Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________ to __________________
Commission File Number 0-20006
ANCHOR BANCORP WISCONSIN INC.
-----------------------------
(Exact name of registrant as specified in its charter)
Wisconsin 39-1726871
- --------------------------------- -------------------
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
25 West Main Street
Madison, Wisconsin 53703
------------------------
(Address of principal executive office)
Registrant's telephone number, including area code (608) 252-8700
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
--------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 or 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 the Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). [X]
As of September 30, 2002, the aggregate market value of the 22,207,552
shares of the registrant's common stock deemed to be held by non-affiliates of
the registrant was $448.6 million, based upon the closing price of $20.20 per
share of common stock as reported by the Nasdaq Stock Market, National Market
System on such date. Although directors and executive officers of the registrant
and certain of its employee benefit plans were assumed to be "affiliates" of the
registrant for purposes of this calculation, the classification is not to be
interpreted as an admission of such status.
As of May 30, 2003, 23,836,013 shares of the registrant's common stock
were outstanding. There were also 100,000 series A- preferred stock purchase
rights authorized with none outstanding, as of the same date.
Documents Incorporated by Reference
Portions of the definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on July 22, 2003
(Part III, Items 10 to 13)
[This page intentionally left blank]
PART I
ITEM 1. BUSINESS
GENERAL
Anchor BanCorp Wisconsin Inc. (the "Corporation") is a registered
savings and loan holding company incorporated under the laws of the State of
Wisconsin and is engaged in the savings and loan business through its
wholly-owned banking subsidiary, AnchorBank, fsb (the "Bank"). The Corporation
also has a non-banking subsidiary, Investment Directions, Inc. ("IDI"), a
Wisconsin corporation, which invests in real estate partnerships. IDI has two
subsidiaries, Nevada Investment Directions, Inc. ("NIDI") and California
Investment Directions, Inc. ("CIDI"), both of which invest in real estate held
for development and sale.
The Bank was organized in 1919 as a Wisconsin-chartered savings
institution. In July 2000, the Bank converted to a federally-chartered savings
institution, and the Bank's deposits are insured up to the maximum allowable
amount by the Federal Deposit Insurance Corporation ("FDIC"). The Bank is a
member of the Federal Home Loan Bank of Chicago ("FHLB"), and is regulated by
the Office of Thrift Supervision ("OTS"), and the FDIC. The Corporation is
subject to the periodic reporting requirements of the Securities and Exchange
Commission ("SEC") under the Securities Exchange Act of 1934, as amended
("Exchange Act"). The Bank is also regulated by the Board of Governors of the
Federal Reserve System ("Federal Reserve Board") relating to reserves required
to be maintained against deposits and certain other matters. See "Regulation."
The Bank blends an interest in the consumer and small business markets
with the willingness to expand its numerous checking, savings and lending
programs to meet customers' changing financial needs. The Bank offers checking,
savings, money market accounts, mortgages, home equity and other consumer loans,
student loans, credit cards, annuities and related consumer financial services.
The Bank also offers banking services to businesses, including checking
accounts, lines of credit, secured loans and commercial real estate loans.
The Bank has three wholly owned subsidiaries. Anchor Investment
Services, Inc. ("AIS"), a Wisconsin corporation, offers investments and credit
life and disability insurance to the Bank's customers and other members of the
general public. ADPC Corporation ("ADPC"), a Wisconsin corporation, holds and
develops certain of the Bank's foreclosed properties. Anchor Investment
Corporation ("AIC") is an operating subsidiary that is located in and formed
under the laws of the State of Nevada. AIC was formed for the purpose of
managing a portion of the Bank's investment portfolio (primarily
mortgage-related securities).
The Corporation maintains a web site at www.anchorbank.com. All the
Corporation's filings under the Exchange Act are available through that web
site, free of charge, including copies of Annual Reports on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those
reports, on the date that the Corporation files those materials with, or
furnishes them to, the SEC.
CAUTIONARY FACTORS
This Form 10-K contains or incorporates by reference various
forward-looking statements concerning the Corporation's prospects that are based
on the current expectations or beliefs of management. Forward-looking statements
may also be made by the Corporation from time to time in other reports and
documents as well as oral presentations. When used in written documents or oral
statements, the words "anticipate," "believe," "estimate," "expect," "objective"
and similar expressions and verbs in the future tense, are intended to identify
forward-looking statements. The statements contained herein and such future
statements involve or may involve certain assumptions, risks and uncertainties,
many of which are beyond the Corporation's control, that could cause the
Corporation's actual results and performance to differ materially from what is
expected. In addition to the assumptions and other factors referenced
specifically in connection with such statements, the following factors could
impact the business and financial prospects of the Corporation: general economic
conditions; legislative and
1
regulatory initiatives; increased competition and other effects of deregulation
and consolidation of the financial services industry; monetary and fiscal
policies of the federal government; deposit flows; disintermediation; the cost
of funds; general market rates of interest; interest rates or investment returns
on competing investments; demand for loan products; demand for financial
services; changes in accounting policies or guidelines; general economic
developments; acts of terrorism and developments in the war on terrorism; and
changes in the quality or composition of loan and investment portfolios. See
also the factors regarding future operations discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" below,
particularly those under the caption "Risk Factors."
MARKET AREA
The Bank's primary market area consists of the metropolitan area of
Madison, Wisconsin, the suburban communities of Dane County, Wisconsin,
south-central Wisconsin, the Fox Valley in east-central Wisconsin, the Milwaukee
metropolitan area in southeastern Wisconsin, as well as contiguous counties in
Iowa and Illinois. As of March 31, 2003, the Bank conducted business from its
headquarters and main office in Madison, Wisconsin and from 54 other
full-service offices located primarily in south-central and southwest Wisconsin
and two loan origination offices.
COMPETITION
The Bank is subject to extensive competition from other savings
institutions as well as commercial banks and credit unions in both attracting
and retaining deposits and in real estate and other lending activities.
Competition for deposits also comes from money market funds, bond funds,
corporate debt and government securities. Competition for the origination of
real estate loans comes principally from other savings institutions, commercial
banks and mortgage banking companies. Competition for consumer loans is
primarily from other savings institutions, commercial banks, consumer finance
companies and credit unions.
The principal factors that are used to attract deposit accounts and
that distinguish one financial institution from another include rates of return,
types of accounts, service fees, convenience of office locations and hours, and
other services. The primary factors in competing for loans are interest rates,
loan fee charges, timeliness and quality of service to the borrower.
LENDING ACTIVITIES
GENERAL. At March 31, 2003 the Bank's net loans held for investment
totaled $2.8 billion, representing approximately 78.3% of its $3.5 billion of
total assets at that date. Approximately $2.3 billion or 78.4% of the Bank's
total loans held for investment at March 31, 2003 were secured by first liens on
real estate.
The Bank's primary lending emphasis is on the origination of
single-family residential loans secured by properties located primarily in
Wisconsin, with adjustable-rate loans generally being originated for inclusion
in the Bank's loan portfolio and fixed-rate loans generally being originated for
sale into the secondary market. In order to increase the yield and interest rate
sensitivity of its portfolio, the Bank also originates commercial real estate,
multi-family, construction, consumer and commercial business loans in its
primary market area.
Non-real estate loans originated by the Bank consist of a variety of
consumer loans and commercial business loans. At March 31, 2003, the Bank's
total loans held for investment included $502.6 million or 16.9% of consumer
loans and $137.4 million or 4.6% of commercial business loans.
2
LOAN PORTFOLIO COMPOSITION. The following table presents information
concerning the composition of the Bank's consolidated loans held for investment
at the dates indicated.
MARCH 31,
-----------------------------------------------------------------------------
2003 2002 2001
-----------------------------------------------------------------------------
PERCENT PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL AMOUNT OF TOTAL
-----------------------------------------------------------------------------
(Dollars in Thousands)
Mortgage loans:
Single-family residential $ 724,900 24.44% $ 855,437 30.33% $ 872,718 34.17%
Multi-family residential 474,678 16.00 388,919 13.79 305,009 11.94
Commercial real estate 747,682 25.20 686,237 24.33 501,640 19.64
Construction 331,338 11.17 288,377 10.22 266,712 10.44
Land 47,951 1.62 45,297 1.61 43,849 1.72
---------- ----- ---------- ----- ---------- -----
Total mortgage loans 2,326,549 78.43 2,264,267 80.28 1,989,928 77.90
---------- ----- ---------- ----- ---------- -----
Consumer loans:
Second mortgage and home equity 269,990 9.10 226,134 8.02 271,733 10.64
Education 166,507 5.61 130,752 4.64 130,215 5.10
Other 66,150 2.23 75,808 2.69 72,274 2.83
---------- ----- ---------- ----- ---------- -----
Total consumer loans 502,647 16.94 432,694 15.34 474,222 18.57
---------- ----- ---------- ----- ---------- -----
Commercial business loans:
Loans 136,090 4.59 121,723 4.32 90,212 3.53
Lease receivables 1,270 0.04 1,803 0.06 - 0.00
---------- ----- ---------- ----- ---------- -----
Total commercial business loans 137,360 4.63 123,526 4.38 90,212 3.53
---------- ----- ---------- ----- ---------- -----
Gross loans receivable
2,966,556 100.00% 2,820,487 100.00% 2,554,362 100.00%
====== ====== ======
Contras to loans:
Undisbursed loan proceeds (160,724) (157,667) (111,298)
Allowance for loan losses (29,677) (31,065) (24,076)
Unearned net loan fees (4,946) (4,286) (3,610)
Discount on loans purchased (147) (215) (371)
Unearned interest (74) (6) (31)
---------- ---------- ----------
Total contras to loans (195,568) (193,239) (139,386)
---------- ---------- ----------
Loans receivable, net $2,770,988 $2,627,248 $2,414,976
========== ========== ==========
3
MARCH 31,
---------------------------------------------------
2000 1999
---------------------------------------------------
PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL
---------------------------------------------------
(Dollars in thousands)
Mortgage loans:
Single-family residential $1,001,408 41.24% $1,061,813 47.66%
Multi-family residential 291,917 12.02 233,984 10.50
Commercial real estate 388,678 16.01 282,980 12.70
Construction 210,660 8.68 179,189 8.04
Land 29,232 1.20 17,309 0.78
---------- ----- ---------- -----
Total mortgage loans 1,921,895 79.15 1,775,275 79.69
---------- ----- ---------- -----
Consumer loans:
Second mortgage and home equity 243,124 10.01 214,295 9.62
Education 136,011 5.60 130,254 5.85
Other 65,686 2.71 56,590 2.54
---------- ----- ---------- -----
Total consumer loans 444,821 18.32 401,139 18.01
---------- ----- ---------- -----
Commercial business loans:
Loans 61,419 2.53 51,403 2.31
Lease receivables - 0.00 - 0.00
---------- ----- ---------- -----
Total commercial business loans 61,419 2.53 51,403 2.31
---------- ----- ---------- -----
Gross loans receivable 2,428,135 100.00% 2,227,817 100.00%
====== ======
Contras to loans:
Undisbursed loan proceeds (97,092) (87,401)
Allowance for loan losses (24,404) (24,027)
Unearned net loan fees (3,528) (4,015)
Discount on loans purchased (361) (792)
Unearned interest (29) (16)
---------- ----------
Total contras to loans (125,414) (116,251)
---------- ----------
Loans receivable, net $2,302,721 $2,111,566
========== ==========
4
The following table shows, at March 31, 2003, the scheduled contractual
maturities of the Bank's consolidated gross loans held for investment, as well
as the dollar amount of such loans which are scheduled to mature after one year
which have fixed or adjustable interest rates.
