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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 1999 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-23605
CAVALRY BANCORP, INC.
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(Exact name of registrant as specified in its charter)
Tennessee 62-1721072
- ------------------------------- --------------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation I.D. Number)
or organization)
114 West College Street, Murfreesboro, Tennessee 37130
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, (615) 893-1234
including area code: --------------------
Securities registered pursuant None
to Section 12(b) of the Act: --------------------
Securities registered pursuant to Common Stock, no
Section 12(g) of the Act: par value 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
amendments to this Form 10-K. X
---
The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based on the closing sales price of the Registrant's Common
Stock as quoted on the NASDAQ National Market System under the symbol "CAVB" on
March 22, 2000, was $90,586,213 (7,104,801 shares at $12.75 per share). It is
assumed for purposes of this calculation that none of the Registrant's officers,
directors and 5% stockholders (including the Cavalry Banking Employee Stock
Ownership Plan) are affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of Annual Report to Stockholders for the Fiscal Year Ended
December 31, 1999 ("Annual Report") (Parts I and II).
2. Portions of Definitive Proxy Statement for the 2000 Annual Meeting of
Stockholders (Part III).
PART I
ITEM 1. BUSINESS
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GENERAL
Cavalry Bancorp, Inc. ("Company"), a Tennessee corporation, was organized
on November 5, 1997 for the purpose of becoming the holding company for Cavalry
Banking ("Bank") upon the Bank's conversion from a federally-chartered mutual to
a federally-chartered stock savings bank ("Conversion"). The Conversion was
completed on March 16, 1998. At December 31, 1999, the Company had total assets
of $395.4 million, total deposits of $308.9 million and shareholders' equity of
$38.8 million. The Company has not engaged in any significant activity other
than holding the stock of the Bank. Accordingly, the information set forth in
this report, including financial statement and related data, relates primarily
to the Bank.
The Bank is regulated by the Office of Thrift Supervision ("OTS"), its
primary regulator, and by the Federal Deposit Insurance Corporation ("FDIC"),
the insurer of its deposits. The Bank's deposits have been federally insured
since 1936 and are currently insured by the FDIC under the Savings Association
Insurance Fund ("SAIF"). The Bank has been a member of the Federal Home Loan
Bank ("FHLB") System since 1936.
The Bank is a community-oriented financial institution whose primary
business is attracting deposits from the general public and using those funds to
originate a variety of loans to individuals residing within its primary market
area, and to businesses owned and operated by such individuals. The Bank
originates both adjustable rate mortgage ("ARM") loans and fixed-rate mortgage
loans. Generally, ARM loans are retained in the Bank's portfolio and long-term
fixed-rate mortgage loans are originated for sale in the secondary market. In
addition, the Bank actively originates construction and acquisition and
development loans. The Bank also originates commercial real estate, commercial
business, and consumer and other non-real estate loans.
MARKET AREA
The Bank considers Rutherford, Bedford and Williamson Counties in Central
Tennessee to be its primary market area. A large number of the Bank's
depositors reside, and a substantial portion of its loan portfolio is secured by
properties located, in Rutherford and Bedford Counties.
The economy of Rutherford and Bedford Counties are diverse and generally
stable. According to the Rutherford and Bedford Area Chambers of Commerce,
major employers include Nissan Motor Manufacturing Corp. USA, Rutherford County
Government, Whirlpool Corp., Bridgestone/Firestone Inc., Middle Tennessee State
University, Alvin C. York Veterans Administration Medical Center and Ingram Book
Co., among others.
SELECTED FINANCIAL DATA
This information is incorporated by reference from pages 17 and 18 of the
1999 Annual Report to Stockholders ("Annual Report") included herein as Exhibit
13.
LENDING ACTIVITIES
GENERAL. At December 31, 1999, the Bank's total loans receivable portfolio
amounted to $276.7 million, or 70.0% of total assets at that date. The Bank has
traditionally concentrated its lending activities on conventional first mortgage
loans secured by one-to-four family properties, with such loans amounting to
$60.3 million, or 18.1% of the total loans receivable portfolio at December 31,
1999. In addition, the Bank originates construction loans, commercial real
estate loans, land loans, consumer loans and commercial business loans. A
substantial portion of the Bank's loan portfolio is secured by real estate,
either as primary or secondary collateral, located in its primary market area.
