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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
Commission file number...................................................0-18046
FIRST FEDERAL CAPITAL CORP
(Exact name of Registrant as specified in its charter)
WISCONSIN 39-1651288
(State or other jurisdiction of (IRS employer
incorporation or organization) identification no.)
605 STATE STREET
LA CROSSE, WISCONSIN 54601
(Address of principal executive office) (Zip code)
Registrant's telephone number, including area code: (608) 784-8000
Securities registered pursuant to Section 12(b) of the Act: NOT APPLICABLE
Securities registered pursuant to Section 12(g)of the Act:
COMMON STOCK, PAR VALUE $.10 PER SHARE
PREFERRED STOCK PURCHASE RIGHTS
(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 such shorter period as the Registrant
has been subject to such requirements), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate value of the common stock of the Registrant that was held by
non-affiliates as of most recently completed second fiscal quarter (June 30,
2002), was approximately $356.8 million. This amount was based on the closing
price of $22.10 per share of the Registrant's common stock as of the same date.
Indicate by check mark if the Registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2). Yes [X] No [ ]
The number of shares of common stock of the Registrant outstanding as of March
3, 2003, was 19,702,712 (net of 513,221 shares held as treasury stock).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2003 Annual Meeting of Stockholders are
incorporated into Part III, Items 10 through 13 of this Form 10-K.
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FORM 10-K TABLE OF CONTENTS
Page
PART I
Item 1--Business.................................................................................. 2
Item 2--Properties................................................................................ 15
Item 3--Legal Proceedings......................................................................... 15
Item 4--Submission of Matters to a Vote of Security Holders....................................... 15
PART II
Item 5--Market for Registrant's Common Equity and Related Stockholder Matters..................... 16
Item 6--Selected Financial Data................................................................... 17
Item 7--Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................................ 18
Item 7A--Quantitative and Qualitative Disclosures about Market Risk............................... 37
Item 8--Financial Statements and Supplementary Data............................................... 40
Item 9--Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................................ 72
PART III
Item 10--Directors and Executive Officers of the Registrant....................................... 73
Item 11--Executive Compensation................................................................... 73
Item 12--Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters...................................................................... 73
Item 13--Certain Relationships and Related Transactions........................................... 73
PART IV
Item 14--Controls and Procedures.................................................................. 73
Item 15--Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................... 73
SIGNATURES................................................................................................ 76
CERTIFICATION............................................................................................. 78
EXHIBITS.................................................................................................. 81
1
FORWARD-LOOKING STATEMENTS
This report includes certain forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. Such statements
include words and phrases such as "will likely result", "are expected to", "will
continue", "is anticipated", "is estimated", "is projected", "intends to", or
similar expressions. Forward-looking statements are based on management's
current expectations. Examples of factors which could cause future results to
differ from management's expectations include, but are not limited to, the
following: general economic and competitive conditions; legislative and
regulatory initiatives; monetary and fiscal policies of the federal government;
general market rates of interest; interest rates on competing investments;
interest rates on funding sources; consumer and business demand for deposit and
loan products and services; consumer and business demand for other financial
services; changes in accounting policies or guidelines; and changes in the
quality or composition of the Corporation's loan and investment portfolios.
Readers are cautioned that forward-looking statements are not guarantees of
future performance and that actual results may differ materially from
management's current expectations.
Management of the Corporation does not undertake and specifically
disclaims any obligation to update any forward-looking statements to reflect the
occurrence of anticipated or unanticipated events or circumstances after the
date of such statements.
PART I
ITEM 1--BUSINESS
FIRST FEDERAL CAPITAL CORP
This section of the report contains general information about First
Federal Capital Corp (the "Corporation"), its wholly-owned subsidiary First
Federal Capital Bank (the "Bank"), and the Bank's wholly-owned subsidiaries
(collectively "the reporting group"). Included in this section is information
regarding the reporting group's markets and business environments, significant
operating and accounting policies, practices, and procedures, as well as its
competitive and regulatory environments. Information regarding the reporting
group's current financial condition and results of operations is included in
Part II, Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations", Part II, Item 7A, "Quantitative and Qualitative
Disclosures about Market Risk", and Part II, Item 8, "Financial Statements and
Supplementary Data". This section should be read in conjunction with those
sections.
The Corporation's principal office is located at 605 State Street, La
Crosse, Wisconsin, 54601, and its telephone number is (608) 784-8000. The
Corporation's web page is located at www.firstfed.com. The Corporation will make
available on its website free of charge its Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to
those Reports filed pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 as soon as reasonably practicable after they are filed with
the Securities and Exchange Commission.
FIRST FEDERAL CAPITAL BANK
The Bank was founded in 1934 and is a federally-chartered,
federally-insured, savings bank headquartered in La Crosse, Wisconsin. Effective
March 1, 2003, the Bank changed its name from "First Federal Savings Bank La
Crosse-Madison" to "First Federal Capital Bank". The new name will appear on all
legal documents and official communications beginning on that date. Signs,
promotional messages, letterhead, and business cards will not change, but will
continue to carry the "First Federal" name and logo. This change was made to
more appropriately reflect the Bank's expansion into many new geographic markets
in recent years, as well as its expansion into business banking in 2001.
The Bank's primary business is community banking, which includes
attracting deposits from and making loans to the general public and private
businesses, as well as governmental and non-profit entities. In addition to
deposits, the Bank obtains funds through borrowings from the Federal Home Loan
Bank of Chicago ("FHLB"), as
2
well as through other sources such as securities sold under agreements to
repurchase and purchases of federal funds. These funding sources are principally
used to originate loans, including single-family residential loans, commercial
real estate loans, business loans and lines of credit, consumer loans, and
education loans. The Bank also purchases and/or participates in loans from
third-party financial institutions and invests in mortgage-backed and related
securities. The Bank is also an active seller of residential loans in the
secondary market.
The Bank's primary market areas for conducting its activities consist
of communities located in the southern two-thirds of Wisconsin, northern
Illinois, and south-eastern Minnesota. The Bank maintains 89 banking offices in
its market areas. Twenty of these offices are located in the Madison
metropolitan area, six in the La Crosse metropolitan area, five in the city of
Eau Claire, four in the Appleton and Wausau areas, three each in the Beloit,
Hudson, Oshkosh, and Green Bay areas, and two each in the cities of Kenosha,
Janesville, Neenah, and Racine, Wisconsin. The Bank also maintains one banking
facility in fifteen other cities located throughout its market area in
Wisconsin. The Bank also has six offices in the Rockford, Illinois, area and
seven offices in Minnesota, including four in Rochester. Finally, the Bank has
two separate residential loan production offices in Appleton, Wisconsin.
The Bank is subject to regulation and examination by the Office of
Thrift Supervision ("OTS"), its chartering authority and primary regulator, and
by the Federal Deposit Insurance Corporation ("FDIC"), which administers the
Savings Association Insurance Fund ("SAIF"), which insures the Bank's deposits
to the maximum extent permitted by law.
The Bank's principal executive offices are located at 605 State Street,
La Crosse, Wisconsin, 54601, and its telephone number is (608) 784-8000. The
Bank's internet site is www.firstfed.com.
ORGANIZATIONAL STRUCTURE AND SEGMENT REPORTING
In 2001, the Corporation completed a reorganization along functional
lines rather than product lines. The principal components of the Corporation's
organization now consist of a Community Banking Group, which has primary
responsibility for the sale and delivery of all the Corporation's products and
services, and a Corporate Administration and Operations Group, which has primary
responsibility for product support, data and technology management, and property
management. The Corporation also has a Commercial Real Estate Lending Division,
which is responsible for the origination and servicing of commercial real estate
loans, a Finance and Treasury Division, and a Human Resources Division. Each
group or division is led by an executive officer that reports directly to the
president of the Corporation.
Despite its reorganization along functional rather than product lines,
the Corporation continues to account for its operations along product lines. The
Corporation tracks profitability in five major areas: (i) residential lending,
(ii) commercial real estate lending, (iii) consumer lending, (iv) education
lending, and (v) investment and mortgage-related securities. Residential lending
is divided into two profit centers for segment reporting purposes: (i) a
mortgage banking profit center that is responsible for loan origination, sales
of loans in the secondary market, and servicing of residential loans, and (ii) a
residential loan portfolio that consists of loans held by the Corporation for
investment purposes (loans held for sale are included in the mortgage banking
profit center). This profit center also includes mortgage-backed securities
("MBSs") that are collateralized by loans that were originated by the
Corporation. Commercial real estate lending consists of the Corporation's
portfolio of multi-family and non-residential mortgage loans, as well as
functions related to the origination and servicing of such loans. Consumer
lending consists of the Corporation's second mortgage, automobile, and other
consumer installment loans, as well as functions related to the origination and
servicing of such loans. The education loan portfolio consists of loans
originated through programs sponsored by the federal government, as well as
functions related to the origination and servicing of such loans. Finally, the
Corporation's investment and mortgage-related securities portfolio is considered
a profit center for segment reporting purposes. As previously noted, however,
MBSs collateralized by loans originated by the Corporation are included in the
residential loan profit center, rather than the investment and mortgage-related
securities portfolio.
The Corporation's extensive branch network, which delivers checking,
savings, certificates of deposit and other financial products and services to
customers, is considered a support department for segment reporting purposes.
3
In October 2001, the Corporation completed the acquisition of American
Community Bankshares, Inc. ("ACB"). In addition, in April 2002 the Corporation
completed the acquisition of three bank offices in Rochester, Minnesota, from
another financial institution. These purchases included the customer loans and
deposits at those branches. In addition to offering products and services
similar to the Corporation's existing product lines, these institutions also
deliver commercial loan and deposit products and services to business customers.
This represents a new line of business for the Corporation and a new reportable
segment. The financial results of this new line of business have not been
separately reported in 2002 due to continuing efforts to develop the
departmental allocations of costs and revenues necessary to fairly present the
operating results of this line of business.
For additional discussion regarding the Corporation's reportable
segments, refer to Note 14 of the Corporation's Audited Consolidated Financial
Statements, included herein under Part II, Item 8, "Financial Statements and
Supplementary Data", as well as Part II, Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations".
LENDING ACTIVITIES
GENERAL The principal categories of loans in the Corporation's
portfolio are conventional real estate loans secured by single-family
residences, commercial real estate loans secured by multi-family residential and
non-residential real estate, consumer loans secured primarily by second
mortgages on single-family residences and automobiles, government-guaranteed
education loans, and commercial loans to businesses secured by varied collateral
or consideration. Although the Corporation also originates single-family
residential loans that are insured or partially guaranteed by federal and state
agencies, the Corporation does not generally retain such loans in its
residential loan portfolio. As of December 31, 2002, approximately 69% of the
Corporation's total assets consisted of loans held for investment purposes.
