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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1999
[ ] TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
Commission File No. 0-25704
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FIRST FEDERAL BANCORPORATION
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(Name of Small Business Issuer in Its Charter)
Minnesota 41-1796238
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
214 5th Street, Bemidji, Minnesota 56601
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (218) 751-5120
Securities registered pursuant to Section 12(b) of the Act:
Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Common stock, par value $.01 per share
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(Title of Class)
Check whether the issuer(1) has filed all reports required by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for past 90 days.
Yes X No
---- ____
Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B
is not contained in this form, 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 issuer's revenues for its most recent fiscal year: $9.32 million.
As of December 10, 1999, the aggregate market value of the 642,564 shares of
Common Stock of the registrant issued and outstanding held by non-affiliates on
such date was approximately $4,979,871 based on the closing sale price of $7.75
per share of the registrant's Common Stock on December 10, 1999 as listed on the
National Association of Securities Dealers Automated Quotation SmallCap Market.
For purposes of this calculation, it is assumed that the 780,705 shares held by
directors, officers, the Employee Stock Ownership Plan (unallocated shares
only), the Stock Ownership Plan and Management Recognition Plan Trusts, and
beneficial owners of more than 10% of the registrant's outstanding voting stock,
are shares held by affiliates.
Number of shares of Common Stock outstanding as of December 10, 1999: 1,423,269.
DOCUMENTS INCORPORATED BY REFERENCE
The following lists the documents incorporated by reference and the Part
of the Form 10-KSB into which the document is incorporated:
1. Portions of the Annual Report to Stockholders for the fiscal year
ended September 30, 1999. (Parts I and II)
2. Portions of Proxy Statement for 2000 Annual Meeting of Stockholders.
(Part III)
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PART I
Item 1. Business
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General
First Federal Bancorporation. First Federal Bancorporation (the "Company")
was incorporated under the laws of the State of Minnesota in September 1994 at
the direction of the Board of Directors of First Federal Banking and Savings,
FSB ("First Federal" or the "Bank") for the purpose of serving as a savings and
loan holding company of the Bank upon the acquisition of all of the capital
stock issued by the Bank upon its conversion from the mutual to the stock form
of ownership (the "Conversion"). The Conversion was completed on April 3, 1995.
The Company's principal business is the business of the Bank. The Company has no
significant assets other than the outstanding capital stock of the Bank,
$281,000 of cash and cash equivalents, $2.10 million in securities available for
sale, and $236,000 in other assets. At September 30, 1999, the Company had total
consolidated assets of $132.29 million, deposits of $88.11 million and
stockholders' equity of $13.06 million. Because substantially all of the
Company's operations consist of the operations of the Bank, this Form 10-KSB
largely is a discussion of the Bank's operations.
The Company's executive offices are located at 214 5th Street, Bemidji,
Minnesota 56601, and its main telephone number is (218) 751-5120.
First Federal Bank. First Federal was originally chartered in 1910 as
Beltrami County Savings and Building Association, a state-chartered savings
institution, and commenced operations in that same year. First Federal has been
a member of the Federal Home Loan Bank ("FHLB") of Des Moines since 1933, and
its deposits have been federally insured since 1938. In August 1997, the Bank
changed its name from "First Federal Banking and Savings, FSB" to its current
name; "First Federal Bank." First Federal currently operates as a federally
chartered savings bank through its main office located in Bemidji, Minnesota and
four branch offices, which are located in Bemidji, Bagley, Baudette and Walker,
Minnesota. The Bank's market area is located approximately 200 miles north of
Minneapolis, Minnesota. At September 30, 1999, First Federal had total assets of
$129.98 million, deposits of $88.29 million, mortgage-backed and related
securities and investment securities totaling $62.99 million and stockholders'
equity of $10.46 million.
First Federal is primarily engaged in the business of attracting deposits
from the general public and originating loans secured by first mortgages on
owner occupied one- to four-family residences in First Federal's market area.
First Federal also originates consumer loans, including automobile and home
improvement loans, as well as other consumer loans, loans on commercial real
estate and multi-family real estate, and commercial business loans. Due to
limited loan demand in its market area, First Federal has invested excess funds
in mortgage-backed and related securities and in other investment securities,
and during fiscal 1999 continued to be active in originating and purchasing
participation interests in commercial real estate loans. First Federal has also,
in recent years, increased its consumer lending activities in its local markets.
The Bank is subject to examination and comprehensive regulation by the
Office of Thrift Supervision ("OTS"), and the Bank's savings deposits are
insured up to applicable limits by the Savings Association Insurance Fund
("SAIF"), which is administered by the Federal Deposit Insurance Corporation
("FDIC"). The Bank is a member of, and owns capital stock in the Federal Home
Loan Bank ("FHLB") of Des Moines, which is one of 12 regional banks in the FHLB
System. The Bank is further subject to regulations of the Board of Governors of
the Federal Reserve System (the "Federal Reserve Board") governing reserves to
be maintained and certain other matters.
The Bank's executive offices are located at 214 5th Street, Bemidji,
Minnesota 56601, and its main telephone number is (218) 751-5120.
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Recent Regulatory and Legislative Changes
On November 12, 1999, the Gramm-Leach-Bliley Act was signed into law. The
Act calls for the modernization of the banking system and which could have a
far-reaching effect on the financial services industry and significantly affect
First Federal's operations. For additional information on the provisions of this
Act, see "Regulation -- Recently Enacted Legislation."
Market Area
First Federal serves the Bemidji, Minnesota marketplace, which is located
in northwestern Minnesota approximately 200 miles north of Minneapolis,
Minnesota. The primary market area of First Federal consists of the five
counties of Beltrami, Cass, Hubbard, Clearwater and Lake of the Woods in
Minnesota. These counties are served by the Bank's main office and branch office
located in Bemidji and three branch offices located in Bagley, Baudette and
Walker, Minnesota. These communities are the county seats and largest towns in
each of the counties where the branches are located. No branch office is located
in Hubbard County, but the northern border of Hubbard County is only four miles
from the Bank's main office. Bemidji is the largest community in the market
area, while the balance of the Bank's market area consists primarily of rural
areas and small towns. The primary market area also includes three Indian
reservations, a portion of which land is owned by the federal government in
trust for the Native Americans. This portion of the area is not open to mortgage
lending, therefore, an enforceable lien is not possible. The Bank does receive a
limited number of consumer loan applications from the area. In addition, the
Bank's primary market area also includes large tracts of land covered by water
and national and state forests and, thus, not available for home building.
In the Bank's most critical market, Beltrami County, median household
income of $28,200, based on estimates released February 1999, was 75.2% of the
median for the state of Minnesota and 72.5% of the United States at large.
National, state and local medians show modest household income growth, the
result of projected low inflation and continued modest economic growth.
The Bank's limited lending opportunities are primarily a function of
Bemidji's economy, which exhibits moderate growth. For the period from 1990 to
1998, the population of the Bank's market area increased 13.75%, as compared to
an increase of 7.99% for the State of Minnesota, and an increase of 8.36% for
the United States as a whole. Lacking growth in local residential loan
originations, First Federal has been forced to turn toward out-of-area real
estate lending, multi-family and commercial real estate lending, and to
investment in mortgage-backed and other securities. Such "out-of-area" real
estate lending constituted 8.78% of the Bank's gross loan portfolio at September
30, 1999 while loans on multi-family and commercial real estate constituted
21.16% of the Bank's gross loan portfolio at that date.
Lending Activities
General. First Federal's principal lending activity consists of the
origination of loans secured by first mortgages on owner occupied one- to four-
family residences in the Bank's market area, which consists of the Minnesota
Counties of Beltrami, Cass, Hubbard, Clearwater and Lake of the Woods. First
Federal serves these counties through its main office and a branch office
located in Bemidji and three branch offices located in Bagley, Baudette and
Walker, Minnesota. The largest concentration of First Federal's loans are within
a ten mile radius of the main office in Bemidji. To a lesser extent, First
Federal also originates loans secured by multi-family properties such as
apartment houses and commercial properties such as motels and retail
developments. In recent years, First Federal has become active in originating
consumer loans, including automobile loans and home equity and home improvement
loans. First Federal also makes a limited amount of commercial business loans.
First Federal attempts to manage interest rate risk by emphasizing the
origination of one-year adjustable-rate mortgage loans and short-term (15 years
or less) fixed-rate mortgage loans. Fixed-rate mortgage loans continue to be
offered by the Bank, but substantially all such loans in excess of 15 year terms
are sold in the secondary market. To date, such loan sale activities have not
been a significant contributor to the Bank's profitability. First Federal offers
a full range of mortgage products, including conventional adjustable-rate and
fixed-rate mortgage loans, short-term
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mortgages, and FHA and VA insured loans. First Federal has also participated in
the Minnesota Housing Finance Agency ("MHFA") housing program, and has
originated and purchased participation interests in multi-family and commercial
mortgage loans.
Loan Portfolio Composition. The following table sets forth selected data
relating to the composition of First Federal's loan portfolio by type of loan at
the dates indicated. At September 30, 1999, First Federal had no concentrations
of loans exceeding 10% of total loans other than as disclosed below.
<TABLE>
<CAPTION>
At September 30,
------------------------------------------
1999 1998
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Amount % Amount %
-------- ------ ---------- -------
(Dollars in thousands)
Type of Loan:
- ------------
<S> <C> <C> <C> <C>
Real estate loans --
Construction loans...................... $ 1,130 1.94% $ 2,115 3.67%
One- to four-family residential......... 26,432 45.28 26,981 46.77
Multi-family residential................ 3,232 5.54 2,939 5.10
Commercial.............................. 9,117 15.62 10,411 18.05
Consumer loans --
Automobiles............................. 7,757 13.29 5,199 9.01
Mobile home loans....................... 367 0.63 458 0.79
Savings account loans................... 467 0.80 415 0.72
Home improvement loans.................. 1,978 3.39 1,939 3.36
Home equity lines of credit............. 277 0.47 513 0.89
Other consumer loans.................... 6,678 11.44 5,273 9.14
Commercial business loans................ 936 1.60 1,441 2.50
------- ------ ------- ------
$58,371 100.00% $57,684 100.00%
======= ====== ======= ======
Less:
Loans in process........................ 631 1,222
Deferred fees and discounts (premiums).. (72) (100)
Allowance for loan losses............... 555 498
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Total.................................. $57,257 $56,064
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</TABLE>
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Loan Maturity. The following table sets forth certain information at
September 30, 1999, regarding the dollar amount of loans maturing in the Bank's
portfolio based on their contractual terms to maturity. Loans having no stated
schedule of repayments and no stated maturity, and overdrafts are reported as
due in one year or less. Scheduled contractual principal repayments of loans do
not necessarily reflect the actual life of such assets. The average life of
long-term loans is substantially less than their contractual terms, due to
prepayments. The average life of mortgage loans tends to increase when current
mortgage loan market rates are substantially higher than rates on existing
mortgage loans and tends to decrease when current mortgage loan market rates are
substantially lower than rates on existing mortgage loans.
<TABLE>
<CAPTION>
Due after Due
Due in the year ending 1 through 5 years after 5 years
9/30/00 after 9/30/99 after 9/30/99 Total
---------------------- ------------------ ----------------- -------
<S> <C> <C> <C> <C>
Real estate mortgage...... $ 1,223 $ 7,876 $29,682 $38,781
Real estate construction.. 1,048 82 0 1,130
Consumer.................. 1,832 10,517 5,175 17,524
Commercial................ 336 565 35 936
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Total................ $ 4,439 $19,040 $34,892 $58,371
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</TABLE>
Loan Repricing. The following table sets forth at September 30, 1999, the
dollar amount of all loans due one year after September 30, 1999 which have
predetermined interest rates and have floating or adjustable interest rates.
Predetermined Floating or
Rate Adjustable Rates
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(In thousands)
Real estate mortgage...... $12,095 $25,463
Real estate construction.. 0 82
Consumer.................. 6,927 8,765
Commercial................ 403 197
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$19,425 $34,507
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Loan Originations, Purchases and Sales. The following table sets forth
certain information with respect to First Federal's loan originations during the
periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------
1999 1998
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(In thousands)
<S> <C> <C>
Loans originated:
Real estate loans:
Construction loans........................... $ 823 $ 653
One- to four-family residential.............. 5,925 6,943
Multi-family residential..................... 665 --
Commercial................................... -- 341
Consumer loans................................ 12,269 8,453
Commercial business........................... 142 225
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$19,824 $16,615
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Loans purchased:
Real estate loans:
One-to-four-family residential............... $ 609 $ 1,728
Multi-family residential..................... 2,189 1,675
Commercial................................... 764 2,296
Commercial business........................... 387 750
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Total loans purchased....................... $ 3,958 $ 6,449
======= =======
Loans sold:
Whole loans................................... $ 707 $ 475
Participation loans........................... -- --
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Total loans sold............................ $ 707 $ 475
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</TABLE>
First Federal's primary lending activity has been the origination of
residential and commercial mortgages as well as consumer loans (including
automobile and home equity loans) for its loan portfolio. The Bank has
aggressively pursued mortgages in its market area in recent years but has been
constrained in building its portfolio by a combination of lack of economic
growth in the Bemidji area and prepayments, which generally equaled or exceeded
loan originations. First Federal sells substantially all long-term, fixed-rate
mortgage loans it originates in the secondary market. For the five years ended
September 30, 1999, 63 fixed-rate mortgage loans, secured by single-family homes
totaling $3.93 million were sold in the secondary market, with servicing rights
released.
Due to limited demand for one- to four-family residential real estate loans
in its market area, First Federal has also purchased participation interests in
multi-family and commercial mortgage loans in recent years. Specifically, during
the last five years, First Federal purchased participation interests in 67
commercial real estate and multi-family residential real estate loans originated
by other lenders totaling $16.27 million, 23 of these loans totaling $3.79
million were participation interests in commercial real estate loans on
properties outside the Bank's primary market area, with a total loan balance at
September 30, 1999 of $2.22 million. Of the 34 participation interests in
commercial real estate loans, five loans totaling $764,000 were purchased during
the year ended September 30, 1999. See "Commercial and Multi-Family Real Estate
Lending." First Federal has not sold any whole or participation interests in
commercial real estate or multi-family loans within the past five years.
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One- to Four-Family Residential Lending. The Bank historically has been
and continues to be an originator of owner occupied, one- to four-family
residential properties located in its market area. At September 30, 1999,
approximately $26.43 million or 45.28% of the Bank's loan portfolio consisted of
loans secured by one- to four-family residential properties.
First Federal began originating adjustable-rate residential mortgage loans
in 1980. Since that time, substantially all one- to four-family mortgage loans
originated by the Bank for retention in the Bank's portfolio have been
adjustable-rate loans which provide for annual interest rate adjustments, and
have terms to maturity of from 15 to 30 years. While the Bank does offer
"teaser" or reduced interest rates for the initial one-year adjustment period,
all borrowers are qualified at the fully-indexed interest rate. After the
initial one-year period, the rate adjustments on the Bank's adjustable-rate
loans are indexed to the rate paid on one-year U.S. Treasury Bills. The
interest rates on these mortgages include limitations on adjustments of two
percentage points per adjustment period, and a lifetime cap of six percentage
points.
At September 30, 1999, the Bank's loan portfolio included $14.34 million in
adjustable-rate one- to four-family residential mortgage loans, or 24.57% of the
Bank's loan portfolio.
The retention of adjustable-rate loans in First Federal's portfolio
mitigates First Federal's exposure to increases in market interest rates.
However, there are unquantifiable credit risks resulting from potential
increases in costs to borrowers in the event of upward repricing of adjustable-
rate loans. It is possible that during periods of rising interest rates, the
risk of default on adjustable-rate loans may increase due to increases in
interest costs to borrowers. Further, although adjustable-rate loans allow
First Federal to increase the sensitivity of its interest-earning assets to
changes in interest rates, the extent of this interest sensitivity is limited by
the repricing frequency and the periodic and lifetime interest rate adjustment
limitations. Accordingly, there can be no assurance that yields on First
Federal's adjustable-rate loans will fully adjust to compensate for increases in
First Federal's cost of funds. Finally, adjustable-rate loans increase First
Federal's exposure to decreases in market interest rates, although decreases in
First Federal's cost of funds tend to offset this effect.
In general, First Federal originates residential mortgage loans with loan-
to-value ratios of up to 95%, with private mortgage insurance required for loans
with loan-to-value ratios greater than 80%. The Bank also originates FHA and VA
loans and participates in the MHFA housing programs. The majority of these
loans are long-term, fixed-rate loans, which are primarily originated for sale
in the secondary market or sold to the MHFA.
Construction and Land Lending. First Federal offers construction loans to
qualified borrowers for construction of one- to four-family residences in First
Federal's market area. Typically, First Federal limits its construction lending
to single-settlement, construction-permanent loans to individuals building their
primary residences and second homes or vacation homes. These loans generally
have adjustable interest rates and are underwritten in accordance with the same
standards as First Federal's mortgages on existing properties, except the loans
generally provide for disbursement in stages during a construction period of up
to twelve months, during which period the borrower is required to make monthly
payments of accrued interest on the outstanding loan balance. Construction
loans generally have a maximum loan-to-value ratio of 80%. Borrowers must
satisfy all credit requirements which would apply to First Federal's permanent
mortgage loan financing for the subject property.
Construction lending is considered to involve a higher degree of risk of
loss than long-term financing on improved, occupied real estate. Risk of loss
on a construction loan is dependent largely upon the accuracy of the initial
estimate of the property's value at completion of development or construction
and the estimated cost (including interest) thereof. During the construction
phase, a number of factors could result in delays and cost overruns. If the
estimate of construction costs proves to be inaccurate, First Federal may be
required to advance funds beyond the amount originally committed to permit
completion of the project. If the estimate of value proves to be inaccurate,
First Federal may be confronted, at or prior to the maturity of the loan, with a
project having a value which is insufficient to assure full repayment. The
ability of a developer to sell developed lots or a builder to sell completed
dwelling units will depend on, among other things, demand, pricing, availability
of comparable properties and economic conditions. First Federal
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has sought to minimize this risk by limiting construction lending to qualified
borrowers in First Federal's market area and by limiting the aggregate amounts
of outstanding construction loans.
Commercial and Multi-Family Real Estate Lending. The Bank is active in the
origination and purchase of commercial and multi-family real estate loans, in
part due to limited residential lending opportunities in the Bank's market area.
The Bank's primary emphasis in its commercial and multi-family real estate
lending has been loans on motel properties which totaled $2.17 million, or
3.72%, of gross loans at September 30, 1999, and loans on apartment houses,
which constituted $3.23 million, or 5.54%, of gross loans at September 30, 1999.
Commercial real estate loans (including motel loans) totaled $9.12 million, or
15.62%, of gross loans at September 30, 1999, a decrease of 12.43% from the
balance of $10.41 million at September 30, 1998. Mortgages secured by multi-
family real estate (including apartment houses) had a balance of $3.23 million
at September 30, 1999, compared to $2.94 million at the same date in 1998.
As discussed above, in recent years, the Bank has become more active in the
origination and purchase of multi-family and commercial real estate lending.
During the year ended September 30, 1999, the Bank did not originate any
commercial real estate loans, but purchased participation interests in five
loans secured by commercial real estate projects or properties, in amounts
ranging from $60,000 to $497,000 and totaling $764,000. These loans are secured
by four motels and one manufacturing company. Four of these projects are located
in Colorado and one is located in Wisconsin. The lead lenders on each of these
loans are institutions with whom the Bank is familiar, and has done business in
the past. While the Bank believes that in purchasing these participation
interests, it has taken the appropriate steps consistent with lending policies
and procedures it uses in originating loans, there are significant additional
risks attendant to loan purchases, and to this type of lending.
At September 30, 1999, the Bank's portfolio includes both originated
mortgages and purchased loan participations on commercial and multi-family
properties generally located in the State of Minnesota. On both participations
and on loan originations, the Bank lends based on a project's cash flow and
ability to meet debt service requirements. Each property is appraised by a
Board of Directors-approved appraiser. Credit verification on the borrower is
obtained and personal guarantees are generally required of all borrowers.
Annual financial statements or tax returns are required on the securing
property.
As of September 30, 1999, the Bank's largest loan was for $675,000 and was
one of eight loans secured by motels, four of which are located in either the
western suburbs of Minneapolis or in Bemidji, Minnesota. The other four motel
loans are secured by properties in North Dakota, South Dakota, Colorado and
Iowa. The other seven loans secured by motels had outstanding balances ranging
from $35,000 to $634,000 at September 30, 1999. The Bank has several loans in
the $300,000 to $500,000 range secured by an assortment of properties, which are
described above.
As noted above, included in the Bank's $9.12 million in commercial real
estate loans at September 30, 1999 were eight loans on motel properties, with
balances outstanding totaling $2.17 million at September 30, 1999. The higher
loan amounts and dependence on income and cash flow of the property to cover
operating expenses and debt service means these loans involve significantly more
credit risk than loans on one- to four-family properties. While the Bank has
not in recent years experienced losses from its loans secured by motel
properties or other commercial real estate, such losses are possible, and if
incurred, could have a significant effect on the Bank's net income and capital
position. All of the Bank's loans secured by multi-family and commercial real
estate are performing within their terms except one in the amount of $290,000.
Commercial and multi-family real estate lending entails significant
additional risks compared with one- to four-family residential lending. For
example, commercial and multi-family real estate loans typically involve large
loan balances to single borrowers or groups of related borrowers, the payment
experience on such loans typically is dependent on the successful operation of
the real estate project, and these risks can be significantly impacted by supply
and demand conditions in the market for multi-family residential units and
commercial office, retail and warehouse space, and for motel loans, tourism and
general economic conditions. While the Bank has not experienced significant
losses from its multi-family residential and commercial real estate lending
activities in recent years, the higher loan
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balances on each of these loans means that if the Bank experiences problems with
any one of these loans, its net income and financial condition could be severely
impacted.
The aggregate amount of loans which federally chartered savings
institutions may make on the security of liens on commercial real estate may not
exceed 400% of the institution's capital; however, the limits on commercial real
estate lending do not require divestiture of any loan or investment that was
lawful when made. See "-- Loan Solicitation and Processing."
Consumer Lending. First Federal offers consumer loans as part of a broad
commitment to be a full-service consumer-oriented banking institution. Such
lending activities have increased in recent years as the Bank has used its
excess funds to increase its consumer loan origination activities. The consumer
loans originated by the Bank include automobile loans, savings account loans and
mobile home loans, as well as home equity loans and home improvement loans, and
unsecured consumer loans. At September 30, 1999, the Bank's consumer loan
balance totaled $17.52 million, or 30.02%, of its total loan portfolio. Of the
consumer loan balance at September 30, 1999, $7.76 million were automobile
loans, $277,000 were home equity lines of credit, $1.98 million were home
improvement loans, $367,000 were mobile home loans and $467,000 were savings
account loans. The Bank has more aggressively pursued consumer loans outside
its customer base but within the markets it serves.
In addition, included in the Bank's consumer loan portfolio at September
30, 1999 were $6.68 million in other consumer loans, which included: $5.63
million in home equity loans; $403,000 in loans secured by recreational vehicles
such as RVs, boats, motorcycles or snowmobiles; $203,000 in other secured loans;
$168,000 in unsecured overdraft protection; and $276,000 in unsecured loans.
The Bank's automobile loans are generally underwritten in amounts up to 90%
of the purchase price or the N.A.D.A. book value. The terms of the loan
generally do not exceed 60 months for new vehicles or 48 months for used
vehicles. The Bank requires that the vehicles be insured and the Bank be listed
as loss payee on the insurance policy.
The Bank's home equity lines of credit are made on the security of
residential real estate, do not exceed 80% of the estimated value of the
property, less the outstanding principal of the first mortgage, and have terms
of up to fifteen years. The Bank makes loans secured by savings accounts for up
to 90% of the depositor's savings account balance. The interest rate is
normally three percentage points above the rate paid on the savings account, and
the account must be pledged as collateral to secure the loan.
Consumer loans generally entail greater risk than do residential mortgage
loans, particularly in the case of consumer loans which are unsecured or secured
by rapidly depreciable assets, such as automobiles. Consumer loans are
generally priced relative to the Bank's assessment of the risk associated with
the loan. Virtually all consumer loans in the Bank's portfolio are either
adjustable-rate or of short or intermediate term. Adjustable-rate consumer
loans are priced off the prime rate and increments are added based on risk
assessment as determined by the Bank's senior lending and executive officers.
Commercial Business Lending. The Bank maintains in portfolio a small
amount of commercial business loans as an additional service to its already
existing banking relationships. At September 30, 1999, these loans amounted to
$936,000, or 1.60%, of gross loans. These loans are for a variety of commercial
purposes and are secured by inventories, receivables and other business assets
from companies in the Bemidji area, including retail establishments and
restaurants. The Bank underwrites commercial business loans based on the
financial condition of the business and the creditworthiness of the borrower.
The Bank seeks personal guarantees whenever possible and, as appropriate, will
cross-collateralize business loans with other assets tied to the business.
Commercial business loans generally involve more credit risk than first
mortgage loans. Repossessed collateral for a defaulted loan may not provide an
adequate source of repayment of the outstanding credit obligation as a result of
damage, loss or depreciation. In such circumstances, the remaining deficiency
often does not warrant further substantial collection efforts against the
obligor. In addition, collections are dependent on the obligor's continuing
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financial stability, and thus are more likely to be adversely affected by job
loss, divorce, illness or personal bankruptcy. Further, the application of
various federal and state laws, including federal and state bankruptcy and
insolvency laws, may limit the amount which can be recovered. These financings
may also give rise to claims and defenses by an obligor against First Federal,
and an obligor may be able to assert against First Federal claims and defenses
which it has against the seller of the underlying collateral. First Federal's
risks associated with commercial loans have been minimized by the immaterial
amount of such loans made by First Federal.
Loan Solicitation and Processing. First Federal's loan originations are
derived from a number of sources, including promotional activity, real estate
brokers, walk-in customers and current customers of the Bank. Construction
loans are often originated through existing customers.
The Bank's Loan Committee is responsible for review and approval of all
loans originated or purchased by the Bank. Loans in excess of $250,000 may be
approved by the Bank's President, but usually receive the pre-approval of a
committee consisting of four members of the Board of Directors or the entire
Board of Directors. The list of outside appraisers is approved annually by the
Board of Directors. All appraisers are fee appraisers and not members of the
Bank's staff.
Under the Bank's loan policy, the loan officer processing an application is
responsible for ensuring that all documentation is obtained prior to submission
of the application to the Loan Committee. In addition, the loan officer
verifies that the application meets the underwriting guidelines of the Bank.
All of the Bank's lending is subject to its written underwriting standards and
to loan origination procedures. Decisions on loan applications are made on the
basis of detailed applications and property valuations. The loan applications
are designed primarily to determine the borrower's ability to repay the loan.
More significant items on the application are verified through use of credit
reports, financial statements, tax returns and written confirmations.
Each individual loan officer is subject to a maximum lending authority
established by the Board of Directors. Loans in excess of an individual's
lending authority are submitted to an officer with sufficient lending authority,
or the Loan Committee for approval. After a loan is closed, it is assigned to a
reviewing officer who reviews the file to assure its accuracy and completeness.
The Bank generally relies on attorneys' opinions of title in its loan
processing. Title insurance is required on all mortgage loans closed for sale
in the secondary market. The Bank also requires title insurance for loans
secured by properties exhibiting unique title conditions which may involve
additional risk. The Bank requires fire and extended coverage casualty
insurance in amounts at least equal to the principal amount of the loan or the
value of improvements on the property, depending on the type of loan. The Bank
also requires flood insurance to protect the property securing its interest when
the property is located on a flood plain, although generally the Bank's primary
market area is not within a designated flood plain.
The Bank makes up to a 90-day loan commitment for each loan approved. If
the borrower desires a longer commitment, the commitment may be extended for
good cause and upon written approval. No fees are charged in connection with
the issuance of a commitment letter.
Under applicable law, with certain limited exceptions, loans and extensions
of credit by a savings institution to a person outstanding at one time shall not
exceed 15% of the institution's unimpaired capital and surplus. Loans and
extensions of credit fully secured by readily marketable collateral may comprise
an additional 10% of unimpaired capital and surplus. Applicable law
additionally authorizes savings institutions to make loans to one borrower, for
any purpose, in an amount not to exceed $500,000 or in an amount not to exceed
the lesser of $30,000,000 or 30% of unimpaired capital and surplus to develop
residential housing, provided (1) the purchase price of each single-family
dwelling in the development does not exceed $500,000, (2) the savings
institution is and continues to be in compliance with its capital requirements
as prescribed by OTS regulations, (3) the loans comply with applicable loan-to-
value requirements, (4) the aggregate amount of loans made under this authority
does not exceed 150% of unimpaired capital and surplus, and (5) the Director of
OTS, by order, permits the savings institution to avail itself of this higher
limit. Under these limits,
10
<PAGE>
the Bank's loans to one borrower were limited to $2.04 million at September 30,
1999. At that date, the Bank had no lending relationships in excess of the OTS's
loans-to-one-borrower limit. The Bank's five largest loans ranged from $497,000
to $675,000 at September 30, 1999. All of these loans were current as of
September 30, 1999.
