<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
Securities and Exchange Commission File Number 0-25722
HF BANCORP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0576146
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
445 East Florida Avenue, Hemet, California 92543
(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: (909) 658-4411
Registrant's Internet site: www.hemetfed.com
Registrant's electronic mail address: [email protected]
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.Yes x No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
There were 6,421,298 shares of the Registrant's common stock, par value
$0.01 per share, outstanding as of May 10, 1999.
<PAGE> 2
HF BANCORP, INC. AND SUBSIDIARY
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Statements Of Financial Condition As Of
March 31, 1999 (unaudited) and June 30, 1998 3 - 4
Consolidated Statements Of Operations (unaudited) For The
Three And Nine Months Ended March 31, 1999 and 1998 5 - 6
Consolidated Statement Of Changes In Stockholders' Equity (unaudited)
For The Nine Months Ended March 31, 1999 7
Consolidated Statements Of Cash Flows (unaudited) For The
Nine Months Ended March 31, 1999 and 1998 8 - 9
Notes To Consolidated Financial Statements (unaudited) 10 - 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 14 - 40
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 40
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 41
ITEM 2. Changes In Securities 41
ITEM 3. Defaults Upon Senior Securities 41
ITEM 4. Submission Of Matters To A Vote Of Security Holders 41
ITEM 5. Other Information 41
ITEM 6. Exhibits And Reports On Form 8-K 41
Signature Page 42
</TABLE>
2
<PAGE> 3
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
<TABLE>
<CAPTION>
March 31, June 30,
1999 1998
--------- --------
(Unaudited)
(Dollars In Thousands)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 42,419 $ 27,720
Securities available-for-sale, at estimated fair value:
Investment securities (amortized cost of $141,352 and $98,792 at
March 31, 1999 and June 30, 1998 respectively) 141,571 98,573
Mortgage-backed securities (amortized cost of $193,633 and $164,400 at
March 31,1999 and June 30,1998, respectively) 192,946 165,004
Securities held-to-maturity, at cost:
Investment securities (estimated fair value of $9,753 at June 30, 1998) -- 9,647
Mortgage-backed securities (estimated fair value of $123,281 at June 30, 1998) -- 123,596
Loans receivable (net of allowance for estimated loan losses of $6,928
and $6,271 at March 31, 1999 and June 30, 1998, respectively) 611,616 581,153
Loans held-for-sale 2,835 3,763
Accrued interest receivable 5,213 6,038
Investment in capital stock of the Federal Home Loan Bank, at cost 8,376 8,048
Premises and equipment, net 6,247 7,145
Real estate acquired through foreclosure, net 825 1,674
Gross intangible assets 10,353 12,118
Other assets 738 1,358
---------- ----------
Total assets $1,023,139 $1,045,837
========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
3
<PAGE> 4
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (CONTINUED)
<TABLE>
<CAPTION>
March 31, June 30,
1999 1998
--------- --------
(Unaudited)
(Dollars In Thousands)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Checking deposits $ 99,053 $ 88,231
Savings deposits 73,424 88,008
Money market deposits 120,967 82,249
Certificates of deposit 591,965 608,236
---------- ----------
Total deposits 885,409 866,724
Advances from the Federal Home Loan Bank 45,000 85,000
Accounts payable and other liabilities 4,410 7,030
Income taxes 2,501 3,305
---------- ----------
Total liabilities 937,320 962,059
Stockholders' equity:
Preferred stock, $.01 par value; 2,000,000 shares authorized; none issued -- --
Common stock, $.01 par value; 15,000,000 shares authorized; 6,612,500 issued
at March 31, 1999 and June 30, 1998; 6,412,073 outstanding at
March 31, 1999 and 6,369,103 outstanding at June 30, 1998 66 66
Additional paid-in capital 51,874 51,557
Retained earnings, substantially restricted 39,822 38,552
Accumulated other comprehensive income (275) 226
Deferred stock compensation (3,639) (4,159)
Treasury stock, 200,427 shares at March 31, 1999 and 243,397 shares
at June 30, 1998 (2,029) (2,464)
---------- ----------
Total stockholders' equity 85,819 83,778
---------- ----------
Total liabilities and stockholders' equity $1,023,139 $1,045,837
========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
4
<PAGE> 5
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED MARCH 31, ENDED MARCH 31,
-------------------- -------------------
1999 1998 1999 1998
------- ------- ------- -------
(Dollars In Thousands)
<S> <C> <C> <C> <C>
INTEREST INCOME:
Interest on loans $12,050 $11,409 $35,677 $31,885
Interest on mortgage-backed securities 2,890 4,697 10,423 14,179
Interest and dividends on investment securities 2,281 2,531 6,725 9,567
------- ------- ------- -------
Total interest income 17,221 18,637 52,825 55,631
INTEREST EXPENSE:
Interest on deposit accounts 9,569 10,037 30,000 30,789
Interest on advances from the Federal Home Loan
Bank and other borrowings 547 1,681 2,854 4,757
Net interest expense of hedging transactions 27 421 841 1,370
------- ------- ------- -------
Total interest expense 10,143 12,139 33,695 36,916
NET INTEREST INCOME BEFORE PROVISION
FOR ESTIMATED LOAN LOSSES 7,078 6,498 19,130 18,715
PROVISION FOR ESTIMATED LOAN LOSSES 400 2,300 1,600 2,700
------- ------- ------- -------
NET INTEREST INCOME AFTER PROVISION
FOR ESTIMATED LOAN LOSSES 6,678 4,198 17,530 16,015
OTHER INCOME (EXPENSE):
Loan and other fees 122 89 345 286
Impairment writedown on securities -- (16) -- (16)
Net gain on sales of securities available-for-sale -- -- 159 62
Net gain on sales of loans held for sale 134 56 385 127
Income (expense) from real estate operations, net 19 (312) 217 (953)
Amortization of intangible assets (588) (588) (1,765) (1,765)
Gain on sale of merchant bankcard portfolio -- 200 -- 200
Branch and deposit related fees 571 640 1,822 1,711
Other income 289 54 956 144
------- ------- ------- -------
Total other income (expense) 547 123 2,119 (204)
</TABLE>
See Notes to Consolidated Financial Statements
5
<PAGE> 6
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED MARCH 31, ENDED MARCH 31,
--------------------- ---------------------
1999 1998 1999 1998
------- ------- ------- -------
(Dollars In Thousands)
<S> <C> <C> <C> <C>
GENERAL AND ADMINISTRATIVE EXPENSES:
Salaries and employee benefits $ 2,965 $ 2,604 $ 8,994 $ 7,214
Occupancy and equipment expense 968 840 3,027 2,747
FDIC insurance and other assessments 180 185 542 547
Legal and professional services 252 195 775 541
Data and item processing service costs 649 623 1,813 1,673
Marketing expense 169 155 613 400
Supplies expense 83 118 285 253
Expenses for pending acquisition 103 0 328 0
Other operating expenses 378 392 1,341 1,127
----------- ----------- ----------- -----------
Total general and administrative expenses 5,747 5,112 17,718 14,502
EARNINGS BEFORE INCOME
TAX EXPENSE 1,478 (791) 1,931 1,309
INCOME TAX EXPENSE 507 (327) 661 544
----------- ----------- ----------- -----------
NET EARNINGS $ 971 $ (464) $ 1,270 $ 765
=========== =========== =========== ===========
SHARES APPLICABLE TO BASIC EARNINGS PER SHARE 6,406,395 6,305,292 6,395,802 6,291,108
BASIC EARNINGS PER SHARE $ 0.15 $ (0.07) $ 0.20 $ 0.12
=========== =========== =========== ===========
SHARES APPLICABLE TO DILUTED EARNINGS PER SHARE 6,535,580 6,305,292 6,514,958 6,488,333
DILUTED EARNINGS PER SHARE $ 0.15 $ (0.07) $ 0.19 $ 0.12
=========== =========== =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements
6
<PAGE> 7
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
NINE MONTHS ENDED MARCH 31, 1999
(UNAUDITED)
(DOLLARS AND SHARES IN THOUSANDS)
<TABLE>
<CAPTION>
Common stock Additional Deferred
----------------- paid-in Retained stock- Treasury
Shares Amount capital earnings compensation stock
------ ------ ------- -------- ------------ -----
<S> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1998 6,613 $ 66 $ 51,557 $ 38,552 $ (4,159) $ (2,464)
Amortization of deferred stock compensation -- -- 320 -- 520 --
Sale of treasury stock -- -- (3) -- -- 435
Comprehensive income:
Net earnings -- -- -- 1,270 -- --
Other comprehensive income:
Change in net unrealized gain on available-
for-sale securities, net of $350 in taxes -- -- -- -- -- --
Total other comprehensive income -- -- -- -- -- --
Total comprehensive income
----- ---- -------- -------- -------- --------
Balance at March 31, 1999 6,613 $ 66 $ 51,874 $ 39,822 $ (3,639) $ (2,029)
===== ==== ======== ======== ======== =========
<CAPTION>
Accumulated
other Total
comprehensive stockholders'
income equity
------ ------
<S> <C> <C>
Balance at June 30, 1998 $ 226 $ 83,778
Amortization of deferred stock compensation -- 840
Sale of treasury stock -- 432
Comprehensive income:
Net earnings -- 1,270
Other comprehensive income:
Change in net unrealized gain on available-
for-sale securities, net of $350 in taxes (501)
Total other comprehensive income -- (501)
-----
Total comprehensive income 769
------ --------
Balance at March 31, 1999 $ (275) $ 85,819
======= ========
</TABLE>
See Notes to Consolidated Financial Statements
7
<PAGE> 8
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED MARCH 31,
----------------------
1999 1998
---- ----
(Dollars In Thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 1,270 $ 765
Adjustments to reconcile net earnings to net cash provided by (used in)
operating activities:
Write-down of interest only security -- 16
Origination of loans held-for-sale (31,382) (14,940)
Proceeds of sale of loans held-for-sale 32,696 11,423
Provisions for estimated loan and real estate losses 1,613 3,639
Depreciation and amortization 761 934
Amortization of deferred loan fees (760) (586)
Amortization (accretion) of premiums (discounts) on loans
and investment and mortgage-backed securities, net 2,035 371
Amortization of intangible assets 1,765 1,765
Federal Home Loan Bank stock dividend (328) (285)
Gain on sales of mortgage backed and investment securities available-for-sale (159) (62)
Gain on sales of loans held-for-sale (385) (127)
Gain on sales of foreclosed real estate, net (243) (151)
(Gain) loss on sale of premises and equipment (30) 21
Decrease in accrued interest receivable 825 811
Decrease in accounts payable and other liabilities (2,621) (1,615)
Decrease in other assets 620 736
Other, net 820 722
-------- --------
Net cash provided by operating activities 6,497 3,437
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in loans receivable (32,354) (106,565)
Purchases of mortgage-backed securities available-for-sale -- (80,163)
Principal repayments on mortgage-backed securities held-to-maturity -- 19,399
Principal repayments on mortgage-backed securities available-for-sale 64,805 29,006
Purchases of investment securities available-for-sale (128,914) (62,869)
Principal repayments on investment securities held-to-maturity -- 747
Principal repayments on investment securities available-for-sale 83,495 4,127
Proceeds from sales of mortgage-backed and investment securities available-for-sale 28,157 58,254
Matured / called investment and mortgage backed securities held-to-maturity -- 16,000
Matured / called investment and mortgage backed securities available-for-sale 11,741 44,033
Proceeds from sales of real estate acquired by foreclosure 2,419 5,593
Proceeds from sales of real estate held for investment -- 427
Proceeds from sale of premises and equipment 1,473 46
Acquisitions of premises and equipment (1,306) (263)
-------- --------
Net cash provided by (used in) investing activities 29,516 (72,228)
</TABLE>
See Notes to Consolidated Financial Statements
8
<PAGE> 9
HF BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED MARCH 31,
-------------------
1999 1998
---- ----
(Dollars In Thousands)
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances received from Federal Home Loan Bank $ 107,000 $ 60,000
Proceeds from other borrowings -- 213,000
Increase in deposit accounts 18,686 28,893
Repayment of advances from Federal Home Loan Bank (147,000) (10,000)
Repayment of other borrowings -- (213,000)
--------- ---------
Net cash (used in) provided by financing activities (21,314) 78,893
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS 14,699 10,102
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 27,720 18,411
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 42,419 $ 28,513
========= =========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid during the period for:
Interest on deposit accounts and other borrowings $ 6,265 $ 7,995
========= =========
Income taxes paid $ 350 $ --
========= =========
SUPPLEMENTAL DISCLOSURES OF NON CASH
INVESTING AND FINANCING ACTIVITIES:
Real estate acquired through foreclosure $ 2,084 $ 2,678
========= =========
Loans to facilitate the sale of real estate acquired through foreclosure $ 92 $ 1,102
========= =========
Transfer of mortgage-backed securities held-to-maturity to available-for-sale classification $ 123,596 $ --
========= =========
Transfer of investment securities held-to-maturity to available-for-sale classification $ 9,647 $ --
========= =========
</TABLE>
See Notes to Consolidated Financial Statements
9
<PAGE> 10
NOTE 1: Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all necessary adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation have been included. The results of operations for the nine month
period ended March 31, 1999 are not necessarily indicative of the results that
may be expected for the entire fiscal year or any other interim period.