RESIDENTIAL LENDING Single-family residential loans accounted for
approximately 35% of the Corporation's gross loans as of December 31, 2002.
Applications for single-family residential and construction loans are accepted
by commission-based employees of the Corporation at a number of locations (most
of which are located with deposit-taking offices) and by salaried employees at a
few other deposit-taking offices that are able to handle such applications.
In general, the Corporation retains in its portfolio only single-family
residential mortgage loans that provide for periodic adjustments of the interest
rate ("adjustable-rate mortgage loans"). These loans generally have terms of up
to 30 years and interest rates that adjust every one to two years in accordance
with an index based on the yield on certain U.S. government securities. A
portion of these loans may guarantee borrowers a fixed rate of interest for the
first three to five years of the loan's term. Furthermore, most of these loans
have annual interest rate change limits ranging from 1% to 2%, maximum lifetime
interest rates ranging from 11% to 14%, and minimum lifetime floor rates of
approximately 6% to 7%. It is the Corporation's practice from time-to-time to
discount the interest rate it charges on its adjustable-rate mortgage loans
during the first one to five years of the loan, which has the effect of reducing
a borrower's payment during such years. In addition, most of the Corporation's
owner-occupied adjustable-rate mortgage loan agreements permit borrowers to
convert their adjustable-rate loans to fixed-rate loans under certain
circumstances in exchange for a fee. Upon conversion, the Corporation generally
sells such loans in the secondary market.
Adjustable-rate mortgage loans decrease the Corporation's exposure to
risks associated with changes in interest rates, but involve other risks because
as interest rates increase, borrowers' monthly payments increase, thus
increasing the potential for default. This risk has not had any adverse effect
on the Corporation to date, although no assurances can be made with respect to
future periods.
The Corporation occasionally purchases adjustable-rate single-family
residential loans from third-party financial institutions. In general, such
loans are subject to the same underwriting standards as loans originated
directly by the Corporation. However, such loans are usually secured by
properties located outside of the Corporation's primary market areas. The seller
generally retains servicing of the loans.
4
Although the Corporation generally retains only adjustable-rate
mortgage loans in its portfolio, it continues to originate and service
fixed-rate mortgage loans in order to provide a full range of products to its
customers. In general, such loans are originated only under terms, conditions,
and documentation standards that make such loans eligible for sale to the
Federal Home Loan Mortgage Corporation ("FHLMC"), the Federal National Mortgage
Association ("FNMA"), the FHLB, and other institutional investors. The
Corporation generally sells these loans at the time they are originated, but
continues to service these loans for its customers. In addition, the Corporation
generally sells any adjustable-rate mortgage loans that convert to fixed-rate
loans in accordance with options granted to such borrowers in the original loan
documents, as previously described. Sales of mortgage loans provide additional
funds for lending and other business purposes.
Sales or securitizations of mortgage loans through FHLMC and FNMA have
generally been under terms that do not provide for any recourse against the
Corporation by the investor. In the case of sales to the FHLB, however, the
Corporation retains the credit risk on the underlying loans in exchange for a
credit enhancement fee. Furthermore, the Corporation on occasion has also
retained the credit risk on certain securitizations of its own loans into MBSs
through FHLMC or FNMA.
The Corporation's general policy is to lend up to 80% of the
independently appraised value of the property securing a first mortgage loan
(referred to as the "loan-to-value ratio"). The Corporation will occasionally
lend in excess of an 80% loan-to-value ratio on a first mortgage loan, but will
generally require the borrower to obtain private mortgage insurance on the
portion of the loan that exceeds 80%. The Corporation receives commission
revenue from the independent insurance providers that sell such policies to the
Corporation's loan customers. Beginning in 2001, premium revenue on the sale of
such policies is also received through a wholly-owned, second-tier subsidiary of
the Bank. This revenue is received in exchange for the subsidiary's reinsurance
of a portion of the mortgage impairment risk. Refer to "Subsidiaries", below,
for additional discussion.
In 2001, the Corporation began to offer loan programs to qualifying
borrowers with good credit standing which will enable them to obtain a second
mortgage loan from the Corporation in conjunction with their first mortgage
loan. Under these programs, the combined principal balance of the loans will not
exceed 100% of the property's value and the Corporation will waive the
requirement for private mortgage insurance.
The Corporation also originates loans to individuals to construct
single-family residences. Such loans accounted for approximately 3% of the
Corporation's gross loans as of December 31, 2002. Construction loans may be
made without commitments to purchase the property being constructed and the
borrower may not have take-out commitments for permanent financing on hand at
the time of origination. Construction loans generally have a maturity of 6 to 12
months and a fixed rate of interest, with payments being made monthly on an
interest-only basis. Construction loans are otherwise underwritten and approved
in the same manner as other single-family residential loans. Construction loans,
however, are generally considered to involve a higher degree of risk than
conventional residential mortgage loans. This is because the risk of loss is
largely dependent on the accuracy of the initial estimate of the property's
value at completion of construction, the estimated cost of construction, and the
borrower's ability to advance additional construction funds, if necessary. This
risk has not had any adverse effect on the Corporation to date, although no
assurances can be made with respect to future periods.
In addition to servicing the loans in its own portfolio, the
Corporation continues to service most of the loans that it sells to third-party
investors (commonly referred to as "loans serviced for others"). Servicing
mortgage loans, whether for its own portfolio or for others, includes such
functions as collecting monthly principal and interest payments from borrowers,
maintaining escrow accounts for real estate taxes and insurance, and making such
payments on behalf of borrowers when they are due. When necessary, servicing of
mortgage loans also includes functions related to the collection of delinquent
principal and interest payments, loan foreclosure proceedings, and disposition
of foreclosed real estate.
When the Corporation services loans for others, it is compensated for
these services through the retention of a servicing fee from borrowers' monthly
payments. The Corporation pays the third-party investors an agreed-upon yield on
the loans, which is generally less than the interest agreed to be paid by the
borrowers. The difference, typically 25 basis points or more, is retained by the
Corporation and recognized as servicing fee income over the lives of the loans,
net of amortization of capitalized mortgage servicing rights. The Corporation
also receives fees and interest income from ancillary sources such as
delinquency charges and float on escrow and other funds. The
5
Corporation also purchases mortgage servicing rights from third parties for
which it retains an agreed-upon fee from borrowers' monthly payments, as
previously described. The Corporation performs substantially the same services
for these loans as it does on its own originations.
Management believes that servicing mortgage loans for third parties
provides a natural hedge against other risks inherent in the Corporation's
mortgage banking operations. That is, fluctuations in volumes of mortgage loan
originations and resulting gains on sales of such loans caused by changes in
market interest rates will generally be offset in part by an opposite change in
loan servicing fee income. These fluctuations are usually the result of actual
loan prepayment activity that is different from that which was anticipated when
the related servicing rights were originally recorded. However, fluctuations in
the value of mortgage servicing rights may also be caused by mark-to-market
adjustments under generally accepted accounting principles ("GAAP"). That is,
the value of servicing rights may fluctuate because of changes in the discount
rates or future prepayment assumptions used to periodically value servicing
rights. Although management believes that most of the Corporation's loans that
prepay are replaced by a new loan to the same customer or even a different
customer (thus preserving the future servicing cash flow), GAAP requires
mark-to-market losses resulting from a change in future prepayment assumptions
to be recorded in the period in which the change occurs. However, the offsetting
gain on the sale of the new loan, if any, cannot be recorded under GAAP until
the customer actually prepays the old loan and the new loan is sold in the
secondary market. Mortgage servicing rights are particularly susceptible to
unfavorable mark-to-market adjustments during periods of declining interest
rates during which prepayment activity typically accelerates to levels above
that which had been anticipated when the servicing rights were originally
recorded. For additional discussion, refer to Notes 1 and 4 of the Corporation's
Audited Consolidated Financial Statements, included herein under Part II, Item
8, "Financial Statements and Supplementary Data", as well as Part II, Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
COMMERCIAL REAL ESTATE LENDING Multi-family residential loans and
non-residential real estate loans (together "commercial real estate loans")
accounted for approximately 24% of the Corporation's gross loans as of December
31, 2002. Applications for commercial real estate loans are accepted at the
Corporation's offices in La Crosse, Madison, Appleton, Milwaukee, and Wausau,
Wisconsin, and Rochester, Minnesota. Underwriting and approval of commercial
real estate loans, originated by commissioned loan officers located in such
offices, is performed at the Corporation's main office in La Crosse, as is the
servicing of such loans on an on-going basis. Commercial real estate loans
originated in conjunction with a business banking relationship are underwritten
and approved by authorized personnel in the local market where business banking
products and services are sold (currently La Crosse, Wausau, and Rochester).
Such loans are subject to the general policies and procedures outlined in
"Commercial Business Lending", below. It is the Corporation's general policy to
restrict its commercial real estate lending to loans secured by properties
located within a 300-mile radius of La Crosse, which includes all or a portion
of the states of Wisconsin, Nebraska, Illinois, Iowa, and Minnesota.
The Corporation's emphasis in commercial real estate lending is on
loans secured by collateral classified as Type A properties, which include
multi-family residential properties, retail shopping establishments, office
buildings, and multi-tenant industrial buildings. To a lesser extent, the
Corporation also makes loans secured by collateral classified as Type B
properties, examples of which include nursing homes, single-tenant industrial
buildings, hotels and motels, and churches. The Corporation's current policy is
to make only a limited amount of loans secured by collateral classified as Type
C properties, examples of which include restaurants, recreation facilities, and
other special purpose facilities.
Applications for commercial real estate loans are generally obtained
from existing borrowers, direct contacts by loan officers, and referrals. In
general, these loans have amortization periods ranging from 20 to 30 years,
mature in ten years or less, and have interest rates which are fixed for one to
five years--thereafter adjusting in accordance with a designated index that is
generally subject to a floor and a ceiling. Loan-to-value ratios on the
Corporation's commercial real estate loans may be as high as 80%. In addition,
as part of the criteria for underwriting commercial real estate loans, the
Corporation generally imposes on potential borrowers a "debt coverage ratio"
(the ratio of net cash from operations before payment of debt service to debt
service). This ratio varies depending on the nature of the collateral, but is
always greater than 115%. It is also the Corporation's general policy to obtain
personal guarantees on its commercial real estate loans and, when such
guarantees cannot be obtained, to impose more stringent loan-to-value ratios,
debt coverage ratios, and other underwriting requirements.