MULTI-FAMILY
RESIDENTIAL
AND
SINGLE-FAMILY COMMERCIAL COMMERCIAL
RESIDENTIAL REAL ESTATE CONSUMER BUSINESS
LOANS LOANS LOANS LOANS
---------------------------------------------------
Amounts due:
In one year or less $ 12,414 $ 166,172 $ 19,109 $ 63,661
After one year through
five years 26,633 579,109 169,111 68,834
After five years 685,853 477,079 314,427 4,865
---------- ---------- ---------- ----------
$ 724,900 $1,222,360 $ 502,647 $ 137,360
========== ========== ========== ==========
Interest rate terms on amounts
due after one year:
Fixed $ 249,445 $ 278,820 $ 398,870 $ 34,474
========== ========== ========== ==========
Adjustable $ 463,041 $ 777,368 $ 84,668 $ 39,225
========== ========== ========== ==========
SINGLE-FAMILY RESIDENTIAL LOANS. Historically, savings institutions,
such as the Bank, have concentrated their lending activities on the origination
of loans secured primarily by first mortgage liens on owner-occupied, existing
single-family residences. At March 31, 2003, $724.9 million or 24.4% of the
Bank's total loans held for investment consisted of single-family residential
loans, substantially all of which are conventional loans, which are neither
insured nor guaranteed by a federal or state agency.
The adjustable-rate loans, currently emphasized by the Bank, have up to
30-year maturities and terms which permit the Bank to annually increase or
decrease the rate on the loans at its discretion, based on a designated index.
This is generally subject to a limit of 2% per adjustment and an aggregate 6%
adjustment over the life of the loan.
Adjustable-rate loans decrease the risks associated with changes in
interest rates but involve other risks, primarily because as interest rates
rise, the payment by the borrower rises to the extent permitted by the terms of
the loan, thereby increasing the potential for default. At the same time, the
marketability of the underlying property may be adversely affected by higher
interest rates. The Bank believes that these risks, which have not had a
material adverse effect on the Bank to date, generally are less than the risks
associated with holding fixed-rate loans in an increasing interest rate
environment. At March 31, 2003, approximately $475.5 million or 65.6% of the
Bank's permanent single-family residential loans held for investment consisted
of loans with adjustable interest rates. Also, as interest rates decline,
borrowers may refinance their mortgages into fixed-rate loans thereby prepaying
the balance of the loan prior to maturity.
The Bank continues to originate long-term, fixed-rate conventional
mortgage loans. The Bank generally sells current production of these loans with
terms of 15 years or more to the Federal Home Loan Mortgage Corporation
("FHLMC"), Federal National Mortgage Association ("FNMA"), FHLB, and other
institutional investors, while keeping some of the 10-year term loans in its
portfolio. In order to provide a full range of products to its customers, the
Bank also participates in the loan origination programs of Wisconsin Housing and
Economic
5
Development Authority ("WHEDA"), and Wisconsin Department of Veterans Affairs
("WDVA"). The Bank retains the right to service substantially all loans that it
sells.
At March 31, 2003, approximately $249.4 million or 34.4% of the Bank's
permanent single-family residential loans held for investment consisted of loans
that provide for fixed rates of interest. Although these loans generally provide
for repayments of principal over a fixed period of 10 to 30 years, it is the
Bank's experience that, because of prepayments and due-on-sale clauses, such
loans generally remain outstanding for a substantially shorter period of time.
MULTI-FAMILY RESIDENTIAL AND COMMERCIAL REAL ESTATE. The Bank
originates multi-family loans that it typically holds in its loan portfolio.
Such loans generally have adjustable rates and shorter terms than single-family
residential loans, thus increasing the sensitivity of the loan portfolio to
changes in interest rates, as well as providing higher fees and rates than
single-family residential loans. At March 31, 2003, the Bank had $474.7 million
of loans secured by multi-family residential real estate and $747.7 million of
loans secured by commercial real estate. These represented 16.0% and 25.2% of
the Bank's total loans held for investment, respectively. The Bank generally
limits the origination of such loans to its primary market area.
The Bank's multi-family residential loans are primarily secured by
apartment buildings and commercial real estate loans are primarily secured by
office buildings, industrial buildings, warehouses, small retail shopping
centers and various special purpose properties, including hotels, restaurants
and nursing homes.
Although terms vary, multi-family residential and commercial real
estate loans generally have maturities of 15 to 30 years, as well as balloon
payments, and terms which provide that the interest rates thereon may be
adjusted annually at the Bank's discretion, based on a designated index, subject
to an initial fixed-rate for a one to five year period and an annual limit
generally of 1.5% per adjustment, with no limit on the amount of such
adjustments over the life of the loan.
CONSTRUCTION AND LAND LOANS. Historically, the Bank has been an active
originator of loans to construct residential and commercial properties
("construction loans"), and to a lesser extent, loans to acquire and develop
real estate for the construction of such properties ("land loans"). At March 31,
2003, construction loans amounted to $331.3 million or 11.2% of the Bank's total
loans held for investment. Land loans amounted to $48.0 million or 1.6% of the
Bank's total loans held for investment at March 31, 2003.
The Bank's construction loans generally have terms of six to 12 months,
fixed interest rates and fees which are due at the time of origination and at
maturity if the Bank does not originate the permanent financing on the
constructed property. Loan proceeds are disbursed in increments as construction
progresses and as inspections by the Bank's in-house appraiser warrant. Land
acquisition and development loans generally have the same terms as construction
loans, but may have longer maturities than such loans.
CONSUMER LOANS. The Bank offers consumer loans in order to provide a
full range of financial services to its customers. At March 31, 2003, $502.6
million or 16.9% of the Bank's consolidated total loans held for investment
consisted of consumer loans. Consumer loans generally have shorter terms and
higher interest rates than mortgage loans but generally involve more risk than
mortgage loans because of the type and nature of the collateral and, in certain
cases, the absence of collateral. These risks are not as prevalent in the case
of the Bank's consumer loan portfolio, however, because a high percentage of
insured home equity loans are underwritten in a manner such that they result in
a lending risk which is substantially similar to single-family residential loans
and education loans. Education loans are generally guaranteed by a federal
governmental agency.
The largest component of the Bank's consumer loan portfolio is second
mortgage and home equity loans, which amounted to $270.0 million or 9.1% of
total loans at March 31, 2003. The primary home equity loan product has an
adjustable interest rate that is linked to the prime interest rate and is
secured by a mortgage, either a primary or a junior lien, on the borrower's
residence. A fixed-rate home equity product is also offered.
6
Approximately $166.5 million or 5.6% of the Bank's total loans at March
31, 2003 consisted of education loans. These are generally made for a maximum of
$2,500 per year for undergraduate studies and $5,000 per year for graduate
studies and are either due within six months of graduation or repaid on an
installment basis after graduation. Education loans generally have interest
rates that adjust annually in accordance with a designated index. Both the
principal amount of an education loan and interest thereon generally are
guaranteed by the Great Lakes Higher Education Corporation, which generally
obtains reinsurance of its obligations from the U.S. Department of Education.
Education loans may be sold to the Student Loan Marketing Association ("SLMA")
or to other investors. The Bank sold $5.0 million of these education loans
during fiscal 2003.
The remainder of the Bank's consumer loan portfolio consists of deposit
account secured loans that have been made for a variety of consumer purposes.
These include credit extended through credit cards issued by the Bank pursuant
to an agency arrangement under which the Bank participates with a third party,
Elan, in 45% of the outstanding balances and is responsible for 45% of the
losses.
The Bank is allocated 32% of the interest paid on assigned debt and 25%
of interchange income established by Visa and MasterCard. The bank also shares
33% of annual fees paid to Elan and 30% of late payments paid to Elan. Also,
account incentive fees of $20 per card are paid to the Bank for newly
established accounts.
At March 31, 2003, the Bank's approved credit card lines and the
outstanding credit pursuant to such lines amounted to $41.7 million and $5.5
million, respectively.
COMMERCIAL BUSINESS LOANS AND LEASES. The Bank originates loans for
commercial, corporate and business purposes, including issuing letters of
credit. At March 31, 2003, commercial business loans amounted to $137.4 million
or 4.6% of the Bank's total loans held for investment. The Bank's commercial
business loan portfolio is comprised of loans for a variety of purposes and
generally is secured by equipment, machinery and other corporate assets.
Commercial business loans generally have terms of five years or less and
interest rates that float in accordance with a designated published index.
Substantially all of such loans are secured and backed by the personal
guarantees of the individuals of the business.
NET FEE INCOME FROM LENDING ACTIVITIES. Loan origination and commitment
fees and certain direct loan origination costs are being deferred and the net
amounts are amortized as an adjustment of the related loan's yield.
The Bank also receives other fees and charges relating to existing
mortgage loans, which include prepayment penalties, late charges and fees
collected in connection with a change in borrower or other loan modifications.
Other types of loans also generate fee income for the Bank. These include annual
fees assessed on credit card accounts, transactional fees relating to credit
card usage and late charges on consumer loans.
ORIGINATION, PURCHASE AND SALE OF LOANS. The Bank's loan originations
come from a number of sources. Residential mortgage loan originations are
attributable primarily to depositors, walk-in customers, referrals from real
estate brokers and builders and direct solicitations. Commercial real estate
loan originations are obtained by direct solicitations and referrals. Consumer
loans are originated from walk-in customers, existing depositors and mortgagors
and direct solicitation. Student loans are originated from solicitation of
eligible students and from walk-in customers.