Interest Rates and Loan Fees. Interest rates charged by First Federal on
mortgage loans are primarily determined by competitive loan rates offered in its
market area and First Federal's yield objectives. Mortgage loan rates reflect
factors such as prevailing market interest rate levels, the supply of money
available to the savings industry and the demand for such loans. These factors
are in turn affected by general economic conditions, the monetary and fiscal
policies of the federal government, including the Federal Reserve Board, the
general supply of money in the economy, tax policies and governmental budget
matters.
First Federal receives fees in connection with loan modifications, late
payments and for miscellaneous services related to its loans. Such loan fees
have not been significant in recent years.
Asset Classification, Allowances for Losses and Non-Performing Assets.
Federal regulations require savings institutions to classify their assets on the
basis of quality on a regular basis. An asset is classified as substandard if
it is determined to be inadequately protected by the current net worth and
paying capacity of the obligor or of the collateral pledged, if any. An asset
is classified as doubtful if full collection is highly questionable or
improbable. An asset is classified as loss if it is considered uncollectible,
even if a partial recovery could be expected in the future. The regulations
also provide for a special mention designation, described as assets which do not
currently expose a savings institution to a sufficient degree of risk to warrant
classification, but do possess credit deficiencies or potential weaknesses
deserving management's close attention. Assets classified as substandard or
doubtful require a savings institution to establish general allowances for loan
losses. If an asset or portion thereof is classified loss, a savings
institution must either establish a specific allowance for loss in the amount of
the portion of the asset classified loss, or charge off such amount. Federal
examiners may disagree with a savings institution's classifications. If a
savings institution does not agree with an examiner's classification of an
asset, it may appeal this determination to the OTS Regional Director. First
Federal regularly reviews its assets to determine whether any assets require
classification or reclassification. The Board of Directors reviews and approves
all classifications. At September 30, 1999, First Federal had no assets
classified as loss, $4,000 of assets classified as doubtful and $1.21 million of
assets classified as substandard. At September 30, 1999, there were none
designated as special mention.
Management will continue to actively monitor First Federal's asset quality
and will establish loan loss reserves and will charge off loans and properties
acquired in settlement of loans against the allowances for losses on such loans
and such properties when appropriate and will provide specific loss allowances
when necessary. Although management believes it uses the best information
available to make determinations with respect to the allowances for losses,
future adjustments may be necessary if economic conditions differ substantially
from the economic conditions in the assumptions used in making the initial
determinations.
The Bank's allowance for loan losses is established through a provision for
loan losses charged to earnings based on management's evaluation of the risk
inherent in it's entire loan portfolio and changes in the nature and volume of
its loan activity. Such evaluation, which includes a review of all loans of
which full collectibility may not be reasonably assured, considers specific
occurrences, general and local economic conditions, loan portfolio composition,
historical and local experience and other factors that warrant recognition in
providing for an adequate allowance for loan losses. In determining the general
reserves under these policies, historical charge-offs and recoveries, changes in
the mix and levels of the various types of loans, net realizable values, the
current loan portfolio and current economic conditions are considered. The
Bank's Asset Classification Policy establishes rates for establishing a general
valuation allowance on risk assets. Each risk asset receives a percentage of
asset rate, which is then the multiplier used in determining the required
reserve for that specific asset in the composition of the general valuation
reserve. These reserve rates vary from 0.05% to 2.00% in establishing the
amount of reserve necessary for unclassified assets. Special mention assets
have a reserve rate of 2.00%. Substandard assets have a 15.0% reserve rate,
while doubtful assets currently have a 50.00% reserve rate. The Bank may also
require additional or specific reserves for certain classified assets.
11
<PAGE>
The above reserve rates establish a minimum general valuation allowance.
As of September 30, 1999, the Bank maintained a general valuation allowance that
the reserve rates dictated. Reserves determined by using the reserve rating
system were $512,000. The general valuation allowance on September 30, 1999,
was in the amount of $512,000. The increase in the provision for losses on
loans relates primarily to an increase in non-performing assets. At September
30, 1999 the Bank had a $43,500 specific reserve established on a commercial
real estate loan.
Real estate acquired as a result of foreclosure or by deed-in-lieu of
foreclosure is classified as real estate in-judgment for the six months or one
year redemption period, and thereafter, as real estate owned until sold. When
property is acquired through the foreclosure process, it is recorded at the
lower of cost or estimated fair value, less the estimated cost of disposition.
After acquisition, all costs incurred in maintaining the property are expensed.
Costs relating to improvement of the property, however, are capitalized to the
extent of fair value, less estimated costs of disposition.
The following table sets forth an analysis of First Federal's allowance for
loan losses for the periods indicated.
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------
1999 1998
------------ ------------
(Dollars in thousands)
<S> <C> <C>
Balance at beginning of period......... $ 498 $ 427
----- -----
Loans charged-off:
Real estate -- mortgages:
Residential........................ (9) --
Commercial......................... -- --
Real estate -- construction.......... -- --
Commercial business.................. -- --
Consumer............................. (43) (109)
----- -----
Total charge-offs...................... (52) (109)
----- -----
Recoveries:
Real estate -- mortgages:
Residential........................ -- --
Commercial......................... -- --
Real estate -- construction.......... -- --
Commercial business.................. -- --
Consumer............................. 11 27
----- -----
Total recoveries....................... 11 27
----- -----
Net loans charged-off.................. (41) (82)
----- -----
Provision for loan losses.............. 98 153
----- -----
Balance at end of period............... $ 555 $ 498
===== =====
Ratio of net charge-offs to average
loans outstanding during the period.. 0.07% 0.15%
===== =====
</TABLE>
12
<PAGE>
The following table allocates the allowance for loan losses by loan
category at the dates indicated. The allocation of the allowance to each
category is not necessarily indicative of future losses and does not restrict
the use of the allowance to absorb losses in any category.
<TABLE>
<CAPTION>
September 30,
------------------------------------------
1999 1998
-------------------- ---------------------
Percent of Percent of
Loans in Loans in
Category to Category to
Amount Total Loans Amount Total Loans
------ ------------ ------ ------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Real estate - mortgage:
Residential........................ $ 91 50.82% $ 123 51.87%
Commercial......................... 191 15.62 132 18.05
Real estate - construction........... 20 1.94 34 3.67
Commercial business.................. 8 1.60 8 2.50
Consumer............................. 245 30.02 201 23.91
---- ------ ----- ------
Total allowance for loan losses.. $555 100.00% $ 498 100.00%
==== ====== ===== ======
</TABLE>
While management believes First Federal has established its existing loss
allowances in accordance with generally accepted accounting principles, there
can be no assurance that regulators, in reviewing First Federal's assets, will
not make First Federal increase its loss allowance, thereby negatively affecting
First Federal's reported financial condition and results of operations.
The following table sets forth information with respect to First Federal's
non-performing assets at the dates indicated.
<TABLE>
<CAPTION>
September 30,
----------------------
1999 1998
----- ----
(Dollars in thousands)
<S> <C> <C>
Loans accounted for on a non-accrual basis: (1)
Real estate:
Residential.................................................. $ 71 $ 154
Commercial................................................... 246 --
Commercial business............................................. -- --
Consumer........................................................ -- --
----- -----
Total...................................................... $ 317 $ 154
===== =====
Accruing loans which are contractually past due 90 days or more:
Real Estate:
Residential.................................................. $ -- $ 3
Commercial................................................... -- 283
Commercial business............................................. -- --
Consumer........................................................ 79 78
----- -----
Total...................................................... $ 79 $ 364
===== =====
Total of non-accrual and 90 days past due loans............ $ 396 $ 518
===== =====
Percentage of total loans......................................... 0.68% 0.90%
===== =====
Other non-performing assets (2)................................... $ 188 $ 152
===== =====
</TABLE>
______________
(1) Non-accrual status denotes loans on which, in the opinion of management,
the collection of additional interest is unlikely. Payments received on a
non-accrual loan are either applied to the outstanding principal balance or
recorded as interest income, depending on assessment of the collectibility
of the loan. Generally, loans contractually past due 90 days or more are
placed on non-accrual except for loans insured for credit loss.
(2) Other non-performing assets represents property acquired by First Federal
through foreclosure or repossession or accounted for as a foreclosure in-
substance. These properties are carried at the lower of fair market value,
less estimated costs of disposition, or the principal balance of the
related loan, whichever is lower.
13
<PAGE>
At September 30, 1999, First Federal's non-performing assets included six
residential mortgage loans, with balances outstanding ranging from $18,000 to
$71,000, one commercial real estate loan, with a balance outstanding of
$246,000, and consumer loans (secured primarily by automobiles) with balances
outstanding ranging from $500 to $25,000.
The one commercial real estate loan accounted for on a non-accrual basis is
a gaming establishment located in Colorado. The outstanding balance of the
Bank's participation interest is $290,000. The Bank has established a specific
reserve against this loan in the amount of $43,500, resulting in a book value of
$246,500.
At September 30, 1999, the Bank had no loans which were not currently
classified as non-accrual, 90 days past due or restructured but where known
information about possible credit problems of borrowers causes management to
have serious concerns as to the ability of the borrowers to comply with present
loan repayment terms.
Investment Activities
General. First Federal is permitted under federal law to make certain
investments, including investments in securities issued by various federal
agencies and state and municipal governments, deposits at the FHLB of Des
Moines, certificates of deposits in federally insured institutions, certain
bankers' acceptances and federal funds. First Federal may also invest, subject
to certain limitations, in commercial paper having one of the four highest
investment ratings of a nationally recognized credit rating agency, and certain
other types of corporate debt securities and mutual funds. Federal regulations
require First Federal to maintain an investment in FHLB of Des Moines stock and
a minimum amount of liquid assets which may be invested in cash and specified
securities. The Bank is also permitted to invest in related securities. From
time to time, the OTS adjusts the percentage of liquid assets which savings
associations are required to maintain. For additional information, see
"Regulation -- Regulation of the Bank -- Liquidity Requirements."
First Federal makes investments in order to diversify its assets, manage
cash flow, obtain yields and maintain the minimum levels of liquid assets
required by regulatory authorities. Under the Bank's current investment policy,
the amount invested with any one issuer may not exceed the lesser of $500,000 or
the net worth of the issuing corporation, except for U.S. Treasury and U.S.
Government Agency Securities and mutual fund investments. The Board of
Directors reviews all securities purchased on a monthly basis.
The investment activities of the Bank consist primarily of investments in
mortgage-backed and related securities and other investment securities,
consisting primarily of securities issued or guaranteed by the United States
Government or agencies thereof. Typical investments include federally sponsored
agency mortgage pass-throughs, and federally sponsored agency and related
securities. Investment and aggregate investment limitations and credit quality
parameters of each class of investment are prescribed in the Bank's investment
policy. The Bank performs analyses on related securities prior to purchase and
on an ongoing basis to determine the impact on earnings and market value under
various interest rate and prepayment conditions. First Federal also invests in
mortgage-related products, which include collateralized mortgage obligations
("CMOs") and real estate mortgage investment conduits ("REMICs"). The CMOs and
REMICs purchased by the Bank comply fully with regulatory requirements
concerning this type of investment. Both the REMICs and CMOs owned by the Bank
are of short- or intermediate-term targeted amortization class securities rated
AA or better.
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
115, the Bank categorizes the securities it purchases as "Trading Securities,"
"Available for Sale Securities" and "Held to Maturity Securities." Securities
that are categorized as "Held to Maturity" are securities that the Bank has the
ability and intent to hold to maturity. Upon acquisition, securities are
classified as to the Bank's intent. Securities "Held to Maturity" are held for
investment purposes and are carried at amortized cost. Securities categorized
as "Available for Sale" are securities that the Bank may not hold to maturity
and thus are carried at aggregate market value with unrealized gains and losses,
net of taxes, recognized in stockholders' equity.
14
<PAGE>
As of September 30, 1999, in accordance with SFAS No. 115, the Company
classified $16.07 million of its investment securities and $15.20 million of its
mortgage-backed and related securities as "Available for Sale". Such
classification gives the Company the ability to sell these securities. At
September 30, 1999 the Company classified $33.57 million of investment
securities and $234,000 of its mortgage-backed and related securities as "held
to maturity." The Company has no "Trading Securities."
Investment Securities. The following table sets forth the carrying value
of the Company's investment securities portfolio, other than mortgage-backed
securities, at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
----------------
1999 1998
------- -------
(In thousands)
<S> <C> <C>
Investment securities:
U.S. government and agency securities.. $43,036 $36,402
Corporate bonds and notes.............. 5,142 4,815
Municipal obligations.................. 505 515
Mutual funds and equity stock.......... 962 993
------- -------
Total investment securities......... $49,645 $42,725
======= =======
</TABLE>
15
<PAGE>
The following table sets forth information regarding the scheduled
maturities, market value and weighted average yields for First Federal's
investments, other than mortgage-backed securities, at September 30, 1999.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years
------------------ ------------------ ------------------
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Investment Securities:
U.S. government and agency
securities (1)..................... $ 250 5.52% $ 915 6.57% $41,871 6.45%
Corporate bonds and notes............. 2,539 6.50 2,268 6.72 252 6.31
Municipal obligations (2)............. 250 6.11 -- -- -- --
------ ------ --------
Total............................... $3,039 6.39 $3,183 6.68 $42,123 6.45
====== ====== ========
Securities with no stated maturity:
Mutual funds and equity stock..........
Total investment securities..............
<CAPTION>
More than Ten Total Investment
Years Portfolio
------------------ ---------------------------
Carrying Average Carrying Market Average
Value Yield Value Value Yield
-------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C>
Investment Securities:
U.S. government and agency
securities (1)..................... $ -- --% $43,036 $41,402 6.45%
Corporate bonds and notes............. 83 7.45 5,142 5,142 6.61
Municipal obligations (2)............. 255 9.50 505 505 7.82
-------- ------- -------
Total............................... $338 8.99 $48,683 $47,049 6.48
======== ======= =======
Securities with no stated maturity:
Mutual funds and equity stock.......... $ 962 $ 962 5.86
------- -------
Total investment securities.............. $49,645 $48,011 6.47
======= =======
</TABLE>
_________
(1) Approximately $20 million of U.S. government and agency securities have
call features which give the option to prepay the debt in one year or less.
(2) Yield on tax exempt investments are not presented at the tax equivalent
yield.
16
<PAGE>
Mortgage-Backed Securities. Mortgage-backed securities represent a
participation interest in a pool of single-family or multi-family mortgages, the
principal and interest payments on which are passed from the mortgage
originators through intermediaries that pool and repackage the participation
interest in the form of securities to investors such as the Bank. Such
intermediaries may include quasi-governmental agencies such as Federal Home Loan
Mortgage Corporation ("FHLMC"), Federal National Mortgage Association ("FNMA")
and Government National Mortgage Association ("GNMA") which guarantee the
payment of principal and interest to investors. Mortgage-backed securities
generally increase the quality of the Bank's assets by virtue of the guarantees
that back them, are more liquid than individual mortgage loans and may be used
to collateralize borrowings or other obligations of the Bank.
Mortgage-backed securities typically are issued with stated principal
amounts and the securities are backed by pools of mortgages that have loans with
interest rates that are within a range and have similar maturities. The
underlying pool of mortgages can be composed of either fixed-rate mortgages or
adjustable rate mortgage ("ARM") loans. Mortgage-backed securities generally
are referred to as mortgage participation certificates or pass-through
certificates. As a result, the interest rate risk characteristics of the
underlying pool of mortgages, i.e., fixed-rate or adjustable-rate, as well as
prepayment risk, are passed on to the certificate holder. The life of a
mortgage-backed pass-through security is equal to the life of the underlying
mortgages.
The actual maturity of a mortgage-backed security varies, depending on when
the mortgagors prepay or repay the underlying mortgages. Prepayments of the
underlying mortgages may shorten the life of the investment, thereby adversely
affecting its yield to maturity and the related market value of the mortgage-
backed security. The yield is based upon the interest income and the
amortization of the premium or accretion of the discount related to the
mortgage-backed security. Premiums and discounts on mortgage-backed securities
are amortized or accreted over the estimated term of the securities using a
level yield method. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed security and these assumptions are reviewed
periodically to reflect the actual prepayment. The actual prepayment experience
of the underlying mortgages, the geographical location of the underlying real
estate collateralizing the mortgages and general levels of market interest
rates. The difference between the interest rates on the underlying mortgages
and the prevailing mortgage interest rates is an important determinant in the
rate of prepayments. During periods of falling mortgage interest rates,
prepayments generally increase. If the coupon rate of the underlying mortgage
significantly exceeds the prevailing market interest rates offered for mortgage
loans, refinancing generally increases and accelerates the prepayment of the
underlying mortgages. Prepayment experience is more difficult to estimate for
adjustable-rate mortgage-backed securities.
The Bank's mortgage-backed securities portfolio consists primarily of
seasoned fixed-rate and adjustable-rate mortgage-backed securities. At
September 30, 1999, the Bank had $9.73 million in mortgage-backed securities
(representing 99.29% of the Bank's gross mortgage-backed securities portfolio or
7.36% of total assets) insured or guaranteed by FNMA, FHLMC or GNMA. At
September 30, 1999, $69,000 (representing 0.71% of the Bank's gross mortgage-
backed securities portfolio, or 0.05% of total assets) consisted of privately
issued securities which are not guaranteed by FHLMC, FNMA, GNMA or any
governmental or quasi-governmental agency.
The Bank's mortgage-backed securities portfolio contains fixed-rate and
floating rate securities. Certain of the Bank's mortgage-backed securities
yield above-market rates of interest and are subject to prepayment. In a
declining interest rate environment, the Bank may experience prepayments of both
fixed-rate and adjustable-rate mortgage-backed and related securities. In a
rising interest rate environment, the prepayments may cease, market yields of
these securities may be less attractive, and the market value of the Bank's
mortgage-backed securities may decline.
17
<PAGE>
Mortgage-Related Securities. CMOs and REMICs are typically issued by a
special purpose entity, which may be organized in a variety of legal forms, such
as a trust, a corporation or a partnership. The entity aggregates pools of
mortgage loans or pass-through securities, which are used to collateralize the
related securities. Once combined, the cash flows can be divided into
"tranches" or "classes" of individual securities, thereby creating more
predictable average lives for each security than the underlying pass-through
pools. Accordingly, under this security structure all principal paydowns from
the various mortgage pools are allocated to a related securities' class or
classes structured to have priority until it has been paid off. These
securities generally have fixed interest rates, and as a result, changes in
interest rates generally would affect the market value and possibly the
prepayment rates of such securities.
Some related securities instruments are like traditional debt instruments
due to their stated principal amounts and traditionally defined interest rate
terms. Purchasers of certain other related securities instruments are entitled
to the excess, if any, of the issuer's cash inflows. These related securities
instruments may include instruments designated as residual interest and are
riskier in that they could result in the loss of a portion of the original
investment. Cash flows from residual interests are very sensitive to
prepayments and, thus, contain a high degree of interest rate risk.
At September 30, 1999, the Bank had $5.63 million in CMOs and REMICs or
4.26% of total assets. The Bank's CMOs and REMICs had a weighted average yield
of 6.33% at September 30, 1999. The Bank's current policy is to purchase CMOs
and REMICs rated AA or better at the time of purchase by nationally recognized
rating services or issued by U.S. government agencies. As of September 30,
1999, $69,000 of the securities in the Bank's mortgage-backed and related
securities portfolio were privately issued securities, $69,000 were rated as
AAA.
The following table sets forth the carrying value of the Bank's mortgage-
backed and related securities at the dates indicated.
<TABLE>
<CAPTION>
At September 30,
----------------
1999 1998
------- -------
(In thousands)
<S> <C> <C>
GNMA................................. $ 860 $ 1,061
FNMA................................. 4,450 3,224
FHLMC................................ 4,422 3,909
FHA.................................. 69 90
Collateralized mortgage obligations.. 5,634 9,124
------- -------
Total........................... $15,435 $17,408
======= =======
</TABLE>
18
<PAGE>
The following table sets forth the scheduled maturities, carrying values,
market values and average yields for the Bank's mortgage-backed and related
securities at September 30, 1999.
<TABLE>
<CAPTION>
One Year or Less One to Five Years Five to Ten Years
----------------------- ----------------------- -----------------------
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
GNMA....................... $ -- --% $ -- --% $ 218 7.49%
FNMA....................... 64 6.18 543 6.11 1,165 6.61
FHLMC...................... 79 5.77 442 6.55 1,803 6.71
FHA........................ -- -- 69 10.39 -- --
Collateralized mortgage
obligations.............. -- -- 16 6.23 2,280 6.22
-------- -------- --------
Total................. $ 143 5.95 $ 1,070 6.57 $ 5,466 6.51
======== ======== ========
<CAPTION>
More than Ten Years Total Investment Portfolio
----------------------- -------------------------------------
Carrying Average Carrying Market Average
Value Yield Value Value Yield
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
GNMA....................... $ 642 6.63% $ 860 $ 861 6.87%
FNMA....................... 2,678 6.46 4,450 4,449 6.45
FHLMC...................... 2,098 6.59 4,422 4,423 6.62
FHA........................ -- -- 69 69 10.39
Collateralized mortgage
obligations.............. 3,338 6.40 5,634 5,631 6.33
-------- --------- --------
Total................. $ 8,756 6.48 $ 15,435 $ 15,433 6.50
======== ========= ========
</TABLE>
19
<PAGE>
Deposit Activity and Other Sources of Funds
General. Deposits are the primary source of First Federal's funds for
lending and other investment activities and general operational purposes. In
addition to deposits, First Federal derives funds from loan and mortgage-backed
and related securities principal repayments, maturities of investment securities
and interest payments. Loan repayments and interest payments are a relatively
stable source of funds, while deposit inflows and outflows are significantly
influenced by prevailing market interest rates and money market conditions.
Borrowings may be used to supplement First Federal's available funds. First
Federal has access to borrow from the FHLB of Des Moines and the Federal Reserve
Bank.
Deposits. First Federal attracts deposits principally from within its
market area by offering a variety of deposit instruments, including savings
accounts, money market accounts, retirement savings accounts and certificates of
deposit which range in term from three to 60 months. Deposit terms vary
principally on the basis of the minimum balance required, the length of time the
funds must remain on deposit and the interest rate. Maturities, terms, service
fees and withdrawal penalties for its deposit accounts are established by the
Bank on a periodic basis. The Bank reviews its deposit mix and pricing on an
ongoing basis. In determining the characteristics of its deposit accounts, the
Bank considers the rates offered by competing institutions, funds acquisition
and liquidity requirements, growth goals, and federal regulations. The Bank
does not accept brokered deposits.
The Bank competes for deposits, including individual retirement accounts
("IRA") and Keogh Plan funds, with other institutions in its market area by
offering deposit instruments that are competitively priced and by providing
customer service through convenient and attractive offices, knowledgeable and
efficient staff and hours of service that meet customers' needs. The Bank
generally does not use premiums to attract savings deposits.
20
<PAGE>
The following table sets forth the average balances and interest rates
based on daily balances for interest-bearing demand and savings deposits and
time deposits as of the dates indicated.
<TABLE>
<CAPTION>
September 30,
---------------------------------------------------------------------------------------------------------------
1999 1998
------------------------------------------------------ ------------------------------------------------------
Interest-Bearing Interest-Bearing Interest-Bearing Interest-Bearing Interest-Bearing Interest-Bearing
Demand Deposits Savings Deposits Time Deposits Demand Deposits Savings Deposits Time Deposits
---------------- ---------------- ---------------- ---------------- ---------------- ----------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Average Balance.. $ 23,397 $ 7,877 $ 55,757 $ 20,273 $ 7,899 $ 56,199
Average Rate..... 2.18% 1.67% 5.53% 2.16% 1.99% 5.79%
</TABLE>
21
<PAGE>
The following table indicates the amount of the certificates of deposit of
$100,000 or more in First Federal by time remaining until maturity at September
30, 1999.
<TABLE>
<CAPTION>
Certificates
Maturity Period of Deposits
--------------- -------------
(In thousands)
<S> <C>
Three months or less.................... $ 1,652
Over three through six months........... 2,092
Over six through 12 months.............. 2,914
Over 12 months.......................... 1,779
-------------
Total................................. $ 8,437
=============
</TABLE>
Borrowings. Savings deposits historically have been the primary source of
funds for First Federal's lending, investment and general operating activities.
First Federal is authorized, however, to use advances from the FHLB of Des
Moines to supplement its supply of lendable funds and to meet deposit withdrawal
requirements. The FHLB of Des Moines functions as a central reserve bank
providing credit for savings institutions and certain other member financial
institutions. As a member of the FHLB System, First Federal is required to own
stock in the FHLB of Des Moines and is authorized to apply for advances.
Advances are made pursuant to several different programs, each of which has its
own interest rate and range of maturities. The Bank is also eligible to borrow
from the Federal Reserve Bank. At September 30, 1999, the Bank had $24.96
million in advances outstanding with the FHLB.
From time to time the Bank utilizes repurchase agreements issued primarily
to local government units. The form of repurchase agreement used by the Bank
involves the sale of securities owned by the Bank with a commitment to
repurchase the same or substantially the same securities at a predetermined
price at a future date, typically one to 180 days thereafter. At September 30,
1999, the Bank had $4.70 million in repurchase agreements outstanding.
The following table presents a summary of the Bank's borrowings, which were
greater than 30% of stockholders' equity as of September 30, 1999 and 1998.
<TABLE>
<CAPTION>
September 30,
----------------------------
1999 1998
---------- ----------
(Dollars in thousands)
<S> <C> <C>
Federal Home Loan Bank advances
outstanding at period end............................ $ 24,957 $ 20,457
Weighted average rate at period end.................... 5.06% 5.22%
Daily average outstanding for the period............... $ 22,554 $ 15,677
Weighted average rate for the period................. 5.16% 5.60%
Highest outstanding at any month end................... $ 24,957 $ 20,959
Repurchase agreements
outstanding at period end............................ $ 4,701 $ 3,135
Weighted average rate at period end.................. 5.06% 5.22%
Daily average outstanding for the period............... $ 4,779 $ 3,321
Weighted average rate for the period................. 5.14% 5.42%
Highest outstanding at any month end................... $ 6,800 $ 4,300
</TABLE>
For more information on borrowings, see "Note 12 - Borrowings" of the Notes
to Consolidated Financial Statements included under Item 7, and part of Exhibit
13 to this Form 10-KSB.
22
<PAGE>
Subsidiary Activities
As a federally chartered savings bank, the Bank is permitted to invest an
amount equal to 2% of its assets in subsidiaries, with an additional investment
of 1% of assets where such investment serves primarily community, inner-city and
community development purposes. Under such limitations, as of September 30,
1999, the Bank was authorized to invest up to approximately $3.90 million in the
stock of or loans to subsidiaries, including the additional 1% investment for
community inner-city and community development purposes.
The Bank has one wholly owned subsidiary: First Federal Service Corporation
("First Federal Service"). First Federal Service, a Minnesota corporation,
sells credit, life and disability insurance and retail non-deposit investment
products. At September 30, 1999, the Bank's total investment in First Federal
Service was $116,000.
SAIF-insured savings institutions must give the FDIC and OTS 30 days' prior
notice before establishing or acquiring a new subsidiary, or commencing any new
activity through an existing subsidiary. Both the FDIC and OTS have authority
to order termination of subsidiary activities determined to pose a risk to the
safety or soundness of the institution. In addition, capital requirements
require savings institutions to deduct from capital the amount of their
investments in and extensions of credit to subsidiaries engaged in activities
not permissible to national banks in determining regulatory capital compliance.
The activities of First Federal Service are not permissible for national banks.
See "-- Regulation of the Bank -- Regulatory Capital Requirements."
Competition
First Federal faces strong competition for deposits and loans. First
Federal's principal competitors for deposits are other banking institutions,
such as commercial banks, credit unions and other savings institutions, as well
as mutual funds and other investments. First Federal principally competes for
deposits by offering a variety of deposit accounts, convenient business hours
and branch locations, customer service and a well trained staff, in addition to
a substantial ATM network. First Federal competes for loans with other
depository institutions, as well as specialty mortgage lenders and brokers and
consumer finance companies. First Federal principally competes for loans on the
basis of interest rates and the loan fees it charges, the types of loans it
originates and the convenience and quick service it provides to borrowers. In
addition, First Federal believes it has developed strong relationships with the
businesses, realtors, builders and general public in its market area. First
Federal is the fourth largest financial institution in its market area, based on
deposit and asset information at September 30, 1999. Of the three larger
institutions, two are located in Bemidji, within two blocks of the Bank's main
office.
