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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 [Fee Required]
For the fiscal year ended December 31, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [No Fee Required]
For the transition period from _______ to _______
Commission File Number 0-20160
COVEST BANCSHARES, INC.
(Exact name of Registrant as specified in its charter)
Delaware 36-3820609
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
749 Lee Street, Des Plaines, Illinois 60016
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (847) 294-6500
Securities Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
NONE NONE
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 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 twelve months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such requirements
for the past 90 days.
YES |X| NO |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
YES |_| NO |X|
1
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant, based on the last sales price quoted on the
Nasdaq National Market System on June 28, 2002, the last business day of the
registrant's most recently completed second fiscal quarter, was approximately
$30,122,791*.
As of March 27, 2003, the Registrant had issued 4,403,803 shares of the
Registrant's Common Stock. In addition, it had also repurchased 956,841 shares
that were being held as treasury stock.
DOCUMENTS INCORPORATED BY REFERENCE
PART III of Form 10-K--Portions of the Proxy Statement for the 2003
Annual Meeting of Stockholders.
* Based on the closing price of the Registrant's Common Stock on June 28, 2002,
and reports of beneficial ownership filed by directors and executive officers of
Registrant and by beneficial owners of more than 5% of the outstanding shares of
Common Stock of Registrant; however, such determination of shares owned by
affiliates does not constitute an admission of affiliate status or beneficial
interest in shares of Registrant's Common Stock.
2
COVEST BANCSHARES, INC.
2002 ANNUAL REPORT ON FORM 10-K
Table of Contents
Page
Number
PART I
Item 1. Business ................................................................ 5
Item 2. Properties .............................................................. 32
Item 3. Legal Proceedings ....................................................... 32
Item 4. Submission of Matters to a Vote of Security Holders ..................... 32
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters .................................................. 33
Item 6. Selected Financial Data ................................................. 35
Item 7. Management's Discussion and Analysis of Results of Operations
and Financial Condition .............................................. 37
Item 7A. Quantitative and Qualitative Disclosures About Market Risk .............. 49
Item 8. Consolidated Financial Statements ....................................... 53
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial
Disclosure ........................................................... 84
PART III
Item 10. Directors and Executive Officers of the Registrant ...................... 84
Item 11. Executive Compensation .................................................. 84
Item 12. Security Ownership of Certain Beneficial Owners and Management ......... 84
Item 13. Certain Relationships and Related Transactions .......................... 85
Item 14. Controls and Procedures ................................................. 85
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ........ 86
SIGNATURE ......................................................................... 87
3
PART I
SPECIAL NOTE CONCERNING FORWARD-LOOKING STATEMENTS
This document (including information incorporated by reference) contains, and
future oral and written statements of CoVest Bancshares, Inc., a Delaware
corporation (the "Company") and its management may contain, forward-looking
statements, within the meaning of such term in the Private Securities Litigation
Reform Act of 1995, with respect to the financial condition, results of
operations, plans, objectives, future performance and business of the Company.
Forward-looking statements, which may be based upon beliefs, expectations and
assumptions of the Company's management and on information currently available
to management, are generally identifiable by the use of words such as "believe,"
"expect," "anticipate," "plan," "intend," "estimate," "may," "will," "would,"
"could," "should" or other similar expressions. Additionally, all statements in
this document, including forward-looking statements, speak only as of the date
they are made, and the Company undertakes no obligation to update any statement
in light of new information or future events.
The Company's ability to predict results or the actual effect of future plans or
strategies is inherently uncertain. Factors which could have a material adverse
effect on the operations and future prospects of the Company and its
subsidiaries include, but are not limited to, the following:
o The strength of the United States economy in general and the strength of
the local economies in which the Company conducts its operations which may
be less favorable than expected and may result in, among other things, a
deterioration in the credit quality and value of the Company's assets.
o The economic impact of past and any future terrorist attacks, acts of war
or threats thereof and the response of the United States to any such
threats and attacks.
o The effects of, and changes in, federal, state and local laws, regulations
and policies affecting banking, securities, insurance and monetary and
financial matters.
o The effects of changes in interest rates (including the effects of changes
in the rate of prepayments of the Company's assets) and the policies of
the Board of Governors of the Federal Reserve System.
o The ability of the Company to compete with other financial institutions as
effectively as the Company currently intends due to increases in
competitive pressures in the financial services sector.
o The inability of the Company to obtain new customers and to retain
existing customers.
o The timely development and acceptance of products and services, including
products and services offered through alternative delivery channels such
as the Internet.
o Technological changes implemented by the Company and by other parties,
including third party vendors, which may be more difficult or more
expensive than anticipated or which may have unforeseen consequences to
the Company and its customers.
o The ability of the Company to develop and maintain secure and reliable
electronic systems.
o The ability of the Company to retain key executives and employees and the
difficulty that the Company may experience in replacing key executives and
employees in an effective manner.
o Consumer spending and saving habits which may change in a manner that
affects the Company's business adversely.
4
o Business combinations and the integration of acquired businesses which may
be more difficult or expensive than expected.
o The costs, effects and outcomes of existing or future litigation.
o Changes in accounting policies and practices, as may be adopted by state
and federal regulatory agencies and the Financial Accounting Standards
Board.
o The ability of the Company to manage the risks associated with the
foregoing as well as anticipated.
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements.
Additional information concerning the Company and its business, including other
factors that could materially affect the Company's financial results, is
included in the Company's filings with the Securities and Exchange Commission.
ITEM 1. BUSINESS
THE COMPANY
GENERAL
CoVest Bancshares, Inc., a Delaware corporation (the "Company"), is a bank
holding company registered under the Bank Holding Company Act of 1956, as
amended (the "BHCA"). The Company's subsidiary is CoVest Banc, National
Association, a national banking association (the "Bank"). The Bank's subsidiary
service corporation, CoVest Investments, Inc., an Illinois corporation ("CII"),
engages in the business of selling annuities, insurance products and complete
brokerage services. The Company was organized in 1992, in connection with the
Bank's conversion from the mutual to the stock form of organization (the
"Conversion") which was completed on June 30, 1992. The Company's common stock
is quoted on the Nasdaq National Market System under the symbol "COVB". Prior to
August 1997, the Company was a savings and loan holding company registered under
the Home Owners Loan Act, as amended. The Company became a bank holding company
effective August 1, 1997, when the Bank completed its conversion from a federal
savings association to a national bank.
The Company entered into an Agreement and Plan of Reorganization with Midwest
Banc Holdings, Inc. ("Midwest Banc") on November 1, 2002 (the "Merger
Agreement") that, if approved by the Company's stockholders at a special meeting
of stockholders, will result in the Company being merged with and into Midwest
Banc. The special meeting of stockholders originally scheduled for March 17,
2003, was cancelled after Midwest Banc informed the Company that bank regulatory
agencies would be delaying the processing of Midwest's applications to acquire
the Company.
The Company, the Bank and CII are subject to comprehensive regulation,
examination and supervision by the Board of Governors of the Federal Reserve
System (the "FRB"), the Office of the Comptroller of the Currency (the "OCC")
and the Federal Deposit Insurance Corporation (the "FDIC"). The Bank is a member
of the Federal Home Loan Bank System (the "FHLB") and its deposits are insured
by the Savings Association Insurance Fund ("SAIF") to the maximum extent
permitted by the FDIC. The Company engages in a general full service retail
banking business and offers a broad variety of commercial and consumer oriented
products and services to customers in its primary market area. The Company is
principally engaged in the business of attracting deposits from the general
public and originating commercial loans and real estate loans in its primary
market area. The Company also originates consumer loans and invests in
securities. Finally, the Company offers, on an agency basis through CII,
annuities, insurance products and complete brokerage services to its customers.
The Company's income is derived from interest on loans and securities, service
charges, loan origination and servicing fees, mortgage origination fees, and
proceeds from the sale of annuity and insurance products through CII. The
Company's operations are affected by general economic conditions, the monetary
and fiscal policies of the federal government and the policies of the various
regulatory authorities, including the OCC, FDIC and the FRB. Its results of
operations are largely dependent upon its net interest income, which is the
difference between the interest it receives on its loan and securities
portfolios and the interest it pays on its deposit accounts and borrowed money.
5
The Company's corporate headquarters are located at 749 Lee Street, Des Plaines,
Illinois. The Company's telephone number is (847) 294-6500. Its Internet address
is www.covestbanc.com.
MARKET AREA
The Company's main office and a drive-up facility are located in downtown Des
Plaines, Illinois. Des Plaines is a mature suburban Chicago community that had a
population of approximately 55,250 in 2000. Des Plaines is located approximately
20 miles from downtown Chicago and five miles north of Chicago's O'Hare airport.
In March, 1994, the Company established its first branch office in Arlington
Heights, Illinois, through the acquisition from the Resolution Trust Corporation
of the deposits and office building of the Arlington Heights branch of the
former Irving Federal Bank, F.S.B. Arlington Heights is a suburban Chicago
community located approximately 10 miles northwest of Des Plaines. Based on the
2000 census, it had a population of approximately 76,500.
On March 2, 1995, the Company opened its second branch in Schaumburg, Illinois.
Schaumburg is located approximately 16 miles southwest of Arlington Heights and
approximately 13 miles west of Des Plaines. Schaumburg had a population of
75,000 in 2000.
Des Plaines and parts of the surrounding contiguous communities such as Park
Ridge, Niles, Mount Prospect, Arlington Heights, Prospect Heights, Buffalo
Grove, Schaumburg and Hoffman Estates have historically constituted the
Company's primary market area. These areas are characterized by single-family
residences and apartment buildings. Many of the residents of the Company's
primary market area consist of professional or "white collar" workers who
commute into Chicago or are engaged in the retail trade of the service sector.