1
LOAN PORTFOLIO ANALYSIS. The following table sets forth the composition of
the Bank's loan portfolio by type of loan as of the dates indicated.
At December 31,
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1999 1998 1997 1996 1995
-------------- -------------- -------------- -------------- --------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
Mortgage Loans:
One-to-four
family(1) $60,261 18.1% $75,554 24.8% $82,930 32.9% $81,279 33.1% $72,302 36.4%
Multi-family 780 0.2 1,125 0.4 1,338 0.5 2,847 1.2 1,705 0.9
Commercial 71,419 21.4 52,516 17.2 39,690 15.8 30,099 12.3 22,140 11.1
Construction 69,421 20.9 84,900 27.9 54,666 21.7 61,032 24.9 47,416 23.9
Land acquisition
and Development 40,645 12.2 15,367 5.1 17,011 6.8 18,799 7.7 13,816 6.8
------- ---- ------ --- ------ --- ------ --- ------ ---
Total mortgage
loans 242,526 72.8 229,462 75.4 195,635 77.7 194,056 79.2 157,379 79.1
------- ---- ------- ---- ------- ---- ------- ---- ------- ----
Consumer Loans:
Home equity
lines of credit 4,788 1.4 3,790 1.2 2,783 1.1 1,964 0.8 941 0.5
Automobile 8,632 2.6 6,788 2.2 5,028 2.0 3,716 1.5 2,735 1.4
Unsecured 1,649 0.5 1,527 0.5 1,684 0.7 1,779 0.7 1,996 1.0
Other secured 38,809 11.7 32,792 10.8 23,852 9.5 23,037 9.4 20,982 10.6
------ ---- ------ ---- ------ --- ------ --- ------ ----
Total consumer
Loans 53,878 16.2 44,897 14.7 33,347 13.3 30,496 12.4 26,654 13.5
------ ---- ------ ---- ------ ---- ------ ---- ------ ----
Commercial
business loans 36,456 11.0 30,213 9.9 22,544 9.0 20,698 8.4 14,771 7.4
------ ---- ------ --- ------ --- ------ --- ------ ----
Total loans 332,860 100.0% 304,572 100.0% 251,526 100.0% 245,250 100.0% 198,804 100.0%
===== ===== ===== ===== =====
Less:
Undisbursed
portion of loans
in process 51,243 52,098 30,178 36,573 32,615
Net deferred
loan fees 785 773 710 701 560
Allowance for
loan losses 4,136 3,231 2,804 2,123 1,997
----- -------- -------- -------- --------
Total loans
receivable,
net $276,696 $248,470 $217,834 $205,853 $163,632
======== ======== ======== ======== ========
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(1) Includes loans held-for-sale.
ONE-TO-FOUR FAMILY REAL ESTATE LENDING. Historically, the Bank has
concentrated its lending activities on the origination of loans secured by first
mortgage loans on existing one-to-four family residences located in its primary
market area. At December 31, 1999, $60.3 million, or 18.1% of the Bank's total
loan portfolio, consisted of such loans. The Bank originated $121.2 million,
$159.3 million and $80.0 million of one-to-four family residential mortgage
loans during the years ended December 31, 1999, 1998 and 1997, respectively.
Generally, the Bank's fixed-rate one-to-four family mortgage loans have
maturities ranging from 15 to 30 years and are fully amortizing with monthly
payments sufficient to repay the total amount of the loan with interest by the
end of the loan term. Generally, they are originated under terms, conditions
and documentation which permit them to be sold to U.S. Government sponsored
agencies such as the Federal Home Loan Mortgage Corporation ("FHLMC"). The
Bank's fixed-rate loans customarily include "due on sale" clauses, which give
the Bank the right to declare a loan immediately due and payable in the event
the borrower sells or otherwise disposes of the real property subject to the
mortgage and the loan is not paid.
