SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1996
---------------------------------
- OR -
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from __________________ to _____________________
Commission file number: 0-25342
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Wells Financial Corp.
- -------------------------------------------------------------------------------
(Exact name of small business issuer in its charter)
Minnesota 48-1799504
- -------------------------------------------- ---------------------
(State or other jurisdiction of (I.R.S. employer
of incorporation or organization) identification no.)
53 First Street, S.W., Wells, Minnesota 56097
- -------------------------------------------- ---------------------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (507) 553-3151
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.10 per share
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(Title of class)
Indicate by check mark whether 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 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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X]
Registrant's voting stock trades on the Nasdaq National Market under the
symbol "WEFC." The aggregate market value of the voting stock held by
non-affiliates of registrant, based upon the closing price of such stock as of
March 10, 1997 ($14.375 per share), was $26.7 million.
As of March 10, 1997, registrant had 2,018,860 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
1. Part II -- Portions of Registrant's Annual Report to Stockholders for the
fiscal year ended December 31, 1996.
2. Part III -- Portions of registrant's Proxy Statement for Annual Meeting of
Stockholders to be held on April 16, 1997.
<PAGE>
PART I
Item 1. Business
- ----------------
General
Wells Financial Corp. ("Registrant" or the "Company") is a unitary savings
and loan holding company that was incorporated in December 1994 under the laws
of the State of Minnesota for the purpose of acquiring all of the issued and
outstanding common stock of Wells Federal Bank, fsb (the "Bank"). This
acquisition occurred in April 1995 at the time the Bank simultaneously converted
from a mutual to stock institution, and sold all of its outstanding capital
stock to the Company and the Company made its initial public offering of common
stock (the "Conversion"). As of December 31, 1996, the Company had total assets
of $201.3 million, total deposits of $145.3 million, and stockholders' equity of
$28.2 million or 14.0% of total assets under generally accepted accounting
principles ("GAAP"). The only subsidiary of the Company is the Bank.
The primary activity of the Company is directing and planning the
activities of the Bank, the Company's primary asset. At December 31, 1996, the
remainder of the assets of the Company were maintained in the form of a loan to
the Bank, a loan to an employee stock ownership plan ("ESOP") that was
established for the benefit of the Bank's employees, deposits in interest
bearing accounts with other financial institutions and selected investments. The
Company engages in no other significant activities. As a result, references to
the Company or Registrant generally refer to the Bank, unless the context
otherwise indicates. In the discussion of regulation, except for the discussion
of the regulation of the Company, all regulations apply to the Bank rather than
the Company.
The Bank is a federally chartered stock savings bank headquartered in
Wells, Minnesota. The Bank has seven full service offices located in Faribault,
Martin, Blue Earth, Nicollet and Freeborn Counties and one loan origination
office located in Steele County, Minnesota. The Bank was founded in 1934 and
obtained its current name in 1991. The Bank's deposits have been federally
insured by the Savings Association Insurance Fund ("SAIF") and its predecessor,
the Federal Savings and Loan Insurance Corporation ("FSLIC"), since 1934, and
the Bank is a member of the Federal Home Loan Bank ("FHLB") System. The Bank is
a community oriented, full service retail savings institution offering
traditional mortgage loan products. It is the Bank's intent to remain an
independent community savings bank serving the local banking needs of Faribault,
Martin, Blue Earth, Nicollet, Steele and Freeborn Counties, Minnesota.
The Bank attracts deposits from the general public and uses such deposits
primarily to invest in residential lending on owner occupied properties. The
Bank also makes consumer loans, commercial loans, and agricultural related loans
and purchases mortgage-backed and investment securities.
The principal sources of funds for the Registrant's lending activities are
deposits, advances from the Federal Home Loan Bank and the amortization,
repayment, and maturity of loans, mortgage-backed securities, and investment
securities. Principal sources of income are interest and fees on loans,
mortgage-backed securities, investment securities, and deposits held in other
financial institutions. The Registrant's principal expense is interest paid on
deposits.
Market Area
The Company's primary market area consists of Faribault, Martin, Blue
Earth, Nicollet, Steele and Freeborn Counties, Minnesota. Located southwest of
Minneapolis, this area is primarily rural and
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<PAGE>
contains approximately 50 communities ranging in population size from 200 to
40,000. The primary lending concentration is in the Mankato and North Mankato
area, an area with a relatively large population base. The Company has two
offices in the Mankato and North Mankato area. Historically, the economy in the
Company's market area has been dependent on agriculture and agriculture related
industries. Economic growth in the Company's market area remains dependent upon
the local economy. In addition, the deposit and loan activity of the Company is
significantly affected by economic conditions in its market area including the
agriculture industry.
Lending Activities. The Company's loan portfolio predominantly consists of
mortgage loans secured by one to four-family residences. The Company also makes
consumer loans and commercial loans. For its mortgage loan portfolio, the
Company originates and retains adjustable rate loans as well as lower
loan-to-value ratio fixed-rate loans with original maturities that are greater
than fifteen years. The Company sells other conventional fixed rate mortgage
loans into the secondary market. The Company's consumer loan portfolio consists
primarily of home equity or improvement loans secured by second liens on real
estate on which the Company has the first lien. To a lesser extent, the consumer
loan portfolio includes loans secured by vehicles and savings accounts. The
Company also originates commercial and multi-family real estate loans, the vast
majority of which are secured by farm land. In addition to loans secured by farm
real estate, the Company makes commercial business loans, the majority of which
are secured by farm operating equipment, livestock, crops on hand, growing crops
and farm real estate.
The consumer, commercial, and commercial business loan portfolios are
primarily composed of adjustable rate loans.
The Company's adjustable rate loans reprice based on a cost of funds index
that is a lagging market index. A lagging index does not adjust as rapidly as
market interest rates and may not adjust as rapidly as would other indices.
During periods of increasing interest rates, use of a lagging index results in
adjustable rate loans repricing upward at a slower rate than if a leading market
index had been used. During periods of decreasing interest rates, use of a
lagging index results in adjustable rate loans repricing downward at a slower
rate than if a leading market index had been used.
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<PAGE>
Loan Portfolio Composition. The following table sets forth information
concerning the composition of the Company's loan portfolio in dollar amounts and
in percentages of the total loan portfolio (before deductions for loans in
process, deferred loan origination fees and costs and allowances for losses) as
of the dates indicated.
<TABLE>
<CAPTION>
At December 31,
------------------------------------------------------------------------------------------
1992 1993 1994 1995 1996
---------------- ---------------- ----------------- ---------------- ---------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
Real Estate Loans:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One- to four-family ................. $ 99,997 81.57% $118,294 82.08% $137,130 82.14% $136,022 79.38% $141,067 78.20%
Multi-family ........................ 1,377 1.12 1,015 0.70 951 0.57 880 0.51 1,355 0.75
Commercial .......................... 7,804 6.37 8,384 5.82 9,654 5.78 10,554 6.16 10,878 6.03
Construction ........................ 1,359 1.11 1,517 1.05 2,149 1.29 2,774 1.62 2,081 1.15
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans ......... 110,537 90.17 129,210 89.65 149,884 89.78 150,230 87.67 155,381 86.13
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Other Loans:
Consumer Loans:
Savings account ..................... 784 0.64 531 0.37 471 0.28 436 0.25 443 0.25
Vehicles ............................ 1,168 0.95 2,308 1.60 2,573 1.54 3,353 1.96 4,619 2.56
Home equity, home improvement and
second mortgages ................... 6,566 5.36 8,135 5.65 10,392 6.23 12,875 7.51 15,197 8.42
Other ............................... 2,393 1.95 2,973 2.06 2,811 1.68 3,279 1.91 3,588 1.99
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans ............ 10,911 8.90 13,947 9.68 16,247 9.73 19,943 11.63 23,847 13.22
Commercial business loans ............. 1,135 0.93 957 0.67 810 0.49 1,191 0.70 1,171 0.65
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total other loans ............... 12,046 9.83 14,904 10.35 17,057 10.22 21,134 12.33 25,018 13.87
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans ..................... 122,583 100.00% 144,114 100.00% 166,941 100.00% 171,364 100.00% 180,399 100.00%
====== ====== ====== ====== ======
Less:
Loans in process .................... 503 1,190 685 493 623
Deferred loan origination fees
and costs .......................... 362 544 695 689 714
Allowance for loan losses ........... 479 398 376 512 615
------- -------- -------- -------- --------
Total loans receivable, net...... $121,239 $141,982 $165,185 $169,670 $178,447
======== ======== ======== ======= =======
</TABLE>
3
<PAGE>
Origination, Purchase, and Repayment of Loans. The following table sets
forth the Company's loan originations, sales, and principal repayments for the
periods indicated. The Company originates loans for retention in its portfolio
and did not purchase loans during the years indicated.
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(In Thousands)
Total gross loans receivable at
<S> <C> <C> <C> <C> <C>
beginning of year ............. $134,291 $122,583 $144,114 $166,941 $171,364
-------- -------- -------- -------- --------
Loans originated:
One- to four-family residential 57,408 64,043 33,854 30,609 43,411
Commercial and multi-family real
estate ....................... 296 1,042 1,623 1,366 1,759
Construction loans ............. 1,556 3,627 5,114 5,522 6,776
Consumer loans ................. 1,507 7,496 8,166 12,103 10,242
Commercial business loans ...... 670 1,257 1,760 1,567 610
-------- -------- -------- -------- --------
Total loans originated ........... 61,437 77,465 50,517 51,167 62,798
-------- -------- -------- -------- --------
Principal reductions:
Loans sold ..................... 39,613 24,552 2,971 13,584 19,209
Loan principal repayments ...... 33,532 31,382 24,719 33,160 34,554
-------- -------- -------- -------- --------
Total principal reductions ....... 73,145 55,934 27,690 46,744 53,763
-------- -------- -------- -------- --------
Total gross loans receivable at
end of year .................... $122,583 $144,114 $166,941 $171,364 $180,399
======== ======== ======== ======== ========
</TABLE>
Loan Sales. During 1996, the Company sold $19.2 million of mortgage loans
into the secondary market. The Company sells the FHA and Veterans Administration
("VA") loans that it originates to another financial institution. The Company
does not retain the servicing on the FHA/VA loans. The Company also sells
conforming fixed-rate conventional loans with loan-to-value ratios of 90% or
higher to the Federal Home Loan Mortgage Corporation ("FHLMC"). The Company
retains the servicing rights on these loans. All loans sold to FHLMC ($17.7
million) were sold without recourse to the Company, except for documentation
deficiencies that may require the Company to repurchase these loans within a
limited time period following the sale to FHLMC. To a lesser extent, the Company
has sold loans with high loan to value ratios to maintain its loan quality.
4
<PAGE>
Loan Maturity Tables. The following table sets forth the maturity of the
Company's loan portfolio at December 31, 1996. The table does not include
prepayments, scheduled principal repayments or loans held for sale. All mortgage
loans are shown as maturing based on contractual maturities.
<TABLE>
<CAPTION>
1- to 4- Other
Family Residential Commercial
Real Estate and Business and
Mortgage Commercial Construction Consumer Total
-------- ---------- ------------ -------- -----
(In Thousands)
Amounts Due:
<S> <C> <C> <C> <C> <C>
Within 1 year....... $ 439 $ 2 $2,081 $ 2,706 $ 5,228
1 to 3 years........ 1,281 513 -- 3,609 5,403
3 to 5 years........ 1,689 1,283 -- 5,298 8,270
5 to 10 years....... 8,228 937 -- 12,266 21,431
Over 10 years....... 129,430 9,498 -- 1,139 140,067
------- ------ ----- ------ -------
Total amount due...... $141,067 $12,233 $2,081 $25,018 180,399
======= ====== ===== ====== -------
Less:
Allowance for loan losses.................................................. 615
Loans in process........................................................... 623
Deferred loan fees......................................................... 714
-------
Loans receivable, net.................................................... $178,447
=======
</TABLE>
The following table sets forth the dollar amount of all loans due after
December 31, 1997 that have pre-determined interest rates and which have
floating or adjustable interest rates. This table does not include loans held
for sale.
<TABLE>
<CAPTION>
Floating or
Fixed Rates Adjustable Rates Total
----------- ---------------- -----
(In Thousands)
<S> <C> <C> <C>
One- to four-family ................... $ 49,203 $ 91,425 $140,628
Commercial and multi-family real estate 3,286 8,945 12,231
Construction .......................... - - -
Commercial business and consumer ...... 9,550 12,762 22,312
-------- -------- --------
Total ............................... $ 62,039 $113,132 $175,171
======== ======== ========
</TABLE>
One- to Four-Family Residential Loans. The Company's primary lending
activity consists of the origination of single family residential mortgage loans
secured by property located in the Company's primary market area. The Company
generally originates one- to four-family residential mortgage loans without
private mortgage insurance in amounts up to 80% of the lesser of the appraised
value or selling price of the mortgaged property. The Company will not originate
any loan which exceeds 95% of the lesser of the appraised value or selling price
and typically requires private mortgage insurance on any loans at 80% or more of
the value of the mortgaged property. Typically, fixed rate loans with
loan-to-value ratios of 90% or higher will be sold into the secondary market.
The Company originates adjustable rate mortgage loans for retention in its
portfolio with loan-to-value ratios of up to 95% and requires private mortgage
insurance when the loan-to-value ratio exceeds 80%.
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<PAGE>
For its adjustable rate loans, the Company may offer low initial interest
rates ("teaser rates") but requires the borrower to qualify at the fully indexed
rate. The Company's adjustable rate loans provide for annual 1%-2% interest rate
adjustments with a maximum adjustment over the term of the loan of between 5%
and 6%. The Company also permits adjustable rate loans to be converted into
fixed-rate loans.
Loan originations are generally obtained from existing customers, members of
the local community, and referrals from realtors within the Company's lending
area. Mortgage loans originated and held by the Company in its portfolio include
due-on sale clauses which provide the Company with the contractual right to deem
the loan immediately due and payable in the event that the borrower transfers
ownership of the property without the Company's consent.
The Company primarily originates fixed and adjustable rate mortgage loans
with 15-30 year terms. The Company offers various loan programs, including low
documentation loans for loans with lower loan-to-value ratios and other loan
programs using cost of funds or one-year U.S. treasury indices for adjustable
rate loan repricing. Interest rates charged on mortgage loans are competitively
priced based on market conditions and the Company's cost of funds. Throughout
the year, origination fees for loans were generally 1% of the loan amount. The
Company's standard underwriting guideline for fixed-rate mortgage loans conform
to FHLMC guidelines and the loans may be sold in the secondary market to private
investors. The Company customarily sells all Federal Housing Administration and
Veterans' Administration ("FHA/VA") loans as well as certain conforming fixed
rate mortgage loans in the secondary market. The Company also originates
adjustable rate mortgages ("ARMs") which adjust every year based upon various
indices.
At December 31, 1996, the Company was servicing approximately $66.1 million
of loans for others, primarily long term fixed rate loans sold to FHLMC.
Generally, the Company retains all servicing on loans sold to FHLMC and does not
retain servicing on FHA/VA loans sold. Except for document deficiencies that may
occur during origination that may require a repurchase by the Company, loans are
sold without recourse.
Consumer Loans. The Company offers second mortgage loans on one- to
four-family residences which are typically offered as adjustable rate loans.
Such loans are only made on owner-occupied one- to four-family residences and
are subject to a 95% combined loan-to-value ratio. The Company holds the
majority of the underlying first mortgages on these loans. The underwriting
standards for second mortgage loans are similar to the Company's standards
applicable to one- to four-family residential loans. To a lesser extent, the
Company makes loans secured by vehicles and by savings accounts held with the
Company. Loans secured by vehicles totalled $4.6 million, or 2.56%, of the loan
portfolio at December 31, 1996.
Federal regulations permit federally chartered thrift institutions to make
secured and unsecured consumer loans up to 35% of an institution's assets. In
addition, a federal thrift has lending authority above the 35% category for
certain consumer loans, property improvement loans, and loans secured by savings
accounts. The Company originates consumer loans in order to provide a wide range
of financial services to its customers and because the shorter terms and
normally higher interest rates on such loans help maintain a profitable spread
between its average loan yield and its cost of funds. Consumer loans, however,
tend to have a higher risk of default than residential mortgage loans.
Typically, based on the Company's experience, a borrower faced with either
paying a mortgage loan to avoid foreclosure on the borrower's home or defaulting
on a consumer loan will continue paying the mortgage loan. At December 31, 1996,
the Company had approximately $75,000 in consumer loans that were more than 90
days delinquent.
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<PAGE>
Commercial Real Estate Loans. In order to enhance yields on its assets, the
Company originates loans secured by commercial real estate. Approximately
three-quarters of this portfolio is secured by farm real estate. Most of the
remainder of the portfolio is secured by church real estate. At December 31,
1996, loans secured by farm real estate were originated in amounts up to the
lesser of 65% of the appraised value of the property or $1,000 per tillable
acre. These loans are evaluated on a cash flow basis in addition to an asset
value basis. Loans secured by church real estate are generally originated in
amounts up to 70% of the appraised value of the property. At December 31, 1996,
the Company's largest commercial real estate loan consisted of a $525,000
performing loan secured by a multi-family building in North Mankato, Minnesota.
All commercial real estate loans, excluding those secured by farm real estate,
require prior approval by the Bank's Board of Directors. As part of its
underwriting, the Company requires that borrowers qualify for a commercial loan
at the fully indexed interest rate rather than at the origination interest rate.
Loans secured by commercial real estate generally involve a greater degree
of risk than residential mortgage loans and carry larger loan balances. This
increased credit risk is a result of several factors, including the
concentration of principal in a limited number of loans and borrowers, the
effects of general economic conditions on income producing properties and the
increased difficulty of evaluating and monitoring these types of loans.
Furthermore, the repayment of loans secured by commercial real estate is
typically dependent upon the successful operation of the related real estate
project. If the cash flow from the project is reduced, the borrower's ability to
repay the loan may be impaired. For loans secured by farm real estate, repayment
may be affected by weather conditions and government policies and subsidies
concerning farming. For loans secured by church real estate, repayment is
dependent upon the continuing financial support of the church's members.
Commercial Business Loans. The Company's commercial business loans consist
of agricultural operating loans secured primarily by farm equipment, livestock,
crops, and farm real estate. These loans are generally originated in amounts up
to 70% of the appraised value of the property. These loans typically are
adjustable rate loans with quarterly adjustments. Agricultural operating loans
generally involve a greater degree of risk than residential mortgage loans. This
increased credit risk is a result of several factors, including the effects of
general economic conditions on income producing property and the increased
difficulty of evaluating and monitoring these types of loans. Furthermore, the
repayment of agricultural operating loans is typically dependent upon the
successful operation of the related property. If the cash flow from the property
is reduced, the borrower's ability to repay the loan may be impaired.
Construction Loans. Construction loans are made on single family residential
property to the individuals who are the owners and occupants upon completion of
construction. These loans are made on a long term basis and are classified as
construction permanent loans with no principal payments required during the
first six months, after which the payments are set at an amount that will
amortize over the term of the loan. The maximum loan-to-value ratio is 80% and
is made at a variable or fixed interest rate.
The Company does not originate many speculative loans to builders and limits
the loan-to-value ratio to 70% with a maximum loan term of 18 months. In
underwriting such loans, the Company takes into consideration the number of
units that the builder has on a speculative basis that remain unsold.