The Company's success has been due, in part, to its market area's growth,
favorable population and income demographics.
LENDING ACTIVITIES
GENERAL
The Company faces strong competition both in originating loans and in attracting
deposits. Competition for commercial, commercial real estate, construction and
multi-family loans comes primarily from large commercial banks and community
banks. Competition in originating real estate loans comes primarily from
mortgage bankers, other savings institutions and commercial banks, all of which
also make loans secured by real estate located in the Company's primary market
area. The Company competes for real estate loans principally on the basis of the
interest rates, the types of loans it offers and the quality of services it
provides to borrowers. The competition for consumer loans comes primarily from
commercial banks, smaller community banks, and finance companies.
The principal lending activity of the Bank before 1996 had historically been
originating first mortgage loans for its portfolio, secured by owner occupied
one-to-four family residential properties located in its primary market area.
Beginning in 1996, the Bank began a major balance sheet restructuring project,
and is now a full-service commercial bank.
The Bank provides a full array of first mortgage products for which it acts as a
loan originator and placer. Most loans are sold on a service-released basis to
other financial institutions, for which the Bank receives a fee and has no
additional rights.
6
LOAN PORTFOLIO COMPOSITION
The following table outlines the composition of the Company's loan portfolio in
dollar amounts and in percentages as of the dates indicated:
December 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
(Dollars in Thousands)
Commercial loans $ 56,519 10.43% $ 46,770 9.08% $ 36,397 7.21% $ 17,207 3.69% $ 8,035 1.98%
Real estate loans
One-to-four family(1) 55,485 10.24 59,551 11.56 121,076 23.98 130,235 27.91 154,182 37.94
Multi-family 252,165 46.55 222,556 43.19 162,102 32.09 126,109 27.03 55,661 13.70
Commercial real estate 84,552 15.61 79,403 15.41 79,298 15.70 73,596 15.77 66,776 16.43
Construction 54,587 10.07 58,933 11.44 48,324 9.57 46,177 9.90 40,572 9.98
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 446,789 82.47 420,443 81.60 410,800 81.34 376,117 80.61 317,191 78.05
Commercial leases 522 0.10 1,774 0.34 5,928 1.17 22,029 4.72 35,166 8.66
Consumer loans
Automobile 7,292 1.35 10,661 2.07 15,550 3.08 21,387 4.58 21,036 5.18
Home equity Improvement 28,837 5.32 33,460 6.49 33,567 6.65 27,786 5.96 22,654 5.57
Other 1,773 0.33 2,152 0.42 2,753 0.55 2,066 0.44 2,290 0.56
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans 37,902 7.00 46,273 8.98 51,870 10.28 51,239 10.98 45,980 11.31
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans 541,732 100.00% 515,260 100.00% 504,995 100.00% 466,592 100.00% 406,372 100.00%
====== ====== ====== ====== ======
Net deferred costs 331 907 1,091 938 269
-------- -------- -------- -------- --------
Total loans receivable $542,063 $516,167 $506,086 $467,530 $406,641
======== ======== ======== ======== ========
(1) Including loans held for sale.
7
The following table shows the composition of the Company's loan portfolio by
fixed and adjustable rates at the dates indicated:
December 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- -------- ------- -------- ------- -------- -------
(Dollars in Thousands)
Fixed rate loans
Commercial loans $ 20,319 3.75% $ 21,465 4.17% $ 19,747 3.91% $ 9,799 2.10% $ 1,722 0.42%
Real estate loans
One-to-four family(1) 18,448 3.40 25,486 4.95 54,774 10.85 65,526 14.04 89,390 22.00
Multi-family 11,141 2.06 12,168 2.36 2,736 0.54 4,390 0.94 391 0.10
Commercial real estate 26,033 4.81 44,472 8.63 35,367 7.00 29,687 6.36 19,735 4.86
Construction 3,793 0.70 -- -- -- -- 600 0.13 199 0.05
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 59,415 10.97 82,126 15.94 92,877 18.39 100,203 21.47 109,715 27.01
Commercial leases 522 0.10 1,774 0.34 5,928 1.17 22,029 4.72 35,166 8.65
Consumer loans 16,184 2.98 25,616 4.97 31,618 6.26 31,436 6.74 27,292 6.71
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total fixed rate loans 96,440 17.80 130,981 25.42 150,170 29.73 163,467 35.03 173,895 42.79
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Adjustable-rate loans
Commercial loans 36,200 6.68 25,305 4.91 16,650 3.30 7,408 1.59 6,313 1.56
Real estate loans
One-to-four family 37,037 6.84 34,065 6.61 66,302 13.13 64,709 13.87 64,792 15.94
Multi-family 241,024 44.49 210,388 40.83 159,366 31.56 121,719 26.09 55,270 13.60
Commercial real estate 58,519 10.80 34,931 6.78 43,931 8.70 43,909 9.41 47,041 11.58
Construction 50,794 9.38 58,933 11.44 48,324 9.57 45,577 9.77 40,373 9.93
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate loans 387,374 71.51 338,317 65.66 317,923 62.96 275,914 59.14 207,476 51.05
Consumer loans 21,718 4.01 20,657 4.01 20,252 4.01 19,803 4.24 18,688 4.60
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total adjustable-rate
loans 445,292 82.20 384,279 74.58 354,825 70.27 303,125 64.97 232,477 57.21
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans 541,732 100.00% 515,260 100.00% 504,995 100.00% 466,592 100.00% 406,372 100.00%
====== ====== ====== ====== ======
Net deferred costs 331 907 1,091 938 269
-------- -------- -------- -------- --------
Total loans receivable $542,063 $516,167 $506,086 $467,530 $406,641
======== ======== ======== ======== ========
(1) Including loans held for sale.
Adjustable rate loans are indexed to the prime rate, 91-day Treasury Bill, 1
year, 3 year and 5 year constant maturity Treasuries. The terms of the
multi-family loans and commercial real estate loans are subject to floors and
ceilings for the entire term of the loan. This means that if the rates go down,
the rates on the loans cannot go below the floors level. Some loans may
currently be at their floor level, which in a rising rate environment may not
increase proportionally with the index. On the other hand, when rates go up,
loans that have hit their ceiling, may not go up in relation to their individual
indexes.
8
The following schedule illustrates the contractual maturities of the Company's
loan portfolio at December 31, 2002. Mortgages that have adjustable or floating
interest rates are shown as maturing in the period during which the contract is
due. The schedule does not reflect the effects of possible prepayments or
enforcement of due-on-sale clauses:
One-to-Four Family
Residential Loans Commercial Real
(1) Commercial Loans (2) Estate Loans (3) Consumer Loans (4) Total
------------------ -------------------- ---------------- ------------------ -----
Coming due during Weighted Weighted Weighted Weighted Weighted
years ending Average Average Average Average Average
December 31, Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
- ------------ ------ ---- ------ ---- ------ ---- ------ ---- ------ ----
2003 $ 1,785 6.77% $ 34,545 5.30% $ 71,361 5.96% $ 5,314 6.68% $113,005 5.80%
2004 6,511 6.74 6,488 6.66 20,900 6.17 3,374 6.97 37,273 6.43
2005 1,915 7.52 8,334 7.49 11,425 5.78 2,043 6.85 23,717 6.61
2006 to 2007 3,312 6.95 6,158 6.07 127,212 5.10 2,808 6.75 139,490 5.22
2008 to 2012 6,387 6.61 1,516 5.10 160,406 6.77 24,340 5.71 192,649 6.62
2013 to 2027 25,753 6.71 -- 0.00 -- 0.00 23 9.00 25,776 6.71
2028 and beyond 9,822 6.54 -- 0.00 -- 0.00 -- 0.00 9,822 6.54
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total $ 55,485 6.71% $ 57,041 5.85% $391,304 5.99% $ 37,902 6.10% $541,732 6.08%
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
(1) Includes loans held for sale.
(2) Commercial loans consist of commercial loans and commercial leases.
(3) Commercial real estate loans consist of commercial real estate loans,
construction loans and multi-family loans.
(4) Consumer loans consist of home equity, auto and various secured and
unsecured loans.
Approximately $77.0 million in fixed rate loans and $351.7 million in variable
rate loans had maturities in excess of one year at December 31, 2002.
The aggregate amount of loans that the Bank is permitted to make to any one
borrower is generally limited to 15% of unimpaired capital and surplus (25% if
the security for such loan has a "readily ascertainable" value). At December 31,
2002, the Bank's regulatory loan-to-one borrower limit was $7.7 million. On the
same date, the Bank's largest lending relationship was $7.5 million. As of
December 31, 2002, the Bank had five relationships in the range of $6.4 million
to $7.0 million.
All of the Company's lending activities is conducted in accordance with its
written underwriting standards and its loan origination procedures. The Company
is an equal opportunity lender and each year offers its Affordable Housing
Program for families with a maximum household income of 115% of the median
income as published by the Federal Housing Finance Board. Decisions on all loan
approvals or denials are made on the basis of detailed applications and property
valuations (consistent with the Company's written appraisal policy) prepared by
independent appraisers. The loan applications are designed primarily to
determine the borrower's ability to repay and the more significant items on the
application are verified through use of credit reports, financial statements,
tax returns and/or third-party confirmations.
COMMERCIAL LENDING
Over the past six years, the Company has continued to increase its originations
of commercial real estate loans, multi-family loans and commercial loans.
Management intends to continue to focus on this type of lending. The commercial
real estate loans, multi-family loans and construction loans are secured by
property generally within the Company's market area. Commercial real estate
lending is generally considered to involve a higher level of risk than
single-family residential lending. This is due to concentration of principal in
a limited number of loans and borrowers, the effects of general economic
conditions on real estate developers and managers, and on income producing
properties.
