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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED: DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No.: 0-24611
CFS BANCORP, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 33-2042093
- ------------------------------------- ----------------------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
707 Ridge Road
Munster, Indiana 46321
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(Address of Principal (Zip Code)
Executive Offices)
Registrant's telephone number, including area code: (219) 836-9990
Securities registered pursuant to Section 12(b) of the Act:
Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Common Stock (par value $0.01 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 12 months
(or for such shorter period that the Registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 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 Exchange Act Rule 12b-2). YES [X] NO [ ]
As of June 30, 2002, the aggregate value of the 12,472,591 shares of
Common Stock of the Registrant outstanding on such date, which excludes 784,757
shares held by all directors and executive officers of the Registrant as a
group, was approximately $192.8 million. This figure is based on the last known
trade price of $15.46 per share of the Registrant's Common Stock on June 30,
2002.
Number of shares of Common Stock outstanding as of March 7, 2003: 12,289,297
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents incorporated by reference and
the Part of the Form 10-K into which the document is incorporated:
(1) Portions of the Company's Annual Report to Stockholders for the year
ended December 31, 2002 (the "2002 Annual Report") are incorporated into Parts
II and IV.
(2) Portions of the definitive proxy statement for the Annual Meeting of
Stockholders to be held on April 29, 2003 are incorporated into Part III.
2
When used in this Annual Report on Form 10-K or future filings by the
Company with the Securities and Exchange Commission ("SEC"), in the Company's
press releases or other public or stockholder communications, the words or
phrases "would be," "will allow," "intends to," "will likely result," "are
expected to," "will continue," "is anticipated," "estimate," "project," or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Litigation Reform Act of 1995.
The Company wishes to caution readers not to place undue reliance on
any such forward-looking statements, which speak only as of the date made, and
to advise readers that various factors, including regional and national economic
conditions, changes in levels of market interest rates, credit and other risks
which are inherent in the Company's lending and investment activities,
legislative changes, changes in the cost of funds, demand for loan products and
financial services, changes in accounting principles and competitive and
regulatory factors, could affect the Company's financial performance and could
cause the Company's actual results for future periods to differ materially from
those anticipated or projected. Such forward-looking statements are not
guarantees of future performance. The Company does not undertake, and
specifically disclaims any obligation, to update any forward-looking statements
to reflect occurrences or unanticipated events or circumstances after the date
of such statements.
PART I.
ITEM 1. BUSINESS
GENERAL
CFS Bancorp, Inc. (the "Company") was organized in March 1998 at the
direction of the Board of Directors of Citizens Financial Services, FSB (the
"Bank" or "Citizens Financial") for the purpose of holding all of the capital
stock of the Bank and in order to facilitate the conversion of the Bank from a
federally-chartered mutual savings bank to a federally-chartered stock savings
bank (the "Conversion"). (Unless the context otherwise requires, reference to
the Company includes the Bank and the Bank's subsidiaries). In connection with
the Conversion, the Office of Thrift Supervision (the "OTS") approved the
Company's application to become a savings and loan holding company. The Company
now conducts business as a registered unitary savings and loan holding company
and is subject to oversight and examination by the OTS. See "Regulation -
Regulation of Savings and Loan Holding Companies."
Immediately after the Conversion, on July 24, 1998, SuburbFed Financial
Corp., a Delaware corporation with its principal place of business in Illinois
("SFC"), merged with and into the Company (the "Merger"). In connection with the
Merger, each outstanding share of SFC common stock, par value $0.01 per share,
was converted into the right to receive 3.6 shares of the Company's Common
Stock. The Conversion and the Merger were interdependent transactions. The
Merger was accounted for on a pooling-of-interests basis and, as such, all
financial data in this report includes the assets and the liabilities of the
Company and SFC and their subsidiaries on a combined basis.
The Company's assets consist of the outstanding shares of common stock
of the Bank, investments made with the portion of the net proceeds from the sale
of Company shares in the
3
Company's July 1998 initial public offering (which was undertaken in conjunction
with the Conversion) (the "Offering") retained by the Company, and the Company's
loan to the Bank for the employee stock ownership plan (the "ESOP"). The Company
has no significant liabilities. The management of the Company and the Bank are
substantially identical, and the Company neither owns nor leases any property
but instead uses the premises, equipment and furniture of the Bank. The Company
does not employ any persons other than officers who are also officers of the
Bank. In addition the Company utilizes the support staff of the Bank from time
to time. Additional employees may be hired as appropriate to the extent the
Company expands or changes its business in the future.
Management believes that the holding company structure provides the
Company and the Bank with additional flexibility to diversify its business
activities through existing or newly-formed subsidiaries, or through
acquisitions of other entities, including potentially other financial
institutions and financial services-related companies. Such expansion is subject
to regulatory limitations and the Company's financial position. The activities
of the Company have been funded by the portion of the net proceeds of the
Offering which was retained by the Company and earnings thereon, as well as
dividends from the Bank.
The Bank is subject to examination and comprehensive regulation by the
OTS, which is the Bank's chartering authority and primary federal regulator. The
Bank is also regulated by the Federal Deposit Insurance Corporation (the
"FDIC"), administrator of the Savings Association Insurance Fund (the "SAIF").
The Bank is also subject to certain reserve requirements established by the
Board of Governors of the Federal Reserve System (the "FRB") and is a member of
the Federal Home Loan Bank (the "FHLB") of Indianapolis, which is one of the 12
regional banks comprising the FHLB System.
Citizens Financial is a federally-chartered stock savings bank that was
originally organized in 1934. The Bank conducts its business from its executive
offices in Munster, Indiana, as well as 23 banking centers located in Lake and
Porter Counties in northwest Indiana and Cook, DuPage and Will Counties in
Illinois. At December 31, 2002, the Company had $1.6 billion in total assets,
$954.2 million in deposits, $449.4 million in borrowed funds and $160.7 million
of stockholders' equity. The Bank is primarily engaged in attracting deposits
from the general public and using those funds to originate loans and invest in
securities. During 1998 the Bank began leveraging its capital base, using
borrowings to provide additional funds to support its lending and investing
activities. Historically, the Bank's primary lending emphasis was on loans
secured by the first liens on single-family (one-to four-units) residential
properties located in northwest Indiana and southeastern Cook County, Illinois.
However, the Bank decided not to participate aggressively in the substantial
refinancing of home loans that occurred nationally in 2001 and 2002 due to
record low interest rates. Instead the Banks' strategy was to accumulate
liquidity in order to take advantage of loans and other investments that would
become available as the economy improved and interest rates rose to expected
higher levels.
The Bank also originated construction and land development loans,
multi-family residential real estate loans, commercial real estate and other
commercial loans, home equity loans and other loans. Since 1998, the Bank has
shifted its lending emphasis, increasing its involvement in construction and
land development loans, commercial loans and commercial and multi-family real
estate loans while concurrently reducing its originations of single-family
residential loans.
4
AVAILABLE INFORMATION
CFS Bancorp, Inc. is a public company and files annual, quarterly and
special reports, proxy statements and other information with the Securities and
Exchange Commission. The Company's filings are available to the public at the
SEC's web site at http://www.sec.gov. Members of the public may also read and
copy any document the Company files at the SEC's Public Reference Room at 450
Fifth Street, N.W., Washington, D.C. 20549. You can request copies of these
documents by writing to the SEC and paying a fee for the copying cost. Please
call the SEC at 1-800-SEC-0330 for more information about the operation of the
public reference room. In addition, the Company's stock is listed for trading on
the Nasdaq National Market and trades under the symbol "CITZ." You may find
additional information regarding the Company at www.nasdaq.com. In addition to
the foregoing, the Company maintains a web site at www.bankcfs.com. The Company
makes available on its Internet web site copies of its Annual Reports on Form
10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any
amendments to such documents as soon as reasonably practicable after we file
such material with or furnish such documents to the SEC.
MARKET AREA AND COMPETITION
Citizens Financial operates out of its headquarters in Munster,
Indiana, which is located in Lake County in northwest Indiana. Citizens
Financial also maintains 23 banking centers in Lake and Porter Counties in
northwest Indiana and in Cook, DuPage and Will Counties in Illinois. The areas
served by Citizens Financial are part of the Chicago Metropolitan Statistical
Area.
Citizens Financial has historically concentrated its efforts in the
market surrounding its offices. Citizens Financial's market area reflects
diverse socioeconomic factors. Traditionally, the market area in northwest
Indiana and the suburban areas south of Chicago were dependent on heavy
manufacturing. While manufacturing still is an important component of the local
economies, service-related industries have become increasingly significant to
the region in the last decade. Growth in the local economies can be expected to
occur largely as a result of the continued interrelation with Chicago as well as
suburban business centers in the area.
The Bank faces significant competition both in making loans and in
attracting deposits. The Chicago metropolitan area is one of the largest money
centers in the United States, and the market for deposit funds is highly
competitive. The Bank's competition for loans comes principally from commercial
banks, other savings banks, savings associations and mortgage-banking companies.
The Bank's most direct competition for deposits has historically come from
savings banks, commercial banks and credit unions. The Bank faces additional
competition for deposits from short-term money market funds, other corporate and
government securities funds and from other non-depository financial institutions
such as brokerage firms and insurance companies.
