UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to ____________
Commission File Number 0-27940
HARRINGTON FINANCIAL GROUP, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Indiana 48-1050267
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
722 East Main
Richmond, Indiana 47374
- --------------------------------------------------------------------------------
(Address of principal executive office) (Zip Code)
(765) 962-8531
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: As of February 8,
1999, there were issued and outstanding 3,205,339 shares of the Registrant's
Common Stock, par value $.125 per share.
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
TABLE OF CONTENTS
Page
----
Part I. Financial Information
- ------- ---------------------
Item 1. Financial Statements
Consolidated Balance Sheets as of December 31, 1998
(unaudited) and June 30, 1998 1
Consolidated Statements of Operations (unaudited) for the three
and six months ended December 31, 1998 and 1997. 2
Consolidated Statements of Cash Flows (unaudited) for the six
months ended December 31, 1998 and 1997. 3
Notes to Unaudited Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 6
Item 3. Quantitative and Qualitative Disclosures About Market Risk 13
Part II. Other Information
Item 1. Legal Proceedings 16
Item 2. Changes in Securities 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security-Holders 16
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
Signatures
<PAGE>
<TABLE>
<CAPTION>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
Consolidated Balance Sheets
(Dollars in Thousands)
(Unaudited)
December 31, June 30,
1998 1998
--------- ---------
<S> <C> <C>
ASSETS
Cash ...................................................... $ 1,980 $ 1,567
Interest-bearing deposits ................................. 9,293 10,212
--------- ---------
Total cash and cash equivalents ......................... 11,273 11,779
Securities held for trading - at fair value
(amortized cost of $278,679 and $289,137) ............... 283,959 290,609
Securities available for sale - at fair value
(amortized cost of $873 and $924) ....................... 902 922
Loans receivable, net ..................................... 234,691 163,546
Interest receivable, net .................................. 2,491 2,318
Premises and equipment, net ............................... 5,856 5,614
Federal Home Loan Bank of Indianapolis stock .............. 4,878 4,878
Other ..................................................... 5,887 4,731
--------- ---------
Total assets ............................................ $ 549,937 $ 484,397
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits .................................................. $ 277,913 $ 178,311
Securities sold under agreements to repurchase ............ 191,125 240,396
Federal Home Loan Bank advances ........................... 40,000 26,000
Interest payable on securities sold under agreements to
repurchase .............................................. 414 282
Other interest payable .................................... 2,183 1,596
Note payable .............................................. 13,495 13,495
Due to brokers ............................................ 3,898 --
Advance payments by borrowers for taxes & insurance ....... 866 785
Accrued expenses payable and other liabilities ............ 885 868
--------- ---------
Total liabilities ....................................... 530,779 461,733
--------- ---------
Common stock .............................................. 425 425
Additional paid-in-capital ................................ 16,946 16,962
Treasury stock, 194,599 and 124,052 shares at cost ........ (2,162) (1,467)
Retained earnings ......................................... 3,931 6,745
Accumulated other comprehensive income (loss), net of taxes 18 (1)
--------- ---------
Total stockholders' equity .............................. 19,158 22,664
--------- ---------
Total liabilities and stockholders' equity ............ $ 549,937 $ 484,397
========= =========
</TABLE>
See notes to unaudited consolidated financial statements.
-1-
<PAGE>
<TABLE>
<CAPTION>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
Consolidated Statements of Operations
(Dollars in Thousands Except Share Data)
(Unaudited)
Three Months Ended Six Months Ended
December 31, December 31,
----------------------- -----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
INTEREST INCOME
Securities held for trading ................... $ 5,168 $ 6,459 $ 10,936 $ 12,536
Securities available for sale ................. 19 23 39 48
Loans receivable .............................. 3,709 1,927 6,905 3,751
Dividends on Federal Home Loan Bank stock ..... 98 98 197 199
Deposits ...................................... 161 272 278 581
Net interest expense on interest rate contracts
maintained in the trading portfolio ......... (271) (330) (553) (529)
-------- -------- -------- --------
Interest income ............................... 8,884 8,449 17,802 16,586
-------- -------- -------- --------
INTEREST EXPENSE
Deposits ...................................... 3,495 1,987 6,221 3,895
Federal Home Loan Bank advances ............... 654 467 1,155 889
Short-term borrowings ......................... 3,402 4,510 7,856 8,514
Long-term borrowings .......................... 274 219 568 437
-------- -------- -------- --------
Interest expense .............................. 7,825 7,183 15,800 13,735
-------- -------- -------- --------
NET INTEREST INCOME .............................. 1,059 1,266 2,002 2,851
PROVISION FOR LOAN LOSSES ........................ 95 -- 245 --
-------- -------- -------- --------
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES ..................... 964 1,266 1,757 2,851
-------- -------- -------- --------
OTHER INCOME (LOSS)
Gain (loss) on sale of securities held for .... 2,927 (1,072) (6,314) (1,270)
trading
Unrealized gain (loss) on securities held for
trading .................................... (1,963) 173 3,808 496
Other ......................................... 114 78 214 146
-------- -------- -------- --------
Total other income (loss) ..................... 1,078 (821) (2,292) (628)
-------- -------- -------- --------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
OTHER EXPENSE
Salaries and employee benefits ................ 984 752 1,931 1,401
Premises and equipment expense ................ 286 163 574 315
FDIC insurance premiums ....................... 26 22 52 43
Marketing ..................................... 81 33 181 57
Computer services ............................. 88 51 170 98
Consulting fees ............................... 76 71 150 141
Other ......................................... 351 392 748 686
-------- -------- -------- --------
Total other expenses .......................... 1,892 1,484 3,806 2,741
-------- -------- -------- --------
INCOME (LOSS) BEFORE INCOME TAX
PROVISION ..................................... 150 (1,039) (4,341) (518)
INCOME TAX PROVISION (BENEFIT) ................... 60 (430) (1,721) (226)
-------- -------- -------- --------
NET INCOME (LOSS) ................................ $ 90 $ (609) $ (2,620) $ (292)
======== ======== ======== ========
BASIC EARNINGS (LOSS) PER SHARE .................. $ 0.03 $ (0.19) $ (0.81) $ (0.09)
======== ======== ======== ========
DILUTED EARNINGS (LOSS) PER SHARE ................ $ 0.03 $ (0.19) $ (0.81) $ (0.09)
======== ======== ======== ========
</TABLE>
See notes to unaudited consolidated financial statements.