Construction lending is generally considered to involve a higher degree of
credit risk than long-term financing of residential properties. The Company's
risk of loss on a construction loan is dependent largely upon the accuracy of
the initial estimate of the property's value at completion of construction or
development and the estimated cost of construction. If the estimate of
construction cost and the marketability of the property upon completion of the
project prove to be inaccurate, the Company may
7
<PAGE>
be compelled to advance additional funds to complete the development.
Furthermore, if the estimate of value proves to be inaccurate, the Company may
be confronted, at or prior to the maturity of the loan, with a property with a
value that is insufficient to assure full repayment. For the small number of
speculative loans originated to builders, the ability of the builder to sell
completed dwelling units will depend, among other things, on demand, pricing,
and availability of comparable properties and economic conditions.
Loan Approval Authority and Underwriting. All loans, other than smaller
dollar value consumer loans, must be approved by the Company's Loan Committee. A
minimum of two committee members may approve loans on one- to four-family
residential units, non-owner occupied residential properties that do not exceed
eight units, farm real estate loans of $200,000 or less, farm operating loans of
$100,000 and less, and all consumer loans. All commercial real estate loans and
other loans that exceed the above limitations must be submitted to the Board of
Directors for prior approval.
For all loans originated by the Company, upon receipt of a completed loan
application from a prospective borrower, a credit report is generally ordered,
income and certain other information is verified and, if necessary, additional
financial information is requested. For real estate loans, an appraisal of the
real estate intended to be used as security for the proposed loan is obtained
from an independent appraiser designated and approved by the Board of Directors
of the Bank. In certain cases, an appropriate valuation is completed by Company
staff as allowed by regulation. In addition, the relationship of the loan to the
value of the collateral is considered. The Company makes construction/permanent
loans on individual properties. Funds advanced during the construction phase are
held in a loan-in-process account and disbursed based upon various stages of
completion in accordance with the results of inspection reports that are
obtained through physical inspection of the construction by an independent
contractor hired by the Company or in some cases by a loan officer. For real
estate loans, the Company will require either title insurance or a title
opinion. Borrowers must also obtain hazard or flood insurance (for loans on
property located in a flood zone, flood insurance is required) prior to the
closing of the loan.
Loan Commitments. The Company issues written commitments or verbal
commitments to prospective borrowers on all real estate approved loans.
Generally, the commitment requires acceptance within 90 days of the date of
issuance. Commitments for consumer loans are given verbally and not in writing
and generally expire in a shorter period of time. At December 31, 1996, the
Company had $11.9 million of commitments to cover originations, undisbursed
funds for loans in process and unused lines of credit. The Company estimates
that the majority of the Company's commitments are funded.
Loans to One Borrower. Loans-to-one borrower are limited in an amount equal
to 15% of unimpaired capital and unimpaired surplus and an additional amount
equal to 10% of unimpaired capital and unimpaired surplus if the loan is secured
by readily marketable collateral (generally, financial instruments, not real
estate) or $500,000, whichever is higher. The Company's maximum loan-to-one
borrower limit was approximately $3.1 million as of December 31, 1996.
At December 31, 1996, the Company's largest amount of loans to one borrower
was $900,000, consisting of performing loans secured by multi-family buildings
and real estate for approximately 19 dwelling units and a personal residence,
all of which are located in the Company's market area.
Loan Delinquencies. The Company's collection procedures provide that when a
mortgage loan is 15 days past due, a notice of nonpayment is sent. If payment is
still delinquent after 30 days past due the customer will receive a letter
and/or telephone call and may receive a visit from a representative of the
Company. If the delinquency continues, similar subsequent efforts are made to
eliminate the
8
<PAGE>
delinquency. If the loan continues in a delinquent status for 60 days past due
and no repayment plan is in effect, a notice of right to cure default is mailed
to the customer giving 30 additional days to bring the account current before
foreclosure is commenced. The loan committee meets regularly to determine when
foreclosure proceedings should be initiated and the customer is notified when
foreclosure has been commenced.
Loans are reviewed on a monthly basis and are generally placed on a
non-accrual status when a mortgage loan or a non-mortgage loan becomes 120 or 90
days delinquent, respectively, and, in the opinion of management, the collection
of additional interest is doubtful. Interest accrued and unpaid at the time a
loan is placed on non-accrual status is charged against interest income.
Subsequent interest payments, if any, are either applied to the outstanding
principal balance or recorded as interest income, depending on the assessment of
the ultimate collectibility of the loan.
Non-accrual loans fluctuate over time due to a variety of factors. For the
Company, non-accrual loans may be affected by the payments on one large loan or
a delay in the harvesting of crops due to weather conditions. The Company's
experience has been that these fluctuations are normal and are not dependant on
any one factor over time.
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<PAGE>
The following table sets forth information regarding non-accrual loans, real
estate owned, and certain other repossessed assets and loans. On January 1,
1995, the Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 114, as amended by SFAS No. 118. The adoption of this statement had no
effect on the consolidated financial statements of the Company.
<TABLE>
<CAPTION>
At December 31,
---------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(Dollars in Thousands)
Loans accounted for on a non-accrual basis:
Mortgage loans:
<S> <C> <C> <C> <C> <C>
Construction loans ........................................... $ -- $ -- $ -- $ -- $ --
Permanent loans secured by 1- to 4-family
residences ................................................. 942 614 556 265 164
All other mortgage loans ..................................... 20 75 168 -- 59
Non-mortgage loans:
Commercial ................................................... 7 -- 5 7 --
Consumer ..................................................... 70 71 88 26 75
-------- ---------- ---- ---- ----------
Total .......................................................... $ 1,039 $ 760 $817 $298 $ 298
======== ========== ==== ==== ==========
Accruing loans which are contractually past due 90 days or more:
Mortgage loans:
Construction loans ........................................... $ -- $ -- $ -- $-- $ --
Permanent loans secured by 1- to 4-family
residences ................................................. -- -- -- -- 147
All other mortgage loans ..................................... -- -- -- -- --
Non-mortgage loans:
Commercial ................................................... -- -- -- -- --
Consumer ..................................................... -- -- -- 1 --
-------- ---------- ---- ---- ----------
Total .......................................................... $ -- $ -- $ -- $ 1 $ 147
======== ========== ==== ==== ==========
Total non-accrual and accruing loans
past due 90 days or more ..................................... $ 1,039 $ 760 $817 $299 $ 445
======== ========== ==== ==== ==========
Foreclosed real estate ......................................... $ 136 $ 160 $151 $ 29 $ 78
======== ========== ==== ==== ==========
Other nonperforming assets ..................................... $ -- $ -- $ -- $ -- $ --
======== ========== ==== ==== ==========
Total nonperforming assets ..................................... $ 1,175 $ 920 $968 $328 $ 523
======== ========== ==== ==== ==========
Total non-accrual and accruing loans past
due 90 days or more to net loans ............................. 0.86% 0.53% 0.50% 0.18% 0.25%
======== ========== ==== ==== ==========
Total non-accrual and accruing loans past
due 90 days or more to total assets........................... 0.59% 0.46% 0.45% 0.15% 0.22%
======== ========== ==== ==== ==========
Total nonperforming assets to total assets...................... 0.67% 0.56% 0.53% 0.17% 0.26%
======== ========== ==== ==== ==========
</TABLE>
Interest income that would have been recorded on loans accounted for on a
non-accrual basis under the original terms of such loans was immaterial for the
year ended December 31, 1996. Amounts included in the Company's interest income
on non-accrual loans for the year ended December 31, 1996 was likewise
immaterial.
Classified Assets. Office of Thrift Supervision ("OTS") regulations provide
for a classification system for problem assets of insured institutions which
covers all problem assets. Under this classification system, problem assets of
insured institutions are classified as "substandard," "doubtful," or "loss." An
asset is considered substandard if it is inadequately protected by the current
net worth and paying capacity of the obligor or of the collateral pledged, if
any. Substandard assets include those
10
<PAGE>
characterized by the "distinct possibility" that the insured institution will
sustain "some loss" if the deficiencies are not corrected. Assets classified as
doubtful have all of the weaknesses inherent in those classified substandard,
with the added characteristic that the weaknesses present make "collection or
liquidation in full," on the basis of currently existing facts, conditions and
values, "highly questionable and improbable." Assets classified as loss are
those considered "uncollectible" and of such little value that their continuance
as assets without the establishment of a specific loss reserve is not warranted.
Assets may be designated "special mention" because of potential weakness that do
not currently warrant classification in one of the aforementioned categories.
When an insured institution classifies problem assets as either substandard
or doubtful, it may establish general allowances for loan losses in an amount
deemed prudent by management. General allowances represent loss allowances which
have been established to recognize the inherent risk associated with lending
activities, but which, unlike specific allowances, have not been allocated to
particular problem assets. When an insured institution classifies problem assets
as loss, it is required either to establish a specific allowance for losses
equal to 100% of that portion of the asset so classified or to charge off such
amount. An institution's determination as to the classification of its assets
and the amount of its valuation allowances is subject to review by the OTS,
which may order the establishment of additional general or specific loss
allowances. A portion of general loss allowances established to cover possible
losses related to assets classified as substandard or doubtful may be included
in determining an institution's regulatory capital, while specific valuation
allowances for loan losses generally do not qualify as regulatory capital.
The following table provides further information about the Company's problem
assets as of December 31, 1996.
(In Thousands)
Special Mention............... $ 497
Substandard................... 496
Doubtful assets............... --
Loss assets................... 29
General loss allowance........ 615
Foreclosed Real Estate. Real estate acquired by the Company as a result of
foreclosure or by deed in lieu of foreclosure is classified as real estate owned
until it is sold. When property is acquired it is recorded at the lower of the
loan balance or the fair value at the date of foreclosure less estimated costs
of disposition. There may be significant other expenses incurred such as
attorney and other extraordinary servicing costs involved with foreclosures.
Foreclosed real estate, net of allowance for losses, totaled $78,000 at December
31, 1996.
Allowance for Loan and Real Estate Losses. It is management's policy to
provide for losses on unidentified loans in its loan portfolio and foreclosed
real estate. A provision for loan losses is charged to operations based on
management's evaluation of the potential losses that may be incurred in the
Company's loan portfolio. Such evaluation, which includes a review of all loans
of which full collectibility of interest and principal may not be reasonably
assured, considers the Company's past loan loss experience, known and inherent
risks in the portfolio, adverse situations that may affect the borrower's
ability to repay, estimated value of any underlying collateral and current
economic conditions.
11
<PAGE>
Management will continue to review the entire loan portfolio to determine
the extent, if any, to which further additional loss provisions may be deemed
necessary. There can be no assurance that the allowance for losses will be
adequate to cover losses which may in fact be realized in the future and that
additional provisions for losses will not be required.
12
<PAGE>
Allocation of Allowance for Loan Losses. The following table sets forth the
allocation of the Company's allowance for loan losses by loan category and the
percent of loans in each category to total loans receivable, at the dates
indicated. The portion of the loan loss allowance allocated to each loan
category does not represent the total available for future losses which may
occur within the loan category since the total loan loss allowance is a
valuation reserve applicable to the entire loan portfolio. The allocation of the
allowance for loan losses is based on management's evaluation of the loans in
the respective portfolios; the Company does not attempt to manage the percentage
of the allocation between loan categories. As part of management's evaluation,
for each loan category, the allowance is determined after examination of prior
period experience but is adjusted for various factors such as delinquencies,
expected charge-offs, recoveries, amount of classified assets, amount of
non-accrual loans and any known local economic trends. As a result, the
allocation of the allowance does not reflect relative levels of historic
charge-offs between loan categories.
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------------------------------------------------------------
1992 1993 1994 1995 1996
------------------- ------------------ -------------------- ------------------ -------------------
Percent of Percent of Percent of Percent of Percent of
Loans in Each Loans in Each Loans in Each Loans in Each Loans in 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)
At end of year allocated to:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage................ $379 90.17% $272 89.65% $251 89.78% $394 87.67% $484 86.13%
Consumer and non-mortgage 100 9.83 126 10.35 125 10.22 118 12.33 131 13.87
--- ------ --- ------ --- ------ --- ----- --- ------
Total allowance........ $479 100.00% $398 100.00% $376 100.00% $512 100.00% $615 100.00%
=== ====== === ====== === ====== === ====== === ======
</TABLE>
13
<PAGE>
Analysis of the Allowance for Loan Losses. The following table sets forth
information with respect to the Company's allowance for loan losses for the
years indicated:
<TABLE>
<CAPTION>
At December 31,
--------------------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(Dollars in Thousands)
<S> <C> <C> <C> <C> <C>
Total loans outstanding....... $122,583 $144,114 $166,941 $171,364 $180,399
======= ======= ======= ======= =======
Average loans outstanding..... $129,260 $130,026 $153,477 $170,395 $173,383
======= ======= ======= ======= =======
Beginning allowance balances.. $ 515 $ 479 $ 398 $ 376 $ 512
Provision:
One- to four-family......... 72 -- 32 166 180
Commercial and multi-family
real estate............... -- -- -- -- --
Consumer.................... 100 -- 81 -- --
Charge-offs:
One- to four-family......... 64 61 53 23 21
Commercial and multi-family
real estate............... 80 -- -- -- --
Consumer.................... 93 59 91 18 67
Recoveries:
One- to four-family......... 4 19 -- -- --
Commercial and multi-family
real estate............... -- -- -- -- --
Consumer.................... 25 4 9 11 11
Other......................... -- 16 -- -- --
------- ------- ------- ------- -------
Ending allowance balance...... $ 479 $ 398 $ 376 $ 512 $ 615
======= ======= ======= ======= =======
Allowance for loan losses as a
percent of total loans
outstanding................. 0.39% 0.28% 0.23% 0.30% 0.34%
Net loans charged off as a
percent of average loans
outstanding................. 0.16% 0.07% 0.09% 0.02% 0.04%
</TABLE>
14
<PAGE>
Analysis of the Allowance for Foreclosed Real Estate. The following table
sets forth information with respect to the Company's allowance for losses on
foreclosed real estate at the dates indicated.
<TABLE>
<CAPTION>
At December 31,
--------------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- ----
(Dollars in Thousands)
Total foreclosed real estate and real estate
<S> <C> <C> <C> <C> <C>
in judgment, net ............................ $ 136 $ 160 $ 151 $ 29 $ 78
===== ======= ====== ======= ====
Allowance balances - beginning ................ 34 16 -- -- --
Provision ..................................... -- -- -- -- --
Charge-offs ................................... 18 -- -- -- --
Recoveries .................................... -- -- -- -- --
Other ......................................... -- (16) -- -- --
---- ------- ------ ------- ----
Allowance balances - ending ................... $ 16 $ -- $ -- $ -- $ --
===== ======= ====== ======= ====
Allowance for losses on foreclosed real estate
in judgment to net foreclosed real estate and
real estate in judgment ..................... 11.76% --% --% --% --%
===== ======= ====== ======= ====
</TABLE>
Mortgage-Backed Securities
To supplement lending activities, the Company invests in residential
mortgage-backed securities. Mortgage-backed securities can serve as collateral
for borrowings (although the Company has not used them as such) and, through
repayments, as a source of liquidity.
At December 31, 1996, the mortgage-backed securities portfolio had a fair
value of $428,000 and an amortized cost of $427,000. Because the portfolio is
classified as available for sale (the Company had no mortgage-backed securities
held to maturity at December 31, 1996), the portfolio is recorded at $428,000.
The mortgage-backed securities portfolio at December 31, 1996 consisted solely
of real estate mortgage investment conduits ("REMICs"), a form of collateralized
mortgage obligations ("CMOs"). The Company receives monthly interest payments on
the securities in this portfolio based on fixed coupon rates. These securities
are guaranteed as to principal by the Federal National Mortgage Association
("FNMA") or Federal Home Loan Mortgage Corporation ("FHLMC") and management does
not believe that there is a material credit risk associated with the repayment
of principal.
To assess price volatility, the Federal Financial Institutions Examination
Council ("FFIEC") and OTS have adopted a policy that requires an annual "stress"
test of mortgage derivative securities. This policy requires the Company to
annually test its CMOs and other mortgage-related securities to determine
whether they are high-risk or non-high-risk securities. At December 31, 1996,
the Company's CMOs met the criteria established by the policy for non-high-risk
securities. If interest rates remain stable, the weighted average life of the
FNMA CMO is 0.66 years. According to stress tests mandated by the Company's
regulators, a 300 basis point upward shift in interest rates increases the
weighted average life of this security to 1.12 years. This same 300 basis point
upward shift would result in a 2.72% decrease in price. Currently, the weighted
average life of the FHLMC CMO is 0.17 years. A 300 basis point upward shift in
interest rates increases the weighted average life to 0.27 years and results in
a 0.75% decrease in the price. The carrying value of these securities is
adjusted on a quarterly basis to reflect current market value.
15
<PAGE>
Investment Activities
The Company is required under federal regulations to maintain a minimum
amount of liquid assets which may be invested in specified short-term securities
and certain other investments. The Company has maintained a liquidity portfolio
in excess of regulatory requirements. Liquidity levels may be increased or
decreased depending upon the yields on investment alternatives and upon
management's judgment as to the attractiveness of the yields then available in
relation to other opportunities and its expectation of future yield levels, as
well as management's projections as to the short-term demand for funds to be
used in the Company's loan origination and other activities. At December 31,
1996, the Company had an investment portfolio of approximately $9.8 million,
consisting primarily of U.S. Treasury securities and U.S. government corporate
and agency obligations. To a lesser extent, the portfolio also includes mutual
funds, FHLMC stock, mortgage-backed securities, certificates of deposit and FHLB
stock, as permitted by the OTS regulations. The Company classifies its
investments, including debt and equity securities, as either held to maturity or
available for sale, in accordance with SFAS 115. The Company will continue to
seek high quality investments. The primary and secondary goals of the investment
portfolio are safety of principal and rate of return, respectively.
Investment Portfolio. The following table sets forth the carrying value of
the Company's investments, including short-term investments, FHLB stock, and
mortgage-backed securities, at the dates indicated. At December 31, 1996, the
Company's securities that were classified as available for sale had an
unrealized net gain of $583,000. The Company's securities that were classified
as held to maturity had a net unrealized loss of $5,000. This unrealized loss is
not reflected in the table below because these securities are carried at
amortized cost in accordance with SFAS 115. At December 31, 1996, the market
value for the interest bearing deposits shown below approximated their cost.
At December 31,
---------------------------------
1994 1995 1996
------- ------ --------
(In Thousands)
Securities available for sale:
Equity securities................ $ 5,951 $ 6,753 $ 7,100
Securities held to maturity:
U.S. government securities........ 1,793 800 --
U.S. agency securities............ 4,198 3,399 2,049
------ ------ -----
Total investment securities..... 11,942 10,952 9,149
Interest-bearing deposits.......... 100 800 200
Mortgage-backed securities available
for sale........................ 961 867 428
------ ------ ------
Total investments............... $13,003 $12,619 $ 9,777
====== ====== ======
16
<PAGE>
Investment Portfolio Maturities. The following table sets forth certain
information regarding the carrying values, weighted average yields and
maturities of the Company's investment securities portfolio.