Applications for all types of loans are obtained at the Bank's seven
regional lending offices, certain of its branch offices and two loan origination
facilities. Loans may be approved by members of the Officers' Loan Committee,
within designated limits. Depending on the type and amount of the loans, one or
more signatures of the members of the Senior Loan Committee also may be
required. For loan requests of $1.5 million or less, loan approval authority is
designated to an Officers' Loan Committee and requires at least three of the
members' signatures. Senior Loan Committee members are authorized to approve
loan requests between $1.5 million and $3.0 million and approval requires at
least three of the members' signatures. Loan requests in excess of $3.0 million
must be approved by the Board of Directors.
7
The Bank's general policy is to lend up to 80% of the appraised value
or purchase price of the property securing a single-family residential loan
(referred to as the loan-to-value ratio). The Bank will lend more than 80% of
the appraised value of the property, but generally will require that the
borrower obtain private mortgage insurance in an amount intended to reduce the
Bank's exposure to 80% or less of the appraised value of the underlying
property. At March 31, 2003, the Bank had approximately $39.3 million of loans
that had loan-to-value ratios of greater Than 80% and did not have private
mortgage insurance for the portion of the loans above such amount.
Property appraisals on the real estate and improvements securing the
Bank's single-family residential loans are made by the Bank's staff or
independent appraisers approved by the Bank's Board of Directors during the
underwriting process. Appraisals are performed in accordance with federal
regulations and policies.
The Bank's underwriting criteria generally require that multi-family
residential and commercial real estate loans have loan-to-value ratios which
amount to 80% or less and debt coverage ratios of at least 110%. The Bank also
generally obtains personal guarantees on its multi-family residential and
commercial real estate loans from the principals of the borrowers, as well as
appraisals of the security property from independent appraisal firms.
The portfolio of commercial real estate and multi-family residential
loans is reviewed on a continuing basis (annually for loans of $1.0 million or
more, and bi-annually for loans of $750,000 to $1.0 million) to identify any
potential risks that exist in regard to the property management, financial
criteria of the loan, operating performance, competitive marketplace and
collateral valuation. The credit analysis function of the Bank is responsible
for identifying and reporting credit risk quantified through a loan rating
system and making recommendations to mitigate credit risk in the portfolio.
These and other underwriting standards are documented in written policy
statements, which are periodically updated and approved by the Bank's Board of
Directors.
The Bank generally obtains title insurance policies on most first
mortgage real estate loans it originates. If title insurance is not obtained or
is unavailable, the Bank obtains an abstract of title and title opinion.
Borrowers must obtain hazard insurance prior to closing and, when required by
the United States Department of Housing and Urban Development, flood insurance.
Borrowers may be required to advance funds, with each monthly payment of
principal and interest, to a loan escrow account from which the Bank makes
disbursements for items such as real estate taxes, hazard insurance premiums,
flood insurance premiums, and mortgage insurance premiums as they become due.
The Bank encounters certain environmental risks in its lending
activities. Under federal and state environmental laws, lenders may become
liable for costs of cleaning up hazardous materials found on secured properties.
Certain states may also impose liens with higher priorities than first mortgages
on properties to recover funds used in such efforts. Although the foregoing
environmental risks are more usually associated with industrial and commercial
loans, environmental risks may be substantial for residential lenders, like the
Bank, since environmental contamination may render the secured property
unsuitable for residential use. In addition, the value of residential properties
may become substantially diminished by contamination of nearby properties. In
accordance with the guidelines of FNMA and FHLMC, appraisals for single-family
homes on which the Bank lends include comments on environmental influences and
conditions. The Bank attempts to control its exposure to environmental risks
with respect to loans secured by larger properties by monitoring available
information on hazardous waste disposal sites and requiring environmental
inspections of such properties prior to closing the loan. No assurance can be
given, however, that the value of properties securing loans in the Bank's
portfolio will not be adversely affected by the presence of hazardous materials
or that future changes in federal or state laws will not increase the Bank's
exposure to liability for environmental cleanup.
The Bank has been actively involved in the secondary market since the
mid-1980s and generally originates single-family residential loans under terms,
conditions and documentation which permit sale to FHLMC, FNMA, FHLB and other
investors in the secondary market. The Bank sells substantially all of the
fixed-rate, single-family residential loans with terms over 15 years it
originates in order to decrease the amount of such loans in its loan portfolio.
The volume of loans originated and sold is reliant on a number of factors but is
most influenced by general interest rates. In periods of lower interest rates,
such as fiscal 2003, customer demand for fixed-rate
8
mortgages increases. In periods of higher interest rates, such as occurred in
fiscal 2000, customer demand for fixed-rate mortgages declines. The Bank's sales
are usually made through forward sales commitments. The Bank attempts to limit
any interest rate risk created by forward commitments by limiting the number of
days between the commitment and closing, charging fees for commitments, and
limiting the amounts of its uncovered commitments at any one time. Forward
commitments to cover closed loans and loans with rate locks to customers range
from 70% to 90% of committed amounts. The Bank also periodically has used its
loans to securitize mortgage-backed securities.
The Bank generally services all originated loans that have been sold to
other investors. This includes the collection of payments, the inspection of the
secured property, and the disbursement of certain insurance and tax advances on
behalf of borrowers. The Bank recognizes a servicing fee when the related loan
payments are received. At March 31, 2003, the Bank was servicing $2.5 billion of
loans for others.
The Bank is not an active purchaser of loans because of sufficient loan
demand in its market area. Servicing of loans or loan participations purchased
by the Bank is performed by the seller, with a portion of the interest being
paid by the borrower retained by the seller to cover servicing costs. At March
31, 2003, approximately $83.6 million of mortgage loans were being serviced for
the Bank by others.
The following table shows the Bank's consolidated total loans
originated, purchased, sold and repaid during the periods indicated.
YEAR ENDED MARCH 31,
------------------------------------------
2003 2002 2001
------------------------------------------
(In Thousands)
Gross loans receivable at beginning of year(1) $ 2,867,007 $ 2,571,984 $ 2,429,899
Loans originated for investment:
Single-family residential 99,380 18,245 43,851
Multi-family residential 168,882 188,077 42,424
Commercial real estate 524,941 344,131 273,142
Construction and land 420,231 362,507 332,145
Consumer 263,628 181,782 203,929
Commercial business 72,199 67,390 71,982
------------ ------------ ------------
Total originations 1,549,261 1,162,132 967,473
------------ ------------ ------------
Loans purchased for investment:
Single-family residential - - -
Multi-family residential - - 330
Commercial real estate - - 766
------------ ------------ ------------
Total purchases - - 1,096
Total originations and purchases 1,549,261 1,162,132 968,569
Repayments (1,279,077) (896,007) (713,885)
Transfers of loans to held for sale (124,115) - (128,456)
------------ ------------ ------------
Net activity in loans held for investment 146,069 266,125 126,228
------------ ------------ ------------
Loans originated for sale:
Single-family residential 1,757,299 1,097,655 579,699
Transfers of loans from held for investment 124,115 - 128,456
Sales of loans (1,760,765) (1,068,757) (563,842)
Loans converted into mortgage-backed
securities (124,115) - (128,456)
------------ ------------ ------------
Net activity in loans held for sale (3,466) 28,898 15,857
------------ ------------ ------------
Gross loans receivable at end of period $ 3,009,610 $ 2,867,007 $ 2,571,984
============ ============ ============
(1) Includes loans held for sale and loans held for investment
9
DELINQUENCY PROCEDURES. Delinquent and problem loans are a normal part
of any lending business. When a borrower fails to make a required payment by the
15th day after which the payment is due, the loan is considered delinquent and
internal collection procedures are generally instituted. The borrower is
contacted to determine the reason for the delinquency and attempts are made to
cure the loan. In most cases, deficiencies are cured promptly. The Bank
regularly reviews the loan status, the condition of the property, and
circumstances of the borrower. Based upon the results of its review, the Bank
may negotiate and accept a repayment program with the borrower, accept a
voluntary deed in lieu of foreclosure or, when deemed necessary, initiate
foreclosure proceedings.
A decision as to whether and when to initiate foreclosure proceedings
is based upon such factors as the amount of the outstanding loan in relation to
the original indebtedness, the extent of delinquency, the value of the
collateral, and the borrower's ability and willingness to cooperate in curing
the deficiencies. If foreclosed on, the property is sold at a public sale and
the Bank will generally bid an amount reasonably equivalent to the lower of the
fair value of the foreclosed property or the amount of judgment due the Bank. A
judgment of foreclosure for residential mortgage loans will normally provide for
the recovery of all sums advanced by the mortgagee including, but not limited
to, insurance, repairs, taxes, appraisals, post-judgment interest, attorneys'
fees, costs and disbursements.
Real estate acquired as a result of foreclosure or by deed in lieu of
foreclosure is classified as foreclosed property until it is sold. When property
is acquired, it is carried at the lower of carrying or estimated fair value at
the date of acquisition, with charge-offs, if any, charged to the allowance for
loan losses prior to transfer to foreclosed property. Upon acquisition, all
costs incurred in maintaining the property are expensed. Costs relating to the
development and improvement of the property, however, are capitalized to the
extent of fair value. Remaining gain or loss on the ultimate disposal of the
property is included in operations.
LOAN DELINQUENCIES. Loans are placed on non-accrual status when, in the
judgment of management, the probability of collection of interest is deemed to
be insufficient to warrant further accrual. When a loan is placed on non-accrual
status, previously accrued but unpaid interest is deducted from interest income.
As a matter of policy, the Bank does not accrue interest on loans past due more
than 90 days.
The interest income that would have been recorded during fiscal 2003 if
the Bank's non-accrual loans at the end of the period had been current in
accordance with their terms during the period was $651,000. The amount of
interest income attributable to these loans and included in interest income
during fiscal 2003 was $228,000.
The following table sets forth information relating to delinquent loans
of the Bank and their relation to the Bank's total loans held for investment at
the dates indicated.
MARCH 31,
---------------------------------------------------------------------------
2003 2002 2001
---------------------------------------------------------------------------
% OF % OF % OF
TOTAL TOTAL TOTAL
DAYS PAST DUE BALANCE LOANS BALANCE LOANS BALANCE LOANS
- --------------------------------------------------------------------------------------------------
(Dollars in Thousands)
30 to 59 days $ 10,083 0.34% $ 17,647 0.63% $ 7,141 0.28%
60 to 89 days 5,612 0.19 2,671 0.09 716 0.03
90 days and over 10,069 0.34 9,042 0.32 5,047 0.20
---------- ---- ---------- ---- ---------- ----
Total $ 25,764 0.87% $ 29,360 1.04% $ 12,904 0.51%
========== ==== ========== ==== ========== ====
There were two non-accrual loans with carrying values of $1.0 million
or greater at March 31, 2003. For additional discussion of the Corporation's
asset quality, see "Management's Discussion and Analysis of Financial
10
Condition and Results of Operations - Financial Condition-Non-Performing Assets"
in Item 7. See also Notes 1 and 5 to the Consolidated Financial Statements in
Item 8.