The Company has attempted to minimize the foregoing risks by adopting what
management believes are conservative underwriting guidelines that impose more
stringent loan-to-value ratios, applicant's payment history, cash flow, value of
collateral, and credit worthiness of the business.
9
At December 31, 2002, the Company had $84.5 million in commercial real estate
loans, $54.6 million in construction loans, $56.5 million in commercial loans,
$0.5 million in commercial leases, and $252.2 million in multi-family loans. The
allowance for loan losses included $6.5 million for these types of loans at
December 31, 2002.
Multi-family loans showed the largest dollar increase in 2002. These loans are
concentrated in the counties surrounding the Company's locations with the major
dollar volumes and numbers being situated in Cook County, Illinois. As of
December 31, 2002, 16% of outstanding multi-family loans are out of territory.
Most of these loans are to finance or refinance apartment buildings ranging in
size from five units up to 24 units. The terms of the loans are prime rate
adjustable, weekly three-month treasury bill adjustable, one year adjustable
rate, three year adjustable rate, or five year adjustable rate, adjusting in
accordance with a designated index, that is generally subject to a floor, a
ceiling, prepayment penalties and have a maximum loan-to-value ratio of 80%. The
Company, to augment its liquidity needs and reduce credit exposure, may sell
participations on less than two-year originated multi-family loans. As of
December 31, 2002, $22.3 million of the multi-family loan portfolio had been
participated without recourse.
Construction lending is primarily for rehabilitation projects in Cook County and
some land development projects around the Company's lending area. These
rehabilitation projects are for the conversion of old warehouse and factory
space into single family townhouses or condominiums. The typical build out time
is less than eighteen months and is priced at a margin above the prime rate. The
Company, to augment its liquidity needs and reduce credit exposure, may sell
participations of construction loans. As of December 31, 2002, $14.0 million of
the construction loan portfolio had been participated without recourse. The
Company intends to limit its exposure in this type of lending in 2003.
Commercial real estate loans are primarily for mixed use properties, owner
occupied office buildings, operating strip malls and hotel or motel loans. These
loans usually reprice at least every five years based upon a margin over the
five year constant maturity treasury. The Company, to augment its liquidity
needs and reduce credit exposure, may sell participations of commercial real
estate loans. As of December 31, 2002, $5.1 million of the commercial real
estate loan portfolio had been participated without recourse.
ONE-TO-FOUR FAMILY RESIDENTIAL REAL ESTATE LENDING
In general, the Company retains in its portfolio single-family residential
mortgage loans that provide periodic adjustments of the interest rate
(adjustable-rate mortgage loans). These loans generally have terms of up to
30-years and interest rates which adjust every one or two years in accordance
with an index based on the yield on certain U.S. government securities. A
portion of these loans may guarantee borrowers a fixed rate of interest for the
first three to five years of the loan's term. It is the Company's normal
practice to discount the interest rate it charges on its adjustable-rate
mortgage loans during the first one to five years of the loan, which has the
effect of reducing a borrower's payment during such years. In addition, most of
the Company's adjustable-rate mortgage loan agreements permit borrowers to
convert their adjustable-rate loans to fixed rate loans.
Adjustable-rate mortgage loans decrease the Company's exposure to risks
associated with changes in interest rates, but involve other risks because as
interest rates increase, borrowers' monthly payments increase, thus increasing
the potential for default. This risk has not had any adverse effect on the
Company to date, although no assurances can be made with respect to future
periods.
The Company also originates fixed-rate mortgage loans in order to provide a full
range of product to its customers. Such loans are originated usually under
terms, conditions, and documentation standards that make such loans eligible for
sale to the Federal Home Loan Mortgage Corporation ("FHLMC"), the Federal
National Mortgage Association ("FNMA") and other institutional investors. The
Company generally sells these loans at the time they are originated. Sales of
mortgage loans provide additional funds for lending and other business purposes
and have generally been under terms that do not provide for any recourse to the
Company by the purchaser.
During 2002, mortgage banking originated and sold on a service release basis 246
loans. Additionally, 123 loans were originated and retained in the Company's
portfolio.
10
The Company will continue to originate loans targeted at low and moderate income
home buyers, through the Affordable Housing Program, which will be retained in
its portfolio. Of the 123 loans originated, 76 were through the affordable
housing program that represented $11.9 million.
At December 2002, $55.5 million, including loans held for sale, of the Company's
loan portfolio consisted of loans on one-to-four family residences. At December
31, 2002, the Company's largest outstanding residential loan was $832,000.
Substantially all of the residential loans originated by the Company are secured
by properties located in the Company's primary market area. See "Originations,
Purchases and Sales of Loans".
Mortgage loans retained by the Company may have loan-to-value ratios of up to
100%. Mortgage loans exceeding an 80% loan-to-value ratio at the time of
origination may require private mortgage insurance to reduce the Company's
exposure to 80% or less of the appraised value of the underlying property. In
other instances, secondary financing may be provided to allow for a total loan
to value ratio of 100%. The Company's residential mortgage loans customarily
include due-on-sale clauses, giving the Company the right to declare the loan
immediately due and payable in the event that, among other things, the borrower
sells or otherwise disposes of the property subject to the mortgage.
When the Company services loans for others, it is compensated for the
aforementioned services through retention of servicing fee from borrowers'
monthly payments. The Company also receives fees and interest income from
ancillary sources such as delinquency charges and float on escrow accounts and
other funds.
CONSUMER LENDING
Management believes that offering consumer loan products helps to expand and
create stronger ties to the Company's existing customer base. The Company offers
a variety of secured consumer loans, including direct automobile loans, second
mortgage loans (including home improvement loans), home equity lines, and loans
secured by deposit accounts. In addition, the Company offers unsecured consumer
loans. Management believes that these loans, which carry a higher rate of
interest, can enhance the bottom line when offered in conjunction with a prudent
credit risk policy and collection program. In 1999, the Company also began
accepting loan applications through the Internet, which expands the market area.
The Company currently originates substantially all of its consumer loans in its
primary market area. At December 31, 2002, the Company's consumer loans totaled
$37.9 million or 7.00% of the Company's loan portfolio.
For second mortgage and home equity loans, the Company evaluates both the
borrower's ability to make principal, interest and escrow payments and the value
of the property that will secure the loan. The Company's second mortgage loans
and home equity lines of credit are generally originated in amounts which,
together with the amount of the first mortgage, do not exceed 100% of the
appraised value of the property securing the loan. Home equity loans are
revolving lines-of-credit, with the interest rate floating at a stated margin
over the prime rate. Second mortgage loans are generally made for terms of up to
ten years with fixed interest rates. Other consumer loan terms vary according to
the type of collateral, length of contract and creditworthiness of the borrower.
The outstanding balance of these types of loans was $28.8 million at December
31, 2002.
The Company employs risk-based underwriting standards for consumer loans. These
include a determination of the applicant's payment history on other debt, and an
assessment of the borrower's ability to meet payments on the proposed loan along
with existing obligations, and an assessment of the borrower's FICO credit
score. In addition to the creditworthiness of the applicant, the underwriting
process also includes a comparison of the value of the security, if any, in
relation to the proposed loan amount.
Consumer loans may entail greater risk than residential mortgage loans,
particularly in the case of consumer loans which are unsecured or secured by
depreciable assets such as automobiles. The outstanding balance in automobile
loans and other consumer loans at December 31, 2002 was $9.1 million. In such
cases, any repossessed collateral for defaulted consumer loans may not provide
adequate sources of repayment for the outstanding loan balances as a result of
the greater likelihood of damage, loss or depreciation. In addition, consumer
loan collections are dependent on the borrower's continuing financial stability,
and thus are more likely to be affected by adverse personal circumstances.
Furthermore, the application of various federal and state laws, including
federal and state bankruptcy
11
and insolvency laws, may limit the amount which can be recovered on such loans.
Although the level of delinquencies in the Company's consumer loan portfolio has
been manageable, there can be no assurance that delinquencies will not increase
in the future.
ORIGINATIONS, PURCHASES AND SALES OF LOANS AND MORTGAGE-BACKED SECURITIES
The Company originates loans through loan officers, including commissioned
originators. Walk-in customers and referrals from real estate brokers, builders
and commercial lenders in the area are also important sources for loan
originations.
In 2002 and 2001, the Company did not purchase any mortgage backed securities or
residential loans. There were no mortgage-backed securities in the Company's
investment portfolio as of December 31, 2002. Plans in 2003 do not currently
include purchase of either any mortgage-backed securities or residential loans.
The Company has securitized residential real estate loans from time to time.
When loans have been securitized, the Company retains the responsibility for
servicing the loan. At December 31, 2002, and 2001, there were approximately
$38.1 million and $66.0 million in the loan servicing portfolio.
The Company sold $54.1 million of its single family mortgage loan portfolio in
March 2001, in anticipation of falling rates and the risk of prepayments. This
reduced the Company's interest rate risk exposure on long term fixed rate assets
that had the ability to be refinanced by the borrower without penalty should
rates decline. The sale consisted of a $28.5 million sale of single use customer
mortgages and a $25.6 million sale of multi-use service customer mortgages.
Single use customer mortgages are customers with no other banking relationship
with the Company besides the mortgage loan. These loans were sold on a service
release basis, which means discontinuing the collection of principal and
interest payments, thereby giving up the rights of collecting servicing income.
Multi-service customer mortgages are customers with other banking relationship
with the Company, such as deposit account relationships and home equity lines of
credit. These multi-service customer mortgages were sold on a service retained
basis, which means continuing the collection of principal and interest payments
for the remaining term of the loan and the right to receive servicing income
from the loan purchaser. Proceeds from the sale were used to fund growth in the
commercial and multi-family portfolios.