The Bank also originates ARM loans at rates and terms competitive with
market conditions. At December 31, 1999, $50.2 million, or 15.1% of the Bank's
gross loan portfolio, were subject to periodic interest rate adjustments. The
Bank originates for its portfolio ARM loans which provide for an interest rate
which adjusts every year or which is fixed for one, three or five years and then
adjusts every year after the initial period. Most of the Bank's one-year,
three-year and five-year ARMs adjust every year after the initial fixed rate
period based on the one year Treasury constant maturity index. The Bank's ARMs
are typically based on a 30-year amortization schedule. The Bank qualifies the
borrowers on its nonconforming ARM loans (i.e., loans not originated in
conformity with standards that would permit the loans to be sold in the
secondary market) based on the initial rate. The Bank qualifies the borrowers
on its conforming ARM loans based on the maximum note interest rate during the
second year of the loan. A one-year ARM loan that is originated according to
FHLMC secondary market standards may be converted to a fixed-rate loan within
five years of the origination date. ARM loans that are not saleable to the
FHLMC are not permitted to be converted to fixed rate loans. The Bank does not
offer deep discount or "teaser" rates. The Bank's current ARM loans do not
provide for negative amortization. The Bank's ARM loans generally provide for
annual and lifetime interest rate adjustment limits of 2% and 5% to 6%,
respectively.
Borrower demand for ARM loans versus fixed-rate mortgage loans is a
function of the level of interest rates, the expectations of changes in the
level of interest rates and the difference between the initial interest rates
and fees charged for each type of loan. The relative amount of fixed-rate
mortgage loans and ARM loans that can be originated at any time is largely
determined by the demand for each in a competitive environment.
The retention of ARM loans in the Bank's loan portfolio helps reduce the
Bank's exposure to changes in interest rates. There are, however,
unquantifiable credit risks resulting from the potential of increased costs due
to changed rates to be paid by the customer. It is possible that during periods
of rising interest rates the risk of default on ARM loans may increase as a
result of repricing and the increased payments required by the borrower. In
addition, although ARM loans allow the Bank to increase the sensitivity of its
asset base to changes in the interest rates, the extent of this interest
sensitivity is limited by the annual and lifetime interest rate adjustment
limits. Because of these considerations, the Bank has no assurance that yields
on ARM loans will be sufficient to offset increases in the Bank's cost of funds.
The Bank believes 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 the portfolio during a rising interest rate environment.
The Bank also originates one- to- four family mortgage loans under Federal
Housing Administration ("FHA") and Veterans Administration ("VA") programs and
the Tennessee Housing and Development Agency ("THDA"), an affordable housing
program. FHA and VA loans are generally sold to private investors, servicing
released (i.e., the right to collect principal and interest payments and forward
it to the purchaser of the loan, maintain escrow accounts for payment of taxes
and insurance and perform other loan administration functions is sold with the
loan). THDA loans are sold with servicing rights retained. See "-- Loan
Originations, Sales and Purchases."
The Bank generally requires title insurance insuring the status of its lien
or an acceptable attorney's opinion on all loans where real estate is the
primary source of security. The Bank also requires that fire and casualty
insurance (and, if appropriate, flood insurance) be maintained in an amount at
least equal to the outstanding loan balance.
The Bank's one- to- four family residential mortgage loans typically do not
exceed 80% of the appraised value of the security property. Pursuant to
underwriting guidelines adopted by the Bank's Board of Directors, the Bank can
lend up to 95% of the appraised value of the property securing a one- to- four
family residential loan; however, the Bank generally obtains private mortgage
insurance on the portion of the principal amount that exceeds 80% to 95% of the
appraised value of the security property.
2
CONSTRUCTION LENDING. The Bank actively originates three types of
residential construction loans: (i) speculative construction loans, (ii)
pre-sold construction loans and (iii) construction/permanent loans. To a
substantially lesser extent, the Bank also originates construction loans for the
development of multi-family and commercial properties.
At December 31, 1999, the composition of the Bank's construction loan portfolio
was as follows:
Outstanding Percent of
Balance(1) Total
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(In thousands)
Residential:
Speculative construction $35,270 50.81%
Pre-sold construction 12,110 17.44
Construction/permanent 9,313 13.42
Commercial and multi-family 12,728 18.33
------- ------
Total $ 69,421 100.00%
======== ======
____________________
(1) Includes loans in process.
