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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2002
or
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number: 0-28080
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UNITED FINANCIAL CORP.
(Exact Name of Registrant as Specified in its Charter)
MINNESOTA 81-0507591
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
P.O. Box 2779, 120 1st Avenue North, Great Falls, Montana 59403
(Address of Principal Executive Offices)
(406) 727-6106
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of Class)
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
requirements for the past 90 days. YES |X| NO | |
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. | |
Indicate by checkmark whether the Registrant is an accelerated filer
(as defined by Rule 12b-2 of the Securities Exchange Act of 1934).
Yes | | No |X|
The aggregate market value of the voting common stock held by
non-affiliates of the Registrant, as of June 28, 2002 (the last day of the
Registrant's most recently completed second fiscal quarter), was $20,791,494
(based on the last sale price of such stock as quoted on the Nasdaq National
Market ($23.00) on such date).
The number of shares of Registrant's common stock outstanding on
February 28, 2003 was 1,626,150. Registrant's common stock is traded on the
Nasdaq National Market, under the symbol UBMT.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2003 Annual Meeting of
Stockholders are incorporated by reference into Part III of this Form 10-K.
UNITED FINANCIAL CORP.
2002 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS 1
ITEM 2. PROPERTIES 17
ITEM 3. LEGAL PROCEEDINGS 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS 18
ITEM 6. SELECTED FINANCIAL DATA 19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 20
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 34
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 36
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE 36
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 36
ITEM 11. EXECUTIVE COMPENSATION 36
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 36
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 36
ITEM 14. CONTROLS AND PROCEDURES 36
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K 37
SIGNATURES AND CERTIFICATIONS 38
EXHIBIT INDEX 41
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PART I
------
ITEM 1. BUSINESS
GENERAL. United Financial Corp. ("UFC") is a bank holding company
headquartered in Great Falls, Montana, with operations in 12 Montana communities
and Phoenix and Scottsdale, Arizona. UFC's banking business in Montana is
conducted through its wholly-owned subsidiary, Heritage Bank ("Heritage Bank"),
and in Arizona is conducted through Valley Bank of Arizona ("Valley Bank"), the
wholly-owned subsidiary of Valley Bancorp, Inc. ("Valley"), a majority-owned
subsidiary of UFC. Heritage Bank and Valley Bank are collectively referred to
herein as the "Banks". UFC's wholly-owned subsidiary, United Financial-Montana
Capital Trust I ("Capital Trust") was established in 2001 to issue and
administer $3.0 million of Capital Trust Pass-Through Securities. (See Part IV,
Item 15-"Notes to Consolidated Financial Statements-Trust Preferred
Securities"). UFC, Capital Trust, Heritage Bank and Valley are collectively
referred to herein as ("United"). United had assets of approximately $378.0
million, deposits of approximately $287.0 million and stockholders' equity of
approximately $30.5 million at December 31, 2002.
UFC owned approximately 65% of Valley at December 31, 2002. As a result of
acquiring over 50% of the outstanding shares of Valley in January 2000, UFC has
consolidated Valley in its financial statements effective January 1, 2000. The
aggregate purchase price of all shares of Valley purchased by UFC to date is
approximately $7.2 million. Valley had assets of approximately $74.5 million,
deposits of approximately $61.8 million and stockholders' equity of
approximately $8.5 million at December 31, 2002.
Effective January 1, 2001, Heritage Bank F.S.B., a federally-chartered
stock savings bank, merged into Heritage State Bank's state banking charter.
Heritage State Bank ("State Bank") then changed its name to Heritage Bank and
relocated its main office to Great Falls, Montana. Since 2001, Heritage Bank has
been regulated by the FDIC and the State of Montana. Heritage Bank F.S.B. and
State Bank were both wholly-owned subsidiary banks of UFC, prior to their
merger.
Heritage Bank is a state-chartered commercial bank with locations in
Bozeman, Chester, Fort Benton, Geraldine, Glendive, Great Falls, Hamilton,
Havre, Kalispell, Libby, Missoula and Shelby, Montana. In 2003, Heritage Bank
received approval from the State of Montana and the Federal Deposit Insurance
Corporation ("FDIC") to open a full service branch in Billings, Montana, which
is scheduled to be in operation by the end of 2003. Valley Bank is a
state-chartered commercial bank with locations in Phoenix and Scottsdale,
Arizona. The Banks are engaged in the community banking business of attracting
deposits from the general public through their offices and using those deposits,
together with other available funds, to originate commercial (including lease
financing), commercial real estate, residential, agricultural and consumer loans
primarily in their market areas in Montana and Arizona. A majority of the Banks'
banking business is conducted in the Great Falls and Phoenix areas. Based on
total assets, 43% of United's assets are located at Heritage Bank's Great Falls
locations and 18% at Valley Bank's Phoenix location. The Banks also invest in
mortgage-backed securities, U.S. Treasury obligations, other U.S. Government
agency obligations and other interest-earning assets. Heritage Bank also holds a
14% ownership interest in Bankers' Resource Center, a computer data center.
The Banks' financial condition and results of operations, and therefore
the financial condition and results of operations of United, are dependent
primarily on net interest income and fee income. The Banks' financial condition
and results of operations are also significantly influenced by local and
national economic conditions, changes in market interest rates, governmental
policies, tax laws and the actions of various regulatory agencies.
UFC's principal offices are located at 120 First Avenue North, Great
Falls, Montana, and its telephone number is (406) 727-6106.
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UFC makes available all periodic and current reports, free of charge, on
its website as soon as reasonably practicable after such material is
electronically filed with or furnished to the Securities and Exchange Commission
("SEC"). UFC's website address is www.ufcmontana.com. The contents of our
website are not incorporated into this report or into our other filings with the
SEC.
LENDING ACTIVITIES
GENERAL. Lending activities are United's primary source of both interest
income and fee income. United's interest income from loans receivable was
approximately $19.5 million, $22.4 million and $20.9 million, or approximately
83%, 83% and 81% of total interest income, for the years ended December 31,
2002, 2001 and 2000, respectively. United's principal lending activity has been
the origination of real estate loans, including conventional residential real
estate loans (loans which are neither insured nor partially guaranteed by
government agencies) and residential real estate loans insured by the Federal
Housing Administration ("FHA") or partially guaranteed by the Veterans
Administration ("VA"). United also originates agricultual and commercial loans
secured by real estate. In addition to loans secured by real estate, United's
lending activity includes the origination of non-mortgage commercial,
agricultural and consumer loans.
The following table sets forth the composition of United's loans
receivable at December 31, 2002, 2001, 2000, 1999 and 1998:
(Dollars in thousands)
December 31, December 31, December 31,
-------------------------- -------------------------- -------------------------
2002 2001 2000
-------------------------- -------------------------- -------------------------
Amount Percent Amount Percent Amount Percent
------------ ------------ ------------ ------------ ----------- -----------
Loans secured by real
estate:
1 - 4 residential $ 27,551 10.9% $ 32,539 12.3% $ 33,855 13.3 %
5 or more residential 4,693 1.9 5,010 1.9 6,326 2.5
Construction 15,259 6.0 19,384 7.3 12,850 5.0
Agricultural 26,298 10.3 24,655 9.3 24,689 9.7
Commercial 72,993 28.7 77,628 29.5 65,268 25.7
------------ ------------ ------------ ------------ ----------- -----------
Total loans secured by real
estate 146,794 57.8 159,216 60.3 142,988 56.2
Commercial loans 59,428 23.4 60,579 22.9 69,324 27.3
Tax exempt municipal loans 1,469 .6 1,685 .6 1,489 .6
Agricultural loans 14,548 5.7 11,607 4.4 10,469 4.1
Savings account and other
loans 875 .3 1,532 .6 1,138 .5
Second mortgage consumer
loans 5,559 2.2 5,438 2.1 4,745 1.9
Consumer loans 25,331 10.0 23,970 9.1 24,019 9.4
------------ ------------ ------------ ------------ ----------- -----------
Total loans receivable 254,004 100.0% 264,027 100.0% 254,172 100.0 %
============ ============ ===========
Less:
Allowance for loan losses 3,573 3,503 2,526
------------ ------------ -----------
Net loans receivable $250,431 $260,524 $251,646
============ ============ ===========
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(Dollars in thousands) December 31, December 31,
-------------------------- --------------------------
1999 1998
-------------------------- --------------------------
Amount Percent Amount Percent
------------ ----------- ------------ ------------
Loans secured by real estate:
1 - 4 residential $ 34,097 18.1% $ 27,109 18.7%
5 or more residential 5,237 2.8 6,601 4.6
Construction 10,564 5.6 9,224 6.4
Agricultural 16,210 8.6 10,275 7.1
Commercial 30,594 16.3 27,449 18.9
------------ ----------- ------------ ------------
Total loans secured by real
Estate
96,702 51.4 80,658 55.7
Commercial loans 60,060 32.0 37,564 25.9
Tax exempt municipal loans 1,428 .8 1,477 1.0
Agricultural loans 9,805 5.2 8,191 5.7
Savings account and other loans 961 .5 728 .5
Second mortgage consumer loans 7,702 4.1 9,066 6.3
Consumer loans 11,276 6.0 7,160 4.9
------------ ----------- ------------ ------------
Total loans receivable 187,934 100.0% 144,844 100.0%
=========== ============
Less:
Allowance for loan losses 1,586 1,485
------------ ------------
Net loans receivable $186,348 $143,359
============ ============
RESIDENTIAL (NON-CONSTRUCTION) REAL ESTATE LENDING. Residential mortgage
lending constitutes a significant portion of United's lending activities.
United's residential loan originations are conducted by residential loan
production officers in its twelve banking offices, its one loan production
office in Montana and the Scottsdale banking office in Arizona. The greatest
majority of United's residential loan production is secured by properties
located in Montana.
Under United's residential lending policies, most loans originated conform
to Government National Mortgage Association/Federal National Mortgage
Association ("GNMA/FNMA") secondary mortgage market standards and are secured by
residential property with a value of not more than 80% (or 95% if private
mortgage insurance is obtained) of the principal amount of the loan. In
accordance with federal guidelines, an appraisal by an independent licensed or
certified appraiser is required for residential loans in excess of $250,000.