LENDING ACTIVITIES
GENERAL. At December 31, 2002, the Company's net loans amounted to
$930.3 million, or 58.7% of the Company's total assets, at such date. In
addition to loans secured by single-family residential real estate, the Bank's
mortgage loan portfolio at December 31, 2002 includes loans secured by
multi-family (over four units) residential properties, which amounted to an
aggregate of
5
$71.2 million, or 7.3% of the total loan portfolio, construction and land
development loans, which totaled $165.0 million, or 16.8% of the total loan
portfolio, loans secured by commercial real estate, which amounted to $271.4
million, or 27.7% of the loan portfolio, and home equity loans, which totaled
$45.1 million, or 4.6% of the total loan portfolio. In addition to mortgage
loans, the Bank originates various other loans which, at December 31, 2002,
amounted to an aggregate of $42.6 million, or 4.4% of the total loan portfolio.
Included in this total were $40.0 million of commercial loans and $2.6 million
of consumer loans at December 31, 2002.
The types of loans that the Bank may originate are subject to federal
and state laws and regulations. Interest rates charged by the Bank on loans are
affected principally by the demand for such loans, the supply of money available
for lending purposes, the rates offered by its competitors and the risks
involved on such loans. These factors are, in turn, affected by general and
economic conditions, the monetary policy of the federal government, including
the Federal Reserve Board, legislative tax policies and governmental budgetary
matters.
6
LOAN PORTFOLIO COMPOSITION. The following table sets forth the
composition of the Bank's loans at the dates indicated.
December 31,
------------------------------------------------------------------------------
2002 2001 2000
------------------------------------------------------------------------------
Percent of Percent of Percent of
Amount Total Amount Total Amount Total
------------------------------------------------------------------------------
(Dollars in Thousands)
Mortgage loans:
Single-family residential $ 386,050 39.34% $ 535,197 58.38% $ 700,790 66.62%
Multi-family residential 71,170 7.25 51,635 5.63 41,903 3.98
Commercial real estate 271,426 27.66 142,663 15.56 124,477 11.83
Construction and land
development:
Single-family residential 12,118 1.23 17,208 1.88 29,889 2.84
Multi-family residential 63,893 6.51 26,443 2.88 43,689 4.16
Commercial and land
development 88,951 9.06 76,168 8.31 70,486 6.70
Home equity 45,106 4.60 41,416 4.52 20,534 1.95
---------------------------------------------------------------------------
Total mortgage loans 938,714 95.65 890,730 97.16 1,031,768 98.08
Other loans:
Commercial, non-real estate 40,034 4.08 23,996 2.62 17,503 1.66
Consumer 2,610 .27 2,066 .22 2,727 .26
---------------------------------------------------------------------------
Total loans receivable 981,358 100.00% 916,792 100.00% 1,051,998 100.00%
====== ====== ======
Less:
Undisbursed portion of loan
proceeds 39,704 24,454 45,022
Allowance for losses on loans 8,674 7,662 7,187
Net deferred yield adjustments 2,632 1,324 1,062
---------- ---------- ----------
Loans receivable, net $ 930,348 $ 883,352 $ 998,727
========== ========== ==========
December 31,
----------------------------------------------------
1999 1998
----------------------------------------------------
Percent of Percent of
Amount Total Amount Total
----------------------------------------------------
(Dollars in Thousands)
Mortgage loans:
Single-family residential $ 669,280 69.46% $ 596,199 80.08%
Multi-family residential 33,840 3.51 21,050 2.83
Commercial real estate 93,320 9.68 38,999 5.24
Construction and land
development:
Single-family residential 39,045 4.05 31,516 4.23
Multi-family residential 36,843 3.82 - -
Commercial and land
development 57,417 5.96 19,645 2.64
Home equity 16,001 1.66 19,589 2.63
-------------------------------------------------
Total mortgage loans 945,746 98.14 726,998 97.65
Other loans:
Commercial, non-real estate 13,646 1.42 11,072 1.49
Consumer 4,215 .44 6,431 .86
-------------------------------------------------
Total loans receivable 963,607 100.00% 744,501 100.00%
====== ======
Less:
Undisbursed portion of loan
proceeds 73,086 13,068
Allowance for losses on loans 5,973 5,357
Net deferred yield adjustments 1,872 (5)
---------- ----------
Loans receivable, net $ 882,676 $ 726,081
========== ==========
7
CONTRACTUAL PRINCIPAL REPAYMENTS AND INTEREST RATES. The following
table sets forth scheduled contractual amortization of the Bank's loans at
December 31, 2002, as well as the dollar amount of such loans which are
scheduled to mature after one year which have fixed or adjustable interest
rates. Demand loans, loans having no schedule of repayments and no stated
maturity, and overdraft loans are reported as due in one year or less.
Principal Repayments Contractually Due
In Year(s) Ended December 31,
-----------------------------------------
Total at
December 31,
2002 2003 2004-2007 Thereafter
-----------------------------------------------------------
(In Thousands)
Mortgage loans:
Single-family residential $386,050 $ 2,315 $ 14,939 $368,796
Multi-family residential 71,170 1,420 30,393 39,357
Commercial real estate 271,426 6,826 64,835 199,765
Construction and land
development 164,962 61,541 72,198 31,223
Home equity 45,106 3,111 7,287 34,708
Other loans:
Commercial 40,034 26,396 6,926 6,712
Consumer 2,610 843 1,608 159
-----------------------------------------------------------
Total (1) $981,358 $102,452 $198,186 $680,720
==========================================================
- ----------
(1) Of the $878.9 million of loan principal repayments contractually due
after December 31, 2003, $281.8 million have fixed rates of interest,
and $597.1 million have adjustable rates of interest.
Scheduled contractual amortization of loans does not reflect the
expected term of the Bank's loan portfolio. The average life of loans is
substantially less than their contractual terms because of prepayments and
due-on-sale clauses, which give the Bank the right to declare a conventional
loan immediately due and payable in the event, among other things, that the
borrower sells the real property subject to the mortgage and the loan is not
repaid. The average life of mortgage loans tends to increase when current market
rates of interest for mortgage loans are higher than rates on existing mortgage
loans and, conversely, decrease when rates on existing mortgage loans are higher
than current market rates as borrowers refinance adjustable-rate and fixed-rate
loans at lower rates. Under the latter circumstance, the weighted average yield
on loans decreases as higher yielding loans are repaid or refinanced at lower
rates.
8
ACTIVITY IN LOANS. The following table shows the activity in the Bank's
loans during the years indicated.
Year Ended December 31,
--------------------------------------------------------------
2002 2001 2001 1999
--------------------------------------------------------------
(In Thousands)
Gross loans held at beginning of year $ 916,792 $ 1,051,998 $ 963,607 $ 744,501
Originations of loans:
Mortgage loans:
Single-family residential 41,007 23,541 85,871 164,302
Multi-family residential 22,588 2,477 6,165 13,910
Commercial real estate 136,994 23,191 31,035 52,596
Construction and land development:
Single-family residential 10,337 12,893 37,832 47,197
Multi-family residential 41,339 6,629 15,166 37,874
Commercial and land development 46,450 43,482 38,465 57,788
Home equity 42,331 30,689 19,078 13,163
Other loans:
Commercial 76,137 14,831 17,883 21,009
Consumer 2,947 1,328 825 3,715
--------------------------------------------------------------
Total originations 420,130 159,061 252,320 411,554
--------------------------------------------------------------
Purchases of participating interests in loans:
Single-family residential 2,515 12,920 13 24
Multi-family residential 7,840 -- -- --
Commercial real estate 46,861 1,108 -- --
Commercial 8,709 15,000 -- --
--------------------------------------------------------------
Total purchases 65,925 29,028 13 24
--------------------------------------------------------------
Total originations and purchases 486,055 188,089 252,333 411,578
--------------------------------------------------------------
Single-family residential loans sold (22,014) (5,873) (1,335) (8,628)
Multi-family residential loans sold (900) -- -- --
Transfers to real estate owned (2,382) (1,875) (1,721) (1,112)
Charge-offs (1,183) (855) (2,279) (171)
Repayments (395,010) (314,692) (158,607) (182,561)
--------------------------------------------------------------
Net activity in loans 64,567 (135,206) 88,391 219,106
--------------------------------------------------------------
Gross loans held at end of year $ 981,358 $ 916,792 $ 1,051,998 $ 963,607
==============================================================
The lending activities of Citizens Financial are subject to the credit
policy approved by the Bank's Board of Directors. Applications for mortgage and
consumer loans are taken at all of the Bank's branch offices, while commercial
loan officers take loan applications at both the Bank's offices and the
customers' offices. In addition, the Bank's business development officers call
on individuals and businesses in the Bank's market area in their efforts to
solicit new loan
9
originations as well as other banking relationships. All loan applications are
forwarded to the Bank's credit administration offices for underwriting and
analysis. The Bank requires that a property appraisal or evaluation be obtained
in connection with all new real estate mortgage loans. Citizens Financial
requires that title insurance and hazard insurance be maintained on all security
properties (except for home equity loans) and that adequate flood insurance be
maintained if the property is within a designated flood plain.
Certain officers of the Bank have been authorized by the Board of
Directors to approve loans up to certain designated amounts. The Asset/Liability
Management Committee of Citizens Financial meets weekly and reviews all loans
that exceed individual loan authority. The full Board of Directors of Citizens
Financial is provided with a monthly report of all loans made in the period.
A federal savings bank generally may not make loans to one borrower and
related entities in an amount which exceeds 15% of its unimpaired capital and
surplus (or approximately $19.8 million in the case of the Bank at December 31,
2002), although loans in an amount equal to an additional 10% of unimpaired
capital and surplus may be made to a borrower if the loans are fully secured by
readily marketable securities. Generally, Citizens Financial's aggregate loans
to one borrower and related entities have been well below the regulatory limits.