HF Bancorp Inc. ("HFB") is the holding company for Hemet Federal Savings
& Loan ("Bank") and the Bank's subsidiary, First Hemet Corporation ("FHC"). The
Company's headquarters are in Hemet, California. The Company offers a broad
range of financial services to both consumers and small businesses. All
significant intercompany transactions and balances have been eliminated. Certain
reclassifications have been made to prior year's consolidated financial
statements to conform to the current presentation.
These unaudited consolidated financial statements and the information
under the heading "Item 2. Management's Discussion And Analysis Of Financial
Condition And Results Of Operations" have been prepared with the presumption
that the users of this interim financial information have read, or have access
to, the most recent audited consolidated financial statements and notes thereto
of HF Bancorp, Inc. for the fiscal year ended June 30, 1998 included in the
Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1998.
The preparation of the consolidated financial statements of HF Bancorp,
Inc. and subsidiary requires management to make estimates and assumptions that
affect reported amounts. These estimates are based on information available as
of the date of the financial statements. Therefore, actual results could differ
from those estimates.
NOTE 2: Computation Of Earnings Per Share
The Company calculates earnings per share ("EPS") in accordance with
Statement Of Financial Accounting Standards ("SFAS") No. 128 "Earnings Per
Share". All of the Company's net income has been available to common
shareholders during the periods covered in this Form 10-Q. Basic and diluted EPS
were calculated based upon the following information:
<TABLE>
<CAPTION>
PLUS: PLUS:
EQUALS: Treasury Treasury EQUALS: Shares Shares *
LESS: Shares Stock Stock Shares * For For
Average Average For Method: Method: For Quarterly Fiscal Fiscal
Total Shares Quarterly Shares For Shares For Quarterly Average YTD YTD
Quarter Shares Treasury BASIC Stock Stock DILUTED Share BASIC DILUTED
Ending Issued Stock EPS Options Awards EPS Price EPS EPS
------ --------- -------- --------- ---------- ---------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
09/30/97 6,612,500 330,625 6,281,875 148,044 23,922 6,453,841 $14.94 6,281,875 6,453,841
12/31/97 6,612,500 326,343 6,286,157 184,928 30,785 6,501,870 $16.60 6,284,016 6,477,856
03/31/98 6,612,500 307,208 6,305,292 179,413 24,583 6,509,288 $17.13 6,291,108 6,488,333
06/30/98 6,612,500 280,391 6,332,109 148,744 17,672 6,498,525 $16.98 6,301,358 6,490,881
09/30/98 6,612,500 227,410 6,385,090 103,878 12,697 6,501,665 $16.14 6,385,090 6,501,665
12/31/98 6,612,500 216,578 6,395,922 98,921 12,785 6,507,628 $15.98 6,390,506 6,504,647
03/31/99 6,612,500 206,105 6,406,395 117,232 11,953 6,535,580 $17.34 6,395,802 6,514,958
</TABLE>
*Share counts for diluted EPS are applicable only in the event of positive
earnings.
10
<PAGE> 11
NOTE 3: Derivative Financial Instruments
Effective July 1, 1998, the Company adopted SFAS No. 133 "Accounting For
Derivative Instruments And Hedging Activities". At that date, the Company
maintained $35.0 million (notional amount) in active interest rate exchange
agreements which had previously been designated as "cash flow hedges" within the
meaning defined in the Statement. The $35.0 million was comprised of two
separate swaps, both of which contractually matured in January 1999; and both of
which placed the Company in a "net payment" position based upon the current
market interest rates applicable to the swap agreements. Also at July 1, 1998,
the Company maintained one deferred loss with a remaining book value of $272
thousand associated with a terminated swap previously designated as a "cash flow
hedge". These derivative positions were established many years ago in order to
stabilize the effective cost of short term deposits. Prior to the adoption of
SFAS No. 133, these positions were accounted for on an accrual basis, with the
net periodic amount payable (receivable) debited (credited) to interest expense.
Due to the historic hedging relationship and accounting treatment for
these derivatives, and per the applicable requirements of SFAS No. 133,
effective July 1, 1998, the active interest rate swaps were marked to fair value
and recorded as liabilities on the Company's balance sheet. A corresponding
adjustment, net of tax effect, was posted to a separate component of
shareholders' equity through Other Comprehensive Income as defined in SFAS No.
130. For the terminated swap, the related deferred loss was reclassified, net of
tax effect, to a separate component of stockholders' equity, through a charge to
Other Comprehensive Income. Also per SFAS No. 133, no restatement was recorded
for periods prior to the adoption of the Statement.
Also effective July 1, 1998, the Company evaluated the effectiveness of
the cash flow hedges and determined them to be ineffective as defined in SFAS
No. 133. As a result, future changes in the fair values of the active interest
rate swaps due to changes in interest rates were reflected in current earnings,
whereas changes in fair value due to the passage of time were amortized from
Other Comprehensive Income into earnings over the remaining terms of the
interest rate swaps. The amount charged to Other Comprehensive Income associated
with the terminated swap was amortized into income over the remaining life of
the original agreement, which had an expiration date of November 21, 1998.
Because the two active swaps matured during fiscal 1999 and because the
original amortization period for the deferred loss associated with the
terminated swap concluded in fiscal 1999, the adoption of SFAS No. 133 therefore
presented no net impact upon fiscal 1999 aggregate earnings or shareholders'
equity. Results within each quarter of fiscal 1999, however, were impacted by
the adoption of the Statement.
In conjunction with the adoption of SFAS No. 133, the Company
reclassified 100% of its securities to "available-for- sale" as defined under
SFAS No. 115. A total of $133.2 million (amortized cost) in mortgage-backed and
investment securities were reclassified from "held-to-maturity" on July 1, 1998.
The Company reclassified these securities in order to provide additional
flexibility in future balance sheet and interest rate risk management, and due
to the clarification of regulatory capital treatment for unrealized gains and
losses accounted for under SFAS No. 115 since the initial adoption of that
Statement.
NOTE 4: Non-qualified Pension Plans
During the nine months ended March 31, 1999, the Company commenced cash
distributions of accumulated participant benefits under the non-qualified
Directors Retirement Plan. All but three participants have elected to receive
and have by March 31, 1999 received cash payments in lieu of future monthly
benefits under this plan. The substantial liquidation of this plan will reduce
Company administrative costs in future periods, while also constraining a
potential source of volatility in future general & administrative expenses
stemming from changes in Director fees and / or general market interest rates.
The cash distributions also accelerated the deductibility of these expenses by
the Company, thereby reducing associated deferred tax assets as accounted for
under SFAS No. 109. At March 31, 1999, the Company maintained an accrued
liability of $251 thousand in conjunction with the three participants who
determined not to receive a cash distribution. In addition, the one participant
in the non-qualified Retirement Restoration Plan had received by March 31, 1999
a cash distribution in lieu of future monthly benefits under that plan.
11
<PAGE> 12
NOTE 5: Stock Plan
The Company maintains the HF Bancorp, Inc. Stock Based Incentive Plan,
which includes both a stock option and a stock award component. All outstanding
stock options and awards under the plan vest in the event of a change in
control, such as the Company's planned acquisition by Temple-Inland, Inc. The
following tables summarize the status of this plan:
HF BANCORP, INC. STOCK BASED INCENTIVE PLAN: STOCK OPTION INFORMATION
<TABLE>
<CAPTION>
Stock Stock Average
Options Stock Options Exercise
Stock Stock Cumulatively Options Available Price Of
Options Options Vested & Cumulatively For Future Vested
Date Authorized Outstanding Outstanding Exercised Grants Options
- ---- ---------- ----------- ------------ ------------ ---------- --------
<S> <C> <C> <C> <C> <C> <C>
06/30/98 811,250 565,960 163,528 87,228 158,062 $10.47
09/30/98 811,250 587,010 165,328 109,428 114,812 $11.10
12/31/98 811,250 580,890 160,008 117,048 113,312 $11.17
03/31/99 811,250 564,980 222,535 130,198 116,072 $11.47
</TABLE>
Activity during the nine months ended March 31, 1999 included:
<TABLE>
<S> <C>
Granted 47,250
Canceled 5,260
Exercised 42,970
</TABLE>
The exercise price of individual vested stock options ranged from a low
of $9.50 per share to a high of $17.50 per share as of March 31, 1999.
HF BANCORP, INC. STOCK BASED INCENTIVE PLAN: STOCK AWARD INFORMATION
<TABLE>
<CAPTION>
Stock
Stock Awards
Stock Stock Awards Available
Awards Awards Cumulatively For Future
Date Authorized Outstanding Vested Grants
- ---- ---------- ----------- ------------ ----------
<S> <C> <C> <C> <C>
06/30/98 198,375 102,925 68,257 27,193
09/30/98 198,375 99,565 74,917 23,893
12/31/98 198,375 107,565 74,917 15,893
03/31/99 198,375 84,712 97,770 15,893
</TABLE>
Activity during the nine months ended March 31, 1999 included:
<TABLE>
<S> <C>
Granted 11,300
Canceled 0
Vested 29,513
</TABLE>
12
<PAGE> 13
NOTE 6: Restructuring Charges
During the quarter ended June 30, 1998, the Company recorded a $1.06
million charge associated with restructuring the Bank's branch network and
eliminating eight full-time equivalent positions, including a layer of
management. This restructuring charge was recognized in conjunction with a
business restructuring plan meeting the criteria for accrual under the guidance
of EITF 94-3. The types of expenses incorporated in the restructuring charge
included costs for employee severance, lease buyouts, abandoned building
improvements, long lived asset impairment as defined under SFAS No. 121, and
construction work to return several then existing branch sites to "retail shell"
or similar condition. At June 30, 1998, $716 thousand of these charges remained
accrued and were included in Accounts Payable And Other Liabilities on the
Consolidated Statements Of Financial Condition.
In the three quarters since the charge was announced, the Company has
completed the vast majority of the business restructuring plan. The Rancho
Bernardo, Idyllwild, San Jacinto, and Rancho Mirage branches were relocated to
new facilities. The former Diamond Valley branch was merged into the nearby, and
larger, Hemet West branch. The targeted staff positions (eight full-time
equivalents) were eliminated. As of March 31, 1999, the Company maintained a
remaining accrued restructuring charge balance of $212 thousand. At March 31,
1999, the primary remaining outstanding cost associated with the restructuring
plan was the settlement of a lease termination for one of the former branch
sites. The Bank has been conducting ongoing negotiations with the landlord for
this site, and management anticipates settling the lease termination for no more
than the remaining accrued balance.
NOTE 7: Commitments And Contingencies
At March 31, 1999, the Company maintained commitments to sell $934
thousand in residential fixed rate mortgage loans on a servicing released basis,
to originate $12.6 million in various types of loans, and to purchase $640
thousand in loans secured by multifamily real estate. The Company maintained no
commitments to assume borrowings, purchase securities, or sell securities at
March 31, 1999.
NOTE 8: Recent Accounting Pronouncements
In October 1998, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 134 "Accounting For Mortgage-Backed Securities Retained After
The Securitization Of Mortgage Loans Held For Sale By A Mortgage Banking
Enterprise". The Company realized no impact upon adoption of this Statement on
January 1, 1999, as the Company has not securitized mortgage loans held for sale
during fiscal 1999 and has had no such securities on its balance sheet during
fiscal 1999.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
Certain matters discussed in this Form 10-Q Report constitute forward
looking statements within the meaning of the Private Securities Litigation
Reform Act Of 1995. These forward looking statements relate to, among other
things, the nature and timing of the proposed acquisition by Temple-Inland,
Inc., expectations of the business environment in which the Company operates,
projections of future performance, adequacy of the allowance for estimated loan
losses, trends in credit experience, perceived opportunities in the market, and
statements regarding the Company's mission and vision. These forward looking
statements are based upon current management expectations, and therefore involve
risks and uncertainties. The Company's actual results, performance, or
achievements may differ materially from those suggested, expressed, or implied
by forward looking statements due to a wide range of factors including, but not
limited to, the extent to which the Company's operations and results are
impacted by its proposed acquisition, customer response to the proposed
acquisition, the general business environment, the California real estate
market, competitive conditions among bank and non-bank financial services
providers, changes in laws or regulations, and other risks detailed in the
Company's reports filed with the Securities and Exchange Commission, including
the Annual Report on Form 10-K for the fiscal year ended June 30, 1998. The
Company does not undertake, and specifically disclaims any obligation, to update
any forward looking statements to reflect occurrences or unanticipated events or
circumstances after the date of such statements.