NON-PERFORMING REAL ESTATE HELD FOR DEVELOPMENT AND SALE. At March 31,
2003, there were no properties in non-performing real estate held for
development and sale with a carrying value greater than $1.0 million.
Non-performing real estate held for development and sale remained relatively
constant during the fiscal year. For additional discussion of real estate held
for development and sale that is not considered a part of non-performing assets,
see the discussion under "Subsidiaries - Investment Directions, Inc." and "-
Nevada Investment Directions, Inc." and Note 16 to the Consolidated Financial
Statements in Item 8.
FORECLOSED PROPERTIES. At March 31, 2003, the Bank had no foreclosed
properties with a net carrying value of $1.0 million or more. Foreclosed
properties and repossessed assets remained relatively constant with an increase
of $60,000 during the fiscal year.
CLASSIFIED ASSETS. OTS regulations require that each insured savings
institution classify its assets on a regular basis. In addition, in connection
with examinations of insured associations, OTS examiners have authority to
identify problem assets and, if appropriate, require them to be classified.
There are three classifications for problem assets: "substandard," "doubtful"
and "loss." Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full highly questionable and
improbable, on the basis of currently existing facts, conditions, and values. An
asset that is classified loss is considered uncollectible and of such little
value, that continuance as an asset of the institution is not warranted. Another
category designated special mention also must be established and maintained for
assets which do not currently expose an insured institution to a sufficient
degree of risk to warrant classification as substandard, doubtful or loss but do
possess credit deficiencies or potential weaknesses deserving management's close
attention.
Assets classified as substandard or doubtful require the institution to
establish general allowances for losses. If an asset or portion thereof is
classified loss, the insured institution must either establish specific
allowances for losses in the amount of 100% of the portion of the assets
classified loss or charge off such amount.
At March 31, 2003, there were $25.1 million of classified assets
including non-performing assets plus other loans and assets, meeting the
criteria for classification. The criteria for the classification of assets comes
from information causing management to have doubts as to the ability of such
borrowers to comply with the present loan repayment terms and would indicate
that such loans have the potential to be included as non-accrual, past due, or
impaired (as defined in SFAS No. 114), in the future periods. However, no loss
is anticipated at this time.
As of March 31, 2003, there were no loans classified as special
mention, doubtful or loss. At March 31, 2002, substandard assets amounted to
$24.7 million and no loans were classified as special mention, doubtful or loss.
The increase of $400,000 in classified assets was not attributable to any one
specific loan.
ALLOWANCE FOR LOSSES. A provision for losses on loans and foreclosed
properties is provided when a loss is probable and can be reasonably estimated.
The allowance is established by charges against operations in the period in
which those losses are identified.
The Bank establishes general allowances based on current levels of
components of the loan portfolio and the amount, type of its classified assets,
and other factors. In addition, the Bank monitors and uses standards for these
allowances that depend on the nature of the classification and loan location of
the security property.
Additional discussion on the allowance for losses at March 31, 2003 has
been presented as part of the discussion under "Allowance for Loan and
Foreclosure Losses" in Management's Discussion and Analysis, which is contained
in Item 7.
11
SECURITIES - GENERAL
Management determines the appropriate classification of securities at
the time of purchase. Debt securities are classified as held-to-maturity when
the Corporation has the intent and ability to hold the securities to maturity.
Held-to-maturity securities are carried at amortized cost. Securities are
classified as trading when the Corporation intends to actively buy and sell
securities in order to make a profit. Trading securities are carried at fair
value, with unrealized holding gains and losses included in the income
statement.
Securities not classified as held to maturity or trading are classified
as available-for-sale. Available-for-sale securities are carried at fair value,
with the unrealized gains and losses, net of tax, reported as a separate
component of stockholders' equity. For the years ended March 31, 2003 and 2002,
stockholders' equity increased $1.7 million (net of deferred income tax payable
of $1.1 million), and increased $519,000 (net of deferred income tax payable of
$2.3 million), respectively, to reflect net unrealized gains and losses on
holding securities classified as available for sale. There were no securities
designated as trading during the three years ending March 31, 2003.
INVESTMENT SECURITIES
In addition to lending activities and investments in mortgage-related
securities, the Corporation conducts other investment activities on an ongoing
basis in order to diversify assets, limit interest rate risk and credit risk and
meet regulatory liquidity requirements. Investment decisions are made by
authorized officers in accordance with policies established by the respective
boards of directors.
The Corporation's policy does not permit investment in non-investment
grade bonds and permits investment in various types of liquid assets permissible
for the Bank under OTS regulations, which include U.S. Government obligations,
securities of various federal agencies, certain certificates of deposit of
insured banks and savings institutions, certain bankers' acceptances, repurchase
agreements and federal funds. Subject to limitations on investment grade
securities, the Corporation also invests in corporate debt securities from time
to time.
12
The table below sets forth information regarding the amortized cost and
fair values of the Corporation's investment securities at the dates indicated.
MARCH 31,
---------------------------------------------------------------------------
2003 2002 2001
---------------------------------------------------------------------------
AMORTIZED AMORTIZED AMORTIZED
COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE
---------------------------------------------------------------------------
(In Thousands)
Available For Sale:
U.S. Government and federal
agency obligations $ 75,675 $ 75,823 $ 43,261 $ 43,442 $ 9,081 $ 9,219
Mutual fund 9,815 9,812 10,587 10,582 5,996 6,005
Corporate stock and other 10,151 11,557 11,040 11,969 7,837 6,992
---------- ---------- ---------- ---------- ---------- ----------
$ 95,641 $ 97,192 $ 64,888 $ 65,993 $ 22,914 $ 22,216
Held To Maturity:
U.S. Government and federal
agency obligations $ 2,998 $ 3,095 $ 7,747 $ 7,897 $ 33,913 $ 34,096
Other securities - - - - - -
---------- ---------- ---------- ---------- ---------- ----------
2,998 3,095 7,747 7,897 33,913 34,096
---------- ---------- ---------- ---------- ---------- ----------
Total investment securities $ 98,639 $ 100,287 $ 72,635 $ 73,890 $ 56,827 $ 56,312
========== ========== ========== ========== ========== ==========
For additional information regarding the Corporation's investment
securities, see the Corporation's Consolidated Financial Statements, including
Note 3 thereto included in Item 8.
MORTGAGE-RELATED SECURITIES
The Corporation purchases mortgage-related securities to supplement
loan production and to provide collateral for borrowings. The Corporation
invests in mortgage-backed securities which are insured or guaranteed by FHLMC,
FNMA, or the Government National Mortgage Association ("GNMA") backed by FHLMC,
FNMA and GNMA mortgage-backed securities.
At March 31, 2003, the amortized cost of the Corporation's
mortgage-backed securities held to maturity amounted to $60.4 million and
included $53.9 million, $6.5 million and $20,000 which are insured or guaranteed
by FNMA, FHLMC and GNMA, respectively. The adjustable-rate securities included
in the above totals for March 31, 2003, are $400,000 and $1.1 million for FNMA
and FHLMC, respectively.
The fair value of the Corporation's mortgage-backed securities
available for sale amounted to $131.6 million at March 31, 2003, of which $1.4
million are five- and seven-year balloon securities, $59.0 million are 10-, 15-
and 30-year securities and $71.2 million are adjustable-rate securities.
Mortgage-backed securities increase the quality of the Corporation's
assets by virtue of the insurance or guarantees of federal agencies that back
them, require less capital under risk-based regulatory capital requirements than
non-insured or guaranteed mortgage loans, are more liquid than individual
mortgage loans and may be used to collateralize borrowings or other obligations
of the Corporation. At March 31, 2003, $98.0 million of the Corporation's
mortgage-backed securities available for sale and $56.9 million of the
Corporation's mortgage-backed securities held to maturity were pledged to secure
various obligations of the Corporation.
13
The table below sets forth information regarding the amortized cost and
fair values of the Corporation's mortgage-related securities at the dates
indicated.
MARCH 31,
---------------------------------------------------------------------------
2003 2002 2001
---------------------------------------------------------------------------
AMORTIZED AMORTIZED AMORTIZED
COST FAIR VALUE COST FAIR VALUE COST FAIR VALUE
---------------------------------------------------------------------------
(In Thousands)
Available For Sale:
Agency CMO/Remic's $ 44,929 $ 45,082 $ 33,231 $ 33,418 $ 12,180 $ 12,416
Corporate CMO's 8,808 9,072 18,369 18,874 7,992 8,476
Mortgage Pool Securities 127,116 131,597 91,139 93,001 149,914 153,076
---------- ---------- ---------- ---------- ---------- ----------
$ 180,853 $ 185,751 $ 142,739 $ 145,293 $ 170,086 $ 173,968
Held To Maturity:
Agency CMO/Remic's $ 2,600 $ 2,661 $ 5,776 $ 5,879 $ 11,042 $ 11,170
Mortgage Pool Securities 60,398 63,416 134,517 135,451 194,149 196,499
---------- ---------- ---------- ---------- ---------- ----------
$ 62,998 $ 66,077 $ 140,293 $ 141,330 $ 205,191 $ 207,669
---------- ---------- ---------- ---------- ---------- ----------
Total Mortgage Related Securities $ 243,851 $ 251,828 $ 283,032 $ 286,623 $ 375,277 $ 381,637
========== ========== ========== ========== ========== ==========
Management believes that certain mortgage-derivative securities
represent an attractive alternative relative to other investments due to the
wide variety of maturity and repayment options available through such
investments and due to the limited credit risk associated with such investments.
The Corporation's mortgage-derivative securities are made up of collateralized
mortgage obligations ("CMOs"), including CMOs which qualify as Real Estate
Mortgage Investment Conduits ("REMICs") under the Internal Revenue Code of 1986,
as amended ("Code"). At March 31, 2003, the Corporation's had $2.6 million in
mortgage-derivative securities held to maturity. The fair value of the
mortgage-derivative securities available for sale held by the Corporation
amounted to $54.2 million at the same date.
14
The following table sets forth the maturity and weighted average yield
characteristics of the Corporation's mortgage-related securities at March 31,
2003, classified by term to maturity. The balance is at amortized cost for
held-to-maturity securities and at fair value for available-for-sale securities.