6
The Corporation occasionally purchases commercial real estate loans
from third-party financial institutions. In general, such loans are subject to
the same geographic restrictions and underwriting standards as loans originated
directly by the Corporation. The Corporation, however, does not generally
service such loans after their acquisition.
From time-to-time the Corporation originates loans to construct
multi-family residential and non-residential real estate properties. Such loans
accounted for approximately 2% of the Corporation's gross loans as of December
31, 2002. Construction loans are generally considered to involve a higher degree
of risk than mortgage loans on completed properties. The Corporation's risk of
loss on a construction loan is dependent largely upon the accuracy of the
initial estimate of the property's value at completion of construction, the
estimated cost of construction, and the borrower's ability to advance additional
construction funds if such should become necessary.
Commercial real estate lending is generally considered to involve a
higher level of risk than single-family residential lending. This is due to the
concentration of principal in a limited number of loans and borrowers, the
effects of general economic conditions on real estate developers and managers
and on income producing properties, and the increased difficulty of evaluating
and monitoring these types of loans. Moreover, a construction loan can involve
additional risks because of the inherent difficulty in estimating both a
property's value at completion of the project and the estimated cost of the
project. In addition, loans secured by properties located outside of the
Corporation's immediate market area may involve a higher degree of risk. This is
because the Corporation may not be as familiar with market conditions and other
relevant factors as it would be in the case of loans secured by properties
located within its market areas. The Corporation does not have a material
concentration of commercial real estate loans outside of its immediate market
area.
The Corporation has attempted to minimize the foregoing risks by
adopting what management believes are conservative underwriting guidelines that
impose more stringent loan-to-value ratios, debt coverage ratios, and other
requirements on loans, which are believed to involve higher elements of risk.
The Corporation also requires independent appraisals on all loans, requires
personal guarantees where appropriate, limits the geographic area in which the
Corporation will make construction loans, and limits the types of loans in its
portfolio, as previously described.
CONSUMER LENDING The Corporation offers consumer loans in order to
provide a full range of financial services to its customers. Such loans
accounted for approximately 24% of the Corporation's gross loans as of December
31, 2002. Most of the Corporation's consumer loan portfolio consists of second
mortgage loans and home equity lines of credit, but also includes automobile
loans, recreational vehicle and mobile home loans, deposit account secured
loans, and unsecured lines of credit or signature loans. The Corporation
services all of its own consumer loans.
Applications for consumer loans are taken at most of the Corporation's
banking offices, through its internet banking channel, and over the phone at the
Corporation's headquarters in La Crosse. Applications for automobile loans are
also accepted through relationships established with a limited number of
qualifying automobile dealerships ("indirect automobile lending"). The majority
of consumer loans are underwritten, approved, and serviced on an on-going basis
at the Corporation's headquarters. In the case of indirect automobile lending,
such loans are underwritten and approved by the office that has established the
business banking relationship with the automobile dealership. As of December 31,
2002, indirect lending was only being conducted in Rochester, Minnesota.
Consumer loans generally have shorter terms and higher rates of
interest than conventional mortgage loans, but typically involve more credit
risk than such loans because of the nature of the collateral and, in some
instances, the absence of collateral. In general, consumer loans are more
dependent upon the borrower's continuing financial stability, are more likely to
be affected by adverse personal circumstances, and are often secured by rapidly
depreciating personal property such as automobiles. In addition, various laws,
including bankruptcy and insolvency laws, may limit the amount that may be
recovered from a borrower. However, such risks are mitigated to some extent in
the case of second mortgage loans and home-equity lines of credit. These types
of loans are secured by a second mortgage on the borrower's residence for which
the total principal balance outstanding (including the first mortgage) does not
generally exceed 100% of the property's value. Second mortgage loans are
generally fixed-rate and may have terms of up to ten years.
7
The Corporation believes that the higher yields earned on consumer
loans compensate for the increased risk associated with such loans and that
consumer loans are important to the Corporation's efforts to increase the
interest rate sensitivity and shorten the average maturity of its loan
portfolio. Furthermore, the Corporation's net charge-offs on consumer loans as a
percentage of gross loans have not been significant in recent years, despite the
risks inherent in consumer lending.
In conjunction with its consumer lending activities, the Corporation
offers customers credit life and disability insurance products underwritten and
administered by an independent insurance provider. The Corporation receives
commission revenue related to the sales of these products. In addition, a
wholly-owned subsidiary of the Bank receives premium revenue in exchange for the
portion of the insurance risk it has reinsured on these sales. Refer to
"Subsidiaries", below, for additional discussion.
EDUCATION LENDING The Corporation offers education loans through
programs sponsored by the federal government. As such, the federal government
guarantees most of the principal and interest on such loans. A third party
services the loans for the Corporation after they are originated. Education
loans accounted for approximately 9% of the Corporation's gross loans as of
December 31, 2002.
COMMERCIAL BUSINESS LENDING As of December 31, 2002, commercial
business loans accounted for approximately 3% of the Corporation's gross loans.
These loans may take the form of lines of credit, single payment loans, or term
payment loans, and may be secured or unsecured depending on the creditworthiness
of the borrower. The Corporation operates under a commercial business lending
policy that establishes a number of tenets that guide management in making
commercial lending decisions. Among these tenets are the purpose of the loan,
the source of repayment, and an alternate source of repayment (generally in the
form of collateral or outside guarantee). Applications for commercial business
loans are accepted at the Corporation's offices in La Crosse and Wausau,
Wisconsin, as well as Rochester, Minnesota. Lending relationships with total
related borrowings of less than $1.0 million are underwritten and approved by
authorized personnel in these local markets. Lending relationships between $1.0
million and $2.5 million are approved by an intermediate commercial loan
committee. Lending relationships between $2.5 million and $5.0 million are
approved by the Corporation's senior loan committee. Finally, lending
relationships in excess of $5.0 million are approved by the Corporation's board
of directors. It is the Corporation's general policy to restrict its commercial
business lending to a market area defined as within a 150-mile radius of any
office location where business banking products and services are sold.
Commercial business loans are generally made for business expansion or
ongoing business needs. The purpose of commercial business loans can include the
purchase of equipment or the provision of operating capital for the financing of
accounts receivable and inventory. Commercial business loans are not generally
made for the purpose of acquiring real estate. Rather, such loans are typically
classified as "commercial real estate loans". However, real estate may
occasionally be accepted as incidental collateral on a loan made for another
business purpose. In general, such loans continue to be classified as
"commercial business loans".
Commercial business loans generally have shorter terms and higher rates
of interest than conventional mortgage loans but typically involve more credit
risk than such loans because of the nature of the collateral and, in some
instances, the absence of collateral. Credit risk is controlled and monitored
through active asset quality management and the use of lending standards,
thorough review of potential borrowers, and active asset quality administration.
Active asset quality administration, including early problem loan identification
and timely resolution of problems, further ensures appropriate management of
credit risk and minimization of loan losses.
The Corporation occasionally participates in commercial business loans
originated by third-party financial institutions. In general, such loans are
subject to the same geographic restrictions and underwriting standards as loans
originated by the Corporation. The Corporation, however, does not generally
service such loans.
The Corporation believes that the higher yields earned on commercial
business loans compensate for the increased risk associated with such loans and
that commercial business loans are important to the Corporation's efforts to
increase the interest rate sensitivity and shorten the average maturity of its
loan portfolio.
NON-PERFORMING AND OTHER CLASSIFIED ASSETS Loans are generally placed
on non-accrual status and considered "non-performing" when, in the judgment of
management, the probability of collection of principal or
8
interest is deemed to be insufficient to warrant further accrual of interest.
When a loan is placed on non-accrual and/or non-performing status, previously
accrued but unpaid interest is deducted from interest income. In general, the
Corporation does not record accrued interest on loans 90 or more days past due.
Refer to Notes 1 and 3 of the Corporation's Audited Consolidated Financial
Statements, included herein under Part II, Item 8, "Financial Statements and
Supplementary Data".
When a loan is placed on non-accrual and/or non-performing status, the
Corporation generally institutes foreclosure or other collection proceedings.
Real estate property acquired by the Corporation as a result of foreclosure or
deed-in-lieu of foreclosure is classified as "real estate" and is considered
"non-performing" until it is sold. Other property acquired through adverse
judgment, such as automobiles and other depreciable assets, are generally
classified as an "other asset". The amount of foreclosed real estate and other
repossessed property has not been material to the Corporation in recent years.
Federal regulations require thrift institutions to classify their
assets on a regular basis. Accordingly, the Corporation has internal policies
and procedures in place to evaluate risk ratings on all loans. In addition, in
connection with examinations of thrift institutions, federal examiners have
authority to classify problem assets as "Substandard", "Doubtful", or "Loss". An
asset is classified as "Substandard" if it is determined to involve a distinct
possibility that the Corporation could sustain some loss if deficiencies
associated with the loan are not corrected. An asset is classified as "Doubtful"
if full collection is highly questionable or improbable. An asset is classified
as "Loss" if it is considered uncollectible, even if a partial recovery could be
expected in the future. The regulations also provide for a "Special Mention"
designation, described as assets which do not currently expose the Corporation
to a sufficient degree of risk to warrant adverse classification, but which
possess credit deficiencies or potential weaknesses deserving management's close
attention. If an asset or portion thereof is classified as "Loss", the
Corporation must either establish a specific allowance for the portion of the
asset classified as "Loss", or charge off such amount. Refer to Part II, Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", for additional discussion.
ALLOWANCES FOR LOSSES ON LOANS AND REAL ESTATE The Corporation's policy
is to establish allowances for estimated losses on specific loans and real
estate when it determines that losses are probable. In addition, the Corporation
maintains a general loss allowance against its loan and real estate portfolios
that is based on its own loss experience, management's ongoing assessment of
current economic conditions, the credit risk inherent in the portfolios, and the
experience of the financial services industry. For additional information, refer
to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and Notes 1 and 3 of the Corporation's Audited
Consolidated Financial Statements, included herein under Part II, Item 8,
"Financial Statements and Supplementary Data".
Management of the Corporation believes that the current allowances
established by the Corporation are adequate to cover probable and estimable
losses in the Corporation's loan and real estate portfolios. However, future
adjustments to these allowances may be necessary and the Corporation's results
of operations could be adversely affected if circumstances differ substantially
from the assumptions used by management in making its determinations in this
regard.
INVESTMENT AND MORTGAGE-RELATED SECURITIES
The Corporation periodically invests in collateralized mortgage
obligations ("CMOs") and MBSs (collectively "mortgage-backed and related
securities"). As of December 31, 2002, such investments accounted for
approximately 13% of the Corporation's total assets.