General
HF Bancorp, Inc. (referred to herein on an unconsolidated basis as
"HFB" and on a consolidated basis as the "Company") is a savings & loan holding
company incorporated in the State of Delaware whose principal business is to
serve as a holding company for Hemet Federal Savings & Loan Association (the
"Bank") and for other banking or banking related subsidiaries which the Company
may establish or acquire. The Company's common stock is listed on the Nasdaq
National Market ("NASDAQ") under the symbol "HEMT".
At March 31, 1999, the Company had $1,023.1 million in assets, $611.6
million in net loans receivable, and $885.4 million in deposits. The Company is
subject to regulation by the Office Of Thrift Supervision ("OTS"), the Federal
Deposit Insurance Corporation ("FDIC"), and the Securities and Exchange
Commission ("SEC"). The principal executive offices of the Company and the Bank
are located at 445 East Florida Avenue, Hemet, California, 92543, telephone
number (909) 658-4411, toll free (800) 540-4363, facsimile number (909)
925-5398, electronic mail address [email protected]. The Bank is a member of
the Federal Home Loan Bank of San Francisco ("FHLB") and its deposit accounts
are insured by the FDIC through the Savings Association Insurance Fund ("SAIF")
to the maximum extent permitted by law.
The Company conducts business from eighteen full service branch offices
(including one supermarket branch), one loan production office, and one
centralized loan servicing center. In addition, the Company supports its
customers through 24 hour telephone banking, a transaction capable Internet
site, and ATM access through an array of networks including STAR, CIRRUS, PLUS,
and NOVUS. Through its banking offices, the Bank emphasizes personalized service
focused upon two primary markets: households and small businesses. The Bank
offers a wide complement of lending and depository products. The Bank also
supports its customers by functioning as a federal tax depository, providing
merchant bankcard services, issuing debit cards, and supplying various forms of
electronic funds transfer. In addition, the Bank, through third party
relationships and its First Hemet Corporation ("FHC") subsidiary, makes various
non FDIC insured investment products available to its customers, including
mutual funds and selected insurance related products.
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Acquisition By Temple-Inland, Inc.
As previously announced, on November 14, 1998, the Company entered into
an Agreement and Plan of Merger with Temple Inland, Inc., pursuant to which the
Company will be merged with and into Temple-Inland. The merger is subject to
regulatory and shareholder approvals. An application for regulatory approval has
been filed with the Office Of Thrift Supervision and is pending. The Company has
scheduled a special shareholders meeting to consider the proposed acquisition on
June 22, 1999.
Year 2000 Computer Issue
The Year 2000 Issue concerns the potential impact of historic computer
software code that only utilizes two digits to represent the calendar year (e.g.
"99" for "1999"). Software so developed could produce inaccurate or
unpredictable results upon January 1, 2000, when current and future dates
present a lower two digit year number than dates in the prior century. The
Company, similar to most financial services providers, is significantly subject
to the potential impact of the Year 2000 Issue due to the extensive presence of
dates in financial information. Potential impacts to the Company may arise from
software, hardware, and equipment both within the Company's direct control and
outside of the Company's ownership, yet with which the Company electronically or
operationally interfaces. Financial institution regulators have intensively
focused upon Year 2000 issues, issuing guidance concerning the responsibilities
of senior management and directors. Year 2000 testing and certification is being
addressed as a key safety and soundness issue in conjunction with regulatory
exams.
In order to address the Year 2000 Issue, the Company has developed and
implemented a five phase plan divided into the following major components:
1. awareness
2. assessment
3. renovation
4. validation
5. implementation
The Company has finished the first three phases of its Year 2000 plan,
and has completed the vast majority of the final two phases. The Company is
currently working internally and with external vendors on completing the final
two phases prior to June 30, 1999. Because the Company outsources its data
processing and item processing operations, a significant component of the Year
2000 plan is to work with external vendors to test and certify their systems as
Year 2000 compliant. Other important segments of the Year 2000 plan are to
identify loan customers whose possible lack of Year 2000 preparedness might
expose the Bank to financial loss, and to highlight any servicers of purchased
loans or securities which might present Year 2000 related operating problems.
The Board Of Directors has established a Year 2000 subcommittee to
monitor progress with achieving and certifying Year 2000 compliance. In
addition, the Company has utilized an external consulting firm to assist with
its Year 2000 program.
The Company has no significant internally generated software coding to
correct, as substantially all of the software utilized by the Company is
purchased or licensed from external providers. The Company believes that it has
relatively little exposure to contingencies related to the Year 2000 Issue for
products it has sold due to the nature of its business.
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<PAGE> 16
The Company has recently conducted the following Year 2000 related activities:
o Validation testing with the Company's primary data processor has been
completed. No significant shortcomings arose as a result of the
testing. Regulatory examinations for the Company's primary data
processor have been satisfactory. The Company's primary data processor
has contacted 100% of third-party vendors with which it interfaces. 97%
of those vendors have responded. The primary data processor has
scheduled testing with 76% of the third party vendors and has completed
61% of this testing. Test results to date have been successful. The
remaining third-party testing is scheduled to be completed by June 30,
1999.
o The Company continues to monitor Year 2000 testing and validation
performed by its primary item processor. This testing and validation
has not indicated any significant shortcomings. Recent regulatory
examinations for the Company's primary item processor have been
satisfactory.
o The Company has communicated with servicers and trustees for a majority
of its securities portfolio. These entities (primarily government
sponsored enterprises such as the Federal National Mortgage
Association) have provided information in regards to their Year 2000
readiness. No significant risk to the Company has been identified
through this process. However, the Company maintains little opportunity
to independently verify the responses from most servicers, including
the government sponsored enterprises.
o Due to the age of much of the hardware and software utilized by the
Company at the beginning of calendar year 1998, and in conjunction with
its strategic plan, the Company has installed a new branch computer
environment. The new PC hardware associated with this upgrade completed
the Company's certification of all PC, network, and data
telecommunications hardware throughout the organization as Year 2000
compliant.
o Those ATM's requiring new hardware and / or software to achieve Year
2000 compliance have been upgraded, and all new ATM's acquired have
been Year 2000 certified. In addition, Year 2000 testing for the third
party which drives the Company's ATM's has been completed by the Bank's
primary data processor with no significant issues identified.
o The Company introduced debit cards and a transaction capable Internet
site during the quarter ended December 31, 1998. Prior to implementing
these new services, Year 2000 testing was conducted with no
shortcomings identified.
o In conjunction with the Federal Reserve, the Bank is in the process of
testing of its FedWire wire transfer system for Year 2000 compliance.
This testing will be completed in May, 1999. All test results to date
have been favorable, with no lack of Year 2000 compliance indicated.
o The Company has corresponded with those loan customers whose business
or cash flow might be interrupted by a lack of Year 2000 compliance in
some aspect of their operation and who present a credit exposure of at
least $500 thousand to the Company. No responses received to date have
highlighted the likelihood of significant financial loss to the
Company. A risk analysis has been completed for these loan customers
and no significant Year 2000 exposure to the Company has been
identified.
o The Company continues to communicate awareness and readiness to its
customers through marketing materials in the branches and information
posted on its web site.
The Company's Year 2000 compliance plans have been finalized.
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<PAGE> 17
The Company has conducted formal communications with all of its
significant suppliers (112 vendors) to determine the extent to which it is
vulnerable to those third parties' failure to remediate their own Year 2000
issues. These formal communications included a request that the vendor complete
a Year 2000 status survey. The Company also requested that third party vendors
represent their products and services to be Year 2000 compliant and that they
have a program to test for that compliance. Each vendor was ranked as High,
Medium, or Low on their impact to the Company in event of a Year 2000 failure.
If the vendor failed to respond to the first inquiry, a second letter was mailed
certified receipt requested.
Of the one hundred twelve vendors contacted, forty-three were ranked
has having a High impact to the bank in case of a Year 2000 failure. Only one of
the High impact vendors has failed to respond. Twelve vendors were ranked as
having a Medium impact. Only one of the Medium impact vendors has failed to
respond. Fifty-seven were ranked as having a Low impact with only three failing
to respond.
For each of those vendors that have failed to respond, HF Bancorp has
contingency plans or replacement vendors for these services lined up in case of
Year 2000 failures. Every vendor that has been ranked as having a High or Medium
impact to the Company has a Year 2000 testing script associated with it. Each of
these vendors has been or is in the process of being tested for their Year 2000
compliance. Where the Company can test these vendors, teams have been set up to
execute test scripts once the testing time slots have been made available by the
vendors. Significant successful testing has been completed with several material
third party vendors. In some circumstances, the Company will not be able to
perform actual testing of their systems and will have to rely on proxy testing
for validation. This proxy testing is in progress with successful results coming
in regularly. The Company anticipates that this testing will be completed by
June 30, 1999.
In the unlikely event that a disruption occurs that materially affects
operations, the Company would implement disaster recovery contingency plans. The
Company has conducted both applications and third party testing during the 1998
calendar year as part of its annual disaster recovery plan testing. In addition,
the Company used a full day system outage by its primary service bureau in
February, 1999 as an opportunity to test its Year 2000 contingency plans. The
Company plans to replicate this testing as well as other scenarios in the second
quarter of calendar 1999. The Company intends to complete substantially all of
its contingency testing no later than June 30, 1999. Year 2000 contingency
planning involves four phases:
1. establishing organizational planning guidelines
2. completing a business impact analysis
3. developing a business resumption contingency plan
4. validating the business resumption contingency plan
The Company's total Year 2000 estimated project cost, which is based
upon currently available information, includes expenses for the review and
testing of third parties, including government entities. However, there can be
no guarantee that the hardware, software, and systems of such third parties will
be without unfavorable Year 2000 issues and therefore not present a material
adverse impact upon the Company. Year 2000 compliance costs incurred during
fiscal 1999 totaled approximately $11 thousand. This figure does not include the
implicit costs associated with the reallocation of internal staff hours to Year
2000 project related efforts. At this time, management currently estimates
additional Year 2000 compliance costs, which are expensed on a current period
basis, at between zero and $25 thousand. This range of costs does not include
normal ongoing costs for computer hardware and software that would be replaced
even without the presence of the Year 2000 Issue in conjunction with the
Company's ongoing programs for updating its delivery and service infrastructure.
At this time, no significant projects have been delayed as a result of the
Company's Year 2000 effort.
While there can be no guarantee that Year 2000 problems will not occur,
the Company believes its efforts have addressed the risks and that contingency
plans will be in place for the unexpected.
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<PAGE> 18
Overview Of Business Activity And Results
Results for the nine months ended March 31, 1999 were significantly
influenced by four primary factors:
1. A significant decline in the provision for estimated loan losses in the
nine months ending March 31, 1999 versus the same period the prior
fiscal year. This reduction stemmed from historically high provisions
during the third quarter of fiscal 1998, real estate appreciation over
the past twelve months in the vast majority of the markets in which the
Company lends, and a continuing favorable trend in most of the
Company's measures of credit profile during fiscal 1999.
2. Expenses associated with the implementation of the Company's strategic
plan of evolving an almost 80 year old savings & loan into a community
based financial services firm.
3. The November 14, 1998 signing of a definitive agreement to sell the
Company to Temple-Inland, Inc., which triggered various events,
including the liability for significant merger related expenses,
restrictions on the Company's operations, a modification in the
Company's strategic plan, and a redirection of various internal
resources towards facilitating a timely and effective close to the
transaction.
4. The historically low level of general market interest rates during the
fiscal year, combined with a relatively flat Treasury curve,
particularly during the first six months of fiscal 1999. This
environment fostered high prepayments on a variety of mortgage related
assets, which in turn affected net interest income and the composition
of the Company's balance sheet.
The confluence of the above factors led to improved financial results
for the three and nine months ended March 31, 1999 compared to like periods
during the prior fiscal year, as progress in net interest income, credit
experience, and fee income more than offset higher operating costs. However,
despite this improvement, the Company's return on assets, return on equity, and
efficiency ratio in fiscal 1999 remained below peer institutions.