<TABLE>
<CAPTION>
At December 31, 1996
--------------------------------------------------------------------------------------------------------
Total
One Year or Less One to Five Years Five to Ten Years More than Ten Years Investment Securities
------------------ ----------------- ------------------- ------------------- -------------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Market
Value Yield Value Yield Value Yield Value Yield Value Yield Value
-------- ------- ------- ------- ------- ------- ------- ------- ------- ------ ------
(Dollars in Thsands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-backed Securities $ 428 6.81% $ -- --% $ -- -- % $ -- -- % $ 428 6.81% $ 428
U.S. Government Obligations -- -- -- -- -- -- -- -- -- -- --
U. S. Agency Obligations .. -- -- 2,049 6.44 -- -- -- -- 2,049 6.44 2,044
FHLB Stock ................ -- -- -- -- -- -- -- -- 1,633 -- 1,633
Equity Securities(1) ...... -- -- -- -- -- -- -- -- 5,467 -- 5,467
Interest Bearing Deposits . 200 5.75 -- -- -- -- -- -- 200 5.75 200
----- ----- ----- ----- ----- -----
Total ................... $ 628 6.47 $2,049 6.44 $ -- -- -- -- $9,777 $9,772
====== ====== ===== ===== ===== =====
</TABLE>
- ------------------------
(1) Includes funds held by the Asset Management Fund for Financial Institutions
for the Company in the following portfolios: $2,320,000 in the Short U.S.
Government Securities Portfolio, $1,171,000 in the U.S. Government Mortgage
Portfolio and $1,149,000 in the Intermediate Mortgage Securities Portfolio.
17
<PAGE>
Sources of Funds
General. Deposits are the major external source of the Company's funds for
lending and other investment purposes. The Company derives funds from
amortization and prepayment of loans and, to a much lesser extent, maturities of
investment securities, borrowings and operations. Scheduled loan principal
repayments are a relatively stable source of funds, while deposit inflows and
outflows and loan prepayments are significantly influenced by general interest
rates and market conditions. The Company may also borrow from the FHLB of Des
Moines as a source of funds.
Deposits. Consumer and commercial deposits are attracted principally from
within the Company's primary market area through the offering of a broad
selection of deposit instruments including regular savings accounts, NOW
accounts, and term certificate accounts. The Company also offers IRA and KEOGH
accounts. Deposit account terms vary according to the minimum balance required,
the time period the funds must remain on deposit and the interest rate, among
other factors.
Jumbo Certificate Accounts. The following table indicates, at December 31,
1996, the amount of the Company's certificates of deposit of $100,000 or more by
time remaining until maturity.
Maturity Period
(In Thousands)
Within three months.................. $2,767
Three through six months............. 1,710
Six through twelve months............ 1,147
Over twelve months................... 3,823
------
$9,447
======
Borrowings. Deposits are the primary source of funds of the Company's
lending and investment activities and for its general business purposes. Through
the Bank, the Company may obtain advances from the FHLB of Des Moines to
supplement its supply of lendable funds. Advances from the FHLB of Des Moines
are typically secured by a pledge of the Bank's stock in the FHLB of Des Moines
and a portion of the Company's first mortgage loans and certain other assets.
The Bank, if the need arises, may also access the Federal Reserve Bank discount
window to supplement its supply of lendable funds and to meet deposit withdrawal
requirements. At December 31, 1996, the Company had $26.5 million in advances
outstanding from the FHLB of Des Moines of which $12.5 million have fixed rates
and $11.0 million and $3.0 million have variable rates that reprice monthly and
daily, respectively. Most of these advances provide for a prepayment penalty.
See Note 12 of the Notes to Consolidated Financial Statements. At December 31,
1996, the Bank had $4.0 million in borrowings (in the form of a loan) from the
Company. The interest rate on this loan adjusts quarterly. The Company expects
that the use of borrowings will continue and may increase after the Company uses
available liquid assets to fund loan originations. During recent periods, the
Company has found that obtaining wholesale funds through FHLB advances is less
expensive than increasing the interest rates on deposit accounts to increase the
amount of deposits. If, in the future, increased deposits become less expensive
than FHLB advances, the Company will likely rely more on increased deposits than
on FHLB advances. At December 31, 1996, the Company had the ability to borrow
approximately 3.4 times its then outstanding advances.
18
<PAGE>
The following table sets forth certain information as to FHLB advances at
the dates indicated.
As of and for the Years Ended December 31,
------------------------------------------
1994 1995 1996
---- ---- ----
(Dollars in Thousands)
FHLB advances................... $ 23,650 $ 18,000 $ 26,500
Weighted average interest rate
of FHLB advances.............. 5.64% 5.72% 5.74%
Maximum amount of advances...... $ 23,650 $ 23,650 $ 28,500
Average amount of advances...... 12,610 18,938 19,269
Weighted average interest rate
of average amount of advances. 4.96% 6.14% 5.64%
Subsidiary Activity
The Company has one wholly owned subsidiary, the Bank. The Bank has one
wholly owned subsidiary, known as Wells Insurance Agency, Inc. (the "WIA").
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 investment is
utilized primarily for community development purposes. Under the 2% limitation,
as of December 31, 1996, the Bank was authorized to invest up to approximately
$4.0 million in the stock of, or loans to, service corporations.
WIA was incorporated under the laws of the State of Minnesota in 1976. WIA
offers life, health, casualty, and business insurance on behalf of others and
also offers fixed-rate annuities. The Bank's investment in WIA totalled $436,000
at December 31, 1996.
Personnel
As of December 31, 1996, the Bank had 50 full-time and 6 part-time
employees. None of the Bank's employees are represented by a collective
bargaining group. The Company, with no employees of its own, utilizes those of
the Bank.
Competition
The competition for deposit products includes banks ranging in size from
larger, Minneapolis- based regional banks with branches in the Company's market
area to local independent community banks. Deposit competition also includes a
number of insurance products sold by local agents and investment products sold
by local and regional sales people.
Loan competition varies depending upon market conditions. Loan competition
includes branches of large Minneapolis-based commercial banks and thrifts,
credit unions, mortgage bankers with local sales staff and local banks. The
Company believes that it is one of the few area lenders that has consistently
offered a variety of loans throughout all types of economic conditions.
The Company has traditionally maintained a leadership position in mortgage
loan volume and market share throughout its service area by virtue of its local
presence. The Company believes that it has been able to effectively market its
larger variety of loan and other financial products and services
19
<PAGE>
when compared to other local-based institutions and its superior customer
service when compared to branches of larger institutions based outside of the
Company's market area.
Regulation
Set forth below is a brief description of certain laws that relate to the
regulation of the Company and the Bank. The description does not purport to be
complete and is qualified in its entirety by reference to applicable laws and
regulations.
Regulation of the Company
General. The Company is a unitary savings and loan holding company subject
to regulatory oversight by the OTS. As such, the Company is required to register
and file reports with the OTS and is subject to regulation and examination by
the OTS. In addition, the OTS has enforcement authority over the Company and its
non-savings association subsidiaries, should such subsidiaries be formed, which
also permits the OTS to restrict or prohibit activities that are determined to
be a serious risk to the subsidiary savings association. This regulation and
oversight is intended primarily for the protection of the depositors of the Bank
and not for the benefit of stockholders of the Company.
Qualified Thrift Lender Test. As a unitary savings and loan holding company,
the Company generally is not subject to activity restrictions, provided the Bank
satisfies the Qualified Thrift Lender ("QTL") test. If the Company acquires
control of another savings association as a separate subsidiary, it would become
a multiple savings and loan holding company, and the activities of the Company
and any of its subsidiaries (other than the Bank or any other SAIF-insured
savings association) would become subject to restrictions applicable to bank
holding companies unless such other associations each also qualify as a QTL and
were acquired in a supervisory acquisition. See "-- Regulation of the Bank --
Qualified Thrift Lender Test."
Regulation of the Bank
General. As a federally chartered, SAIF-insured savings association, the
Bank is subject to extensive regulation by the OTS and the Federal Deposit
Insurance Corporation ("FDIC"). Lending activities and other investments must
comply with various federal statutory and regulatory requirements. The Bank is
also subject to certain reserve requirements promulgated by the Federal Reserve
Board.
The OTS, in conjunction with the FDIC, regularly examines the Bank and
prepares reports for the consideration of the Bank's Board of Directors on any
deficiencies that are found in the Bank's operations. The Bank's relationship
with its depositors and borrowers is also regulated to a great extent by federal
and state law, especially in such matters as the ownership of savings accounts
and the form and content of the Bank's mortgage documents.
The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition, in addition to obtaining regulatory
approvals prior to entering into certain transactions such as mergers with or
acquisitions of other savings institutions. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the SAIF and depositors.
The regulatory structure also gives the regulatory authorities extensive
discretion in connection with their supervisory and enforcement activities and
examination policies, including policies with respect to the classification of
assets and the establishment of adequate loan loss reserves for regulatory
purposes. Any change in such regulations, whether by the OTS, the
20
<PAGE>
FDIC, or the Congress could have a material adverse impact on the Company, the
Bank, and their operations.
Insurance of Deposit Accounts. The Bank's deposit accounts are insured by
the SAIF to a maximum of $100,000 for each insured member (as defined by law and
regulation). Insurance of deposits may be terminated by the FDIC upon a finding
that the institution has engaged in unsafe or unsound practices, is in an unsafe
or unsound condition to continue operations, or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC or the institution's
primary regulator. The FDIC may also prohibit an insured depository institution
from engaging in any activity the FDIC determines to pose a serious threat to
the SAIF.
The FDIC charges an annual assessment for the insurance of deposits based on
the risk a particular institution poses to its deposit insurance fund, depending
upon the institution's risk classification. This risk classification is based on
an institution's capital group and supervisory subgroup assignment. In addition,
the FDIC is authorized to increase deposit insurance rates on a semi-annual
basis if it determines that such action is necessary to cause the balance in the
SAIF to reach the designated reserve ratio of 1.25% of SAIF-insured deposits
within a reasonable period of time. The FDIC may impose special assessments on
SAIF members to repay amounts borrowed from the U.S. Treasury or for any other
reason deemed necessary by the FDIC. Prior to September 30, 1996, savings
associations paid within a range of .23% to .31% of domestic deposits and the
SAIF was substantially underfunded. By comparison, prior to September 30, 1996,
members of the Bank Insurance Fund ("BIF"), predominantly commercial banks, were
required to pay substantially lower, or virtually no, federal deposit insurance
premiums.
Effective September 30, 1996, federal law was revised to mandate a one-time
special assessment on SAIF members such as the Bank of approximately .657% of
deposits held on March 31, 1995. The Bank recorded a $1,085,000 pre-tax expense
for this assessment at September 30, 1996. Beginning January 1, 1997, deposit
insurance assessments for SAIF members will be reduced to approximately .064% of
deposits on an annual basis; this rate may continue through the end of 1999.
During this same period, BIF members are expected to be annually assessed
approximately .013% of deposits. Thereafter, assessments for BIF and SAIF
members should be the same and the SAIF and BIF may be merged. It is expected
that these continuing assessments for both SAIF and BIF members will be used to
repay outstanding Financing Corporation bond obligations. As a result of these
changes, beginning January 1, 1997, the rate of deposit insurance assessed the
Bank is expected to substantially decline.
Regulatory Capital Requirements. OTS capital regulations require savings
institutions to meet three capital standards: (1) tangible capital equal to 1.5%
of total adjusted assets, (2) a leverage ratio (core capital) equal to at least
3% of total adjusted assets, and (3) a risk-based capital requirement equal to
8.0% of total risk-weighted assets. The Bank exceeded these minimum standards at
December 31, 1996. The Bank's capital ratios are set forth in Note 15 to the
Consolidated Financial Statements referenced in Items 7 and 13 to this Form
10-K.
Savings associations with a greater than "normal" level of interest rate
exposure may, in the future, be subject to a deduction for an interest rate risk
("IRR") component may be from capital for purposes of calculating their
risk-based capital requirement.
Dividend and Other Capital Distribution Limitations. OTS regulations require
the Bank to give the OTS 30 days advance notice of any proposed declaration of
dividends to the Company, and the OTS has the authority under its supervisory
powers to prohibit the payment of dividends to the Company. In addition, the
Bank may not declare or pay a cash dividend on its capital stock if the effect
thereof
21
<PAGE>
would be to reduce the regulatory capital of the Bank below the amount required
for the liquidation account established in connection with the Conversion.
OTS regulations impose limitations upon all capital distributions by savings
institutions, such as cash dividends, payments to repurchase or otherwise
acquire its shares, payments to shareholders of another institution in a
cash-out merger and other distributions charged against capital. The rule
establishes three tiers of institutions, based primarily on an institution's
capital level. An institution that exceeds all fully phased-in capital
requirements before and after a proposed capital distribution ("Tier 1
institution") and has not been advised by the OTS that it is in need of more
than the normal supervision can, after prior notice but without the approval of
the OTS, make capital distributions during a calendar year equal to the greater
of (i) 100% of its net income to date during the calendar year plus the amount
that would reduce by one-half its "surplus capital ratio" (the excess capital
over its fully phased-in capital requirements) at the beginning of the calendar
year, or (ii) 75% of its net income over the most recent four quarter period.
Any additional capital distributions require prior regulatory approval. At
December 31, 1996, the Bank was a Tier 1 institution. In the event the Bank's
capital fell below its fully phased-in requirement or the OTS notified it that
it was in need of more than normal supervision, the Bank's ability to make
capital distributions could be restricted. In addition, the OTS could prohibit a
proposed capital distribution by any institution, which would otherwise be
permitted by the regulation, if the OTS determines that such distribution would
constitute an unsafe or unsound practice.
Finally, a savings association is prohibited from making a capital
distribution if, after making the distribution, the savings association would be
undercapitalized (not meet any one of its minimum regulatory capital
requirements).
Qualified Thrift Lender Test. Savings institutions must meet a QTL test. If
the Bank maintains an appropriate level of Qualified Thrift Investments
(primarily residential mortgages and related investments, including certain
mortgage-related securities) ("QTIs") and otherwise qualifies as a QTL, it will
continue to enjoy full borrowing privileges from the FHLB of Des Moines. The
required percentage of QTIs is 65% of portfolio assets (defined as all assets
minus intangible assets, property used by the institution in conducting its
business and liquid assets equal to 20% of total assets). Certain assets are
subject to a percentage limitation of 20% of portfolio assets. In addition,
savings associations may include shares of stock of the FHLBs, FNMA and FHLMC as
qualifying QTIs. As of December 31, 1996, the Bank was in compliance with its
QTL requirement with 91.37% of its assets invested in QTIs.
Loans-to-One Borrower. See "Business -- Loans-to-One Borrower."
Federal Home Loan Bank System. The Bank is a member of the FHLB of Des
Moines, which is one of 12 regional FHLBs that administers the home financing
credit function of savings associations. Each FHLB serves as a reserve or
central bank for its members within its assigned region. It is funded primarily
from proceeds derived from the sale of consolidated obligations of the FHLB
System. It makes loans to members (i.e., advances) in accordance with policies
and procedures established by the Board of Directors of the FHLB.
As a member, the Bank is required to purchase and maintain stock in the FHLB
of Des Moines 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.
Federal Reserve System. The Federal Reserve Board requires all depository
institutions to maintain non-interest bearing reserves at specified levels
against their transaction accounts (primarily checking, NOW, and Super NOW
checking accounts) and non-personal time deposits. The balances
22
<PAGE>
maintained to meet the reserve requirements imposed by the Federal Reserve Board
may be used to satisfy the liquidity requirements that are imposed by the OTS.
Recent and Proposed Legislation. Bills have been introduced to congressional
committees that would consolidate the OTS with the Office of the Comptroller of
the Currency ("OCC"). The resulting agency would regulate all federally
chartered commercial banks and thrift institutions. In the event that the OTS is
consolidated with the OCC, it is possible that the thrift charter could be
eliminated and thrifts could be forced to convert to commercial banks.
Legislation passed in 1996 required the recapture (for income tax purposes) of
the Bank's post 1987 additions to bad debt reserves; however, this recapture did
not have a material effect on the earnings of the Bank or the Company because
the Bank had previously provided deferred taxes on its bad debt reserves. Under
current law and regulations, a unitary savings and loan holding company, such as
the Company, which has only one thrift subsidiary such as the Bank, has
essentially unlimited investment authority. Legislation has also been proposed
which, if enacted, would limit the non-banking related activities of savings and
loan holding companies to those activities permitted for bank holding companies.
Item 2. Description of Properties
- ---------------------------------
The Company does not own any real property but utilizes the offices of the
Bank. The Bank operates from its main office located at 53 First Street, S.W.,
Wells, Minnesota with six full service branch offices and one loan origination
office. The Bank owns the offices in Wells and one branch facility, and leases
the remaining locations. The physical condition of each of the offices is good.
Item 3. Legal Proceedings
- -------------------------
There are various claims and lawsuits in which Registrant is periodically
involved, such as claims to enforce liens, condemnation proceedings on
properties in which Registrant holds security interests, claims involving the
making and servicing of real property loans, and other issues incident to
Registrant's business. In the opinion of management, no material loss is
expected from any of such pending claims or lawsuits.
Item 4. Submission of Matters to a Vote of Security Holders
- -------------------------------------------------------------
Not Applicable.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
- -------------------------------------------------------------------
The information contained under the section captioned "Stock Market
Information" on pages 1 and 2 of the Company's Annual Report to Stockholders for
the fiscal year ended December 31, 1996 (the "Annual Report"), is incorporated
herein by reference.
Item 6. Management's Discussion and Analysis or Plan of Operation
- -------------------------------------------------------------------
The information contained in the section captioned "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in the Annual
Report is incorporated herein by reference.
23
<PAGE>
Item 7. Financial Statements
- ------------------------------
The Registrant's consolidated financial statements listed under Item 13 are
incorporated herein by reference.
Item 8. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
----------------------------------------------------------------------
Not applicable.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act
-------------------------------------------------------------
The information contained under the section captioned "I. Information with
Respect to Nominees for Director and Directors Continuing in Office" in
Registrant's definitive proxy statement for Registrant's Annual Meeting of
Stockholders (the "Proxy Statement") is incorporated herein by reference.
Item 10. Executive Compensation
- --------------------------------
The information contained under the section captioned "Director and
Executive Officer Compensation" in the Proxy Statement is incorporated herein by
reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by
reference to the section captioned "Voting Securities and Principal
Holders Thereof" in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by
reference to the section captioned "Voting Securities and Principal
Holders Thereof" and to the first table under "I. Information with
Respect to Nominees for Director and Directors Continuing in Office"
in the Proxy Statement.
(c) Management of Registrant knows of no arrangements, including any
pledge by any person of securities of Registrant, the operation of
which may at a subsequent date result in a change in control of
Registrant.
Item 12. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Certain Relationships and Related Transactions" in the
Proxy Statement.
24
<PAGE>
PART IV
Item 13. Exhibits, List, and Reports on Form 8-K
- ------------------------------------------------
(a) The following documents are filed as a part of this report:
1. The following financial statements and the report of independent
accountants of Registrant included in Registrant's Annual Report to Stockholders
are incorporated herein by reference and also in Item 7 hereof.
Independent Auditor's Report.
Consolidated Statements of Financial Condition as of December 31, 1996 and
1995.
Consolidated Statements of Income for the Years Ended December 31, 1996,
1995, and 1994.
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1996, 1995, and 1994.
Consolidated Statements of Cash Flows for the Years Ended December 31,
1996, 1995 and 1994.
Notes to Consolidated Financial Statements.
2. Except for Exhibits 11 and 27 below, Financial Statement
Schedules for which provision is made in the applicable accounting regulations
of the SEC are not required under the related instructions or are inapplicable
and therefore have been omitted.
3. The following exhibits are included in this Report or
incorporated herein by reference:
(a) List of Exhibits:
3(i) Articles of Incorporation of Wells Financial Corp.*
3(ii)Bylaws of Wells Financial Corp.*
10.1 1995 Stock Option Plan of Wells Financial Corp.**
10.2 Management Stock Bonus Plan and Trust Agreements**
10.3 Change in Control Severance Agreement with James D. Moll***
10.4 Change in Control Severance Agreement with Gerald D. Bastian***
11 Statement Regarding Computation of Earnings per Share
13 Annual Report to Stockholders for the fiscal year ended December
31, 1996
21 Subsidiaries of Registrant***
25
<PAGE>
23 Consent of McGladrey & Pullen, LLP
27 Financial Data Schedule
(b) No reports on Form 8-K were filed during the last quarter of the
period covered by this report.