As of December 31, 2002, Citizens Financial's two largest relationships with one
borrower and related entities amounted to $24.2 million and $19.9 million, and
all of the Bank's loans included in such relationships were performing in
accordance with their terms. Both relationships were originated when the Bank's
loans to one borrower limitation was greater than the current level of $19.8
million. The Bank currently has a general policy of limiting any one loan or
multiple loans to the same borrower to 75% of the legal limit.
SINGLE-FAMILY RESIDENTIAL AND HOME EQUITY LOANS. Substantially all of
the Bank's single-family residential mortgage loans consist of conventional
loans. Conventional loans are loans that are neither insured by the Federal
Housing Administration ("FHA") nor partially guaranteed by the Department of
Veterans Affairs ("VA"). The vast majority of the Bank's single-family
residential mortgage loans are secured by properties located in northwest
Indiana and DuPage, Will and Cook Counties, Illinois. Historically, the Bank
retained virtually all mortgage loans which it originated and did not engage in
sales of residential mortgage loans. Beginning July 1, 1999, the Bank instituted
a new policy and began selling its newly originated fixed-rate loans; such sales
amounted to $22.0 million in 2002 and included the release of servicing. As of
December 31, 2002, $386.1 million, or 39.3%, of the Bank's total loans consisted
of single-family residential mortgage loans. Citizens Financial originated $41.0
million, $23.5 million and $85.9 million of single-family residential mortgage
loans in 2002, 2001 and 2000, respectively. Although the Bank will continue to
originate single-family residential mortgage loans, it anticipates construction
and land development, commercial and commercial real estate and multi-family
real estate loans will continue to increase as a percentage of total new loan
originations as the Bank continues to implement its strategic plan.
Citizens Financial's residential mortgage loans have either fixed rates
of interest or interest rates which adjust periodically during the term of the
loan. Fixed-rate loans generally have maturities of 10, 15 or 30 years and are
fully amortizing with monthly loan payments
10
sufficient to repay the total amount of the loan with interest by the end of the
loan term. The Bank's fixed-rate loans are generally originated under terms,
conditions and documentation which permit them to be sold to U.S.
Government-sponsored agencies ("GSE's"), such as the Federal National Mortgage
Association ("Fannie Mae"), and other investors in the secondary market for
mortgages. At December 31, 2002, $97.4 million, or 25.3% of the Bank's
single-family residential mortgage loans, were fixed-rate loans. Substantially
all of the Bank's single-family residential mortgage loans contain due-on-sale
clauses, which permit the Bank to declare the unpaid balance to be due and
payable upon the sale or transfer of any interest in the property securing the
loan. The Bank enforces such due-on-sale clauses.
The adjustable-rate single-family residential mortgage ("ARM") loans
currently offered by the Bank have interest rates which are fixed for the
initial three or five years and are thereafter adjusted on an annual basis in
accordance with a designated index such as one-year U.S. Treasury obligations
adjusted to a constant maturity ("CMT"), plus a stipulated margin. The Bank's
adjustable-rate single-family residential real estate loans generally have a cap
of 2% on any increase or decrease in the interest rate at any adjustment date
and include a specified cap on the maximum interest rate over the life of the
loan, which cap generally is 6% above the initial rate. From time to time, based
on prevailing market conditions, the Bank may offer ARM loans with initial rates
which are below the fully indexed rate. Such loans generally are underwritten
based on the fully indexed rate. The Bank's adjustable-rate loans require that
any payment adjustment resulting from a change in the interest rate of an
adjustable-rate loan be sufficient to result in full amortization of the loan by
the end of the loan term and, thus, do not permit any of the increased payment
to be added to the principal amount of the loan, or so-called negative
amortization. At December 31, 2002, $288.7 million, or 74.7% of the Bank's
single-family residential mortgage loans, were adjustable-rate loans.
Adjustable-rate loans decrease the Bank's risks associated with changes
in interest rates but involve other risks, primarily because as interest rates
increase, the loan payment by the borrower increases to the extent permitted by
the terms of the loan, thereby increasing the potential for default. Moreover,
as with fixed-rate loans, as interest rates increase, the marketability of the
underlying collateral property may be adversely affected by higher interest
rates. Also, when interest rates decline substantially, borrowers tend to
refinance into fixed rate loans. The Bank believes that these risks, which have
not had a material adverse effect on the Bank to date, generally are less than
the risks associated with holding fixed-rate loans in an increasing interest
rate environment.
The volume and types of ARMs originated by Citizens Financial are
affected by such market factors as the level of interest rates, competition,
consumer preferences and availability of funds. Accordingly, although the Bank
anticipates that it will continue to offer single-family ARMs, the increased
emphasis over the past few years on originating more construction and land
development and commercial and multi-family real estate loans has reduced the
proportion that single-family residential loans bear to total loans.
The Bank's single-family residential mortgage loans generally do not
exceed amounts limited to the maximum amounts contained in GSE guidelines. In
addition, the maximum loan-to-value ("LTV") ratio for the Bank's single-family
residential mortgage loans generally is 95%
11
of the appraised value of the security property, provided, however, that private
mortgage insurance generally is obtained on the portion of the principal amount
that exceeds 80% of the appraised value.
At December 31, 2002, Citizens Financial's home equity loans amounted
to $45.1 million, or 4.6% of the Bank's total loans. The preponderance of the
Bank's home equity loans are structured as fixed-rate, fixed-term loans,
although the Bank also offers floating rate home equity lines of credit. Home
equity loans, like single-family residential mortgage loans, are secured by the
underlying equity in the borrower's residence. However, the Bank generally
obtains a second mortgage position to secure its home equity loans. The Bank's
home equity loans require LTV ratios of 90% or less after taking into
consideration any first mortgage loan. The Bank originated $42.3 million, $30.7
million and $19.1 million of home equity loans in 2002, 2001 and 2000,
respectively.
MULTI-FAMILY RESIDENTIAL AND COMMERCIAL REAL ESTATE LOANS. After the
completion of the Conversion in July 1998, the Company increased its emphasis on
the origination of commercial real estate loans, multi-family residential loans
and construction and land development loans. In order to implement the Bank's
strategy, the Bank has significantly increased the number of employees dedicated
to multi-family residential and commercial real estate lending. Such loans often
have interest rates that are adjustable or float based on the prime rate and
generally have shorter terms to maturity and higher yields than the Bank's
single-family residential mortgage loans. At December 31, 2002, Citizens
Financial's multi-family residential mortgage loans and commercial real estate
loans amounted to $71.2 million and $271.4 million, or 7.3% and 27.7%,
respectively, of the Bank's total loan portfolio, as compared to $21.1 million
and $39.0 million, or 2.8% and 5.2%, respectively, of the Bank's total loan
portfolio at December 31, 1998 (the first fiscal year end after Conversion).
The Bank's multi-family residential real estate loans are concentrated
in northwest Indiana and DuPage, Will and Cook Counties, Illinois. The Bank
originated $22.6 million of multi-family residential real estate loans in 2002
compared to $2.5 million and $6.2 million in 2001 and 2000, respectively.
The Bank's commercial real estate loans generally are secured by
hotels, medical office facilities, churches, small office buildings, strip
shopping centers and other commercial uses primarily located in the Bank's
market area. The Bank's commercial real estate loans usually are less than $5.0
million, and as of December 31, 2002, the average size of the Bank's commercial
real estate loans was approximately $1.3 million. The Bank originated $137.0
million of commercial real estate loans during the year ended December 31, 2002
compared to $23.2 million and $31.0 million, respectively, in 2001 and 2000. As
of December 31, 2002, the Bank's five largest commercial real estate and
multi-family residential loan relationships were $24.2 million, $19.9 million,
$17.5 million, $14.8 million and $13.8 million, all of which were performing in
accordance with their terms.
The Bank's multi-family residential and commercial real estate loans
generally are five-year, fixed-rate loans with an amortization period of up to
25 years and loan to value ratios of not more than 80%. Citizens Financial also
originates floating-rate and adjustable-rate multi-family
12
residential and commercial real estate loans. Generally, fees of between 0.5%
and 1.0% of the principal loan balance are charged to the borrower upon closing.
The Bank generally charges prepayment penalties on commercial real estate and
multi-family residential mortgage loans. The Bank generally obtains personal
guarantees of the borrower's principals as additional security for any
commercial real estate and multi-family residential loans.
Citizens Financial evaluates various aspects of commercial and
multi-family residential real estate loan transactions in an effort to mitigate
credit risk to the greatest extent possible. In underwriting these loans,
consideration is given to the stability of the property's cash flow history,
future operating projections, management experience, current and projected
occupancy, position in the market, location and physical condition. The Bank has
also generally imposed a debt coverage ratio (the ratio of net cash from
operations before payment of debt service to debt service) of not less than 120%
for commercial real estate loans and for multi-family residential loans. The
underwriting analysis also includes credit checks and a review of the financial
condition of the borrower and guarantor. An appraisal report is prepared by an
independent appraiser commissioned by the Bank to substantiate property values
for every commercial real estate and multi-family loan transaction. All
appraisal reports are reviewed by the Bank prior to the closing of the loan, as
are environmental site assessments that are deemed necessary.