In April 2002, the Company sold $20.1 million of its multi-family loan portfolio
which consisted of 5-year adjustable rate loans where the rate is fixed for the
first 5-year term and then reprice off the 5-year Treasury index for the next
five years. There was no gain or loss on the transaction and the loans were sold
at 7% pass-through until the next rate adjustment. The overall average gross
rate was 8.00%. The Company retains the servicing of the loans for a 0.25%
servicing fee and a 50/50 split of the prepayment fee negotiated for the life of
the contract.
12
The following table shows the originations, purchases, sales, and repayments of
loans and mortgage-backed securities of the Company for the periods indicated:
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
(In Thousands)
Originations of portfolio loans
Adjustable rate
Commercial loans $ 21,136 $ 14,703 $ 13,698
One-to-four family 14,876 16,985 12,229
Multi-family 102,322 115,842 57,944
Commercial real estate 18,007 8,183 11,749
Construction loans 40,931 49,879 48,655
Consumer 347 4,139 2,437
--------- --------- ---------
Total adjustable rate 197,619 209,731 146,712
Fixed rate
Commercial loans 5,773 7,225 12,918
One-to-four family 1,966 1,655 247
Multi-family 20,678 3,413 632
Commercial real estate 14,597 15,120 2,633
Commercial leases -- -- --
Consumer 2,633 5,388 7,294
--------- --------- ---------
Total fixed rate 45,647 32,801 23,724
--------- --------- ---------
Total loans originated 243,266 242,532 170,436
Sales and repayments of loans and mortgage-backed
securities
Sales of mortgage-backed securities (2,060) (2,958) (11,948)
Sale of one-to-four family loans -- (54,140) --
Sale of multi-family loans (20,083) -- --
Principal repayments (198,599) (180,356) (129,601)
--------- --------- ---------
Total reductions (220,742) (237,454) (141,549)
Decrease in other items, net (576) (185) (165)
--------- --------- ---------
Net increase in loans and mortgage-backed securities $ 21,948 $ 4,893 $ 28,722
========= ========= =========
13
DELINQUENCY PROCEDURES
When a borrower fails to make a required payment on a loan, the Company attempts
to cure the delinquency by contacting the borrower. In the case of residential
loans subject to late charges, a late notice is sent 15 days after the due date,
at which time a late charge is assessed. If the delinquency is not cured by the
30th day, contact with the borrower is made by phone or a second notice is
mailed. Additional written and oral contacts are made with the borrower between
30 and 60 days after the due date.
In the event a real estate loan payment is past due for 90 days or more,
management performs an in-depth review of the condition of the property and
circumstances of the borrower. Based upon the results of its review, management
will decide whether to try to negotiate a repayment program with the borrower,
or initiate foreclosure proceedings. These loans are also placed on non-accrual
status.
Delinquent consumer loans are handled in a similar manner, except that initial
contact is made when the payment is ten days past due, personal contact is made
when the loan becomes more than twenty days past due, and the loan is classified
as a delinquent loan when it is past due for 30 days or more. Certain consumer
loans secured by real property are placed on non-accrual status when delinquent
more than 90 days and as deemed appropriate in the collection process. All other
consumer loans are charged off after 90 days.
The following table sets forth the Company's loan delinquencies by type, by
amount, and by percentage. Non performing assets are excluded from the table.
Loans Delinquent For
-------------------------------------------------------------------- Total
30 - 89 Days 90 Days and Over Delinquent Loans
------------------------------- ------------------------------- -------------------------------
Percent Percent Percent
of of of
Loan Loan Loan
Number Amount Category Number Amount Category Number Amount Category
------ ------ -------- ------ ------ -------- ------ ------ --------
(Dollars in Thousands)
One-to-four
family 4 $ 401 0.72% -- $ -- --% 4 $ 401 0.72%
Commercial real
estate 1 220 0.26 1 38 0.04 2 258 0.30
Multi-family -- -- -- -- -- -- -- -- --
Construction -- -- -- -- -- -- -- -- --
Commercial 3 674 1.19 3 1,415 2.49 6 2,089 3.68
Commercial leases -- -- -- 1 14 2.68 1 14 2.68
Consumer 4 30 0.08 -- -- -- 4 30 0.08
------ ------ ------ ------ ------ ------ ------ ------ ------
Total 12 $1,325 0.24% 5 $1,467 0.27% 17 $2,792 0.51%
====== ====== ====== ====== ====== ====== ====== ====== ======
CLASSIFICATION OF ASSETS
OCC policies require that each national bank classify its own assets on a
regular basis. In addition, in connection with examinations of national banks,
OCC 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. The regulations also include a Special
Mention category. Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the institution will sustain some
loss if the deficiencies are not corrected. Doubtful assets have the weaknesses
of Substandard assets, with the additional characteristics that the weaknesses
make collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss. An
asset classified as Loss is considered uncollectible and of such little value
that continuance as an asset of the institution is not warranted.
The Special Mention category consists of assets which do not currently expose a
financial institution to a sufficient degree of risk to warrant classification,
but do possess credit deficiencies or potential weaknesses deserving
management's close attention. Assets classified as Substandard or Doubtful
require the institution to establish prudent general allowances for loan losses.
These loans are considered non-performing. If an asset or portion
14
thereof is classified as Loss, the institution must either establish specific
allowances for loan and lease losses in the amount of 100% of the portion of the
asset classified as Loss, or charge off such amount. If an institution does not
agree with an examiner's classification of an asset, it may appeal this
determination to the Regional Director of the OCC. Certain loans delinquent less
than 90 days are categorized as Special Mention. As a result of management's
review of its assets, at December 31, 2002, the Company had categorized none of
its assets as Special Mention, $3.9 million as Substandard, and none as Doubtful
or Loss. The Company's classified assets consist of non-performing loans.
NON-PERFORMING ASSETS
The Company's financial statements are prepared on the accrual basis of
accounting, including the recognition of interest income on its loan portfolio,
unless a loan is placed on non-accrual status. Loans are placed on non-accrual
status when there are serious doubts regarding the collectibility of all
principal and interest due under the terms of the loans. Amounts received on
non-accrual loans generally are applied first to principal and then to interest
after all principal has been collected. It is the policy of the Company not to
renegotiate the terms of a loan because of a delinquent status. Rather, a loan
is generally transferred to non-accrual status if it is not in the process of
collection and is delinquent in payment of either principal or interest beyond
90 days.
Under Statement of Financial Accounting Standards No. 114 and No. 118, the
Company defined loans that will be individually evaluated for impairment to
include commercial loans and mortgage loans secured by commercial properties or
five-plus family residences that are in non-accrual status or were restructured.
All other smaller balance homogeneous loans are evaluated for impairment in
total.
The classification of a loan as impaired or non-accrual does not necessarily
indicate that the principal is uncollectible, in whole or in part. The Company
makes a determination as to collectibility on a case-by-case basis. The Company
considers both the adequacy of the collateral and the other resources of the
borrower in determining the steps to be taken to collect impaired or non-accrual
loans. The final determination as to the steps taken is made based upon the
specific facts of each situation. Alternatives that are typically considered to
collect impaired or non-accrual loans are foreclosure, collection under
guarantees, loan restructuring, or judicial collection actions.
Loans which are considered to be impaired are reduced to the present value of
expected future cash flows or to the fair value of the related collateral, by
allocating a portion of the allowance to such loans. If these allocations cause
the allowance for loan losses to require an increase, such increase is reported
as a provision for loan losses charged to expense. Loans are evaluated for
impairment when payments are delinquent 90 days or more, or when management
downgrades the loan classification to doubtful.
At December 31, 2002, the Company had $3,934,000 of impaired loans. The Company
had three commercial real estate loans to related borrowers totaling $3,016,000
that were put to non-accrual status in the third quarter of 2002. The Company
has begun the foreclosure process and is having new appraisals performed on the
properties. As of December 31, 2002, the Company had allocated $300,000 of the
allowance for loan losses to these impaired loans. Subsequently, in the first
quarter of 2003, the Company charged off the $300,000. A $1,426,000 multi-family
loan was classified as non-accrual in June 2002. The Company charged-off
$159,000 of this loan during the second quarter of 2002. A subsequent payment
was made on this loan, which now has a balance of $918,000. The average balance
of impaired loans during the year was $4,352,000. Interest income recognized on
impaired loans was not material in 2002.
The $661,000 other real estate owned is an undeveloped commercial property in
Chicago. The loan balance was $780,000 and the Company charged off $118,000 on
the loan during 2001. The property was sold in February 2003 and the Company
incurred $57,000 of expenses. The loss incurred on the sale was $27,000.
15
The table below sets forth the amounts and categories of non-performing assets
in the Company's loan portfolio. Loans are placed on non-accrual status when the
collection of principal and/or interest becomes doubtful.
December 31,
--------------------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
(Dollars in Thousands)
Non-accruing loans
One-to-four family $ 530 $ 668 $ 425 $766 $ 996
Commercial real estate loans 3,016 1,540 1,843 -- --
Multi-family loans 918 -- -- -- --
Construction loans -- 48 -- -- --
Commercial loans -- -- 29 -- --
Commercial leases -- -- -- -- --
Consumer 35 43 62 -- 25
------ ------ ------ ---- ------
Total 4,499 2,299 2,359 766 1,021
Accruing loans delinquent 90 days or more
One-to-four family -- 119 -- -- --
Commercial real estate loans -- -- 542 -- --
Multi-family loans -- -- -- -- --
Construction loans -- -- 2,300 -- --
Commercial loans 1,416 100 298 -- --
Commercial leases 14 21 -- -- --
Consumer 38 -- -- -- --
------ ------ ------ ---- ------
Total 1,468 240 3,140 -- --
------ ------ ------ ---- ------
Total non-performing loans 5,967 2,538 5,499 766 1,021
------ ------ ------ ---- ------
Other real estate owned 661 661 -- -- --
------ ------ ------ ---- ------
Total non-performing assets $6,628 $3,200 $5,499 $766 $1,021
====== ====== ====== ==== ======
Total non-performing loans
to net loans 1.12% 0.50% 1.10% 0.17% 0.25%
====== ====== ====== ==== ======
Total non-performing loans
as percentage of assets 0.98% 0.43% 0.94% 0.14% 0.19%
====== ====== ====== ==== ======
Total non-performing assets
as percentage of assets 1.09% 0.55% 0.94% 0.14% 0.19%
====== ====== ====== ==== ======
Management has considered the Company's non-performing loans in establishing its
allowance for loan losses.
