PROSPECTUS
1,100,000 SHARES
[LOGO]
HARRINGTON FINANCIAL GROUP, INC.
COMMON STOCK
All of the 1,100,000 shares (the "Shares") of common stock, $0.125 par value
per share (the "Common Stock"), offered hereby (the "Offering"), are newly
issued shares of Harrington Financial Group, Inc. (the "Company").
Prior to the Offering, the Shares have not been traded on any exchange or
actively traded in any established public trading market. See "Dividends and
Market for Common Stock." See "Underwriting" for a discussion of factors
considered in determining the initial public offering price.
The Shares have been approved for quotation on the National Association of
Securities Dealers Automated Quotation National Market System (the "Nasdaq Stock
Market") under the symbol "HFGI."
-------------------
SEE "RISK FACTORS" ON PAGE 11 FOR CERTAIN INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE INVESTORS.
-------------------
THE SHARES OFFERED HEREBY ARE NOT SAVINGS OR DEPOSIT ACCOUNTS OR OTHER
OBLIGATIONS OF A BANK AND ARE NOT INSURED BY THE SAVINGS ASSOCIATION
INSURANCE FUND OR THE BANK INSURANCE FUND OF THE FEDERAL DEPOSIT
INSURANCE CORPORATION OR ANY OTHER GOVERNMENTAL AGENCY.
-------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS SUCH
COMMISSION OR ANY STATE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO THE
PUBLIC DISCOUNT (1)(2) COMPANY (2)(3)
<S> <C> <C> <C>
Per Share.............................. $10.00 $0.70 $9.30
Total (4).............................. $11,000,000 $770,000 $10,230,000
</TABLE>
(1) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933. See
"Underwriting."
(2) Before certain adjustments to the Underwriting Discount. See "Underwriting."
(3) Before deducting expenses payable by the Company, estimated to be $485,000.
(4) The Company has granted the Underwriters a 30-day option to purchase up to
165,000 additional Shares on the same terms and conditions as set forth
above, to cover over-allotments, if any. If all such Shares are purchased,
the total Price to Public, Underwriting Discount and Proceeds to the Company
will be $12,650,000, $885,500 and $11,764,500, respectively. See
"Underwriting."
-------------------
The Shares are offered by the several Underwriters subject to receipt and
acceptance by them, to prior sale and to the Underwriters' right to reject any
order in whole or in part and to withdraw, cancel or modify the offer without
notice. It is expected that delivery of the certificates for the Shares will be
made in St. Louis, Missouri on or about May 10, 1996.
STIFEL, NICOLAUS & COMPANY NATCITY INVESTMENTS, INC.
INCORPORATED
May 6, 1996
<PAGE>
[INSERT MAP]
IN CONNECTION WITH THE OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
2
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PROSPECTUS SUMMARY
This summary is qualified in its entirety by the more detailed information
and the Company's Consolidated Financial Statements, including the accompanying
Notes, appearing elsewhere in this Prospectus. Unless otherwise indicated, the
information in this Prospectus is adjusted to reflect the Company's four-for-one
stock split in October 1994 and two-for-one stock split in October 1995, and
assumes that the Underwriters' over-allotment option will not be exercised.
Prospective investors should carefully consider the information set forth under
the heading "Risk Factors." Unless the context otherwise requires, references
herein to the Company include Harrington Bank, FSB.
THE COMPANY
Harrington Financial Group, Inc. (the "Company") is an Indiana-chartered,
registered thrift holding company for Harrington Bank, FSB (the "Bank"). The
Bank, which was originally organized in 1889, is a federally chartered savings
bank which conducts business through three full-service offices located in
Carmel and Fishers, Indiana, both suburbs of Indianapolis, and Richmond,
Indiana. The Company's business consists primarily of attracting deposits and
utilizing borrowings and other funding sources to originate single-family
residential loans and acquire mortgage-backed and related securities. While the
Company's focus is to expand its portfolio of originated mortgage loans, over
75% of its assets currently consists of purchased mortgage-backed and related
securities. Although mortgage-backed and related securities often carry lower
yields than traditional mortgage loans, such securities generally increase the
quality of the Company's assets by virtue of the securities' underlying
insurance or guarantees, are more liquid than individual mortgage loans (which
enhances the Company's ability to actively manage its portfolio) and may be used
to collateralize borrowings or other obligations of the Company. Moreover, as a
result of the Company maintaining a substantial portion of its assets in
mortgage-backed and related securities, the Company has been able to maintain a
relatively low level of operating expenses. All of the Company's assets are
actively managed by the Company in order to reduce interest rate risk, increase
liquidity and enhance the Company's overall profitability and long term value.
At December 31, 1995, the Company had total consolidated assets of $307.4
million, total consolidated borrowings of $177.0 million, total consolidated
deposits of $114.8 million, and total consolidated stockholders' equity of $11.0
million.
The Company was organized in March 1988 by certain principals of Smith
Breeden Associates, Inc. ("Smith Breeden") for the sole purpose of acquiring the
Bank. The Bank was purchased with the intention of expanding the Bank's mortgage
and investment operations and improving the Bank's return on equity by utilizing
Smith Breeden's asset and liability management expertise. Smith Breeden
presently advises the Company and the Bank with respect to, among other things,
the management of its investments and borrowings and the pricing of loans and
deposits, as well as the use of various financial instruments to reduce interest
rate risk. Smith Breeden renders investment advice and asset and liability
management services to financial institutions, corporate and government pension
plans, foundations and government agencies nationally and, as of December 31,
1995, advised or managed assets exceeding $20 billion. Certain directors and
officers of the Company and the Bank are principals or affiliates of Smith
Breeden and, as of December 31, 1995, principals and affiliates of Smith Breeden
beneficially owned 95.3% of the Common Stock of the Company. See
"Management--Transactions With Certain Related Persons" and "Beneficial
Ownership of Securities."
The Company attempts to enhance profitability and reduce credit, interest
rate and liquidity risk by: (i) investing in mortgage-backed and related
securities and originating (both directly and through correspondents) loans
secured primarily by single-family residences; (ii) actively managing its
investment portfolio and funding sources in order to secure favorable spreads in
a variety of interest rate environments; (iii) controlling interest rate risk
and net portfolio volatility through the use of interest
3
<PAGE>
rate swaps, collars, caps, floors, options and futures (collectively, "interest
rate contracts"), and collateralized mortgage obligations, mortgage-backed
residuals and interest-only and principal-only strips (collectively,
"mortgage-backed derivative securities"); (iv) seeking to access cost-efficient
funding sources given prevailing market conditions, consisting primarily of
deposits, securities sold under agreements to repurchase and advances from the
Federal Home Loan Bank ("FHLB") of Indianapolis; (iv) managing its costs in
order to maintain high operating efficiency; and (v) attempting to grow its
retail banking operations through increased loan originations and retail deposit
growth.
Highlights of the principal elements of the Company's business strategy are
as follows:
. Active Portfolio Management. The Company actively manages its interest-earning
assets and, with the assistance of Smith Breeden, utilizes "option-adjusted
pricing analysis" to quantify the costs embedded in the yield of an
investment, including the funding cost, the cost of the options embedded in
the investment's cash flows, if any (such as a borrower's ability to prepay a
mortgage), and any servicing costs. The objective of the Company's investment
management process is to select assets (including loans and securities) with
attractive risk-adjusted net spreads (over the Company's funding costs) and
actively manage the underlying risks of these investments. The Company uses
interest rate contracts and mortgage-backed derivative securities to secure
favorable interest rate spreads and to maintain the overall market value of
its assets and liabilities in changing interest rate environments. The Company
believes that this strategy will enhance the long-term market value of the
Company. Nevertheless, because the Company actively manages its portfolio,
nearly all of its mortgage-backed and related securities and interest rate
contracts are classified for accounting purposes as held for trading (with
unrealized gains and losses included in earnings) and, as a result, the
Company's earnings have and may in the future fluctuate significantly on a
period-to-period basis as has been illustrated by the Company's results of
operations over the past five years. The Company attempts to reduce, to the
extent possible, such fluctuations through its asset and liability management
strategies. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Business."
. Control Interest Rate Risk. The Company attempts to manage its assets and
liabilities in order to maintain a portfolio which produces positive returns
in either an increasing or decreasing interest rate environment. The Company
has sought to control interest rate risk both internally through the
management of the composition of its assets and liabilities and externally
through the utilization of interest rate contracts. Interest rate contracts
are purchased with the intention of protecting both the net interest income of
the Bank and, along with mortgage-backed derivative securities, the market
value of the Bank's portfolio on a mark-to-market basis. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Asset and Liability Management."
. Control Credit Risk. In order to limit the Company's credit exposure and as
part of its strategy to earn a positive interest rate spread, the Company
maintains a substantial portion of its assets in mortgage-backed and related
securities, which are primarily issued or guaranteed by U.S. Government
agencies or government sponsored enterprises, and single-family residential
loans. At December 31, 1995, the Company's investment in mortgage-backed and
related securities amounted to $226.2 million or 97.2% of the Company's
securities portfolio (both held for trading and available for sale) and 73.6%
of the Company's total assets. In addition, as of such date, the Company's
investment in single-family residential loans amounted to $54.0 million or
17.7% of total assets. See "Business-- Lending" and "--Investment Activities."
. Reduce Funding Costs. The Company attempts to reduce its overall funding costs
by evaluating all potential sources of funds (including retail and non-retail
deposits and short and long-term borrowings) and identifying which particular
source will result in an all-in cost to the Company that meets its funding
benchmark. At the same time, the Company has attempted to price the deposits
offered
4
<PAGE>
through its branch system in order to promote retail deposit growth and offer
a wide array of deposit products to satisfy its customers. See
"Business--Sources of Funds."
. Increase Emphasis on Retail Banking. An integral part of the Company's
strategy is to increase the Bank's emphasis on retail products and services.
The Company's primary lending emphasis is on the origination (both directly
and through correspondents) of loans secured by first liens on single-family
(one-to-four units) residences. Originations of such loans have increased from
$8.8 million during fiscal 1993 to $18.9 million during fiscal 1995 and
further increased to $25.1 million during the six months ended December 31,
1995. See "Business--Lending Activities." In addition, the Company's retail
deposits (including transaction accounts and retail certificates of deposit)
have increased from $45.9 million or 51.1% of total deposits at June 30, 1993
to $84.9 million or 73.9% of total deposits at December 31, 1995. See
"Business--Sources of Funds--Deposits." The Company believes that
single-family residential loan originations generally offer attractive yields,
provide a source of fee income and, with respect to direct originations, allow
the Company to establish a relationship with the underlying borrower which the
Company can utilize to cross-sell additional products and services. In
addition, the Company believes that retail deposits are a cost-effective
source of funds, provide an additional source of fee income and also permit
the further cross-selling of additional products and services. Consequently,
the Company expects to continue to focus on increasing its retail deposit base
and its portfolio of single-family residential loans.
. Control Operating Expenses. As a result of the Company maintaining a
substantial portion of its assets in mortgage-backed and related securities,
the Company has been able to maintain a low level of operating expenses.
Accordingly, the Company's total other expenses to average total assets for
the six months ended December 31, 1995 and the year ended June 30, 1995
amounted to 1.08% (annualized) and 1.30%, respectively. Although the Company
strives to maintain a low level of operating expenses, management recognizes
that as the Bank increases its emphasis on retail banking, its operating
expenses will correspondingly increase.
. Trust and Investment Management Services. In order to provide a more complete
range of financial services to its customers, in December 1994, the Company
began offering a variety of trust and investment management services through
Harrington Investment Management and Trust Services, a separate division of
the Bank. As of December 31, 1995, the Bank administered approximately 49
accounts with aggregate assets of $11.5 million at such date. See
"Business--Trust and Fiduciary Services."
. Asset Growth and Acquisitions. The Company has and will continue to pursue a
policy of utilizing its existing capital and infrastructure to grow through
the purchase of mortgage-backed and related securities and the continued
growth of the Bank's retail operations. The Company will also consider
acquisition opportunities when it perceives that they are advantageous to the
Company and its stockholders. There are currently no plans, arrangements,
understandings or agreements regarding any such acquisition opportunities. The
Company believes that it can initially deploy its capital, including the net
proceeds of the Offering, quickly by purchasing mortgage-backed and related
securities funded primarily through securities sold under agreements to
repurchase, and subsequently redeploy such capital into single-family
residential loans as market conditions permit.
5
<PAGE>
THE OFFERING
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<S> <C>
Shares Offered...................... 1,100,000 Shares (1,265,000 Shares, assuming full
exercise of the over-allotment option).
Shares Reserved for Purchase
by Affiliates..................... In addition to the Company's Employee Stock Ownership
Plan ("ESOP"), which expects to purchase 7,000
Shares, the Company's directors and executive
officers and certain other affiliates of Smith
Breeden as a group (20 persons) have indicated to the
Company that they intend to order in the aggregate
343,000 Shares in the Offering. Assuming the full
purchases indicated by the ESOP and the Company's
directors and executive officers and certain other
affiliates of Smith Breeden, such persons and entity
would be deemed to beneficially own 73.7% of the
Common Stock to be outstanding on a pro forma basis
following the Offering (70.0% assuming full exercise
of the over-allotment option). See "Beneficial
Ownership of Securities."
Common Stock Outstanding After the
Offering............................ 3,091,738 shares (3,256,738 shares, assuming full
exercise of the over-allotment option), which does
not include 247,200 shares of Common Stock reserved
for issuance upon exercise of outstanding and
to-be-outstanding stock options (137,200 of which
relate to previously issued stock options (which are
not currently exercisable) and 110,000 of which
relate to Common Stock reserved for future issuance
pursuant to the Company's Stock Option Plan). See
"Management--Benefits--Stock Option Plan,"
"Beneficial Ownership of Securities" and
"Underwriting."
Dividends........................... The Company does not expect to pay a dividend on the
Common Stock following the Offering, but intends to
retain earnings and increase capital in furtherance
of its overall business objectives. See "Dividends
and Market for Common Stock."
Use of Proceeds..................... The Company proposes to retain $1.0 million of the
net proceeds from this Offering for general corporate
purposes. The remainder of the net proceeds will be
used to increase the capital base of the Bank, which
will allow the Company to increase its investment in
mortgage-backed and related securities as well as the
origination (both directly and through
correspondents) of single-family residential loans.
Although the Offering will result in an increase in
the Bank's capital, management believes that as it
deploys the capital raised, the Bank's capital ratios
will remain generally consistent with historical
levels. See "Use of Proceeds."
Nasdaq Symbol....................... The Shares have been approved for quotation on the
Nasdaq Stock Market under the symbol "HFGI." See
"Dividends and Market for Common Stock."
</TABLE>
6
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
AT OR FOR THE
SIX MONTHS ENDED
DECEMBER 31, AT OR FOR THE YEAR ENDED JUNE 30,
------------------- ----------------------------------------------------
1995 1994 1995 1994 1993 1992 1991
-------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Securities held for trading and
available for sale...................... $232,629 $184,665 $249,274 $174,347 $186,582 $185,805 $181,853
Loans receivable--net.................. 55,910 23,757 37,010 20,682 16,620 21,409 26,640
Total assets........................... 307,405 225,820 300,174 211,688 220,095 226,622 236,538
Deposits............................... 114,814 122,751 115,312 108,300 89,788 93,476 92,048
Securities sold under agreements to
repurchase.............................. 141,448 53,569 130,217 54,651 83,709 116,993 121,138
FHLB advances.......................... 26,000 31,000 31,000 31,000 31,000 -- 7,000
Note payable........................... 9,521 7,730 9,200 7,880 7,431 8,435 9,358
Stockholders' equity................... 11,009 7,317 10,361 5,926 5,294 5,128 4,311
Stockholders' equity per share......... 5.53 4.70 5.28 4.20 3.75 3.63 3.05
INCOME STATEMENT DATA
Interest income........................ $ 11,553 $ 7,423 $ 17,560 $ 13,607 $ 12,746 $ 15,407 $ 19,270
Interest expense....................... 8,996 5,275 12,779 8,284 8,975 12,714 15,799
-------- -------- -------- -------- -------- -------- --------
Net interest income.................. 2,557 2,148 4,781 5,323 3,771 2,693 3,471
Provision for loan losses.............. (1) 21 15 (3) 66 8 26
-------- -------- -------- -------- -------- -------- --------
Net interest income after provision for
loan losses............................. 2,558 2,127 4,766 5,326 3,705 2,685 3,445
Other income:
Gain (loss) on sale of securities
held for trading........................ (2,621) (338) 66 (2,169) -- -- --
Gain on sale of securities available
for sale................................ -- -- -- 392 1,384 1,108 288
Unrealized gain on securities held
for trading............................. 2,452 750 1,535 710 -- -- --
Permanent impairment of securities
available for sale...................... -- -- (414) (610) (2,531) (1,057) --
-------- -------- -------- -------- -------- -------- --------
Total portfolio income (1).......... 2,389 2,539 5,953 3,649 2,558 2,736 3,733
Other miscellaneous income........... 114 123 238 267 249 106 93
Other expense.......................... 1,711 1,483 3,167 2,519 2,749(2) 1,835 1,592
-------- -------- -------- -------- -------- -------- --------
Income before income tax provision and
cumulative effect of change in
accounting for deferred income
taxes................................... 792 1,179 3,024 1,397 58 1,007 2,234
Income tax provision................... 249 409 1,171 391 188 190 835
Income (loss) before cumulative effect
of change in accounting for deferred
income taxes............................ 543 770 1,853 1,006 (130) 817 1,399
Cumulative effect of change in
accounting for deferred income taxes
(3)..................................... -- -- -- (79) -- -- --
-------- -------- -------- -------- -------- -------- --------
Net income (loss)...................... $ 543 $ 770 $ 1,853 $ 927 $ (130) $ 817 $ 1,399
-------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- --------
Net income (loss) per share............ $ 0.28 $ 0.54 $ 1.20 $ 0.66 $ (0.09) $ 0.58 $ 0.99
-------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- --------
PERFORMANCE RATIOS
Return on average assets............... 0.34% 0.69% 0.76% 0.44% (0.06)% 0.36% 0.68%
Return on average equity............... 10.06 22.88 22.24 14.98 (2.67) 17.06 39.45
Interest rate spread................... 1.63 2.07 2.13 2.63 1.79 1.65 1.22
Net interest margin.................... 1.69 2.06 2.10 2.64 1.81 1.25 1.71
Average interest-earning assets to
average
interest-bearing liabilities......... 100.95 99.80 99.57 100.25 100.39 100.61 100.89
Net interest income after provision for
loan losses to total other
expenses................................ 149.50 143.40 150.50 211.40 134.80 146.30 216.40
Total other expenses to average total
assets.................................. 1.08 1.34 1.30 1.19 1.27 0.82 0.78
Full service offices................... 3 2 2 2 1 1 1
ASSET QUALITY RATIOS (AT END OF PERIOD)
Non-performing loans to total loans
(4)..................................... 0.65 2.13 0.95 2.70 3.00 2.56 1.60
Non-performing assets to total assets
(4)..................................... 0.51 1.06 0.59 1.34 0.24 0.24 0.24
Allowance for loan losses to total
loans................................... 0.21 0.53 0.33 0.51 0.94 0.46 0.34
Allowance for loan losses to total
non-performing loans (4)............. 32.97 25.10 34.57 18.96 29.71 18.07 15.96
CAPITAL RATIOS (5)
Tangible capital ratio................. 6.33 6.12 6.12 6.07 5.58 5.31 4.92
Core capital ratio..................... 6.33 6.12 6.12 6.07 5.58 5.35 4.97
Risk-based capital ratio............... 22.33 23.91 24.62 21.40 18.56 16.59 16.23
Equity to assets at end of period...... 3.58 3.24 3.45 2.80 2.41 2.26 1.82
</TABLE>
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(1) Consists of net interest income after provision for loan losses and other
income relating to the Company's securities activities.
(2) Includes a write-off of goodwill and core deposit intangible of $663,000.
(3) Reflects the Company's adoption of Statement of Financial Accounting
Standards ("SFAS") No. 109, "Accounting for Income Taxes," effective July 1,
1993.
(4) Non-performing loans consist of non-accrual loans and accruing loans that
are contractually past due 90 days or more, and non-performing assets
consist of non-performing loans, real estate acquired by foreclosure or
deed-in-lieu thereof and a single non-agency participation certificate
classified as substandard.
(5) Regulatory capital ratios apply to the Bank as a federally chartered savings
bank. For additional information see "Regulatory Capital" and "Supervision
and Regulation--The Bank--Regulatory Capital Requirements."
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SUMMARY OF RECENT DEVELOPMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
AT AT AT
MARCH 31, 1996 DECEMBER 31, 1995 JUNE 30, 1995
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<S> <C> <C> <C>
BALANCE SHEET DATA
Securities held for trading and available
for sale..................................... $245,636 $ 232,629 $ 249,274
Loans receivable--net.......................... 58,901 55,910 37,010
Total assets................................... 321,756 307,405 300,174
Deposits....................................... 127,017 114,814 115,312
Securities sold under agreements to
repurchase...................................... 143,129 141,448 130,217
FHLB advances.................................. 26,000 26,000 31,000
Note payable................................... 9,263 9,521 9,200
Stockholders' equity........................... 11,616 11,009 10,361
Stockholders' equity per share................. 5.83 5.53 5.28
</TABLE>
<TABLE>
<CAPTION>
AT OR FOR THE
THREE AT OR FOR THE NINE
MONTHS ENDED MONTHS ENDED
MARCH 31, MARCH 31,
------------------ ------------------
1996 1995 1996 1995
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<S> <C> <C> <C> <C>
INCOME STATEMENT DATA
Total interest income.................................... $ 5,616 $ 4,440 $17,169 $11,863
Total interest expense................................... 4,338 3,231 13,334 8,506
------- ------- ------- -------
Net interest income.................................... 1,278 1,209 3,835 3,357
Provision for loan losses................................ -- (1) (1) 20
------- ------- ------- -------
Net interest income after provision for loan losses...... 1,278 1,210 3,836 3,337
Other income:
Gain (loss) on sale of securities held for trading..... 5,088 (1,114) 2,467 (1,452)
Unrealized gain (loss) on securities held for
trading................................................... (4,498) 2,149 (2,046) 2,899
------- ------- ------- -------
Total portfolio income(1)............................ 1,868 2,245 4,257 4,784
Other miscellaneous income............................. 76 51 190 174
Other expense............................................ 1,044 828 2,755 2,311
------- ------- ------- -------
Income before income tax provision....................... 900 1,468 1,692 2,647
Income tax provision..................................... 293 528 542 937
------- ------- ------- -------
Net income............................................... $ 607 $ 940 $ 1,150 $ 1,710
------- ------- ------- -------
------- ------- ------- -------
Net income per share..................................... $ 0.30 $ 0.54 $ 0.58 $ 1.16
------- ------- ------- -------
------- ------- ------- -------
PERFORMANCE RATIOS
Return on average assets................................. 0.75% 1.58% 0.48% 1.00%
Return on average equity................................. 21.06 39.27 13.93 29.70
Interest rate spread..................................... 1.67 2.25 1.65 2.13
Net interest margin...................................... 1.68 2.20 1.68 2.11
Average interest-earning assets to average
interest-bearing liabilities.............................. 100.08 99.09 100.66 99.55
Net interest income after provision for loan losses to
total other expenses................................... 122.41 146.14 139.24 144.40
Total other expenses to average total assets............. 1.29 1.39 1.15 1.36
Full service offices..................................... 3 2 3 2
ASSET QUALITY RATIOS (AT END OF PERIOD)
Non-performing loans to total loans (2).................. 0.44 1.34 0.44 1.34
Non-performing assets to total assets (2)................ 0.43 0.79 0.43 0.79
Allowance for loan losses to total loans................. 0.20 0.44 0.20 0.44
Allowance for loan losses to total non-performing
loans..................................................... 45.98 32.64 45.98 32.64
CAPITAL RATIOS(3)
Tangible capital ratio................................... 6.18 6.32 6.18 6.32
Core capital ratio....................................... 6.18 6.32 6.18 6.32
Risk-based capital ratio................................. 24.65 25.94 24.65 25.94
Equity to assets at end of period........................ 3.61 3.80 3.61 3.80
</TABLE>
- - - ------------
(1) Consists of net interest income after provision for loan losses and other
income relating to the Company's securities activities.
(2) Non-performing loans consist of non-accrual loans and accruing loans that
are contractually past due 90 days or more, and non-performing assets
consist of non-performing loans, real estate acquired by foreclosure or
deed-in-lieu thereof and a single non-agency participation certificate
classified as substandard.
(3) Regulatory capital ratios apply to the Bank as a federally chartered savings
bank. For additional information see "Regulatory Capital" and "Supervision
and Regulation--The Bank--Regulatory Capital Requirements."
8
<PAGE>
At March 31, 1996, the Company's total assets amounted to $321.8 million, as
compared to $307.4 million at December 31, 1995. The $14.4 million or 4.7%
increase in total assets during the three months ended March 31, 1996 was
primarily the result of a $13.2 million increase in securities held for trading
and a $3.0 million increase in loans receivable. The increase in securities held
for trading was a result of additional investments in adjustable-rate
mortgage-backed securities issued by the Government National Mortgage
Association. The increase in loans receivable reflected the Company's continuing
efforts to increase its retail banking operations, particularly the origination
(both directly and through correspondent mortgage banking companies) of
single-family residential loans to individuals residing in eastern and central
Indiana.
The increase in the Company's assets from December 31, 1995 to March 31,
1996 was funded primarily by a $12.2 million or 10.6% increase in deposits and a
$1.7 million or 1.2% increase in securities sold under agreements to repurchase.
The increase in the Company's deposits during the period reflected the Company's
opening of a new branch office in Fishers, Indiana in December 1995 and various
promotional efforts which were utilized to attract retail deposits.
At March 31, 1996, the Company's stockholder's equity amounted to $11.6
million, as compared to $11.0 million at December 31, 1995. The 5.5% increase in
stockholders' equity was due to the $607,000 of net income recognized during the
quarter. At March 31, 1996, the Bank's tangible and core capital amounted to
$19.8 million or 6.2% of adjusted total assets, which exceeded the minimum 1.5%
and 3.0% requirements by $15.0 million and $10.2 million, respectively.
Additionally, as of such date, the Bank's risk-based capital totalled $19.9
million or 24.7% of total risk-adjusted assets, which exceeded the minimum 8.0%
requirement by $13.5 million.
The Company reported net income of $607,000 or $0.30 per share and $1.2
million or $0.58 per share during the three and nine months ended March 31,
1996, as compared to $940,000 or $0.54 per share and $1.7 million or $1.16 per
share during the prior comparable periods. The $333,000 or 35.4% decrease in net
income during the three months ended March 31, 1996, as compared to the same
period in the prior year, was primarily due to a $377,000 decline in total
portfolio income (net interest income after provision for loan losses and other
income relating to the Company's securities activities) and a $216,000 increase
in total other expense, which was partially offset by a $235,000 decrease in the
Company's income tax provision. The $560,000 or 32.7% decrease in net income
during the nine months ended March 31, 1996, as compared to the same period in
the prior year, was primarily the result of a $527,000 decline in total
portfolio income and a $444,000 increase in total other expense, which was
partially offset by a $395,000 decrease in the income tax provision.
Net interest income increased by $69,000 or 5.7% during the three months
ended March 31, 1996, as compared to the same period in the prior year. This
increase was primarily due to an increase in the ratio of average
interest-earning assets to average interest-bearing liabilities, from 99.09% to
100.08%, primarily reflecting increases in the average balances of securities
held for trading and loans, which was partially offset by a 58 basis point
decline in the Company's interest rate spread (from 2.25% to 1.67%). Net
interest income increased by $478,000 or 14.2% during the nine months ended
March 31, 1996, as compared to the same period in the prior year. This increase
was primarily due to an increase in the ratio of average interest-earning assets
to average interest-bearing liabilities, from 99.55% to 100.66%, primarily
reflecting increases in the average balances of securities held for trading and
loans, which was partially offset by a 48 basis point decline in the Company's
interest rate spread (from 2.13% to 1.65%). The decline in the Company's
interest rate spread during the three and nine months ended March 31, 1996 was
primarily due to the Bank reinvesting the capital raised in the Company's fiscal
1995 private placement through the purchase of highly liquid but lower yielding
mortgage-backed and related securities, which were funded primarily through
securities sold under agreements to repurchase.
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Total other income amounted to $666,000 and $611,000 during the three and
nine months ended March 31, 1996, as compared to $1.1 million and $1.6 million
during the same respective periods in the prior year. This income principally
represents the net mark-to-market value gain or loss (realized or unrealized) on
securities held for trading, offset by the net mark-to-market value gain or loss
(realized or unrealized) on interest rate contracts used for hedging such
securities. Management's objective in actively hedging and managing the
Company's investment trading portfolio is to reduce the interest rate risk of
this portfolio. Through the Company's employment of option-adjusted spread
analysis, the Company attempts to select investments with high relative values
and to earn positive returns with respect to such securities. The overall
profitability with respect to the Company's securities activities is
significantly affected by changes in spread relationships between
mortgage-backed and related securities and the interest rate contracts utilized
by the Company for hedging purposes. During the three and nine months ended
March 31, 1996, the Company recognized $5.1 million and $2.5 million,
respectively, of gains on securities held for trading (which include interest
rate contracts used for hedging purposes), which was partially offset by $4.5
million and $2.0 million, respectively of unrealized losses on securities held
for trading. During the three and nine months ended March 31, 1995, the Company
recognized $2.1 million and $2.9 million, respectively, of unrealized gains on
securities held for trading, which was partially offset by $1.1 million and $1.5
million, respectively, of losses on the sale of securities held for trading. The
decline in the Company's income from securities activities during the three and
nine months ended March 31, 1996 reflected fluctuations with respect to the
values of the Company's mortgage-backed and related securities as well as
fluctuations with respect to the values of the various interest rate contracts
utilized by the Company to hedge its interest rate exposure.
Total other expense amounted to $1.0 million and $2.8 million during the
three and nine months ended March 31, 1996, as compared to $828,000 and $2.3
million during the same respective periods in the prior year. The increase in
total other expense during the three and nine month periods reflected increases
in salaries, marketing costs and other operating expenses, which were primarily
the result of the Company's retail growth during such periods (including the
opening of a new branch office in Fishers, Indiana). However, total other
expense as a percentage of average total assets amounted to 1.29% and 1.15%
during the three and nine months ended March 31, 1996, as compared to 1.39% and
1.36% during the same respective periods in the prior year.
The Company's income tax provision amounted to $293,000 and $542,000 during
the three and nine months ended March 31, 1996, as compared to $528,000 and
$937,000 during the same respective periods in the prior year. The Company's
effective tax rate amounted to 32.6% and 32.0% during the three and nine months
ended March 31, 1996, as compared to 36.0% and 35.4% during the same respective
periods in the prior year.
The liquidity of the Bank, as measured by the ratio of cash, cash
equivalents (not committed, pledged or required to liquidate specific
liabilities), investments and qualifying mortgage-backed securities to the sum
of total deposits plus borrowings payable within one year, was 5.40% at March
31, 1996, as compared to 5.36% and 7.95% at June 30, 1995 and 1994,
respectively. At March 31, 1996, the Bank's "liquid" assets totalled
approximately $14.7 million, which was $1.1 million in excess of the current OTS
minimum requirement. At March 31, 1996, the total approved loan commitments
outstanding amounted to $3.4 million. Certificates of deposit scheduled to
mature in one year or less at March 31, 1996 totalled $79.8 million.
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RISK FACTORS
The following risk factors, in addition to those discussed elsewhere in this
Prospectus, should be carefully considered by investors in deciding whether to
purchase the Shares offered hereby.
EARNINGS VOLATILITY
The Company maintains a substantial portion of its assets in mortgage-backed
and related securities and actively manages its investment portfolio in order to
obtain favorable interest rate spreads in a variety of interest rate
environments. Due to the Company's strategy of actively managing its securities
portfolio, nearly all of the Company's mortgage-backed and related securities
and interest rate contracts are classified for accounting purposes as held for
trading. Consequently, such securities and contracts are reported at fair value
with unrealized gains and losses included in earnings. In addition, as discussed
below under "--Potential Effects of Changes in Interest Rates," despite the
Company's sophisticated asset and liability management strategies, the Company
cannot perfectly match the elasticity of its assets and liabilities or
completely eliminate the Company's interest rate risk. As a result of the
foregoing, the Company's earnings have historically and may continue in the
future to fluctuate significantly on a period-to-period basis. During the six
months ended December 31, 1995 and 1994, the Company reported net income of
$543,000 and $770,000, respectively, while during the years ended June 30, 1995,
1994, 1993, 1992 and 1991, the Company reported net income (loss) of $1.9
million, $927,000, $(130,000), $817,000 and $1.4 million, respectively. See
"Management Discussion and Analysis of Financial Condition and Results of
Operations."
POTENTIAL EFFECTS OF CHANGES IN INTEREST RATES
The operations of the Company are substantially dependent on its net
interest income, which is the difference between the interest income earned on
its interest-earning assets and the interest expense paid on its
interest-bearing liabilities, and the change in value of the Company's
securities portfolio. Because the Company's interest-earning assets have longer
effective maturities than its interest-bearing liabilities, the yield on the
Company's interest-earning assets generally will adjust more slowly than the
cost of its interest-bearing liabilities and, as a result, if left unhedged, the
Company's net interest income and the value of its securities portfolio
generally would be adversely affected by material and prolonged increases in
interest rates and positively affected by comparable declines in interest rates.
In addition to affecting net interest income, changes in interest rates also can
affect the value of the Company's interest-earning assets, which are comprised
of fixed and adjustable-rate instruments. Generally, the value of fixed-rate
instruments declines when interest rates rise and, conversely, increases when
interest rates fall. Nearly all of the Company's securities are classified as
held for trading and are reported at fair value with unrealized gains and losses
included in earnings. Accordingly, declines in the value of the Company's
securities held for trading could, in the absence of hedging, have a negative
impact on the Company's earnings regardless of whether any securities were
actually sold by the Company.
The Company has sought to reduce the vulnerability of its operations to
changes in interest rates by managing the nature and composition of its rate
sensitive assets and rate sensitive liabilities. In general, the Company's goal
in managing its interest rate risk is to match the elasticities of its assets
and liabilities as closely as possible. The Company attempts to manage its
exposure to interest rate risk externally through the use of interest rate
contracts. The net expense relating to such interest rate contracts has
effectively reduced the Company's interest rate spread and net interest margin
over the past five years. However, in a different interest rate environment,
interest rate contracts could increase the Company's interest rate spread and
net interest margin. The Company also attempts to attract longer-term sources of
funds or utilizes mortgage-backed derivative securities in order to internally
manage the Company's interest rate exposure. Such interest rate contracts and
mortgage-backed
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derivative securities are included in the Company's trading portfolio and, as
discussed above, reported at fair value, with unrealized gains and losses
thereon included in earnings.
Changes in net interest income and the value of the Company's
mortgage-backed and related securities are generally offset by changes in the
value of the Company's interest rate contracts and mortgage-backed derivative
securities and, consequently, the effect of changing interest rates on the
Company's operations is mitigated to a large degree by the Company's active
management of its assets and liabilities. However, because of a variety of
factors, including the inefficiencies of completely matching the elasticities of
its assets and liabilities, the widening or tightening of asset spreads and
changes in actual prepayment experience as compared to the prepayment
assumptions used by the Company in modeling interest rate spreads, the Company
cannot perfectly match the elasticity of its assets and liabilities or
completely eliminate the Company's exposure to interest rate risk. In addition,
because of the Company's strategies associated with managing its exposure to
interest rate risk, particularly its accounting of its securities portfolio on a
mark-to-market basis, changes in market conditions may result in volatility with
respect to the Company's earnings. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Changes in Financial Condition,"
"--Results of Operations" and "--Asset and Liability Management."
PRICING RISK
In order to establish the fair value of the individual securities within the
Company's securities portfolio, the Company obtains price quotations from
various broker-dealers and electronic quotation and market information services.
Although these quotations are believed to be accurate, no assurances can be made
that such prices truly reflect the fair value of such securities. In addition,
certain of the mortgage-backed derivative securities held by the Company may
have a thin or limited trading market. The lack of a liquid trading market for
the Company's mortgage-backed derivative securities or other securities may have
an adverse effect on the market price of such securities and the Company's
ability to dispose of such securities and may also make it more difficult for
the Company to obtain accurate market quotations for purposes of valuing these
instruments. Market quotations for these securities may not necessarily reflect
prices obtainable with respect to an actual sale. Since a substantial portion of
the Company's securities portfolio are held for trading, with unrealized gains
and losses included in earnings, any inaccurate price quotations could adversely
affect the Company's results of operations.
USE OF INTEREST RATE CONTRACTS AND OTHER DERIVATIVES
A principal element of the Company's business strategy is the reduction of
interest rate exposure through the utilization of various interest rate
contracts such as interest rate swaps, collars, caps, floors, options and
futures. In addition, the Company's trading portfolio includes a variety of
mortgage-backed derivative instruments such as collateralized mortgage
obligations, mortgage-backed residuals and interest-only and principal-only
strips. Interest rate contracts and mortgage-backed derivative securities
(collectively "derivative securities") are, by their nature, subject to various
risks (all of which risks also apply to most other financial instruments) which
could, in the case of certain interest rate contracts, result in losses
exceeding the carrying value of the particular instrument. Among the risks
inherent with respect to the purchase and/or sale of derivative securities are
(i) basis risk, which consists of the risk of loss associated with variations in
the spread between the asset yield and the funding and/or hedge cost; (ii)
credit or default risk, which consists of the risk of insolvency or other
inability of the counterparty to a particular transaction to perform its
obligations thereunder; (iii) prepayment risk, which consists of reinvestment
risk to the extent the Company is not able to reinvest prepayments, if any, at a
yield which is comparable to the yield being generated on the particular
security; (iv) interest rate risk, which consists of the risks relating to
fluctuating interest rates; (v) liquidity risk, which consists of the risk that
the Company may not be able to sell a particular security for a particular
price; and (vi) volatility risk,
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which consists of the risk that actual volatility (i.e., the degree of
uncertainty relating to the price of the underlying asset) differs from the
historical volatility or "implied" volatility of the instrument.
With the assistance of Smith Breeden, the Company manages the foregoing
risks with respect to its derivative securities within the context of its
overall asset and liability management strategies. With respect to basis risk,
the Company closely monitors fluctuations in the spreads of its assets,
liabilities and hedges and actively manages its portfolio, including selling
specific securities when spreads tighten and buying specific securities when
spreads widen. With respect to credit or default risk, the Company generally
only deals with large investment brokerage firms, requires such firms to post
collateral in certain cases and limits its unsecured exposure to any one firm to
25% of the Bank's equity for any two-month period and 35% of the Bank's equity
for any one-month period. With respect to prepayment risk, Smith Breeden
provides the Company with extensive information regarding prepayments and
performs a variety of stress tests regarding the Company's portfolio. With
regard to interest rate risk, the Company analyzes the interest rate exposure of
its assets and liabilities as a whole (including any derivative securities held
in the portfolio) and utilizes various interest rate contracts to hedge the
interest rate risk exhibited by the Company's overall portfolio of assets and
liabilities. With respect to liquidity risk, the Company generally purchases
mortgage-backed and related securities which are issued or guaranteed by U.S.
Government agencies and government sponsored enterprises, which facilitates the
Company's ability to trade such securities. Finally, the Company attempts to
address volatility risk through the purchase and management of offsetting option
contracts. Despite the Company's adherence to the foregoing policies and
procedures, the Company is still subject to the risk of potential losses with
respect to its derivative securities. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Asset and Liability
Management" and "Business-- Investment Activities."
ABILITY OF THE COMPANY TO ACHIEVE BUSINESS OBJECTIVES
The Company's business strategy is dependent upon its ability to (i)
increase its interest-earning assets, including its investment in
mortgage-backed and related securities and single-family residential loans, (ii)
effectively control interest rate and credit risk through the active management
of its assets and liabilities and the selection of appropriate interest rate
contracts and mortgage-backed derivative securities and (iii) reduce funding and
operating costs. The Company's ability to maintain profitability as it pursues
its business strategy will be dependent upon, among other things, (i)
maintaining appropriate procedures, policies and standards with respect to its
investments and loan activities, (ii) maintaining, augmenting and implementing
internal reporting and management systems to accommodate substantial increases
in its investment and loan portfolios, (iii) retaining and attracting qualified
personnel or advisors, (iv) attracting additional capital, and (v) operating in
competitive, economic and regulatory environments that are conducive to the
Company's business activities. Changes in the Company's ability to obtain or
maintain any or all of these factors or to successfully implement its business
strategy could have a material adverse impact on the Company's operations,
profitability and growth. See "Business--General."
COMPETITION
The Company and the Bank face strong direct competition for deposits and
loans from other thrifts, commercial banks, credit unions and other financial
institutions. Some of the Company's competitors are local, while some are
statewide or nationwide. Some of the financial institutions and financial
service organizations with which the Company and the Bank compete are not
subject to the same degree of regulation as that imposed upon thrift holding
companies, bank holding companies, or federally insured thrifts and banks, and
therefore may have advantages with respect to providing certain services.
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The Bank competes for deposits and loans with other financial institutions,
many of whom are larger and have greater resources than the Bank. There can be
no assurance that the Bank will, in the future, be able to continue to increase
its deposit base or purchase or originate loans in the amounts or on the terms
necessary for the Company to achieve its growth strategies.
EXTERNAL FINANCING
The Company obtained a revolving credit facility and term loan in the
aggregate amount of $10.0 million from a third party financial institution which
will expire in March 2000 (subject to the ability to extend for an additional
five years). Effective upon consummation of the Offering, the credit facility
and term loan will be amended to provide for an additional $3.0 million line of
credit. See "Business-- Sources of Funds--Borrowings." Although the Company
considers such credit facility (as proposed to be amended), in addition to the
net proceeds of the Offering, adequate for its current capital needs, the
Company may seek in the future additional debt or equity capital in order to
achieve its longer-term business objectives. There can be no assurance that
additional financing sources, if sought, would be available to the Company or,
if available, would be on terms favorable to the Company.
RECAPITALIZATION OF SAIF AND RELATED LEGISLATIVE PROPOSALS
The deposits of the Company are currently insured by the Savings Association
Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC").
Both the SAIF and the Bank Insurance Fund ("BIF"), the federal deposit insurance
fund that covers commercial bank deposits, are required by law to attain and
thereafter maintain a reserve ratio of 1.25% of insured deposits. The BIF has
achieved a fully funded status in contrast to the SAIF and, therefore, as
discussed below, the FDIC recently substantially reduced the average deposit
insurance premium paid by commercial banks to a level substantially below the
average premium paid by savings institutions.
On November 14, 1995, the FDIC approved a final rule regarding deposit
insurance premiums. The final rule reduced deposit insurance premiums for BIF
member institutions to zero basis points (subject to a $2,000 minimum) for
institutions in the lowest risk category, while holding deposit insurance
premiums for SAIF members at their current levels (23 basis points for
institutions in the lowest risk category). The reduction was effective with
respect to the semiannual premium assessment beginning January 1, 1996.
Accordingly, in the absence of further legislative action, SAIF members such as
the Bank will be competitively disadvantaged as compared to commercial banks by
the resulting premium differential.
The U.S. House of Representatives and Senate have actively considered
legislation which would have eliminated the premium differential between
SAIF-insured institutions and BIF-insured institutions by recapitalizing the
SAIF's reserves to the required ratio. The proposed legislation would have
provided that all SAIF member institutions pay a special one-time assessment to
recapitalize the SAIF, which in the aggregate would have been sufficient to
bring the reserve ratio in the SAIF to 1.25% of insured deposits. Based on the
current level of reserves maintained by the SAIF, it was anticipated that the
amount of the special assessment required to recapitalize the SAIF would have
been approximately 80 to 85 basis points of the SAIF-assessable deposits. It was
anticipated that after the recapitalization of the SAIF, premiums paid by
SAIF-insured institutions would be reduced to match those currently being
assessed BIF-insured commercial banks. The legislation also provided for the
merger of the BIF and the SAIF, with such merger being conditioned upon the
prior elimination of the thrift charter.
The legislation discussed above had been, for some time, included as part of
a fiscal 1996 federal budget bill, but was eliminated prior to the bill being
enacted on April 26, 1996. In light of the legislation's elimination and the
uncertainty of the legislative process generally, management cannot predict
whether legislation reducing SAIF premiums and/or imposing a special one-time
assessment will be adopted, or, if adopted, the amount of the assessment, if
any, that would be imposed on the Bank.
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If legislation were to be enacted in the future which would assess a
one-time special assessment of 85 basis points, the Bank would (based upon the
Bank's SAIF deposits as of March 31, 1995) pay approximately $700,000, net of
related tax benefits. In addition, the enactment of such legislation might have
the effect of immediately reducing the Bank's capital by such an amount.
Nevertheless, management does not believe, based upon the foregoing assumptions,
that a one-time assessment of this nature would have a material adverse effect
on the Company's consolidated financial condition.
PENDING LEGISLATION REGARDING BAD DEBT RESERVES
Under Section 593 of the Internal Revenue Code of 1986, as amended (the
"Code"), thrift institutions such as the Bank, which meet certain definitional
tests primarily relating to their assets and the nature of their business, are
permitted to establish a tax reserve for bad debts and to make annual additions
thereto, which additions may, within specified limitations, be deducted in
arriving at their taxable income. The Company's deduction with respect to
"qualifying loans," which are generally loans secured by certain interests in
real property, may currently be computed using an amount based on the Company's
actual loss experience (the "experience method"), or a percentage equal to 8.0%
of the Company's taxable income (the "percentage of taxable income method"),
computed without regard to this deduction and with additional modifications and
reduced by the amount of any permitted addition to the non-qualifying reserve.
See generally "Supervision and Regulation--Federal Taxation."
Under proposed legislation, the percentage of taxable income method would be
repealed and the Bank would be permitted to use only the experience method of
computing additions to its bad debt reserve. In addition, the Bank would be
unable to make additions to its tax bad debt reserve, would be permitted to
deduct bad debts only as they occur and would additionally be required to
recapture (i.e., take into income) over a six-year period the excess of the
balance of its bad debt reserves as of December 31, 1995 over the balance of
such reserves as of December 31, 1987. However, under the proposed legislation,
such recapture requirements would be suspended for each of two successive
taxable years beginning January 1, 1996, in which the Bank originates a minimum
amount of certain residential loans based upon the average of the principal
amounts of such loans made by the Bank during its six taxable years preceding
1996. It is anticipated that any recapture of the Bank's bad debt reserves
accumulated after 1987 would not have a material adverse effect on the Company's
consolidated financial condition or results of operations.
NO PRIOR MARKET; DILUTION
Prior to the Offering, there has been no public market for the Company's
Common Stock. The Company has received approval to have the Common Stock quoted
on the Nasdaq Stock Market under the symbol "HFGI." However, there can be no
assurance that an established and liquid trading market for the Common Stock
will develop, that it will continue if it does develop, or that after the
completion of the Offering the Common Stock will trade at or above the Price to
Public set forth on the cover of this Prospectus. In addition, the substantial
amount of Common Stock which is expected to be held by the directors and
officers of the Company and the Bank, certain other affiliates of Smith Breeden
and the Company's ESOP may adversely affect the development of an active and
liquid trading market. See "--Concentration of Ownership" below. Stifel,
Nicolaus & Company, Incorporated and NatCity Investments, Inc. (the
"Underwriters") have advised the Company that they intend to make a market in
the Company's Common Stock as long as the volume of trading activity in the
Common Stock and certain other market making considerations justify doing so.
See "Dividends and Market for Common Stock."
Purchasers of the Shares offered hereby will incur immediate net tangible
book value dilution. Without taking into account any changes in net tangible
book value after December 31, 1995, other than those resulting from the sale by
the Company of the 1,100,000 Shares offered hereby (assuming no exercise of the
over-allotment option and after deduction of underwriting discounts and
commissions and estimated offering expenses), the pro forma net tangible book
value at December 31, 1995 would
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have been $6.74 per share, representing an immediate dilution of $3.26 per share
to persons purchasing the Shares offered hereby at the Price to Public set forth
on the cover of this Prospectus. See "Dilution."
SHARES AVAILABLE FOR FUTURE SALE
The Company, stockholders of the Company prior to the commencement of the
Offering and any principal of Smith Breeden or executive officer or director of
the Company who buys in the Offering have agreed that for a period of 180 days
after the date of this Prospectus, they will not, directly or indirectly, offer,
sell or otherwise dispose of any shares of Common Stock or any securities
convertible into or exchangeable for, or any rights to purchase or acquire, any
shares of Common Stock, without the prior written consent of the Underwriters.
See "Underwriting." Notwithstanding the foregoing, the future sale of a
substantial number of shares of Common Stock by existing stockholders, holders
of outstanding options or stockholders purchasing Shares in the Offering could
have an adverse effect on the market price of the Company's Common Stock. See
"Management--Benefits--Stock Option Plan," "--Executive Compensation,"
"Beneficial Ownership of Securities" and "Shares Eligible For Future Sale."
CONCENTRATION OF OWNERSHIP
Upon completion of the Offering, the directors and officers of the Company
and the Bank, certain other affiliates of Smith Breeden and the Company's ESOP
will own approximately 73.7% of the Company's Common Stock, or approximately
70.0% assuming full exercise of the Underwriters' over-allotment option. In
addition, upon completion of the Offering, Douglas T. Breeden, the current
Chairman of the Board of the Company, is expected to own approximately 43.2% of
the Company's Common Stock, or approximately 41.0% assuming full exercise of the
Underwriters' over-allotment option. Accordingly, such persons will effectively
have the ability to control the Company and direct its affairs and business,
which may include taking actions which are not supported by non-affiliated
stockholders. Moreover, such voting control could enable the Board of Directors
and senior management to block the approval of transactions requiring the
approval of more than a majority of the stockholders under the Company's Amended
and Restated Articles of Incorporation. See "Management," "Beneficial Ownership
of Securities" and "Description of Capital Stock--Restrictions on Acquisition of
the Company."
IMPORTANCE OF KEY EMPLOYEE AND INVESTMENT ADVISOR
The Company's future success depends, to a great extent, upon the services
of Craig J. Cerny, the President of the Company and the Chairman of the Board
and Chief Executive Officer of the Bank. In addition to his duties with the
Company and the Bank, Mr. Cerny holds management positions with Smith Breeden
and another financial institution. Although it is not anticipated, the interests
of these other institutions may require substantial amounts of Mr. Cerny's
management time and attention. The Company believes that the prolonged
unavailability or the unexpected loss of the services of Mr. Cerny may have a
material adverse effect upon the Company, as attracting a suitable replacement
may involve significant time and/or expense. The Company has not entered into
any employment or noncompete agreement with Mr. Cerny and does not maintain life
insurance with respect to Mr. Cerny for the Company's benefit.
