to pay the highest rates in the market resulted in an overall decline in deposit
accounts during the year. However, total interest-costing liabilities increased
as the Company borrowed additional funds from the FHLB to fund its wholesale
arbitrage program.
Stockholders' equity decreased by $496,000 during the year. The decline was
primarily the result of the Company's stock repurchase made during the year
ended September 30, 1998 and cash dividends paid to stockholders.
Loans
The Company continued its focus on one- to four-family portfolio lending
throughout the fiscal year ended September 30, 1998. For most of the year, the
interest rates on one- to four-family loans remained at levels that allowed the
Company to place into portfolio all of its fixed rate loans with an original
maturity of 15 years or less. The Company continued its policy to sell all fixed
rate loans with an original maturity of greater than 15 years into the secondary
market. Fixed rate loans continued to be the predominant choice of mortgage
borrowers in the Company's market. For the year ended September 30, 1998, the
Company originated a total of approximately $31.3 million in loans. Fixed
interest rate loans accounted for approximately 97.2% of the total while
adjustable rate loans accounted for approximately 2.8%. At September 30, 1998,
approximately 82.7% of the Company's loan portfolio was comprised of loans with
fixed rates of interest and approximately 17.3% of the portfolio was comprised
of loans with adjustable interest rates. At September 30, 1998, the
weighted-average yield on the Company's loan portfolio was 7.71%, compared to
7.92% at September 30, 1997.
The portfolio was comprised of approximately $52.3 million in one- to
four-family loans or approximately 83.3% of gross loans-receivable. The Company
expects to continue to focus on one- to four-family portfolio lending in 1999.
However, the overall level of interest rates and therefore the level of mortgage
rates will dictate the Company's ability to place such loans into portfolio. A
continued period of lower interest rates and a strong local economy will help
the Company's overall one- to four-family lending efforts, but loans could be
made at interest rates that will not meet the Company's guidelines for placing
such loans into portfolio. The result would be an overall substantial decline in
interest income on loans receivable and a decline in net income as cash flow is
redirected to other interest earning assets at lower interest rates.
Gross interim construction loans totaled $2.3 million or approximately 3.6% of
the gross loan portfolio at September 30, 1998. Interim construction one- to
four-family loans are generally made for terms of up to nine months and usually
at or near the prime lending rate. The interest rate is fixed for the term of
the loam. The Company does not expect to increase its one- to four-family
interim construction lending significantly in 1999.
The Company began offering home equity loans on January 1, 1998, the first time
allowed by Texas law. Home equity loans are generally made with terms of between
5 and 15 years. These loans are made with fixed rates of interest at or near the
19
<PAGE>
prime lending rate. Rates vary according to the term and size of the loan. At
September 30, 1998, the Company had approximately $2.5 million in home equity
loans in its loan portfolio. The Company expects to continue to increase the
balance in home equity loans during the fiscal year ended September 30, 1999.
Nonresidential real estate loans totaled $4.1 million at September 30, 1998,
compared to $4.0 million at September 30, 1997. Nonresidential real estate loans
are generally made with fixed rates of interest and for terms of up to 15 years.
Interest rates on such loans are generally made at or near the prime lending
rate. The Company anticipates increasing the balance in nonresidential real
estate loans significantly during the upcoming fiscal year.
As interest rates on traditional one- to four-family loans continued to decline
during the year and borrowers continued to refinance their mortgages to lower
interest rates, the Company continued to experience a decline in its overall net
interest margin on earning assets. The result was a continued decline in net
income for the Company. As a result of this decline, the Company made the
decision during the fiscal year ended September 30, 1998 to expand its current
lines of business into commercial and consumer lending.
The Company's strategy will be to increase its total loan production, to
diversify into lending products with higher yields and shorter terms, and
reverse the trend of declining margins that all traditional one- to four-family
lenders have experienced as interest rates have declined. In conjunction with
this change of business strategy, the Company announced its intention to open a
new branch office facility in the rapidly growing area of South Tyler. The
location will offer all of the lines of business the Company has traditionally
offered. In addition, the new location and all of the Company's full service
locations will begin offering a full line of commercial banking services,
including commercial and consumer lending, commercial checking accounts,
personal banking products such as credit and debit cards, investment brokerage
services, automated teller machines, and extended banking hours.
The Company anticipates initially hiring approximately nine additional full time
and two additional part time employees to open the new office location. The
staff will include persons responsible for starting the commercial and consumer
lending programs for the Company. The Company anticipates hiring lenders from
within the Tyler market. The additional expense from starting such an operation
will be extensive, and the Company does not anticipate that the operation will
be profitable within the first year of operation. However, the Company believes
that the long-term benefits from adding these additional business lines offset
the initial costs of starting the operation.
20
<PAGE>
Loan Portfolio Analysis
<TABLE>
<CAPTION>
September 30,
------------------------------------------------------------------------------------
1998 1997 1996
Amount Percent Amount Percent Amount Percent
------------------------------------------------------------------------------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate loans:
One- to four-family residences $ 52,298 83.34 % $ 49,412 83.88 % $ 42,773 85.98 %
Other residential property 551 0.88 569 0.97 701 1.41
Nonresidential property 4,106 6.54 4,023 6.83 3,458 6.95
Construction loans 2,256 3.60 3,600 6.11 1,806 3.63
--------- ----- ---------- ----- ---------- -----
Total real estate loans 59,211 94.36 57,604 97.79 48,738 97.97
--------- ----- ---------- ----- ---------- -----
Other loans:
Loans secured by deposits 403 0.64 488 0.83 500 1.00
Home improvement 517 0.82 563 0.96 455 0.92
Home Equity 2,454 3.91 0 0.00 0 0.00
Commercial 168 0.27 252 0.42 54 0.11
--------- ----- ---------- ----- ---------- -----
Total other loans 3,542 5.64 1,303 2.21 1,009 2.03
--------- ----- ---------- ----- ---------- -----
Total loans 62,753 100.00 % 58,907 100.00 % 49,747 100.00 %
====== ====== ======
Less:
Loans in process 1373 1,506 1,514
Deferred fees and discounts 28 18 19
Allowance for loan losses 233 273 289
--------- ---------- ----------
Total loans receivable, net 61,119 57,110 47,925
Less:
Loans held for sale 0 0 0
--------- ---------- ----------
Net portfolio loans $ 61,119 $ 57,110 $ 47,925
========= ========== ==========
</TABLE>
Mortgage-backed Securities
At September 30, 1998, the Company reported $23.8 million in mortgage-backed
securities, a $1.3 million increase from the $22.5 million at September 30,
1997. Mortgage-backed securities in an available-for-sale classification totaled
$12.8 million and securities in a held-to-maturity classification totaled $10.9
million. The weighted-average yield on the entire portfolio was approximately
6.67% at September 30, 1998.
<PAGE>
The increase in the available-for-sale securities was a result of the Company's
decision to continue its program of borrowing wholesale funds from the FHLB and
investing the proceeds in adjustable rate mortgage-backed securities. The
securities have interest rate adjustment frequencies of either monthly,
quarterly, semi-annually or annually. The interest rates earned on the
securities are determined by an index and generally have a margin above the
index of 100 to 225 basis points. The index is typically based upon market
interest rates such as the one year U.S. Treasury rate or the one, three, or six
month LIBOR. Management's intention is to continue to increase the balance, in
the program, as market conditions are favorable. The goal of the program would
be to leverage a portion of the Company's excess capital and to achieve a rate
of return on the difference in
21
<PAGE>
the rate earned on the securities and the cost of the advance of approximately
100 to 150 basis points on a pre-tax basis. The advances from the FHLB generally
will have terms of 30 to 35 days. Interest rates on the advances, which are
established by the FHLB, are based on short-term interest rates such as the
one-month U.S. Treasury bill rate or the one-month LIBOR. At September 30, 1998,
the Company had approximately $12.9 million in the program.
Investment Securities
Investment securities totaled $29.8 million at September 30, 1998, a $6.7
million increase from the $23.1 million reported at September 30, 1997. The
entire portfolio was in a held-to-maturity classification and had a composite
yield of approximately 6.04% at year-end. All of the securities had fixed
interest rates. The increase in the outstanding balances was a result of the
Company's decision to transfer excess interest-earning bank balances and federal
funds sold into longer term higher yielding investments. At September 30, 1998,
the portfolio contained $8.0 million in securities with remaining terms until
maturity of less than one year, $8.0 million with remaining terms of one through
three years, $13.8 million with remaining terms of three through five years. Of
the $29.8 million in the portfolio at September 30, 1998, $15.7 million are
callable at various dates between November 1998 and June 2001.
Deposit and Borrowings
Total deposits were reported as $86.6 million at September 30, 1998, a $1.9
million decrease from the $88.6 million at September 30, 1997. Continued local
competition for certificate of deposit accounts and the Company's decision to
not pay the highest interest rates in the local market accounted for the
decrease in total deposit account. Certificate of deposit accounts declined by
$2.3 million during the year. In addition, the Company utilized its borrowing
privileges from the FHLB to fund a greater portion of its interest earning
assets during the year.
Advances from the FHLB totaled $14.9 million at September 30, 1998, a $10.7
million increase from the $4.2 million at September 30, 1997. The increase in
FHLB advances was primarily the result of the Company's decision to continue its
wholesale arbitrage program of borrowing adjustable rate advances from the FHLB
and investing the proceeds in adjustable rate mortgage-backed securities. Also
during the year ended September 30, 1998, the Company utilized approximately
$3.0 million in fixed term interest rate FHLB advances to fund matching- term
commercial real estate loans.
Interest Rate Sensitivity
Interest rate sensitivity is a measure of the extent to which the Company's net
interest income and net portfolio value may be affected by future changes in
market interest rates. Numerous assumptions, primarily future changes in
interest rates, changes in cash flows on assets and liabilities and future
product preferences of customers, which are affected by assumptions about future
pricing of products, are required to arrive at the approximation of the net
interest income impact.
22
<PAGE>
The Company also monitors interest rate risk by measuring the difference between
rate sensitive assets and rate sensitive liabilities that mature or reprice
within a given time period, adjusted for the effects of estimated prepayments
and early withdrawals on interest sensitive assets and liabilities.
Certain deficiencies are inherent in the assumptions and methods used to
calculate the Company's level of interest rate sensitivity. For example, changes
in the overall levels of interest rates could affect prepayment and early
withdrawal assumptions assumed in the calculations. Also, interest rates on
certain assets and liabilities may change in advance of or lag behind changes in
market rates.
The Office of Thrift Supervision adopted a final rule in August of 1993
incorporating an interest rate risk component into the risk-based capital rules.
Under the rule, an institution with a greater than normal level of interest rate
risk will be subject to a deduction of its interest rate component from total
capital for purposes of calculating the risk-based capital requirement. An
institution with greater than normal interest rate risk is defined as an
institution that would suffer a loss of net portfolio value exceeding 2.0% of
the estimated market value of its assets in the event of a 200 basis point
increase or decrease in interest rates.
Net portfolio value is the difference between incoming and outgoing discounted
cash flows from assets, liabilities and off-balance sheet contracts. A resulting
change in net portfolio value of more than 2.0% of the estimated market value of
an institution's assets will require the institution to deduct from its capital
50% of that excess change when calculating regulatory capital ratios. The
effective date of the rule has been postponed by the Office of Thrift
Supervision until further notice. Further, institutions with less than $300
million in total assets and a risk-based capital ratio of greater than 12.0% are
generally exempt from the requirements of the rule and exempt from filing
information with the Office of Thrift Supervision necessary to calculate the
component. Under the current rule, the Association would not be subject to the
interest rate risk component.
In an attempt to ensure that interest rate risk is maintained within limits
established by the Board of Directors, management presently monitors and
evaluates the potential impact of interest rate changes upon the market value of
the Association's equity and the level of its net interest income on a quarterly
basis. Management conducts this analysis with an asset and liability management
simulation model using estimated prepayment rates for various classes of
interest sensitive assets and estimated decay rates for interest-bearing NOW
accounts, money market accounts and savings accounts. The assumptions used may
not be indicative of future withdrawals of deposits or prepayments on loans and
mortgage-backed securities.
23
<PAGE>
The following table presents the Association's analysis of its net portfolio
value and net interest income under various instantaneous changes in interest
rates at September 30, 1998.