-2-
<PAGE>
<TABLE>
<CAPTION>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(Dollars in Thousands)
(Unaudited)
Six Months Ended
December 31,
-------------------------
1998 1997
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ............................................................... $ (2,620) $ (292)
Adjustments to reconcile net loss to net cash used
in operating activities:
Provision for loan losses ........................................... 245 --
Depreciation ........................................................ 250 138
Premium and discount amortization of securities, net ................ 1,109 521
Amortization of premiums and discounts on loans ..................... 173 62
Loss on sale of securities held for trading ......................... 6,314 1,270
Unrealized gain on securities held for trading ...................... (3,808) (496)
Deferred income tax provision ....................................... (78) (218)
Increase in interest receivable ..................................... (173) (76)
Increase in interest payable ........................................ 719 116
Purchases of securities held for trading ........................... (363,271) (442,570)
Decrease in amounts due from brokers ................................ -- 11,308
Increase in amounts due to brokers .................................. 3,898 --
Proceeds from maturities of securities held for trading ............. 26,619 12,967
Proceeds from sales of securities held for trading .................. 339,687 334,872
Decrease (increase) in other assets ................................. (1,078) 651
Increase in accrued expenses and other liabilities .................. 98 445
--------- ---------
Net cash provided by (used in) operating activities ............... 8,084 (81,302)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of securities available for sale ........... 39 147
Change in loans receivable, net ..................................... (71,563) (16,272)
Purchases of premises and equipment ................................. (492) (790)
--------- ---------
Net cash used in investing activities ............................. (72,016) (16,915)
--------- ---------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits ............................................ 99,602 1,353
Increase (decrease) in securities sold under agreements to repurchase (49,271) 56,825
Proceeds from stock options exercised ............................... -- 66
Proceeds from Federal Home Loan Bank advances ....................... 53,000 55,000
Proceeds from note payable .......................................... -- 2,000
Principal repayments on Federal Home Loan Bank advances ............. (39,000) (17,000)
Purchase of treasury stock .......................................... (784) (239)
Proceeds from issuance of treasury stock ............................ 73 --
Dividends paid on common stock ...................................... (194) (195)
--------- ---------
Net cash provided by financing activities ......................... 63,426 97,810
--------- ---------
NET DECREASE IN CASH AND EQUIVALENTS .................................. (506) (407)
CASH AND CASH EQUIVALENTS
Beginning of period ................................................. 11,779 9,516
--------- ---------
CASH AND CASH EQUIVALENTS
End of period ....................................................... $ 11,273 $ 9,109
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid for interest .............................................. $ 16,277 $ 13,786
Cash paid for income taxes ......................................... -- 321
</TABLE>
See notes to unaudited consolidated financial statements.
-3-
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
Notes to Unaudited Consolidated Financial Statements
Note 1 - Business of the Company
Harrington Financial Group, Inc. (the "Company") is a thrift holding
company incorporated in 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 seven
full-service branch offices located in Carmel, Fishers, Noblesville and
Indianapolis, Indiana, and Mission, Kansas. The Company is a growing
community bank with a focus on the origination and management of
mortgage loans and securities. The Company also operates a commercial
loan division for business customers and a trust and investment
management division for individuals and institutions.
Earnings per Share
The following is a reconciliation of the weighted average common shares
for the basic and diluted earnings per share computations in accordance
with Statement of Accounting Standards (SFAS) No. 128:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
------------------------------- ------------------------------
1998 1997 1998 1997
-------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
Basic earnings per share:
Weighted average common shares 3,205,339 3,253,231 3,227,694 3,254,985
============== ============= ============== =============
Diluted earnings per share:
Weighted average common shares 3,205,339 3,253,231 3,227,694 3,254,985
Dilutive effect of stock options (1) --- 63,749 --- 62,227
-------------- ------------- -------------- -------------
Weighted average common and
incremental shares 3,205,339 3,316,980 3,227,694 3,317,212
============== ============= ============== =============
</TABLE>
(1) No dilutive effect of stock options for the three and six months
ended December 31, 1998 was used in the calculation as the effects of
the stock options were anti-dilutive.
Note 2 - Basis of Presentation
The accompanying unaudited consolidated financial statements of the
Company have been prepared in accordance with instructions to Form 10-Q.
Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete
financial statements. However, such information reflects all adjustments
(consisting solely of normal recurring adjustments) which are, in the
opinion of management, necessary for a fair presentation of results for
the interim periods.
<PAGE>
The results of operations for the three and six months ended December
31, 1998 are not necessarily indicative of the results to be expected
for the year ending June 30, 1999. The unaudited consolidated financial
statements and notes thereto should be read in conjunction with the
audited financial statements and notes thereto for the year ended June
30, 1998.
-4-
<PAGE>
Note 3 - Recent Accounting Pronouncements
The Company adopted SFAS No. 130, Comprehensive Income, effective July
1, 1998. It requires that changes in the amounts of certain items,
including gains and losses on certain securities, be shown in the
financial statements. SFAS No. 130 does not require a specific format
for the financial statement in which comprehensive income is reported,
but does require that an amount representing total comprehensive income
be reported in that statement. All prior year financial statements have
been reclassified for comparative purposes.
The following is a summary of the Corporation's total comprehensive
income (loss) for the interim three and six month periods ended December
31, 1998 and 1997 under SFAS No. 130:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income (loss) ................................. $ 90 $ (609) $(2,620) $ (292)
------- ------- ------- -------
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains arising during period 6 11 19 19
------- ------- ------- -------
Other comprehensive income......................... 6 11 19 19
------- ------- ------- -------
COMPREHENSIVE INCOME (LOSS) ....................... $ 96 $ (598) $(2,601) $ (273)
======= ======= ======= =======
</TABLE>
In June 1997, SFAS No. 131, Disclosures about Segments of an Enterprise
and Related Information, was issued. This Statement will change the way
public companies report information about segments of their business in
their annual financial statements and requires them to report selected
segment information in their quarterly reports issued to shareholders.
It also requires entity-wide disclosures about the products and services
an entity provides, the material countries in which it holds assets and
reports revenues, and its major customers. SFAS No. 131 is effective for
fiscal years beginning after December 15, 1997. The Company will include
the appropriate segment information beginning in the annual financial
statements for the year ending June 30, 1999, and all quarterly reports
thereafter. Management has not yet determined the effect, if any, of
SFAS No. 131 on the consolidated financial statements.
SFAS No. 133, Accounting for Derivative and Similar Financial
Instruments and for Hedging Activities, was issued in June 1998 and is
<PAGE>
effective for all fiscal quarters of all fiscal years beginning after
June 15, 1999. This statement establishes accounting and reporting
standards for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of
financial condition and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically designated
as a fair value hedge, a cash flow hedge, or a hedge of foreign currency
exposure. The accounting for changes in the fair value of a derivative
(that is, gains and losses) depends on the intended use of the
derivative and the resulting designation. Management has not yet
quantified the effect of the new standard on the consolidated financial
statements.
-5-
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Condition
At December 31, 1998, the Company's total assets amounted to $549.9
million, as compared to $484.4 million at June 30, 1998. The $65.5 million or
13.5% increase in total assets during the six months ended December 31, 1998 was
primarily the result of a $71.1 million increase in net loans receivable which
was partially offset by a $6.7 million decrease in securities held for trading.
The increase in net 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 and business loans through its commercial division. The
decrease in securities held for trading was due to the shifting emphasis to
retail lending operations. The increase in the Company's assets from June 30,
1998 to December 31, 1998 was funded by a $99.6 million or 55.9% increase in
deposits and a $14.0 million or 53.8% increase in Federal Home Loan Bank
advances which were partially offset by a $49.3 million or 20.5% decrease in
securities sold under agreements to repurchase.
At December 31, 1998, the Company's stockholders' equity amounted to
$19.2 million, as compared to $22.7 million at June 30, 1998. The 15.5% decrease
in stockholders' equity was primarily due to the $2.6 million of net loss
recognized during the six month period, the quarterly $0.03 per share payments
of cash dividends totaling $194,000, and the repurchase of stock for $784,000
which were partially offset by $73,000 from treasury stock purchased by the
Company's employee stock ownership plan. At December 31, 1998, the Bank's Tier 1
core capital amounted to $31.1 million or 5.67% of adjusted total assets, which
exceeded the minimum 4.0% requirement by $9.2 million. Additionally, as of such
date, the Bank's risk-based capital totaled $31.7 million or 12.25% of total
risk-adjusted assets, which exceeded the minimum 8.0% requirement by $11.0
million.
Results of Operations
General. The Company reported earnings of $90,000 or $0.03 per share and
losses of $2.6 million or $0.81 per share during the three and six months ended
December 31, 1998, as compared to losses of $609,000 or $0.19 per share and
$292,000 or $0.09 per share during the prior comparable periods. The $699,000
increase in earnings during the three months ended December 31, 1998, as
compared to the same period in the prior year, was primarily due to a $1.9
million increase in realized and unrealized net gains on securities held for
trading which was partially offset by a $490,000 increase in the Company's
income tax provision, a $408,000 increase in operating expenses, a $207,000
decrease in net interest income and a $95,000 increase in the provision for loan
losses. The $2.3 million decrease in earnings during the six months ended
December 31, 1998, as compared to the same period in the prior year, was
primarily due to a $1.7 million increase in realized and unrealized net losses
on securities held for trading, a $1.1 million increase in operating expenses, a
$849,000 decrease in net interest income and a $245,000 increase in the
provision for loan losses which were partially offset by a $1.5 million decrease
in the Company's income tax provision.