The Bank entered into an Investment Advisory Agreement with Smith Breeden
dated as of April 1, 1992, as amended on March 1, 1995. Under the terms of the
agreement, Smith Breeden acts as investment advisor with respect to the
management of the Bank's portfolio of investments and its asset and liability
management strategies. Specifically, Smith Breeden advises and consults with the
Bank with respect to its investment activities, including the acquisition of
mortgage-backed and related securities, the utilization of securities sold under
agreements to repurchase and other borrowings and the acquisition of certain
interest rate contracts and mortgage-backed derivative securities to reduce the
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interest rate risk of the Bank's portfolio. The Bank employs "option-adjusted
pricing analysis" with respect to the purchase and sale of mortgage-backed and
related securities for its investment portfolio and relies on Smith Breeden with
respect to such analysis as well as the implementation of the Bank's asset and
liability management strategies. The Company believes that there are other
investment advisory firms that could perform the services currently being
provided by Smith Breeden; however, there can be no assurance as to whether an
alternative investment advisor could be retained on a timely basis if the Bank's
agreement with Smith Breeden was terminated or Smith Breeden was otherwise
unable to perform its services to the Bank. In addition, Smith Breeden provides
consulting and investment advice for a number of other financial institutions.
Although Smith Breeden has adopted a policy in order to reduce potential
conflicts of interest with respect to its financial institution consulting
practice, no assurance can be made that a conflict of interest would not arise
which conflict could adversely affect the Bank. Certain directors and officers
of the Company and the Bank are also principals or affiliates of Smith Breeden
and, as of December 31, 1995, principals and affiliates of Smith Breeden
beneficially owned 95.3% of the Common Stock of the Company. See "Management--
Transactions With Certain Related Persons" and "Beneficial Ownership of
Securities."
REGULATION
The Company, as a savings and loan holding company, and the Bank, as a
federally chartered savings bank, are subject to extensive governmental
supervision and regulation, which is intended primarily for the protection of
depositors. In addition, the Company and the Bank are subject to changes in
federal and state law, as well as changes in regulations, governmental policies
and accounting principles. The effects of any such potential changes cannot be
accurately predicted at this time but could adversely affect the business and
operations of the Company and the Bank. See "Supervision and Regulation."
ANTI-TAKEOVER PROVISIONS
In addition to the amount of Common Stock controlled by the directors and
officers of the Company and the Bank, the Company's ESOP and certain other
affiliates of Smith Breeden as described under "--Concentration of Ownership,"
certain provisions of the Company's Amended and Restated Articles of
Incorporation and Bylaws and the Indiana Business Corporation Law could have the
effect of discouraging non-negotiated takeover attempts which certain
stockholders might deem to be in their interest and make it more difficult for
stockholders of the Company to remove members of its Board of Directors and
management. In addition, various federal laws and regulations could affect the
ability of a person, firm or entity to acquire the Company or shares of its
Common Stock. See "Description of Capital Stock--Restrictions on Acquisition of
the Company."
17
<PAGE>
THE COMPANY
The Company is an Indiana-chartered, registered thrift holding company for
the Bank. The Bank is a federally chartered savings bank which conducts business
through three full-service offices located in Carmel and Fishers, Indiana, both
suburbs of Indianapolis, and Richmond, Indiana. The Company was organized in
March 1988 in connection with its acquisition of the Bank. The Bank was
originally organized in 1889 as an Indiana-chartered savings association under
the name "The Peoples Home and Savings Association of Richmond, Indiana." In
1936, the Bank obtained federal insurance and in 1984 adopted a federal charter
and changed its name to "Peoples Federal Savings Association." In 1985, the Bank
converted from mutual to stock form and, in March 1994, changed its name to
"Harrington Bank, FSB." At December 31, 1995, the Company had total consolidated
assets of $307.4 million, total consolidated borrowings of $177.0 million, total
consolidated deposits of $114.8 million, and total consolidated stockholders'
equity of $11.0 million.
The Company was organized in March 1988 by certain principals of Smith
Breeden for the sole purpose of acquiring the Bank. This investor group
purchased the Bank with the intention of expanding the Bank's mortgage and
investment operations and improving the Bank's return on equity through the use
of Smith Breeden's "option-adjusted pricing analysis." Smith Breeden presently
advises the Company and the Bank with respect to, among other things, the
management of its investments and borrowings, the pricing of loans and deposits,
as well as the use of various financial instruments to reduce interest rate
risk. Certain directors and officers of the Company and the Bank are principals
or affiliates of Smith Breeden and, as of December 31, 1995, principals and
affiliates of Smith Breeden beneficially owned 95.3% of the Common Stock of the
Company. See "Management--Transactions With Certain Related Persons" and
"Beneficial Ownership of Securities."
The Company, as a registered savings and loan holding company, is subject to
examination and regulation by the Office of Thrift Supervision ("OTS") and is
subject to various reporting and other requirements of the Securities and
Exchange Commission ("SEC"). The Bank, as a federally chartered savings bank, is
subject to comprehensive regulation and examination by the OTS, as its
chartering authority and primary regulator, and by the FDIC, which administers
the SAIF, which insures the Bank's deposits to the maximum extent permitted by
law. The Bank is a member of the FHLB of Indianapolis, which is one of the 12
regional banks which comprise the FHLB System. The Bank is further subject to
regulations of the Board of Governors of the Federal Reserve System ("Federal
Reserve Board") governing reserves required to be maintained against deposits
and certain other matters. See "Supervision and Regulation."
The Company's principal executive offices are located at 7300 College
Boulevard, Suite 430, Overland Park, Kansas, and its telephone number is (913)
451-1566.
18
<PAGE>
USE OF PROCEEDS
The net proceeds from the sale of the 1,100,000 Shares offered on behalf of
the Company are estimated to be $9.8 million ($11.3 million if the Underwriters'
over-allotment option is exercised in full), after deducting the estimated
underwriting discount and offering expenses. The Company proposes to retain $1.0
million in net proceeds for general corporate purposes and to use the remainder
of the net proceeds to increase the Bank's regulatory capital, which will allow
the Company to increase its investment in mortgage-backed and related securities
as well as the origination (both directly and through correspondents) of
single-family residential loans. Although the Offering will result in an
increase in the Bank's capital, management believes that as it deploys the
capital raised, the Bank's capital ratios will remain generally consistent with
historical levels.
DIVIDENDS AND MARKET FOR COMMON STOCK
The Company has never paid a dividend and is presently prohibited from
paying any dividends on its Common Stock under the terms of an outstanding loan
facility with an unrelated financial institution. While the Company is permitted
to pay dividends on the Common Stock, in an amount equal to up to 35% of the
Company's average consolidated earnings for the prior four quarters (see
"Business--Sources of Funds--Borrowings"), the Company does not expect to pay a
dividend on its Common Stock following the Offering. Rather, the Company intends
to retain earnings and increase capital in furtherance of its overall business
objectives. The Company will periodically review its dividend policy in view of
the operating performance of the Company, and may declare dividends in the
future if such payments are deemed appropriate and in compliance with applicable
law and regulations. Cash and stock dividends are subject to determination and
declaration by the Board of Directors, which will take into account the
Company's consolidated earnings, financial condition, liquidity and capital
requirements, applicable governmental regulations and policies, and other
factors deemed relevant by the Board of Directors. See "Supervision and
Regulation--The Bank--Capital Distributions" and "-- Federal Taxation."
Substantially all of the outstanding Common Stock of the Company prior to
the Offering is held by the directors and officers of the Company and the Bank
and certain affiliates of Smith Breeden. As such, there is no established market
for the Common Stock at this time. The Company expects that following the
Offering, the Common Stock will be traded in the over-the-counter market. The
Company has received approval to have the Common Stock quoted on the Nasdaq
Stock Market under the symbol "HFGI."
The Underwriters have advised the Company that, upon completion of the
Offering, they intend to make a market in the Common Stock. Making a market
involves maintaining bid and ask quotations and being able, as principal, to
effect transactions in reasonable quantities at those quoted prices, subject to
various securities laws and other regulatory requirements. Additionally, the
development of a liquid public market depends on the existence of willing buyers
and sellers, the presence of which is not within the control of the Company or
any market maker. Given the concentration of ownership by the directors and
officers of the Company and the Bank, the Company's ESOP and certain affiliates
of Smith Breeden that is expected to continue after the Offering, see
"Beneficial Ownership of Securities," the number of active buyers and sellers of
the Common Stock at any particular time may be limited. Accordingly, there can
be no assurance that an active and liquid trading market for the Common Stock
will develop or that, if developed, it will continue, nor is there any assurance
that persons purchasing shares of Common Stock will be able to sell them at or
above the Price to Public set forth on the cover page hereof.
19
<PAGE>
CAPITALIZATION
The following table sets forth (i) the consolidated capitalization of the
Company at December 31, 1995 and (ii) the consolidated capitalization of the
Company on an as adjusted basis to reflect the issuance of the Shares pursuant
to the Offering and receipt by the Company of the net proceeds therefrom, as if
the sale of the Shares had been consummated on December 31, 1995 and assuming
that the Underwriters' over-allotment option was not exercised. For a tabular
presentation of the estimated pro forma effects of the Offering on the
regulatory capital ratios of the Bank, see "Regulatory Capital."
<TABLE>
<CAPTION>
DECEMBER 31, 1995
---------------------------
ACTUAL AS ADJUSTED
-------- -----------
(DOLLARS IN THOUSANDS,
EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C>
LIABILITIES:
Deposits.................................................. $114,814 $ 114,814
Securities sold under agreements to repurchase............ 141,448 141,448
Federal Home Loan Bank advances........................... 26,000 26,000
Note payable.............................................. 9,521 9,521
Other liabilities......................................... 4,613 4,613
-------- -----------
Total liabilities......................................... $296,396 $ 296,396
-------- -----------
-------- -----------
STOCKHOLDERS' EQUITY:
Preferred Stock (authorized: 5,000,000 shares, par value
$1.00; outstanding: none)................................... $ -- $ --
Common Stock (authorized: 10,000,000 shares, par value
$0.125; issued: 1,991,738 shares and 3,091,738 shares,
as adjusted)............................................ 249 386
Additional paid-in capital................................ 4,344 14,074
Retained earnings......................................... 6,414 6,372(2)
Unrealized gain on securities available for sale, net..... 2 2
-------- -----------
Total stockholders' equity.............................. $ 11,009 $ 20,834
-------- -----------
-------- -----------
Book value per share of Common Stock(1)................... $ 5.53 $ 6.74
-------- -----------
-------- -----------
Total stockholders' equity to total assets................ 3.58% 6.57%
-------- -----------
-------- -----------
</TABLE>
- - - ------------
(1) Book value per share of Common Stock is determined by dividing the Company's
actual and as adjusted consolidated total stockholders' equity at December
31, 1995 by 1,991,738 shares of issued and outstanding Common Stock and
3,091,738 shares of Common Stock, as adjusted, respectively.
(2) As adjusted retained earnings reflects compensation expense from the
purchase of 7,000 shares of Common Stock by the Company's ESOP, net of
applicable income taxes, with the funds contributed by the Company.
20
<PAGE>
REGULATORY CAPITAL
Under regulations adopted by the OTS, each savings institution is currently
required to maintain tangible and core capital equal to at least 1.5% and 3.0%,
respectively, of its adjusted total assets, and total capital equal to at least
8.0% of its risk-weighted assets.
The following table sets forth the actual regulatory capital ratios of the
Bank at December 31, 1995 and as adjusted to give effect to the receipt of the
estimated net proceeds from the sale of the Shares in the Offering, based on the
Company's contribution of approximately $8.8 million of the net proceeds to the
Bank. See "Use of Proceeds" and "Supervision and Regulation--The
Bank--Regulatory Capital Requirements." Although the Offering will result in an
increase in the Bank's capital, management believes that as it deploys the
capital raised, the Bank's capital ratios will remain generally consistent with
historical levels.
<TABLE>
<CAPTION>
AS ADJUSTED
HISTORICAL PRO FORMA
AT DECEMBER 31, 1995 AT DECEMBER 31, 1995
------------------------------- -------------------------------
CAPITAL EXCESS CAPITAL EXCESS
CAPITAL REQUIREMENT CAPITAL CAPITAL REQUIREMENT CAPITAL
------- ----------- ------- ------- ----------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
DOLLAR BASIS:
Tangible...................... $19,420 $ 4,598 $14,822 $28,246 $ 4,731 $23,515
Core.......................... 19,420 9,197 10,223 28,246 9,462 18,784
Risk-based(1)................. 19,535 6,999 12,536 28,361 7,141 21,220
PERCENTAGE BASIS:
Tangible...................... 6.33% 1.50% 4.83% 8.96% 1.50% 7.46%
Core.......................... 6.33 3.00 3.33 8.96 3.00 5.96
Risk-based(1)................. 22.33 8.00 14.33 31.77 8.00 23.77
</TABLE>
- - - ------------
(1) Assumes the net proceeds are initially invested in 20% risk-weighted assets.
21
<PAGE>
DILUTION
As of December 31, 1995, the Company had an aggregate of 1,991,738 shares of
Common Stock outstanding, and the Company's Common Stock had a net tangible book
value of $5.53 per share. "Net tangible book value per share" represents the
tangible net worth of the Company (total assets less goodwill and total
liabilities), divided by the number of shares of Common Stock deemed to be
outstanding. Without taking into account any changes in net tangible book value
after December 31, 1995, other than those resulting from the sale by the Company
of the 1,100,000 Shares offered hereby (assuming no exercise of the
over-allotment option and after deduction of underwriting discounts and
commissions and estimated offering expenses), the pro forma net tangible book
value at December 31, 1995 would have been $6.74 per share, representing an
immediate increase of $1.21 per share to current stockholders and an immediate
dilution of $3.26 per share to persons purchasing the Shares offered hereby. The
following table illustrates this per share dilution.
<TABLE>
<CAPTION>
<S> <C> <C>
Price to Public............................................ $10.00
Net tangible book value before Offering.................. $5.53
Increase attributable to investors participating in
Offering................................................... 1.21
-----
Pro forma net tangible book value after Offering........... 6.74
------
Dilution to investors participating in Offering............ $ 3.26
------
------
</TABLE>
The following table compares on a pro forma basis at December 31, 1995, the
total number of shares of Common Stock purchased from the Company, the total
cash consideration paid and the average price per share paid by present
stockholders and the persons purchasing shares offered hereby (assuming the sale
of 1,100,000 shares of Common Stock and before deduction of underwriting
discounts and commissions and estimated offering expenses).
<TABLE>
<CAPTION>
TOTAL
SHARES PURCHASED CONSIDERATION AVERAGE
-------------------- ------------------ PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- ------- ------- ------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Existing stockholders......................... 1,991,738 64.4% $ 4,593 29.5% $ 2.31
Investors participating in Offering(1)........ 1,100,000 35.6 11,000 70.5 10.00
--------- ------- ------- -------
Total....................................... 3,091,738 100.0% $15,593 100.0%
--------- ------- ------- -------
--------- ------- ------- -------
</TABLE>
- - - ------------
(1) Includes 343,000 (31.2%) to be purchased by existing stockholders in the
Offering.
The above calculations do not take into account the exercise of the
Underwriters' over-allotment option or the exercise of outstanding stock options
granted to directors and officers of the Company and the Bank and certain other
affiliates of Smith Breeden to purchase an aggregate of 137,200 shares of Common
Stock at $7.50 per share, which are exercisable between December 15, 1997 and
January 15, 1998. The Company has also adopted the Stock Option Plan, pursuant
to which an aggregate of 110,000 shares will be available for future issuance,
and an ESOP, a qualified employee stock benefit plan which is authorized to
acquire shares of Common Stock both through open market purchases as well as
upon the original issuance of shares by the Company or upon the sale of treasury
shares by the Company. See "Management--Executive Compensation,"
"--Benefits--Employee Stock Ownership Plan," "--Benefits--Stock Option Plan" and
"Beneficial Ownership of Securities."
22
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents selected consolidated financial and other data
of the Company for the six months ended December 31, 1995 and 1994, and for each
of the five years in the period ended June 30, 1995. The selected consolidated
financial data should be read in conjunction with the Consolidated Financial
Statements of the Company, including the accompanying Notes, presented elsewhere
herein. The financial information presented for the six months ended December
31, 1995 and 1994 is unaudited. In the opinion of management, this information
reflects all adjustments, consisting of normal recurring accruals and
adjustments, necessary for a fair presentation.
<TABLE>
<CAPTION>
AT OR FOR THE
SIX MONTHS ENDED
DECEMBER 31, AT OR FOR THE YEAR ENDED JUNE 30,
------------------- -------------------------------------------------------
1995 1994 1995 1994 1993 1992 1991
-------- -------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Securities held for trading and available for
sale........................................... $232,629 $184,665 $249,274 $174,347 $186,582 $185,805 $181,853
Loans receivable--net......................... 55,910 23,757 37,010 20,682 16,620 21,409 26,640
Total assets.................................. 307,405 225,820 300,174 211,688 220,095 226,622 236,538
Deposits...................................... 114,814 122,751 115,312 108,300 89,788 93,476 92,048
Securities sold under agreements to
repurchase..................................... 141,448 53,569 130,217 54,651 83,709 116,993 121,138
FHLB advances................................. 26,000 31,000 31,000 31,000 31,000 -- 7,000
Note payable.................................. 9,521 7,730 9,200 7,880 7,431 8,435 9,358
Stockholders' equity.......................... 11,009 7,317 10,361 5,926 5,294 5,128 4,311
Stockholders' equity per share................ 5.53 4.70 5.28 4.20 3.75 3.63 3.05
INCOME STATEMENT DATA
Interest income............................... $ 11,553 $ 7,423 $ 17,560 $ 13,607 $ 12,746 $ 15,407 $ 19,270
Interest expense.............................. 8,996 5,275 12,779 8,284 8,975 12,714 15,799
-------- -------- -------- -------- -------- -------- --------
Net interest income......................... 2,557 2,148 4,781 5,323 3,771 2,693 3,471
Provision for loan losses..................... (1) 21 15 (3) 66 8 26
-------- -------- -------- -------- -------- -------- --------
Net interest income after provision for loan
losses......................................... 2,558 2,127 4,766 5,326 3,705 2,685 3,445
Other income:
Gain (loss) on sale of securities held for
trading........................................ (2,621) (338) 66 (2,169) -- -- --
Gain on sale of securities available for
sale........................................... -- -- -- 392 1,384 1,108 288
Unrealized gain on securities held for
trading........................................ 2,452 750 1,535 710 -- -- --
Permanent impairment of securities available
for sale....................................... -- -- (414) (610) (2,531) (1,057) --
-------- -------- -------- -------- -------- -------- --------
Total portfolio income (1)................. 2,389 2,539 5,953 3,649 2,558 2,736 3,733
Other miscellaneous income.................. 114 123 238 267 249 106 93
Other expense................................. 1,711 1,483 3,167 2,519 2,749(2) 1,835 1,592
-------- -------- -------- -------- -------- -------- --------
Income before income tax provision and
cumulative effect of change in accounting
for deferred income taxes...................... 792 1,179 3,024 1,397 58 1,007 2,234
Income tax provision.......................... 249 409 1,171 391 188 190 835
Income (loss) before cumulative effect of
change in accounting for deferred income
taxes.......................................... 543 770 1,853 1,006 (130) 817 1,399
Cumulative effect of change in accounting for
deferred income taxes (3)................... -- -- -- (79) -- -- --
-------- -------- -------- -------- -------- -------- --------
Net income (loss)............................. $ 543 $ 770 $ 1,853 $ 927 $ (130) $ 817 $ 1,399
-------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- --------
Net income (loss) per share................... $ 0.28 $ 0.54 $ 1.20 $ 0.66 $ (0.09) $ 0.58 $ 0.99
-------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- --------
PERFORMANCE RATIOS
Return on average assets...................... 0.34% 0.69% 0.76% 0.44% (0.06)% 0.36% 0.68%
Return on average equity...................... 10.06 22.88 22.24 14.98 (2.67) 17.06 39.45
Interest rate spread.......................... 1.63 2.07 2.13 2.63 1.79 1.65 1.22
Net interest margin........................... 1.69 2.06 2.10 2.64 1.81 1.25 1.71
Average interest-earning assets to average
interest-bearing liabilities................ 100.95 99.80 99.57 100.25 100.39 100.61 100.89
Net interest income after provision for loan
losses to total other expenses.............. 149.50 143.40 150.50 211.40 134.80 146.30 216.40
Total other expenses to average total
assets......................................... 1.08 1.34 1.30 1.19 1.27 0.82 0.78
Full service offices.......................... 3 2 2 2 1 1 1
ASSET QUALITY RATIOS (AT END OF PERIOD)
Non-performing loans to total loans (4)....... 0.65 2.13 0.95 2.70 3.00 2.56 1.60
Non-performing assets to total assets (4)..... 0.51 1.06 0.59 1.34 0.24 0.24 0.24
Allowance for loan losses to total loans...... 0.21 0.53 0.33 0.51 0.94 0.46 0.34
Allowance for loan losses to total
non-performing loans (4)....................... 32.97 25.10 34.57 18.96 29.71 18.07 15.96
CAPITAL RATIOS (5)
Tangible capital ratio........................ 6.33 6.12 6.12 6.07 5.58 5.31 4.92
Core capital ratio............................ 6.33 6.12 6.12 6.07 5.58 5.35 4.97
Risk-based capital ratio...................... 22.33 23.91 24.62 21.40 18.56 16.59 16.23
Equity to assets at end of period............. 3.58 3.24 3.45 2.80 2.41 2.26 1.82
</TABLE>
- - - ------------
(1) Consists of net interest income after provision for loan losses and other
income relating to the Company's securities activities.
(2) Includes a write-off of goodwill and core deposit intangible of $663,000.
(3) Reflects the Company's adoption of SFAS No. 109, "Accounting for Income
Taxes," effective July 1, 1993.
(4) Non-performing loans consist of non-accrual loans and accruing loans that
are contractually past due 90 days or more, and non-performing assets
consist of non-performing loans, real estate acquired by foreclosure or
deed-in-lieu thereof and a single non-agency participation certificate
classified as substandard.
(5) Regulatory capital ratios apply to the Bank as a federally chartered savings
bank. For additional information see "Regulatory Capital" and "Supervision
and Regulation--The Bank--Regulatory Capital Requirements."
23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company attempts to enhance profitability with acceptable levels of
credit, interest rate and liquidity risk by actively managing its
interest-earning assets and funding sources to secure favorable interest rate
spreads. The Company invests primarily in mortgage-backed and related securities
and originates (both directly and through correspondents) loans secured by
single-family residences located primarily in eastern and central Indiana. To
reduce the institution's exposure to interest rate risk, the Company utilizes
interest rate contracts and mortgage-backed derivative securities in conjunction
with regular adjustments to the composition of the Company's investment
portfolio. The Company's funding strategy focuses on accessing cost-efficient
funding sources, including securities sold under agreements to repurchase,
retail and non-retail deposits and FHLB advances. The Company is focusing on
continuing to build a community-oriented retail banking operation in order to
sustain loan originations and deposit growth and generate additional fee income.
The Company's overall goal is to increase stockholders' value, as measured on a
risk-adjusted total return basis.
The Company's business strategy focuses on achieving attractive returns
consistent with prudent risk management. The Company has sought to implement
this strategy by (i) controlling interest rate risk by using interest rate
contracts to match the interest rate sensitivity of its assets to that of its
liabilities; (ii) maintaining a substantial portion of the Company's assets in
mortgage-backed and related securities and single-family residential loans which
are actively managed with the intention of limiting credit exposure and
enhancing net interest income and portfolio income; (iii) reducing funding costs
through the utilization of retail and non-retail deposits and other borrowings;
(iv) increasing its emphasis on retail banking through the origination (both
directly and through correspondents) of single-family residential loans and the
expansion of its core deposit base; (v) maintaining a low level of operating
expenses; (vi) meeting the banking needs of its customers through, among other
things, the offering of trust and investment management services; and (vii)
continued internal growth and the pursuit of acquisition opportunities when
appropriate.
While the Company's focus is to expand its portfolio of originated mortgage
loans, over 75% of its assets currently consists of purchased mortgage-backed
and related securities. Although mortgage-backed and related securities often
carry lower yields than traditional mortgage loans, such securities generally
increase the quality of the Company's assets by virtue of the securities'
underlying insurance or guarantees, are more liquid than individual mortgage
loans (which enhances the Company's ability to actively manage its portfolio)
and may be used to collateralize borrowings or other obligations of the Company.
In addition, although the Company's strategy of investing a substantial portion
of its assets in mortgage-backed and related securities and utilizing various
interest rate contracts to hedge the Company's interest rate exposure has
resulted in lower interest rate spreads and margins as compared to the Company's
peer group, management believes that the lower operating expenses and reduced
credit and interest rate risk attendant to such strategy have enhanced the
Company's overall profitability as well as its ability to remain profitable over
a variety of interest rate scenarios. Although the Company intends to expand its
portfolio of single-family residential loans following consummation of the
Offering, management expects that mortgage-backed and related securities will
remain a substantial portion of the Company's assets.
Since 1991, the Company's results of operations have been characterized by
what management believes are favorable expense and loan charge-off ratios and
higher leverage ratios as compared to the Company's peer group. These operating
characteristics have contributed to what management believes are above average
returns on equity, notwithstanding somewhat lower than average net interest
margins. The Company has operated profitably over the past five and one-half
years except for a $130,000 loss recognized during the fiscal year ended June
30, 1993. The loss in fiscal 1993 included a write-off of $663,000 of goodwill
and core deposit intangibles (with no related tax benefits) which
24
<PAGE>
related to the Company's acquisition of the Bank in 1988. Although the Company's
return on average equity has fluctuated over the past five years from a low of
(2.67)% during fiscal 1993 to a high of 39.45% during fiscal 1991, the Company's
return on average equity during the five fiscal years ended June 30, 1995
amounted to over 18% on a compounded basis. For the six months ended December
31, 1995, the Company's return on average equity amounted to 10.06%
(annualized).
The Company marks a substantial portion of its assets to market in order to
fully account for the market value changes in the Company's investment
portfolio. This method of accounting is consistent with the Company's strategy
of active portfolio management and provides the Company with the flexibility to
quickly adjust the mix of its interest-earning assets in response to changing
market conditions. The Company recognizes that marking substantially all of its
assets to market subjects the Company to the potential for earnings volatility,
which is reflected to a significant degree by the Company's results of
operations over the past five years. The extent of the volatility demonstrated
by the Company over the past five years, however, has in part resulted from the
implementation of different accounting methods for the Company's mortgage-backed
and related securities owned as well as the call of certain mortgage-backed
residuals in 1994 and the write-down of an investment in a single non-agency
participation certificate in fiscal 1994 and 1995, each of which is described
under "--Results of Operations."
ASSET AND LIABILITY MANAGEMENT
In general, financial institutions are negatively affected by an increase in
interest rates to the extent that interest-bearing liabilities mature or reprice
more rapidly than interest-earning assets. The lending activities of savings
institutions have historically emphasized the origination of long-term,
fixed-rate loans secured by single-family residences, and the primary source of
funds of such institutions has been deposits, which largely mature or are
subject to repricing within a shorter period of time. This factor has
historically caused the income earned by savings institutions on their loan
portfolios to adjust more slowly to changes in interest rates than their cost of
funds. While having liabilities that reprice more frequently than assets is
generally beneficial to net interest income in times of declining interest
rates, such an asset/liability mismatch is generally detrimental during periods
of rising interest rates.
The Company believes that its asset and liability management strategy, as
discussed below, provides the Company with a competitive advantage over other
financial institutions. As a result of the Company's ability to effectively
hedge its interest rate exposure through the use of various financial
instruments, the Company can acquire loans and investments which offer
attractive net risk-adjusted spreads without having to consider whether
individual loans or investments are fixed-rate or adjustable-rate or short-term
or long-term. Similarly, the Company can choose a cost-effective source of funds
and subsequently engage in an interest rate swap or other hedging transaction so
that the interest rate sensitivities of its interest-earning assets and
interest-bearing liabilities are generally matched.
The Company's asset and liability management strategy is formulated and
monitored by the Boards of Directors of both the Company and the Bank. The
Boards' written policies and procedures are implemented by the Investment
Committee of the Bank, which is comprised of the Chief Executive Officer, Chief
Financial Officer, Chief Investment Officer, Investment Officer, and three
outside directors of the Bank. The Investment Committee meets at least monthly
to review, among other things, the sensitivity of the Bank's assets and
liabilities to interest rate changes, including those transactions attributable
to altering the interest rate risk, the book and market values of assets and
liabilities, unrealized gains and losses, the past month's purchase and sale
activity and maturities of investments and borrowings. The Investment Committee
also consults with the Chief Operating Officer of the Bank regarding retail
pricing and funding decisions with respect to the Bank's overall asset and
liability composition. In accordance therewith, the Investment Committee reviews
the Bank's liquidity, cash flow needs, maturities of investments, deposits and
borrowings, core deposit activity, current market conditions and interest rates
on both a local and national level.
25
<PAGE>
The Investment Committee regularly reviews interest rate risk by reviewing
analysis prepared by Smith Breeden with respect to the impact of alternative
interest rate scenarios on net interest income and on the Bank's market value of
portfolio equity ("MVPE"), which is defined as the net present value of an
institution's existing assets, liabilities and off-balance sheet instruments,
and by evaluating such impact against the maximum potential changes in net
interest income and MVPE that is authorized by the Board of Directors of the
Bank. MVPE analysis is the general measure used by regulatory authorities for
assessing an institution's interest rate risk. The extent to which assets will
gain or lose value in relation to the gains or losses of liabilities and/or
interest rate contracts determines the appreciation or depreciation in equity on
a market-value basis. Such market value analysis is intended to evaluate the
impact of immediate and sustained parallel interest-rate shifts of the current
yield curve upon the market value of the current balance sheet. The Investment
Committee also reviews analyses prepared by Smith Breeden with respect to the
impact of changing market volatility, prepayment forecast error, changes in
option-adjusted spreads and non-parallel yield curve shifts.
In the absence of the Company's hedging activities, the MVPE of the Company
would decline as a result of a general increase in market rates of interest.
This decline would be due to the market values of the Company's assets being
generally more sensitive to interest rate fluctuations than are the market
values of the Company's liabilities due to the Company's investment in generally
longer-term assets (such as loans and mortgage-backed and related securities)
which are funded with shorter-term liabilities (such as short-term certificates
of deposit and securities sold under agreements to repurchase). Consequently,
the elasticity (i.e, the change in the market value of an asset or liability as
a result of a change in interest rates) of the Company's assets is greater than
the elasticity of its liabilities.
Accordingly, the primary goal of the Company's asset and liability
management policy is to effectively increase the elasticity of the Company's
liabilities and/or effectively contract the elasticity of the Company's assets
so that the respective elasticities are matched as closely as possible. This
elasticity adjustment can be accomplished internally by restructuring the
Company's balance sheet, or externally by adjusting the elasticities of the
Company's assets and/or liabilities through the use of interest rate contracts,
such as interest rate swaps, collars, caps, floors, options and futures. The
Company's strategy is to hedge either internally through the use of longer-term
certificates of deposits, FHLB advances and mortgage-backed derivative
securities, or externally through the use of various interest rate contracts,
which effectively adjust the elasticities of the Company's assets and
liabilities. The foregoing strategies are more fully described below.
Internal hedging through balance sheet restructuring generally involves
either the attraction of longer-term funds (i.e., certificates of deposit or
FHLB advances) or the investment in certain types of mortgage-backed derivative
securities such as CMOs, residuals, interest-only and principal-only strips.
Such mortgage-backed derivative securities often exhibit elasticity and
convexity characteristics (i.e., respond differently to changes in interest
rates) which the Company can utilize to hedge other components of the Company's
portfolio. The Company had deposits of $114.8 million, $115.3 million and $108.3
million as of December 31, 1995 and June 30, 1995 and 1994, respectively, and
had FHLB advances of $26.0 million, $31.0 million and $31.0 million as of
December 31, 1995 and June 30, 1995 and 1994, respectively. The approximate
market value of the Company's mortgage-backed derivative securities totalled
$14.6 million, $21.2 million and $38.0 million as of such respective dates.
External hedging involves the use of interest rate swaps, collars, caps,
floors, options and futures. The notional amount of interest rate contracts
represents the underlying amount of which periodic cash flows are calculated and
exchanged between counterparties. However, this notional amount does not
represent the principal amount of securities which would effectively be hedged
by that interest rate contract. In selecting the type and amount of interest
rate contract to utilize, the Company compares the elasticity of a particular
contract, or its change in value for a 100 basis point movement in interest
rates, to that of the securities to be hedged. An interest rate contract with
the appropriate offsetting
26
<PAGE>
elasticity may have a notional amount much greater than the face amount of the
securities being hedged. This situation is particularly true in the case of
interest rate futures.
For example, the Company uses a significant amount of Eurodollar future
contracts, which are based on 91-day instruments. One Eurodollar futures
contract has a notional amount of $1.0 million, but a 100 basis point change in
interest rates could result in only a $2,500 gain or loss in market values with
respect to that contract. Since the underlying instrument has such a short
maturity, its market value is much less sensitive to changes in interest rates
than that of mortgages or other longer-term investments. On the other hand, a
10-year Treasury note futures contract has a notional amount of $100,000 but
could have an average gain or loss of about $6,000 given a 100 basis point
change in rates. If a mortgage gained or lost $18,000 for a 100 basis point
change in rates, the applicable hedge might consist of seven Eurodollar futures
contracts with a notional amount of $7.0 million or three 10-year Treasury note
futures contracts with a notional amount of $300,000. An interest rate swap is
an agreement where one party (generally the Company) agrees to pay a fixed-rate
of interest on a notional principal amount to a second party (generally a
broker) in exchange for receiving from the second party a variable-rate of
interest on the same notional amount for a predetermined period of time. No
actual assets are exchanged in a swap of this type and interest payments are
generally netted. These swaps are generally utilized by the Company to
synthetically convert fixed-rate assets into adjustable-rate assets without
having to sell or transfer the underlying assets.
At December 31, 1995, the Company was a party to 10 interest rate swap
agreements. The agreements have an aggregate notional amount of approximately
$81.0 million and expire from August 1996 to April 2001. With respect to the
agreements whereby the Company pays a fixed-rate and receives a floating-rate
(which constitute the majority of the agreements), the Company makes weighted
average fixed interest payments ranging from 4.55% to 6.58% and receives
payments based upon the three-month London Interbank Offer Rate ("LIBOR"). The
Company also has two swaps whereby it pays a floating-rate (based on three-month
LIBOR) and receives a fixed-rate ranging from 6.12% to 6.96%. At December 31,
1995, three-month LIBOR was 5.66%. The net expense (income) relating to the
Company's fixed-pay interest rate swaps (which are held in the Company's trading
portfolio) was $(163,000), $(113,000), $1.3 million and $1.6 million during the
six months ended December 31, 1995 and the years ended June 30, 1995, 1994 and
1993, respectively. The approximate market value of the Company's fixed-pay
interest rate swaps which are maintained in the trading portfolio was
$(608,000), $(219,000) and $3.4 million as of December 31, 1995 and June 30,
1995 and 1994, respectively.
The Company's two floating-pay swaps are not included in the Company's
trading portfolio. These swaps are used to modify the interest rate sensitivity
of certain certificates of deposit issued by the Bank. These certificates of
deposit, called inverse variable-rate certificates, adjust according to a
formula in such a way as to pay a higher rate of interest when the index falls,
and a lower rate of interest when the index rises. The swaps protect the Company
against the exposure to falling rates inherent in these certificates of deposit.
The net (income) relating to the Company's floating-pay swaps (which are not
held in the Company's trading portfolio) was $(60,000), $(158,000), $(596,000)
and $(429,000) during the six months ended December 31, 1995 and the years ended
June 30, 1995, 1994 and 1993, respectively. This income is netted against
interest expense in the Company's Consolidated Statements of Income. The
approximate market value of the Company's floating-pay interest rate swaps
(which are not reflected in the Company's financial statements) was $471,000,
$403,000 and $298,000 as of December 31, 1995 and June 30, 1995 and 1994,
respectively. See Notes 2 and 13 to the Consolidated Financial Statements.
An interest rate cap and an interest rate floor consist of a guarantee given
by one party, referred to as the issuer (i.e., a broker), to another party,
referred to as the purchaser (i.e., the Company), in exchange for the payment of
a premium, that if interest rates rise above (in the case of a cap) or fall
below (in the case of a floor) a specified rate on a specified interest rate
index, the issuer will pay to the
27
<PAGE>
purchaser the difference between the then current market rate and the specified
rate on a notional principal amount for a predetermined period of time. No funds
are actually borrowed or repaid. Similarly, an interest rate collar is a
combination of a purchased cap and a written floor at different rates.
Accordingly, an interest rate collar requires no payments if interest rates
remain within a specified range, but will require the Company to be paid if
interest rates rise above the cap rate or require the Company to pay if interest
rates fall below the floor rate. Consequently, interest rate caps are a means of
reducing interest expense by placing a ceiling on the cost of floating-rate
liabilities, such as reverse repurchase agreements, while interest rate floors
permit the Company to maintain its desired interest rate spread in the event
that falling interest rates lead to increased prepayments with respect to the
Company's mortgage-backed and related securities portfolio.
At December 31, 1995, the Company had purchased six interest rate cap
agreements, five interest rate floor agreements and one interest rate collar,
which expire from October 1996 to June 2004 and cover an aggregate notional
amount of approximately $251.1 million. The interest rate cap agreements are
triggered, depending on the particular contract, whenever the defined
floating-rate exceeds 5.0% to 9.0%. The interest rate floor agreements are
triggered, depending on the particular contract, whenever the defined
floating-rate is less than 5.0% to 7.5%. The interest rate collar is triggered
whenever the defined floating-rate is greater than 10.25% or less than 5.25%.
The aggregate net expense (income) relating to the Company's interest rate caps,
collars and floors was $(141,000), $58,000, $542,000 and $970,000 during the six
months ended December 31, 1995 and the years ended June 30, 1995, 1994 and 1993,
respectively. The approximate market value of the Company's interest rate caps,
collars and floors which are maintained in the trading portfolio was $5.5
million, $5.3 million and $4.9 million as of December 31, 1995 and June 30, 1995
and 1994, respectively. See Notes 2 and 13 to the Consolidated Financial
Statements.
Interest rate futures are commitments to either purchase or sell designated
instruments at a future date for a specified price. Futures contracts are
generally traded on an exchange, are marked to market daily and subject to
initial and maintenance margin requirements. The Company generally uses 91-day
Eurodollar certificates of deposit contracts ("Eurodollar futures contracts")
which are priced off of LIBOR as well as Treasury Note futures contracts. The
Company will from time to time agree to sell a specified number of contracts at
a specified date. In order to close out a contract, the Company will enter into
an offsetting position to the original transaction. If interest rates rise, the
value of the Company's short futures positions increases. Consequently, sales of
futures contracts serve as a hedge against rising interest rates. At December
31, 1995, the Company has sold Eurodollar and Treasury Note futures contracts
with an aggregate notional amount of approximately $1.3 billion. The net expense
relating to the Company's futures contracts was $4,000 and $39,000 for the years
ended June 30, 1994 and 1993, respectively. The approximate market value of the
Company's interest rate futures contracts which are maintained in the trading
portfolio was $(168,000), $(134,000) and $0 as of December 31, 1995 and June 30,
1995 and 1994, respectively. See Notes 2 and 13 to the Consolidated Financial
Statements.
Options are contracts which grant the purchaser the right to buy or sell the
underlying asset by a certain date for a specified price. Generally the Company
will purchase options on financial futures in order to hedge the changing
elasticity exhibited by mortgage loans and mortgage-backed securities. The
changing elasticity in this case results from the ability of a borrower to
prepay a mortgage. As market rates of interest decline, it becomes more likely
that borrowers will prepay their mortgages and the elasticity of the mortgages
will shorten. Consequently, where interest rates are declining, the value of
mortgage loans or mortgage-backed securities will increase at a slower rate than
would be expected if borrowers did not have the ability to prepay their
mortgages. Accordingly, the Company will generally purchase out-of-the-money
calls and puts so that the increase in value of the options resulting from
interest rate movements offset the reductions in MVPE resulting from the
changing elasticity inherent in the Company's balance sheet. At December 31,
1995, the Company had 175 purchased options contracts covering an aggregate
notional amount of approximately $17.5 million. The net expense
28
<PAGE>
relating to the Company's options contracts was $418,000, $148,000, $0 and
$22,000 during the six months ended December 31, 1995 and the years ended June
30, 1995, 1994 and 1993, respectively. The approximate market value of the
Company's options contracts which are maintained in the trading portfolio was
$127,000, $200,000 and $0 as of December 31, 1995 and June 30, 1995 and 1994,
respectively. See Notes 2 and 13 to the Consolidated Financial Statements.
The following table summarizes the periodic exchanges of interest payments
with counterparties and the amortization of premiums paid for interest rate
contracts maintained in the trading portfolio as discussed above. Such payments
and amortization amounts are accounted for as adjustments to the yields of
securities held for trading, and are reported as a separate component of
interest income.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
SIX MONTHS ENDED -------------------------
DECEMBER 31, 1995 1995 1994 1993
----------------- ----- ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest rate contract (income) expense:
Swaps............................................ $(163) $(113) $1,334 $1,613
Caps, floors, and collars........................ (141) 58 542 970
Futures.......................................... -- -- 4 39
Options.......................................... 418 148 -- 22
------ ----- ------ ------
Net interest expense on interest rate
contracts.......................................... $ 114 $ 93 $1,880 $2,644
------ ----- ------ ------
------ ----- ------ ------
</TABLE>
The above table does not include realized and unrealized gains and losses
with respect to the market value of interest rate contracts held in the trading
portfolio. Such gains and losses are generally offset by fluctuations in the
market value of the Company's assets held for trading. All realized and
unrealized gains and losses pertaining to interest rate contracts in the trading
portfolio are reported as other income in the Company's Consolidated Statements
of Income. See Notes 2 and 13 to the Consolidated Financial Statements.
In engaging in the Company's asset and liability management activities, the
Company is subject to the risk that the counterparties with respect to which it
enters into various interest rate contracts (such as swaps, collar, caps,
floors, options and futures) may default at or prior to maturity of a particular
instrument. In such a case, the Company might be unable to recover any
unrealized gains with respect to a particular contract. In order to minimize
this potential risk, the Company generally deals with large, established
investment brokerage firms when entering into these transactions. In addition,
if the Company enters into an interest rate contract with a non AA-rated (or
above) entity and the Company has an unrealized gain with respect to such
contract, the Company generally requires the entity to post some form of
collateral in order to secure its obligations. Furthermore, the Company has a
policy whereby it limits its unsecured exposure to any one counterparty to 25%
of the Bank's equity during any two-month period and 35% of the Bank's equity
during any one-month period. At December 31, 1995, the Company had interest rate
contracts with 10 entities, and the largest unsecured exposure to any one
counterparty amounted to 9.2% of the Bank's equity. For a discussion of certain
other risks inherent with respect to the purchaser and/or sale of interest rate
contracts (such as basis risk, prepayment risk, interest rate risk and
volatility risk), see "Risk Factors--Use of Interest Rate Contracts and Other
Derivatives."
The Company's total portfolio income, which includes net interest income
after provision for loan losses, realized and unrealized gains and losses with
respect to the Company's securities portfolio (which includes mortgage-backed
derivative securities and interest rate contracts), approximates the net effect
of the Company's management of its assets and liabilities. Total portfolio
income for the six months ended December 31, 1995 and December 31, 1994 amounted
to $2.4 million and $2.5 million, respectively, and for the years ended June 30,
1995, 1994 and 1993 amounted to $6.0 million, $3.6 million and $2.6 million,
respectively.
29
<PAGE>
The OTS requires each thrift institution to calculate the estimated change
in the institution's MVPE assuming an instantaneous, parallel shift in the
Treasury yield curve of 100 to 400 basis points either up or down. The OTS
permits institutions to perform this MVPE analysis using their own internal
model (based upon reasonable assumptions), or they may utilize the OTS' model,
which is based upon data submitted in the institution's quarterly thrift
financial reports. The Company uses Smith Breeden's model to perform the
required calculation of the sensitivity of its market value to changes in
interest rates. Both Smith Breeden and the OTS use option-adjusted pricing
analysis and present value calculations of estimated cash flows through the use
of simulation models. Nevertheless, the results of the OTS model may vary from
Smith Breeden's model primarily due to differences between assumptions utilized
in the two models, including estimated interest rates and volatilities,
prepayment rates, reinvestment rates and decay rates. In addition, the Smith
Breeden model utilizes detailed data with respect to individual loans and
securities while the OTS model uses aggregated data with respect to similar
instruments. The OTS reviews the Smith Breeden analysis in conjunction with its
regular examinations of the Bank.
With the assistance of Smith Breeden, the Company uses market value analysis
to perform the required calculation of the sensitivity of its MVPE to changes in
interest rates. In order to calculate the respective market values, the Company
utilizes a simulation model which generates a variety of interest rate paths
based upon a current yield curve scenario and assumed interest rate volatility
factors. The model projects the cash flows for each path with respect to the
Bank's assets, liabilities and off-balance sheet instruments under each interest
rate scenario. Each path's cash flows are then discounted to the present. The
average of the market values under each interest rate path (as discounted to the
present) calculated by the model represents the estimated market value of a
particular instrument for a particular interest rate scenario.
In estimating the market value of mortgage loans and mortgage-backed
securities, the Company utilizes various prepayment assumptions which vary, in
accordance with historical experience, based upon the term, interest rate and
other factors with respect to the underlying loans. At December 31, 1995, such
prepayment assumptions varied from 5% for fixed-rate mortgage loans and
mortgage-backed securities carrying below market yields to 30% for fixed-rate
mortgage loans and mortgage-backed securities carrying above market yields.
Adjustable-rate mortgage loans and mortgage-backed securities were estimated to
prepay at rates ranging from 17% to 36% over the life of the particular loan
and/or security.
With respect to deposit accounts which do not have a defined maturity date
(such as NOW, checking and savings accounts), the Company assumes various decay
rates which reflect a variety of interest rate scenarios. For example, if
short-term market rates of interest increase, the Company would expect a portion
of its lower yielding NOW and savings accounts to be withdrawn and reinvested
into higher yielding certificates of deposit and money market deposit accounts.
At December 31, 1995, assumed decay rates ranged from 5% to 40%.
30
<PAGE>
The following table sets forth at December 31, 1995 the estimated
sensitivity of the Bank's MVPE to parallel yield curve shifts using the
Company's market value analysis (with the assistance of Smith Breeden). The
table demonstrates the sensitivity of the Bank's assets and liabilities both
before and after the inclusion of its interest rate contracts.
<TABLE><CAPTION>
CHANGE IN INTEREST RATES (IN BASIS POINTS)(1)
-------------------------------------------------------------------------------
-400 -300 -200 -100 -- +100 +200 +300 +400
------- ------- ------- ------- ---- ------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Market value gain (loss) of
assets..................... $18,491 $13,798 $ 9,510 $ 5,254 $-- $(7,737) $(17,501) $(28,686) $(40,549)
Market value gain (loss) of
liabilities................ (4,688) (4,107) (2,997) (1,607) -- 1,598 3,104 4,530 5,885
------- ------- ------- ------- ------- -------- -------- --------
Market value gain (loss) of
net assets before interest
rate contracts............. 13,803 9,691 6,513 3,647 -- (6,139) (14,397) (24,156) (34,664)
Market value gain (loss) of
interest rate contracts... (9,505) (8,037) (6,129) (3,599) -- 5,249 11,740 19,445 27,789
------- ------- ------- ------- ------- -------- -------- --------
Total change in MVPE(2)... $ 4,298 $ 1,654 $ 384 $ 48 -- $ (890) $ (2,657) $ (4,711) $ (6,875)
------- ------- ------- ------- ------- -------- -------- --------
------- ------- ------- ------- ------- -------- -------- --------
Change in MVPE as a percent
of:
MVPE(2)................... 20.0% 7.7% 1.8% 0.2% -- (4.1)% (12.4)% (21.9)% (32.0)%
------- ------- ------- ------- ------- -------- -------- --------
------- ------- ------- ------- ------- -------- -------- --------
Total assets of the
Bank....................... 1.4% 0.5% 0.1% --% -- (0.3)% (0.9)% (1.5)% (2.2)%
------- ------- ------- ------- ------- -------- -------- --------
------- ------- ------- ------- ------- -------- -------- --------
</TABLE>
- - - ------------
(1) Assumes an instantaneous parallel change in interest rates at all
maturities.
(2) Based on the Bank's pre-tax MVPE of $21.5 million at December 31, 1995.
As discussed under "Supervision and Regulation--The Bank--Regulatory Capital
Requirements," the OTS adopted a final rule in August 1993 incorporating an
interest rate risk component into the risk-based capital rules. Under the rule,
an institution with a greater than "normal" level of interest rate risk will be
subject to a deduction of its interest rate component from total capital for
purposes of calculating the risk-based capital requirement. An institution with
a greater than "normal" interest rate risk is defined as an institution that
would suffer a loss of MVPE exceeding 2.0% of the estimated market value of its
assets in the event of a 200 basis point increase or decrease in interest rates.
A resulting change in MVPE of more than 2% of the estimated market value of an
institution's assets will require the institution to deduct from its capital 50%
of that excess change. Although the OTS has recently indicated that no
institution will be required to deduct capital for interest rate risk until
further notice, if such requirement had been in effect at December 31, 1995 the
Bank would not have been subject to any additional capital requirement. See
"Supervision and Regulation--The Bank--Regulatory Capital Requirements."
The table set forth above does not purport to show the impact of interest
rate changes on the Company's equity under generally accepted accounting
principles. Market value changes only impact the Company's income statement or
the balance sheet (i) to the extent the affected instruments are marked to
market, and (ii) over the life of the instruments as an impact on recorded
yields. Since a large portion of the Company's assets is recorded at market
value, the following table is included to show the estimated impact on the
Company's equity of instantaneous, parallel shifts in the yield curve. The
assets and interest rate contracts included in the table below are only those
which are either classified by the Company as held for trading or available for
sale and, therefore, reflected at market value. Consequently, the Company's
liabilities, which are reflected at cost, are not included in the table below.
All amounts are shown net of taxes, with an estimated effective tax rate of
36.0%.