Employees
As of September 30, 1999, the Company and the Bank had 35 full-time and 14
part-time employees, none of whom was represented by a collective bargaining
agreement.
Regulation
General. As a federally chartered savings bank, the Bank is subject to
extensive regulation by the OTS and FDIC and to OTS regulations governing such
matters as capital standards, mergers, establishment of branch offices,
subsidiary investments and activities and general investment authority. The
lending activities and other investments of the Bank must comply with various
federal regulatory requirements. The OTS periodically examines the Bank for
compliance with various regulatory requirements. The FDIC also has the
authority to conduct special examinations of the Bank because its deposits are
insured by the SAIF. The Bank must file reports with OTS describing its
activities and financial condition and is also subject to certain reserve
requirements promulgated by the Federal Reserve Board. This supervision and
regulation is intended primarily for the protection of depositors. Certain of
these regulatory requirements are referred to below or appear elsewhere herein.
23
<PAGE>
Recently Enacted Legislation. On November 12, 1999, the Gramm-Leach-Bliley
("G-L-B") Act was signed into law. The G-L-B Act authorizes affiliations
between banking, securities and insurance firms and authorizes bank holding
companies and national banks to engage in a variety of new financial activities.
Among the new activities that will be permitted to bank holding companies are
securities and insurance brokerage, securities underwriting, insurance
underwriting and merchant banking. The Federal Reserve Board, in consultation
with the Department of Treasury, may approve additional financial activities.
National bank subsidiaries will be permitted to engage in similar financial
activities but only on an agency basis unless they are one of the 50 largest
banks in the country. National bank subsidiaries will be prohibited from
insurance underwriting, real estate development and merchant banking. The G-L-B
Act, however, prohibits future acquisitions of existing unitary savings and loan
holding companies, like the Company, by firms that are engaged in commercial
activities and prohibits the formation of new unitary holding companies.
The G-L-B Act also imposes new requirements on financial institutions with
respect to customer privacy. The G-L-B Act generally prohibits disclosure of
customer information to non-affiliated third parties unless the customer has
been given the opportunity to object and has not objected to such disclosure.
Financial institutions are further required to disclose their privacy policies
to customers annually. Financial institutions, however, will be required to
comply with state law if it is more protective of customer privacy than the G-L-
B Act. The G-L-B Act directs the federal banking agencies, the National Credit
Union Administration, the Secretary of the Treasury, the Securities and Exchange
Commission and the Federal Trade Commission, after consultation with the
National Association of Insurance Commissioners, to promulgate implementing
regulations within six months of enactment. The privacy provisions will become
effective six months thereafter.
The G-L-B Act contains significant revisions to the Federal Home Loan Bank
System. The G-L-B Act imposes new capital requirements on the Federal Home Loan
Banks and authorizes them to issue two classes of stock with differing dividend
rates and redemption requirements. The G-L-B Act deletes the current
requirement that the Federal Home Loan Banks annually contribute $300 million to
pay interest on certain government obligations in favor of a 20% of net earnings
formula. The G-L-B Act expands the permissible uses of Federal Home Loan Bank
advances by community financial institutions (under $500 million in assets) to
include funding loans to small businesses, small farms and small agri-
businesses. The G-L-B Act makes membership in the Federal Home Loan Bank System
voluntary for federal savings associations.
The G-L-B Act contains a variety of other provisions including a
prohibition against ATM surcharges unless the customer has first been provided
notice of the imposition and amount of the fee. The G-L-B Act reduces the
frequency of Community Reinvestment Act examinations for smaller institutions
and imposes certain reporting requirements on depository institutions that make
payments to non-governmental entities in connection with the Community
Reinvestment Act. The G-L-B Act also eliminates the SAIF special reserve and
authorizes a federal savings association that converts to a national or state
bank charter to continue to use the term "federal" in its name and to retain any
interstate branches.
The Company and Bank are unable to predict the impact of the G-L-B Act on
their operations and competitive environment at this time.
Regulation of the Bank
Federal Home Loan Bank System. The Bank is a member of the FHLB System,
which consists of 12 district FHLBs subject to supervision and regulation by the
Federal Housing Finance Board ("FHFB"). The FHLBs provide a central credit
facility primarily for member institutions. As a member of the FHLB of Des
Moines, the Bank is required to acquire and hold shares of capital stock in the
FHLB of Des Moines in an amount at least equal to 1% of the aggregate unpaid
principal of its home mortgage loans, home purchase contracts, and similar
obligations at the end of each year, or 1/20 of its advances (borrowings) from
the FHLB of Des Moines, whichever is greater. The Bank was in compliance with
this requirement with an investment in FHLB of Des Moines stock at September 30,
1999 of $1.25 million.
24
<PAGE>
The FHLB of Des Moines serves as a reserve or central bank for its member
institutions within its assigned district. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System. It makes
advances to members in accordance with policies and procedures established by
the FHFB and the Board of Directors of the FHLB of Des Moines. Long-term
advances may only be made for the purpose of providing funds for residential
housing finance. At September 30, 1999, the Bank had $24.96 million in advances
outstanding from the FHLB of Des Moines. See "-- Deposit Activity and Other
Sources of Funds -- Borrowings."
Liquidity Requirements. The Bank is required to maintain average daily
balances of liquid assets (cash, certain time deposits, bankers' acceptance,
highly rated corporate debt and commercial paper, securities of certain mutual
funds and specified United States government, state or federal agency
obligations) equal to the average daily balance of not less than a specified
percentage (currently 4%) of its net withdrawable savings deposits plus short-
term borrowings. Monetary penalties may be imposed for failure to meet
liquidity requirements. The average daily liquidity ratio of the Bank for the
month of September 1999 was 35.49% with respect to liquid assets.
Qualified Thrift Lender Test. A savings institution that does not meet the
Qualified Thrift Lender ("QTL") test must either convert to a bank charter or
comply with the following restrictions on its operations: (i) the institution
may not engage in any new activity or make any new investment, directly or
indirectly, unless such activity or investment is permissible for both a
national bank and a savings institution; (ii) the branching powers of the
institution shall be restricted to those of a national bank; (iii) the
institution shall not be eligible to obtain any advances from its FHLB; and (iv)
payment of dividends by the institution shall be subject to the rules regarding
payment of dividends by a national bank. In addition, any company that controls
a savings institution that fails to qualify as a QTL will be required to
register as, and to be deemed, a bank holding company subject to all of the
provisions of the Bank Holding Company Act of 1956 (the "BHCA") and other
statutes applicable to bank holding companies. Upon the expiration of three
years from the date the institution ceases to be a QTL, it must cease any
activity and not retain any investment not permissible for both a national bank
and a savings institution and immediately repay any outstanding FHLB advances
(subject to safety and soundness considerations).
To qualify as a QTL, a savings institution must either qualify as a
"domestic building and loan association" under the Internal Revenue Code or
maintain at least 65% of its "portfolio assets" in Qualified Thrift Investments.
Portfolio assets are defined as total assets less intangibles, property used by
a savings institution in its business and liquidity investments in an amount not
exceeding 20% of assets. All of the following may be included as Qualified
Thrift Investments: investments in residential mortgages, home equity loans,
loans made for educational purposes, small business loans, credit card loans and
shares of stock issued by an FHLB. Subject to a 20% of portfolio assets limit,
savings institutions are also able to treat the following as Qualified Thrift
Investments: (i) 50% of the dollar amount of residential mortgage loans subject
to sale under certain conditions, (ii) investments, both debt and equity, in the
capital stock or obligations of and any other security issued by a service
corporation or operating subsidiary, provided that such subsidiary derives at
least 80% of its annual gross revenues from activities directly related to
purchasing, refinancing, constructing, improving or repairing domestic
residential housing or manufactured housing, (iii) 200% of their investments in
loan to finance "starter homes" and loans for construction, development or
improvement of housing and community service facilities or for financing small
businesses in "credit-needy" areas, (iv) loans for the purchase, construction,
development or improvement of community service facilities, (v) loans for
personal, family, household or educational purposes, and (vi) shares of stock
issued by FNMA or FHLMC.
A savings institution must maintain its status as a QTL on a monthly basis
in nine out of every 12 months. A savings institution that fails to maintain
Qualified Thrift Lender status will be permitted to requalify once, and if it
fails the QTL test a second time, it will become immediately subject to all
penalties as if all time limits on such penalties had expired. At September 30,
1999, the Bank qualified as a QTL.
Uniform Lending Standards. Under OTS regulations, savings banks must adopt
and maintain written policies that establish appropriate limits and standards
for extensions of credit that are secured by liens or interests in real estate
or are made for the purpose of financing permanent improvements to real estate.
These policies must establish loan
25
<PAGE>
portfolio diversification standards, prudent underwriting standards, including
loan-to-value limits, that are clear and measurable, loan administration
procedures and documentation, approval and reporting requirements. The real
estate lending policies must reflect consideration of the Interagency Guidelines
for Real Estate Lending Policies (the "Interagency Guidelines") that have been
adopted by the federal bank regulators.
The Interagency Guidelines, among other things, call upon depository
institutions to establish internal loan-to-value limits for real estate loans
that are not in excess of the following supervisory limits: (i) for loans
secured by raw land, the supervisory loan-to-value limit is 65% of the value of
the collateral; (ii) for land development loans (i.e., loans for the purpose of
improving unimproved property prior to the erection of structures), the
supervisory limit is 75%; (iii) for loans for the construction of commercial,
multifamily or other nonresidential property, the supervisory limit is 80%; (iv)
for loans for the construction of one- to four-family properties, the
supervisory limit is 85%; and (v) for loans secured by other improved property
(e.g., farmland, completed commercial property and other income-producing
property including non-owner-occupied, one- to four-family property), the limit
is 85%. Although no supervisory loan-to-value limit has been established for
owner-occupied, one- to four-family and home equity loans, the Interagency
Guidelines state that for any such loan with a loan-to-value ratio that equals
or exceeds 90% at origination, an institution should require appropriate credit
enhancement in the form of either mortgage insurance or readily marketable
collateral.
The Interagency Guidelines state that it may be appropriate in individual
cases to originate or purchase loans with loan-to-value ratios in excess of the
supervisory loan-to-value limits, based on the support provided by other credit
factors. The aggregate amount of loans in excess of the supervisory loan-to-
value limits, however, should not exceed 100% of total capital and the total of
such loans secured by commercial, agricultural, multifamily and other non-one-
to-four family residential properties should not exceed 30% of total capital.
The supervisory loan-to-value limits do not apply to certain categories of loans
including loans insured or guaranteed by the U.S. government and its agencies or
by financially capable state, local or municipal governments or agencies, loans
backed by the full faith and credit of a state government, loans that are to be
sold promptly after origination without recourse to a financially responsible
party, loans that are renewed, refinanced or restructured without the
advancement of new funds, loans that are renewed, refinanced or restructured in
connection with a workout, loans to facilitate sales of real estate acquired by
the institution in the ordinary course of collecting a debt previously
contracted and loans where the real estate is not the primary collateral.
Management believes that the Bank's current lending policies conform to the
Interagency Guidelines and does not anticipate that the Interagency Guidelines
will have a material effect on its lending activities.
Regulatory Capital Requirements. Under the OTS's regulatory capital
requirements, savings associations must maintain "tangible" capital equal to
1.5% of adjusted total assets, "core" capital equal to at least 4.0% or 3.0% (if
the institution is rated composite 1 CAMELS under the OTS examination rating
system) of adjusted total assets and "total" capital (a combination of "core"
and "supplementary" capital) equal to 8.0% of risk-weighted assets. In
addition, the OTS has adopted regulations which impose certain restrictions on
savings associations that have a total risk-based capital ratio that is less
than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of less than 4.0%
or a ratio of Tier 1 capital to adjusted total assets of less than 4.0% (or 3.0%
if the institution is rated composite 1 CAMELS under the OTS examination rating
system). For purposes of these regulations, Tier 1 capital has the same
definitions as core capital. See "--Prompt Corrective Regulatory Action."
Core capital is defined as common stockholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Core capital is generally reduced by the amount of the savings
association's intangible assets for which no market exists. Limited exceptions
to the deduction of intangible assets are provided for purchased mortgage
servicing rights and qualifying supervisory goodwill. Tangible capital is given
the same definition as core capital but does not include an exception for
qualifying supervisory goodwill and is reduced by the amount of all the savings
association's intangible assets with only a limited exception for purchased
mortgage servicing rights. Both core and tangible capital are further reduced
by an amount
26
<PAGE>
equal to a savings institution's debt and equity investments in subsidiaries
engaged in activities not permissible to national banks (other than subsidiaries
engaged in activities undertaken as agent for customers or in mortgage banking
activities and subsidiary depository institutions or their holding companies).
Investments in and extensions of credit to such subsidiaries are required to be
fully netted against tangible and core capital. At September 30, 1999, the Bank
had no such investments.
Adjusted total assets are a savings association's total assets as
determined under generally accepted accounting principles increased by certain
goodwill amounts and by a pro rated portion of the assets of unconsolidated
includable subsidiaries in which the savings association holds a minority
interest. Adjusted total assets are reduced by the amount of assets that have
been deducted from capital, the portion of savings association's investments in
unconsolidated includable subsidiaries, and, for purpose of the core capital
requirement, qualifying supervisory goodwill. At September 30, 1999, the Bank's
adjusted total assets for the purposes of the core and tangible capital
requirements were approximately $130.54 million.
In determining compliance with the risk-based capital requirement, a
savings association is allowed to include both core capital and supplementary
capital in its total capital provided the amount of supplementary capital
included does not exceed the savings association's core capital. Supplementary
capital is defined to include certain preferred stock issues, nonwithdrawable
accounts and pledged deposits that do not qualify as core capital, certain
approved subordinated debt, certain other capital instruments, a portion of the
savings association's general loss allowances and up to 45% of unrealized gains
on equity securities. Total core and supplementary capital are reduced by the
amount of capital instruments held by other depository institutions pursuant to
reciprocal arrangements, all equity investments and that portion of the
institution's land loans and non-residential construction loans in excess of 80%
loan-to-value ratio. As of September 30, 1999, the Bank had no high ratio land
or non-residential construction loans and no equity investments for which OTS
regulations require a deduction from total capital.
The risk-based capital requirement is measured against risk-weighted assets
which equal the sum of each asset and the credit-equivalent amount of each off-
balance sheet item after being multiplied by an assigned risk weight. Under the
OTS risk-weighting system, one- to four-family first mortgages not more than 90
days past due with loan-to-value ratios under 80% are assigned a risk weight of
50%. Consumer and residential construction loans are assigned a risk weight of
100%. Mortgage-backed securities issued, or fully guaranteed as to principal
and interest, by the FNMA or FHLMC are assigned a 20% risk weight. Cash and
U.S. Government securities backed by the full faith and credit of the U.S.
Government are given a 0% risk weight. As of September 30, 1999, the Bank's
risk-weighted assets were approximately $62.64 million.
27
<PAGE>
The table below provides information with respect to the Bank's compliance
with its regulatory capital requirements at September 30, 1999.
<TABLE>
<CAPTION>
To Be Well Capitalized
Under Prompt
Actual For Capital Adequacy Purposes Corrective Action Provisions
--------------------------------------------------------------------------------------------
Amount Amount Amount
(000's) Ratio (000's) Ratio (000's) Ratio
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
As of September 30, 1999:
Total capital (to risk-
weighted assets) $11,302 18.04% $5,011 8.00% $6,264 10.00%
Tier 1 capital (to risk-
weighted assets) 10,790 17.23 2,506 4.00 3,758 6.00
Tier 1 capital (to average
assets) 10,790 8.49 5,084 4.00 6,356 5.00
As of September 30, 1998:
Total capital (to risk-
weighted assets) 11,549 19.00 4,855 8.00 6,069 10.00
Tier 1 capital (to risk-
weighted assets) 11,051 18.20 2,428 4.00 3,641 6.00
Tier 1 capital (to average
assets) 11,051 9.40 4,700 4.00 5,874 5.00
</TABLE>
The risk-based capital standards of the OTS require savings institutions
with more than a "normal" level of interest rate risk to maintain additional
total capital. A savings institution's interest rate risk is measured in terms
of the sensitivity of its "net portfolio value" to changes in interest rates.
Net portfolio value is defined, generally, as the present value of expected cash
inflows from existing assets and off-balance sheet contracts less the present
value of expected cash outflows from existing liabilities. A savings
institution will be considered to have a "normal" level of interest rate risk
exposure if the decline in its net portfolio value after an immediate 200 basis
point increase or decrease in market interest rates (whichever results in the
greater decline) is less than 2.0% of the current estimated economic value of
its assets.
The OTS calculates the sensitivity of a savings institution's net portfolio
value based on data submitted by the institution in a schedule to its quarterly
Thrift Financial Report and using the interest rate risk measurement model
adopted by the OTS. The amount of the interest rate risk component, if any, to
be deducted from a savings institution's total capital is based on the
institution's Thrift Financial Report filed two quarters earlier. Savings
institutions with less than $300 million in assets and a risk-based capital
ratio above 12% are generally exempt from filing the interest rate risk schedule
with their Thrift Financial Reports. However, the OTS requires any exempt
savings institution that it determines may have a high level of interest rate
risk exposure to file such schedule on a quarterly basis and may be subject to
an additional capital requirement based upon its level of interest rate risk as
compared to its peers. The Bank has determined that, on the basis of current
financial data, it will not be deemed to have more than normal level of interest
rate risk under the rule and believes that it will not be required to increase
its total capital as a result of the rule.
In addition to requiring generally applicable capital standards for savings
institutions, the OTS is authorized to establish the minimum level of capital
for a savings institution at such amount or at such ratio of capital-to-assets
as the OTS determines to be necessary or appropriate for such institution in
light of the particular circumstances of the institution. Such circumstances
would include a high degree of exposure to interest rate risk, prepayment risk,
credit risk, concentration of credit risk and certain risks arising from non-
traditional activities. The OTS may treat the failure of any savings
institution to maintain capital at or above such level as an unsafe or unsound
practice and may issue a directive requiring any savings institution which fails
to maintain capital at or above the minimum level required by the OTS to submit
and adhere to a plan for increasing capital. Such an order may be enforced in
the same manner as an order issued by the FDIC.
28
<PAGE>
At September 30, 1999, the Bank exceeded all regulatory minimum capital
requirements.
Prompt Corrective Regulatory Action. Under the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators
are required to take prompt corrective action if an insured depository
institution fails to satisfy certain minimum capital requirements. All
institutions, regardless of their capital levels, are restricted from making any
capital distribution or paying any management fees if the institution would
thereafter fail to satisfy the minimum levels for any of its capital
requirements. An institution that fails to meet the minimum level for any
relevant capital measure (an "undercapitalized institution") may be: (i) subject
to increased monitoring by the appropriate federal banking regulator; (ii)
required to submit an acceptable capital restoration plan within 45 days; (iii)
subject to asset growth limits; and (iv) required to obtain prior regulatory
approval for acquisitions, branching and new lines of businesses. The capital
restoration plan must include a guarantee by the institution's holding company
that the institution will comply with the plan until it has been adequately
capitalized on average for four consecutive quarters, under which the holding
company would be liable up to the lesser of 5% of the institution's total assets
or the amount necessary to bring the institution into capital compliance as of
the date it failed to comply with its capital restoration plan. A
"significantly undercapitalized" institution, as well as any undercapitalized
institution that did not submit an acceptable capital restoration plan, may be
subject to regulatory demands for recapitalization, broader application of
restrictions on transactions with affiliates, limitations on interest rates paid
on deposits, asset growth and other activities, possible replacement of
directors and officers, and restrictions on capital distributions by any bank
holding company controlling the institution. Any company controlling the
institution could also be required to divest the institution or the institution
could be required to divest subsidiaries. The senior executive officers of a
significantly undercapitalized institution may not receive bonuses or increases
in compensation without prior approval and the institution is prohibited from
making payments of principal or interest on its subordinated debt. In their
discretion, the federal banking regulators may also impose the foregoing
sanctions on an undercapitalized institution if the regulators determine that
such actions are necessary to carry out the purposes of the prompt corrective
action provisions. If an institution's ratio of tangible capital to total
assets falls below a "critical capital level," the institution will be subject
to conservatorship or receivership within 90 days unless periodic determinations
are made that forbearance from such action would better protect the deposit
insurance fund. Unless appropriate findings and certifications are made by the
appropriate federal bank regulatory agencies, a critically undercapitalized
institution must be placed in receivership if it remains critically
undercapitalized on average during the calendar quarter beginning 270 days after
the date it became critically undercapitalized.
Under regulations jointly adopted by the federal banking regulators,
including the OTS, a depository institution's capital adequacy for purposes of
the prompt corrective action rules is determined on the basis of the
institution's total risk-based capital ratio (the ratio of its total capital to
risk-weighted assets), Tier 1 risk-based capital ratio (the ratio of its core
capital to risk-weighted assets) and leverage ratio (the ratio of its core
capital to adjusted total assets). Under the regulations, a depository
institution that is not subject to an order or written directive by its primary
federal regulator to meet or maintain a specific capital level will be deemed
"well capitalized" if it also has: (i) a total risk-based capital ratio of 10%
or greater; (ii) a Tier 1 risk-based capital ratio of 6.0% or greater; and (iii)
a leverage ratio of 5.0% or greater. An "adequately capitalized" depository
institution is an institution that does not meet the definition of well
capitalized and has: (i) a total risk-based capital ratio of 8.0% or greater;
(ii) a Tier 1 capital risk-based ratio of 4.0% or greater; and (iii) a leverage
ratio of 4.0% or greater (or 3.0% or greater if the institution has a composite
1 CAMELS rating). An "undercapitalized" depository institution is an
institution that has: (i) a total risk-based capital ratio less than 8.0%; or
(ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage
ratio of less than 4.0% (or 3.0% if the institution has a composite 1 CAMELS
rating). A "significantly undercapitalized" institution is defined as a
depository institution that has: (i) a total risk-based capital ratio of less
than 6.0%; or (ii) a Tier 1 risk-based capital ratio of less than 3.0%; or (iii)
a leverage ratio of less than 3.0%. A "critically undercapitalized" institution
is defined as a depository institution that has a ratio of "tangible equity" to
total assets of less than 2.0%. "Tangible equity" is defined as core capital
plus the institution's outstanding cumulative perpetual preferred stock (and
related surplus) less all intangibles other than qualifying supervisory goodwill
and certain purchased mortgage servicing rights. The appropriate federal
banking agency may reclassify a well capitalized depository institution as
adequately capitalized and may require an adequately capitalized or
undercapitalized institution to comply with the supervisory actions
29
<PAGE>
applicable to institutions in the next lower capital category (but may not
reclassify a significantly undercapitalized institution as critically
undercapitalized) if the OTS determines, after notice and an opportunity for a
hearing, that the depository institution is in an unsafe or unsound condition or
that the institution has received and not corrected a less-than-satisfactory
rating for any CAMELS rating category. As of September 30, 1999, the Bank was
classified as "well capitalized" under the prompt corrective action regulations.
Deposit Insurance. The Bank is required to pay assessments, based on a
percentage of its insured deposits, to the FDIC for insurance of its deposits by
the FDIC through the SAIF. Under the Federal Deposit Insurance Act, the FDIC is
required to set semi-annual assessments for SAIF-insured institutions at a level
necessary to maintain the designated reserve ratio of the SAIF at 1.25% of
estimated insured deposits, or at a higher percentage of estimated insured
deposits that the FDIC determines to be justified for that year by circumstances
indicating a significant risk of substantial future losses to the SAIF.
Under the FDIC's risk-based deposit insurance assessment system, the
assessment rate for an insured depository institution depends on the assessment
risk classification assigned to the institution by the FDIC, which is determined
by the institution's capital level and supervisory evaluations. Based on the
data reported to regulators for the date closest to the last day of the seventh
month preceding the semi-annual assessment period, institutions are assigned to
one of three capital groups -- well capitalized, adequately capitalized or
undercapitalized -- using the same percentage criteria as under the prompt
corrective action regulations. See " -- Prompt Corrective Regulatory Action."
Within each capital group, institutions are assigned to one of three subgroups
on the basis of supervisory evaluations by the institution's primary supervisory
authority, and such other information as the FDIC determines to be relevant to
the institution's financial condition and the risk posed to the deposit
insurance fund. Subgroup A consists of financially sound institutions with only
a few minor weaknesses. Subgroup B consists of institutions that demonstrate
weaknesses which, if not corrected, could result in significant deterioration of
the institution and increased risk of loss to the deposit insurance fund.
Subgroup C consists of institutions that pose a substantial probability of loss
to the deposit insurance fund unless effective corrective action is taken.
Historically, institutions with SAIF-assessable deposits, like the Bank,
were required to pay higher deposit insurance premiums than institutions with
deposits insured by the Bank Insurance Fund ("BIF"). In order to recapitalize
the SAIF and address the premium disparity, in November 1996 the FDIC imposed a
one-time special assessment on institutions with SAIF-assessable deposits based
on the amount determined by the FDIC to be necessary to increase the reserve
levels of the SAIF to the designated reserve ratio of 1.25% of insured deposits.
Institutions were assessed at the rate of 65.7 basis points based on the amount
of their SAIF-assessable deposits as of March 31, 1995.
The special assessment recapitalized the SAIF, and as a result, the FDIC
lowered the SAIF deposit insurance assessment rates to zero for "well
capitalized" institutions with the highest supervisory ratings and 0.27% of
insured deposits for institutions in the highest risk-based premium category.
Until December 31, 1999, SAIF-insured institutions will be required to pay
assessments to the FDIC at the rate of 6.5 basis points to help fund interest
payments on certain bonds issued by the Financing Corporation ("FICO"), an
agency of the federal government established to finance takeovers of insolvent
thrifts. During this period, BIF members will be assessed for these obligations
at the rate of 1.3 basis points. After December 31, 1999, both BIF and SAIF
members will be assessed at the same rate for FICO payments, or sooner if the
two funds are merged.
Substantial entrance and exit fees apply to conversions from SAIF to BIF
insurance and such fees may make a SAIF to BIF conversion prohibitively
expensive. In the past the substantial disparity existing between deposit
insurance premiums paid by BIF and SAIF members gave BIF-insured institutions a
competitive advantage over SAIF-insured institutions like the Bank. The
reduction of SAIF deposit insurance premiums effectively eliminated this
disparity and could have the effect of increasing the net earnings of the Bank
and restoring the competitive equality between BIF-insured and SAIF-insured
institutions.
30
<PAGE>
The FDIC has adopted a regulation which provides that any insured
depository institution with a ratio of Tier 1 capital to total assets of less
than 2% will be deemed to be operating in an unsafe or unsound condition, which
would constitute grounds for the initiation of termination of deposit insurance
proceedings. The FDIC, however, would not initiate termination of insurance
proceedings if the depository institution has entered into and is in compliance
with a written agreement with its primary regulator, and the FDIC is a party to
the agreement, to increase its Tier 1 capital to such level as the FDIC deems
appropriate. Tier 1 capital is defined as the sum of common stockholders'
equity, noncumulative perpetual preferred stock (including any related surplus)
and minority interests in consolidated subsidiaries, minus all intangible assets
other than mortgage servicing rights and qualifying supervisory goodwill
eligible for inclusion in core capital under OTS regulations and minus
identified losses and investments in certain securities subsidiaries. Insured
depository institutions with Tier 1 capital equal to or greater than 2% of total
assets may also be deemed to be operating in an unsafe or unsound condition
notwithstanding such capital level. The regulation further provides that in
considering applications that must be submitted to it by savings institutions,
the FDIC will take into account whether the savings institution is meeting with
the Tier 1 capital requirement for state non-member banks of 4% of total assets
for all but the most highly rated state non-member banks.
Federal Reserve System. Pursuant to regulations of the Federal Reserve
Board, a savings institution must maintain average daily reserves equal to 3% on
net transaction accounts between $4.9 million and $46.5 million, plus 10% on the
remainder. This percentage is subject to adjustment by the Federal Reserve
Board. Because required reserves must be maintained in the form of vault cash
or in a non-interest bearing account at a Federal Reserve Bank, the effect of
the reserve requirement is to reduce the amount of the institution's interest-
earning assets. As of September 30, 1999, the Bank met its reserve
requirements.