- ---------------------
* Incorporated by reference to the registration statement on Form S-1 (File
No. 33-87922) declared effective by the SEC on February 13, 1995.
** Incorporated by reference to the proxy statement for a special meeting of
stockholders held on November 15, 1995 and filed with the SEC on October 2,
1995 (File No. 0-25342).
*** Incorporated by reference to the Registrant's Form 10-K for the year ended
December 31, 1995.
26
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized as of March 27, 1997.
WELLS FINANCIAL CORP.
By: /s/ Lawrence H. Kruse
--------------------------------
Lawrence H. Kruse
President and Chief Executive
Officer
(Duly Authorized Representative)
Pursuant to the requirement of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated as of March 27, 1997.
/s/ Lawrence H. Kruse /s/ James D. Moll
- ------------------------------------------ --------------------------------
Lawrence H. Kruse James D. Moll
President, Chief Executive Officer Treasurer and Principal Financial
and Director (Principal Executive Officer) and Account Officer
(Principal Financial and
Accounting Officer)
Date: March 27, 1997 Date: March 27, 1997
/s/ Wallace J. Butson /s/ Gerald D. Bastion
- ----------------------------------------- ---------------------------------
Dr. Wallace J. Butson Gerald D. Bastion
Secretary and Director Vice President and Director
Date: March 27, 1997 Date: March 27, 1997
/s/ Joseph R. Gadola /s/ Richard A. Mueller
- ------------------------------------------ ---------------------------------
Joseph R. Gadola Richard A. Mueller
Director Director
Date: March 27, 1997 Date: March 27, 1997
EXHIBIT 11
<PAGE>
Exhibit 11
WELLS FINANCIAL CORP.
COMPUTATION OF EARNINGS PER SHARE
For year ended
December 31, 1996
Net income $ 1,200
Weighted average shares outstanding 1,953,731
Weighted average allocated ESOP shares 7,000
Incremental shares relating to stock options 6,454
---------
Weighted average number of common stock equivalents 1,967,185
=========
Per share, primary and fully diluted $ 0.61
=========
EXHIBIT 13
<PAGE>
[** LOGO **]
WELLS
FINANCIAL
CORP.
1996 ANNUAL REPORT
<PAGE>
WELLS FINANCIAL CORP.
ANNUAL REPORT
WELLS SAVINGS BANK fsb TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C>
MAIN OFFICE: Profile and Stock Market Information..................... 1-2
Wells Selected Consolidated Financial and Other Data........... 3
53 First Street S.W.
Wells, Minnesota 56097 Letter to Stockholders................................... 4
BRANCH OFFICES: Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 5-15
Blue Earth
303 South Main Street Independent Auditor's Report.............................. 16
Blue Earth, Minnesota 56013
Consolidated Statements of Financial Condition............ 17
Mankato - Madison East
Madison East Center Consolidated Statements of Income......................... 18
1400 Madison Avenue
Mankato, Minnesota 56001 Consolidated Statements of Stockholders' Equity........... 19
Mankato - Riverfront Consolidated Statements of Cash Flows.....................20-22
1300 South Riverfront Drive
Mankato, Minnesota 56002 Notes to Consolidated Financial Statements................23-46
Fairmont Office Location and Other Corporate Information........... 47
Five Lakes Centre
300 South State Street
Fairmont, Minnesota 56031
Albert Lea
Skyline Mall
1710 West Main Street
Albert Lea, Minnesota 56007
St. Peter
120 South Minnesota Avenue
St. Peter, Minnesota 56082
LOAN ORIGINATION OFFICE:
Owatonna Loan Origination Office
108 West Park Square
Owatonna, Minnesota 55060
</TABLE>
<PAGE>
Wells Financial Corp.
Profile
Wells Financial Corp. (the "Company") is a Minnesota corporation organized in
December 1994 at the direction of the Board of Directors of Wells Federal Bank,
fsb (the "Bank") to acquire all of the capital stock that the Bank issued upon
its conversion from mutual to stock form of ownership. The Company is a unitary
savings and loan holding company which, under existing laws, generally is not
restricted in the types of business activities in which it may engage provided
that the Bank retains a specified amount of its assets in housing-related
investments. At the present time, because the Company does not conduct any
active business, the Company does not intend to employ any persons other than
officers of the Bank but utilizes the support staff of the Bank from time to
time.
The Bank is a federally chartered stock savings bank headquartered in Wells,
Minnesota. The Bank has seven full service offices located in Faribault, Martin,
Blue Earth, Nicollet, and Freeborn Counties, Minnesota and one loan origination
office located in Steele County, Minnesota. The Bank was founded in 1934 and its
deposits have been federally insured by the Savings Association Insurance Fund
("SAIF") and its predecessor, the Federal Savings and Loan Insurance Corporation
("FSLIC"), since 1934. The Bank is a member of the Federal Home Loan Bank
("FHLB") System. The Bank is a community oriented, full service retail savings
institution offering traditional mortgage loan products.
The Bank attracts deposits from the general public and uses such deposits
primarily to invest in residential lending on owner occupied properties. The
Bank also makes consumer, commercial and agricultural real estate, agricultural
operating and multi-family loans and purchases investment securities.
Stock Market Information
Since its issuance on April 11, 1995, the Company's common stock has been traded
on the Nasdaq National Market under the symbol "WEFC." The following table
reflects high and low bid information during the periods shown. The quotations
reflect inter-dealer prices, without retail mark-up, mark-down, or commission,
and may not represent actual transactions.
HIGH LOW
-----------------------
April 11, 1995 - June 30, 1995 $ 9.75 $ 8.50
July 1, 1995 - September 30, 1995 $11.25 $ 8.875
October 1, 1995 - December 31, 1995 $11.375 $ 10.875
January 1, 1996 - March 31, 1996 $11.50 $ 10.125
April 1, 1996 - June 30, 1996 $11.875 $ 9.875
July 1, 1996 - September 30, 1996 $12.25 $ 11.375
October 1, 1996 - December 31, 1996 $13.25 $ 12.50
The number of stockholders of record of common stock as of the record date of
March 3, 1997, was approximately 593. This does not reflect the number of
persons or entities who held stock in nominee or "street" name through various
brokerage firms. At February 15, 1997, there were 2,023,860 shares outstanding.
1
<PAGE>
No dividends were declared on the common stock during the years ended December
31, 1996 or 1995.
The Company's ability to pay dividends to stockholders is subject to the
requirements of Minnesota law. No dividend may be paid by the Company unless its
board of directors determines that the Company will be able to pay its debts in
the ordinary course of business after payment of the dividend. In addition, the
Company's ability to pay dividends is dependent, in part, upon the dividends it
receives from the Bank. The Bank may not declare or pay a cash dividend on any
of its stock if the effect thereof would cause the Bank's regulatory capital to
be reduced below (1) the amount required for the liquidation account established
in connection with the Bank's conversion from mutual to stock form, or (2) the
regulatory capital requirements imposed by the Office of Thrift Supervision
("OTS").
2
<PAGE>
WELLS FINANCIAL CORP.
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
<TABLE>
<CAPTION>
(Dollars in thousands, except per share amounts)
Financial Condition
- --------------------------------------------------------------------------------------------------------------------
December 31, 1992 1993 1994 1995 1996
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total assets $ 176,357 $ 165,188 $ 182,716 $ 195,158 $ 201,326
Loans held for sale 2,253 775 114 1,944 1,791
Loans receivable, net 121,239 141,982 165,185 169,760 178,447
Mortgage-backed securities - 1,023 - - -
Mortgage-backed securities available for sale - - 961 867 428
Securities available for sale - - 5,951 6,753 7,100
Investment securities 8,832 14,759 5,991 4,199 2,049
Certificates of deposit 3,074 424 100 800 200
Cash and cash equivalents 37,718 3,480 1,480 8,192 8,301
Deposits 166,512 153,769 146,412 146,686 145,349
Borrowed funds - - 23,650 18,000 26,500
Equity 8,985 10,181 11,506 28,852 28,202
Summary of Operations
- --------------------------------------------------------------------------------------------------------------------
Years Ended December 31, 1992 1993 1994 1995 1996
- --------------------------------------------------------------------------------------------------------------------
Interest income $ 13,197 $ 11,164 $ 11,573 $ 13,489 $ 14,669
Interest expense 9,243 6,726 6,510 8,165 8,146
Net interest income 3,954 4,438 5,063 5,324 6,523
Provision for loan losses 172 - 113 166 180
Noninterest income 845 999 737 809 1,014
Noninterest expense (1) 3,247 3,356 3,574 3,855 5,245
Income before cumulative effect of change
in accounting principle 805 1,179 1,283 1,270 1,200
Net income 805 1,248 1,283 1,270 1,200
Other Selected Data
- --------------------------------------------------------------------------------------------------------------------
Years Ended December 31, 1992 1993 1994 1995 1996
- --------------------------------------------------------------------------------------------------------------------
Return on average assets before cumulative effect 0.45% 0.70% 0.74% 0.67% 0.61%
Return on average assets after cumulative effect 0.45% 0.74% 0.74% 0.67% 0.61%
Return on average equity before cumulative effect 9.39% 12.40% 11.66% 5.50% 4.24%
Return on average equity after cumulative effect 9.39% 13.12% 11.66% 5.50% 4.24%
Average equity to average assets 4.77% 5.62% 6.31% 12.11% 14.40%
Equity to assets 5.09% 6.16% 6.30% 14.78% 14.01%
Net interest rate spread (2) 2.22% 2.61% 2.80% 2.29% 2.72%
Nonperforming assets to total loans (3) 0.67% 0.56% 0.53% 0.17% 0.19%
Allowance for loan losses to total loans 0.39% 0.28% 0.23% 0.30% 0.34%
Allowance for loan losses to nonperforming loans (3) 46.10% 52.37% 45.85% 171.24% 206.52%
Earnings per share (4) N/A N/A N/A $0.50 $0.61
</TABLE>
(1) For 1996, includes a special SAIF recapitalization assessment of $1,085.
(2) Interest rate spread represents the difference between the average yield
on interest-earning assets and the average cost of interest-bearing
liabilities.
(3) Nonperforming loans are loans over 90 days past due. Nonperforming assets
include nonperforming loans and foreclosed real estate.
(4) Does not include earnings prior to April 11, 1995, the date of conversion
to stock form.
3
<PAGE>
To Our Stockholders:
We are pleased to present our second annual stockholders' report. This report
represents the first full calendar year of operations since the conversion from
mutual to stock ownership.
With the positive economic environment of 1996, our management team expected net
income to increase over 1995. Our operating results, however, were negatively
affected by two factors.
The biggest impact came as a result of congressional action approving a special
assessment on the industry to recapitalize the Savings Association Insurance
Fund (SAIF). The Bank's portion of that assessment was $1,085,000, which
negatively impacted earnings. While this assessment had a negative impact in
1996, we will benefit positively in future years as our annual deposit insurance
premium rate was reduced from twenty three basis points per dollar of deposit to
approximately six basis points. A further reduction in the deposit insurance
premium rate is scheduled for the year 2000.
The second factor was the installation of new data processing equipment and
software. As a result of that conversion we are now able to offer our customers
the latest in financial products in a cost effective manner. While this had a
$132,000 non-recurring negative impact on our bottom line, the largest impact
was on our dedicated staff who are to be congratulated for completing a
monumental task.
We consider 1996 to be a successful year. Even with the negative impacts
described above, pre-tax income for 1996 equaled pre-tax income for 1995.
We had scheduled the conversion of our loan origination office in Owatonna,
Minnesota to a full service branch in 1996, however, that conversion was delayed
until February 1997 and is operational as of this date.
Your Board of Directors, management team and staff members continue to work on
ways to improve and provide additional services to our customers as well as
protect and enhance the value of your investment in Wells Financial Corp. To our
stockholders who have been investors from the date of conversion and to our new
stockholders who have invested since conversion, thank you for the confidence
you have placed in us.
Best Regards,
/s/ Lawrence H. Kruse
Lawrence H. Kruse
President and Chief Executive Officer
4
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in Thousands)
General
The Company's business activities to date have been limited to its
investment in and loan to the Bank and a loan made to the Bank's Employee Stock
Ownership Plan ("ESOP") to enable the ESOP to purchase shares of the Company's
common stock and, to a lesser degree, investing in securities and deposits in
other financial institutions. The Company's investment securities consist of
obligations issued by agencies of the U.S. government. As a result of the
limited operations of the Company, this discussion primarily relates to the
Bank. The principal business of the Bank consists of attracting deposits from
the general public and using such deposits, together with borrowings, primarily
to invest in residential lending on owner occupied properties. The Bank also
makes consumer loans and agricultural related loans and purchases investment
securities. The Bank's investment securities consist of U.S. government and
agency obligations, mortgage-backed securities, equity securities and FHLB
stock. The Bank's loans consist primarily of loans secured by residential real
estate located in its market area and, to a lesser extent, commercial real
estate loans and consumer loans.
The Bank's net earnings are dependent primarily on its net interest
income, which is the difference between interest income earned on its investment
and loan portfolios and interest paid on interest-bearing liabilities. Net
interest income is determined by (i) the difference between yields earned on
interest-earning assets and rates paid on interest-bearing liabilities (interest
rate spread) and (ii) the relative amounts of interest-earning assets and
interest-bearing liabilities. The Bank's interest rate spread is affected by
regulatory, economic, and competitive factors that influence interest rates,
loan demand, and deposit flows. To a lesser extent, the Bank's net earnings also
are affected by the level of noninterest income, which primarily consists of
service charges and other fees. In addition, net earnings are affected by the
level of noninterest (general and administrative) expenses.
The operations of the Bank and the entire thrift industry are
significantly affected by prevailing economic conditions, competition, and the
monetary and fiscal policies of the federal government and governmental
agencies. Lending activities are influenced by the demand for and supply of
housing, competition among lenders, the level of interest rates, and the
availability of funds. Deposit flows and costs of funds are influenced by
prevailing market rates of interest, primarily on competing investments, account
maturities, and the levels of personal income and savings in the Bank's market
area.
Asset/Liability Management
Net interest income, the primary component of the Bank's net earnings,
is derived from the difference or "spread" between the yield on interest-earning
assets and the cost of interest-bearing liabilities. The Bank has sought to
reduce its exposure to changes in interest rates by matching more closely the
effective maturities or repricing characteristics of its interest-earning assets
and interest-bearing liabilities. The matching of the Bank's assets and
liabilities may be analyzed by examining the extent to which its assets and
liabilities are interest rate sensitive and by monitoring the expected effects
of interest rate changes on its net portfolio value.
An asset or liability is interest rate sensitive within a specific time
period if it will mature or reprice within that time period. If the Bank's
assets mature or reprice more quickly or to a greater extent than its
liabilities, the Bank's net portfolio value and net interest income would tend
to increase during periods of rising interest rates but decrease during periods
of falling interest rates. If the Bank's assets mature or reprice more slowly or
to a lesser extent than its liabilities, the Bank's net portfolio value and net
interest income would tend to decrease during periods of rising interest rates
but increase during periods of falling interest rates. The Bank's policy has
been to mitigate the interest rate risk inherent in
5
<PAGE>
(Dollars in Thousands)
the historical savings institution business of originating long-term loans
funded by short-term deposits by pursuing certain strategies designed to
decrease the vulnerability of its earnings to material and prolonged changes in
interest rates.
The Bank's lending strategy is focused on the origination of
traditional one- to four-family mortgage loans primarily secured by single
family residences in the Bank's primary market area. In the Bank's market area,
loan demand has exceeded deposits and the Bank has not found it necessary or
desirable to purchase mortgage backed securities to any significant extent.
During recent periods, the Bank has utilized borrowings as a way of
accommodating loan demand, consistent with its goal of maintaining asset
quality. The Bank also invests a portion of its assets in consumer and
commercial business and commercial real estate loans and investment securities
as a method of reducing interest rate risk. These loans typically have
adjustable interest rates and are for shorter terms than residential first
mortgage loans. The Bank's entire commercial business loan portfolio and most of
the commercial real estate portfolio are secured by equipment or real estate
used for farming. These loans typically have higher interest rates than one- to
four-family loans but have not historically resulted in greater losses for the
Bank. As a key element of its strategy, the Bank sells higher loan to value
ratio fixed rate mortgage loans and mortgage loans with original maturities of
fifteen years or less into the secondary market and retains adjustable rate
mortgage loans and lower loan to value ratio fixed rate loans with original
maturities greater than fifteen years. Although it is perceived that mortgage
loans with original maturities of fifteen years or less offer greater protection
from interest rate risk due to their shorter contractual maturities than
mortgage loans with original maturities greater than fifteen years, it is
management's belief that the actual average life of mortgage loans with original
maturities of fifteen years or less is approximately equal to the average life
of mortgage loans with original maturities greater than fifteen years.
Management also believes that the benefit of higher yields on mortgage loans
with original maturities that are greater than fifteen years more than offsets
the higher contractual cash flows that are generated by mortgage loans with
original maturities of fifteen years or less. In addition, the Bank retains
servicing on most of the loans that it sells, enabling it to generate additional
income and maintain certain economies of scale in loan processing.
In order to improve the Bank's interest rate sensitivity, improve asset
quality, and provide diversification in the asset mix, the Bank maintains a
percentage of its assets in investment securities, which generally have either
adjustable rates or shorter terms to maturity. The Bank's purchase of investment
securities is designed primarily for safety of principal and secondarily for
rate of return.
On a weekly basis, the Bank monitors the interest rates of its
competitors and sets its interest rates such that its rates are neither the
highest or lowest in its market area. The Bank intends for its rates to be
competitive and perhaps slightly above the average rates being paid in its
market area. The Bank has sought to remain competitive in its market by offering
a variety of products. The Bank attempts to manage the interest rates it pays on
deposits while maintaining a stable deposit base and providing quality services
to its customers.
6
<PAGE>
(Dollars in Thousands)
Net Portfolio Value
To encourage associations to reduce their interest rate risk, the OTS
adopted a rule incorporating an interest rate risk ("IRR") component into the
risk-based capital rules. This rule in not yet in effect. The IRR component is a
dollar amount that will be deducted from total capital for the purpose of
calculating an institution's risk-based capital requirement and is measured in
terms of the sensitivity of its net portfolio value ("NPV") to changes in
interest rates. NPV is the difference between incoming and outgoing discounted
cash flows from assets, liabilities, and off-balance sheet contracts. An
institution's IRR is measured as the change to its NPV as a result of a
hypothetical 200 basis point change in market interest rates. A resulting change
in NPV of more than 2% of the estimated market value of its assets will require
the institution to deduct from its capital 50% of that excess change. The rule
provides that the OTS will calculate the IRR component quarterly for each
institution. The Bank, based on asset size and risk-based capital, has been
informed by the OTS that it is exempt from this rule. Nevertheless, the
following table presents the Bank's NPV at December 31, 1996, as calculated by
the OTS, based on information provided to the OTS by the Bank.