<TABLE><CAPTION>
CHANGE IN INTEREST RATES (IN BASIS POINTS)
----------------------------------------------------------------------------
-400 -300 -200 -100 -- +100 +200 +300 +400
------ ------ ------- ------- ---- ------- ------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Market value gain (loss) of
assets....................... $9,513 $7,056 $ 4,824 $ 2,636 -- $(3,875) $(8,816) $(14,557) $(20,711)
Market value gain (loss) of
interest rate contracts..... (7,070) (5,870) (4,398) (2,537) -- 3,584 7,955 13,095 18,637
------ ------ ------- ------- ------- ------- -------- --------
After tax gain (loss) in
equity....................... $2,443 $1,186 $ 426 $ 99 -- $ (291) $ (861) $ (1,462) $ (2,074)
------ ------ ------- ------- ------- ------- -------- --------
------ ------ ------- ------- ------- ------- -------- --------
After tax gain (loss) in
equity as a percent of the
Company's equity at December
31, 1995..................... 22.2% 10.8% 3.9% 0.9% -- (2.6)% (7.8)% (13.3)% (18.8)%
------ ------ ------- ------- ------- ------- -------- --------
------ ------ ------- ------- ------- ------- -------- --------
</TABLE>
31
<PAGE>
As indicated in the tables above, based upon the hedge-adjusted composition
of the Company's balance sheet at December 31, 1995 and assuming an
instantaneous, parallel shift in the yield curve, a 100 basis point increase in
interest rates would result in $890,000 or 4.1% reduction in the MVPE of the
Bank and an after tax loss with respect to the Company's equity of $291,000 or
2.6%. Similarly, as the tables demonstrate, a 100 basis point decrease in
interest rates would result in a $48,000 or 0.2% increase in the MVPE of the
Bank and an after-tax gain with respect to the Company's equity of $99,000 or
0.9%. However, management of the Company believes that the actual loss in MVPE
or equity due to an increase in interest rates would be less than shown in the
tables above because recent empirical studies indicate that market spreads may
tighten (resulting in higher relative market values) as interest rates rise. In
addition, the tables above assume an instantaneous, parallel change in rates
which is highly unlikely. As rates tend to increase or decrease over time,
management expects to be able to actively manage its portfolio in order to
respond to such changes over time. Although management of the Company believes
that all of the assumptions used in the foregoing analysis to evaluate the
vulnerability of the Company's operations to changes in interest rates
approximate actual experience and considers them reasonable, the interest rate
sensitivity of the Company's assets and liabilities and the estimated effects of
changes in interest rates on the Bank's MVPE and the Company's equity indicated
in the above tables could vary substantially if different assumptions were used
or if actual experience differs from the projections on which they are based.
CHANGES IN FINANCIAL CONDITION
General. At December 31, 1995, the Company's total assets amounted to $307.4
million, as compared to $300.2 million and $211.7 million at June 30, 1995 and
1994, respectively. The increase in total assets during the periods was
primarily due to the completion in fiscal 1995 of the Company's private
placement of Common Stock, which raised $2.4 million in net proceeds. The
proceeds from the offering permitted the Company to utilize the capital raised
by purchasing additional mortgage-backed securities funded primarily by
securities sold under agreements to repurchase.
Cash and Interest-Bearing Deposits. Cash and interest-bearing deposits
amounted to $10.9 million, $5.7 million and $10.4 million at December 31, 1995
and June 30, 1995 and 1994, respectively. The Company actively manages its cash
and cash equivalents based upon the Company's operating, investing and financing
activities. Based upon the Company's current size, cash and cash equivalents
generally fluctuate within a range of $4.0 million to $15.0 million. The Company
generally attempts to invest its excess liquidity into higher yielding assets
such as loans or securities. At December 31, 1995, the Bank's regulatory
liquidity amounted to 5.19% (which exceeded the minimum OTS requirement of 5.00%
by $509,000), as compared to 5.36% and 7.95% at June 30, 1995 and 1994,
respectively.
See "--Liquidity and Capital Resources."
Securities Held for Trading and Available for Sale. In order to limit the
Company's credit risk exposure and to earn a positive interest rate spread, the
Company maintains a substantial portion of its assets in mortgage-backed and
related securities, which are primarily issued or guaranteed by U.S. Government
agencies or government sponsored enterprises. At December 31, 1995, the
Company's investment in mortgage-backed and related securities amounted to
$226.2 million or 97.2% of the Company's securities portfolio (both held for
trading and available for sale) and 73.6% of the Company's total assets.
Although mortgage-backed and related securities often carry lower yields than
traditional mortgage loans, such securities generally increase the quality of
the Company's assets by virtue of the securities' underlying insurance or
guarantees, are more liquid than individual mortgage loans (which enhances the
Company's ability to actively manage its portfolio) and may be used to
collateralize borrowings or other obligations of the Company. Moreover, as a
result of the Company maintaining a substantial portion of its assets in
mortgage-backed and related securities, the Company has been able to maintain a
relatively low level of operating expenses.
32
<PAGE>
On June 30, 1993, the Company adopted SFAS No. 115, which addresses the
accounting and reporting for investments in equity securities that have readily
determinable fair values and all investments in debt securities. See "--Recent
Accounting Pronouncements" and "Business--Investment Activities." Upon adoption
of SFAS No. 115, the Company classified all of its securities as available for
sale. However, during fiscal 1994, in recognition of the Company's business
strategy of actively managing its portfolio, the Company reclassified
substantially all of its securities as held for trading. At December 31, 1995,
the only securities held by the Company in its available for sale portfolio
consisted of a $1.2 million non-agency mortgage-backed security which is
currently classified as substandard and $1.1 million of municipal bonds. See
"Business--Asset Quality--Classified Assets." Pursuant to SFAS No. 115,
securities classified as trading securities are reported at fair value with
unrealized gains and losses included in earnings, and securities classified as
available for sale are similarly reported at fair value, but with unrealized
gains and losses excluded from earnings and instead reported as a separate
component of stockholders' equity.
Securities held for trading (consisting of mortgage-backed securities,
mortgage-backed derivative securities, interest rate contracts and equity
securities) amounted to $230.3 million, $246.7 million and $170.9 million at
December 31, 1995 and June 30, 1995 and 1994, respectively. During the six
months ended December 31, 1995, securities held for trading declined by $16.4
million or 6.6%, due primarily to reductions in mortgage-backed securities and
mortgage-backed derivative securities. Such declines reflected the Company's
increased emphasis on loan origination activities (both directly and through
correspondents) during the period. During the year ended June 30, 1995,
securities held for trading increased significantly by $75.8 million or 44.4%,
due primarily to an increase in mortgage-backed securities, which was partially
offset by a decline in mortgage-backed derivative securities. The increase in
mortgage-backed securities during fiscal 1995 reflected the utilization of the
capital associated with the January 1995 completion of the Company's private
placement, which raised $2.4 million in net proceeds.
Securities classified as available for sale (consisting of a non-agency
mortgage-backed security and municipal bonds) remained relatively stable at the
end of the periods covered, and amounted to $2.3 million, $2.5 million and $3.4
million at December 31, 1995 and June 30, 1995 and 1994, respectively. The
$255,000 or 10.0% decrease during the six months ended December 31, 1995 was due
primarily to a $205,000 decline in the non-agency participation certificate
which was substantially a result of regular principal repayments. The $887,000
or 25.9% decrease during fiscal 1995 was due primarily to a $868,000 or 38.0%
decline in the non-agency mortgage-backed security partially due to regular
principal repayments and a $414,000 permanent impairment write-down with respect
to such security. See "--Results of Operations--Other Income" and
"Business--Asset Quality--Classified Assets."
Loans Receivable. At December 31, 1995, loans receivable (net of the
Company's allowance for loan losses) amounted to $55.9 million or 18.2% of total
assets, as compared to $37.0 million or 12.3% and $20.7 million or 9.8% as of
June 30, 1995 and 1994, respectively. Since fiscal 1993, the Company has
actively attempted to increase its retail banking operations, particularly the
origination (both directly and through correspondent mortgage banking companies)
of single-family residential loans to individuals residing in eastern and
central Indiana. As a result, loans receivable increased by $18.9 million or
51.1% and $16.3 million or 78.9% during the six months ended December 31, 1995
and the year ended June 30, 1995, respectively. The increase during the six
months ended December 31, 1995 was primarily due to $10.4 million of direct loan
originations ($9.7 million of which consisted of single-family residential
loans) and $15.4 million of correspondent loan originations (all of which
consisted of single-family residential loans), which were partially offset by
principal repayments of $7.1 million. The increase in loans receivable during
fiscal 1995 was primarily due to direct loan originations of $11.7 million ($9.1
million of which consisted of single-family residential loans) and $9.8 million
of correspondent loan originations (all of which consisted of single-family
residential loans), which were partially offset by $5.3 million of principal
repayments. Beginning in fiscal 1995, the Company began originating
single-family residential loans through correspondent mortgage banking companies
headquartered in
33
<PAGE>
Prairie Village, Kansas and Indianapolis, Indiana. Currently, the Company is
continuing its relationship with the Indianapolis firm and desires to expand
further its originations of single-family residential loans through the use of
additional correspondent mortgage banking companies located within central
Indiana. See "Business--Lending Activities--Origination, Purchase and Sale of
Loans."
Allowance for Loan Losses. At December 31, 1995, the Company's allowance for
loan losses totalled $120,000, which represented a $1,000 or 0.8% decrease and a
$14,000 or 13.2% increase from the levels maintained at June 30, 1995 and 1994,
respectively. At December 31, 1995, the Company's allowance represented
approximately 0.2% of the total loan portfolio and 33.0% of total non-performing
loans, as compared to 0.3% and 34.6% at June 30, 1995 and 0.5% and 19.0% at June
30, 1994, respectively. The ratio of total non-performing loans to total loans
amounted to 0.7% at December 31, 1995, as compared to 1.0% and 2.7% at June 30,
1995 and 1994, respectively, which reflects the Company's emphasis on reducing
credit risk with respect to its operations. Although management of the Company
believes that its allowance for loan losses at December 31, 1995 was adequate
based on facts and circumstances available to it (including the historically low
level of loan charge-offs), there can be no assurances that additions to such
allowance will not be necessary in future periods, particularly if the growth in
the Company's retail banking operations continues, which could adversely affect
the Company's results of operations.
Deposits. At December 31, 1995, deposits totalled $114.8 million, as
compared to $115.3 million and $108.3 million as of June 30, 1995 and 1994,
respectively. The Company attempts to reduce its overall funding costs by
evaluating all potential sources of funds (including retail and non-retail
deposits and short and long-term borrowings) and identifying which particular
source will result in an all-in cost to the Company that meets its funding
benchmark. At the same time, the Bank has attempted to price the deposits
offered through its branch system in order to promote retail deposit growth and
offer a wide array of deposit products to satisfy its customers. In addition to
providing a cost-efficient funding source, these retail deposits provide a
source of fee income and the ability to cross-sell other products or services.
As a result, retail deposits (including transaction accounts and retail
certificates of deposit) have increased from $52.0 million or 48.1% of total
deposits at June 30, 1994 to $84.9 million or 73.9% of total deposits at
December 31, 1995. See "Business--Sources of Funds--Deposits."
Borrowings. Since fiscal 1995, securities sold under agreements to
repurchase (consisting of agreements to purchase on a specified later date the
same securities or substantially identical securities (the latter of which are
referred to as "dollar rolls") (collectively, "reverse repurchase agreements"))
have constituted the Company's primary source of funds. At December 31, 1995,
reverse repurchase agreements totalled $141.4 million, as compared to $130.2
million and $54.7 million as of June 30, 1995 and 1994, respectively. The $11.2
million or 8.6% increase during the six months ended December 31, 1995 and the
$75.6 million or 138.3% increase during the year ended June 30, 1995 was
principally due to the utilization of the capital raised in the Company's fiscal
1995 private placement through the purchase of mortgage-backed securities funded
primarily by reverse repurchase agreements. At December 31, 1995, the average
rate paid on reverse repurchase agreements amounted to 6.0%, as compared to 6.0%
and 4.1% at June 30, 1995 and 1994, respectively. Although a substantial portion
of the Company's growth in recent periods has been funded by reverse repurchase
agreements, part of management's strategy is to gradually replace such
borrowings with retail deposits. Retail deposits are considered to be a
cost-effective source of funds, provide the Company with an additional source of
fee income and permit the Company to cross-sell additional products and
services. See "Business--Sources of Funds--Borrowings."
Advances from the FHLB of Indianapolis amounted to $26.0 million, $31.0
million and $31.0 million as of December 31, 1995 and June 30, 1995 and 1994,
respectively. At December 31, 1995, all $26.0 million of FHLB advances were
scheduled to mature in 1997, with an average interest rate thereon of 5.9%, as
compared to 6.1% and 4.3% at June 30, 1995 and 1994, respectively. See
"Business--Sources of Funds--Borrowings."
34
<PAGE>
The Company's note payable amounted to $9.5 million, $9.2 million and $7.9
million at December 31, 1995 and June 30, 1995 and 1994, respectively. Proceeds
from the note payable have been contributed to the Bank in order to increase the
Bank's capital, thereby permitting the Company to increase the Bank's
originations of single-family residential loans and purchases of mortgage-backed
and related securities. The note payable relates to a loan facility which was
used to refinance, to a significant extent, the unpaid balance of a $10.0
million acquisition loan which financed the Company's acquisition of the Bank.
The loan facility, as amended in 1995, includes a $9.2 million term loan and a
non-revolving line of credit of $800,000. The increase in the balance of the
loan facility since June 30, 1994 reflects subsequent draws by the Company with
respect to the line of credit which were utilized to increase the Bank's capital
and provide additional funds for its operations. The loan facility matures in
March 2000 (which can, under certain circumstances, be extended for an
additional five years) and carries an interest rate of 1/2% over the prime rate
published in the Wall Street Journal if the ratio of the loan balance to the
Bank's capital is equal to or less than 50%; otherwise, the interest rate is 1%
over the prime rate. The loan facility requires quarterly principal and interest
repayments. The loan facility is secured by (i) a general pledge agreement
between the parties pursuant to which the Company has pledged 100% of the
outstanding stock of the Bank; (ii) a security agreement between the parties
pursuant to which the Company has provided a blanket security interest in all of
its assets; (iii) a guaranty from Smith Breeden and from Douglas T. Breeden, the
Chairman of the Board of Smith Breeden (and of the Company), personally; and
(iv) the assignment of life insurance policies on Messrs. Breeden and Cerny by
the Company in the aggregate amount of $1.25 million. An April 1996 amendment to
the loan facility, which is effective solely upon consummation of the Offering,
would recharacterize the aggregate $9.3 million principal balance outstanding as
a term loan and provide an additional $3.0 million non-revolving line of credit
which is intended to further increase the capital of the Bank. Among certain
modifications, the guarantees of Smith Breeden and Douglas T. Breeden,
referenced above, would be removed. See "Business--Sources of
Funds--Borrowings."
Stockholders' Equity. Stockholders' equity increased from $5.9 million at
June 30, 1994 to $10.4 million at June 30, 1995 and further increased to $11.0
million at December 31, 1995. These increases were due to (i) $927,000, $1.9
million and $543,000 of net income recognized during fiscal 1994 and 1995 and
the six months ended December 31, 1995, respectively; (ii) $2.4 million in net
proceeds from the fiscal 1995 private placement of Common Stock; and (iii)
$101,000 and $165,000 raised in connection with the exercise of existing stock
options during fiscal 1995 and the six months ended December 31, 1995,
respectively. In addition, at June 30, 1995 and December 31, 1995, the Company's
stockholders' equity included $61,000 and $2,000, respectively, of unrealized
gains on securities classified as available for sale, net of deferred taxes. See
Note 16 to the Consolidated Financial Statements.
RESULTS OF OPERATIONS
Summary of Earnings. The Company reported net income of $543,000 or $0.28
per share for the six months ended December 31, 1995, compared to $770,000 or
$0.54 per share for the six months ended December 31, 1994. This $227,000 or
29.5% decrease in net income during the six months ended December 31, 1995, as
compared to the same period in the prior year, was due to a $227,000 increase in
total other expense and a $590,000 decrease in total other income, which were
partially offset by a $409,000 increase in net interest income, a $22,000
reduction in the provision for loan losses and a $160,000 decrease in the income
tax provision.
Net income for the year ended June 30, 1995 was $1.9 million or $1.20 per
share, compared to $927,000 or $0.66 per share during the year ended June 30,
1994. The $926,000 or 99.8% increase in net income was due to a $2.8 million
increase in total other income and, to a much lesser extent, the absence of a
$79,000 cumulative effect of change in accounting principle for deferred income
taxes which was recognized during fiscal 1994, which more than offset a $780,000
increase in the income tax
35
<PAGE>
provision, a $647,000 increase in total other expense, a $542,000 decrease in
net interest income and a $17,000 increase in the provision for loan losses.
Net income for the year ended June 30, 1994 was $927,000 or $0.66 per share,
compared to a net loss of $130,000 or $0.09 per share during the year ended June
30, 1993. The $1.1 million increase in net income was due to a $1.6 million
increase in net interest income (reflecting $1.5 million of non-recurring
interest earned from the call of two mortgage-backed residuals), a $531,000
decrease in losses from securities activities, a $230,000 decrease in total
other expense (reflecting the Company's write-off of $663,000 of goodwill and
core deposit intangible during fiscal 1993) and a $69,000 decline in the
provision for loan losses, which were partially offset by a $203,000 increase in
the income tax provision and a $79,000 charge recognized during fiscal 1994
relating to the cumulative effect of change in accounting principle for deferred
income taxes.
Average Balances, Net Interest Income and Yields Earned and Rates Paid. The
following table presents for the periods indicated the total dollar amount of
interest from average interest-earning assets and the resultant yields, as well
as the interest expense on average interest-bearing liabilities, expressed both
in dollars and rates, and the net interest margin. The table does not reflect
any effect of income taxes. All average balances are based on average month end
balances for the Company and average daily balances for the Bank during the
periods presented.
36
<PAGE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED DECEMBER 31, YEAR ENDED JUNE 30,
---------------------------------------------------------------- ----------------------------
1995 1994 1995
-------------------------------- ----------------------------- ----------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE(1)(2) BALANCE INTEREST RATE(2) BALANCE INTEREST RATE
-------- -------- ---------- -------- -------- ------- -------- -------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS
Interest-bearing deposits...... $ 13,604 $ 388 5.70% $ 10,886 $ 267 4.91% $ 11,493 $ 603 5.25%
Securities held for
trading(3)(4)................... 238,668 9,028 7.57 170,901 6,020 7.05 185,014 14,332 7.75
Securities available for
sale(3)......................... 2,818 102 7.24 3,392 130 7.67 3,110 250 8.04
Loans receivable, net(5)....... 45,548 1,934 8.49 21,777 947 8.70 25,467 2,223 8.73
FHLB stock..................... 2,500 101 8.08 1,843 59 6.40 2,172 152 7.00
-------- -------- -------- -------- -------- --------
Total interest-earning
assets.......................... 303,138 11,553 7.62% 208,799 7,423 7.11% 227,256 17,560 7.73%
----- ------- ------
----- ------- ------
Non-interest-earning assets 14,472 13,224 15,654
-------- -------- --------
Total assets................. $317,610 $222,023 $242,910
-------- -------- --------
-------- -------- --------
INTEREST-BEARING LIABILITIES
Deposits:
NOW and checking accounts.... $ 3,476 52 2.99% $ 3,460 49 2.83% $ 3,352 94 2.80%
Savings accounts............. 15,185 289 3.81 16,636 283 3.40 16,068 568 3.53
Money market deposit
accounts........................ 1,791 39 4.36 2,258 42 3.72 2,147 88 4.10
Certificates of deposit...... 100,797 3,138 6.23 92,420 2,460 5.32 99,443 5,904 5.94
-------- -------- -------- -------- -------- --------
Total deposits................. 121,249 3,518 5.80 114,774 2,834 4.94 121,010 6,654 5.50
Securities sold under
agreements to repurchase..... 140,058 4,127 5.89 55,690 1,302 4.68 68,277 3,654 5.35
FHLB advances.................. 29,172 876 6.01 31,000 777 5.01 31,051 1,722 5.55
Note payable................... 9,800 475 9.69 7,755 362 9.34 7,890 749 9.49
-------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities..................... 300,279 8,996 5.99% 209,219 5,275 5.04% 228,228 12,779 5.60%
-------- ----- -------- ------- -------- ------
----- ------- ------
Non-interest-bearing
liabilities..................... 6,533 6,074 6,349
-------- -------- --------
Total liabilities.............. 306,812 215,293 234,577
Stockholders' equity............ 10,798 6,730 8,333
-------- -------- --------
Total liabilities and
stockholders' equity............ $317,610 $222,023 $242,910
-------- -------- --------
-------- -------- --------
Net interest income; interest
rate spread(4)(6)............... $ 2,557 1.63% $ 2,148 2.07% $ 4,781 2.13%
-------- ----- -------- ------- -------- ------
-------- ----- -------- ------- -------- ------
Net interest margin(4)(6)(7).... 1.69% 2.06% 2.10%
----- ------- ------
----- ------- ------
Average interest-earning assets
to average interest-bearing
liabilities..................... 100.95% 99.80% 99.57%
----- ------- ------
----- ------- ------
<CAPTION>
1994 1993
---------------------------- ----------------------------
AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE
-------- -------- ------ -------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS
Interest-bearing deposits...... $ 12,454 $ 415 3.33% $ 11,884 $ 398 3.35%
Securities held for
trading(3)(4)................... 163,825 10,996 6.71 -- -- --
Securities available for
sale(3)......................... 3,928 311 7.92 175,135 10,079 5.75
Loans receivable, net(5)....... 19,369 1,778 9.18 19,437 2,075 10.68
FHLB stock..................... 1,843 107 5.81 1,843 194 10.53
-------- -------- -------- --------
Total interest-earning
assets.......................... 201,419 13,607 6.76% 208,299 12,746 6.12%
------ ------
------ ------
Non-interest-earning assets 10,904 8,515
-------- --------
Total assets................. $212,323 $216,814
-------- --------
-------- --------
INTEREST-BEARING LIABILITIES
Deposits:
NOW and checking accounts.... $ 2,872 83 2.89% $ 2,191 71 3.24%
Savings accounts............. 18,271 598 3.27 17,563 631 3.59
Money market deposit
accounts........................ 5,396 184 3.41 1,988 66 3.32
Certificates of deposit...... 69,336 3,651 5.27 70,543 4,171 5.91
-------- -------- -------- --------
Total deposits................. 95,875 4,516 4.71 92,285 4,939 5.35
Securities sold under
agreements to repurchase..... 66,813 2,134 3.19 82,626 2,650 3.21
FHLB advances.................. 31,000 1,057 3.41 24,664 803 3.26
Note payable................... 7,227 577 7.98 7,905 583 7.38
-------- -------- -------- --------
Total interest-bearing
liabilities..................... 200,915 8,284 4.12% 207,480 8,975 4.33%
-------- ------ -------- ------
------ ------
Non-interest-bearing
liabilities..................... 5,221 4,472
-------- --------
Total liabilities.............. 206,136 211,952
Stockholders' equity............ 6,187 4,862
-------- --------
Total liabilities and
stockholders' equity............ $212,323 $216,814
-------- --------
-------- --------
Net interest income; interest
rate spread(4)(6)............... $ 5,323 2.64% $ 3,771 1.79%
-------- ------ -------- ------
-------- ------ -------- ------
Net interest margin(4)(6)(7).... 2.64% 1.81%
------ ------
------ ------
Average interest-earning assets
to average interest-bearing
liabilities..................... 100.25% 100.39%
------ ------
------ ------
</TABLE>
- - - ------------
(1) At December 31, 1995, the yields earned and rates paid were as follows:
interest-bearing deposits, 5.24%; securities held for trading, 7.74%;
securities available for sale, 6.85%; loans receivable, net, 7.91%; FHLB
stock, 8.00%; total interest-earning assets, 7.68%; deposits, 5.83%;
securities sold under agreements to repurchase, 6.00%; FHLB advances, 5.87%;
note payable, 9.36%; total interest-bearing liabilities, 6.03%; interest
rate spread, 1.65%.
(2) Yields and rates for the six months ended December 31, 1995 and 1994 have
been annualized.
(3) Both the interest and yields earned on the Company's securities portfolio
reflect the net interest expense incurred with respect to various interest
rate contracts (such as interest rate swaps, collars, caps, floors, options
and futures) which were utilized to hedge the Company's interest rate
exposure. During the six months ended December 31, 1995 and 1994 and the
years ended June 30, 1995 and 1994, the net costs of hedging the Company's
interest rate exposure with respect to its securities held for trading
amounted to $114,000 or 0.10%, $418,000 or 0.49%, $93,000 or 0.05% and $1.9
million or 1.15%, respectively. During fiscal 1993, the net costs of hedging
the Company's interest rate exposure with respect to its securities
available for sale amounted to $2.6 million or 1.51%.
(4) During fiscal 1994, interest earned on securities held for trading reflected
$1.5 million of non-recurring interest earned from the call of two
mortgage-backed residuals. Excluding this non-recurring income, the
Company's interest rate spread and net interest margin would have amounted
to 1.87% and 1.88%, respectively.
(5) Net of deferred loan fees, loan discounts and undisbursed loan funds.
Includes nonaccrual loans. Interest on nonaccrual loans is recorded when
received.
(6) Excluding the costs of hedging the Company's interest rate exposure (which
has effectively reduced the yields earned on the Company's securities
portfolio), the Company's interest rate spread amounted to 1.71%, 2.47%,
2.17%, 3.57% and 3.06% and the Company's net interest margin amounted to
1.76%, 2.46%, 2.14%, 3.58% and 3.08% for the six months ended December 31,
1995 and 1994 and the years ended June 30, 1995, 1994 and 1993,
respectively.
(7) Net interest margin is net interest income divided by average
interest-earning assets.
37
<PAGE>
Rate/Volume Analysis. The following table describes the extent to which
changes in interest rates and changes in volume of interest-related assets and
liabilities have affected the Company's interest income and interest expense
during the periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (change in volume multiplied by prior year rate), (ii)
changes in rate (change in rate multiplied by prior year volume), and (iii)
total change in rate and volume. The combined effect of changes in both rate and
volume has been allocated in proportion to the absolute dollar amounts of the
changes due to rate and volume.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, YEAR ENDED JUNE 30,
---------------------------- -----------------------------------------------------------
1995 VS. 1994 1995 VS. 1994 1994 VS. 1993
---------------------------- ---------------------------- ----------------------------
INCREASE INCREASE INCREASE
(DECREASE) (DECREASE) (DECREASE)
DUE TO TOTAL DUE TO TOTAL DUE TO TOTAL
--------------- INCREASE --------------- INCREASE --------------- INCREASE
RATE VOLUME (DECREASE) RATE VOLUME (DECREASE) RATE VOLUME (DECREASE)
------ ------ ---------- ------ ------ ---------- ------ ------ ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Interest-bearing deposits........... $ 48 $ 73 $ 121 $ 222 $ (34) $ 188 $ (2) $ 19 $ 17
Securities held for trading and
securities available for sale..... 466 2,514 2,980 1,810 1,465 3,275 1,667 (439 ) 1,228
Loans receivable, net............... (23) 1,010 987 (91) 536 445 (290) (7 ) (297)
FHLB stock.......................... 18 24 42 24 21 45 (87) -- (87)
------ ------ ----- ------ ------ ----- ------ ------ -----
Total interest-earning assets..... $ 509 $3,621 4,130 $1,965 $1,988 3,953 $1,288 $(427 ) 861
------ ------ ----- ------ ------ ----- ------ ------ -----
------ ------ ------ ------ ------ ------
Interest-bearing liabilities:
NOW and Super NOW accounts.......... $ 3 $ -- 3 $ (3) $ 14 11 $ (8) $ 20 12
Savings accounts.................... 32 (26) 6 46 (76) (30) (58) 25 (33)
Money market deposit accounts....... 6 (9) (3) 32 (128) (96) 2 116 118
Certificates of deposit............. 442 236 678 511 1,742 2,253 (450) (70 ) (520)
------ ------ ----- ------ ------ ----- ------ ------ -----
Total deposits.................... 483 201 684 586 1,552 2,138 (514) 91 (423)
Securities sold under agreements to
repurchase........................... 414 2,411 2,825 1,472 48 1,520 (11) (505 ) (516)
FHLB advances....................... 147 (48) 99 663 2 665 39 215 254
Note payable........................ 14 99 113 116 56 172 46 (52 ) (6)
------ ------ ----- ------ ------ ----- ------ ------ -----
Total interest-bearing
liabilities.......................... $1,058 $2,663 3,721 $2,837 $1,658 4,495 $ (440) $(251 ) (691)
------ ------ ----- ------ ------ ----- ------ ------ -----
------ ------ ------ ------ ------ ------
Increase (decrease) in net interest
income............................... $ 409 $ (542) $1,552
----- ----- -----
----- ----- -----
</TABLE>
Net Interest Income. Six Months Ended December 31, 1995 and 1994. Net
interest income is determined by the Company's interest rate spread (i.e., the
difference between the yields earned on its interest-earning assets and the
rates paid on its interest-bearing liabilities) and the relative amounts of
interest-earning assets and interest-bearing liabilities. For the six months
ended December 31, 1995, the Company's net interest income increased by $409,000
or 19.0%, to $2.6 million, compared to the same period in 1994. The increase was
primarily due to an increase in the amount of average interest-earning assets by
45.2%, and an increase in the ratio of average interest-earning assets to
average interest-bearing liabilities, from 99.80% to 100.95%, primarily due to
the large increases in the average balances of securities held for trading and
loans and an increase in the percentage of average interest-earning assets
consisting of loans (which tend to earn a higher yield), which was partially
offset by a 44 basis point decline (with 100 basis points equalling 1.0%) in the
Company's interest rate spread (from 2.07% to 1.63%). The decline in the
Company's interest rate spread during the period was primarily due to the Bank
reinvesting the capital raised in the Company's fiscal 1995 private placement
through the purchase of highly liquid but lower yielding mortgage-backed and
related securities, which were funded primarily through reverse repurchase
agreements.
Total interest income increased by $4.1 million or 55.6% during the six
months ended December 31, 1995, as compared to the same period in the prior
year, due primarily to a $3.0 million or 48.5% increase in interest income (net
of costs relating to interest rate contracts) on securities held for trading and
available for sale, the largest component of the Company's interest-earning
assets, and to a
38
<PAGE>
$987,000 or 104.2% increase in interest income on loans. The average balance of
securities held for trading increased by $67.8 million, reflecting management's
decision to deploy the additional capital raised in the Company's fiscal 1995
private placement by purchasing additional mortgage-backed securities, which
were funded primarily through reverse repurchase agreements. In addition, the
average yield earned on securities held for trading increased by 52 basis
points, reflecting, among other things, a 39 basis point decrease in hedging
costs (from 49 to 10 basis points) over the comparable period. Such costs
reflect the net interest expense incurred with respect to various interest rate
contracts (such as interest rate swaps, collars, caps, floors, options and
futures) which are utilized by the Company to hedge its interest rate exposure.
See "--Asset and Liability Management."
The increase in interest income on loans was due to a $23.8 million increase
in the average balance of loans receivable, which reflected increased loans
originated (both directly and through correspondents) during the period. During
fiscal 1993, in order to increase its portfolio of single-family residential
loans, the Company stopped selling loans in the secondary market, increased its
direct origination of single-family residential loans and, beginning in fiscal
1995, began originating single-family residential loans through select
correspondents.
Total interest expense increased by $3.7 million or 70.5% during the six
months ended December 31, 1995, as compared to the same period in the prior
year, primarily due to increases in the average balances of deposits and reverse
repurchase agreements as well as increases in the average rates paid thereon.
Interest expense on deposits increased by $684,000 or 24.1%, due primarily to an
increase in the average rates paid on deposits (primarily certificates of
deposit) of 86 basis points and a $6.5 million increase in the average balance
of deposits (primarily non-retail certificates of deposit). Interest expense on
reverse repurchase agreements increased significantly by $2.8 million or 217.2%
during the six months ended December 31, 1995, primarily due to an $84.4 million
increase in the average balance of such borrowings (which were utilized
primarily to purchase mortgage-backed securities during the period) and, to a
much lesser extent, an increase in the average rate paid thereon of 121 basis
points. The increases in the average rates paid on deposits and reverse
repurchase agreements reflected the increase in market rates of interest during
the period.
Years Ended June 30, 1995 and 1994. For the year ended June 30, 1995, the
Company's net interest income amounted to $4.8 million, compared to $5.3 million
for the year ended June 30, 1994. The $542,000 or 10.2% decrease was primarily
due to a 51 basis point decline in the Company's interest rate spread, from
2.64% to 2.13%, as the increase in the rates paid on interest-bearing
liabilities more than offset increases in the average balances of
interest-earning assets and the yields earned thereon. A principal reason for
the decrease in the interest rate spread was the $1.5 million of non-recurring
interest earned during fiscal 1994 due to the call of two mortgage-backed
residuals during the year. Excluding this non-recurring income, the Company's
interest rate spread would have increased by 26 basis points during the year.
Total interest income increased by $4.0 million or 29.1% between fiscal 1995
and 1994, due to a $3.3 million or 29.0% increase in interest income (net of
costs relating to interest rate contracts) on securities held for trading and
available for sale, a $446,000 or 25.1% increase in interest income on loans and
a $232,000 or 44.4% increase in interest and dividends on other interest-earning
assets. The increase in interest earned on securities held for trading and
available for sale was due to a 104 basis point increase in the average yield
earned thereon (reflecting, among other things, a 110 basis point decrease in
hedging costs (from 115 to 5 basis points)), together with $21.2 million net
increase in the average balance of such securities. The increase in interest
income on loans was due to a $6.1 million increase in the average balance of
loans, which reflected increased loans originated, while the increase in
interest and dividends on other interest-earning assets was due primarily to a
192 basis point increase in the average yield earned thereon, which reflected
the general increase in market rates of interest during the year.
39
<PAGE>
Total interest expense increased by $4.5 million or 54.3% during fiscal
1995, due primarily to an increase in the average balance of deposits as well as
to an increase in the average rates paid on all interest-bearing liabilities.
Interest expense on deposits increased by $2.1 million or 47.4%, due primarily
to a $25.1 million increase in the average balance of certificates of deposit
(primarily retail certificates of deposit) and, to a lesser extent, a 79 basis
point increase in the average rate paid on
deposits (primarily certificates of deposit).
Interest expense on FHLB advances increased by $664,000 or 62.8% during
fiscal 1995, due to a 214 basis point increase in the average rate paid thereon,
while interest expense on reverse repurchase agreements increased by $1.5
million or 71.3% during fiscal 1995, due primarily to a 216 basis point increase
in the average rate paid thereon. Interest expense on note payable increased by
$172,000 or 29.7% during fiscal 1995, due to a 151 basis point increase in the
average rate paid thereon and, to a lesser extent, a $663,000 increase in the
average balance (reflecting additional draws on the Company's line of credit).
The increases in the average rates paid on such borrowings reflected the general
increase in market rates of interest.
Years Ended June 30, 1994 and 1993. Net interest income amounted to $5.3
million during the fiscal year ended June 30, 1994, compared to $3.8 million for
the fiscal year ended June 30, 1993. The $1.6 million or 41.2% increase was
primarily due to an 85 basis point increase in the Company's interest rate
spread (from 1.79% to 2.64%), which reflected the $1.5 million of non-recurring
interest earned during fiscal 1994 from the call of two mortgage-backed
residuals during the year.
Total interest income increased by $861,000 or 6.8% during fiscal 1994 over
the prior fiscal year. The primary contributor to the increase was a $1.2
million or 12.2% increase in interest income (net of costs relating to interest
rate contracts) on securities held for trading and available for sale, primarily
due to a 99 basis point increase in the average yield earned thereon, which
reflected, among other things, a 36 basis point decrease in hedging costs (from
151 to 115 basis points) and the $1.5 million of non-recurring interest earned
during fiscal 1994 from the call of two mortgage-backed residuals. Interest
income on loans decreased by $297,000 or 14.3% during fiscal 1994 over the prior
fiscal year, due primarily to a decrease in the average yield earned of 150
basis points, while interest and dividends on other interest-earning assets
decreased by $69,000 or 11.7%.
Total interest expense decreased by $691,000 or 7.7% during fiscal 1994 over
the prior fiscal year, primarily due to a decrease in the average rates paid on
interest-bearing liabilities, which more than offset an increase in the average
balance of FHLB advances. Interest expense on deposits decreased by $423,000 or
8.6%, due primarily to a 64 basis point reduction in the average rate paid on
deposits (primarily certificates of deposit). Interest expense on FHLB advances
increased by $254,000 or 31.6% during fiscal 1994, due primarily to a $6.3
million increase in the average balance. Interest expense on reverse repurchase
agreements decreased by $517,000 or 19.5% during fiscal 1994, due primarily to a
$15.8 million reduction in the average balance, which reflected the increased
use of FHLB advances as well as an overall reduction in asset size.
Provision for Loan Losses. The provision for loan losses is charged to
earnings to bring the total allowance to a level considered appropriate by
management based on the estimated net realizable value of the underlying
collateral, general economic conditions, particularly as they relate to the
Company's market area, historical loan loss experience and other factors related
to the collectability of the Company's loan portfolio. While management
endeavors to use the best information available in making its evaluations,
future allowance adjustments may be necessary if economic conditions change
substantially from the assumptions used in making the evaluations.
The Company established provisions (recoveries) for loan losses of $(1,000),
$21,000, $15,000, $(3,000) and $66,000, during the six months ended December 31,
1995 and 1994 and the years ended June 30, 1995, 1994 and 1993, respectively.
During such respective periods, loan charge-offs (net of recoveries) amounted to
$0, $0, $0, $47,000 and $9,000, respectively. The allowance for loan losses as a
40
<PAGE>
percentage of total non-performing loans was 33.0%, 25.1%, 35.0%, 19.0% and
30.0% at December 31, 1995 and 1994 and June 30, 1995, 1994 and 1993,
respectively. The allowance for loan losses as a percentage of total loans was
0.2%, 0.5%, 0.3%, 0.5% and 0.9% at December 31, 1995 and 1994 and June 30, 1995,
1994 and 1993, respectively. Although the Company's allowance for loan losses as
a percentage of total loans has declined since June 30, 1993 and the Company's
allowance for loan losses as a percentage of total non-performing loans has
declined since June 30, 1995, management believes that its allowance for loan
losses at December 31, 1995, was adequate based upon, among other things, the
significant level of single-family residential loans within the Company's
portfolio (as compared to multi-family residential, commercial real estate and
consumer loans, which are considered by management to carry a higher degree of
credit risk), the modest level of non-performing loans generally and the low
level of loan charge-offs with respect to the Company's loan portfolio.
Nevertheless, there can be no assurances that additions to such allowance will
not be necessary in future periods, particularly if the growth in the Company's
retail banking operations continues, which could adversely affect the Company's
results of operations.
Other Income. Total other income has fluctuated considerably over the
periods presented, due to the Company's active management of its securities
portfolio, which is intended to enhance both net interest income as well as
other income by capitalizing on changes in option-adjusted spreads, as well as
the Company's utilization of market value accounting. The following table sets
forth information regarding other income for the periods shown.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, YEAR ENDED JUNE 30,
---------------- ---------------------------
1995 1994 1995 1994 1993
------- ----- ------ ------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Gain (loss) on sale of securities held for
trading.......................................... $(2,621) $(338) $ 66 $(2,169) $ --
Gain on sale of securities available for sale.... -- -- -- 392 1,384
Unrealized gain on securities held for trading... 2,452 750 1,535 710 --
Permanent impairment of securities available for
sale............................................. -- -- (414) (610) (2,531)
Other(1)......................................... 114 123 238 267 249
------- ----- ------ ------- ------
Total other income............................. $ (55) $ 535 $1,425 $(1,410) $ (898)
------- ----- ------ ------- ------
------- ----- ------ ------- ------
</TABLE>
- - - ------------
(1) Consists primarily of loan servicing fees, service charges on NOW and
checking accounts, late charges and fees, ATM charges, fees from the
Company's trust and investment management services, rental income and other
miscellaneous fees.
Management's goal is to attempt to offset any change in the market value of
its securities portfolio by the change in the market value of the interest rate
contracts and mortgage-backed derivative securities utilized by the Company to
hedge its interest rate exposure. In addition, management attempts to report an
overall gain with respect to its securities portfolio through the use of option-
adjusted pricing analysis which the Company utilizes in order to select
securities with wider spreads for purchase, and as spreads tighten, to sell
these securities for a gain (net of the gain or loss recognized with respect to
related interest rate contracts).
Total other income amounted to a loss of $55,000 during the six months ended
December 31, 1995, representing a $590,000 or 110.3% decline over the prior
comparable period, due primarily to $2.6 million of losses on the sale of
securities held for trading, which was partially offset by $2.4 million of
unrealized gains on securities held for trading. The $535,000 of total other
income recognized during the six months ended December 31, 1994 was due
primarily to $750,000 of unrealized gains on securities held for trading, which
was partially offset by $338,000 of losses on the sale of securities held for
trading. The unrealized gains on securities held for trading reflected the
Company's adoption of SFAS No. 115, which requires that unrealized gains and
losses with respect to trading securities be
41
<PAGE>
recognized in other income in the period in which such unrealized gains or
losses occur. Such unrealized gains not only represent fluctuations with respect
to the value of the Company's mortgage-backed and related securities, but also
represent fluctuations with respect to the values of the various interest rate
contracts the Company utilizes to hedge its interest rate exposure. See "--Asset
and Liability Management."
Total other income amounted to $1.4 million during the year ended June 30,
1995, primarily due to $1.5 million of unrealized gains on securities held for
trading which was partially offset by a $414,000 charge relating to the
permanent impairment of securities classified as available for sale. Pursuant to
SFAS No. 115, if a security classified as available for sale experiences a
decline in value below the amortized cost of the security and such decline is
determined to be other than temporary (e.g., it is probable that the Company
will be unable to collect all amounts due according to the contractual terms of
the security), the cost basis of the security is required to be written down to
fair value and the amount of the write-down included in earnings. As a result,
during fiscal 1995, the Company recorded $414,000 of such impairment adjustments
which related to a non-agency participation certificate which was issued by an
unrelated financial institution and was secured by a significant amount of
delinquent single-family residential loans. See "Business--Asset
Quality--Classified Assets."
Total other income amounted to a loss of $1.4 million during the year ended
June 30, 1994, due primarily to a $2.2 million loss on the sale of securities
held for trading (reflecting the early call of two mortgage-backed residuals,
which resulted in less proceeds being realized at auction than anticipated, as
well as the general widening of net risk adjusted spreads with respect to
mortgage-backed and related securities) and a $610,000 impairment adjustment on
securities available for sale. These losses were partially offset by $392,000 of
gains on the sale of securities available for sale and $710,000 of unrealized
gains on securities held for trading as well as by $1.5 million of non-recurring
interest earned from the call of such mortgage-backed residuals. See "--Net
Interest Income." With respect to the impairment adjustment recognized during
fiscal 1994, $253,000 related to the non-agency participation certificate
described above and $357,000 related to mortgage-backed residuals and
interest-only strips which were being utilized by the Company to hedge its
mortgage-backed and related securities portfolio. When interest rates declined
during fiscal 1993 and 1994, the Company wrote-down the residuals and strips as
a result of revised prepayment projections in accordance with generally accepted
accounting principles.
The $898,000 loss with respect to total other income during the year ended
June 30, 1993 was due primarily to a $2.5 million impairment adjustment of
securities available for sale reflecting the write-down of the mortgage-backed
residuals and interest-only strips discussed above, which was partially offset
by $1.4 million of gains on the sale of securities available for sale.
Other Expense. In order to enhance the Company's profitability, management
strives to maintain a low level of operating expenses relative to its peer
group. During the six months ended December 31, 1995 and 1994 and the years
ended June 30, 1995, 1994 and 1993, total other expense as a percentage
42
<PAGE>
of average total assets amounted to 1.1%, 1.3%, 1.3%, 1.2% and 1.3%,
respectively. The following table sets forth certain information regarding other
expense for the periods shown.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, YEAR ENDED JUNE 30,
---------------- ------------------------------------------
1995 1994 1995 1994 1993
------ ------ ---------------------- ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Salaries and employee benefit........... $ 694 $ 583 $1,295 $ 925 $ 758
Premises and equipment.................. 214 207 414 331 235
FDIC insurance premiums................. 140 122 260 238 177
Marketing............................... 95 74 122 136 61
Computer services....................... 65 54 112 83 63
Consulting fees......................... 114 93 195 183 187
Write-off of goodwill and core
deposit................................. -- -- -- -- 663
Other(1)................................ 388 350 769 623 605
------ ------ ------- ------ ------
Total other expense................... $1,710 $1,483 $3,167 $2,519 $2,749
------ ------ ------- ------ ------
------ ------ ------- ------ ------
</TABLE>
- - - ------------
(1) Consists primarily of costs relating to postage, forms and supplies,
professional fees, supervisory assessments and other miscellaneous expenses.
The principal category of the Company's other expense is salaries and
employee benefits, which increased by $111,000 or 19.1% during the six months
ended December 31, 1995, as compared to the same period in the prior year, and
increased by $370,000 or 40.0% and $167,000 or 22.1% during fiscal 1995 and
1994, respectively. Such increases were primarily due to the hiring of
additional employees in connection with the opening of two new branch offices,
the growth in the Bank's mortgage lending operations and the opening of
Harrington Investment Management and Trust Services.
Premises and equipment expense increased by $7,000 or 3.5% during the six
months ended December 31, 1995, as compared to the same period in the prior
year, and increased by $83,000 or 25.0% and $96,000 or 41.0% during fiscal 1995
and 1994, respectively. The increase in premises and equipment expense during
the periods was primarily due to the opening in metropolitan Indianapolis of new
branches in Carmel, Indiana in May 1994 and in Fishers, Indiana in December
1995.
FDIC insurance premiums increased by $18,000 or 14.7% during the six months
ended December 31, 1995, as compared to the same period in the prior year, and
increased by $22,000 or 9.3% and $60,000 or 34.0% during fiscal 1995 and 1994,
respectively. FDIC insurance premiums are a function of the size of the Bank's
deposit base. See "Supervision and Regulation--The Bank--Insurance of Accounts."
In addition, see "Risk Factors--Recapitalization of SAIF and Related Legislative
Proposals" for a discussion of a proposed special assessment which would be
required to be paid by all financial institutions holding SAIF-insured deposits
(including the Bank) in order to recapitalize the SAIF.
The Company incurred marketing expense of $95,000, $74,000, $122,000,
$136,000 and $61,000 during the six months ended December 31, 1995 and 1994 and
the years ended June 30, 1995, 1994 and 1993, respectively. The fluctuations in
marketing expense during the periods reflected the costs associated with the
Bank's name change during fiscal 1994 and advertising relating to the opening of
the Bank's new branch offices during fiscal 1994 and the six months ended
December 31, 1995.
Computer services expense increased by $11,000 or 20.9% during the six
months ended December 31, 1995, as compared to the same period in the prior
year, and increased by $29,000 or 35.5% and $19,000 or 30.9% during fiscal 1995
and 1994, respectively. Computer services expense relates to the fees paid by
the Company to a third party who performs the Company's data processing
functions (which fees increased during the periods due primarily to the increase
in loans and deposit accounts) as well as to the third party servicer who
performs the back-office functions with respect to the Company's trust and
investment management services (which were implemented in December 1994).
The Company has contracted with Smith Breeden to provide investment advisory
services and interest rate risk analysis. Certain controlling stockholders of
the Company are also principals of Smith
43
<PAGE>
Breeden. See "Management of the Company--Transactions with Certain Related
Persons." The consulting fees paid by the Company to Smith Breeden during the
six months ended December 31, 1995 and 1994 and the years ended June 30, 1995,
1994 and 1993, amounted to $114,000, $93,000, $195,000, $183,000 and $187,000,
respectively.
During fiscal 1993, the Company reevaluated the useful lives of the core
deposit intangible and goodwill recognized in connection with its acquisition of
the Bank in September 1988 and deemed such intangibles to have no remaining
value. Consequently, the Company wrote-off the remaining $663,000 of goodwill
and core deposit intangible during fiscal 1993.
Income Tax Provision. The Company incurred income tax expense of $249,000,
$409,000, $1.2 million, $391,000 and $188,000 during the six months ended
December 31, 1995 and 1994 and the years ended June 30, 1995, 1994 and 1993,
respectively. The Company's effective tax rate amounted to 31.5%, 34.7%, 38.7%,
28.0% and 323.7% during the six months ended December 31, 1995 and 1994 and the
years ended June 30, 1995, 1994 and 1993, respectively. The high effective tax
rate during fiscal 1993 was due to the non-deductibility of the Company's
write-off of goodwill and core deposit intangible during the year.
Effective July 1, 1993, the Company changed its method of accounting for
income taxes pursuant to SFAS No. 109. SFAS No. 109 establishes an asset and
liability approach for financial accounting and reporting for income taxes. The
cumulative effect of the change in adopting SFAS No. 109 amounted to a $79,000
charge to earnings for the year ended June 30, 1994. See "--Recent Accounting
Pronouncements."
LIQUIDITY AND CAPITAL RESOURCES
The Bank is required under applicable federal regulations to maintain
specified levels of "liquid" investments in qualifying types of U.S. Government
and government agency obligations and other similar investments having
maturities of five years or less. Such investments are intended to provide a
source of relatively liquid funds upon which the Bank may rely if necessary to
fund deposit withdrawals and for other short-term funding needs. The required
level of such liquid investments is currently 5% of certain liabilities as
defined by the OTS and may be changed to reflect economic conditions.
The liquidity of the Bank, as measured by the ratio of cash, cash
equivalents (not committed, pledged or required to liquidate specific
liabilities), investments and qualifying mortgage-backed securities to the sum
of total deposits plus borrowings payable within one year, was 5.19% at December
31, 1995, as compared to 5.36% and 7.95% at June 30, 1995 and 1994,
respectively. At December 31, 1995, the Bank's "liquid" assets totalled
approximately $13.8 million, which was $509,000 in excess of the current OTS
minimum requirement.
The Company manages its liquidity so as to maintain a minimum regulatory
ratio of 5%. However, as a result of the Company's active portfolio management,
the Bank's regulatory liquidity can be expected to fluctuate from a minimum of
5% to approximately 6%, based upon investment alternatives available and market
conditions. In addition, the Company also prepares an internal liquidity report
which calculates the amount of cash which could be raised in one, seven or
thirty days, either by selling unpledged assets or by borrowing against them.
The ratio of this amount of liquidity to total deposits generally ranges from
over 50% to 90% or more for one- and thirty-day time frames, respectively.
The Company's liquidity, represented by cash and cash equivalents, is a
product of its operating, investing and financing activities. The Company's
primary sources of funds are deposits, borrowings, prepayments and maturities of
outstanding loans and mortgage-backed and related securities, maturities of
short-term investments, sales of mortgage-backed and related securities and
funds provided from operations. While scheduled loan and mortgage-backed and
related securities amortization and maturing short-term investments are
relatively predictable sources of funds, deposit flows and loan prepayments are
greatly influenced by general interest rates, economic conditions and
competition. The
44
<PAGE>
Company generates cash through both the retail and non-retail deposit market
and, to the extent deemed necessary, utilizes borrowings for liquidity purposes
(primarily consisting of reverse repurchase agreements and advances from the
FHLB of Indianapolis).
Liquidity management is both a daily and long-term function of business
management. Excess liquidity is generally used to pay down short-term
borrowings. On a longer-term basis, the Company maintains a strategy of
investing in various mortgage-backed and related securities and loans as
described in greater detail under "--Business--Lending Activities" and
"--Investment Activities." The Company uses its sources of funds primarily to
meet its ongoing commitments, to pay maturing savings certificates and savings
withdrawals, fund loan commitments and maintain a portfolio of mortgage-backed
and related securities. At December 31, 1995, the total approved loan
commitments outstanding amounted to $1.1 million. Certificates of deposit
scheduled to mature in one year or less at December 31, 1995 totalled $64.3
million. The Company believes that it has adequate resources to fund all of its
commitments and that it could either adjust the rate of certificates of deposit
in order to retain deposits in changing interest rate environments or replace
such deposits with reverse repurchase agreements if it proved to be
cost-effective to do so.
INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and related data 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 (except with respect to securities which are carried at
market value), without considering changes in the relative purchasing power of
money over time due to inflation. Unlike most industrial companies,
substantially all of the assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a more significant impact on the
Company's performance than the effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or in the same magnitude as
the prices of goods and services.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 1993, the Financial Accounting Standard Board ("FASB") issued SFAS
No. 114, "Accounting by Creditors for Impairment of a Loan." SFAS No. 114 is
effective for years beginning after December 15, 1994. SFAS No. 114 establishes
accounting measurement, recognition and reporting standards for impaired loans.
SFAS No. 114 provides that a loan is impaired when, based on current information
and events, it is probable that the creditor will be unable to collect all
amounts due according to the contractual terms (both principal and interest).
SFAS No. 114 requires that when a loan is impaired, impairment should be
measured based on the present value of the expected cash flows, discounted at
the loan's effective interest rate. If the loan is collateral dependent, as a
practical expedient, impairment can be based on a loan's observable market price
or the fair value of the collateral. The value of the loan is adjusted through a
valuation allowance created through a charge against income. Mortgages, consumer
installment obligations and credit card loans which are homogeneous in nature
are excluded. Loans that were treated as in-substance foreclosures under
previous accounting pronouncements are considered to be impaired loans and
remain in the loan portfolio under SFAS No. 114. SFAS No. 114 was amended in
October 1994 by SFAS No. 118, "Accounting by Creditors for Impairment of a
Loan--Income Recognition and Disclosures." SFAS No. 118 amended SFAS No. 114
primarily to remove its income recognition requirements and add some disclosure
requirements. The Company adopted SFAS No. 114, as amended by SFAS No. 118, on
July 1, 1995 as required, without any material effect to its financial condition
or results of operations.
In November 1993, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 93-6 entitled "Employers' Accounting for
Employee Stock Ownership Plans" ("SOP 93-6"). SOP 93-6 requires an employer to
record compensation expense in an amount equal to the fair value of shares
committed to be released to employees from an employee stock ownership plan
instead of an amount equal to the cost basis of such shares. If the shares of
Common Stock appreciate in
45
<PAGE>
value over time, SOP 93-6 will result in increased compensation expense with
respect to the ESOP as compared with prior guidance which required the
recognition of compensation expense based on the cost of shares acquired by the
ESOP. See "Management--Benefits--Employee Stock Ownership Plan."
In March 1995, the FASB issued SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed of," effective for
fiscal years beginning after December 15, 1995. SFAS No. 121 establishes
accounting standards for the impairment of long-lived assets, certain
identifiable intangibles and goodwill related to those assets to be held and
used and for long-lived assets and certain identifiable intangibles to be
disposed of. The standard requires an impairment loss to be recognized when the
carrying amount of the asset exceeds the fair value of the asset. The fair value
of an asset is the amount at which the asset could be bought or sold in a
current transaction between willing parties, that is, other than in a forced
liquidation sale. An entity that recognizes an impairment loss shall disclose
additional information in the financial statements related to the impaired
asset. All long-lived assets and certain identifiable intangibles to be disposed
of and for which management has committed to a plan to dispose of the assets,
whether by sale or abandonment, shall be reported at the lower of the carrying
amount or fair value less cost to sell. Subsequent revisions in estimates of
fair value less cost to sell shall be reported as adjustments to the carrying
amount of assets to be disposed of, provide that the carrying amount of the
asset does not exceed the carrying amount of the asset before an adjustment was
made to reflect the decision to dispose of the asset. The statement requires
additional disclosure in the footnotes regarding assets to be disposed of.
Management does not believe the adoption of this statement will have a material
effect on the financial position or results of operations of the Company.
In December 1994, the Accounting Standards Division of the AICPA approved
SOP 94-6, "Disclosure of Certain Significant Risks and Uncertainties." SOP 94-6
requires disclosures in the financial statements beyond those now being required
or generally made in the financial statements about the risk and uncertainties
existing as of the date of those financial statements in the following areas:
nature of operations, use of estimates in the preparation of financial
statements, certain significant estimates, and current vulnerability due to
certain concentrations. The standard is effective for financial statements
issued for fiscal years ending after December 15, 1995.
In May 1995, the FASB issued SFAS No. 122, "Accounting for Mortgage
Servicing Rights and Excess Servicing Receivables and for Securitization of
Mortgage Loans." SFAS No. 122, which is effective for years beginning after
December 15, 1995, will require the Company, to the extent it services mortgage
loans for others in return for servicing fees, to recognize these servicing
rights as assets, regardless of how such assets were acquired. Additionally, the
Company would be required to assess the fair value of these assets at each
reporting date to determine any potential impairment. Management of the Company
does not believe adoption of SFAS No. 122 will have a material effect on the
Company's financial condition or results of operations.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," establishing financial accounting and reporting standards for
stock-based employee compensation plans. This Statement encourages all entities
to adopt a new method of accounting to measure compensation cost of all employee
stock compensation plans based on the estimated fair value of the award at the
date it is granted. Companies are, however, allowed to continue to measure
compensation cost for those plans using the intrinsic value based method of
accounting, which generally does not result in compensation expense recognition
for most plans. Companies that elect to remain with the existing accounting are
required to disclose in a footnote to the financial statements pro forma net
income and, if presented, earnings per share, as if this Statement had been
adopted. The accounting requirements of this Statement are effective for
transactions entered into during fiscal years that begin after December 15,
1995; however, companies are required to disclose information for awards granted
in their first fiscal year beginning after December 15, 1994. Management of the
Company has not completed an analysis of the potential effects of this Statement
on its financial condition or results of operations.
46
<PAGE>
BUSINESS
GENERAL
The Company attempts to enhance profitability and reduce credit, interest
rate and liquidity risk by: (i) investing in mortgage-backed and related
securities and originating (both directly and through correspondents) loans
secured primarily by single-family residences; (ii) actively managing its
investment portfolio and funding sources in order to secure favorable spreads in
a variety of interest rate environments; (iii) controlling interest rate risk
and net portfolio volatility through the use of interest rate contracts and
mortgage-backed derivative securities; (iv) seeking to access cost-efficient
funding sources given prevailing market conditions, consisting primarily of
deposits, reverse repurchase agreements and FHLB advances; (iv) managing its
costs in order to maintain high operating efficiency; and (v) attempting to grow
its retail banking operations through increased loan originations and retail
deposit growth.
Highlights of the principal elements of the Company's business strategy are
as follows:
. Active Portfolio Management. The Company actively manages its interest-earning
assets and, with the assistance of Smith Breeden, utilizes "option-adjusted
pricing analysis" to quantify the costs embedded in the yield of an
investment, including the funding cost, the cost of the options embedded in
the investment's cash flows, if any (such as a borrower's ability to prepay a
mortgage), and any servicing costs. The objective of the Company's investment
management process is to select assets (including loans and securities) with
attractive risk-adjusted net spreads (over the Company's funding costs) and
actively manage the underlying risks of these investments. The Company uses
interest rate contracts and mortgage-backed derivative securities to secure
favorable interest rate spreads and to maintain the overall market value of
its assets and liabilities in changing interest rate environments. The Company
believes that this strategy will enhance the long-term market value of the
Company. Nevertheless, because the Company actively manages its portfolio,
nearly all of its mortgage-backed and related securities and interest rate
contracts are classified for accounting purposes as held for trading (with
unrealized gains and losses included in earnings) and, as a result, the
Company's earnings have and may in the future fluctuate significantly on a
period-to-period basis as has been illustrated by the Company's results of
operations over the past five years. The Company attempts to reduce, to the
extent possible, such fluctuations through its asset and liability management
strategies. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
. Control Interest Rate Risk. The Company attempts to manage its assets and
liabilities in order to maintain a portfolio which produces positive returns
in either an increasing or decreasing interest rate environment. The Company
has sought to control interest rate risk both internally through the
management of the composition of its assets and liabilities and externally
through the utilization of interest rate contracts. Interest rate contracts
are purchased with the intention of protecting both the net interest income of
the Bank and, along with mortgage-backed derivative securities, the market
value of the Bank's portfolio on a mark-to-market basis. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Asset and Liability Management."
. Control Credit Risk. In order to limit the Company's credit exposure and as
part of its strategy to earn a positive interest rate spread, the Company
maintains a substantial portion of its assets in mortgage-backed and related
securities, which are primarily issued or guaranteed by U.S. Government
agencies or government sponsored enterprises, and single-family residential
loans. At December 31, 1995, the Company's investment in mortgage-backed and
related securities amounted to $226.2 million or 97.2% of the Company's
securities portfolio (both held for trading and available for sale) and 73.6%
of the Company's total assets. In addition, as of such date, the Company's
investment in single-family residential loans amounted to $54.0 million or
17.7% of total assets. See "--Lending" and "--Investment Activities."
47
<PAGE>
. Reduce Funding Costs. The Company attempts to reduce its overall funding costs
by evaluating all potential sources of funds (including retail and non-retail
deposits and short and long-term borrowings) and identifying which particular
source will result in an all-in cost to the Company that meets its funding
benchmark. At the same time, the Company has attempted to price the deposits
offered through its branch system in order to promote retail deposit growth
and offer a wide array of deposit products to satisfy its customers. See
"--Sources of Funds."
. Increase Emphasis on Retail Banking. An integral part of the Company's
strategy is to increase the Bank's emphasis on retail products and services.
The Company's primary lending emphasis is on the origination (both directly
and through correspondents) of loans secured by first liens on single-family
(one-to-four units) residences. Originations of such loans have increased from
$8.8 million during fiscal 1993 to $18.9 million during fiscal 1995 and
further increased to $25.1 million during the six months ended December 31,
1995. See "--Lending Activities." In addition, the Company's retail deposits
(including transaction accounts and retail certificates of deposit) have
increased from $45.9 million or 51.1% of total deposits at June 30, 1993 to
$84.9 million or 73.9% of total deposits at December 31, 1995. See "--Sources
of Funds--Deposits." The Company believes that single-family residential loan
originations generally offer attractive yields, provide a source of fee income
and, with respect to direct originations, allow the Company to establish a
relationship with the underlying borrower which the Company can utilize to
cross-sell additional products and services. In addition, the Company believes
that retail deposits are a cost-effective source of funds, provide an
additional source of fee income and also permit the further cross-selling of
additional products and services. Consequently, the Company expects to
continue to focus on increasing its retail deposit base and its portfolio of
single-family residential loans.
. Control Operating Expenses. As a result of the Company maintaining a
substantial portion of its assets in mortgage-backed and related securities,
the Company has been able to maintain a low level of operating expenses.
Accordingly, the Company's total other expenses to average total assets for
the six months ended December 31, 1995 and the year ended June 30, 1995
amounted to 1.08% (annualized) and 1.30%, respectively. Although the Company
strives to maintain a low level of operating expenses, management recognizes
that as the Bank increases its emphasis on retail banking, its operating
expenses will correspondingly increase.
. Trust and Investment Management Services. In order to provide a more complete
range of financial services to its customers, in December 1994, the Company
began offering a variety of trust and investment management services through
Harrington Investment Management and Trust Services, a separate division of
the Bank. As of December 31, 1995, the Bank administered approximately 49
accounts with aggregate assets of $11.5 million at such date. See "--Trust and
Fiduciary Services."
. Asset Growth and Acquisitions. The Company has and will continue to pursue a
policy of utilizing its existing capital and infrastructure to grow through
the purchase of mortgage-backed and related securities and the continued
growth of the Bank's retail operations. The Company will also consider
acquisition opportunities when it perceives that they are advantageous to the
Company and its stockholders. There are currently no plans, arrangements,
understandings or agreements regarding any such acquisition opportunities. The
Company believes that it can initially deploy its capital, including the net
proceeds of the Offering, quickly by purchasing mortgage-backed and related
securities funded primarily through reverse repurchase agreements, and
subsequently redeploy such capital into single-family residential loans as
market conditions permit.
INVESTMENT ADVISOR
Smith Breeden is a money management and consulting firm involved in (i)
money management for separate accounts such as corporate, state and municipal
pensions, endowments and mutual funds, (ii) financial institution consulting and
investment advice, and (iii) equity investments. Smith Breeden
48
<PAGE>
specializes in mortgage-backed and related securities, interest rate risk
management, and the application of option pricing to loans and investments.
Smith Breeden currently advises, or manages on a discretionary basis, assets
totaling in excess of $20 billion. The firm has acted as a consultant to banks,
thrifts and governmental agencies charged with the regulation of financial
institutions and the resolution of troubled thrifts.
Smith Breeden's initial focus was on the hedging of interest rate risk and
prepayment options in mortgage-backed and related securities. In 1990, Smith
Breeden broadened its initial focus on mortgage-backed and related securities to
diversify into discretionary money management. Smith Breeden now manages over
$1.9 billion in the aggregate on a discretionary basis for a number of large
corporations, states and charitable foundations. In 1992, the firm began
managing several mutual funds. It currently manages two U.S. Government bond
funds investing principally in mortgage-backed related securities and a fund
indexed to the Standard & Poor's 500 Stock Index.
Smith Breeden was co-founded in 1982 by Douglas T. Breeden. Dr. Breeden is a
former professor at Stanford University, where he obtained his Ph.D. in Finance.
Dr. Breeden currently serves on the faculty at Duke University's Fuqua School of
Business and previously served on the faculty at the Massachusetts Institute of
Technology and the University of Chicago. Dr. Breeden also serves as Chairman of
the Board of Roosevelt Bank, FSB, a savings institution headquartered in
Missouri with over $9 billion in assets.
Since 1988, Smith Breeden and certain of its principals have been involved
in making equity investments in financial institutions in tandem with the
application of modern investment and interest rate risk management techniques.
Certain of the principals of Smith Breeden, including Dr. Breeden, the current
Chairman of the Board of the Company, and Craig J. Cerny, the current President
of the Company, are investors in Harrington West Financial Group, Inc. ("HWFG"),
a newly formed savings and loan holding company which recently acquired Los
Padres Savings Bank, F.S.B., a federally chartered savings bank headquartered in
Solvang, California. Certain principals of Smith Breeden have also made minority
investments in other banks and thrift institutions.
Smith Breeden is based in Overland Park, Kansas, and employs over 60 people
in its main office and its offices in Chapel Hill, North Carolina, Dallas, Texas
and Boulder, Colorado.
MARKET AREA
The Bank maintains offices in two Indiana markets: Carmel and Fishers in
Hamilton County and Richmond in Wayne County. The Bank has operated in Wayne
County since it was organized in 1889. The Bank expanded into Hamilton County
with the opening of the Carmel branch during fiscal 1994 and, in December 1995,
the Bank opened the Fishers branch. At December 31, 1995, the Bank had deposits
of $85.1 million, $29.6 million and $129,000 at the Richmond, Carmel and Fishers
branches, respectively.
Hamilton County, situated in the north central section of the Indianapolis
metropolitan statistical area ("MSA"), is a 400 square mile suburban county of
over 120,000 residents. Hamilton County has been the fastest growing county in
the state of Indiana, with a 32.8% growth rate from 1980 to 1990. The 1995
population for the County is estimated at 120,600, which represents an increase
of more than 11,000 or 10.7% since 1990.
Hamilton County is generally younger and more affluent than the remainder of
the Indianapolis MSA, with only 16% of the population over 55 years of age
compared to 19.0% for the Indianapolis MSA. Hamilton County has an estimated
average household income of $66,924 as of 1994, compared to $46,088 for the
Indianapolis MSA as of the same year end. The unemployment rate of 1.8% as of
September 1995 was well below Indiana's rate of 3.9%, and the national rate of
5.6%. The labor force is skewed to managerial and professional occupations, as
well as technical sales and administrative
49
<PAGE>
support. The County is the leading suburban location in greater Indianapolis for
headquarters and other office operations of companies such as USA Group, Inc.,
Thomson Consumer Electronics, Conseco, Mayflower Group, Marsh Supermarkets, as
well as many large manufacturing and distribution operations.
Wayne County is located in east central Indiana, with Ohio as its eastern
border. In contrast to Hamilton County, Wayne County has experienced a
population decline over the period from 1980 to 1994, due primarily to
unfavorable economic conditions, which resulted in a loss of over 1,200
manufacturing jobs over the ten years ended 1994. Population in Wayne County and
Richmond in 1994 was 72,370 and 38,810, respectively, which represented a
decline since 1980 of 4.8% and 6.1%, respectively.
Unemployment in Wayne County reached a peak of 18.8% in January 1983 but has
declined to 4.0% as of September 1995, as non-manufacturing employment has grown
steadily. Even though Wayne County and Richmond had a higher rate of
unemployment than the Indiana average for much of this period, these areas have
started to experience recovery in the last few years and now have their lowest
unemployment rates in more than ten years. Estimated average household income
remains low at $35,618 in Wayne County and $33,059 for the City of Richmond in
1994, which represents a 20.4% and 24.2% increase, respectively, since 1990. The
occupational groups with the largest decline have been manufacturing, finance
and mining. The largest growth has been experienced in professional specialty
fields, technical fields, and related support areas by skilled groups of
workers, such as transportation, communication, construction and public
utilities as well as wholesale and retail trade and services. Richmond and Wayne
County have a diversified economy consisting of manufacturing, retail, service,
and governmental entities. Major employers include Belden Wire and Cable, Dana
Corporation, Kemper Division of WCI, Alcoa, Mosey Manufacturing, Reid Hospital,
Richmond State Hospital, City of Richmond, and Richmond Community Schools.
LENDING ACTIVITIES
General. At December 31, 1995, the Bank's net loan portfolio totaled $55.9
million, representing approximately 18.2% of the Company's $307.4 million of
total assets at that date. In addition to utilizing "option-adjusted pricing
analysis" in order to manage the Company's investment portfolio, the Company
also uses such analysis to price its loan originations and ascertain the net
spread expected to be earned with respect to the Bank's loan portfolio. The
Bank's primary focus with respect to its lending operations has historically
been the direct origination and servicing of single-family residential mortgage
loans. The Bank has built an efficient mortgage operation which has produced
record loan volumes each year since fiscal 1993. Since fiscal 1995, the Bank has
also been active in originating whole residential mortgage loans through
correspondents which meet its pricing and credit quality objectives. To a much
lesser extent, the Bank originates commercial real estate loans and consumer
loans. Substantially all of the Bank's loan portfolio consists of conventional
loans, which are loans that are neither insured by the Federal Housing
Administration nor partially guaranteed by the Department of Veterans Affairs.
The risks associated with mortgage lending are well-defined and
controllable. Credit risk is controlled through the adherence, with few
exceptions, to secondary market underwriting guidelines. A strong internal loan
review program monitors compliance with the Bank's underwriting standards, which
is reflected by the low level of non-performing assets. See--"Asset
Quality--Non-Performing Assets." Market risk is controlled by a disciplined
approach to pricing and by regular monitoring and hedging of the institution's
overall sensitivity to interest rate changes. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Asset and Liability
Management."
As a federally chartered savings institution, the Bank has general authority
to originate and purchase loans secured by real estate located throughout the
United States. Notwithstanding this
50
<PAGE>
nationwide lending authority, the Company estimates that at December 31, 1995,
approximately 90% of the loans in the Bank's portfolio are secured by properties
located or made to customers residing in its primary market area, which consists
of Wayne and Hamilton counties in eastern and central Indiana and contiguous
counties.
Although the Bank historically originated loans with lesser dollar balances
than were permitted by federal regulations, current loans-to-one borrower
limitations may restrict its ability to do business with certain customers. A
savings institution generally may not make loans to any one borrower and related
entities in an amount which exceeds 15% of its unimpaired capital and surplus,
although loans in an amount equal to an additional 10% of unimpaired capital and
surplus may be made to a borrower if the loans are fully secured by readily
marketable securities. At December 31, 1995, the Bank's regulatory limit on
loans-to-one borrower was $3.0 million and its five largest loans or groups of
loans-to-one borrower, including related entities, aggregated $588,000,
$414,000, $378,000, $355,000 and $349,000. All five of the Bank's largest loans
or groups of loans are secured primarily by single-family residential real
estate located in its primary market area were performing in accordance with
their terms at December 31, 1995.
Loan Portfolio Composition. The following table sets forth the composition
of the Bank's loan portfolio by type of loan at the dates indicated.
<TABLE>
<CAPTION>
JUNE 30,
-------------------------------------------------------------------------------
DECEMBER 31,
1995 1995 1994 1993 1992 1991
---------------- ---------------- ---------------- ---------------- ---------------- -------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Single-family residential(1)... $54,500 97.1% $35,998 96.1% $20,525 96.6% $16,696 96.0% $21,701 96.8% $27,342
Commercial real estate(2)...... 665 1.2 711 1.9 349 1.6 456 2.6 484 2.2 511
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total real estate loans....... 55,165 98.3 36,709 98.0 20,874 98.2 17,152 98.6 22,185 99.0 27,853
Consumer loans:
Deposit secured............... 254 0.5 255 0.7 150 0.7 88 0.5 120 0.5 132
Home improvement/equity....... 696 1.2 498 1.3 210 1.0 160 0.9 91 0.4 107
Other......................... -- -- -- -- 17 0.1 3 -- 20 0.1 48
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total consumer loans........ 950 1.7 753 2.0 377 1.8 251 1.4 231 1.0 287
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total loans................ 56,115 100.0% 37,462 100.0% 21,251 100.0% 17,403 100.0% 22,416 100.0% 28,140
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Less:
Unamortized push-down
accounting adjustment(3).... (227) (350) (419) (592) (865) (1,336)
Unamortized discount on
loans.......................... (12) (13) (19) (21) (33) (48)
Undisbursed funds(4).......... (99) (43) (8) (7) 1 (2)
Deferred loan origination
(fees) costs................... 253 75 (17) (7) (11) (24)
Allowance for loan losses..... (120) (121) (106) (156) (99) (90)
------- ------- ------- ------- ------- -------
Net loans..................... $55,910 $37,010 $20,682 $16,620 $21,409 $26,640
------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- -------
<CAPTION>
PERCENT
-------
<S> <C>
Single-family residential(1)... 97.2%
Commercial real estate(2)...... 1.8
-------
Total real estate loans....... 99.0
Consumer loans:
Deposit secured............... 0.5
Home improvement/equity....... 0.4
Other......................... 0.1
-------
Total consumer loans........ 1.0
-------
Total loans................ 100.0%
-------
-------
Less:
Unamortized push-down
accounting adjustment(3)....
Unamortized discount on
loans..........................
Undisbursed funds(4)..........
Deferred loan origination
(fees) costs...................
Allowance for loan losses.....
Net loans.....................
</TABLE>
- - - ------------
(1) Includes multi-family residential loans and single-family residential
construction loans. At December 31, 1995, the Bank's single-family
residential loan portfolio included $220,000 of multi-family residential
loans and $328,000 of single-family residential construction loans.
(2) Includes $306,000, $321,000, $349,000, $456,000, $484,000 and $511,000 of
mortgage revenue bonds secured by commercial real estate at each of the
respective dates.
(3) Reflects the balance of the fair value adjustments made on the loan
portfolio as a result of the completion in September 1988 of the Company's
acquisition of the Bank, which acquisition was accounted for under the
purchase method of accounting.
(4) Includes undisbursed funds relating to single-family residential
construction loans.
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<PAGE>
Contractual Principal Repayments and Interest Rates. The following table
sets forth certain information at December 31, 1995 regarding the dollar amount
of loans maturing in the Bank's total loan portfolio, based on the contractual
terms to maturity, before giving effect to net items.
<TABLE>
<CAPTION>
DUE AFTER DUE AFTER
DUE IN ONE ONE TO FIVE FIVE OR MORE
YEAR OR LESS YEARS YEARS TOTAL
------------ ------------- -------------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Single-family residential................... $286 $ 499 $ 53,715 $54,500
Commercial real estate...................... 125 45 495 665
Consumer.................................... 421 252 277 950
----- ----- -------------- -------
Total................................... $832 $ 796 $ 54,487 $56,115
----- ----- -------------- -------
----- ----- -------------- -------
</TABLE>
The following table sets forth the dollar amount of all loans, before net
items, due after one year from December 31, 1995, which have fixed interest
rates or which have floating or adjustable interest rates.
<TABLE>
<CAPTION>
FLOATING OR
FIXED RATES ADJUSTABLE-RATES TOTAL
----------- ---------------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Single-family residential............................... $38,390 $ 15,824 $54,214
Commercial real estate.................................. 495 45 540
Consumer................................................ 500 29 529
----------- -------- -------
Total............................................... $39,385 $ 15,898 $55,283
----------- -------- -------
----------- -------- -------
</TABLE>
Origination, Purchase and Sale of Loans. The lending activities of the Bank
are subject to the written, non-discriminatory underwriting standards and loan
origination procedures established by the Bank's Board of Directors and
management. Loan originations are obtained by a variety of sources, including
referrals from real estate brokers, builders, existing customers, walk-in
customers, loan officers and advertising. In its marketing, the Bank emphasizes
its community ties, customized personal service, competitive rates, and an
efficient underwriting and approval process. Loan applications are taken by
lending personnel, and the loan department supervises the obtainment of credit
reports, appraisals and other documentation involved with a loan. Property
valuations are performed by independent outside appraisers approved by the
Bank's Board of Directors. The Bank requires title, hazard and, to the extent
applicable, flood insurance on all security property.
Mortgage loan applications are initially processed by loan officers who have
approval authority up to designated limits. All loans in excess of an
individual's designated limits are referred to the Bank's Loan Committee, which
has approval authority for all loans up to $1.0 million. Any loans exceeding
$1.0 million (of which, at December 31, 1995, there were none) must be approved
by the Board of Directors of the Bank. In addition, the Board of Directors of
the Bank ratifies all loans originated and purchased by the Bank.
The single-family residential loans originated by the Bank are generally
made on terms, conditions and documentation which permit the sale to the Federal
Home Loan Mortgage Corporation ("FHLMC"), the Federal National Mortgage
Association ("FNMA") and other institutional investors in the secondary market.
From fiscal 1991 to fiscal 1993, the Bank sold substantially all of its
fixed-rate single-family residential loans to FNMA in the secondary market as a
means of generating fee income as well as providing additional funds for
lending, investing and other purposes. Sales of loans were generally under terms
which did not provide any recourse to the Company by the purchaser in the event
of default on the loan by the borrower. With respect to such loan sales, the
Company generally retained responsibility for collecting and remitting loan
payments, inspecting the properties, making certain insurance and tax payments
on behalf of borrowers and otherwise servicing the loans it sold, and
52
<PAGE>
received a fee for performing these services. At December 31, 1995, the Company
was servicing $6.3 million of loans for others.
During fiscal 1994, the Bank determined to increase its portfolio of
single-family residential loans and terminated its loan sale program while at
the same time emphasizing increased originations of such loans. In addition,
during fiscal 1995, the Bank began originating single-family residential loans
through correspondent mortgage banking companies headquartered in Prairie
Village, Kansas and Indianapolis, Indiana. Currently, the Bank is continuing its
relationship with the Indianapolis firm and desires to expand further its
single-family residential loan portfolio through the use of additional
correspondent mortgage banking companies located within central Indiana.
The Bank requires that all loans originated through correspondents be
underwritten in accordance with its underwriting guidelines and standards. The
Bank reviews the loans, particularly scrutinizing the borrower's ability to
repay the obligation, the appraisal and the loan-to-value ratio. Such loans are
generally obtained with servicing released.
The following table sets forth the loan origination and sale activity of the
Company during the periods indicated.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, YEAR ENDED JUNE 30,
----------------- -----------------------------
1995 1994 1995 1994 1993
------- ------ ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Direct loan originations:
Single-family residential................... $ 9,664 $2,893 $ 9,082 $10,295 $ 8,760
Commercial real estate...................... -- 865 1,387 -- --
Consumer.................................... 687 427 1,255 580 624
------- ------ ------- ------- -------
Total loans originated directly........... 10,351 4,185 11,724 10,875 9,384
Originations by correspondents(1)............. 15,417 949 9,830 -- --
------- ------ ------- ------- -------
Total loans originated.................... 25,768 5,134 21,554 10,875 9,384
Sales and loan principal reductions:
Loans sold(1)............................... -- -- -- (91) (5,631)
Loan principal reductions................... (7,115) (2,023) (5,343) (6,936) (8,766)
------- ------ ------- ------- -------
Total loans sold and principal
reductions.................................... (7,115) (2,023) (5,343) (7,027) (14,397)
------- ------ ------- ------- -------
Net increase (decrease) in loan portfolio..... $18,653 $3,111 $16,211 $ 3,848 $(5,013)
------- ------ ------- ------- -------
------- ------ ------- ------- -------
</TABLE>
- - - ------------
(1) Consisted solely of single-family residential loans.
Single-Family Residential Real Estate Loans. Historically, savings
institutions such as the Bank have concentrated their lending activities on the
origination of loans secured primarily by first mortgage liens on existing
single-family residences. At December 31, 1995, $54.0 million or 96.2% of the
Bank's total loan portfolio consisted of single-family residential real estate
loans, substantially all of which are conventional loans.
The Bank offers fixed-rate single family residential loans with terms of 10
to 30 years. Such loans are amortized on a monthly basis with principal and
interest due each month. Generally, the value of fixed-rate loans fluctuates
inversely with changes in interest rates. Consequently, if left unhedged, long-
term fixed-rate single-family residential loans would increase the Bank's
interest rate risk. However, the Bank believes that its sophisticated asset and
liability management techniques provide the Bank with a competitive advantage
and allow for the Bank to continue to offer fixed-rate residential mortgage
loans over a variety of interest rate scenarios.
53
<PAGE>
Since the early 1980s, the Bank has also been offering adjustable-rate
single-family residential mortgage loans. Such loans generally have up to
30-year terms and an interest rate which adjusts after one, three or five years
in accordance with a designated index (the weekly average yield on U.S. Treasury
securities adjusted to a constant comparable maturity of one year, as made
available by the Federal Reserve Board). Such loans currently have a 2% cap on
the amount of any increase or decrease in the interest rate per year, and a 6%
limit on the amount by which the interest rate can increase or decrease over the
life of the loan. In addition, the Bank's adjustable-rate loans are currently
not convertible into fixed-rate loans and do not contain prepayment penalties.
Approximately 29.1% of the single-family residential loans in the Bank's loan
portfolio at December 31, 1995 had adjustable interest rates.
Adjustable-rate mortgage loans decrease but do not eliminate the risks
associated with changes in interest rates. Because periodic and lifetime caps
limit the interest rate adjustments, the value of adjustable-rate mortgage loans
also fluctuates inversely with changes in interest rates. In addition as
interest rates increase, the required payments by the borrower increase, thus
increasing the potential for default.
Due to the recent trend of declining interest rates, the Bank's originations
of adjustable-rate loans as a percentage of total loans have decreased as
consumer preference for fixed-rate loans has increased. The demand for
adjustable-rate loans in the Bank's primary market area has been a function of
several factors, including the level of interest rates, the expectations of
changes in the level of interest rates and the difference between the interest
rates and loan fees offered for fixed-rate loans and adjustable-rate loans. The
relative amount of fixed-rate and adjustable-rate residential loans that can be
originated at any time is largely determined by the demand for each in a
competitive environment.
The Bank is permitted to lend up to 100% of the appraised value of the real
property securing a residential loan (referred to as the loan-to-value ratio);
however, if the amount of a residential loan originated or refinanced exceeds
90% of the appraised value, the Bank is required by federal regulations to
obtain private mortgage insurance on the portion of the principal amount that
exceeds 80% of the appraised value of the security property. Pursuant to
underwriting guidelines adopted by the Board of Directors, the Bank will
generally lend up to 95% of the appraised value of the property securing a
single-family residential loan. However, the Bank generally obtains private
mortgage insurance on the principal amount that exceeds 80% of appraised value
of the security property.
Although the Bank does not emphasize the origination of residential
construction loans, in recent years the Bank has occasionally originated loans
in its primary market area to construct single-family residences. At December
31, 1995, the Bank had three construction loans amounting to $328,000 in the
aggregate or 0.6% of the Bank's total loan portfolio.
Similarly, although the Bank does not emphasize the origination of
multi-family residential loans, the Bank has occasionally originated loans
secured by multi-family residential properties (generally small residential
buildings with more than four units). At December 31, 1995, the Bank's portfolio
of multi-family residential loans consisted of five loans which amounted to
$220,000 in the aggregate or 0.4% of the Bank's total loan portfolio.
Commercial Real Estate Loans. At December 31, 1995, $665,000 or 1.2% of the
Bank's total loan portfolio consisted of loans secured by commercial real
estate. At December 31, 1995, the Bank's commercial real estate loan portfolio
included five loans (which include mortgage revenue bonds) secured by commercial
buildings, vacant land and a church, all of which are located within the
Company's primary market area. The Company's largest commercial real estate loan
at December 31, 1995 was a $206,000 loan secured by a commercial building
located in Richmond, Indiana.
Commercial real estate lending entails different and significant risks when
compared to single-family residential lending because such loans typically
involve large loan balances to single borrowers
54
<PAGE>
and because the payment experience on such loans is typically dependent on the
successful operation of the project or the borrower's business. The Bank
attempts to minimize its risk exposure by limiting the extent of its commercial
lending generally. In addition, the Bank imposes stringent loan-to-value ratios,
requires conservative debt coverage ratios, and continually monitors the
operation and physical condition of the collateral. The Bank intends to continue
to originate small commercial real estate loans on a case-by-case basis that
comply with its strict underwriting standards.
Consumer Loans. The Bank is authorized to make loans for a wide variety of
personal or consumer purposes. The Bank has been originating consumer loans in
recent years in order to provide a wider range of financial services to its
customers and because such loans generally have higher interest spreads than
mortgage loans. The consumer loans offered by the Bank include home equity loans
and lines of credit, home improvement loans and deposit account secured loans.
At December 31, 1995, $950,000 or 1.7% of the Bank's total loan portfolio
consisted of consumer loans.
Home equity loans and lines of credit are originated by the Bank for up to
80% of the appraised value, less the amount of any existing prior liens on the
property. The Bank also offers home improvement loans in amounts up to 95% of
the appraised value (provided the borrower has or maintains private mortgage
insurance on the principal balance that exceeds 80% of the appraised value),
less the amount of any existing prior liens on the property. Home equity loans
and home improvement loans have a maximum term of twenty years and carry fixed
interest rates. Home equity lines of credit have a maximum repayment term of 10
years, a five-year term with respect to draws, and carry interest rates which
adjust monthly in accordance with a designated prime rate. The Bank will secure
each of these types of loans with a mortgage on the property (generally a second
mortgage) and will originate the loan even if another institution holds the
first mortgage. At December 31, 1995, home equity loans and lines of credit and
home improvement loans totalled $696,000 or 73.3% of the Bank's total consumer
loan portfolio.
The Bank currently offers loans secured by deposit accounts, which amounted
to $254,000 or 26.7% of the Bank's total consumer loan portfolio at December 31,
1995. Such loans are originated for up to 95% of the deposit account balance,
with a hold placed on the account restricting the withdrawal of the account
balance.
Consumer loans generally have shorter terms and higher interest rates than
mortgage loans but generally involve more credit risk than mortgage loans
because of the type and nature of the collateral. In addition, consumer lending
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness and
personal bankruptcy. The Bank believes that the generally higher yields earned
on consumer loans compensate for the increased credit risk associated with such
loans and the Company intends to continue to offer consumer loans in order to
provide a full range of services to its customers.
ASSET QUALITY
Loan Delinquencies. When a borrower fails to make a required payment on a
loan, the Bank attempts to cure the deficiency by contacting the borrower and
seeking payment. Contacts are generally made following the fifteenth day after a
payment is due, at which time a late payment is assessed. In most cases,
deficiencies are cured promptly. If a delinquency extends beyond 15 days, the
loan and payment history is reviewed and efforts are made to collect the loan.
While the Bank generally prefers to work with borrowers to resolve such
problems, when the account becomes 90 days delinquent, the Bank does institute
foreclosure or other proceedings, as necessary, to minimize any potential loss.
Non-Performing Assets. All loans are reviewed on a regular basis and are
placed on non-accrual status when, in the opinion of management, the collection
of additional interest is deemed insufficient to warrant further accrual. As a
matter of policy, the Bank does not accrue interest on loans past due 90
55
<PAGE>
days or more except when the estimated value of the collateral and collection
efforts are deemed sufficient to ensure full recovery. The Bank provides an
allowance for the loss of uncollected interest on all non-accrual loans.
Impaired loans covered under SFAS No. 114 and No. 118 are defined by the Company
to consist of non-accrual commercial loans which have not been collectively
evaluated for impairment. The allowance is established by a charge to interest
income equal to all interest previously accrued, and income is subsequently
recognized only to the extent that cash payments are received until, in
management's judgment, the borrower's ability to make periodic interest and
principal payments returns to normal, in which case the loan is returned to
accrual status.
Real estate acquired through foreclosure is carried at the lower of the
loan's unpaid principal balance (cost) or fair value less estimated selling
expenses at the date of transfer. A loan charge-off is recorded for any
writedown in the loan's carrying value to fair value at the date of transfer.
Real estate loss provisions are recorded if the properties' fair value
subsequently declines below the value determined at the recording date. In
determining the lower of cost or fair value at acquisition, costs relating to
development and improvement of property are considered. Costs relating to
holding real estate acquired through foreclosure, net of rental income, are
charged against earnings as incurred.
The following table sets forth the amounts and categories of the Bank's
non-performing assets at the dates indicated. The Bank did not have any troubled
debt restructuring at any of the periods presented.
<TABLE>
<CAPTION>
JUNE 30,
DECEMBER 31, ---------------------------------------
1995 1995 1994 1993 1992 1991
------------ ------ ------ ----- ----- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Non-accruing loans:
Single-family residential........................... $ 364 $ 350 $ 559 $ 449 $ 488 $ 362
Commercial real estate.............................. -- -- -- 50 50 50
Consumer............................................ -- -- -- -- 10 2
------ ------ ------ ----- ----- -----
Total non-accruing loans.......................... 364 350 559 499 548 414
Accruing loans greater than 90 days delinquent....... -- -- -- -- -- 12
------ ------ ------ ----- ----- -----
Total non-performing loans........................ 364 350 559 499 548 426
Real estate owned.................................... -- -- -- 26 -- 138
Other non-performing assets(1)....................... 1,210 1,415 2,282 -- -- --
------ ------ ------ ----- ----- -----
Total non-performing assets......................... $1,574 $1,765 $2,841 $ 525 $ 548 $ 564
------ ------ ------ ----- ----- -----
------ ------ ------ ----- ----- -----
Total non-performing loans as a percentage of total
loans................................................ 0.65% 0.95% 2.70% 3.00% 2.56% 1.60%
------ ------ ------ ----- ----- -----
------ ------ ------ ----- ----- -----
Total non-performing assets as a percentage of total
assets............................................... 0.51% 0.59% 1.34% 0.24% 0.24% 0.24%
------ ------ ------ ----- ----- -----
------ ------ ------ ----- ----- -----
</TABLE>
- - - ------------
(1) Consists of a non-agency participation certificate. See "--Classified
Assets."
The interest income that would have been recorded during the six months
ended December 31, 1995 and the years ended June 30, 1995, 1994 and 1993 if the
Bank's non-accrual loans at the end of such periods had been current in
accordance with their terms during such periods was $11,000, $46,000, $26,000
and $13,000, respectively.
Classified Assets. Federal regulations require that each insured savings
institution classify its assets on a regular basis. In addition, in connection
with examinations of insured institutions, federal examiners have authority to
identify problem assets and, if appropriate, classify them. There are three
classifications for problem assets: "substandard," "doubtful" and "loss."
Substandard assets have one or more defined weaknesses and are characterized by
the distinct possibility that the insured institution will sustain some loss if
the deficiencies are not corrected. Doubtful assets have the weaknesses of
substandard assets with the additional characteristic that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified loss is considered uncollectible and of such little value that
56
<PAGE>
continuance as an asset of the institution is not warranted. Another category
designated "special mention" also must be established and maintained for assets
which do not currently expose an insured institution to a sufficient degree of
risk to warrant classification as substandard, doubtful or loss. Assets
classified as substandard or doubtful require the institution to establish
general allowances for loan losses. If an asset or portion thereof is classified
loss, the insured institution must either establish specific allowances for loan
losses in the amount of 100% of the portion of the asset classified loss, or
charge-off such amount. General loss allowances established to cover possible
losses related to assets classified substandard or doubtful may be included in
determining an institution's regulatory capital, while specific valuation
allowances for loan losses do not qualify as regulatory capital.
The Bank's classified assets at December 31, 1995 consisted of $1.6 million
of assets classified as substandard (including $428,000 of loans and $1.2
million of securities) and no loans classified as doubtful. In addition, at
December 31, 1995, $767,000 of the Bank's loans were designated special mention.
The $1.2 million of securities classified as substandard at December 31,
1995 relates to a single non-agency participation certificate which was
purchased by the Bank during fiscal 1991. The security was issued by a savings
institution located in Huntington Beach, California and the underlying mortgages
consist of six-month adjustable-rate notes (priced off of LIBOR) which are
secured by single-family properties located in southern California. As of
December 31, 1995, approximately 38.5% of the underlying mortgages were at least
30 days past due and/or in foreclosure or already foreclosed upon by the
servicer. The security was structured into both senior and subordinate classes
and the Bank owns only senior classes. As of December 31, 1995, the pool had
cumulative realized losses of $16.2 million which were initially absorbed by
certain credit supports and subsequently absorbed by subordinate certificate
holders. Currently, senior certificate holders (such as the Bank) are having to
absorb some of the losses. The credit supports, which totalled $11.0 million at
the date of issuance, had been depleted as of December 31, 1995. The security is
currently held in the Bank's available for sale portfolio and its $1.2 million
carrying value at December 31, 1995 reflects $54,000 of net unrealized losses as
of such date as well as $414,000 and $253,000 of write-downs with respect to
such security which were recognized by the Bank during fiscal 1995 and 1994,
respectively.
Allowance for Loan Losses. It is management's policy to maintain an
allowance for estimated losses on loans based upon the estimated net realizable
value of the underlying collateral, general economic conditions, particularly as
they relate to the Bank's market area, historical loss experience, and other
factors related to the collectibility of the loan portfolio. Although management
believes that it uses the best information available to make such
determinations, future adjustments to the allowance may be necessary, and net
income could be significantly affected, if circumstances differ substantially
from the assumptions used in making the initial determinations.
Effective December 21, 1993, the OTS, in conjunction with the Office of the
Comptroller of the Currency, the FDIC and the Federal Reserve Board, issued an
Interagency Policy Statement on the Allowance for Loan and Lease Losses ("Policy
Statement"). The Policy Statement, which effectively supersedes the proposed
guidance issued in September 1992, includes guidance (i) on the responsibilities
of management for the assessment and establishment of an adequate allowance and
(ii) for the agencies' examiners to use in evaluating the adequacy of such
allowance and the policies utilized to determine such allowance. The Policy
Statement also sets forth quantitative measures for the allowance with respect
to assets classified substandard and doubtful and with respect to the remaining
portion of an institution's loan portfolio. Specifically, the Policy Statement
sets forth the following quantitative measures which examiners may use to
determine the reasonableness of an allowance: (i) 50% of the portfolio that is
classified doubtful; (ii) 15% of the portfolio that is classified substandard
and (iii) for the portions of the portfolio that have not been classified
(including loans designated special mention), estimated credit losses over the
upcoming twelve months based on facts and circumstances available on the
evaluation date. While the Policy Statement sets forth this quantitative
measure, such guidance is not intended as a "floor" or "ceiling."
57
<PAGE>
The following table sets forth an analysis of the Bank's allowance for loan
losses during the periods indicated.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, YEAR ENDED JUNE 30,
----------------- -----------------------------------------------
1995 1994 1995 1994 1993 1992 1991
------- ------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Total loans outstanding, net............. $55,910 $23,757 $37,010 $20,682 $16,620 $21,409 $26,640
------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- -------
Average loans outstanding, net........... $45,548 $21,777 $25,467 $19,369 $19,437 $24,267 $28,087
------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- -------
Balance at beginning of period........... $ 121 $ 106 $ 106 $ 156 $ 99 $ 90 $ 84
Charge-offs:
Single-family residential............... -- -- -- 2 -- -- 21
Commercial real estate(1)............... -- -- -- 45 -- -- --
Consumer................................ -- -- -- -- 10 -- --
------- ------- ------- ------- ------- ------- -------
Total charge-offs..................... -- -- -- 47 10 -- 21
Recoveries:
Consumer................................ -- -- -- -- 1 -- --
------- ------- ------- ------- ------- ------- -------
Total recoveries...................... -- -- -- -- 1 -- --
------- ------- ------- ------- ------- ------- -------
Net charge-offs.......................... -- -- -- 47 9 -- 21
Provision (recovery) for loan losses..... (1) 21 15 (3) 66 9 27
------- ------- ------- ------- ------- ------- -------
Balance at end of period................. $ 120 $ 127 $ 121 $ 106 $ 156 $ 99 $ 90
------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- -------
Allowance for loan losses as a percent of
total loans outstanding................. 0.2% 0.5% 0.3% 0.5% 0.9% 0.5% 0.3%
------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- -------
Ratio of net charge-offs to average loans
outstanding.............................. --% --% --% 0.2% --% --% 0.1%
------- ------- ------- ------- ------- ------- -------
------- ------- ------- ------- ------- ------- -------
</TABLE>
- - - ------------
(1) The $45,000 charge-off during fiscal 1994 related to a mortgage revenue bond
secured by commercial real estate.
The following table sets forth information concerning the allocation of the
Bank's allowance for loan losses by loan categories at the dates indicated.
<TABLE>
<CAPTION>
JUNE 30,
----------------------------------------------------------------------------------
DECEMBER 31,
1995 1995 1994 1993 1992
------------------- ------------------- ------------------- ------------------- -------------------
PERCENT OF PERCENT OF PERCENT OF PERCENT OF PERCENT OF
LOANS IN LOANS IN LOANS IN LOANS IN LOANS IN
EACH EACH EACH EACH EACH
CATEGORY TO CATEGORY TO CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Single-family residential
loans..................... $ 95 97.1% $ 96 96.1% $ 91 96.6% $ 96 96.0% $ 32 96.8%
Commercial real estate
loans(1).................. 10 1.2 10 1.9 -- 1.6 45 2.6 40 2.2
Consumer loans............ 15 1.7 15 2.0 15 1.8 15 1.4 27 1.0
--
------ --- ------ --- ------ --- ------ --- ---
Total..................... $120 100.0% $121 100.0% $106 100.0% $156 100.0% $ 99 100.0%
------ --- ------ --- ------ --- ------ --- -- ------
------ --- ------ --- ------ --- ------ --- -- ------
<CAPTION>
1991
-------------------
PERCENT OF
LOANS IN
EACH
CATEGORY TO
AMOUNT TOTAL LOANS
------ -----------
<S> <C> <C>
Single-family residential
loans..................... $ 33 97.2%
Commercial real estate
loans(1).................. 40 1.8
Consumer loans............ 17 1.0
--
---
Total..................... $ 90 100.0%
-- ---
-- ---
</TABLE>
- - - ------------
(1) Includes mortgage revenue bonds.
INVESTMENT ACTIVITIES
General. The Company's securities portfolio is managed by investment
officers in accordance with a comprehensive written investment policy which
addresses strategies, types and levels of allowable investments and which is
reviewed and approved by the Bank's Board of Directors on an annual basis. The
management of the securities portfolio is set in accordance with strategies
developed by the Bank's Investment Committee. In addition, the Bank has entered
into an agreement with Smith Breeden
58
<PAGE>
whereby Smith Breeden has been appointed as investment advisor with respect to
the management of the Bank's securities portfolio. See "Management--Transactions
With Certain Related Persons." With the assistance of Smith Breeden, the Bank's
Chief Executive Officer (who is also a principal of Smith Breeden), Chief
Investment Officer, and Investment Officer (who is also a principal of Smith
Breeden) execute various transactions with respect to the portfolio and are
responsible for informing the Investment Committee of the types of investments
available, the status and performance of the portfolio and current market
conditions. The investment officers are authorized to: purchase or sell any
securities as well as commitments to hedge eligible investments; purchase or
sell eligible investments under repurchase or reverse repurchase agreements;
execute hedging strategies approved by the Investment Committee; pledge
securities owned as collateral for public agency deposits or repurchase accounts
or agreements; and lend securities to approved dealers in government securities
or approved commercial banks. Any one investment officer has the authority to
purchase or sell securities up to $5.0 million in any one transaction and acting
together, two members of the Investment Committee have authority to purchase or
sell securities up to $10.0 million in any one transaction. For purchases or
sales greater than $10.0 million, the prior approval of a majority of the
Investment Committee is required. Investment officers are also authorized to
invest excess liquidity in approved liquid investment vehicles. In addition,
both the Investment Committee and the Board of Directors of the Bank ratify all
securities purchased and sold by the Bank.
The Company invests in a portfolio of mortgage-backed securities,
mortgage-backed derivative securities, interest rate contracts, equity
securities and municipal bonds. In selecting securities for its portfolio, the
Company employs option-adjusted pricing analysis with the assistance of Smith
Breeden in order to ascertain the net risk-adjusted spread expected to be earned
with respect to the various investment alternatives. The nature of this analysis
is to quantify the costs embedded in the yield of an investment, such as the
funding cost, the costs of the options embedded in the investment's cash flows
(such as a borrower's ability to prepay a mortgage), credit costs, if any, and
servicing costs. The objective of the Company's investment management process is
to select investments with the greatest net spreads and actively manage the
underlying risks of these investments.
The Company actively manages its securities portfolio in order to enhance
net interest and other income on a risk-adjusted basis. As a result, the Company
continuously monitors the net risk-adjusted spreads of its investments and
compares them with the spreads available with respect to other securities in the
market. Accordingly, as market conditions fluctuate (e.g., as risk-adjusted
spreads narrow), the Company will sell individual securities prior to their
maturity and reinvest the proceeds into new investments which generally carry
wider risk-adjusted spreads. The Company's securities portfolio also contains
various interest rate contracts (such as interest rate swaps, collars, caps,
floors, options and futures) which are primarily utilized to hedge the Company's
interest rate exposure in the trading portfolio and which require active
management in order to respond to changing market conditions. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--Asset
and Liability Management."
In recognition of the Company's business strategy of actively managing its
securities portfolio, during fiscal 1994, the Company reclassified substantially
all of its securities as held for trading. Pursuant to SFAS No. 115, securities
classified as trading securities are reported at fair value with unrealized
gains and losses included in earnings, and securities classified as available
for sale are similarly reported at fair value, but with unrealized gains and
losses excluded from earnings and instead reported as a separate component of
stockholders' equity.
Mortgage-Backed and Related Securities. The Company maintains a significant
portfolio of mortgage-backed and related securities as a means of investing in
housing-related mortgage instruments without the costs associated with
originating mortgage loans for portfolio retention. At December 31, 1995, the
Company's mortgage-backed and related securities portfolio (including $14.6
million of mortgage-backed derivative securities) amounted to $226.2 million or
97.2% of the Company's
59
<PAGE>
securities portfolio (both held for trading and available for sale) and 73.6% of
the Company's total assets. By investing in mortgage-backed and related
securities, management seeks to achieve a targeted option-adjusted spread over
applicable funding costs.