Management believes CMOs represent attractive investment alternatives
relative to other investment vehicles, due to the variety of maturity and
repayment options available through such investments and due to the limited
credit risk associated with such securities. CMOs purchased by the Corporation
represent a participation interest in a pool of single-family residential
mortgage loans and are generally rated "AAA" by independent credit-rating
agencies. In addition, such investments are secured by credit enhancements
and/or subordinated tranches or are collateralized by U.S. government agency
MBSs. The Corporation generally invests only in sequential-pay, planned
amortization class ("PAC"), and targeted amortization class ("TAC") tranches
that, at the time of their purchase, are not considered to be high-risk
derivative securities, as defined in applicable regulations. The
9
Corporation does not invest in support-, companion-, or residual-type tranches.
Furthermore, the Corporation does not invest in interest-only, principal-only,
inverse-floating-rate CMO tranches, or similar complex securities.
The Corporation also invests in MBSs that are guaranteed by FHLMC,
FNMA, or the Government National Mortgage Association ("GNMA"). In addition, the
Corporation periodically securitizes or "swaps" mortgage loans in its own
portfolio into FHLMC or FNMA MBSs and continues to hold such securities. MBSs
enhance the quality of the Corporation's assets by virtue of the guarantees that
back them, although the Corporation at times has relinquished such guarantee on
loans it has swapped into MBSs (for additional discussion, refer to Note 2 of
the Corporation's Audited Consolidated Financial Statements, included herein
under Part II, Item 8, "Financial Statements and Supplementary Data"). In
addition, MBSs are more liquid than individual mortgage loans and receive
treatment that is more favorable when used to collateralize certain borrowings
of the Corporation.
In addition to MBSs and CMOs, federally-chartered savings institutions
such as the Bank have authority to invest in various other types of investment
securities, including U.S. and state government obligations, securities of
various federal agencies, certificates of deposit issued by insured banks and
savings institutions, and federal funds. Subject to various restrictions,
federally-chartered savings institutions may also invest a portion of their
assets in commercial paper, corporate debt securities, and mutual funds whose
assets conform to the investments that a federally-chartered savings institution
is authorized to make directly. In general, investments in these types of
securities are limited to the four highest credit categories as established by
the major independent credit-rating agencies. Excluding U.S. government and
federal agency securities and mutual funds that invest exclusively in such
securities, the Corporation does not invest in individual securities that exceed
10% of its stockholder's equity. As of December 31, 2002, the Corporation held
no investment securities.
The Corporation classifies its mortgage-backed and related securities
and its other investment securities as either available for sale or held for
investment. For additional discussion, refer to Note 1 of the Corporation's
Audited Consolidated Financial Statements, included herein under Part II, Item
8, "Financial Statements and Supplementary Data".
SOURCES OF FUNDS
DEPOSIT LIABILITIES The Corporation's current deposit products include
regular savings accounts, checking accounts, money market deposit accounts,
individual retirement accounts, and certificates of deposit ranging in terms
from three months to five years. Substantially all of the Corporation's deposits
are obtained from individuals and businesses located in Wisconsin, northern
Illinois, and south-eastern Minnesota. As of December 31, 2002, deposit
liabilities accounted for approximately 78% of the Corporation's total
liabilities and equity.
In addition to serving as the Corporation's primary source of funds,
deposit liabilities (especially checking accounts) are a substantial source of
non-interest income. This income is generally received in the form of overdraft
fees, periodic service charges, automated teller machine ("ATM") and debit card
fees, and other transaction charges. The Corporation's extensive branch network
also creates opportunities for sales of non-deposit products such as
tax-deferred annuities, mutual funds, and other investment products. In exchange
for these sales, the Corporation receives commission revenue from the
third-party providers of the financial products and/or services.
The principal methods used by the Corporation to attract deposit
accounts include offering a variety of products and services, competitive
interest rates, and convenient office locations and hours. Most of the
Corporation's free-standing banking offices have drive-up facilities and 49 of
the Corporation's banking facilities are located in supermarkets. The
Corporation also owns over 114 ATM machines, most of which are located in the
Corporation's primary markets. Depositors may also obtain a debit card from the
Corporation, which allows them to purchase goods and services directly from
merchants. The same debit card also provides access to the ATM network.
From time-to-time, the Corporation has also used certificates of
deposit sold through third-party brokers ("brokered deposits") as an alternative
to borrowings from the FHLB. FDIC regulations govern the acceptance of brokered
deposits by insured depository institutions such as the Corporation. At December
31, 2002, the Corporation had $5.3 million in brokered deposits outstanding.
10
FEDERAL HOME LOAN BANK ADVANCES The Corporation obtains advances from
the FHLB secured by certain of its home mortgage loans and mortgage-related
securities, as well as stock in the FHLB, a minimum amount of which the
Corporation is required to own. Such advances may be made pursuant to several
different credit programs, each with its own interest rate and range of maturity
dates. As of December 31, 2002, FHLB advances accounted for approximately 13% of
the Corporation's total liabilities and equity.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE The Corporation
occasionally enters into sales of securities under agreements to repurchase
(commonly referred to as "reverse-repurchase agreements"). In form, these
transactions are an arrangement in which the sale of securities is accompanied
by a simultaneous agreement to repurchase the identical securities (or
substantially the same securities) at a future date. In substance, however,
these arrangements are borrowings secured by high-quality, highly-liquid
securities such as FNMA or FHLMC MBSs. Accordingly, these arrangements are
accounted for as borrowings in the Corporation's financial statements.
Securities sold under repurchase agreements are physically delivered to
the broker-dealers that arrange the transactions. The broker-dealers may sell,
loan, or otherwise dispose of such securities to other parties in the normal
course of their operations. The Corporation is exposed to risk in these types of
transactions in that changes in market prices, economic losses, or other factors
could prevent or delay the counter-parties in the transaction from returning the
securities at the maturity of the agreement. The Corporation limits its exposure
to such risk by utilizing standard industry agreements, limiting transactions to
large, reputable broker-dealers, limiting the amount that can be borrowed from
an individual broker-dealer, and limiting the duration of such agreements
(typically one to six months). There were no securities sold under agreements to
repurchase as of December 31, 2002.
FEDERAL FUNDS PURCHASED AND OTHER BORROWINGS The Corporation has lines
of credit with three financial institutions. These lines, which amount to $60.0
million in the aggregate, permit the overnight purchase of federal funds. The
Corporation also has a standard line of credit with one of these institutions in
the amount of $35.0 million. As of December 31, 2002, there was $17.0 million
outstanding under these lines of credit.
SUBSIDIARIES
The Bank has a number of subsidiaries that engage in certain activities
that management believes are more appropriately conducted by a subsidiary of the
Bank. Following is a brief description of each subsidiary.
FIRST CAP HOLDINGS, INC. The Bank formed a wholly-owned subsidiary in
the State of Nevada in 1993. The subsidiary, First Cap Holdings, Inc. ("FCHI"),
was formed to consolidate and improve the efficiency, management, safekeeping,
and operations of the Bank's investment securities portfolio and certain other
holdings. In addition, the formation of FCHI has resulted in a lower effective
income tax rate for the Bank because the State of Nevada does not currently
impose a corporate income tax. As of December 31, 2002, FCHI was managing $396
million in investments and mortgage-related securities and $306 million in
purchased single-family residential loans for the Bank. FCHI's net income was
$21.7 million, $26.4 million, and $27.7 million during the years ended December
31, 2002, 2001, and 2000, respectively. The Bank's net investment in FCHI as of
December 31, 2002, was $788 million, which was eliminated in consolidation in
accordance with GAAP.
FIRST REINSURANCE, INC. The Bank formed a wholly-owned subsidiary in
the State of Arizona in 1998. The subsidiary, First Reinsurance, Inc. ("FRI"),
was formed to reinsure or "underwrite" credit life and disability insurance
policies sold to the Bank's consumer loan customers. FRI assumes the first level
of risk on these policies and a third-party insurer assumes the remaining risk.
The third-party insurer is also responsible for performing most of the
administrative functions of the subsidiary on a contract basis. FRI's net income
was $153,000, $227,000, and $163,000 during the years ended December 31, 2002,
2001, and 2000, respectively. At December 31, 2002, the Bank's net investment in
FRI was $1.3 million, which was eliminated in consolidation in accordance with
GAAP.
TURTLE CREEK CORPORATION The Bank acquired Turtle Creek Corporation
("Turtle Creek") in 1995 as a result of its acquisition of another financial
institution. Turtle Creek, a Wisconsin corporation, holds a 40% limited
partnership interest in an apartment complex providing housing for
low-to-moderate income and elderly persons. Turtle Creek's aggregate investment
in this project was $51,000 at December 31, 2002. Turtle Creek had net losses of
$23,000, $18,000, and $10,000 during the years ended December 31, 2002, 2001,
and 2000, respectively. The
11
Bank's net investment in Turtle Creek as of December 31, 2002, was $70,000,
which was eliminated in consolidation in accordance with GAAP.
FIRST ENTERPRISES, INC. The Bank's wholly-owned subsidiary, First
Enterprises, Inc. ("FEI"), was incorporated in 1971 in the State of Wisconsin.
During the period from the late-1970s to the mid-1980s, FEI was primarily
involved in the acquisition and development of hotels. Except for the
maintenance of its two remaining hotel investments, however, FEI is no longer
involved in these types of activities. The principal asset of FEI is its
investment in FFMR, described in the next paragraph. FEI had net income of
$350,000, $113,000, and $30,000 during the years ended December 31, 2002, 2001,
and 2000, respectively. At December 31, 2002, the Bank's net investment in FEI
was $1.1 million, which was eliminated in consolidation in accordance with GAAP.
FF MORTGAGE REINSURANCE, INC. In December 2000, FEI formed FF Mortgage
Reinsurance, Inc. ("FFMR"), a Vermont corporation. FFMR was formed to reinsure
or "underwrite" a portion of the mortgage impairment insurance policies
purchased by the Bank's loan customers (refer to "Lending
Activities--Residential Lending"). FFMR assumes a second level of risk on these
policies, which is capped at a certain level. Third-party insurers assume the
first level of risk, as well as any risk above the capped amount. A third-party
management company is responsible for performing most of the administrative
functions of the subsidiary on a contract basis. FFMR had net income of $315,000
during the year ended December 31, 2002, and $42,000 in the year ended December
31, 2001, its first year of operations. FEI's net investment in FFMR as of
December 31, 2002, was $1.0 million, which was eliminated in consolidation in
accordance with GAAP.