United generally also obtains appraisals or valuations on most residential loans
under $250,000. The terms of United's conventional real estate loans provide
that the loan can be prepaid without penalty and typically include a due-on-sale
clause that provides for acceleration of indebtedness upon the sale or other
disposition of secured property. Evidence of fire, casualty and hazard insurance
with a mortgagee clause in favor of United is required prior to settlement of
residential and commercial real estate loans. Title insurance is generally
required on properties securing such loans.
Most of United's residential loans are originated through personal
contacts of loan officers, including contacts with local realtors, and through
referrals from deposit customers. Although the majority of United's loans are
fixed rate loan products that are subsequently sold, United does offer a variety
of adjustable rate residential loans. The interest rates on variable loans vary
with the movement of the index upon which the interest rates are based. If the
interest rates change, loan payments, balances or terms may be adjusted.
United's primary indexes are the 1, 3 and 5-year constant maturity Treasury
indexes. Most of the ARMs currently originated by United have loan terms of 15
to 30 years with rate adjustments generally every 1, 3 or 5 years during the
term of the loan. Generally, interest rate adjustments on United's ARMs are
limited to changes of 2.5% - 3.25% per year and 6% - 10% for the life of the
loan.
The majority of United's total production of long-term (15 to 30-year
maturity) fixed rate residential loans is originated according to pre-arranged
underwriting standards that result in immediate sale to the secondary market,
primarily to mortgage bankers and pension funds. While origination and sale of
these loans produces fee
3
income, the loans are carried at their outstanding principal balance,
which is the contracted purchase price, and therefore no gain or loss is
realized at sale, except for gains associated with recognizing any retained
mortgage servicing rights. United sold long-term fixed-rate mortgage loans to
the secondary market in aggregate amounts of approximately $196.8 million in
2002, $167.5 million in 2001 and $108.7 million in 2000. United also sells
long-term fixed-rate loans that are refinances of existing portfolio loans or
permanent financing of completed construction loans to the secondary market or
State of Montana housing agencies. These loans are carried at their outstanding
principal balance, which was the contracted purchase price, and therefore no
gain or loss is realized at sale. United retains a limited number of adjustable
rate mortgages and fixed rate mortgage loans up to 15-year maturities for its
own portfolio.
REAL ESTATE CONSTRUCTION LOANS. In addition to permanent real estate
mortgage loans, United also provides interim financing for the construction of
single-family and multi-unit dwellings, commercial real estate and improvements
of real estate. Construction loans are generally made for periods of
approximately nine months, with interest paid at periodic intervals. Such loans
may be extended for several months due to adverse weather conditions or other
justifiable delays in construction. United provides financing primarily for a
limited number of registered contractors who have demonstrated an ability to
complete projects in residential development and construction, have operated in
United's lending area for a number of years and are deemed to be financially
responsible. United also provides construction loans for clients who have made
the decision to construct a new home for their personal use and in that case the
Bank client will choose their own contractor who is then approved by the Banks.
The Banks assure that permanent financing is in place prior to entering into a
construction loan for an individual client.
COMMERCIAL AND AGRICULTURAL REAL ESTATE LOANS. United engages in
commercial real estate lending secured by both commercial and agricultural
properties. Occasionally when making such loans, United participates in the U.S.
Small Business Administration's program for guaranteed commercial real estate
loans. United's loans on commercial and agricultural real estate are primarily
first lien loans with 10 to 15-year maturities and adjustable interest rates
based on U.S. Treasury indexes for 1, 3 and 5 years. While government
regulations limit the level of commercial real estate lending by a financial
institution to 400% of its capital, this limitation has not had a material
impact on the lending activities of the Banks to date.
NON-MORTGAGE COMMERCIAL AND AGRICULTURAL LENDING. In addition to real
estate lending, United offers commercial and agricultural non-mortgage loans.
United offers commercial lines of credit, equipment term loans, working capital
loans and loans guaranteed by the Small Business Administration to its business
customers. It also offers seasonal lines of credit and term equipment loans to
its agricultural borrowers and purchases, on a participation basis, loans
originated outside its normal market areas. Participaion loans are generally
purchased from commercial banks and third party loan production offices.
Generally, these purchased participations allow United to diversify its
geographic risk and are purchased with a higher level of underwriting standards
since a direct customer relationship does not exist.
CONSUMER LENDING. United's consumer loan portfolio includes home equity,
home improvement, line of credit, auto, deposit account, dealer loans and credit
card receivables. United has entered into agreements with certain local
merchants to purchase qualifying conditional sales contracts. United's consumer
lending is conducted at branch offices and United's home offices in Great Falls
and Phoenix. United requires fire, hazard and casualty insurance for loans
secured by home equity and casualty insurance for loans secured by autos and
recreational vehicles. The Banks also maintain an underlying vendors single
interest insurance policy to protect it in the event a loss is incurred to a
non-insured customer vehicle.
INVESTMENT ACTIVITIES
The investment activities of United are designed to provide an investment
alternative for funds not presently required to meet loan demand, assist in
maximizing
4
income, supply collateral to secure public funds and retail repurchase
agreements, provide a means for balancing market and credit risks, and provide
consistent income and market value throughout changing economic times.
Interest income from investment activities was approximately $3.6 million,
$3.9 million and $4.4 million, or approximately 15.3%, 14.4% and 17.1% of
United's total interest income, for the years ended December 31, 2002, 2001 and
2000, respectively.
United's portfolio consists primarily of obligations of the U.S.
government and its agencies, mortgage-backed securities, municipal bonds and
corporate bonds and equity securities. United's investment portfolio does not
contain a concentration of investments in any one issuer in excess of 10% of
United's total investment portfolio, except for securities of the U.S.
government and U.S. government agencies. All of United's investments are
classified as available-for-sale.
The following table sets forth the carrying values of United's investments
at December 31, 2002, 2001 and 2000:
(Dollars in thousands)
December 31, December 31, December 31,
2002 2001 2000
--------------- --------------- --------------
U.S. government and federal agencies $14,031 $30,707 $ 23,872
Mortgage-backed securities 43,255 39,282 41,536
Municipal bonds 1,999 1,745 2,717
Corporate bonds and equity securities 1,651 1,529 1,939
--------------- --------------- --------------
$60,936 $73,263 $ 70,064
=============== =============== ==============
During 2002, United received $22.2 million in mortgage-backed security
principal payments and had $48.0 million of calls and maturities of investment
securities. Sales of investment securities and mortgage-backed securities were
$3.1 million in 2002 and purchases totaled $60.0 million. United recorded an
unrealized gain in market values of its investment portfolio of $.9 million,
before taxes. The increase in principal payments on mortgage-backed securities
and the increase in calls of investment securities are both results of the
unprecedented drops in interest rates during 2002 as compared to 2001. United's
purchases of investment securities increased accordingly to maintain its
investment portfolio.
During 2001, United received $14.6 million in mortgage-backed security
principal payments and had $21.4 million of calls and maturities of investment
securities. United sold $7.8 million of investment securities and
mortgage-backed securities while purchasing $46.3 million in investment
securities and mortgage-backed securities. United recorded an unrealized gain in
market values of its investment portfolio of $.8 million, and a realized gain of
$.2 million, before taxes.
SOURCES OF FUNDS
The primary sources of funds for United's lending and investment
activities are deposits, repurchase agreements, Federal Home Loan Bank ("FHLB")
borrowings, loan and mortgage-backed securities repayments, proceeds from loan
sales, investment securities, interest payments and maturities, and net
operating revenues.
DEPOSIT ACTIVITIES. Deposits are attracted from within United's market
area through the offering of a broad selection of deposit instruments, including
NOW accounts, money market accounts, regular savings accounts, certificates of
deposit and retirement savings plans. Deposit account terms vary, according to
the minimum balance required, the time periods the funds must remain on deposit
and the interest rate, among other factors. In determining the terms of its
deposit accounts, United considers current market interest rates, profitability
to United, matching deposit and loan products offered by its competition and its
customer preferences and concerns. United reviews its deposit mix and pricing
weekly.
5
The following table sets forth the composition of United's deposits at
December 31, 2002, 2001 and 2000:
(Dollars in thousands) December 31, December 31, December 31,
------------------------- ------------------------ -------------------------
2002 2001 2000
------------------------- ------------------------ -------------------------
Type: Amount Percent Amount Percent Amount Percent
------------- ---------- ----------- ----------- ------------ -----------
Non-interest bearing $ 48,227 16.8% $ 46,689 16.5% $ 33,349 12.7%
Interest bearing:
NOW & money market
demand accounts 59,752 20.8 50,990 18.1 52,018 20.0
Savings accounts 50,980 17.8 50,829 18.0 39,033 14.9
Time deposits 128,021 44.6 133,892 47.4 136,779 52.4
------------- ---------- ----------- ----------- ------------ -----------
Total $286,980 100.0% $ 282,400 100.0% $ 261,179 100.0%
============= ========== =========== =========== ============ ===========
Scheduled maturities of certificates of deposit at December 31, 2002 are
as follows:
(Dollars in thousands)
Due within one year $ 88,010
Due within two to three years 35,751
Due within four to five years 4,259
-----------
Totals $128,020
Time deposits of $100,000 or more were approximately $36.1 million, $34.0
million and $30.8 million at December 31, 2002, 2001 and 2000, respectively.
Amounts in excess of $100,000 are not insured by a federal agency.
The maturity of time deposits of $100,000 or more at December 31, 2002 was
as follows:
(Dollars in thousands)
Less than three months $12,194
Three to six months 6,244
Six to twelve months 8,787
Greater than twelve months 8,826
-------
Total $36,051
=======
Early withdrawal from time deposits subjects the depositor to an early
withdrawal penalty which is currently equal to six months of simple, nominal
interest when the original maturity is longer than one year, three months of
simple, nominal interest when original maturity is 92 days to one year, and all
interest earned when original maturity is 91 days or less.
As a matter of policy, United does not accept, place or solicit brokered
deposits. Although deposits are not solicited outside of Montana, historically,
a small number of the Banks' depositors have resided outside Montana and
Arizona. As market demand generally dictates deposit maturities and rates,
United intends to continue to offer those types of accounts that it believes
have broad market appeal.