Speculative construction loans are made to home builders and are termed
"speculative" because the home builder does not have, at the time of loan
origination, a signed contract with a home buyer who has a commitment for
permanent financing with either the Bank or another lender for the finished
home. The home buyer may be identified either during or after the construction
period, with the risk that the builder will have to pay debt service on the
speculative construction loan and finance real estate taxes and other carrying
costs of the completed home for a significant time after the completion of
construction until the home buyer is identified. The Bank lends to
approximately 130 local builders, many of whom may have only one or two
speculative loans outstanding from the Bank. The Bank considers approximately 25
builders as core borrowers with several speculative loans outstanding at any one
time. Rather than originating lines of credit to homebuilders to construct
several homes at once, the Bank originates and underwrites a separate loan for
each home. Speculative construction loans are originated for a term of 12
months, with interest rates ranging from 0.5% to 2.0% above the prime lending
rate, and with a loan-to-value ratio of no more than 80% of the appraised
estimated value of the completed property. At December 31, 1999, the Bank had
16 borrowers each with aggregate outstanding speculative loan balances of more
than $500,000, all of which were performing according to their respective terms
and the largest of which amounted to $1.2 million.
Unlike speculative construction loans, pre-sold construction loans are made
to home builders who, at the time of construction, have a signed contract with a
home buyer who has a commitment for permanent financing for the finished home
with the Bank or another lender. Pre-sold construction loans are generally
originated for a term of 12 months, with adjustable interest rates ranging from
0.5% to 1.0% above the prime lending rate, and with loan-to-value ratios of 80%
of the appraised estimated value of the completed property or cost, whichever is
less. At December 31, 1999, the largest outstanding pre-sold construction loan
had an outstanding balance of $520,000 and was performing according to its
terms.
Construction/permanent loans are originated to the homeowner rather than
the homebuilder. The construction phase of a construction/permanent loan
generally lasts 12 months and the interest rate charged is generally 7.25% to
8.25%, fixed, and with loan-to-value ratios of 80% (or up to 95% with private
mortgage insurance) of the appraised estimated value of the completed property
or cost, whichever is less. At the completion of construction, the Bank may
either originate a fixed-rate mortgage loan or an ARM loan. See "-- Lending
Activities -- One- to- Four Family Real Estate Lending." At December 31, 1999,
the largest outstanding construction/permanent loan had an outstanding balance
of $448,000 and was performing according to its terms.
To a lesser extent, the Bank also provides construction financing for
non-residential properties (i.e., multi-family and commercial properties). At
December 31, 1999, such construction loans amounted to $12.7 million.
3
Construction loans up to $1,000,000 may be approved by combining the
lending authority of loan officers up to the required level. The maximum
lending authority for any one loan officer is $500,000. The level of each
individual loan officer s lending authority is reviewed and approved annually.
All construction loans over $1,000,000 must be approved by the Board of
Directors. See "-- Loan Solicitation and Processing." Prior to preliminary
approval of any construction loan application, an appraiser approved by the
Board of Directors inspects the site and the Bank reviews the existing or
proposed improvements, identifies the market for the proposed project, analyzes
the pro forma data and assumptions on the project. In the case of a speculative
or pre-sold construction loan, the Bank reviews the experience and expertise of
the builder. After preliminary approval has been given, the application is
processed, which includes obtaining credit reports, financial statements and tax
returns on the borrowers and guarantors, an independent appraisal of the
project, and any other expert reports necessary to evaluate the proposed
project. In the event of cost overruns, the Bank requires that the borrower use
its own funds to maintain the original loan-to-value ratio.
The construction loan documents require that construction loan proceeds be
disbursed in increments as construction progresses. Disbursements are based on
periodic on-site inspections by an appraiser and/or Bank personnel approved by
the Board of Directors. The Bank regularly monitors the construction loan
portfolio and the economic conditions and housing inventory. Property
inspections are performed by the Bank's property inspector. The Bank believes
that the internal monitoring system helps reduce many of the risks inherent in
its construction lending.
Construction lending affords the Bank the opportunity to achieve higher
interest rates and fees with shorter terms to maturity than does its
single-family permanent mortgage lending. Construction lending, however, is
generally considered to involve a higher degree of risk than single-family
permanent mortgage lending because of the inherent difficulty in estimating both
a property's value at completion of the project and the estimated cost of the
project. The nature of these loans is such that they are generally more
difficult to evaluate and monitor. If the estimate of construction cost proves
to be inaccurate, the Bank may be required to advance funds beyond the amount
originally committed to permit completion of the project. If the estimate of
value upon completion proves to be inaccurate, the Bank may be confronted with a
project whose value is insufficient to assure full repayment. Projects may also
be jeopardized by disagreements between borrowers and builders and by the
failure of builders to pay subcontractors. Loans to builders to construct homes
for which no purchaser has been identified carry more risk because the payoff
for the loan depends on the builder's ability to sell the property prior to the
time that the construction loan is due. The Bank has sought to address these
risks by adhering to strict underwriting policies, disbursement procedures, and
monitoring practices. In addition, because the Bank's construction lending is
in its primary market area, changes in the local economy and real estate market
could adversely affect the Bank's construction loan portfolio.