COMPETITION
The Corporation faces significant competition in attracting deposits
through its branch network. Its most direct competition has historically come
from commercial banks, credit unions, and other savings institutions located in
its market area. In addition, the Corporation faces significant competition from
mutual fund and insurance companies, as well as primary financial markets such
as the stock and bond markets. The Corporation competes for deposits principally
by offering customers a variety of deposit products, competitive prices,
convenient branch locations and operating hours, and other services. The
Corporation does not rely upon any individual group or entity for a material
portion of its deposits.
The Corporation's competition for loans comes principally from mortgage
banking companies, other savings institutions, commercial banks, finance and
insurance companies, and credit unions. The Corporation competes for loan
originations primarily through the interest rates and loan fees it charges, the
efficiency and quality of services it provides borrowers, the variety of its
products, and on referrals from real estate brokers, builders, and business
customers.
REGULATION AND SUPERVISION
References in this section to applicable laws and regulations are brief
summaries only. All such summaries are qualified in their entirety by the
applicable laws and regulations, which you should consult to understand their
details and operation.
REGULATION OF THE CORPORATION The Corporation is a savings and loan
holding company within the meaning of Section 10 of the Home Owners' Loan Act
("HOLA"). As such, the Corporation is registered with and subject to OTS
examination and supervision as well as to certain OTS reporting requirements.
The Corporation is also required to file certain reports and otherwise comply
with the rules and regulations of the Securities and Exchange Commission
("SEC"). Furthermore, the Corporation is limited with respect to the
transactions it can execute with its affiliates (including the Bank), and its
ability to acquire control of another insured financial institution, as
specified more fully in the applicable regulations. There generally are no
restrictions as to activities of a unitary savings and loan holding company such
as the Corporation as long as its sole insured subsidiary, the Bank, continues
to meet certain regulatory requirements, which management believes it did as of
December 31, 2002.
REGULATION OF THE BANK The Bank, as a federally-chartered savings bank,
is subject to federal regulation and oversight by the OTS extending to all
aspects of its operations. The Bank also is subject to regulation and
examination by the FDIC, which insures the deposits of the Bank to the maximum
extent permitted by law, and to
12
certain requirements established by the Federal Reserve Board. The laws and
regulations governing the Bank generally have been promulgated to protect
depositors and not for the purpose of protecting stockholders of financial
institutions or their holding companies.
The investment and lending authority of a federally-chartered savings
bank is prescribed by federal laws and regulations. The Bank is also subject to
regulatory provisions affecting a wide variety of matters including, but not
limited to, branching, loans to one borrower, investment restrictions,
activities of subsidiaries, loans to "insiders," and transactions with
affiliates. Certain of the regulatory requirements applicable to the Bank are
described in more detail in the following paragraphs.
INSURANCE OF DEPOSITS The Bank's savings deposits are insured
by SAIF, which is administered by the FDIC, up to the maximum extent provided by
law, currently $100,000 for each depositor. The Bank is subject to a risk-based
insurance assessment system under which higher insurance assessment rates are
charged to those thrift institutions that are deemed to pose greater risk to the
deposit insurance fund. Under this system, insurance assessments range from 0%
of deposits for the healthiest financial institutions to 0.27% of deposits for
the weakest. This risk-based assessment schedule is identical to that for
institutions insured by the Bank Insurance Fund ("BIF"), which is also
administered by the FDIC. Under both funds, the insurance assessment paid by a
particular institution will depend on the "supervisory rating" it receives from
the FDIC ("A," "B," or "C") and on its regulatory capital level ("well
capitalized," "adequately capitalized," or "undercapitalized"). Based upon its
current supervisory rating and regulatory capital level, and assuming no change
in the Bank's risk classification or in overall premium assessment levels, the
Bank anticipates that its insurance assessment for 2003 will be zero, which is
the same as the Bank's 2002 rate.
CAPITAL STANDARDS The Bank is subject to minimum regulatory
capital requirements as specified by OTS regulations. As more fully described in
such regulations, the Bank is subject to a leverage limit of at least 3% of
total assets, a tangible capital limit of at least 1.5% of total assets and a
risk-based capital limit of at least 8% of risk-weighted assets. As of December
31, 2002, the Bank exceeded all minimum regulatory capital requirements as
specified by the OTS.
The Bank is also subject to minimum regulatory capital
requirements as specified by FDIC regulations. As more fully described in such
regulations, the Bank must meet the following capital standards to be classified
as "adequately capitalized" under FDIC guidelines: (1) Tier 1 capital in an
amount not less than 4% of adjusted total assets, (ii) Tier 1 capital in an
amount not less than 4% of risk-weighted assets, and (iii) total capital in an
amount not less than 8% of risk-weighted assets. As of December 31, 2002, the
Bank exceeded all minimum regulatory capital requirements as specified by the
FDIC. For additional discussion, refer to Note 12 of the Corporation's Audited
Consolidated Financial Statements, included herein under Part II, Item 8,
"Financial Statements and Supplementary Data."
CLASSIFICATION OF ASSETS As previously described, the Bank's
problem assets are subject to classification according to one of three
categories: "Substandard", "Doubtful" and "Loss". An institution is required to
develop its own program to classify its assets on a regular basis and to set
aside appropriate loss reserves on the basis of such classification. The Bank
believes that it is in compliance with the foregoing requirements.
QUALIFIED THRIFT LENDER TEST A savings association that does
not meet the Qualified Thrift Lender Test ("QTL Test"), as set forth in the HOLA
and OTS regulations, may lose access to FHLB advances and must either convert to
a bank charter or comply with certain restrictions on its operations. Under the
QTL Test, a savings association is required to maintain a certain percentage of
its assets in qualifying investments, as defined by regulations. In general,
qualifying investments consist of housing-related assets. At December 31, 2002,
the Bank's assets invested in qualifying investments exceeded the percentage
required to qualify the Bank under the QTL Test.
FEDERAL HOME LOAN BANK SYSTEM The Bank is a member of the FHLB
System, which consists of 12 regional FHLBs, subject to supervision and
regulation by the Federal Housing Finance Board. The FHLBs provide a central
credit facility primarily for member financial institutions. The Bank, as a
member of the FHLB of Chicago, is required to purchase and hold shares of
capital stock in the FHLB of Chicago. The requirement is equal to the greater of
1% of the Bank's aggregate unpaid residential mortgage loans, home purchase
contracts and similar
13
obligations at the beginning of each year or 5% of its outstanding advances from
the FHLB of Chicago. At December 31, 2002, the Bank had a $55.6 million
investment in the stock of the FHLB of Chicago and was in compliance with this
requirement.
The Bank's investment in FHLB stock, its single-family
mortgage loans, and certain other assets (consisting principally of CMOs and
MBSs) are used to secure advances from the FHLB of Chicago. The interest rates
charged on advances vary with the maturity of the advance and the FHLBs own cost
of funds.
FEDERAL RESERVE SYSTEM Regulation D, as promulgated by the
Federal Reserve Board, requires savings institutions to maintain
non-interest-earning reserves against certain transaction deposit accounts and
other liabilities. At December 31, 2002, the Bank's minimum required reserve
level was $49.6 million and it was in compliance with the regulation.
DIVIDEND RESTRICTIONS The payment of dividends by the Bank is
subject to various limitations set forth in federal regulations and as briefly
described in Note 12 of the Corporation's Audited Consolidated Financial
Statements, included herein under Part II, Item 8, "Financial Statements and
Supplementary Data." The Bank has not paid any dividends in violation of these
regulations.
COMMUNITY REINVESTMENT ACT Under the Community Reinvestment
Act of 1977, as amended (the "CRA"), and as implemented by OTS regulations, a
savings institution has a continuing and affirmative obligation, consistent with
its safe and sound operation, to help meet the credit needs of its entire
community, including low and moderate income neighborhoods. The CRA does not
establish specific lending requirements or programs for financial institutions
nor does it limit an institution's discretion to develop the types of products
and services that it believes are best suited to its particular community,
consistent with the CRA. The CRA requires the OTS, in connection with its
examination of a savings institution, to assess the institution's record of
meeting the credit needs of its community and to take such record into account
in its evaluation of certain applications by such institution. The CRA also
requires all institutions to make public disclosure of their CRA ratings. The
Bank's latest CRA rating, received in 2002, was "Outstanding".
TAXATION
FEDERAL TAXATION The Corporation is subject to those rules of federal
income taxation generally applicable to corporations under the Internal Revenue
Code of 1986, as amended (the "IRC"). The Corporation, the Bank, and the Bank's
wholly-owned subsidiaries (excluding FRI) file consolidated federal income tax
returns, which has the effect of eliminating or deferring the tax consequences
of intercompany distributions, including dividends, in the computation of
consolidated taxable income. The consolidated entity pays taxes at the federal
statutory rate of 35% of its taxable income, as defined in the IRC. Refer to
Notes 1 and 9 of the Corporation's Audited Consolidated Financial Statements,
included herein under Part II, Item, 8, "Financial Statements and Supplemental
Data," for additional discussion. As of December 31, 2002, the Corporation had
no material disputes outstanding with Internal Revenue Service.
STATE TAXATION The states of Wisconsin, Illinois and Minnesota impose a
tax on their apportioned shares of the Corporation's taxable income at the rate
of 7.9%, 7.3% and 9.8%, respectively (all state income taxes are deductible on
the Corporation's federal income tax return). These states' definitions of
taxable income are generally similar to the federal definition, except that
interest from state and municipal obligations is taxable, no deduction is
allowed for state income taxes (except for Illinois, which allows a deduction
for taxes paid to other states), and, in Wisconsin and Minnesota, net operating
losses may be carried forward but not back. Minnesota and Illinois require the
filing of combined state income tax returns, whereas Wisconsin currently
requires separate returns for each entity in the consolidated group.
FCHI is incorporated in the State of Nevada, which does not currently
impose a corporate income tax. Although the earnings of FCHI are not currently
subject to taxation in the State of Wisconsin, from time-to-time the government
of the State of Wisconsin proposes legislation that would require consolidated
income tax returns for entities headquartered in the state. To date, none of
these legislative proposals have been passed into law. In addition, from
time-to-time the Wisconsin Department of Revenue ("WDR") attempts to impose
consolidated
14
income tax reporting on banking entities in the state that have investment
subsidiaries in Nevada similar to the Corporation, although the Corporation has
never been the target of such efforts by the WDR.
If legislation referred to in the previous paragraph were to ever be
passed into law, or were the WDR to be successful in imposing consolidated
income tax reporting on banking entities within the state, such efforts could
result in the earnings of FCHI being subject to taxation in the State of
Wisconsin. If the Corporation had been required to file a consolidated state
income tax return in Wisconsin for the year ended December 31, 2002, the
Corporation's income tax expense would have been approximately $1.7 million
higher than that which has been reported. This would have reduced diluted and
basic earnings per share by approximately $0.08 per share. At this time,
management of the Corporation is not aware of any legislative proposals that
would result in the filing of a consolidated state income tax return in the
State of Wisconsin. Furthermore, the Corporation is not aware of any successes
on the part of the WDR in imposing combined reporting on any banking entities in
the state. However, there can be no assurances that legislation will not be
introduced and passed into law in the future or that the WDR will not be
successful in imposing combined reporting on the banking industry in the state.