BORROWINGS. United relies to a significant extent on borrowings from the
FHLB to finance its short-term, and increasingly its longer term, financing
needs. The FHLB functions as the central reserve bank providing credit for
savings institutions and certain other member financial institutions. Borrowings
from the FHLB are available at various maturities, which facilitates the
accurate matching of asset and liability maturity dates. In 2002, United used
these available borrowings to manage interest rate risk.
As members of the FHLB, the Banks are required to own capital stock in the
FHLB and are authorized to apply for advances on the security of specified
collateral.
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Advances are made pursuant to several different credit programs. Each
credit program has its own interest rate and range of maturities. Each of
Heritage Bank's and Valley Bank's established available FHLB advance credit
lines for 2002 was 25% of assets. The FHLB is required to review its credit
limitations and standards at least annually. For the years ended December 31,
2002, 2001 and 2000, FHLB advances averaged $44.8 million, $52.4 million and
$53.4 million, respectively. The maximum outstanding at any month end during the
years ended December 31, 2002, 2001 and 2000 was $46.5 million, $61.8 million
and $63.9 million, respectively. At December 31, 2002, 2001 and 2000, $38.0
million, $50.5 million and $52.2 million, respectively, of FHLB advances were
outstanding. The weighted average interest rate on FHLB advances at December 31,
2002, 2001 and 2000 was 4.56%, 5.65% and 6.57%, respectively.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE. United also generates
funds through the sale of investment securities under agreements requiring their
repurchase at a premium that represents interest. The securities underlying
agreements to repurchase are for the same securities originally sold and are
held in a custody account by a third party. For the years ended December 31,
2002, 2001 and 2000, securities sold under agreements to repurchase averaged
approximately $9.9 million, $8.7 million and $11.5 million, respectively. The
maximum outstanding at any month end during the years ended December 31, 2002,
2001 and 2000 was approximately $13.5 million, $9.6 million and $13.9 million,
respectively. United had $12.8 million, $9.6 million and $11.4 million of
securities sold under agreements to repurchase at December 31, 2002, 2001 and
2000, respectively. The weighted average interest rate on securities sold under
agreements to repurchase at December 31, 2002, 2001 and 2000 was 1.69%, 3.68%
and 6.16%, respectively.
TRUST PREFERRED SECURITIES. In July 2001, UFC issued junior subordinated
debentures, aggregating $3.0 million to United Financial-Montana Capital Trust I
(Trust). The Trust issued preferred securities, as part of a pooled issue, with
an aggregate liquidation amount of $3.0 million ($1,000 per capital security) to
third-party investors. The junior subordinated debentures and cash are the sole
assets of the Trust. The preferred securities are includable as Tier I capital
for regulatory capital purposes. The offering price was $1,000 per capital
security. The junior subordinated debentures and the preferred securities pay
interest and dividends, respectively, on a semi-annual basis, which are included
in interest expense. The variable interest rate resets on January 30 and July 30
of each year, based upon six month LIBOR plus 3.75%. The interest rate reset on
January 30, 2003 was 5.10%. The Trust is a statutory business trust formed under
the laws of the State of Delaware and is wholly-owned by UFC. The junior
subordinated debentures and preferred securities will mature on July 25, 2031.
The junior subordinated debentures and preferred securities can be redeemed
contemporaneously, in whole or in part, after five years at decreasing premiums
with the permission of the Board of Governors of the Federal Reserve System (the
"Federal Reserve"). UFC has provided a full and unconditional guarantee of the
obligations of the Trust in the event of the occurrence of an event of default,
as defined. Debt issuance costs totaling $118,812 were capitalized related to
the debenture offering and are being amortized over the 10-year non-premium
callable life of the preferred securities.
OTHER ACTIVITIES
Heritage Bank also holds a 14% ownership interest in Bankers' Resource
Center, a computer data center, which provides certain data processing services
to Heritage Bank and UFC. Heritage Bank had a wholly-owned service corporation,
CSC, which owned and managed a limited amount of real estate held for investment
during 1999, was inactive during 2000 and was dissolved in 2001.
MARKET AREA
Great Falls, the county seat of Cascade County and a regional trade
center, is one of the largest cities in Montana. The estimated 2002 Great Falls
and Cascade County populations were approximately 57,000 and 80,000,
respectively. The economy of Great Falls is largely based on agriculture, health
care and Department of Defense activities. Malmstrom Air Force Base ("MAFB"),
which employs approximately 4,000
7
people, is the largest employer in Great Falls and Cascade County. Any
significant reduction in size or closure of MAFB would likely adversely affect
United and its results of operations and financial condition.
The economies of Chester, Fort Benton, Geraldine, Glendive, Havre and
Shelby, Montana are dependent to a large extent on agricultural, livestock and
railroad activities. Areas such as Bozeman, Great Falls, Hamilton, Kalispell,
Libby and Missoula are supported in part by tourism, higher education and
natural resources. Nevertheless, agriculture and natural resources are among the
predominant activities in the State of Montana, and any adverse trends in either
of these two industries could adversely affect United and its results of
operations and financial condition.
Phoenix is the largest metropolitan area in Arizona with a population of
approximately 3 million. Arizona was one of the fastest growing states in the
nation, according to the 2000 Census. Arizona's population grew to 5.1 million
or 40% over the past decade, more than triple the national rate. Major
employment industries are service industries, construction in Arizona and light
manufacturing. A slowdown in the real estate economy or manufacturing could
adversely affect United and its results of operations and financial condition.
COMPETITION
The Banks, like other depository institutions, are operating in a rapidly
changing environment and, therefore, face considerable competition in the
attraction of deposits and the origination of loans. Historically, the most
direct competition for deposits has come from other savings banks, credit unions
and commercial banks. There are approximately 39 depository institutions,
commercial banks, credit unions and savings banks with offices in United's
Montana market areas, and approximately 95 in its Arizona market area. In
addition to these entities, United estimates there are approximately 31 mortgage
companies directly competing with its real estate originators in the Montana
market area. Non-depository financial service organizations, primarily in the
securities and insurance industries, have also become competitors for retail
savings and investment funds. United's deposit programs compete with money
market mutual funds, government securities and other investment alternatives.
United competes for deposits by offering a variety of deposit accounts at
interest rates based upon market conditions, convenient business hours, quality
service and convenient branch locations.
EMPLOYEES
At February 28, 2003, Heritage Bank employed 104 full-time employees and
28 part-time employees, and Valley employed 17 full-time employees and 5
part-time employees. United maintains a comprehensive employee benefit program
providing, among other benefits, hospitalization and major medical insurance,
paid sick leave, disability, life insurance and 401K retirement plans. United's
employees are not represented by any collective bargaining group. See Part IV,
Item 14. - "Notes to Consolidated Financial Statements - Employee Benefit
Plans."
8
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information with respect to the executive
officers of UFC. All executive officers are elected annually by the Board of
Directors. There are no arrangements or understandings between individual
officers and any other person pursuant to which he or she was elected as an
officer.
Name Age Position Held
---- --- -------------
John M. Morrison 66 Director of UFC, Heritage Bank and Valley
Kurt R. Weise 46 Chairman and Chief Executive Officer of UFC;
Director and Vice President of Heritage Bank ;
Vice President and Director of Valley and Valley
Bank
Kevin P. Clark 47 Director, Secretary and Senior Vice President of
UFC; Director, President and Chief Executive
Officer of Heritage Bank; Director of Valley
Steve L. Feurt 47 Director, Senior Vice President and Chief Credit
Officer of UFC; Director, Executive Vice
President and Senior Lending Officer of Heritage
Bank
Paula J. Delaney 42 Chief Financial Officer of UFC; Director and
Vice President of Heritage Bank
Mr. Morrison served as Chairman of UFC from February 1998 to his
resignation in January 2003. Mr. Morrison's term of office as director of UFC
expires at UFC's annual shareholder meeting in 2003. Mr. Morrison was elected to
the Valley and Valley Bank boards in March 1996. Prior to February 1998, he
served as Chairman of Heritage Bank since 1994. Mr. Morrison is the Chief
Executive Officer and sole shareholder of Central Bancshares, Inc. ("Central
Bancshares"), the parent company of Central Bank, located in Stillwater,
Minnesota, which was founded by Mr. Morrison in 1988. He is also the sole
shareholder and Chairman of the Board of Directors of Central Financial Services
("CFS"), a bank-consulting firm. In August 2001, Mr. Morrison became Chairman of
the Board of Directors and Chief Executive Officer of Allina Health Systems, a
non-profit organization in Minnesota that provides healthcare services through
hospitals and clinics in Minnesota and Wisconsin. To avoid a conflict of
interest, Mr. Morrison resigned from the boards of Fairview Corporation,
Fairview-University Medical Center and Fairview-University of Minnesota upon
taking the Allina position. He resigned as a director of Valley Bank in October
2002 but continues as a director at Valley. Also in October 2002, Mr. Morrison
resigned as CEO of Allina, but remained as Chairman. In March 2003, Mr. Morrison
resigned as Chairman and remains as Vice Chairman of Allina. Mr. Morrison is
involved in various other businesses, and serves as Chairman of the Executive
Committee of the Board of Trustees of the University of St. Thomas, and is a
member of the board of the University of St. Thomas Law School.
Mr. Weise has served as Chief Executive Officer of UFC since the annual
shareholder meeting in 1999 and became chairman of UFC upon Mr. Morrison's
resignation in January 2003. Mr. Weise has served as President and director of
UFC, and director and Vice President of Heritage Bank, since February 1998. Mr.
Weise's term of office as a director of UFC expires at UFC's annual shareholder
meeting in 2003. Mr. Weise was elected to the Valley and Valley Bank boards in
March 1999. Prior to February 1998, he served as Vice President, Treasurer and a
director of Heritage Bank. Mr. Weise also serves as President of CFS and
President of Central Bancshares. He has been involved in various capacities with
the Central Bank group of companies since they were founded in 1988. He was the
Chief Financial Officer of Bank of Montana Systems ("BMS") until its sale to
Norwest Corporation in 1994.
Mr. Clark has served as Senior Vice President and Secretary of UFC, and
director, President and Chief Executive Officer of Heritage Bank, since February
1998. Mr. Clark was elected as Vice President and a director of UFC in May 1998,
and his term of office as a director of UFC expires at UFC's annual shareholder
meeting in 2003. Mr. Clark was elected to the Valley board in May 2000. Prior to
February 1998, he served as President, Chief Executive Officer and a director of
Heritage Bank since
9
1994. Mr. Clark served in various capacities with BMS until its sale to Norwest
Corporation, including President, Chief Executive Officer and a director of Bank
of Montana, a subsidiary of BMS, and Regional Vice President of BMS.