<TABLE>
<CAPTION>
Percent of Change in
Change Interest Estimated Amount of Estimated NPV NPV Ratio(4)
Rates (basis points) NPV Change(1) NPV(2) Ratio(3) (basis points)
-------------------- --------- --------- ---------- -------- --------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
+400 $10,168 $(14,999) (60)% 5.48% -691 bp
+300 14,327 (10,841) (43)% 7.52% -486 bp
+200 18,381 (6,787) (27)% 9.42% -297 bp
+100 22,086 (3,081) (12)% 11.07% -131 bp
-- 25,167 12.39%
-100 27,388 2,220 9 % 13.29% 90 bp
-200 28,681 3,513 14 % 13.79% 140 bp
-300 29,741 4,573 18 % 14.18% 179 bp
-400 31,272 6,104 24 % 14.75% 237 bp
</TABLE>
(1) Represents the excess (deficiency) of the estimated NPV assuming the
indicated change in interest rates minus the estimated NPV assuming no
change in interest rates.
(2) Calculated as the amount of change in the estimated NPV divided by the
estimated NPV assuming no change in interest rates.
(3) Calculated as the estimated NPV divided by average total assets.
(4) Calculated as the excess (deficiency) of the NPV ratio assuming the
indicated change in interest rates over the estimated NPV ratio assuming no
change in interest rates.
7
<PAGE>
(Dollars in Thousands)
At
December 31,
1996
-------------------
*** Risk Measures: 200 bp rate shock ***
Pre-Shock NPV Ratio: NPV as % of PV of Assets 12.39 %
Exposure Measure: Post-Shock NPV Ratio 9.42 %
Sensitivity Measure: Change in NPV Ratio (297) bp
Although the OTS has informed the Bank that it is not subject to the
IRR component discussed above, the Bank is still subject to interest rate risk
and, as can be seen above, rising interest rates will reduce the Bank's NPV. If
the Bank were subject to the IRR component at December 31, 1996, a deduction
from capital would have been required.
Also, during periods of increasing interest rates, the Bank's interest
rate sensitive liabilities would reprice faster than its interest rate sensitive
assets (repricing periods on adjustable-rate loans affect the repricing of
interest rate sensitive assets, with longer repricing periods delaying the
repricing of such assets more than shorter repricing periods would delay the
repricing of such assets), causing a decline in the Bank's interest rate spread
and margin. In times of decreasing interest rates, the value of fixed rate
assets could increase in value and the lag in repricing of interest rate
sensitive assets could be expected to have a positive effect on the Bank.
8
<PAGE>
- --------------------------------------------------------------------------------
Average Balance Sheet (Dollars in Thousands)
- --------------------------------------------------------------------------------
The following table sets forth certain information relating to the
Bank's average balance sheet and reflects the average yield on assets and
average cost of liabilities for the periods indicated and the average yields
earned and rates paid. Such yields and costs are derived by dividing income or
expense by the average balance of assets or liabilities, respectively, for the
periods presented. The yields for the periods presented include loan origination
fees that are considered adjustments to yield. Average balances are derived from
month-end balances. Management does not believe that the use of month-end
balances instead of daily average balances has caused any material difference in
the information presented.
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------------------------------------------
1994 1995 1996
--------------------------------------------------------------------------------------------
Average Average Average Average Average Average
Balance Interest Yield/Cost Balance Interest Yield/Cost Balance Interest Yield/Cost
--------------------------------------------------------------------------------------------
Interest-earning assets:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans receivable (1) $153,477 $10,813 7.05% $170,395 $12,571 7.38% $173,383 $13,617 7.85%
Mortgage-backed securities 993 68 6.85% 949 55 5.80% 661 45 6.81%
Investments (2) 15,025 692 4.61% 15,618 863 5.53% 18,281 1,007 5.51%
------------------ ------------------- -------------------
Total interest-earning assets $169,495 $11,573 6.83% 186,962 $13,489 7.22% 192,325 $14,669 7.63%
--------- --------- --------
Noninterest earning assets 4,853 3,847 4,163
-------- ---------- ---------
Total assets $174,348 $190,809 $196,488
======== ========== =========
Interest bearing liabilities:
Savings, NOW and money
market accounts (3) $ 38,910 $ 857 2.20% $ 36,553 $ 937 2.56% $ 36,578 $ 949 2.59%
Certificates of deposit 110,173 5,027 4.56% 110,169 6,066 5.51% 110,139 6,111 5.55%
Borrowed funds 12,610 626 4.96% 18,938 1,162 6.14% 19,269 1,086 5.64%
------------------ -------------------- --------------------
Total interest bearing
liabilities 161,693 $ 6,510 4.03% 165,660 $ 8,165 4.93% 165,986 $ 8,146 4.91%
-------- --------- --------
Noninterest bearing liabilities 1,651 2,050 2,199
-------- ---------- ---------
Total liabilities 163,344 167,710 168,185
Equity 11,004 23,099 28,303
-------- ---------- ---------
Total liabilities and equity $174,348 $190,809 $196,488
======== ========== =========
Net interest income $ 5,063 $ 5,324 $ 6,523
========= ========= ========
Interest rate spread (4) 2.80% 2.29% 2.72%
Net yield on interest earning assets(5) 2.99% 2.85% 3.39%
Ratio of average interest earning
assets to average interest bearing
liabilities 1.05X 1.13X 1.16X
</TABLE>
(1) Average balances include non-accrual loans and loans held for sale.
(2) Includes interest-bearing deposits in other financial institutions.
(3) For 1996, the average balance and average cost for savings accounts and
demand deposit accounts were $16,219 and $20,359 and 2.65% and 2.55%,
respectively.
(4) Interest-rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(5) Net yield on interest-earning assets represents net interest income as a
percentage of average interest-earning assets.
9
<PAGE>
Rate/Volume Analysis (Dollars in Thousands)
The table below sets forth certain information regarding changes in
interest income and interest expense of the Bank for the years indicated. For
each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume
(changes in average volume multiplied by old rate); (ii) changes in rates
(changes in rate multiplied by old average volume); (iii) changes in rate-volume
(changes in rate multiplied by the change in average volume).
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------- --- ---------------------------------------
1995 vs. 1994 1996 vs. 1995
-------------------------------------- ---------------------------------------
Increase (Decrease) Due to Increase (Decrease) Due to
-------------------------------------- ---------------------------------------
Rate/ Rate/
Volume Rate Volume Net Volume Rate Volume Net
--------- -------- ---------- -------- --------- --------- --------- ---------
Interest Income:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans receivable $ 1,193 $ 506 $ 59 $1,758 $ 220 $ 811 $ 15 $ 1,046
Mortgage-backed securities (3) (10) - (13) (17) 10 (15) (22)
Investments 27 138 6 171 147 (3) 12 156
--------- -------- ---------- -------- --------- --------- --------- ---------
Total interest-earning assets 1,217 634 65 1,916 350 818 12 1,180
--------- -------- ---------- -------- --------- --------- --------- ---------
Interest expense:
Deposit accounts (93) 1,222 (10) 1,119 - 57 - 57
Borrowed funds 314 149 73 536 19 (94) (1) (76)
--------- -------- ---------- -------- --------- --------- --------- ---------
Total interest-bearing 221 1,371 63 1,655 19 (37) (1) (19)
liabilities
--------- -------- ---------- -------- --------- --------- --------- ---------
Net change in interest income $ 996 $(737) $ 2 $ 261 $ 331 $ 855 $ 13 $ 1,199
========= ======== ========== ======== ========= ========= ========= =========
</TABLE>
10
<PAGE>
(Dollars in Thousands)
Financial Condition
Total assets increased by $6,168 from $195,158 at December 31, 1995 to
$201,326 at December 31, 1996. The increase in total assets was primarily the
result of an $8,777 increase in the loan portfolio from $169,670 at December 31,
1995 to $178,447 at December 31, 1996. The increase in loans receivable is the
result of management's decision to retain higher yielding thirty year fixed rate
loans that were originated during 1996. The increase in the loan portfolio was
partially offset by a $600 decrease in certificates of deposit which matured and
a $2,150 decrease in securities held to maturity. The decrease in securities
held to maturity was the result of $2,500 of securities issued by agencies of
the United States being called during the last two months of 1996. Mortgage
backed securities that are available for sale decreased by $439 due to the
repayment of principal. Premises and equipment increased by $282 during 1996
primarily due to the upgrading by the Bank of its data processing system with
new computer hardware and software.
In accordance with the Bank's internal classification of assets policy,
management evaluates the loan portfolio on a quarterly basis to identify and
determine the adequacy of the allowance for loan losses. As of December 31, 1995
and December 31, 1996 the balance in the allowance for loan losses and the
allowance for loan losses as a percentage of total loans was $512 and $615 and
0.30% and 0.34%, respectively.
Loans on which the accrual of interest has been discontinued amounted
to $298 at December 31, 1996 and 1995. The effect of nonaccrual loans was not
significant to the results of operations. The Company includes all loans
considered impaired under FASB Statement No. 114 in nonaccrual loans. The amount
of impaired loans was not material at December 31, 1996 and 1995.
Deposits decreased by $1,337 from $146,686 at December 31, 1995 to $145,349
at December 31, 1996. To fund the increase in loans receivable referred to
above, borrowed funds increased by $8,500 during the same period.
Equity decreased by $650 from $28,852 at December 31, 1995 to $28,202
at December 31, 1996. This decrease is primarily due to the repurchase of
163,640 shares of treasury stock, at a cost of $1,763, and the purchase of
49,735 of the Company's shares, at a cost of $539, for Management Stock Bonus
Plan awards. These decreases in equity were partially offset by net income of
$1,200, the allocation of $163 of employee stock ownership plan shares and the
amortization of $259 of unearned compensation.
Comparison of Operating Results for the Years Ended December 31, 1996 and 1995
General. For the year ended December 31, 1996, net interest income
increased by $1,199 when compared to the same period in 1995. This increase in
net interest income would normally result in an increase in income before income
taxes. However, on September 30, 1996, a law was enacted which required savings
institutions insured by the Savings Association Insurance Fund (SAIF) to pay a
one time special assessment to recapitalize the SAIF. The Bank's assessment
amounted to $1,085, which was recorded as an expense during the third quarter of
1996. This special SAIF assessment was the primary reason for income before
income taxes for fiscal year 1996 being equal to income before income taxes for
fiscal year 1995. Income tax expense for the year ended December 31, 1996 was
$70 higher than income tax for the year ended December 31, 1995 primarily due to
an increase in nondeductible expenses incurred by the Company, which resulted in
a reduction in net income of $70 from $1,270 for the year ended December 31,
1995 to $1,200 for the year ended December 31, 1996.
11
<PAGE>
(Dollars in Thousands)
Interest Income. The Company's interest income increased by $1,180 for
the year ended December 31, 1996 when compared to the year ended December 31,
1995. This is primarily the result of an upward repricing of the Bank's
adjustable rate loan portfolio and the increase in loans receivable. To a lesser
extent, the increase in interest income was the result of an increase in the
average balance of investment securities.
Interest Expense. The average amount of deposits during 1996 remained
approximately equal to the average amount of deposits during 1995. An increase
in the interest rates paid on deposits caused interest expense on deposits to
increase by $57, from $7,003 for the year ended December 31, 1995 to $7,060 for
the year ended December 31, 1996. The average amount of borrowed funds during
1996 increased by $331 when compared to 1995. This increase in the average
amount of borrowed funds was offset by a decrease in the interest rates paid on
borrowed funds, which resulted in a decrease in interest expense on borrowed
funds. The decrease in the interest paid on borrowed funds offset the increase
in interest paid on deposits and resulted in a $19 decrease in interest expense
for fiscal year 1996 when compared to fiscal year 1995.
Net Interest Income. Net interest income increased by $1,199 for the
year ended December 31, 1996 when compared to the year ended December 31, 1995.
Again, this is primarily the result of the increase in loans receivable and the
result of the repricing of the Bank's adjustable rate loan portfolio as
described above, as well as below under the 1995 to 1994 comparison under
"Interest Income" and "Net Interest Income" and to a lesser extent, the result
of the decrease in interest expense. During 1996, the adjustable rate loan
portfolio repriced from the increase in interest rates that began in late 1994,
making it unlikely that interest income will increase due to rate increases
during the next several quarters.
Provision for Loan Losses. The provision for loan losses increased by
$14 for 1996 when compared to 1995. Management monitors the allowance for loan
loss in relation to the size and quality of the loan portfolio and adjusts the
provision for loan losses to adequately provide for loan losses. While the
Company maintains its allowance for loan losses at a level that is considered to
be adequate to provide for potential losses, there can be no assurance that
further additions will not be made to the loss allowance and that losses will
not exceed estimate amounts.
Noninterest Income. Noninterest income increased by $205 from $809 for
the year ended December 31, 1995 to $1,014 for the year ended December 31, 1996.
This increase is primarily due to increases in the gain on sale of loans
originated for sale and insurance commissions. The increase in the gain on the
sale of loans originated for sale resulted primarily from the recording of
mortgage servicing rights on loans sold during the year due to the adoption of
FASB Statement No. 122 during the period. The increase in insurance commissions
was the result of the acquisition of additional local accounts by the Bank's
insurance subsidiary.
Noninterest Expense. Noninterest expense increased by $1,390 from
$3,855 for the year ended December 31, 1995 to $5,245 for the year ended
December 31, 1996. As described above, the legislation that was signed into law
on September 30, 1996 resulted in a one time special assessment to the Bank of
$1,085. This assessment is the primary reason for the increase in noninterest
expense. As a result of this legislation, the Bank's annual assessment was
reduced from twenty three basis points per dollar of deposits to approximately
six basis points per dollar of deposits. Also, as part of management's
commitment to provide competitive products and excellent service to the Bank's
customers, the Bank converted to a new data processing software system during
the second quarter of 1996. The decision to convert the data processing software
was based upon management's desire to improve marketing of the Bank's products
to current as well as potential customers. The software conversion resulted in a
non-recurring expense of approximately $132 that was
12
<PAGE>
(Dollars in Thousands)
recorded during 1996. In addition, approximately $498 in hardware and software
costs were capitalized and will be depreciated over their useful lives.
Income Tax Expense. While income before income taxes was the same for
the years ended December 31, 1996 and 1995, income tax expense increased during
1996 primarily due to an increase in nondeductible expenses incurred by the
Company. Income tax expense as a percentage of income before taxes for the years
ended December 31, 1996 and 1995 was 43.18% and 39.87%, respectively.
Comparison of Operating Results for the Years Ended December 31, 1995 and 1994
General. Net income decreased by $13 from $1,283 for the year ended
December 31, 1994 to $1,270 for the year ended December 31, 1995. As discussed
in more detail below, this decrease was due to an increase in noninterest
expense, which was partially offset by an increase in net interest income and
noninterest income.
Interest Income. Interest income increased by $1,916 for the year ended
December 31, 1995 as compared to the year ended December 31, 1994. This was
primarily the result of the increase in loans receivable and other interest
earning assets which were funded through the use of proceeds from the sale of
common stock. To a lesser degree, the increase was due to the Company's
adjustable rate loan portfolio, which constitutes approximately 60% of its total
loan portfolio, repricing upward as this loan portfolio uses lagging indices.
Interest Expense. Interest expense increased by $1,655 for the year
ended December 31, 1995 when compared to the year ended December 31, 1994. The
increase resulted from increases of interest rates paid on deposits and
borrowings. A portion of the proceeds from the sale of common stock were used to
reduce interest sensitive Federal Home Loan Bank borrowings, which resulted in
lower interest expense for the year ended December 31, 1995 than if those
proceeds had been used for other purposes.
Net Interest Income. Net interest income increased by $261 from $5,063
to $5,324 on December 31, 1994 and 1995, respectively. Because the Company's
interest-bearing liabilities reprice faster than its interest-earning assets,
the Company generally experiences a decrease in its net interest income when
interest rates increase. However, since interest rates began rising in late
1994, the delayed effect in 1995 of the lagging indices on the Company's
adjustable rate loan portfolio, coupled with the increase in its total loan
portfolio, caused interest income to increase by more than interest expense
during the year ended December 31, 1995. The Company therefore experienced an
increase in net interest income.
Provision for Loan Losses. The provision for loan losses increased by
$53 for the year ended December 31, 1995 when compared to the year ended
December 31, 1994. In accordance with the Bank's internal classification of
assets policy, management evaluates the loan portfolio on a quarterly basis to
identify and determine the adequacy of the allowance for loan losses. During
1995, management made the decision to increase the provision for loan losses due
to the increase in the Company's loan portfolios. While the Company maintains
its allowance for loan losses at a level that it considers to be adequate to
provide for potential losses, there can be no assurance that further additions
will not be made to the loss allowances and that losses will not exceed
estimated amounts.
13
<PAGE>
(Dollars in Thousands)
Noninterest Income. Noninterest income increased by $72, from $737 for
the year ended December 31, 1994 to $809 for the year ended December 31, 1995.
This increase was caused primarily by an increase of $80 in loan origination,
commitment and other fees due to an increase in loan originations during 1995.
In addition, insurance commissions increased by $34 resulting primarily from the
acquisition of additional local accounts by the Bank's insurance subsidiary.
These increases in noninterest income were partially offset by a decrease of $43
in loan servicing fees. This decrease was the result of a reduction in loans
serviced for others during the first ten months of 1995.
Noninterest Expense. Noninterest expense increased by $281 for the year
ended December 31, 1995 when compared to the year ended December 31, 1994. The
majority of this increase resulted from compensation and benefits which
increased by $239, due primarily to increased employee benefit costs and normal
compensation adjustments. These employee benefit costs are expected to further
increase in 1996 as the result of vesting of shares awarded through the
Management Stock Bonus Plan. The increase during 1996 is not expected to be as
great as the increase during 1995. Professional fees associated with operating
as a publicly traded company resulted in a $55 increase for the same period.
Income Tax Expense. The Company's income tax expense as a percentage of
income before income taxes remained stable at 39.9% for the year ended December
31, 1995 as compared to 39.3% for the year ended December 31, 1994.
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,
federal agency and other investments having maturities of five years or less.
Current OTS regulations require that a savings association maintain liquid
assets of not less than 5% of its average daily balance of net withdrawable
deposit accounts and borrowings payable in one year or less, of which short-term
liquid assets must consist of not less than 1%. At December 31, 1996, the Bank's
liquidity, as measured for regulatory purposes, was 6.11%. The Bank adjusts
liquidity as appropriate to meet its asset/liability objectives.
The Bank's primary sources of funds are deposits, amortization and
prepayment of loans, maturities of investment securities and funds provided from
operations. While scheduled loan repayments are a relatively predictable source
of funds, deposit flows and loan prepayments are significantly influenced by
general interest rates, economic conditions and competition. If needed, the
Bank's primary source of funds can be supplemented by wholesale funds obtained
through additional advances from the Federal Home Loan Bank system. The Bank
invests excess funds in overnight deposits, which not only serve as liquidity,
but also earn interest as income until funds are needed to meet required loan
funding.
The Bank's most liquid asset is cash including investments in interest
bearing accounts at the FHLB of Des Moines that have no withdrawal restrictions.
The level of these assets are dependent on the Bank's operating, financing and
investing activities during any given period. At December 31, 1996, the Bank's
cash totaled $6,675. This compares to the Bank's cash at December 31, 1995 of
$7,600.
14
<PAGE>
(Dollars in Thousands)
Also available to the Bank to meet liquidity requirements are
borrowings from the Federal Home Loan Bank. At December 31, 1996, the Bank had
$26,500 in outstanding advances from the FHLB of Des Moines, which have been
used to fund loan originations. At December 31, 1996, the Bank had the ability
to borrow approximately 3.5 times its then outstanding advances.