<TABLE>
<CAPTION>
Net Portfolio Value Net Interest Income
--------------------------------------------- ---------------------------------------------
Change In
Interest Rates Estimated Amount Of Percent Net Interest Amount Of Percent Of
(basis points) NPV Change Of Change Income Change Change
- ---------------- ----------- ----------- ------------ ----------- ----------- -------------
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C> <C>
+400 $ 13,846 $ (8,430) (37.8) % $ 2,242 $ (883) (28.3) %
+300 15,963 (6,313) (28.3) 2,520 (605) (19.4)
+200 18,138 (4,138) (18.6) 2,761 (364) (11.6)
+100 20,138 (2,138) (9.6) 2,938 (187) (6.0)
0 22,276 3,125
-100 24,524 2,248 10.1 3,295 170 5.4
-200 23,834 1,558 7.0 3,159 34 1.1
-300 25,490 3,214 14.4 2,981 (144) (4.6)
-400 27,302 5,026 22.6 2,706 (419) (13.4)
</TABLE>
The table indicates that the Association's estimated net portfolio value (market
value of assets less market value of liabilities) is approximately $22.3 million
or 17.3% of the market value of assets at September 30, 1998. The estimated net
portfolio value is approximately $3.8 million more than the Association's
reported net worth of $18.5 million, which is approximately 14.9% of total
assets. In addition, under a worst case scenario of a 400 basis point immediate
and permanent increase in interest rates, the Association's estimated net
portfolio value would only decline by 37.8% to $13.8 million and would still be
approximately 11.9% of market value of assets.
The table also shows that the Association's net interest income, in an unchanged
rate scenario, would approximate $3.1 million and would only vary by $883,000 or
28.3%, under changes in the level of interest rates up to 400 basis points.
24
<PAGE>
Asset Quality
The following table sets forth an analysis of the Company's allowance for loan
losses:
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------------------------------------
1998 1997 1996 1995
--------------- --------------- --------------- -----------------
(Dollars in Thoousands)
<S> <C> <C> <C> <C>
Balance at beginning of period $ 273 $ 289 $ 296 $ 300
Charge-offs:
One- to four-family (40) (26) (7) (4)
Other loans 0 (1) 0 0
------------- ------------- ------------- -------------
Total charge-offs (40) (27) (7 ) (4)
------------- ------------- ------------- -------------
Recoveries:
One- to four-family 0 6 0 0
Other loans 0 0 0 0
------------- ------------- ------------- -------------
Total recoveries 0 6 0 0
------------- ------------- ------------- -------------
Net charge-offs (40) (21) (7) (4)
Additions charged to operations 0 5 0 0
------------- ------------- ------------- -------------
Balance at end of period $ 233 $ 273 $ 289 $ 296
============= ============= ============= =============
Ratio of net charge-offs during the period to
Average loans outstanding during the period 0.07 % 0.04 % 0.02 % 0.01 %
============= ============= ============= =============
Ratio of net charge-offs during the period to
Average non-performing assets 14.87 % 5.53 % 1.66 % 1.14 %
============= ============= ============= =============
</TABLE>
At September 30, 1998, non-performing assets were $228,000 or .18% of total
assets, compared to $310,000 or .27% of total assets at September 30, 1997. At
September 30, 1998, non-performing assets were comprised of non-accruing loans,
all of which were one- to four-family residential loans and one foreclosed real
estate property. All of the Company's multi-family, commercial real estate and
construction loans were performing at year end.
The Company's allowance for loan losses totaled $233,000 at September 30, 1998,
down $40,000 from $273,000 at September 30, 1997. At September 30, 1998, the
Company's allowance for loan losses was .38% of loans receivable, compared to
.48% at September 30, 1997, and was 102.2% of non-performing loans at September
30, 1998, compared to 88.1% at September 30, 1997.
25
<PAGE>
The following table presents the amounts and categories of non-performing assets
of the Company:
<TABLE>
<CAPTION>
September 30,
-----------------------------------------------------------------------
1998 1997 1996 1995
-------------- -------------- -------------- --------------
(Dollars in Thousands)
<S> <C> <C> <C> <C>
Non-accruing loans:
One- to four-family $ 187 $ 306 $ 449 $ 294
Other loans 0 4 1 0
---------- ----------- ---------- ----------
Total 187 310 450 294
---------- ----------- ---------- ----------
Accruing loans delinquent more than 90 days:
One- to four-family 6 0 0 12
---------- ----------- ---------- ----------
Total 6 0 0 12
---------- ----------- ---------- ----------
Foreclosed assets:
One- to four-family 35 0 0 90
---------- ----------- ---------- ----------
Total 35 0 0 90
---------- ----------- ---------- ----------
Total non-performing assets $ 228 $ 310 $ 450 $ 396
========== =========== ========== ==========
Total as a percentage of total assets 0.18 % 0.27 % 0.39 % 0.34 %
========== =========== ========== ==========
</TABLE>
Liquidity and Capital Position
The Company's principal sources of funds are deposits from customers, advances
from the FHLB, amortization and prepayments of loan principal (including
mortgage-backed securities), maturities of securities, sales of loans and
operations.
As of September 30, 1998, Office of Thrift Supervision regulations required cash
and eligible investments (liquid assets), in an amount not less than 4.0% of net
withdrawable savings deposits and borrowings payable on demand or within five
years or less be held by the Association. Liquid assets include cash, certain
time deposits, and U. S. Government and agency securities having maturities of
less than five years. At September 30, 1998, the Association's liquid asset
ratio equaled 40.1%.
The Company uses its liquidity and capital resources principally to meet ongoing
commitments to fund maturing certificates of deposit and loan commitments,
maintain liquidity and pay operating expenses. At September 30, 1998, the
Company had outstanding commitments to extend credit on $4.1 million of single
family residential loans.
<PAGE>
Cash and cash equivalents totaled $1.7 million at September 30, 1998, compared
to $6.9 million at September 30, 1997. The primary use of funds during the year
was to fund loan originations, purchase securities, and purchase treasury stock.
The primary source of funds during the year was from maturing investment
securities and payments on mortgage-backed securities and loans and borrowings
from the FHLB. Management believes that it has adequate resources to fund all of
its current commitments.
26
<PAGE>
During the fiscal year ended September 30, 1998, the Company repurchased an
additional 76,973 shares of stock at an average price of $14.04 per share. The
Company also issued an additional 1,568 shares of treasury stock in conjunction
with the exercise of stock options during the year under the Company's 1995
Stock Option and Incentive Plan. At September 30, 1998, the Company owned
420,436 shares of treasury stock at an average price of $11.40 per share. The
Company ended the year with 1,464,056 shares outstanding. The closing stock
price on that date was $13.25 per share. The high and low prices for the year
were $16.25 and $13.00 respectively.
The Company continued its current dividend policy by declaring and paying four
quarterly cash dividends of $.05 per share for a total of $257,000 during the
year. Based on the September 30, 1998 closing stock price of $13.25 per share,
the annualized dividend amount of $.20 per share would equal an annual dividend
rate of 1.51%.
Total stockholders' equity equaled $20.4 million at September 30, 1998, a
decrease of $496,000 from the $20.9 million reported at September 30, 1997. As
of September 30, 1998, the Company's reported book value per share, using a
total stockholders' equity of $20.4 million (net of unallocated ESOP and RRP
shares) and 1,464,056 outstanding shares of common stock (the total outstanding
shares including unallocated ESOP and RRP shares), equaled $13.92 per share.
Under the Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA"), Congress imposed a three part capital requirement for thrift
institutions. At September 30, 1998, the Association's actual and required
capital amounts under each of the three requirements were as follows:
- Tangible Capital (stockholders' equity plus certain intangible
assets) was $18.6 million, or 14.95% of total assets, exceeding the
minimum requirement of 1.5% by $16.7 million.
- Core Capital (tangible capital plus certain intangible assets) was
$18.6 million, or 14.95% of total assets, exceeding the minimum
requirements of 4.0% by $13.6 million.
- Risk-based capital (core capital plus general loan and valuation
allowances) equaled $18.8 million, or 38.29% of risk weighted assets,
as of September 30, 1998, exceeding the minimum requirement of 8.0% of
risk weighted assets by $14.9 million.
At September 30, 1998, the Association met all of the requirements to be
considered a "well capitalized" institution under the Federal Deposit Insurance
Corporation Improvement Act.
Impact of Accounting Pronouncements
SFAS NO. 128 In February 1997, the FASB issued SFAS No. 128, Earnings Per Share.
SFAS No. 128 establishes standards for computing and presenting earnings per
share (EPS) and applies to entities with publicly held common stock or potential
common stock. The Statement simplifies the standards for computing EPS and makes
them comparable with international EPS standards.
27
<PAGE>
SFAS No. 128 replaces the presentation of primary EPS previously prescribed in
APB No. 15, Earnings Per Share, with a presentation of basic EPS. It also
requires dual presentation of basic and diluted EPS on the face of the income
statement for all entities with complex capital structures and requires a
reconciliation of the numerator and denominator of the basic EPS computation to
the numerator and denominator of the diluted EPS computation.
Basic EPS does not include dilution and is computed by dividing income available
to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of common
stock that then shared in the earnings of the entity. Diluted EPS is computed
similarly to fully diluted EPS pursuant to APB Opinion No. 15.
The Statement is effective for financial statements issued for periods ending
after December 15, 1997.
SFAS No. 130 In June of 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS ) No. 130, Reporting
Comprehensive Income. SFAS No. 130 establishes standards for reporting and
displaying comprehensive income and its components in general purpose financial
statements. Comprehensive income includes net income and several other items
that current accounting standards require to be recognized outside of net
income.
SFAS No. 130 requires companies to display comprehensive income in its financial
statements, to classify items of comprehensive income by their nature in their
financial statements and to display accumulated balances of comprehensive income
in stockholders' equity separately from retained earnings and addition paid-in
capital.
The Statement is effective for fiscal years beginning after December 31, 1997.
The Company adopted the Statement effective October 1, 1998.
SFAS No. 131 In June of 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS) No. 131, Disclosure About
Segments of and Enterprise and Related Information. The Statement requires
entities to report certain information about their operating segments in a
complete set of financial statements. It requires them to report certain
enterprise-wide information about their products and services, activities in
different geographic regions and their reliance on major customers, and to
disclose certain segment information in their interim financial statements.
The Statement is effective for fiscal years beginning after December 15, 1997.
The Company has not determined the effects, if any, that the disclosure
requirements will have on its financial statements. The Company adopted the
Statement effective October 1, 1998.
SFAS No. 132 In February of 1998, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standard (SFAS) No. 132, Employers'
Disclosures about Pensions and Other Postretirement Benefits. SFAS No. 132
revises
28
<PAGE>
current disclosures for employers' disclosures for pensions and other
postretirement benefit plans. It standardizes the disclosure requirements for
these plans to the extent possible, and it requires additional information about
changes in the benefit obligations and the fair value of plan assets that are
expected to enhance financial analysis. It does not change measurement or
recognition standards for these plans.
SFAS No. 132 is effective for fiscal years beginning after December 15, 1997.
The Company anticipates changing the disclosure requirements of its defined
benefit pension plan as a result of the statement. The Company has no other
postretirement benefit plans.
Year 2000 Compliance Assessment
The Year 2000 or Century Date Change issue is a result of computer programs
being written using two digits rather than four digits to define the applicable
year. The possibility that a computer system may recognize "00" as the year 1900
rather than the year 2000, could result in a system failure or miscalculations
causing disruptions of operations.
The Company has established a management committee to identify all of its
systems potentially affected by the year 2000 and to ensure that reprogramming
of affected systems is completed. The committee is responsible for testing all
company computer systems and ensuring that all third party computer system
vendors complete Year 2000 remediation.
Financial institution regulators have increased their focus upon Year 2000
compliance issues and have issued guidance concerning the responsibilities of
senior management and directors. Federal banking agencies have asserted that
Year 2000 testing and certification is a primary safety and soundness issue in
conjunction with regulatory examinations and, thus, that an institution's
failure to properly address Year 2000 issues could result in supervisory action,
including the reduction of an institution's supervisory ratings, the denial of
applications for approval of mergers or acquisitions, or the imposition of civil
monetary penalties.
During 1997, the Company formulated its plan to address the Year 2000 issue.