With the signing of the definitive agreement, the Company became liable
to pay its investment banking firm 1.25% of the market value of the
consideration paid to the shareholders of the Company, with such fee segmented
into a series of payments based upon the progress of the sale. Additional costs
were incurred, and will be incurred through the close of the sale, for legal,
accountant, and other services. These additional expenses reduced fiscal 1999
year to date earnings and will continue to impact results through to the close
of the proposed transaction. The definitive agreement includes various operating
restrictions, including limitations on investment security purchases and lending
activity. These restrictions unfavorably affected earnings during the period
following the signing of the definitive agreement. With the announcement of the
Company's sale, certain strategic projects, including a new loan origination
system and the migration to a "proof of deposit" ("POD") branch operations
environment, were placed on hold. Internal resources previously assigned to
these projects were reallocated toward facilitating the legal and operational
(including systems conversion) aspects of timely concluding the transaction with
Temple- Inland, Inc.
Additional information concerning the above factors and events is
presented in the pages which follow.
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<PAGE> 19
Changes In Financial Condition From June 30, 1998 to March 31, 1999
Total assets decreased $22.7 million, or 2.2%, from $1,045.8 million at
June 30, 1998 to $1,023.1 million at March 31, 1999. Total assets rose $1.5
million during the three months ended March 31, 1999, primarily due to a $1.2
million rise in deposits.
Cash & cash equivalents rose from $27.7 million at June 30, 1998 to
$42.4 million at March 31, 1999. In HF Bancorp Inc.'s Form 10-Q as of December
31, 1998, the Company reported that it had built up a balance of short term
funds in preparation for a planned wholesale loan purchase during the third
quarter of fiscal 1999. Due to limited secondary market supply of the types of
residential loans (Treasury based adjustable rate mortgages, 3/1 and 5/1 hybrid
loans) sought by the Company and the resulting comparatively high pricing,
management decided to instead purchase short term collateralized mortgage
obligations. While the Company purchased $66.0 million (par value) in
collateralized mortgage obligations during the third quarter of fiscal 1999, it
would have acquired an additional $15.0 million if suitable product had been
available. As a result, as of March 31, 1999, the Company carried cash
equivalent balances approximately $15.0 million in excess of those normally
maintained.
In conjunction with the Company's adoption of SFAS No. 133 (see Note
3), all investment and mortgage-backed securities were designated as
available-for-sale effective July 1, 1998 in order to provide the Company with
enhanced flexibility in balance sheet and interest rate risk management.
Total securities declined from $396.8 million at June 30, 1998 to
$334.5 million at March 31, 1999 due to amortization, prepayments, sales, and
calls being only partially offset by new purchases. Funds from the reduction in
mortgage-backed security balances were reinvested into the loan portfolio, used
to repay maturing borrowings, and retained in short term cash equivalents, as
described above. The Company experienced historically high prepayment speeds for
mortgage related securities during fiscal 1999 primarily because of the
availability of new fixed rate mortgages with rates below 7.00% and the
historically flat and low shape of the Treasury yield curve throughout most of
the fiscal year.
Security acquisitions in fiscal 1999 have been concentrated in fixed
rate, private label, AAA rated, low duration collateralized mortgage
obligations, resulting in a significant reduction in the Company's
mortgage-backed security portfolio, as prepayments and sales associated with
mortgage-backed securities were not offset with sufficient new purchases.
Security purchases since the signing of the definitive agreement have been
conducted in accordance with the limitations and terms contained within that
document. During fiscal 1999, the Company has generally avoided purchasing
adjustable rate securities because of concerns over prepayment exposure and
declines in underlying indices, both of which present the potential for impaired
total return. The Company sold $27.9 million in long term, fixed rate mortgage
backed securities in the quarter ended December 31, 1998 to support its interest
rate risk management program and to better diversify the Bank's investment
portfolio. This was the only security sale during the first nine months of
fiscal 1999.
Net loans receivable increased 5.2% from $581.2 million at June 30,
1998 to $611.6 million at March 31, 1999. Net loans receivable were almost flat
during the most recent three months, as prepayments and sales offset new credit
commitments. The ratio of loans to deposits rose from 67.5% at the end of the
prior fiscal year to 69.4 % at the conclusion of the most recent quarter. The
nominal and relative increases in the loan portfolio have been key objectives of
management in implementing the Company's strategic plan.
Credit commitments during the first nine months of fiscal 1999 totaled
$206.0 million, down from $226.6 million during the same period during the prior
fiscal year. However, the prior fiscal year total included $107.7 million in
wholesale purchases of residential hybrid loans which are fixed for an extended
initial period (generally three to five years) and then convert to an adjustable
rate mortgage (generally annually adjusting based upon the One Year Treasury
Constant Maturity Index). No such wholesale residential loan purchases occurred
during the first nine months of fiscal 1999. However, the first nine months of
fiscal 1999 included the acquisition of $47.2 million in apartment loans sourced
through a mortgage banker, whereas the first nine months of the prior fiscal
year contained no similar activity.
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<PAGE> 20
Expansion in net loans receivable was constrained by prepayments,
particularly on the Company's portfolio of residential adjustable rate loans, as
consumers sought to refinance with interest rates at historically low levels.
The Company originated $66.2 million in multifamily real estate loans during the
nine months ending March 31, 1999, up significantly from the $14.1 million
funded during the first nine months of the prior fiscal year. The Company
increased its emphasis upon apartment loans during fiscal 1999 in order to
diversify its loan portfolio away from its historically high concentration in
lower yielding single family mortgages and in order to improve the efficiency of
origination in conjunction with the larger average loan sizes for apartment
loans. Construction lending expanded from $7.6 million to $13.6 million during
the three months ended March 31, 1999 and from $24.9 million to $35.4 million
during the nine months ended March 31, 1999. The strength of the real estate
markets in many of the communities in which the Company operates combined with
the limited supply of housing built during the recessionary period from the
early to the mid 1990's to create enhanced construction lending opportunities
for the Company.
Net loans available for sale decreased from $3.8 million at June 30,
1998 to $2.8 million at March 31, 1999. The Company's pipeline of fixed rate,
refinance mortgages began to decline toward the end of the fiscal third quarter
due to a moderating of the refinance boom experienced earlier in the fiscal year
and due to customer and counterparty response to the pending sale of the
Company. Management believes that segments of retail customers and mortgage
brokers are uncomfortable having their mortgage loan(s) in process with a bank
during an acquisition and pending a computer systems conversion, and that this
will continue to impact credit commitments during the remaining period prior to
the close of the proposed acquisition.
The Company's investment in the capital stock of the Federal Home Loan
Bank ("FHLB") increased from $8.0 million at June 30, 1998 to $8.4 million at
March 31, 1999 due to dividends credited. The Bank has been notified by the FHLB
that its excess capital stock ownership position ($1.1 million) is below the
threshold for mandatory redemption. Management may, however, determine to sell
some or all of its excess FHLB stock consistent with liquidity, profitability,
and tax planning considerations.
Net premises and equipment declined from $7.1 million at June 30, 1998
to $6.2 million at March 31, 1999 due to the sale of the former sites for the
Bank's Rancho Bernardo and Idyllwild branches, periodic depreciation and
amortization, and a reduction in capital spending activity following the signing
of the definitive agreement.
The Company's net investment in real estate acquired through
foreclosure decreased from $1.7 million at June 30, 1998 to $825 thousand at
March 31, 1999. The Company sold $2.2 million in foreclosed real estate during
the past nine months, highlighting the relatively rapid turnover experienced in
the Company's inventory of foreclosed properties. This has resulted from a
continued strengthening in real estate values in many of the Company's lending
markets, which in turn has increased buyer interest and supported better sales
prices. At March 31, 1999, the Company's inventory of foreclosed properties was
comprised of one multifamily building and twelve residential properties, four of
which were in escrow for sale at prices exceeding net book value. However, no
assurances can be given regarding whether these escrows will close or concerning
the financial results from such transactions.
Gross intangible assets declined from $12.1 million at June 30, 1998 to
$10.4 million at March 31, 1999 due to the continued amortization of the
intangible assets generated in conjunction with the North San Diego County
branch purchase from Hawthorne Savings and the Palm Springs Savings Bank
("PSSB") acquisition. Under OTS regulations, intangible assets net of associated
deferred tax liabilities reduce regulatory capital, resulting in lower capital
ratios than would otherwise be the case. At March 31, 1999, the reduction in the
Bank's regulatory capital resulting from intangible assets was $7.8 million.
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Total deposits rose 2.2% from $866.7 million at June 30, 1998 to $885.4
million at March 31, 1999. Key trends within the deposit portfolio included:
o Checking account balances expanded from $88.2 million at June 30, 1998
to $99.1 million at March 31, 1999. The Company has continued to target
increases in checking accounts as a source of low cost funds and
non-interest income, with efforts in fiscal 1999 including the
introduction of a transaction capable Internet site, the installation
of additional ATM's, and an alteration in branch staff incentive
program emphasis.
o Customers responded positively to the Bank's "Platinum" money market
deposit account, which provides competitive, highly tiered rates for
liquid funds. In conjunction with this product, total money market
deposits increased from $82.2 million at June 30, 1998 to $121.0
million nine months later. This growth occurred despite repeated
reductions in pricing in response to the three cuts in the federal
funds rate implemented by the Federal Reserve during the nine months
ended March 31, 1999.
o Savings deposits fell from $88.0 million at June 30, 1998 to $73.4
million at March 31, 1999, as the Company continued to price its
passbook based products less aggressively in order to encourage
customer migration into statement based products. Management believes
statement based products present the Bank with fewer operational issues
(and losses), result in faster customer service, and more effectively
mesh with upcoming advances in technology. The decline in savings
balances during the most recent quarter also stemmed from a number of
higher balance customers moving their savings funds into the Platinum
money market product. In the fourth quarter of fiscal 1999, the Company
will cease opening new passbook based accounts in preparation for the
conversion to Guaranty Federal Bank's computer system, which does not
support passbook based depository products.
o Certificate of deposit balances fell $16.3 million, or 2.7%, from
$608.2 million at June 30, 1998 to $592.0 million at March 31, 1999.
During fiscal 1999, the Company priced its certificates of deposit
relatively less aggressively than in prior periods to more quickly
reduce the Bank's cost of funds and due to the Company's high
liquidity. This pricing strategy, when combined with the aforementioned
changes in mix and some significant rate rolldowns on maturing longer
term CD's, led to a 30 basis point decline in the Bank's weighted
average cost of deposits during the first nine months of fiscal 1999.
During the nine months ended March 31, 1999, the Bank experienced
relatively favorable results for the four branches relocated and one branch
merged during the fiscal year. Deposit attrition from relocated portfolios was
very moderate. In addition, new account activity has been strong for several of
the relocated branches, particularly at the Palm Desert location (moved into
during January, 1999). The San Jacinto branch, relocated earlier this fiscal
year to the Company's first supermarket facility, has experienced favorable new
account activity for checking and money market accounts, in addition to
significant internal and "foreign" customer utilization of the newly installed
ATM.
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Advances from the FHLB-SF declined from $85.0 million at June 30, 1998
to $45.0 million at March 31, 1999. $65.0 million of the June 30 inventory of
advances matured during October, 1998. The Company utilized this opportunity to:
o redeploy funds from security prepayments and sales to reduce borrowings
o extend $25.0 million in advances out to between two and three years,
thereby improving the Company's interest rate risk profile
o decrease the weighted average nominal cost of advances from 5.24% to
4.91%
Total stockholders' equity rose from $83.8 million at June 30, 1998 to
$85.8 million at March 31, 1999. Factors contributing to this increase included:
o net income generated for the fiscal year to date
o continued amortization of the Company's deferred stock compensation
o the exercise of stock options (funded with Treasury stock) during the
current fiscal year
The above factors more than offset:
o depreciation in the portfolios of investments designated as
available-for-sale, with the equity impact of this depreciation
augmented by the realization of $159 thousand in pre-tax gains on the
sale of available-for-sale securities during fiscal 1999.
As a result of the above equity increase and the continued amortization
of intangible assets, the Company's tangible book value per share increased from
$11.71 at June 30, 1998 to $12.16 at March 31, 1999.
Interest Rate Risk Management And Exposure
In an effort to limit the Company's exposure to interest rate changes,
management monitors and evaluates interest rate risk on a regular basis,
including participation in the OTS Net Portfolio Value Model and associated
regulatory reporting. Management acknowledges that interest rate risk and credit
risk compose the two greatest financial exposures faced by the Company in the
normal course of its business.
In recent quarters, the Company has maintained a net liability
sensitivity in regards to net portfolio value, also referred to as market value
of portfolio equity. This means that the fair value of the Company's assets is
more volatile than that of its liabilities. This net liability sensitivity
primarily arises from the longer term, higher duration mortgage-backed
securities and whole loans maintained on the Company's balance sheet, for which
the Company's only current match funding sources are demand deposit accounts,
non interest bearing liabilities, a segment of core deposits transaction
accounts, certain borrowings, and capital. A net liability sensitive position
typically translates to improved net portfolio value during periods of falling
general market interest rates. Conversely, this position presents the likelihood
of reductions in net portfolio value during increasing rate environments.