Commercial real estate and multi-family residential lending entails
substantially different risks when compared to single-family residential lending
because such loans often involve large loan balances to single borrowers and
because the payment experience on such loans is typically dependent on the
successful operation of the project or the borrower's business. These risks can
also be significantly affected by supply and demand conditions in the local
market for apartments, offices, warehouses, or other commercial space. The Bank
attempts to minimize its risk exposure by limiting such lending to proven
businesses, only considering properties with existing operating performance
which can be analyzed, requiring conservative debt coverage ratios, and
periodically monitoring the operation and physical condition of the collateral
as well as the business occupying the property.
As of December 31, 2002, multi-family residential real estate loans
totaling $36,000 were considered non-performing loans while $5.6 million, or
2.1%, of its commercial real estate loans were considered non-performing.
The Bank also invests, on a participating basis, in multi-family and
commercial real estate loans originated by other lenders. In these transactions,
the Bank reviews such loans utilizing the same credit policies applicable to
loans it originates. At December 31, 2002 participation loans purchased totaled
approximately $60.0 million.
CONSTRUCTION AND LAND DEVELOPMENT LOANS. As previously indicated, the
Bank increased its emphasis on construction and land development loans beginning
in the second half of 1998. Historically, in the several years prior to the
Bank's Conversion, the Bank had concentrated its construction lending efforts
primarily on residential construction loans to local real estate builders,
generally with whom it had an established relationship. The Bank also originated
such loans to individuals for the construction of their residences. Commencing
in the second half of 1998, the Bank expanded its efforts to originate
construction loans for commercial
13
real estate and multi-family residential properties. At December 31, 2002 the
average size of construction loans for commercial real estate and multi-family
residential properties was approximately $1.5 million. At December 31, 2002,
construction and land development loans amounted to $165.0 million, or 16.8% of
the Bank's loan portfolio (including $39.7 million of loans in process). Of the
Bank's construction and land development loans at December 31, 2002, $1.7
million were construction/permanent, single-family residential loans which
loans, by their terms, convert to permanent mortgage loans upon the completion
of construction. The Bank originated $98.1 million of construction and land
development loans during 2002, compared to $63.0 million and $91.5 million of
construction and land development loans in 2001 and 2000, respectively. Of the
$98.1 million of construction and land development loans originated in 2002, an
aggregate of $87.8 million was for commercial real estate and multi-family
residential construction loans. Of the Bank's commercial real estate and
multi-family residential mortgage loans at December 31, 2002, $73.0 million were
construction/permanent loans.
Prior to making a commitment to fund a construction loan, the Bank
requires an appraisal of the property by an approved independent appraiser. The
Bank's staff, or a third-party contractor retained by Citizens Financial, also
reviews and inspects each project at the commencement of construction and prior
to every disbursement of funds during the term of the construction loan. Loan
proceeds are disbursed after inspections of the project based on a percentage of
completion and acknowledgement of title company lien endorsements.
The Bank originates land loans to local developers for the purpose of
developing the land (i.e., roads, sewer and water) for sale. Such loans are
secured by a mortgage on the property, are generally limited to 75% of the
appraised value of the secured property and are typically made for a period of
up to two years. The Bank requires monthly interest payments during the term of
the loan. The principal of the loan is reduced as lots are sold and released.
All of the Bank's land loans are secured by property located in its primary
market area. In addition, the Bank generally obtains personal guarantees from
the borrowers' principals.
The Bank's loan underwriting and processing procedures require that
construction and development loans be reviewed by independent architects,
engineers or other qualified third parties for verification of costs.
Disbursements during the construction phase are based on regular on-site
inspections and approved certifications. In the case of construction loans on
commercial projects where the Bank provides the permanent financing, the Bank
usually requires firm lease commitments on some portion of the property under
construction from qualified tenants. In addition, the Bank limits both its
residential and commercial construction lending to northwest Indiana and the
Chicago-land area. At December 31, 2002 the Bank's five largest construction and
land development relationships were $13.0 million, $10.4 million, $7.5 million,
$6.7 million and $6.7 million, all of which were performing in accordance with
their terms.
Construction and development financing is generally considered to
involve a higher degree of risk of loss than long-term financing on improved,
owner-occupied real estate. The Bank's risk of loss on a construction loan is
dependent largely upon the accuracy of the initial estimate of the property's
value at completion of construction or development and the estimated
14
cost (including interest) of construction. If the estimate of construction cost
proves to be inaccurate, the Bank may need to advance funds beyond the amount
originally committed to permit completion of the development. Construction and
development loans generally are considered to be more difficult to evaluate and
monitor than single-family residential mortgage loans. In addition, the Bank's
commercial real estate and construction and development loans generally have
larger principal balances than its single-family residential mortgage loans.
In evaluating any new originations of construction and development
loans, the Bank generally considers evidence of the availability of permanent
financing or a takeout commitment to the borrower, the reputation of the
borrower and the contractor, the amount of the borrower's equity in the project,
independent valuations and reviews of cost estimates, pre-construction sale and
leasing information, and cash flow projections of the borrower. To reduce the
risk inherent in such lending, on certain occasions the Bank may require
performance bonds in the amount of the construction contract and often obtains
personal guarantees from the principals of the borrower.
As of December 31, 2002, $1.3 million, or 0.8%, of Citizens Financial's
construction and land development loans were considered non-performing.
OTHER LOANS. Citizens Financial's other loans consist primarily of
commercial loans, consumer loans and loans secured by deposit accounts. Included
in the category of commercial loans are loans secured by business assets other
than real estate, unsecured loans, and secured and unsecured operating lines of
credit. As of December 31, 2002, Citizens Financial's other loans amounted to
$42.6 million compared to $26.1 million and $20.2 million at December 31, 2001
and 2000, respectively. The Bank is not actively marketing its consumer loans
and offers them primarily as a service to its existing customers.
ASSET QUALITY
GENERAL. All of the Bank's assets are subject to review under its
classification system. Loans are periodically reviewed, and the classifications
are reviewed by the Asset/Liability Management Committee of the Board of
Directors on at least a quarterly basis. When a borrower fails to make a
required payment on a loan, the Bank attempts to cure the deficiency by
contacting the borrower and seeking payment. Contacts are generally made 30 days
after a payment is due. In most cases, deficiencies are cured promptly. If a
delinquency continues, late charges are assessed and additional efforts are made
to collect the past due payments. While the Bank generally prefers to work with
borrowers to resolve such problems, when the account becomes 90 days delinquent,
the Bank institutes foreclosure or other proceedings, as necessary, to minimize
any potential loss.
Loans are placed on non-accrual status when, in the judgment of
management, the probability of collection of interest is deemed to be
insufficient to warrant further accrual. When a loan is placed on non-accrual
status, previously accrued but unpaid interest is deducted from interest income.
As a matter of policy, the Bank does not accrue interest on loans past due 90
days or more.
15
Real estate acquired by the Bank as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as real estate owned until sold.
Foreclosed assets are held for sale and such assets are carried at the lower of
fair value minus estimated costs to sell the property, or cost (generally the
balance of the loan on the property at the date of acquisition with any
resulting losses being charged to the allowance for losses on loans). After the
date of acquisition, all costs incurred in maintaining the property are
expensed, and costs incurred for the improvement or development of such property
are capitalized up to the extent of their net realizable value.
DELINQUENT LOANS. The following table sets forth information concerning
certain delinquent loans, at the dates indicated, in dollar amounts and as a
percentage of each category of the Bank's loan portfolio. The amounts presented
represent the total outstanding principal balances of the related loans. The
following table contains information on loans that are 60 to 89 days delinquent.
Loans that are delinquent 90 days or more are included in the table on page 17
in the non accrual loans category.
At December 31,
-------------------------------------------------------------------
2002 2001 2000
-------------------------------------------------------------------
60-89 Days Delinquent 60-89 Days Delinquent 60-89 Days Delinquent
-------------------------------------------------------------------
Percent of Percent of Percent of
Loan Loan Loan
Amount Category Amount Category Amount Category
-------------------------------------------------------------------
(Dollars in Thousands)
Residential:
Single-family $ 4,537 1.18% $ 3,593 0.68% $ 4,905 0.70%
Multi-family 360 0.51 1,945 3.77 30 0.07
Commercial real estate 79 0.03 4,842 3.40 163 0.13
Construction and land
development 1,035 0.63 846 0.71 275 0.19
Home equity 522 1.16 257 0.62 288 1.40
Other:
Commercial 1,536 3.84 396 1.65 892 5.10
Consumer 292 11.2 29 1.41 65 2.39
-------------------------------------------------------------------
Total $ 8,361 0.85% $11,908 1.30% $ 6,618 0.63%
===================================================================
16
NON-PERFORMING AND UNDER-PERFORMING ASSETS. The following table sets
forth information with respect to non-performing and certain under-performing
assets identified by Citizens Financial, including non-accrual loans and other
real estate owned. Citizens Financial had no accruing loans 90 days or more past
due as to principal or interest at any of the below-referenced dates.