As of December 31, 2002, there were no other loans that were not included in the
table or discussed above where known information about the possible credit
problems of borrowers caused management to have serious doubts as to the ability
of the borrower to comply with present loan repayment terms. As of March 27,
2003, loans delinquent 90 days or more and still accruing totaling $675,000 had
been made current.
16
ALLOWANCE FOR LOAN LOSSES
The Company recognizes that credit losses will be experienced and the risk of
loss will vary with, among other things, general economic conditions; the type
of loan being made; the creditworthiness of the borrower over the term of the
loan; and in the case of a collateralized loan, the quality of the collateral
for such loan. The allowance for loan losses represents the Company's estimate
of the allowance necessary to provide for probable incurred losses in the
portfolio. In making this determination, the Company analyzes the ultimate
collectibility of the loans in its portfolio, incorporating feedback provided by
internal loan staff, an independent loan review function, and information
provided by examinations performed by regulatory agencies. The Company makes an
ongoing evaluation as to the adequacy of the allowance for loan losses.
On a quarterly basis, management of the Bank meets to review the adequacy of the
allowance for loan losses. Each loan officer grades these individual commercial
credits and the Company's outsourced loan review function validates the
officers' grades. In the event that loan review downgrades the loan, it is
included in the allowance analysis at the lower grade. The grading system is in
compliance with the regulatory classifications and the allowance is allocated to
the loans based on the regulatory grading, except in instances where there are
known differences (i.e. collateral value is nominal, etc.).
The analysis of the allowance for loan losses is comprised of three components:
specific credit allocation, general portfolio allocation, and subjective
determined allocation. The specific credit allocation includes a detailed review
of the credit in accordance with SFAS 114 and 118 and an allocation is made
based on this analysis. The general portfolio allocation consists of an assigned
reserve percentage based on the credit rating of the loan. The subjective
portion is determined based on loan history and the Company's evaluation of
various factors including future economic and industry outlooks. In addition the
subjective portion of the allowance is influenced by current economic conditions
and trends in the portfolio including delinquencies and impairments, as well as
changes in the composition of the portfolio.
The allowance for loan losses is based on estimates, and ultimate losses will
vary from current estimates. These estimates are reviewed monthly, and as
adjustments, either positive or negative, become necessary, a corresponding
increase or decrease is made in the provision for loan losses. During 2002, the
loan portfolio continued its migration from a lower risk single family
residential loan portfolio to a higher risk commercial loan portfolio. There
have been substantial increases in the multi-family, commercial real estate and
commercial loan portfolios. The methodology used to determine the adequacy of
the allowance for loan losses is consistent with prior years.
17
The following table sets forth an analysis of the Company's allowance for loan
losses:
Year Ended December 31,
----------------------------------------------------------
2002 2001 2000 1999 1998
------ ------ ------ ------ ------
(Dollars in Thousands)
Balance at beginning of year $6,547 $5,655 $4,833 $4,312 $3,977
Charge-offs
One-to-four family 49 -- 26 107 38
Commercial real estate loans 240 404 -- -- --
Multi-family loans 159 45 -- -- --
Construction loans -- -- -- -- --
Commercial loans 19 29 7 399 --
Commercial leases -- -- -- -- --
Consumer 147 269 205 195 1,355
------ ------ ------ ------ ------
Total charge-offs 614 747 238 701 1,393
Recoveries
One-to-four family -- -- -- -- --
Commercial real estate loans -- -- -- -- --
Multi-family loans -- -- -- -- --
Construction loans -- -- -- -- --
Commercial loans 10 -- -- -- --
Commercial leases -- -- -- -- --
Consumer 43 37 50 90 161
------ ------ ------ ------ ------
Total Recoveries 53 37 50 90 161
------ ------ ------ ------ ------
Net charge-offs 561 710 188 611 1,232
------ ------ ------ ------ ------
Additions charged to operations 1,053 1,602 1,010 1,132 1,567
------ ------ ------ ------ ------
Balance at end of year $7,039 $6,547 $5,655 $4,833 $4,312
====== ====== ====== ====== ======
Ratio of net charge-offs during the
year to average loans outstanding
during the year 0.11% 0.14% 0.04% 0.15% 0.37%
====== ====== ====== ====== ======
Ratio of allowance to non-performing loans 1.18x 2.58x 1.03x 6.31x 4.22x
====== ====== ====== ====== ======
Because some loans may not be repaid in full, an allowance for loan losses is
recorded. Increases to the allowance are recorded by a provision for loan losses
charged to expense. Estimating the risk of the loss and the amount of loss on
any loan is necessarily subjective. Accordingly, the allowance is maintained by
management at a level considered adequate to cover probable incurred losses that
are currently anticipated based on past loss experience, general economic
conditions, information about specific borrower situations including their
financial position and collateral values, and other factors and estimates which
are subject to change over time. While management may periodically allocate
portions of the allowance for specific problem loan situations, the entire
allowance is available for any loan charge-offs that occur. A loan is charged
off against the allowance by management as a loss when deemed uncollectible,
although collection efforts continue and future recoveries may occur.
18
The distribution of the Company's allowance for loan losses at the dates
indicated is summarized as follows:
(Dollars in Thousands)
December 31,
------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Percent Percent Percent Percent Percent
of of of of of
Loans Loans Loans Loans Loans
Allow- in Each Allow- in Each Allow- in Each Allow- in Each Allow- in Each
ance Category ance Category ance Category ance Category ance Category
for to for to for to for to for to
Loan Total Loan Total Loan Total Loan Total Loan Total
Losses Loans Losses Loans Losses Loans Losses Loans Losses Loans
(1) (2) (3)
One-to-four family loans $ 167 10.24% $ 178 11.56% $ 364 23.98% $ 390 27.91% $ 387 37.94%
Commercial loans and
leases 1,165 10.53 1,180 9.42 1,064 8.38 738 8.41 412 10.64
Commercial real estate 1,692 15.61 1,588 15.41 1,586 15.70 1,472 15.77 1,335 16.43
Construction loans 1,088 10.07 1,326 11.44 966 9.57 924 9.90 811 9.98
Multi-family loans 2,512 46.55 1,886 43.19 1,065 32.09 878 27.03 807 13.70
Consumer loans 415 7.00 389 8.98 610 10.28 431 10.98 560 11.31
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total $7,039 100.00% $6,547 100.00% $5,655 100.00% $4,833 100.00% $4,312 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
Note:
(1) In 2002, the Company re-allocated $238,000 from the allowance on
construction loans to allowance for losses on multi-family loans.
Construction loans decreased $4.3 million in 2002.
(2) In 2001, the Company re-allocated $186,000 from the allowance on
one-to-four family loans to allowance for losses on commercial real estate
loans. The Company sold $54.5 million of its one-to-four family loans in
March 2001.
(3) In 1999, management re-allocated $220,000 from the allowance on consumer
loans and $203,000 from the allowance on one-to-four family loans to the
allowance for losses on commercial loans. During 1999, the Company
incurred $399,000 of losses on commercial loans.
(4) In 1998, management re-allocated $837,000 from the allowance on consumer
loans after the sale of the credit card portfolio in November 1998.
$551,000 of this amount was re-allocated to the allowance for losses on
commercial and commercial real estate loans and $286,000 was re-allocated
to the allowance for losses on one-to-four family loans.
Management regularly reviews its loan portfolio and charge-off experience to
maintain the allowance at a level management feels is adequate, although there
can be no assurance that actual losses will not exceed estimated amounts.
19
SECURITIES ACTIVITIES
The Company invests in high quality short- and medium-term securities, including
U.S. government and agency securities, municipal bonds and, to a lesser extent,
marketable equity securities.
The following table sets forth the composition of the Company's securities
portfolio at the dates indicated. All items in the table are included at fair
value.
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Fair % of Fair % of Fair % of
Value Total Value Total Value Total
-------- -------- -------- -------- -------- --------
(Dollars in Thousands)
U.S. government agency $ 33,040 67.20% $ 31,931 61.21% $ 30,459 53.26%
Marketable equity securities 2,389 4.86 2,258 4.33 1,476 2.58
Municipal bonds 6,060 12.32 6,708 12.86 9,302 16.27
FHLMC mortgage-backed
and related -- -- 3,948 7.57 6,767 11.83
FNMA mortgage-backed
and related -- -- -- -- 2,314 4.05
-------- -------- -------- -------- -------- --------
Subtotal 41,489 84.38 44,845 85.97 50,318 87.99
FHLB stock 7,212 14.67 6,850 13.13 6,397 11.19
FRB stock 469 0.95 469 0.90 469 0.82
-------- -------- -------- -------- -------- --------
Total securities
and stock $ 49,170 100.00% $ 52,164 100.00% $ 57,184 100.00%
======== ======== ======== ======== ======== ========
Average remaining life
of non-mortgage-backed
securities 2.34 years 2.29 years 2.58 years
The composition and contractual maturities of the securities portfolio at
December 31, 2002 excluding Federal Reserve Bank of Chicago stock, FHLB of
Chicago stock, and marketable equity securities, is indicated in the following
table.