ONE TO FIVE YEARS FIVE TO TEN YEARS OVER TEN YEARS
----------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
BALANCE YIELD BALANCE YIELD BALANCE YIELD TOTAL
----------------------------------------------------------------------------------------
(Dollars In Thousands)
Available for Sale:
Mortgage-derivative securities $ 16 5.49% $ 8,793 5.37% $ 45,345 5.12% $ 54,154
Mortgage-backed securities 1,988 5.49 13,101 5.93 116,508 5.70 131,597
---------- ---- ---------- ---- ---------- ---- ----------
2,004 5.49 21,894 5.70 161,853 5.54 185,751
---------- ---- ---------- ---- ---------- ---- ----------
Held to Maturity:
Mortgage-derivative securities 114 7.23 1,884 5.95 602 6.00 2,600
Mortgage-backed securities 7,765 5.89 8,583 6.54 44,050 6.29 60,398
---------- ---- ---------- ---- ---------- ---- ----------
7,879 5.91 10,467 6.43 44,652 6.29 62,998
---------- ---- ---------- ---- ---------- ---- ----------
Mortgage-related securities $ 9,883 5.82% $ 32,361 5.94% $ 206,505 5.70% $ 248,749
========== ==== ========== ==== ========== ==== ==========
Due to repayments of the underlying loans, the actual maturities of
mortgage-related securities are expected to be substantially less than the
scheduled maturities.
For additional information regarding the Corporation's mortgage-related
securities, see the Corporation's Consolidated Financial Statements, including
Note 4 thereto, included in Item 8.
SOURCES OF FUNDS
GENERAL. Deposits are a major source of the Bank's funds for lending
and other investment activities. In addition to deposits, the Bank derives funds
from principal repayments and prepayments on loan and mortgage-related
securities, maturities of investment securities, sales of loans and securities,
interest payments on loans and securities, advances from the FHLB and, from time
to time, repurchase agreements and other borrowings. Loan repayments and
interest payments are a relatively stable source of funds, while deposit inflows
and outflows and loan prepayments are significantly influenced by general
interest rates, economic conditions and competition. Borrowings may be used on a
short-term basis to compensate for reductions in the availability of funds from
other sources. They also may be used on a longer term basis for general business
purposes, including providing financing for lending and other investment
activities and asset/liability management strategies.
DEPOSITS. The Bank's deposit products include passbook savings
accounts, demand accounts, NOW accounts, money market deposit accounts and
certificates of deposit ranging in terms of 42 days to seven years. Included
among these deposit products are Individual Retirement Account certificates and
Keogh retirement certificates, as well as negotiable-rate certificates of
deposit with balances of $100,000 or more ("jumbo certificates").
The Bank's deposits are obtained primarily from residents of Wisconsin.
The Bank has entered into agreements with certain brokers that provide funds for
a specified fee. While brokered deposits are a good source of funds, they are
market rate driven and thus inherently have more liquidity and interest rate
risk. To mitigate this
15
risk, the Bank's liquidity policy limits the amount of brokered deposits to 10%
of assets and to the total amount of borrowings. At March 31, 2003, the Bank had
$239.4 million in brokered deposits.
The Bank attracts deposits through a network of convenient office
locations by utilizing a detailed customer sales and service plan and by
offering a wide variety of accounts and services, competitive interest rates and
convenient customer hours. Deposit terms offered by the Bank vary according to
the minimum balance required, the time period the funds must remain on deposit
and the interest rate, among other factors. In determining the characteristics
of its deposit accounts, consideration is given to the profitability of the
Bank, matching terms of the deposits with loan products, the attractiveness to
customers and the rates offered by the Bank's competitors.
The following table sets forth the amount and maturities of the Bank's
certificates of deposit at March 31, 2003.
OVER SIX OVER OVER TWO
MONTHS ONE YEAR YEARS OVER
SIX MONTHS THROUGH THROUGH THROUGH THREE
INTEREST RATE AND LESS ONE YEAR TWO YEARS THREE YEARS YEARS TOTAL
- ----------------------------------------------------------------------------------------------------
(In Thousands)
1.00% to 2.99% $ 269,298 $ 81,652 $ 157,799 $ 19,728 $ 1,322 $ 529,799
3.00% to 4.99% 328,464 329,600 118,250 20,788 72,455 869,557
5.00% to 6.99% 34,748 14,143 58,743 23,607 70,034 201,275
7.00% to 8.99% 498 100 - 128 - 726
9.00% to 10.99% - - - - - -
Ledger PVA (1) - - - - - 3,119
---------- ---------- ---------- ---------- ---------- ----------
$ 633,008 $ 425,495 $ 334,792 $ 64,251 $ 143,811 $1,604,476
========== ========== ========== ========== ========== ==========
(1) Stemming from the Bank's purchase of Ledger Bank on November 10, 2001, an
adjustment was made to the market values of certificate of deposit and core
deposit accounts. The market value of certificate of deposit accounts was
determined by discounting cash flows using current deposit rates for the
remaining contractual maturity. The market value of core deposits (checking,
money market, and passbook accounts) was determined using discounted cash flows
with estimated decay rates.
At March 31, 2003, the Bank had $204.6 million of certificates greater
than or equal to $100,000, of which $2.2 million are scheduled to mature in
seven through twelve months and $202.4 million in over twelve months.
BORROWINGS. From time to time the Bank obtains advances from the FHLB,
which generally are secured by capital stock of the FHLB that is required to be
held by the Bank and by certain of the Bank's mortgage loans. See "Regulation."
Such advances are made pursuant to several different credit programs, each of
which has its own interest rate and range of maturities. The FHLB may prescribe
the acceptable uses for these advances, as well as limitations on the size of
the advances and repayment provisions. The Bank has pledged a substantial
portion of its loans receivable and all of its investment in FHLB stock as
collateral for these advances. A portion of the Bank's mortgage-related
securities has also been pledged as collateral.
From time to time the Bank enters into repurchase agreements with
nationally recognized primary securities dealers. Repurchase agreements are
accounted for as borrowings by the Bank and are secured by mortgage-backed
securities. The Bank did not utilize this source of funds during the year ended
March 31, 2003 but may do so in the future.
16
The Corporation has a short-term line of credit used in part to fund
IDI's partnership interests and investments in real estate held for development
and sale. This line of credit also funds other Corporation needs. The interest
is based on LIBOR (London InterBank Offering Rate), and is payable monthly and
each draw has a specified maturity. The final maturity of the line of credit is
in October 2003. See Note 9 to the Corporation's Consolidated Financial
Statements in Item 8 for more information on borrowings.
The following table sets forth the outstanding balances and weighted
average interest rates for the Corporation's borrowings (short-term and
long-term) at the dates indicated.
MARCH 31,
----------------------------------------------------------------------------
2003 2002 2001
----------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
BALANCE RATE BALANCE RATE BALANCE RATE
----------------------------------------------------------------------------
(Dollars In Thousands)
FHLB advances $ 554,268 4.33% $ 569,500 4.78% $ 669,896 6.05%
Repurchase agreements - 0.00 - 0.00 27,948 5.32
Other loans payable 41,548 2.78 52,090 3.62 42,754 7.33
The following table sets forth information relating to the
Corporation's short-term (maturities of one year or less) borrowings at the
dates and for the periods indicated.
MARCH 31,
------------------------------------------
2003 2002 2001
------------------------------------------
In Thousands)
Maximum month-end balance:
FHLB advances $ 188,900 $ 431,296 $ 498,446
Repurchase agreements - 32,101 116,551
Other loans payable 52,695 52,174 43,015
Average balance:
FHLB advances 145,342 228,523 455,828
Repurchase agreements - 8,233 83,310
Other loans payable 42,325 46,743 35,224
SUBSIDIARIES
INVESTMENT DIRECTIONS, INC. IDI is a wholly owned non-banking
subsidiary of the Corporation that has invested in various limited partnerships
and subsidiaries funded by borrowings from the Corporation. The Corporation's
investment in IDI at March 31, 2003 amounted to $2.2 million as compared to $2.9
million for the year ended March 31, 2002. IDI had total assets of $40.9 million
and a net loss of $600,000. This compares to total assets of $38.6 million and a
net loss of $520,000 for the prior year ended March 31, 2002.
NEVADA INVESTMENT DIRECTIONS, INC. NIDI is a wholly owned non-banking
subsidiary of IDI formed in March 1997 that has invested in various limited
partnerships such as Oakmont. NIDI was organized in the state of Nevada. IDI's
investment in NIDI at March 31, 2003 amounted to $4.3 million and $4.5 million
for the prior fiscal year. For the year ended March 31, 2003, NIDI had total
assets of $4.5 million and a net loss of $220,000. This compares to total assets
of $4.9 million and net income of $36,000 for the prior year ended March 31,
2002.
17
OAKMONT. Oakmont became a wholly owned non-banking subsidiary of NIDI
and IDI in January 2000. Oakmont was organized in the state of Texas. Oakmont is
a limited partner in Chandler Creek Business Park Round Rock Texas, a joint
venture partnership formed to develop an industrial park located in Round Rock,
Texas. The office park consists of four office warehouse buildings totaling
163,000 square feet. The project is currently in the lease up stage and is also
being marketed for sale. At March 31, 2003, Oakmont's investment in Chandler
Creek was $2.6 million, and Oakmont had extended $3.6 million to the unrelated
partner in Chandler Creek. This compares to a carrying value of $3.1 million and
a loan to the partner of $2.0 million for the prior year ended March 31, 2002.
For the year ended March 31, 2003, Oakmont had total assets of $6.3 million and
a net loss of $560,000. This compares to total assets of $5.2 million and a net
loss of $200,000 at March 31, 2002.
S&D INDIAN PALMS, LTD. Indian Palms is a wholly owned non-banking
subsidiary of IDI organized in the state of California which owns a golf resort
and land for residential lot development in California. Indian Palms sells land
to Davsha who in turn sells land to its subsidiaries and subsequently to its
real estate partnerships for lot development. Gains are realized as fully
developed lots are sold to outside parties. As a result of these land sales,
Indian Palms had a deferred gain of $820,000 as of March 31, 2003. IDI's
investment in Indian Palms at March 31, 2003 amounted to $21.3 million. IDI's
investment in Indian Palms at March 31, 2002 amounted to $22.2 million. For the
year ended March 31, 2003, Indian Palms had total assets of $25.5 million, a net
loss of $990,000, and deferred gains of $820,000. This compares to total assets
of $28.6 million, a net loss of $1.4 million and deferred gains of $960,000 for
the year ended March 31, 2002. As of March 31, 2003, Indian Palms had borrowed
$3.2 million from another bank, which is secured by the land. This compares to a
principal balance of $5.2 million for the year ended March 31, 2002.