Dividend Restrictions. Under the OTS prompt corrective action regulations,
the Bank would be prohibited from making any capital distributions if, after
making the distribution, it would have: (i) a total risk-based capital ratio of
less than 8.0%; (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or
(iii) a Tier 1 leverage ratio of less than 4.0%. See "Prompt Corrective
Regulatory Action." The OTS, after consultation with the FDIC, however, may
permit an otherwise prohibited stock repurchase if made in connection with the
issuance of additional shares in an equivalent amount and the repurchase will
reduce the institution's financial obligations or otherwise improve the
institution's financial condition. Under OTS regulations, the Bank is not
permitted to pay dividends on its capital stock if its regulatory capital would
thereby be reduced below the amount then required for the liquidation account
established for the benefit of certain depositors of the Bank at the time of its
conversion to stock form.
Savings institutions must submit notice to the OTS prior to making a
capital distribution if (a) they would not be well-capitalized after the
distribution, (b) the distribution would result in the retirement of any of the
institution's common or preferred stock or debt counted as its regulatory
capital, or (c) the institution is a subsidiary of a holding company. A savings
institution must make application to the OTS to pay a capital distribution if
(x) the institution would not be adequately capitalized following the
distribution, (y) the institution's total distributions for the calendar year
exceeds the institution's net income for the calendar year to date plus its net
income (less distributions) for the preceding two years, or (z) the distribution
would otherwise violate applicable law or regulation or an agreement with or
condition imposed by the OTS.
In addition to the foregoing, earnings of the Bank appropriated to bad debt
reserves and deducted for federal income tax purposes are not available for
payment of cash dividends or other distributions to the Company without payment
of taxes at the then current tax rate by the Bank on the amount of earnings
removed from the reserves for such distributions. See "Taxation." The Company
intends to make full use of this favorable tax treatment afforded to the Bank
and the Company and does not contemplate use of any post-Conversion earnings of
the Bank in a manner which would limit either institution's bad debt deduction
or create federal tax liabilities.
Transactions with Related Parties. Transactions between savings
institutions and any affiliate are governed by Sections 23A and 23B of the
Federal Reserve Act. An affiliate of a savings institution is any company or
entity which controls, is controlled by or is under common control with the
savings institution. In a holding company context,
31
<PAGE>
the parent holding company of a savings institution (such as the Company) and
any companies which are controlled by such parent holding company are affiliates
of the savings institution. Generally, Sections 23A and 23B (i) limit the extent
to which the savings institution or its subsidiaries may engage in "covered
transactions" with any one affiliate to an amount equal to 10% of such
institution's capital stock and surplus, and contain an aggregate limit on all
such transactions with all affiliates to an amount equal to 20% of such capital
stock and surplus, and (ii) require that all such transactions be on terms
substantially the same, or at least as favorable, to the institution or
subsidiary as those provided to a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
similar other types of transactions. In addition to the restrictions imposed by
Sections 23A and 23B, OTS regulations provide that no savings institution may
(i) make a loan or otherwise extend credit to an affiliate, except for any
affiliate which engages only in activities which are permissible for bank
holding companies, or (ii) purchase or invest in any stocks, bonds, debentures,
notes or similar obligations of any affiliate, except for affiliates which are
subsidiaries of the savings institution. Section 106 of the BHCA which applies
to the Bank, prohibits the Bank from extending credit to or offering any other
services, or fixing or varying the consideration for such extension of credit or
service, on the condition that the customer obtain some additional service from
the institution or certain of its affiliates or not obtain services of a
competitor of the institution, subject to certain exceptions.
Loans to Directors, Executive Officers and Principal Stockholders. Savings
institutions are also subject to the restrictions contained in Section 22(h) and
Section 22(g) of the Federal Reserve Act on loans to executive officers,
directors and principal stockholders. Under Section 22(h), loans to a director,
executive officer and to a greater than 10% stockholder of a savings institution
and certain affiliated entities of such persons, may not exceed, together with
all other outstanding loans to such person and affiliated entities, the
institution's loans-to-one-borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus and an additional 10% of such
capital and surplus for loans fully secured by readily marketable collateral).
Section 22(h) also prohibits loans, above amounts prescribed by the appropriate
federal banking agency, to directors, executive officers and greater than 10%
stockholders of a savings institution, and their respective affiliates, unless
such loan is approved in advance by a majority of the board of directors of the
institution with any "interested" director not participating in the voting. The
Federal Reserve Board has prescribed the loan amount (which includes all other
outstanding loans to such person) as to which such prior board of director
approval is required, as being the greater of $25,000 or 5% of capital and
surplus (up to $500,000). Further, Section 22(h) requires that loans to
directors, executive officers and principal stockholders be made on terms
substantially the same as offered in comparable transactions to other persons.
Section 22(h) also generally prohibits a depository institution from paying the
overdrafts of any of its executive officers or directors.
Section 22(g) of the Federal Reserve Act requires that loans to executive
officers of depository institutions not be made on terms more favorable than
those afforded to other borrowers, requires approval by the board of directors
of the depository institution for such extensions of credit to executive
officers of the institution, and imposes reporting requirements for and
additional restrictions on the type, amount and terms of credits to such
officers. In addition, Section 106 of the BHCA prohibits extensions of credit
to executive officers, directors, and greater than 10% stockholders of a
depository institution by any other institution which has a correspondent
banking relationship with the institution, unless such extension of credit is on
substantially the same terms as those prevailing at the time for comparable
transactions with other persons and does not involve more than the normal risk
of repayment or present other unfavorable features.
Safety and Soundness Standards. Under FDICIA, as amended by the Riegle
Community Development and Regulatory Improvement Act of 1994 (the "CDRI Act"),
each federal banking agency is required to establish safety and soundness
standards for depository institutions under its authority. On July 10, 1995,
the federal banking agencies, including the OTS, released Interagency Guidelines
Establishing Standards for Safety and Soundness and published a final rule
establishing deadlines for submission and review of safety and soundness
compliance plans. The final rule and the guidelines went into effect on August
9, 1995. The guidelines require savings institutions to maintain internal
controls and information systems and internal audit systems that are appropriate
for the size, nature and scope of the institution's business. The guidelines
also establish certain basic standards for loan documentation, credit
underwriting, interest rate risk exposure, and asset growth. The guidelines
further provide that savings institutions should maintain
32
<PAGE>
safeguards to prevent the payment of compensation, fees and benefits that are
excessive or that could lead to material financial loss, and should take into
account factors such as comparable compensation practices at comparable
institutions. If the OTS determines that a savings institution is not in
compliance with the safety and soundness guidelines, it may require the
institution to submit an acceptable plan to achieve compliance with the
guidelines. A savings institution must submit an acceptable compliance plan to
the OTS within 30 days of receipt of a request for such a plan. Failure to
submit or implement a compliance plan may subject the institution to regulatory
sanctions. Management believes that the Bank already meets substantially all the
standards adopted in the interagency guidelines, and therefore does not believe
that implementation of these regulatory standards will materially affect the
Bank's operations.
Under federal banking regulations, savings institutions must also adopt and
maintain written policies that establish appropriate limits and standards for
extensions of credit that are secured by liens or interests in real estate or
are made for the purpose of financing permanent improvements to real estate.
These policies must establish loan portfolio diversification standards, prudent
underwriting standards, including loan-to-value limits, that are clear and
measurable, loan administration procedures and documentation, approval and
reporting requirements. A savings institution's real estate lending policy
must reflect consideration of the Interagency Guidelines for Real Estate Lending
Policies (the "Real Estate Lending Guidelines") that have been adopted by the
federal banking regulators. The Real Estate Lending Guidelines, among other
things, call upon savings institutions to establish internal loan-to-value
limits for real estate loans that are not in excess of the specified loan-to-
value limits for the various types of real estate loans. The Real Estate
Lending Guidelines state, however, that it may be appropriate in individual
cases to originate or purchase loans with loan-to-value ratios in excess of the
supervisory loan-to-value limits.
Additionally, under FDICIA, as amended by the CDRI Act, the federal banking
agencies are required to establish standards relating to the asset quality and
earnings that the agencies determine to be appropriate. On July 10, 1995, the
federal banking agencies, including the OTS, issued proposed guidelines relating
to asset quality and earnings. Under the proposed guidelines, a savings
institution should maintain systems, commensurate with its size and the nature
and scope of its operations, to identify problem assets and prevent
deterioration in those assets as well as to evaluate and monitor earnings and
ensure that earnings are sufficient to maintain adequate capital and reserves.
Management believes that the asset quality and earnings standards, in the form
proposed by the banking agencies, would not have a material effect on the Bank's
operations.
Regulation of the Company
General. The Company is a unitary savings and loan holding company as
defined by the Home Owners' Loan Act ("HOLA"). As such, the Company is
registered with the OTS and is subject to OTS regulation, examination,
supervision and reporting requirements. As a subsidiary of a savings and loan
holding company, the Bank is subject to certain restrictions in its dealings
with the Company and affiliates thereof. The Company is required to file
certain reports with, and otherwise comply with the rules and regulations of the
Securities and Exchange Commission ("SEC") under federal securities laws.
Activities Restrictions. The Board of Directors of the Company presently
intends to operate the Company as a unitary savings and loan holding company.
There are generally no restrictions on the activities of a unitary savings and
loan holding company. However, if the Director of the OTS determines that there
is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings institution, the
Director of the OTS may impose such restrictions as deemed necessary to address
such risk including limiting: (i) payment of dividends by the savings
institution; (ii) transactions between the savings institution and its
affiliates; and (iii) any activities of the savings institution that might
create a serious risk that the liabilities of the holding company and its
affiliates may be imposed on the savings institution. Notwithstanding the above
rules as to permissible business activities of unitary savings and loan holding
companies, if the savings institution subsidiary of such a holding company fails
to meet the QTL test, then such unitary holding company shall also presently
become subject to the activities restrictions applicable to multiple holding
33
<PAGE>
companies and, unless the savings institution requalifies as a QTL within one
year thereafter, register as, and become subject to, the restrictions applicable
to a bank holding company. See "-- Regulation of the Bank -- Qualified Thrift
Lender Test."
If the Company were to acquire control of another savings institution,
other than through merger or other business combination with the Bank, the
Company would thereupon become a multiple savings and loan holding company.
Except where such acquisition is pursuant to the authority to approve emergency
thrift acquisitions and where each subsidiary savings institution meets the QTL
test, the activities of the Company and any of its subsidiaries (other than the
Bank or other subsidiary savings institutions) would thereafter be subject to
further restrictions. Among other things, no multiple savings and loan holding
company or subsidiary thereof which is not a savings institution shall commence
or continue for a limited period of time after becoming a multiple savings and
loan holding company or subsidiary thereof, any business activity, upon prior
notice to, and no objection by, the OTS, other than: (i) furnishing or
performing management services for a subsidiary savings institution; (ii)
conducting an insurance agency or escrow business; (iii) holding, managing, or
liquidating assets owned by or acquired from a subsidiary savings institution;
(iv) holding or managing properties used or occupied by a subsidiary savings
institution; (v) acting as trustee under deeds of trust; (vi) those activities
previously directly authorized by regulation as of March 5, 1987 to be engaged
in by multiple holding companies; or (vii) unless the Director of the OTS by
regulation prohibits or limits such activities for savings and loan holding
companies, those activities authorized by the Federal Reserve Board as
permissible for bank holding companies. Those activities described in (vii)
above must also be approved by the Director of the OTS prior to being engaged in
by a multiple savings and loan holding company.
Restrictions on Acquisitions. The HOLA generally prohibits savings and
loan holding companies from acquiring, without prior approval of the Director of
OTS, (i) control of any other savings institution or savings and loan holding
company or substantially all the assets thereof, or (ii) more than 5% of the
voting shares of a savings institution or holding company thereof which is not a
subsidiary. Except with the prior approval of the Director of the OTS, no
director or officer of a savings and loan holding company or person owning or
controlling by proxy or otherwise more than 25% of such company's stock, may
also acquire control of any savings institution, other than a subsidiary savings
institution, or of any other savings and loan holding company.
The Director of the OTS may only approve acquisitions resulting in the
formation of a multiple savings and loan holding company which controls savings
institutions in more than one state if: (i) the multiple savings and loan
holding company involved controls a savings institution which operated a home or
branch office in the state of the institution to be acquired as of March 5,
1987; (ii) the acquiror is authorized to acquire control of the savings
institution pursuant to the emergency acquisition provisions of the Federal
Deposit Insurance Act; or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by state-chartered institutions or savings and loan holding companies
located in the state where the acquiring entity is located (or by a holding
company that controls such state-chartered savings institutions).
OTS regulations permit federal savings institutions to branch in any state
or states of the United States and its territories. Except in supervisory cases
or when interstate branching is otherwise permitted by state law or other
statutory provision, a federal savings institution may not establish an out-of-
state branch unless (i) the federal savings institution qualifies as a QTL or as
a "domestic building and loan institution" under section 7701(a)(19) of the
Internal Revenue Code and the total assets attributable to all branches of the
savings institution in the state would qualify such branches taken as a whole
for treatment as a QTL or for a domestic building and loan association and (ii)
such branch would not result in (a) formation of a prohibited multi-state
multiple savings and loan holding company or (b) a violation of certain
statutory restrictions on branching by savings institution subsidiaries of
banking holding companies. Federal savings institutions generally may not
establish new branches unless the savings institution meets or exceeds minimum
regulatory capital requirements. The OTS will also consider the savings
institution's record of compliance with the Community Reinvestment Act of 1977
in connection with any branch application.
34
<PAGE>
Taxation
General. The Company and its subsidiaries (including the Bank) file a
consolidated federal income tax return on a fiscal year basis. Consolidated
returns have the effect of eliminating intercompany distributions, including
dividends, from the computation of taxable income for the taxable year in which
the distributions occur.
Federal Income Taxation. Included in the Small Business Job Protection Act
of 1996 are provisions which repeal the special bad debt reserve method for
savings and loan associations for taxable years beginning after December 31,
1995. The legislation requires institutions to recapture the portion of the tax
bad debt reserves that exceeds the pre-1988 tax bad debt reserve over a period
of six to eight years. The recapture can be deferred for one to two years if
the institution meets a residential loan origination requirement.
For taxable years beginning after December 31, 1995, the bad debt method
for savings and loan associations is conformed to that of banks. Institutions
that qualify as a "small bank" will be able to use the reserve method for bad
debts. Reasonable additions to the reserve for bad debts are calculated using
the experience method. A small bank is an institution with assets less than
$500 million. Institutions that do not qualify as a small bank will not be
allowed to use the reserve method for bad debts.
Earnings appropriated to an institution's bad debt reserve and claimed as a
tax deduction are not available for the payment of cash dividends or for
distribution to shareholders (including distributions made on dissolution or
liquidation), unless such amount is included in taxable income, along with the
amount deemed necessary to pay the resulting federal income tax.
The Bank's federal corporate income tax returns have not been audited in
the last five years.
State Income Taxation. The State of Minnesota imposes a corporate
franchise tax at the rate of 9.8% on income which is considered Minnesota
taxable income. Taxable income for the State of Minnesota is substantially the
same as federal taxable income.
For additional information regarding taxation, see Note 11 of Notes to
Consolidated Financial Statements.
Item 2. Properties
- -------------------
The following table sets forth information regarding the Company's offices
at September 30, 1999.
<TABLE>
<CAPTION>
Year Owned or Book Value at Approximate Deposits at
Opened Leased September 30, 1999 Square Footage September 30, 1999
------ -------- ------------------ -------------- ------------------
(In thousands)
<S> <C> <C> <C> <C> <C>
Main Office:
214 5th Street 1910 Owned $1.31 million 10,990 $52,352
Bemidji, Minnesota 56601
Branch Offices:
22 First Street, NE 1977 Owned 180,000 1,789 18,401
Bagley, Minnesota 56621
109 Main Street West 1983 Owned 294,000 3,083 10,530
Baudette, Minnesota 56623
527 Minnesota Avenue 1987 Owned 107,000 1,700 4,609
Walker, Minnesota 56484
550 Paul Bunyan Drive, N.W. 1995 Leased 234,000 2,158 2,219
Bemidji, Minnesota 56601
</TABLE>
35
<PAGE>
The book value of the Company's investment in premises and equipment
totaled $2.12 million at September 30, 1999. See Note 9 of Notes to
Consolidated Financial Statements.
Item 3. Legal Proceedings.
- -------------------------
At September 30, 1999, there were no legal proceedings to which the
Company or First Federal was a party, or to which any of their property was
subject, which were expected by management to result in a material loss to the
Company or the Bank.
Item 4. Submission of Matters to Vote of Security Holders.
- ---------------------------------------------------------
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year ended September 30, 1999.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholders'
- ---------------------------------------------------------------------------
Matters
- -------
The information contained under the sections captioned "Market and
Dividend Information" in the Company's Annual Report to Stockholders for the
Fiscal Year Ended September 30, 1999 (the "Annual Report") filed as Exhibit 13
hereto is incorporated herein by reference.
Item 6. Management's Discussion and Analysis of Financial Condition and Results
- -------------------------------------------------------------------------------
of Operations
- -------------
The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in the
Annual Report is incorporated herein by reference.
Item 7. Financial Statements
- ----------------------------
The Consolidated Financial Statements, Notes to Consolidated Financial
Statements and Independent Auditors' Report in the Annual Report, which are
listed under Item 13 herein, are incorporated herein by reference.
Item 8. Changes in and Disagreements With Accountants on Accounting and
- -----------------------------------------------------------------------
Financial Disclosure
- --------------------
None.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
- ---------------------------------------------------------------------
Compliance with Section 16(a) of the Exchange Act
- -------------------------------------------------
For information concerning the Board of Directors and executive officers
of the Company, the information contained under the section captioned "Proposal
I -- Election of Directors" in the Company's definitive proxy statement for the
Company's 2000 Annual Meeting of Stockholders (the "Proxy Statement") is
incorporated herein by reference.
For information regarding delinquent filers, as required by Item 405 of
Regulation S-B, reference is made to "Security Ownership of Management" in the
Proxy Statement, which is incorporated herein by reference.
36
<PAGE>
Item 10. Executive Compensation
- --------------------------------
The information contained under the sections captioned "Proposal I --
Election of Directors -- Executive Compensation" "-- Director Compensation," "--
Employment Agreements" and "-- Supplemental Executive Retirement Agreement" in
the Proxy Statement is incorporated herein by reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference
to the section captioned "Voting Securities and Principal Holders
Thereof" in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference
to the sections captioned "Voting Securities and Principal Holders
Thereof" and "Proposal I -- Election of Directors" in the Proxy
Statement.
(c) Changes in Control
Management of the Company knows of no arrangements, including any
pledge by any person of securities of the Company, the operation of
which may at a subsequent date result in a change in control of the
registrant.
Item 12. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information required by this item is incorporated herein by
reference to the section captioned "Proposal I -- Election of Directors --
Transactions with Management" in the Proxy Statement.
PART IV
Item 13. Exhibits List and Reports on Form 8-K.
- -----------------------------------------------
(a) List of Documents Filed as Part of this Report
----------------------------------------------
(1) Financial Statements. The following consolidated financial statements
are incorporated by reference from Item 8 hereof (see Exhibit 13):
Independent Auditors' Report
Consolidated Statements of Financial Condition - September 30, 1999
and 1998
Consolidated Statements of Income - Years ended September 30, 1999 and
1998
Consolidated Statements of Stockholders' Equity - Years ended
September 30, 1999 and 1998
Consolidated Statements of Cash Flows - Years ended September 30, 1999
and 1998
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules. All schedules for which provision is
made in the applicable accounting regulations of the Securities and Exchange
Commission are omitted because of the absence of conditions under which
37
<PAGE>
they are required or because the required information is included in the
consolidated financial statements and related notes thereto.
(3) Exhibits. The following is a list of exhibits filed as part of this
Annual Report on Form 10-K and is also the Exhibit Index.
<TABLE>
<CAPTION>
No. Description
- --- -----------
<S> <C> <C>
3.1 Articles of Incorporation of First Federal Bancorporation *
3.2 Bylaws of First Federal Bancorporation *
4 Form of Common Stock Certificate of First Federal
Bancorporation **
10.1 First Federal Bancorporation 1995 Stock Option and
Incentive Plan **
10.2 First Federal Bancorporation Management Recognition Plan *
10.3(a) Employment Agreement between First Federal Bancorporation
and William R. Belford *
10.3(b) Employment Agreement between First Federal Banking & Savings,
FSB and William R. Belford *
10.4 First Federal Banking & Savings, FSB Retirement Plan
for Non-Employee Directors *
10.5 First Federal Banking & Savings, FSB Deferred Compensation
Plan, as Amended and Restated *
10.6 First Federal Banking & Savings, FSB Supplemental
Retirement plan *
10.7 First Federal Bancorporation 1998 Stock Option Plan
13 Annual Report to Stockholders
21 Subsidiaries of the Registrant
23 Consent of McGladrey & Pullen LLP
27 Financial Data Schedule
</TABLE>
- ---------------------
(*) Incorporated herein by reference from Registration Statement on Form S-1
filed February 8, 1995 (File No. 33-86964).
(**) Incorporated herein by reference from Registration Statement on Form 8-A
filed March 15, 1995 (File No. 0-25704).
(b) Reports on Form 8-K. During the quarter ended September 30, 1999, the
-------------------
Registrant did not file any Current Reports on Form 8-K.
(c) Exhibits. The exhibits required by Item 601 of Regulation S-B are
--------
either filed as part of this Annual Report on Form 10-KSB or incorporated by
reference herein.
(d) Financial Statements and Schedules Excluded from Annual Report. There
--------------------------------------------------------------
are no other financial statements and financial statement schedules which were
excluded from the Annual Report to Stockholders pursuant to Rule 14a-3(b) which
are required to be included herein.
38
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
FIRST FEDERAL BANCORPORATION
December 20, 1999
By: /s/ William R. Belford
-----------------------------------
William R. Belford
President and Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
/s/ William R. Belford December 20, 1999
- ----------------------------------
William R. Belford
President, Chief Executive Officer
and Director
(Principal Executive Officer)
/s/ Dennis M. Vorgert December 20, 1999
- ----------------------------------
Dennis M. Vorgert
Vice President and Treasurer
(Principal Financial and Accounting Officer)
/s/ Ralph T. Smith December 20, 1998
- ----------------------------------
Ralph T. Smith
Chairman of the Board
/s/ Martin R. Sathre December 20, 1998
- ----------------------------------
Martin R. Sathre
Vice Chairman of the Board
/s/ Walter R. Fankhanel December 20, 1998
- ----------------------------------
Walter R. Fankhanel
Director
/s/ James R. Sharp December 20, 1998
- ----------------------------------
James R. Sharp
Director
/s/ Dean J. Thompson December 20, 1998
- ----------------------------------
Dean J. Thompson
Director
<PAGE>
Exhibit 10.7
FIRST FEDERAL BANCORPORATION
- --------------------------------------------------------------------------------
1998 Stock Option Plan
- --------------------------------------------------------------------------------
1. Purpose of the Plan.
The purpose of this Plan is to advance the interests of the Company through
providing select key Employees and Directors of the Bank, the Company, and their
Affiliates with the opportunity to acquire Shares. By encouraging such stock
ownership, the Company seeks to attract, retain and motivate the best available
personnel for positions of substantial responsibility and to provide additional
incentives to Directors and key Employees of the Company or any Affiliate to
promote the success of the business.
2. Definitions.
As used herein, the following definitions shall apply.
(a) "Affiliate" shall mean any "parent corporation" or "subsidiary
corporation" of the Company, as such terms are defined in Section 424(e) and
(f), respectively, of the Code.
(b) "Agreement" shall mean a written agreement entered into in accordance
with Paragraph 5(c).
(c) "Bank" shall mean First Federal Banking and Savings, FSB.
(d) "Board" shall mean the Board of Directors of the Company.
(e) "Change in Control" shall mean any one of the following events: (1) the
acquisition of ownership, holding or power to vote more than 25% of the Bank's
or the Company's voting stock, (2) the acquisition of the ability to control the
election of a majority of the Bank's or the Company's directors, (3) the
acquisition of a controlling influence over the management or policies of the
Bank or the Company by any person or by persons acting as a "group" (within the
meaning of Section 13(d) of the Securities Exchange Act of 1934), (except in the
case of (1), (2), and (3) hereof, ownership or control of the Bank by the
Company itself shall not constitute a "Change in Control"), or (4) during any
period of two consecutive years, individuals (the "Continuing Directors") who at
the beginning of such period constitute the Board of Directors of the Company or
the Bank (the "Existing Board") cease for any reason to constitute at least two-
thirds thereof, provided that any individual whose election or nomination for
election as a member of the Existing Board was approved by a vote of at least
two-thirds of the Continuing Directors then in office shall be considered a
Continuing Director. For purposes of this subparagraph only, the term "person"
refers to an individual or a corporation, partnership, trust, association, joint
venture, pool, syndicate, sole proprietorship, unincorporated organization or
any other form of entity not specifically listed herein. The decision of the
Committee as to whether a change in control has occurred shall be conclusive and
binding.
(f) "Code" shall mean the Internal Revenue Code of 1986, as amended.
(g) "Committee" shall mean the Stock Option Committee appointed by the
Board in accordance with Paragraph 5(a) hereof.
(h) "Common Stock" shall mean the common stock of the Company.
(i) "Company" shall mean First Federal Bancorporation.
<PAGE>
(j) "Continuous Service" shall mean the absence of any interruption or
termination of service as an Employee or Director of the Company or an
Affiliate. Continuous Service shall not be considered interrupted in the case
of sick leave, military leave or any other leave of absence approved by the
Company, in the case of transfers between payroll locations of the Company or
between the Company, an Affiliate or a successor, or in the case of a Director's
performance of services in an emeritus or advisory capacity.
(k) "Director" shall mean any member of the Board, and any member of the
board of directors of any Affiliate that the Board has by resolution designated
as being eligible for participation in this Plan.
(l) "Disability" shall mean a physical or mental condition, which in the
sole and absolute discretion of the Committee, is reasonably expected to be of
indefinite duration and to substantially prevent a Participant from fulfilling
his or her duties or responsibilities to the Company or an Affiliate.
(m) "Effective Date" shall mean the date specified in Paragraph 12 hereof.
(n) "Employee" shall mean any person who receives compensation, from the
Company or an Affiliate, that is reportable to the Internal Revenue Service on
Form W-2 (or a successor to that form).
(o) "Exercise Price" shall mean the price per Optioned Share at which an
Option may be exercised.
(p) "ISO" means an option to purchase Common Stock which meets the
requirements set forth in the Plan, and which is intended to be and is
identified as an "stock option" within the meaning of Section 422 of the Code.
(q) "Market Value" shall mean the fair market value of the Common Stock, as
determined under Paragraph 7(b) hereof.
(r) "Non-Employee Director" shall have the meaning provided in Rule 16b-3.
(s) "Non-ISO" means an option to purchase Common Stock which meets the
requirements set forth in the Plan but which is not intended to be and is not
identified as an ISO.
(t) "Option" means an ISO and/or a Non-ISO.
(u) "Optioned Shares" shall mean Shares subject to an Option granted
pursuant to this Plan.
(v) "Participant" shall mean any person who receives an Option pursuant to
the Plan.
(w) "Plan" shall mean this First Federal Bancorporation 1998 Stock Option
Plan.
(x) "Rule 16b-3" shall mean Rule 16b-3 of the General Rules and Regulations
under the Securities Exchange Act of 1934, as amended.
(y) "Share" shall mean one share of Common Stock.
(z) "Year of Service" shall mean a full twelve-month period, measured from
the grant date of an Option and each annual anniversary of that date, during
which a Participant has not terminated Continuous Service for any reason.
3. Term of the Plan and Options.
(a) Term of the Plan. The Plan shall continue in effect for a term of ten
years from the Effective Date, unless sooner terminated pursuant to Paragraph 14
hereof. No Option shall be granted under the Plan after ten years from the
Effective Date.
<PAGE>
(b) Term of Options. The term of each Option granted under the Plan shall
be established by the Committee, but shall not exceed 10 years; provided,
however, that in the case of an Employee who owns Shares representing more than
10% of the outstanding Common Stock at the time an ISO is granted, the term of
such ISO shall not exceed five years.
4. Shares Subject to the Plan.
Except as otherwise required under Paragraph 9, the aggregate number of
Shares deliverable pursuant to Options shall not exceed 100,000 Shares. Such
Shares may either be authorized but unissued Shares, Shares held in treasury, or
Shares held in a grantor trust created by the Company. If any Options should
expire, become unexercisable, or be forfeited for any reason without having been
exercised, the Optioned Shares shall, unless the Plan shall have been
terminated, be available for the grant of additional Options under the Plan.
5. Administration of the Plan.
(a) Composition of the Committee. The Plan shall be administered by the
Committee, which shall consist of at least two Non-Employee Directors appointed
by the Board. Members of the Committee shall serve at the pleasure of the
Board. In the absence at any time of a duly appointed Committee, the Plan shall
be administered by those members of the Board who are Non-Employee Directors.