ITEM 2--PROPERTIES
As of December 31, 2002, the Corporation conducted its business from
its corporate offices in La Crosse, Wisconsin, 86 other banking facilities
located throughout Wisconsin, northern Illinois, and south-eastern Minnesota,
and two separate loan production offices, also located in Wisconsin. At such
date, the Corporation owned the building and/or land for 29 of its offices and
leased the building and/or the land for its remaining 60 properties, including
49 located in supermarkets. The Corporation also owns or leases certain other
properties to meet various business needs. For additional information, refer to
Note 5 of the Corporation's Audited Consolidated Financial Statements, included
herein under Part II, Item 8, "Financial Statements and Supplementary Data".
ITEM 3--LEGAL PROCEEDINGS
The information required herein is included in Note 11 of the
Corporation's Audited Consolidated Financial Statements, included herein under
Part II, Item 8, "Financial Statements and Supplementary Data".
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to security holders for vote during the
fourth quarter of 2002.
15
PART II
ITEM 5--MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Corporation's common stock is traded on the National Association of
Securities Dealers Automated Quotation ("NASDAQ") National Market System under
the symbol FTFC. As of February 14, 2003, the Corporation had 19,707,112 common
shares outstanding (net of 508,821 shares of treasury stock), 1,410 stockholders
of record, 3,103 estimated beneficial stockholders, and 4,513 estimated total
stockholders.
Dividend and stock price information required by this item, as well as
information relating to the Corporation's stock repurchase plans, is included
under the following sections of this report:
(1) "Liquidity and Capital Resources", included herein under Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
(2) "Note 12--Stockholder's Equity", included herein under Item 8,
"Financial Statements and Supplementary Data--Audited Consolidated Financial
Statements".
(3) "Quarterly Financial Information", included herein under Item 8,
"Financial Statements and Supplementary Data--Supplementary Data".
16
ITEM 6--SELECTED FINANCIAL DATA
The information in the following table contains selected consolidated
financial and other data. This information has been derived in part from the
Audited Consolidated Financial Statements included herein under Item 8,
"Financial Statements and Supplementary Data". Accordingly, the table should be
read in conjunction with such consolidated statements.
Dollars in thousands, except for per share amounts
- ---------------------------------------------------------------------------------------------------------------------
SELECTED BALANCE SHEET DATA AS OF DECEMBER 31 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------
Total assets $3,025,624 $2,717,710 $2,352,726 $2,084,554 $1,786,504
Investment securities available for sale, at fair
value - 35,462 817 873 -
Mortgage-backed and related securities:
Available for sale, at fair value 366,075 305,980 331,237 252,165 204,109
Held for investment, at cost 30,030 134,010 77,299 103,932 102,500
Loans held for investment, net 2,100,642 1,851,316 1,772,477 1,538,595 1,177,526
Allowance for loan losses 11,658 9,962 8,028 7,624 7,624
Mortgage servicing rights, net 30,171 29,909 23,280 21,728 21,103
Intangible assets 43,818 24,946 11,490 12,463 13,485
Deposit liabilities 2,355,148 2,029,254 1,699,252 1,471,259 1,460,136
FHLB advances and other borrowings 417,613 467,447 490,846 469,580 189,778
Stockholders' equity 205,452 192,398 146,549 127,275 122,685
=====================================================================================================================
SELECTED OPERATING DATA FOR YEAR ENDED DECEMBER 31 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------
Interest income $ 161,250 $ 171,533 $ 161,436 $ 130,071 $ 118,668
Interest expense 79,726 108,330 101,896 75,953 71,457
- ---------------------------------------------------------------------------------------------------------------------
Net interest income 81,525 63,202 59,540 54,117 47,211
Provision for loan losses 3,468 1,763 1,009 387 293
- ---------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan
losses 78,057 61,438 58,531 53,730 46,918
- ---------------------------------------------------------------------------------------------------------------------
Gain (loss) from sale of investments and other
assets (166) 63 1,386 - 343
Other non-interest income 63,801 49,464 34,247 35,178 31,017
- ---------------------------------------------------------------------------------------------------------------------
Total non-interest income 63,635 49,527 35,633 35,178 31,360
Non-interest expense 87,378 67,119 58,250 54,299 47,597
- ---------------------------------------------------------------------------------------------------------------------
Income before income tax expense 54,313 43,847 35,914 34,609 30,681
Income tax expense 19,398 15,398 12,770 12,167 11,257
- ---------------------------------------------------------------------------------------------------------------------
Net income $ 34,916 $ 28,448 $ 23,144 $ 22,441 $ 19,424
=====================================================================================================================
SELECTED OTHER DATA AT OR FOR THE YEAR ENDED DECEMBER 31 2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------
Return on average assets 1.23% 1.14% 1.04% 1.19% 1.19%
Return on average equity 17.56 17.19 17.01 17.63 16.59
Equity to assets at end of period 6.79 7.08 6.23 6.11 6.87
Tangible equity to tangible assets at end of period 5.42 6.22 5.77 5.54 6.16
Average interest rate spread 2.64 2.12 2.34 2.58 2.51
Average net interest margin 3.08 2.70 2.83 3.05 3.07
Ratio of allowance for loan losses to total loans
held for investment at end of period 0.55 0.54 0.45 0.50 0.65
Ratio of non-performing assets to total assets at
end of period 0.30 0.31 0.19 0.10 0.13
Ratio of non-interest income to total revenue (1) 43.84 43.93 37.44 39.40 39.91
Ratio of non-interest expense to average assets 3.08 2.70 2.62 2.88 2.91
Efficiency ratio during period (2) 59.71 58.58 60.88 59.65 60.10
Earnings per share:
Diluted earnings per share $ 1.73 $ 1.51 $ 1.25 $ 1.17 $ 0.98
Basic earnings per share 1.76 1.52 1.26 1.21 1.05
Dividends paid per share 0.51 0.47 0.42 0.34 0.27
Stock price at end of period 19.31 15.70 14.50 14.63 16.38
Book value per share at end of period 10.43 9.52 7.99 6.92 6.68
Tangible book value per share at end of period 8.20 8.29 7.36 6.24 5.95
Banking facilities at end of period 89 78 72 64 61
Full-time equivalent employees at end of period 1,213 1,033 897 831 808
=====================================================================================================================
(1) Total revenue is defined as the sum of net interest income and
non-interest income.
(2) Excludes amortization of intangible assets and gains on sales of investment
securities and other assets.
17
ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion and analysis in this section should be read in
conjunction with Item 8, "Financial Statements and Supplementary Data", as well
as Item 7A, "Quantitative and Qualitative Disclosures about Market Risk", and
Part I, Item 1, "Business".
APPLICATION OF CRITICAL ACCOUNTING POLICIES
CRITICAL JUDGMENTS AND ESTIMATES The Corporation describes all of its
significant accounting policies in Note 1, of the Corporation's Audited
Consolidated Financial Statements, included herein under Item 8. Particular
attention should be paid to two accounting areas that, in management's judgment,
require significant judgments and/or estimates on the part of management because
of the inherent uncertainties surrounding these areas and/or the subjective
nature of the areas. These areas are itemized and referenced as follows.
MORTGAGE SERVICING RIGHTS For a detailed discussion of the
judgments and estimates relating to the initial recording of and ongoing
accounting for mortgage servicing rights, refer to the appropriate section in
Note 1 of the Corporation's Audited Consolidated Financial Statements, included
herein under Item 8. Additional discussion is also available in the "Residential
Lending" section of Part I, Item 1, "Business--Lending Activities". Finally,
information on the impact mortgage servicing rights have had on the
Corporation's financial condition and results of operations for the years ending
December 31, 2002, 2001, and 2000, can be found, below, in the sections entitled
"Financial Condition--Mortgage Servicing Rights" and "Results of
Operations--Non-Interest Income--Mortgage Banking Revenue".
ALLOWANCE FOR LOSSES ON LOANS AND REAL ESTATE For a detailed
discussion of the judgments and estimates relating to allowances for losses on
loans and real estate, refer to the appropriate section in Note 1 of the
Corporation's Audited Consolidated Financial Statements, included herein under
Item 8. Additional discussion is also available in the "Non-Performing and Other
Classified Assets" section and the "Allowances for Losses on Loans and Real
Estate" section of Part I, Item 1, "Business--Lending Activities". Finally,
information on the impact loss allowances have had on the Corporation's
financial condition and results of operations for the years ending December 31,
2002, 2001, and 2000, can be found, below, in the sections entitled "Financial
Condition--Non-Performing Assets" and "Results of Operations--Provisions for
Loan Losses".
NEW ACCOUNTING STANDARDS AND POLICIES During the three-year period
ended December 31, 2002, the Corporation adopted no new accounting standards or
policies that, in management's judgment, had a material impact on its financial
condition or results of operations. However, three new accounting standards were
adopted during the period that were significant to the financial services
industry as a whole. These standards are itemized in the paragraphs that follow.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 133,
"ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("SFAS 133") The
Corporation adopted SFAS 133 in January 2001. For further discussion, refer to
"Loans Held for Sale, Derivative Instruments, and Hedging Activities" in Note 1
of the Corporation's Audited Consolidated Financial Statements, included herein
under Item 8.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 141, "BUSINESS
COMBINATIONS" ("SFAS 141") This new standard requires the purchase method of
accounting for all mergers and acquisitions, except in very limited instances.
The Corporation adopted SFAS 141 in January 2002. This adoption did not have a
material impact on the Corporation because the acquisitions it completed in 2002
and 2001 would have been accounted for using the purchase method regardless of
SFAS 141. Refer to Note 15 of the Corporation's Audited Consolidated Financial
Statements, included herein under Item 8.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 142, "GOODWILL
AND OTHER INTANGIBLE ASSETS" ("SFAS 142") The Corporation adopted SFAS 142 in
January 2002. For further discussion, refer to "Goodwill and Intangible Assets"
in Note 1, as well as Note 6 of the Corporation's Audited Consolidated Financial
Statements, included herein under Item 8.
18
RESULTS OF OPERATIONS
OVERVIEW The Corporation's earnings for the years ended December 31,
2002, 2001, and 2000, were $34.9 million, $28.4 million, and $23.1 million,
respectively. These amounts represented returns on average assets of 1.23%,
1.14%, and 1.04%, respectively, and returns on average equity of 17.56%, 17.19%,
and 17.01%, respectively. Diluted earnings per share during these periods were
$1.73, $1.51, and $1.25, respectively.