The Bank has other sources of liquidity if a need for additional funds
arises although the Bank has not used them. Additional sources of funds include
borrowing against mortgage-backed or other securities. At December 31, 1996, the
mortgage-backed securities portfolio consisted solely of collateralized mortgage
obligations guaranteed as to principal by FNMA or FHLMC. These securities are
considered non-high-risk securities under applicable criteria. These securities
had a market value of $428 at December 31, 1996 and the carrying value of these
securities are adjusted quarterly to reflect market value.
In 1996, the Company approved stock buy back programs in which up to
317,188 shares of the common stock of the Company may be acquired. An additional
191,313 shares may be purchased in the future in accordance with these programs.
The Bank is required to maintain specified amounts of capital. The
capital standards generally require the maintenance of regulatory capital
sufficient to meet a tangible capital requirement, a core capital requirement
and a risk-based capital requirement. At December 31, 1996, the Bank's tangible
capital totaled $20.5 million, or 10.31% of adjusted total assets, and core
capital totaled $20.5 million, or 10.31% of adjusted total assets, which
substantially exceeded the respective 1.5% tangible capital and 3.0% core
capital requirements at that date by $17.5 million and $14.5 million,
respectively, or 8.81% and 7.31% of adjusted total assets, respectively. The
Bank's risk-based capital totaled $21.1 million at December 31, 1996 or 18.61%
of risk-weighted assets, which exceeded the current requirements of 8.0% of
risk-weighted assets by $12.0 million or 10.61% of risk-weighted assets.
Impact of Inflation and Changing Prices
The consolidated financial statements and notes thereto presented
herein have been prepared in accordance with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars without considering the change in the
relative purchasing power of money over time and due to inflation. The impact of
inflation is reflected in the increased cost of the Bank's operations. Unlike
most industrial companies, nearly all the assets and liabilities of the Bank are
monetary in nature. As a result, interest rates have a greater impact on the
Bank's performance than do the effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or to the same extent as the
price of goods and services.
15
<PAGE>
[LOGO]
McGLADREY & PULEN, LLP
----------------------
Certified Public Accountants and Consultants
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Wells Financial Corp. and Subsidiary
Wells, Minnesota
We have audited the accompanying consolidated statements of financial condition
of Wells Financial Corp. and Subsidiary as of December 31, 1996 and 1995, and
the related consolidated statements of income, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Wells Financial
Corp. and Subsidiary as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996 in conformity with generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, effective
January 1, 1994, the Company changed its method of accounting for investments in
debt and marketable equity securities to adopt FASB Statement No. 115.
/s/McGladrey & Pullen, LLP
Rochester, Minnesota
February 11, 1997
16
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, 1996 and 1995
(dollars in thousands)
ASSETS 1996 1995
- ---------------------------------------------------------------------------
Cash, including interest-bearing accounts
1996 $7,560; 1995 $6,316 $ 8,301 $ 8,192
Certificates of deposit (Note 2) 200 800
Securities available for sale (Notes 3 and 12) 7,100 6,753
Securities held to maturity (Note 4) 2,049 4,199
Mortgage-backed securities available for sale
(Notes 3 and 5) 428 867
Loans held for sale, net of unrealized losses
1996 $30; 1995 $-0- (Note 6) 1,791 1,944
Loans receivable, net (Notes 6, 12, 16 and 17) 178,447 169,670
Accrued interest receivable 1,060 1,120
Premises and equipment (Note 9) 1,519 1,237
Foreclosed real estate (Note 8) 78 29
Other assets 353 347
-----------------------
Total assets $ 201,326 $ 195,158
=======================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ---------------------------------------------------------------------------
Liabilities
Deposits (Note 10) $ 145,349 $ 146,686
Borrowed funds (Note 12) 26,500 18,000
Advances from borrowers for taxes and insurance 681 683
Income taxes (Note 13):
Current - 54
Deferred 358 340
Accrued interest payable 126 221
Accrued expenses and other liabilities (Note 11) 110 322
-----------------------
Total liabilities 173,124 166,306
-----------------------
Commitments, contingencies and credit risk (Notes
14, 16, and 17)
Stockholders' Equity (Notes 11, 15 and 20)
Preferred stock, no par value; 500,000 shares
authorized; none outstanding - -
Common stock, $.10 par value; 7,000,000 shares
authorized; 2,187,500 shares issued 219 219
Additional paid-in capital 16,588 16,537
Retained earnings, substantially restricted 13,986 12,786
Unrealized appreciation on securities
available for sale, net of related taxes 348 318
Unearned Employee Stock Option Plan shares (896) (1,008)
Unearned compensation-restricted stock awards (280) -
Less cost of 163,640 shares of treasury stock (1,763) -
-----------------------
Total stockholders' equity 28,202 28,852
-----------------------
Total liabilities and stockholders' equity $ 201,326 $ 195,158
=======================
See Notes to Consolidated Financial Statements.
17
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1996, 1995 and 1994
(dollars in thousands, except per share data)
1996 1995 1994
- --------------------------------------------------------------------------
Interest and Dividend Income
Loans receivable
First mortgage loans $ 11,558 $ 10,854 $ 9,505
Consumer and other loans 2,059 1,717 1,308
Investment securities and other
interest- bearing deposits 1,052 918 760
----------------------------------
Total interest income 14,669 13,489 11,573
----------------------------------
Interest Expense
Deposits 7,060 7,003 5,884
Borrowed funds 1,086 1,162 626
----------------------------------
Total interest expense 8,146 8,165 6,510
----------------------------------
Net interest income 6,523 5,324 5,063
Provision for loan losses (Note 6) 180 166 113
----------------------------------
Net interest income after
provision for loan losses 6,343 5,158 4,950
----------------------------------
Noninterest Income
Gain on sale of loans 102 31 8
Loan origination and commitment fees 81 60 30
Loan servicing fees 202 186 229
Insurance commissions 318 247 213
Fees and service charges 246 225 175
Other 65 60 82
----------------------------------
Total noninterest income 1,014 809 737
----------------------------------
Noninterest Expense
Compensation and benefits (Note 11) 1,911 1,890 1,651
Occupancy and equipment (Note 14) 644 535 531
Federal insurance premiums and
assessment (Note 10) 1,406 336 346
Data processing 359 263 243
Advertising 150 144 136
Other 775 687 667
----------------------------------
Total noninterest expense 5,245 3,855 3,574
----------------------------------
Income before income taxes 2,112 2,112 2,113
Income tax expense (Note 13) 912 842 830
----------------------------------
Net income $ 1,200 $ 1,270 $ 1,283
==================================
Earnings per share (Note 18):
Primary and fully diluted $ 0.61 $ 0.50
======================
See Notes to Consolidated Financial Statements.
18
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1996, 1995 and 1994
(dollars in thousands)
<TABLE>
<CAPTION>
Unrealized Unearned
Appreciation Employee Unearned
(Depreciation) Stock Compensation-
Additional on Securities Ownership Restricted Total
Common Paid-In Retained Available Plan Stock Treasury Stockholders'
Stock Capital Earnings for Sale, net Shares Awards Stock Equity
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, December 31, 1993 $ - $ - $ 10,233 $ (52) $ - $ - $ - $ 10,181
Net income - - 1,283 - - - - 1,283
Net changes in unrealized
appreciation (depreciation)
on securities available for
sale, net of related taxes - - - 42 - - - 42
----------------------------------------------------------------------------------------------------
Balances, December 31, 1994 - - 11,516 (10) - - - 11,506
Proceeds from sale of
2,187,500 shares,
net of offering costs
of $775 (Note 20) 219 16,506 - - (1,120) - - 15,605
Net income - - 1,270 - - - - 1,270
Net changes in unrealized
appreciation on
securities available
for sale, net of
related taxes - - - 328 - - - 328
Allocated ESOP shares - 31 - - 112 - - 143
----------------------------------------------------------------------------------------------------
Balances, December 31, 1995 219 16,537 12,786 318 (1,008) - - 28,852
Net income - - 1,200 - - - - 1,200
Net changes in
unrealized appreciation
on securities
available for sale,
net of related taxes - - - 30 - - - 30
Treasury stock purchases,
163,640 shares
(Notes 11 & 15) - - - - - - (1,763) (1,763)
Purchase of common stock
for restricted stock
awards (Note 11) - - - - - (539) - (539)
Amortization of unearned
compensation - - - - - 259 - 259
Allocated ESOP shares - 51 - - 112 - - 163
----------------------------------------------------------------------------------------------------
Balances, December 31, 1996 $ 219 $ 16,588 $ 13,986 $ 348 $ (896) $ (280) $ (1,763) $ 28,202
====================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
19
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1996, 1995 and 1994
(dollars in thousands)
1996 1995 1994
- --------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net income $ 1,200 $ 1,270 $ 1,283
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Provision for loan losses 180 166 113
Gain on sale of loans (102) (31) (8)
Amortization of mortgage servicing rights 17 - -
FHLB stock dividends - (32) -
Compensation on allocation of ESOP shares 163 143 -
Amortization of unearned compensation 228 - -
Write-down of foreclosed real estate 8 18 -
Gain on sale of foreclosed realestate (17) (16) (25)
Unrealized loss on loans held for sale 30 - -
Loss on disposal of equipment 7 - 17
Deferred income taxes (8) 34 59
Depreciation and amortization on premises
and equipment 264 192 203
Amortization of deferred loan
origination fees (145) (136) (217)
Amortization of excess servicing fees 14 14 15
Amortization of securities premiums
and discounts (2) 1 (19)
Loans originated for sale 19,207 (15,414) (2,310)
Proceeds from the sale of loans held
for sale (19,057) 13,615 2,979
Changes in assets and liabilities:
Accrued interest receivable 60 (208) (94)
Other assets 67 52 (192)
Income taxes payable, current (54) 119 (336)
Accrued expenses and other liabilities (276) 158 84
-------------------------------
Net cash provided by (used in)
operating activities 1,784 (55) 1,552
-------------------------------
(Continued)
20
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years Ended December 31, 1996, 1995 and 1994
(dollars in thousands)
1996 1995 1994
- -------------------------------------------------------------------------------
Cash Flows From Investing Activities
Net increase in loans $ (8,999) $ (4,624) $(23,216)
Certificates of deposit:
Maturities 800 100 424
Purchases (200) (800) (100)
Purchase of securities available for sale (287) (280) (233)
Securities held to maturity:
Maturities and calls 5,900 3,795 5,026
Purchases (3,749) (1,994) (1,860)
Proceeds from principal repayments of
mortgage backed securities 436 138 -
Purchase of premises and equipment (552) (36) (147)
Proceeds from the sale and redemption
of foreclosed real estate 117 229 151
----------------------------------
Net cash (used in) investing
activities (6,534) (3,472) (19,955)
----------------------------------
Cash Flows From Financing Activities
Net increase (decrease) in deposits (1,337) 274 (7,357)
Net increase (decrease) from advances
from borrowers for taxes and insurance (2) 10 110
Proceeds from borrowed funds 35,000 18,000 23,650
Repayments on borrowed funds (26,500) (23,650) -
Proceeds from issuance of common stock - 15,605 -
Purchase of treasury stock (1,763) - -
Purchase of common stock for
restricted stock awards (539) - -
----------------------------------
Net cash provided by financing
activities 4,859 10,239 16,403
----------------------------------
Net increase (decrease) in cash 109 6,712 (2,000)
Cash
Beginning 8,192 1,480 3,480
----------------------------------
Ending $ 8,301 $ 8,192 $ 1,480
----------------------------------
(Continued)
21
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years Ended December 31, 1996, 1995 and 1994
(dollars in thousands)
1996 1995 1994
- ----------------------------------------------------------------------------
Supplemental Disclosures of Cash Flow
Information
Cash payments for:
Interest on deposits $ 7,164 $ 6,901 $ 5,862
Interest on borrowed funds 1,076 1,172 611
Income taxes 981 723 1,171
=================================
Supplemental Schedule of Noncash
Investing and Financing Activities
Transfers from loans to foreclosed
real estate $ 157 $ 109 $ 117
Issuance of shares to ESOP in
conjunction with conversion from
mutual to stock form - 1,120 -
Allocation of ESOP shares to
participants 112 112 -
Transfer of investment and
mortgage-backed securities held
for investment to investment
and mortgage-backed securities
available for sale (adoption
of FASB Statement No. 115) - - 6,656
=================================
See Notes to Consolidated Financial Statements.
22
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 1. Summary of Significant Accounting Policies
Nature of operations: Operations of Wells Financial Corp. (Company)
primarily consist of banking services through it's subsidiary, Wells Federal
Bank, fsb (Bank). The Bank's subsidiary, Wells Insurance Agency, Inc. is a
property and casualty insurance agency. The Company serves it's customers
through the Bank's seven locations in South Central Minnesota.
Basis of financial statement presentation: The consolidated financial statements
have been prepared in conformity with generally accepted accounting principles.
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the statements of financial condition and revenues
and expenses for the reporting period. Actual results could differ from those
estimates. A material estimate that is particularly susceptible to significant
change in the near term relates to the determination of the allowance for loan
losses.
Management believes that the allowances for losses on loans are adequate. While
management uses available information to recognize losses on loans, future
additions to the allowances may be necessary based on changes in economic
conditions.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowances for losses on
loans. Such agencies may require the Company to recognize additions to the
allowances based on their judgments about information available to them at the
time of their examination.
Principles of consolidation: The accompanying consolidated financial statements
include the accounts of Wells Financial Corp., its wholly owned subsidiary,
Wells Federal Bank, fsb, and the Bank's wholly owned insurance subsidiary, Wells
Insurance Agency, Inc. All significant intercompany transactions and balances
are eliminated in consolidation.
Securities and accounting change: The Company adopted the provisions of
Financial Accounting Standards Board (FASB) Statement No. 115, Accounting for
Certain Investments in Debt and Equity Securities, as of January 1, 1994.
Statement No. 115 requires that management determine the appropriate
classification of securities at the date of adoption, and thereafter, at the
date individual securities are acquired, and that the appropriateness of such
classification be reassessed at each reporting date.
Securities to be held to maturity are those debt securities that the Company has
both the positive intent and ability to hold to maturity regardless of changes
in market condition, liquidity needs, or changes in general economic conditions.
These securities are stated at amortized cost. Securities available for sale are
those debt or equity securities that the Company intends to hold for an
indefinite period of time but not necessarily to maturity. Any decision to sell
a security available for sale would be based on various factors, including
significant movements in interest rates, changes in the maturity mix of the
Company's assets and liabilities, liquidity needs, regulatory capital
considerations, and other similar factors. Securities available for sale are
carried at market value. Unrealized gains or losses are reported as increases or
decreases in stockholders' equity, net of the related deferred tax effect.
23
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 1. Summary of Significant Accounting Policies (Continued)
Prior to the adoption of Statement No. 115, debt securities which the Company
had the intent and ability to hold to maturity were carried at amortized cost.
Equity securities were carried at the lower of aggregate cost or market value
net of unrealized losses which were recognized through a valuation allowance
that was shown as a reduction in the carrying value of the related securities
and as a corresponding reduction in stockholders' equity.
Under both the newly adopted accounting standard and the Company's former
accounting practices, premiums and discounts on securities are amortized over
the contractual lives of those securities, except for mortgage-backed
securities, for which prepayments are probable and predictable, which are
amortized over the estimated expected repayment terms of the underlying
mortgages. The method of amortization results in a constant effective yield on
those securities (the interest method). Interest on debt securities is
recognized in income as accrued. Realized gains and losses on the sale of
securities are determined using the specific identification method.
Declines in the fair value of individual securities classified as available for
sale below their amortized cost that are determined to be other than temporary
result in write-downs of the individual securities to their fair value with the
resulting write-downs included in current earnings as realized losses.
The effect of the adoption of Statement No. 115 on January 1, 1994 was to
increase securities by $332, increase deferred tax liabilities by $136 and
increase equity by $196.
Loans held for sale: Loans held for sale are those loans that the Company may
sell or intends to sell prior to maturity. They are carried at the lower of
aggregate cost or market value. Gains and losses on sales of loans are
recognized at settlement dates and are determined by the difference between the
sales proceeds and the carrying value of the loans, after allocating a portion
of the cost to the servicing rights retained. All sales are made without
recourse.
Loans receivable: Loans receivable are stated at the amount of unpaid principal,
reduced by an allowance for loan losses and net deferred loan origination fees.
The allowance for loan losses is increased by provisions charged to income and
reduced by charge-offs (net of recoveries). Management's periodic evaluation of
the adequacy of the allowance is based on the Company's past loan loss
experience, known and inherent risks in the portfolio, adverse situations that
may affect the borrower's ability to repay, estimated value of any underlying
collateral, and current economic conditions. While management uses its best
information available to make its evaluation, it is possible that adjustments to
the allowance may be necessary if there are significant changes in economic
conditions.
Impaired loans are measured based on the present value of expected future cash
flows discounted at the loan's effective interest rate or, as a practical
expedient, at the loan's observable market price or the fair value of the
collateral if the loan is collateral dependent. A loan is impaired when it is
probable the creditor will be unable to collect all principal and interest
payments due in accordance with the terms of the loan agreement. The Company's
loans considered impaired at December 31, 1996 and 1995 were immaterial.
24
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 1. Summary of Significant Accounting Policies (Continued)
Interest on loans is recognized over the terms of the loans and is calculated
using the simple-interest method on principal amounts outstanding. Accrual of
interest is discontinued when management believes, after considering economics,
business conditions, and collection efforts, that the borrower's financial
condition is such that collection of interest is doubtful. Interest on these
loans is recognized only when actually paid by the borrower if collection of
principal is likely to occur. Accrual of interest is generally resumed when, in
management's judgment, the borrower's ability to make periodic interest and
principal payments is back to normal.
Loan origination fees and related costs: Loan fees and certain direct loan
origination costs are deferred, and the net fee or cost is recognized as an
adjustment to interest income using the interest method over the contractual
life of the loans, adjusted for estimated prepayments based on the Company's
historical prepayment experience.
Mortgage servicing rights: The Company generally continues to service mortgage
loans sold to others and receives a servicing fee over the lives of the loans.
Beginning January 1, 1996, a portion of the cost of such loans is allocated to
the mortgage servicing rights retained and recognized as a separate asset. The
recorded mortgage servicing rights are being amortized in proportion to, and
over the period of, estimated net servicing income.
Mortgage servicing rights recognized are periodically evaluated for impairment
based on the fair value of those rights. Fair values are estimated using
discounted cash flows based on current market rates of interest. For purposes of
measuring impairment, the rights must be stratified by one or more predominant
risk characteristics of the underlying loans. The Company stratifies its
mortgage servicing rights based on the interest rate and term of the underlying
loans. The amount of impairment recognized is the amount, if any, by which the
amortized cost of the rights for each stratum exceed their fair value.
Foreclosed real estate: Real estate properties acquired through, or in lieu of,
loan foreclosure are initially recorded at lower of cost or fair value less
estimated costs to sell at date of foreclosure. Costs relating to improvement of
property are capitalized, whereas costs relating to the holding of property are
expensed.
Valuations are periodically performed by management and charge-offs to
operations are made if the carrying value of a property exceeds its estimated
fair value less estimated costs to sell.
Income taxes: Deferred taxes are provided on an asset and liability method
whereby deferred tax assets are recognized for deductible temporary differences
and operating loss or tax credit carry forwards and deferred tax liabilities are
recognized for taxable temporary differences. Temporary differences are the
differences between the amounts of assets and liabilities recorded for income
tax and financial reporting purposes. Deferred tax assets are reduced by a
valuation allowance when management determines that it is more likely than not
that some portion or all of the deferred tax assets will not be realized.