(b) Powers of the Committee. Except as limited by the express provisions
of the Plan or by resolutions adopted by the Board, the Committee shall have
sole and complete authority and discretion (i) to select Participants and grant
Options, (ii) to determine the form and content of Options to be issued in the
form of Agreements under the Plan, (iii) to interpret the Plan, (iv) to
prescribe, amend and rescind rules and regulations relating to the Plan, and (v)
to make other determinations necessary or advisable for the administration of
the Plan. The Committee shall have and may exercise such other power and
authority as may be delegated to it by the Board from time to time. A majority
of the entire Committee shall constitute a quorum and the action of a majority
of the members present at any meeting at which a quorum is present, or acts
approved in writing by a majority of the Committee without a meeting, shall be
deemed the action of the Committee.
(c) Agreement. Each Option shall be evidenced by a written agreement
containing such provisions as may be approved by the Committee. Each such
Agreement shall constitute a binding contract between the Company and the
Participant, and every Participant, upon acceptance of such Agreement, shall be
bound by the terms and restrictions of the Plan and of such Agreement. The
terms of each such Agreement shall be in accordance with the Plan, but each
Agreement may include such additional provisions and restrictions determined by
the Committee, in its discretion, provided that such additional provisions and
restrictions are not inconsistent with the terms of the Plan. In particular,
the Committee shall set forth in each Agreement (i) the Exercise Price of an
Option, (ii) the number of Shares subject to, and the expiration date of, the
Option, (iii) the manner, time and rate (cumulative or otherwise) of exercise or
vesting of such Option, and (iv) the restrictions, if any, to be placed upon
such Option, or upon Shares which may be issued upon exercise of such Option.
The Chairman of the Committee and such other Directors and officers as
shall be designated by the Committee are hereby authorized to execute Agreements
on behalf of the Company and to cause them to be delivered to the recipients of
Options.
(d) Effect of the Committee's Decisions. All decisions, determinations and
interpretations of the Committee shall be final and conclusive on all persons
affected thereby.
(e) Indemnification. In addition to such other rights of indemnification
as they may have, the members of the Committee shall be indemnified by the
Company in connection with any claim, action, suit or proceeding relating to any
action taken or failure to act under or in connection with the Plan or any
Option, granted hereunder to the full extent provided for under the Company's
governing instruments with respect to the indemnification of Directors.
<PAGE>
6. Grant of Options.
(a) General Rule. The Committee shall have the discretion to make
discretionary grants of Options to Employees and Directors (including members of
the Committee), provided that the following Options shall automatically be
granted on the Effective Date:
<TABLE>
<CAPTION>
Percentage of Shares Reserved
Optionee Under the Plan
-------- --------------
<S> <C>
Belford 30.02%
Each non-employee Director 10.07%
Vorgert, Meissner, Sherwood, Jacobson, Nielson 3.02%
Sutton, Kaiser, Funk, Kroeger, Frenzel 1.51%
Lindgren, Collins, Sander, Roeder 0.76%
</TABLE>
Options granted on the Effective Date shall have an Exercise Price equal to
the Market Value per share on the Effective Date, shall have a term of ten
years, and shall become exercisable in accordance with the general rule set
forth in Paragraph 8 hereof.
(b) Reload Grants. In any Agreement or in a formal or informal program,
the Committee may establish terms and conditions under which an Option will be
granted upon the exercise of an Option or stock option granted under another
Company plan; provided that the Exercise Price for the new Option shall equal
the Market Value of the underlying Shares on that date.
7. Exercise Price for Options.
(a) Limits on Committee Discretion. The Exercise Price as to any
particular Option shall not be less than 100% of the Market Value of the
Optioned Shares on the date of grant. In the case of an Employee who owns
Shares representing more than 10% of the Company's outstanding Shares of Common
Stock at the time an ISO is granted, the Exercise Price shall not be less than
110% of the Market Value of the Optioned Shares at the time the ISO is granted.
(b) Standards for Determining Exercise Price. If the Common Stock is
listed on a national securities exchange (including the NASDAQ National Market
System) on the date in question, then the Market Value per Share shall be the
average of the highest and lowest selling price on such exchange on such date,
or if there were no sales on such date, then the Exercise Price shall be the
mean between the bid and asked price on such date. If the Common Stock is
traded otherwise than on a national securities exchange on the date in question,
then the Market Value per Share shall be the mean between the bid and asked
price on such date, or, if there is no bid and asked price on such date, then on
the next prior business day on which there was a bid and asked price. If no
such bid and asked price is available, then the Market Value per Share shall be
its fair market value as determined by the Committee, in its sole and absolute
discretion.
8. Exercise of Options.
(a) Generally. Unless the Committee specifically eliminates any vesting
requirement or imposes a different vesting schedule in an Agreement granting an
Option, each Option grant shall be vested and exercisable with respect to 50% of
the Optioned Shares on the date of the grant, and shall become vested and
exercisable with respect to the remaining 50% on the Optionee's completion of
one Year of Service; provided that vesting otherwise scheduled to occur prior to
stockholder approval of the Plan pursuant to Paragraph 12 hereof shall be
deferred until the date of such approval. An Option may not be exercised for a
fractional Share.
(b) Procedure for Exercise. A Participant may exercise Options, subject to
provisions relative to its termination and limitations on its exercise, only by
(1) written notice of intent to exercise the Option with respect to a specified
number of Shares, and (2) payment to the Company (contemporaneously with
delivery of such notice) in cash, in Common Stock, or a combination of cash and
Common Stock, of the amount of the Exercise Price for the number of Shares with
respect to which the Option is then being exercised. Each such notice (and
payment where required) shall be delivered, or mailed by prepaid registered or
certified mail, addressed to the Treasurer of the Company at its
<PAGE>
executive offices. Common Stock utilized in full or partial payment of the
Exercise Price for Options shall be valued at its Market Value at the date of
exercise, and may consist of Shares subject to the Option being exercised.
(c) Period of Exercisability. Except to the extent otherwise provided in
the terms of an Agreement, an Option may be exercised by a Participant only
while he is an Employee and has maintained Continuous Service from the date of
the grant of the Option, or within one year after termination of such Continuous
Service (but not later than the date on which the Option would otherwise
expire), except if the Employee's Continuous Service terminates by reason of -
(1) "Just Cause" which for purposes hereof shall have the meaning set
forth in any unexpired employment or severance agreement between the
Participant and the Bank and/or the Company (and, in the absence of any
such agreement, shall mean termination because of the Employee's personal
dishonesty, incompetence, willful misconduct, breach of fiduciary duty
involving personal profit, intentional failure to perform stated duties,
willful violation of any law, rule or regulation (other than traffic
violations or similar offenses) or final cease-and-desist order), then the
Participant's rights to exercise such Option shall expire on the date of
such termination;
(2) death, then to the extent that the Participant would have been
entitled to exercise the Option immediately prior to his death, such Option
of the deceased Participant may be exercised within two years from the date
of his death (but not later than the date on which the Option would
otherwise expire) by the personal representatives of his estate or person
or persons to whom his rights under such Option shall have passed by will
or by laws of descent and distribution.
(d) Effect of the Committee's Decisions. The Committee's determination
whether a Participant's Continuous Service has ceased, and the effective date
thereof, shall be final and conclusive on all persons affected thereby.
(e) Mandatory Six-Month Holding Period. Notwithstanding any other
provision of this Plan to the contrary, Common Stock that is purchased upon
exercise of an Option may not be sold within the six-month period following the
grant date of that Option, except in the event of the Participant's death or
disability, or such other event as the Board may specifically deem appropriate.
9. Change in Control; Effect of Changes in Common Stock Subject to the
Plan.
(a) Change in Control. Upon the earlier of a Change in Control or the
execution of an agreement to effect a Change in Control, all Options shall
become fully exercisable, notwithstanding any other provision of the Plan or any
Agreement.
(b) Recapitalizations; Stock Splits, Etc. The number and kind of shares
reserved for issuance under the Plan, and the number and kind of shares subject
to outstanding Options, and the Exercise Price thereof, shall be proportionately
adjusted for any increase, decrease, change or exchange of Shares for a
different number or kind of shares or other securities of the Company which
results from a merger, consolidation, recapitalization, reorganization,
reclassification, stock dividend, split-up, combination of shares, or similar
event in which the number or kind of shares is changed without the receipt or
payment of consideration by the Company.
(c) Transactions in which the Company is Not the Surviving Entity. In the
event of (i) the liquidation or dissolution of the Company, (ii) a merger or
consolidation in which the Company is not the surviving entity, or (iii) the
sale or disposition of all or substantially all of the Company's assets (any of
the foregoing to be referred to herein as a "Transaction"), all outstanding
Options, together with the Exercise Prices thereof, shall be equitably adjusted
for any change or exchange of Shares for a different number or kind of shares or
other securities which results from the Transaction.
<PAGE>
(e) Conditions and Restrictions on New, Additional, or Different Shares or
Securities. If, by reason of any adjustment made pursuant to this Paragraph, a
Participant becomes entitled to new, additional, or different shares of stock or
securities, such new, additional, or different shares of stock or securities
shall thereupon be subject to all of the conditions and restrictions which were
applicable to the Shares pursuant to the Option before the adjustment was made.
(f) Other Issuances. Except as expressly provided in this Paragraph, the
issuance by the Company or an Affiliate of shares of stock of any class, or of
securities convertible into Shares or stock of another class, for cash or
property or for labor or services either upon direct sale or upon the exercise
of rights or warrants to subscribe therefor, shall not affect, and no adjustment
shall be made with respect to, the number, class, or Exercise Price of Shares
then subject to Options or reserved for issuance under the Plan.
10. Non-Transferability of Options.
Options may not be sold, pledged, assigned, hypothecated, transferred or
disposed of in any manner other than by will or by the laws of descent and
distribution. Notwithstanding the foregoing, or any other provision of this
Plan, a Participant who holds Options may transfer such Options (but not ISOs)
to his or her spouse, lineal ascendants, lineal descendants, or to a duly
established trust for the benefit of one or more of these individuals. Options
so transferred may thereafter be transferred only to the Participant who
originally received the grant or to an individual or trust to whom the
Participant could have initially transferred the Options pursuant to this
Paragraph. Options which are transferred pursuant to this Paragraph shall be
exercisable by the transferee according to the same terms and conditions as
applied to the Participant.
11. Time of Granting Options.
The date of grant of an Option shall, for all purposes, be the later of the
date on which the Committee makes the determination of granting such Option, and
the Effective Date. Notice of the determination shall be given to each
Participant to whom an Option is so granted within a reasonable time after the
date of such grant.
12. Effective Date.
The Plan shall be effective November 24, 1998; provided that (i) the
effectiveness of the Plan and any Option shall be absolutely contingent upon the
Plan's approval by a favorable vote of stockholders owning at least a majority
of the total votes cast at a duly called meeting of the Company's stockholders
held in accordance with applicable laws, and (ii) no Options shall become
exercisable prior to approval of the Plan by the stockholders of the Company.
13. Modification of Options.
At any time, and from time to time, the Board may authorize the Committee
to direct execution of an instrument providing for the modification of any
outstanding Option, provided no such modification shall confer on the holder of
said Option any right or benefit which could not be conferred on him by the
grant of a new Option at such time, or impair the Option without the consent of
the holder of the Option.
14. Amendment and Termination of the Plan.
The Board may from time to time amend the terms of this Plan and, with
respect to any Shares at the time not subject to Options, suspend or terminate
this Plan. No amendment, suspension or termination of this Plan shall, without
the consent of any affected holders of an Option, alter or impair any rights or
obligations under any Option theretofore granted.
15. Conditions Upon Issuance of Shares.
(a) Compliance with Securities Laws. Shares of Common Stock shall not be
issued with respect to any Option unless the issuance and delivery of such
Shares shall comply with all relevant provisions of law, including, without
limitation, the Securities Act of 1933, as amended, the rules and regulations
promulgated thereunder, any applicable state securities law, and the
requirements of any stock exchange upon which the Shares may then be listed.
<PAGE>
(b) Special Circumstances. The inability of the Company to obtain approval
from any regulatory body or authority deemed by the Company's counsel to be
necessary to the lawful issuance and sale of any Shares hereunder shall relieve
the Company of any liability in respect of the non-issuance or sale of such
Shares. As a condition to the exercise of an Option, the Company may require
the person exercising the Option to make such representations and warranties as
may be necessary to assure the availability of an exemption from the
registration requirements of federal or state securities law.
(c) Committee Discretion. The Committee shall have the discretionary
authority to impose in Agreements such restrictions on Shares as it may deem
appropriate or desirable, including but not limited to the authority to impose a
right of first refusal, or to establish repurchase rights, or to pay an Optionee
the in-the-money value of his Option in consideration for its cancellation, or
all of these restrictions.
16. Reservation of Shares.
The Company, during the term of the Plan, will reserve and keep available a
number of Shares sufficient to satisfy the requirements of the Plan.
17. Withholding Tax.
The Company's obligation to deliver Shares upon exercise of Options shall
be subject to the Participant's satisfaction of all applicable federal, state
and local income and employment tax withholding obligations. The Committee, in
its discretion, may permit the Participant to satisfy the obligation, in whole
or in part, by irrevocably electing to have the Company withhold Shares, or to
deliver to the Company Shares that he already owns, having a value equal to the
amount required to be withheld. The value of the Shares to be withheld, or
delivered to the Company, shall be based on the Market Value of the Shares on
the date the amount of tax to be withheld is to be determined. As an
alternative, the Company may retain, or sell without notice, a number of such
Shares sufficient to cover the amount required to be withheld.
18. No Employment or Other Rights.
In no event shall an Employee's or Director's eligibility to participate or
participation in the Plan create or be deemed to create any legal or equitable
right of the Employee, Director, or any other party to continue service with the
Company, the Bank, or any Affiliate of such corporations. Except to the extent
provided in Paragraphs 6(b) and 9(a), no Employee or Director shall have a right
to be granted an Option or, having received an Option, the right to again be
granted an Option. However, an Employee or Director who has been granted an
Option may, if otherwise eligible, be granted an additional Option or Options.
19. Governing Law.
The Plan shall be governed by and construed in accordance with the laws of
the State of Minnesota, except to the extent that federal law shall be deemed to
apply.
<PAGE>
Exhibit 13
[ L O G O ]
ANNUAL REPORT FOR
THE YEAR ENDED
SEPTEMBER 30, 1999
<PAGE>
[FIRST FEDERAL BANCORPORATION LETTER]
December 15, 1999
To Our Stockholders:
We are pleased to present our fourth Annual Report of First Federal
Bancorporation and its principal subsidiary, First Federal Bank. This report
details a productive year for First Federal Bank.
We are pleased to report the following positive changes during 1999:
* The Bank completed its Y2K testing and contingency effort to prepare
itself for the new millennium.
* On May 20, 1999 First Federal Bancorporation paid a 50% stock dividend
to shareholders of record as of May 5, 1999 as a result of a three for
two stock split declared April 20, 1999.
* During the fiscal year, First Federal Bancorporation completed the
acquisition of 58,780 shares under a previously announced stock
repurchase plan. In addition, on October 26, 1999 the company announced
a 10% additional repurchase, or 142,326 shares, of outstanding shares.
* During 1999, First Federal Bank introduced new products including
Internet Banking/Bill Paying Services and sales of securities and
insurance products through its wholly owned subsidiary, First Federal
Service Corporation.
We thank you for your support and pledge our continuing effort toward enhancing
shareholder value.
Sincerely,
/s/ William R. Belford
- ----------------------
William R. Belford
President
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
At September 30, Change
------------------------- -----------------------
1999 1998 Amount Percent
---------- ---------- --------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Financial Position:
Total assets......................... $ 132,290 $ 125,251 $ 7,039 5.62%
Loans receivable, net................ 57,257 56,064 1,193 2.13
Securities available for sale........ 31,272 36,833 (5,561) (15.10)
Securities held to maturity.......... 33,809 23,299 10,510 45.11
Deposits............................. 88,111 85,866 2,245 2.61
Stockholders' equity................. 13,061 13,082 (21) (0.16)
Number of common shares issued (1)... 1,431,069 1,489,913 (58,844) (3.95)
</TABLE>
<TABLE>
<CAPTION>
For the Year Ended
September 30, Change
---------------------- ---------------------
1999 1998 Amount Percent
---------- ---------- -------- ----------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Results of Operations:
Interest income...................... $ 8,756 $ 8,520 $ 236 2.77%
Interest expense..................... 5,133 4,906 227 4.63
Net interest income.................. 3,623 3,614 9 0.25
Provision for loan losses............ 98 153 (55) (35.95)
Net interest income after provision
for loan losses..................... 3,525 3,461 64 1.85
Non-interest income.................. 567 651 (84) (12.90)
Non-interest expense................. 2,849 2,811 38 1.35
Earnings before income taxes......... 1,243 1,301 (58) (4.46)
Net earnings......................... 770 814 (44) (5.41)
</TABLE>
______________
(1) Adjusted to retroactively give effect to a 3-for-2 stock split paid in the
form of a stock dividend on May 20, 1999.
1
<PAGE>
SELECTED FINANCIAL INFORMATION
Summary of Financial Condition
<TABLE>
<CAPTION>
At September 30,
------------------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Total amount of:
Assets.................................. $132,290 $125,251 $111,492 $107,256 $ 99,507
Loans receivable, net................... 57,257 56,064 53,589 51,003 48,044
Investment securities:
Available for sale...................... 16,071 19,732 28,757 25,750 15,632
Held to maturity........................ 33,574 22,992 -- -- --
Mortgage-backed and related securities:
Available for sale...................... 15,201 17,101 18,834 19,903 20,417
Held to maturity........................ 234 307 530 846 1,106
Deposit accounts......................... 88,111 85,866 83,003 81,047 82,060
Advances from FHLB....................... 24,957 20,457 9,534 6,943 --
Other borrowings......................... 4,701 4,435 4,697 4,955 1,000
Stockholders' equity..................... 13,061 13,082 11,941 12,323 15,091
</TABLE>
Summary of Operations
<TABLE>
<CAPTION>
Year Ended September 30,
-----------------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- -------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Interest income.......................... $ 8,756 $ 8,520 $ 7,891 $ 7,429 $ 6,732
Interest expense......................... 5,133 4,906 4,457 4,016 3,547
-------- -------- -------- -------- -------
Net interest income before
provision for loan losses............... 3,623 3,614 3,434 3,413 3,185
Provision for loan losses................ 98 153 -- -- 4
Non-interest income...................... 567 651 571 533 361
Non-interest expense..................... 2,849 2,811 2,805 3,414 2,387
-------- -------- -------- -------- -------
Income before income tax expense......... 1,243 1,301 1,200 532 1,155
Income tax expense....................... 473 487 492 216 473
-------- -------- -------- -------- -------
Net income............................... $ 770 $ 814 $ 708 $ 316 $ 682
======== ======== ======== ======== =======
- ---------------------------------------------------------------------------------------------------------
Per Share Data:
Basic earnings per share (1)........... $ .66 $ .70 $ .58 $ .20 .22
Diluted earnings per share (1)......... .64 .65 .56 .19 .22
Pro forma basic earnings per share(1).. -- -- -- -- .38
Book value (1)......................... 10.56 10.09 9.05 8.25 7.78
</TABLE>
_________________
(1) Adjusted to retroactively give effect to a 3-for-2 stock split paid in the
form of a stock dividend on May 20, 1999.
2
<PAGE>
Key Operating Ratios
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------------------------
1999 1998 1997 1996 1995
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Return on assets (net earnings divided
by average total assets).................. 0.60% 0.69% 0.65% 0.31% 0.73%
Return on equity (net earnings
divided by average equity)................ 5.85 6.60 5.87 2.31 6.45
Tangible-equity-to-assets ratio (average
equity divided by average total assets).. 10.22 10.44 11.10 13.25 11.40
Interest rate spread....................... 2.61 2.87 2.94 3.02 3.29
Net interest margin (1).................... 2.94 3.23 3.32 3.51 3.63
Non-performing loans to total loans (2).... 0.68 0.90 0.17 0.41 0.18
Non-performing assets to total assets (3).. 0.44 0.53 0.32 0.38 0.24
Allowance for loan losses to total loans... 0.95 0.86 0.78 0.87 0.99
Allowance for loan losses to non-performing
loans.................................... 140.15 96.14 464.13 214.93 564.37
Net charge-offs to average loans........... 0.07 0.15 0.05 0.08 0.09
Non-interest expense to average assets..... 2.21 2.38 2.58 3.30 2.57
Average interest-earning assets to average
interest-bearing liabilities............. 107.83 108.32 108.73 111.96 108.27
</TABLE>
___________
(1) Net interest income/average interest earning assets.
(2) Includes non-accruing loans and loans delinquent 90 days or more.
(3) Includes non-performing loans and real estate owned.
Note: The following discussion is provided to assist readers in their
understanding of the consolidated financial statements of First Federal
Bancorporation. This discussion should be read in conjunction with the
consolidated financial statements and other financial information presented
elsewhere in this report.
3
<PAGE>
BUSINESS OF THE COMPANY AND THE BANK
First Federal Bancorporation
First Federal Bancorporation (the "Company") was incorporated under
the laws of the State of Minnesota in September 1994 at the direction of the
Board of Directors of First Federal Banking & Savings, FSB ("First Federal" or
the "Bank") for the purpose of serving as a savings and loan holding company of
the Bank upon the acquisition of all of the capital stock issued by the Bank
upon its conversion from the mutual to the stock form of ownership (the
"Conversion"). On April 3, 1995, the Bank completed the Conversion and the
Company completed its offering of Common Stock through the sale and issuance of
1,940,625 shares of Common Stock at a price of $4.44 per share realizing gross
proceeds of $8.63 million and net proceeds of $7.96 million. Since the
Conversion, the Company has repurchased 509,556 shares of its Common Stock, and
as of September 30, 1999, there were 1,431,069 shares of Common Stock issued and
1,141,465 shares of Common Stock outstanding. Prior to the Conversion, the
Company did not engage in any material operations. Currently, the Company's
principal business is the business of the Bank. The Company has no significant
assets other than the outstanding capital stock of the Bank, $281,000 of cash
and cash equivalents and $2.10 million in securities available for sale, and
$236,000 in other assets. All share numbers in this Annual Report have been
adjusted for the 3-for-2 stock split paid in the form of a stock dividend on May
20, 1999.
First Federal Bank
First Federal was originally chartered in 1910 as Beltrami County
Savings and Building Association, a state-chartered savings institution, and
commenced operations in that same year. First Federal has been a member of the
Federal Home Loan Bank ("FHLB") of Des Moines since 1933, and its deposits have
been federally insured since 1938. In August 1997, the Bank changed its name to
"First Federal Bank." First Federal currently operates as a federally chartered
savings bank through its main office located in Bemidji, Minnesota and four
branch offices, which are located in Bemidji, Bagley, Baudette and Walker,
Minnesota. The Bank's market area is located approximately 200 miles north of
Minneapolis, Minnesota.
First Federal is primarily engaged in the business of attracting
deposits from the general public and originating loans secured by first
mortgages on owner occupied one- to four-family residences in First Federal's
market area. First Federal also originates loans on commercial real estate,
multi-family real estate, home equity lines of credit and other consumer loans,
and commercial business loans. Due to limited loan demand in its market area,
First Federal has increased its consumer lending activities in recent years
(primarily automobile and home equity loans) and has invested excess funds in
mortgage-backed and related securities and in other investment securities, and
during fiscal 1999 continued to be active in originating and purchasing
participation interests in commercial real estate loans.
The Bank is subject to examination and comprehensive regulation by the
Office of Thrift Supervision ("OTS"), and the Bank's savings deposits are
insured up to applicable limits by the Savings Association Insurance Fund
("SAIF"), which is administered by the Federal Deposit Insurance Corporation
("FDIC"). The Bank is a member of, and owns capital stock in the FHLB of Des
Moines, which is one of 12 regional banks in the FHLB System. The Bank is
further subject to regulations of the Board of Governors of the Federal Reserve
System (the "Federal Reserve Board") governing reserves to be maintained and
certain other matters.
The Company's and the Bank's executive offices are located at 214 5th
Street, Bemidji, Minnesota 56601, and the main telephone number is (218) 751-
5120.
4
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The Bank is primarily engaged in the business of attracting deposits
from the general public and originating loans secured by mortgages on owner
occupied one- to four-family residences in the Bank's market area. First Federal
also originates loans on commercial real estate, multi-family real estate, home
equity lines of credit and other consumer loans. In recent years, due to limited
loan demand in the Bank's market area, First Federal has significantly increased
its origination of consumer loans, including automobile and home equity loans,
and has invested excess funds in mortgage-backed and related securities and in
other investment securities.
The Bank's net income is dependent primarily on its net interest
income, which is the difference between interest earned on loans and
investments, and the interest paid on interest bearing liabilities, primarily
deposits. Net interest income is determined by (i) the difference between the
yield earned on interest-earning assets and rates paid on interest-bearing
liabilities ("interest rate spread") and (ii) the relative amounts of interest-
earning assets and interest-bearing liabilities. The Bank's interest rate spread
is also affected by regulatory, economic and competitive factors that influence
interest rates, loan demand and deposit flows. The Bank's net income is also
affected by the generation of non-interest income, which primarily consists of
fees and service charges. In addition, net income is affected by the level of
operating expenses and provisions for loan losses.
The operations of financial institutions, including the Bank, are
significantly affected by prevailing economic conditions, competition and
regulatory policies, and the monetary and fiscal policies of the U.S. Government
and government agencies. Lending activities are influenced by the demand for,
and supply of housing, competition among lenders, the level of interest rates
and the availability of funds. Deposit flows and costs of funds are influenced
by prevailing market rates of interest primarily on competing investments,
account maturities and the levels of personal income and savings in the market
area of the Bank.
Year 2000 Readiness Disclosure
The Year 2000 ("Y2K") issue is the result of computer programs using a
two-digit format, as opposed to four digits, to indicate the year. Such computer
systems will be unable to interpret dates beyond the year 1999, which could
cause a system failure or other computer errors, leading to disruptions in
operations. The Company's Year 2000 Action Plan was presented to the Board of
Directors in September 1997. The year 2000 Action Plan includes the following
phases: awareness, assessment, renovation, validation and implementation. During
the assessment phase, the Year 2000 Project Team identified those areas which
could be affected by the year 2000 date change. During August 1998, the Company
completed the renovation of both the hardware and software for its operating and
teller systems. The Company has renovated some of its ancillary systems (i.e.
check processing, ATM network, etc.) The Company has participated in user group
testing of its operating and teller system. This testing has now been completed
and a review and analysis of the test results has been done. The review did not
disclose any items of concern as a result of changing the dates into the Year
2000. Testing for other mission-critical systems (communication software) has
also been completed. The Company has incurred $412,000 for capital expenditures
relating to Year 2000 hardware and software issues. Progress reports are
presented to the Board of Directors at least quarterly. The Company's
subsidiary, First Federal Bank (the 'Bank') is monitoring the status of its
commercial customers to determine the potential for loss in relation to these
customers not being ready for the year 2000.
The most likely, worst case scenario for the transition to the Year
2000 would be the failure of the application software and teller software. Due
to the complexity and time needed to convert to an alternative system in the
event that the Bank's application and teller system do not operate in the Year
2000, it will be necessary to manually update information until such time that
the programs and applications are corrected to accommodate the year 2000. When
data processing functions are completed on December 31, 1999, a detailed trial
balance of all the applications will be
5
<PAGE>
generated. Authorization for withdrawals will be based on the information
contained in these trial balances. Any transactions completed in subsequent days
will be reflected in an addendum to the trial balances on a daily basis.
Asset and Liability Management
General. The interest rate sensitivity of assets and liabilities may
be analyzed by examining the extent to which such assets and liabilities will
mature or reprice within the same period. The interest rate sensitivity gap is
defined as the difference between the amount of interest-earning assets maturing
or repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within that time period. A gap is considered
positive within a particular period when the amount of interest rate sensitive
assets exceeds the amount of interest rate sensitive liabilities, and is
considered negative when the amount of interest rate sensitive liabilities
exceeds the amount of interest rate sensitive assets. Generally, during a period
of rising interest rates, a negative gap would adversely affect net interest
income while a positive gap would result in an increase in net interest income.
Conversely, during a period of falling interest rates, a negative gap would
result in an increase in net interest income and a positive gap would adversely
affect net interest income.
Interest Rate Risk. The Bank seeks to maximize its net interest margin
within an acceptable level of interest rate risk. Interest rate risk can be
defined as the change in the Bank's net portfolio value resulting from favorable
or unfavorable movements in interest rates. Interest rate risk, or sensitivity,
arises when the maturity or repricing characteristics of assets differ
significantly from the maturity or repricing characteristics of liabilities.