Since that time, the Company has taken the following steps:
Established a senior management team to coordinate Year 2000
issues;
Completed an inventory of application and system software;
Initiated and verified Year 2000 compliance by third party
software vendors;
Identified any large customers that may be affected by the Year
2000 issue;
Tested all personal and network computers used by the Company for
Year 2000 compliance;
Designed test scripts and tested the Company's third party major
data processing service provider;
Reviewed the results from the Company's major data processing
service provider's proxy testing of application systems.
29
<PAGE>
Discussed strategies for notifying customers about the risks of
Year 2000;
Implemented the design of a business resumption plan as it
relates to the Year 2000 issue that will interface with the
Company's Disaster Recovery Plan.
Based upon the Company's own internal testing and the results of proxy testing
by the Company's major data processing service provider, the Company believes
that the risk that the major data processing service provider will not be Year
2000 compliant is low. As a result, the Company believes that a contingency plan
with respect to its major data processing service provider is not required. The
Company has also received correspondence from all other third party software
providers that indicate that all of such software will be Year 2000 compliant.
The Company has budgeted approximately $25,000 for its Year 2000 program. As of
September 30, 1998, the Company has expensed or is aware of future expenditures
totaling approximately $8,000.
The Company is in the process of developing a business resumption plan that will
interface with its existing Disaster Recovery and Contingency Plan. Such plan
will address the likelihood that major systems, other than the Company's major
data processing service provider, will not be available. Major systems include
but are not limited to telephone, electrical, transportation and other similar
systems. The business resumption plan will address cash and liquidity needed to
meet customer demands as the year 2000 approaches.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented herein have
been prepared in accordance with generally accepted account principles, which
require the measurement of financial position and operating results in terms of
historical dollars without considering changes in the relative power of money
due to inflation.
Most of the Company's assets and liabilities are monetary in nature. As a
result, interest rates have a greater impact on the Company's performance than
do the effects of general levels of inflation. Interest rates do not necessarily
move in the same direction or at the same magnitude as the prices of goods and
services.
Market Price of Common Stock
At September 30, 1998, East Texas Financial Services, Inc. traded on The Nasdaq
National Market under the symbol "ETFS". On such date, the Company had 1,464,056
shares outstanding and approximately 450 stockholders of records. Subsequent to
the year end, the Company was notified by Nasdaq Stock Market that it did not
meet the minimum number of round lot
30
<PAGE>
stockholders required for continued listing on either the National or the
SmallCap Market. The Company has approximately 275 round lot stockholders. As a
result, the Company's stock was moved to the Over-The-Counter Electronic
Bulletin Board on November 27, 1998.
The following table sets forth the cash dividends paid per share and the high,
low and closing prices for the fiscal periods indicated:
High Low Close Dividends
Fiscal 1998
First Quarter $15.83 $12.92 $15.83 $0.05
Second Quarter $15.83 $14.00 $15.00 $0.05
Third Quarter $16.25 $14.22 $15.00 $0.05
Fourth Quarter $15.50 $13.00 $13.25 $0.05
High Low Close Dividends
Fiscal 1997
First Quarter $16.50 $14.75 $16.38 $0.05
Second Quarter $19.00 $16.88 $17.75 $0.05
Third Quarter $18.88 $16.88 $18.00 $0.05
Fourth Quarter $20.50 $18.00 $20.50 $0.05
High Low Close Dividends
Fiscal 1996
First Quarter $17.00 $15.13 $16.25 0
Second Quarter $16.75 $14.50 $14.81 $0.05
Third Quarter $15.75 $14.50 $14.63 $0.05
Fourth Quarter $15.50 $14.00 $15.50 $0.05
31
<PAGE>
Report of Independent Accountants
Board of Directors and Shareholders
East Texas Financial Services, Inc.
Tyler, Texas
We have audited the accompanying consolidated statements of financial condition
of East Texas Financial Services, Inc. and Subsidiary as of September 30, 1998
and 1997, and the related consolidated statements of income, stockholders'
equity, and cash flows for each of the three years ended September 30, 1998.
These financial statements are the responsibility of the Company'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 our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of East
Texas Financial Services, Inc. and Subsidiary as of September 30, 1998 and 1997,
and the consolidated results of their operations and their consolidated cash
flows for each of the three years in the period ended September 30, 1998, in
conformity with generally accepted accounting principles.
Tyler, Texas
November 13, 1998
32
<PAGE>
<TABLE>
<CAPTION>
East Texas Financial Services, Inc. and Subsidiary
Consolidated Statements of Financial Condition
September 30, 1998 and 1997
Assets 1998 1997
------------- -------------
<S> <C> <C>
Cash and due from banks ............................................. $ 592,363 $ 508,729
Interest-bearing deposits due from banks ............................ 1,104,695 6,422,404
------------- -------------
Total cash and cash equivalents ................................ 1,697,058 6,931,133
Interest-earning time deposits ...................................... 1,959,617 1,565,573
Federal funds sold .................................................. 129,187 753,847
Securities held-to-maturity (fair value of $30,115,954 in 1998
and $23,128,073 in 1997) ......................................... 29,766,844 23,058,359
Mortgage-backed securities available-for-sale ....................... 12,810,165 4,356,271
Mortgage-backed securities held-to-maturity (fair value
of $11,088,555 in 1998 and $18,611,834 in 1997) ................... 10,940,500 18,151,765
Loans, net .......................................................... 61,119,047 57,110,029
Accrued interest receivable ......................................... 978,378 885,383
Federal Home Loan Bank stock, at cost ............................... 789,100 1,005,700
Premises and equipment, net ......................................... 2,273,067 1,123,311
Foreclosed real estate, net ......................................... 34,500 0
Mortgage servicing rights, net ...................................... 216,879 149,094
Other assets ........................................................ 1,303,120 858,147
------------- -------------
Total assets ........................................................ $ 124,017,462 $ 115,948,612
============= =============
Liabilities and Stockholders' Equity
Liabilities:
Demand deposits ................................................ $ 1,528,374 $ 1,882,109
Savings and NOW deposits ....................................... 10,504,973 9,771,266
Other time deposits ............................................ 74,610,310 76,897,274
------------- -------------
Total deposits ............................................. 86,643,657 88,550,649
Advances from Federal Home Loan Bank ........................... 14,945,852 4,195,000
Advances from borrowers for taxes and insurance ................ 844,188 881,685
Federal income taxes
Current .................................................... 0 0
Deferred ................................................... 31,618 127,909
Accrued expenses and other liabilities ......................... 1,168,453 1,314,001
------------- -------------
Total liabilities .......................................... 103,633,768 95,069,244
------------- -------------
Commitments and contingencies
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Stockholders' equity:
Preferred stock, $0.01 par value, 500,000 shares authorized,
none outstanding
Common stock, $0.01 par value, 5,500,000 shares authorized 1,884,492 shares
issued and 1,464,056 outstanding at September 30, 1998, and 1,256,387
shares issued and
1,026,366 outstanding at September 30, 1997 .................. 18,845 12,564
Additional paid-in capital ..................................... 12,319,624 12,196,879
Deferred compensation - RRP shares ............................. (213,366) (329,748)
Unearned employee stock ownership plan shares .................. (543,564) (650,614)
Retained earnings (substantially restricted) ................... 13,661,392 13,365,792
Net unrealized gain on available-for-sale securities, net of tax (64,974) 15,512
Treasury stock, at cost, 420,436 shares at September 30, 1998,
and 345,031 shares at September 30, 1997 ..................... (4,794,263) (3,731,017)
------------- -------------
Total stockholders' equity ................................. 20,383,694 20,879,368
------------- -------------
Total liabilities and stockholders' equity .......................... $ 124,017,462 $ 115,948,612
============= =============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
33
<PAGE>
<TABLE>
<CAPTION>
East Texas Financial Services, Inc. and Subsidiary
Consolidated Statements of Income
Years Ended September 30, 1998, 1997, and 1996
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Interest income
Loans receivable:
First mortgage loans ......................... $4,665,915 $4,104,554 $3,564,258
Consumer and other loans ..................... 104,721 86,614 77,456
Securities available-for-sale .................... 53,616 57,360 55,329
Securities held-to-maturity ...................... 1,687,024 1,803,994 2,074,033
Mortgage-backed securities available-for-sale .... 473,084 52,207 0
Mortgage-backed securities held-to-maturity ...... 1,053,114 1,511,985 2,000,439
Deposits with banks .............................. 226,256 275,517 292,525
---------- ---------- ----------
Total interest income ........................ 8,263,730 7,892,231 8,064,040
---------- ---------- ----------
Interest expense
Deposits ......................................... 4,425,979 4,425,797 4,511,934
Advances from Federal Home Loan Bank ............. 540,094 46,752 0
---------- ---------- ----------
Total interest expense ....................... 4,966,073 4,472,549 4,511,934
---------- ---------- ----------
Net interest income .......................... 3,297,657 3,419,682 3,552,106
Provisions for loan losses ............................ 0 5,000 0
---------- ---------- ----------
Net interest income after provision
for loan losses ............................ 3,297,657 3,414,682 3,552,106
---------- ---------- ----------
Noninterest income
Net gain on sale of loans ........................ 152,603 71,888 116,316
Net realized gain on sale of investment securities 0 1,381 0
Loan origination and commitment fees ............. 74,086 65,990 83,769
Loan servicing fees .............................. 70,417 94,969 110,576
Other ............................................ 63,535 67,906 60,156
---------- ---------- ----------
Total noninterest income ..................... 360,641 302,134 370,817
---------- ---------- ----------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Noninterest expense
Compensation and benefits ........................ 1,843,610 1,678,962 1,586,838
Occupancy and equipment .......................... 191,671 157,488 154,321
SAIF deposit insurance premium ................... 56,471 80,462 867,859
Loss on foreclosed real estate ................... 12,911 5,538 4,826
Other ............................................ 663,416 600,772 586,067
---------- ---------- ----------
Total noninterest expense .................... 2,768,079 2,523,222 3,199,911
---------- ---------- ----------
Income before provision for income taxes .............. 890,219 1,193,594 723,012
Income tax expense .................................... 329,273 426,819 265,136
---------- ---------- ----------
Net income ............................................ $ 560,946 $ 766,775 $ 457,876
========== ========== ==========
Basic earnings per common share ....................... $ .39 $ .52 $ .28
========== ========== ==========
Diluted earnings per common share ..................... $ .38 $ .51 $ .28
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
34
<PAGE>
<TABLE>
<CAPTION>
East Texas Financial Services, Inc. and Subsidiary
Consolidated Statements of Changes in Stockholders' Equity
Years Ended September 30, 1998, 1997, and 1996
Net
Deferred Unearned Unrealized
Compensation Employee Gain (Loss)
Additional Recognition Stock on Available-
Common Paid-in Retained Treasury & Retention Ownership for-sale
Stock Capital Earnings Stock Plan Plan Shares Securities Total
------- ----------- ----------- ----------- ----------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1995 $ 12,564 $12,048,775 $12,529,044 $ (562,511) $(881,477) $23,146,395
Net income 457,876 457,876
Deferred compensation
amortization 116,382 116,382
Release of employee stock
ownership plan shares 118,271 118,271
Appreciation in employee stock
ownership plan shares released 63,741 63,741
Purchase of treasury stock
at cost (179,192 shares) $(2,831,237) (2,831,237)
Exercise of stock
options (2,090 shares) (4,702) 34,224 29,522
Cash dividends of $0.15 per share (170,337) (170,337)
------- ----------- ----------- ----------- ----------- --------- --------- -----------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1996 12,564 12,112,516 12,811,881 (2,797,013) (446,129) (763,206) 20,930,613
Net income 766,775 766,775
Deferred compensation
amortization 116,381 116,381
Release of employee stock
ownership plan shares 112,592 112,592
Appreciation in employee stock
ownership plan shares released 84,363 84,363
Net change in unrealized gain
on mortgage-backed securities
available-for-sale net of
deferred taxes of $7,991 $ 15,512 15,512
Purchase of treasury stock
at cost (53,964 shares) (951,116) (951,116)
Exercise of stock
options (1,045 shares) (2,351) 17,112 14,761
Cash dividends of $0.20 per share (210,513) (210,513)
------- ----------- ----------- ----------- ----------- --------- --------- -----------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at September 30, 1997 12,564 12,196,879 13,365,792 (3,731,017) (329,748) (650,614) 15,512 20,879,368
Common stock split effected in
the form of a dividend 6,281 (6,281) 0
Net income 560,946 560,946
Deferred compensation
amortization 116,382 116,382
Release of employee stock
ownership plan shares 107,050 107,050
Appreciation in employee stock
ownership plan shares released 122,745 122,745
Net change in unrealized gain
on mortgage-backed securities
available-for-sale net of
deferred tax benefit of $41,462 (80,486) (80,486)
Purchase of treasury stock