CALIFORNIA INVESTMENT DIRECTIONS, INC. CIDI is a wholly owned
non-banking subsidiary of IDI formed in April 2000 to purchase and hold the
general partnership interest in Indian Palms and a minority interest in Davsha,
LLC. CIDI was organized in the state of California. IDI's investment in CIDI at
March 31, 2003 amounted to $340,000 compared to an investment in CIDI at March
31, 2002 of $214,000. For the year ended March 31, 2003, CIDI had total assets
of $450,000 and net income of $100,000. This compares to total assets of
$290,000 and net income of $160,000 for the year ended March 31, 2002.
DAVSHA, LLC. Davsha is a wholly owned non-banking subsidiary of IDI and
CIDI. Davsha was organized in the state of California where it purchased land
from Indian Palms and develops residential housing for sale. For the year ended
March 31, 2003, Davsha had total assets of $10.8 million and net income of
$950,000. This compares to total assets of $12.3 million and net income of $1.5
million for the year ended March 31, 2002.
Davsha has five wholly owned non-banking subsidiaries, Davsha II,
Davsha III, Davsha IV, Davsha V and Davsha VI. Each of these subsidiaries formed
partnerships with developers and purchased lots from Davsha.
DAVSHA II, LLC. Davsha II is a wholly owned non-banking subsidiary of
Davsha formed in April 2000. Davsha II was organized in the state of California.
Davsha II is a limited partner in Paragon Indian Palms Associates, a partnership
formed in February 2000, to develop residential housing. Davsha's investment in
Davsha II at March 31, 2003, amounted to $700,000 as compared to $210,000 at
March 31, 2002. For the year ended March 31, 2003, Davsha II had total assets of
$1.5 million and net income of $490,000 as compared to total assets of $1.7
million and net income of $160,000 for the year ended March 31, 2002. As of
March 31, 2003, Paragon had $1.2 million in outside borrowings guaranteed by
IDI. This compares to a principal balance of $3.2 million at March 31, 2002.
DAVSHA III, LLC. Davsha III is a wholly owned non-banking subsidiary of
Davsha formed in February 2001. Davsha III was organized in the state of
California and is a limited partner in Indian Palms 147, LLC, a partnership
formed in February 2001 to develop residential housing. Davsha's investment in
Davsha III at March 31, 2003 amounted to $940,000 as compared to $20,000 for the
year ended March 31, 2002. Davsha III had total assets of $5.6 million and net
income of $920,000 as compared to total assets of $3.2 million and net income of
$20,000 for the year ended March 31, 2002. Indian Palms 147 has $2.7 million in
outside borrowings guaranteed by IDI. This compares to a principal balance of
$4.4 million at March 31, 2002.
18
DAVSHA IV, LLC. Davsha IV is a wholly owned non-banking subsidiary of
Davsha formed in July 2001. Davsha IV was organized in the state of California
and is a limited partner in DH Indian Palms I, LLC., a partnership formed in
July 2001 to develop residential housing. Davsha's investment in Davsha IV at
March 31, 2003 and 2002 amounted to $1.6 million and ($20,000), respectively.
For the year ended March 31, 2003, Davsha IV had total assets of $420,000 and
net income of $220,000. This compares to total assets of $1.5 million and a net
loss of $20,000 for the year ended March 31, 2002. DH Indian Palms I had $1.7
million in outside borrowings guaranteed by IDI at March 31, 2003. This compares
to $1.8 million in outside borrowings guaranteed by IDI at March 31, 2002.
DAVSHA V, LLC. Davsha IV is a wholly owned non-banking subsidiary of
Davsha formed in July 2001. Davsha V was organized in the state of California
and is a limited partner in Villa Santa Rosa, LLC., a partnership formed in July
2002 to develop residential housing. Davsha's investment in Davsha V at March
31, 2003 amounted to $1.2 million. For the year ended March 31, 2003, Davsha V
had total assets of $470,000 and a net loss of $1,000. Villa Santa Rosa had $3.3
million in outside borrowings guaranteed by IDI at March 31, 2003.
DAVSHA VI, LLC. Davsha VI is a wholly owned non-banking subsidiary of
Davsha formed in July 2001. Davsha VI was organized in the state of California
and is a limited partner in Bellasara, LLC, a partnership formed in July 2002 to
develop residential housing. Davsha's investment in Davsha VI at March 31, 2003
amounted to $520,000. For the year ended March 31, 2003, Davsha VI had total
assets of $(290,000) and a net loss of $1,000. Bellasara had $2.6 million in
outside borrowings guaranteed by IDI at March 31, 2003.
Together, IDI, NIDI, CIDI, Indian Palms, Davsha, Davsha II, Davsha III,
Davsha IV, Davsha V, Davsha VI and Oakmont represent the real estate investment
segment of the Corporation's business. This segment is categorized as real
estate held for development and sale on the Corporation's consolidated financial
statements. Net of specific reserves of $650,000 and non-performing real estate
held for development and sale of $1.5 million, the segment represents $45.0
million of total assets. The specific reserve of $650,000 has been established
for probable and reasonably estimatable declines in the property value of the
golf course land at the Indian Palms subsidiary's golf course operation. For
further discussion of the real estate held for development and sale segment, see
Note 16 to the Corporation's Consolidated Financial Statements in Item 8.
In fiscal 2002, IDI's non-subsidiary partnership located in Tampa Bay,
Florida sold 50% of its interest to a Florida developer. IDI transferred a
portion of its interest and now owns a 50% interest in Dune Golfers Club, LLC
and Dune Development, LLC with the developer. Dune Golfers Club is the golf
operation and Dune Development owns the residential lots. Dune Development plans
to develop the lots for sale. IDI also transferred its remaining interest into
IDI Holdings, LLC Florida and IDI Commercial, LLC Florida. IDI Holdings holds
50% of Seville Development Holdings, LLC, the owner of the undeveloped land and
golf course real estate. At present, no plans have been made to develop the
land. Some tracts may be sold in the future. IDI Commercial holds 50% of Parkway
98 Holdings, LLC, the owner of all the undeveloped commercial and multi-family
real estate. It plans to develop these parcels in the future.
As of March 31, 2003, IDI's total investment in the Florida project was
$4.3 million. This compares to $3.8 million for the prior year ended March 31,
2002. The project reported net income of $9,000 for the year ended March 31,
2003 as compared to a net loss of $225,000 for the year ended March 31, 2002. As
a result of the changes in ownership interest and reorganization, the Florida
project had a deferred gain of $810,000 as of March 31, 2003. This compares to a
deferred gain of $820,000 as of March 31, 2002. This gain will be realized as
lots are developed and sold. IDI holds three lines of credit with the Florida
operation totaling $550,000 as of March 31, 2003 as compared to $340,000 in
notes as of March 31, 2002. IDI has also funded $600,000 to their partner in
this project.
The balance of assets at IDI includes loans to finance the acquisition
and development of property for various partnerships and subsidiaries. At March
31, 2003, IDI had extended $19.3 million to Indian Palms, $6.0 million to
Davsha, $390,000 to Davsha II, $720,000 to Davsha III, $190,000 to CIDI and $1.8
million to Oakmont as compared to $19.3 million to Indian Palms, $4.3 million to
Davsha, and $1.3 million to Davsha II, $730,000 to
19
Davsha III, $200,000 to CIDI and $360,000 to Oakmont at March 31, 2002. These
amounts are eliminated in consolidation.
At March 31, 2003, the Corporation had extended $34.0 million to IDI to
fund various partnership and subsidiary investments. This represents an increase
of $1.6 million from borrowings of $32.4 million at March 31, 2002. These
amounts are eliminated in consolidation.
At March 31, 2003, the Corporation had extended $140,000 to NIDI to
fund various partnership investments. NIDI had borrowings from the Corporation
of $250,000 as of March 31, 2002. These amounts are eliminated in consolidation.
At March 31, 2003, IDI had a specific valuation allowance of $650,000,
unchanged from its level of $650,000 for the prior year ended March 31, 2002. As
of March 31, 2003 and March 31, 2002, there have been no charge-offs for any of
the partnerships or subsidiaries within IDI. The valuation reserve in the real
estate held for development and sale segment was established in 1997 and is a
specific valuation set up for losses that are probable and reasonably
estimatable related to declines in property values.
ANCHOR INVESTMENT SERVICES, INC. AIS is a wholly owned subsidiary of
the Bank that offers fixed and variable annuities as well as mutual funds to its
customers and members of the general public. AIS also processes stock and bond
trades and provides credit life and disability insurance services to the Bank's
consumer and mortgage loan customers as well as some group and individual
coverage. For the year ended March 31, 2003, AIS had a net loss of $70,000 as
compared to a net loss of $90,000 for the year ended March 31, 2002. The Bank's
investment in AIS amounted to $60,000 at March 31, 2003 as compared to $140,000
at March 31, 2002.
ADPC CORPORATION. ADPC is a wholly owned subsidiary of the Bank that
holds and develops certain of the Bank's foreclosed properties. The Bank's
investment in ADPC at March 31, 2003 amounted to $350,000 as compared to
$650,000 at March 31, 2002. ADPC had net income of $5,000 for the year ended
March 31, 2003 as compared to a net loss of $50,000 for the year ended March 31,
2002.
ANCHOR INVESTMENT CORPORATION. AIC is an operating subsidiary of the
Bank that was incorporated in March 1993. Located in the state of Nevada, AIC
was formed for the purpose of managing a portion of the Bank's investment
portfolio (primarily mortgage-backed securities). The Bank also sells commercial
real estate and multi-family loans to AIC in the form of loan participations
with the Bank retaining servicing and charging a servicing fee of .125%. As an
operating subsidiary, AIC's results of operations are combined with the Bank's
for financial and regulatory purposes. The Bank's investment in AIC amounted to
$720.0 million at March 31, 2003 as compared to $696.0 million at March 31,
2002. AIC had net income of $23.9 million for the year ended March 31, 2003 as
compared to $27.3 million for the year ended March 31, 2002. The Bank had
outstanding notes to AIC of $151.0 million with a weighted average rate of 4.39%
as of March 31, 2003 as compared to $151.0 million at March 31, 2002, with a
weighted average rate of 4.96% and maturities during the next six months of
fiscal 2003.
EMPLOYEES
The Corporation had 748 full-time employees and 143 part-time employees
at March 31, 2003. The Corporation promotes equal employment opportunity and
considers its relationship with its employees to be good. The employees are not
represented by a collective bargaining unit.
20
REGULATION
Set forth below is a brief description of certain laws and regulations
that relate to the regulation of the Corporation and the Bank. The description
of these laws and regulations, as well as descriptions of laws and regulations
contained elsewhere herein, does not purport to be complete and is qualified in
its entirety by reference to applicable laws and regulations.