The increase in net income from 2001 to 2002 was principally due to
increases in net interest income, mortgage banking revenue, and community
banking revenue. These developments were partially offset by increases in
non-interest expense (particularly compensation and employee benefits),
provision for loan losses, and income tax expense (the latter due to higher
pre-tax earnings).
The increase in net income from 2000 to 2001 was principally due to
increases in mortgage banking revenue, community banking revenue, and net
interest income. These developments were partially offset by increases in
non-interest expense (particularly compensation and employee benefits),
provision for loan losses, and income tax expense (the latter due to higher
pre-tax earnings).
The following paragraphs discuss the aforementioned changes in greater
detail along with other changes in the components of net income during the years
ended December 31, 2002, 2001, and 2000.
NET INTEREST INCOME Net interest income increased by $18.3 million or
almost 30% and $3.7 million or 6.2% during the years ended December 31, 2002 and
2001, respectively. The improvement in both of these periods was partly volume
related as the Corporation's average interest-earning assets grew by $301
million or 12.8% in 2002 and by $241 million or 11.5% in 2001. The principal
source of this growth occurred in the Corporation's consumer, commercial real
estate, and commercial business loan portfolios, as well as overnight
investments. Asset growth in both periods was principally funded by increases in
deposit liabilities and stockholders' equity.
Also contributing to the increase in net interest income during 2002
and 2001 were significant increases in average non-interest-bearing deposit
liabilities, which was the principal reason the Corporation's ratio of average
interest-earning assets to average interest-bearing liabilities improved from
110% in 2000 to 112% in 2001 and to 115% in 2002. These improvements were due in
part to an increase in custodial deposit accounts. The Corporation maintains
borrowers' principal and interest payments in these accounts on a temporary
basis pending their remittance to the third-party owners of the loans. Balances
in these accounts increased significantly because of increased loan prepayment
activity, which was brought about by a historically low interest rate
environment.
The Corporation's interest rate spread increased from 2.12% in 2001 to
2.64% in 2002. This improvement was primarily the result of declines earlier in
the year in the Corporation's cost of deposits, which for the year exceeded the
decline in yield on the Corporation's earning assets. Despite an overall
improvement in interest rate spread during 2002, the current interest rate
environment has had an adverse impact on the Corporation's interest rate spread
during the latter half of the year. During this time the Corporation's asset
yields declined faster than its funding costs due to high levels of refinance
activity and an increase in liquidity. Management does not expect the
Corporation's interest rate spread to improve substantially in the near term.
However, should market interest rates rise later in 2003, management believes
that asset yields may improve more quickly than increases in its cost of funds,
although there can be no assurances.
The Corporation's interest rate spread declined from 2.34% in 2000 to
2.12% in 2001. This development partially offset the improvement in net interest
income caused by the favorable developments discussed in previous paragraphs.
Beginning in 1999 and continuing into 2000, market interest rates increased
significantly, led generally by short-term interest rates. The yield curve also
flattened substantially, and was even inverted at times during 2000. Although
higher interest rates resulted in an increase in the average yield on the
Corporation's earning assets in 2000, the cost of the Corporation's
interest-bearing liabilities increased by a greater amount, which resulted in an
overall decline in the Corporation's average interest rate spread in that year.
In 2001, market interest rates reversed trend and declined dramatically,
particularly on the short end of the yield curve. However, the Corporation's
interest rate spread did not improve because only a relatively small portion of
its funding sources repriced or matured during the year.
19
The following table sets forth information regarding the average
balances of the Corporation's assets, liabilities, and equity, as well as the
interest earned or paid and the average yield or cost of each. The information
is based on daily average balances for the years ended December 31, 2002, 2001,
and 2000.
Dollars in thousands 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST COST BALANCE INTEREST COST BALANCE INTEREST COST
- ----------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Single-family mortgage loans $ 789,722 $ 49,673 6.29% $ 817,647 $ 58,799 7.19% $ 769,755 $ 56,637 7.36%
Commercial real estate loans 542,680 41,224 7.60 498,796 39,973 8.01 433,512 34,479 7.95
Consumer loans 439,491 33,476 7.62 355,504 30,530 8.59 306,650 26,202 8.54
Education loans 202,375 10,169 5.02 202,504 14,300 7.06 197,415 17,130 8.68
Commercial business loans 53,247 3,070 5.77 6,459 405 6.27 68 6 8.82
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans 2,027,515 137,611 6.79 1,880,910 144,007 7.66 1,707,400 134,454 7.87
Mortgage-backed and
related securities 399,748 18,470 4.62 378,413 24,060 6.36 360,087 24,516 6.81
Investment securities 2,865 92 3.14 6,482 209 3.15 799 40 5.03
Interest-bearing deposits
with banks 166,482 2,505 1.50 52,111 1,585 3.04 10,530 603 5.73
Other earning assets 48,455 2,571 5.31 26,281 1,672 6.36 24,359 1,822 7.48
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest-earning
assets 2,645,065 161,250 6.10 2,344,197 171,533 7.32 2,103,175 161,436 7.68
Non-interest-earning assets:
Office properties and equipment 33,560 28,652 25,621
Other assets 160,343 116,035 95,178
- ----------------------------------------------------------------------------------------------------------------------------------
Total assets $2,838,968 $2,488,884 $2,223,974
==================================================================================================================================
Interest-bearing liabilities:
Regular savings accounts $ 159,953 $ 1,151 0.72% $ 116,809 $ 1,529 1.31% $ 108,965 $ 1,619 1.49%
Checking accounts 118,122 475 0.41 80,221 573 0.71 75,062 571 0.76
Money market accounts 234,044 3,239 1.38 177,128 5,539 3.13 160,950 6,578 4.09
Certificates of deposit 1,346,628 52,218 3.89 1,257,943 75,944 6.04 1,082,318 64,819 5.99
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
deposits 1,858,747 57,083 3.07 1,632,101 83,585 5.12 1,427,295 73,588 5.16
FHLB advances 432,325 22,393 5.18 401,954 22,061 5.49 380,328 22,078 5.80
Other borrowings 16,254 249 1.53 51,208 2,685 5.24 101,317 6,230 6.15
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 2,307,327 79,726 3.46 2,085,263 108,330 5.20 1,908,940 101,896 5.34
Non-interest-bearing liabilities:
Non-interest-bearing deposits 300,090 209,986 160,963
Other liabilities 32,680 28,098 18,003
- ----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 2,640,097 2,323,347 2,087,906
Stockholders' equity 198,871 165,537 136,068
- ----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
stockholders' equity $2,838,968 $2,488,884 $2,223,974
==================================================================================================================================
Net interest income $ 81,525 $ 63,202 $ 59,540
==================================================================================================================================
Interest rate spread 2.64% 2.12% 2.34%
==================================================================================================================================
Net interest income as a
percent of average
earning assets 3.08% 2.70% 2.83%
==================================================================================================================================
Average interest-earning
assets to average
interest-bearing liabilities 114.64% 112.42% 110.18%
==================================================================================================================================
20
The following table sets forth the effects of changing rates and
volumes on net interest income of the Corporation for the periods indicated.
Information is provided with respect to (i) effects on net interest income
attributable to changes in volume (changes in volume multiplied by prior rate);
(ii) effects on net interest income attributable to changes in rate (changes in
rate multiplied by prior volume); (iii) changes attributable to combined effects
of rate and volume (changes in rate multiplied by changes in volume); and (iv)
the net change in interest income.
2002 COMPARED TO 2001 2001 COMPARED TO 2000
Dollars in thousands (INCREASE(DECREASE) (INCREASE(DECREASE)
- ------------------------------------------------------------------------------------------------------------------------------
RATE/ RATE/
RATE VOLUME VOLUME NET RATE VOLUME VOLUME NET
- ------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets:
Single-family mortgage loans ($ 7,369) ($ 2,008) $ 251 ($ 9,126) ($ 1,283) $ 3,524 ($ 80) $ 2,161
Commercial real estate loans (2,088) 3,523 (178) 1,251 260 5,193 39 5,492
Consumer loans (3,452) 7,213 (815) 2,946 133 4,174 21 4,328
Education loans (4,125) (9) 3 (4,131) (3,187) 442 (83) (2,828)
Commercial business loans (33) 2,934 (236) 2,665 (2) 564 (163) 399
- ------------------------------------------------------------------------------------------------------------------------------
Total loans (17,067) 11,653 (982) (6,396) (4,079) 13,897 (266) 9,553
Mortgage-backed and related securities (6,576) 1,356 (370) (5,590) (1,621) 1,248 (83) (456)
Investment securities -- (116) (1) (117) (14) 286 (103) 169
Interest-bearing deposits with banks (800) 3,478 (1,758) 920 (283) 2,382 (1,117) 981
Other earning assets (279) 1,410 (232) 899 (273) 144 (21) (150)
- ------------------------------------------------------------------------------------------------------------------------------
Total net change in income on
interest-earning assets (24,722) 17,781 (3,342) (10,283) (6,270) 17,957 (1,591) 10,096
- ------------------------------------------------------------------------------------------------------------------------------
Interest-bearing liabilities:
Interest-bearing deposits (31,173) 7,969 (3,298) (26,502) (1,250) 11,331 (84) 9,997
FHLB advances (1,241) 1,667 (94) 332 (1,204) 1,255 (68) (17)
Other borrowings (1,899) (1,833) 1,296 (2,436) (918) (3,081) 453 (3,544)
- ------------------------------------------------------------------------------------------------------------------------------
Total net change in expense on
interest-bearing liabilities (34,313) 7,803 (2,094) (28,604) (3,372) 9,505 301 6,434
- ------------------------------------------------------------------------------------------------------------------------------
Net change in net interest income $ 9,591 $ 9,978 ($ 1,246) $ 18,323 ($ 2,898) $ 8,452 ($ 1,892) $ 3,662
==============================================================================================================================
PROVISION FOR LOAN LOSSES Provision for loan losses was $3.5 million,
$1.8 million, and $1.0 million during the years ended December 31, 2002, 2001,
and 2000, respectively. During 2002 and 2001, the Corporation recorded
approximately $1.7 million and $672,000, respectively, in provision for loan
losses over-and-above its actual net charge-off activity. These additional
provisions were recorded to maintain the Corporation's allowance for loan losses
at a level deemed appropriate by management, and were considered proper in light
of significant growth in the Corporation's loans held for investment in recent
periods, an increased mix of higher-risk consumer loans, commercial real estate
loans, and commercial business loans, and an increase in non-performing and
classified assets. In addition, in December 2002, $550,000 in specific loss
provisions were established on three business loan relationships following
management's review of the loans. In all three cases, all or a portion of the
loans were past due and/or legal action had commenced to collect that which was
owed. Management of the Corporation deemed these loss provisions prudent after
consideration of factors such as the absence of current financial information,
deteriorating operating results, declines in the valuation of associated
collateral, and/or weakening economic conditions. Management does not expect to
incur additional losses on this group of loans at this time, although there can
be no assurances.