ACQUISITION AND DEVELOPMENT LENDING. The Bank originates acquisition and
development loans for the purpose of developing the land (i.e., installing
roads, sewers, water and other utilities) for sale for residential housing
construction. At December 31, 1999, the Bank had land A&D loans with aggregate
approved commitments of $40.6 million, of which an aggregate of $23.0 million
was outstanding. At December 31, 1999, the largest land A&D loan had an
outstanding balance of $1.9 million and was performing according to its terms.
All of the land A&D loans are secured by properties located in the Bank's
primary market area.
Land A&D loans are usually repaid through the sale of the developed land.
However, the Bank believes that its land A&D loans are made to individuals with,
or to corporations the principals of which possess, sufficient personal
financial resources out of which the loans could be repaid, if necessary.
Land A&D loans are secured by a lien on the property, made for a two year
term, and with an interest rate that adjusts with the prime rate. The Bank
requires monthly interest payments during the term of the land A&D loan. After
the expiration of the two year term, the loan is reevaluated, adjusted and/or
extended as a fixed or adjustable rate loan. In addition, the Bank generally
obtains personal guarantees from the principals of its corporate borrowers. At
December 31, 1999, the Bank did not have any nonaccruing land A&D loans.
4
Loans secured by undeveloped land or improved lots involve greater risks
than one- to- four family residential mortgage loans because such loans are more
difficult to monitor and foreclose as the Bank may be confronted with a property
the value of which is insufficient to assure full repayment. Furthermore, if
the borrower defaults the Bank may have to expend its own funds to complete
development and also incur costs associated with marketing and holding the
building lots pending sale. Land A&D loans are generally considered to involve
a higher degree of risk than single-family permanent mortgage loans because of
the concentration of principal among relatively few borrowers and development
projects, the increased difficulty at the time the loan is originated of
estimating the development building costs, the increased difficulty and costs of
monitoring the loan, the higher degree of sensitivity to increases in market
rates of interest, and the increased difficulty of working out problem loans. A
concentration of loans secured by properties in any single area presents the
risk that any adverse change in regional economic or employment conditions may
result in increased delinquencies and loan losses. The Bank attempts to
minimize this risk by limiting the maximum loan-to-value ratio on acquisition
and development loans to 75%, although the Board of Directors has the authority
to approve acquisition and development loans with loan-to-value ratios of up to
80%.
COMMERCIAL REAL ESTATE LENDING. The Bank originates mortgage loans for the
acquisition and refinancing of commercial real estate properties. At December
31, 1999, $71.4 million, or 21.4% of the Bank's total loan portfolio, consisted
of loans secured by existing commercial real estate properties. The majority of
the Bank's commercial real estate properties are secured by small businesses,
retail properties and churches located in the Bank's primary market area.
The Bank requires an evaluation of all properties securing commercial real
estate loans which are $250,000 and less. Evaluations are performed by the
Bank's commercial loan officers or in-house appraiser, an outside fee appraiser,
or an employee of the Bank designated by the Board of Directors. Appraisals are
required for all properties securing commercial real estate loans in excess of
$250,000. Appraisals are performed by an independent appraiser designated by
the Bank and are reviewed by management. The Bank considers the quality and
location of the real estate, the credit of the borrower, the cash flow of the
project and the quality of management involved with the property.
The average size of a commercial real estate loan in the Bank's portfolio
is approximately $100,000 to $200,000. Commercial real estate loans are
generally structured with fixed rates of interest and terms of three to five
years based on amortization schedules of 15 to 20 years. At December 31, 1999,
the largest commercial real estate loan had an outstanding balance of $2.4
million.