At December 31,
-----------------------------------------------------------
2002 2001 2000 1999 1998
-----------------------------------------------------------
(Dollars in Thousands)
Non-accrual loans:
Mortgage loans:
Single-family residential $ 7,294 $ 8,579 $ 5,230 $ 7,303 $ 5,137
Multi-family residential 36 36 -- 460 516
Commercial real estate 5,621 1,798 1,330 2,498 2,754
Construction and land development 1,323 1,361 4,167 1,313 469
Home equity 324 692 405 206 1
Other loans:
Commercial 692 1,117 559 -- --
Consumer 35 291 158 52 76
-----------------------------------------------------------
Total non-accruing loans 15,325 13,874 11,849 11,832 8,953
Other real estate owned, net 893 1,128 1,058 609 435
-----------------------------------------------------------
Total non-performing assets $16,218 $15,002 $12,907 $12,441 $ 9,388
===========================================================
Performing troubled debt restructurings $ 338 $ 417 $ 586 $ 668 $ 916
Non-performing assets to total assets 1.02% 0.94% 0.75% 0.75% 0.64%
Non-performing loans to total loans 1.56 1.51 1.13 1.23 1.20
Total non-performing assets and troubled
debt restructurings to total assets 1.05 0.96 0.75 0.75 0.64
Included in non-accrual commercial real estate loans at December 31,
2002 is a loan secured by a motel with a carrying value of approximately $3.9
million. A receiver has been appointed. Citizens ordered and received an
appraisal for this property indicating an amount in excess of the carrying
value. This property is expected to become real estate owned sometime during
2003.
17
The interest income that would have been recorded during the year ended
December 31, 2002, if all of the Bank's non-performing loans at the end of such
period had been current in accordance with their terms during such periods, was
$1.9 million. The actual amount of interest recorded as income (on a cash basis)
on such loans during the period amounted to $1.0 million.
CLASSIFIED AND CRITICIZED ASSETS. Federal regulations require that each
insured institution classify its assets on a regular basis. Furthermore, in
connection with examinations of insured institutions, federal examiners have
authority to identify problem assets and, if appropriate, classify them. There
are three classifications for problem assets: "substandard," "doubtful" and
"loss." Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
probability 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. Another category designated "special mention" is also established and
maintained for assets which have some identified weaknesses but do not currently
expose an insured institution to a sufficient degree of risk to warrant
classification as substandard, doubtful or loss. At December 31, 2002, Citizens
Financial had an aggregate of $48.3 million of classified assets, 98.3% of which
were classified substandard and 1.7% of which were classified as doubtful,
compared to $39.3 million of classified assets as of December 31, 2001. The Bank
utilizes a third party to review the Bank's commercial loans and commercial real
estate loans. As a result of the third party consultant's review the Company
hired and/or reassigned personnel to perform monitoring functions.
ALLOWANCE FOR LOSSES ON LOANS. The Bank's policy is to establish
allowances for estimated losses on loans when it determines that losses are
expected to be incurred on such loans. The allowance for losses on loans is
maintained at a level believed adequate by management to absorb losses inherent
in the portfolio. Management's determination of the adequacy of the allowance is
based on an evaluation of the portfolio, past loss experience, current economic
conditions, volume, growth and composition of the portfolio, and other relevant
factors. The allowance is increased by provisions for loan losses which are
charged against income. As shown in the table below, at December 31, 2002, the
Bank's allowance for losses on loans amounted to $8.7 million or 56.6% and 0.92%
of the Bank's non-performing loans and total loans receivable, respectively. The
Bank's provision for losses on loans amounted to $2.0 million for the year ended
December 31, 2002 and $1.2 million for 2001. While no assurance can be given
that future charge-offs and/or additional provisions will not be necessary,
management of the Company believes that, as of December 31, 2002, the allowance
for losses on loans was adequate.
A savings institution's determination as to the classification of its
assets and the amount of its valuation allowances is subject to review by the
Office of Thrift Supervision which can order the establishment of additional
general or specific loss allowances. The Office of Thrift Supervision, in
conjunction with the other federal banking agencies, has adopted an interagency
policy statement on the allowance for loan and lease losses. The policy
statement provides guidance for financial institutions on both the
responsibilities of management for the assessment
18
and establishment of adequate allowances and guidance for banking agency
examiners to use in determining the adequacy of general valuation guidelines.
Generally, the policy statement recommends that institutions have effective
systems and controls to identify, monitor and address asset quality problems;
that management has analyzed all significant factors that affect the
collectibility of the portfolio in a reasonable manner; and that management has
established acceptable allowance evaluation processes that meet the objectives
set forth in the policy statement. Our policy for establishing loan losses is
consistent with the Office of Thrift Supervision's policy statement. In July
2001, the SEC issued Staff Accounting Bulletin ("SAB") No. 102, "Selected Loan
Loss Allowance Methodology and Documentation Issues." The guidance contained in
the SAB was effective immediately and focuses on the documentation the SEC staff
normally expects registrants to prepare and maintain in support of the allowance
for loan and lease losses. Concurrent with the SEC's issuance of SAB No. 102,
the federal banking agencies, represented by the Federal Financial Institutions
Examination Council ("FFIEC"), issued an interagency policy statement entitled
"Allowance for Loan and Lease Losses Methodologies and Documentation for Banks
and Savings Institutions" (Policy Statement). The SAB and Policy Statement were
the result of an agreement between the SEC and the federal banking agencies in
March 1999 to provide guidance on allowance for loan and lease losses
methodologies and supporting documentation. There was no impact on earnings,
financial condition, or stockholder's equity upon implementation of the SAB or
FFIEC pronouncement.
19
The following table sets forth the activity in the Bank's allowance for
losses on loans during the periods indicated.
Year Ended December 31,
---------------------------------------------------------------
2002 2001 2000 1999 1998
---------------------------------------------------------------
(In Thousands)
---------------------------------------------------------------
Allowance at beginning of period $ 7,662 $ 7,187 $ 5,973 $ 5,357 $ 3,825
---------------------------------------------------------------
Provisions 1,956 1,150 3,375 675 1,630
Charge-offs:
Mortgage loans:
Single-family residential (82) (120) (203) (138) (49)
Multi-family residential (3) -- -- -- --
Commercial real estate (974) (429) (2,048) -- --
Construction and land development (31) (6) (10) -- (13)
Other loans (93) (300) (18) (33) (63)
---------------------------------------------------------------
Total charge-offs (1,183) (855) (2,279) (171) (125)
---------------------------------------------------------------
Recoveries:
Mortgage loans:
Single-family residential 210 124 64 70 25
Multi-family residential -- -- 1 -- --
Commercial real estate development 24 56 -- -- --
Construction and land development -- -- 50 -- --
Other loans 5 -- 3 42 2
---------------------------------------------------------------
Total recoveries 239 180 118 112 27
---------------------------------------------------------------
Net loans charged-off to allowance
for losses on loans (944) (675) (2,161) (59) (98)
---------------------------------------------------------------
Allowance at end of period $ 8,674 $ 7,662 $ 7,187 $ 5,973 $ 5,357
===============================================================
Allowance for losses on loans to total
non-performing loans at end of period 56.60% 55.23% 60.65% 50.48% 59.84%
===============================================================
Allowance for losses on loans to total loans
at end of period .92% 0.86% 0.71% 0.67% 0.74%
===============================================================
Net charge-offs to average loans outstanding 0.10% 0.07% 0.22% 0.01% 0.02%
===============================================================
ALLOCATION OF THE ALLOWANCE FOR LOSSES ON LOANS. Management of the Bank
determines the sufficiency of the allowance for losses on loans based upon its
periodic assessment of the risk elements in its loan portfolio. Management of
Citizens Financial utilizes analytical data as well as anticipated borrower
performance in light of general economic conditions existing in the Bank's
market area.
20
The determination of the adequacy of the allowance at December 31, 2002
specifically considered various factors, including the balance of outstanding
loans and the increases in the ratio of commercial, commercial land multi-family
real estate and construction and land development loans to total loans. These
loans are in excess of 50% of total loans receivable at December 31, 2002.
Because of the increase in balances of these types of loans and the fact that
such loans have historically resulted in more losses than single-family
residential mortgage loans, management adjusted the manner by which the
allowance for losses on loans is allocated during 2002. Previously, various
percentages were assigned to loan categories based on management's analysis of
their relative risks. Beginning in 2002, classified commercial type loans were
evaluated and allocated separately from the general allocation of the entire
portfolio.
Citizens Financial will continue to monitor and modify its approach to
estimate the allowances for losses on loans as conditions dictate. While
management believes that, based on information currently available, the Bank's
allowance for losses on loans is sufficient to cover losses inherent in its loan
portfolio at this time, no assurance will be given that the Bank's level of
allowance for losses on loans will be sufficient to absorb loan losses inherent
in the portfolio or that future adjustments to the allowance for losses on loans
will not be necessary if economic and other conditions differ substantially from
the economic and other conditions used by management to determine the current
level of the allowance for losses on loans. In addition, the OTS, as an integral
part of its examination process, periodically reviews the Bank's allowance for
loan losses. Such agency may require the Bank to make additional provisions for
estimated loan losses based upon judgments different from those of management.
The resulting allocation as of December 31, 2002 was as follows:
Allowance Allocation
For Allowance as a Allowance Allowance as a
Specifically For Percentage of Allocation Percentage of
Identified Classified Classified for Remainder Remainder of Total
Category Losses Loans Loans of Category Category Allocated
-------------------------------------------------------------------------------------------
(Dollars in Thousands)
Residential real estate:
Single-family owner occupied $ -- $ 55 50.00% $ 417 .10% $ 472
Single-family non-owner occupied -- 162 8.41 71 .15 233
Multi-family -- 1,966 5.39 316 .50 2,282
Business/Commercial 150 2,110 7.62 1,899 .75 4,159
Business/Commercial non-real estate 55 82 6.36 265 1.00 402
Developed lots -- -- -- 55 .75 55
Land -- 127 6.39 305 1.00 432
Consumer -- 245 50.00 32 1.50 277
Other Assets -- 180 10.00 9 1.00 189
-------------------------------------------------------------------------------------------
$ 205 $4,927 $3,369 $8,501
====== ====== ======
Unallocated 173
------
Total $8,674
======
21
The Bank allocates its allowance for losses on loans by loan category.