at cost (76,973 shares) (1,080,369) (1,080,369)
Exercise of stock
options (1,568 shares) (2,352) 17,123 14,771
Cash dividends of $0.20 per share (256,713) (256,713)
------- ----------- ----------- ----------- ----------- --------- --------- -----------
Balance at September 30, 1998 18,845 $12,319,624 $13,661,392 $(4,794,263) $ (213,366) $(543,564) $ (64,974) $20,383,694
======= =========== =========== =========== =========== ========= ========= ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
35
<PAGE>
<TABLE>
<CAPTION>
East Texas Financial Services, Inc. and Subsidiary
Consolidated Statements of Cash Flows
Years Ended September 30, 1998, 1997, and 1996
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income .............................................. $ 560,946 $ 766,775 $ 457,876
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization of deferred loan origination fees ...... (2,474) (486) (2,988)
Amortization of premiums and discounts on
investment securities, mortgage-backed
securities, and loans ............................. 136,080 106,306 201,336
Amortization of deferred compensation ............... 116,382 116,382 116,382
Amortization of mortgage servicing rights ........... 52,710 28,730 15,618
Compensation charge related to
release of ESOP shares ........................ 132,587 99,747 84,805
Depreciation ........................................ 96,236 68,952 74,424
Provision for loan losses and losses on real estate . 0 5,000 0
Deferred income taxes ............................... (54,829) 250,743 (193,299)
Stock dividend on FHLB stock ........................ (53,500) (57,200) (55,100)
Net (gain) loss on sale of:
Investment securities held-to-maturity:
Obligations-U.S. Govt. and agencies ........ 0 (1,381) 0
Loans held for sale ............................ (32,108) (13,908) (22,326)
Equipment ...................................... 2,512 (9,563) 4,101
Foreclosed real estate ......................... 2,124 0 0
Proceeds from sale of loans ............................. 10,064,554 4,753,985 7,740,431
Originations of loans held for sale ..................... (10,032,446) (4,740,077) (7,718,105)
(Increase) decrease in:
Accrued interest receivable ......................... (92,995) 45,274 125,669
Other assets ........................................ (444,973) (441,331) 44,255
Increase (decrease) in:
Federal income tax payable .......................... 0 (5,044) (33,638)
Accrued expenses and other liabilities .............. (145,548) (438,386) 482,275
------------ ------------ ------------
Net cash provided by operating activities .................... 305,258 534,518 1,321,716
------------ ------------ ------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Cash flows from investing activities:
Net (increase) decrease in interest-earning time deposits (394,044) 98,000 (781,573)
Net (increase) decrease in fed funds sold ............... 624,660 (273,562) 146,311
Purchase of securities held-to-maturity ................. (18,765,094) (6,495,391) (11,633,820)
Proceeds from maturities of securities held-to-maturity . 12,000,000 12,500,000 11,615,000
Proceeds from sales of obligations -
U. S. Govt. and agencies held-to-maturity ............. 0 1,000,937 0
Purchases of mortgage-backed securities
available-for-sale .................................... (11,513,223) (4,469,653) 0
Principal payments on mortgage-backed
securities available-for-sale ......................... 2,862,783 129,747 0
Purchases of mortgage-backed securities held-to-maturity 0 (512,122) (913,080)
Principal payments on mortgage-backed
securities held-to-maturity ........................... 7,206,392 7,286,201 9,647,677
Proceeds from redemption of FHLB stock .................. 270,100 0 0
Net increase in loans ................................... (4,073,492) (9,591,071) (6,071,127)
Proceeds from sale of foreclosed real estate ............ 30,670 401,595 (680)
Acquisition costs related to foreclosed real estate ..... (346) 0 0
Proceeds from sales of equipment ........................ 0 17,500 0
Expenditures for premises and equipment ................. (1,248,504) (230,016) (27,744)
Origination of mortgage servicing rights ................ (120,495) (57,979) (93,990)
------------ ------------ ------------
Net cash provided (used) by investing activities ............. (13,120,593) (195,814) 1,886,974
------------ ------------ ------------
</TABLE>
(continued)
36
<PAGE>
<TABLE>
<CAPTION>
East Texas Financial Services, Inc. and Subsidiary
Consolidated Statements of Cash Flows
Years Ended September 30, 1998, 1997, and 1996
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from financing activities:
Net increase (decrease) in:
Noninterest-bearing deposits, savings,
and NOW accounts ....................... $ 379,972 $ (1,442,629) $ 784,276
Time deposits ............................. (2,286,964) (774,392) (1,596,950)
Advances from borrowers ................... (37,497) (35,537) (61,361)
Proceeds from advances from Federal Home
Loan Bank ................................... 114,351,500 13,104,841 0
Payments of advances from Federal Home
Loan Bank ................................... (103,600,648) (8,909,841) 0
Purchase of treasury stock at cost ............ (1,080,369) (951,116) (2,831,237)
Exercise of stock options ..................... 14,771 14,761 29,522
Dividends paid ................................ (256,713) (210,513) (170,337)
ESOP loan repayment ........................... 97,208 97,208 97,208
------------- ------------- -------------
Net cash provided (used) by financing activities ... 7,581,260 892,782 (3,748,879)
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents (5,234,075) 1,231,486 (540,189)
Cash and cash equivalents at beginning of year ..... 6,931,133 5,699,647 6,239,836
------------- ------------- -------------
Cash and cash equivalents at end of year ........... $ 1,697,058 $ 6,931,133 $ 5,699,647
============= ============= =============
Supplemental disclosure of cash flow information Cash paid for:
Interest on deposits ...................... $ 2,161,979 $ 2,213,797 $ 2,354,934
Interest on FHLB advances ................. 521,896 42,233 0
Income taxes .............................. 173,358 415,820 492,083
Transfers from loans to real estate acquired
through foreclosures ........................ 246,620 482,578 0
Loans made to facilitate the sale of REO ...... 140,000 60,800 84,000
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
37
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 1 - Nature of Operations and Summary of Significant Accounting Policies
East Texas Financial Services, Inc. (the Company) is a savings and loan holding
company for its wholly-owned subsidiary, First Federal Savings and Loan
Association of Tyler, (the Association). The Association offers customary
banking services, including acceptance of checking, saving and time deposits and
the making of mortgage, commercial, and consumer loans to customers located
primarily in Tyler and Smith County, Texas, and surrounding areas. The
Association operates under a federal savings and loan charter and is subject to
regulations by the Office of Thrift Supervision.
Principles of consolidation - The consolidated financial statements include the
accounts of East Texas Financial Services, Inc. and its wholly-owned subsidiary,
which owns all of the Association's premises. All intercompany transactions and
balances have been eliminated in consolidation.
Cash and cash equivalents - For purposes of the consolidated statements of cash
flows, cash and cash equivalents include cash, deposits due from banks, and
interest-bearing deposits due from banks.
Use of estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Securities - Securities that management has both the positive intent and ability
to hold to maturity are classified as securities held-to-maturity and are
carried at cost, adjusted for amortization of premium or accretion of discounts
using the interest method. Securities that may be sold prior to maturity for
asset/liability management purposes, or that may be sold in response to changes
in interest rates, to changes in prepayment risk, to increase regulatory capital
or to other similar factors, are classified as other similar securities
available-for-sale and carried at fair value with any adjustments to fair value,
after tax, reported as a separate component of shareholders' equity. Declines in
the fair value of individual held-to-maturity and available-for-sale securities
below their cost that are other than temporary have resulted in write-downs of
the individual securities to their fair value. The related write-downs are
included in earnings as realized losses. Securities purchased for trading
purposes are held in the trading portfolio at fair value, with changes in fair
value included in noninterest income.
Interest and dividends on securities, including the amortization of premiums and
the accretion of discounts, are reported in interest and dividends on securities
using the interest method. Gains and losses on the sale of securities are
recorded on the trade date and are calculated using the specific-identification
method.
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. The Company did not have any loans held for sale
on hand at September 30, 1998, 1997, or 1996.
<PAGE>
Loans - Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff generally are reported at their
outstanding unpaid principal balances adjusted for charge-offs, the allowance
for loan losses, and any deferred fees or costs on originated loans or
unamortized premiums or discounts on purchased loans. Interest income is accrued
on the unpaid principal balance. Discounts and premiums are amortized to income
using the interest method. Loan origination fees, net of certain direct
origination costs, are deferred and recognized as an adjustment of the yield
(interest income) of the related loans.
38
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 1 - Nature of Operations and Summary of Significant Accounting Policies,
continued
Loans are generally classified as nonaccrual when there exists reasonable doubt
as to the full, timely collection of interest or principal of the loan (usually
when a loan is delinquent for greater than 90 days). Uncollectible interest on
loans that is contractually past due is charged off, or an allowance is
established based on management's periodic valuation. 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 is back to normal, in which case the
loan is returned to accrual status.
Allowance for loan losses - The allowance for loan losses is established through
charges to operations in the form of a provision for loan losses. Increases and
decreases in the allowance due to changes in the measurement of the impaired
loans are included in the provision for loan losses. Loans continue to be
classified as impaired unless they are brought fully current and the collection
of scheduled interest and principal is considered probable. When a loan is
determined to be uncollectible, the portion deemed uncollectible is charged
against the allowance and subsequent recoveries, if any, are credited to the
allowance.
The adequacy of the allowance for loan losses is periodically evaluated by the
Company. Such evaluation includes a review of loans on which full collectibility
may not be reasonably assured and considers the estimated value of the
underlying collateral on the loan, current and anticipated economic conditions,
and other factors, which in management's judgment deserve recognition. The
evaluation of the adequacy of loan collateral is often based upon estimates and
appraisals. Because of changing economic conditions, the valuations determined
from such estimates and appraisals may also change. Accordingly, losses may
ultimately be incurred in amounts different from management's current estimates.
Additionally, the Association is subject to regulatory examinations and may be
directed to record loss allowances by regulatory authorities. Adjustments to the
allowance for estimated losses will be reported in the period such adjustments
become known or are reasonably estimable. The Association's most recent
regulatory examination, dated April 1998, did not result in an increase to the
allowance for loan losses.
Federal Home Loan Bank stock - The FHLB stock is a required investment for
institutions that are members of the Federal Home Loan Bank system. The required
investment in the common stock is based on a predetermined formula and is
carried at cost.
Premises and equipment - Land is carried at cost. Buildings, furniture,
fixtures, and equipment are carried at cost, less accumulated depreciation.
Depreciation is provided over the estimated useful lives of the respective
assets on a straight-line basis. Maintenance and repairs are charged to
operating expense, and renewals and betterments are capitalized. Gains or losses
on dispositions are reflected currently in the statement of income.
<PAGE>
Foreclosed real estate - Real estate acquired in settlement of loans is
initially recorded at the lower of the outstanding loan balance or fair value.
Fair value is defined as the amount of cash or cash-equivalent value of other
consideration that a real estate parcel would yield in a current sale between a
willing buyer and a willing seller - that is, in other than a forced or
liquidation sale. The resulting loss, if any, is charged to the allowance for
loan losses. Subsequent to foreclosure, real estate is carried at the lower of
its new cost basis or fair value minus selling costs. Costs of improvements to
property are capitalized. Operating expenses, including depreciation, of such
properties, net of related income, and gains and losses on disposition are
included in current operations. Recognition of gain on sale of real estate is
dependent upon the transaction meeting certain criteria relating to the nature
of the property sold and the terms of the sale. Under certain circumstances, the
gain, or a portion thereof, is deferred until the necessary criteria are met.
39
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 1 - Nature of Operations and Summary of Significant Accounting Policies,
continued
Mortgage servicing rights - Effective January 1, 1997, the Company adopted
Statement of Financial Accounting Standards No. 125 (SFAS 125), Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,
which superseded SFAS 122, Accounting for Mortgage Servicing Rights. However,
the adoption of SFAS 125 did not result in any significant changes in the
accounting for mortgage servicing rights.
For originated mortgage servicing rights, the Company allocates the net cost of
the mortgage loans to the mortgage servicing rights and the loans (without the
mortgage servicing rights) based on their relative fair values. Fair values are
based on quoted market prices in active markets for loans and loan servicing
rights.