The following table sets forth the Bank's interest rate sensitivity
gaps for selected maturity periods at September 30, 1999 (in thousands).
<TABLE>
<CAPTION>
Rate Sensitivity Period
----------------------------------------------
1-180 181-365 1-2 Over 2
Days Days Years Years Total
----- ------- ----- ------ -----
<S> <C> <C> <C> <C> <C>
Earning assets:
Loans
Fixed-rate........................... $ 1,993 $ 1,840 $ 3,367 $13,445 $ 20,655
Variable-rate........................ 21,087 8,665 1,699 5,151 36,602
Securities
Fixed-rate (1)....................... 4,713 1,022 1,189 17,333 24,257
Variable-rate........................ 43,002 414 1,000 -- 44,416
------- -------- ------- ------- --------
Total earning assets................. 70,795 11,941 7,255 35,939 125,930
------- -------- ------- ------- --------
Interest-bearing liabilities:
Time deposits.......................... 21,558 13,307 10,582 8,892 54,339
Now and money market
deposits (2)....................... 1,829 1,829 -- 21,850 25,508
Savings deposits (2)................... 556 556 -- 7,152 8,264
Borrowings............................. 29,453 168 37 -- 29,658
------- -------- ------- ------- --------
Total interest-bearing liabilities.. 53,396 15,860 10,619 37,894 117,769
------- -------- ------- ------- --------
Incremental asset (liability) gap........ 17,399 (3,919) (3,364) (1,955) 8,161
------- -------- ------- ------- --------
Cumulative asset (liability) gap......... 17,399 13,480 10,116 8,161 8,161
------- -------- ------- ------- --------
</TABLE>
___________
(1) Maturity of mortgage-backed and asset-backed securities are presented
based on the current estimated cash flows.
(2) Historically, the Bank's NOW accounts and savings deposits have been
relatively insensitive to interest rate changes. However, the Bank
considers a portion of savings deposits to be rate sensitive based on
historical growth trends and management's expectations.
6
<PAGE>
While the gap analysis provides an indication of interest rate sensitivity,
experience has shown that it does not fully capture the true dynamics of
interest rate changes. Essentially, the analysis presents only a static
measurement of asset and liability volumes based on contractual maturity, cash
flow estimates or repricing opportunity. It fails to reflect the differences in
the timing and degree of repricing of assets and liabilities due to interest
rate changes. In analyzing interest rate sensitivity, management considers these
differences and incorporate other assumptions and factors, such as balance sheet
growth and prepayments, to better measure interest rate risk.
A principal objective of the Bank's asset/liability management effort is to
balance the various factors that generate interest rate risk, thereby
maintaining the interest rate sensitivity of the Bank within acceptable risk
levels. To manage interest rate risk, the Bank assesses its current risk
position in light of interest rate forecasts and develops and implements
specific lending, funding and investment strategies. The Bank may also use
derivative financial instruments, including interest rate swaps, caps, floors,
future and options, to manage interest rate risk. To date such instruments have
not been utilized.
Financial Condition and Results of Operations
Financial Condition. The Company's total assets increased by $7.04 million,
or 5.62%, from $125.25 million at September 30, 1998 to $132.29 million at
September 30, 1999. The increase in total assets resulted primarily from an
increase in investment securities of $6.92 million, and an increase in loans
receivable, net, of $1.19 million, offset by a decrease in mortgage-backed and
related securities of $1.97 million.
Investment securities and mortgage-backed and related securities totaling
$65.08 million at September 30, 1999, consisted of $31.27 million in securities
classified as available for sale and $33.81 million in securities classified as
held to maturity. Loans receivable, net, increased $1.19 million as a result of
an excess of new loan originations and purchases over repayments and refinances.
The Company experienced an increase in deposits during fiscal 1999 of $2.24
million, or 2.61%, from $85.87 million at September 30, 1998 to $88.11 million
at September 30, 1999. Repurchase agreements increased $1.56 million, or 49.94%,
from $3.14 million at September 30, 1998 to $4.70 million at September 30, 1999.
The Company has made extensive use of the Federal Home Loan Bank Advance
program during the twelve months ended September 30, 1999. Federal Home Loan
Bank advances have increased from $20.46 million at September 30, 1998 to $24.96
million at September 30, 1999. These borrowings have been used to generate
income on the spread between the yield on the investments purchased with the
borrowings and the rate on the borrowings.
Comparison of Operating Results for the Years Ended September 30, 1999 and
September 30, 1998
Net Earnings. The Company had net earnings of $770,000 for the year ended
September 30, 1999, as compared to $814,000 for the year ended September 30,
1998. As discussed below, the decrease in net earnings of $44,000 was primarily
the result of a decrease in non-interest income of $84,000 and an increase in
non-interest expense of $38,000, partially offset by a $9,000 increase in net
interest income and a $55,000 decrease in the provision for loan losses.
Net Interest Income. Net interest income increased by $9,000, or 0.26%,
from $3.61 million for the year ended September 30, 1998 to $3.62 million for
the year ended September 30, 1999. Average interest-earning assets increased
$11.37 million, or 10.15%, while average interest-bearing liabilities increased
$11.01 million, or 10.65%. During this same period, the interest rate spread
decreased from 2.87% for the year ended September 30, 1998 to 2.61% for the year
ended September 30, 1999.
Interest Income. Interest income increased by $236,000, or 2.77%, from
$8.52 million for the year ended September 30, 1998 to $8.76 million for the
year ended September 30, 1999. This increase was due primarily to an increase in
the average outstanding balance of interest-earning assets. Total average
interest-earning assets increased
7
<PAGE>
10.15% during the year ended September 30, 1999. At the same time the overall
yield on interest-earning assets decreased 51 basis points from 7.61% for the
year ended September 30, 1998 to 7.10% for the year ended September 30, 1999.
Interest Expense. Interest expense increased by $226,000, or 4.61%, from
$4.91 million for the year ended September 30, 1998 to $5.13 million for the
year ended September 30, 1999. The increase was primarily the result of a $6.88
million increase in the average outstanding balances of Federal Home Loan Bank
advances, a $2.60 million increase in average outstanding balances of money
market deposit accounts and a $1.42 million increase in average outstanding
balances of repurchase agreements.
Provision for Losses on Loans. The Bank decreased its provision for loan
losses by $55,000 during the year ended September 30, 1999, from $153,000 for
the year ended September 30, 1998 to $98,000 for the year ended September 30,
1999. The Bank continues to monitor and modify its allowance for losses as
conditions dictate. Although the Bank maintains its allowance for losses at a
level it considers adequate to provide for probable losses, there can be no
assurance that such losses will not exceed the estimated amounts or that
additional provisions for loan losses will not be required in future periods.
Non-interest Income. Total non-interest income decreased by $84,000, or
12.90%, from $651,000 for the year ended September 30, 1998 to $567,000 for the
year ended September 30, 1999. This decrease was primarily due to an $83,000
provision for loss on investment securities, a $21,000 decrease in fees and
service charges, primarily loan processing fees, individual retirement account
fees and ATM access fees, and a $5,000 decrease in other non-interest income.
These decreases were offset by a $25,000 decrease in the loss on the sales of
foreclosed real estate.
Non-interest Expense. Non-interest expense increased $38,000, or 1.36%,
from $2.81 million for the year ended September 30, 1998 to $2.85 million for
the year ended September 30, 1999. This increase was primarily due to a $27,000
increase in occupancy expense, an $8,000 increase in advertising expense and a
$3,000 increase in other non-interest expenses.
Income Tax Expense. Income tax expense decreased $14,000, or 2.86%, from
$487,000 for the year ended September 30, 1998 to $473,000 for the year ended
September 30, 1999.
Comparison of Operating Results for the Years Ended September 30, 1998 and
September 30, 1997
Net Earnings. The Company had net earnings of $814,000 for the year ended
September 30, 1998, as compared to $708,000 for the year ended September 30,
1997. As discussed below, the increase in net earnings of $106,000 was primarily
the result of an increase in net interest income of $180,000 and an increase in
non-interest income of $80,000, partially offset by an increase in the provision
for loan losses of $153,000.
Net Interest Income. Net interest income increased by $180,000, or 5.23%,
from $3.43 million for the year ended September 30, 1997 to $3.61 million for
the year ended September 30, 1998. Average interest-earning assets increased
$8.51 million, or 8.22%, while average interest-bearing liabilities increased
$8.22 million, or 8.63%. During this same period, the interest rate spread
decreased from 2.94% for the year ended September 30, 1997 to 2.86% for the year
ended September 30, 1998.
Interest Income. Interest income increased by $629,000, or 7.97%, from
$7.89 million for the year ended September 30, 1997 to $8.52 million for the
year ended September 30, 1998. This increase was due primarily to an increase in
the average outstanding balance of interest-earning assets. Total average
interest-earning assets increased 8.22% during the year ended September 30,
1998. At the same time the overall yield on interest-earning assets remained
relatively unchanged for the same period.
Interest Expense. Interest expense increased by $449,000, or 10.08%, from
$4.46 million for the year ended September 30, 1997 to $4.91 million for the
year ended September 30, 1998. The increase was primarily the result of
8
<PAGE>
an increase in the average outstanding balances of Federal Home Loan Bank
advances and certificates of deposits, and partially offset by a decrease in the
average balances of repurchase agreements.
Provision for Losses on Loans. The Bank increased its provision for loan
losses by $153,000 during the year ended September 30, 1998 compared to no
provisions for the year ended September 30, 1997. The increase in the provision
for losses on loans relates primarily to an increase in non-performing loans.
The Bank continues to monitor and modify its allowance for losses as conditions
dictate. Although the Bank maintains its allowance for losses at a level it
considers adequate to provide for probable losses, there can be no assurance
that such losses will not exceed the estimated amounts or that additional
provisions for loan losses will not be required in future periods.
Non-interest Income. Total non-interest income increased by $80,000, or
14.07%, from $571,000 for the year ended September 30, 1997 to $651,000 for the
year ended September 30, 1998. This increase was related to a $135,000 increase
in fees and service charges, primarily loan processing fees, deposit account
fees and ATM access fees; and a $15,000 increase in other non-interest income.
These increases were offset by a $70,000 decrease in the gains on the sales of
securities and foreclosed real estate.
Non-interest Expense. Non-interest expense remained relatively unchanged,
increasing only $7,000, or 0.23%, from $2.80 million for the year ended
September 30, 1997 to $2.81 million for the year ended September 30, 1998. This
increase was primarily due to a $58,000 increase in compensation and employee
benefits, and a $32,000 increase in other non-interest expenses, offset by a
$29,000 decrease in occupancy expense, primarily depreciation, a $33,000
decrease in federal deposit insurance premiums, and a $24,000 decrease in
advertising expense.
Income Tax Expense. Income tax expense decreased $5,000, or 1.07%, from
$492,000 for the year ended September 30, 1997 to $487,000 for the year ended
September 30, 1998.
Allowance for Loan Losses
In originating loans, the Company recognizes that credit losses will be
experienced and that the risk of loss will vary with, among other things, the
type of loan being made, the creditworthiness of the borrower over the term of
the loan, general economic conditions and, in the case of a secured loan, the
quality of the security for the loan. It is management's policy to maintain an
adequate allowance for loan losses based on, among other things, the Company's
historical loan loss experience, evaluation of economic conditions, regular
reviews of delinquencies and loan portfolio quality. The Company increases its
allowance for loan losses by charging provisions for loan losses against the
Company's income. Management will continue to actively monitor the Company's
asset quality and allowance for loan losses. Management will charge off loans
and properties acquired in settlement of loans against the allowance for losses
on such loans and such properties when appropriate and will provide specific
loss allowances when necessary. Although management believes it uses the best
information available to make determinations with respect to the allowance for
losses, future adjustments may be necessary if economic conditions differ
substantially from the economic conditions in the assumptions used in making the
initial determination.
9
<PAGE>
The following table reflects the activity in the allowance for loan losses.
<TABLE>
<CAPTION>
At or for the
Year Ended September 30,
------------------------
1999 1998
------- ------
(Dollars in thousands)
<S> <C> <C>
Balance at the beginning of the year.................................... $ 498 $ 427
Provision for losses.................................................... 98 153
Charge-offs............................................................. (52) (109)
Recoveries.............................................................. 11 27
------- -------
Net charge-offs....................................................... (41) (82)
------- -------
Balance at end of the year.............................................. $ 555 $ 498
======= =======
Ratio of net charge-offs to average loans
outstanding during the period.......................................... 0.07% 0.15%
======= =======
Ratio of allowance for loan losses
to total loans......................................................... 0.95% 0.86%
======= =======
</TABLE>
Non-Performing Assets
Non-performing assets totaled $584,000 at September 30, 1999 compared to
$670,000 at September 30, 1998. Non-performing assets are summarized in the
following table.
<TABLE>
<CAPTION>
Year Ended September 30,
------------------------
1999 1998
------- ------
(Dollars in thousands)
<S> <C> <C>
Non-performing loans.................................................... $ 396 $ 518
Foreclosed assets....................................................... 188 152
------- ------
Total non-performing assets.......................................... $ 584 $ 670
======= ======
Non-performing assets to total assets................................... 0.44% 0.53%
======= ======
Non-performing assets to total loans.................................... 1.00% 1.16%
======= ======
Allowance for loan losses to non-performing loans....................... 140.15% 96.14%
======= ======
</TABLE>
The non-performing loans reflected above consist of non-accruing loans and
accruing loans 90 days or more past due.
Average Balance, Interest and Average Yields and Rates
The following table sets forth certain information relating to the
Company's average interest-earning assets and interest-bearing liabilities and
reflects the average yield on assets and average cost of liabilities for the
periods indicated. Such yields and costs are derived by dividing income or
expense by the average balance of assets or liabilities, respectively, for the
periods presented. Average balances are derived from daily balances.
The table also presents information for the periods indicated with respect
to the difference between the weighted average yield earned on interest-earning
assets and weighted average rate paid on interest-bearing liabilities, or
"interest rate spread," which savings institutions have traditionally used as an
indicator of profitability. Another
10
<PAGE>
indicator of an institution's net interest income is its "net yield on interest-
earning assets," which is its net interest income divided by the average balance
of interest-earning assets or "net interest margin." Net interest income is
affected by the interest rate spread and by the relative amounts of interest-
earning assets and interest-bearing liabilities. When interest-earning assets
approximate or exceed interest-bearing liabilities, any positive interest rate
spread will generate net interest income.
<TABLE>
<CAPTION>
For the Year Ended September 30,
---------------------------------------------------------
At September 30, 1999 1999 1998
--------------------- --------------------------- ---------------------------
Average Average Average
Yield/ Average Yield/ Average Yield/
Balance Cost Balance Interest Cost Balance Interest Cost
------- ------ ------- -------- ------ ------- -------- ------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans receivable (1)..................... $ 57,257 8.56% $ 55,216 $4,637 8.40% $ 55,166 $4,918 8.91%
Other marketable securities (2).......... 49,645 6.47 46,237 2,978 6.44 33,179 2,297 6.92
Mortgage-backed and related securities... 15,435 6.50 16,541 1,021 6.17 18,853 1,186 6.29
Other.................................... 3,593 5.62 5,385 120 2.23 4,813 119 2.47
-------- -------- ------ -------- ------
Total interest-earning assets.......... 125,930 7.40 123,379 8,756 7.10 112,011 8,520 7.61
------ ------
Non-interest-earning assets................ 6,360 5,527 6,152
-------- -------- --------
Total assets........................... $132,290 $128,906 118,163
======== ======== ========
Interest-bearing liabilities:
Deposits:
NOW accounts........................... $ 12,806 1.17 $ 11,809 131 1.11 $ 11,288 169 1.50
Passbook accounts...................... 8,264 1.80 7,877 130 1.65 7,899 157 1.99
Money market deposits.................. 12,702 3.56 11,588 378 3.26 8,985 268 2.98
Certificate accounts................... 54,339 5.37 55,757 3,081 5.53 56,199 3,254 5.79
Borrowings:
FHLB advances.......................... 24,957 5.06 22,554 1,163 5.16 15,677 878 5.60
Other borrowed money................... 4,701 5.06 4,831 249 5.15 3,359 180 5.36
-------- -------- ------ -------- ------
Total interest-bearing liabilities.. 117,769 4.39 114,416 5,132 4.49 103,407 4,906 4.74
------ ------
Non-interest-bearing liabilities........... 1,460 1,319 2,424
-------- -------- --------
Total liabilities...................... 119,229 115,735 105,831
Stockholders' equity....................... 13,061 13,171 12,332
-------- -------- --------
Total liabilities and retained
earnings............................. $132,290 $128,906 $118,163
======== ======== ========
Net interest income........................ $3,624 $3,614
====== ======
Interest rate spread....................... 3.01% 2.61% 2.87%
====== ====== ======
Net interest margin........................ 3.29% 2.94% 3.23%
====== ====== ======
Ratio of average interest-earning
assets to average interest-
bearing liabilities...................... 106.93% 107.83% 108.32%
====== ====== ======
</TABLE>
- ----------
(1) Average balance of non-accruing loans are included in the average balance
of loans receivable. Loan fees included in interest income is not material.
(2) Interest on tax exempt investments is not presented at the tax equivalent
yield.
11
<PAGE>
Rate/Volume Analysis
The table below sets forth certain information regarding changes in
interest income and interest expense of the Company for the periods indicated.
For each category of interest-earning asset and interest-bearing liability,
information is provided on changes attributable to: (i) changes in volume
(changes in volume multiplied by old rate); and (ii) changes in rates (change in
rate multiplied by old volume). For purposes of this table, changes attributable
to both rate and volume which cannot be segregated have been allocated
proportionately to the change due to volume and change due to rate.
<TABLE>
<CAPTION>
Year Ended September 30,
-----------------------------------------------------------
1999 vs. 1998 1998 vs. 1997
---------------------------- -------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
---------------------------- -------------------------
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest income:
Loans receivable....................... $ 4 $(285) $(281) $ 302 $(78) $ 224
Marketable securities.................. 850 (169) 681 390 92 482
Mortgage-backed and related
securities......................... (143) (22) (165) (61) (31) (92)
Other interest-earning assets.......... 13 (12) 1 11 4 15
----- ----- ----- ----- ---- -----
Total interest-earning assets....... 724 (488) 236 642 (13) 629
Interest expense:
Deposits:
NOW accounts......................... 8 (46) (38) 8 (7) 1
Passbook accounts.................... -- (27) (27) (8) -- (8)
Money market accounts................ 83 27 110 (2) 1 (1)
Certificate accounts................. (26) (147) (173) 103 22 125
Borrowings:
FHLB advances........................ 359 (74) 285 413 (15) 398
Other borrowed money................. 76 (7) 69 (59) (7) (66)
----- ----- ----- ----- ---- -----
Total interest-bearing
liabilities....................... 500 (274) 226 455 (6) 449
----- ----- ----- ----- ---- -----
Change in net interest income............ $ 224 $(214) $ 10 $ 187 $ (7) $ 180
===== ===== ===== ===== ==== =====
</TABLE>
Liquidity and Capital Resources
The Company's primary sources of funds for operations are deposits from its
market area; principal and interest payments on loans, securities available for
sale and securities held to maturity; proceeds from the sale or maturation of
securities and advances from the FHLB of Des Moines. While maturities and
scheduled amortization of loans and securities are predictable sources of funds,
deposit flows and mortgage prepayments are greatly influenced by general
interest rates, economic conditions, and competition.
The primary investing activities of the Company are the origination of one-
to four-family loans, the origination of consumer loans and the purchase of
securities. During the years ended September 30, 1999 and 1998, the Bank's loan
originations totaled $19.82 million and $16.62 million, respectively. The
Company purchased investment securities and mortgage backed and related
securities during the years ended September 30, 1999 and 1998 of $47.94 million
and $58.77 million, respectively.
12
<PAGE>
The primary financing activity of the Company is the attraction of
deposits. During the year ended September 30, 1999, the Bank experienced a net
increase in deposits of $2.24 million. During the year ended September 30, 1998,
the Bank experienced a net increase in deposits of $2.86 million.
During the year ended September 30, 1999, the Bank continued to be active
in the area of repurchase agreements. Repurchase agreements at September 30,
1999 totaled $4.70 million compared to a total of $3.14 million at September 30,
1998.
At September 30, 1999, the FHLB advances were secured by the FHLB stock and
a blanket pledge of residential loans, and governmental agency securities. Under
the agreement, the Bank must maintain eligible collateral in amounts exceeding
130 percent of the outstanding advances. At September 30, 1999, the Bank had
$24.96 million in advance outstanding with the FHLB.
The Bank is required to maintain minimum levels of liquid assets as defined
by OTS regulations. This requirement, which may be varied by the OTS depending
upon economic conditions and deposit flows, is based upon a percentage of
deposits and short-term borrowings. The required minimum liquidity ratio is
currently 4.0%. The Bank's average daily liquidity ratio for the month of
September 1999 was 35.49%.
The Company's most liquid assets are cash and cash equivalents, which
consist of short-term highly liquid investments with original maturities of less
than three months that are readily convertible to known amounts of cash and
interest-bearing deposits. The level of these assets is dependent on the
Company's operating, financing and investing activities during any given period.
At September 30, 1999 and 1998, cash and cash equivalents totaled $4.54 million
and $4.29 million, respectively.
The Bank anticipates that it will have sufficient funds available to meet
its current commitments. At September 30, 1999, the Bank had commitments to
originate/purchase loans of $1.17 million. Certificates of deposit which are
scheduled to mature in one year or less at September 30, 1999, totaled $34.66
million. Management believes that a significant portion of such deposits will
remain with the Bank.
At September 30, 1999, the Bank exceeded each of the three regulatory
capital requirements.
Impact of Inflation and Changing Prices
The Consolidated Financial Statements and Notes thereto presented herein
have been prepared in accordance with generally accepted accounting principles,
which require the measurement of financial position and operating results in
terms of historical dollars without considering the change in the relative
purchasing power of money over time and due to inflation. The impact of
inflation is reflected in the increased cost of the Bank's operations. Unlike
most industrial companies, nearly all the assets and liabilities of the Company
are monetary. As a result, interest rates have a greater impact on the Company's
performance than do the effects of general levels of inflation. Interest rates
do not necessarily move in the same direction or to the same extent as the price
of goods and services.
13
<PAGE>
CONSOLIDATED FINANCIAL STATEMENTS
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
Page
<S> <C>
Independent Auditors' Report............................................................ 15
Consolidated Statements of Financial Condition
September 30, 1999 and 1998........................................................... 16
Consolidated Statements of Income for the years ended
September 30, 1999 and 1998........................................................... 17
Consolidated Statements of Stockholders' Equity for the years ended
September 30, 1999 and 1998........................................................... 18
Consolidated Statements of Cash Flows for the years ended
September 30, 1999 and 1998........................................................... 20
Notes to Consolidated Financial Statements.............................................. 22
</TABLE>
14
<PAGE>
[LETTERHEAD OF McGLADREY & PULLEN, LLP]
INDEPENDENT AUDITORS' REPORT
The Board of Directors
First Federal Bancorporation
Bemidji, Minnesota
We have audited the accompanying consolidated statements of financial condition
of First Federal Bancorporation and subsidiaries (the Company) as of September
30, 1999 and 1998, and the related consolidated statements of income,
stockholders' equity, and cash flows for the years then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of First Federal
Bancorporation and subsidiaries as of September 30, 1999 and 1998, and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
/s/ McGladrey & Pullen, LLP
------------------------------
McGLADREY & PULLEN, LLP
Duluth, Minnesota
October 29, 1999
15
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash $ 2,194,436 $ 2 056,775
Interest-bearing deposits with banks 2,344,936 2,233,413
------------------------------------
Cash and cash equivalents 4,539,372 4,290,188
Available-for-sale securities 31,272,121 36,833,559
Held-to-maturity securities 33,808,632 23,299,208
Loans receivable, less allowance for loan losses
$555,388 in 1999 and $498,340 in 1998 57,256,941 56,063,951
Federal Home Loan Bank stock, at cost 1,248,000 1,148,000
Foreclosed real estate, net 188,300 152,754
Accrued interest receivable 1,075,399 991,507
Premises and equipment, net 2,123,863 2,098,531
Other assets 777,687 372,930
------------------------------------
$ 132,290,315 $ 125,250,628
------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 88,110,758 $ 85,866,264
Borrowings 29,658,337 24,892,673
Advance payments by borrowers for taxes and insurance 186,123 163,022
Accrued interest payable 577,585 543,886
Accrued expenses and other liabilities 696,151 702,335
------------------------------------
Total liabilities 119,228,954 112,168,180
------------------------------------
Commitments and Contingencies
Stockholders' Equity
Common stock ($.01 par value); authorized 4,000,000 shares;
issued 1,431,069 and 1,489,913 shares in 1999 and 1998 14,311 9,933
Additional paid-in capital 5,971,251 6,173,130
Retained earnings, subject to certain restrictions 9,260,477 8,691,092
Accumulated other comprehensive income (loss), net (335,848) 220,566
Unearned employee stock ownership plan shares (345,000) (414,000)
Unearned management recognition plan shares (94,444) (188,887)
Treasury stock, at cost, 289,605 and 287,301 shares in
1999 and 1998 (1,989,226) (1,939,384)
Deferred compensation payable in common stock 579,840 529,998
------------------------------------
Total stockholders' equity 13,061,361 13,082,448
------------------------------------
$ 132,290,315 $ 125,250,628
------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
16
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended September 30, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest Income
Loans receivable $ 4,637,348 $ 4,917,597
Mortgage-backed and related securities 1,020,602 1,186,089
Other marketable securities 2,978,192 2,296,966
Interest-bearing deposits with banks 42,991 61,722
Dividends 76,594 57,674
------------------------------------
8,755,727 8,520,048
------------------------------------
Interest Expense
Deposits 3,720,298 3,848,369
Borrowings 1,412,073 1,057,803
------------------------------------
5,132,371 4,906,172
------------------------------------
Net interest income 3,623,356 3,613,876
Provision for Loan Losses 97,970 153,000
------------------------------------
Net interest income after provision for loan losses 3,525,386 3,460,876
------------------------------------
Noninterest Income
Fees and service charges 585,923 607,393
Loss on sales of foreclosed real estate (4,004) (29,377)
Provision for loss on securities available-for-sale (83,129) -
Other income 68,176 72,949
------------------------------------
566,966 650,965
------------------------------------
Noninterest Expense
Compensation and employee benefits 1,583,406 1,585,321
Occupancy 515,309 488,607
Federal deposit insurance premiums 51,246 52,116
Data processing 77,094 77,079
Advertising 121,517 113,965
Other expenses 500,670 493,976
------------------------------------
2,849,242 2,811,064
------------------------------------
Income before income tax expense 1,243,110 1,300,777
Income Tax Expense 472,704 486,642
------------------------------------
Net income $ 770,406 $ 814,135
------------------------------------
Earnings per Common Share
- Basic $ 0.66 $ 0.70
------------------------------------
- Diluted $ 0.64 $ 0.65
------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements.
17
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended September 30, 1999 and 1998
<TABLE>
<CAPTION>
Additional
Comprehensive Common Paid-In
Income Stock Capital
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, September 30, 1997 $ 6,726 $ 6,109,390
Comprehensive income:
Net income $ 814,135 - -
Change in net unrealized gain (loss) on securities
available for sale, net of tax effect 235,081 - -
-----------------
Comprehensive income $ 1,049,216
=================
Reclassification of stock to deferred
compensation payable - -
Settlement of deferred compensation payable in
common stock - 23,975
Stock split 3,328 (4,165)
Purchase and retirement of common stock (121) (103,510)
Amortization of management recognition plan - 21,600
Earned employee stock ownership plan shares - 125,840
--------------------------
Balance, September 30, 1998 9,933 6,173,130
Comprehensive income:
Net income $ 770,406 - -
Change in net unrealized gain (loss) on securities
available for sale, net of tax effect (556,414) - -
-----------------
Comprehensive income $ 213,992
=================
Increase in deferred compensation payable in
common stock - -
Stock split 4,835 (5,633)
Settlement of deferred compensation payable in
common stock - 4,500
Purchase and retirement of common stock (457) (260,934)
Amortization of management recognition plan 23,500
Earned employee stock ownership plan shares - 36,688
-------- -------------
Balance, September 30, 1999 $ 14,311 $ 5,971,251
-------- -------------
</TABLE>
See Notes to Consolidated Financial Statements.