However, in addition to the overall direction of general market interest rates,
changes in relative rates (i.e. the slope of the term structure of interest
rates) also impact net portfolio value and the Company's profitability.
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<PAGE> 23
The Company's net liability sensitivity declined during the first nine
months of fiscal 1999 due to multiple factors, including:
o The sale of $27.9 million in long term, fixed rate Agency
mortgage-backed securities during the second fiscal quarter.
o The extension of $25.0 million in maturing FHLB advances to terms of
between two and three years during the second fiscal quarter.
o A $35.0 million rise in transaction accounts. Checking accounts (and to
a lesser degree savings and money market accounts) are generally less
interest rate sensitive than certificates of deposit and other
alternative funding sources.
o An increase in prepayment speeds on higher duration assets maintained
on the balance sheet. As a result, there are both fewer such remaining
assets and those which do remain present shorter average lives and thus
less volatility in value.
o Associated with the above factor, long term, fixed rate residential
loans held for portfolio declined from $134.9 million at June 30, 1998
to $121.5 million at March 31, 1999.
o An increase in capital. Higher capital levels reduce the percentage
impact or relative exposure from a given volatility in net portfolio
value.
o The call of the final $10.8 million in long term, fixed rate Agency
debentures owned by the Company on June 30, 1998.
o The concentration of new security purchases into relatively low
duration collateralized mortgage obligations with above market coupons
and limited extension risk, thereby moderating the average duration of
the Company's assets and providing some measure of total return
protection in rising interest rate environments.
The Company's final two active interest rate swaps matured in January,
1999. The amortization period for the Other Comprehensive Income adjustment
stemming from the Company's final terminated interest rate swap concluded in
November, 1998. Consequently, at March 31, 1999, the Company maintained no
derivative positions and recorded no equity adjustment resulting from its July
1, 1998 adoption of SFAS No. 133.
Liquidity
Liquidity is actively managed to ensure sufficient funds are available
to meet the ongoing needs of both the Company in general and the Bank in
particular. Liquidity management includes projections of future sources and uses
of funds to ensure the availability of sufficient liquid reserves to provide for
unanticipated circumstances. HFB's and the Bank's investment portfolios are
structured to provide an ongoing source of cash from scheduled payments and
anticipated prepayments from mortgage related securities, in addition to cash
flows from periodic maturities.
At March 31, 1999, the Company maintained $42.4 million in cash and
cash equivalents, untapped borrowing capacity of $390.4 million at the FHLB-SF,
and significant excess collateral in both loans and securities; collateral which
is available for either liquidation or secured borrowings in order to meet
future liquidity requirements. In addition, the Bank has been granted three
federal funds lines of credit from correspondent financial institutions, with an
aggregate borrowing capacity of $20.0 million. However, there can be no
assurance that funds from such lines will be available at all times, or that
such lines will be maintained in future periods.
The Bank's regulatory liquidity ratio under revised guidelines adopted
on January 1, 1998 has exceeded 15.0% since that date, versus a regulatory
requirement of 4.0%. Liquidity needs for HFB on a stand alone basis are met
through available cash, periodic earnings, cash flows from its investment
portfolio, exercises of vested stock options, and payments associated with its
loan to the ESOP.
23
<PAGE> 24
Regulatory Capital Compliance
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") required the OTS to implement a system providing for regulatory
sanctions against institutions that are not adequately capitalized. The severity
of these sanctions increases to the extent that an institution's capital
continues to decline. Under FDICIA, the OTS issued the Prompt Corrective Action
("PCA") regulations with established specific capital ratios for five separate
capital categories as set forth below:
<TABLE>
<CAPTION>
Core Capital To
Adjusted Core Capital To Total Capital
Total Assets Risk-weighted To
(Leverage Ratio) Assets Risk-weighted Assets
---------------- ------ --------------------
<S> <C> <C> <C>
Well capitalized 5% or above 6% or above 10% or above
Adequately capitalized 4% or above 4% or above 8% or above
Undercapitalized Under 4% Under 4% Under 8%
Significantly undercapitalized Under 3% Under 3% Under 6%
Critically undercapitalized Ratio of tangible equity to adjusted total assets of 2% or less
</TABLE>
The following table summarizes the capital ratios required by FDICIA
for an institution to be considered well capitalized and the Bank's regulatory
capital at March 31, 1999 as compared to such ratios.
<TABLE>
<CAPTION>
Core Capital To Core Capital To Total Capital To
Adjusted Risk-weighted Risk-weighted
Total Assets Assets Assets
-------------------- ------------------- -------------------
Balance Percent Balance Percent Balance Percent
------- ------- ------- ------- ------- -------
(Dollars In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Hemet Federal's regulatory capital $ 67,978 6.74% $ 67,978 14.97% $ 73,457 16.17%
Well capitalized requirement 50,464 5.00 27,253 6.00 45,422 10.00
---------- ---- -------- ----- -------- -----
Excess $ 17,514 1.74% $ 40,725 8.97% $ 28,035 6.17%
========== ==== ======== ===== ======== =====
Adjusted assets (1) $1,009,289 $454,220 $454,220
========== ======== ========
</TABLE>
(1) The term "adjusted assets" refers to the term "adjusted total assets" as
defined in 12 C.F.R. section 567.1(a) for purposes of core capital requirements,
and refers to the term "risk-weighted assets" as defined in 12 C.F.R. section
567.1(bb) for purposes of risk-based capital requirements.
24
<PAGE> 25
The Bank is also subject to OTS capital regulations under the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") and
amendments thereto. These regulations require the Bank to maintain: (a) tangible
capital of at least 1.5% of adjusted total assets (as defined in the
regulations), (b) core capital of at least 4.0% of adjusted total assets (as
defined in the regulations), and (c) total capital of at least 8.0% of
risk-weighted assets (as defined in the regulations).
The following table summarizes the regulatory capital requirements
under FIRREA for the Bank. As indicated in the table, Hemet Federal's capital
levels at March 31, 1999 exceeded all three of the currently applicable minimum
FIRREA capital requirements.
<TABLE>
<CAPTION>
Percent Of
Adjusted
Amount Total Assets
------ ------------
(Dollars In Thousands)
<S> <C> <C>
Tangible Capital
Regulatory capital $ 67,978 6.74%
Minimum required 15,139 1.50
-------- ----
Excess $ 52,839 5.24%
======== ====
Core Capital
Regulatory capital $ 67,978 6.74%
Minimum required 40,372 4.00
-------- ----
Excess $ 27,606 2.74%
======== ====
</TABLE>
<TABLE>
<CAPTION>
Percent Of
Risk-weighted
Amount Assets
------ ------
<S> <C> <C>
Risk-based Capital
Actual capital $ 73,457 16.17%
Minimum required 36,338 8.00
-------- -----
Excess $ 37,119 8.17%
======== =====
</TABLE>
At March 31, 1999, the Bank's regulatory capital levels exceeded the
thresholds required to be classified as a "well capitalized" institution. The
Bank's regulatory capital ratios detailed above do not reflect the additional
capital (and assets) maintained by the holding company. Management believes
that, under current regulations, the Bank will continue to meet its minimum
capital requirements. However, events beyond the control of the Bank, such as
changing interest rates or a downturn in the economy in the areas where the Bank
has most of its loans, could adversely affect future earnings and, consequently,
the ability of the Bank to meet its future minimum capital requirements.
25
<PAGE> 26
Credit Profile
Nonperforming Assets
The following table sets forth information regarding non accrual loans,
real estate acquired through foreclosure, and repossessed consumer assets.
<TABLE>
<CAPTION>
March 31, 1999 June 30, 1998
-------------- -------------
(Dollars In Thousands)
<S> <C> <C>
Gross non accrual loans before valuation reserves $ 7,107 $ 4,276
Investment in foreclosed real estate before valuation reserves 916 1,853
------- -------
Total nonperforming assets $ 8,023 $ 6,129
======= =======
Non accrual loans to gross loans net of undisbursed loan funds 1.14% 0.72%
Nonperforming assets to total assets 0.78% 0.59%
</TABLE>
The following table presents a profile of gross non accrual loans at
March 31, 1999.
<TABLE>
<CAPTION>
Gross Non Accrual Loans March 31, 1999
--------------
(Dollars In Thousands)
<S> <C>
Residential real estate $ 4,079
Multifamily real estate 338
Commercial & industrial real estate 611
Construction 90
Land / Lots 1,742
Consumer 193
Commercial business 54
---------
Total $ 7,107
=========
</TABLE>
The increase in non accrual loans during fiscal 1999 primarily resulted
from:
o the placement of a $975 thousand loan secured by residential lots onto
non accrual status
o cash flow deterioration for certain income property loans
o retaining reinstated loans on non accrual status pending verification
of collateral values and cash flow adequacy
Approximately $2.2 million of the non accrual loans at March 31, 1999
were paying according to contractual terms. In addition, a continuing recovery
in real estate markets and the economy in the Company's primary lending areas
has favorably impacted the Company's ability to dispose of foreclosed real
estate, contributing to the reduction in foreclosed real estate balances during
fiscal 1999 year to date.
26
<PAGE> 27
Criticized And Classified Assets
The following table presents information concerning the Company's
inventory of criticized ("OAEM") and classified ("substandard" and lower)
assets. The category "OAEM" refers to "Other Assets Especially Mentioned", or
those assets which present indications of potential future credit deterioration.
<TABLE>
<CAPTION>
History of Classified Assets
(Dollars In Thousands)
OAEM Substandard Doubtful Loss Total
---- ----------- -------- ---- -----
<S> <C> <C> <C> <C> <C>
June 30, 1997 $9,586 $19,834 -- $2,952 $32,372
September 30, 1997 $8,656 $15,805 -- $3,051 $27,512
December 31, 1997 $9,572 $12,932 -- $1,843 $24,347
March 31, 1998 $10,885 $11,701 $55 $2,526 $25,167
June 30, 1998 $20,477 $14,383 -- $2,718 $37,578
September 30, 1998 $16,698 $16,746 -- $2,010 $35,454
December 31, 1998 $14,813 $17,136 -- $1,654 $33,603
March 31, 1999 $9,443 $16,956 -- $1,540 $27,939
</TABLE>
The portfolio of loans acquired in conjunction with the Palm Springs
Savings Bank acquisition, which experienced a disproportionately high charge-off
rate following the acquisition, totaled $79.5 million in gross principal balance
at March 31, 1999. Of this total, $61.9 million was composed of residential
mortgages and $9.7 million was comprised of loans secured by commercial &
industrial real estate.
Impaired Loans
At March 31, 1999, the Company maintained total gross impaired loans,
before specific reserves, of $9.7 million, constituting 83 credits. This
compares to total gross impaired loans of $10.7 million at June 30, 1998. This
decrease was caused by the Company's continuing to foreclose upon, and generally
subsequently sell, its existing problem credits secured by real estate, the
reinstatement of previously impaired loans combined with evidence of the
capacity for future financial performance, and a limited inflow of new problem
credits due to the strength of the economy, the rebound in Southern California
real estate markets, and the favorable impact of the Company's credit management
program. A total of $1.4 million in specific reserves were established against
impaired loans at March 31, 1999, down from $2.5 million at June 30, 1998. The
average recorded investments in impaired loans during the three and nine months
ended March 31, 1999 were $9.9 million and $10.2 million, respectively.
Of the total impaired loans at March 31, 1999, $2.6 million were either
fully current or exhibited only minor delinquency and were therefore maintained
on accrual status. Interest is accrued on impaired loans on a monthly basis
except for those loans that are 90 or more days delinquent or those loans which
are less than 90 days delinquent but where management has identified concerns
regarding the collection of the credit. For the nine months ended March 31,
1999, accrued interest on impaired loans was $18 thousand and interest of $581
thousand was received in cash. If all non accrual loans had been performing in
accordance with their original loan terms, the Company would have recorded
interest income of $569 thousand during the nine months ended March 31, 1999,
instead of interest income actually recognized on cash payments of $401
thousand.
27
<PAGE> 28
Allowance For Loan Losses
The allowance for loan losses is established through a provision for
loan losses based on management's evaluation of the risks inherent in the loan
portfolio. Management reviews the Bank's loan loss allowance on a monthly basis.