Mr. Feurt has served as Senior Vice President and Chief Credit Officer of
UFC, and director and Executive Vice President and Senior Lending Officer of
Heritage Bank, since February 1998. Mr. Feurt was elected as a director of UFC
in May 1998, and his term of office as a director of UFC expires at UFC's annual
shareholder meeting in 2005. Prior to February 1998, he served as Senior Vice
President, Senior Credit Officer and a director of Heritage Bank since 1994. Mr.
Feurt served as Senior Vice President, Senior Credit Officer and a director of
BMS and Bank of Montana from 1984 until the sale of BMS to Norwest Corporation.
Ms. Delaney was elected to the Heritage Bank board in October 2000 and has
served as Chief Financial Officer of UFC since January 2001, and as Vice
President of Heritage Bank since December 1998. Previously, Ms. Delaney was
employed in public accounting from 1984 to 1998, with Hamilton Misfeldt & Co.
P.C., a Great Falls based public accounting firm.
SUPERVISION AND REGULATION
UFC is a bank holding company because of its ownership of Heritage Bank, a
Montana- state chartered commercial bank.
Bank holding companies are subject to the general supervision and
regulation by the Federal Reserve Bank ("FRB"). Under the Bank Holding Company
Act of 1956, as amended ("BHCA"), and FRB regulations, a bank holding company
may engage in banking, managing or controlling banks, furnishing or performing
services for banks it controls and conducting activities that the FRB has
determined to be closely related to banking. Bank holding companies must also
obtain the prior approval of the FRB before acquiring 5% or more of the
outstanding shares of another bank or bank holding company and must provide
notice to, and in some situations obtain the prior approval of, the FRB in
connection with the acquisition of 5% or more of the outstanding shares of a
company engaged in a "bank related" business.
Under FRB regulations, a bank holding company is required to serve as a
source of financial and managerial strength to its subsidiary banks and may not
conduct its operations in an unsafe or unsound manner. In addition, it is the
FRB's policy that in serving as a source of strength to its subsidiary banks, a
bank holding company should stand ready to use available resources to provide
adequate capital to its subsidiary banks during periods of financial stress or
adversity. A bank holding company's failure to meet its obligations to serve as
a source of strength to its subsidiary banks will generally be considered by the
FRB to be an unsafe and unsound practice or a violation of FRB regulations, or
both.
Bank holding companies are subject to certain limitations on redemption of
common stock or other equity securities. In addition, the FRB has issued
regulations setting minimum capital standards for bank holding companies.
Depending on the capital classification of a bank holding company, it may be
restricted from engaging in certain non-bank activities or from acquiring
interests in additional banks or other depository institutions. As of December
31, 2002, UFC met the minimum capital requirements issued by the FRB.
Under the BHCA, as amended by the Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "Interstate Act"), a bank holding company
may acquire banks throughout the United States subject only to state or federal
deposit caps and state minimum age requirements. Effective June 1, 1997, the
Interstate Act authorized interstate branching by acquisition and consolidation
in those states that had not opted out by that date. Montana opted out of the
interstate branching by acquisition and consolidation until October 1, 2001. The
State of Arizona adopted the Interstate Act immediately and allows interstate
banking.
10
The Gramm-Leach-Bliley Act of 1999 (the "Financial Services Modernization
Act") came into effect on March 11, 2000. The Financial Services Modernization
Act repeals the two affiliation provisions of the Glass-Steagall Act: Section
20, which restricted the affiliation of Federal Reserve member banks with firms
"engaged principally" in specified securities activities; and Section 32, which
restricts officer, director, or employee interlocks between a member bank and
any company or person "primarily engaged" in specified securities activities. In
addition, the Financial Services Modernization Act contains provisions that
expressly preempt any state law restricting the establishment of financial
affiliation, primarily related to insurance. The general effect of the law is to
establish a comprehensive framework to permit affiliation among commercial
banks, insurance companies, securities firms, and other financial service
providers by revising and expanding the bank holding company framework to permit
a holding company system to engage in a full range of financial activities
through a new entity known as a financial holding company. To date, UFC has not
elected to become a financial holding company.
Bank holding companies that elect to become a financial holding company
may affiliate with securities firms and insurance companies and engage in other
activities that are financial in nature or are incidental or complementary to
activities that are financial in nature. "Financial in nature" activities
include securities underwriting, dealing, and market making, sponsoring mutual
funds and investment companies, insurance underwriting and agency, merchant
banking, and activities that the Federal Reserve, in consultation with the
Secretary of the Treasury, determines from time to time to be so closely related
to banking or managing or controlling banks as to be a proper incident thereto.
United does not believe that the Financial Services Modernization Act has
negatively affected its operations in the near-term. However, to the extent that
the legislation permits banks, securities firms, and insurance companies to
affiliate, the financial services industry may experience further consolidation.
The Financial Services Modernization Act is intended to grant to community banks
certain powers as a matter of right that larger institutions have accumulated on
and ad hoc basis. Nevertheless, this legislation may increase the amount of
competition from larger institutions and other types of companies with
substantially greater resources and a wider variety of financial products than
United currently offers.
Under the Financial Services Modernization Act, federal banking regulators
have adopted rules that limit the ability of banks and other financial
institutions to disclose non-public information about consumers to nonaffiliated
third parties. These limitations require disclosure of privacy policies to
consumers and, in some circumstances, allow consumers to prevent disclosure of
certain personal information to a nonaffiliated third party. The rules were
effective November 13, 2000, but compliance was optional until July 1, 2001.
United has implemented procedures to comply with these rules and believes that
compliance has not adversely affected its operations.
United and its subsidiaries are deemed affiliates within the meaning of
the Federal Reserve Act, and transactions between the affiliates are subject to
certain restrictions. Accordingly, UFC and its respective subsidiaries must
comply with Sections 23A and 23B of the Federal Reserve Act (the "FRA").
Generally, these sections restrict "covered transactions" (i.e., loans,
purchases of assets, guaranties and similar transactions) to a percentage of the
depository institution's capital and surplus, require that such transaction be
appropriately collateralized and require that such transactions be on terms as
favorable to the depository institution as transactions with non-affiliates.
Loans to insiders (officers, directors and 10% shareholders) of a depository
institution are subject to Sections 22(g) and (h) of the FRA and regulations
thereunder. Among other things, such loans must be made on terms substantially
the same as loans to non-insiders.
On October 26, 2001, President Bush signed the Uniting and Strengthening
America by Providing Appropriate Tools Required to Intercept and Obstruct
Terrorism ("USA Patriot Act") of 2001. Among other things, the USA Patriot Act
(1) prohibits banks from providing correspondent accounts directly to foreign
shell banks; (2) imposes due
11
diligence requirements on banks opening or holding accounts for foreign
financial institutions or wealthy foreign individuals (3) required financial
institutions to establish an anti-money-laundering compliance program, and (4)
generally eliminates civil liability for persons who file suspicious activity
reports. The Act also increased governmental powers to investigate terrorism,
including expanded government access to account records. The Department of the
Treasury is empowered to administer and make rules to implement the Act. While
the USA Patriot Act may, to some degree, affect United's record-keeping and
reporting expenses, it does not believe that the Act will have a material
adverse effect on its business and operation. Management believes United is in
compliance with the USA Patriot Act.
DEPOSITORY INSTITUTION SUBSIDIARIES--HERITAGE BANK AND VALLEY BANK.
Effective January 1, 2001, Heritage Bank became a Montana-chartered commercial
bank, having merged into State Bank's commercial bank charter. As such, Heritage
Bank is subject to regulation and supervision by the Montana Department of
Commerce, Division of Banking and Financial Institutions (the "Montana
Division") and the FDIC. Valley Bank is a Arizona-chartered commercial bank and
a member of the Federal Reserve Bank System. As such, Valley Bank is subject to
regulation and supervision by the Arizona State Banking Department (the "Arizona
Department") and the FRB. The Banks' deposits are insured by the FDIC up to
$100,000.
The Montana and Arizona statutes and regulations place limitations on the
business and other activities of Heritage Bank and Valley Bank which may be more
restrictive than limitations applicable to depository institutions that are not
state-chartered commercial banks. In particular, and among other limitations,
the establishment and operation of new branch offices, is limited by, and
subject to approval by, the Montana Division and the Arizona Department. In
addition, state-chartered commercial banks are generally not authorized to make
investments in subsidiary companies or to make other investments in equity
securities or to engage in securities or insurance activities. Some federally
chartered depository institutions located in Montana and Arizona may engage in
such activities without regard to State law.
By reason of FDIC insurance, the Banks are insured depository institutions
for purposes of certain federal laws and regulations. The federal laws that
apply to the Banks regulate, among other things, the scope of their businesses,
their investments, the reserves against deposits, the timing and availability of
deposited funds and certain aspects of their lending activities. These laws and
regulations governing the depository institution activities have generally been
promulgated to protect depositors and not to protect stockholders of such
institutions or their holding companies. These laws and regulations are designed
to ensure that appropriate action is taken to address concerns regarding the
safe and sound operation of insured depository institutions and generally relate
to internal control and information systems, loan documentation and credit
underwriting, asset growth, management performance and earnings. If an insured
depository institution fails to meet the applicable standards and regulatory
requirements, an appropriate banking agency may require that the institution
prepare and submit to the agency an acceptable plan for addressing the
regulatory concern. If the plan submitted is deemed inadequate, or if the
institution fails to submit or comply with the required plan, a banking agency
may take further action with respect to the regulatory concerns, including
institution of an enforcement action with respect to the institution.
The Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA") required federal banking regulators to adopt regulations in a number
of specific areas to insure depository institution safety and soundness,
including internal controls, credit underwriting, asset growth, management
compensation, asset quality and earnings performance. FDICIA also contains
provisions intended to change independent auditing requirements, to restrict the
activities of certain insured depository institutions, to change various
consumer banking laws and to limit the ability of "under-capitalized banks" to
borrow from the FRB's discount window or to acquire brokered deposits.