Loan-to-value ratios on the Bank's commercial real estate loans are
generally limited to 80%. As part of the criteria for underwriting commercial
real estate loans, the Bank generally imposes a debt coverage ratio (the ratio
of net cash from operations before payment of debt service to debt service) of
not less than 1.2 times. Generally, it is also the Bank's policy to obtain
personal guarantees from the principals of its corporate borrowers on its
commercial real estate loans.
Commercial real estate lending affords the Bank an opportunity to receive
interest at rates higher than those generally available from one- to- four
family residential lending. However, loans secured by such properties usually
are greater in amount, more difficult to evaluate and monitor and, therefore,
involve a greater degree of risk than one- to- four family residential mortgage
loans. Because payments on loans secured by multi-family and commercial
properties are often dependent on the successful operation and management of the
properties, repayment of such loans may be affected by adverse conditions in the
real estate market or the economy. The Bank seeks to minimize these risks by
limiting the maximum loan-to-value ratio to 80% and strictly scrutinizing the
financial condition of the borrower, the quality of the collateral and the
management of the property securing the loan. The Bank also obtains loan
guarantees from financially capable parties based on a review of personal
financial statements.
COMMERCIAL BUSINESS LENDING. The Bank's commercial business lending
activities focuses primarily on small to medium size businesses owned by
individuals well known to the Bank and who reside in the Bank's primary market
area. At December 31, 1999, commercial business loans amounted to $36.5
million, or 11.0% of total loans.
5
Commercial business loans may be unsecured loans, but generally are secured
by various types of business collateral other than real estate (i.e., inventory,
equipment, etc.). In many instances, however, such loans are often also secured
by junior liens on real estate. Commercial business loans are generally made in
amounts between $50,000 to $75,000 and may be either lines of credit or term
loans. Lines of credit are generally renewable and made for a one-year term.
Lines of credit are generally variable rate loans indexed to the prime rate.
Term loans are generally originated with three to five year maturities, with a
maximum of seven years, on a fully amortizing basis. As with commercial real
estate loans, the Bank generally requires annual financial statements from its
commercial business borrowers and, if the borrower is a corporation, personal
guarantees from the principals.
At December 31, 1999, the largest commercial business loan to an
unaffiliated borrower was a $1.0 million line of credit secured by marketable
equity securities, with an outstanding balance of $205,000 at that date. At
December 31, 1999, the largest commercial business loan with an outstanding
balance had a balance of $503,000 and was secured by equipment and real estate.
Such loans were performing according to their terms at December 31, 1999.
Commercial business lending generally involves greater risk than
residential mortgage lending and involves risks that are different from those
associated with residential, commercial and multi-family real estate lending.
Real estate lending is generally considered to be collateral based lending with
loan amounts based on predetermined loan to collateral values and liquidation of
the underlying real estate collateral is viewed as the primary source of
repayment in the event of borrower default. Although commercial business loans
are often collateralized by equipment, inventory, accounts receivable or other
business assets, the liquidation of collateral in the event of a borrower
default is often not a sufficient source of repayment because accounts
receivable may be uncollectible and inventories and equipment may be obsolete or
of limited use, among other things. Accordingly, the repayment of a commercial
business loan depends primarily on the creditworthiness of the borrower (and any
guarantors), while liquidation of collateral is a secondary and often
insufficient source of repayment.
As part of its commercial business lending activities, the Bank issues
standby letters of credit or performance bonds as an accommodation to its
borrowers. See "-- Loan Commitments and Letters of Credit."
CONSUMER LENDING. The Bank originates a variety of consumer loans that
generally have shorter terms to maturity and higher interest rates than
residential mortgage loans. At December 31, 1999, the Bank's consumer loans
totaled $53.9 million, or 16.2%, of the Bank's loans receivable. The Bank's
consumer loans consist primarily of home equity lines of credit, automobile
loans, and a variety of other secured loans, a substantial portion of which are
secured by junior mortgages on real estate. To a substantially lesser extent,
the Bank also originates unsecured consumer loans.
The Bank anticipates that it will continue to be an active originator of
consumer loans. Factors that may affect the ability of the Bank to increase its
originations in this area include the demand for such loans, interest rates and
the state of the local and national economy. Consumer loans accounted for
12.3%, 12.8% and 11.9% of the Bank's total loan originations in the fiscal years
ended December 31, 1999, 1998 and 1997, respectively.