Mortgage servicing rights are amortized in proportion to, and over the period
of, estimated net servicing income which approximates the level-yield method.
The Company stratifies mortgage servicing rights based on one or more of the
predominant risk characteristics of the underlying loans. The Company
periodically evaluates the carrying value of the mortgage servicing rights in
relation to the present value of the estimated future net servicing revenue
based on management's best estimate of remaining loan lives. Impairment is
recognized through a valuation allowance for an individual stratum, and the
amount of impairment is the amount by which the mortgage servicing rights for a
stratum exceed their fair value.
Income taxes - Deferred tax assets and liabilities are determined using the
liability method. Under this method, the net deferred tax asset or liability is
determined based on the differences between the book and tax bases of the
various statement of financial condition assets and liabilities and gives
current recognition to changes in tax rates and laws.
Advertising - The Company expenses the costs of advertising the first time the
advertising takes place.
Financial instruments - All derivative financial instruments held or issued by
the Company are held or issued for purposes other than trading. In the ordinary
course of business the Company has entered into off-balance-sheet financial
instruments consisting of commitments to extend credit. Such financial
instruments are recorded in the financial statements when they are funded.
Reclassifications - Certain amounts previously reported in the financial
statements for 1997 and 1996 have been reclassified to facilitate comparability
with 1998. These reclassifications had no effect on net income or stockholders'
equity.
Accounting pronouncements - Effective October 1, 1998, the Company adopted
Statements of Financial Accounting Standards No. 130 (SFAS 130), Reporting
Comprehensive Income, No. 131 (SFAS 131), Disclosures about Segments of an
Enterprise and Related Information, No. 132 (SFAS 132), Employers' Disclosure
about Pensions and Other Post Retirement Benefits, and No. 133 (SFAS 133),
Accounting for Derivative Instruments and Hedging Activities. The adoption of
the above referenced statements will not have a material impact on the Company's
financial position or results of operations.
40
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 2 - Conversion of the Association
The Association completed a conversion from a mutual to a stock savings and loan
association on January 10, 1995. Simultaneous with the conversion was the
formation of the Holding Corp., incorporated in the State of Delaware. The
initial issuance of shares of common stock in the Holding Corp. on January 10,
1995, was 1,215,900 shares at $10 per share and was accomplished through an
offering to a tax-qualified employee stock ownership plan, eligible account
holders of record, and other members of the Association. The cost of the
conversion and stock offering was accounted for as a reduction of the proceeds
from the issuance of common stock of the Holding Corp. Upon closing of the stock
offering, the Holding Corp. purchased all common shares issued by the
Association for $5,750,000. This transaction was accounted for in a manner
similar to the pooling of interests method.
The following schedule summarizes the issuance of common stock by the Holding
Corp. in the conversion:
Deposit accounts converted to purchase stock $ 1,906,000
Stock issued to ESOP 972,150
Proceeds received from other investors 9,273,750
------------
12,151,900
Conversion costs (700,215)
------------
$ 11,451,685
============
Federal regulations require that, upon conversion from a mutual to stock form of
ownership, a "liquidation account" be established by restricting a portion of
retained earnings for the benefit of eligible savings account holders who
maintain their savings accounts with the Association after conversion. In the
event of complete liquidation (and only in such event), each savings account
holder who continues to maintain his savings account shall be entitled to
receive a distribution from the liquidation account after payment to all
creditors, but before any liquidation distribution with respect to capital
stock. This account will be proportionately reduced for any subsequent reduction
in the eligible holders' savings accounts.
Federal regulations impose limitations on the payment of dividends and other
capital distributions, including, among others, that the Association may not
declare or pay a cash dividend on any of its stock if the effect thereof would
cause the Association's capital to be reduced below the amount required for the
liquidation account or the capital requirements imposed by the Financial
Institutions Reform, Recovery and Enforcement Act (FIRREA) and the Office of
Thrift Supervision (The "OTS").
<PAGE>
Note 3 - Investment Securities
The amortized cost and fair values of investment securities held-to-maturity,
consisting of U.S. Government and agency obligations, are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
September 30, 1998 $29,766,844 $ 349,110 $ 0 $30,115,954
=========== =========== =========== ===========
September 30, 1997 $23,058,359 $ 81,219 $ 11,505 $23,128,073
=========== =========== =========== ===========
</TABLE>
41
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 3 - Investment Securities, continued
The following is a summary of amortized cost and fair value of investment
securities held-to-maturity at September 30, 1998, by contractual maturity:
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
----------- -----------
<S> <C> <C>
Due in one year or less .................... $ 8,014,309 $ 8,068,931
Due after one year through five years ...... 21,027,535 21,320,748
Due after five years through ten years ..... 725,000 726,275
Due after ten years ........................ 0 0
----------- -----------
$29,766,844 $30,115,954
=========== ===========
</TABLE>
Information related to sales of investment securities for 1998, 1997, and 1996
is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Debt securities:
Sales proceeds 0 $ 1,000,937 $ 0
Amortized cost 0 999,556 0
------------ ------------- -------------
Realized gain (loss) $ 0 $ 1,381 $ 0
============ ============= =============
</TABLE>
The Company's management sold securities during the year ended September 30,
1997, since the securities were within sixty days of maturity. It was
management's determination that changes in market interest rates would not have
significantly affected the securities' fair value.
<PAGE>
Note 4 - Mortgage-backed Securities
The amortized cost and fair values of mortgage-backed securities
available-for-sale are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- -------- ----------- -----------
<S> <C> <C> <C> <C>
September 30, 1998:
U.S. government
agency pass-through
certificates ........ $ 4,529,973 $ 0 $ 79,722 $ 4,450,251
U.S. government
agency collateralized
mortgage obligations 8,378,638 51,670 70,394 8,359,914
----------- -------- ----------- -----------
$12,908,611 $ 51,670 $ 150,116 $12,810,165
----------- -------- ----------- -----------
September 30, 1997:
U.S. government
agency pass-through
certificates ........ $ 4,332,768 $ 23,503 $ 0 $ 4,356,271
=========== ======== =========== ===========
</TABLE>
42
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 4 - Mortgage-backed Securities, continued
There were no sales of mortgage-backed securities available-for-sale for 1998
and 1997.
The following is a summary of the amortized cost and fair value of
mortgage-backed securities available-for-sale at September 30, 1998, by
contractual maturity. These contractual maturities do not take into
consideration the effects of scheduled repayments or the effects of possible
prepayments.
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
----------- -----------
<S> <C> <C>
Due in one year or less $ 0 $ 0
Due after one year through five years 0 0
Due after five years through ten years 0 0
Due after ten years 12,908,611 12,810,165
----------- -----------
$12,908,611 $12,810,165
----------- -----------
</TABLE>
The amortized cost and fair values of mortgage-backed securities
held-to-maturity are summarized as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
September 30, 1998:
U.S. government
agency pass-through
certificates ...... $10,940,500 $ 148,897 $ 842 $11,088,555
=========== =========== =========== ===========
September 30, 1997:
U.S. government
agency pass-through
certificates ...... $18,151,765 $ 508,606 $ 48,537 $18,611,834
=========== =========== =========== ===========
</TABLE>
<PAGE>
There were no sales of mortgage-backed securities held-to-maturity for 1998,
1997, or 1996.
The following is a summary of the amortized cost and fair value of
mortgage-backed securities held-to-maturity at September 30, 1998, by
contractual maturity. These contractual maturities do not take into
consideration the effects of scheduled repayments or the effects of possible
prepayments.
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
----------- -----------
<S> <C> <C>
Due in one year or less .............. $ 1,084,538 $ 1,086,380
Due after one year through five years 815,760 818,093
Due after five years through ten years 0 0
Due after ten years .................. 9,040,202 9,184,082
----------- -----------
$10,940,500 $11,088,555
=========== ===========
</TABLE>
43
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 5 - Loans Receivable
Loans receivable are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
First mortgage loans (principally conventional):
Principal balances:
Secured by one-to-four family residences $ 54,752,183 $ 49,412,358
Secured by other residential property .. 550,666 568,458
Secured by nonresidential property ..... 4,106,448 4,023,304
Construction loans ..................... 2,255,867 3,600,405
------------ ------------
61,665,164 57,604,525
Less:
Undisbursed portion of loans ............... (1,373,029) (1,506,002)
Net deferred loan origination fees ......... (28,098) (18,028)
------------ ------------
Total first mortgage loans ............. 60,264,037 56,080,495
------------ ------------
Consumer and other loans:
Principal balances:
Loans to depositors, secured by savings 403,381 487,584
Commercial ............................. 167,869 251,500
Home improvement ....................... 516,940 563,301
------------ ------------
Total consumer and other loans ......... 1,088,190 1,302,385
------------ ------------
Less allowance for loan losses .................. (233,180) (272,851)
------------ ------------
$ 61,119,047 $ 57,110,029
============ ============
</TABLE>
A summary of the changes in the allowance for loan losses is as follows
(charge-offs include transfers to allowance for losses on real estate acquired
in settlement of loans):
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ----------
<S> <C> <C> <C>
Balance at beginning of year ...... $ 272,851 $ 289,120 $ 295,800
Provision charged to income ....... 0 5,000 0
Charge-offs and recoveries, net ... (39,671) (21,269) (6,680)
--------- --------- ---------
Balance at end of year ............ $ 233,180 $ 272,851 $ 289,120
========= ========= =========
</TABLE>
<PAGE>
The Company does not have any loans which are considered troubled debt
restructured loans as defined by SFAS No. 15, Accounting by Debtors and
Creditors for Troubled Debt Restructuring.
As of September 30, 1998 and 1997, in the opinion of management, there are no
loans which should be considered as impaired as defined by SFAS No. 114,
Accounting by Creditors for Impairment of a Loan, and as amended by SFAS No.
118, Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosure.
44
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 5 - Loans Receivable, continued
At September 30, 1998 and 1997, the Company had discontinued the accrual of
interest on nonperforming loans aggregating approximately $187,279 and $309,524,
respectively. Net interest income for 1998, 1997, and 1996 would have been
higher by $3,963, $8,768, and $10,654, respectively, had interest been accrued
at contractual rates on the nonperforming loans. The Company has no commitments
to lend additional funds to debtors whose loans are nonperforming.
Certain officers, directors, and employees were indebted to the Association in
the aggregate amount of $438,595 and $487,301 as of September 30, 1998 and 1997,
respectively. In the opinion of management, these loans were substantially on
the same terms, including interest rates and collateral, as those prevailing at
the same time for comparable transactions with other customers and did not
involve more than a normal risk of collectibility or present any other
unfavorable features to the Association. A summary of the activity of loans to
directors and executives in excess of $60,000 is as follows:
<TABLE>
<CAPTION>
1998 1997
--------- ----------
<S> <C> <C>
Balance, beginning of year ............. $ 475,212 $ 530,066
New loans .............................. 0 17,985
Repayment .............................. (36,617) (72,839)
--------- ---------
Balance, end of year ................... $ 438,595 $ 475,212
========= =========
</TABLE>
Note 6 - Loan Servicing
The principal balances of loans serviced for investors are not included in the
consolidated statement of financial condition. Information related to mortgage
loans serviced for investors is summarized as follows:
<TABLE>
<CAPTION>
September 30,
--------------------------------
1998 1997
----------- -----------
<S> <C> <C>
Principal balance .................... $42,566,350 $39,390,855
Custodial escrow balance ............. 965,653 1,129,082
</TABLE>
<PAGE>
The following is an analysis of the changes in loan servicing rights
capitalized:
<TABLE>
<CAPTION>
1998 1997
--------- ----------
<S> <C> <C>
Balance, beginning of year ............. $ 149,094 $ 119,845
Addition ............................... 120,495 57,979
Amortization ........................... (52,710) (28,730)
--------- ---------
Balance, end of year ................... $ 216,879 $ 149,094
========= =========
</TABLE>
45
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 7 - Accrued Interest Receivable
Accrued interest receivable is summarized as follows:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Investment securities ........................ $ 453,895 $ 338,840
Mortgage-backed securities ................... 184,151 221,505
Loans receivable ............................. 351,437 338,889
Allowance for uncollectible interest ......... (11,105) (13,851)
--------- ---------
$ 978,378 $ 885,383
========= =========
</TABLE>
Note 8 - Foreclosed Real Estate
The Company has acquired various properties through loan foreclosures. At
September 30, 1998 and 1997, the properties are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
------- ---------
<S> <C> <C>
Residential ..................... $34,500 $ 0
======= =========
</TABLE>
There was no activity in the allowance for real estate losses during 1998, 1997,
and 1996.