The Company invests in mortgage-backed and related securities, including
mortgage participation certificates, which are insured or guaranteed by U.S.
Government agencies and government sponsored enterprises, and CMOs and real
estate mortgage investment conduits ("REMICs"). Mortgage-backed securities
(which also are known as mortgage participation certificates or pass-through
certificates) represent a participation interest in a pool of single-family or
multi-family mortgages, the principal and interest payments on which are passed
from the mortgage originators, through intermediaries (generally U.S. Government
agencies and government sponsored enterprises) that pool and repackage the
participation interests in the form of securities, to investors such as the
Company. Such U.S. Government agencies and government sponsored enterprises,
which guarantee the payment of principal and interest to investors, primarily
include the FHLMC, the FNMA and the Government National Mortgage Association
("GNMA").
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
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 term of a mortgage-backed pass-through security thus approximates
the term of the underlying mortgages.
The Company's mortgage-backed derivative securities include CMOs, which
include securities issued by entities which have qualified under the Code as
REMICs. CMOs and REMICs (collectively CMOs) have been developed in response to
investor concerns regarding the uncertainty of cash flows associated with the
prepayment option of the underlying mortgagor and are typically issued by
governmental agencies, government sponsored enterprises and special purpose
entities, such as trusts, corporations or partnerships, established by financial
institutions or other similar institutions. A CMO can be collateralized by loans
or securities which are insured or guaranteed by FNMA, FHLMC or GNMA. In
contrast to pass-through mortgage-backed securities, in which cash flow is
received pro rata by all security holders, the cash flow from the mortgages
underlying a CMO is segmented and paid in accordance with a predetermined
priority to investors holding various CMO classes. By allocating the principal
and interest cash flows from the underlying collateral among the separate CMO
classes, different classes of bonds are created, each with its own stated
maturity, estimated average life, coupon rate and prepayment characteristics.
The Company's mortgage-backed derivative securities also include
mortgage-backed residuals and interest-only and principal-only strips.
Mortgage-backed residuals consist of certificates of particular tranches of a
CMO whereby the principal repayments and prepayments with respect to the
underlying pool of loans are generally not allocated to the residual until all
other certificates or tranches have been fully paid and retired. Interest-only
strips are a particular class of mortgage-backed derivative security which
receives and pays only interest with respect to the underlying pool of loans,
while principal-only strips receive and pay only principal repayments and
prepayments. As a result of the foregoing, mortgage-backed derivative securities
often exhibit elasticity and convexity characteristics (i.e., respond
differently to changes in interest rates) which the Company can utilize to
internally hedge other components of the Company's portfolio of assets against
interest rate risk.
The OTS has issued a statement of policy which states, among other things,
that mortgage derivative products (including CMOs and CMO residuals and stripped
mortgage-backed securities such as interest-only and principal-only strips)
which possess average life or price volatility in excess of a benchmark
fixed-rate 30-year mortgage-backed security are "high risk mortgage securities,"
and must be carried in the institution's trading account or as assets held for
sale, and therefore marked to market on a regular basis. At December 31, 1995,
$8.1 million or 3.5% of the securities held in the Company's
60
<PAGE>
portfolio consisted of such "high risk mortgage securities," as defined in such
policy statement. However, the Bank is in compliance with this OTS policy
statement since all of such securities are held in the Company's trading account
and marked to market on a regular basis in accordance with generally accepted
accounting principles.
Like most fixed-income securities, mortgage-backed and related securities
are subject to interest rate risk. See "Risk Factors--Potential Effects of
Changes in Interest Rates." However, unlike most fixed-income securities, the
mortgage loans underlying a mortgage-backed or related security generally may be
prepaid at any time without penalty. The ability to prepay a mortgage loan
generally results in significantly increased price and yield volatility (with
respect to mortgage-backed and related securities) than is the case with
non-callable fixed income securities. Furthermore, mortgage-backed derivative
securities often are more sensitive to changes in interest rates and prepayments
than traditional mortgage-backed securities and are, therefore, even more
volatile. Nevertheless, the Company utilizes sophisticated asset and liability
management techniques to hedge against both interest rate and prepayment risk.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Asset and Liability Management." For a discussion of certain other
risks inherent with respect to the purchase and/or sale of mortgage-backed
derivative securities (such as basis risk, credit or default risk, liquidity
risk and volatility risk), see "Risk Factors--Use of Interest Rate Contracts and
Other Derivatives."
Although mortgage-backed and related securities often carry lower yields
than traditional mortgage loans, such securities generally increase the quality
of the Company's assets by virtue of the securities' underlying insurance or
guarantees, are more liquid than individual mortgage loans (which enhances the
Company's ability to actively manage its portfolio) and may be used to
collateralize borrowings or other obligations of the Company. At December 31,
1995, $33.0 million or 14.6% of the Company's mortgage-backed and related
securities were pledged to secure various obligations of the Company (such as
reverse repurchase agreements and interest rate swaps). In addition, as a result
of the Company maintaining a substantial portion of its assets in
mortgage-backed and related securities, the Company has been able to maintain a
relatively low level of operating expenses. Furthermore, mortgage-backed
derivative securities are often utilized by the Company to internally hedge its
interest rate exposure and can be attractive alternatives to other hedge
vehicles when their option-adjusted spreads are abnormally wide.
61
<PAGE>
The following table sets forth information relating to the amortized cost
and market value of the Company's securities held for trading and securities
available for sale portfolios.
<TABLE>
<CAPTION>
JUNE 30,
-------------------------------------------------------------
DECEMBER 31,
1995 1995 1994 1993
------------------- ------------------- ------------------- -------------------
AMORTIZED MARKET AMORTIZED MARKET AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE COST VALUE COST VALUE
--------- -------- --------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Securities held for trading:
FHLMC participation
certificates.................... $ 70,743 $ 72,288 $ 54,685 $ 55,247 $ 11,313 $ 11,239 $ -- $ --
FNMA participation
certificates.................... 66,459 68,234 68,286 69,201 65,900 63,347 -- --
GNMA participation
certificates.................... 64,245 66,232 90,408 91,751 46,121 45,071 -- --
Non-agency participation
certificates.................... 3,552 3,608 3,893 3,918 4,650 4,654 -- --
--------- -------- --------- -------- --------- -------- --------- --------
Total mortgage-backed
securities...................... 204,999 210,362 217,272 220,117 127,984 124,311 -- --
Collateralized mortgage
obligations..................... 6,347 6,542 12,910 13,022 23,447 23,469 -- --
Residuals...................... 3,859 4,157 4,470 4,364 3,848 4,806 -- --
Interest-only strips........... 4,063 2,708 4,570 2,998 10,062 9,712 -- --
Principal only strips.......... 1,179 1,238 781 803 -- -- -- --
--------- -------- --------- -------- --------- -------- --------- --------
Total mortgage-backed
derivative securities...... 15,448 14,645 22,731 21,187 37,357 37,987 -- --
Interest rate swaps............ -- (608) -- (219) -- 3,358 -- --
Interest rate collars.......... 94 (95) 155 (71) 270 58 -- --
Interest rate caps............. 2,952 1,539 2,297 1,995 2,573 4,054 -- --
Interest rate floors........... 1,645 4,016 1,544 3,409 1,625 751 -- --
Options........................ 63 127 266 200 -- -- -- --
Futures........................ -- (168) -- (134) -- -- -- --
--------- -------- --------- -------- --------- -------- --------- --------
Total interest rate
contracts....................... 4,754 4,811 4,262 5,180 4,468 8,221 -- --
Equity securities.............. 445 525 223 249 401 401 -- --
--------- -------- --------- -------- --------- -------- --------- --------
Total securities held for
trading......................... $ 225,646 $230,343 $ 244,488 $246,733 $ 170,210 $170,920 $ -- $ --
--------- -------- --------- -------- --------- -------- --------- --------
--------- -------- --------- -------- --------- -------- --------- --------
Securities available for sale:
FHLMC participation
certificates.................... $ -- $ -- $ -- $ -- $ -- $ -- $ 13,861 $ 14,071
FNMA participation
certificates.................... -- -- -- -- -- -- 77,267 79,496
GNMA participation
certificates.................... -- -- -- -- -- -- 30,706 31,436
Non-agency participation
certificates.................... 1,264 1,210 1,426 1,415 2,363 2,282 10,399 10,690
--------- -------- --------- -------- --------- -------- --------- --------
Total mortgage-backed
securities...................... 1,264 1,210 1,426 1,415 2,363 2,282 132,233 135,693
Collateralized mortgage
obligations..................... -- -- -- -- -- -- 30,773 31,600
Residuals...................... -- -- -- -- -- -- 6,464 7,464
Interest-only strips........... -- -- -- -- -- -- 11,310 9,122
Principal-only strips.......... -- -- -- -- -- -- -- --
--------- -------- --------- -------- --------- -------- --------- --------
Total mortgage-backed
derivative securities...... -- -- -- -- -- -- 48,547 48,186
Interest rate swaps............ -- -- -- -- -- -- -- (2,081)
Interest rate collars.......... -- -- -- -- -- -- 603 (1,226)
Interest rate caps............. -- -- -- -- -- -- 1,527 891
Interest rate floors........... -- -- -- -- -- -- 1,923 3,647
Options........................ -- -- -- -- -- -- -- --
Futures........................ -- -- -- -- -- -- -- --
--------- -------- --------- -------- --------- -------- --------- --------
Total interest rate
contracts....................... -- -- -- -- -- -- 4,053 1,231
Municipal bonds................ 1,019 1,076 1,017 1,126 1,064 1,145 1,060 1,253
Equity securities.............. -- -- -- -- -- -- 219 219
--------- -------- --------- -------- --------- -------- --------- --------
Total securities available
for sale........................ $ 2,283 $ 2,286 $ 2,443 $ 2,541 $ 3,427 $ 3,427 $ 186,112 $186,582
--------- -------- --------- -------- --------- -------- --------- --------
--------- -------- --------- -------- --------- -------- --------- --------
</TABLE>
62
<PAGE>
The following table sets forth the market value of the Company's securities
activities (both held for trading and available for sale) for the periods
indicated:
<TABLE>
<CAPTION>
AT OR FOR THE
SIX MONTHS ENDED AT OR FOR THE YEARS ENDED
DECEMBER 31, JUNE 30,
------------------- ------------------------------
1995 1994 1995 1994 1993
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Beginning balance.............................. $249,273 $174,347 $174,347 $186,582 $184,250
Mortgage-backed securities purchased--held
for trading................................ 117,431 222,363 497,661 54,637 --
Mortgage-backed securities
purchased--available for sale.............. -- -- -- 107,793 178,496
Collateralized mortgage obligations
purchased-- held for trading............... -- 4,739 7,093 -- --
Collateralized mortgage obligations
purchased-- available for sale............. -- -- -- 11,001 24,136
Mortgage-backed derivative securities
purchased-- held for trading............... 495 -- 2,741 975 --
Mortgage-backed derivative securities
purchased-- available for sale............. -- -- -- 3,440 10,945
Interest rate contracts purchased--held for
trading........................................ 1,608 1,166 1,935 1,082 --
Interest rate contracts purchased--available
for sale................................... -- -- -- 348 2,993
Equity securities purchased--held for
trading........................................ 247 721 880 -- --
Equity securities purchased--available for
sale........................................... -- -- -- 401 29
-------- -------- -------- -------- --------
Total securities purchased................. 119,781 228,989 510,310 179,677 216,599
Less:
Sale of mortgage-backed securities--held for
trading........................................ 119,989 189,097 394,967 56,602 --
Sale of mortgage-backed securities--available
for sale................................... -- -- -- 81,675 127,576
Sale of collateralized mortgage
obligations--held for trading.............. 7,798 14,952 17,321 -- --
Sale of collateralized mortgage obligations--
available for sale............................. -- -- -- 17,022 57,193
Sale of mortgage-backed derivative
securities-- held for trading.............. -- 5,503 6,933 284 --
Sale of mortgage-backed derivative
securities-- available for sale............ -- -- -- 619 3,836
Sale of interest rate contracts--held for
trading........................................ (3,749) (155) (1,450) -- --
Sale of interest rate contracts--available
for sale....................................... -- -- -- (887) (3,382)
Sale of equity securities--held for
trading........................................ 30 224 1,081 -- --
Sale of equity securities--available for
sale........................................... -- -- -- 219 114
-------- -------- -------- -------- --------
Total securities sold...................... 124,068 209,621 418,852 155,534 185,337
Less proceeds from maturities of securities.... 11,064 8,721 16,371 31,945 26,783
Realized gain (loss) on sale of securities held
for trading.................................. (2,621) (338) 66 (2,169) --
Realized gain on sale of securities available
for sale....................................... -- -- -- 392 1,384
Unrealized gain on securities held for
trading........................................ 2,452 750 1,535 710 --
Change in net unrealized gain (loss) on
securities available for sale................ (94) (52) 97 (470) 290
Amortization of (premium) discount............. (1,099) (689) (1,445) (2,286) (1,290)
Permanent impairment of securities available
for sale..................................... -- -- (414) (610) (2,531)
Other.......................................... 69 -- -- -- --
-------- -------- -------- -------- --------
Ending balance................................. $232,629 $184,665 $249,273 $174,347 $186,582
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
63
<PAGE>
At December 31, 1995, the contractual maturity of substantially all of the
Company's mortgage-backed or related securities was in excess of ten years. The
actual maturity of a mortgage-backed or related security is less than its stated
maturity due to prepayments of the underlying mortgages. Prepayments that are
faster than anticipated may shorten the life of the security and affect its
yield to maturity. The yield to maturity is based upon the interest income and
the amortization of any premium or discount related to the security. In
accordance with generally accepted accounting principles, premiums and discounts
are amortized over the estimated lives of the loans, which decrease and increase
interest income, respectively. The prepayment assumptions used to determine the
amortization period for premiums and discounts can significantly affect the
yield of the mortgage-backed or related security, and these assumptions are
reviewed periodically to reflect actual prepayments. Although prepayments of
underlying mortgages depend on many factors, including the type of mortgages,
the coupon rate, the age of 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 generally is the
most significant determinant of the rate of prepayments. During periods of
falling mortgage interest rates, if the coupon rate of the underlying mortgages
exceeds the prevailing market interest rates offered for mortgage loans,
refinancing generally increases and accelerates the prepayment of the underlying
mortgages and the related security. At December 31, 1995, of the $226.2 million
of mortgage-backed and related securities held by the Company, an aggregate of
$155.7 million were secured by fixed-rate mortgage loans and an aggregate of
$70.5 million were secured by adjustable-rate mortgage loans.
Other Securities. Other securities owned by the Company at December 31, 1995
include various interest rate contracts, including interest rate swaps, collars,
caps, floors, options and futures, equity securities and municipal bonds. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Asset and Liability Management." At December 31, 1995, the carrying
value of the Company's interest rate contracts, equity securities and municipal
bonds amounted to $4.8 million, $525,000 and $1.1 million, respectively. Of the
$1.1 million of municipal bonds held by the Company at December 31, 1995,
$100,000 was scheduled to mature in one year or less, $202,000 was scheduled to
mature between one and five years and $774,000 was scheduled to mature between
five and ten years. See Note 2 to the Notes to Consolidated Financial
Statements.
SOURCES OF FUNDS
General. The Company will consider various sources of funds to fund its
investing and lending activities and evaluates the available sources of funds in
order to reduce the Company's overall funding costs. Deposits, reverse
repurchase agreements, advances from the FHLB of Indianapolis, notes payable,
and sales, maturities and principal repayments on loans and securities have been
the major sources of funds for use in the Company's lending and investing
activities, and for other general business purposes. Management of the Company
closely monitors rates and terms of competing sources of funds on a daily basis
and utilizes the source which it believes to be cost effective.
Deposits. The Bank attempts to price its deposits in order to promote
deposit growth and offers a wide array of deposit products in order to satisfy
its customers' needs. The Bank's current deposit products include statement
savings accounts, negotiable order of withdrawal ("NOW") and checking accounts,
money market deposit accounts, fixed-rate, fixed-maturity retail certificates of
deposit ranging in terms from seven days to 10 years, individual retirement
accounts, and non-retail certificates of deposit consisting of jumbo (generally
greater than $95,000) certificates, inverse variable-rate certificates and
brokered certificates of deposit.
The Bank's retail deposits are generally obtained from residents in its
primary market area. The principal methods currently used by the Bank to attract
deposit accounts include offering a wide variety of value-added products and
services and competitive interest rates. The Bank utilizes traditional
64
<PAGE>
marketing methods to attract new customers and savings deposits, including
various forms of advertising. The Bank also utilizes the services of deposit
brokers to attract non-retail certificates of deposit. Management estimates that
as of December 31, 1995, non-retail deposit accounts totalled $29.9 million or
26.1% of the Bank's total deposits. These non-retail deposits consist largely of
jumbo certificates of deposit, inverse variable-rate certificates (which are
obtained through brokers) and brokered deposits. The Bank's jumbo certificates
of deposit and other deposits are also obtained through the posting of deposit
rates on national computerized bulletin boards at no cost to the Bank. The
Bank's inverse variable-rate certificates carry rates which fluctuate inversely
with respect to market rates of interest. For example, if market rates of
interest increase, the rates on the inverse variable-rate certificates would
decrease, while if market rates of interest decrease, the rates on the inverse
variable-rate certificates would increase. As a result, the Bank would generally
be paying a higher rate on such certificates during a declining interest rate
environment. The Bank offers inverse variable-rate certificates when they
represent a lower cost source of funds.
The following table shows the distribution of and certain other information
relating to the Bank's deposits by type as of the dates indicated.
<TABLE>
<CAPTION>
JUNE 30,
--------------------------------------------------------------------
DECEMBER 31, 1995 1995 1994 1993
--------------------- ----------------
--------------------- --------------------
PERCENT OF PERCENT OF PERCENT OF PERCENT OF
AMOUNT DEPOSITS AMOUNT DEPOSITS AMOUNT DEPOSITS AMOUNT DEPOSITS
-------- ---------- -------- ---------- -------- ---------- ------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Transaction accounts:
NOW and checking.................. $ 3,651 3.2% $ 3,266 2.8% $ 3,178 2.9% $ 2,475 2.8%
Savings accounts.................. 15,744 13.7 15,183 13.2 16,502 15.3 18,777 20.9
Money market deposit accounts..... 1,836 1.6 1,976 1.7 7,563 7.0 3,565 4.0
-------- --- -------- --- -------- --- ------- ---
Total transaction accounts...... 21,231 18.5 20,425 17.7 27,243 25.2 24,817 27.7
-------- --- -------- --- -------- --- ------- ---
Certificates of deposit:
Within 1 year..................... 64,260 55.9 57,304 49.8 41,911 38.7 32,845 36.5%
1-2 years......................... 12,251 10.7 17,890 15.5 15,909 14.7 9,957 11.1
2-3 years......................... 6,058 5.3 6,844 5.9 9,292 8.6 5,792 6.4
3-4 years......................... 4,374 3.8 5,352 4.6 3,620 3.3 6,363 7.1
Over 4 years...................... 6,640 5.8 7,497 6.5 10,325 9.5 10,014 11.2
-------- --- -------- --- -------- --- ------- ---
Total certificate accounts...... 93,583 81.5 94,887 82.3 81,057 74.8 64,971 72.3
-------- --- -------- --- -------- --- ------- ---
Total deposits.................. $114,814 100.0% $115,312 100.0% $108,300 100.0% $89,788 100.0%
-------- --- -------- --- -------- --- ------- ---
-------- --- -------- --- -------- --- ------- ---
</TABLE>
The following table shows the distribution of and certain other information
relating to the Bank's certificates of deposit as of the dates indicated.
<TABLE>
<CAPTION>
JUNE 30,
------------------------------------------------------------------
DECEMBER 31, 1995 1995 1994 1993
-------------------- ---------------
-------------------- --------------------
PERCENT OF PERCENT OF PERCENT OF PERCENT OF
AMOUNT DEPOSITS AMOUNT DEPOSITS AMOUNT DEPOSITS AMOUNT DEPOSITS
------- ---------- ------- ---------- ------- ---------- ------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Total retail certificates....... $64,277 55.9% $62,465 54.1% $31,845 29.4% $32,892 36.6%
-- -- -- --
------- ------- ------- -------
Non-retail certificates:
Jumbo certificates............. 7,779 6.8 9,963 8.6 21,445 19.8 12,388 13.8
Inverse variable-rate
certificates.................... 9,704 8.5 9,993 8.7 12,065 11.1 11,875 13.2
Non-brokered out-of-state
deposits........................ 11,131 9.7 11,476 10.0 13,029 12.0 -- --
Brokered deposits.............. 692 0.6 990 0.9 2,673 2.5 7,816 8.7
-- -- -- --
------- ------- ------- -------
Total non-retail
certificates(1)................. 29,306 25.6 32,422 28.2 49,212 45.4 32,079 35.7
-- -- -- --
------- ------- ------- -------
Total certificates of deposit... $93,583 81.5% $94,887 82.3% $81,057 74.8% $64,971 72.3%
-- -- -- --
-- -- -- --
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
- - - ------------
(1) Of the Company's $29.3 million of non-retail certificates as of December 31,
1995, $13.3 million was scheduled to mature in six months or less, $2.4
million was scheduled to mature in 7-12 months, $7.1 million was scheduled
to mature in 13-36 months and $6.5 million was scheduled to mature in over
36 months.
65
<PAGE>
The following table presents the average balance of each deposit type and
the average rate paid on each deposit type for the periods indicated.
<TABLE>
<CAPTION>
SIX MONTHS ENDED DECEMBER 31, YEAR ENDED JUNE 30,
------------------------------------------- ----------------------------------------------------
1995 1994 1995 1994 1993
-------------------- -------------------- -------------------- ------------------- -------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE RATE PAID BALANCE RATE PAID BALANCE RATE PAID BALANCE RATE PAID BALANCE
-------- --------- -------- --------- -------- --------- ------- --------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NOW and checking
accounts................ $ 3,476 3.0% $ 3,460 2.8% $ 3,352 2.8% $ 2,872 2.9% $ 2,191
Savings accounts........ 15,185 3.8 16,636 3.4 16,068 3.5 18,271 3.3 17,563
Money market deposit
accounts................ 1,791 4.4 2,258 3.7 2,147 4.1 5,396 3.4 1,988
Certificates of
deposit................. 100,797 6.2 92,420 5.3 99,443 5.9 69,336 5.3 70,543
-------- -------- -------- ------- -------
Total deposits.......... $121,249 5.8% $114,774 4.9% $121,010 5.5% $95,875 4.7% $92,285
- - - -
- - - -
-------- -------- -------- ------- -------
-------- -------- -------- ------- -------
<CAPTION>
AVERAGE
RATE PAID
---------
<S> <C>
NOW and checking
accounts................ 3.2%
Savings accounts........ 3.6
Money market deposit
accounts................ 3.3
Certificates of
deposit................. 5.9
Total deposits.......... 5.4%
-
-
</TABLE>
The following table sets forth the deposit account activities of the Bank
during the periods indicated.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, YEAR ENDED JUNE 30,
------------------ --------------------------------
1995 1994 1995 1994 1993
------- ------- -------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Deposits................................. $88,554 $95,460 $184,399 $173,083 $ 97,249
Withdrawals.............................. 90,507 83,045 182,443 157,579 104,313
------- ------- -------- -------- --------
Net increase (decrease) before interest
credited................................. (1,953) 12,415 1,956 15,504 (7,064)
Interest credited........................ 1,455 2,036 5,056 3,008 3,376
------- ------- -------- -------- --------
Net increase (decrease) in deposits.... $ (498) $14,451 $ 7,012 $ 18,512 $ (3,688)
------- ------- -------- -------- --------
------- ------- -------- -------- --------
</TABLE>
The following table shows the interest rate and maturity information for the
Bank's certificates of deposit at December 31, 1995.
<TABLE>
<CAPTION>
MATURITY DATE
---------------------------------------------------------------------------
INTEREST RATE ONE YEAR OR LESS OVER 1-2 YEARS OVER 2-3 YEARS OVER 3 YEARS TOTAL
- - - ----------------------------------- ---------------- -------------- -------------- ------------ -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
3.00% or less...................... $ 198 $ 1 $ 2 $ 14 $ 215
3.01--5.00%........................ 7,521 1,619 772 407 10,319
5.01--7.00%........................ 49,331 7,538 3,349 5,104 65,322
7.01--9.00%........................ 6,468 3,093 1,645 4,713 15,919
9.01% or greater................... 742 -- 290 776 1,808
------- ------- ------ ------------ -------
Total............................ $ 64,260 $ 12,251 $6,058 $ 11,014 $93,583
------- ------- ------ ------------ -------
------- ------- ------ ------------ -------
</TABLE>
The following table sets forth the maturities of the Bank's certificates of
deposit having principal amounts of $100,000 or more at December 31, 1995.
<TABLE>
<CAPTION>
CERTIFICATES OF DEPOSIT MATURING
IN QUARTER ENDING: AMOUNT
- - - ------------------------------------------------------------------------------- --------------
(DOLLARS IN
THOUSANDS)
<S> <C>
March 31, 1996................................................................. $ 7,784
June 30, 1996.................................................................. 3,745
September 30, 1996............................................................. 677
After September 30, 1996....................................................... 3,801
--------------
Total certificates of deposit with balances of $100,000 or more.............. $ 16,007
--------------
--------------
</TABLE>
66
<PAGE>
BORROWINGS. The following table sets forth certain information regarding the
borrowings of the Company at or for the dates indicated.
<TABLE>
<CAPTION>
AT OR FOR THE
SIX MONTHS ENDED AT OR FOR THE YEAR ENDED JUNE
DECEMBER 31, 30,
------------------- -----------------------------
1995 1994 1995 1994 1993
-------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
FHLB advances:
Average balance outstanding.............. $ 29,172 $31,000 $31,051 $31,000 $24,664
Maximum amount outstanding at any
month-end during the period................ 31,000 31,000 31,000 31,000 31,000
Balance outstanding at end of period..... 26,000 31,000 31,000 31,000 31,000
Average interest rate during the
period..................................... 6.0% 5.0% 5.6% 3.4% 3.3%
Average interest rate at end of period... 5.9% 5.8% 6.1% 4.3% 3.1%
Securities sold under agreements to
repurchase:
Average balance outstanding.............. $140,058 $55,690 $68,277 $66,813 $82,626
Maximum amount outstanding at any
month-end during the period................ 145,565 61,042 130,217 78,545 103,819
Balance outstanding at end of period..... 141,448 53,569 130,217 54,651 83,709
Average interest rate during the
period..................................... 5.9% 4.7% 5.4% 3.2% 3.2%
Average interest rate at end of period... 6.0% 5.1% 6.0% 4.1% 2.7%
</TABLE>
The Company obtains both fixed-rate and variable-rate long-term and
short-term advances from the FHLB of Indianapolis upon the security of certain
of its residential first mortgage loans and other assets, provided certain
standards related to creditworthiness of the Bank have been met. FHLB of
Indianapolis advances are available for general business purposes to expand
lending and investing activities. Borrowings have generally been used to fund
the purchase of mortgage-backed and related securities or lending activities and
have been collateralized with a pledge of loans, securities in the Company's
portfolio or any mortgage-backed or related securities purchased.
Advances from the FHLB of Indianapolis are made pursuant to several
different credit programs, each of which has its own interest rate and range of
maturities. The Company currently has two variable-rate advances from the FHLB
of Indianapolis which mature in 1997. At December 31, 1995, the Company had
total FHLB of Indianapolis advances of $26.0 million at a weighted average
interest rate of 5.9%.
The Company also obtains funds from the sales of securities to investment
dealers under agreements to repurchase ("reverse repurchase agreements"). In a
reverse repurchase agreement transaction, the Company will generally sell a
mortgage-backed security agreeing to repurchase either the same or a
substantially identical security (i.e., "dollar rolls") on a specified later
date (generally not more than 90 days) at a price less than the original sales
price. The difference in the sale price and purchase price is the cost of the
use of the proceeds. The mortgage-backed securities underlying the agreements
are delivered to the dealers who arrange the transactions. For agreements in
which the Company has agreed to repurchase substantially identical securities,
the dealers may sell, loan or otherwise dispose of the Company's securities in
the normal course of their operations; however, such dealers or third party
custodians safe-keep the securities which are to be specifically repurchased by
the Company. Reverse repurchase agreements represent a competitive cost funding
source for the Company. Nevertheless, the Company is subject to the risk that
the lender may default at maturity and not return the collateral. The amount at
risk is the value of the collateral which exceeds the balance of the borrowing.
In order to minimize this potential risk, the Company only deals with large,
established investment brokerage firms when entering into these transactions.
Reverse repurchase transactions are accounted for as financing
67
<PAGE>
arrangements rather than as sales of such securities, and the obligation to
repurchase such securities is reflected as a liability in the Consolidated
Financial Statements.
In April 1993, the Company entered into a $10.0 million loan facility with
an unrelated financial institution. This facility, as amended in 1995, includes
a $9.2 million term loan (the "Refinancing Loan") and a non-revolving line of
credit of $800,000. Proceeds from the Refinancing Loan were utilized to repay
the unpaid balance of a $10.0 million loan that the Company obtained in 1988 in
connection with its acquisition of the Bank (which loan had a principal balance
of $6.6 million as of the date of repayment), reduce the average interest rate
paid on such indebtedness and increase the capitalization of the Bank. The loan
facility matures in March 2000 (which can, under certain circumstances, be
extended for an additional five years) and carries an interest rate of 1/2% over
the prime rate published in the Wall Street Journal if the ratio of the loan
balance to the Bank's capital is equal to or less than 50%; otherwise, the
interest rate is 1% over the prime rate. The loan facility requires quarterly
principal and interest repayments. The loan facility is secured by (i) a general
pledge agreement between the parties pursuant to which the Company has pledged
100% of the outstanding stock of the Bank; (ii) a security agreement between the
parties pursuant to which the Company has provided a blanket security interest
in all of its assets; (iii) a guaranty from Smith Breeden and from Douglas T.
Breeden, the Chairman of the Board of Smith Breeden (and of the Company),
personally; and (iv) the assignment of life insurance policies on Messrs.
Breeden and Cerny by the Company in the aggregate amount of $1.25 million. At
December 31, 1995, the total balance of the loan facility was $9.5 million. An
April 1996 amendment to the loan facility, which is effective solely upon
consummation of the Offering, would recharacterize the aggregate $9.3 principal
balance outstanding as a term loan and provide an additional $3.0 million
non-revolving line of credit which is intended to further increase the capital
of the Bank. Among certain modifications, the guarantees of Smith Breeden and
Douglas T. Breeden, referenced above, would be removed.
TRUST AND FIDUCIARY SERVICES
The Company also provides a full range of trust and investment services, and
acts as executor or administrator of estates and as trustee for various types of
trusts. Trust and investment services are offered through Harrington Investment
Management and Trust Services ("Trust Department"), which was created in
December 1994 as a separate division of the Bank. Services offered include
financial services related to trusts and estates, money management, custodial
services and pension and employee benefits consulting and plan administration.
As of December 31, 1995, the Trust Department administered approximately 49
trust/fiduciary accounts, with aggregate assets of $11.5 million at such date.
Gross fee income from the Trust Department amounted to $7,000 during the six
months ended December 31, 1995 and $4,000 during fiscal 1995, while the Trust
Department recognized net losses with respect to its operations of $35,000 and
$91,000 during the respective periods.
The Company receives fees dependent upon the level and type of service
provided. The Trust Department administers trust accounts (revocable,
irrevocable and charitable trusts, and trusts under wills), agency accounts
(various investment fund products), estate accounts, and employee benefit plan
accounts (assorted plans and IRA accounts). The administration of trust and
fiduciary accounts are monitored by the Trust Committee of the Board of
Directors of the Bank.
SUBSIDIARIES
The Bank is permitted to invest up to 2% of its assets in the capital stock
of, or secured or unsecured loans to, subsidiary corporations, with an
additional investment of 1% of assets when such additional investments is
utilized primarily for community development purposes. The Bank's only
subsidiary, Pine Tree Mortgage Corp., is an inactive corporation formed in 1987
to originate mortgage loans in North Carolina, and has conducted no business
since 1988. The Bank's investment in the subsidiary is not material to its
operations or financial condition.
68
<PAGE>
OFFICES AND OTHER PROPERTIES
The Company's principal executive office is located at 7300 College
Boulevard, Suite 430, Overland Park, Kansas 66210, which is an office of Smith
Breeden. The Company pays no rent or fees to Smith Breeden with respect to such
facility. The following table sets forth certain information with respect to the
offices and other properties of the Bank at December 31, 1995.
<TABLE>
<CAPTION>
NET BOOK VALUE
DESCRIPTION/ADDRESS LEASED/OWNED OF PROPERTY(1) DEPOSITS
- - - ------------------------------------------------------- ------------ -------------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Main Office............................................ Owned $1,681 $ 85,106
722 Promenade
Richmond, Indiana
Carmel Branch(2)....................................... Leased(3) 116 29,579
11592 Westfield Boulevard
Carmel, Indiana
Fishers Branch(4)...................................... Owned 742(5) 129
7150 East 116th Street
Fishers, Indiana
</TABLE>
- - - ------------
(1) Includes leasehold improvements.
(2) Branch opened in May 1994.
(3) The lease expires in June 2008 and may be extended for an additional ten
years provided that proper notice is timely given.
(4) Branch opened in December 1995.
(5) Reflects the net book value at December 31, 1995. Upon completion of final
improvements to the branch, the net book value is estimated to amount to
$930,000.
PERSONNEL
As of December 31, 1995, the Company (on a consolidated basis) had 41
full-time employees and 9 part-time employees. The employees are not represented
by a collective bargaining agreement and the Company believes that it has good
relations with its employees.
LEGAL PROCEEDINGS
The Company is involved in routine legal proceedings occurring in the
ordinary course of business which, in the aggregate, are believed by management
to be immaterial to the financial condition and results of operations of the
Company.
69
<PAGE>
SUPERVISION AND REGULATION
Set forth below is a brief description of those laws and regulations which,
together with the descriptions of laws and regulations contained elsewhere
herein, are deemed material to an investor's understanding of the extent to
which the Company and the Bank are regulated. The description of the laws and
regulations hereunder, as well as descriptions of laws and regulations contained
elsewhere herein, does not purport to be complete and is qualified in its
entirety by reference to applicable laws and regulations.
THE COMPANY
General. The Company is a registered savings and loan holding company within
the meaning of the Home Owners' Loan Act ("HOLA"), and is subject to OTS
regulations, examinations, 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.
Activities Restrictions. Although there are generally no restrictions on the
activities of a savings and loan holding company which holds only one subsidiary
savings institution under applicable OTS regulations, the Company may be
considered to be a multiple savings and loan holding company because principals
and affiliates of Smith Breeden are deemed for regulatory purposes to control
both the Company and HWFG, a recently formed savings and loan holding company
which owns all of the outstanding common stock of Los Padres Savings Bank,
F.S.B., Los Padres, California.
Multiple savings and loan holding companies are subject to restrictions
which do not apply to unitary savings and loan holding companies. 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 authorized by regulation as of March 5,
1987 to be engaged in by multiple savings and loan 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 also must be approved by the Director of the
OTS prior to being engaged in by a multiple savings and loan holding company.
The Company does not believe that if the OTS designates it as a multiple thrift
holding company, such a designation will limit its ability to conduct its normal
business operations.
In addition, 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 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 (ii) 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.
Limitations on Transactions with Affiliates. 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, the parent holding company of
a savings institution (such as the Company) and any companies which are
controlled by such parent holding company are
70
<PAGE>
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
other similar transactions. In addition to the restrictions imposed by Sections
23A and 23B, no savings institution may (i) 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.
In addition, Sections 22(h) and (g) of the Federal Reserve Act places
restrictions on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, an executive officer and
to a greater than 10% stockholder of a savings institution, and certain
affiliated interests of either, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the savings
institution's loans to one borrower limit (generally equal to 15% of the
institution's unimpaired capital and surplus). Section 22(h) also 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 and also requires prior board approval for certain loans. In addition,
the aggregate amount of extensions of credit by a savings institution to all
insiders cannot exceed the institution's unimpaired capital and surplus.
Furthermore, Section 22(g) places additional restrictions on loans to executive
officers. At December 31, 1995, the Bank was in compliance with the above
restrictions.
Restrictions on Acquisitions. Except under limited circumstances, savings
and loan holding companies are prohibited from acquiring, without prior approval
of the Director of the 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 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 located 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 ("FDIA"); or (iii) the statutes of the state in which the
institution to be acquired is located specifically permit institutions to be
acquired by the 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).
Under the Bank Holding Company Act of 1956, the Federal Reserve Board is
authorized to approve an application by a bank holding company to acquire
control of a savings institution. In addition, a bank holding company that
controls a savings institution may merge or consolidate the assets and
liabilities of the savings institution with, or transfer assets and liabilities
to, any subsidiary bank which is a member of the BIF with the approval of the
appropriate federal banking agency and the Federal Reserve Board. As a result of
these provisions, there have been a number of acquisitions of savings
institutions by bank holding companies in recent years.
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THE BANK
General. The OTS has extensive authority over the operations of federally
chartered savings institutions. As part of this authority, savings institutions
are required to file periodic reports with the OTS and are subject to periodic
examinations by the OTS and the FDIC. The last regulatory examination of the
Bank by the OTS was conducted in January 1995. The Bank was not required to make
any material changes to its operations as a result of such examination. The
investment and lending authority of savings institutions are prescribed by
federal laws and regulations, and such institutions are prohibited from engaging
in any activities not permitted by such laws and regulations. Those laws and
regulations generally are applicable to all federally chartered savings
institutions and may also apply to state-chartered savings institutions. Such
regulation and supervision is primarily intended for the protection of
depositors.
The OTS' enforcement authority over all savings institutions and their
holding companies includes, among other things, the ability to assess civil
money penalties, to issue cease and desist or removal orders and to initiate
injunctive actions. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with the OTS.
Insurance of Accounts. The deposits of the Bank are insured to the maximum
extent permitted by the SAIF, which is administered by the FDIC, and are backed
by the full faith and credit of the U.S. Government. As insurer, the FDIC is
authorized to conduct examinations of, and to require reporting by, FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious threat
to the FDIC. The FDIC also has the authority to initiate enforcement actions
against savings institutions, after giving the OTS an opportunity to take such
action.
Both the SAIF and BIF are statutorily required to be capitalized to a ratio
of 1.25% of insured reserve deposits. While the BIF has reached the required
reserve ratio, the SAIF is not expected to be recapitalized until 2002 at the
earliest. Legislation has authorized $8 billion for the SAIF; however, such
funds only become available to the SAIF if the FDIC determines that the funds
are needed to cover losses of the SAIF and several other stringent criteria are
met.
On November 14, 1995, the FDIC approved a final rule regarding deposit
insurance premiums. The final rule will reduce deposit insurance premiums for
BIF member institutions to zero basis points (subject to a $2,000 minimum) for
institutions in the lowest risk category, while holding deposit insurance
premiums for SAIF members at their current levels (23 basis points for
institutions in the lowest risk category, as discussed below.) The reduction was
effective with respect to the semiannual premium assessment beginning January 1,
1996.
Under current FDIC regulations, SAIF member institutions are assigned to one
of three capital groups which are based solely on the level of an institution's
capital--"well capitalized," "adequately capitalized," and "undercapitalized."
These three groups are then divided into three subgroups which reflect varying
levels of supervisory concern, from those which are considered to be healthy to
those which are considered to be of substantial supervisory concern. The matrix
so created results in nine assessment risk classifications, with rates ranging
from .23% for well capitalized, healthy institutions to .31% for
undercapitalized institutions with substantial supervisory concerns. The
insurance premium for the Bank for 1995 was .23% (per annum) of insured
deposits. For a discussion of alternatives to mitigate the effect of the
BIF/SAIF premium disparity, see "Risk Factors--Recapitalization of SAIF and
Related Legislative Proposals."
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices or is in
an unsafe or unsound condition to continue operations, or if the insured
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depository institution or any of its directors or trustees have violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which would result in
termination of the Bank's deposit insurance.
Regulatory Capital Requirements. Federally insured savings institutions are
required to maintain minimum levels of regulatory capital. The OTS has
established capital standards applicable to all savings institutions. These
standards generally must be as stringent as the comparable capital requirements
imposed on national banks. The OTS also is authorized to impose capital
requirements in excess of these standards on individual institutions on a
case-by-case basis.
Current OTS capital standards require savings institutions to satisfy three
different capital requirements. Under these standards, savings institutions must
maintain "tangible" capital equal to at least 1.5% of adjusted total assets,
"core" capital equal to at least 3.0% of adjusted total assets and "total"
capital (a combination of core and "supplementary" capital) equal to at least
8.0% of "risk-weighted" assets. For purposes of the regulation, core capital
generally consists of 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." Tangible capital is given the same definition as core capital but
does not include qualifying supervisory goodwill and is reduced by the amount of
all the savings institution's intangible assets, with only a limited exception
for purchased mortgage servicing rights. The Bank had no goodwill or other
intangible assets at December 31, 1995. Both core and tangible capital are
further reduced by an amount 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). At December 31, 1995, there were no
such adjustments to the Bank's regulatory capital.
In determining compliance with the risk-based capital requirement, a savings
institution is allowed to include both core capital and supplementary capital in
its total capital, provided that the amount of supplementary capital included
does not exceed the savings institution's core capital. Supplementary capital
generally consists of hybrid capital instruments; perpetual preferred stock
which is not eligible to be included as core capital; subordinated debt and
intermediate-term preferred stock; and general allowances for loan losses up to
a maximum of 1.25% of risk-weighted assets. In determining the required amount
of risk-based capital, total assets, including certain off-balance sheet items,
are multiplied by a risk weight based on the risks inherent in the type of
assets. The risk weights assigned by the OTS for principal categories of assets
are (i) 0% for cash and securities issued by the U.S. Government or
unconditionally backed by the full faith and credit of the U.S. Government; (ii)
20% for securities (other than equity securities) issued by U.S.
Government-sponsored agencies and mortgage-backed securities issued by, or fully
guaranteed as to principal and interest by, FNMA or FHLMC, except for those
classes with residual characteristics or stripped mortgage-related securities;
(iii) 50% for prudently underwritten permanent one- to four-family first lien
mortgage loans not more than 90 days delinquent and having a loan-to-value ratio
of not more than 80% at origination unless insured to such ratio by an insurer
approved by FNMA or FHLMC, qualifying residential bridge loans made directly for
the construction of one- to four-family residences and qualifying multi-family
residential loans; and (iv) 100% for all other loans and investments, including
consumer loans, commercial loans, and one- to four-family residential real
estate loans more than 90 days delinquent, and for repossessed assets.
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In August 1995, the OTS and other federal banking agencies published a final
rule modifying their existing risk-based capital standards to provide for
consideration of interest rate risk when assessing capital adequacy of a bank.
Under the final rule, the OTS must explicitly include a bank's exposure to
declines in the economic value of its capital due to changes in interest rates
as a factor in evaluating a bank's capital adequacy. In addition, in August
1995, the OTS and the other federal banking agencies published a joint policy
statement for public comment that describes the process the banking agencies
will use to measure and assess the exposure of a bank's net economic value to
change in interest rates. Under the policy statement, the OTS will consider
results of supervisory and internal interest rate risk models as one factor in
evaluating capital adequacy. The OTS intends, at a future date, to incorporate
explicit minimum requirements for interest rate risk in its risk-based capital
standards through the use of a model developed from the policy statement, a
future proposed rule and the public comments received therefrom. See "Regulatory
Capital Requirements" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Asset and Liability Management."
Any savings institution that fails any of the capital requirements is
subject to possible enforcement actions by the OTS or the FDIC. Such actions
could include a capital directive, a cease and desist order, civil money
penalties, the establishment of restrictions on the institution's operations
(including growth), termination of federal deposit insurance and the appointment
of a conservator or receiver. The OTS' capital regulation provides that such
actions, through enforcement proceedings or otherwise, could require one or more
of a variety of corrective actions.
Liquidity Requirements. All savings institutions are required to maintain an
average daily balance of liquid assets equal to a certain percentage of the sum
of its average daily balance of net withdrawable deposit accounts and borrowings
payable in one year or less. The liquidity requirement may vary from time to
time (between 4% and 10%) depending upon economic conditions and savings flows
of all savings institutions. At the present time, the required minimum liquid
asset ratio is 5%. At December 31, 1995, the Bank's liquidity ratio was 5.19%.
Capital Distributions. OTS regulations govern capital distributions by
savings institutions, which include cash dividends, stock redemptions or
repurchases, cash-out mergers, interest payments on certain convertible debt and
other transactions charged to the capital account of a savings institution to
make capital distributions. Generally, the regulation creates a safe harbor for
specified levels of capital distributions from institutions meeting at least
their minimum capital requirements, so long as such institutions notify the OTS
and receive no objection to the distribution from the OTS. Savings institutions
and distributions that do not qualify for the safe harbor are required to obtain
prior OTS approval before making any capital distributions.
Generally, a savings institution that before and after the proposed
distribution meets or exceeds its fully phased-in capital requirements (Tier 1
institutions) may make capital distributions during any calendar year equal to
the higher of (i) 100% of net income for the calendar year-to-date plus 50% of
its "surplus capital ratio" at the beginning of the calendar year or (ii) 75% of
net income over the most recent four-quarter period. The "surplus capital ratio"
is defined to mean the percentage by which the institution's ratio of total
capital to assets exceeds the ratio of its fully phased-in capital requirement
to assets. "Fully phased-in capital requirement" is defined to mean an
institution's capital requirement under the statutory and regulatory standards
applicable on December 31, 1994, as modified to reflect any applicable
individual minimum capital requirement imposed upon the institution. Failure to
meet fully phased-in or minimum capital requirements will result in further
restrictions on capital distributions, including possible prohibition without
explicit OTS approval. In order to make distributions under these safe harbors,
Tier 1 institutions such as the Bank must submit 30 days written notice to the
OTS prior to making the distribution. The OTS may object to the distribution
during that 30-day period based on safety and soundness concerns.
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In December 1994, the OTS published a notice of proposed rulemaking to amend
its capital distribution regulation. Under the proposal, institutions would be
permitted to only make capital distributions that would not result in their
capital being reduced below the level required to remain "adequately
capitalized." Because the Bank will be a subsidiary of a holding company, the
proposal would require the Bank to provide notice to the OTS of its intent to
make a capital distribution. The Bank does not believe that the proposal will
adversely affect its ability to make capital distributions if it is adopted
substantially as proposed.
Loans to One Borrower. The permissible amount of loans-to-one borrower now
generally follows the national bank standard for all loans made by savings
institutions, as compared to the pre-FIRREA rule that applied that standard only
to commercial loans made by federally chartered savings institutions. The
national bank standard generally does not permit loans-to-one borrower to exceed
the greater of $500,000 or 15% of unimpaired capital and surplus. Loans in an
amount equal to an additional 10% of unimpaired capital and surplus also may be
made to a borrower if the loans are fully secured by readily marketable
securities. For information about the largest borrowers from the Bank, see
"Business--Lending Activities."
Branching by Federal Savings Institutions. OTS policy permits interstate
branching to the full extent permitted by statute (which is essentially
unlimited). Generally, federal law prohibits federal savings institutions from
establishing, retaining or operating a branch outside the state in which the
federal institution has its home office unless the institution meets the IRS'
domestic building and loan test (generally, 60% of a thrift's assets must be
housing-related) ("IRS Test"). The IRS Test requirement does not apply if, among
other things, the law of the state where the branch would be located would
permit the branch to be established if the federal savings institution were
chartered by the state in which its home office is located. Furthermore, the OTS
will evaluate a branching applicant's record of compliance with the Community
Reinvestment Act of 1977 ("CRA"). An unsatisfactory CRA record may be the basis
for denial of a branching application.
Qualified Thrift Lender Test. All savings institutions are required to meet
a QTL test to avoid certain restrictions on their operations. A savings
institution that does not meet the 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 a
national bank; (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. Upon the expiration of three years from the date the savings
institution ceases to be a QTL, it must cease any activity and not retain any
investment not permissible for a national bank and immediately repay any
outstanding FHLB advances (subject to safety and soundness considerations).
Currently, the QTL test requires that 65% of an institution's "portfolio
assets" (as defined) consist of certain housing and consumer-related assets on a
monthly average basis in nine out of every 12 months. Assets that qualify
without limit for inclusion as part of the 65% requirement are loans made to
purchase, refinance, construct, improve or repair domestic residential housing
and manufactured housing; home equity loans; mortgage-backed securities (where
the mortgages are secured by domestic residential housing or manufactured
housing); stock issued by the FHLB of Indianapolis; and direct or indirect
obligations of the FDIC. In addition, the following assets, among others, may be
included in meeting the test subject to an overall limit of 20% of the savings
institution's portfolio assets: 50% of residential mortgage loans originated and
sold within 90 days of origination; 100% of consumer and educational loans
(limited to 10% of total portfolio assets); and stock issued by FHLMC or FNMA.
Portfolio assets consist of total assets minus the sum of (i) goodwill and other
intangible assets, (ii) property used by the savings institution to conduct its
business, and (iii) liquid assets up to 20% of the
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institution's total assets. At December 31, 1995, the qualified thrift
investments of the Bank were approximately 96.8% of its portfolio assets.
Accounting Requirements. Applicable OTS accounting regulations and reporting
requirements apply the following standards: (i) regulatory reports will
incorporate generally accepted accounting principles ("GAAP") when GAAP is used
by federal banking agencies; (ii) savings institution transactions, financial
condition and regulatory capital must be reported and disclosed in accordance
with OTS regulatory reporting requirements that will be at least as stringent as
for national banks; and (iii) the Director of the OTS may prescribe regulatory
reporting requirements more stringent than GAAP whenever the Director determines
that such requirements are necessary to ensure the safe and sound reporting and
operation of savings institutions.
Federal Home Loan Bank System. The Bank is a member of the FHLB of
Indianapolis, which is one of 12 regional FHLBs that administers the home
financing credit function of savings institutions. Each FHLB serves as a reserve
or central bank for its members within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the
FHLB System. It makes loans to members (i.e., advances) in accordance with
policies and procedures established by the Board of Directors of the FHLB. At
December 31, 1995, the Company had $26.0 million of FHLB advances. See
"Business--Sources of Funds--Borrowings."
As a member, the Bank is required to purchase and maintain stock in the FHLB
of Indianapolis in an amount equal to at least 1% of its aggregate unpaid
residential mortgage loans, home purchase contracts or similar obligations at
the beginning of each year. At December 31, 1995, the Bank had $2.5 million in
FHLB stock, which was in compliance with this requirement.
The FHLBs are required to provide funds for the resolution of troubled
savings institutions and to contribute to affordable housing programs through
direct loans or interest subsidies on advances targeted for community investment
and low- and moderate-income housing projects. These contributions have
adversely affected the level of FHLB dividends paid in the past and could
continue to do so in the future. These contributions also could have an adverse
effect on the value of FHLB stock in the future.