18
<PAGE>
<TABLE>
<CAPTION>
Unearned Deferred
Accumulated Employee Unearned Comp
Other Stock Management Payable in
Retained Comprehensive Ownership Recognition Treasury Common
Earnings Income (Loss) Plan Shares Plan Shares Stock Stock Total
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
8,015,142 $ (14,515) $ (483 000) $ (283,331) $(1,409,386) $ - $ 11,941,026
814,135 - - - - - 814,135
- 235,081 - - - - 235,081
- - - - (562,045) 562,045 -
- - - - 32,047 (32,047) 23,975
- - - - - (837)
(138,185) - - - - - (241816)
- - - 94,444 - - 116,044
- - 69,000 - - - 194,840
- -------------------------------------------------------------------------------------------------------
8,691,092 220,566 (414,000) (188,887) (1,939,384) 529,998 13,082,448
770,406 - - - - - 770,406
- (556,414) - - - - (556,414)
- - - - (785,000) 78,500 -
- - - - - - (798)
- - - - 28,658 (28,658) 4,500
(201,021) - - - - - (462,412)
- - - 94,443 - - 117,943
- - 69,000 - - - 105,688
- -------------------------------------------------------------------------------------------------------
9,260,477 $ (335,848) $ (345,000) $ (94,444) $(1,989,226) $ 579,840 $ 13,061,361
=======================================================================================================
</TABLE>
19
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended September 30, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows from Operating Activities
Net income $ 770,406 $ 814,135
Adjustments to reconcile net income to net cash
provided by operating activities:
Provisions for loan losses 97,970 153,000
Provision for loss on securities available-for-sale 83,129 -
Depreciation and amortization 270,677 242,528
Amortization of premium and discount, net (73,254) (82,220)
Increase in accrued interest receivable (83,892) (105,244)
Increase (decrease) in accrued interest payable 33,699 (51,034)
Loss on sales of foreclosed real estate 4,004 29,377
(Increase) decrease in other assets (18,097) 378,921
Increase (decrease) in accrued expenses and other liabilities (6,184) (278,951)
Increase in deferred compensation payable in common stock 78,500 79,326
Earned ESOP shares priced above original cost 64,688 122,440
Decrease in unearned ESOP shares 69,000 69,000
Decrease in unamortized restricted stock 94,443 94,444
---------------------------------
Net cash flows provided by operating activities 1,385,089 1,465,722
---------------------------------
Cash Flows from Investing Activities
Net increase in loans receivable (1,290,960) (2,628,409)
Purchase of securities available for sale (23,855,750) (18,779,744)
Purchase of securities held to maturity (24,081,719) (39,988,125)
Purchase of Federal Home Loan Bank stock (100,000) (447,500)
Purchase of premises and equipment (296,009) (446,102)
Proceeds from maturities of securities available for sale 20,387,235 23,220,719
Proceeds from maturities of securities held to maturity 13,500,011 16,995,914
Principal payments on mortgage-backed
and related securities available for sale 8,077,004 6,797,408
Principal payments on mortgage-backed
and related securities held to maturity 72,284 222,967
Net (increase) decrease in foreclosed real estate (39,550) 76,345
---------------------------------
Net cash flows used by investing activities (7,627,454) (14,976,527)
---------------------------------
Cash Flows from Financing Activities
Net increase in deposits 2,244,494 2,862,952
Increase (decrease) in advance payments by borrowers
for taxes and insurance 23,101 (854)
Net increase (decrease) in repurchase agreements 1,566,004 (1,561,416)
FHLB advances 22,989,000 44,951,000
Repayment of FHLB advances (18,489,340) (34,028,113)
Increase (decrease) in Federal funds purchased (1,300,000) 1,300,000
Purchase of treasury stock (78,500) (79,326)
Purchase of fractional shares on stock split (798) (837)
Purchase and retirement of common stock (462,412) (241,816)
---------------------------------
Net cash flows provided by financing activities 6,491,549 13,201,590
---------------------------------
</TABLE>
(Continued)
20
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended September 30, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
Net decrease in cash and cash equivalents $ 249,184 $ (309,215)
Cash and cash equivalents:
Beginning of year 4,290,188 4,599,403
----------------------------
End of year $ 4,539,372 $ 4,290,188
============================
Supplemental disclosures of cash flow information
Cash paid during the year for:
Interest $ 5,098,672 $ 4,957,206
============================
Income taxes $ 677,750 $ 432,000
============================
Supplemental Schedule of Noncash Investing and
Financing Activities
Net change in unrealized gain (loss) on securities
available for sale $ (556,414) $ 235,081
============================
Real estate acquired in settlement of loans $ 261,196 $ 174,459
============================
Stock issued in settlement of deferred compensation
Obligation $ 28,657 $ 32,047
============================
Deferred compensation obligation and related stock in
grantor trust reclassified to stockholder's equity $ - $ 529,998
============================
</TABLE>
See Notes to Consolidated Financial Statements.
21
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
Note 1. Description of the Business
First Federal Bancorporation (the Company) is the unitary thrift holding company
for First Federal Bank (the Bank) with its main office in Bemidji, Minnesota and
four branch offices located in Bemidji, Bagley, Baudette and Walker, Minnesota.
The Bank provides retail and commercial loan and deposit services principally to
customers within a 30-mile radius of the Bank's locations.
Note 2. Summary of Significant Accounting Policies
Basis of financial statement presentation and accounting estimates: The
consolidated financial statements have been prepared in conformity with
generally accepted accounting principles. In preparing the financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the statement of
financial condition and revenues and expenses for the period. Actual results
could differ significantly from those estimates. A material estimate that is
particularly susceptible to significant change in the near-term relates to the
determination of the allowance for loan losses.
Effective October 1, 1998, the Company adopted FASB Statement No. 130, which was
issued in June 1997. Statement No. 130 establishes new rules for the reporting
and display of comprehensive income and its components but has no effect on the
Company's net income or total stockholders' equity. Statement No. 130 requires
unrealized gains and losses on the Company's available-for-sale securities,
which prior to adoption were reported separately in stockholders' equity, to be
included in comprehensive income. Prior-year financial statements have been
reclassified to conform to the requirements of Statement No. 130.
Principles of consolidation: The consolidated financial statements included
herein are for the Company, the Bank, and the Bank's wholly-owned subsidiary,
First Federal Service Corporation. All significant intercompany accounts and
transactions have been eliminated in consolidation.
Cash equivalents and cash flows: Cash equivalents primarily represent amounts on
deposit at other financial institutions and highly liquid financial instruments
with original maturities at the date of purchase of three months or less. Cash
flows from loans, deposits, short-term borrowings and FHLB advances are reported
net.
Available-for-sale securities: Securities classified as available-for-sale (AFS)
are debt and marketable equity securities that the Company intends to hold for
an indefinite period of time, but not necessarily to maturity. Any decision to
sell an AFS security would be based on factors including movements in interest
rates, changes in the maturity mix of the Company's assets and liabilities,
liquidity needs, regulatory capital considerations, and similar factors. AFS
securities are carried at fair value. Unrealized gains or losses, net of the
related deferred tax effect, are reported as increases or decreases in
stockholders' equity. Realized gains or losses, determined on the basis of the
cost of specific securities sold, and provisions for impairment of AFS
securities are included in earnings.
22
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
Held-to-maturity securities: Securities classified as held to maturity are those
debt securities the Company has both the intent and ability to hold to maturity
regardless of changes in market conditions, liquidity needs, or changes in
general economic conditions. These securities are carried at cost adjusted for
amortization of premiums and discounts, computed by the interest method over
contractual lives. The sale of a security within three months of its maturity
date or after at least 85 percent of the principal outstanding has been
collected is considered a maturity for purposes of classification and
disclosure.
Loans, allowance for loan losses: Loans are stated at the amount of unpaid
principal, reduced by an allowance for loan losses.
Discounts and premiums on loans purchased are amortized to income using the
interest method over the estimated average loan life. Loan origination and
commitment fees and certain direct loan origination costs are deferred and
amortized over the life of the related loans using the interest method.
The allowance for loan losses is maintained at an amount considered adequate to
provide for probable losses. The allowance for loan losses is based on periodic
analysis of the loan portfolio by management. In this analysis, management
considers factors including, but not limited to, specific occurrences, general
economic conditions, loan portfolio composition, and historical experience.
Loans are charged against the allowance for loan losses when management believes
that collectibility of the principal is unlikely. Management believes that the
allowance for loan losses is adequate. While management used available
information to recognize losses on loans, future additions to the allowance may
be necessary based on changes in economic conditions. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the allowance for loan losses. Such agencies may require
additions to the allowance based on their judgment about information available
to them at the time of their examination.
The Company defines a loan as impaired when it is probable it will be unable to
collect principal and interest payments due in accordance with the terms of the
loan agreement. Impaired loans that have been separately identified for
evaluation are measured based on the present value of expected future cash flows
or, alternatively, the observable market price of the loans or the fair value of
the collateral. However, for those loans that are collateral dependent (that is,
if repayment of those loans is expected to be provided solely by the underlying
collateral) and for which management has determined foreclosure is probable, the
measure of impairment of those loans is to be based on the fair value of the
collateral.
Interest on loans is recognized over the terms of the loans and is calculated
using the simple interest method on principal amounts outstanding. For impaired
loans, accrual of interest is generally stopped when a loan is greater than
three months past due. Interest on these loans is recognized only when actually
paid by the borrower if collection of the principal is likely to occur. Accrual
of interest is generally resumed when the customer is current on all principal
and interest payments and has been paying on a timely basis for a period of
time.
Foreclosed real estate: Real estate acquired in the settlement of loans is
carried at the lower of the unpaid loan balance plus settlement costs or
estimated fair market value less selling costs at the time of foreclosure. The
carrying value of individual properties is periodically evaluated and reduced to
the extent cost exceeds estimated fair value less selling costs. Costs of
developing and improving such properties are capitalized. Expenses related to
holding such real estate, net of rental and other income, are charged against
income as incurred.
23
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
Premises and equipment: Land is carried at cost. Bank premises, improvements,
furniture, and equipment are carried at cost less accumulated depreciation.
Depreciation is computed on a straight-line basis over the estimated useful
lives of 20 to 40 years for bank premises and improvements and 3 to 10 years for
furniture and equipment.
Income taxes: Deferred taxes are provided on an asset and liability method
whereby deferred tax assets are recognized for deductible temporary differences,
operating loss or tax credit carryforwards and deferred tax liabilities are
recognized for taxable temporary differences. Temporary differences are the
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets are reduced
by a valuation allowance when management determines that it is more likely than
not that some portion or all of the deferred tax assets will not be realized.
Deferred tax assets and liabilities are adjusted for the effects of changes in
tax rates on the date of enactment.
Earnings per common share: Earnings per common share data has been computed on
the basis of the weighted-average number of common shares outstanding during
each period presented. As explained further in Note 13, the Company declared a
3-for-2 common stock split effected in the form of a 50 percent stock dividend
payable to stockholders of record on May 5, 1999. Retroactive effect has been
given to the shares issued in connection with the stock dividend as if the
dividend had been declared on October 1, 1997. Following is information about
the computation of the earnings per share data for the years ended September 30,
1999 and 1998.
<TABLE>
<CAPTION>
Year Ended September 30,
----------------------------------------------------------------------------------------------
1999 1998
------------------------------------------- -------------------------------------------
Net Income Net Income
Numerator Denominator Per Share Numerator Denominator Per Share
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Basic earnings
per share,
income available
to common
stockholders $ 770,406 1,159,547 $ 0.66 $ 814,135 1,157,418 $ 0.70
Effect of dilutive
securities:
Stock options - 39,602 0.02 - 70,619 0.04
Management
recognition
plan - 8,898 - - 23,356 0.01
----------------------------------------------------------------------------------------------
Diluted earnings
per share,
income available
to common
stockholders $ 770,406 1,208,047 $ 0.64 $ 814,135 1,251,393 $ 0.65
==============================================================================================
</TABLE>
24
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
Other Accounting Policies: The Company's accounting policies for employee
benefit plans, retirement plans and the methods and assumptions used to estimate
fair values of financial instruments are disclosed in Notes 15, 16 and 19,
respectively.
Reclassifications: Certain prior year amounts have been reclassified to conform
with the 1998 presentation. These reclassifications had no effect on net income
or stockholders' equity.
New Accounting Standards: In June 1998, the Financial Accounting Standards Board
issued Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities, which is required to be adopted in years beginning after June 15,
1999. The statement permits early adoption as of the beginning of any fiscal
quarter after its issuance. The Company has not determined whether to adopt the
new statement early. The statement will require the Company to recognize all
derivatives on the consolidated balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through income. If the derivative
is a hedge, depending in the nature of the hedge, changes in the fair value of
derivatives will either be offset against the change in fair value of the hedged
assets, liabilities or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings.
Because of the Company's minimal use of derivatives, management does not
anticipate that the adoption of the new statement will have a significant effect
on the Company's earnings or financial position.
25
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
Note 3. Securities Available for Sale
Summaries of securities available for sale at September 30, 1999 and 1998 are
presented below:
<TABLE>
<CAPTION>
1999
------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 9,819,412 $ 14,377 $ 199,183 $ 9,634,606
Collateralized mortgage
obligations and REMICS 5,666,265 1,572 101,398 5,566,439
------------------------------------------------------------------------
Total mortgage-backed
and related securities 15,485,677 15,949 300,581 15,201,045
------------------------------------------------------------------------
Other marketable securities
U.S. government and agency
securities 9,670,238 5,706 213,704 9,462,240
Corporate bonds and notes 5,178,836 11,391 48,314 5,141,913
Municipal bonds 498,791 5,984 - 504,775
Mutual funds 1,007,812 6,125 51,789 962,148
------------------------------------------------------------------------
Total other marketable
securities 16,355,677 29,206 313,807 16,071,076
------------------------------------------------------------------------
$ 31,841,354 $ 45,155 $ 614,388 $ 31,272,121
========================================================================
<CAPTION>
1998
------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 7,890,713 $ 161,733 $ 7,661 $ 8,044,785
Collateralized mortgage
obligations and REMICS 8,975,849 81,357 817 9,056,389
------------------------------------------------------------------------
Total mortgage-backed
and related securities 16,866,562 243,090 8,478 17,101,174
------------------------------------------------------------------------
Other marketable securities
U.S. government and agency
securities 13,326,640 83,186 - 13,409,826
Corporate bonds and notes 4,760,588 123,245 68,786 4,815,047
Municipal bonds 498,116 16,741 - 514,857
Mutual funds 1,007,812 4,688 19,845 992,655
------------------------------------------------------------------------
Total other marketable
securities 19,593,156 227,860 88,631 19,732,385
------------------------------------------------------------------------
$ 36,459,718 $ 470,950 $ 97,109 $ 36,833,559
========================================================================
</TABLE>
26
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
The amortized cost and fair value of other marketable securities available for
sale at September 30, 1999 by contractual maturity is shown below. Expected
maturities may differ from contractual maturities because obligors may have the
right to call or prepay obligations with or without call or prepayment
penalties:
<TABLE>
<CAPTION>
1999
--------------------------------
Amortized
Cost Fair Value
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less $ 2,773,852 $ 2,809,012
Due after one year through five years 3,486,952 3,412,996
Due after five years through ten years 8,753,270 8,549,756
Due after ten years 333,791 337,164
Mortgage-backed securities 15,485,677 15,201,045
Mutual funds 1,007,812 962,148
--------------------------------
$ 31,841,354 $ 31,272,121
================================
</TABLE>
Anticipated maturities on mortgage-backed securities are not readily
determinable since they may be prepaid without penalty and mutual funds do not
have stated maturity dates.
Proceeds from maturities of securities available for sale during 1999 and 1998
were $20,387,235 and $23,220,719, respectively. There were no available for sale
securities sold in 1999 or 1998.
Securities are pledged under various borrowing arrangements as discussed in Note
12.
Changes in the unrealized gain (loss) on available-for-sale securities:
<TABLE>
<CAPTION>
Year Ended September 30,
--------------------------------
1999 1998
- ---------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance, beginning $ 220,566 $ (14,515)
Unrealized gain (loss) during the year (943,074) 399,398
Deferred tax effect related to unrealized gain (loss) 386,660 (164,317)
--------------------------------
Balance, ending $ (335,848) $ 220,566
================================
</TABLE>
27
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
Note 4. Securities Held to Maturity
Summaries of securities held to maturity at September 30, 1999 and 1998 are
presented below:
<TABLE>
<CAPTION>
1999
------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 16,6161 $ 1,905 $ 1,092 $ 166,974
Collateralized mortgage
obligations and REMICS 68,136 - 2,982 65,154
------------------------------------------------------------------------
Total mortgage-backed
and related securities 234,297 1,905 4,074 232,128
Other marketable securities
US government and agency
securities 33,574,335 - 1,634,025 31,940,310
------------------------------------------------------------------------
Total securities held to
maturity $ 33,808,632 $ 1,905 $ 1,638,099 $ 32,172,438
========================================================================
<CAPTION>
1998
------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage-backed securities $ 238,810 $ 4,226 $ 608 $ 242,428
Collateralized mortgage
obligations and REMICS 68,147 - 631 67,516
------------------------------------------------------------------------
Total mortgage-backed
and related securities 306,957 4,226 1,239 309,944
Other marketable securities
US government and agency
securities 22,992,251 143,567 - 23,135,818
------------------------------------------------------------------------
Total securities held to
maturity $ 23,299,208 $ 147,793 $ 1,239 $ 23,445,762
========================================================================
</TABLE>
All of the securities held to maturity that are not mortgage-backed are due in
five to ten years. The securities may be subject to call before their scheduled
maturity.
Securities are pledged under various borrowing arrangements as discussed in Note
12.
28
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
Note 5. Loans Receivable
Loans receivable consisted of the following:
<TABLE>
<CAPTION>
September 30,
----------------------------------------
1999 1998
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
One-to-four family residential loans $ 26,432,098 $ 26,981,456
Commercial real estate and multifamily residential loans 13,479,126 15,464,796
Consumer loans 17,524,276 13,796,819
Commercial business loans 935,795 1,440,722
----------------------------------------
58,371,295 57,683,793
Less:
Loans in process (630,548) (1,221,946)
Unamortized loan origination fees/costs and
discounts/premiums, net 71,582 100,444
Allowance for loan losses (555,388) (498,340)
----------------------------------------
$ 57,256,941 $ 56,063,951
========================================
</TABLE>
Nonaccrual loans, totaling $361,189 and $153,648 at September 30, 1999 and 1998,
respectively are considered by management as impaired. The related allowance for
credit losses was $54,178 at September 30, 1999 and $23,047 at September 30,
1998. The average investment in impaired loans during fiscal 1999 and 1998 was
$153,903 and $104,728, respectively.
The aggregate amount of loans to directors, executive officers and their related
interests was $1,143,358 and $1,160,194 at September 30, 1999 and 1998,
respectively. Activity with respect to these loans during fiscal 1999 included
net decreases of $16,836. Activity with respect to these loans during fiscal
1998 included net increases of $974,851. In the opinion of management, such
loans were made in the ordinary course of business on normal credit terms,
including interest rate and collateralization, and do not represent more than
normal risk of collection.
The Bank grants residential and commercial real estate loans and consumer loans
primarily to customers in northern Minnesota. Although the Bank has a
diversified loan portfolio, a substantial portion of its debtors' abilities to
honor their loans is dependent upon the local economy in northern Minnesota.
At September 30, 1999 and 1998 the Bank was servicing real estate loans for
others with aggregate unpaid principal balances of approximately $370,110 and
$147,547, respectively.
Certain loans are pledged under various borrowing arrangements as discussed in
Note 12.
29
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
Note 6. Allowance for Loan Losses
<TABLE>
<CAPTION>
September 30,
--------------------------------------
1999 1998
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance, beginning $ 498,340 $ 427,255
Provision charged to operations 97,970 153,000
Loans charged off (50,925) (109,976)
Recoveries 10,003 28,061
--------------------------------------
Balance, ending $ 555,388 $ 498,340
======================================
</TABLE>
Note 7. Foreclosed Real Estate
Foreclosed real estate consisted of the following:
<TABLE>
<CAPTION>
September 30,
--------------------------------------
1999 1998
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Real estate acquired through foreclosure or deed
in lieu of foreclosure $ 21,914 $ 76,300
Real estate in judgment (subject to redemption) 166,386 78,161
--------------------------------------
188,300 154,461
Less allowance for losses - 1,707
--------------------------------------
$ 188,300 $ 152,754
======================================
</TABLE>
Note 8. Accrued Interest Receivable
Accrued interest receivable is summarized as follows:
<TABLE>
<CAPTION>
September 30,
--------------------------------------
1999 1998
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Mortgage-backed and related securities $ 66,774 $ 56,398
Other marketable securities 673,120 571,097
Loans receivable 335,505 364,012
--------------------------------------
$ 1,075,399 $ 991,507
======================================
</TABLE>
30
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
________________________________________________________________________________
Note 9. Premises and Equipment
Premises and equipment consisted of the following:
<TABLE>
<CAPTION>
September 30,
-------------------------------
1999 1998
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Land and improvements $ 235,172 $ 235,172
Bank premises 1,581,285 1,573,531
Furniture and equipment 2,101,605 1,909,931
Leasehold improvements 187,930 187,930
Automobile 26,153 27,519
-------------------------------
4,132,145 3,934,083
Less accumulated depreciation and amortization 2,008,282 1,835,552
-------------------------------
$ 2,123,863 $ 2,098,531
===============================
</TABLE>
Note 10. Deposits
Deposits consisted of the following:
<TABLE>
<CAPTION>
1999 1998
------------------------------------------------- ----------------------------------------------
Weighted Weighted Percent
Average Percent of Average of
Rate Amount Total Rate Amount Total
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Noninterest NOW -% $ 3,538,689 4.02% -% $ 2,648,425 3.08%
NOW 1.61 9,267,299 10.52 1.88 8,450,647 9.84
Passbook 1.80 8,264,464 9.38 2.00 8,028,595 9.35
Money Market 3.56 12,701,780 14.42 3.00 8,837,230 10.30
-------------------------------------------- -------------------------------------------
2.22 33,772,232 38.34 2.09 27,964,897 32.57
-------------------------------------------- -------------------------------------------
Certificates
2-2.99% - - - 2.50 2,596 -
4-4.99% 4.65 21,775,975 24.70 4.84 2,308,521 2.69
5-5.99% 5.50 19,679,859 22.34 5.52 35,182,369 40.97
6-6.99% 6.30 11,365,181 12.90 6.28 18,082,222 21.06
7-7.99% 7.19 1,517,511 1.72 7.19 2,325,659 2.71
-------------------------------------------- -------------------------------------------
5.37 54,338,526 61.66 5.80 57,901,367 67.43
-------------------------------------------- -------------------------------------------
4.16% $ 88,110,758 100.00% 4.59% $ 85,866,264 100.00%
-------------------------------------------- -------------------------------------------
</TABLE>
At September 30, 1999 and 1998, the Bank had $12,449,947 and $11,313,217,
respectively, of deposit accounts with balances of $100,000 or more. The Bank
did not have any brokered deposits at September 30, 1999 or 1998.
31
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
_______________________________________________________________________________
Certificates had the following remaining maturities:
<TABLE>
<CAPTION>
September 30,
------------------------------------------------------------------------
1999 1998
---------------------------------- ----------------------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
0-6 months $ 21,194,931 5.32% $ 20,851,918 5.51%
7-12 months 13,461,902 5.29 13,116,420 5.81
13-36 months 15,244,041 5.48 18,924,067 6.04
Over 36 months 4,437,652 5.52 5,008,962 6.05
------------------------------------------------------------------------
$ 54,338,526 5.37% $ 57,901,367 5.80%
========================================================================
</TABLE>
Mortgage-backed securities with a fair value of $3,032,124 and $3,434,766 at
September 30, 1999 and 1998, respectively, were pledged as collateral for
certain deposits.
Interest expense on deposits is summarized as follows:
<TABLE>
<CAPTION>
1999 1998
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
NOW $ 131,393 $ 169,294
Passbook 130,441 157,312
Money Market 377,711 268,116
Certificates 3,080,753 3,253,647
-------------------------------------------------
$ 3,720,298 $ 3,848,369
=================================================
</TABLE>
Note 11. Income Taxes
Federal and state income tax expense (benefit) is as follows:
<TABLE>
<CAPTION>
1999 1998
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Current
Federal $ 366,080 $ 438,569
State 118,090 141,623
-------------------------------------------------
484,170 580,192
=================================================
Deferred
Federal (8,689) (70,895)
State (2,777) (22,655)
(11,466) (93,550)
-------------------------------------------------
$ 472,704 $ 486,642
=================================================
</TABLE>
32
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
_______________________________________________________________________________
The actual effective tax rate differs from the "expected" income tax rate,
computed at the statutory federal corporate tax rate, as follows:
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------
1999 1998
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Statutory federal rate 34.0% 34.0%
State tax, net of federal benefit 6.50 6.50
Other (2.50) (3.10)
---------------------------------
38.0% 37.4%
=================================
</TABLE>
The tax effects of temporary differences that give rise to the deferred tax
assets and deferred tax liabilities are as follows at September 30:
<TABLE>
<CAPTION>
1999 1998
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred Tax Assets
Allowance for loan losses $ 159,851 $ 157,932
Deferred compensation 298,622 303,426
Deferred loan fees 6,301 12,604
Unrealized loss on securities available for sale 233,385 -
Other 9,860 12,164
-----------------------------------------
Total gross deferred tax assets 708,019 486,126
-----------------------------------------
Deferred Tax Liabilities
Premises and equipment 55,345 66,892
FHLB stock 102,627 102,632
Accrued real estate taxes 22,599 27,037
Prepaid insurance (1,690) 5,278
Unrealized gain on securities available for sale - 153,275
-----------------------------------------
Total deferred tax liabilities 178,881 355,114
-----------------------------------------
Net deferred tax assets $ 529,138 $ 131,012
=========================================
</TABLE>
No valuation allowance was required as of September 30, 1999 or 1998.
In prior years the Company was permitted to deduct an annual addition to a
reserve for bad debts. Bad debt deductions for income tax purposes are included
in taxable income of later years only if the bad debt reserves are used for
purposes other than to absorb bad debt losses. Because the Bank does not intend
to use the reserve for purposes other than to absorb losses, no deferred income
taxes have been provided. Retained earnings at September 30, 1999 include
approximately $2,860,000 for which no deferred taxes have been provided.
33
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
_______________________________________________________________________________
Note 12. Borrowings
<TABLE>
<CAPTION>
September 30,
----------------------------------------
1999 1998
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Federal funds purchased $ - $ 1,300,000
Repurchase agreements 4,701,492 3,135,488
Borrowing from the Federal Home Loan Bank 24,956,845 20,457,185
----------------------------------------
$ 29,658,337 $ 24,892,673
========================================
</TABLE>
Repurchase agreements consist of sales of securities under agreements to
repurchase the identical securities. The agreements generally mature within 180
days and bear a weighted average interest rate of approximately 5.1% and 5.5% at
September 30, 1999 and 1998, respectively. The agreements are treated as
financings with the obligations to repurchase securities reflected as a
liability and the dollar amount of the securities collateralizing the agreements
remaining in the asset accounts. The securities collateralizing the agreements
are in safekeeping at the Federal Home Loan Bank of Des Moines in the Bank's
account. At September 30, 1999, the agreements were collateralized by securities
totaling approximately $6,914,450.
Advances from the Federal Home Loan Bank (FHLB) of Des Moines as of September
30, 1999 are summarized as follows:
<TABLE>
<CAPTION>
Year Due Average Rate Amount
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
1999 4.54% $ 4,420,000
2000 5.53 3,500,000
2001 6.24 36,845
2003 and beyond 5.92 17,000,000
------------------------------------------
5.29% $ 24,956,845
==========================================
</TABLE>
At September 30, 1999, the FHLB advances are secured by the FHLB stock and a
blanket pledge of residential mortgage loans, and government agency securities.
Under the agreement, the Bank must maintain eligible collateral in amounts
exceeding 125 percent of the outstanding advances. The $17,000,000 in advances
with due dates in 2003 and beyond have provisions which give the FHLB the option
to call the debt on a quarterly basis.
Note 13. Capital Stock
On May 20, 1999 the Company issued additional shares necessary to effect a 3-
for-2 common stock split in the form of a 50 percent stock dividend to
shareholders of record on May 5, 1999. The share and per share amounts,
including shares held in treasury and shares to be issued under the various
stock-based compensation plans, have been retroactively restated.
34
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
_______________________________________________________________________________
Note 14. Retained Earnings and Regulatory Capital
The Bank, as a member of the Federal Home Loan Bank System, is required to hold
a specified number of shares of capital stock in the Federal Home Loan Bank of
Des Moines which is carried at cost. In addition, the Bank is required to
maintain cash and other liquid assets in an amount equal to 5% of its deposit
accounts and other obligations due within one year. Management believes the
Bank has met these requirements.
The Company's Subsidiary Bank is subject to various regulatory capital
requirements administered by the Bank's primary federal regulatory agency.