<PAGE>
Note 9 - Premises and Equipment
Premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
----------- ------------
<S> <C> <C>
Land ..................................... $ 1,523,439 $ 282,503
Buildings and premises ................... 949,263 949,263
Furniture, fixtures, and equipment ....... 452,959 523,317
Autos .................................... 58,742 58,742
----------- -----------
2,984,403 1,813,825
Less accumulated depreciation ............ (711,336) (690,514)
----------- -----------
$ 2,273,067 $ 1,123,311
=========== ===========
</TABLE>
Certain premises and equipment are leased under operating leases. Rental expense
was $7,350 in 1998, $3,662 in 1997, and $-0- in 1996.
46
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 9 - Premises and Equipment, continued
Future minimum rental commitments under noncancelable leases are:
1999 $ 59,862
2000 64,434
2001 9,225
-----------
$ 133,521
===========
Note 10 - Other Assets
Other assets are summarized below:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Principal receivable on mortgage-backed securities $ 381,748 $ 326,754
Prepaid federal income tax ....................... 23,842 234,587
Funds due from sales of loans .................... 776,625 230,900
Prepaid expenses ................................. 88,554 58,383
Other ............................................ 32,351 7,523
---------- ----------
$1,303,120 $ 858,147
========== ==========
</TABLE>
Note 11 - Deposits
The aggregate amount of accounts with a minimum denomination of $100,000 was
approximately $28,712,775 and $29,054,138 at September 30, 1998 and 1997.
At September 30, 1998, scheduled maturities of certificates of deposit are as
follows:
1999 $ 52,407,187
2000 15,591,133
2001 5,382,483
2002 267,873
2003 698,510
Thereafter 263,124
-------------
$ 74,610,310
=============
47
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 11 - Deposits, continued
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C>
Demand deposits ................ $ 0 $ 0 $ 0
Savings and NOW deposits ....... 303,617 324,480 331,326
Time deposits .................. 4,122,362 4,101,317 4,180,608
---------- ---------- ----------
$4,425,979 $4,425,797 $4,511,934
========== ========== ==========
</TABLE>
The Association held deposits of approximately $3,403,167 and $3,032,639 for
related parties at September 30, 1998 and 1997, respectively.
Note 12 - Advances from Federal Home Loan Bank
The outstanding advances from the FHBL consisted of the following at September
30, 1998 and 1997:
<TABLE>
<CAPTION>
Maturity 1998 Rate 1997 Rate
-------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
October 23, 1997 .................... $ 4,195,000 5.54%
October 2, 1998 ..................... $13,150,000 5.38%
December 31, 2004 ................... 260,412 6.09%
January 3, 2005 ..................... 129,059 6.03%
January 1, 2013 ..................... 486,106 6.09%
January 1, 2013 ..................... 461,845 6.13%
February 1, 2013 .................... 458,430 5.91%
-----------
$14,945,852 5.94% $ 4,195,000 5.54%
=========== ===========
</TABLE>
Pursuant to collateral agreements with the Federal Home Loan Bank (FHLB),
advances are secured by all stock and deposit accounts in the FHLB, mortgage
collateral, securities collateral, and other collateral.
<PAGE>
Note 13 - Pension Plan
The Company has a qualified, noncontributory defined benefit retirement plan
covering substantially all of its employees. Benefits are based on years of
service and the employee's highest average rate of earnings for the five
consecutive years during the last ten full years before retirement. The benefits
are reduced by a specified percentage of the employee's social security
benefits. An employee becomes fully vested upon completion of five years of
qualifying service. It is the policy of the Company to fund the maximum amount
that can be deducted for federal income tax purposes.
48
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 13 - Pension Plan, continued
The following table sets forth the plan's funded status and amounts recognized
in the Company's statements of financial condition at September 30:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Actuarial present value of benefit obligations:
Accumulated benefit obligation:
Vested ................................. $ 1,586,361 $ 1,156,009 $ 1,247,505
Nonvested .............................. 145,237 136,719 91,899
----------- ----------- -----------
$ 1,731,598 $ 1,292,728 $ 1,339,404
=========== =========== ===========
Projected benefit obligation for service
rendered to date .............................. $(2,364,813) $(2,145,930) $(1,856,303)
Plan assets at fair value, primarily certificates
of deposit and U.S. government securities ..... 2,149,711 2,035,418 1,907,532
----------- ----------- -----------
Plan assets in excess (shortfall) of benefit
obligation .................................... (215,102) (110,512) 51,229
Unrecorded net loss from past experience
different from that assumed and effects
of changes in assumptions ..................... 480,213 361,361 210,557
Prior service cost not yet recognized
in periodic pension cost ...................... 101,422 108,781 116,140
Unrecognized net assets at 10-1-88
being recognized over 20.658 years ............ (351,490) (384,470) (417,450)
----------- ----------- -----------
(Accrued) prepaid pension cost .................. $ 15,043 $ (24,840) $ (39,524)
=========== =========== ===========
</TABLE>
A summary of the components of income follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Service cost-benefits earned during the year $ 144,524 $ 106,287 $ 125,062
Interest cost on projected benefit obligation 157,582 139,094 133,210
Return on plan assets ....................... (172,048) (151,525) (110,589)
Net asset gain recognition .................. 8,783 0 0
Amortization of unrecognized net asset ...... (32,980) (32,980) (32,980)
Amortization of prior service cost .......... 7,359 7,359 7,359
--------- --------- ---------
Net periodic pension cost ................... $ 113,220 $ 68,235 $ 122,062
========= ========= =========
</TABLE>
<PAGE>
Assumptions used in the accounting for the pension plan were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Weighted average discount rate 7.50% 8.00% 7.00%
Rate of increase in future compensation levels 5.00% 5.00% 5.00%
Expected long-term rate of return on assets 8.00% 8.00% 7.00%
</TABLE>
The Company contributed $153,103, $82,919, and $124,284 to the plan in 1998,
1997, and 1996, respectively.
49
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 14 - Income Taxes
The Company and the Association file a consolidated federal income tax return.
The consolidated provision for income taxes for 1998, 1997, and 1996 consists of
the following:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ----------
<S> <C> <C> <C>
Current (benefit) ......... $ 384,102 $ 176,076 $ 458,435
Deferred (benefit) ........ (54,829) 250,743 (193,299)
--------- --------- ---------
$ 329,273 $ 426,819 $ 265,136
========= ========= =========
</TABLE>
Total income tax expense differed from the amounts computed by applying the U.S.
federal income tax rate of 34 percent to income before income taxes and
cumulative effect of change in accounting for income taxes as a result of the
following: <TABLE> <CAPTION>
1998 1997 1996
-------- -------- ---------
<S> <C> <C> <C>
Expected income tax expense at
statutory tax rate of 34% ....... $302,674 $405,822 $245,828
Other ............................. 26,599 20,997 19,308
-------- -------- --------
$329,273 $426,819 $265,136
======== ======== ========
Effective tax rate ................ 37% 36% 37%
======== ======== ========
</TABLE>
<PAGE>
Deferred tax assets and liabilities included in the statement of financial
condition at September 30 consist of the following:
<TABLE>
<CAPTION>
1998 1997
--------- ----------
<S> <C> <C>
Deferred tax assets:
Allowance for loan losses ........................... $ 66,945 $ 66,945
Deferred compensation ............................... 28,373 25,028
Other ............................................... 8,471 5,222
--------- ---------
103,789 97,195
--------- ---------
Deferred tax liabilities:
FHLB stock .......................................... (11,390) (85,034)
Mortgage servicing rights ........................... (73,739) (50,692)
Depreciable assets .................................. (36,241) (36,484)
Unrealized gain (loss) on loans held for sale ....... 25,992 (1,293)
Pension liability ................................... (73,500) (43,610)
Net unrealized (gain) loss on market value adjustment
to mortgage-backed securities available-for-sale .. 33,471 (7,991)
--------- ---------
(135,407) (225,104)
--------- ---------
Net deferred tax asset (liability) ....................... $ (31,618) $(127,909)
========= =========
</TABLE>
50
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 14 - Income Taxes, continued
No valuation allowance for deferred tax assets was recorded as of September 30,
1998 and 1997, as management believes that the amounts representing future
deferred tax benefits will more likely than not be recognized since the Company
is expected to have sufficient taxable income of an appropriate character within
the carryback and carryforward period as permitted by the tax law to allow for
utilization of the future deductible amounts.
Retained earnings at September 30, 1998 and 1997, includes approximately
$2,692,722, 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. Reduction of amounts so allocated for purposes
other than tax bad debt losses or adjustments arising from 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 $915,525 at September
30, 1998 and 1997.
Note 15 - Stock Option and Incentive Plan
The 1995 Stock Option and Incentive Plan (the "Stock Option Plan") provides for
awards in the form of stock options, stock appreciation rights, limited stock
appreciation rights, and restricted stock.
Options to purchase shares of common stock of the Company may be granted to
selected directors, officers, and key employees. The number of shares of common
stock reserved for issuance under the stock option plan was equal to 182,278 or
10% of the total number of common shares issued pursuant to the conversion. The
option exercise price cannot be less than the fair market value of the
underlying common stock as of the date of the option grant, and the maximum
option term cannot exceed ten years. Awards vest at a rate of 20% per year
beginning at the date of the grant. The Company plans to use treasury stock for
the exercise of options. The following is a summary of changes in options
outstanding:
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Options outstanding
Balance, September 30, 1996 ............................... 101,321
Granted ............................................... 0
Exercised at $14.125 per share ........................ (1,045)
Forfeited and expired ................................. 0
--------
Balance, September 30, 1997 ............................... 100,276
Increase due to 3 for 2 stock split ................... 50,135
Granted ............................................... 0
Exercised at $9.42 per share .......................... (1,568)
Forfeited and expired ................................. 0
--------
Balance, September 30, 1998 ............................... 148,843
========
Options exercisable at year end under stock option plan ........ 86,807
========
Shares available for future grants ............................. 27,162
========
</TABLE>
51
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 15 - Stock Option and Incentive Plan, continued
Stock appreciation rights ("SARs") may be granted under the Option and Incentive
Plan giving the participant the right to receive the excess of the market value
of the shares on the date exercised over the exercise price. Upon exercise, the
participant will receive either cash or shares as determined by the Company.
Limited SARs may be granted which are exercisable only for a limited period of
time in the event of a tender or exchange offer for shares of Holding Corp.
stock. Payment upon exercise of a limited SAR shall be in cash. No SARs or
limited SARs have been granted.
Restricted stock may also be granted under the Option and Incentive Plan,
subject to forfeiture if the participant fails to remain in the continuous
service of the Company. The time period for such restriction may be removed or
accelerated at the Company's discretion.
Note 16 - Employee Stock Ownership Plan (ESOP)
In conjunction with the stock conversion, the Company established an ESOP for
eligible employees. Employees with at least one year of employment and who have
attained the age of twenty-one are eligible to participate. The ESOP borrowed
funds in the amount of $972,080 from the Company to purchase 145,823 common
shares issued in the conversion. Collateral for the loan is the common stock
purchased by the ESOP. The ESOP loan is payable in quarterly principal payments
of $24,302 over a ten-year period plus interest at an annual rate of 7.93%. In
accordance with generally accepted accounting principles, the unpaid balance of
the ESOP loan on the Association's books and the related receivable on the
Holding Corp.'s books have been eliminated in the consolidated statement of
financial condition. The cost of shares not committed to be released and
unallocated shares is reported as a reduction of stockholders' equity. Shares
are released to participants' accounts under the shares allocated method.
The Company intends to make annual contributions to the ESOP in an amount to be
determined annually by the Board of Directors, but not less than the amount
required to pay any currently maturing obligations under loans made to the ESOP.
The Company will not make contributions if such contributions would cause the
Company to violate its regulatory capital requirements.
Company contributions to the ESOP and shares released from the suspense account
in an amount proportional to the repayment of the ESOP loan will be allocated
among ESOP participants on the basis of compensation in the year of allocation.
Benefits generally become 100% vested after five years of credited service.