Federal Reserve System. The Federal Reserve Board requires all depository
institutions to maintain reserves against their transaction accounts (primarily
NOW and Super NOW checking accounts) and non-personal time deposits. As of
December 31, 1995, the Bank was in compliance with this requirement. Because
required reserves must be maintained in the form of vault cash or a
noninterest-bearing account at a Federal Reserve Bank, the effect of this
reserve requirement is to reduce an institution's earning assets.
FEDERAL TAXATION
General. The Company and Bank are subject to the generally applicable
corporate tax provisions of the Code, and Bank is subject to certain additional
provisions of the Code which apply to thrifts and other types of financial
institutions. The following discussion of federal taxation is intended only to
summarize certain pertinent federal income tax matters material to the taxation
of the Company and the Bank and is not a comprehensive discussion of the tax
rules applicable to the Company and Bank.
Year. The Company files a consolidated federal income tax return on the
basis of a fiscal year ending on June 30. The Company's federal income tax
returns for the tax years ended June 30, 1992 forward are open under the statute
of limitations and are subject to review by the IRS.
Bad Debt Reserves. Savings institutions, such as the Bank, which meet
certain definitional tests primarily relating to their assets and the nature of
their businesses, are permitted to establish a reserve for bad debts and to make
annual additions to the reserve. These additions may, within specified
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formula limits, be deducted in arriving at the institution's taxable income. For
purposes of computing the deductible addition to its bad debt reserve, the
institution's loans are separated into "qualifying real property loans" (i.e.,
generally those loans secured by certain interests in real property) and all
other loans ("non-qualifying loans"). The deduction with respect to
non-qualifying loans must be computed under the experience method as described
below. The following formulas may be used to compute the bad debt deduction with
respect to qualifying real property loans: (i) actual loss experience, or (ii) a
percentage of taxable income. Reasonable additions to the reserve for losses on
non-qualifying loans must be based upon actual loss experience and would reduce
the current year's addition to the reserve for losses on qualifying real
property loans, unless that addition is also determined under the experience
method. The sum of the additions to each reserve for each year is the
institution's annual bad debt deduction.
Under the experience method, the deductible annual addition to the
institution's bad debt reserves is the amount necessary to increase the balance
of the reserve at the close of the taxable year to the greater of (a) the amount
which bears the same ratio to loans outstanding at the close of the taxable year
as the total net bad debts sustained during the current and five preceding
taxable years bear to the sum of the loans outstanding at the close of the six
years, or (b) the lower of (i) the balance of the reserve account at the close
of the Bank's "base year," which was its tax year ended December 31, 1987, or
(ii) if the amount of loans outstanding at the close of the taxable year is less
than the amount of loans outstanding at the close of the base year, the amount
which bears the same ratio to loans outstanding at the close of the taxable year
as the balance of the reserve at the close of the base year bears to the amount
of loans outstanding at the close of the base year.
Under the percentage of taxable income method, the bad debt deduction equals
8% of taxable income determined without regard to that deduction and with
certain adjustments. The availability of the percentage of taxable income method
permits a qualifying savings institution to be taxed at a lower effective
federal income tax rate than that applicable to corporations in general. This
resulted generally in an effective federal income tax rate payable by a
qualifying savings institution fully able to use the maximum deduction permitted
under the percentage of taxable income method, in the absence of other factors
affecting taxable income, of 31.3% exclusive of any minimum tax or environmental
tax (as compared to 34% for corporations generally). For tax years beginning on
or after January 1, 1993, the maximum corporate tax rate was increased to 35%,
which increased the maximum effective federal income tax rate payable by a
qualifying savings institution fully able to use the maximum deduction to 32.2%.
Any savings institution at least 60% of whose assets are qualifying assets, as
described in the Code, will generally be eligible for the full deduction of 8%
of taxable income. As of December 31, 1995, approximately 91.5% of the assets of
the Bank were "qualifying assets" as defined in the Code, and the Bank
anticipates that at least 60% of its assets will continue to be qualifying
assets in the immediate future. If this ceases to be the case, the institution
may be required to restore some portion of its bad debt reserve to taxable
income in the future.
Under the percentage of taxable income method, the bad debt deduction for an
addition to the reserve for qualifying real property loans cannot exceed the
amount necessary to increase the balance in this reserve to an amount equal to
6% of such loans outstanding at the end of the taxable year. The bad debt
deduction is also limited to the amount which, when added to the addition to the
reserve for losses on non-qualifying loans, equals the amount by which 12% of
deposits at the close of the year exceeds the sum of surplus, undivided profits
and reserves at the beginning of the year. Based on experience, it is not
expected that these restrictions will be a limiting factor for the Bank in the
foreseeable future. In addition, the deduction for qualifying real property
loans is reduced by an amount equal to all or part of the deduction for
non-qualifying loans.
At December 31, 1995, the federal income tax reserves of the Company
included $3.0 million for which no federal income tax has been provided.
Deferred income taxes have not been provided on such bad debt deductions since
the Company does not intend to use the accumulated bad debt deductions for
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purposes other than to absorb loan losses. If, in the future, this portion of
retained earnings is used for any purpose other than to absorb bad debt losses,
federal income taxes may be imposed on such amounts at the then current
corporation income tax rate.
For information concerning pending legislation which would restrict the
Bank's ability to utilize the percentage of taxable income method and require
recapture of a portion of the Company's bad debt reserves, see "Risk
Factors--Pending Legislation Regarding Bad Debt Reserves."
STATE TAXATION
The State of Indiana imposes a franchise tax on the "adjusted gross income"
of financial institutions at a fixed rate of 8.5% per annum. This franchise tax
is imposed in lieu of the gross income tax, adjusted gross income tax, and
supplemental net income tax otherwise imposed on certain corporate entities.
"Adjusted gross income" is computed by making certain modifications to an
institution's federal taxable income. Tax-exempt interest, for example, is
included in the savings association's adjusted gross income and the bad debt
deduction is limited to actual charge-offs for purposes of the financial
institutions tax.
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MANAGEMENT
DIRECTORS
The following table sets forth information with respect to the directors of
the Company and the Bank. For information regarding the number of shares of
Common stock beneficially owned by each director, see "Beneficial Ownership of
Securities." There are no arrangements or understandings between the Company and
the Bank and any person pursuant to which such person has been elected as a
director, and no director is related to any other directors or executive officer
of the Company or the Bank by blood, marriage or adoption.
<TABLE>
<CAPTION>
DIRECTOR TERM
NAME AGE(1) SINCE EXPIRES
- - - ------------------------------------------------------ ------ -------- -------
<S> <C> <C> <C>
THE COMPANY
Craig J. Cerny........................................ 40 1988 1996
Douglas T. Breeden.................................... 45 1988 1997
William F. Quinn, C.F.A............................... 31 1991 1996
Gerald J. Madigan..................................... 42 1988 1997
Michael J. Giarla..................................... 37 1988 1998
Stephen A. Eason, C.F.A............................... 39 1991 1997
Daniel C. Dektar...................................... 36 1996 1997
Lawrence E. Golaszewski, C.P.A........................ 36 1991 1998
David F. Harper, C.P.A................................ 52 1995 1998
Stanley J. Kon........................................ 47 1994 1996
John J. McConnell..................................... 50 1995 1998
THE BANK
Craig J. Cerny........................................ 40 1992 1997
David F. Harper....................................... 52 1991 1998
Merrill W. Baxter..................................... 73 1978 1996
John J. McConnell..................................... 50 1993 1996
Stanley J. Kon........................................ 47 1993 1997
Essie M. Fagan........................................ 41 1996 1996
</TABLE>
- - - ------------
(1) As of December 31, 1995.
Information concerning the principal position with the Company and the Bank
and principal occupation of each director during the past five years is set
forth below.
Craig J. Cerny. Mr. Cerny has been the President of the Company and the
Chairman of the Board and Chief Executive Officer of the Bank since February
1992. Prior thereto, Mr. Cerny was the Company's Executive Vice President since
1988. Mr. Cerny has been the Bank's President since July 1994. Mr. Cerny
currently serves as the Chairman of the Board and Chief Executive Officer of
HWFG and as a director of its wholly owned subsidiary, Los Padres Savings Bank,
F.S.B. Mr. Cerny is a Principal, Executive Vice President and Director of Smith
Breeden where he has been employed since April 1985. Mr. Cerny is active in
Smith Breeden's bank consulting and investment advisory practice. He holds a
Master of Business Administration in Finance from Arizona State University,
where he graduated with distinction. Mr. Cerny earned a Bachelor of Science in
Finance from Arizona State University and was a member of the Honors
Convocation.
Douglas T. Breeden. Dr. Breeden is currently the Chairman of the Board of
the Company and is Chairman of the Board, President and Chief Executive Officer
of Smith Breeden, which he co-founded in June 1982. He is a Research Professor
of Finance at Duke University's Fuqua School of Business, where he has been on
the faculty since 1985. Dr. Breeden has also served on business school faculties
at Stanford University and the University of Chicago, and as a visiting
professor at Yale University and at
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the Massachusetts Institute of Technology. He is the Editor of the Journal of
Fixed Income. Dr. Breeden has served as Associate Editor for five journals in
financial economics, and was elected to the Board of Directors of the American
Finance Association. He holds a Ph.D. in Finance from the Stanford University
Graduate School of Business, and a B.S. in Management Science from the
Massachusetts Institute of Technology. Dr. Breeden also serves as a director of
Roosevelt Financial Group, St. Louis, Missouri, the nation's 10th largest
thrift, with over $9 billion in assets.
William F. Quinn, C.F.A. Mr. Quinn has been an Executive Vice President of
the Company since March 1992 and serves on the Bank's Investment Committee,
where he participates in the determination of the Bank's investment strategies.
Mr. Quinn is a Vice President and Principal of Smith Breeden where he has been
employed since June 1986. Mr. Quinn is in charge of Smith Breeden's client
services group, where he provides investment and risk management advice to a
number of institutional clients. He is actively involved in the formulation and
implementation of investment and risk management policies and procedures as well
as clients' strategic plans and business plans. Mr. Quinn holds a Master of
Science in Management with Concentrations in Finance, MIS and System Dynamics
from the Sloan School of Management, Massachusetts Institute of Technology. He
earned a Bachelor of Science in Management Science from the Massachusetts
Institute of Technology.
Gerald J. Madigan. Mr. Madigan is an Executive Vice President and Director
of Smith Breeden where he has been employed since 1984. He is a Senior Portfolio
manager dealing with both pension and financial institution accounts. Mr.
Madigan founded the Smith Breeden Mutual Funds in 1992 and served as President
of the Smith Breeden Mutual Funds from 1992 through 1994. Mr. Madigan served as
the President of the Company from its incorporation in March 1988 until February
1992. Mr. Madigan also served as the Bank's Vice Chairman from November 1988
until February 1990, its Chairman from February 1990 until February 1992 and its
President and Chief Executive Officer from January 1989 until February 1992. Mr.
Madigan holds a Master of Business Administration, Concentration in Finance with
Distinction (from the Honors Program) from Indiana University. He earned a
Bachelor of Science in Accounting with High Distinction from Indiana University.
Michael J. Giarla. Mr. Giarla is an Executive Vice President, Chief
Operating Officer and Director of Smith Breeden where he has been employed since
July 1985. He also serves as President of the Smith Breeden Mutual Funds.
Formerly Smith Breeden's Director of Research, he was involved in research and
programming, particularly in the development and implementation of models to
evaluate and hedge mortgage securities. Mr. Giarla holds a Master of Business
Administration with Concentration in Finance from the Stanford University
Graduate School of Business. He earned a Bachelor of Arts in Statistics, summa
cum laude, from Harvard University.
Stephen A. Eason, C.F.A. Mr. Eason is an Executive Vice President and
Director of Smith Breeden where he has been employed since April 1988. Mr. Eason
manages Smith Breeden's Dallas office and is director of the firm's
discretionary separate account management business. He holds a Master of
Business Administration with Concentration in Finance from The Wharton School,
Graduate Division, University of Pennsylvania. Mr. Eason earned a Bachelor of
Science in Business Administration, Finance and Banking, from the University of
Arkansas, where he graduated with Highest Honors.
Daniel C. Dektar. Mr. Dektar is a Director, Principal and Executive Vice
President of Smith Breeden where he has been employed since August 1986. He
serves as a liaison among the trading, client service, and research groups to
ensure accurate analysis and timely execution of trading opportunities. Mr.
Dektar manages mortgage portfolios for the Smith Breeden Family of Mutual Funds
and is a Vice President of several of the funds. Mr. Dektar consults
institutional clients in the areas of investments and risk management. He holds
a Master of Business Administration from Stanford University Graduate School of
Business. Mr. Dektar received a Bachelor of Science in Business Administration,
summa cum laude, from the University of California at Berkeley, where he was a
University of California Regent's Scholar.
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<PAGE>
Lawrence E. Golaszewski, C.P.A. Mr. Golaszewski served as Vice President and
Principal of Smith Breeden where he was employed from July 1987 until December
1995. At Smith Breeden, Mr. Golaszewski was actively involved in the analysis,
trading and hedging of complex mortgage securities. Mr. Golaszewski has
particular expertise in the analysis and evaluation of mortgage banking
operations, including the formulation of models for evaluating excess mortgage
servicing, pipeline hedging, and pipeline fallout rates. Mr. Golaszewski holds a
Master of Business Administration with Specialization in Finance from University
of Chicago Graduate School of Business. He holds a Bachelor of Science in
Finance/Accounting, summa cum laude, from the State University of New York at
Buffalo, where he won the New York State Regents Scholarship.
David F. Harper, C.P.A. Mr. Harper has been a Vice President of Harris
Harper Counsel, Inc., an investment advisory firm located in Richmond, Indiana,
since January 1991. Mr. Harper also has maintained a public accounting practice
since October 1990. He previously was a Partner in the Indiana C.P.A. Firm of
Geo. S. Olive & Co. from October 1978 to October 1990. Mr. Harper has served as
a director of the Bank since 1991. He holds a Bachelor of Business
Administration in Accounting, magna cum laude, from the University of
Cincinnati.
Stanley J. Kon. Dr. Kon has served as Professor of Finance at the University
of Michigan since 1987 and has been on the faculty of that institution since
1982. He also serves on the Advisory Board of the Mitsui Life Financial Research
Center and has served as a director of two financial institutions. Dr. Kon holds
a Ph.D. in Finance from the State University of New York at Buffalo, and a
Master of Business Administration in Finance and Economics from St. John's
University. He received his undergraduate degree in chemical engineering from
the Lowell Technological Institute.
John J. McConnell. Dr. McConnell is the Emanuel T. Weiler Distinguished
Professor of Management and the Director of Doctoral Programs and Research at
the Krannert School of Management, Purdue University, and has served in that
capacity since 1989. He has been a professor of Finance at that institution
since 1983. He served on the Board of Directors of the Federal Home Loan Bank of
Indianapolis from 1983 to 1986 and has done consulting work for various
government agencies, trade associations and corporations. He has authored
numerous publications on topics related to financial services and general
finance. Dr. McConnell holds a Ph.D. in Finance from Purdue University and a
Master of Business Administration in Finance and Accounting from the University
of Pittsburgh. He received his undergraduate degree in Economics from Dennison
University.
Merrill W. Baxter. Mr. Baxter has served as a consultant to Friends
Fellowship Community, Inc., Richmond, Indiana, a retirement community, since
January 1992. Prior thereto, Mr. Baxter served as its President and Chief
Executive Officer from February 1971 to December 1989 and as the Assistant to
the President from January 1990 until December 1992.
Essie M. Fagan. Ms. Fagan has served as Program Manager for Community
Relations and Communications at Thomson Consumer Electronics, located in
Indianapolis, Indiana, since April 1993. She previously was the Administrative
Manager of the Indiana Youth Institute from August 1989 to December 1992. Ms.
Fagan holds a Masters in Public Affairs from Indiana University. She received a
Bachelor of Science in Criminal Justice from Indiana University.
BOARD OF DIRECTORS MEETINGS AND COMMITTEES OF THE COMPANY AND THE BANK
Regular meetings of the Board of Directors of the Company are held as
necessary. During the year ended June 30, 1995, the Board of Directors of the
Company held four meetings and acted by executing statements of unanimous
consent in lieu of a meeting on five occasions. No incumbent director attended
fewer than 75% of the aggregate of the total number of Board meetings held
during the period he served as a director in fiscal 1995. The Company does not
have a standing nominating committee. The full Board of Directors performs this
function.
81
<PAGE>
Regular meetings of the Board of Directors of the Bank are held monthly and
special meetings may be called at any time as necessary. During the year ended
June 30, 1995, the Board of Directors of the Bank held 12 meetings. No incumbent
director attended fewer than 75% of the aggregate of the total number of Board
meetings held during the period he served as a director and the total number of
meetings held by committees of the Board of Directors on which he served in
fiscal 1995.
The Audit Committee of the Bank's Board is responsible for reviewing the
reports of the independent auditors and internal auditors, and generally
overseeing compliance with internal policies and procedures. The Audit Committee
members are Messrs. Harper and Baxter. This Committee met 4 times during fiscal
1995. The Company intends to establish an Audit Committee in fiscal 1996, which
will replace the Bank's Audit Committee.
The Investment Committee of the Bank is responsible for monitoring the
Bank's investment portfolio and determining strategies for the efficient
deployment of capital consistent with the Investment Policy of the Bank's Board.
The Investment Committee, which is comprised of Messrs. Cerny, Haglund, Quinn,
Harper, Kon, McConnell, and Ms. Habschmidt, met 12 times during fiscal 1995.
The Trust Committee of the Bank is responsible for overseeing and directing
the Trust Department of the Bank. The Trust Committee, which is comprised of
Messrs. Cerny, Baxter, Harper, Kon and McConnell met one time during fiscal
1995.
The Executive Committee of the Bank reviews the compensation of senior
executive officers and recommends to the Board adjustments in such compensation
based on a number of factors, including the profitability of the Bank. The
Executive Committee is also empowered to act on behalf of the Bank's Board of
Directors when the Board is not in session. Messrs. Cerny, Kon and McConnell
comprise the Executive Committee, which met one time during fiscal 1995.
BOARD FEES
Directors of the Company who are not affiliated with Smith Breeden received
fees of $500 for each meeting attended during fiscal 1995. In addition,
directors of the Bank received fees of $500 for each meeting attended during
fiscal 1995. The two directors who do not reside in the Company's market area
also receive a $500 travel allowance per meeting. Directors (except for the
Chief Executive Officer who does not receive committee fees) received fees of
$500 for Investment Committee meetings attended, $300 for Audit Committee
meetings attended and $100 for Executive Committee meetings attended. Directors
are not compensated for attendance at Trust Committee meetings. In January 1996,
the Bank increased its Board fees to $1,000 per Board meeting attended in
person, $500 per Board meeting attended by conference call, $500 per Executive
Committee meeting, and $200 per Trust Committee meeting. Fees for Audit and
Investment Committees were unchanged.
EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS
Set forth below is information concerning the executive officers of the
Company and the Bank who do not serve on the Board of Directors of the Company
or the Bank. All executive officers are elected by the Board of Directors of
their respective company and serve until their successors are elected and
qualified. No executive officer is related to any director or other executive
officer of the Company or the Bank by blood, marriage or adoption, and there are
no arrangements or understandings between a director of the Company or the Bank
and any other person pursuant to which such person was elected an executive
officer.
Catherine A. Habschmidt, C.P.A. Ms. Habschmidt is presently Chief Financial
Officer and Treasurer of the Company and Senior Vice President, Chief Financial
Officer and Secretary of the Bank. Ms. Habschmidt became Chief Financial Officer
and Treasurer of the Company in November 1995. Ms. Habschmidt has served as the
Bank's Chief Financial Officer since 1989, and as Senior
82
<PAGE>
Vice President and Secretary since 1994. Prior thereto, she served as Controller
of the Bank since 1987 and was employed by a public accounting firm from 1985 to
1987. Ms. Habschmidt holds a Master of Science in Accounting from Ball State
University where she received the Outstanding Graduate Student Award. She holds
a Bachelor of Arts in Mathematics from Earlham College where she was elected to
Phi Beta Kappa.
James C. Stapleton. Mr. Stapleton has been Executive Vice President and
Chief Operating Officer of the Bank since June 1992. From August 1989 to June
1992, Mr. Stapleton served as the Bank's Compliance Officer. Prior thereto, Mr.
Stapleton was a Loan Officer for the Bank from 1986 through July 1989 and served
in various management positions for the Richmond Palladium--Item newspaper from
1976 to 1986.
Daniel H. Haglund. Mr. Haglund has been Chief Investment Officer and
Treasurer of the Bank since June 1994 and Senior Vice President since October
1995. From September 1988 to June 1994, Mr. Haglund served as Portfolio Manager
for Hemet Federal Savings and Loan Association, Hemet, California. Mr. Haglund
holds a Master of Business Administration in Finance from Indiana University and
a Bachelor of Arts in Psychology from Alma College.
Debra L. Dugan. Ms. Dugan has been an Executive Assistant at Smith Breeden
since April 1987. She was appointed Corporate Secretary of the Company in
November 1995.
BENEFITS
Employee Stock Ownership Plan. The Company has recently established the ESOP
for employees of the Company and the Bank. Full-time employees of the Company
and the Bank who have been credited with at least 1,000 hours of service during
a twelve month period and who have attained age 21 are eligible to participate
in the ESOP.
The Company expects to contribute sufficient funds to the ESOP in order to
cause the ESOP to purchase up to 7,000 shares in the Offering. The Company may,
in any plan year, make additional discretionary contributions for the benefit of
plan participants in either cash or shares of Common Stock, which may be
acquired through the purchase of outstanding shares of Common Stock in the
market or from individual stockholders, upon the original issuance of additional
shares by the Company or upon the sale of treasury shares by the Company. Such
purchases, if made, could be funded through borrowing by the ESOP or additional
contributions from the Company. The timing, amount and manner of future
contributions to the ESOP will be affected by various factors, including
prevailing regulatory policies, the requirements of applicable laws and
regulations and market conditions.
Any shares of Common Stock purchased by the ESOP with the proceeds of a loan
will be held in a suspense account and released on a pro rata basis as debt
service payments are made. Discretionary contributions to the ESOP and shares
released from the suspense account will be allocated among participants on the
basis of compensation. Forfeitures will be reallocated among remaining
participating employees and may reduce any amount the Company might otherwise
have contributed to the ESOP. Participants will vest in their right to receive
their account balances within the ESOP at the rate of 20 percent per year. In
the case of a "change in control," as defined, however, participants will become
immediately fully vested in their account balances, subject to certain tax
considerations. Benefits may be payable upon retirement, early retirement,
disability or separation from service.
Catherine A. Habschmidt, James C. Stapleton and Craig J. Cerny will serve as
trustees of the ESOP. Under the ESOP, the trustee must vote all allocated shares
held in the ESOP in accordance with the instructions of the participating
employees, and allocated shares for which employees do not give instructions,
and unallocated shares, will be voted in the same ratio on any matter as to
those shares for which instructions are given.
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<PAGE>
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations-- Recent Accounting Pronouncements" for a discussion of SOP 93-6,
which changes the measure of compensation expense recorded by employers for
leveraged ESOPs from the cost of ESOP shares to the fair value of ESOP shares.
GAAP requires that any third party borrowing by the ESOP be reflected as a
liability on the Company's statement of financial condition. If the ESOP
purchases newly-issued shares from the Company, total stockholders' equity would
neither increase nor decrease, but per share stockholders' equity and per share
net earnings would decrease because of the increase in the number of outstanding
shares.
The ESOP will be subject to the requirements of the Employee Retirement
Income Security Act of 1974, as amended ("ERISA"), and the regulations of the
IRS and the Department of Labor thereunder.
Stock Option Plan. The Board of Directors of the Company recently adopted
the Stock Option Plan, which is designed to attract and retain qualified
personnel in key positions, provide officers and key employees with a
proprietary interest in the Company as an incentive to contribute to the success
of the Company, reward key employees for outstanding performance and the
attainment of targeted goals, and retain qualified directors for the Company and
the Bank. The Stock Option Plan was approved by the Company's stockholders in
March 1996. An amount of Common Stock equal to 10% of the Shares sold in the
Offering will be authorized under the Stock Option Plan, which may be filled by
authorized but unissued shares, treasury shares or shares purchased by the
Company on the open market or from private sources. The Stock Option Plan
provides for the grant of incentive stock options intended to comply with the
requirements of Section 422 of the Code ("incentive stock options"),
non-incentive or compensatory stock options and stock appreciation rights
(collectively "Awards"). Awards are available for grant to directors and key
employees of the Company and any subsidiaries, except that directors will not be
eligible to receive incentive stock options.
The Stock Option Plan will be administered and interpreted by a committee of
the Board of Directors ("Committee") which is "disinterested" pursuant to
applicable regulations under the federal securities laws. Unless sooner
terminated, the Stock Option Plan will be in effect for a period of ten years
from the earlier of adoption by the Board of Directors or approval by the
Company's stockholders.
Under the Stock Option Plan, the Committee will determine which officers and
key employees will be granted options, whether such options will be incentive or
compensatory options, the number of shares subject to each option, whether such
options may be exercised by delivering other shares of Common Stock and when
such options become exercisable. The per share exercise price of all stock
options shall be required to be at least equal to the fair market value of a
share of Common Stock on the date the option is granted.
Stock options shall become vested and exercisable in the manner specified by
the Committee at the rate of 20% per year, beginning one year from the date of
grant. Each stock option or portion thereof shall be exercisable at any time on
or after it vests and is exercisable until ten years after its date of grant or
three months after the date on which the optionee's employment terminates,
unless extended by the Committee to a period not to exceed one year from such
termination. However, failure to exercise incentive stock options within three
months after the date on which the optionee's employment terminates may result
in adverse tax consequences to the optionee. Stock options are non-transferable
except by will or the laws of descent and distribution.
Under the Stock Option Plan, the Committee will be authorized to grant
rights to optionees ("stock appreciation rights") under which an optionee may
surrender any exercisable incentive stock option or compensatory stock option or
part thereof in return for payment by the Company to the optionee of cash or
Common Stock in an amount equal to the excess of the fair market value of the
shares of Common
84
<PAGE>
Stock subject to option at the time over the option price of such shares, or a
combination of cash and Common Stock. Stock appreciation rights may be granted
concurrently with the stock options to which they relate or at any time
thereafter which is prior to the exercise or expiration of such options.
Options granted to directors under the Stock Option Plan are awarded under a
formula pursuant to which directors will receive a specified number of shares
upon commencement of the Offering and a specified number of shares annually for
four years thereafter. Such stock options to directors will be vested and
exercisable under the same terms as options granted by the Committee to officers
and employees. Although no awards have been made to date to officers and
employees under the Stock Option Plan, it is expected that options to acquire
shares of Common Stock will be awarded to key employees of the Company and the
Bank.
All unvested options are accelerated in the event of retirement under the
Bank's normal retirement policies or a change in control of the Company, as
defined in the Stock Option Plan. In addition, if an optionee dies or terminates
service due to disability, while serving as an employee or non-employee
director, all unvested options are accelerated. Under such circumstances, the
optionee or, as the case may be, the optionee's executors, administrators,
legatees or distributees, shall have the right to exercise all unexercised
options during the twelve-month period following termination due to disability,
retirement or death, provided no option will be exercisable within six months
after the date of grant or more than ten years from the date it was granted.
In the event of a stock split, reverse stock split or stock dividend, the
number of shares of Common Stock under the Stock Option Plan, the number of
shares to which any Award relates and the exercise price per share under any
option or stock appreciation right shall be adjusted to reflect such increase or
decrease in the total number of shares of the Common Stock outstanding.
Under current provisions of the Code, the federal income tax treatment of
incentive stock options and compensatory stock options is different. With
respect to incentive stock options, an optionee who meets certain holding period
requirements will not recognize income at the time the option is granted or at
the time the option is exercised, and a federal income tax deduction generally
will not be available to the Company at any time as a result of such grant or
exercise. With respect to compensatory stock options, the difference between the
fair market value on the date of exercise and the option exercise price
generally will be treated as compensation income upon exercise, and the Company
will be entitled to a deduction in the amount of income so recognized by the
optionee. Upon the exercise of a stock appreciation right, the holder will
realize income for federal income tax purposes equal to the amount received by
him, whether in cash, shares of stock or both, and the Company will be entitled
to a deduction for federal income tax purposes in the same amount.
The Company has previously awarded options on a periodic basis without a
specific option plan. At December 31, 1995, the Company had granted stock
options to directors and officers of the Company and the Bank and certain other
affiliates of Smith Breeden to purchase an aggregate of 137,200 shares of Common
Stock at $7.50 per share, which are exercisable between December 15, 1997 and
January 15, 1998. See also "--Executive Compensation" and "Beneficial Ownership
of Securities."
Profit Sharing Plan. On July 1, 1990, the Bank adopted the Financial
Institutions Thrift Plan ("Profit Sharing Plan"), which is a tax-qualified
defined contribution plan. All employees are eligible to participate in the
Profit Sharing Plan on the first day of the month following the employee's date
of employment. Under the Profit Sharing Plan, a separate account is established
for each participating employee and the Bank may make discretionary
contributions to the Profit Sharing Plan which are allocated to the
participants' accounts. Participants vest in employer discretionary
contributions over a six year period. Distributions from the Profit Sharing Plan
are made upon termination of service, death or disability in a lump sum. The
normal retirement age under the plan is age 65.
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EXECUTIVE COMPENSATION
Summary Compensation Table. The following table includes individual
compensation information with respect to the President of the Company and the
Bank (who serves as the Chief Executive Officer), who is the only officer of the
Company and its subsidiaries whose total compensation exceeded $100,000 for
services rendered in all capacities during the fiscal year ended June 30, 1995.
<TABLE>
<CAPTION>
ALL OTHER
LONG-TERM COMPENSATION
COMPENSATION ------------
ANNUAL COMPENSATION AWARDS
NAME AND -------------------- --------------------
PRINCIPAL POSITION SALARY(1) BONUS NUMBER OF OPTIONS(2)
- - - ------------------------------------------ --------- ------- --------------------
<S> <C> <C> <C> <C>
Craig J. Cerny, President................. $ 73,077 $35,000 16,000 $11,058(3)
</TABLE>
- - - ------------
(1) Does not include amounts attributable to miscellaneous benefits received by
Mr. Cerny. The costs to the Company of providing such benefits to Mr. Cerny
during the year ended June 30, 1995 did not exceed the lesser of $50,000 or
10% of the total of annual salary and bonus reported.
(2) Adjusted to take into consideration a four-for-one stock split with respect
to the Common Stock effective in October 1994 and a two-for-one stock split
effective in October 1995. Consists of stock options granted in August 1994,
which options were exercised in December 1995.
(3) Comprised of $6,000 of Bank director fees and $5,058 in contributions
pursuant to the Bank's Profit Sharing Plan. See "--The Bank--Profit Sharing
Plan.'
The following table discloses the total options granted to the executive
officer named in the Summary Compensation Table during the year ended June 30,
1995.
<TABLE>
<CAPTION>
% OF TOTAL POTENTIAL REALIZABLE VALUE
NUMBER OF OPTIONS AT ASSUMED ANNUAL RATES
OPTIONS GRANTED TO EXERCISE OF STOCK PRICE
NAME GRANTED EMPLOYEES(1) PRICE(2) EXPIRATION DATE APPRECIATION(3)
- - - ------------------------- --------- ------------ -------- ----------------- ---------------------------
<S> <C> <C> <C> <C> <C> <C>
5% 10%
Craig J. Cerny........... 16,000 39.0% $5.625 December 31, 1995 -- --
</TABLE>
- - - ------------
(1) Percentage of options granted to all employees and directors during fiscal
1995.
(2) The exercise price of the options varied depending upon when the options
were exercised. All options exercised after December 31, 1994 had an
exercise price of $5.625.
(3) The options would be considered out-of-the-money at the end of their term
based upon the book value of the Common stock at June 30, 1995.
The following table sets forth, with respect to the executive officer named
in the Summary Compensation Table, information with respect to the aggregate
amount of options exercised during the last fiscal year, any value realized
thereon, the number of unexercised options at the end of the fiscal year
(exercisable and unexercisable) and the value with respect thereto under
specified assumptions.
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN THE MONEY OPTIONS AT
SHARES OPTIONS AT FISCAL YEAR END JUNE 30, 1995
ACQUIRED ON VALUE --------------------------- ------------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE(3)
- - - ------------------------------ ----------- -------- ----------- ------------- ----------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Craig J. Cerny................ -- -- 16,000(1) 16,000(2) -- --(3)
</TABLE>
- - - ------------
(1) Such options were exercised in full on December 31, 1995 at $5.625 per
share.
(2) Exercisable between December 15, 1997 and January 15, 1998 at $7.50 per
share.
(3) The options were considered out-of-the-money based upon the book value of
the Common Stock at June 30, 1995.
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<PAGE>
TRANSACTIONS WITH CERTAIN RELATED PERSONS
Under applicable federal law, loans or extensions of credit to executive
officers and directors must be made on substantially the same terms, including
interest rates and collateral, as those prevailing at the time for comparable
transactions with the general public and must not involve more than the normal
risk of repayment or present other unfavorable features.
The Bank's policy provides that all loans made by the Bank to its directors
and officers are made in the ordinary course of business, on substantially the
same terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with other persons. The Bank's policy provides
that such loans may not involve more than the normal risk of collectibility or
present other unfavorable features. As of December 31, 1995, mortgage and
consumer loans to employees in excess of $60,000 aggregated $74,000 or 0.7% of
the Company's consolidated stockholders' equity as of such date. All such loans
were made by the Bank in accordance with the aforementioned policy.
The Bank entered into an Investment Advisory Agreement with Smith Breeden
dated as of April 1, 1992, as amended on March 1, 1995. Under the terms of the
agreement, the Bank appointed Smith Breeden as investment advisor with respect
to the management of the Bank's portfolio of investments and its asset and
liability management strategies (the "Account"). Specifically, Smith Breeden
advises and consults with the Bank with respect to its investment activities,
including the acquisition of mortgage-backed securities, the use of repurchase
agreement transactions in funding and the acquisition of certain hedging
instruments to reduce the interest rate risk of the Account's investments. Under
the Agreement, Smith Breeden, as agent and attorney-in-fact with respect to the
Account, may (i) buy, sell, exchange and otherwise trade in mortgage-backed
securities or other investments, and (ii) arrange for necessary placement of
orders, execution of transactions, purchases, sales and conveyances with or
through such brokers, dealers, issuers or other persons as Smith Breeden may
select, subject to the approval of the Bank, and establish the price and trade
conditions, including brokerage commissions. For its services, Smith Breeden
receives a monthly fee which is based on the Bank's total consolidated assets
plus unsettled purchases of securities and minus unsettled sales of securities.
Smith Breeden received fees of $114,000, $195,000, $183,000 and $187,000 during
the six months ended December 31, 1995 and fiscal 1995, 1994 and 1993,
respectively, under such agreement. As of December 31, 1995, principals and
affiliates of Smith Breeden beneficially owned 95.3% of the Common Stock of the
Company. See "Beneficial Ownership of Securities."
BENEFICIAL OWNERSHIP OF SECURITIES
As of December 31, 1995, there were 1,991,738 shares of the Company's Common
Stock issued and outstanding and held of record by 25 holders. The following
table sets forth the beneficial ownership of the Common Stock as of December 31,
1995 with respect to (i) each director and executive officer of the Company and
the Bank; (ii) all directors and executive officers of the Company and the Bank
as a group, and (iii) other stockholders of the Company affiliated with Smith
Breeden. Other than as indicated in the table below, no stockholder of the
Company owns 5% or more of the Common Stock.
87
<PAGE>
The address for all directors and officers of the Company and the Bank is
Harrington Financial Group, Inc., 7300 College Boulevard, Suite 430, Overland
Park, Kansas 66210.
<TABLE>
<CAPTION>
ESTIMATED
OWNERSHIP PRIOR OWNERSHIP AFTER
TO THE OFFERING(1) THE OFFERING(1)(3)
--------------------- STOCK ---------------------
NAME OF BENEFICIAL OWNER SHARES PERCENT OPTIONS(2) SHARES PERCENT
- - - ---------------------------------------- --------- ------- ---------- --------- -------
<S> <C> <C> <C> <C> <C>
COMPANY DIRECTORS AND OFFICERS
Douglas T. Breeden*.................... 1,125,668(4) 56.5% 16,000 1,335,256 43.2%
Craig J. Cerny*........................ 235,760 11.8 16,000 245,760 8.0
Michael J. Giarla*..................... 150,760 7.6 8,000 200,760 6.5
Stephen A. Eason*...................... 90,706 4.6 8,000 120,706 3.9
William F. Quinn*...................... 68,040 3.4 6,000 77,540 2.5
Daniel C. Dektar*...................... 51,928 2.6 8,000 56,928 1.8
Lawrence E. Golaszewski*............... 58,064 2.9 8,000 63,064 2.0
Gerald J. Madigan*..................... 55,040 2.8 8,000 55,040 1.8
Stanley J. Kon......................... 6,388 0.3 8,000 9,924 0.3
John J. McConnell...................... 2,000 0.1 8,000 3,092 0.1
David F. Harper........................ 2,000 0.1 6,000 3,092 0.1
Catherine A. Habschmidt................ 6,884 0.4 4,000 9,084 0.3
BANK DIRECTORS AND OFFICERS
Merrill W. Baxter...................... 2,000 0.1 4,000 3,092 0.1
James C. Stapleton..................... 6,884 0.3 4,000 8,284 0.3
Daniel Haglund......................... 3,388 0.2 -- 5,388 0.2
All directors and officers of the
Company and the Bank as a group (15
persons)................................ 1,865,510 93.7 112,000 2,197,010 71.1
OTHER STOCKHOLDERS AFFILIATED WITH SMITH
BREEDEN
John C. Appel*......................... 31,984 1.6 4,000 31,984 1.0
John B. Sprow*......................... 11,112 0.6 6,000 11,112 0.4
Timothy D. Rowe*....................... 11,112 0.6 6,000 18,612 0.6
Michael L. Bamburg*.................... 5,556 0.3 6,000 9,556 0.3
Carl D. Bell*.......................... 3,000 0.1 -- 3,000 0.1
Other Smith Breeden affiliates as a
group (5 persons).................. 62,764 3.2 22,000 74,264 2.4
Total Smith Breeden affiliates as a
group (13 persons)..................... 1,898,730 95.3 100,000 2,229,318 72.1
</TABLE>
- - - ------------
* Represents a Smith Breeden director, principal or officer.
(1) Based upon information furnished by the respective individuals. Under
regulations promulgated pursuant to the Securities Exchange Act of 1934, as
amended ("Exchange Act"), shares are deemed to be beneficially owned by a
person if he or she directly or indirectly has or shares (i) voting power,
which includes the power to vote or to direct the voting of the shares, or
(ii) investment power, which includes the power to dispose or to direct the
disposition of the shares. Unless otherwise indicated, the named beneficial
owner has sole voting and dispositive power with respect to the shares.
(2) Stock options have been granted for an aggregate of 137,200 shares of Common
Stock, all of which are exercisable between December 15, 1997 and January
15, 1998 at $7.50 per share. Does not reflect any options to be granted
pursuant to the Stock Option Plan. See "Management-- Benefits--Stock Option
Plan."
(3) Assumes no exercise of the Underwriters' over-allotment option.
(4) An aggregate of 726,710 shares of Common Stock owned by Mr. Breeden have
been pledged to secure repayment of certain indebtedness. See
"Business--Sources of Funds--Borrowings."
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SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offering, the Company will have outstanding 3,091,738
shares of Common Stock (3,256,738 if the Underwriters' over-allotment option is
fully exercised). The 1,100,000 Shares being offered hereby (1,265,000 Shares if
the Underwriters' over-allotment option is fully exercised) will be freely
tradeable without restriction or further registration under the Securities Act
of 1933, as amended (the "Act"), except for shares purchased by "affiliates" of
the Company. The 1,991,738 outstanding shares of Common Stock which were issued
and sold by the Company in private transactions prior to the Offering are
"restricted securities" within the meaning of Rule 144 ("Rule "144") of the SEC.
Consequently, such shares may not be resold unless they are registered under the
Act or sold pursuant to an applicable exemption from registration, such as Rule
144.
In general, under Rule 144 as currently in effect, a shareholder (or
shareholders whose shares are aggregated) who has beneficially owned
"restricted" shares for at least two years or an affiliate is entitled to sell
within any three-month period a number of shares that does not exceed the
greater of (i) one percent of the then outstanding shares or (ii) the average
weekly trading volume of the shares reported through the Nasdaq Stock Market
during the four calendar weeks preceding the date on which notice of the sale is
filed with the SEC. Sales under Rule 144 are subject to certain manner of sale
provisions, notice requirements and the availability of current public
information about the Company. A shareholder who is not deemed an affiliate of
the Company at any time during the 90 days preceding a sale, and who has
beneficially owned his or her shares for a least three years, is entitled to
sell such shares under Rule 144 without regard to volume limitations, manner of
sale provisions, notice requirements or the availability of current public
information concerning the Company.
The Company has granted stock options for an aggregate of 137,200 shares of
Common Stock to directors and officers of the Company and the Bank and
affiliates of Smith Breeden, which are exercisable between December 15, 1997 and
January 15, 1998. Shares acquired upon the exercise of these options will be
"restricted securities" subject to the resale provisions of Rule 144, as
described above, except for any such shares registered under the Securities Act
if held by non-affiliates of the Company. The Company has also reserved for
issuance 110,000 shares of common stock under the Stock Option Plan. The Company
intends to file a registration statement on Form S-8 under the Securities Act to
register the 110,000 shares issuable under the Stock Option Plan. Any such
shares issued upon exercise of such stock options by non-affiliates will, after
the effective date of such registration statement, generally be available for
sale in the open market.
The Company, its ESOP, and its directors and executive officers and certain
other affiliates of Smith Breeden, who collectively will own 2,278,274 shares of
Common Stock after the Offering (73.7% of the outstanding shares of Common Stock
following the Offering) have agreed that they will not sell any shares owned by
them without the prior written consent of the Underwriters for a period of 180
days from the date of this Prospectus (the "Lockup Period"). Following the
expiration of the Lockup Period, such shares will be available for sale in the
public market subject to compliance with Rule 144. See "Underwriting."
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DESCRIPTION OF CAPITAL STOCK
GENERAL
The Company is authorized to issue 15,000,000 shares of capital stock, of
which 10,000,000 are shares of Common Stock, par value $0.125 per share, and
5,000,000 are shares of preferred stock, par value $1.00 per share. The Company
will issue up to a maximum of 1,265,000 shares of Common Stock (assuming full
exercise of the Underwriters' over-allotment option) and no shares of preferred
stock in the Offering. Each Share will have the same relative rights as, and
will be identical in all respects with, each other share of Common Stock.
Neither the Amended and Restated Articles of Incorporation ("Articles") nor
Amended and Restated Bylaws ("Bylaws") of the Company contain a restriction on
the issuance of shares of capital stock to directors, officers or controlling
persons of the Company. Thus, stock-related compensation plans could be adopted
by the Company without shareholder approval and shares of Company capital stock
could be issued directly to directors, officers or controlling persons without
shareholder approval. The Bylaws of the National Association of Securities
Dealers, Inc., however, generally require corporations with securities which are
quoted on the Nasdaq Stock Market to obtain shareholder approval of most stock
compensation plans for directors, officers and key employees of the corporation.
Moreover, although generally not required, shareholder approval of stock-related
compensation plans may be sought in certain instances in order to qualify such
plans for favorable federal income tax and securities law treatment under
current laws and regulations.
THE COMMON STOCK OF THE COMPANY DOES NOT REPRESENT NONWITHDRAWABLE CAPITAL,
IS NOT AN ACCOUNT OF AN INSURABLE TYPE, AND IS NOT INSURED BY THE FDIC.
COMMON STOCK
Dividends. The Company has never paid a dividend and is presently prohibited
from paying any dividends on its Common Stock under the terms of an outstanding
loan facility with an unrelated financial institution. While the Company will be
permitted to pay dividends on the Common Stock following consummation of the
Offering in an amount equal to up to 35% of the Company's average consolidated
earnings for the prior four quarters (see "Business--Sources of
Funds--Borrowings"), the Company does not expect to pay a dividend on its Common
Stock following the Offering. Rather, the Company intends to retain earnings and
increase capital in furtherance of its overall business objectives. See
"Dividends and Market for Common Stock." The holders of Common Stock of the
Company will be entitled to receive and share equally in such dividends as may
be declared by the Board of Directors of the Company out of funds legally
available therefor. If the Company issues preferred stock, the holders thereof
may have a priority over the holders of the Common Stock with respect to
dividends.
Voting Rights. The holders of Common Stock of the Company possess exclusive
voting rights in the Company. They elect the Company's Board of Directors and
act on such other matters as are required to be presented to them under Indiana
law or the Company's Articles or as are otherwise presented to them by the Board
of Directors. Except as discussed in "Restrictions on Acquisition of the
Company," each holder of Common Stock will be entitled to one vote per share and
will not have any right to cumulate votes in the election of directors. Although
there are no present plans to do so, if the Company issues preferred stock,
holders of the preferred stock may also possess voting rights.
Liquidation. In the event of any liquidation, dissolution or winding up of
the Bank, the Company, as the sole holder of the Bank's capital stock, would be
entitled to receive, after payment or provision for payment of all debts and
liabilities of the Bank (including all deposit accounts and accrued interest
thereon), all assets of the Bank available for distribution. In the event of any
liquidation, dissolution or winding up of the Company, the holders of its Common
Stock would be entitled to receive, after payment or provision for payment of
all its debts and liabilities, all of the assets of the Company available for
distribution. If preferred stock is issued, the holders thereof may have a
priority over the holders of the Common Stock in the event of liquidation or
dissolution.
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Preemptive Rights. Holders of the Common Stock of the Company will not be
entitled to preemptive rights with respect to any shares which may be issued in
the future. The Common Stock is not subject to redemption.
PREFERRED STOCK
None of the shares of the Company's authorized preferred stock has been
issued. Such stock may be issued with such preferences and designations as the
Board of Directors may from time to time determine. The Board of Directors can,
without stockholder approval, issue preferred stock with voting, dividend,
liquidation and conversion rights as it may deem appropriate in the
circumstances.
RESTRICTIONS ON ACQUISITION OF THE COMPANY
Restrictions in the Company's Articles and Bylaws. A number of provisions of
the Company's Articles and Bylaws deal with matters of corporate governance and
certain rights of stockholders. The following discussion is a general summary of
certain provisions of the Company's Articles and Bylaws which might be deemed to
have a potential "anti-takeover" effect. Reference should be made in each case
to such Articles and Bylaws, which are incorporated herein by reference. See
"Additional Information" as to how to obtain a copy of these documents.
Board of Directors. The Articles of the Company contain provisions relating
to the Board of Directors and provide, among other things, that the Board of
Directors shall be divided into three classes as nearly equal in number as
possible with the term of office of one class expiring each year. See
"Management." Cumulative voting in the election of directors is prohibited.
Directors may be removed only with cause at a duly constituted meeting of
stockholders called expressly for that purpose. Any vacancy occurring in the
Board of Directors for any reason (including an increase in the number of
authorized directors) may be filled by the affirmative vote of a majority of the
Directors then in office, though less than a quorum of the Board, or by the sole
remaining director, and a director appointed to fill a vacancy shall serve for
the remainder of the term to which the director has been elected, and until his
successor has been elected and qualified.
The Bylaws govern nominations for election to the Board, and provide that
nominations for election to the Board of Directors may be made by the nominating
committee of the Board of Directors or by a stockholder eligible to vote at an
annual meeting of stockholders who has complied with specified notice
requirements. Written notice of a stockholder nomination must be delivered to,
or mailed to and received at, the Company's principal executive offices not
later than ninety days prior to the anniversary date of the mailing of proxy
materials by the Company in connection with the immediately preceding annual
meeting and, with respect to an election to be held at a special meeting of
stockholders, no later than the close of business on the tenth day following the
date on which notice of such meeting is first given to stockholders.
Limitation of Liability. The Company's Articles provide that a director of
the Company shall not be personally liable for monetary damages for any action
taken or any failure to take any action as a director except to the extent that
by law a director's liability for monetary damages may not be limited. The
Indiana Business Corporation Law ("IBCL") currently provides that directors (but
not officers) of corporations that have adopted such a provision will not be so
liable, unless (i) the director has breached or failed to perform the duties of
the director's office in compliance with that section, and (ii) the breach or
failure to perform constitutes willful misconduct or recklessness.
Indemnification of Directors, Officers, Employees and Agents. The Company's
Articles provide that the Company shall indemnify any person who was or is a
party or is threatened to be made a party to any threatened, pending or
completed action, suit or proceeding, except actions by or in right of the
Company, whether civil, criminal, administrative or investigative, by reason of
the fact that such person is or was a director, officer, employee or agent of
the Company against expenses (including attorneys' fees), judgments, fines and
amounts paid in settlement actually and reasonably incurred by such person in
connection with such action, suit or proceeding to the fullest extent authorized
by the IBCL, provided
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that no indemnification shall be made to or on behalf of any individual if a
judgment or final adjudication establishes that his or her acts or omissions (i)
were in breach of his or her fiduciary duty of loyalty to the Company or its
stockholders, (ii) were not in good faith or involved a knowing violation of
law, or (iii) resulted in the receipt of an improper personal benefit. The
Company's Articles also provide that reasonable expenses incurred by a director,
officer, employee or agent of the Company in defending any civil, criminal, suit
or proceeding described above shall be paid by the Company in advance of the
final disposition of such action, suit or proceeding to the full extent
permitted under Indiana law.
Special Meetings of Stockholders and Stockholder Proposals. The Company's
Bylaws provide that special meetings of the Company's stockholders, for any
purpose or purposes, may be called by the Chairman of the Board, the President,
the affirmative vote of a majority of the Board of Directors then in office or
the Secretary upon the written request of the holders of not less than 75% of
the shares of capital stock of the Company entitled to vote at that meeting.
Only such business as shall have been properly brought before an annual meeting
of stockholders shall be conducted at the annual meeting. In order to be
properly brought before an annual meeting, business must either be brought
before the meeting by or at the direction of the Board of Directors or otherwise
by a stockholder who has given timely notice thereof (along with specified
information) in writing to the Company. For stockholder proposals to be included
in the Company's proxy materials, the stockholder must comply with all the
timing and informational requirements of Rule 14a-8 of the Exchange Act. With
respect to stockholder proposals to be considered at the annual meeting of
stockholders but not included in the Company's proxy materials, the
stockholder's notice must be delivered to or mailed and received at the
principal executive offices of the Company not later than 90 days prior to the
anniversary date of the mailing of proxy materials by the Company in connection
with the immediately preceding annual meeting.
Amendment of Certificate of Incorporation and Bylaws. The Company's Articles
generally provide that any amendment of the Articles must be first approved by a
majority of the Board of Directors and, to the extent required by law, then by
the holders of a majority of the shares of the Company entitled to vote in an
election of directors, except that the approval of 75% of the shares of the
Company entitled to vote in an election of directors is required for any
amendment to Articles V (directors), VIII (meetings of stockholders and bylaws),
IX (limitation on liability of directors and officers and indemnification) and X
(amendment), unless any such proposed amendment is approved by a vote of 80% of
the Board of Directors then in office. The Articles also provide, consistent
with the IBCL, that the Bylaws of the Company may be amended only by a majority
of the Board of Directors then in office.