The Bank offers open-ended home equity lines of credit secured by a second
mortgage on the borrower's primary residence. These lines of credit have an
interest rate that is one to two percentage points above the prime lending rate,
as published in The Wall Street Journal, which adjusts monthly. The majority of
the approved lines of credit at December 31, 1999 were less than $50,000. At
December 31, 1999, approved lines of credit totaled $7.1 million, of which $4.8
million was outstanding.
At December 31, 1999, the Bank's automobile loan portfolio amounted to $8.6
million, or 2.6%, of total loans at such date, a substantial portion of which
were secured by used automobiles. The maximum term for the Bank's automobile
loans is 60 months. The Bank generally lends up to 80% to 90% of the purchase
price of the automobile. The Bank requires all borrowers to maintain automobile
insurance, including collision, fire and theft, with a maximum allowable
deductible and with the Bank listed as loss payee. The Bank does not engage in
indirect automobile lending.
6
The Bank's consumer loan portfolio also includes other consumer loans
secured by a variety of collateral, such as recreational vehicles, boats,
motorcycles, deposit accounts and, in many instances, junior mortgages on real
estate. Such other secured consumer loans were $38.8 million, or 11.7% of total
loans, at December 31, 1999.
At December 31, 1999, unsecured consumer loans amounted to $1.6 million, or
0.5% of total loans. Unsecured loans are made for a term up to 24 months with
fixed rates of interest and are offered primarily to existing customers of the
Bank. Included in the unsecured consumer loan portfolio are credit card loans
with an aggregate outstanding balance of $497,000 at December 31, 1999.
Approved credit card lines totaled $1.8 million at December 31, 1999. The Bank
is a VISA and MASTERCARD card issuer. The Bank does not actively solicit credit
card business beyond its customer base and market area and has not engaged in
mailing of pre-approved credit cards. The rate currently charged by the Bank on
its credit card loans is the prime rate, as published in The Wall Street
Journal, plus 6.9%, and the Bank is permitted to change the interest rate
monthly.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of loans that are unsecured or secured by rapidly
depreciating assets such as automobiles and other vehicles. In such cases, any
repossessed collateral for a defaulted consumer loan may not provide an adequate
source of repayment of the outstanding loan balance as a result of the greater
likelihood of damage, loss or depreciation. The remaining deficiency often does
not warrant further substantial collection efforts against the borrower beyond
obtaining a deficiency judgment. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability, and thus are more
likely to be adversely affected by job loss, divorce, illness or personal
bankruptcy. Furthermore, the application of various federal and state laws,
including federal and state bankruptcy and insolvency laws, may limit the amount
that can be recovered on such loans. At December 31, 1999, the Bank had $5,000
of consumer loans accounted for on a nonaccrual basis.
MATURITY OF LOAN PORTFOLIO. The following table sets forth certain
information at December 31, 1999 regarding the dollar amount of loans maturing
in the Bank's portfolio based on their contractual terms to maturity, but does
not include scheduled payments or potential prepayments. Demand loans, loans
having no stated schedule of repayments and no stated maturity, and overdrafts
are reported as due in one year or less. Loan balances do not include
undisbursed loan proceeds and do not reflect the deduction for unearned
discounts, unearned income and allowance for loan losses.
After After
One Year 3 Years 5 Years
Within Through Through Through After
One Year 3 Years 5 Years 10 Years 10 Years Total
-------- ------- ------- -------- ------- -------
(In thousands)
Mortgage loans:
Residential $ 4,824 $ 4,106 $ 3,759 $ 9,799 $39,851 $ 62,339
Construction 46,249 12,484 - - 86 58,819
Commercial 17,330 15,300 31,813 5,362 277 70,082
Consumer and other loans 11,886 17,993 21,438 2,540 63 53,920
Commercial business loans 21,227 7,842 6,080 618 690 36,457
------ ------ ------ ---- ------ ------
Total $101,516 $57,725 $63,090 $18,319 $40,967 $281,617
======== ======= ======= ======= ======= ========
7
The following table sets forth the dollar amount of all loans due after
December 31, 2000, which have fixed interest rates and have floating or
adjustable interest rates.