Selected Financial Ratios. The following schedule shows selected
financial ratios for the three and six months ended December 31, 1998 and 1997.
-6-
<PAGE>
<TABLE>
<CAPTION>
At or for the Three At or for the Six
Months Ended Months Ended
December 31, December 31,
----------------------- -----------------------
1998 1997 1998 1997
------ ------ ------ -----
<S> <C> <C> <C> <C>
Return on average assets 0.06% (0.46)% (0.90)% (0.11)%
Return on average equity 1.93 (9.86) (26.19) (2.35)
Interest rate spread (1) 0.75 0.81 0.68 0.97
Net interest margin (2) 0.75 0.98 0.72 1.15
Operating expenses to average assets 1.28 1.12 1.31 1.07
Efficiency ratio (3) 175.51 110.42 193.10 91.46
Non-performing assets to total assets 0.15 0.18 0.15 0.18
Loan loss reserves to non-performing loans 289.47 69.97 289.47 69.97
</TABLE>
- -----------------------------------------------------
(1) Interest rate spread is the difference between interest income as a
percentage of interest-earning assets and interest expense as a percentage of
interest-bearing liabilities.
(2) Net interest margin is net interest income divided by average
interest-earning assets.
(3) The efficiency ratio is total other expense as a percentage of the net
interest income after provision for loan losses plus other income, excluding
gains and losses on securities held for trading.
Interest Income. Interest income increased by $435,000 or 5.1% during
the three months ended December 31, 1998, as compared to the same period in the
prior year. This increase was primarily due to a $1.8 million increase in
interest income from the loan portfolio and a $59,000 decrease in net interest
expense on interest rate contracts maintained in the trading portfolio which
were partially offset by a $1.3 million decrease in interest income from the
Company's investment portfolio and an $111,000 decrease in interest income from
deposits. The increase in interest income on the loan portfolio was a direct
result of the $107.0 million increase in the level of the average loan portfolio
which was partially offset by a 42 basis point decline in the interest yield
earned. The decrease in interest income from the Company's investment portfolio
was a result of a $52.8 million decrease in the level of the average investment
portfolio and a 49 basis point decline in the interest yield earned. The decline
in the return or yield in the investment portfolio was largely a result of the
Company's low initial rate GNMA one-year adjustable rate mortgage securities and
the shifting of the portfolio's fixed rate mortgage investments to lower coupons
with lower accounting yields but higher option adjusted spreads. The decrease in
interest income from deposits was a result of a $5.3 million decrease in the
level of the average interest-bearing deposits and a 105 basis point decline in
the interest yield earned.
<PAGE>
Interest income increased by $1.2 million or 7.3% during the six months
ended December 31, 1998, as compared to the same period in the prior year. This
increase was primarily due to a $3.2 million increase in interest income from
the loan portfolio which was partially offset by a $1.6 million decrease in
interest income from the Company's investment portfolio and a $303,000 decrease
in interest income from deposits. The increase in interest income on the loan
portfolio was a direct result of the $93.0 million increase in the level of the
average loan portfolio which was partially offset by a 37 basis point decline in
the interest yield earned. The decrease in interest income from the Company's
investment portfolio was a result of a $22.3 million decrease in the level of
the average investment portfolio and a 49 basis point decline in the interest
yield earned. The decrease in interest income from deposits was a result of a
$9.3 million decrease in the level of the average interest-bearing deposits and
an 81 basis point decline in the interest yield earned.
-7-
<PAGE>
Interest Expense. Interest expense increased by $642,000 during the
three months ended December 31, 1998, as compared to the same period in the
prior year. This increase was primarily due to a $64.7 million increase in the
level of average interest-bearing liabilities which was partially offset by a 20
basis point decrease in the cost of interest-bearing liabilities resulting from
an overall decrease in the wholesale and retail funding costs.
Interest expense increased by $2.1 million during the six months ended
December 31, 1998, as compared to the same period in the prior year. This
increase was primarily due to a $73.7 million increase in the level of average
interest-bearing liabilities.
Net Interest Income. Net interest income decreased by $207,000 or 16.4%
during the three months ended December 31, 1998, as compared to the same period
in the prior year. Net interest income decreased by $849,000 or 29.8% during the
six months ended December 31, 1998, as compared to the same period in the prior
year.
Provision for Loan Losses. During the three and six months ended
December 31, 1998, the Company increased the general allowance for loan losses
by $95,000 and $245,000, respectively, in response to the substantial loan
growth. Delinquencies and loan write-offs continue to be minimal, and the
non-performing assets remain stable. No additional provision for loan losses was
made during the three and six months ended December 31, 1997.
Other Income (Loss). Total other income (loss) amounted to $1.1 million
and ($2.3) million during the three and six months ended December 31, 1998, as
compared to ($821,000) and ($628,000) during the respective periods in the prior
year. This income (loss) principally represents the net market value gain or
loss (realized or unrealized) on securities held for trading, offset by the net
market value gain or loss (realized or unrealized) on interest rate contracts
used for hedging such securities. Management's goal is to attempt to offset any
change in the market value of its securities portfolio with the change in the
market value of the interest rate risk management contracts and mortgage-backed
derivative securities utilized by the Company to hedge its interest rate
exposure. In addition, management attempts to produce a positive hedged excess
return (i.e. total return, which includes interest income plus realized and
unrealized net gains/losses on investments minus the one month LIBOR funding
cost for the period) on the investment portfolio using option-adjusted pricing
analysis.