The Financial Institution Reform, Recovery and Enforcement Act of 1989
("FIRREA") significantly changed existing federal banking legislation and
regulation,
12
including significant increases in FDIC insurance premiums, separation of the
FDIC insurance into two deposit insurance funds, authorizing bank holding
companies to own savings associations, increasing the federal banking agencies'
enforcement powers and increasing the civil and criminal penalties for
violations of federal banking laws and regulations.
The Banks are subject to certain federal consumer laws, including the
Community Reinvestment Act of 1977, as amended ("CRA"), and other fair lending
laws and regulations which impose nondiscriminatory lending requirements on
insured depository institutions. In recent periods, federal regulatory agencies
have sought a more rigorous enforcement of the CRA and other fair lending laws
and regulations. A successful challenge to a depository institution's
performance under the CRA and related fair lending laws and regulations could
result in a variety of sanctions, including the required payment of damages and
civil money penalties, prospective and retrospective injunctive relief and the
imposition of restrictions on mergers and acquisitions or other activities of
the depository institution or the holding companies controlling such depository
institutions. Private parties may also have the ability to challenge an
institution's performance under the fair lending laws in private class action
litigation.
The FDIC conducted a CRA performance evaluation in April 2000 and State
Bank was rated as having had "a satisfactory record in providing for the credit
needs of its assessment area". The OTS conducted a CRA performance evaluation in
July 1999 and Heritage Bank was rated as having had "an outstanding record of
meeting community credit needs".
Federal regulatory banking agencies have also established uniform capital
requirements for all insured depository institutions. An insured depository
institution that does not achieve and maintain required capital levels may be
subject to supervisory action through the issuance of capital directives, cease
and desist orders or other written orders or agreements with the appropriate
federal banking agency. Failure of an insured depository institution to meet the
required capital levels may also prohibit or limit the ability of a bank holding
company controlling such institution to engage in merger and acquisition
activities or other expansion activities. As of December 31, 2002, the Banks met
the "well capitalized" requirements issued by the applicable federal banking
agency.
Depository institutions generally depend upon the difference between the
interest rate paid by them on deposits and other borrowings and the interest
rate received on loans extended to customers and on investment securities. The
interest rates are highly sensitive to many factors beyond the control of
depository institutions, including general economic conditions in their primary
market area and the broader economy. In addition to general economic conditions
affecting business generally, depository institutions such as the Banks are
affected by federal government policies and actions of regulatory agencies. In
particular, the FRB through its various operations and powers may affect
interest rates charged on loans or paid on deposits. Such changes in interest
rates affect the growth and quality of depository institution loans, investments
and deposits.
Federal banking regulatory agencies may institute enforcement actions
against depository institutions, their parent holding companies and other
institution-affiliated parties with respect to violations of any federal law or
regulation. Enforcement actions may include the appointment of a conservator or
receiver, the issuance of cease and desist orders or other formal action,
termination of insurance of deposits and the imposition of civil money
penalties. The Banks are currently not subject to any such enforcement actions.
From time to time, various types of federal and state legislation have
been proposed that would result in additional regulation of, or restrictions on,
the business of depository institutions. It cannot be predicted whether such
legislation will be adopted or how such legislation would affect the business of
the Banks.
13
DEPOSIT INSURANCE AND FDIC REGULATION. As a result of the Heritage Bank
and State Bank merger, effective January 1, 2001, Heritage Bank is a member of
the Savings Association Insurance Fund ("SAIF"), and the Bank Insurance Fund
("BIF"), both administered by the FDIC. Section 5(d) of the Federal Deposit
Insurance Act ("FDI Act"), known as the Oakar Amendment, permits merger
transactions between SAIF- and BIF-member institutions resulting in an
institution with deposits that are proportionally insured by both SAIF and BIF.
Valley Bank is a member of the BIF.
Savings deposits are insured up to the applicable limits (generally
$100,000 per insured depositor) by the FDIC. The FDIC is empowered to impose
deposit insurance premiums, conduct examinations and require reporting by the
Banks. The FDIC may also prohibit the Banks from engaging in any activity the
FDIC determines by regulation or order to pose a serious risk to the FDIC. The
FDIC can also initiate enforcement actions against the Banks, after, in the case
of Heritage Bank, giving the OTS an opportunity to take such action, and may
terminate the deposit insurance of the Banks if it determines that the Banks
have engaged or are engaging in any unsafe or unsound practice, or are in an
unsafe or unsound condition.
For 2002, the FDIC assessment rate for the Banks decreased each quarter
from 1.82 basis points per $100 of insured deposits during the first quarter, to
1.70 basis points for the fourth quarter. As a result, the Banks' 2002 FDIC
deposit insurance premium was approximately $.1 million. FDIC has published
assessment rates for the first and second quarters of 2003, per $100 of insured
deposits, of 1.68 and 1.62 basis points, respectively.
STATE LENDING LIMITS. As of January 1, 2001, Heritage Bank became subject
to a State of Montana lending limit of 20% of capital. The maximum aggregate
amount of loans outstanding to a single borrower at Heritage Bank at December
31, 2002 and 2001 was approximately $2.3 million and $2.2 million, respectively.
At December 31, 2002 and 2001 Heritage Bank was in compliance with the State of
Montana lending limit.
The maximum aggregate amount of loans outstanding to a single borrower at
Valley Bank at December 31, 2002 and 2001 was approximately $1.2 million for
both years. At December 31, 2002 and 2001 Valley Bank was in compliance with the
State of Arizona lending limit.
CAPITAL ADEQUACY. FDIC emphasizes capital as a measure of performance and
establishes a rigid regulatory scheme based almost entirely on capital levels.
The five statutory capital categories established by FDIC are "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." The Banks' capital position
exceeds the definition of "well capitalized." FDIC also mandates that
regulations be promulgated adding other risk-based capital requirements covering
(a) concentrations of credit risk, (b) risks from nontraditional activities and
(c) the capital impact of fair value adjustments associated with FASB Statement
No. 115, "Accounting for Certain Investments in Debt and Equity Securities." See
Part IV, Item 14 - "Notes to Consolidated Financial Statements - Regulatory
Matters."
Federal bank regulatory agencies use capital adequacy guidelines in the
examination and regulation of bank holding companies and banks. If capital falls
below minimum guideline levels, the holding company or bank may be denied
approval to acquire or establish additional banks or nonbank businesses or to
open new facilities.
The FDIC and Federal Reserve use risk-based capital guidelines for banks
and bank holding companies. These are designed to make such capital requirements
more sensitive to differences in risk profiles among banks and bank holding
companies, to account for off-balance sheet exposure, and to minimize
disincentives for holding liquid assets. Assets and off-balance sheets items are
assigned to broad risk categories, each with appropriate weights. The resulting
capital ratios represent capital as a percentage of total risk-weighted assets
and off-balance sheet items. The guidelines are minimums, and the Federal
Reserve has noted that bank holding companies contemplating significant
expansion programs should not allow expansion to diminish their capital ratios
and should maintain ratios well in excess of the
14
minimum. The current guidelines require all bank holding companies and federally
regulated banks to maintain a minimum risk-based total capital ratio equal to
8%, of which at least 4% must be Tier I capital.
Tier I capital for bank holding companies includes common shareholders'
equity, qualifying perpetual preferred stock (up to 25% of total Tier I capital,
if cumulative, although under a Federal Reserve rule, redeemable perpetual
preferred stock may not be counted as Tier I capital unless the redemption is
subject to the prior approval of the Federal Reserve), and minority interests in
equity accounts of consolidated subsidiaries, less intangibles, except as
described above.
The Federal Reserve also employs a leverage ratio, which is Tier I capital
as a percentage of total assets less intangibles, to be used as a supplement to
risk-based guidelines. Except for the most highly rated banks, the minimum
leverage ratio is 4%.
Banks are assigned to one of five capital categories depending on their
total risk-based capital ratio, Tier I risk-based capital ratio, and leverage
ratio, together with certain subjective factors. Banks which are deemed to be
"undercapitalized" are subject to certain mandatory supervisory corrective
actions.
LIQUIDITY. In 2001, as a state-chartered bank, Heritage Bank was not
subject to the same liquidity requirements as the OTS requirements for savings
associations. However, a recent FDIC exam found Heritage Bank's liquidity to be
satisfactory. A June 1999 exam by the Arizona State Banking Commission found
Valley Bank's liquidity to be satisfactory. A June 2002 examination by the FRB
found Valley Bank's liquidity to be satisfactory. Savings associations are
required to maintain qualifying liquid assets equal to a percentage designated
by the Director of the OTS (currently 4%) of the balance of its withdrawable
deposit accounts and borrowings payable in one year or less. Liquid assets for
purposes of this ratio include specified short-term assets (e.g., cash, certain
time deposits, certain banker's acceptances and short-term United States
Government obligations), and long-term assets (e.g., United States Government
obligations and certain state agency obligations). Monetary penalties will be
imposed, unless waived, for failure to meet liquidity requirements. Heritage
Bank exceeded liquidity requirements for 2000.
FEDERAL HOME LOAN BANK SYSTEM. Heritage Bank is a member of the FHLB of
Seattle, Washington . Valley Bank is a member of the FHLB of San Francisco,
California. Each FHLB serves as a reserve or central bank for its members within
its assigned region, is funded primarily from proceeds derived from the sale of
consolidated obligations of the FHLB system and makes loans (advances) to its
members in accordance with the policies and the procedures established by the
FHLB board of directors. All advances from the FHLB are required to be fully
secured by sufficient collateral as is determined by the FHLB. The Banks are
required to purchase and maintain FHLB stock in an amount equal to the greater
of 1% of the unpaid principal of residential mortgage loans, or 5% of FHLB
advances outstanding.
SARBANES-OXLEY ACT OF 2002. United is also subject to the information,
proxy solicitation, insider trading restrictions and other requirements of the
Securities Exchange Act of 1934, including certain requirements under the
Sarbanes-Oxley Act of 2002. On July 30, 2002, President Bush signed into law the
Sarbanes-Oxley Act of 2002 ("the Act") implementing legislative reforms intended
to address corporate and accounting fraud. The Act, which applies to any issuer
that has securities registered, or that is required to file reports, under the
Securities Exchange Act, provides significant revisions to the U.S. securities
laws. Among other things, the Act and the accompanying regulation include the
following:
o Certification and Accountability. The Act requires chief executive officers
and chief financial officers or their equivalent to certify to the accuracy
of periodic reports filed with the SEC, subject to civil and criminal
penalties if they knowingly or willfully violate this certification
requirement.