Various percentages are assigned to the loan categories based on management's
analysis of their relative risks. At December 31, 2001, 2000, 1999 and 1998, the
allowance for losses on loans was allocated as follows:
December 31,
---------------------------------------------------------------------------------------
2002 2001 2000
---------------------------------------------------------------------------------------
Allowance as a Allowance as a Allowance as a
Allowance Percentage of Allowance Percentage of Allowance Percentage of
CATEGORY Allocation Category Allocation Category Allocation Category
---------------------------------------------------------------------------------------
(Dollars in Thousands)
Residential real estate:
Single-family owner
occupied $ 472 .11% $2,262 .40% $2,845 .40%
Single-family non-
owner occupied 233 .47 276 .80 298 .80
Multi-family 2,282 2.29 716 1.00 773 1.00
Business/Commercial 4,159 1.47 3,067 1.75 2,393 1.75
Business/Commercial
non-real estate 402 1.41 388 2.50 419 2.50
Developed Lots 55 .75 95 1.25 57 1.25
Land 432 1.33 247 1.75 198 1.75
Consumer 277 .71 48 2.00 73 2.00
Other assets 189 N/A -- -- -- --
---------------------------------------------------------------------------------------
8,501 7,099 7,056
Unallocated 173 563 131
-------- ------ ------
Total $8,674 $7,662 $7,187
======== ====== ======
December 31,
------------------------------------------------------
1999 1998
------------------------------------------------------
Allowance as a Allowance as
Allowance Percentage of Allowance a Percentage
CATEGORY Allocation Category Allocation of Category
------------------------------------------------------
(Dollars in Thousands)
Residential real estate:
Single-family owner
occupied $2,663 .40% $3,052 .50%
Single-family non-
owner occupied 280 .80 229 .75
Multi-family 409 1.00 203 1.00
Business/Commercial 1,003 1.75 884 1.75
Business/Commercial
non-real estate 280 2.50 296 2.50
Developed Lots 62 1.25 121 1.25
Land 221 1.75 82 1.75
Consumer 73 2.00 110 2.00
Other assets -- -- -- --
------------------------------------------------------
4,991 4,977
Unallocated 982 380
------ ------
Total $5,973 $5,357
====== ======
22
INVESTMENT SECURITIES ACTIVITIES
GENERAL. As of December 31, 2002, the Company had an aggregate of $39.1
million of investment securities, or 2.5%, of its total assets at such date. At
such date, the unrealized loss on the Company's available-for-sale investment
securities amounted to $630,000, net of deferred income taxes.
The Company's investment securities consist primarily of callable
agency securities, which amounted to $15.3 million, and commercial paper, which
amounted to $15.7 million, at December 31, 2002. The Company attempts to
maintain a high degree of liquidity in its other securities and generally does
not invest in debt securities with estimated average lives in excess of 10
years. In recent years, the Company has purchased substantial amounts of
callable agency securities, which are U.S. Government agency debt obligations,
generally having a contractual term to maturity of 10 years. These securities
may be called for redemption at predetermined dates (generally every three
months) throughout their terms. During 1998 and the first half of 1999 virtually
all of the Company's callable agency securities were called within one year of
purchase. As interest rates rose during the second half of 1999, these agency
securities were not called. This trend continued into 2000, with no securities
being called until late in the year, when rates again began to decline. The
trend to lower interest rates continued throughout 2001 and 2002 with the
Federal Reserve Board reducing rates eleven times in 2001. As of December 31,
2002, the contractual weighted average lives of the Company's investment
securities was 3.0 years.
At December 31, 2002, all of the Company's investment securities were
classified as available-for-sale, and none were classified as held to maturity.
Securities classified as available-for-sale are carried at fair value.
Unrealized gains and losses on available-for-sale securities are recognized as
direct increases or decreases in equity, net of applicable deferred income
taxes. Securities which are classified as held-to-maturity are carried at cost,
adjusted for the amortization of premiums and the accretion of discounts using a
method which approximates a level yield.
The investment policy of the Company, which has been established by the
Board of Directors, is designed, among other things, to assist the Company in
its asset/liability management policies. The Company's investment policy
emphasizes principal preservation, favorable returns on investment, liquidity
within designated guidelines, minimal credit risk, and flexibility. The
Company's current investment policy permits investments in various types of
securities including obligations of the U.S. Treasury and federal agencies,
investment grade corporate obligations ("A" rated or better), trust preferred
stocks, other equity securities, commercial paper, certificates of deposit, and
federal funds sold to financial institutions approved by the Board of Directors.
The Company currently does not participate in hedging programs,
interest rate swaps, or other activities involving the use of off-balance sheet
derivative instruments.
23
The following table set forth information regarding the carrying and
fair value of the Company's investment securities at the dates indicated.
December 31,
-----------------------------------------------------------------------
2002 2001 2000
-----------------------------------------------------------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
-----------------------------------------------------------------------
(Dollars in Thousands)
Available-for-sale:
Callable agency securities, corporate notes
and commercial paper $30,767 $31,087 $33,169 $33,148 $20,017 $20,056
Trust preferred securities 4,931 4,400 4,929 4,395 4,926 4,566
Equity securities 4,400 3,577 7,489 7,646 9,763 9,164
Asset-backed note -- -- 2,026 2,036 -- --
-----------------------------------------------------------------------
$40,098 $39,064 $47,613 $47,225 $34,706 $33,786
=======================================================================
The following table sets forth certain information regarding the
maturities of the Company's callable agency securities, corporate bonds,
commercial paper and trust preferred securities at December 31, 2002.
Contractually Maturing
-----------------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted
Under 1 Average 1-5 Average 6-10 Average Over 10 Average
Year Yield Years Yield Years Yield Years Yield
-----------------------------------------------------------------------------------------
(Dollars in Thousands)
-----------------------------------------------------------------------------------------
Callable agency securities $ -- --% $10,277 4.00% $5,041 5.21% $ -- --%
Corporate notes -- -- 50 10.00 -- -- -- --
Commercial paper 15,719 1.68 -- -- -- -- -- --
Trust preferred -- -- -- -- -- -- 4,400 2.33
MORTGAGE-BACKED SECURITIES
GENERAL. At December 31, 2002, the Company's mortgage-backed securities
included $318.0 million of mortgage participation certificates, collateralized
mortgage obligations ("CMOs") and securities which qualified as real estate
mortgage investment conduits ("REMICs"). At December 31, 2002 the unrealized
gain on the Company's mortgage-backed securities available-for-sale amounted to
$507,000, net of deferred income taxes. At December 31, 2002, $296.6 million of
the Company's mortgage-backed securities were classified as available-for-sale,
and $21.4 million were classified as held to maturity. Securities classified as
available-for-sale are carried at fair value. Unrealized gains and losses on
available-for-sale securities are recognized as direct increases or decreases in
equity, net of applicable deferred income taxes. Securities which are held to
maturity are carried at cost, adjusted for the amortization of premiums and the
accretion of discounts using a method which approximates a level yield.
24
The following table sets forth information regarding the carrying and
fair value of the Company's mortgage-backed securities at the dates indicated.
December 31,
-----------------------------------------------------------------------
2002 2001 2000
-----------------------------------------------------------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
-----------------------------------------------------------------------
(Dollars in Thousands)
Available-for-sale (at fair value):
Participation certificates and collateralized
mortgage obligations $ 64,084 $ 64,768 $ 32,089 $ 33,225 $ 54,227 $ 54,460
REMICs 231,752 231,870 239,776 242,933 229,535 225,137
-----------------------------------------------------------------------
$295,836 $296,638 $271,865 $276,158 $283,762 $279,597
=======================================================================
Held to maturity:
Participation certificates and collateralized
mortgage obligations $ 20,651 $ 21,161 $ 28,644 $ 29,234 $ 34,349 $ 34,074
REMICs 751 816 8,390 8,510 44,508 44,442
-----------------------------------------------------------------------
$ 21,402 $ 21,977 $ 37,034 $ 37,744 $ 78,857 $ 78,516
=======================================================================
At December 31, 2002, $39.9 million, or 12.6%, of the Company's
mortgage-backed securities portfolio consisted of adjustable-rate securities, as
compared to $28.7 million, or 9.2%, and $26.6 million, or 7.4%, at December 31,
2001 and 2000, respectively.
Participation certificates represent a participation interest in a pool
of single-family or multi-family mortgages. The principal and interest payments
on mortgage-backed securities are passed from the mortgage originators, as
servicers, through intermediaries (generally U.S. Government agencies and
government-sponsored enterprises) that pool and repackage the participation
interests in the form of securities, to investors such as the Company. Such U.S.
Government agencies and government sponsored enterprises, which guarantee the
payment of principal and, in some cases, interest to investors, primarily
include the Federal Home Loan Mortgage Corporation, the Federal National
Mortgage Association and the Government National Mortgage Association.
In contrast to pass-through mortgage-backed securities, in which cash
flow is received pro rata by all security holders, the cash flow from the
mortgages underlying a CMO is segmented and paid in accordance with a
predetermined priority to investors holding various CMO classes. By allocating
the principal and interest cash flows from the underlying collateral among the
separate CMO classes, different classes of bonds are created, each with its own
stated maturity. CMOs are typically issued by governmental agencies, government
sponsored enterprises and special purpose entities, such as trusts, corporations
or partnerships, established by financial institutions or other similar
institutions. REMICS are a form of CMOs with particular attributes under the
Internal Revenue Code. At December 31, 2002 $173.0 million of the Company's
REMICs were issued by government-related entities while $59.6 million were
issued by other issuers.