During the three months ended December 31, 1998, the Company recognized
$2.9 million of realized gains on the sale of securities held for trading which
were partially offset by $2.0 million of unrealized losses on securities held
for trading (which include interest rate contracts used for hedging purposes).
During the six months ended December 31, 1998, the Company recognized $6.3
million of realized losses on the sale of securities held for trading which were
partially offset by $3.8 million of unrealized gains on securities held for
trading. Losses on hedge contracts during the first half of the six months ended
December 31, 1998 substantially exceeded gains on mortgage investments as U.S.
Treasury and mortgage rates declined to the lowest level in many years. The
primary reasons for the underperformance of mortgages were (1) fears of an
unprecedented wave of mortgage refinancings and (2) dramatically increased
volatility in many financial markets (stocks, corporate bonds, and emerging
markets). This volatility caused a flight to quality that increased risk
premiums and widened spreads to comparable Treasury securities in all of these
markets, including mortgage securities. During the latter half of the six months
ended December 31, 1998, the slight narrowing of risk adjusted spreads on
mortgages and strategic trades between adjustable and fixed rate securities
-8-
<PAGE>
contributed to a significant improvement in performance, as hedge gains exceeded
the losses on the mortgage investments.
During the three and six months ended December 31, 1997, the Company
recognized $1.1 million and $1.3 million of realized losses on the sale of
securities and hedge contracts held for trading which were partially offset by
$173,000 and $496,000 of unrealized gains on securities held for trading.
Other Expense. Total other expense amounted to $1.9 million and $3.8
million during the three and six months ended December 31, 1998, as compared to
$1.5 million and $2.7 million during the respective periods in the prior year.
The increase in total other expense was due to increases in salaries, premises
and equipment expense, and other operating expenses, which were primarily the
result of the Company's retail growth (including the opening of four new branch
offices in the Indianapolis, Indiana area). Furthermore, the Company added a new
commercial loan division and an additional branch in Mission, Kansas, which
opened in August of 1998.
Income Tax Provision. The Company recorded an income tax provision of
$60,000 during the three months ended December 31, 1998 as compared to an income
tax benefit of $430,000 during the respective period in the prior year. For the
six months ended December 31, 1998 and 1997, the Company recorded income tax
benefits of $1.7 million and $226,000, respectively. During the three and six
months ended December 31, 1998, the Company's effective tax rate amounted to
40.0% and 39.6% as compared to 41.4% and 43.6% during the same periods in 1997.
Changes in the effective tax rates were primarily a result of different levels
of permanent differences.
Liquidity and Capital Resources
The Bank is required under applicable federal regulations to maintain
specified levels of "liquid" investments as defined by the Office of Thrift
Supervision ("OTS"). As of November 24, 1997, the required level of such liquid
investments was changed from 5% to 4% of certain liabilities as defined by the
OTS. In addition to the change in the percentage of required level of liquid
assets, the OTS also modified its definition of investments that are considered
liquid. As a result of this change, the level of assets eligible for regulatory
liquidity calculations increased considerably.
The total eligible regulatory liquidity of the Bank was 10.0% at
December 31, 1998, as compared to 15.6% and 5.3% at June 30, 1998 and 1997,
respectively. At December 31, 1998, the Bank's average "liquid" assets totaled
approximately $52.8 million, which was $31.6 million in excess of the current
OTS minimum requirement.
At December 31, 1998, the Company's total approved originated loan
commitments outstanding amounted to $12.1 million, and the unused lines of
credit outstanding totaled $8.9 million. At the same date, commitments
outstanding to purchase investment securities and loans were $73.2 million and
$2.8 million, respectively. Certificates of deposit scheduled to mature in one
year or less at December 31, 1998 totaled $142.1 million. The Company believes
that it has adequate resources to fund ongoing commitments such as investment
security and loan purchases as well as deposit account withdrawals and loan
commitments.
-9-
<PAGE>
"Safe Harbor" Statement under the Private Securities Litigation Reform Act of
1995
In addition to historical information, forward-looking statements are
contained herein that are subject to risks and uncertainties that could cause
actual results to differ materially from those reflected in the forward-looking
statements. Factors that could cause future results to vary from current
expectations, include, but are not limited to, the impact of economic conditions
(both generally and more specifically in the markets in which the Company
operates), the impact of competition for the Company's customers from other
providers of financial services, the impact of government legislation and
regulation (which changes from time to time and over which the Company has no
control), and other risks detailed in this Form 10-Q and in the Company's other
Securities and Exchange Commission (SEC) filings. Readers are cautioned not to
place undue reliance on these forward-looking statements, which reflect
management's analysis only as of the date hereof. The Company undertakes no
obligation to publicly revise these forward-looking statements, to reflect
events or circumstances that arise after the date hereof. Readers should
carefully review the risk factors described in other documents the Company files
from time to time with the SEC.
Year 2000 Disclosure
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. The Company's
computer programs and those of third-party computer related providers may
recognize a date using "00" as the year 1900 rather than the year 2000. This
situation could result in system failures or miscalculations causing disruption
of operations that could affect the ability of the Company to operate
effectively and service customers.