15
o Criminal Penalty Enhancement. Longer prison terms will also be applied to
corporate executives who violate federal securities laws, the period during
which certain types of suits can be brought against a company or its
officers has been extended, and bonuses issued to top executives prior to
restatement of a company's financial statements are now subject to
disgorgement if such restatement was due to corporate misconduct.
Executives are also prohibited from insider trading during retirement plan
"blackout" periods, and loans to company executives are restricted. In
addition, a provision directs that civil penalties levied by the SEC as a
result of any judicial or administrative action under the Act be deposited
to a fund for the benefit of harmed investors.
o Enhanced Financial Disclosures and Reporting Requirements. The legislation
accelerates the time frame for disclosures by public companies and
insiders, as they must more promptly disclose any material changes in their
financial condition or operations. Directors and executive officers must
also provide information for most changes in ownership in a company's
securities within two business days of the change.
o Audit Committee Independence Requirements. United anticipates that the SEC
will adopt the proposed rules regarding audit committee independence as
final rules on, or around April 26, 2003. The final rules will direct all
national securities exchanges and national securities associated, including
NYSE and NASDAQ, to prohibit the listing of any security of an issuer that
is not in compliance with the audit committee requirements set out in the
proposed rules. United anticipates on being in compliance with the rules
when they become final rules and at such time when the final rules are
applicable to United.
o Financial Expert. The Act also requires issuers to disclose whether at
least one member of the audit committee is a "financial expert" (as such
term will be defined by the SEC) and if not, why not. United is not
required to disclose whether at least one member of its audit committee is
a "financial expert" in this report; however, United will be required to
make such a disclosure in its next annual report for fiscal year ending
2003.
o Code of Ethics. The Act also requires issuers to disclose whether they have
adopted a code of ethics for their senior financial officers, and if not,
the reason therefore, as well as changes to, or waiver of any provision of,
that code of ethics. United is not required to disclose whether it has a
code of ethics in place for its senior financial officers in this report;
however, United will be required to make such a disclosure in its next
annual report for fiscal year ending 2003.
TAXATION
GENERAL. UFC files consolidated Federal and State of Montana income tax
returns pursuant to a tax sharing agreement. Valley files separate consolidated
Federal and State of Arizona income tax returns. Generally, with some
exceptions, including Heritage Bank's reserve for bad debts discussed below, the
Banks are subject to Federal and state income taxes in the same manner as other
corporations.
The following discussion of tax matters is intended solely as a summary
and does not purport to be a comprehensive description of all the tax rules
applicable to the Banks.
TAX BAD DEBT RESERVES. For taxable years beginning prior to January 1,
1996, savings institutions, which met certain definitional tests primarily
relating to their assets and the nature of their business ("qualifying
thrifts"), were permitted to establish a reserve for bad debts and to make
annual additions thereto, which additions may, within specified formula limits,
were deducted in arriving at their taxable income.
16
Federal legislation repealed the reserve method of accounting for bad debt
reserves for tax years beginning after December 31, 1995. As a result, savings
associations could no longer calculate their deduction for bad debts using the
percentage-of-taxable-income method. Instead, savings associations were required
to compute their deduction based on actual charge-offs during the taxable year
or, if the savings association or its controlled group had assets of less than
$500 million, based on actual loss experience over a period of years. This
legislation also required savings associations to recapture into income over a
six-year period their post-1987 additions to their bad debt tax reserves,
thereby generating additional current tax liability. At December 31, 2002,
Heritage Bank's bad debt reserve for tax purposes was approximately $3.5
million. For additional information regarding federal and state income taxes,
see Part IV, Item 14 - "Notes to Consolidated Financial Statements - Income
Taxes."
ITEM 2. PROPERTIES
At December 31, 2002, United owned 12 of its 16 offices, including its
headquarters and other property having an aggregated book value including land
of approximately $5.2 million, and leased the remaining branches. Three
locations are leased in Montana and one office is leased in Arizona. The
following schedule provides property information for the United's locations as
of December 31, 2002.
(Dollars in thousands) Properties Properties Net Leasehold Net Book
Leased Owned Improvements Value Owned
---------- ---------- ------------- -----------
HERITAGE BANK:
Great Falls 1 2 $ 36 $2,155
Bozeman - 1 - 1,250
Missoula - 1 - 793
Havre - 1 - 242
Libby - 1 - 159
Chester - 1 - 147
Shelby - 1 - 131
Fort Benton - 1 - 121
Glendive - 1 - 88
Geraldine - 1 - 74
Kalispell 1 - 102 -
Hamilton 1 - 2 -
---------- ---------- ------------- -----------
Total Montana locations 3 11 $140 $5,160
========== ========== ============= ===========
VALLEY BANK:
Phoenix 1 - $ 38 -
Scottsdale 1 - 772 -
---------- ---------- ------------- -----------
Total Arizona locations 2 - $810 $ -
========== ========== ============= ===========
ITEM 3. LEGAL PROCEEDINGS
Although United was not involved in any material pending litigation as
of February 28, 2003, it is a plaintiff in various legal proceedings arising in
the normal course of business. In the opinion of management, the disposition of
current litigation will not have a material effect on United's consolidated
financial position, results of operations, or liquidity.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders through the
solicitation of proxies or otherwise during the quarter ended December 31, 2002.
17
PART II
-------
ITEM 5. MARKET FOR UFC'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
UFC common stock is quoted on the Nasdaq National Market under the symbol
"UBMT." The closing sale price per share of UFC common stock on February 28,
2003 was $24.20.
SHAREHOLDER DATA
As of February 17, 2003 there were approximately 190 owners of record of
UFC common stock and an estimated 875 additional beneficial holders whose shares
of UFC common stock were held in street name by brokerage houses.
COMMON STOCK MARKET PRuICES
The quarterly (high and low) sale prices for UFC's common stock on the
Nasdaq National Market the past two years were as follows:
UBMT Stock Price
----------------------
High Low
--------- --------
2001 First Quarter $16.75 $15.07
Second Quarter 17.50 16.51
Third Quarter 19.23 17.01
Fourth quarter 18.98 16.96
2002 First Quarter $21.00 $18.35
Second Quarter 24.10 19.50
Third Quarter 23.50 19.61
Fourth quarter 22.40 20.45
DIVIDEND PAYMENT HISTORY ON UFC COMMON STOCK
- --------------------------------------------
The UFC Board declared the following cash dividends for each of the four
quarters of 2001 and 2002, adjusted for the 10% stock dividend in June 2002:
2001 First Quarter $ .23
Second Quarter .24
Third Quarter .24
Fourth quarter .24
------------
$ .95
============
2002 First Quarter $ .25
Second Quarter .25
Third Quarter .25
Fourth quarter .25
------------
$ 1.00
============
The declaration and payment of future dividends by the UFC Board is
dependent upon United's net income, financial condition, economic and market
conditions, industry standards, certain regulatory and tax considerations and
limitations and other conditions. See "Supervision and Regulation." No assurance
can be given, or should be assumed, as to the amount, timing or frequency of
future dividend payments.
18
ITEM 6. SELECTED FINANCIAL DATA
FIVE YEAR SUMMARY OF OPERATIONS AND SELECTED FINANCIAL DATA
(Dollars in thousands, As Of And For The Years Ended December 31,
except per share data) --------------------------------------------------------------------
2002(3) 2001(3) 2000(3) 1999 1998
--------- --------- --------- -------- --------
OPERATING DATA:
Interest income $ 23,637 $ 26,882 $ 25,740 $ 17,517 $ 14,249
Interest expense 10,736 14,824 14,956 9,538 7,393
--------- --------- --------- -------- --------
Net interest income 12,901 12,058 10,784 7,979 6,856
Provision for loan losses 1,170 1,640 1,629 204 335
--------- --------- --------- -------- --------
Net interest income after provision
for loan losses 11,731 10,418 9,155 7,775 6,521
Non-interest income 5,400 4,914 3,837 3,335 3,292
Non-interest expense 12,041 11,168 9,550 7,102 6,147
--------- --------- --------- -------- --------
Income before income taxes 5,090 4,164 3,442 4,008 3,666
Provision for income taxes 1,922 1,633 1,287 1,539 1,399
--------- --------- --------- -------- --------
Net income before minority interest 3,168 2,531 2,155 2,469 2,267
Minority interest (213) (156) (151) -- --
--------- --------- --------- -------- --------
Net income $ 2,955 $ 2,375 $ 2,004 $ 2,469 $ 2,267
========= ========= ========= ======== ========
PER SHARE DATA(1):
Basic earnings per share $ 1.82 $ 1.42 $ 1.11 $ 1.33 $ 1.30
Diluted earnings per share $ 1.79 $ 1.41 $ 1.11 $ 1.33 $ 1.30
Cash dividends per share $ 1.00 $ .95 $ .95 $ .95 $ .68
Book value per share $ 18.74 $ 17.59 $ 16.82 $ 16.16 $ 16.34
Shares used to calculate per share
data (Book Value) 1,626 1,626 1,776 1,817 1,868
Shares used to calculate per share
data (Earnings - basic) 1,626 1,677 1,812 1,852 1,747
Shares used to calculate per share
data (Earnings - diluted) 1,645 1,683 1,812 1,852 1,747
FINANCIAL CONDITION DATA(2):
Assets $ 377,980 $ 382,730 $ 363,801 $270,226 $232,561
Net loans and loans held for sale 264,079 268,238 254,627 187,539 149,076
Investment securities 60,936 73,263 70,064 53,044 51,900
Deposits 286,980 282,400 261,179 179,882 167,620
FHLB advances 38,000 50,500 52,175 46,425 22,175
Other borrowings and securities sold
under agreements to repurchase
13,487 11,604 12,616 11,546 9,451
Stockholders' equity 30,476 28,597 29,947 29,359 30,528
SELECTED FINANCIAL RATIOS AND OTHER
DATA:
Return on average assets .77% .64% .57 % .98 % 1.06 %
Return on average stockholders'
equity 10.06 8.21 6.87 8.44 7.47
Net interest margin 3.60 3.42 3.31 3.40 3.34
Efficiency ratio 65.79 65.80 65.32 62.77 60.58
Net charge-offs to average loans .42 .25 .44 .06 .03
Nonperforming loans to total loans .38 .91 .46 .18 .68
Allowance for loan losses to total
loans 1.40 1.33 .99 .84 1.03
Nonperforming loans to allowance for
loan losses 27.36 68.74 45.96 21.88 66.07
Average equity to average assets 7.66 7.69 8.37 11.62 14.17
Dividend payout ratio 54.30 66.40 85.52 70.94 56.18
(1) Share and per share amounts in 1998 have been restated to retroactively
reflect the issuance of 475,000 shares of United common stock in
exchange for all outstanding shares of common stock of Heritage. All
years have been restated for the effect of the June 2002 10% stock
dividend.