Deferred tax assets and liabilities are adjusted for the effects of changes in
tax laws and rates on the date of enactment.
25
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 1. Summary of Significant Accounting Policies (Continued)
Premises and equipment: Land is carried at cost. Bank premises, leasehold
improvements, and furniture, fixtures, and equipment are carried at cost, less
accumulated depreciation and amortization. Bank premises and furniture,
fixtures, and equipment are depreciated using the straight-line method over the
estimated useful lives of the assets ranging from 10 to 40 years for bank
premises, 7 to 10 years for leasehold improvements and 3 to 7 years for
furniture, fixtures and equipment. The cost of leasehold improvements is being
amortized using the straight-line method over the terms of the related leases.
Fair value of financial instruments: The following methods and assumptions were
used by the Company in estimating the fair value of its financial instruments:
Cash: The carrying amounts reported in the consolidated statement of
financial condition for cash and interest-bearing accounts approximate
their fair values.
Certificates of deposit: The carrying amounts reported in the consolidated
statement of financial condition for certificate of deposits approximate
their fair values.
Securities: Fair values for securities available for sale, securities held to
maturity and mortgage-backed securities are based on quoted market prices,
where available. If quoted market prices are not available, fair values are
based on quoted market prices of comparable instruments, except for stock in
the Federal Home Loan Bank for which fair value is equal to cost.
Loans held for sale: Fair values are based on quoted market prices of similar
loans sold on the secondary market.
Loans and accrued interest receivable: For variable-rate loans that reprice
frequently and that have experienced no significant change in credit risk,
fair values are based on carrying values. Fair values for all other loans are
estimated based on discounted cash flows, using interest rates currently
being offered for loans with similar terms to borrowers with similar credit
quality. The carrying amount of accrued interest receivable approximates its
fair value.
Mortgage servicing rights: The fair value of mortgage servicing rights
approximates its carrying value as the interest rate and repayment
assumptions used in the calculation of mortgage servicing rights have not
changed significantly.
Deposits and other liabilities: The fair values of demand deposits and
savings accounts equal their carrying amounts, which represent the amounts
payable on demand. Fair values for fixed-rate certificates of deposit are
estimated using a discounted cash flow calculation that applies interest
rates currently being offered on certificates to a schedule of aggregated
expected monthly maturities on those certificates. The carrying amounts of
advances by borrowers for taxes and insurance and accrued interest payable
approximate their fair values.
26
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 1. Summary of Significant Accounting Policies (Continued)
Borrowed funds: The fair value of long term fixed rate borrowed funds are
estimated by using a discounted cash flow analysis based on current
incremental borrowing rates for similar types of borrowing arrangements. The
fair value of the variable rate borrowed funds approximates carrying value as
these borrowings reprice monthly.
Off-statement of financial condition instruments: Since the majority of the
Company's off-statement of financial condition instruments consist of non
fee-producing, variable rate commitments, the Company has determined they do
not have a distinguishable fair value.
Emerging accounting standards: The FASB issued Statement No. 125, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.
This Statement establishes basic principles that state that an entity should
recognize only assets it controls and liabilities it has incurred. Assets should
be "derecognized" only when control has been surrendered, liabilities should be
"derecognized" only when they have been extinguished, and recognition of
financial assets and liabilities should not be affected by the sequence of
transactions unless the effect of the transactions is to maintain effective
control over a transferred financial asset. This Statement applies to
transactions that occur after December 31, 1996. FASB Statement No. 127,
Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125,
defers certain provisions of Statement No. 125 to transactions after December
31, 1997. These Statements will not have a material effect on the financial
position and results of operations of the Company or its subsidiary.
Reclassification of certain income and expenses: Certain income and expenses on
the consolidated statements of income for the years ended December 31, 1995 and
1994 have been reclassified, with no effect on net income, to be consistent with
the classifications adopted for the year ended December 31, 1996.
Note 2. Certificates of Deposit
Certificates of deposit with a carrying value of $200 and $800 at December 31,
1996 and 1995, respectively, had weighted average yields of 5.75% and 6.58%,
respectively, and contractual maturities of less than one year.
27
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 3. Securities Available for Sale
December 31, 1996
------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
- -------------------------------------------------------------------------------
Mutual Funds:
Short term U.S. government
securities fund $ 2,396 $ - $ (76) $ 2,320
U.S. Government mortgage
securities fund 1,251 - (80) 1,171
Intermediate mortgage securities
fund 1,209 - (60) 1,149
Stock in Federal Home Loan Bank 1,633 - - 1,633
FHLMC stock 29 798 - 827
-----------------------------------------
6,518 798 (216) 7,100
Mortgage-backed securities 427 1 - 428
-----------------------------------------
$ 6,945 $ 799 $ (216) $ 7,528
-----------------------------------------
December 31, 1995
------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
- -------------------------------------------------------------------------------
Mutual Funds:
Short term U.S. government
securities fund $ 2,261 $ - $ (22) $ 2,239
U.S. Government mortgage
securities fund 1,170 - (32) 1,138
Intermediate mortgage securities
fund 1,137 - (20) 1,117
Stock in Federal Home Loan Bank 1,633 - - 1,633
FHLMC stock 29 597 - 626
-----------------------------------------
6,230 597 (74) 6,753
Mortgage-backed securities 862 5 - 867
-----------------------------------------
$ 7,092 $ 602 $ (74) $ 7,620
-----------------------------------------
Equity securities do not have contractual maturities. Mortgage-backed securities
lack a single maturity date as the borrowers retain the right to prepay the
obligations.
The Company's subsidiary, as a member of the Federal Home Loan Bank system, is
required to maintain an investment in capital stock of the Federal Home Loan
Bank in an amount equal to 1% of its outstanding home loans. No ready market
exists for the bank stock, and it has no quoted market value. For disclosure
purposes, such stock is assumed to have a market value which is equal to cost.
28
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 3. Securities Available for Sale (Continued)
Changes in unrealized appreciation (depreciation) on securities available for
sale:
Years Ended December 31,
--------------------------
1996 1995 1994
- --------------------------------------------------------------------------------
Balance, beginning $ 318 $ (10) $ -
Transfer of unrealized loss on securities carried at
the lower of cost or market at January 1, 1994 - - (52)
Initial unrealized gain on date of adoption of
statement No. 115, not of related deferred
tax effect - - 196
Unrealized appreciation (depreciation) during
the year 56 531 (291)
Deferred tax effect relating to unrealized
appreciation (depreciation) (26) (203) 137
---------------------
Balance, ending $ 348 $ 318 $ (10)
---------------------
There were no sales of securities during the years ended December 31, 1996, 1995
and 1994.
Securities with a carrying value of $-0- and $100 at December 31, 1996 and 1995,
respectively, were pledged to secure public deposits and for other purposes as
required or permitted by law.
Note 4. Securities Held to Maturity
<TABLE>
<CAPTION>
December 31, 1996
----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
- ------------------------------------------------------------------------------------------------
Debt securities:
<S> <C> <C> <C> <C>
U.S. Government corporations and agencies $ 2,049 $ - $ (5) $ 2,044
====================================================
</TABLE>
<TABLE>
<CAPTION>
December 31, 1995
----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Debt securities:
U.S. Treasury securities $ 800 $ - $ - $ 800
U.S. Government corporations and agences 3,399 2 (11) 3,390
-----------------------------------------------------
$ 4,199 $ 2 $ (11) $ 4,190
=====================================================
</TABLE>
29
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 4. Securities Held to Maturity (Continued)
Contractual maturities: All securities held to maturity as of December 31, 1996
have contractual maturities from over one year through five years.
Note 5. Mortgage-Backed Securities Available For Sale
The amortized cost and approximate market values of mortgage-backed securities
available for sale, which consist solely of REMICs, are summarized as follows:
Years Ended December 31,
------------------------
1996 1995
- ---------------------------------------------------------------------------
Cost:
Principal balance $ 427 $ 862
Unamortized premiums - -
-----------------------
$ 427 $ 862
=======================
Approximate fair value $ 428 $ 867
=======================
Note 6. Loans Receivable and Loans Held for Sale
Composition of loans receivable:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995
- --------------------------------------------------------------------------------------------
<S> <C> <C>
First mortgage loans (principally conventional):
Principal balances:
Secured primarily by one-to-four family residences $ 140,444 $ 135,529
Secured by other properties, primarily agricultural real estate 12,233 11,434
Construction 2,081 2,774
Less net deferred loan origination fees (714) (689)
-----------------------
Total first mortgage loans 154,044 149,048
-----------------------
Consumer and other loans:
Principal balances:
Home equity, home improvement and second mortgages 15,197 12,875
Agricultural operating loans 1,171 1,191
Vehicle loans 4,619 3,353
Other 4,031 3,715
-----------------------
Total consumer and other loans 25,018 21,134
-----------------------
Total loans 179,062 170,182
Less allowance for loan losses (615) (512)
-----------------------
Loan receivable, net $ 178,447 $ 169,670
=======================
</TABLE>
30
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 6. Loans Receivable and Loans Held for Sale (Continued)
Allowance for loan losses:
Years Ended December 31,
-----------------------------------
1996 1995 1994
- --------------------------------------------------------------------------
Balance, beginning $ 512 $ 376 $ 398
Provision for loan losses 180 166 113
Loans charged off (88) (41) (144)
Recoveries 11 11 9
-----------------------------------
Balance, ending $ 615 $ 512 $ 376
-----------------------------------
Nonaccrual loans: Loans on which the accrual of interest has been discontinued
amounted to $298, $298 and $839 at December 31, 1996, 1995 and 1994,
respectively. The effect of nonaccrual loans was not significant to the results
of operations.
The Company includes all loans considered impaired under FASB Statement No. 114
in nonaccrual loans. The amount of impaired loans was not material at December
31, 1996 and 1995.
Related party loans: The Company has entered into transactions with its
executive officers, directors, significant shareholders, and their affiliates
(related parties). The aggregate amount of loans to such related parties at
December 31, 1996 was $380. During 1996, new loans to such related parties were
$8 and repayments were $52.
Loans held for sale: As of December 31, 1996 and 1995, the Company's loans held
for sale were $1,791 and $1,944, respectively, and consisted of one to four
family residential real estate loans. Loans held for sale have been reduced by
estimated unrealized losses of $30 and $-0- at December 31, 1996 and 1995,
respectively.
Outstanding commitments to sell loans at December 31, 1996 were $563.
Note 7. Loan Servicing
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid principal balances of
these loans as of December 31, 1996 and 1995 were $66,125 and $56,263,
respectively, and consist of one-to-four family residential real estate loans.
These loans are serviced primarily for the Federal Home Loan Mortgage
Corporation.
The Company adopted FASB Statement No. 122, Accounting for Mortgage Servicing
Rights, effective January 1, 1996 on a prospective basis. The Statement requires
that a portion of the loan cost be allocated to the mortgage servicing rights
retained and be recognized as a separate asset. Mortgage servicing rights in the
amount of $105 were capitalized during the year ended December 31, 1996. The
Company recognized amortization of the cost of mortgage servicing rights in the
amount of $17 for the year ended December 31, 1996. This resulted in net income
being $88 greater than had Statement No. 122 not been adopted. A valuation
allowance was not required for the mortgage servicing rights at December 31,
1996.
31
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 8. Foreclosed Real Estate
The Company had investment in real estate acquired through foreclosure or deeded
to the Company in lieu of foreclosure of $78 and $29 as of December 31, 1996 and
1995, respectively. No allowances for losses on foreclosed real estate were
required at these dates.
Note 9. Premises and Equipment
Premises and equipment are summarized as follows:
Years Ended December 31,
-----------------------
1996 1995
- ---------------------------------------------------------------------------
Cost:
Land $ 71 $ 71
Buildings and improvements 1,075 1,075
Leasehold improvements 537 533
Furniture, fixtures and equipment 1,682 1,245
-----------------------
3,365 2,924
Less accumulated depreciation and amortization 1,846 1,687
-----------------------
$ 1,519 $ 1,237
=======================
Note 10. Deposits
Composition of deposits:
Years Ended December 31,
-----------------------
1996 1995
- ---------------------------------------------------------------------------
Demand and NOW accounts $ 21,638 $ 20,182
Savings accounts 16,312 15,878
Certificates of deposit 107,399 110,626
-----------------------
$ 145,349 $ 146,686
=======================
The aggregate amount of certificates of deposit over $100 was $9,447 and $7,152
at December 31, 1996 and 1995, respectively.
32
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 10. Deposits (Continued)
A summary of scheduled maturities of certificates of deposits is as follows:
Years Ending December 31,
- ----------------------------------------------------------------------------
1997 $ 80,023
1998 15,893
1999 10,570
2000 913
-----------
$ 107,399
===========
Eligible savings accounts are insured up to $100 by the Savings Association
Insurance Fund (SAIF) under management of the Federal Deposit Insurance
Corporation (FDIC). On September 30, 1996, legislation was signed into law
requiring savings institutions insured by the SAIF to pay a special assessment
to recapitalize the fund. The Company recorded its assessment of $1,085 in
September, 1996.
Note 11. Employee Benefit Plans
Defined benefit plan: The Bank had a qualified, noncontributory defined-benefit
retirement plan covering substantially all of its employees. The benefits were
based on each employee's years of service and average monthly compensation and
reduced by a percentage of the employee's social security benefit. It was the
policy of the Bank to fund the maximum amount that could be deducted for federal
income tax purposes.
Effective December 31, 1995, the plan was amended such that no further benefits
will be earned for employee service. In conjunction therewith, the Bank
recognized a curtailment gain of $75 for the year ended December 31, 1995. The
plan was terminated on November 1, 1996 and all obligations were settled on that
date by payments to the participants in cash or by payments to their individual
accounts in the Bank's 401(k) plan (see below).
33
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 11. Employee Benefit Plans (Continued)
The following table sets forth the plan's funded status and amounts recognized
in the Company's consolidated statements of financial condition:
<TABLE>
<CAPTION>
December 31,
-----------------------
1996 1995
- ----------------------------------------------------------------------------------
<S> <C> <C>
Actuarial present value of benefit obligations:
Accumulated benefit obligation:
Vested $ - $ 896
Nonvested - -
--------------------
Projected benefit obligation for service rendered to date - 896
Plan assets at fair value; primarily certificates of
deposit issued by the Bank - 783
---------------------
Plan assets greater (less) than projected benefit obligation - 113
Unrecognized net transition obligation - -
--------------------
Accrued pension liability (included in other liabilities) $ - $ 113
====================
</TABLE>
The components of net pension expense are summarized as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
1996 1995 1994
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost-benefits earned during the period $ - $ 100 $ 93
Interest cost on projected benefit obligation 45 82 69
Actual return on plan assets (39) (39) (20)
Net amortization and deferral - (22) (34)
Curtailment gain - (75) -
-------------------------------
Net pension expense $ 6 $ 46 $ 108
===============================
</TABLE>
Assumptions used to develop the net periodic cost were:
December 31,
-----------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------
Discount rate N/A 8.0% 8.0%
Expected long-term rate of return on assets N/A 9.0% 9.0%
Rate of increase in compensation levels N/A N/A 5.5%
34
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 11. Employee Benefit Plans (Continued)
Defined Contribution 401(k) Plan: The Bank provides a 401(k) plan which covers
substantially all of the Bank's employees who are eligible as to age and length
of service. A participant may elect to make contributions of up to 15 percent of
the participant's annual compensation. At the discretion of the Board of
Directors, the Bank may make matching contributions of up to 4 percent of each
participant's contribution. Contributions made by the Bank for the years ended
December 31, 1996, 1995 and 1994 were $-0-, $-0-, and $33, respectively.
Employee Stock Ownership Plan: An Employee Stock Ownership Plan (ESOP) was
adopted on April 11, 1995 covering all full-time employees of the Company who
have attained age 21 and completed one year of service during which they work at
least 1,500 hours.
The Company makes annual contributions to the ESOP equal to the ESOP's debt
service less any dividends received by the ESOP on unallocated shares. The
ESOP's debt was incurred when the Company loaned the ESOP $1,120 which was used
by the ESOP to purchase common stock of the Company. All dividends received by
the ESOP on unallocated shares are used to pay debt service. The ESOP shares
initially were pledged as collateral for its debt. As the debt is repaid, shares
are released from collateral and allocated to employees based on the proportion
of debt service paid in the year. The shares pledged as collateral are deducted
from stockholders' equity as unearned ESOP shares in the accompanying statement
of financial condition. As shares are released from collateral, the Company
reports compensation expense equal to the current market price of the shares,
and the shares become outstanding for earnings per share computations. Dividends
on allocated ESOP shares are recorded as a reduction of retained earnings;
dividends on unallocated ESOP shares are recorded as compensation expense.
Compensation expense for the ESOP was $163 and $143 for the years ended December
31, 1996 and 1995, respectively.
Shares of the Company held by the ESOP at December 31, 1996 and 1995 are as
follows:
1996 1995
- ---------------------------------------------------------------------------
Shares released for allocation 28,000 14,000
Unreleased (unearned) shares 112,000 126,000
--------------------
140,000 140,000
--------------------
Fair value of unreleased (unearned) shares $ 1,470 $ 1,386
====================
Stock Option Plan: The Company, effective November 15, 1995, adopted a stock
option plan (Plan). Pursuant to the Plan, stock options for 218,750 common
shares may be granted to directors, officers and key employees of the Bank.
Options granted under the Plan may be either options that qualify as Incentive
Stock Options, as defined in Section 422 of the Internal Revenue Code of 1986,
as amended, or options that do not so qualify.
35
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 11. Employee Benefit Plans (Continued)
The exercise price under the awards was established at $11.00 per share which
was the fair market price on the date of adoption. Under APB Opinion No. 25, no
expense has been recorded for these options for the years ended December 31,
1996 and 1995 as the option price is the quoted market price of the shares at
the date of the awards.
Grants under the Plan are accounted for following APB Opinion No. 25 and related
Interpretations. Accordingly, no compensation cost has been recognized, as noted
above, for this Plan. Had compensation cost for the Plan been determined based
on the grant date fair values of awards (the method described in FASB Statement
No. 123), additional compensation cost charged to income would have been $176
and $23 for the years ended December 31, 1996 and 1995, respectively. Reported
net income and earnings per common share would have been reduced to the pro
forma amounts shown below:
Years Ended December 31,
------------------------
1996 1995
- ----------------------------------------------------------------------------
Net Income:
As reported $ 1,200 $ 1,270
Pro forma 1,095 1,256
Primary and fully diluted earnings per share:
As reported $ 0.61 $ 0.50
Pro forma 0.56 0.49
The Plan may grant options to purchase up to 218,750 shares of common stock,
with a maximum term of 10 years, at the market price on the date of grant. The
options vest at the rate of 20% per year.
The fair value of the options granted was estimated at the grant date using the
Black-Scholes option-pricing model using a dividend rate of 0%, price volatility
of 10%, a risk-free interest rate of 5.65%, and an estimated life of 6 years.
The estimated fair value was $408 at November 15, 1995, the grant date.
The status of the Company's fixed stock option plan as of December 31, 1996 and
1995, and changes during the years ended on those dates is presented below:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------
1996 1995
------------------------------------------------------
Weighted-Average Weighted-Average
Fixed Options Shares Exercise Price Shares Exercise Price
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 125,405 $ 11 - $ -
of year
Granted - - 125,405 11
Exercised - - - -
Forfeited - - - -
------------------------------------------------------
Outstanding at end of year 125,405 $ 11 125,405 $ 11
======================================================
</TABLE>
36
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 11. Employee Benefit Plan (Continued)
As of December 31, 1996, there were 125,405 options outstanding, all options had
an exercise price of $11.00 per share, and their remaining contractual life was
8.8 years. As of December 31, 1996 and 1995, 25,081 and -0- shares,
respectively, were exercisable.