THE CORPORATION
The Bank is a federally chartered stock savings association whose
primary regulator is the OTS. The FDIC under the SAIF insures its deposits up to
applicable limits. The Bank is currently subject to extensive regulation,
examination and supervision by the OTS as its chartering agency, and by the FDIC
as its deposit insurer. The Bank must file reports with the OTS and the FDIC
concerning its activities and financial condition, and must obtain regulatory
approval prior to entering into certain transactions such as mergers with or
acquisitions of, other depository institutions and opening or acquiring branch
offices.
The OTS currently conducts periodic examinations to assess the Bank's
compliance with various regulatory requirements. In addition, the FDIC has the
right to perform examinations of the Bank should the OTS or the FDIC determine
the Bank is in a weakened financial condition or a failure is foreseeable. This
regulation and supervision establishes a comprehensive framework of activities
in which a savings bank can engage and is intended primarily for the protection
of the deposit insurance fund and depositors. The regulatory structure also
gives the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies, including
policies with respect to the classification of assets and the establishment of
adequate loan loss reserves for regulatory purposes.
The Corporation is deemed a unitary savings and loan holding company
within the meaning of Section 10(O) of the Homeowners' Loan Act ("HOLA"). The
Corporation is required to register and file reports with the OTS and is subject
to regulation and examination by the OTS. The Corporation is required to file
certain reports with, and otherwise comply with, the rules and regulations of
the Securities and Exchange Commissions ("SEC") under the federal securities
laws.
As a unitary savings and loan holding company in existence on or before
May 4, 1999, the Corporation generally is not subject to activity restrictions
as long as the Bank is in compliance with the Qualified Thrift Lender ("QTL")
Test. See "Qualified Thrift Lender Requirement."
Any change in these laws and regulations, whether by the OTS, the FDIC,
the SEC, or through legislation, could have a material adverse impact on the
Bank and the Corporation and their operations and shareholders.
Certain laws and regulations applicable to the Bank and the Corporation
are summarized below. These summaries do not purport to be complete and are
qualified in their entirety by reference to such laws and regulations.
FEDERAL REGULATION OF THE BANK
GENERAL. As a federally chartered, SAIF-insured savings bank, the Bank
is subject to extensive regulation by the OTS and the FDIC. Lending activities
and other investments must comply with federal statutory and regulatory
requirements. This federal regulation establishes a comprehensive framework of
activities in which an institution can engage and is intended primarily for the
protection of the SAIF, the FDIC, and the depositors. This regulatory structure
gives the regulatory authorities extensive discretion in connection with their
supervisory and enforcement activities and examination policies, including
policies regarding the classification of assets and the establishment of
adequate loan loss reserves.
21
The OTS regularly examines the Bank and issues a report of its
examination findings to the board of directors. The Bank's relationship with its
depositors and borrowers is also regulated by federal law, especially in such
matters as the ownership of savings accounts and the form and content of the
Bank's mortgage documents.
The Bank must file reports with the OTS and the FDIC concerning its
activities and financial condition, and must obtain regulatory approvals prior
to entering into transactions such as mergers with or acquisitions of other
financial institutions. Any change in such regulations, whether by the OTS, the
FDIC or the United States Congress, could have a material adverse affect on the
Bank and its operations.
QUALIFIED THRIFT LENDER REQUIREMENT. Federal savings associations must
meet a qualified thrift lender test or they become subject to operating
restrictions. Until recently, the chief restriction was the elimination of
borrowing rights from the savings association's Federal Home Loan Bank. However,
with the passage of the Gramm-Leach-Bliley Financial Modernization Act of 1999
by Congress, the failure to maintain qualified thrift lender status will not
affect the Bank's borrowing rights with the FHLB of Chicago. Notwithstanding
these changes, the Bank anticipates that it will maintain an appropriate level
of investments consisting primarily of residential mortgages, mortgage backed
securities and other mortgage-related investments, and otherwise qualify as
qualified thrift lenders. The required percentage of these mortgage-related
investments is 65% of portfolio assets. Portfolio assets are all assets minus
goodwill and other intangible assets, property used by the institution in
conducting its business and liquid assets equal to 20% of total assets.
Compliance with the qualified thrift lender test is determined on a monthly
basis in nine out of every twelve months.
INSURANCE OF DEPOSITS. The Bank's deposits are insured up to applicable
limits under the SAIF of the FDIC. The FDIC regulations assign institutions to a
particular capital group based on the level of an institution's capital - "well
capitalized," "adequately capitalized," or "undercapitalized." These three
groups are then divided into three subgroups reflecting varying levels of
supervisory concern, from those institutions considered to be healthy to those
that are considered to be of substantial supervisory concern. This matrix
results in nine assessment risk classifications, with well capitalized,
financially sound, institutions paying lower rates than those paid by
undercapitalized institutions, which are likely to pose a risk of loss to the
insurance fund absent corrective actions.
An institution's assessment rate depends on the capital category to
which it is assigned. Assessment rates for deposit insurance currently range
from 0 basis points to 27 basis points. The capital and supervisory subgroup to
which an institution is assigned by the FDIC is confidential and may not be
disclosed. A bank's rate of deposit insurance assessments will depend upon the
category or subcategory to which the bank is assigned by the FDIC. Any increase
in insurance assessments could have an adverse effect on the earnings of insured
institutions, including the Bank.
REGULATORY CAPITAL REQUIREMENTS. OTS capital regulations require
savings institutions to meet three capital standards: (1) tangible capital equal
to 1.5% of total adjusted assets, (2) core capital equal to at least 3% of total
adjusted assets, and (3) risk-based capital equal to 8% of total risk-weighted
assets.
Tangible capital is defined as core capital less all intangible assets
(including supervisory goodwill), certain mortgage servicing rights and certain
investments. Core capital is defined as common stockholders' equity (including
retained earnings), noncumulative perpetual preferred stock, minority interests
in the equity accounts of consolidated subsidiaries, certain nonwithdrawable
accounts and pledged deposits of mutual savings associations and qualifying
supervisory goodwill, less nonqualifying intangible assets, certain mortgage
servicing rights and certain investments.
The risk-based capital standard for savings institutions requires the
maintenance of total risk-based capital (which is defined as core capital plus
supplementary capital) of 8% of risk-weighted assets. The components of
supplementary capital include, among other items, cumulative perpetual preferred
stock, perpetual subordinated debt, mandatory convertible subordinated debt,
intermediate-term preferred stock, and the portion of the allowance for loan
losses not designated for specific loan losses. The portion of the allowance for
loan and lease losses includable in supplementary capital is limited to a
maximum of 1.25% of risk-weighted assets. Overall, supplementary capital is
limited to 100% of core capital. A savings association must calculate its
risk-weighted
22
assets by multiplying each asset and off-balance sheet item by various risk
factors as determined by the OTS, which range from 0% for cash to 100% for
delinquent loans, property acquired through foreclosure, commercial loans, and
other assets.
The risk-based capital standards of the OTS generally require savings
institutions with more than a "normal" level of interest rate risk to maintain
additional total capital. An institution's interest rate risk will be measured
in terms of the sensitivity of its "net portfolio value" to changes in interest
rates. Net portfolio value is defined, generally, as the present value of
expected cash inflows from existing assets and off-balance sheet contracts less
the present value of expected cash outflows from existing liabilities. A savings
institution will be considered to have a "normal" level of interest rate risk
exposure if the decline in its net portfolio value after an immediate 200 basis
point increase or decrease in market interest rates (whichever results in the
greater decline) is less than two percent of the current estimated economic
value of its assets. An institution with a greater than normal interest rate
risk will be required to deduct from total capital, for purposes of calculating
its risk-based capital requirement, an amount (the "interest rate risk
component") equal to one-half the difference between the institution's measured
interest rate risk and the normal level of interest rate risk, multiplied by the
economic value of its total assets. For additional discussion of regulatory
capital requirements, refer to Note 10 to the Consolidated Financial Statements
in Item 8 included herewith.
LIMITATION ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS. OTS
regulations impose various restrictions or requirements on associations with
respect to their ability to pay dividends or make other distributions of
capital.
The OTS rules regarding capital distributions, which were substantially
updated effective April 1, 1999 define the term "capital distribution" as a
distribution of cash or other property to a savings association's owners, made
on account of their ownership. The definition specifically excludes dividends
consisting only of a savings association's shares or rights to purchase shares,
and payments that a mutual savings association is required to make under the
terms of a deposit instrument.
Under the revised OTS rules, capital distributions also include a
savings association's payment to repurchase, redeem, retire or otherwise acquire
any of its shares or other ownership interests, any payment to repurchase,
redeem or otherwise acquire debt instruments included in its total capital, and
any extension of credit to finance an affiliate's acquisition of those shares or
interests. Additionally, a capital distribution includes any direct or indirect
payment of cash or other property to owners or affiliates made in connection
with a corporate restructuring. The revised rule also defines as a capital
distribution any transaction the OTS or FDIC determines, by order or regulation,
to be in substance a distribution of capital. Because more than one year has
passed since the Corporation's formation, under the revised rules the
Corporation generally no longer needs specific OTS approval to repurchase its
shares; however, share repurchases still must be made in a prudent manner and
amount under a "safety and soundness" analysis.
A final category of capital distribution under the revised OTS rules is
any other distribution charged against a savings association's capital accounts
if the savings association would not be well capitalized following the
distribution. As such, the revised capital distribution rules of the OTS do not
apply to capital distributions by wholly owned operating subsidiaries of savings
associations. This it true because generally, for reporting purposes, the
accounts of a wholly-owned subsidiary are consolidated with those of the parent
savings association and any distributions by such subsidiary would not affect
the capital levels of the parent savings association.
For regulatory capital purposes, where the consolidated subsidiary is
not wholly owned, the balance sheet account "minority interests in the equity
accounts of subsidiaries that are fully consolidated" may be included in Tier I
capital and total capital if certain conditions are met. Distributions by such
consolidated subsidiaries to shareholders other than the savings association
reduce the cited balance sheet account and, therefore, reduce capital.
Consequently, distributions by subsidiaries that are not wholly owned by the
savings association are subject to the revised OTS capital distribution rules if
the savings association will not be well capitalized following the distribution.
23
The revised OTS rule generally requires all savings associations to
file a notice or an application for approval before making a capital
distribution. A savings association must file an application if the association
is not eligible for expedited treatment under the application processing rules
of the OTS, the total amount of all capital distributions including the proposed
capital distribution, for the applicable calendar year would exceed an amount
equal to the savings association's net income for that year to date plus the
savings association's retained net income for the preceding two years, or the
proposed distribution would violate a prohibition contained in any applicable
statute, regulation, or agreement between the savings association and the OTS,
or the FDIC, or a condition imposed on the savings association in an
OTS-approved application notice.