As of December 31, 2002, 2001, and 2000, the Corporation's allowance
for loan losses was $11.7 million, $10.0 million, and $8.0 million,
respectively, or 0.55%, 0.54%, and 0.45% of loans held for investment,
respectively. The allowance for loan losses was 217%, 176%, and 256% of
non-performing loans as of the same dates, respectively. For additional
discussion, refer to "Financial Condition--Non-Performing Assets".
21
The following table summarizes the activity in the Corporation's
allowance for loan losses during each of years indicated. The purchased
allowances shown for 2001 were from the acquisition of ACB in October 2001.
Dollars in thousands 2002 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 9,962 $8,028 $7,624 $7,624 $7,638
Provision for losses 3,468 1,763 1,009 387 293
- -------------------------------------------------------------------------------------------------------------------
Charge-offs:
Single-family mortgage loans 49 96 - - -
Consumer loans 1,759 1,057 632 408 332
Education loans 31 36 33 26 33
Commercial business loans 6 - - - -
- -------------------------------------------------------------------------------------------------------------------
Total loans charged-off 1,845 1,189 665 434 365
Recoveries 73 98 60 47 58
- -------------------------------------------------------------------------------------------------------------------
Charge-offs net of recoveries 1,772 1,091 605 387 307
Purchased allowances - 1,262 - - -
- -------------------------------------------------------------------------------------------------------------------
Balance at end of period $11,658 $9,962 $8,028 $7,624 $7,624
===================================================================================================================
Net charge-offs as a percentage of average loans outstanding 0.09% 0.06% 0.04% 0.03% 0.03%
===================================================================================================================
Ratio of allowance to total loans held for investment at end of period 0.55% 0.54% 0.45% 0.50% 0.65%
===================================================================================================================
Ratio of allowance to total non-performing loans 217% 176% 256% 724% 686%
===================================================================================================================
Note: there were no charge-offs of commercial real estate loans during the five
years ended December 31, 2002.
The following table shows the Corporation's total allowance for loan
losses and the allocation to the various loan categories as of December 31 for
each of the years indicated.
Dollars in thousands 2002 2001 2000 1999 1998
- ----------------------------------------------------------------------------------------------------------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT % AMOUNT %
- ----------------------------------------------------------------------------------------------------------------
Single-family mortgage loans $ 1,159 0.16% $ 140 0.02% $ 149 0.02% $ 144 0.02% $ 156 0.04%
Commercial real estate loans 5,669 1.12 7,665 1.50 7,257 1.65 7,088 2.00 7,017 2.43
Consumer loans 1,138 0.23 873 0.25 585 0.17 355 0.13 414 0.19
Commercial business loans 3,692 5.13 1,284 3.31 37 18.97 37 12.50 37 9.97
- ----------------------------------------------------------------------------------------------------------------
Total allowance for loan losses $11,658 0.55% $9,962 0.54% $8,028 0.45% $7,624 0.50% $7,624 0.65%
================================================================================================================
The amounts in the preceding table are expressed as a percentage of
gross loans outstanding for each loan category, excluding construction loans.
The total allowance is expressed as a percent of net loans held for investment.
There was no allowance for loan losses allocated to education loans as of
December 31 for any of the years presented.
Although management believes that the Corporation's present level of
allowance for loan losses is adequate, there can be no assurance that future
adjustments to the allowance will not be necessary, which could adversely affect
the Corporation's results of operations.
NON-INTEREST INCOME Non-interest income for the years ended December
31, 2002, 2001, and 2000, was $63.6 million, $49.5 million, and $35.6 million,
respectively. These amounts represented 44%, 44%, and 37% of the Corporation's
total revenue during such periods, respectively. The following paragraphs
discuss the principal components of non-interest income and the primary reasons
for their changes from 2001 to 2002 and 2000 to 2001.
22
COMMUNITY BANKING REVENUE Community banking revenue increased
by $4.6 million or 15.8% in 2002 and by $3.8 million or 15.3% in 2001. The
following table shows the Corporation's community banking revenue for the
twelve-month periods ended December 31.
Dollars in thousands 2002 2001 2000
- -------------------------------------------------------------------------------------------
Overdraft fees $16,411 $14,132 $12,644
ATM and debit card fees 9,837 7,916 6,564
Account service charges 2,205 1,863 1,730
Other fee income 1,464 1,299 1,523
- -------------------------------------------------------------------------------------------
Total deposit account revenue 29,917 25,210 22,461
- -------------------------------------------------------------------------------------------
Consumer loan insurance premiums and commissions 1,021 1,061 1,072
Other consumer loan fees 350 320 101
- -------------------------------------------------------------------------------------------
Total consumer loan revenue 1,371 1,381 1,173
- -------------------------------------------------------------------------------------------
Investment services revenue 2,310 2,420 1,537
- -------------------------------------------------------------------------------------------
Total community banking revenue $33,598 $29,011 $25,171
===========================================================================================
Overdraft fees increased by $2.3 million or 16.1% in 2002 and
by $1.5 million or 11.8% in 2001. These increases were due in part to growth of
12.1% and 12.8% in the number of checking accounts serviced by the Corporation
during 2002 and 2001, respectively. Also contributing to the growth in community
banking revenue was a $1.9 million or almost 25% increase and a $1.4 million or
over 20% increase in fees from customers' use of debit cards and ATMs in 2002
and 2001, respectively.
Consumer loan revenue declined by $10,000 or less than 1% in
2002 and increased by $208,000 or 17.7% in 2001. The Corporation's principal
sources of consumer loan revenue consist of sales of credit life and disability
insurance policies to consumer loan customers. In 2002, increased premium and
commission revenue associated with increased originations was substantially
offset by increased losses on insurance claims. The Bank's wholly-owned
reinsurance subsidiary, FRI, assumes the first level of risk on these credit
life and disability policies. Refer to Part I, Item 1, "Business--Subsidiaries"
for additional discussion.
Investment services revenue declined by $110,000 or 4.5% in
2002 and increased by $883,000 or 57% in 2001. The Corporation's principal
sources of investment services revenue consist of commissions from sales of
tax-deferred annuities, mutual funds, and other debt and equity securities.
Investment services revenue declined in 2002 in response to general declines in
market interest rates that made tax-deferred annuities less attractive to the
Corporation's customers. In addition, general declines in equity markets caused
by a declining economy and investor concerns over corporate governance issues
and geopolitical risks resulted in lower commissions from sales of mutual funds
and other equity investments. Investment services revenue increased in 2001
because of higher sales of tax-deferred annuities in that period. Also
contributing was an increase in commissions from sales of mutual funds and other
equity investments caused by an increase in the number of registered investment
representatives in the Corporation's offices.
MORTGAGE BANKING REVENUE Mortgage banking revenue increased by
$9.2 million or 50% in 2002 and by $11.0 million or over 150% in 2001. The
following table shows the Corporation's mortgage banking revenue for the periods
ended December 31.
Dollars in thousands 2002 2001 2000
- --------------------------------------------------------------------------------------------
Gross servicing fees $ 9,532 $ 8,374 $ 7,481
Mortgage servicing rights amortization (25,274) (15,971) (3,607)
Mortgage servicing rights valuation (loss) recovery (750) 67 -
- --------------------------------------------------------------------------------------------
Total loan servicing fees, net (16,492) (7,530) 3,874
- --------------------------------------------------------------------------------------------
Gain on sale of mortgage loans 42,208 24,373 2,540
Other mortgage-related income 1,758 1,421 851
- --------------------------------------------------------------------------------------------
Total mortgage banking revenue $ 27,474 $ 18,264 $ 7,265
============================================================================================
Gross servicing fees increased by $1.2 million or 13.8% in
2002 and by $893,000 or 11.9% in 2001. These increases were due primarily to
$505 million or 22.0% and a $345 million or 17.7% in growth in average loans
serviced for others in 2002 and 2001, respectively, compared to year-ago
periods. The growth in both periods was caused by a significant increase in the
origination and sale of fixed-rate mortgage loans, as described in a later
paragraph. Also contributing were increased conversions by borrowers of
adjustable-rate mortgage loans into fixed-rate loans. Upon conversion, such
loans are generally sold in the secondary market and the Corporation
23
retains the servicing. Finally, in 2001 the Corporation purchased mortgage
servicing rights ("MSRs") related to $89.4 million in mortgage loans. Such loans
consisted principally of fixed-rate, residential mortgage loans on properties
located in Iowa.
Amortization of mortgage servicing rights was $25.3 million,
$16.0 million, and $3.6 million in 2002, 2001, and 2000, respectively. With
market interest rates at historically low levels in 2001 and 2002, loan
prepayment activity increased dramatically as borrowers refinanced older,
higher-rate residential mortgage loans, into lower-rate loans. As a result of
this activity, the Corporation recorded significantly more amortization of
mortgage servicing rights in 2002 and 2001 than it did in the year-ago periods.
Management expects that interest rates will remain at
historically low levels in the near future. If this trend continues, the
Corporation will most likely continue to experience high levels of amortization
on its MSRs as a result of high levels of loan prepayment activity. Such
amortization, however, will most likely be offset by high levels of gains on
sales of mortgage loans, although there can be no assurances. It should be
noted, however, that declines in market interest rates may also expose the
Corporation to unfavorable mark-to-market adjustments against its portfolio of
MSRs--primarily because of increases in market expectations for future
prepayments. Although management believes that most of the Corporation's loans
that prepay are replaced by a new loan to the same customer or even a different
customer (thus preserving the future servicing cash flow), GAAP requires
mark-to-market losses resulting from increases in market expectations for future
prepayments to be recorded in the current period. However, the offsetting gain
on the sale of the new loan, if any, cannot be recorded until the customer
actually prepays the old loan and the new loan is sold in the secondary market.
As of December 31, 2002, the Corporation had recorded $3.4 million in
unfavorable mark-to-market adjustments against its mortgage servicing rights, of
which $750,000 was recorded through earnings in 2002. If interest rates
increase, management expects that future prepayment expectations will decline.
If such occurs, the Corporation may be required to recapture through earnings
some or all of the mark-to-market adjustment on its MSRs.