(2) At year end.
(3) Includes Valley Bancorp. Inc.
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS. This Annual Report on Form 10-K contains
forward-looking statements. Statements that are not historical or current facts,
including statements about beliefs and expectations, are forward-looking
statements. Forward-looking statements involve inherent risks and uncertainties,
and important factors could cause actual results to differ materially from those
anticipated, including the following. In addition to those contained in United's
reports on file with the SEC; (i) general economic or industry conditions could
be less favorable than expected, resulting in a deterioration in credit quality,
a change in the allowance for loan losses, or a reduced demand for United's
products and services (ii) changes in the domestic interest rate environment
could reduce net interest income and could increase loan losses; (iii) changes
in the extensive laws, regulations and policies governing financial services
companies could alter United's business environment or affect operations; (iv)
the potential need to adapt the industry changes in information technology
systems, on which United is highly dependent, could present operational issues
or require significant capital spending; (v) competitive pressures could
intensify and affect United's profitability, including as a result of continued
industry consolidation, the increased availability of financial services from
non-banks, technological developments, or bank regulatory reform; (vi) the
impact of weather conditions in the geographic markets and business areas in
which United conducts it business; and (vii) capital investments in United's
businesses may not produce expected growth in earnings anticipated at the time
of the expenditure. Forward-looking statements speak only as of the date they
are made, and United undertakes no obligation to update them in light of new
information of future events.
GENERAL. UFC is the result of the combination on February 3, 1998("the
Heritage Merger") of two Montana-based savings and loan holding companies:
Heritage Bancorporation ("Heritage") and United Financial Corp. (as it existed
prior to the merger, "Old United"). Although UFC was the surviving corporation,
the merger was treated as a reverse merger for accounting purposes because the
stockholders and management of Heritage controlled the operation of UFC after
the Heritage Merger. Using purchase accounting, the historical financial
statements of UFC included in this Report for periods preceding the Heritage
Merger reflect only the operations of Heritage, while the historical financial
statements for periods after the Heritage Merger reflect combined operations.
20
SELECTED UNITED FINANCIAL DATA
The following results of operations for 2002, 2001 and 2000 is derived
from the audited consolidated financial statements.
(In thousands, December December December
except per share data) 31, 31, 31,
-------- -------- --------
2002 2001 2000
-------- -------- --------
Total interest income $ 23,637 $ 26,882 $ 25,740
Total interest expense 10,736 14,824 14,956
-------- -------- --------
Net interest income 12,901 12,058 10,784
Provision for loan losses 1,170 1,640 1,629
-------- -------- --------
Net interest income after
Provision for loan losses
provision for loan losses 11,731 10,418 9,155
Total non-interest income 5,400 4,914 3,837
Total non-interest expense 12,041 11,168 9,550
-------- -------- --------
Income before income taxes 5,090 4,164 3,442
Provision for income tax expense 1,922 1,633 1,287
-------- -------- --------
Net income before minority interest 3,168 2,531 2,155
--------
-------- --------
Minority interest (213) (156) (151)
-------- -------- --------
Net income $ 2,955 $ 2,375 $ 2,004
======== ======== ========
Net income per share - basic $ 1.82 $ 1.42 $ 1.11
======== ======== ========
Weighted average shares
outstanding - basic 1,626 1,677 1,812
======== ======== ========
Net income per share - diluted $ 1.79 $ 1.41 $ 1.11
======== ======== ========
Weighted average shares
outstanding - diluted 1,645 1,683 1,812
RESULTS OF OPERATIONS
Net income for 2002 was $3.0 million, an increase of $.6 million from
2001. Net interest income increased $.8 million or 7.0% and the provision for
loan losses decreased $.5 million, resulting in a total increase of $1.3 million
or 12.6% in net interest income after provision for loan losses. The majority of
the $.5 million increase in non-interest income was the result of the increase
in gain on sale of loans generated by United's mortgage lending activities in
2002. Salaries and commissions are the bulk of the $.8 million increase in
non-interest expense in 2002.
United's net income, and more specifically its net interest income, for
2002 was also affected by the following two interest related events which
occurred in December 2002. Heritage Bank incurred prepayment penalties when it
repaid $8.0 million in FHLB advances prior to their scheduled maturity dates in
the form of interest expense on the repayments. Heritage Bank also incurred a
writedown of loan premium of $.2 million, which was also charged against net
income in the form of interest expense.
Net income was $2.4 million in 2001 as compared to $2.0 million in 2000.
Increased loan volumes in 2001 were the primary reason for increased interest
income. Net interest income increased $1.3 million, or 11.8%, to $12.1 million
in 2001 from $10.8 million in 2000. Non-interest income increased $1.1 million,
or 28.9%, in 2001 compared to 2000. Non-interest expense increased $1.6 million,
or 16.7% in 2001 as compared to 2000.
NET INTEREST INCOME. Like most financial institutions, the most
significant component of United's earnings is net interest income, which is the
difference between the interest earned on interest-earning assets (loans,
investment securities, mortgage-backed securities and other interest-earning
assets), and the interest paid on deposits and borrowings. This amount, when
divided by average interest-earning assets, is referred to as the net interest
margin and expressed as a percentage. Net
21
interest income and net interest margin are affected by changes in interest
rates, the volume and the mix of interest-earning assets and interest-bearing
liabilities, and the level of non-performing assets. The difference between the
yield on interest-earning assets and the cost of interest-bearing liabilities
expressed as a percentage is referred to as the net interest rate spread.
The following table illustrates the changes in United's net interest
income due to changes in volume and changes in net interest income due to
changes in rates:
(Dollars in thousands) Year Ended December 31, Year Ended December 31,
2002 vs. 2001 2001 vs. 2000
------------------------------------- --------------------------------------
Increase (decrease) due to Increase (decrease) due to
------------------------------------- --------------------------------------
Rate/ Rate/
Volume Rate Volume Total Volume Rate Volume Total
------ ------- ------ ------- ------- ----- ------ -------
Interest earning assets:
Loans $(278) $(2,633) $ 33 $(2,878) $ 1,888 $(425) $ (38) $ 1,425
Investment and mortgage
backed securities 103 (352) (9) (258) (232) (316) 17 (531)
Other interest earning
assets
310 (282) (136) (108) 491 (108) (135) 248
----- ------- ----- ------- ------- ----- ----- -------
Total interest earning
assets 135 (3,267) (112) (3,244) 2,147 (849) (156) 1,142
Interest bearing
liabilities:
Interest bearing
checking 193 (508) (78) (393) 335 (645) (126) (436)
Savings deposits (45) (458) 14 (489) 529 (261) (102) 166
Time deposits 80 (2,580) (25) (2,525) 183 312 7 502
Borrowings (322) (323) (36) (681) (293) (191) 121 (363)
----- ------- ----- ------- ------- ----- ----- -------
Total interest bearing
liabilities (94) (3,869) (125) (4,088) 754 (785) (100) (131)
----- ------- ----- ------- ------- ----- ----- -------
Net interest income $ 229 602 13 844 $ 1,393 $ (64) $ (56) $ 1,273
===== ======= ===== ======= ======= ===== ===== =======
22
The following tables set forth average balances for interest-earning
assets and interest-bearing liabilities, the interest and yield on interest
earning assets, the interest and rate paid on interest bearing liabilities, the
net interest income and net interest spread, and the net interest margin for the
years indicated:
Average Balance Sheet
(Dollars in thousands)
Year Ended December 31, 2002
--------------------------------------
Average Average
Balance Interest Yield/Rate
--------- --------- ----------
Interest earning assets:
Loans (1) $264,983 $ 19,497 7.36 %
Investment and mortgage backed
securities 70,492 3,605 5.11 %
Other interest earning assets 23,006 536 2.33 %
--------- --------- ----------
Total interest earning assets 358,481 23,638 6.59 %
Non-interest earning assets 25,022
---------
Total assets $383,503
=========
Interest bearing liabilities:
Interest bearing checking $ 98,570 879 .89 %
Savings deposits 53,156 1,026 1.93 %
Time deposits 131,557 5,625 4.28 %
Borrowings 58,608 3,206 5.47 %
--------- --------- ----------
Total interest bearing liabilities $341,891 10,736 3.14 %
=========
Stockholders' equity 29,389
=========
---------
Net interest income $ 12,902
=========
Net interest spread 3.45 %
Net interest margin(2) 3.60 %
Average Balance Sheet
(Dollars in thousands)
Year Ended December 31, 2001
--------------------------------------
Average Average
Balance Interest Yield/Rate
--------- --------- ----------
Interest earning assets:
Loans (1) $268,322 $ 22,376 8.34 %
Investment and mortgage
backed securities 68,648 3,863 5.63 %
Other interest earning assets 15,527 643 4.14 %
--------- --------- ---------
Total interest earning assets 352,497 26,882 7.63 %
Non-interest earning assets 23,866
---------
Total assets $376,363
=========
Interest bearing liabilities:
Interest bearing checking $ 85,570 1,271 1.49 %
Savings deposits 54,789 1,515 2.77 %
Time deposits 130,275 8,150 6.26 %
Borrowings 64,203 3,888 6.06 %
--------- --------- ---------
Total interest bearing liabilities $334,837 14,824 4.43 %
=========
Stockholders' equity $ 28,935
=========
---------
Net interest income $ 12,058
=========
Net interest spread 3.20 %
Net interest margin(2) 3.42 %
(1) Includes nonaccrual loans.