Management Stock Bonus Plan: The Bank adopted a Management Stock Bonus Plan
(Plan) which was approved by the Company's stockholders on November 15, 1995.
Restricted stock awards covering shares representing an aggregate of up to 4%
(87,500 shares) of the common stock issued by the Company in the mutual to stock
conversion may be granted to directors and employees of the Bank. These awards
vest at the rate of 20% per year of continuous service with the Bank. The status
of shares awarded as of December 31, 1996 and 1995 and the changes during the
years ended on those dates is presented below:
Years Ended December 31,
----------------------
1996 1995
- ---------------------------------------------------------------------------
Outstanding at beginning of year 49,735 -
Granted - 49,735
Vested and distributed (9,595) -
Forfeited (1,760) -
----------------------
Outstanding at end of year 38,380 49,735
======================
The Bank recorded expense of $228 relating to this Plan for the year ended
December 31, 1996 and $31 for the year ended December 31, 1995.
The Company contributed funds to the Plan's trust to allow the trust to purchase
all 87,500 shares on the open market. The trust purchased these shares in 1996.
49,735 shares were purchased for outstanding awards and the remaining 37,765
shares are recorded as treasury stock. Unearned compensation cost, recognized in
an amount equal to the fair value of the awarded shares at the award date, is
recorded in stockholders' equity and amortized to operations as the shares vest.
Note 12. Borrowed Funds
Borrowed funds consisted of advances from Federal Home Loan Bank (FHLB), as
follows:
December 31,
-----------------------
1996 1995
- -------------------------------------------------------------------------
Due Date Interest Rate
- ----------------------------------
06/05/96 5.70% $ - $ 7,500
09/20/96 5.91% - 3,000
06/05/97 5.67% 7,500 7,500
06/05/97 5.91% 5,000 -
06/27/97 6.35% 3,000 -
05/04/98 5.46% 5,000 -
05/26/98 5.61% 6,000 -
-----------------------
$ 26,500 $ 18,000
=======================
37
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 12. Borrowed Funds (Continued)
The Company had $2,000 of unused borrowings available on the advance due June
27, 1997 as of December 31, 1996.
The advances due on June 5, 1997 have fixed interest rates. The advances due on
June 27, 1997, May 4, 1998 and May 26, 1998 have variable interest rates, at
December 31, 1996 the current rates were as stated above. Prepayment of the
advances will result in prepayment penalties.
The advances are collateralized by FHLB stock and first mortgage loans of
$39,750 at December 31, 1996.
Note 13. Income Tax Matters
The Company and its subsidiary file consolidated federal income tax returns. For
the years ended December 31, 1995 and 1994, if certain conditions are met in
determining taxable income, the Company was allowed a special bad debt deduction
based on a percentage of taxable income (8 percent) or on specified experience
formulas. The Company used the taxable income method in 1995 and 1994.
Effective for the year ended December 31, 1996, federal income tax laws changed
to eliminate the percentage of taxable income formula for the Company and will
only allow bad debt deductions based on actual charge-offs.
The components of income tax expense are as follows:
Years Ended December 31,
-----------------------------------
1996 1995 1994
- --------------------------------------------------------------------------
Federal:
Current $ 690 $ 612 $ 582
Deferred (credit) (6) 24 42
-----------------------------------
684 636 624
-----------------------------------
State:
Current 230 196 189
Deferred (credit) (2) 10 17
-----------------------------------
228 206 206
-----------------------------------
Total $ 912 $ 842 $ 830
===================================
38
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 13. Income Tax Matters (Continued)
Total income tax expense differed from the amounts computed by applying the
statutory U.S. Federal income tax rates to income before income taxes as a
result of the following:
Years Ended December 31,
----------------------------------
1996 1995 1994
- --------------------------------------------------------------------------
Statutory rate applied to income $ 739 $ 739 $ 740
before income taxes
State income taxes, net of federal 137 137 137
benefit
Effect of graduated rates (21) (21) (21)
Other 57 (13) (26)
----------------------------------
Income tax expense $ 912 $ 842 $ 830
==================================
The net deferred tax liability included in liabilities in the accompanying
statements of financial condition includes the following amounts of deferred tax
assets and liabilities:
December 31,
-----------------------
1996 1995
- ---------------------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $ 189 $ 131
Deferred loan origination fees 40 94
Other 35 54
-----------------------
264 279
Less valuation allowance - -
-----------------------
264 279
-----------------------
Deferred tax liabilities:
Premises and equipment 169 192
Securities available for sale 236 210
FHLB stock dividends 217 217
-----------------------
622 619
-----------------------
$ (358) $ (340)
=======================
Retained earnings at December 31, 1996 and 1995 include approximately $1,839
related to the pre-1987 allowance for loan losses for which no deferred federal
income tax liability has been recognized. This amount represents an allocation
of income to bad debt deductions for tax purposes only. Reduction of amounts so
allocated for purposes other than tax bad debts or adjustments arising from
carryback of net operating losses would create income for tax purposes only,
which would be subject to the then current corporate income tax rate. The
unrecorded deferred income tax liability on the above amount for financial
statement purposes was approximately $736 at December 31, 1996 and 1995.
39
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 14. Lease Commitments
The Company leases certain branch facilities under operating leases. Some leases
require the Company to pay related insurance, maintenance and repairs, and real
estate taxes. Future minimum rental commitments under operating leases as of
December 31, 1996 are as follows:
Years Ending
- ----------------------------------------------------------------------------
1997 $ 130
1998 68
1999 31
2000 26
2001 26
Thereafter 15
-----------
$ 296
===========
Total rental expense related to operating leases was approximately $162, $163
and $158 for the years ended December 31, 1996, 1995 and 1994, respectively.
Note 15. Stockholders' Equity, Regulatory Capital and Dividend Restrictions
In 1996, the Company approved two stock buy back programs in which up to 14.5%
of the common stock of the Company may be acquired by April 11, 1997. In
accordance with the provisions of its stock buy back programs, the Company had
purchased 125,875 shares of treasury stock as of December 31, 1996.
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory - and possibly additional discretionary - actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. The Bank's capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios of total and Tier I
capital (as defined in the regulations) to risk-weighted assets (as defined),
and of Tier I capital (as defined) to average assets (as defined). Management
believes, as of December 31, 1996, that the Bank meets all capital adequacy
requirements to which it is subject.
As of May 20, 1996, the most recent examination by the Office of Thrift
Supervision categorized the Bank as "well capitalized" under the regulatory
framework for Prompt Corrective Action. To be categorized as adequately
capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based,
and Tier I leverage ratios. There are no conditions or events since that
notification that management believes have changed the Bank's category.
40
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 15. Regulatory Capital and Dividend Restrictions (Continued)
The following table summarizes the Bank's compliance with its regulatory capital
requirements at December 31, 1996:
Bank's Capital Bank's Capital Bank's Capital
---------------------------------------------------------
Amount Percent Amount Percent Amount Percent
- --------------------------------------------------------------------------------
Tier 1 (core) capital $20,478 10.31 % $ 5,961 3.00 % $14,517 7.31 %
Risk-based capital 21,064 18.61 % 9,054 8.00 % 12,010 10.61 %
Under current regulations, the Bank is not permitted to pay dividends on its
stock if its regulatory capital would reduce below (i) the amount required for
the liquidation account established to provide a limited priority claim to the
assets of the Bank to certain qualifying depositors who had deposits at the Bank
and who continue to maintain those deposits after its conversion from a Federal
mutual savings and loan association to a Federal stock savings bank pursuant to
its Plan of Conversion (Plan) adopted October 19, 1994, or (ii) the Bank's
regulatory capital requirements. As a "Tier 1" institution (an institution with
capital in excess of its capital requirements, both immediately before the
proposed capital distribution and after giving effect to such distribution), the
Bank may make capital distributions without the prior consent of the Office of
Thrift Supervision (OTS) in any calendar year. The capital distribution is equal
to the greater of 100% of net income for the year to date plus 50% of the amount
by which the lesser of the institution's tangible, core or risk-based capital
exceeds its capital requirement for such capital commitment, as measured at the
beginning of the calendar year or up to 75% of net income over the most recent
four quarter period.
Note 16. Financial Instruments with Off-Statement of Financial Condition Risk
The Company is a party to financial instruments with off-statement of financial
condition risk in the normal course of business to meet the financing needs of
its customers. These financial instruments include primarily commitments to
extend credit. Those instruments involve, to varying degrees, elements of credit
risk and interest-rate risk in excess of the amount recognized in the
consolidated statement of financial condition. The contract or notional amounts
of those instruments reflect the extent of the Company's involvement in
particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit,
standby letters of credit, and financial guarantees written is represented by
the contractual notional amount of those instruments. The Company uses the same
credit policies in making commitments and conditional obligations as it does for
on-statement of financial condition instruments.
Commitments to extend credit on loans totaled approximately $11,850 and $11,506
at December 31, 1996 and 1995, respectively. The portion of commitments to
extend credit that related to fixed rate loans is $676 and $957 as of December
31, 1996 and 1995, respectively.
41
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 16. Financial Instruments with Off-Statement of Financial Condition
Risk (Continued)
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since some of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
it is deemed necessary by the Company upon extension of credit, is based on
management's credit evaluation of the counterparty. Collateral held varies but
normally includes real estate and personal property.
Note 7. Concentrations
Concentration by geographic location: The Company makes agricultural,
commercial, residential and consumer loans to customers primarily in south
central Minnesota. Although the Company's loan portfolio is diversified, there
is a relationship in this region between the agricultural economy and the
economic performance of loans made to nonagricultural customers. The Company's
lending policies for agricultural and nonagricultural customers require loans to
be well-collateralized and supported by cash flows. Collateral for agricultural
loans includes equipment, crops, livestock and land. Credit losses from loans
related to the agricultural economy are consistent with credit losses
experienced in the portfolio as a whole. The concentration of credit in the
regional agricultural economy is consistent with credit losses experienced in
the portfolio as a whole. The concentration of credit in the regional
agricultural economy is taken into consideration by management in determining
the allowance for loan losses.
Concentration by institution: As of December 31, 1996 the Company had $7,554 on
deposit with the FHLB of Des Moines.
Note 18. Earnings Per Share
Earnings per share is calculated by dividing net income by the weighted average
number of shares of common and common equivalent shares outstanding, including
shares issuable upon exercise of dilutive options outstanding. The weighted
number of common and common equivalent shares outstanding for the year ended
December 31, 1996 and the period from April 11, 1995 to December 31, 1995 were
1,967,185 and 2,063,166, respectively.
The earnings per share calculation for 1995 includes earnings from April 11,
1995, the date of conversion, to December 31, 1995.
42
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 19. Fair Values of Financial Instruments
The estimated fair values of the Company's financial instruments are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------
1996 1995
- ------------------------------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------------------------------------------
<S> <C> <C> <C> <C>
Financial assets
Cash $ 8,301 $ 8,301 $ 8,192 $ 8,192
Certificates of deposit 200 200 800 800
Securities and mortgage backed
securities available for sale 7,528 7,528 7,620 7,620
Securities held to maturity 2,049 2,044 4,199 4,190
Loans receivable, net 178,447 179,721 169,670 170,972
Loans held for sale 1,791 1,791 1,944 1,944
Mortgage servicing rights 88 88 - -
Accrued interest receivable 1,060 1,060 1,120 1,120
Financial liabilities
Deposits 145,349 145,702 146,686 146,966
Borrowed funds 26,500 26,502 18,000 18,012
Advances from borrowers for
taxes and insurance 681 681 683 683
Accrued interest payable 126 126 221 221
==============================================
</TABLE>
Note 20. Conversion to Stock Form Ownership
On October 19, 1994, the Board of Directors of the Bank adopted a Plan of
Conversion (the "Conversion"). The OTS approved this transaction and the
registration statement was declared effective by the SEC as of February 13,
1995. The institution converted from a federal mutual savings bank to a federal
stock savings bank with the concurrent formation of a holding company on April
11, 1995.
As part of the Conversion, the Company issued 2,187,500 shares of common stock
(140,000 shares of which were acquired by the ESOP) at $8 per share in a
community offering resulting in gross proceeds of $17,500. Expenses relating to
the Conversion totaled $775. One-half of the net proceeds, excluding the common
stock acquired by the ESOP, or $8,362, were used by the Company to acquire 100%
of the common stock of the Bank.
43
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 20. Conversion to Stock Form Ownership (Continued)
At the time of the Conversion, the Bank established a liquidation account in an
amount equal to its retained earnings as of the date of the latest statement of
financial condition appearing in the final prospectus. The liquidation account
is maintained for the benefit of eligible and supplemental eligible account
holders who continue to maintain their accounts at the Bank after the
Conversion. The liquidation account will be reduced annually to the extent that
eligible and supplemental eligible account holders have reduced their qualifying
deposits. Subsequent increases will not restore an eligible and supplemental
eligible account holder's interest in the liquidation account. In the event of a
complete liquidation, each eligible and supplemental eligible account holder
will be entitled to receive a distribution from the liquidation account in an
amount proportionate to the current adjusted qualifying balances for accounts
then held.
Note 21. Financial Information of Wells Financial Corp. (Parent Only)
The Company's condensed statements of financial condition as of December 31,
1996 and 1995 and related condensed statements of income and cash flows for the
year ending December 31, 1996 and the period April 11, 1995, date of conversion,
to December 31, 1995 are as follows:
December 31, December 31,
Condensed Statements of Financial Condition 1996 1995
- --------------------------------------------------------------------------------
Assets
Cash, including deposits with Wells Federal
Bank, fsb 1996 $203; 1995 $880 $ 1,829 $ 1,500
Certificates of deposit 200 800
Securities held to maturity 499 200
Investment in Wells Federal Bank, fsb 21,731 21,355
Loan to Wells Federal Bank, fsb 4,000 5,000
Accrued interest receivable 15 10
--------------------------
Total assets $ 28,274 $ 28,865
==========================
Liabilities and Stockholders' Equity
Liabilities $ 72 $ 13
Stockholders' equity 28,202 28,852
--------------------------
Total liabilities and stockholders' equity $ 28,274 $ 28,865
==========================
Year Ended Period Ended
December 31, December 31,
Condensed Statements of Income 1996 1995
- --------------------------------------------------------------------------------
Interest income $ 466 $ 326
Other expense 73 87
----------------------------
Income before income taxes 393 239
Income tax expense 169 97
----------------------------
Net income before equity in net
income of subsidiary 224 142
Equity in net income of subsidiary 976 889
----------------------------
Net income $ 1,200 $ 1,031
============================
44
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ------------------------------------------------------------------------------
Note 21. Financial Information of Wells Financial Corp. (Parent Only)
(Continued)
<TABLE>
<CAPTION>
Year Ended Period Ended
December 31, December 31,
Condensed Statements of Cash Flows 1996 1995
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows From Operating Activities
Net income $ 1,200 $ 1,031
Adjustment to reconcile net income to net cash
provided by operating activities:
Equity in undistributed net income of subsidiary (976) (889)
Increase in accrued interest receivable (5) (10)
Increase in other liabilities 59 13
-----------------------------
Net cash provided by operating activities 278 145
-----------------------------
Cash Flows From Investing Activities
Purchase of certificates of deposit (200) (800)
Purchase of securities held to maturity (1,999) (800)
Proceeds from the maturities of certificates of deposit 800 -
Proceeds from maturity of securities held to maturity 1,700 600
Investment in Wells Federal Bank, fsb - (8,362)
(Increase) decrease in loan to Wells Federal Bank, fsb 1,000 (5,000)
-----------------------------
Net cash provided by (used in) investing activities 1,301 (14,362)
-----------------------------
Cash Flows From Financing Activities
Net proceeds from sale of common stock - 15,605
Payments relating to ESOP stock 112 112
Purchase of treasury stock (1,362) -
-----------------------------
Net cash provided by (used in) financing activities (1,250) 15,717
-----------------------------
Net increase in cash 329 1,500
Cash
Beginning of period 1,500 -
-----------------------------
End of period $ 1,829 $ 1,500
=============================
</TABLE>
45
<PAGE>
WELLS FINANCIAL CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
- ---------------------------------------------------------------------------
Note 22. Selected Quarterly Financial Data (Unaudited)
(dollars in thousands, except per share data)
Year Ended December 31, 1996
- ---------------------------------------------------------------------------
First Second Third Fourth
----------------------------------------------
Interest income $ 3,578 $ 3,583 $ 3,715 $ 3,793
Net interest income 1,552 1,577 1,686 1,708
Provision for loan losses 45 45 45 45
Net income (loss) 500 363 (144) 481
Earnings per share, primary
and fully diluted 0.24 0.19 (0.07) 0.25
Year Ended December 31, 1995
- ---------------------------------------------------------------------------
First Second Third Fourth
----------------------------------------------
Interest income $ 3,132 $ 3,299 $ 3,489 $ 3,569
Net interest income 1,120 1,302 1,405 1,497
Provision for loan losses 31 45 45 45
Net income 197 303 400 370
Earnings per share from
April 11,
1995, the date of
conversion:
Primary and fully
diluted - 0.13 0.19 0.18
46
<PAGE>
OFFICE LOCATION AND OTHER CORPORATE INFORMATION
CORPORATE OFFICE
Wells Financial Corp.
53 First Street, S.W.
Wells, Minnesota 56097
Board of Directors of Wells Financial Corp.
Lawrence H. Kruse
President, Wells Federal Bank
Gerald D. Bastian Joseph R. Gadola
Branch Manager, Wells Federal Bank Attorney, Gadola Law Office
Wallace J. Butson Richard Mueller
Secretary, Wells Federal Bank Pharmacist, Wells Drug, Co
Executive Officers of Wells Financial Corp.
Lawrence H. Kruse James D. Moll
President and Chief Treasurer and Principal Financial
Executive Officer and Accounting Officer
Gerald D. Bastian Wallace J. Butson
Vice President Secretary
---------------------------
Corporate Counsel: Independent Auditors:
Joseph R. Gadola, Esq. McGladrey & Pullen, LLP
28 South Broadway Suite 400
Wells, Minnesota 56097 102 South Broadway
Rochester, Minnesota 55904
Special Counsel: Transfer Agent and Registrar:
Malizia, Spidi, Sloane & Fisch, P.C. Registrar and Transfer Company
One Franklin Square 10 Commerce Drive
Suite 700 East Cranford, New Jersey 07016
1301 K Street, N.W.
Washington, D.C. 20005
---------------------------
The Company's Annual Report for the Year Ended December 31, 1996, filed with the
Securities and Exchange Commission on Form 10-K is available without charge upon
written request. For a copy of the Form 10-K or any other investor information,
please write the Secretary of the Company, at the Company's corporate office in
Wells, Minnesota. The annual meeting of stockholders will be held on April 16,
1997 at 4:00 p.m. at the Corporate Office, Wells, Minnesota.
47
EXHIBIT 23
<PAGE>
INDEPENDENT ACCOUNTANT'S CONSENT
Board of Directors
Wells Financial Corp.
58 First Street S.W.
Wells, Minnesota 56097
We hereby consent to the incorporation of our report dated February 11, 1997,
included in this Form 10-KSB in the previously filed Registration Statement of
Wells Financial Corp. on Form S-8 (No. 333-3520).
/S/MCGLADREY & PULLEN, LLP
Rochester, Minnesota
March 26, 1997
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
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0
0
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</TABLE>