25
SOURCE OF FUNDS
GENERAL. Deposits are the primary source of the Bank's funds for
lending and other investment purposes. In addition to deposits, the Bank derives
funds from loan principal repayments and prepayments and borrowings. Loan
repayments are a relatively stable source of funds, while deposit inflows and
outflows are significantly influenced by general interest rates and money market
conditions. The Bank also uses borrowings, primarily Federal Home Loan Bank
advances, to supplement its deposits as a source of funds.
DEPOSITS. Citizens Financial's deposit products include a broad
selection of deposit instruments, including checking accounts, money market
accounts, passbook and statement savings accounts, and term certificate
accounts. Deposit account terms may vary, with the principal differences being
the minimum balance required, the time periods the funds must remain on deposit
and the interest rate.
Citizens Financial utilizes traditional marketing methods to attract
new customers and deposits. The Bank does not advertise for deposits outside of
its market area. The Bank does not utilize the services of deposit brokers. The
Bank traditionally has relied on customer service and convenience in marketing
its deposit products. In addition, Citizens Financial generally has been
competitive in the types of accounts and interest rates offered, and often it
has been among the leaders in its market area on the rates paid on its deposits.
Citizens Financial experienced a net decrease in deposits before interest
credited of $14.5 million in 2002 and $24.6 million in 2001.
The following table sets forth the activity in the Bank's deposits
during the periods indicated.
Year Ended December 31,
--------------------------------------------
2002 2001 2000
--------------------------------------------
(In Thousands)
Beginning balance $945,444 $933,073 $924,193
Net before interest credited (14,469) (24,574) (29,651)
Interest credited 22,886 36,945 38,531
--------------------------------------------
Net increase in deposits 8,417 12,371 8,880
--------------------------------------------
Ending balance $953,861 $945,444 $933,073
============================================
26
The following table sets forth the amount and remaining maturities of
the Bank's certificates of deposit at December 31, 2002.
Over One Year Over Two Years Interest
Through One Through Two Through Three Over Three Category
Year Years Years Years Totals
--------------------------------------------------------------------------------
(Dollars in Thousands)
2.00% to 2.99% $282,483 $18,262 $ 3,326 $ 37 $304,108
3.00% to 3.99% 28,823 13,611 5,746 3,150 51,330
4.00% to 4.99% 7,759 3,976 867 10,584 23,186
5.00% to 5.99% 17,185 5,475 3,192 4,065 29,917
6.00% to 6.99% 36,078 13,036 13,336 8,508 70,958
7.00% to 8.99% 4,884 2,759 7,900 2,533 18,076
--------------------------------------------------------------------------------
Total $377,212 $57,119 $34,367 $28,877 $497,575
================================================================================
As of December 31, 2002, the aggregate amount of outstanding time
certificates of deposit in amounts greater than or equal to $100,000 was $117.1
million. The following table presents the maturity of these time certificates of
deposit at such dates.
December 31, 2002
-----------------
(In Thousands)
3 months or less $ 29,838
Over 3 months through 6 months 30,524
Over 6 months through 12 months 25,190
Over 12 months 31,530
-----------------
$117,082
=================
The following table sets forth the dollar amount of deposits and the
percentage of total deposits in various types of deposits offered by the Bank at
the dates indicated.
December 31,
----------------------------------------------------------------------------------
2002 2001 2000
----------------------------------------------------------------------------------
Amount Percentage Amount Percentage Amount Percentage
----------------------------------------------------------------------------------
(Dollars in Thousands)
Passbook accounts $212,370 22.27% $203,165 21.49% $207,422 22.23%
Certificates of deposit 497,575 52.16 544,887 57.63 568,399 60.90
Money market accounts 121,693 12.76 89,205 9.44 47,226 5.07
Checking accounts:
Noninterest-bearing 31,318 3.28 26,970 2.85 26,468 2.84
Interest-bearing 90,905 9.53 81,217 8.59 83,558 8.96
----------------------------------------------------------------------------------
Total $953,861 100.00% $945,444 100.00% $933,073 100.00%
==================================================================================
27
BORROWINGS
The following table sets forth certain information as to the Bank's
FHLB advances and other borrowings at the dates indicated and the
weighted-average interest rates paid on borrowings for the years ended December
31, 2002, 2001 and 2000.
At December 31,
-------------------------------------------------------
2002 2001 2000
-------------------------------------------------------
(Dollars in Thousands)
FHLB advances $449,431 $462,658 $483,151
Securities sold under agreements
to repurchase -- -- 64,925
-------------------------------------------------------
Total borrowings $449,431 $462,658 $548,076
=======================================================
Weighted average interest rate of borrowings 5.87% 5.88% 5.92%
Refer to Note 8, "Borrowed Money", in the Consolidated Financial Statements for
additional information related to Borrowings.
TRUST ACTIVITIES
The Company also provides fiduciary services through the Bank's Trust
Department. Services offered include fiduciary services for trusts and estates
and land trusts. As of December 31, 2002, the Trust Department maintained 69
trust/fiduciary accounts, of which 49 were land trusts with an aggregate
principal balance of $3.0 million at such date. Revenue from the Trust
Department for the year ended December 31, 2002 was $27,000.
The accounts maintained by the Trust Department consist of "managed"
and "non-managed" accounts. "Managed accounts" are those accounts under custody
for which the Bank has responsibility for administration and investment
management and/or investment advice. "Non-managed" accounts are those accounts
for which the Bank merely acts as a custodian. The Company receives fees
dependent upon the level and type of service provided. The Trust Department
administers various trust accounts (revocable and irrevocable trusts, and trusts
under wills), estates and guardianships. Executive management of the department
is provided by the Bank's Vice President and Corporate Counsel, subject to
direction by the Trust Committee.
SUBSIDIARIES
During 2002 the Bank had three active, wholly-owned subsidiaries, CFS
Holdings, Ltd., CFS Insurance Agency, Inc. and CFS Investment Services, Inc.
CFS Holdings, Ltd. ("CFS Holdings") was approved by the Office of
Thrift Supervision in January 2001 and was funded and began operations in June
2001. CFS Holdings is located in Hamilton, Bermuda. It was funded with
approximately $140.0 million of the Bank's investments and performs a
significant amount of the Bank's investment securities and mortgage-backed
securities investing activities. Certain of these activities are performed by a
resident agent in Hamilton in accordance with the operating procedures and
investment policy established for CFS
28
Holdings by the Bank. Revenues of CFS Holdings were $5.6 million for the year
ended December 31, 2002 compared to $4.2 million for the period from inception
through December 31, 2001. Operating expenses of this operation were $61,000 for
the year ended December 31, 2002 compared to $35,000 for the seven months of
2001.
CFS Insurance Agency, Inc. ("CFS Insurance") was an independent
insurance brokerage subsidiary which offered a full line of insurance products
to the general public. CFS Insurance operated out of the Bank's
Insurance/Investment Center in Munster, Indiana. The Bank has owned CFS
Insurance since 1972. Effective November 30, 2002 the Bank sold the assets of
this agency and entered into a five year lease, with the purchaser, for the
building from which the agency conducted its operations. Pre-tax profit on the
sale of these assets was approximately $1.1 million. Revenues of CFS Insurance
were $1.3 million, $1.1 million, and $902,000 in 2002, 2001 and 2000,
respectively.
CFS Investments Services, Inc. ("CFS Investments") was primarily
involved in the sale of mutual funds and other securities to members of the
general public in the Bank's primary market area. CFS Investments commenced full
service securities brokerage activities in 1994. During August 2002 the Bank
entered into an agreement to outsource this activity and discontinue providing
these services directly through CFS Investment Services, Inc. In addition to its
presence in the CFS Insurance/Investments Center, CFS Investments maintained
offices in eight of the Bank's branches. CFS Investments had total commission
revenue of $770,000, $873,000 and $1.4 million in each of the years ended 2002,
2001 and 2000, respectively.
EMPLOYEES
Citizens Financial had 328 full-time equivalent employees at December
31, 2002. None of these employees is represented by a collective bargaining
agent, and the Bank believes that it enjoys good relations with its personnel.
REGULATION
REGULATION OF SAVINGS AND LOAN HOLDING COMPANIES
The Company is a registered savings and loan holding company. The Home
Owners' Loan Act, as amended ("HOLA"), and OTS regulations generally prohibit a
savings and loan holding company, without prior OTS approval, from acquiring,
directly or indirectly, the ownership or control of any other savings
association or savings and loan holding company, or all, or substantially all,
of the assets or more than 5% of the voting shares thereof. These provisions
also prohibit, among other things, any director or officer of a savings and loan
holding company, or any individual who owns or controls more than 25% of the
voting shares of such holding company, from acquiring control of any savings
association not a subsidiary of such savings and loan holding company, unless
the acquisition is approved by the OTS.
Holding Company Activities. The Company currently operates as a unitary
savings and loan holding company. Generally, there are limited restrictions on
the activities of a unitary savings and loan holding company and its non-savings
association subsidiaries. If the Company
29
ceases to be a unitary savings and loan holding company, the activities of the
Company and its non-savings association subsidiaries would thereafter be subject
to substantial restrictions.
The HOLA requires every savings association subsidiary of a savings and
loan holding company to give the OTS at least 30 days' advance notice of any
proposed dividends to be made on its guarantee, permanent or other
non-withdrawable stock, or else such dividend will be invalid.