In determining levels of risk, management considers a variety of factors,
including asset classifications, economic trends, industry experience and
trends, geographic concentrations, estimated collateral values, management's
assessment of the credit risk inherent in the portfolio, historical loan loss
experience, and the Bank's underwriting policies. The allowance for loan losses
is maintained at an amount management considers adequate to cover losses in
loans receivable which are deemed probable and estimable. While management uses
the best information available to make these estimates, future adjustments to
the allowances may be necessary due to economic, operating, regulatory, and
other conditions that may be beyond the Bank's control. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to recognize additions to the allowance based on judgments
different from those of management.
The following table presents activity in the Bank's allowances for
estimated loan losses during the nine months ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
Nine Months Ended March 31,
---------------------------
1999 1998
---- ----
(Dollars In Thousands)
<S> <C> <C>
Allowance for Loan Losses:
Balance at June 30 $ 6,271 $ 4,780
Loan chargeoffs:
Residential real estate (362) (446)
Multifamily real estate (125) (197)
Commercial & industrial real estate (336) (313)
Construction --- ---
Land / Lots (12) (288)
Consumer (41) (160)
Commercial business (117) (90)
------- -------
Total chargeoffs (993) (1,494)
Loan recoveries:
Residential real estate 50 ---
------- -------
Total recoveries 50 ---
Provision for estimated loan losses 1,600 2,700
------- -------
Balance at March 31 $ 6,928 $ 5,986
======= =======
Ratio of net charge-offs during the period to average gross loans
net of loans in process outstanding during the period 0.20% 0.36%
March 31, 1999 June 30, 1998
-------------- -------------
Allowance for estimated loan losses as a percent of
nonperforming loans 97.49% 146.64%
Allowance for estimated loan losses as a percent of
gross loans receivable net of loans in process 1.11% 1.06%
</TABLE>
28
<PAGE> 29
Loan charge-offs during fiscal 1999 included $336 thousand for a loan
secured by a retail strip center and $125 thousand for a loan secured by an
apartment complex, both of which were located in Hemet. The ratio of allowance
for estimated loan losses to non accrual loans decreased from 146.64% at June
30, 1998 to 97.49% at March 31, 1999 due to the $2.8 million rise in non accrual
loans during the period. However, specific reserves for loans declined from $2.5
million at June 30, 1998 to $1.4 million at March 31, 1999, in part because of
improved financial performance, property values, and / or updated cash flow
information for certain loans secured by income properties. The ratio of
allowance for estimated losses to gross loans receivable net of loans in process
rose slightly from 1.06% at June 30, 1998 to 1.11% at March 31, 1999, with the
increase concentrated in the quarter ending March 31, 1999, when the Company
recorded net recoveries combined with a $400 thousand provision for estimated
loan losses. At March 31, 1999, 60.8% of the Bank's gross loan portfolio was
comprised of residential real estate loans. Multifamily loans constituted the
next largest segment, at 17.3% of the gross loan portfolio. In addition, 96.3%
of the gross loan portfolio at March 31, 1999 was composed of loans secured by
real estate of various types.
The following presents activity in the Bank's allowances for estimated
real estate losses during the nine months ended March 31, 1999 and 1998:
<TABLE>
<CAPTION>
Nine Months Ended March 31,
---------------------------
1999 1998
---- ----
(Dollars In Thousands)
<S> <C> <C>
Valuation Allowances: Real Estate Acquired Through Foreclosure
Balance at June 30 $ 179 $ 1,020
Net chargeoffs (101) (1,313)
Provision to increase valuation allowances 13 939
------- -------
Balance at March 31 $ 91 $ 646
Valuation Allowances: Real Estate-Development
Balance at June 30 $ 0 $ 577
Net chargeoffs 0 (577)
Provision to increase valuation allowances 0 0
------- -------
Balance at March 31 $ 0 $ 0
Total Valuation Allowances For Real Estate $ 91 $ 646
======= =======
</TABLE>
The Company exited the real estate development business during the
first half of fiscal 1998, after the final two development projects were sold.
The Company's inventory of foreclosed properties (thirteen at March 31,
1999) and repossessed consumer assets is summarized as follows:
Real Estate Acquired By Foreclosure and Repossessed Consumer Assets
March 31, 1999
<TABLE>
<CAPTION>
(Dollars In Thousands) Gross Valuation Net Percent
Type Of Property Balance Reserves Balance Of Total
- ---------------- ------- -------- ------- --------
<S> <C> <C> <C> <C>
Residential 1 - 4 Units $ 778 $ 91 $ 687 83.3%
Multifamily More Than 4 Units 138 0 138 16.7%
Commercial / Industrial 0 0 0 0.0%
Land / Developed Lots 0 0 0 0.0%
Repossessed Consumer Assets 0 0 0 0.0%
------- --------- -------- -----
Total $ 916 $ 91 $ 825 100.0%
======= ========= ======== =====
</TABLE>
Upon acquisition, the Bank accounts for real estate owned through
foreclosure at fair market value less estimated costs to sell. Management
believes that adequate valuation reserves have been established based upon
current market conditions.
29
<PAGE> 30
Comparison Of Operating Results For The Three Months And Nine Months Ended March
31, 1999 and March 31, 1998
General
For the fiscal 1999 third quarter ended March 31, 1999, the Company
reported net income of $971 thousand, equivalent to $0.15 basic and diluted
earnings per share. This compares to a loss of $464 thousand, or $0.07 basic and
diluted loss per share, during the same period during the prior fiscal year. For
the nine months ended March 31, 1999, the Company generated net income of $1.27
million, equivalent to $0.20 basic and $0.19 diluted earnings per share. This
compares to earnings of $765 thousand, or $0.12 basic and diluted earnings per
share during the first nine months of the prior fiscal year.
Primary factors which led to these changes in earnings included:
1. The various impacts, particularly during the first six months of fiscal
1999, stemming from the historically low and flat shape of the Treasury
yield curve.
2. The November, 1998 conclusion of the amortization period for the
Company's final terminated interest rate swap and the maturity of the
Bank's remaining active interest rate swap agreements during January,
1999.
3. Significantly lower provisions for estimated loan losses fiscal 1999
year to date versus the first nine months of fiscal 1998. During the
third quarter of fiscal 1998, the Company recorded substantial credit
related costs in conjunction with the completion of an extensive review
of the Bank's credit portfolio, which included input stemming from a
periodic examination by the Office Of Thrift Supervision, the Bank's
primary federal regulator.
4. Fiscal 1999 acquisition related operating costs of $328 thousand,
including attorney, investment banker, and accountant fees.
5. Fiscal 1999 general & administrative expenses running above prior year
levels due to a combination of business initiatives and particular
events.
The above factors are discussed in more detail in the sections which
follow.
Net Interest Income
Net interest income increased $580 thousand (8.9%) from $6.50 million
during the quarter ended March 31, 1998 to $7.08 million during the most recent
three months. Reduced net interest expense on hedging transactions accounted for
$394 thousand, or 67.9%, of the improvement in net interest income. The figures
for net hedging expense reported by the Company reflect the adoption of SFAS No.
133 as of July 1, 1998. An increase in net interest earning assets also
significantly contributed to the expansion in net interest income.
Net interest income for the nine months ended March 31, 1999 totaled
$19.13 million, up $415 thousand (2.2%) from $18.72 million during the same
period the prior fiscal year, as net interest expense on hedging transactions
declined $529 thousand and average net interest earning assets increased by
22.5%.
30
<PAGE> 31
Net interest income during fiscal 1999 has been constrained by the
unfavorable impacts stemming from the historically low and flat shape of the
Treasury yield curve. As a result of this interest rate environment, the Company
experienced accelerated prepayments, particularly on its portfolios of
adjustable rate mortgage related assets and higher coupon collateralized
mortgage obligations, many of which are owned at a premium to par value, as
customers took advantage of historically low fixed interest rates to refinance.
In addition, the flatness of the yield curve in fiscal 1999 reduced the spread
derived from the Company's net liability sensitive position, pressuring net
interest income, and discouraged borrowers from selecting the adjustable rate
loans that the Company utilizes to build its balance sheet.
The Company's average spread on total assets increased from 2.41%
during the third quarter of fiscal 1998 to 2.77% during the most recent three
months. The Company's average spread on total assets during the first nine
months of the current fiscal year was 2.42%, up from 2.35% for the similar
period the prior fiscal year. During the first nine months of fiscal 1999, the
Company achieved a 30 basis point decrease in the weighted average cost of
deposits, a 33 basis point fall in the weighted average cost of borrowings,
greater ratios of loans to deposits and average interest earning assets to
average interest bearing liabilities, and a reduced loan portfolio concentration
in lower yielding residential mortgages. In addition, during the first nine
months of fiscal 1998, the Company maintained certain short term investment
positions which increased nominal net interest income, but also constrained the
average spread on total assets. The fiscal 1999 accomplishments were, however,
somewhat offset by the aforementioned impacts from the general interest rate
environment and by the imposition of balance sheet composition restrictions
commencing in mid-November with the signing of the definitive agreement to sell
the Company.
The following tables present certain information relating to net
interest income for the three and nine months ended March 31, 1999 and 1998. The
average rates and costs are derived by dividing annualized interest income or
expense by the average balance of assets or liabilities, respectively, for the
periods shown.
31
<PAGE> 32
<TABLE>
<CAPTION>
Three Months Ended March 31, 1999 Three Months Ended March 31, 1998
------------------------------------- -----------------------------------
(Dollars In Thousands) Average Average Average Average
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
ASSETS:
Interest Earning Assets:
<S> <C> <C> <C> <C> <C> <C>
Real Estate Loans, Net (1) 591,380 11,444 7.74% 574,975 11,008 7.66%
Non Real Estate Loans, Net (1) 24,563 606 9.87% 17,544 401 9.14%
Mortgage-backed Securities (2) 198,168 2,890 5.83% 293,699 4,697 6.40%
CMO's (3) 96,474 1,397 5.79% 45,396 743 6.55%
FHLB Stock 8,247 107 5.19% 6,395 85 5.31%
Other Interest Earning Assets (4) 60,820 777 5.11% 85,773 1,703 7.94%
----------- -------- ----- ----------- ------- -----
Total Interest Earning Assets 979,652 17,221 7.03% 1,023,782 18,637 7.28%
Non Interest Earning Assets 43,991 53,967
----------- -----------
TOTAL ASSETS 1,023,643 1,077,749
LIABILITIES & SHAREHOLDERS' EQUITY:
Interest Bearing Liabilities:
Deposits 833,222 9,569 4.59% 822,728 10,037 4.88%
Net Hedging Expense (5) 27 421
Borrowings (6) 45,000 547 4.86% 115,000 1,681 5.85%
----------- -------- ----- ------- ----- -----
Total Interest Bearing Liabilities 878,222 10,143 4.62% 937,728 12,139 5.18%
Non Interest Bearing Liabilities 60,118 55,841
----------- -----------
Total Liabilities 938,340 993,569
Shareholders' Equity 85,303 84,180
----------- -----------
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY 1,023,643 1,077,749
Net Interest Income 7,078 6,498
Interest Rate Spread (7) 2.41% 2.10%
Net Interest Earning Assets 101,430 86,054
Net Interest Margin (8) 2.89% 2.54%
Net Interest Income / Average Total Assets 2.77% 2.41%
Int. Earning Assets / Int. Bearing Liabilities 111.55% 109.18%
</TABLE>
- ------------------------------------------
Average balances in the above table were calculated using average daily balances
for fiscal 1999 and month end balances for fiscal 1998.
1) In computing the average balance of loans, non-accrual loans and loans
held-for-sale have been included.
2) Includes both mortgage-backed securities available-for-sale and
held-to-maturity.
3) Includes both collateralized mortgage obligations available-for-sale and
held-to-maturity.
4) Includes federal funds sold, interest earning deposit accounts, securities
purchased under agreement to resell, and US Government and Agency
obligations.
5) Represents the net expense of interest rate swaps, both active and
terminated.
6) Includes advances from the FHLB, securities sold under agreements to
repurchase, and federal funds purchased.
7) Interest rate spread represents the difference between the average rate on
interest earning assets and the average rate on interest bearing liabilities.
8) Net interest margin equals annualized net interest income divided by average
interest earning assets.