Other Restrictions on Acquisition of the Company. Several provisions of the
IBCL could affect the acquisition of Common Stock or control of the Company.
Chapter 43 of the IBCL prohibits, without advance approval by the Board,
business combinations between corporations such as the Company and any ten
percent stockholder for five years following the date on which the person became
a ten percent stockholder. If such prior approval is not obtained, several price
and procedural requirements must be satisfied before a business combination can
be completed.
In addition, the IBCL contains provisions designed to assure that minority
stockholders have a voice in determining their future relationship with such
corporations in the event that a person makes a tender offer for, or otherwise
acquires, shares giving the acquiror more than 20.0%, 331/3%, and 50.0% of the
outstanding voting securities of the corporation (the "Control Share Acquisition
Statute"). If the Control Share Acquisition Statute applies, control shares
acquired in a control share acquisition may be subject to redemption at their
fair value if such shares are not accorded voting rights by the corporation's
stockholders at a special meeting. In addition, in the event control shares
acquired in a control share acquisition are accorded full voting rights and the
acquiring person has acquired control shares with a majority or more of the
voting power, all shareholders of the corporation will have dissenters' rights
and will be able to receive the fair value of their shares, as defined.
The Change in Bank Control Act provides that no person, acting directly or
indirectly or through or in concert with one or more other persons, may acquire
control of a savings association unless the
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OTS has been given 60 days' prior written notice. The HOLA provides that no
company may acquire "control" of a savings association without the prior
approval of the OTS. Any company that acquires such control becomes a savings
and loan holding company subject to registration, examination and regulation by
the OTS.
UNDERWRITING
The Underwriters named below, represented by Stifel, Nicolaus & Company,
Incorporated and NatCity Investments, Inc. (the "Underwriters"), have severally
agreed, subject to the terms and conditions contained in the Underwriting
Agreement, the form of which is filed as an exhibit to the Registration
Statement of which this Prospectus is a part, to purchase from the Company the
number of Shares indicated below opposite their respective names at the initial
offering price less the underwriting discount set forth on the cover page of
this Prospectus; provided, however, that with respect to 350,000 Shares expected
to be purchased by the Company's officers, directors, existing stockholders and
ESOP and principals of Smith Breeden (the "Affiliate Shares"), the underwriting
discount shall be $0.35 per share. The Underwriting Agreement provides that the
obligations of the Underwriters are subject to certain conditions precedent, and
that the Underwriters are committed to purchase all of such Shares, if any are
purchased.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS SHARES
- - - ---------------------------------------------------------------- ---------
<S> <C>
Stifel, Nicolaus & Company, Incorporated........................ 715,000
NatCity Investments, Inc........................................ 385,000
---------
Total..................................................... 1,100,000
---------
---------
</TABLE>
The Underwriters have advised the Company that the Underwriters propose
initially to offer the Shares to the public on the terms set forth on the cover
page of this Prospectus. The Underwriters may allow to selected dealers a
concession of not more than $0.315 per Share, and the Underwriters may allow,
and such dealers may reallow, a concession of not more than $0.10 to certain
other dealers. After the initial Offering, the offering price and other selling
terms may be changed by the Underwriters. No reduction in such terms shall
change the amount of proceeds to be received by the Company as set forth on the
cover page of this Prospectus. The Shares are offered subject to receipt and
acceptance by the Underwriters, and to certain other conditions, including the
right to reject an order in whole or in part.
The Company has granted an option to the Underwriters, exercisable once
during the 30-day period after the date of this Prospectus, to purchase up to a
maximum of 165,000 additional Shares to cover over-allotments, if any, at the
same price per Share as the initial 1,100,000 Shares to be purchased by the
Underwriters (exclusive of the Affiliate Shares). To the extent that the
Underwriters exercise this option, the Underwriters will be committed, subject
to certain conditions, to purchase such additional Shares. The Underwriters may
purchase such Shares only to cover over-allotments made in connection with the
Offering.
The Underwriting Agreement provides that the Company will indemnify the
Underwriters against certain liabilities, including civil liabilities under the
Act, or will contribute to the payments the Underwriters may be required to make
in respect thereof.
The Company and its directors and executive officers and certain other
shareholders have agreed not to offer, sell or otherwise dispose of any shares
of the Common Stock, with certain limited exceptions, for a period of 180 days
after the date of this Prospectus without the prior written consent of the
Underwriters.
Prior to the Offering, there has been no public market for the Shares.
Consequently, the initial public offering price was determined by negotiations
among the Company and the Underwriters. Among the factors considered in such
negotiations were the history of, and the prospects for, the
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<PAGE>
Company and the industry in which it competes, an assessment of the Company's
management, the Company's past and present operations, its past and present
earnings and the trend of such earnings, the prospects for future earnings of
the Company, the present state of the Company's development, the general
condition of the securities markets at the time of the Offering and the market
prices of publicly traded common stocks of comparable companies in recent
periods.
The Shares have been approved for listing on the NASDAQ Stock Market under
the symbol "HFGI."
LEGAL MATTERS
The validity of the Common Stock being offered hereby will be passed upon
for the Company by Elias, Matz, Tiernan & Herrick L.L.P., Washington, D.C., and
for the Underwriters by Vedder, Price, Kaufman & Kammholz, Chicago, Illinois.
EXPERTS
The Consolidated Financial Statements of the Company as of June 30, 1995 and
for the year ended June 30, 1995, included in this Prospectus have been audited
by Deloitte & Touche LLP, independent auditors, as stated in their report
appearing herein and elsewhere in the Registration Statement, and have been so
included in reliance upon the report of such firm given upon their authority as
experts in accounting and auditing. The Consolidated Financial Statements of the
Company as of June 30, 1994 and for each of the years in the two-year period
ended June 30, 1994, have been included herein in reliance upon the report of
Geo. S. Olive & Co. LLC, independent certified public accountants, which appears
elsewhere in this Prospectus, and upon the authority of said firm as experts in
accounting and auditing.
Following completion of the audit on the Consolidated Financial Statements
for the year ended June 30, 1994, the Company dismissed Geo. S. Olive & Co. LLC,
and engaged Deloitte & Touche LLP, effective June 29, 1995. The change in
accountants was recommended by the Board of Directors of the Company. For the
fiscal years ended June 30, 1994 and 1993, the independent auditor's reports
with respect to the Company's consolidated financial statements neither
contained an adverse opinion or a disclaimer of opinion, nor were such reports
qualified or modified as to uncertainty, audit-scope or accounting principles.
For the fiscal years ended June 30, 1994 and 1993 and up to the date of the
discontinuation of services of Geo. S. Olive & Co. LLC, there were no
disagreements with Geo. S. Olive & Co. LLC, on any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedure which, if not resolved to the satisfaction of Geo. S. Olive & Co. LLC,
would have caused it to make a reference to the subject matter of the
disagreement in connection with its reports. During that period, the Company did
not consult with Deloitte & Touche LLP regarding either (i) the application of
accounting principles to a specific transaction, either completed or proposed,
or the type of audit opinion that might be rendered on the Company's financial
statements or (ii) any other matter that would be required to be reported
herein.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Company's Common Stock is American
Stock Transfer & Trust Co., New York, New York.
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ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-1 (the "Registration Statement", which term shall encompass any amendments
thereto) under the Act with respect to the Shares offered hereby. This
Prospectus does not contain all of the information set forth in the Registration
Statement and the exhibits and schedules thereto and reference is made to the
Registration Statement and exhibits and schedules filed therewith. Each
statement made in this Prospectus referring to a document filed as an exhibit to
the Registration Statement is qualified by reference to the exhibit for a
complete statement of its terms and conditions. Any interested party may inspect
the Registration Statement without charge at the offices of the Commission at
450 Fifth Street, N.W., Washington, D.C. 20549 and at the Commission's Regional
Offices at Northwestern Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661 and 7 World Trade Center, Suite 1300, New York, New York
10048, and copies of all or any part of the Registration Statement may be
obtained from the Public Reference Section of the Commission upon payment of the
prescribed fee.
The Company has not previously been subject to the reporting requirements of
the Exchange Act. In connection with the sale of the Shares hereunder, the
Company has registered the Common Stock with the Commission under Section 12(g)
and the Company (and the holders of its Common Stock) has become subject to the
proxy solicitation rules, reporting requirements and restrictions on stock
purchases and sales by directors, officers and greater than 10% stockholders,
the annual and periodic reporting and certain other requirements of the Exchange
Act. Reports, proxy statements, and other information filed by the Company under
the Exchange Act may be inspected and copied at prescribed rates at the public
reference facilities of the Commission at the addresses set forth above. In
addition, such reports, proxy statements and other information concerning the
Company will also be available for inspection at the National Association of
Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006.
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report.......................................................... F-1
Independent Auditors' Report.......................................................... F-2
Consolidated Balance Sheets as of December 31, 1995 (unaudited) and as of June 30,
1995 and 1994....................................................................... F-3
Consolidated Statements of Income for the six months ended December 31, 1995 and 1994
(unaudited) and for the years ended June 30, 1995, 1994 and 1993...................... F-4
Consolidated Statements of Changes in Stockholders' Equity for the six months ended
December 31, 1995 and 1994 (unaudited) and for the years ended June 30, 1995, 1994
and 1993.............................................................................. F-5
Consolidated Statements of Cash Flows for the six months ended December 31, 1995 and
1994 (unaudited) and for the years ended June 30, 1995, 1994 and 1993................. F-6
Notes to Consolidated Financial Statements............................................ F-8
</TABLE>
All financial statement schedules are omitted because the required
information either is not applicable or is shown in the financial statements or
in the notes thereto.
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INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Harrington Financial Group, Inc.:
We have audited the accompanying consolidated balance sheet of Harrington
Financial Group, Inc. and its subsidiary (the "Company") as of June 30, 1995,
and the related consolidated statement of income, changes in stockholders'
equity and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit 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 audit provides 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 Harrington
Financial Group, Inc. and its subsidiary as of June 30, 1995, and the results of
their operations and their cash flows for the year then ended, in conformity
with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Indianapolis, Indiana
September 8, 1995
(February 5, 1996 as to Note 19)
F-1
<PAGE>
[LOGO]
INDEPENDENT AUDITOR'S REPORT
Board of Directors
Harrington Financial Group, Inc.
Richmond, Indiana
We have audited the accompanying consolidated balance sheet of Harrington
Financial Group, Inc. (formerly Financial Research Corporation) and subsidiary
as of June 30, 1994, and the related consolidated statements of income, changes
in stockholders' equity and cash flows for the years ended June 30, 1994 and
1993. 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 consolidated financial position of
Harrington Financial Group, Inc. and subsidiary as of June 30, 1994, and the
results of their operations and cash flows for the years ended June 30, 1994 and
1993, in conformity with generally accepted accounting principles.
As discussed in the notes to the consolidated financial statements, the
Company changed its method of accounting for income taxes in 1994 and effective
June 30, 1993 adopted Statement of Financial Accounting Standards No. 115,
Accounting for Certain Investments in Debt and Equity Securities.
/s/ Geo. S. Olive & Co. LLC
Richmond, Indiana
August 9, 1994
F-2
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
------------ ----------------------------
ASSETS 1995 1995 1994
------------ ------------ ------------
<S> <C> <C> <C>
(UNAUDITED)
Cash.............................................. $ 972,204 $ 773,355 $ 748,100
Interest-bearing deposits (Note 13)............... 9,956,850 4,932,172 9,657,041
------------ ------------ ------------
Total cash and cash equivalents............... 10,929,054 5,705,527 10,405,141
Securities held for trading--at market value
(amortized cost of $225,645,696, $244,487,677
and $170,210,235)
(Notes 2, 8, 13)................................ 230,342,696 246,732,677 170,920,235
Securities available for sale--at market value
(amortized cost of $2,283,071, $2,443,504 and
$3,427,213)
(Note 2)........................................ 2,286,071 2,540,504 3,427,213
Loans receivable (net of allowance for loan losses
of $120,130, $120,870 and $105,651) (Note 3).... 55,909,807 37,009,729 20,682,019
Interest receivable, net (Note 4)................. 1,192,153 1,353,449 1,312,400
Premises and equipment, net (Note 5).............. 2,864,210 2,392,078 2,156,345
Federal Home Loan Bank of Indianapolis stock--at
cost.............................................. 2,500,000 2,500,000 1,843,400
Accrued income taxes receivable................... 904,885
Other............................................. 476,152 1,939,652 941,463
------------ ------------ ------------
TOTAL ASSETS...................................... $307,405,028 $300,173,616 $211,688,216
------------ ------------ ------------
------------ ------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (Note 6)................................. $114,813,717 $115,311,998 $108,300,346
Securities sold under agreements to repurchase
(Note 7).......................................... 141,448,115 130,216,865 54,650,713
Federal Home Loan Bank advances (Note 8).......... 26,000,000 31,000,000 31,000,000
Interest payable.................................. 1,939,568 1,691,772 1,474,941
Note payable (Note 9)............................. 9,520,713 9,200,000 7,880,000
Advance payments by borrowers for taxes and
insurance......................................... 360,704 263,960 155,451
Deferred income taxes, net (Note 10).............. 1,790,229 1,575,597 866,484
Accrued income taxes payable (Note 10)............ 195,115 448,913
Deferred compensation payable (Note 12)........... 135,549 152,571 189,012
Accrued expenses payable and other liabilities.... 387,088 205,057 796,778
------------ ------------ ------------
Total liabilities............................. 296,395,683 289,812,935 205,762,638
------------ ------------ ------------
COMMITMENTS AND CONTINGENCIES
(Notes 13, 14, 16)
STOCKHOLDERS' EQUITY (Notes 10, 11, 12,
16, 19):
Preferred Stock ($1 par value) Authorized and
unissued--5,000,000 shares
Common Stock:
Voting ($.125 par value) Authorized--10,000,000
shares issued and outstanding 1,991,738,
1,961,626 and 1,412,384....................... 248,967 245,203 176,548
Additional paid-in capital........................ 4,343,830 4,182,518 1,730,258
Unrealized gain on securities available for sale,
net of deferred taxes of $1,110 and $35,890
(Note 1).......................................... 1,890 61,110
Retained earnings................................. 6,414,658 5,871,850 4,018,772
------------ ------------ ------------
Total stockholders' equity.................... 11,009,345 10,360,681 5,925,578
------------ ------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $307,405,028 $300,173,616 $211,688,216
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, YEARS ENDED JUNE 30,
----------------------- ---------------------------------------
1995 1994 1995 1994 1993
---------- ---------- ----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
INTEREST INCOME:
Securities held for trading..................... $9,141,608 $6,437,521 $14,423,866 $12,875,018
Securities available for sale................... 101,573 130,288 250,233 310,669 $12,723,130
Loans receivable (Note 3)....................... 1,934,245 946,758 2,223,486 1,777,890 2,075,236
Dividends on Federal Home Loan Bank of
Indianapolis stock............................. 100,822 59,241 151,974 107,490 194,254
Deposits........................................ 388,426 267,369 603,045 415,286 397,621
Net interest expense on interest rate contracts
maintained in the trading portfolio and for
1993 the available for sale portfolio (Note
13)............................................. (113,783) (418,121) (92,818) (1,879,714) (2,644,388)
---------- ---------- ----------- ----------- -----------
11,552,891 7,423,056 17,559,786 13,606,639 12,745,853
---------- ---------- ----------- ----------- -----------
INTEREST EXPENSE:
Deposits (Notes 6, 13).......................... 3,517,793 2,833,699 6,654,482 4,515,809 4,938,626
Federal Home Loan Bank advances (Note 8)........ 875,591 777,183 1,721,746 1,057,438 803,480
Short-term borrowings (Note 7).................. 4,127,487 1,301,428 3,653,456 2,133,304 2,650,036
Long-term borrowings (Note 9)................... 474,825 362,475 748,872 577,181 582,927
---------- ---------- ----------- ----------- -----------
8,995,696 5,274,785 12,778,556 8,283,732 8,975,069
---------- ---------- ----------- ----------- -----------
NET INTEREST INCOME............................. 2,557,195 2,148,271 4,781,230 5,322,907 3,770,784
PROVISION FOR LOAN LOSSES (Note 3).............. (960) 20,746 14,739 (2,707) 66,176
---------- ---------- ----------- ----------- -----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN
LOSSES.......................................... 2,558,155 2,127,525 4,766,491 5,325,614 3,704,608
---------- ---------- ----------- ----------- -----------
OTHER INCOME (LOSS):
Gain (loss) on sale of securities held for
trading (Note 13)............................... (2,621,395) (337,986) 66,108 (2,169,072)
Gain on sale of securities available for sale... 391,804 1,384,055
Unrealized gain on securities held for trading
(Notes 2, 13)................................... 2,452,000 750,000 1,535,000 710,000
Permanent impairment of securities available for
sale (Note 2).................................. (413,906) (609,926) (2,530,709)
Other........................................... 113,896 122,889 237,674 268,326 249,037
---------- ---------- ----------- ----------- -----------
(55,499) 534,903 1,424,876 (1,408,868) (897,617)
---------- ---------- ----------- ----------- -----------
OTHER EXPENSE:
Salaries and employee benefits (Note 12)........ 693,892 582,740 1,294,769 925,107 757,808
Premises and equipment expense (Note 5)......... 214,073 206,858 413,668 331,029 234,733
FDIC insurance premiums......................... 139,628 121,689 259,858 237,665 177,327
Marketing....................................... 94,626 73,611 122,310 135,694 60,776
Computer services............................... 64,825 53,621 111,852 82,549 63,053
Consulting fees (Note 15)....................... 114,180 93,374 194,813 183,435 186,668
Write-off of goodwill and core deposit.......... 663,131
Other........................................... 389,211 351,230 769,600 623,916 605,524
---------- ---------- ----------- ----------- -----------
1,710,435 1,483,123 3,166,870 2,519,395 2,749,020
---------- ---------- ----------- ----------- -----------
INCOME BEFORE INCOME TAX PROVISION AND
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR
DEFERRED INCOME TAXES........................... 792,221 1,179,305 3,024,497 1,397,351 57,971
INCOME TAX PROVISION (Note 10).................. 249,413 409,226 1,171,419 391,011 187,635
---------- ---------- ----------- ----------- -----------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING FOR DEFERRED INCOME TAXES........ 542,808 770,079 1,853,078 1,006,340 (129,664)
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR
DEFERRED INCOME TAXES (Note 10)................ (78,915)
---------- ---------- ----------- ----------- -----------
NET INCOME (LOSS)............................... $ 542,808 $ 770,079 $ 1,853,078 $ 927,425 $ (129,664)
---------- ---------- ----------- ----------- -----------
---------- ---------- ----------- ----------- -----------
EARNINGS PER SHARE (Notes 1, 19):
INCOME PER SHARE BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGE............................... $ 0.28 $ 0.54 $ 1.20 $ 0.72 $ (0.09)
CUMULATIVE EFFECT OF ACCOUNTING CHANGE......... (0.06)
---------- ---------- ----------- ----------- -----------
NET INCOME PER SHARE........................... $ 0.28 $ 0.54 $ 1.20 $ 0.66 $ (0.09)
---------- ---------- ----------- ----------- -----------
---------- ---------- ----------- ----------- -----------
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ADDITIONAL UNREALIZED
SHARES COMMON PAID-IN GAIN RETAINED
FOR THE YEARS ENDED JUNE 30, 1993, 1994 AND 1995: OUTSTANDING STOCK CAPITAL (LOSS) EARNINGS
- - - ------------------------------------------------------ ----------- -------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
BALANCES, JULY 1, 1992................................ 176,548 $176,548 $1,730,258 $3,221,011
Net loss.............................................. (129,664)
Net change in unrealized gain on securities available
for sale............................................ $ 296,100
----------- -------- ---------- ---------- ----------
BALANCES, JUNE 30, 1993............................... 176,548 176,548 1,730,258 296,100 3,091,347
Reclassification of securities available for sale to
securities held for trading......................... (252,000)
Net income............................................ 927,425
Net change in unrealized gain on securities available
for sale............................................ (44,100)
----------- -------- ---------- ---------- ----------
BALANCES, JUNE 30, 1994............................... 176,548 176,548 1,730,258 4,018,772
Stock split 4 for 1................................... 529,644
Issuance of common stock under equity offering (Note
16)................................................... 263,821 65,955 2,354,304
Stock options exercised (Note 12)..................... 10,800 2,700 97,956
Net income............................................ 1,853,078
Net change in unrealized gain on securities available
for sale, net of deferred tax of $35,890............ 61,110
----------- -------- ---------- ---------- ----------
BALANCES, JUNE 30, 1995............................... 980,813 $245,203 $4,182,518 $ 61,110 $5,871,850
----------- -------- ---------- ---------- ----------
----------- -------- ---------- ---------- ----------
<CAPTION>
FOR THE SIX MONTHS ENDED DECEMBER 31, 1994 AND 1995
(UNAUDITED):
- - - ------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCES, JULY 1, 1994................................ 176,548 $176,548 $1,730,258 $4,018,772
Stock split 4 for 1................................... 529,644
Issuance of common stock under equity offering (Note
16)................................................... 72,638 18,160 635,591
Net income............................................ 770,079
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of
$(19,240)............................................. $ (32,760)
----------- -------- ---------- ---------- ----------
BALANCES, DECEMBER 31, 1994 (Unaudited)............... 778,830 $194,708 $2,365,849 $ (32,760) $4,788,851
----------- -------- ---------- ---------- ----------
----------- -------- ---------- ---------- ----------
BALANCES, JULY 1, 1995................................ 980,813 $245,203 $4,182,518 $ 61,110 $5,871,850
Stock split 2 for 1 (Note 19)......................... 980,813
Stock options exercised............................... 30,112 3,764 161,312
Net income............................................ 542,808
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of
$(34,780)............................................. (59,220)
----------- -------- ---------- ---------- ----------
BALANCES, DECEMBER 31, 1995 (Unaudited)............... 1,991,738 $248,967 $4,343,830 $ 1,890 $6,414,658
----------- -------- ---------- ---------- ----------
----------- -------- ---------- ---------- ----------
<CAPTION>
TOTAL
STOCKHOLDERS'
FOR THE YEARS ENDED JUNE 30, 1993, 1994 AND 1995: EQUITY
- - - ------------------------------------------------------ -------------
<S> <C>
BALANCES, JULY 1, 1992................................ $ 5,127,817
Net loss.............................................. (129,664)
Net change in unrealized gain on securities available
for sale............................................ 296,100
-------------
BALANCES, JUNE 30, 1993............................... 5,294,253
Reclassification of securities available for sale to
securities held for trading......................... (252,000)
Net income............................................ 927,425
Net change in unrealized gain on securities available
for sale............................................ (44,100)
-------------
BALANCES, JUNE 30, 1994............................... 5,925,578
Stock split 4 for 1...................................
Issuance of common stock under equity offering (Note
16)................................................... 2,420,259
Stock options exercised (Note 12)..................... 100,656
Net income............................................ 1,853,078
Net change in unrealized gain on securities available
for sale, net of deferred tax of $35,890............ 61,110
-------------
BALANCES, JUNE 30, 1995............................... $ 10,360,681
-------------
-------------
FOR THE SIX MONTHS ENDED DECEMBER 31, 1994 AND 1995
(UNAUDITED):
- - - ------------------------------------------------------
<S> <C>
BALANCES, JULY 1, 1994................................ $ 5,925,578
Stock split 4 for 1...................................
Issuance of common stock under equity offering (Note
16)................................................... 653,751
Net income............................................ 770,079
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of
$(19,240)............................................. (32,760)
-------------
BALANCES, DECEMBER 31, 1994 (Unaudited)............... $ 7,316,648
-------------
-------------
BALANCES, JULY 1, 1995................................ $ 10,360,681
Stock split 2 for 1 (Note 19).........................
Stock options exercised............................... 165,076
Net income............................................ 542,808
Net change in unrealized gain (loss) on securities
available for sale, net of deferred tax of
$(34,780)............................................. (59,220)
-------------
BALANCES, DECEMBER 31, 1995 (Unaudited)............... $ 11,009,345
-------------
-------------
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, YEARS ENDED JUNE 30,
------------------------------ -----------------------------------------------
1995 1994 1995 1994 1993
------------- ------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income (loss)................. $ 542,808 $ 770,079 $ 1,853,078 $ 927,425 $ (129,664)
Adjustments to reconcile net
income to net cash provided by
(used in) operating activities:
Provision for loan losses........ (960) 20,746 14,739 (2,707) 66,176
Depreciation..................... 88,389 88,610 175,828 141,151 114,729
Premium and discount amortization
on securities, net............. 1,064,719 669,697 1,485,314 2,285,913 1,274,074
Amortization of fair value
adjustment of deposits......... 607 4,770
Amortization of premiums and
discounts on loans............. (89,291) 32,873 (131,562) (211,147) (290,599)
Amortization of intangible
assets............................ 724,521
(Gain) loss on sale of securities
held for trading............... 2,621,395 337,986 (66,108) 2,169,072
Gain on sale of securities
available for sale............. (391,804) (1,384,055)
Unrealized gain on securities
held for trading............... (2,452,000) (750,000) (1,535,000) (710,000)
Permanent impairment of
securities available for
sale.............................. 413,906 609,926 2,530,709
Gain on sale of loans held for
sale.............................. (85,122)
Deferred income tax provision.... 249,412 673,223 164,639 222,989
(Increase) decrease in interest
receivable........................ 161,296 52,817 (41,049) 271,314 710,883
Increase in interest payable..... 247,796 404,864 218,683 175,055 326,617
Increase (decrease) in accrued
income taxes................... (1,100,000) (281,025) (253,798) 448,913
Purchases of securities held for
trading........................... (119,781,828) (228,989,445) (510,309,049) (69,425,113)
Proceeds from maturities of
securities held for trading.... 10,832,926 8,295,687 15,797,684 7,809,131
Proceeds from sales of securities
held for trading............... 124,067,837 209,621,285 419,340,058 66,432,973
(Increase) decrease in other
assets............................ 1,463,500 (450,417) (1,510,560) (192,176) 356,007
Increase (decrease) in accrued
expenses.......................... 165,009 (592,762) (641,909) 412,305 (396,989)
Increase (decrease) in other
liabilities....................... 96,744 10,122 123,469 32,568 (44,894)
------------- ------------- ------------- ------------- -------------
Net cash provided by (used
in) operating activities... 18,177,752 (10,758,883) (74,393,053) 10,948,045 4,000,152
------------- ------------- ------------- ------------- -------------
</TABLE>
F-6
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, YEARS ENDED JUNE 30,
------------------------------ -----------------------------------------------
1995 1994 1995 1994 1993
------------- ------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchase of Federal Home Loan Bank
of Indianapolis stock............ $ (656,600)
Purchases of securities available
for sale.......................... $(110,250,745) $(228,262,445)
Proceeds from maturities of
securities available for sale.... $ 231,612 $ 427,148 573,767 24,134,482 39,561,956
Proceeds from sales of securities
available for sale............... 89,100,666 186,171,035
Change in loans receivable, net... (18,844,074) (3,110,622) (16,210,887) (3,822,275) 5,072,851
Purchases of premises and
equipment......................... (560,521) (43,578) (411,560) (470,783) (32,465)
Other investment
activities--increase in purchased
interest.......................... (907,121)
------------- ------------- ------------- ------------- -------------
Net cash provided by (used
in) investing activities... (19,172,983) (2,727,052) (16,705,280) (1,308,655) 1,603,811
------------- ------------- ------------- ------------- -------------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Net (decrease) increase in
deposits.......................... (498,281) 14,450,343 7,011,652 18,511,251 (3,692,403)
Increase (decrease) in securities
sold under agreements to
repurchase........................ 11,231,250 (831,745) 75,566,152 (29,058,574) (33,283,410)
Proceeds from issuance of common
stock under equity offering...... 653,751 2,420,259
Proceeds from stock options
exercised......................... 165,076 100,656
Proceeds from Federal Home Loan
Bank advances.................... 10,000,000 31,000,000
Proceeds from note payable........ 800,000 1,900,000 8,000,000
Principal repayments on Federal
Home Loan Bank advances.......... (15,000,000)
Principal repayments on note
payable........................... (479,287) (400,000) (600,000) (7,630,775) (1,004,000)
------------- ------------- ------------- ------------- -------------
Net cash provided by (used
in) financing activities... 6,218,758 13,872,349 86,398,719 (10,178,098) (6,979,813)
------------- ------------- ------------- ------------- -------------
NET INCREASE (DECREASE) IN CASH
AND EQUIVALENTS................... 5,223,527 386,414 (4,699,614) (538,708) (1,375,850)
CASH AND CASH EQUIVALENTS,
Beginning of period.............. 5,705,527 10,405,141 10,405,141 10,943,849 12,319,699
------------- ------------- ------------- ------------- -------------
CASH AND CASH EQUIVALENTS,
End of period.................... $ 10,929,054 $ 10,791,555 $ 5,705,527 $ 10,405,141 $ 10,943,849
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid for interest........... $ 8,747,900 $ 4,869,921 $ 12,561,725 $ 8,108,677 $ 8,648,452
Cash paid (refunded) for income
taxes............................. 1,100,000 693,000 753,000 (427,057) (360,038)
Non-cash reclassification of
securities from available for
sale to held for trading....... 166,092,000
</TABLE>
See notes to consolidated financial statements.
F-7
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS OF THE COMPANY--Harrington Financial Group, Inc. ("HFG" or the
"Company") is a savings and loan holding company incorporated on March 3, 1988
to acquire and hold all of the outstanding common stock of Harrington Bank, FSB
(the "Bank"), a federally chartered savings bank with principal offices in
Richmond, Indiana and branch locations in Hamilton County, Indiana.
BASIS OF PRESENTATION--The consolidated financial statements include the
accounts of HFG and the Bank. All significant intercompany accounts and
transactions have been eliminated. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
The consolidated balance sheet as of December 31, 1995 and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for the six months ended December 31, 1995 and 1994 are unaudited.
However, in the opinion of management, the interim consolidated financial
statements include all adjustments, which consist of only normal recurring
adjustments, necessary for fair presentation of the Company's financial
statements. The results of operations for the unaudited six month period ended
December 31, 1995, are not necessarily indicative of the results which may be
expected for the entire fiscal year 1996.
CASH AND CASH EQUIVALENTS--All highly liquid investments with an original
maturity of three months or less are considered to be cash equivalents.
SECURITIES HELD FOR TRADING AND AVAILABLE FOR SALE--Effective June 30, 1993,
the Company implemented Statement of Financial Accounting Standards (SFAS) No.
115, Accounting for Certain Investments in Debt and Equity Securities. SFAS No.
115 addresses the accounting and reporting for investments in equity securities
that have readily determinable fair values and all investments in debt
securities. SFAS No. 115 requires these securities to be classified in one of
three categories and accounted for as follows:
. Debt securities that the Company has the positive intent and ability to hold
to maturity are classified as "securities held to maturity" and reported at
amortized cost.
. Debt and equity securities that are acquired and held principally for the
purpose of selling them in the near term with the objective of generating
economic profits on short-term differences in market characteristics are
classified as "securities held for trading" and reported at fair value, with
unrealized gains and losses included in earnings.
. Debt and equity securities not classified as either held to maturity or
trading securities are classified as "securities available for sale" and
reported at fair value, with unrealized gains and losses, after applicable
taxes, excluded from earnings and reported in a separate component of
stockholders' equity. Declines in the value of debt securities and marketable
equity securities that are considered to be other than temporary are recorded
as a permanent impairment of securities available for sale in the statement of
income.
Premiums and discounts are amortized over the contractual lives of the
related securities using the level yield method. Gains or losses on sales of
these securities are based on the specific identification method. The Company
records the balance sheet effects of security transactions on a settlement date
basis, however, unrealized and realized gains and losses from security
transactions are recorded as of the trade date in the statement of income for
the year in which the securities are purchased or sold. Net unsettled security
purchases were approximately $18,100,000 and $10,300,000 as of June 30, 1995 and
1994, respectively.
F-8
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
In implementing SFAS No. 115 on June 30, 1993, the Company designated all of
its securities as available for sale. During fiscal year 1994, the Company
reclassified substantially all of its securities into the trading portfolio. At
the time of reclassification to the trading category from the available for sale
category, gross gains of $7,210,000 and gross losses of $6,958,000 were included
in earnings. The Company's trading portfolio consists of mortgage-backed
securities, mortgage-backed security derivatives, equity securities and interest
rate contracts, which accordingly are carried at market value. Realized and
unrealized changes in market values are recognized in other income in the period
in which the changes occur. Interest income from trading activities are included
in the statement of income as part of net interest income.
The Company's available for sale portfolio consists of municipal bonds and a
non-agency participation certificate.
Management's estimates of fair value of securities are based upon a number
of assumptions such as prepayments which may shorten the life of such
securities. Although prepayments of underlying mortgages depend on many factors,
including the type of mortgages, the coupon rate, the age of 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 generally is the most significant determinant of the rate of
prepayments. While management endeavors to use the best information available in
determining prepayment assumptions, actual results could differ from those
assumptions.
FINANCIAL INSTRUMENTS HELD FOR ASSET AND LIABILITY MANAGEMENT
PURPOSES--Effective June 30, 1995, the Bank adopted the provisions of SFAS No.
119, Disclosure About Derivative Instruments and Fair Value of Financial
Instruments. The statement addresses disclosures of derivative financial
instruments such as futures, forward rate agreements, interest rate swap
agreements, option contracts and other financial instruments with similar
characteristics. SFAS No. 119 requires disclosures about amounts and the nature
and terms of derivative financial instruments regardless of whether they result
in off-balance-sheet risk or accounting loss. The Bank has incorporated the
requirements of this statement in Note 13.
The Bank is party to a variety of interest rate contracts consisting of
interest rate futures, options, caps, swaps, floors and collars in the
management of its interest rate exposure of the trading portfolio. These
financial instruments are included in the trading portfolio and are reported at
market value with realized and unrealized gains and losses on these instruments
recognized in other income (See Note 2).
The Bank enters into certain other interest rate swap agreements as a means
of managing the interest rate exposure of certain inverse variable rate
deposits. These interest rate swaps are accounted for under the accrual method.
Under this method, the differential to be paid or received on these interest
rate swap agreements is recognized over the lives of the agreements in interest
expense. Changes in market value of interest rate swaps accounted for under the
accrual method are not reflected in the accompanying financial statements.
Realized gains and losses on terminated interest rate swaps are deferred as an
adjustment to the carrying amount of the designated instruments and amortized
over the remaining original life of the agreements. If the designated
instruments are disposed of, the fair value of the interest rate swap or
unamortized deferred gains or losses are included in the determination of the
gain or loss on the disposition of such instruments. To qualify for such
accounting, the interest rate swaps are designated to the inverse variable rate
deposits and alter their interest rate characteristics.
F-9
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
LOANS RECEIVABLE are carried at the principal amount outstanding, adjusted
for premiums or discounts which are amortized or accreted using a level-yield
method. The Company adopted SFAS No. 114 and No. 118, Accounting by Creditors
for Impairment of a Loan and Income Recognition and Disclosures, as amended,
effective July 1, 1995. These statements require that impaired loans be measured
based on the present value of future cash flows discounted at the loan's
effective interest rate or the fair value of the underlying collateral, and
specifies alternative methods for recognizing interest income on loans that are
impaired or for which there are credit concerns. For purposes of applying these
standards, impaired loans have been defined as all nonaccrual commercial loans
which have not been collectively evaluated for impairment. The Company's policy
for income recognition was not affected by adoption of these standards. The
adoption of SFAS No. 114 and No. 118 did not have any effect on the total
reserve for credit losses or related provision. At July 1, 1995 and December 31,
1995 the Company had no impaired loans required to be disclosed under SFAS No.
114 and No. 118.
LOAN ORIGINATION FEES--Nonrefundable origination fees net of certain direct
origination costs are deferred and recognized, as a yield adjustment, over the
life of the underlying loan.
ALLOWANCE FOR LOSSES--A provision for estimated losses on loans is charged
to operations based upon management's evaluation of the potential losses. Such
an evaluation, which includes a review of all loans for which full
collectibility may not be reasonably assured, considers, among other matters,
the estimated net realizable value of the underlying collateral, as applicable,
economic conditions, historical loan loss experience and other factors that are
particularly susceptible to changes that could result in a material adjustment
in the near term. While management endeavors to use the best information
available in making its evaluations, future allowance adjustments may be
necessary if economic conditions change substantially from the assumptions used
in making the evaluations.
INTEREST RECEIVABLE--Interest income on securities and loans is accrued
according to the contractual terms of the underlying asset including interest
rate, basis and date of last payment. Income on derivatives of mortgage-backed
securities is recorded based on the median of major brokers' prepayment
assumptions for the underlying securities. The Bank provides an allowance for
the loss of uncollected interest on loans which are more than 90 days past due.
The allowance is established by a charge to interest income equal to all
interest previously accrued, and income is subsequently recognized only to the
extent that cash payments are received until, in management's judgment, the
borrower's ability to make periodic interest and principal payments returns to
normal, in which case the loan is returned to accrual status.
PREMISES AND EQUIPMENT are carried at cost less accumulated depreciation.
Depreciation is computed on the straight-line method over estimated useful lives
ranging from 3 to 40 years. Maintenance and repairs are expensed as incurred
while major additions and improvements are capitalized. Gains and losses on
dispositions are included in current operations.
FEDERAL INCOME TAXES--The Company and its wholly-owned subsidiary file a
consolidated tax return. The Company adopted SFAS No. 109 effective July 1,
1993. The Statement requires, among other things, a change from the deferred
method to the liability method of accounting for deferred income taxes. Deferred
income tax assets and liabilities reflect the impact of temporary differences
between amounts of assets and liabilities for financial reporting purposes and
basis of such assets and liabilities as measured by tax laws and regulations.
F-10
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
INTANGIBLE ASSETS--During 1993, management reevaluated the useful lives of
the core deposit intangible and goodwill recognized in conjunction with HFG's
acquisition of Harrington Bank, FSB and deemed them to have no remaining value
as of June 30, 1993. The remaining balance of goodwill and core deposit
intangible was written off during the year ended June 30, 1993.
EARNINGS PER SHARE--Earnings per share of common stock is based on the
weighted average number of common shares outstanding during the year. The
weighted average number of common shares outstanding was 1,965,652 and 1,427,252
for the six month periods ended December 31, 1995 and 1994, 1,544,080 for fiscal
1995 and 1,412,384 for fiscal 1994 and fiscal 1993, respectively. All per share
information has been restated to reflect the Company's four-for-one stock split
in October 1994 and the Company's two-for-one stock split in October 1995 (see
Note 19).
NEW ACCOUNTING PRONOUNCEMENTS--SFAS No. 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed of, is effective
for fiscal years beginning after December 15, 1995. This statement establishes
accounting standards for the impairment of long-lived assets, certain
liabilities, certain intangibles and goodwill. Management does not believe the
adoption of this statement will have a material effect on the financial position
or results of operations of the Company.
SFAS No. 122, Accounting for Mortgage Servicing Rights an Amendment of FASB
Statement No. 65, is effective for fiscal years beginning after December 15,
1995. This Statement specifies conditions under which mortgage servicing rights
should be accounted for separately from the underlying mortgage loans.
Management does not believe the adoption of this statement will have a material
effect on the financial position or results of operations of the Company.
SFAS No. 123, Accounting for Stock-Based Compensation, was issued in October
1995 and requires adoption no later than fiscal years beginning after December
15, 1995. The new standard defines a fair value method of accounting for stock
options and similar equity instruments. Under the fair value method,
compensation cost is measured at the grant date based on the fair value of the
award and is recognized over the service period, which is usually the vesting
period.
Pursuant to the new standard, companies are encouraged, but not required, to
adopt the fair value method of accounting for employee stock-based transactions.
Companies are also permitted to continue to account for such transactions under
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees", but would be required to disclose in a note to the financial
statements pro forma net income and, if presented, earnings per share as if the
company had applied the new method of accounting.
The accounting requirements of the new method are effective for all employee
awards granted after the beginning of the fiscal year of adoption. The Company
has not yet determined if it will elect to change to the fair value method, nor
has it determined the effect the new standard will have on net income and
earnings per share should it elect to make such a change. Adoption of the new
standard will have no effect on the Company's cash flows.
RECLASSIFICATIONS of certain amounts in the 1994 and 1993 consolidated
financial statements have been made to conform to the 1995 presentation. In
addition, certain reclassifications and modifications have been made to comply
with the disclosure requirements of the U.S. Securities and Exchange Commission.
F-11
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SECURITIES
The amortized cost and estimated market values of securities held for trading
and securities available for sale are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 (UNAUDITED)
--------------------------------------------------------
GROSS GROSS APPROXIMATE
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
------------ ---------- ---------- ------------
<S> <C> <C> <C> <C>
Securities held for trading:
GNMA certificates................... $ 64,245,298 $2,007,810 $ 21,305 $ 66,231,803
FHLMC certificates.................. 70,742,967 1,552,390 7,195 72,288,162
FNMA certificates................... 66,458,461 1,783,856 9,872 68,232,445
Non-Agency participation
certificates...................... 3,552,230 56,201 3,608,431
Collateralized mortgage
obligations....................... 6,346,577 195,837 6,542,414
Residuals........................... 3,858,674 544,995 247,100 4,156,569
Interest-only strips................ 4,063,070 34,730 1,389,445 2,708,355
Principal-only strip................ 1,178,547 59,437 1,237,984
Interest rate swaps................. 287,000 895,000 (608,000)
Interest rate collar................ 94,367 189,367 (95,000)
Interest rate caps.................. 2,952,385 23,359 1,436,744 1,539,000
Interest rate floors................ 1,645,192 2,370,808 4,016,000
Options............................. 62,645 72,017 7,412 127,250
Futures............................. 168,000 (168,000)
Equity securities................... 445,283 80,000 525,283
------------ ---------- ---------- ------------
Totals................................ $225,645,696 $9,068,440 $4,371,440 $230,342,696
------------ ---------- ---------- ------------
------------ ---------- ---------- ------------
Securities available for sale:
Municipal bonds..................... $ 1,019,199 $ 56,429 $ 1,075,628
Non-Agency participation
certificates...................... 1,263,872 $ 53,429 1,210,443
------------ ---------- ---------- ------------
Totals................................ $ 2,283,071 $ 56,429 $ 53,429 $ 2,286,071
------------ ---------- ---------- ------------
------------ ---------- ---------- ------------
</TABLE>
The Bank's collateralized mortgage obligations (CMO) portfolio at December
31, 1995 consisted of two agency investments with an estimated remaining
weighted average life of 8.6 years.
F-12
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SECURITIES--(CONTINUED)
<TABLE>
<CAPTION>
JUNE 30, 1995
--------------------------------------------------------
GROSS GROSS APPROXIMATE
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
------------ ---------- ---------- ------------
<S> <C> <C> <C> <C>
Securities held for trading:
GNMA certificates................... $ 90,408,143 $1,400,367 $ 57,713 $ 91,750,797
FHLMC certificates.................. 54,685,041 750,334 189,028 55,246,347
FNMA certificates................... 68,285,674 1,007,522 92,315 69,200,881
Non-Agency participation
certificates...................... 3,893,290 43,363 18,382 3,918,271
Collateralized mortgage
obligations....................... 12,909,730 115,592 3,581 13,021,741
Residuals........................... 4,470,191 385,550 492,008 4,363,733
Interest-only strips................ 4,569,574 35,942 1,607,099 2,998,417
Principal-only strip................ 780,897 22,103 803,000
Interest rate swaps................. 1,320,000 1,539,000 (219,000)
Interest rate collar................ 154,884 225,884 (71,000)
Interest rate caps.................. 2,297,091 316,727 618,818 1,995,000
Interest rate floors................ 1,544,062 1,914,126 49,188 3,409,000
Options............................. 265,771 8,686 74,296 200,161
Futures............................. 3,000 137,000 (134,000)
Equity securities................... 223,329 26,000 249,329
------------ ---------- ---------- ------------
Totals................................ $244,487,677 $7,349,312 $5,104,312 $246,732,677
------------ ---------- ---------- ------------
------------ ---------- ---------- ------------
Securities available for sale:
Municipal bonds..................... $ 1,017,357 $ 108,643 $ 1,126,000
Non-Agency participation
certificates...................... 1,426,147 $ 11,643 1,414,504
------------ ---------- ---------- ------------
Totals................................ $ 2,443,504 $ 108,643 $ 11,643 $ 2,540,504
------------ ---------- ---------- ------------
------------ ---------- ---------- ------------
</TABLE>
The Bank's CMO portfolio at June 30, 1995 consisted of four agency
investments with an estimated remaining weighted average life of 9.2 years.
F-13
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SECURITIES--(CONTINUED)
<TABLE>
<CAPTION>
JUNE 30, 1994
--------------------------------------------------------
GROSS GROSS APPROXIMATE
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
------------ ---------- ---------- ------------
<S> <C> <C> <C> <C>
Securities held for trading:
GNMA certificates..................... $ 46,121,367 $ 81,785 $1,132,433 $ 45,070,719
FHLMC certificates.................... 11,313,196 60,564 135,137 11,238,623
FNMA certificates..................... 65,900,035 290,770 2,843,331 63,347,474
Non-Agency participation
certificates........................ 4,650,488 42,941 39,342 4,654,087
Collateralized mortgage obligations... 23,447,182 195,540 173,703 23,469,019
Residuals............................. 3,848,020 1,254,914 296,926 4,806,008
Interest-only strips.................. 10,062,176 1,413,136 1,763,557 9,711,755
Interest rate swaps................... 3,358,000 3,358,000
Interest rate collar.................. 269,726 211,726 58,000
Interest rate caps.................... 2,573,106 1,699,179 218,285 4,054,000
Interest rate floors.................. 1,624,389 211,720 1,084,109 752,000
Equity securities..................... 400,550 400,550
------------ ---------- ---------- ------------
Totals.................................. $170,210,235 $8,608,549 $7,898,549 $170,920,235
------------ ---------- ---------- ------------
------------ ---------- ---------- ------------
Securities available for sale:
Municipal bonds....................... $ 1,063,652 $ 81,348 $ 1,145,000
Non-Agency participation
certificates........................ 2,363,561 $ 81,348 2,282,213
------------ ---------- ---------- ------------
Totals.................................. $ 3,427,213 $ 81,348 $ 81,348 $ 3,427,213
------------ ---------- ---------- ------------
------------ ---------- ---------- ------------
</TABLE>
For a complete discussion of the Bank's Risk Management Activities, see
Note 13.
The amortized cost and estimated market values of securities by contractual
maturity are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 (UNAUDITED)
--------------------------------------------------------
HELD FOR TRADING AVAILABLE FOR SALE
---------------------------- ------------------------
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
------------ ------------ ---------- ----------
<S> <C> <C> <C> <C>
Debt securities:
Due in 1 year or less................. $ 100,000 $ 100,000
Due after 1 year through 5 years...... 195,000 202,059
Due after 5 years through 10 years.... 724,199 773,569
Mortgage-backed securities.............. $201,446,726 $206,752,410
Non-agency participation certificates... 3,552,230 3,608,431 1,263,872 1,210,443
Collateralized mortgage obligations..... 6,346,577 6,542,414
Mortgage-backed derivatives............. 9,100,291 8,102,908
Interest rate contracts................. 4,754,589 4,811,250
Equity securities....................... 445,283 525,283
------------ ------------ ---------- ----------
$225,645,696 $230,342,696 $2,283,071 $2,286,071
------------ ------------ ---------- ----------
------------ ------------ ---------- ----------
</TABLE>
F-14
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
2. SECURITIES--(CONTINUED)
<TABLE>
<CAPTION>
JUNE 30, 1995
--------------------------------------------------------
HELD FOR TRADING AVAILABLE FOR SALE
---------------------------- ------------------------
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
------------ ------------ ---------- ----------
<S> <C> <C> <C> <C>
Debt securities:
Due in 1 year or less............... $ 100,000 $ 101,150
Due after 1 year through 5 years.... 350,000 384,479
Due after 5 years through 10
years............................. 567,357 640,371
Mortgage-backed securities............ $213,378,858 $216,198,025
Non-agency participation
certificates...................... 3,893,290 3,918,271 1,426,147 1,414,504
Collateralized mortgage obligations... 12,909,730 13,021,741
Mortgage-backed derivatives........... 9,820,662 8,165,150
Interest rate contracts............... 4,261,808 5,180,161
Equity securities..................... 223,329 249,329
------------ ------------ ---------- ----------
$244,487,677 $246,732,677 $2,443,504 $2,540,504
------------ ------------ ---------- ----------
------------ ------------ ---------- ----------
</TABLE>
Securities with a total amortized cost of $32,528,985 (unaudited),
$73,827,479 and $98,311,970, and a total market value of $33,015,260
(unaudited), $75,339,913 and $95,795,713, were pledged at December 31, 1995,
June 30, 1995 and June 30, 1994 to secure interest rate swaps, advances and
securities sold under agreements to repurchase. As of December 31, 1995, the
Bank had a blanket collateral agreement for the advances instead of utilizing
specific securities as collateral.
Activities related to the sale of securities are summarized as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, YEARS ENDED JUNE 30,
--------------------------- -----------------------------------------
1995 1994 1995 1994 1993
------------ ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
(UNAUDITED)
Proceeds from sales of
securities held for trading.... $124,067,837 $209,621,285 $419,340,058 $66,432,973
Proceeds from sales of
securities available for
sale........................... 89,100,666 $186,171,035
Gross gains on sales of
securities held for trading.... 8,027,403 1,980,039 12,761,147 34,165
Gross losses on sales of
securities held for trading.... 10,648,798 2,318,025 12,695,039 2,203,237
Gross gains on sales of
securities available for
sale........................... 2,592,998 5,659,165
Gross losses on sales of
securities available for
sale........................... 2,201,194 4,275,110
</TABLE>
Declines in the value of a non-agency participation certificate which is
included in the available for sale portfolio which are considered to be other
than temporary totaling $413,906 and $253,000 were recorded in the statements of
income for the years ended June 30, 1995 and 1994, respectively. In addition, an
other than temporary decline totaling $356,926 and $2,530,709 from certain
mortgage derivatives which were included in the available for sale portfolio
were recorded in the statements of income for the years ended June 30, 1994 and
1993, respectively.