Due In
------------------------------------------------------------
Less than 1 to 5 5 to 10 Over 10 Total
1 Year Years Years Years Securities
------ ---------- ---------- ---------- ----------
(Dollars in Thousands)
U.S. government agency $2,504 $ 30,536 $ -- $ -- $ 33,040
Municipal bonds 3,386 2,674 -- -- 6,060
------ ---------- ---------- ---------- ----------
Total securities $5,890 $ 33,210 $ -- $ -- $ 39,100
====== ========== ========== ========== ==========
Weighted average yield 4.42% 4.06% --% --% 4.11%
====== ========== ========== ========== ==========
Of the $33.0 million U.S. Government Agency investments at December 31, 2002,
$23.5 million had call features within 2 years from purchase. If called, the
average remaining life, including municipal bonds would be 0.76 years.
20
SOURCES OF FUNDS
GENERAL
Deposit accounts have traditionally been the principal source of the Company's
funds for use in lending and for other general business purposes. In addition to
deposits, the Company derives funds from borrowings, loan repayments, loan
participations, and cash flows generated from operations. Scheduled loan
payments are a relatively stable source of funds, while loan prepayments and
deposit flows are greatly influenced by general interest rates and competition.
The Company faces substantial competition in attracting deposits from other
savings institutions, commercial banks, securities firms, money market and
mutual funds, and credit unions. The ability of the Company to attract and
retain deposits depends on its ability to provide an investment opportunity that
satisfies the requirements of investors as to rate of return, liquidity, risk
and other factors. The Company competes for these deposits by offering a variety
of deposit accounts at competitive rates, convenient business hours and a
customer oriented staff.
The primary source of borrowings has been the FHLB of Chicago. The Company has
regularly used this as an alternative source of funding. At December 31, 2002,
the Company had outstanding borrowings of $62.2 million from the FHLB of
Chicago. The Company has also utilized credit lines with other financial
institutions for short term funding needs. Two additional non-deposit sources of
funds that the Company used during 2002 are the Treasury Tax and Loan Option
Account and the Retail Repurchase Agreement. The Treasury Tax and Loan Option
Account enables the U. S. Treasury to keep tax dollars with the Company at a
floating interest rate, and the Retail Repurchase Agreement allows customers to
lend the Company money which is secured by a security that the Bank owns.
DEPOSITS
The Company attracts both short-term and long-term deposits from the Company's
primary market area by offering a wide assortment of accounts and rates. The
Company offers checking accounts (both interest bearing and non-interest
bearing), High Yield money market accounts, savings accounts, fixed interest
rate certificates of deposits with varying maturities and individual retirement
accounts.
Deposit account terms vary, according to the minimum balance required, the time
period the funds must remain on deposit and the interest rate, among other
factors. In setting rates, the Company regularly evaluates: (i) its investment
and lending opportunities; (ii) its liquidity position; (iii) the rates offered
by competing institutions; and (iv) its internal costs of funds. In order to
decrease the volatility of its deposits, the Company imposes penalties on early
withdrawal on its certificates of deposit.
The Company believes that non-certificate accounts can provide relatively low
cost funds and accordingly, the Company introduces promotions to attract new
checking and money market accounts. The CoVest High Yield Account, a high-rate
money market account, was introduced in March 2000. It is a tiered account that
indexes its rate to the 91-day Treasury Bill auction. The High Yield Money
Market Account decreased by $28.5 million in 2002. The Company believes that the
decline was due to the decline in the 91-day Treasury Bill rate to which the
account is indexed. The Company also believes that the decrease in the High
Yield Money Market index rate caused savings deposits to increase, as the rate
remained at a fixed 2.50% until October 1, 2002. On October 1, 2002, the Company
implemented relationship pricing on savings accounts where savings accounts with
related checking accounts earn 2.25%, while non-relationship savings accounts
earn 1.50%. As of December 31, 2002, relationship savings amounts totaled $74.1
million. The floor set on the High Yield Money Market Account was 1.25% at
inception. On January 30, 2003, the floor rate was decreased to 1.00% to be in
line with the 91-day Treasury Bill rate to which the High Yield Money Market
Account is indexed.
The Company also offers services to make its checking accounts more desirable,
such as Telephone Banking and debit cards, both of which have been extensively
utilized by customers. In 1999, the Company introduced Gold Star Checking, a
high-rate checking account requiring a minimum balance of $3,500. It also
launched the Diamond Club, which requires a minimum deposit balance of $100,000,
a Gold Star checking account and a CoVest High Yield money market account, and
provides additional benefits and services to the customer. Focus continues on
these products and services.
21
In November 2000, the Company launched an Internet Banking and Bill Payment
solution for its retail customers and an Internet Cash Management solution for
its commercial customers. Over 1,200 Internet users were added in 2001 with an
additional 1,000 users in 2002, reaching a 16% penetration of the Bank's
depositor base and a 24% penetration of the Bank's checking account base. The
Bank also had success with Internet Bill Payment in 2002, achieving an18%
penetration of its overall Internet customer base.
Also adding to the convenience-driven services already utilized by CoVest
customers such as debit cards and Telephone Banking, during 2001 the Company
joined STARsf, an alliance of financial institutions that belong to the STAR
network that offer each other's customers surcharge-free ATM transactions.
CoVest customers can now use over 500 surcharge-free ATMs throughout
Chicagoland. In addition to joining STARsf, the Company also added a fourth ATM
in 2001 to its own ATM network, a drive-up machine located at the Company's Des
Plaines branch.
The Company continues to build its volume of non-interest and interest-bearing
checking accounts along with complementary deposit products and services such as
direct deposit and debit cards. The checking account is a core account of the
community bank. From the Company's perspective, it also helps improve
non-interest income and will help to improve the Company's net interest margin.
The Company offers promotions to attract new checking accounts and provides
additional services, such as Internet Banking and Telephone Banking; to make
these accounts more desirable in the marketplace.
Another service added to the Company's robust set of complementary deposit
products in 2001 was check imaging. Check imaging leverages technology to
provide laser-copied images of the checks that a customer writes in each account
cycle's monthly statement. CoVest customers can now choose either check
truncation, check imaging, or check return. The Company continues to use
technology to provide its customers with added convenience and flexibility.
In April 2001, the Company introduced a revised checking account product set
that included a new account, CoVest Foundation Checking. The account structure
of Foundation Checking allows the Company to do business with customers that may
not otherwise be able to obtain a checking account due to an imperfect credit
history or other financial woes. As a true community bank, it's important that
the Company offers a broad range of financial solutions designed to meet a wide
range of needs in a diverse marketplace.
The Company also introduced the CoVest Community Interest Checking Account in
April 2001. The Company donates $25 to a local charity of the customer's
choosing every time a Community Interest account is opened. As a result of the
Company's community orientation and success with this new account, over $2,500
was donated to six local charities, above and beyond the Company's standard
donations and contributions.
In December 2001, the Company unveiled a relationship pricing strategy for its
Home Equity portfolio. Recognizing the value of a complete customer
relationship, the Company discounts its competitive Home Equity rate 25 basis
points when a Home Equity customer opens one of six CoVest checking accounts
with direct deposit. Another 25 basis points discount can be obtained if the
customer chooses to open any other deposit account, including the CoVest High
Yield Account, a Savings account, or a Certificate of Deposit. A maximum
discount of 50 basis points will be awarded per customer, and the Company's Home
Equity rate will not go below 5.00%. This relationship pricing strategy supports
the Company's business plan of building non-interest and interest-bearing
checking account volume.
The Company also solicits deposits from outside its primary market area. As of
December 31, 2002, purchased money deposits totaled $66.9 million, up $21.1
million from December 31, 2001. The Company will continue to use this funding
source in 2003 to augment funding requirements and match liability maturities
when those funds cannot be raised from our local market.