32
<PAGE> 33
<TABLE>
<CAPTION>
Nine Months Ended March 31, 1999 Nine Months Ended March 31, 1998
------------------------------------- -----------------------------------
(Dollars In Thousands) Average Average Average Average
Balance Interest Rate Balance Interest Rate
---------- -------- ------- ---------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Interest Earning Assets:
Real Estate Loans, Net (1) 585,848 34,118 7.76% 528,096 30,727 7.76%
Non Real Estate Loans, Net (1) 23,666 1,559 8.78% 16,317 1,158 9.46%
Mortgage-backed Securities (2) 237,472 10,423 5.85% 292,165 14,179 6.47%
CMO's (3) 103,188 4,306 5.56% 36,935 1,743 6.29%
FHLB Stock 8,130 328 5.38% 6,304 286 6.04%
Other Interest Earning Assets (4) 49,021 2,091 5.69% 129,497 7,538 7.76%
---------- ------ ----- ---------- ------- ----
Total Interest Earning Assets 1,007,325 52,825 6.99% 1,009,314 55,631 7.35%
Non Interest Earning Assets 46,116 54,392
---------- ----------
TOTAL ASSETS 1,053,441 1,063,706
LIABILITIES & SHAREHOLDERS' EQUITY:
Interest Bearing Liabilities:
Deposits 836,522 30,000 4.78% 821,804 30,789 5.00%
Net Hedging Expense (5) 841 1,370
Borrowings (6) 72,812 2,854 5.23% 107,500 4,757 5.90%
---------- ------- ----- ------- ------- ----
Total Interest Bearing Liabilities 909,334 33,695 4.94% 929,304 36,916 5.30%
Non Interest Bearing Liabilities 59,396 51,305
---------- ----------
Total Liabilities 968,730 980,609
Shareholders' Equity 84,711 83,097
---------- ----------
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY 1,053,441 1,063,706
Net Interest Income 19,130 18,715
Interest Rate Spread (7) 2.05% 2.05%
Net Interest Earning Assets 97,991 80,010
Net Interest Margin (8) 2.53% 2.47%
Net Interest Income / Average Total Assets 2.42% 2.35%
Int. Earning Assets / Int. Bearing Liabilities 110.78% 108.61%
</TABLE>
- ------------------------------------------
Average balances in the above table were calculated using average daily balances
for fiscal 1999 and month end balances for fiscal 1998.
1) In computing the average balance of loans, non-accrual loans and loans
held-for-sale have been included.
2) Includes both mortgage-backed securities available-for-sale and
held-to-maturity.
3) Includes both collateralized mortgage obligations available-for-sale and
held-to-maturity.
4) Includes federal funds sold, interest earning deposit accounts, securities
purchased under agreement to resell, and US Government and Agency
obligations.
5) Represents the net expense of interest rate swaps, both active and
terminated.
6) Includes advances from the FHLB, securities sold under agreements to
repurchase, and federal funds purchased.
7) Interest rate spread represents the difference between the average rate on
interest earning assets and the average rate on interest bearing liabilities.
8) Net interest margin equals annualized net interest income divided by average
interest earning assets.
33
<PAGE> 34
Rate / Volume Analysis
The following tables utilize the figures from the preceding tables to
present a comparison of interest income and interest expense resulting from
changes in volumes and the rates on average interest earning assets and average
interest bearing liabilities for the periods indicated. Changes in interest
income or interest expense attributable to volume changes are calculated by
multiplying the change in volume by the prior period average interest rate. The
changes in interest income or interest expense attributable to changes in rate
are calculated by multiplying the change in interest rate by the prior period
average volume. The changes in interest income or interest expense attributable
to the combined impact of changes in volume and changes in interest rate are
calculated by multiplying the change in volume by the change in rate.
<TABLE>
<CAPTION>
Three Months Ended March 31, 1999
Compared To
Three Months Ended March 31, 1998
------------------------------------------------------------------
(Dollars In Thousands) Increase (Decrease) Due To:
------------------------------------------------------------------
Volume Rate Volume / Rate Net
------ ---- ------------- ---
<S> <C> <C> <C> <C>
INTEREST INCOME:
Real Estate Loans, Net $ 314 $ 119 $ 3 $ 436
Non Real Estate Loans, Net 160 32 13 205
Mortgage-backed Securities (1,528) (414) 135 (1,807)
CMO's 836 (86) (96) 654
FHLB Stock 25 (2) (1) 22
Other Interest Earning Assets (495) (608) 177 (926)
-------- -------- -------- --------
TOTAL INTEREST INCOME (688) (959) 231 (1,416)
INTEREST EXPENSE:
Deposit Accounts 128 (588) (8) (468)
Net Hedging Expense 0 (394) 0 (394)
Borrowings (1,023) (284) 173 (1,134)
-------- -------- -------- --------
TOTAL INTEREST EXPENSE (895) (1,266) 165 (1,996)
NET CHANGE IN NET INTEREST INCOME $ 207 $ 307 $ 66 $ 580
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended March 31, 1999
Compared To
Nine Months Ended March 31, 1998
------------------------------------------------------------------
(Dollars In Thousands) Increase (Decrease) Due To:
------------------------------------------------------------------
Volume Rate Volume / Rate Net
------ ---- ------------- ---
<S> <C> <C> <C> <C>
INTEREST INCOME:
Real Estate Loans, Net $ 3,360 $ 28 $ 3 $ 3,391
Non Real Estate Loans, Net 522 (84) (37) 401
Mortgage-backed Securities (2,654) (1,356) 254 (3,756)
CMO's 3,126 (201) (362) 2,563
FHLB Stock 83 (32) (9) 42
Other Interest Earning Assets (4,684) (2,015) 1,252 (5,447)
-------- -------- ------- --------
TOTAL INTEREST INCOME (247) (3,660) 1,101 (2,806)
INTEREST EXPENSE:
Deposit Accounts 551 (1,316) (24) (789)
Net Hedging Expense 0 (529) 0 (529)
Borrowings (1,535) (543) 175 (1,903)
-------- -------- ------- --------
TOTAL INTEREST EXPENSE (984) (2,388) 151 (3,221)
NET CHANGE IN NET INTEREST INCOME $ 737 $ (1,272) $ 950 $ 415
======== ======== ======== ========
</TABLE>
34
<PAGE> 35
Interest Income
Interest income declined from $18.6 million and $55.6 million in the
three and nine months ended March 31, 1998 to $17.2 million and $52.8 million in
the three and nine months ended March 31, 1999, respectively, as a shift in
asset mix toward loans and away from securities was insufficient to offset the
impacts of a generally lower interest rate environment, increased premium
amortization on assets owned with a basis exceeding par, and smaller average
balance sheets. The following table highlights the change in general interest
rate environment between the first nine months of fiscal 1998 and fiscal 1999:
<TABLE>
<CAPTION>
Treasury Bond Equivalent Yield On Bond Equivalent Yield On Bond Equivalent Yield On Bond Equivalent Yield On
------------------------ ------------------------ ------------------------ ------------------------
Security 6/30/97 6/30/98 9/30/97 9/30/98 12/31/97 12/31/98 3/31/98 3/31/99
- -------- ------- ------- ------- ------- -------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
3 month 5.17% 5.09% 5.09% 4.36% 5.34% 4.46% 5.13% 4.47%
6 month 5.25% 5.23% 5.27% 4.47% 5.44% 4.54% 5.25% 4.52%
1 year 5.65% 5.37% 5.44% 4.39% 5.47% 4.52% 5.38% 4.71%
2 year 6.06% 5.48% 5.78% 4.27% 5.64% 4.53% 5.56% 4.98%
5 year 6.37% 5.47% 5.99% 4.22% 5.71% 4.54% 5.61% 5.10%
10 year 6.49% 5.45% 6.11% 4.41% 5.74% 4.65% 5.65% 5.23%
30 year 6.78% 5.63% 6.40% 4.97% 5.92% 5.09% 5.93% 5.62%
</TABLE>
In addition, the 11th District Cost Of Funds Index declined from 4.92% for March
1998 to 4.52% for March 1999.
Interest income on loans rose 5.6% from $11.4 million during the three
months ended March 31, 1998 to $12.1 million during the quarter ending March 31,
1999. For the nine months ended March 31, 1999, interest income on loans rose
11.9% versus the same period during the prior fiscal year. These increases were
primarily generated by an expansion in the Company's loan portfolio and by a
gradual shift in loan mix towards a lower concentration in residential
mortgages. At March 31, 1999, 60.8% of the Company's gross loan portfolio was
comprised of residential mortgages, down from 74.9% one year earlier. Over the
same time period, loans secured by multifamily real estate expanded from 6.2% to
17.3% of gross loans. The rise in interest income on loans would have been
greater if not for the year to year decline in the various indices underlying
the Company's adjustable rate loans. At March 31, 1999, 48.5% of the Company's
gross loans repriced based upon various Treasury indices.
Interest income on mortgage backed securities declined from $4.7
million and $14.2 million for the three months and nine months, respectively,
ended March 31, 1998 to $2.9 million and $10.4 million during the like periods
in fiscal 1999. These reductions stemmed from both reduced average volumes and
lower average effective rates. The lower average effective rates resulted from
declines in indices underlying the Company's adjustable rate mortgage backed
securities and by a significant rise in prepayments on adjustable rate
mortgage-backed securities owned at a premium to par value. The accelerated
payoff of these securities caused a similarly accelerated amortization of the
purchase premiums, depressing yield. The Company experienced this constrained
yield despite concentrating its adjustable rate mortgage backed securities in
seasoned GNMA ARMs, which historically and recently have exhibited relatively
less prepayment volatility than conventional adjustable rate mortgage backed
securities.
Interest income on collateralized mortgage obligations ("CMO's")
increased from $743 thousand and $1.7 million for the three and nine months,
respectively, ended March 31, 1998 to $1.4 million and $4.3 million during the
same periods in fiscal 1999. These increases were due to significantly expanded
volume. Over the past year, the Company has focused a majority of its security
purchases into low duration, fixed rate, AAA rated, private label CMO's due to
concerns over total return volatility for adjustable rate securities and because
of management's plan to build a stream of cash flows off of the securities
portfolio in order to provide liquidity for potential future increases in credit
commitments. The relatively short term of the new CMO purchases therefore
constrained the yield versus what could have been acquired for longer average
lives.
35
<PAGE> 36
Interest income on other earning assets fell significantly in fiscal
1999 when compared to the prior fiscal year due to reductions in both average
rate and average volume. These reductions largely stemmed from the Company's
eliminating its portfolio of long term, fixed rate, callable Agency debentures
in conjunction with its interest rate risk management program. In addition,
restrictions contained in the definitive agreement governing the Company's sale
restrict the profile of investments which the Company may purchase. These
restrictions constrained interest income during the period following the signing
of the document.
Interest Expense
Interest expense on deposits declined from $10.0 million and $30.8
million during the three and nine months ended March 31, 1998, respectively, to
$9.6 million and $30.0 million during the like periods in fiscal 1999.
Reductions in average rate were more than sufficient to offset the effect of
increases in the average balances of interest bearing deposits. The Company has
continued to pursue a series of initiatives to reduce its average cost of funds,
including:
o a sales and incentive emphasis upon transaction accounts in general and
checking accounts in particular
o the introduction of new transaction products aimed at reducing the
funding concentration in certificates of deposit
o the development of new certificate products that default to a roll over
into less costly products upon maturity
o the conduct of relationship based pricing, where higher CD rates are
coordinated with lower cost transaction accounts
o working to attract deposits with factors other than rate, including ATM
access, a transaction capable Internet site, companion loan products
for income property and small business customers, and improved facility
locations and hours of operation
In addition, deposit rates among the Company's competition were lower in fiscal
1999 versus one year earlier due to the decline in general market interest
rates, thereby facilitating the Company's reducing its deposit price points.
Interest expense on borrowings fell from $1.7 million and $4.8 million
during the three and nine months ended March 31, 1998 to $547 thousand and $2.9
million for the same periods in fiscal 1999. These reductions were because of
both smaller average volumes and lower average rates. $65.0 million of the
Company's FHLB advances at June 30, 1998 matured in November, 1998, providing
the Company with the opportunity to reduce its debt level and acquire new FHLB
advances at rates below the maturing advances. In addition, during fiscal 1998,
the Company utilized short term borrowings to fund short term investments to a
much greater extent than occurred in fiscal 1999.
Net interest expense of hedging transactions declined from $421
thousand and $1.4 million during the three and nine months ended March 31, 1998
to $27 thousand and $841 thousand during the same periods in fiscal 1999.
Figures for net hedging expense reflect the Company's adoption of SFAS No. 133
effective July 1, 1998. The reduction in net hedging expense from the fiscal
1998 periods to the fiscal 1999 periods was generated by the maturity of
interest rate swap contracts and the conclusion of the amortization periods for
deferred losses associated with terminated interest rate swaps. As of January
31, 1999, all of the Company's interest rate swap positions matured.