I. THE COMPANY'S STATE OF READINESS
The Company is preparing for the year 2000 by testing and evaluating
both its information technology (IT) and non-information technology systems. The
Company does not have any mission critical processes that are dependent on
non-IT systems. The non-IT systems, such as the telephone system, are either
currently compliant or are expected to be compliant in fiscal year 1999. The IT
systems used by the Company have been or are being tested. The components of the
IT systems being examined are: 1) personal computers (PCs), hardware and
software, 2) data service bureau, and 3) other service providers.
Hardware and software on all PCs have been inventoried and tested. The
limited number of PCs and software that were not year 2000 compliant have been
replaced or are scheduled to be replaced in the first quarter of calendar year
1999.
Given the expiration of the Bank's data processing agreement with its
current service provider in early calendar year 1999, the Company evaluated its
data processing requirements under its strategic plan and considered alternative
solutions to meet these requirements. The Company signed a contract with another
data service provider, FISERV Vision, to replace its current provider. The
conversion to this system is expected to be accomplished in April of 1999.
FISERV has provided the Company with assurances that the Vision product is Year
2000 compliant, and the Company will be conducting tests on this software system
to confirm this compliance.
-10-
<PAGE>
If, for some unexpected reason, the Company is unable to accomplish
this conversion to FISERV, then it would retain its current vendor and ensure
compliance with Year 2000 through written assurance from the vendor and adequate
testing of the operating system. The existing data service vendor has revised
its code and has tested for Year 2000 compliance.
Other service providers, such as the Company's financial advisors or
the FHLB of Indianapolis, are either Year 2000 compliant or are keeping the
Company apprised of their progress towards being Year 2000 compliant. As part of
the Company's Year 2000 compliance program, the Company will be monitoring the
vendors' progress toward compliance and, if necessary, testing systems to help
ensure compliance.
II. THE COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES
The limited number of PCs and software that were not Year 2000
compliant have been replaced or are scheduled to be replaced in the first
quarter of calendar year 1999. The cost of replacing these machines and software
is estimated to be $43,500 in capitalized fixed assets in fiscal year 1999.
III. THE RISKS OF THE COMPANY'S YEAR 2000 ISSUES
The Company has established parameters and processes for management to
identify material customers, evaluate their preparedness, assess their credit
risk and implement controls to manage the risk arising from their failure to
properly address Year 2000 technology issues. The Company faces increased
credit, liquidity, or counterparty trading risk when customers encounter Year
2000-related problems. Customers that must be evaluated and monitored are those
that, if adversely impacted by Year 2000 technology issues, represent a
significant financial exposure to the Company in terms of either credit loss or
liquidity. The organizations that have been identified as material customers of
the Company will be monitored because of their reliance on technology for their
successful business operations.
Failure of borrowers, counterparties or servicers to address Year 2000
problems may increase credit risk to the Company through the inability of these
parties to meet the terms of their contracts and make timely payments of
principal and interest to the Company. Liquidity risk may result if depositors,
lenders or counterparties experience Year 2000-related business disruption or
operational failures and are unable to provide funds or fulfill funding
commitments to the Company. Capital market counterparties, such as trading
counterparties or interest rate swap or interest rate cap/floor counterparties,
provide contracts that allow the Company to enter into forward commitments to
purchase or sell securities or to use hedges to reduce interest rate risk.
Liquidity and credit risk may result if capital market counterparties are unable
to fulfill contractual commitments due to operational problems caused by the
Year 2000 date change.
In those cases where the Company is not fully satisfied that its
counterparties will be Year 2000 ready, mitigating controls will be established
such as early termination agreements, additional collateral, netting
arrangements, and third-party payment arrangements or guarantees. In cases where
the Company has a high degree of uncertainty regarding a counterparty's ability
to address its Year 2000 problems, the Company will avoid all transactions with
that counterparty that mature on or after January 1, 2000 with liquidity,
credit, or settlement risk. The Company
-11-
<PAGE>
will not resume normal transaction activities until the counterparty has
demonstrated that it is prepared for the Year 2000.
IV. THE COMPANY'S CONTINGENCY PLAN
DATA SERVICE BUREAU
- -------------------
In the event, the data service bureau used by the Bank fails to operate
satisfactorily after the turn of the century, the Bank would be forced to
operate on a manual system until a conversion could be made to a different
service bureau or the existing service bureau corrects its problems. The Bank
would establish ledger cards for each customer account and would manually post
transactions to the cards each day. Transactions would also be batched and
manually posted to the general ledger. The ledger cards would be balanced to the
general ledger frequently to provide some assurance that the manual system is
functioning accurately.
The Bank would have to make some temporary changes in its product menu
during the time operating on a manual system. For instance, the Bank would
probably discontinue originating mortgage loans because of the complexities
involved with them. The Bank would also stop opening new checking accounts. The
Bank might have to convert its existing checking accounts to savings accounts
(with appropriate advance notice and disclosures to the customers) so that the
Bank could more efficiently process these accounts. The Bank would also have to
put a temporary moratorium on ATM transactions because the Bank would be
effectively running in an off-line mode.
Undoubtedly, the Bank would experience significant deposit run-off were
the Bank to function in such a limited capacity for any length of time. However,
the Bank has a substantial mortgage-backed security portfolio which provides the
Bank with ready liquidity should the need arise to liquidate deposits.