Prior to the completion of five years of credited service, a participant who
terminates employment for reasons other than death, retirement (or normal
retirement), or disability will not receive any benefit under the ESOP.
Forfeitures will be reallocated among the remaining participating employees, in
the same proportion as contributions. Benefits may be payable in the form of
stock or cash upon termination of employment.
52
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 16 - Employee Stock Ownership Plan (ESOP), continued
ESOP compensation expense for the years ended September 30, 1998, 1997, and
1996, totaled $229,795, $196,955, and $182,013, respectively. The fair value of
unearned ESOP shares at September 30, 1998 and 1997, totaled $1,080,339 and
$1,333,751, respectively. Following is a summary of ESOP shares at September 30:
<TABLE>
<CAPTION>
1998 1997
------ ------
<S> <C> <C>
Shares allocated ............................. 63,713 48,230
Shares committed to be released .............. 0 0
Unearned ..................................... 81,534 97,593
------- -------
Total ........................................ 145,247 145,823
======= =======
</TABLE>
The share amounts for 1997 are restated to reflect a 3 for 2 stock split during
1998.
Note 17 - Recognition and Retention (RRP)
On July 26, 1995, the stockholders approved the Company's formation of a RRP
which was authorized to award 4%, or 72,912 shares (48,608 shares prior to stock
split), of the total shares of common stock issued in the conversion. On July
26, 1995, the RRP awarded 61,796 (41,197 shares prior to stock split) shares of
common stock to directors and employees in key management positions in order to
provide them with a proprietary interest in the Company in a manner designed to
encourage such employees to remain with the Company.
Unearned compensation of $581,908, representing the shares' fair market value of
$14.125 per share at the date of award, will be charged to income on a
straight-line basis over the five year vesting period as the Company's directors
and employees perform the related future services. The unamortized balance,
which is comparable to deferred compensation, is reflected as a reduction of
stockholders' equity. The Company recognized $116,382 as compensation and
benefits expense relating to this plan for the years ended September 30, 1998,
1997, and 1996.
53
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 18 - Earnings per Common Share
Basic earnings per common share are computed by dividing earnings available to
common stockholders by the weighted average number of common shares outstanding
during the period, adjusted retroactively for a 3 for 2 stock split in the form
of a stock dividend, which was authorized by the Board of Directors on February
18, 1998, to shareholders of record as of March 11, 1998. Diluted earnings per
share reflect per share amounts that would result if dilutive potential common
stock had been converted to common stock. The following reconciles amounts
reported in the financial statements:
<TABLE>
<CAPTION>
1998 1997
------------------------------------- -----------------------------------------
Income Shares Per-Share Income Shares Per-Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- ------ ----------- ------------- ------
<S> <C> <C> <C> <C> <C> <C>
Income from
continuing
operations ..... $ 560,946 $ 766,775
Less preferred
stock dividends 0 0
Income available
to common
stockholders -
basis earnings
per share ...... 560,946 1,431,623 $ 0.39 766,775 1,470,358 $ 0.52
Effect of dilutive
securities:
Options .......... 0 51,266 0 29,122
Income available
to common
stockholders -
diluted earnings
per share ...... $ 560,946 1,482,889 $ 0.38 $ 766,775 1,499,480 $ 0.51
========== ========= ========== ========== ========= =============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
1996
--------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------- ------------- ----------
<S> <C> <C> <C>
Income from
continuing
operations ..... $ 457,876
Less preferred
stock dividends 0
----------
Income available
to common
stockholders -
basis earnings
per share ...... 457,876 1,627,323 $ 0.28
Effect of dilutive
securities:
Options .......... 0 12,635
--------- ---------
Income available
to common
stockholders -
diluted earnings
per share ...... $ 457,876 1,639,958 $ 0.28
========== ========== ==============
</TABLE>
Note 19 - Subsequent Event
At the October 14, 1998, directors' meeting, a cash dividend of $0.05 was
declared. This dividend is to holders of record on November 11, 1998, and
payable on November 25, 1998.
Note 20 - Significant Group Concentration of Credit Risk
The Company invests a portion of its cash in deposit accounts with various
financial institutions in amounts which may exceed the insured amount of
$100,000. The Company has not experienced any losses on these investments which
typically are payable on demand. The Company performs ongoing evaluations of the
financial institutions in which it invests deposits and periodically assesses
its credit risk with respect to these accounts.
At September 30, 1998 and 1997, the Company had $1,104,695 and $4,354,021,
respectively, on deposit with the Federal Home Loan Bank of Dallas, and $533,610
and $1,086,177, respectively, on deposit with Nations Bank of Texas.
54
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 21 - Financial Instruments
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financial needs of its customers.
These financial instruments include commitments to extend credit and involve, to
varying degrees, elements of credit risk and interest-rate risk in excess of the
amount recognized in the consolidated statements of financial condition.
The exposure to credit loss in the event of nonperformance by the other party to
the financial instruments for commitments to extend credit is represented by the
contractual amount of those instruments. The Company uses the same credit
policies in making commitments and condition obligations as it does for
on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. The Company evaluates each customer's creditworthiness
on a case-by-case basis. The amount and nature of collateral obtained, if deemed
necessary by the Company upon extension of credit, is based on management's
credit evaluation of the counter-party. Such collateral includes primary real
estate.
The Company has not been required to perform on any financial guarantee during
the past two years. The Company has not incurred any losses on its commitments
in either 1998 or 1997.
The Association had outstanding commitments to originate loans as follows:
<TABLE>
<CAPTION>
September 30, 1998 September 30, 1997
-------------------------------------- --------------------------------------
Fixed Variable Fixed Variable
Rate Rate Total Rate Rate Total
---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
First mortgage $4,114,767 $ 0 $4,114,767 $4,281,570 $ 0 $4,281,570
Consumer and
other loans 0 0 0 0 0 0
---------- ---------- ---------- ---------- ---------- ----------
$4,114,767 $ 0 $4,114,767 $4,281,570 $ 0 $4,281,570
========== ========== ========== ========== ========== ==========
</TABLE>
Note 22 - Fair Value of Financial Instruments
Management uses its best judgment in estimating the fair value of the Company's
financial instruments; however, there are inherent weaknesses in any estimation
technique. Therefore, for substantially all financial instruments, the fair
value estimates herein are not necessarily indicative of the amounts the Company
could have realized in a sales transaction on the dates indicated. The estimated
<PAGE>
fair value amounts have been measured as of their respective year ends and have
not been reevaluated or updated for purposes of these consolidated financial
statements subsequent to those respective dates. As such, the estimated fair
values of these financial instruments subsequent to the respective reporting
dates may be different than the amounts reported at each year end.
The following information should not be interpreted as an estimate of the fair
value of the entire Company since a fair value calculation is only provided for
a limited portion of the Company's assets. Due to a wide range of valuation
techniques and the degree of subjectivity used in making the estimates,
comparisons between the Company's disclosures and those of other companies may
not be meaningful. The following methods and assumptions were used to estimate
the fair values of the Company's financial instruments at September 30, 1998 and
1997:
55
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 22 - Fair Value of Financial Instruments, continued
Cash and cash equivalents. The carrying amounts of cash and cash equivalents
approximate their fair value.
Interest-earning time deposits. Fair values for time deposits are estimated
using a discounted cash flow analysis that applies interest rates currently
being offered on certificates.
Available-for-sale and held-to-maturity securities. Fair values for securities,
excluding restricted equity securities, are based on available quoted market
prices. If quoted market prices are unavailable, fair values are based on quoted
market prices of comparable instruments. Available-for-sale securities are
carried at their aggregate fair value.
Loans receivable. Fair values for loans receivable are estimated using
discounted cash flow analysis, using interest rates currently being offered for
loans with similar terms to borrowers of similar credit quality.
Federal Home Loan Bank stock. The fair value of stock in the Federal Home Loan
Bank of Dallas is estimated to be equal to its carrying amount, since it is not
a publicly traded equity security, has an adjustable dividend rate, and
transactions in the stock have been executed at the stated par value.
Deposit liabilities. The fair values disclosed for 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 deposit (CDS) approximate their fair
values at the reporting date. Fair values for fixed-rate CDS are estimated using
a discounted cash flow calculation that applies interest rates currently being
offered on certificates to a schedule of aggregated expected monthly maturities
on time deposits.
Borrowings. The estimated fair value of the FHLB advance is based upon the
discounted value of the difference between contractual rates and current market
rates for similar agreements.
Advance from borrowers for taxes and insurance. The carrying amount of escrow
accounts approximate fair value.
Accrued interest. The carrying amounts of accrued interest approximate their
fair values.
Off-balance-sheet instruments. Commitments to extend credit were evaluated and
fair value was estimated using the fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
present creditworthiness of the counter parties. For fixed-rate loan
commitments, fair value also considers the difference between current levels of
interest rates and the committed rates.
56
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 22 - Fair Value of Financial Instruments, continued
The estimated fair values of the Company's financial instruments were as follows
at:
<TABLE>
<CAPTION>
September 30, 1998 September 30, 1997
------------------------------- ------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 1,697,058 $ 1,697,058 $ 6,931,133 $ 6,931,133
Interest-earning time deposits 1,959,617 1,988,000 1,565,573 1,568,000
Securities held-to-maturity 29,766,844 30,115,954 23,058,359 23,128,073
Mortgage-backed securities
available-for-sale 12,810,165 12,810,165 4,356,271 4,356,271
Mortgage-backed securities
held-to-maturity 10,940,500 11,088,555 18,151,765 18,611,834
Loans receivable, net 61,119,047 64,421,000 57,110,029 58,145,000
Accrued interest receivable 978,378 978,378 885,383 885,383
Federal Home Loan Bank stock 789,100 789,100 1,005,700 1,005,007
Financial liabilities:
Deposit liabilities 86,643,657 87,374,000 88,550,649 90,346,500
Advances from Federal Home
Loan Bank 14,945,852 15,058,000 4,195,000 4,196,000
Advances from borrowers for
taxes and insurance 844,188 844,188 881,685 881,685
</TABLE>
The carrying amounts in the preceding table are included in the statement of
financial condition under the applicable captions. The contract or notional
amounts of the Company's financial instruments with off-balance-sheet risk are
disclosed in Note 21.
Note 23 - Regulatory Matters
The Association is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possible additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Association and the consolidated financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Association must meet specific capital guidelines that
involve quantitative measures of the Association's assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The Association's capital amounts and classification are also subject
to qualitative judgments by the regulators about components, risk weightings,
and other factors.
<PAGE>
Quantitative measures established by regulation to ensure capital adequacy
require the Association to maintain minimum amounts and ratios (set forth in the
table below) of total risk-based capital and Tier 1 capital to risk-weighted
assets (as defined in the regulations), Tier 1 capital to adjusted total assets
(as defined), and tangible capital to adjusted total assets (as defined).
Management believes, as of September 30, 1998, that the Association meets all
capital adequacy requirements to which it is subject.
57
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 23 - Regulatory matters, continued
As of September 30, 1998, the most recent notification from the Office of Thrift
Supervision categorized the Association as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized
the Association must maintain minimum total risk-based, Tier 1 risk-based, Tier
1 leverage, and tangible capital ratios as set forth in the table. There are no
conditions or events since that notification that management believes have
changed the institution's category.
<TABLE>
<CAPTION>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------------- -------------------- ------------------------
Amount Ratio Amount Ratio Amount Ratio
----------- ----- --------- ----- --------- ------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
As of September 30, 1998:
Total risk-based capital
(to risk-weighted assets) $ 18,784 38.3% $ 3,926 8.0% $ 4,907 10.0%
Tier 1 capital
(to risk-weighted assets) $ 18,555 37.8% $ 1,963 4.0% $ 2,944 6.0%
Tier 1 capital
(to adjusted total assets) $ 18,555 14.9% $ 4,965 4.0% $ 6,206 5.0%
Tangible capital
(to adjusted total assets) $ 18,555 14.9% $ 1,862 1.5% $ 1,862 1.5%
As of September 30, 1997:
Total risk-based capital
(to risk-weighted assets) $ 17,895 40.2% $ 3,559 8.0% $ 4,449 10.0%
Tier 1 capital
(to risk-weighted assets) $ 17,622 39.6% $ 1,780 4.0% $ 2,670 6.0%
Tier 1 capital
(to adjusted total assets) $ 17,622 15.2% $ 4,637 4.0% $ 5,796 5.0%
Tangible capital
(to adjusted total assets) $ 17,622 15.2% $ 1,739 1.5% $ 1,739 1.5%
</TABLE>
Note 24 - Compensated Absences
Employees of the Company are entitled to paid vacation after one year of
employment. The vacation time does not vest; therefore, no accrual for vacation
was recorded due to the immateriality. Sick leave is not accrued because it does
not vest. The costs of these compensated absences are recognized when paid.