F-15
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. LOANS RECEIVABLE
Approximately 80% of the Bank's loans are to customers in Wayne and Hamilton
counties in Indiana or surrounding counties. The portfolio consists primarily of
owner occupied single family residential mortgages. Loans receivable are
summarized as follows:
<TABLE>
<CAPTION>
JUNE 30,
--------------------------
1995 1994
----------- -----------
<S> <C> <C>
Loans secured by one to four family residences:
Real estate mortgage.......................... $34,740,215 $19,043,629
Participation loans purchased................. 1,198,019 1,404,064
Commercial...................................... 710,707 349,159
Property improvement............................ 166,426 4,855
Loans on savings accounts....................... 254,578 150,495
Consumer........................................ 332,373 221,882
Real estate sold on contract.................... 59,871 77,217
----------- -----------
Subtotal........................................ 37,462,189 21,251,301
Unamortized discounts on loans.................. (13,326) (18,515)
Unamortized push-down accounting adjustment..... (350,362) (420,825)
Undisbursed loan proceeds....................... (43,133) (7,666)
Deferred loan (fees) costs, net................. 75,231 (16,625)
Allowance for loan losses....................... (120,870) (105,651)
----------- -----------
Loans receivable, net........................... $37,009,729 $20,682,019
----------- -----------
----------- -----------
</TABLE>
The principal balance of loans on nonaccrual status totaled approximately
$350,438 and $559,171 at June 30, 1995 and 1994, respectively. For the years
ended June 30, 1995, 1994 and 1993, gross interest income which would have been
recorded had the Bank's non-accruing loans been current with their original
terms amounted to $13,037, $26,000 and $45,620, respectively.
The Bank had commitments to originate or purchase loans consisting primarily
of real estate mortgages secured by one to four family residences approximating
$5,071,000 and $117,000 excluding undisbursed portions of loans in-process at
June 30, 1995 and 1994, respectively.
The Bank has transactions in the ordinary course of business with directors,
officers and employees. Loans to such individuals totaled $45,261 and $105,661
at June 30, 1995 and 1994, respectively.
The amount of loans serviced for others totaled $6,820,223, $7,539,872 and
$9,774,359 at June 30, 1995, 1994 and 1993, respectively. Servicing loans for
others generally consists of collecting mortgage payments, maintaining escrow
amounts, disbursing payments to investors and foreclosure processing. In
connection with loans serviced for others, the Bank held borrower's escrow
balances of $58,539 and $49,386 at June 30, 1995 and 1994, respectively.
Loan servicing fee income included in other income for the years ended June
30, 1995, 1994 and 1993 was $27,290, $32,440 and $23,477, respectively.
F-16
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. LOANS RECEIVABLE--(CONTINUED)
An analysis of the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
--------------------------------
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
Beginning balance.......................... $105,651 $155,931 $ 98,732
Provision for loan losses.................. 14,739 (2,707) 66,176
Recoveries................................. 480 480 1,480
Charge-offs................................ (48,053) (10,457)
-------- -------- --------
Ending balance............................. $120,870 $105,651 $155,931
-------- -------- --------
-------- -------- --------
</TABLE>
As a federally-chartered savings bank, aggregate commercial real estate
loans may not exceed 400% of capital as determined under the capital standards
provisions of FIRREA. This limitation was approximately $74 million and $51
million at June 30, 1995 and 1994, respectively. Also under FIRREA, the
loans-to-one borrower limitation is generally 15% of unimpaired capital and
surplus which, for the Bank, was approximately $3 million and $2 million at June
30, 1995 and 1994, respectively. The Bank was in compliance with all of these
requirements at June 30, 1995 and 1994.
4. INTEREST RECEIVABLE
Interest receivable is summarized as follows:
<TABLE>
<CAPTION>
JUNE 30,
------------------------
1995 1994
---------- ----------
<S> <C> <C>
Loans (less allowance for uncollectibles--$13,037
and $26,002).................................... $ 180,264 $ 110,948
Interest-bearing deposits......................... 22,881 16,318
Securities held for trading....................... 1,090,644 1,115,609
Securities available for sale..................... 59,660 69,525
---------- ----------
Interest receivable, net.......................... $1,353,449 $1,312,400
---------- ----------
---------- ----------
</TABLE>
5. PREMISES AND EQUIPMENT
Premises and equipment are summarized as follows:
<TABLE>
<CAPTION>
JUNE 30,
------------------------
1995 1994
---------- ----------
<S> <C> <C>
Land.............................................. $ 395,148 $ 70,000
Buildings and leasehold improvements.............. 1,985,279 1,929,428
Parking lot improvements.......................... 147,505 147,505
Furniture, fixtures and equipment................. 578,429 547,867
---------- ----------
Total............................................. 3,106,361 2,694,800
Less accumulated depreciation..................... (714,283) (538,455)
---------- ----------
Premises and equipment, net....................... $2,392,078 $2,156,345
---------- ----------
---------- ----------
</TABLE>
Depreciation expense included in operations during the years ended June 30,
1995, 1994 and 1993 totaled $175,828, $141,151 and $114,729, respectively.
F-17
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. DEPOSITS
<TABLE>
<CAPTION>
JUNE 30,
----------------------------------------------------
1995 1994
------------------------ ------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
------------ -------- ------------ --------
<S> <C> <C> <C> <C>
NOW and Super NOW accounts................... $ 3,265,796 2.77% $ 3,177,979 2.94%
Savings accounts............................. 15,183,068 3.71 16,502,507 3.26
Money market deposit accounts................ 1,976,290 4.36 7,562,644 3.67
------------ ------------
20,425,154 3.65 27,243,130 3.34
------------ --- ------------ ---
--- ---
Certificates of deposit:
1 year and less............................ $ 57,304,088 $ 41,911,272
1 to 2 years............................... 17,889,988 15,908,780
2 to 3 years............................... 6,843,919 9,291,841
3 to 4 years............................... 5,352,417 3,619,833
Over 4 years............................... 7,496,432 10,325,490
------------ ------------
94,886,844 6.17% 81,057,216 5.70%
------------ --- ------------ ---
--- ---
Total deposits............................... $115,311,998 $108,300,346
------------ ------------
------------ ------------
</TABLE>
Certificates of deposit in the amount of $100,000 or more totaled
approximately $18 million at June 30, 1995.
A summary of certificate accounts by scheduled fiscal year maturities at
June 30, 1995, is as follows:
<TABLE>
<CAPTION>
1996 1997 1998 1999 2000 THEREAFTER TOTAL
----------- ----------- ---------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
3.00% or less......... $ 396,179 $ 99,202 $ 769 $ 1,394 $ 14,149 $ 511,693
3.01%-5.00%........... 7,243,717 1,550,132 1,021,370 355,917 95,000 10,266,136
5.01%-7.00%........... 43,745,352 11,135,677 4,546,304 2,306,444 $1,299,436 1,979,969 65,013,182
7.01%-9.00%........... 5,179,234 5,104,977 1,180,476 2,406,142 1,049,771 2,379,203 17,299,803
9.01% or greater...... 739,606 95,000 282,520 5,971 672,933 1,796,030
----------- ----------- ---------- ---------- ---------- ---------- -----------
Totals............... $57,304,088 $17,889,988 $6,843,919 $5,352,417 $2,355,178 $5,141,254 $94,886,844
----------- ----------- ---------- ---------- ---------- ---------- -----------
----------- ----------- ---------- ---------- ---------- ---------- -----------
</TABLE>
Interest expense on deposits is as follows:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
--------------------------------------
1995 1994 1993
---------- ---------- ----------
<S> <C> <C> <C>
NOW and Super NOW accounts............ $ 93,734 $ 83,155 $ 70,650
Savings accounts...................... 567,943 598,212 630,941
Money market deposit accounts......... 87,597 184,157 65,722
Certificates of deposit............... 5,905,208 3,650,285 4,171,313
---------- ---------- ----------
$6,654,482 $4,515,809 $4,938,626
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
Interest expense on certificates of deposit includes interest income on
interest rate contracts of $157,729, $595,695 and $429,319 in 1995, 1994 and
1993, respectively.
For a complete discussion of the Bank's Risk Management Activities, see Note
13.
F-18
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
<TABLE>
<CAPTION>
JUNE 30,
---------------------------
1995 1994
------------ -----------
<S> <C> <C>
Securities sold under agreements to repurchase:
Same securities.............................. $ 29,696,000 $12,933,000
Substantially identical securities........... 100,520,865 41,717,713
------------ -----------
$130,216,865 $54,650,713
------------ -----------
------------ -----------
</TABLE>
At June 30, 1995, securities sold under agreements to repurchase mature
within one month.
An analysis of securities sold under agreements to repurchase is as follows:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
-------------------------------------------
1995 1994 1993
------------ ----------- ------------
<S> <C> <C> <C>
Maximum amount outstanding at any month-end....... $130,216,865 $78,544,974 $103,818,659
Average amount outstanding........................ 68,276,560 66,812,830 79,980,835
Weighted average interest rate at end of year..... 6.01% 4.05% 2.70%
</TABLE>
Assets pledged to secure securities sold under agreements to repurchase are
concentrated among six dealers and the Bank exercises control over the
securities pledged when the same security is repurchased. Assets pledged are as
follows:
<TABLE>
<CAPTION>
BOOK VALUE MARKET VALUE
JUNE 30, JUNE 30,
--------------------------- ---------------------------
1995 1994 1995 1994
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
Mortgage-backed
securities......... $127,991,394 $56,692,850 $130,964,030 $53,971,133
</TABLE>
8. FEDERAL HOME LOAN BANK ADVANCES
Advances from the Federal Home Loan Bank of Indianapolis are as follows:
<TABLE>
<CAPTION>
JUNE 30,
--------------------------------------------------
1995 1994
----------------------- -----------------------
VARIABLE VARIABLE
WEIGHTED WEIGHTED
FISCAL YEAR AVERAGE AVERAGE
MATURITY AMOUNT RATE AMOUNT RATE
- - - ------------------------------ ----------- -------- ----------- --------
<S> <C> <C> <C> <C>
1996.......................... $15,000,000 6.02% $15,000,000 4.40%
1998.......................... 16,000,000 6.12% 16,000,000 4.18%
----------- -----------
Total......................... $31,000,000 $31,000,000
----------- -----------
----------- -----------
</TABLE>
Mortgage-backed securities with a total amortized cost of $37,123,938 and
$33,914,903 and a total market value of $37,604,680 and $34,087,883 were pledged
as collateral for the advances as of June 30, 1995 and 1994, respectively.
F-19
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. NOTE PAYABLE
HFG has a $10,000,000 loan facility from Mark Twain Kansas Bank consisting
of a non-revolving line of credit of $800,000 and a $9,200,000 term loan of
which $800,000 had been repaid under the term loan at June 30, 1995. Interest is
payable quarterly at 1/2% over the prime rate published in the Wall Street
Journal (9.50% at June 30, 1995). Quarterly principal and interest payments of
$470,000 are payable during the term July 1, 1995 through March 31, 2000.
Following is a schedule of principal payments as of June 30, 1995:
YEARS ENDING JUNE 30,
- - - ---------------------
1996.... $1,042,410
1997.... 1,145,023
1998.... 1,257,737
1999.... 1,381,546
2000.... 4,373,284
----------
$9,200,000
----------
----------
The loan is secured by the Harrington, FSB stock held by HFG, a personal
guarantee from a stockholder of HFG, a blanket security interest in all of HFG's
assets, a corporate guarantee of Smith Breeden Associates, Inc., a related
party, and the assignment of certain life insurance policies owned by HFG. Under
the terms of the agreement, HFG is bound by certain restrictive debt covenants.
As of June 30, 1995, HFG was in compliance with all such debt covenants.
10. INCOME TAXES
An analysis of the income tax provision is as follows:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
----------------------------------
1995 1994 1993
---------- -------- --------
<S> <C> <C> <C>
Current:
Federal................................................. $ 371,760 $244,927 $(53,982)
State................................................... 126,436 60,360 18,628
Deferred:
Federal................................................. 572,240 47,191 190,679
State................................................... 100,983 38,533 32,310
---------- -------- --------
Total income tax provision................................ $1,171,419 $391,011 $187,635
---------- -------- --------
---------- -------- --------
</TABLE>
F-20
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. INCOME TAXES--(CONTINUED)
The difference between the financial statement provision and amount computed
by using the statutory rate of 34% is reconciled as follows:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
----------------------------------
1995 1994 1993
---------- -------- --------
<S> <C> <C> <C>
Federal statutory income tax at 34%....................... $1,028,329 $475,099 $ 19,710
Tax exempt interest and dividends......................... (31,716) (32,419) (34,902)
State income taxes, net of federal tax benefit............ 83,448 65,269 33,619
Amortization of fair value adjustments.................... (19,471) (53,477) (86,765)
Amortization of intangible assets......................... 246,337
Other..................................................... 110,829 (63,461) 9,636
---------- -------- --------
Total income tax provision................................ $1,171,419 $391,011 $187,635
---------- -------- --------
---------- -------- --------
</TABLE>
The Company adopted SFAS No. 109 effective July 1, 1993. The cumulative
effect of adopting SFAS No. 109 on the Company's consolidated financial
statements was to decrease income by $78,915 for the year ended June 30, 1994.
Prior to July 1, 1993, the Company followed Accounting Principles Board Opinion
No. 11 for deferred income tax accounting. The provision for deferred income
taxes consists of the following:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
----------------------------------
1995 1994 1993
--------- --------- --------
<S> <C> <C> <C>
Differences in income recognition on investments........ $ 65,249 $(303,338) $465,996
Deferred hedging loss................................... (207,900)
Unrealized gain on securities held for trading.......... 614,000 284,000
State NOL carryforward.................................. 154,653
Permanent impairment on securities available for sale... (104,000) (101,200)
Bad debt reserves, net.................................. 54,629 54,252
Deferred compensation................................... 14,577 15,955 18,401
Differences in depreciation methods..................... (7,038) (7,038) (6,144)
Deferred loan fees/costs, net........................... 36,742 (3,713) 4,608
Other................................................... (936) (7,847) (51,972)
--------- --------- --------
Total deferred income tax provision..................... $ 673,223 $ 85,724 $222,989
--------- --------- --------
--------- --------- --------
</TABLE>
F-21
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. INCOME TAXES--(CONTINUED)
The Company's deferred income tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
JUNE 30,
-----------------------
1995 1994
---------- ---------
<S> <C> <C>
Deferred tax assets:
Permanent impairment on securities available for
sale................................................ $ 205,200 $ 101,200
Deferred compensation............................. 61,028 75,605
Deferred loan fees/costs, net..................... 6,650
Other............................................. 13,996 13,060
---------- ---------
280,224 196,515
---------- ---------
Deferred tax liabilities:
Differences in depreciation methods............... 1,941 8,979
Bad debt reserves, net............................ 150,309 95,680
Unrealized gain on securities held for trading.... 898,000 284,000
Differences in income recognition on
investments......................................... 739,589 674,340
Unrealized gain on securities available for
sale................................................ 35,890
Deferred loan fees/costs, net..................... 30,092
---------- ---------
1,855,821 1,062,999
---------- ---------
Deferred income taxes, net.......................... $1,575,597 $ 866,484
---------- ---------
---------- ---------
</TABLE>
Retained earnings at June 30, 1995 and 1994 includes approximately $3
million of income that has not been subject to tax because of deductions for bad
debts allowed for Federal income tax purposes. Deferred income taxes have not
been provided on such bad debt deductions since the Company does not intend to
use the accumulated bad debt deductions for purposes other than to absorb loan
losses. If, in the future, this portion of retained earnings is used for any
purpose other than to absorb bad debt losses, federal income taxes may be
imposed on such amounts at the then current corporation income tax rate.
11. REGULATORY CAPITAL REQUIREMENTS
Effective December 7, 1989, the Office of Thrift Supervision ("OTS") set
forth capital standards applicable to all thrifts. These standards include a
core capital requirement, a tangible capital requirement and a risk-based
capital requirement. The tables below present the Bank's position relative to
the three capital requirements. The Bank exceeds all of the requirements at June
30, 1995 and 1994.
F-22
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. REGULATORY CAPITAL REQUIREMENTS--(CONTINUED)
The Bank's capital ratios are as follows:
<TABLE>
<CAPTION>
JUNE 30, 1995 JUNE 30, 1994
------------------------------------- -------------------------------------
ACTUAL ACTUAL
REQUIRED CAPITAL CAPITAL
CAPITAL ACTUAL AS A % OF REQUIRED ACTUAL AS A % OF REQUIRED
RATIO CAPITAL ASSETS (1) CAPITAL CAPITAL ASSETS (1) CAPITAL
-------- ----------- ---------- ---------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Total Bank capital......... $18,375,000 $12,760,000
Unrealized gains on certain
available for sale
securities................. (61,000)
----------- -----------
Total Bank tangible
capital.................... 1.50% 18,314,000 6.12% $4,489,000 12,760,000 6.07% $3,153,000
Total Bank core capital
----------- -----------
(Tier 1 capital).......... 3.00% 18,314,000 6.12% $8,978,000 12,760,000 6.07% $6,306,000
General allowance for loan
losses..................... 115,000 90,000
----------- -----------
Total Bank risk-based
capital.................... 8.00% $18,429,000 24.62% $5,989,000 $12,850,000 21.40% $4,803,000
----------- -----------
----------- -----------
</TABLE>
- - - ------------
(1) Tangible capital and core capital are computed as a percentage of Bank
adjusted total assets of $299,253,000 and $210,214,000 as of June 30, 1995
and 1994, respectively. Risk-based capital is computed as a percentage of
bank adjusted risk-weighted assets of $74,865,000 and $60,037,000 as of June
30, 1995 and 1994, respectively.
The various federal banking agencies recently adopted the final Prompt
Corrective Action regulations that are required by the Federal Deposit Insurance
Corporation Improvement Act of 1991 ("FDICIA"). Such regulations require
specific supervisory actions as capital levels decrease.
The specifications of the capital categories are shown below. At June 30,
1995, the Bank exceeded the minimum capital requirements for the
well-capitalized category.
<TABLE>
<CAPTION>
TOTAL TIER 1 TIER 1
RISK-BASED RISK-BASED LEVERAGE
RATIO RATIO (1) RATIO
----------- ----------- -----------
<S> <C> <C> <C>
Capital Category:
Well-capitalized (greater than or equal to)......... 10% 6% 5%
Adequately capitalized (greater than or equal to)... 8% 4% 4%
Under-capitalized (less than)....................... 8% 4% 4%
Significantly under-capitalized (less than)......... 6% 3% 3%
Critically under-capitalized........................ N/A N/A N/A
Bank actual capital at June 30, 1995................ $18,429,000 $18,314,000 $18,314,000
Bank actual capital at June 30, 1994................ $12,850,000 $12,760,000 $12,760,000
As a percentage of adjusted assets:
June 30, 1995..................................... 24.62% 24.46% 6.12%
June 30, 1994..................................... 21.40% 21.25% 6.07%
</TABLE>
- - - ------------
(1) The Tier 1 Risked-based ratio is defined as total core capital (Tier 1
capital) divided by risk-adjusted assets.
F-23
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
12. EMPLOYEE BENEFIT PLANS
PROFIT-SHARING PLAN--The Bank has a qualified noncontributory profit-sharing
plan for all eligible employees. The plan provides for contributions by the Bank
in such amounts as its Board of Directors may annually determine. Contributions
charged to expense for the years ended June 30, 1995, 1994 and 1993 were
$78,935, $68,641 and $54,006, respectively.
DEFERRED COMPENSATION PLAN--On September 30, 1988, three senior officers of
the Bank entered into consulting agreements with the Bank to take effect at
their retirement. The agreements obligate the Bank to make monthly payments to
these individuals for the remainder of their lives. At September 30, 1988, the
Bank recorded a liability for this deferred compensation calculated as the
present value of the estimated future cash payments. The amount of benefit
expense for fiscal years 1995, 1994 and 1993 was $25,959, $22,512 and $18,738,
respectively.
STOCK OPTIONS--The Company has granted stock options to existing
stockholders, officers, directors and other affiliated individuals to purchase
shares of the Company's stock. At June 30, 1995, outstanding stock options of
163,200 were comprised of 147,200 shares exercisable between December 1997 and
January 1998 and 16,000 shares exercisable before December 1995. The options are
nontransferable and are forfeited upon termination of employment, as applicable.
The following is an analysis of stock option activity for each of the three
years in the period ended June 30, 1995 and the stock options outstanding at the
end of the respective years:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTIONS SHARES PRICE
- - - ------------------------------------------------------------------------- ------- --------
<S> <C> <C>
Outstanding July 1, 1992 and June 30, 1993
Granted.................................................................. 161,200 $ 7.50
Forfeited or expired..................................................... (6,000) 7.50
-------
Outstanding June 30, 1994................................................ 155,200 7.50
Granted.................................................................. 41,000 5.04
Exercised................................................................ (21,600) 4.66
Forfeited or expired..................................................... (11,400) 6.66
-------
Outstanding June 30, 1995................................................ 163,200 7.32
-------
-------
</TABLE>
In addition, in September 1995 the Company granted stock options totaling
14,112 shares with a grant price of $5.32 per share, which expire on September
29, 1995.
13. RISK MANAGEMENT ACTIVITIES
The Bank closely monitors the sensitivity of its balance sheet and income
statement to potential changes in the interest rate environment. Derivative
financial instruments such as interest rate swaps, caps, floors, collars,
futures, and options are used on an aggregate basis to protect the trading
portfolio and certain liabilities from adverse rate movements. The Bank's
objective, with regard to managing interest rate risk, is to maintain at an
acceptably low level the sensitivity to rising or falling rates of its market
value of portfolio equity.
INTEREST RATE SWAPS are contracts in which the parties agree to exchange
fixed and floating rate payments for a specified period of time on a specified
(notional) amount. The notional amount is only
F-24
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
13. RISK MANAGEMENT ACTIVITIES--(CONTINUED)
used to calculate the amount of the periodic interest payments to be exchanged,
and does not represent the amount at risk. The Bank uses swaps to modify the
effective duration of various assets and liabilities. The floating rates are
generally indexed to the three-month London Interbank Offerred Rates (LIBOR).
INTEREST RATE CAPS AND FLOORS are instruments in which the writer (seller)
agrees to pay the holder (purchaser) the amount that an agreed-upon index is
above or below the specified cap or floor rate, respectively, times the notional
amount. In return for this promise of future payments, the purchaser pays a
premium to the seller. The notional amount is never exchanged between the two
parties and does not represent the amount at risk. The Bank purchases interest
rate caps and floors to reduce the impact of rising or falling interest rates on
the market value of its trading portfolio. The interest rate caps and floors
generally have indexes equal to one or three month LIBOR, except for one
interest rate cap which is tied to the five year Constant Maturity Treasury.
The Bank is a party to an INTEREST RATE COLLAR which also is used to manage
interest rate risk in the trading portfolio. The interest rate collar consists
of an interest rate cap held by the Bank and an interest rate floor written by
the Bank. The notional amount of the interest rate collar is based on the
balance in the collection accounts of certain Merrill Lynch collateralized
mortgage obligation trusts.
INTEREST RATE FUTURES CONTRACTS are commitments to either purchase or sell
designated instruments at a future date for a specified price. Initial margin
requirements are met in cash or other instruments, and changes in the contract
values are settled in cash daily. The Bank enters into futures contracts when
these instruments are economically advantageous to interest rate swaps, caps and
floors. The Bank uses primarily Eurodollar contracts which are structured in
calendar quarter increments and therefore result in a much larger notional
amount than an equivalent swap, cap or floor.
FINANCIAL OPTIONS are contracts which grant the purchaser, for a premium
payment, the right to either purchase from or sell to the writer a specified
financial instrument under agreed-upon terms. Financial options to buy or sell
securities are typically traded in standardized contracts on organized
exchanges. The Bank purchases financial options to reduce the risk of the
written financial options embedded in mortgage related assets.
CASH RESTRICTIONS--The Bank maintained $399,256 at June 30, 1995 in U.S.
Treasury Securities, which are considered cash equivalents, as a deposit with a
broker for its futures activities.
CREDIT RISK--The Bank is dedicated to managing credit risks associated with
trading activities. The Bank maintains trading positions with a variety of
counterparties or obligors (counterparties). To limit credit exposure arising
from such transactions, the Bank evaluates the credit standing of
counterparties, establishes limits for the total exposure to any one
counterparty, monitors exposure against the established limits and monitors
trading portfolio composition to manage concentrations. In addition, the Bank
maintains qualifying netting agreements with its counterparties and records
gains and losses on derivative financial instruments net in the trading
portfolio.
The Bank's exposure to credit risk from derivative financial instruments is
represented by the fair value of instruments. Credit risk amounts represent the
replacement cost the Bank could incur should counterparties with contracts in a
gain position completely fail to perform under the terms of those contracts and
any collateral underlying the contracts proves to be of no value to the Bank.
Counterparties are subject to the credit approval and credit monitoring policies
and procedures of the Bank. Certain instruments require the Bank or the
counterparty to maintain collateral for all or part of the
F-25
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
13. RISK MANAGEMENT ACTIVITIES--(CONTINUED)
exposure. Limits for exposure to any particular counterparty are established and
monitored. Notional or contract amounts indicate the total volume of
transactions and significantly exceed the amount of the Bank's credit or market
risk associated with these instruments.
The following off balance sheet positions are included in the Bank's trading
portfolio and are thus reported in the financial statements at current market
value.
<TABLE>
<CAPTION>
JUNE 30, 1995
------------------------------------------------------------------------------
ESTIMATED
CONTRACT OR FAIR VALUE WEIGHTED AVERAGE INTEREST RATE
NOTIONAL ----------------------- -------------------------------------
AMOUNT ASSET LIABILITY PAYABLE RECEIVABLE CAP FLOOR
------------ ---------- ---------- ------- ---------- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C>
Interest rate swaps:
Pay fixed rate................ $124,500,000 $ 827,000 $1,539,000 5.87% 6.10% NA NA
Pay floating rate............. 10,000,000 493,000 6.06% 7.23% NA NA
Interest rate caps............. 123,000,000 1,995,000 NA NA 7.00% NA
Interest rate floors........... 95,000,000 3,409,000 NA NA NA 6.55%
Interest rate collar........... 117,972,000 71,000 NA NA 10.25% 5.25%
Futures........................ 455,800,000 3,000 137,000 NA NA NA NA
Options........................ 51,500,000 200,161 NA NA NA NA
------------ ---------- ----------
$977,772,000 $6,927,161 $1,747,000
------------ ---------- ----------
------------ ---------- ----------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED
JUNE 30, 1995
-----------------------
MONTHLY
AVERAGE
FAIR VALUE
-----------------------
ASSET LIABILITY
---------- ---------
<S> <C> <C>
Interest rate swaps:
Pay fixed rate..................................................... $3,280,000 $ 180,000
Pay floating rate.................................................. 59,000
Interest rate caps................................................... 3,779,000
Interest rate floors................................................. 2,467,000
Interest rate collar................................................. 49,000
Futures.............................................................. 8,000
Options.............................................................. 73,000
---------- ---------
$9,648,000 $ 247,000
---------- ---------
---------- ---------
</TABLE>
The following table shows the various components of the Company's recorded
net gain on its trading portfolio. All realized and unrealized gains and losses
are reported as other income in the statement of income. The periodic exchanges
of interest payments and the amortization of premiums paid for contracts are
accounted for as adjustments to the yields, and are reported on the statement of
income as interest income.
F-26
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
13. RISK MANAGEMENT ACTIVITIES--(CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30, 1995
--------------------------------------------------
REALIZED UNREALIZED NET TRADING
GAINS/(LOSSES) GAINS/(LOSSES) GAINS/(LOSSES)
-------------- -------------- --------------
<S> <C> <C> <C>
Interest rate contracts:
Swaps............................................. $ (650,989) $ (3,577,000) $ (4,227,989)
Caps.............................................. (110,383) (1,782,985) (1,893,368)
Floors............................................ 42,495 2,737,327 2,779,822
Collar............................................ (14,158) (14,158)
Futures........................................... (1,854,008) (134,000) (1,988,008)
Options........................................... 135,410 (65,610) 69,800
-------------- -------------- --------------
Total............................................... (2,437,475) (2,836,426) (5,273,901)
MBS and other trading assets........................ 2,503,583 4,371,426 6,875,009
-------------- -------------- --------------
Total trading portfolio............................. $ 66,108 $ 1,535,000 $ 1,601,108
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
The following table sets forth the maturity distributions and weighted
average interest rates of financial instruments used on an aggregate basis to
protect the trading portfolio.
<TABLE>
<CAPTION>
MATURITIES DURING FISCAL YEARS ENDING JUNE 30,
-----------------------------------------------------------------------------------
1996 1997 1998 1999 2000 THEREAFTER
------------ ----------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Interest rate swaps--Pay
fixed rate
Notional amount.......... $ 15,000,000 $16,000,000 $26,500,000 $41,000,000 $ 26,000,000
Weighted average payable
rate...................... 4.00% 5.15% 5.20% 6.59% 6.94%
Weighted average
receivable rate........ 6.19% 6.16% 6.10% 6.04% 6.13%
Interest rate swaps--Pay
floating rate
Notional amount.......... $ 10,000,000
Weighted average payable
rate...................... 6.06%
Weighted average
receivable rate........ 7.23%
Interest rate caps
Notional amount.......... $ 25,000,000 $25,000,000 $37,000,000 $ 36,000,000
Weighted average cap
rate...................... 4.50% 5.00% 8.09% 9.00%
Interest rate floors
Notional amount.......... $35,000,000 $30,000,000 $ 30,000,000
Weighted average floor
rate...................... 7.50% 7.00% 5.00%
Interest rate collar
Notional amount.......... $117,972,000
Weighted average cap
rate...................... 10.25%
Weighted average floor
rate...................... 5.25%
Futures
Notional amount.......... $105,800,000 $67,000,000 $70,000,000 $67,000,000 $49,000,000 $ 97,000,000
Options
Notional amount.......... $ 51,500,000
</TABLE>
The following interest rate hedges are not included in the Bank's trading
portfolio. These swaps are used to modify the interest rate sensitivity of
certain certificates of deposit issued by the Bank. These certificates of
deposit, called inverse variable rate CDs, adjust according to a formula in such
a way as
F-27
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
13. RISK MANAGEMENT ACTIVITIES--(CONTINUED)
to pay a higher rate of interest when the index falls, and a lower rate of
interest when the index rises. As of June 30, 1995, the Bank held approximately
$10 million of inverse variable rate CDs, with original terms to maturity
ranging from three to ten years. The Bank utilizes interest rate swaps with the
same notional amount as the inverse variable rate CDs to convert such
certificates of deposit effectively to fixed rate deposits. A similar notional
amount of interest rate swaps are then utilized to convert such certificates
from fixed rate to variable rate deposits. Consequently, the notional amount of
interest rate swaps is twice that of the inverse variable rate CDs. The swaps
protect the Bank against the exposure to falling interest rates inherent in
these CDs.
The market value of the following swaps is not reflected in the Company's
financial statements. The periodic exchanges of interest payments are included
in interest expense in the statements of income.
<TABLE>
<CAPTION>
JUNE 30, 1995
-------------------------------------------------------------
WEIGHTED AVERAGE
CONTRACT OR ESTIMATED FAIR VALUE INTEREST RATE
NOTIONAL --------------------- ---------------------
AMOUNT ASSET LIABILITY PAYABLE RECEIVABLE
----------- -------- --------- ------- ----------
<S> <C> <C> <C> <C> <C>
Interest rate swaps:
Pay floating rate...................... $22,500,000 $403,000 6.46% 6.59%
</TABLE>
The following table sets forth the maturity distribution and weighted
average interest rates of the interest rate swaps used to protect the inverse
variable rate CDs from adverse rate movements.
<TABLE>
<CAPTION>
MATURITIES DURING FISCAL YEARS ENDING JUNE 30,
-------------------------------------------------------------------------
1996 1997 1998 1999 2000 THEREAFTER
------- ----------- ------- ------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Interest rate swaps-Pay
floating rate
Notional amount........ $10,000,000 $12,500,000
Weighted average
payable rate............... 6.25% 6.63%
Weighted average
receivable rate............ 6.12% 6.96%
</TABLE>
14. CREDIT COMMITMENTS
The Bank is a party to commitments to extend credit as part of its normal
business operations to meet the financing needs of its customers. These
commitments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amount recognized in the balance sheet. 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 contract
amount of those instruments. The Bank uses the same credit policies in making
commitments as it does for on-balance-sheet instruments. Unless noted otherwise,
the Bank does not require collateral or other security to support financial
instruments with credit risk.
Real estate loan commitments whose contract amounts represent credit risk
were approximately $5,071,000 and $117,000 at June 30, 1995 and 1994,
respectively.
F-28
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
15. RELATED PARTY TRANSACTIONS
The Company has contracted with Smith Breeden Associates Inc. ("SBA") to
provide investment advisory services and interest rate risk analysis. Certain
stockholders of HFG are also principals of SBA. The amount of consulting expense
relating to SBA for fiscal years ending June 30, 1995, 1994 and 1993 was
$194,813, $183,435 and $186,668, respectively.
16. STOCKHOLDERS' EQUITY AND REGULATORY MATTERS
EQUITY OFFERING--Under the terms of an offering memorandum the Company
offered up to 555,556 shares of stock to certain stockholders, directors and
officers of the Company and the Bank. The shares of common stock were offered at
$4.50 per share beginning on November 1, 1994; however, the purchase price
increased each day thereafter at a rate of prime plus 2% until the closing of
the equity offering on January 31, 1995.
LIQUIDATION ACCOUNT--On July 10, 1985, the Bank converted from a federally
chartered mutual association to a federally chartered stock association through
the issuance of 463,173 shares of common stock ($1 par value) at a price of $8
per share. From the proceeds, $463,173 was allocated to capital stock at the par
value of $1 per share and $2,918,650, which is net of conversion costs of
$323,561, was allocated to additional paid-in-capital.
The Bank established a special liquidation account (in memorandum form) in
an amount equal to its total retained earnings as of June 1, 1984 for the
purpose of granting to eligible savings account holders a priority in the event
of future liquidation. In the event of future liquidation of the converted
institution (and only in such event), an eligible account holder who continues
to maintain his savings account shall be entitled to receive a distribution from
the liquidation account. The total amount of the liquidation account will be
decreased in an amount proportionately corresponding to decreases in the savings
accounts of eligible account holders on each subsequent annual determination
date.
DIVIDEND RESTRICTIONS--Regulations provide that the Bank may not declare or
pay a cash dividend on or repurchase any of its stock if the result thereof
would be to reduce the consolidated stockholders' equity of the Bank below the
amount required for the liquidation account (as defined by regulations). Under
the capital distribution regulations of the OTS, the Bank, as a "Tier 1"
institution, is permitted to make capital distributions during a calendar year
up to one hundred percent of its net income to date during the calendar year
plus the amount that would reduce by one-half its surplus capital ratio, as
defined, at the beginning of the calendar year. Under this limitation,
$4,913,397 was available for dividends at June 30, 1995.
RECAPITALIZATION OF SAIF AND RELATED LEGISLATIVE PROPOSALS--The deposits of
the Company are currently insured by the Savings Association Insurance Fund
("SAIF") of the FDIC. Both the SAIF and the Bank Insurance Fund ("BIF"), the
federal deposit insurance fund that covers commercial bank deposits, are
required by law to attain and thereafter maintain a reserve ratio of 1.25% of
insured deposits. The BIF has achieved a fully funded status in contrast to the
SAIF and, therefore, as discussed below, the FDIC recently substantially reduced
the average deposit insurance premium paid by commercial banks to a level
approximately 75% below the average premium paid by savings institutions.
On November 14, 1995, the FDIC approved a final rule regarding deposit
insurance premiums. The final rule will reduce deposit insurance premiums for
BIF member institutions to zero basis points (subject to a $2,000 minimum) for
institutions in the lowest risk category, while holding deposit
F-29
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
16. STOCKHOLDERS' EQUITY AND REGULATORY MATTERS--(CONTINUED)
insurance premiums for SAIF members at their current levels (23 basis points for
institutions in the lowest risk category). The reduction was effective with
respect to the semiannual premium assessment beginning January 1, 1996.
Accordingly, in the absence of further legislative action, SAIF members such as
the Bank will be competitively disadvantaged as compared to commercial banks by
the resulting premium differential.
The U.S. House of Representatives and Senate have provided for a resolution
of the recapitalization of the SAIF in the Balanced Budget Act of 1995 (the
"Reconciliation Bill") which was sent to the President on November 29, 1995. The
President recently vetoed the Reconciliation Bill for reasons unrelated to the
recapitalization of the SAIF. The Reconciliation Bill provides that all SAIF
member institutions will pay a special one-time assessment to recapitalize the
SAIF, which in the aggregate will be sufficient to bring the reserve ratio in
the SAIF to 1.25% of insured deposits. Based on the current level of reserves
maintained by the SAIF it is currently anticipated that the amount of the
special assessment required to recapitalize the SAIF will be approximately 80 to
85 basis points of the SAIF-assessable deposits. The special assessment would be
payable based on the amount of SAIF deposits on March 31, 1995. It is
anticipated that after the recapitalization of the SAIF, that premiums of SAIF-
insured institutions would be reduced comparable to those currently being
assessed BIF-insured commercial banks.
The Reconciliation Bill also provides for the merger of the BIF and SAIF on
January 1, 1998, with such merger being conditioned upon the prior elimination
of the thrift charter. The Banking Committees of the House of Representatives
and the Senate in adopting the Reconciliation Bill agreed that Congress should
consider and act upon separate legislation as early as possible in 1996 to
eliminate the thrift charter. If adopted, such legislation would require that
the Bank as a federal savings bank, convert to a bank charter. Such a
requirement to convert to a bank charter could cause savings institutions to
lose favorable tax treatment for their bad debt reserves that they currently
enjoy under Section 593 of the Internal Revenue Code of 1986, as amended (the
"Code").
While the outcome of the proposed legislation cannot be predicted with
certainty, it is likely that some kind of legislative or regulatory action will
be undertaken that will impact the Company's insured deposits. A one-time
special assessment of 85 basis points would result in the Company paying
approximately $700,000, net of related tax benefits. In addition, the enactment
of such legislation may have the effect of immediately reducing the capital of
SAIF-member institutions by the amount of the special assessment, net of taxes.
Nevertheless, management does not believe that this one-time charge to the Bank
if incurred will have a material adverse effect on the Company's consolidated
financial condition.
In light of the different proposals currently under consideration and the
uncertainty of the legislative process generally, management cannot predict
whether legislation reducing SAIF premiums and/or imposing a special one-time
assessment will be adopted, or, if adopted, the amount of the assessment, if
any, that would be imposed on the Company.
F-30
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
17. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS No. 107,
Disclosures about Fair Value of Financial Instruments:
<TABLE>
<CAPTION>
JUNE 30, 1995 JUNE 30, 1994
---------------------------- ----------------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
ASSETS:
Cash............................ $ 773,355 $ 773,355 $ 748,100 $ 748,100
Interest-bearing deposits....... 4,932,172 4,932,172 9,657,041 9,657,041
Securities held for trading..... 246,732,677 246,732,677 170,920,235 170,920,235
Securities available for sale... 2,504,504 2,504,504 3,427,213 3,427,213
Loans receivable, net........... 37,009,729 38,443,000 20,682,019 21,116,000
Interest receivable............. 1,353,449 1,353,449 1,312,400 1,312,400
Federal Home Loan Bank stock.... 2,500,000 2,500,000 1,843,400 1,843,400
LIABILITIES:
Deposits........................ 115,311,998 116,415,000 108,300,346 107,001,000
Securities sold under agreements
to repurchase..................... 130,216,865 130,235,000 54,650,713 54,600,000
Federal Home Loan Bank
advances.......................... 31,000,000 31,000,000 31,000,000 31,000,000
Interest payable................ 1,691,772 1,691,772 1,474,941 1,474,941
Note payable.................... 9,200,000 9,200,000 7,880,000 7,880,000
Advance payments by borrowers
for taxes and insurance........... 263,960 263,960 155,451 155,451
OFF BALANCE SHEET HEDGING
INSTRUMENTS:
Interest rate swaps............. 403,000 298,000
Interest rate floor............. 46,000
</TABLE>
The estimated fair value amounts are determined by the Company, using
available market information and appropriate valuation methodologies. However,
considerable judgment is required in interpreting market data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
CASH, INTEREST-BEARING DEPOSITS, INTEREST RECEIVABLE AND PAYABLE, ADVANCE
PAYMENTS BY BORROWERS FOR TAXES AND INSURANCE AND OTHER BORROWED FUNDS--The
carrying amounts of these items are a reasonable estimate of their fair value.
LOANS RECEIVABLE--The fair value of loans receivable is estimated by
discounting future cash flows at market interest rates for loans of similar
terms and maturities, taking into consideration repricing characteristics and
prepayment risk.
SECURITIES HELD FOR TRADING consist of mortgage-backed securities,
collateralized mortgage obligations, residuals, interest-only strips, a
principal-only strip, interest rate swaps, an interest rate collar, interest
rate caps, interest rate floors, options, futures and equity securities. Fair
values are based on quoted market prices or dealer quotes. Where such quotes are
not available, fair value is estimated by
F-31
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
17. FAIR VALUES OF FINANCIAL INSTRUMENTS--(CONTINUED)
using quoted market prices for similar securities or by discounting future cash
flows at a risk adjusted spread to Treasury.
FEDERAL HOME LOAN BANK STOCK--The fair value is estimated to be the carrying
value which is par. All transactions in the capital stock of the Federal Home
Loan Bank of Indianapolis are executed at par.
DEPOSITS--The fair value of deposits is calculated by discounting the future
cash flows at a market interest rate.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE--Fair values are based on the
discounted value of contractual cash flows using dealer quoted rates for
agreements of similar terms and maturities.
FEDERAL HOME LOAN BANK ADVANCES--The fair value is estimated by discounting
future cash flows using rates currently available to the bank for advances of
similar maturities.
OFF BALANCE SHEET HEDGING INSTRUMENTS consist of interest rate swaps and an
interest rate floor used to modify the interest rate sensitivity of certain
certificates of deposits. Fair values are based on quoted market prices or
dealer quotes. Where such quotes are not available, fair value is estimated by
using quoted market prices for similar securities or by discounting future cash
flows at a risk adjusted spread to Treasury.
COMMITMENTS--The estimated fair value of commitments to originate fixed-rate
loans is determined based on the fees currently charged to enter into similar
agreements and the difference between current levels of interest rates and the
committed rates. Based on that analysis, the estimated fair value of such
commitments is a reasonable estimate of the loan commitments at par.
The fair value estimates presented herein are based on information available
to management as of June 30, 1995 and 1994. Although management is not aware of
any factors that would significantly affect the estimated fair value amounts,
such amounts have not been comprehensively revalued for purposes of these
consolidated financial statements since that date, and therefore, current
estimates of fair value may differ significantly from the amount presented
herein.
F-32
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
18. HARRINGTON FINANCIAL GROUP, INC. FINANCIAL INFORMATION
(PARENT COMPANY ONLY)
The following condensed balance sheets as of June 30, 1995 and 1994, and
condensed statements of income and cash flows for the three years in the period
ended June 30, 1995 for Harrington Financial Group, Inc. should be read in
conjunction with the consolidated financial statements and notes thereto.
<TABLE>
<CAPTION>
JUNE 30,
--------------------------
<S> <C> <C>
1995 1994
----------- -----------
CONDENSED BALANCE SHEETS
Interest-bearing deposits........................................ $ 433,753 $ 318,404
Securities held for trading...................................... 249,329 400,550
Other assets..................................................... 90,541 93,159
Investment in subsidiary......................................... 18,313,571 12,760,075
----------- -----------
Total assets................................................. $19,087,194 $13,572,188
----------- -----------
----------- -----------
Note payable..................................................... $ 9,200,000 $ 7,880,000
Deferred income taxes, net....................................... (4,910) (1,043)
Accrued income taxes............................................. (421,214) (232,347)
Accrued expenses payable and other liabilities................... 13,747
----------- -----------
Total liabilities............................................ 8,787,623 7,646,610
----------- -----------
Common stock..................................................... 245,203 176,548
Additional paid-in capital....................................... 4,182,518 1,730,258
Retained earnings................................................ 5,871,850 4,018,772
----------- -----------
Total stockholders' equity................................... 10,299,571 5,925,578
----------- -----------
Total liabilities and stockholders' equity....................... $19,087,194 $13,572,188
----------- -----------
----------- -----------
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEARS ENDED JUNE 30,
--------------------------------------
1995 1994 1993
---------- ---------- ----------
<S> <C> <C> <C>
CONDENSED STATEMENTS OF INCOME
Dividends from subsidiary.............................. $1,454,910 $ 903,377
Interest income from securities held for trading....... $ 17,429 16,574
Interest income from securities available for sale..... 29,098
Interest on deposits................................... 12,258 6,225 8,416
Gain on sale of securities held for trading............ 24,116
Unrealized gain on securities held for trading......... 26,000
---------- ---------- ----------
Total income....................................... 79,803 1,477,709 940,891
Interest expense on long-term borrowings............... 748,872 577,181 583,142
Salaries and employee benefits......................... 28,500
Other expenses......................................... 48,332 2,681 7,721
---------- ---------- ----------
Total expenses..................................... 825,704 579,862 590,863
---------- ---------- ----------
Income (loss) before equity in undistributed
earnings............................................... (745,901) 897,847 350,028
Income tax provision (benefit)......................... (295,484) (195,296) (231,210)
Equity in undistributed earnings of subsidiary......... 2,303,495 (165,718) (710,902)
---------- ---------- ----------
Net income (loss)...................................... $1,853,078 $ 927,425 $ (129,664)
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
F-33
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
18. HARRINGTON FINANCIAL GROUP, INC. FINANCIAL INFORMATION
(PARENT COMPANY ONLY)--(CONTINUED)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED JUNE 30,
-----------------------------------------
1995 1994 1993
----------- ----------- -----------
<S> <C> <C> <C>
CONDENSED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................... $ 1,853,078 $ 927,425 $ (129,664)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Decrease (increase) in other assets............... 22,617 26,811 18,748
Increase (decrease) in accrued expenses and other
liabilities......................................... 13,747 (41,901) (9,059)
(Gain) loss on sale of securities held for
trading............................................. (24,116)
Unrealized gain on securities held for trading.... (26,000)
Purchase of securities held for trading........... (879,663)
Proceeds from sales of securities held for
trading............................................. 1,081,000
Deferred income tax provision..................... (3,867) 28,618 (29,661)
Increase (decrease) in accrued income taxes....... (188,867) (35,545) (144,097)
Increase in undistributed earnings of
subsidiary.......................................... (2,303,495) 165,718 710,902
----------- ----------- -----------
Net cash provided by (used in) operating
activities.......................................... (455,566) 1,071,126 417,169
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital contributions to subsidiary................. (3,250,000) (1,000,000)
Purchase of securities available for sale........... (400,797) (29,004)
Proceeds from sales of securities available for
sale................................................ 219,000 114,000
----------- ----------- -----------
Net cash used in investing activities........... (3,250,000) (1,181,797) 84,996
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock under equity
offering............................................ 2,420,259
Proceeds from stock options exercised............... 100,656
Proceeds from note payable.......................... 1,900,000 8,000,000
Principal repayments on note payable................ (600,000) (7,630,775) (1,004,000)
----------- ----------- -----------
Net cash provided by (used in) financing
activities.......................................... 3,820,915 369,225 (1,004,000)
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS..... 115,349 258,554 (501,835)
CASH AND CASH EQUIVALENTS,
Beginning of period............................... 318,404 59,850 561,685
----------- ----------- -----------
CASH AND CASH EQUIVALENTS,
End of period..................................... $ 433,753 $ 318,404 $ 59,850
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
19. SUBSEQUENT EVENTS
STOCK SPLIT--Effective October 1995, the Company declared a 2 for 1 stock
split on all its outstanding common stock whereby each stockholder received 1
additional share of common stock for each outstanding share owned by such
stockholder.
F-34
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
19. SUBSEQUENT EVENTS--(CONTINUED)
INITIAL PUBLIC OFFERING--The Company intends to effect an initial public
offering ("Offering") of its common stock through a Registration Statement on
Form S-1 to be filed with the Securities and Exchange Commission. The
transaction is expected to occur in the first quarter of 1996.
STOCK OPTION PLAN--The Board of Directors of the Company adopted a Stock
Option Plan, which is designed to attract and retain qualified personnel in key
positions, provide officers and key employees with a proprietary interest in the
Company as an incentive to contribute to the success of the Company, reward key
employees for outstanding performance and the attainment of targeted goals, and
retain qualified directors for the Company. An amount of Common Stock equal to
10% of the shares sold in the Offering will be authorized under the Stock Option
Plan, which may be filled by authorized but unissued shares, treasury shares or
shares purchased by the Company on the open market or from private sources. The
ability of a stock option recipient to exercise any award will be conditioned on
the Company's receipt of stockholder approval of the Stock Option Plan.
EMPLOYEE STOCK OWNERSHIP PLAN--The Company established an Employee Stock
Ownership Plan (ESOP) on February 5, 1996, for employees of the Company and the
Bank. Full-time employees of the Company and the Bank who have been credited
with at least 1,000 hours of service during a twelve month period and who have
attained age 21 are eligible to participate in the ESOP. The Company expects to
cause the ESOP to purchase up to 7,000 shares in the Offering. The shares
acquired by the ESOP are expected to be contributed by the Company.
* * * * * *
F-35
<PAGE>
- - - ------------------------------------------- -----------------------------------
- - - ------------------------------------------- -----------------------------------
TABLE OF CONTENTS
PAGE
----
Prospectus Summary..................... 3
Summary Consolidated Financial Data.... 7 1,100,000 SHARES
Summary of Recent Developments......... 8
Risk Factors........................... 11
The Company............................ 18 [LOGO]
Use of Proceeds........................ 19
Dividends and Market for Common
Stock.................................. 19 HARRINGTON FINANCIAL GROUP, INC.
Capitalization......................... 20
Regulatory Capital..................... 21
Dilution............................... 22
Selected Consolidated Financial Data... 23 COMMON STOCK
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................. 24 -------------------
Business............................... 47
Supervision and Regulation............. 70 PROSPECTUS
Management............................. 79 MAY 6, 1996
Beneficial Ownership of Securities..... 87
Shares Eligible For Future Sale........ 89 -------------------
Description of Capital Stock........... 90
Underwriting........................... 93
Legal Matters.......................... 94
Experts................................ 94
Transfer Agent and Registrar........... 94
Additional Information................. 95
Index to Consolidated Financial
Statements............................. 96
-------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE
ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS
OFFERING OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH
OTHER INFORMATION AND REPRESENTATIONS MUST
NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR THE UNDERWRITERS. NEITHER
THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE STIFEL, NICOLAUS & COMPANY
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, INCORPORATED
CREATE ANY IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY
SINCE THE DATE HEREOF OR THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS
OF ANY TIME SUBSEQUENT TO ITS DATE.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL OR A SOLICITATION OF AN OFFER TO BUY
ANY SECURITIES OTHER THAN THE REGISTERED
SECURITIES TO WHICH IT RELATES. THIS NATCITY INVESTMENTS, INC.
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO
SELL OR A SOLICITATION OF AN OFFER TO BUY
SUCH SECURITIES IN ANY CIRCUMSTANCES IN
WHICH SUCH OFFER OR SOLICITATION IS
UNLAWFUL.
UNTIL MAY 31, 1996, ALL DEALERS
EFFECTING TRANSACTIONS IN THE REGISTERED
SECURITIES, WHETHER OR NOT PARTICIPATING IN
THIS DISTRIBUTION, MAY BE REQUIRED TO
DELIVER A PROSPECTUS. THIS IS IN ADDITION TO
THE OBLIGATION OF DEALERS TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND
WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
- - - ------------------------------------------- -----------------------------------
- - - ------------------------------------------- -----------------------------------