Affiliate Restrictions. Transactions between a savings association and
its "affiliates" are subject to quantitative and qualitative restrictions under
Sections 23A and 23B of the Federal Reserve Act. Affiliates of a savings
association include, among other entities, the savings association's holding
company and companies that are under common control with the savings
association.
In general, Sections 23A and 23B and OTS regulations issued in
connection therewith limit the extent to which a savings association or its
subsidiaries may engage in certain "covered transactions" with affiliates to an
amount equal to 10% of the association's capital and surplus, in the case of
covered transactions with any one affiliate, and to an amount equal to 20% of
such capital and surplus, in the case of covered transactions with all
affiliates. In addition, a savings association and its subsidiaries may engage
in covered transactions and certain other transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction" is
defined to include a loan: or extension of credit to an affiliate; a purchase of
investment securities issued by an affiliate; a purchase of assets from an
affiliate, with certain exceptions; the acceptance of securities issued by an
affiliate as collateral for a loan or extension of credit to any party; or the
issuance of a guarantee, acceptance or letter of credit on behalf of an
affiliate.
In addition, under OTS regulations, a savings association may not make
a loan or extension of credit to an affiliate unless the affiliate is engaged
only in activities permissible for bank holding companies; a savings association
may not purchase or invest in securities of an affiliate other than shares of a
subsidiary; a savings association and its subsidiaries may not purchase a
low-quality asset from an affiliate; and covered transactions and certain other
transactions between a savings association or its subsidiaries and an affiliate
must be on terms and conditions that are consistent with safe and sound banking
practices. With certain exceptions, each loan or extension of credit by a
savings association to an affiliate must be secured by collateral with a market
value ranging from 100% to 130% (depending on the type of collateral) of the
amount of the loan or extension of credit.
The OTS regulation generally excludes all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the Federal Reserve Board decides to treat
such subsidiaries as affiliates. The regulation also requires savings
associations to make and retain records that reflect affiliate transactions in
reasonable detail and provides that certain classes of savings associations may
be required to give the OTS prior notice of transactions with affiliates.
30
Financial Modernization. Under the Gramm-Leach-Bliley Act enacted into
law on November 12, 1999, no company may acquire control of a savings and loan
holding company after May 4, 1999, unless the company is engaged only in
activities traditionally permitted for a multiple savings and loan holding
company or newly permitted for a financial holding company under Section 4(k) of
the Bank Holding Company Act. Existing savings and loan holding companies, such
as the Company, and those formed pursuant to an application filed with the OTS
before May 4, 1999 may engage in any activity including non-financial or
commercial activities provided such companies control only one savings and loan
association that meets the Qualified Thrift Lender test. Corporate
reorganizations are permitted, but the transfer of grandfathered unitary holding
company status through acquisition is not permitted.
Sarbanes-Oxley Act of 2002. On July 30, 2002, the President signed into
law the Sarbanes-Oxley Act of 2002 implementing legislative reforms intended to
address corporate and accounting fraud. In addition to the establishment of a
new accounting oversight board which will enforce auditing, quality control and
independence standards and will be funded by fees from all publicly traded
companies, the bill restricts provision of both auditing and consulting services
by accounting firms. To ensure auditor independence, any non-audit services
being provided to an audit client will require preapproval by the company's
audit committee members. In addition, the audit partners must be rotated. The
bill requires chief executive officers and chief financial officers, or their
equivalent, to certify to the accuracy of periodic reports filed with the SEC,
subject to civil and criminal penalties if they knowingly or willfully violate
this certification requirement. In addition, under the Act, counsel will be
required to report evidence of a material violation of the securities laws or a
breach of fiduciary duty by a company to its chief executive officer or its
chief legal officer, and, if such officer does not appropriately respond, to
report such evidence to the audit committee or other similar committee of the
Board of Directors or the Board itself.
Longer prison terms will also be applied to corporate executives who
violate federal securities laws, the period during which certain types of suits
can be brought against a company or its officers has been extended, and bonuses
issued to top executives prior to restatement of a company's financial
statements are now subject to disgorgement if such restatement was due to
corporate misconduct. Executives are also prohibited from insider trading during
retirement plan "blackout" periods, and loans to company executives are
restricted. In addition, a provision directs that civil penalties levied by the
SEC as a result of any judicial or administrative action under the Act be
deposited to a fund for the benefit of harmed investors. The Federal Accounts
for Investor Restitution ("FAIR") provision also requires the SEC to develop
methods of improving collection rates. The legislation accelerates the time
frame for disclosures by public companies, as they must immediately disclose any
material changes in their financial condition or operations. Directors and
executive officers must also provide information for most changes in ownership
in a company's securities within two business days of the change.
The Act also increases the oversight of, and codifies certain
requirements relating to audit committees of public companies and how they
interact with the company's "registered public accounting firm" ("RPAF"). Audit
committee members must be independent and are barred from accepting consulting,
advisory or other compensatory fees from the issuer. In addition, companies must
disclose whether at least one member of the committee is a "financial expert" as
31
such term is defined by the SEC and if not, why not. Under the Act, a RPAF is
prohibited from performing statutorily mandated audit services for a company if
such company's chief executive officer, chief financial officer, comptroller,
chief accounting officer or any person serving in equivalent positions has been
employed by such firm and participated in the audit of such company during the
one-year period preceding the audit initiation date. The Act also prohibits any
officer or director of a company or any other person acting under their
direction from taking any action to fraudulently influence, coerce, manipulate
or mislead any independent public or certified accountant engaged in the audit
of the company's financial statements for the purpose of rendering the financial
statement's materially misleading. The Act also requires the SEC to prescribe
rules requiring inclusion of an internal control report and assessment by
management in the annual report to shareholders. The Act requires the RPAF that
issues the audit report to attest to and report on management's assessment of
the company's internal controls. In addition, the Act requires that each
financial report required to be prepared in accordance with (or reconciled to)
generally accepted accounting principles and filed with the SEC reflect all
material correcting adjustments that are identified by a RPAF in accordance with
generally accepted accounting principles and the rules and regulations of the
SEC.
REGULATION OF FEDERAL SAVINGS BANKS
As a federally insured savings bank, lending activities and other
investments of the Bank must comply with various statutory and regulatory
requirements. The Bank is regularly examined by the OTS and must file periodic
reports concerning its activities and financial condition.
Although the OTS is the Bank's primary regulator, the FDIC has "backup
enforcement authority" over the Bank. The Bank's eligible deposit accounts are
insured by the FDIC under the SAIF, up to applicable limits.
Federal Home Loan Banks. The Bank is a member of the FHLB System. Among
other benefits, FHLB membership provides the Bank with a central credit
facility. The Bank is required to own capital stock in a FHLB in an amount equal
to at least 1% of its aggregate unpaid residential mortgage loans, home purchase
contracts and similar obligations at the beginning of each calendar year or 5%
of its advances from the FHLB, whichever is greater.
Regulatory Capital Requirements. OTS capital regulations require
savings banks to satisfy minimum capital standards: risk-based capital
requirements, a leverage requirement, and a tangible capital requirement.
Savings banks must meet each of these standards in order to be deemed in
compliance with OTS capital requirements. In addition, the OTS may require a
savings association to maintain capital above the minimum capital levels.
All savings banks are required to meet a minimum risk-based capital
requirement of total capital (core capital plus supplementary capital) equal to
8% of risk-weighted assets (which includes the credit risk equivalents of
certain off-balance sheet items). In calculating total capital for purposes of
the risk-based requirement, supplementary capital may not exceed 100% of core
capital. Under the leverage requirement, a savings bank is required to maintain
core capital equal to a minimum of 3% of adjusted total assets. (In addition,
under the prompt corrective action
32
provisions of the OTS regulations, all but the most highly-rated institutions
must maintain a minimum leverage ratio of 4% in order to be adequately
capitalized.) A savings bank is also required to maintain tangible capital in an
amount at least equal to 1.5% of its adjusted total assets.
These capital requirements are viewed as minimum standards by the OTS,
and most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings associations, upon a determination that the savings
association's capital is or may become inadequate in view of its circumstances.
The OTS regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others: (1) a
savings association has a high degree of exposure to interest rate risk,
prepayment risk, credit risk, concentration of credit risk, certain risks
arising from nontraditional activities, or similar risks of a high proportion of
off-balance sheet risk; (2) a savings association is growing, either internally
or through acquisitions, at such a rate that supervisory problems are presented
that are not dealt with adequately by OTS regulations; and (3) a savings
association may be adversely affected by activities or condition of its holding
company, affiliates, subsidiaries or other persons or savings associations with
which it has significant business relationships. The Bank is not subject to any
such individual minimum regulatory capital requirement.
The Bank's tangible and core capital ratios were 8.42%, and its total
risk-based capital ratio was 14.0% at December 31, 2002. At such date, the Bank
was classified as a "well-capitalized" institution.
Certain Consequences of Failure to Comply with Regulatory Capital
Requirements. A savings bank's failure to maintain capital at or above the
minimum capital requirements may be deemed an unsafe and unsound practice and
may subject the savings bank to enforcement actions and other proceedings. Any
savings bank not in compliance with all of its capital requirements is required
to submit a capital plan that addresses the bank's need for additional capital
and meets certain additional requirements. While the capital plan is being
reviewed by the OTS, the savings bank must certify, among other things, that it
will not, without the approval of its appropriate OTS Regional Director, grow
beyond net interest credited or make capital