36
<PAGE> 37
Provision For Estimated Loan Losses
Provision for estimated loan losses totaled $400 thousand and $1.6
million in the three and nine months, respectively, ended March 31, 1999. These
figures compare to $2.3 million and $2.7 million during the three and nine
months, respectively, ended March 31, 1998. The substantial provision for
estimated loan losses posted in the third quarter of fiscal 1998 followed an
extensive review of the Bank's credit portfolio in conjunction with a periodic
examination by the Office Of Thrift Supervision, the Bank's primary federal
regulator. This review identified the need to increase provisions for estimated
loan losses as a result of the following factors:
o the appropriateness of expanded general reserves in conjunction with a
significantly increased loan portfolio and in light of peer financial
institution credit experience and reserve levels
o higher charge-off experience in the quarters preceding March 31, 1998,
with such charge-offs disproportionately stemming from the portfolio of
loans acquired through the Palm Springs Savings Bank purchase
o deterioration in individual credits, primarily secured by income
property and land, leading to the need for greater specific reserves
During fiscal 1999, the Company's need to provide for future potential
credit losses has been moderated by the following factors:
o Real estate valuation trends in most of the market areas served by the
Company have remained strong, with improvement in collateral values
providing reduced risk of loss to the Bank.
o Specific reserves declined from $2.5 million at June 30, 1998 to $1.4
million at March 31, 1999, thereby freeing more of the Company's
aggregate allowance for loan losses to address unidentified potential
future losses in the loan portfolio.
o Total criticized plus classified assets declined by $9.6 million during
the nine months ended March 31, 1999.
o The Company's ratio of total allowances for estimated loan losses to
gross loans receivable net of loans in process has expanded from 1.06%
at June 30, 1998 to 1.11% at March 31, 1999.
o The Company's net charge-off experience has improved significantly in
fiscal 1999. Net charge-offs during the first nine months of fiscal
1999 were $943 thousand, down 36.9% from the same period the prior
fiscal year.
o The Company has continued to conduct the enhanced and expanded credit
management process implemented in the latter half of fiscal 1998,
whereby all non-homogeneous credits are reviewed at least annually and
which includes an increased credit monitoring and reporting operation,
augmented by third party review.
37
<PAGE> 38
Other Income & Expense
Other income & expense for the three months ended March 31, 1999 was
$547 thousand in income, up significantly from $123 thousand in income during
the same period the prior fiscal year. For the nine months ended March 31, 1999,
other income & expense totaled $2.1 million in income, comparing favorably to
$204 thousand in expense during the same period in fiscal 1998. Key factors
supporting these improved financial results included:
o Branch & deposit related fee income for the quarter ended March 31,
1999 was $571 thousand, down $69 thousand from the $640 thousand
generated for the like period during the prior fiscal year. This
reduction was caused by $140 thousand in less merchant bankcard gross
income in the most recent quarter following the sale of that portfolio
in March, 1998. Excluding this effect, branch & deposit related fees in
the three months ending March 31, 1999 improved 14.2% versus the
similar quarter during the prior fiscal year. For the nine months ended
March 31, 1999, branch & deposit related fee income totaled $1.8
million, up 6.5% from $1.7 million during the same period the prior
fiscal year despite the sale of the merchant bankcard portfolio. This
rise resulted from an expanded roster of fee based services, the
imposition of new fees, the continued expansion in the number of
transaction accounts, enhanced control over fee waivers, and the
implementation of revised fee and service charge schedules. In
addition, during the quarter ended December 31, 1998, the Company
introduced debit card services to its customers, which constitute a new
source of non interest income to the Bank while providing convenience
for customers making purchases at a wide array of retailers. Moreover,
two branch sites received their first ATM's during fiscal 1999, thereby
creating an additional source of fee income from "foreign"
(non-customer) transactions while also enhancing convenience for the
Bank's customers.
o Results from real estate operations improved from losses of $312
thousand and $953 thousand for the three and nine months ended March
31, 1998 to income of $19 thousand and $217 thousand during the like
periods in fiscal 1999. During fiscal 1999, the Company carried a
comparatively small inventory of foreclosed properties, thereby
moderating operating costs. In addition, due to the continuing price
appreciation in many of the real estate markets in which the Company
operates, a pre-tax gain of $243 thousand on the sale of foreclosed
real estate was recorded during the first nine months of fiscal 1999.
o Net gains on loans held for sale rose to $134 thousand and $385
thousand for the three and nine months ended March 31, 1999 from $56
thousand and $127 thousand for the same periods during the prior fiscal
year, as the Company has continued expanding its mortgage banking
program and has benefitted from the strength of the mortgage loan
refinance market in fiscal 1999, fueled by the continued availability
of residential loans with fixed rates below 7.00%.
o Other income expanded significantly from $54 thousand and $144 thousand
during the three and nine months ended March 31, 1998 to $289 thousand
and $956 thousand during the like periods in fiscal 1999 due to
improved results from the Company's new alternative investment
(non-FDIC insured) sales program, the operation of that program on a
gross (versus net) basis in the current fiscal year, and because of
$145 thousand in aggregate gains on the sale of two former branch
sites. During the first nine months of fiscal 1999, the Company
recorded revenue of $801 thousand from sales of alternative investment
products, up from $111 thousand during the like period the prior fiscal
year.
o Net gains on available-for-sale securities increased from $62 thousand
for the nine months ended March 31, 1998 to $159 thousand during fiscal
1999. During the second quarter of fiscal 1999, $27.9 million in long
term, fixed rate Agency mortgage backed securities were sold in support
of the Company's interest rate risk management program. This sale also
better diversified the Company's investment portfolio, as the Bank had
previously maintained a concentration in 6.50% coupon, traditional
pass-through, mortgage backed securities.
38
<PAGE> 39
General & Administrative Expenses
General & administrative expense rose 12.4% from $5.11 million during
the three months ended March 31, 1998 to $5.75 million during the most recent
quarter. For the first nine months of fiscal 1999, general & administrative
expenses totaled $17.72 million, up $3.22 million (22.2%) from the same period
the prior fiscal year. Factors contributing to the rise in operating costs
included:
o The first nine months of fiscal 1998 included a $533 thousand
non-recurring reduction in salaries & employee benefits expense
associated with a restructuring of the Company's loan to the employee
stock ownership plan ("ESOP").
o $505 thousand in expenses (primarily personnel related) were realized
in fiscal 1999 for the establishment of a commercial lending unit and a
stand alone loan production office in Orange County.
o $328 thousand in acquisition related costs were incurred during fiscal
1999 ($103 thousand in the most recent quarter).
o The conversion of the Company's alternative investment (non-FDIC
insured) product sales program to a gross (versus net) basis as part of
that program's redesign lead to the recognition of $312 thousand in
employee sales commission (compensation) expense during fiscal 1999.
o Training costs were $127 thousand higher in the nine months ended March
31, 1999 versus the same period the prior fiscal year, as the Company
conducted increased training in support of sales effectiveness,
customer service, and the multiple new technologies introduced
throughout the Company in conjunction with its strategic plan.
o The Company introduced a 401(k) benefits plan during fiscal 1999.
Administrative and benefits expenses associated with this plan totaled
$87 thousand during the nine months ended March 31, 1999.
o $91 thousand in employment related litigation settlement costs were
incurred during the nine months ended March 31, 1999, including $41
thousand during the most recent quarter. There were no comparable
expenses during the respective prior year periods.
o In fiscal 1999, the Company "co-sourced" its internal audit function to
an outside party presenting enhanced resources and procedures, but also
higher periodic expenses.
o Credit review expenses were higher during fiscal 1999 compared to the
prior year in conjunction with an expanded credit management function,
which included the recurring use of external credit review specialists
during the current fiscal year.
o Various expenses associated with the implementation of the Company's
strategic plan of converting to a community based financial services
firm were realized during fiscal 1999, including costs for a planned
new loan origination system, opening four new sites for relocated
branches, multiple technology and telecommunications initiatives, the
introduction of debit cards, and the rollout of Internet banking.
39
<PAGE> 40
During fiscal 1999, the Company implemented a frame relay WAN
connecting all of the Company's sites, a new teller system, and a new branch
platform (new accounts) system. Over 10,000 debit cards were issued to current
customers at a cost of $35 thousand. In addition, the Bank switched to a new
transaction capable Internet site operating under 128 bit SSL security
technology. This significant technology program was designed to provide a
foundation for future gains in operating efficiency, improvements in customer
service, and the delivery of a broader range of financial products and services.
This program also furnished the Company with a broad base of technology
certified as Year 2000 compliant by its manufacturer and / or independent third
parties.
As a result of the above increases in general & administrative
expenses, the ratio of general & administrative expenses to average assets
increased from 1.82% during the nine months March 31, 1998 to 2.24% during the
most recent nine months. Due to the increased revenue streams from a number of
the aforementioned initiatives, however, the Company's efficiency ratio rose
less dramatically, increasing from 81.12% for the first nine months of fiscal
1998 to 84.51% during the nine months ended March 31, 1999. For the three months
ended March 31, 1999, the Company's efficiency ratio was 77.09%, comparing
favorably to 79.94% for the same period the prior fiscal year due to increases
in various sources of revenue and improved performance from real estate
operations.
The Company's operating costs during the remaining period before its
proposed acquisition by Temple-Inland, Inc. will most likely be inflated by
significant merger related expenses, including additional fees for investment
banker, attorney, and independent accountant services. At the same time,
revenues may be impaired due to customer and counterparty uncertainty regarding
the potential impacts of the acquisition, likely leading to continued efficiency
ratios above those of peer institutions. Management intends to communicate the
benefits arising from the acquisition. However, no assurance can be provided
concerning the nature and efficacy of such efforts.
Income Taxes
The Company recorded income tax expense of $507 thousand for the three
months ending March 31, 1999, versus an income tax benefit of $327 thousand for
the quarter ended March 31, 1998, as the Company recorded pre-tax income during
the most recent quarter as compared to a pre-tax loss for the same period one
year earlier. Income tax expense increased from $544 thousand during the nine
months ended March 31, 1998 to $661 thousand for fiscal 1999, as the impact of
greater nominal pre-tax income more than offset the effect of a reduction in the
Company's effective book tax rate. The reduction in the effective book tax rate
stems from the fiscal 1999 recapture of valuation allowances established in
prior years for deferred tax assets associated with California State franchise
taxes.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For a current discussion of the nature of market risk exposures, see
"Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Interest Rate Risk Management And Exposure". Readers should also
refer to the qualitative and quantitative disclosures (consisting primarily of
interest rate risk) in the Company's Form 10-K for the fiscal year ending June
30, 1998. There has been no significant change in these disclosures since the
filing of that document.
40
<PAGE> 41
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is not involved in any material pending legal proceedings
other than routine legal proceedings occurring in the ordinary course
of business. Such other routine legal proceedings in the aggregate are
believed by management to be immaterial to the Company's financial
condition or results of operations.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
A. Exhibits
(27) Financial Data Schedule
B. Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter
ended March 31, 1999.
41
<PAGE> 42
SIGNATURES
Pursuant to the requirements of The Securities
Exchange Act Of 1934, the registrant has duly caused
this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HF BANCORP INC.
(Registrant)
Date: May 14, 1999 By: /s/ Richard S. Cupp
--------------------------
Richard S. Cupp
President
Chief Executive Officer
Date: May 14, 1999 By: /s/ Mark R. Andino
--------------------------
Mark R. Andino
Senior Vice President
Chief Financial Officer
42
<TABLE> <S> <C>
<ARTICLE> 9
<CIK> 0000941547
<NAME> HF BANCORP, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 17,453
<INT-BEARING-DEPOSITS> 26
<FED-FUNDS-SOLD> 24,940
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 334,517
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 614,451
<ALLOWANCE> 7,019
<TOTAL-ASSETS> 1,023,139
<DEPOSITS> 885,409
<SHORT-TERM> 0
<LIABILITIES-OTHER> 6,911
<LONG-TERM> 45,000
0
0
<COMMON> 66
<OTHER-SE> 85,753
<TOTAL-LIABILITIES-AND-EQUITY> 1,023,139
<INTEREST-LOAN> 35,677
<INTEREST-INVEST> 17,148
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 52,825
<INTEREST-DEPOSIT> 30,000
<INTEREST-EXPENSE> 33,695
<INTEREST-INCOME-NET> 19,130
<LOAN-LOSSES> 1,600
<SECURITIES-GAINS> 159
<EXPENSE-OTHER> 17,718
<INCOME-PRETAX> 1,931
<INCOME-PRE-EXTRAORDINARY> 1,270
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,270
<EPS-PRIMARY> 0.20
<EPS-DILUTED> 0.19
<YIELD-ACTUAL> 2.53
<LOANS-NON> 7,107
<LOANS-PAST> 0
<LOANS-TROUBLED> 1,363
<LOANS-PROBLEM> 2,618
<ALLOWANCE-OPEN> 6,271
<CHARGE-OFFS> 993
<RECOVERIES> 50
<ALLOWANCE-CLOSE> 6,928
<ALLOWANCE-DOMESTIC> 6,928
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 5,479
</TABLE>