22
The following table sets forth the deposit flows experienced by the Company
during the periods indicated:
Year Ended December 31,
-----------------------
(Dollars in Thousands)
2002 2001 2000
----------- ----------- -----------
Deposit balance at January 1 $ 456,002 $ 451,725 $ 398,055
Deposits 1,958,011 1,827,422 1,314,136
Withdrawals (1,949,891) (1,835,669) (1,282,156)
Interest credited 9,485 12,524 21,690
----------- ----------- -----------
Deposit balance at December 31 $ 473,607 $ 456,002 $ 451,725
=========== =========== ===========
Net increase/(decrease) $ 17,605 $ 4,277 $ 53,670
=========== =========== ===========
Percent increase/(decrease) 3.86% 0.95% 13.48%
=========== =========== ===========
The following table sets forth the dollar amount of deposits in the various
types of deposit programs offered by the Company for the periods indicated:
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
% of % of % of
Amount Total Amount Total Amount Total
-------- -------- -------- -------- -------- --------
(Dollars in Thousands)
Checking accounts $ 68,536 14.47% $ 60,332 13.23% $ 50,853 11.26%
High Yield money market 85,372 18.03 113,864 24.98 119,767 26.51
Saving accounts 94,885 20.03 52,141 11.43 42,906 9.50
-------- -------- -------- -------- -------- --------
Total non-certificates 248,793 52.53 226,337 49.64 213,526 47.27
Certificates of deposit
0.00 - 2.99% 110,026 23.23 68,338 14.99 10 --
3.00 - 3.99% 64,965 13.72 36,363 7.97 -- --
4.00 - 4.99% 21,504 4.54 40,224 8.82 4,704 1.05
5.00 - 5.99% 8,478 1.79 30,396 6.67 50,976 11.28
6.00 - 6.99% 19,336 4.08 50,043 10.97 169,793 37.59
7.00 - 7.99% 505 0.11 4,301 0.94 12,716 2.81
8.00 - 8.99% -- -- -- -- -- --
9.00 - 9.99% -- -- -- -- -- --
-------- -------- -------- -------- -------- --------
Total certificates 224,814 47.47 229,665 50.36 238,199 52.73
-------- -------- -------- -------- -------- --------
Total deposits $473,607 100.00% $456,002 100.00% $451,725 100.00%
======== ======== ======== ======== ======== ========
23
The following table shows rate and maturity information for the Company's
certificates of deposit as of December 31, 2002. The table below details the
scheduled maturities of certificates of deposit:
2003 2004 2005 2006 2007 Thereafter Total
---- ---- ---- ---- ---- ---------- -----
(In Thousands)
0.00 - 2.99% $ 103,040 $ 6,024 $ 689 $ 91 $ 182 $ -- $ 110,026
3.00 - 3.99% 38,230 19,617 2,033 4,872 213 -- 64,965
4.00 - 4.99% 5,056 6,561 5,145 2,978 1,628 136 21,504
5.00 - 5.99% 5,992 1,577 586 235 88 -- 8,478
6.00 - 6.99% 14,328 1,068 3,298 267 256 118 19,336
7.00 - 7.99% 505 -- -- -- -- -- 505
----------- --------- ---------- ---------- ---------- ---------- -----------
$ 167,151 $ 34,847 $ 11,751 $ 8,443 $ 2,367 $ 254 $ 224,814
=========== ========= ========== ========== ========== ========== ===========
The following table indicates the amount of the Company's certificates of
deposit by time remaining until maturity as of December 31, 2002:
Maturity
-----------------------------------------------
3 Months 3 to 6 6 to 12 Over 12
or Less Months Months Months Total
-------- ------ ------ ------ -----
(In Thousands)
Certificates of deposit less than $100,000 $ 32,873 $ 19,972 $ 36,861 $ 25,220 $ 114,926
Certificates of deposit of $100,000 or more(1) 29,028 17,250 31,168 32,442 109,888
---------- ---------- ---------- ---------- -----------
Total certificates of deposit $ 61,901 $ 37,222 $ 68,029 $ 57,662 $ 224,814
========== ========== ========== ========== ===========
(1) Includes "Jumbo" certificates of $1,880,000. "Jumbo" certificates are a
deposit product of over $100,000 that carry a rate and term negotiated between
the Bank and the depositor at the time of issuance. Not all certificates of
deposit with balances in excess of $100,000 are "Jumbo".
At December 31, 2002, the Company had $66.9 million of purchased money deposits
with staggered maturities ranging from one month to four years. Purchased money
deposits issued in 2002 had all inclusive rates ranging from 1.44% to 4.30%.
BORROWINGS
The Company's other available sources of funds include advances from the FHLB of
Chicago, daily advances under credit lines with other financial institutions and
collateralized borrowings. As a member of the FHLB of Chicago, the Company is
required to own stock in the FHLB of Chicago and is authorized to apply for
advances from the FHLB of Chicago. Each FHLB credit program has its own interest
rate, which may be fixed or variable, and a range of maturities. The FHLB of
Chicago may prescribe the acceptable uses for these advances, as well as
limitations on the size of the advances and repayment provisions. The Company
had $62.2 million of FHLB advances outstanding at December 31, 2002, secured by
residential mortgage loans, multi-family loans and various securities. The
maturities of FHLB advances outstanding ranged from one day to up to 10 years. A
$10.0 million advance taken in 1998 at 4.95%, has a maturity date of 2008 and
has a quarterly call feature that started on April 2001. This advance has yet to
be called. A $5.0 million advance taken in 2001 at 4.30%, has a maturity date of
2006 and is subject to a one-time call in July 2003. The Company had $3.2
million in FHLB overnight borrowing as of December 31, 2002. All FHLB term
advances have fixed rates.
24
The following table sets forth the maximum month-end balance, average balance,
and weighted average rates of borrowings for the periods indicated:
2002 2001 2000
------- ------- -------
(Dollars in Thousands)
Maximum month-end balances
FHLB advances $72,000 $71,000 $89,000
Securities sold under repurchase agreements 8,965 11,167 10,432
Other 26,888 12,652 24,461
Average balances
FHLB advances 63,195 52,882 66,344
Securities sold under repurchase agreements 6,605 8,433 8,071
Other 4,000 4,646 4,313
Weighted average rates at end of year
FHLB advances 3.89% 4.63% 6.27%
Securities sold under repurchase agreements 1.54 2.20 6.03
Other 1.09 2.10 6.44
25
SUPERVISION AND REGULATION
GENERAL
Financial institutions, their holding companies and their affiliates are
extensively regulated under federal and state law. As a result, the growth and
earnings performance of the Company may be affected not only by management
decisions and general economic conditions, but also by the requirements of
federal and state statutes and by the regulations and policies of various bank
regulatory authorities, including the Office of the Comptroller of the Currency
(the "OCC"), the Board of Governors of the Federal Reserve System (the "Federal
Reserve") and the Federal Deposit Insurance Corporation (the "FDIC").
Furthermore, taxation laws administered by the Internal Revenue Service and
state taxing authorities and securities laws administered by the Securities and
Exchange Commission (the "SEC") and state securities authorities have an impact
on the business of the Company. The effect of these statutes, regulations and
regulatory policies may be significant, and cannot be predicted with a high
degree of certainty.
Federal and state laws and regulations generally applicable to financial
institutions regulate, among other things, the scope of business, the kinds and
amounts of investments, reserve requirements, capital levels relative to
operations, the nature and amount of collateral for loans, the establishment of
branches, mergers and consolidations and the payment of dividends. This system
of supervision and regulation establishes a comprehensive framework for the
respective operations of the Company and its subsidiaries and is intended
primarily for the protection of the FDIC insured deposits and depositors of the
Bank, rather than shareholders.
The following is a summary of the material elements of the regulatory framework
that applies to the Company and its subsidiaries. It does not describe all of
the statutes, regulations and regulatory policies that apply, nor does it
restate all of the requirements of those statutes, regulations and regulatory
policies that are described. As such, the following is qualified in its entirety
by reference to applicable law. Any change in applicable statutes, regulations
or regulatory policies may have a material effect on the business of the Company
and its subsidiaries.
THE COMPANY
GENERAL
The Company, as the sole shareholder of the Bank, is a bank holding company. As
a bank holding company, the Company is registered with, and is subject to
regulation by, the Federal Reserve under the Bank Holding Company Act of 1956,
as amended (the "BHCA"). In accordance with Federal Reserve policy, the Company
is expected to act as a source of financial strength to the Bank and to commit
resources to support the Bank in circumstances where the Company might not
otherwise do so. Under the BHCA, the Company is subject to periodic examination
by the Federal Reserve. The Company is also required to file with the Federal
Reserve periodic reports of the Company's operations and such additional
information regarding the Company and its subsidiaries as the Federal Reserve
may require.
ACQUISITIONS, ACTIVITIES AND CHANGE IN CONTROL
The primary purpose of a bank holding company is to control and manage banks.
The BHCA generally requires the prior approval of the Federal Reserve for any
merger involving a bank holding company or any acquisition by a bank holding
company of another bank or bank holding company. Subject to certain conditions
(including deposit concentration limits established by the BHCA), the Federal
Reserve may allow a bank holding company to acquire banks located in any state
of the United States. In approving interstate acquisitions, the Federal Reserve
is required to give effect to applicable state law limitations on the aggregate
amount of deposits that may be held by the acquiring bank holding company and
its insured depository institution affiliates in the state in which the target
bank is located (provided that those limits do not discriminate against
out-of-state depository institutions or their holding companies) and state laws
that require that the target bank have been in existence for a minimum period of
time (not to exceed five years) before being acquired by an out-of-state bank
holding company.
The BHCA generally prohibits the Company from acquiring direct or indirect
ownership or control of more than 5% of the voting shares of any company that is
not a bank and from engaging in any business other than that of banking,
managing and controlling banks or furnishing services to banks and their
subsidiaries. This general prohibition is subject to a number of exceptions. The
principal exception allows bank holding companies to engage in, and to own
shares of companies engaged in, certain businesses found by the Federal Reserve
to be "so closely related to banking ...
26
as to be a proper incident thereto." This authority would permit the Company to
engage in a variety of banking-related businesses, including the operation of a
thrift, consumer finance, equipment leasing, the operation of a computer service
bureau (including software development), and mortgage banking and brokerage. The
BHCA generally does not place territorial restrictions on the domestic
activities of non-bank subsidiaries of bank holding companies.
Additionally, bank holding companies that meet certain eligibility requirements
prescribed by the BHCA and elect to operate as financial holding companies may
engage in, or own shares in companies engaged in, a wider range of nonbanking
activities, including securities and insurance underwriting and sales, merchant
banking and any other activity that the Federal Reserve, in consultation with
the Secretary of the Treasury, determines by regulation or order is financial in
nature, incidental to any such financial activity or complementary to any such
financial activity and does not pose a substantial risk to the safety or
soundness of depository institutions or the financial system generally. As of
the date of this filing, the Company has neither applied for nor received
approval to operate as a financial holding company.
Federal law also prohibits any person or company from acquiring "control" of an
FDIC-insured depository institution or its holding company without prior notice
to the appropriate federal bank regulator. "Control" is conclusively presumed to
exist upon the acquisition of 25% or more of the outstanding voting securities
of a bank or bank holding company, but may arise under certain circumstances at
10% ownership.
CAPITAL REQUIREMENTS
Bank holding companies are required to maintain minimum levels of capital in
accordance with Federal Reserve capital adequacy guidelines. If capital levels
fall below the minimum required levels, a bank holding company, among other
things, may be denied approval to acquire or establish additional banks or
non-bank businesses.