INVESTMENT SECURITIES
- ---------------------
The Company has received assurances that most major brokers with which it trades
are Year 2000 compliant. Many smaller regional brokers have yet to provide these
assurances. Beginning in November 1999, the Company will no longer enter into
any transactions with regional brokers that are not Year 2000 compliant. In this
way, the Company will control its exposure to Year 2000 risks with these
brokers. After the turn of the millennium, the Company will carefully evaluate
regional brokers individually before resuming business with them.
Most of the Company's securities are in safekeeping at the FHLB of
Indianapolis, which is progressing towards being year 2000 compliant. If the
FHLB is not Year 2000 compliant in 1999, the Company will engage a new
safekeeping agent that is compliant. Similarly, if any assets are pledged with
brokers, the Company will verify well before the end of 1999 that those brokers
are already Year 2000 compliant and if not, these assets will be pledged only
with Year 2000 compliant brokers.
PERSONAL COMPUTERS
- ------------------
By the end of the first quarter of calendar year 1999, the Company will
have replaced or upgraded all of its personal computers which failed Year 2000
compliance tests. Thus, it is
-12-
<PAGE>
expected that the Company's PCs will be in compliance when the century turns.
The Company has previously tested the software used on its PCs, and those
software packages that did not properly handle the Year 2000 have been replaced.
OTHER VENDORS AND SERVICE PROVIDERS
- -----------------------------------
The Company is closely monitoring all of its other vendors and service
providers to determine if they will be Year 2000 compliant on a timely basis. If
any vendors or service providers have not yet become Year 2000 compliant by the
end of the first quarter of calendar year 1999, the Bank will immediately find a
replacement vendor or service provider who is compliant. It is possible,
although unlikely, that increased cost to the institution could result from
engaging replacement vendors.
GENERAL
- -------
The costs of the project and the date on which the Company plans to
complete the Year 2000 compliance program are based on management's best
estimates which were derived utilizing numerous assumptions of future events
including the continued availability of certain resources, third party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved, and actual results could differ materially
from these estimates.
QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
The OTS requires each thrift institution to calculate the estimated
change in the institution's market value of portfolio equity (MVPE) assuming an
instantaneous, parallel shift in the Treasury yield curve of 100 to 400 basis
points either up or down in 100 basis point increments. MVPE is defined as the
net present value of an institution's existing assets, liabilities and
off-balance sheet instruments. The OTS permits institutions to perform this MVPE
analysis using their own internal model based upon reasonable assumptions. The
Company has contracted with Smith Breeden Associates, Inc. for the provision of
consulting services regarding, among other things, the management of its
investments and borrowings, the pricing of loans and deposits, the use of
various financial instruments to reduce interest rate risk and assistance in
performing the required calculation of the sensitivity of its market value to
changes in interest rates. 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.
The following table sets forth at December 31, 1998, the estimated
sensitivity of the Bank's MVPE to parallel yield curve shifts using the
Company's internal market value calculation. The table demonstrates the
sensitivity of the Bank's assets and liabilities both before and after the
inclusion of its interest rate contracts.
In addition to this internal market value calculation based on projected
cashflows, the Company also evaluates the market value changes using time
varying empirical elasticity (TVEE) analysis. This analysis measures the market
value changes of the mortgage investment based on historical price relationships
to changes in Treasury rates and other variables. This empirical analysis is
conducted for smaller shifts in rates of plus or minus 100 basis points in 25
-13-
<PAGE>
basis point increments. Management believes this empirical based analysis is a
valuable and more accurate tool in estimating the level of net market value
changes of the investment and total portfolios and is in the process of
expanding the analysis to consider larger interest rate changes.
The table set forth below 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 (1) to the extent the affected instruments are
marked to market and (2) over the life of the instruments as an impact on
recorded yields.
<TABLE>
<CAPTION>
Change in Interest Rates
(In Basis Points)(1)
(Dollars in Thousands) -400 -300 -200 -100 - +100 +200 +300 +400
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Market value gain (loss) of assets $41,196 $30,052 $20,326 $12,148 --- $(19,232) $(42,921) $(67,935) $(92,599)
Market value gain (loss) of
liabilities (5,280) (4,177) (2,993) (1,626) --- 1,955 4,275 6,977 9,976
------- ------- ------- ------- ------ -------- -------- -------- --------
Market value gain (loss) of net
assets before interest rate contracts 35,916 25,875 17,333 10,522 --- (17,277) (38,646) (60,958) (82,623)
------
Market value gain (loss) of interest
rate contracts (24,459) (19,824) (14,635) (8,423) --- 12,484 28,541 46,583 65,412
------- ------- ------- ------- ------ -------- -------- -------- --------
Total change in MVPE (2) (Model) $11,457 $ 6,051 $ 2,698 $ 2,099 --- $ (4,793) $(10,105) $(14,375) $(17,211)
======= ======== ======== ======== ====== ======== ======== ======== ========
Total change in MVPE (2) (TVEE) $ (1,014) --- $ 2,050
======== ====== ========
Change in MVPE as a percent of:
MVPE (2) (Model) 33.4% 17.6% 7.9% 6.1% --- (14.0)% (29.5)% (41.9)% (50.2)%
Total assets of the Bank 2.1% 1.1% 0.5% 0.4% --- (0.9)% (1.8)% (2.6)% (3.1)%
</TABLE>
(1) Assumes an instantaneous parallel change in interest rates at all
maturities.