(2) Computed on a fully taxable basis, without regard to tax equivalent yields.
23
Average Balance Sheet
(Dollars in thousands)
Year Ended December 31, 2000
--------------------------------------
Average Average
Balance Interest Yield/Rate
--------- --------- ----------
Interest earning assets:
Loans (1) $246,137 $ 20,951 8.51 %
Investment and mortgage
backed securities 72,469 4,394 6.06 %
Other interest earning assets 6,920 395 5.71 %
--------- --------- --------
Total interest earning assets 325,526 25,740 7.91 %
Non-interest earning assets 23,116
---------
Total assets $348,642
=========
Interest bearing liabilities:
Interest bearing checking $ 71,541 1,707 2.39 %
Savings deposits 39,347 1,349 3.43 %
Time deposits 127,226 7,648 6.01 %
Borrowings 67,604 4,252 6.29 %
--------- --------
---------
Total interest bearing liabilities $305,718 14,956 4.89 %
=========
Stockholders' equity $ 29,185
=========
---------
Net interest income $10,784
=========
Net interest spread 3.02 %
Net interest margin(2) 3.31 %
(1) Includes nonaccrual loans.
(2) Computed on a fully taxable basis, without regard to tax equivalent yields.
United's net interest income increased $.8 million to $12.9 million in
2002 from $12.1 million in 2001, and increased $1.3 million in 2001 from $10.8
million in 2000.
As illustrated in the preceding tables, the principal reason for the
increase in net interest income from 2001 to 2002, was a change in the rates on
United's interest earning assets and liabilities. Interest income decreased $3.3
million in 2002 as compared to 2001. Decreased loan volumes, and more
importantly decreased rates, represented $2.9 million of this decrease.
Decreases in rates on investment securities contributed to a further decrease of
$.3 million. The remaining $.1 million decrease in interest income came from
lower rates on other interest earning assets.
The principal reason for the increase in net interest income from 2000 to
2001 was an increase in the volume of United's interest earning assets. Interest
income increased $1.1 million in 2001 as compared to 2000. Increased loan
volumes, offset by decreased rates, represented $1.4 million of this increase.
Decreases in volumes of investment securities and in rates partially offset the
increases from loans receivable.
Rates paid on deposits decreased dramatically from 2001 to 2002 and from
2000 to 2001 due to rate cuts by the FRB. The decreased interest income in 2002
was more than offset by the decreased interest expense resulting from decreases
in deposit rates of $3.4 million and borrowing rates of $.7 million for a total
decrease of $4.1 million in interest expense in 2002.
Decreases due to rates in 2001 were $.6 million in deposits and $.2
million in borrowings. Increased volumes in deposits offset the rate decreases
somewhat for a net decrease of $.1 million in interest expense in 2001 compared
with 2000. The $.1
24
million decrease in interest expense in 2001 and the $1.2 million increase in
interest income combined for a net interest income increase for United of $1.3
million from $10.8 million in 2000 to $12.1 million in 2001.
PROVISION FOR LOAN LOSS. United provided $1.2 million for loan losses in
2002 compared to $1.6 million in both 2001 and 2000. The slight decrease in the
loan loss provision in 2002 reflects management's estimate of the improvement in
loan quality during 2002.
The provision for loan losses is determined by management as the amount to
be added to the allowance for loan losses after net charge-offs have been
deducted to bring the allowance to a level which is considered adequate to
absorb losses inherent in the loan portfolio in accordance with accounting
principles generally accepted in the United States of America ("GAAP"). Future
additions to United's allowance for loan losses and any change in the related
ratio of the allowance for loan losses to non-performing assets are dependent
upon the performance and composition of United's loan portfolio, the economy,
inflation, changes in real estate values and interest rates and the view of the
regulatory authorities toward adequate reserve levels.
United has identified its most critical accounting policy to be that
related to the allowance for loan losses. United's allowance for loan losses
methodology incorporates a variety of risk considerations in establishing an
allowance for loan losses that management believes is appropriate. Risk factors
include historical loss experience, delinquency and charge-off trends,
collateral values and an internal loan grading system adopted by the Banks.
Other factors include the general economic environment in United's markets and,
in particular, the state of certain industries. Changes in any of the above
factors could have a significant affect on the calculation of the allowance for
loan losses in any given period.
NON-INTEREST INCOME. In addition to net interest income, United generates
significant non-interest income from a range of retail banking services,
including mortgage banking activities and service charges for deposit services.
Non-interest income increased by $.5 million, or 10%, in 2002 to $5.4 million
compared to $4.9 million in 2001, primarily due to the continued increase in
gain on sale of loans from the real estate production activity at the Banks in
2002. Non-interest income increased $1.1 million, or 29%, in 2001 to $4.9
million compared to $3.8 million in 2000. This increase was directly the result
of additional real estate loan production activity at the Banks during 2001.
NON-INTEREST EXPENSE. Non-interest expense increased $.8 million, or 7.1%,
to $12.0 million in 2002, and increased $1.6 million, or 16.7%, to $11.2 million
in 2001. Salary and employee benefit expense increased $.6 million in 2002
largely from salary and bonus increases. Occupancy and equipment expenses
increased $.2 million in 2002. Salary and employee benefit expense represented
$.8 million of the 2001 increase and was the result of additional staffing and
salary increases for existing employees. The remaining $.8 million increase in
2001 was primarily due to higher occupancy expense due in part to significantly
higher utility costs in 2001 as well as additional costs at the new branch
locations.
INCOME TAXES. Income tax expense increased $.3 million in both 2002 and
2001, to $1.9 million for 2002 and to $1.6 million for 2001. The increase is
consistent with the increase in income before taxes. Income tax expense averages
approximately 38% of income before income taxes.
FINANCIAL CONDITION
GENERAL. United's total assets decreased $4.7 million to $378.0 at
December 31, 2002 from $382.7 million at December 31, 2001. The 2002 decrease in
assets included a $4.2 million decrease in loans receivable and loans held for
sale, a $12.4 million decrease in securities available-for-sale, offset by an
$11.2 million increase in cash and cash equivalents. Other assets increased $.7
million in 2002.
25
LOANS RECEIVABLE AND LOANS HELD FOR SALE. Net loans receivable decreased
$10.1 million during 2002 to $250.4 million at December 31, 2002 from $260.5
million at December 31, 2001. Construction loans decreased $4.1 million, 1-4
family residential loans decreased $4.9 million and commercial real estate loans
decreased $4.6 millioN. The decrease in 5 or more residential loans was $.4
million. Agricultural real estate loans increased $1.6 million for a net
decrease in loans secured by real estate of $12.4 million. Commercial
non-mortgage loans decreased $1.2 million in 2002 while agricultural
non-mortgage loans increased $2.9 million. Consumer and other loans increased
$.6 million for a decrease in total loans receivable of $10.1 million.
The diverse loan portfolio includes: real estate residential mortgages,
commercial and agricultural mortgages, agricultural and commercial
non-mortgages, consumer loans secured by real estate, and various consumer
installment loans. The Banks also purchase and participate in commercial and
lease financing loans. The Banks had $41.3 million and $44.4 million of
participation and purchased loans as of December 31, 2002 and 2001,
respectively.
Heritage Bank sells and retains servicing for a portion of its residential
real estate loans to agencies of Montana such as the Montana Board of
Investments and the Montana Board of Housing. Heritage Bank recognizes mortgage
servicing rights as an asset regardless of whether the servicing rights are
acquired or retained on loans originated and subsequently sold. The mortgage
servicing rights are assessed for impairment based on the fair value of the
mortgage servicing rights. In November 2000, Heritage Bank entered into an
agreement with an unrelated third party to sell all of its servicing rights
associated with Montana Board of Housing loans existing at November 30, 2000
which had outstanding principal balances of approximately $49.6 million. The
sales price was 1.03% of the outstanding principal balance at close of business
November 30, 2000, or approximately $510,000. A gain on the sale of
approximately $.3 million is included in other non-interest income for the year
ended December 31, 2000. At December 31, 2000, Heritage Bank had a receivable
related to the sale of approximately $.3 million, which was collected in March
2001. The receivable is included in other assets in the consolidated statement
of financial condition. As of December 31, 2002 and 2001, the carrying value of
originated servicing rights was approximately $.2 million and $.1 million,
respectively. Heritage Bank's servicing portfolio as of December 31, 2002 was
$29.6 million and as of December 31, 2001 was $17.2 million.
Approximately $49.5 million of the servicing portfolio at December 31,
2000 was being serviced under a short-term sub-servicing agreement which expired
in February 2001.
During 2002, loans held for sale by United increased $5.9 million to $13.6
million at December 31, 2002 from $7.7 million at December 31, 2001.
Approximately $202.9 and $172.2 million of loans were originated for sale and
$196.8 and $167.5 million of loans were sold to the secondary market during the
years ending December 31, 2002 and 2001, respectively.
SECURITIES AVAILABLE-FOR-SALE. United's securities available-for-sale
decreased $12.4 million to $60.9 million at December 31, 2002 as compared to
$73.3 million at December 31, 2001. In 2002, United's purchases of securities
available-for-sale were approximately $60.0 million while proceeds from sales,
maturities and paydowns totaled approximately $73.4 million. United also
recorded an unrealized gain in market values of approximately $.9 million in
2002 and a realized gain on sales of $.1 million.
United has identified its accounting method for securities
available-for-sale to be a critical accounting policy. Securities
available-for-sale are carried at fair value and unrealized gains and losses
(net of related tax effects) are excluded from earnings and reported as a
separate component of stockholders' equity. While fair values are determined per
market quotes from independent brokers and not subject to management estimation,
the carrying value of the securities is subject to market variations. At
December 31, 2002, 2001 and 2000, the unrealized gain (loss) on securities
available-for-sale to mark them to market was $1.5 million, $.6 million and $(.1
million), respectively. (See Part IV, Item 15-"Notes to Consolidated Financial
Statements - Securities Available-For-Sale").
26
CASH AND CASH EQUIVALENTS. Cash and cash equivalents increased $11.2
million during 2002 to $33.2 million at December 31, 2002 from $22.0 million at
December 31, 2001. Net cash used by operating activities, or net income adjusted
for non-cash items, was $1.6 million in 2002. Net cash provide