The Federal Reserve's capital guidelines establish the following minimum
regulatory capital requirements for bank holding companies: (i) a risk-based
requirement expressed as a percentage of total assets weighted according to
risk; and (ii) a leverage requirement expressed as a percentage of total assets.
The risk-based requirement consists of a minimum ratio of total capital to total
risk-weighted assets of 8%, and a minimum ratio of Tier 1 capital to total
risk-weighted assets of 4%. The leverage requirement consists of a minimum ratio
of Tier 1 capital to total assets of 3% for the most highly rated companies,
with a minimum requirement of 4% for all others. For purposes of these capital
standards, Tier 1 capital consists primarily of permanent stockholders' equity
less intangible assets (other than certain loan servicing rights and purchased
credit card relationships). Total capital consists primarily of Tier 1 capital
plus certain other debt and equity instruments that do not qualify as Tier 1
capital and a portion of the company's allowance for loan and lease losses.
The risk-based and leverage standards described above are minimum requirements.
Higher capital levels will be required if warranted by the particular
circumstances or risk profiles of individual banking organizations. For example,
the Federal Reserve's capital guidelines contemplate that additional capital may
be required to take adequate account of, among other things, interest rate risk,
or the risks posed by concentrations of credit, nontraditional activities or
securities trading activities. Further, any banking organization experiencing or
anticipating significant growth would be expected to maintain capital ratios,
including tangible capital positions (i.e., Tier 1 capital less all intangible
assets), well above the minimum levels. As of December 31, 2002, the Company had
regulatory capital in excess of the Federal Reserve's minimum requirements.
DIVIDEND PAYMENTS
The Company's ability to pay dividends to its shareholders may be affected by
both general corporate law considerations and policies of the Federal Reserve
applicable to bank holding companies. As a Delaware corporation, the Company is
subject to the limitations of the Delaware General Corporation Law (the "DGCL").
The DGCL allows the Company to pay dividends only out of its surplus (as defined
and computed in accordance with the provisions of the DGCL) or if the Company
has no such surplus, out of its net profits for the fiscal year in which the
dividend is declared and/or the preceding fiscal year. Additionally, policies of
the Federal Reserve caution that a bank holding company should not pay cash
dividends that exceed its net income or that can only be funded in ways that
weaken the bank holding company's financial health, such as by borrowing. The
Federal Reserve also possesses enforcement powers over bank holding companies
and their non-bank subsidiaries to prevent or remedy actions that
27
represent unsafe or unsound practices or violations of applicable statutes and
regulations. Among these powers is the ability to proscribe the payment of
dividends by banks and bank holding companies.
FEDERAL SECURITIES REGULATION
The Company's common stock is registered with the SEC under the Securities Act
of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). Consequently, the Company is subject to the information, proxy
solicitation, insider trading and other restrictions and requirements of the SEC
under the Exchange Act.
THE BANK
GENERAL
The Bank is a national bank, chartered by the OCC under the National Bank Act.
The deposit accounts of the Bank are insured by the FDIC's Savings Association
Insurance Fund ("SAIF"), and the Bank is a member of the Federal Reserve System
and the Federal Home Loan Bank System. As a national bank, the Bank is subject
to the examination, supervision, reporting and enforcement requirements of the
OCC, the chartering authority for national banks. The FDIC, as administrator of
the SAIF, also has regulatory authority over the Bank.
DEPOSIT INSURANCE
As a FDIC-insured institution, the Bank is required to pay deposit insurance
premium assessments to the FDIC. The FDIC has adopted a risk-based assessment
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their respective
levels of capital and results of supervisory evaluations. Institutions
classified as well-capitalized (as defined by the FDIC) and considered healthy
pay the lowest premium while institutions that are less than adequately
capitalized (as defined by the FDIC) and considered of substantial supervisory
concern pay the highest premium. Risk classification of all insured institutions
is made by the FDIC for each semi-annual assessment period.
During the year ended December 31, 2002, SAIF assessments ranged from 0% of
deposits to 0.27% of deposits. For the semi-annual assessment period beginning
January 1, 2003, SAIF assessment rates will continue to range from 0% of
deposits to 0.27% of deposits.
FICO ASSESSMENTS
Since 1987, a portion of the deposit insurance assessments paid by SAIF members
has been used to cover interest payments due on the outstanding obligations of
the Financing Corporation ("FICO"). FICO was created in 1987 to finance the
recapitalization of the Federal Savings and Loan Insurance Corporation, the
SAIF's predecessor insurance fund. As a result of federal legislation enacted in
1996, beginning as of January 1, 1997, both SAIF members and members of the
FDIC's Bank Insurance Fund ("BIF") became subject to assessments to cover the
interest payments on outstanding FICO obligations until the final maturity of
such obligations in 2019. These FICO assessments are in addition to amounts
assessed by the FDIC for deposit insurance. During the year ended December 31,
2002, the FICO assessment rate for BIF and SAIF members was approximately 0.02%
of deposits.
SUPERVISORY ASSESSMENTS
National banks are required to pay supervisory assessments to the OCC to fund
the operations of the OCC. The amount of the assessment is calculated using a
formula that takes into account the bank's size and its supervisory condition
(as determined by the composite rating assigned to the bank as a result of its
most recent OCC examination). During the year ended December 31, 2002, the Bank
paid supervisory assessments to the OCC totaling $135,861.
CAPITAL REQUIREMENTS
Banks are generally required to maintain capital levels in excess of other
businesses. The OCC has established the following minimum capital standards for
national banks, such as the Bank: (i) a leverage requirement consisting of a
minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated
banks with a minimum requirement of at least 4% for all others; and (ii) a
risk-based capital requirement consisting of a minimum ratio of total capital to
total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total
risk-weighted assets of 4%. For purposes of these capital standards, the
components of Tier 1 capital and total capital are the same as those for bank
holding companies discussed above.
28
The capital requirements described above are minimum requirements. Higher
capital levels will be required if warranted by the particular circumstances or
risk profiles of individual institutions. For example, regulations of the OCC
provide that additional capital may be required to take adequate account of,
among other things, interest rate risk or the risks posed by concentrations of
credit, nontraditional activities or securities trading activities.
Further, federal law and regulations provide various incentives for financial
institutions to maintain regulatory capital at levels in excess of minimum
regulatory requirements. For example, a financial institution that is
"well-capitalized" may qualify for exemptions from prior notice or application
requirements otherwise applicable to certain types of activities and may qualify
for expedited processing of other required notices or applications.
Additionally, one of the criteria that determines a bank holding company's
eligibility to operate as a financial holding company is a requirement that all
of its financial institution subsidiaries be "well-capitalized." Under the
regulations of the OCC, in order to be "well-capitalized" a financial
institution must maintain a ratio of total capital to total risk-weighted assets
of 10% or greater, a ratio of Tier 1 capital to total risk-weighted assets of 6%
or greater and a ratio of Tier 1 capital to total assets of 5% or greater.
Federal law also provides the federal banking regulators with broad power to
take prompt corrective action to resolve the problems of undercapitalized
institutions. The extent of the regulators' powers depends on whether the
institution in question is "adequately capitalized," "undercapitalized,"
"significantly undercapitalized" or "critically undercapitalized," in each case
as defined by regulation. Depending upon the capital category to which an
institution is assigned, the regulators' corrective powers include: (i)
requiring the institution to submit a capital restoration plan; (ii) limiting
the institution's asset growth and restricting its activities; (iii) requiring
the institution to issue additional capital stock (including additional voting
stock) or to be acquired; (iv) restricting transactions between the institution
and its affiliates; (v) restricting the interest rate the institution may pay on
deposits; (vi) ordering a new election of directors of the institution; (vii)
requiring that senior executive officers or directors be dismissed; (viii)
prohibiting the institution from accepting deposits from correspondent banks;
(ix) requiring the institution to divest certain subsidiaries; (x) prohibiting
the payment of principal or interest on subordinated debt; and (xi) ultimately,
appointing a receiver for the institution.
As of December 31, 2002: (i) the Bank was not subject to a directive from the
OCC to increase its capital to an amount in excess of the minimum regulatory
capital requirements; (ii) the Bank exceeded its minimum regulatory capital
requirements under OCC capital adequacy guidelines; and (iii) the Bank was
"well-capitalized," as defined by OCC regulations.
DIVIDENDS
The primary source of funds for the Company is dividends from the Bank. Under
the National Bank Act, a national bank may pay dividends out of its undivided
profits in such amounts and at such times as the bank's board of directors deems
prudent. Without prior OCC approval, however, a national bank may not pay
dividends in any calendar year that, in the aggregate, exceed the bank's
year-to-date net income plus the bank's retained net income for the two
preceding years.
The payment of dividends by any financial institution is affected by the
requirement to maintain adequate capital pursuant to applicable capital adequacy
guidelines and regulations, and a financial institution generally is prohibited
from paying any dividends if, following payment thereof, the institution would
be undercapitalized. As described above, the Bank exceeded its minimum capital
requirements under applicable guidelines as of December 31, 2002. Further, the
Bank may not pay dividends in an amount that would reduce its capital below the
amount required for the liquidation account established by the Bank in
connection with its conversion from the mutual to the stock form of ownership in
1992. As of December 31, 2002, approximately $395,000 was available to be paid
as dividends by the Bank. Notwithstanding the availability of funds for
dividends, however, the OCC may prohibit the payment of any dividends by the
Bank if the OCC determines such payment would constitute an unsafe or unsound
practice.
INSIDER TRANSACTIONS
The Bank is subject to certain restrictions imposed by federal law on extensions
of credit to the Company, on investments in the stock or other securities of the
Company and the acceptance of the stock or other securities of the Company as
collateral for loans made by the Bank. Certain limitations an