(2) Based on the Bank's pre-tax MVPE of $34.3 million at December 31, 1998.
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 and
constant option adjusted spreads on assets and liabilities. 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 39.0%.
<PAGE>
<TABLE>
<CAPTION>
Change in Interest Rates
(In Basis Points)(1)
(Dollars in Thousands) -400 -300 -200 -100 - +100 +200 +300 +400
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
After tax market value gain (loss) .... $ 29,322 $ 21,098 13,803 $ 7,579 -- $(11,048) $(24,592) $(39,084) $(53,512)
of assets
After tax market value gain (loss)
of interest rate contracts ......... (18,611) (15,051) (11,064) (6,370) -- 9,016 20,218 32,994 46,604
-------- -------- -------- -------- --- -------- -------- -------- --------
After tax gain (loss) in equity (Model) $ 10,711 $ 6,047 $ 2,739 $ 1,209 -- $ (2,032) $ (4,374) $ (6,090) $ (6,908)
======== ======== ======== ======== --- ======== ======== ======== ========
After tax gain (loss) in equity (TVEE) $ 540 -- $ (839)
======== === ========
After tax gain (loss) in equity as a
percent of the Company's equity at
December 31, 1998 (Model) .......... 34.1% 19.3% 8.7% 3.8% -- (6.5)% (13.9)% (19.4)% (22.0)%
</TABLE>
-14-
<PAGE>
HARRINGTON FINANCIAL GROUP, INC. AND SUBSIDIARY
Part II
Item 1. Legal Proceedings
-----------------
Neither the Company nor the Bank is involved in any pending legal
proceedings other than non-material legal proceedings occurring in the
ordinary course of business.
Item 2. Changes in Securities
---------------------
Not applicable.
Item 3. Defaults Upon Senior Securities
-------------------------------
Not applicable.
Item 4. Submission of Matters to a Vote of Security-Holders
---------------------------------------------------
a) An annual meeting of stockholders ("Annual Meeting") was held
on October 20, 1998
b) Not applicable.
c) Two matters were voted upon at the Annual Meeting. The
stockholders approved matters brought before the Annual
Meeting. The matters voted upon together with the applicable
voting results were as follows:
1) Proposal to elect a director for a one-year term
expiring in 1999 -Russell Breeden III received
votes for 3,078,717; withheld 7,500; not voted
144,300.
Proposal to elect directors for a three-year term
expiring in 2001 - Sharon E. Fankhauser, C.P.A.,
Michael J. Giarla, David F. Harper, C.P.A. and
John J. McConnell each received votes for
3,078,717; withheld 7,500; not voted 144,300.
2) Proposal to ratify the appointment by the Board of
Directors of Deloitte & Touche LLP as the
Company's independent auditors for the fiscal year
ending June 30, 1999 - votes for 3,085,317;
against 200; abstain 700; not voted 144,300.
d) Not applicable.
-15-
<PAGE>
Item 5. Other Information
-----------------
None.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
a) Exhibit 3.1: Amended and Restated Articles of
Incorporation of Harrington Financial Group, Inc. This
exhibit is incorporated herein by reference from the
Registration Statement on Form S-1 (Registration No.
333-1556) filed by the Company with the SEC on February
20, 1996, as amended.
b) Exhibit 3.2: Amended and Restated Bylaws of Harrington
Financial Group, Inc. This exhibit is incorporated herein
by reference from the Registration Statement on Form S-1
(Registration No. 333-1556) filed by the Company with the
SEC on February 20, 1996, as amended.
c) Exhibit 27: Financial Data Schedule
d) No Form 8-K reports were filed during the quarter.
-16-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HARRINGTON FINANCIAL GROUP, INC.
Date: February 8, 1999 By: /s/ Craig J. Cerny
------------------
Craig J. Cerny
President
Date: February 8, 1999 By: /s/ Gregory L. Tislow
---------------------
Gregory L. Tislow
Principal Financial & Accounting Officer
<PAGE>
EXHIBIT 27
Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 9
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-END> DEC-31-1999
<CASH> 1,980
<INT-BEARING-DEPOSITS> 9,293
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 283,959
<INVESTMENTS-HELD-FOR-SALE> 902
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 235,296
<ALLOWANCE> 605
<TOTAL-ASSETS> 549,937
<DEPOSITS> 277,913
<SHORT-TERM> 231,125
<LIABILITIES-OTHER> 8,246
<LONG-TERM> 13,495
0
0
<COMMON> 425
<OTHER-SE> 18,733
<TOTAL-LIABILITIES-AND-EQUITY> 549,937
<INTEREST-LOAN> 6,905
<INTEREST-INVEST> 10,619
<INTEREST-OTHER> 278
<INTEREST-TOTAL> 17,802
<INTEREST-DEPOSIT> 6,221
<INTEREST-EXPENSE> 15,800
<INTEREST-INCOME-NET> 2,002
<LOAN-LOSSES> 245
<SECURITIES-GAINS> (2,292)
<EXPENSE-OTHER> 3,806
<INCOME-PRETAX> (4,341)
<INCOME-PRE-EXTRAORDINARY> (4,341)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,620)
<EPS-PRIMARY> (0.81)
<EPS-DILUTED> (0.81)
<YIELD-ACTUAL> .68
<LOANS-NON> 209
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 360
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 605
<ALLOWANCE-DOMESTIC> 605
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