A savings association must file a notice whenever an application is not
required under the above standards and any of the following criteria is
satisfied:
- - the savings association will not be at least adequately capitalized
following the capital distribution; or
- - the capital distribution would reduce the amount of, or retire any part of
the savings association's common or preferred stock, or retire any part of
debt instruments such as notes or debentures included in the savings
association's capital; or
- - the savings association is a subsidiary of a savings and loan holding
company.
If neither the savings association nor the proposed capital
distribution meet any of the criteria listed in the previous paragraph, the
savings association is not required to file a notice or an application before
making a capital distribution.
Under the revised rule, the OTS will review a savings association's
notice or application and may disapprove a notice or deny an application if the
OTS makes any of the following determinations:
- - the savings association will be undercapitalized, significantly
undercapitalized, or critically undercapitalized under the prompt
corrective action regulations of the FDIC, as adopted by the OTS, following
the capital distribution;
- - the proposed capital distribution raises safety and soundness concerns, or
- - the proposed capital distribution violates a prohibition contained in any
statute, regulation, agreement between the savings association and the OTS
(or the FDIC), or a condition imposed on the savings association in an
OTS-approved application or notice.
Because the Bank is a subsidiary of a savings and loan holding company,
it must file a notice as described above.
LIQUIDITY. In December 2000, legislation was enacted that removed the
provision that authorized the Director of the OTS to establish a liquidity
requirement of any amount within the range of 4% to 10% of a savings
association's average daily balance of net withdrawable deposits plus short-term
borrowings depending upon economic conditions and the deposit flows of member
institutions. In revising the OTS Regulations to conform with the recent
legislation, the OTS removed the specific liquidity requirement but adopted a
rule that requires each savings association and service corporation to maintain
sufficient liquidity to ensure its safe and sound operation. At March 31, 2003,
the Bank believes that it was in compliance with these liquidity requirements.
The Bank's liquidity ratio was 8.13% at March 31, 2003.
FEDERAL RESERVE SYSTEM. The Federal Reserve Board requires all
depository institutions to maintain non-interest bearing reserves at specified
levels against their transaction accounts (primarily checking, NOW and Super NOW
checking accounts) and non-personal time deposits. At March 31, 2003, the Bank
was in compliance with these requirements. The OTS has permitted these reserves
to be used to satisfy liquidity requirements. Because required reserves must be
maintained in the form of cash or a non-interest-bearing account at a Federal
Reserve Bank, the effect of this reserve requirement is to reduce the amount of
the institution's interest-earning assets.
24
Savings institutions also have the authority to borrow from the Federal
Reserve "discount window." Federal Reserve Board regulations, however, require
savings institutions to exhaust all FHLB sources before borrowing from a Federal
Reserve Bank.
RESTRICTIONS ON TRANSACTIONS WITH AFFILIATES. A bank's loans to its
executive officers, directors, any owner of more than 10% of its stock (each, an
insider) and any of certain entities affiliated with any such person (an
insider's related interest) are subject to the conditions and limitations
imposed by Section 22(h) of the Federal Reserve Act and the Federal Reserve
Board's Regulation O thereunder. Under these restrictions, the aggregate amount
of the loans to any insider's related interests may not exceed the loans-to-one
borrower limit applicable to national banks, which is comparable to the
loans-to-one-borrower limit applicable to the Bank's loans. All loans by a bank
to all insiders and insiders' related interests may not exceed the bank's
unimpaired capital and unimpaired surplus. With certain exceptions, loans to an
executive officer, other than loans for the education of the officer's children
and certain loans secured by the officer's residence, may not exceed the greater
of $25,000 or 2.5% of the Bank's unimpaired capital and unimpaired surplus, but
in no event more than $100,000. Regulation O also requires that any proposed
loan to an insider or a related interest of that insider be approved in advance
by a majority of the board of directors of the Bank, with any interested
director not participating in the voting, if such loan, when aggregated with any
existing loans to that insider and the insider's related interests, would exceed
either $500,000 or the greater of $25,000 or 5% of the Bank's unimpaired capital
and surplus. Generally, such loans must be made on substantially the same terms
as, and follow credit underwriting procedures that are no less stringent than,
those that are prevailing at the time for comparable transactions with other
persons and must not present more than a normal risk of collectability.
An exception is made for extensions of credit made pursuant to a
benefit or compensation plan of a bank that is widely available to employees of
the bank and that does not give any preference to insiders of the bank over
other employees of the bank.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB of
Chicago, which is one of 12 regional FHLBs that administers the home financing
credit function of savings associations. The FHLBs provide a central credit
facility for member savings institutions. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System. It makes
loans to members (i.e., advances) in accordance with policies and procedures
established by the board of directors of the FHLB. These policies and procedures
are subject to regulation and oversight of the Federal Housing Finance Board.
All advances from the FHLB are required to be fully secured by sufficient
collateral as determined by the FHLB. In addition, all long-term advances are
required to provide funds for residential home financing.
As a member, the Bank is required to own shares of capital stock in the
FHLB of Chicago in an amount equal to the greatest of $500, 1% of its aggregate
unpaid residential mortgage loans, home purchase contracts or similar
obligations at the beginning of each year, or 20% of its outstanding advances.
The FHLB of Chicago also imposes various limitations on advances made to member
banks, which limitations relate to the amount and type of collateral, the amount
of advances and other items. At March 31, 2003, the Bank owned $81.9 million in
FHLB stock, which is in compliance with this requirement. The Bank received
dividends on its FHLB stock for fiscal 2003 of $3.2 million as compared to $2.6
million for fiscal 2002.
The FHLBs are required to provide funds for the resolution of troubled
savings associations and to contribute to low- and moderately-priced housing
programs through direct loans or interest subsidies on advances targeted for
community investment and low- and moderate-income housing projects. These
contributions have adversely affected the level of FHLB dividends paid and could
continue to do so in the future. These contributions could also have an adverse
effect on the value of FHLB stock in the future. A reduction in value of the
Bank's FHLB stock may result in a charge to the Corporation's earnings.
ACQUISITIONS AND MERGERS. Under the federal Bank Merger Act, any merger
of the Bank - with or into another institution would require the approval of the
OTS, or the primary federal regulator of the resulting entity if it is not an
OTS-regulated institution. Among other things, this meant that when the Bank
combined by a merger of one into the other, the transaction would require the
approval of the OTS.
25
PROHIBITIONS AGAINST TYING ARRANGEMENTS. Banks are subject to the
prohibitions of 12 U.S.C. Section 1972 on certain tying arrangements. A
depository institution is prohibited, subject to certain exceptions, from
extending credit to or offering any other service, or fixing or varying the
consideration for such extension of credit or service, on the condition that the
customer obtain some additional service from the institution or certain of it
affiliates or not obtain services of a competitor of the institution.
UNIFORM REAL ESTATE LENDING STANDARDS. Pursuant to FDICIA, the federal
banking agencies adopted uniform regulations prescribing standards for
extensions of credit that are secured by liens on interests in real estate or
made for the purpose of financing the construction of a building or other
improvements to real estate. Under the joint regulations adopted by the federal
banking agencies, all insured depository institutions must adopt and maintain
written policies that establish appropriate limits and standards for extensions
of credit that are secured by liens or interests in real estate or are made for
the purpose of financing permanent improvements to real estate. These policies
must establish loan portfolio diversification standards, prudent underwriting
standards (including loan-to-value limits) that are clear and measurable, loan
administration procedures, and documentation, approval and reporting
requirements. The real estate lending policies must reflect consideration of the
Interagency Guidelines for Real Estate Lending Policies that have been adopted
by the federal bank regulators.
The Interagency Guidelines, among other things, require a depository
institution to establish internal loan-to-value limits for real estate loans
that are not in excess of the following supervisory limits:
- - for loans secured by raw land, the supervisory loan-to-value limit is 65%
of the value of the collateral;
- - for land development loans (i.e., loans for the purpose of improving
property prior to erection of structures), the supervisory limit is 75%
- - for loans for the construction of commercial, multi-family or other
non-residential property, the supervisory limit is 80%;
- - for loans for the construction of on-to four-family properties, the
supervisory limit is 85%; and
- - for loans secured by other improved property (e.g., farmland, completed
commercial property and other income-producing property, including
non-owner occupied, one- to four-family property), the limit is 85%.
Although no supervisory loan-to-value limit has been established for
owner-occupied, one- to four-family and home equity loans, the Interagency
Guidelines state that for any such loan with the loan-to-value ratio that equals
or exceeds 90% at origination, an institution should require appropriate credit
enhancement in the form of either mortgage insurance or readily marketable
collateral.
COMMUNITY REINVESTMENT ACT. Under the Community Reinvestment Act,
("CRA"), any insured depository institution, including the Bank, 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. The CRA requires the OTS,
in connection with its examination of a savings bank, to assess the depository
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, including applications for additional branches and acquisitions.
Among other things, current CRA regulations replace the prior
process-based assessment factors with a new evaluation system that would rate an
institution based on its actual performance in meeting community needs. In
particular, the new evaluation system focuses on three tests:
- - a lending test, to evaluate the institution's record of making loan in its
service areas;
- - an investment test, to evaluate the institution's record of investing in
community development projects, affordable housing, and programs benefiting
low or moderate income individuals and businesses; and
- - a service test, to evaluate the institution's delivery of services though
its branches, ATMs and other offices.
26
The CRA requires the OTS, in the case of the Bank to provide a written
evaluation of a savings association's CRA performance utilizing a four-tiered
descriptive rating system and requires public disclosure of an association's CRA
rating. The Bank received at least "satisfactory" overall ratings in its most
recent CRA examination.
SAFETY AND SOUNDNESS STANDARDS. Pursuant to the requirements of FDICIA,
as amended by the Riegle Community Development and Regulatory Improvement Act of
1994, each federal banking agency, including the OTS, has adopted guidelines
establishing general standards relating to internal controls, information and
internal audit systems, loan documentation, credit underwriting, interest rate
exposure, asset growth, asset quality, earnings and compensation, fees and
benefits. In general, the guidelines require, among other things, appropriate
systems and practices to identify and manage the risks and exposures specified
in the guidelines. The guidelines prohibit excessive compensation as an unsafe
and unsound practice and describe compensation as excessive when amounts paid
are unreasonable or disproportionate to the services performed by an executive
officer, employee, director, or principal shareholder.