Failure to meet minimum capital requirements can initiate certain mandatory and
possibly additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on the Company's consolidated financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective action, the Bank must meet specific capital guidelines that
involve quantitative measures of assets and certain off-balance sheet items as
calculated under regulatory accounting practices. The Bank's capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company's Subsidiary Bank to maintain minimum ratios (set forth in
the following table) of total and Tier I capital and of Tier I capital to
average assets (as defined in the regulations). Management believes, as of
September 30, 1999, that the Company's Subsidiary Bank meets all capital
adequacy requirements to which it is subject.
As of September 30, 1999, the most recent notification from the Federal Deposit
Insurance Corporation categorized the Bank as "well capitalized" under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based,
and Tier I leverage ratios as set forth in the table below. There are no
conditions or events since that notification that management believes have
changed the Bank's category.
35
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
_______________________________________________________________________________
The Bank's actual capital amounts and ratios are also presented in the table:
<TABLE>
<CAPTION>
To Be Well Capitalized
Under Prompt
For Capital Adequacy Corrective Action
Actual Purposes Provisions
------------------------- --------------------------------- -------------------------------
Amount Amount Amount
(000's) Ratio (000's) Ratio (000's) Ratio
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
As of September 30, 1999:
Total capital (to risk-
weighted assets) $ 11,302 18.0% $ 5,011 *8.0% $ 6,264 *10.0%
Tier I capital (to risk-
weighted assets) 10,790 17.2% 2,506 *4.0% 3,758 *6.0%
Tier I capital (to
average assets) 10,790 8.5% 5,084 *4.0% 6,356 *5.0%
As of September 30, 1998:
Total capital (to risk-
weighted assets) 11,549 19.0% 4,855 *8.0% 6,069 *10.0%
Tier I capital (to risk-
weighted assets) 11,051 18.2% 2,428 *4.0% 3,641 *6.0%
Tier I capital (to
average assets) 11,051 9.4% 4,700 *4.0% 5,874 *5.0%
</TABLE>
*Greater than or equal to
Note 15. Employee Benefits
Employee stock ownership plan: The Company adopted an Employee Stock Ownership
Plan (the ESOP), which meets the requirements of Section 4975(e)(7) of the
Internal Revenue Code and Section 407(d)(6) of the Employee Retirement Income
Security Act of 1974, as amended (ERISA), and, as such, the ESOP is empowered to
borrow in order to finance purchases of the common stock of the Company. The
ESOP borrowed $690,000 from the Company to purchase 155,250 shares of common
stock of the Company on the date of the Conversion. The Bank has committed to
make annual contributions to the ESOP necessary to repay the loan, including
interest.
As the debt is repaid, ESOP shares that were initially pledged as collateral for
its debt are released from collateral and allocated to active employees based on
the proportion of debt service paid in the year. The Company accounts for its
ESOP in accordance with Statement of Position 93-6, Employers' Accounting for
Employee Stock Ownership Plans. Accordingly, the shares pledged as collateral
are reported as unearned ESOP shares in stockholders' equity. As shares are
determined to be ratably released from collateral, the Company reports
compensation expense equal to the current market price of the shares, and the
shares become outstanding for earnings per share computations. ESOP compensation
benefit expense was $133,688 and $191,439 for 1999 and 1998, respectively.
36
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
_______________________________________________________________________________
All employees of the Company are eligible to participate in the ESOP after they
attain age 21 and complete one year of service during which they worked at least
1,000 hours. In 1999 and 1998, the Company committed to release 15,525 (adjusted
for a 3-for-2 stock split) shares of common stock each year which were allocated
to eligible participants subject to the restrictions of the ESOP.
<TABLE>
<CAPTION>
Amount
- --------------------------------------------------------------------------------------------------------
<S> <C>
Shares Released and Allocated 77,625
Unreleased Shares 77,625
-----------------
Total ESOP shares 155,250
=================
Fair Value of Unreleased Shares at September 30, 1999 $ 582,188
=================
</TABLE>
Management recognition plan: The Management Recognition Plan (MRP) provides for
the grant of shares of stock to eligible directors and employees in the form of
restricted stock, which vest over a five-year period at the rate of 20% per
year. Under the MRP, 77,625 shares of restricted stock were granted. MRP
expense was $94,443 and $94,444 in 1999 and 1998, respectively.
Stock option plans: The stock option plans provide for granting of 344,063
options for the purpose of attracting and retaining key personnel and to
facilitate their purchase of a stock interest in the Company. The options
become exercisable over a five-year period at the rate of 20% per year except
for the 1998 plan which vests 50 percent at the grant date and 50 percent one
year from the grant date. If unused, the options expire in October 2005 and
January 2009 for 1998 plan. A summary of the status of the Company's stock
option plans as of September 30, 1999 and 1998, and changes during the years
ending on those dates is presented below:
<TABLE>
<CAPTION>
1999 1998
---------------------------------------- ---------------------------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 158,512 $ 6.49 154,321 $ 6.33
Granted 157,125 8.58 4,191 12.50
Exercised - - - -
Forfeited (3,629) 6.87 - -
--------------------------------- ----------------------------------
Outstanding at end of year 312,008 $ 7.84 158,512 $ 6.49
================================= ==================================
Exercisable at end of year 191,851 61,728
============= ===========
Weighted-average fair value
per option of options granted
during the year $ 4.32 $ 6.68
================== ======================
</TABLE>
37
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
_______________________________________________________________________________
At September 30, 1999, the options outstanding under the stock option plan have
exercise prices from $6.083 to $12.50 and a weighted-average remaining
contractual life of 7.1 years. The shares and prices were 1314 at $6.08,
1,941.75 at $6.778, 21,375 at $7.778, 4,191 at $12.5 and 157,125 at $8.5833. All
of the nonvested options are expected to eventually vest.
As permitted under generally accepted accounting principles, grants under the
plan are accounted for following the provisions of APB Opinion No. 25 and its
related interpretations. Accordingly, no compensation cost has been recognized
for grants made to date. Had compensation cost been determined based on the
fair value method prescribed in the FASB Statement No. 123, reported net income
and earnings per share would have been reduced to the proforma amounts shown
below:
<TABLE>
<CAPTION>
Year Ended September 30,
---------------------------------------
1999 1998
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Net income:
As reported $ 770,406 $ 814,135
Proforma 483,275 781,892
Basic earnings per share:
As reported 0.66 0.70
Proforma 0.42 0.67
Diluted earnings per share:
As reported 0.64 0.65
Proforma 0.40 0.63
</TABLE>
In determining the pro forma amounts above, the fair value of each grant is
estimated at the grant date using the Black-Scholes option-pricing model, with
the following weighted-average assumptions for grants in 1999 and 1998: No
dividends; risk-free interest rate of 6.0% and 5.0%, expected life of 10 and 8
years and price volatility of 34.48% and 33.05%, respectively.
Note 16. Retirement Plans
The Company has a 401(k) plan that covers all full-time employees meeting
certain minimum employment service requirements. The Company's expense for the
years ended September 30, 1999 and 1998 was $53,547 and $48,116, respectively.
The Company has individual deferred compensation and supplemental retirement
agreements with certain directors and officers. The cost of such individual
agreements is being accrued over the period of actual service from the date of
the respective agreement. The cost of such agreements was $72,083 and $79,326
for the years ended September 30, 1999 and 1998, respectively. The agreements
are funded through a grantor trust with assets which match the investment
options selected by the directors and officers.
38
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Under the stock investment option, funds are invested in common stock of the
Company. Investment elections are irrevocable. In accordance with the provisions
of the FASB Emerging Issues Task Force Issue No. 97-14 the cost of common stock
held in the grantor trust is classified as treasury stock and the deferred
compensation obligation payable in common stock is classified as a component of
stockholders' equity.
Note 17. Stockholders' Equity
The Company was incorporated for the purpose of becoming the savings and loan
holding company of the Bank in connection with the Bank's conversion from a
federally chartered mutual savings bank to a federally chartered stock savings
bank.
In order to grant a priority to eligible account holders in the event of future
liquidation, the Bank, at the time of conversion, established a liquidation
account equal to its regulatory capital as of December 31, 1994. In the event of
future liquidation of the Bank, eligible account holders who continue to
maintain their deposit accounts shall be entitled to receive a distribution from
the liquidation account. The total amount of the liquidation account will be
decreased as the balance of eligible account holders is reduced subsequent to
the conversion, based on an annual determination of such balance.
The Bank may not declare or pay a cash dividend to the Company in excess of 100%
of its net income to date during the current calendar year plus the amount that
would reduce by one-half the Bank's surplus capital ratio at the beginning of
the calendar year without prior notice to the Office of Thrift Supervision
(OTS). Additional limitations on dividends declared or paid on, or repurchases
of, the Bank's capital stock are tied to the Bank's level of compliance with its
regulatory capital requirements.
Note 18. Financial Instruments with Off-Balance-Sheet Risk
The Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit. These
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the balance sheet. The contractual
amount of these instruments reflects the extent of involvement by the Company.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual amount of these commitments. The Company uses the
same credit policies in making commitments as it does for on-balance-sheet
instruments.
39
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The contractual amount of these financial instruments at September 30, 1999 and
1998 is as follows (in 000's):
<TABLE>
<CAPTION>
1999 1998
- --------------------------------------------------------------------------------
<S> <C> <C>
Unused lines of credit $ 1,425 $ 1,924
Commitments to originate and purchase loans 1,172 1,109
------------------------------
$ 2,597 $ 3,033
==============================
</TABLE>
Commitments to extend credit are agreements to lend to a customer provided 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. Since a portion of the commitments may expire without
being drawn upon, the total commitment amount does not necessarily represent
future cash requirements. The Company evaluates each customer's creditworthiness
on a case-by-case basis. The amount of collateral obtained, if deemed necessary
by the Company upon extension of credit, is based on the loan type and on
management's credit evaluation of the borrower. Collateral consists primarily of
residential real estate and personal property.
Note 19. Fair Value of Financial Instruments
SFAS No. 107, Disclosures About Fair Values of Financial Instruments, requires
disclosures of estimated fair values of the Company's financial instruments,
including assets, liabilities, and off-balance sheet items for which it is
practicable to estimate fair value. The fair value estimates are made as of
September 30, 1999 and 1998 based upon relevant market information, if
available, and upon the characteristics of the financial instruments themselves.
Because no market exists for a significant portion of the Company's financial
instruments, fair value estimates are based upon judgments regarding future
expected loss experience, current economic conditions, risk characteristics of
various financial instruments, and other factors. The estimates are subjective
in nature and involve uncertainties and matters of significant judgment and,
therefore, cannot be determined with precision. Changes in assumptions could
significantly affect the estimates.
Fair value estimates are based only on existing financial instruments without
attempting to estimate the value of anticipated future business or the value of
assets and liabilities that are not considered financial instruments. In
addition, the tax ramifications related to the realization of the unrealized
gains and losses can have a significant effect on the fair value estimates and
have not been considered in any of the estimates.
The estimated fair value of the Company's financial instruments as of September
30, 1999 and 1998 are shown below. Following the table, there is an explanation
of the methods and assumptions used to estimate the fair value of each class of
financial instruments.
40
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30,
------------------------------------------------------------------------
1999 1998
------------------------------------------------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial Assets
Cash and cash equivalents $ 4,539,372 $ 4,539,372 $ 4,290,188 $ 4,290,188
Securities available for sale 31,272,121 31,272,121 36,833,559 36,833,559
Securities held to maturity 33,808,632 32,172,438 23,299,208 23,445,762
Loans receivable 57,256,941 57,416,000 56,063,951 56,636,000
Federal Home Loan Bank stock 1,248,000 1,248,000 1,148,000 1,148,000
Accrued interest receivable 1,075,399 1,075,399 991,507 991,507
Financial Liabilities
Deposits 88,110,758 87,837,000 85,866,264 86,753,000
Borrowings 29,658,337 29,609,000 24,892,673 24,806,000
Accrued interest payable 577,585 577,585 543,886 543,886
</TABLE>
Cash and cash equivalents: The carrying amount of cash and cash equivalents
approximates their fair value.
Securities available for sale and securities held to maturity: The fair value of
securities is based upon quoted market prices.
Loans receivable: The fair values of loans receivable were estimated for groups
of loans with similar characteristics. The fair value of the loan portfolio was
calculated by discounting the scheduled cash flows through the estimated
maturity using anticipated prepayment speeds and using discount rates that
reflect the credit and interest rate risk inherent in each loan portfolio. The
fair value of the adjustable loan portfolio was estimated by grouping the loans
with similar characteristics and comparing the characteristics of each group to
the prices quoted for similar types of loans in the secondary market.
Federal home loan bank stock: The carrying amount of FHLB stock approximates
its fair value.
Accrued interest receivable: The carrying amount of accrued interest receivable
approximates its fair value since it is short-term in nature and does not
present unanticipated credit concerns.
Deposits: Under SFAS No. 107, the fair value of deposits with no stated
maturity, such as checking, savings, and money market accounts, is equal to the
amount payable on demand. The fair value of certificates of deposit is based on
the discounted value of contractual cash flows using as discount rates the rates
that were offered by the Company as of September 30, 1999 and 1998 for deposits
with maturities similar to the remaining maturities of the existing certificates
of deposit.
The fair value estimate for deposits does not include the benefit that results
from the low cost funding provided by the Company's existing deposits and long-
term customer relationships compared to the cost of obtaining different sources
of funding. This benefit is commonly referred to as the core deposit intangible.
41
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Borrowings: The fair value of borrowings is based on the discounted value of
contractual cash flows using as discount rates the rates that were available to
the Company as of September 30, 1999 and 1998 for borrowings with maturities
similar to the remaining maturities of the existing borrowings.
Accrued interest payable: The carrying amount of accrued interest payable
approximates its fair value since it is short-term in nature.
Note 20. First Federal Bancorporation Financial Information (Parent Company
Only)
The following are the condensed financial statements for the parent company only
as of September 30, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
- ------------------------------------------------------------------------------------------------
CONDENSED STATEMENTS OF FINANCIAL CONDITION
<S> <C> <C>
Assets
Cash and cash equivalents $ 280,598 $ 666,590
Securities available for sale 2,095,688 531,125
Investment in subsidiary 10,472,719 11,256,909
Other assets 235,503 638,196
------------------------------------
Total assets $ 13,084,508 $ 13,092,820
====================================
Liabilities and Stockholders' Equity
Accrued expenses $ 23,147 $ 10,372
Stockholders' equity 13,061,361 13,082,448
------------------------------------
Total liabilities and stockholders' equity $ 13,084,508 $ 13,092,820
====================================
CONDENSED STATEMENTS OF INCOME
Interest income $ 160,264 $ 110,357
Equity in earnings of subsidiary 738,442 806,424
Noninterest expense (106,090) (99,533)
------------------------------------
Income before income tax expense 792,616 817,248
Income tax expense 22,210 3,113
------------------------------------
Net income $ 770,406 $ 814,135
====================================
</TABLE>
42
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
- -----------------------------------------------------------------------------------------------------
CONDENSED STATEMENTS OF CASH FLOWS
<S> <C> <C>
Operating Activities
Net income $ 770,406 $ 814,135
Decrease in other assets 402,693 5,386
(Decrease) increase in accrued expenses 12,775 (72,293)
Equity in earnings of subsidiary (738,442) (806,424)
Cash dividend from subsidiary 1,000,000 500,000
Earned ESOP shares priced above original cost 64,688 122,440
Decrease in unamortized restricted stock 94,443 94,444
Decrease in unearned ESOP shares 69,000 69,000
Amortization of premium and discount, net (50,831) -
---------------------------------
Net cash provided by operating activities 1,624,732 726,688
---------------------------------
Investing Activities
Purchase of securities available for sale (10,096,514) (250,000)
Proceeds from maturities of securities available for sale 8,549,000 -
---------------------------------
Net cash used in investing activities (1,547,514) (250,000)
---------------------------------
Financing Activities
Purchase and retirement of common stock (462,412) (241,816)
Purchase of fractional shares (798) (837)
---------------------------------
Net cash used in financing activities (463,210) (242,653)
---------------------------------
Increase (decrease) in cash and cash equivalents (385,992) 234,035
Cash and cash equivalents:
Beginning of period 666,590 432,555
---------------------------------
End of period $ 280,598 $ 666,590
=================================
</TABLE>
43
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
____________________________________________________________________________
Note 21. Quarterly Financial Data (Unaudited)
Summarized quarterly selected operations data for fiscal 1999 and 1998 are as
follows:
<TABLE>
<CAPTION>
SELECTED OPERATIONS DATA
Three Months Ended
---------------------------------------------------------------------------
September 30, June 30, March 31, December 31,
1999 1999 1999 1998
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest income $ 2,225,755 $ 2,206,990 $ 2,144,083 $ 2,178,899
Interest expense 1,279,061 1,281,637 1,276,968 1,294,705
-------------------------------------------------------------------------
Net interest income 946,694 925,353 867,115 884,194
Provision for loan losses 78,627 13,549 47,086 (41,292)
Noninterest income 192,098 83,497 137,962 153,409
Noninterest expense 724,040 700,853 737,051 687,298
Income tax expense 126,061 108,974 78,903 158,766
-------------------------------------------------------------------------
Net income $ 210,064 $ 185,474 $ 142,037 $ 232,831
=========================================================================
Earnings per common share
-Basic $ 0.18 $ 0.16 $ 0.12 $ 0.20
=========================================================================
-Diluted $ 0.18 $ 0.16 $ 0.12 $ 0.19
=========================================================================
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------------------------------
September 30, June 30, March 31, December 31,
1998 1998 1998 1997
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest income $ 2,220,002 $ 2,088,137 $ 2,119,396 $ 2,092,513
Interest expense 1,313,453 1,194,962 1,197,265 1,200,492
------------------------------------------------------------------------
Net interest income 906,549 893,175 922,131 892,021
Provision for loan losses 57,500 35,000 30,500 30,000
Noninterest income 175,196 176,164 149,433 150,172
Noninterest expense 706,075 659,522 775,656 669,811
Income tax expense 118,892 141,926 97,190 128,634
------------------------------------------------------------------------
Net income $ 199,278 $ 232,891 $ 168,218 $ 213,748
========================================================================
Earnings per common share
-Basic $ 0.17 $ 0.20 $ 0.15 $ 0.18
========================================================================
-Diluted $ 0.16 $ 0.18 $ 0.13 $ 0.17
========================================================================
</TABLE>
44
<PAGE>
FIRST FEDERAL BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
____________________________________________________________________________
SELECTED FINANCIAL CONDITION DATA
<TABLE>
<CAPTION>
September 30, June 30, March 31, December 31,
1999 1999 1999 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total Assets $ 132,290,315 $ 130,498,858 $ 129,823,204 $ 129,488,405
Securities 65,080,753 64,451,261 65,340,918 62,487,070
Net Loans 57,256,941 55,130,832 54,340,918 55,028,329
Deposits 88,110,758 87,743,805 85,873,776 88,106,321
Stockholders' Equity 13,061,361 13,065,266 13,178,073 13,222,040
</TABLE>
<TABLE>
<CAPTION>
September 30, June 30, March 31, December 31,
1998 1998 1998 1997
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total Assets $ 125,250,628 $ 121,315,115 $ 113,159,478 $ 118,837,762
Securities 60,132,767 53,570,871 49,166,001 51,575,712
Net Loans 56,063,951 55,999,086 53,653,381 55,339,912
Deposits 85,866,264 84,852,654 83,035,031 84,379,265
Stockholders' Equity 13,082,448 12,680,749 12,330,061 12,093,100
</TABLE>
45
<PAGE>
MARKET AND DIVIDEND INFORMATION
Trading in the Common Stock
The Company's Common Stock is traded on the Nasdaq SmallCap Market.
There were, as of September 30, 1999, 1,431,069 shares of the Common Stock
outstanding, and approximately 219 holders of record of the Common Stock (not
including shares held in "street name") as of December 10, 1999. The December
10, 1999 closing sale price of the Common Stock as traded on the SmallCap Market
was $7.75 per share. All share numbers in this Annual Report have been adjusted
to reflect the 3-to-2 stock split paid in the form of a stock dividend on May
20, 1999.
The following table sets forth certain information as to the range of
the high and low bid prices for the Company's Common Stock for the calendar
quarters indicated during the most recent two fiscal years.
High Bid (1) Low Bid (1) Dividends Paid
------------ ----------- --------------
Fiscal 1998:
First Quarter 14.667 10.000 --
Second Quarter 14.167 12.500 --
Third Quarter 13.500 12.333 --
Fourth Quarter 12.833 9.167 --
Fiscal 1999:
First Quarter 10.166 9.000 --
Second Quarter 9.167 7.833 --
Third Quarter 10.500 7.833 --
Fourth Quarter 8.500 7.250 --
- ---------------------
(1) Quotations reflect inter-dealer price, without retail mark-up, mark-
down or commissions, and may not represent actual transactions. Prices
have been adjusted retroactively to give effect to a 3-for-2 stock
split paid on May 20, 1999.
Dividend Restrictions
Under OTS regulations, First Federal may not pay dividends on its
capital stock if its regulatory capital would thereby be reduced below the
amount then required for the liquidation account established for the benefit of
certain depositors of First Federal at the time of the Conversion. In addition,
savings institution subsidiaries of savings and loan holding companies are
required to give the OTS 30 days' prior notice of any proposed declaration of
dividends to the holding company.
OTS regulations impose additional limitations on the payment of
dividends and other capital distributions (including stock repurchases and cash
mergers) by First Federal. Under these regulations, a savings institution that,
immediately prior to, and on a pro forma basis after giving effect to, a
proposed capital distribution, has total capital (as defined by OTS regulation)
that is equal to or greater than the amount of its capital requirements (a "Tier
1 Association") is generally permitted, without OTS approval, to make capital
distributions during a calendar year in the amount equal to the greater of: (i)
75% of its net income for the previous four quarters; or (ii) up to 100% of its
net income to date during the calendar year plus an amount that would reduce by
one-half the amount by which its capital-to-assets ratio exceeded regulatory
requirements at the beginning of the calendar year. A savings institution with
total capital in excess of current minimum capital ratio requirements (a "Tier 2
Association") is permitted to make capital distributions without OTS approval of
up to 75% of its net income for the previous four quarters, less dividends
already
46
<PAGE>
paid for such period. A savings institution that fails to meet current minimum
capital requirements (a "Tier 3 Association") is prohibited from making any
capital distributions without the prior approval of the OTS. A Tier 1
Association that has been notified by the OTS that it is in need of more than
normal supervision will be treated as either a Tier 2 or Tier 3 Association.
First Federal is a Tier 1 Association. Under the OTS' prompt corrective action
regulations, First Federal is also prohibited from making any capital
distribution if after making the distribution, First Federal would have: (i) a
total risk-based capital ratio of less than 8.0%; (ii) a Tier 1 risk-based
capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0%.
The OTS, after consultation with the FDIC, however, may permit an otherwise
prohibited stock repurchase if made in connection with the issuance of
additional shares in an equivalent amount and the repurchase will reduce the
institution's financial obligations or otherwise improve the institution's
financial condition.
Furthermore, earnings of the Bank appropriated to bad debt reserves for
federal income tax purposes are not available for payment of cash dividends or
other distributions to the Company without payment of taxes at the then current
tax rate by First Federal on the amount of earnings removed from the reserves
for such distributions. The Company intends to make full use of this favorable
tax treatment afforded to First Federal and the Company and does not contemplate
use of any post-Conversion earnings of First Federal in a manner which would
limit either the Bank's bad debt deduction or create federal tax liabilities.
47
<PAGE>
BOARD OF DIRECTORS
<TABLE>
<S> <C> <C>
Ralph T. Smith William R. Belford Walter R. Fankhanel
Chairman of the Board of the Company and President and Chief Executive Officer Director of the Company and the Bank
the Bank of the Company and the Bank
Martin R. Sathre James R. Sharp Dean J. Thompson
Vice Chairman and Director of the Company Director of Company and the Bank Director of the Company and the Bank
and the Bank
EXECUTIVE OFFICERS
Ralph T. Smith Martin R. Sathre William R. Belford
Chairman of the Board of the Company and Vice Chairman and Director of the President and Chief Executive
the Bank Company and the Bank Officer of the Company and the Bank
Dennis M. Vorgert Karen Jacobson
Treasurer of the Company and the Bank Secretary of the Company and the Bank
OFFICE LOCATIONS
Main Office: Branch Offices:
214 5th Street 22 First Street, N.E. 109 Main Street West
Bemidji, Minnesota 56601 Bagley, Minnesota 56621 Baudette, Minnesota 56623
550 Paul Bunyan Drive, N.W. 527 Minnesota Avenue
Bemidji, Minnesota 56601 Walker, Minnesota 56484
GENERAL INFORMATION
Independent Public Accountants Annual Meeting Annual Report on Form 10-KSB
McGladrey & Pullen LLP The 2000 Annual Meeting of A copy of the Company's Annual
Certified Public Accountants Stockholders will be held on January Report on Form 10-KSB for the
Duluth, Minnesota 18, 2000 at 2:30 p.m. at the main fiscal year ended September 30,
office, 214 5th Street, Bemidji, 1999 as filed with the Securities
General Counsel Minnesota 56601. and Exchange Commission will be
Smith Law Firm furnished without charge to
Bemidji, Minnesota 56601 Transfer Agent and Registrar stockholders as of the record date
Stock Transfer Department for the 2000 Annual Meeting upon
Special Counsel Norwest Bank, N.A. written request to Karen Jacobson,
Housley Kantarian & Bronstein, P.C. P.O. Box 119 214 5th Street, Bemidji, Minnesota
1220 19th Street, N.W. Suite 700 So. St. Paul, Minnesota 55075-9988 56601
Washington, D.C. 20036
</TABLE>
<PAGE>
EXHIBIT 21
Subsidiaries of the Registrant
State or Other
Jurisdiction of Percentage
Incorporation Ownership
------------- ---------
Parent
- ------
First Federal Bancorporation Minnesota N/A
Subsidiary (1)
- ----------
First Federal Bank United States 100%
Subsidiaries of First Federal Bank (1)
- ----------------------------------
First Federal Service Corporation Minnesota 100%
- --------------------
(1) The assets, liabilities and operations of the subsidiaries are included in
the consolidated financial statements contained in the Annual Report to
Stockholders attached hereto as an exhibit.
<PAGE>
EXHIBIT 23
[LETTERHEAD OF MCGLADREY & PULLEN, LLP]
CONSENT OF INDEPENDENT ACCOUNTANTS
The Board of Directors
First Federal Bancorporation
Bemidji, Minnesota
We hereby consent to the incorporation by reference in this Form 10-KSB in the
previously filed Registration Statement of First Federal Bancorporation on Form
S-8 (No. 33-98242) of our report, dated October 29, 1999, relating to the
consolidated financial statements of First Federal Bancorporation and
subsidiaries.
/s/ McGladrey & Pullen, LLP
McGLADREY & PULLEN, LLP
Duluth, Minnesota
December 21, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-END> SEP-30-1999
<CASH> 2,194,436
<INT-BEARING-DEPOSITS> 2,344,936
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 31,272,121
<INVESTMENTS-CARRYING> 33,808,632
<INVESTMENTS-MARKET> 32,172,438
<LOANS> 57,182,329
<ALLOWANCE> 555,388
<TOTAL-ASSETS> 132,290,351
<DEPOSITS> 88,110,758
<SHORT-TERM> 29,658,337
<LIABILITIES-OTHER> 1,459,859
<LONG-TERM> 0
0
0
<COMMON> 14,311
<OTHER-SE> 13,047,050
<TOTAL-LIABILITIES-AND-EQUITY> 132,290,315
<INTEREST-LOAN> 4,637,348
<INTEREST-INVEST> 3,998,794
<INTEREST-OTHER> 119,585
<INTEREST-TOTAL> 8,755,727
<INTEREST-DEPOSIT> 3,720,298
<INTEREST-EXPENSE> 5,132,371
<INTEREST-INCOME-NET> 3,623,356
<LOAN-LOSSES> 97,970
<SECURITIES-GAINS> (83,129)
<EXPENSE-OTHER> 2,849,242
<INCOME-PRETAX> 1,243,110
<INCOME-PRE-EXTRAORDINARY> 1,243,110
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 770,406
<EPS-BASIC> 0.66
<EPS-DILUTED> 0.64
<YIELD-ACTUAL> 2.94
<LOANS-NON> 317,689
<LOANS-PAST> 79,094
<LOANS-TROUBLED> 188,300
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 498,340
<CHARGE-OFFS> 50,925
<RECOVERIES> 10,003
<ALLOWANCE-CLOSE> 555,380
<ALLOWANCE-DOMESTIC> 555,380
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