<PAGE>
Note 25 - Interest and Dividends on Investment Securities
Dividends on Federal Home Loan Bank stock of $53,616, $57,360, and $55,329 were
received for the years ended September 30, 1998, 1997, and 1996, respectively.
Interest income received from investment securities for the years ended
September 30, 1998, 1997, and 1996 was taxable.
58
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 26 - Other Noninterest Income and Expense
Other noninterest income and expense amounts are summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Other noninterest income:
Loan late charges ......................... $ 29,127 $ 25,346 $ 25,825
Bank service charges and fees ............. 21,773 22,345 22,503
Other ..................................... 12,635 20,215 11,828
-------- -------- --------
$ 63,535 $ 67,906 $ 60,156
======== ======== ========
Other noninterest expense:
Advertising and promotion ................. $ 34,895 $ 28,023 $ 36,983
Data processing ........................... 99,501 89,203 86,716
Professional fees ......................... 72,634 77,953 80,434
Supervisory examination ................... 36,307 35,697 36,435
Printing, postage, stationery, and supplies 54,660 51,634 43,829
Telephone ................................. 22,519 18,136 18,884
Insurance and bond premiums ............... 52,332 60,877 61,261
Loan servicing expenses ................... 42,246 22,268 20,686
Franchise taxes ........................... 94,363 94,545 94,304
Other ..................................... 153,959 122,436 106,535
-------- -------- --------
$663,416 $600,772 $586,067
======== ======== ========
</TABLE>
Note 27 - Impact of Year 2000 (Unaudited)
The Year 2000 (Y2K) issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including the
temporary inability to process transactions or engage in similar normal business
activities.
The Company currently does not expect to incur any significant internal costs
relating to the Y2K issue as no internal modifications are necessary, with the
exception of its third party processing system. For this system, the Company has
initiated formal communications and testing procedures with its third party
processor as the Company's interface systems are vulnerable to the processor's
failure to remediate its own Y2K issues. The Company receives regular status
reports from the processor indicating the progress to date and estimated
completion date. <PAGE>
The processor estimates that Y2K modifications to the systems which interface
with the Company will be completed no later than June 30, 1999, which is prior
to any anticipated impact on the Company's operating systems. The Company
believes that with the processor's modifications to existing software and
conversion to new software, the Y2K issue will not pose significant operational
problems for its computer systems. However, if such modifications and
conversions are not made or completed timely by the processor, the Y2K issue
could have a material impact on the operations of the Company.
59
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 28 - Condensed Parent Company Only Financial Statements
The following condensed statements of financial condition as of September 30,
1998 and 1997, and related condensed statements of income and statements of cash
flows for the years ended September 30, 1998 and 1997, should be read in
conjunction with the consolidated financial statements and the related notes.
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
STATEMENT OF FINANCIAL CONDITION
Assets:
Cash ........................................................... $ 975,288 $ 2,146,805
Note receivable - ESOP Trust ................................... 607,550 704,758
Investment in the Association .................................. 18,703,457 17,967,563
Receivable from subsidiary ..................................... 118,102 78,902
Prepaid expenses ............................................... 5,611 6,432
------------ ------------
Total assets ........................................................ $ 20,410,008 $ 20,904,460
============ ============
Liabilities:
Other liabilities .............................................. $ 26,314 $ 25,092
------------ ------------
Stockholders' Equity:
Common stock ................................................... 18,845 12,564
Additional paid-in capital ..................................... 12,319,624 12,196,879
Retained earnings .............................................. 13,661,392 13,365,792
Treasury stock ................................................. (4,794,263) (3,731,017)
Unearned ESOP shares ........................................... (543,564) (650,614)
Deferred compensation - RRP shares ............................. (213,366) (329,748)
Net unrealized gain on available-for-sale securities, net of tax (64,974) 15,512
------------ ------------
Total stockholders' equity ................................. 20,383,694 20,879,368
------------ ------------
Total liabilities and stockholders' equity .......................... $ 20,410,008 $ 20,904,460
============ ============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
STATEMENT OF INCOME
Income:
Equity in earnings of Association .............................. $ 709,330 $ 1,012,661
Interest income ................................................ 53,730 61,546
------------ ------------
Total income ............................................... 763,060 1,074,207
------------ ------------
Expenses:
Management expenses paid to subsidiary ......................... 130,500 303,097
Franchise tax expense .......................................... 50,295 51,014
Professional fees .............................................. 43,843 42,867
Other .......................................................... 53,917 37,122
------------ ------------
278,555 434,100
Total expenses ............................................. _____________ _____________
Income before federal income taxes .................................. 484,505 640,107
Federal income taxes (benefit) ...................................... (76,441) (126,668)
------------ ------------
Net income .......................................................... $ 560,946 $ 766,775
============ ============
</TABLE>
60
<PAGE>
East Texas Financial Services, Inc. and Subsidiary
Notes to Consolidated Financial Statements
Note 28 - Condensed Parent Company Only Financial Statements, continued
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
STATEMENT OF CASH FLOWS Cash flows from operating activities:
Net income ............................................... $ 560,946 $ 766,775
Equity in earnings of the Association, net of dividends .. (709,330) 202,529
(Increase) decrease in prepaid expenses .................. 821 (1,236)
Increase in other liabilities ............................ 1,222 6,670
----------- -----------
Net cash provided (used) by operating activities ..... (146,341) 974,738
----------- -----------
Cash flows from investing activities:
ESOP loan repayment ...................................... 97,208 97,208
Increase in receivable from subsidiary ................... (39,200) (67)
----------- -----------
Net cash provided by investing activities ............ 58,008 97,141
----------- -----------
Cash flows from financing activities:
Net proceeds from issuance of common stock ............... 239,127 200,744
Purchase of treasury stock at cost ....................... (1,080,369) (951,116)
Sale of treasury stock for exercise of stock options ..... 14,771 14,761
Dividends paid ........................................... (256,713) (210,513)
----------- -----------
Net cash used by financing activities ................ (1,083,184) (946,124)
----------- -----------
Net increase (decrease) in cash and cash equivalents .......... (1,171,517) 125,755
Cash and cash equivalents at beginning of year ................ 2,146,805 2,021,050
----------- -----------
Cash and cash equivalents at end of year ...................... $ 975,288 $ 2,146,805
=========== ===========
Supplemental disclosure of cash flow information Cash paid for:
Income tax paid ...................................... $ 0 $ 415,820
Receivable from subsidiary for ESOP shares issued ........ 122,745 84,363
</TABLE>
61
<PAGE>
Corporate Directory
East Texas Financial Services, Inc.
Board of Directors*
Jack W. Flock Gerald W. Free Jim M. Vaughn, M.D.
Chairman of Vice Chairman, Retired Physician
the Board President and Chief Investments
Of Counsel to Executive Officer
Ramey & Flock, P. C.
L. Lee Kidd M. Earl Davis Charles R. Halstead
Oil and Gas Interests Vice President Geologist
Compliance and Oil and Gas Interests
Marketing of the
Association
James W. Fair H.H. Richardson, Jr.
Real Estate Investment President
Oil and Gas Interests H.H. Richardson, Jr.
Construction Company
Officers
Gerald W. Free Derrell W. Chapman ** Sandra J. Allen
Vice Chairman, Vice President and Corporate Secretary
President and Chief Chief Operating and
Executive Officer Chief Financial Officer
<PAGE>
First Federal Savings and Loan Association of Tyler
Officers
Gerald W. Free Derrell W. Chapman **
Vice Chairman, Vice President and
President and Chief Chief Operating and
Executive Officer Chief Financial Officer
William L. Wilson M. Earl Davis
Treasurer and Vice President
Controller Compliance and
Marketing
Joe C. Hobson Sandra J. Allen
Sr. Vice President Corporate Secretary
Mortgage Lending
Elizabeth G. Taylor Marcia R. Shelton
Vice President and Assistant Secretary
Loan Officer and Loan Office
Earlene Cool
Assistant Treasurer
* Directors of the Company also serve as directors of the Association
** Advisory Director
62
<PAGE>
Shareholder
R e f e r e n c e
Executive Offices
1200 South Beckham Avenue
Tyler, Texas 75701
SEC Counsel
Silver, Freedman and Taff, L.L.P.
1100 New York Avenue, N.W.
Washington, D.C. 20005-3934
Transfer Agent
Registrar and Transfer Company
10 Commerce Drive
Cranford, N.J. 07016
Independent Auditors
Bryant and Welborn, L.L.P.
601 Chase Drive
Tyler, Texas 75701
Investor Relations
Shareholders, analysts and others seeking information
about East Texas Financial Services, Inc., are invited to contact:
Gerald W. Free, Vice Chairman, President and CEO
or
Derrell W. Chapman, Vice President and COO, CFO
at (903) 593-1767
(903) 593-1094 (Fax)
Copies of the Company's earnings releases and other
financial publications, including the annual report on
Form 10-KSB filed with the Securities and
Exchange Commission, are available
without cost upon request.
Annual Meeting of Shareholders
January 20, 1999, at 2:00 p.m.
Company Offices
1200 South Beckham Avenue
Tyler, Texas
63
EXHIBIT 21
Subsidiaries of the Registrant
<PAGE>
<TABLE>
<CAPTION>
SUBSIDIARIES OF THE REGISTRANT
Ownership Percentage State of
Parent Subsidiary of Organization Incorporation
------ ---------- --------------- -------------
<S> <C> <C> <C>
East Texas Financial First Federal Savings 100% United States
Services, Inc. and Loan Association
of Tyler
</TABLE>
The financial statements of the Registrant are consolidated with its subsidiary.
EXHIBIT 23
Consent of Expert
<PAGE>
Board of Directors
East Texas Financial Services, Inc.
1200 S. Beckham
Tyler, Texas 75701
Members of the Board:
We consent to the incorporation by reference in this Registration
Statement on Form S-8 of East Texas Financial Services, Inc. (the "Company") of
our report on the financial statements included in the Company's Annual Report
on Form 10-KSB for the year ended September 30, 1998, filed pursuant to the
Securities Exchange Act of 1934, as amended.
/s/ Bryant & Welborn L.L.P.
---------------------------
Bryant & Welborn L.L.P.
Tyler, Texas
December 21, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF EAST TEXAS FINANCIAL SERVICES, INC., AT
SEPTEMBER 30, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-END> SEP-30-1998
<CASH> 592,363
<INT-BEARING-DEPOSITS> 3,064,312
<FED-FUNDS-SOLD> 129,187
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 12,810,165
<INVESTMENTS-CARRYING> 53,517,509
<INVESTMENTS-MARKET> 54,014,674
<LOANS> 61,352,227
<ALLOWANCE> 233,180
<TOTAL-ASSETS> 124,017,462
<DEPOSITS> 86,643,657
<SHORT-TERM> 13,150,000
<LIABILITIES-OTHER> 2,044,259
<LONG-TERM> 1,795,852
0
0
<COMMON> 18,845
<OTHER-SE> 20,364,849
<TOTAL-LIABILITIES-AND-EQUITY> 124,017,642
<INTEREST-LOAN> 4,770,636
<INTEREST-INVEST> 3,266,838
<INTEREST-OTHER> 226,256
<INTEREST-TOTAL> 8,263,730
<INTEREST-DEPOSIT> 4,425,979
<INTEREST-EXPENSE> 540,094
<INTEREST-INCOME-NET> 4,966,073
<LOAN-LOSSES> 0
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 63,535
<INCOME-PRETAX> 890,219
<INCOME-PRE-EXTRAORDINARY> 890,219
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 560,946
<EPS-PRIMARY> .39
<EPS-DILUTED> .38
<YIELD-ACTUAL> 2.00
<LOANS-NON> 228,000
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 488,000
<ALLOWANCE-OPEN> 273,000
<CHARGE-OFFS> 40,000
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 233,180
<ALLOWANCE-DOMESTIC> 52,000
<ALLOWANCE-FOREIGN> 00,000
<ALLOWANCE-UNALLOCATED> 181,000
</TABLE>