Fixed Floating or
Rates Adjustable Rates
------- -----------------
(In thousands)
Mortgage loans:
Residential $7,808 $49,707
Construction - 12,570
Commercial 52,225 527
Consumer and other loans 37,105 4,929
Commercial business loans 14,483 747
------ ------
Total $111,621 $68,480
======== =======
Scheduled contractual principal repayments of loans do not reflect the
actual life of such assets. The average life of a loan is substantially less
than its contractual terms because of prepayments. In addition, due-on-sale
clauses on loans generally give the Bank the right to declare loans 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, however, when current mortgage loan
market rates are substantially higher than rates on existing mortgage loans and,
conversely, decrease when rates on existing mortgage loans are substantially
higher than current mortgage loan market rates. Furthermore, management
believes that a significant number of the Bank's residential mortgage loans are
outstanding for a period less than their contractual terms because of the
transitory nature of many of the borrowers who reside in its primary market
area.
LOAN SOLICITATION AND PROCESSING. The Bank's lending activities are
subject to the written, non-discriminatory, underwriting standards and loan
origination procedures established by the Bank's Board of Directors and
management. Loan originations come from a number of sources. The customary
sources of loan originations are realtors, walk-in customers, referrals and
existing customers. A business development program has been implemented where
loan officers and sales personnel make sales calls on building contractors and
realtors. The Bank also advertises its loan products.
In marketing its products and services, the Bank emphasizes its community
ties, customized personal service and an efficient underwriting and approval
process. The Bank uses professional fee appraisers for most residential real
estate loans and construction loans and all commercial real estate and land
loans. The Bank requires hazard, title and, to the extent applicable, flood
insurance on all security property.
Loan approval authority varies based on loan type. Construction loans and
acquisition and development loans up to $1,000,000 may be approved by any
combining the lending authority of loan officers up to the required level. The
maximum lending authority for any one loan officer is $500,000. The level of
each individual loan officers lending authority is reviewed and approved
annually by the Board of Directors. Loans over $1,000,000 must be approved by
the Board of Directors. One- to- four family residential loans up to $500,000
originated to be held in portfolio may be approved by any two members of the
Loan Committee, while loans over $1,000,000 must be approved by the Board of
Directors. One- to- four family residential mortgage loans that are originated
for sale to investors and that are underwritten to the investor's specifications
may be approved by any member of the Loan Committee up to FHLMC loan limits.
Consumer and commercial business loans may be approved by loan officers
individually or in combination with other loan officers within dollar limits
specified by the Loan Committee. These dollar limits range from $5,000 to
$50,000 for unsecured loans and from $15,000 to $1,000,000 for secured loans.
The maximum approval authority for an individual loan officer is $250,000 for
unsecured loans and $500,000 for secured loans. All unsecured consumer and
commercial business loans over $250,000, and all secured consumer and commercial
business loans over $1,000,000, must be approved by the Board of Directors.
Each approved loan, regardless of type, is reviewed by the Bank's quality
control personnel to insure that proper approval was received.
8
LOAN ORIGINATIONS, SALES AND PURCHASES. While the Bank originates both
adjustable-rate and fixed-rate loans, its ability to generate each type of loan
depends upon relative customer demand for loans in its primary market area.
The Bank sells all loans originated under FHA and VA programs, including
related servicing rights, including those originated for the THDA. The Bank
periodically sells conventional one-to-four family loans (i.e., non-FHA/VA
loans) with servicing retained and without recourse. These sales generally
involve fixed-rate loans which help to reduce the Bank's exposure to interest
rate risk, and the proceeds of sale are used to fund continuing operations.
However, the Bank occasionally may sell ARM loans to satisfy liquidity needs.
Sellers of loans are exposed to various degrees of "pipeline risk," which
is the risk that the value of the loan will decline during the period between
the time the loan is originated and the time of sale because of changes in
market interest rates. The Bank is exposed to a relatively low degree of
pipeline risk because it generally does not fix the loan interest rate until
shortly before or on the closing date and loans are generally closed against a
mandatory purchase commitment by the FHLMC or other purchaser.
When conventional loans are sold, the Bank retains the responsibility for
servicing the loans, including collection and remitting mortgage loan payments,
accounting for principal and interest and holding and disbursing escrow or
impound funds for real estate taxes and insurance premiums. The Bank receives a
servicing fee for performing these services for others. The Bank's servicing
portfolio amounted to $124.1 million at December 31, 1999. The Bank is
generally paid a fee equal to 0.25% of the outstanding principal balance for
servicing sold loans. Loan servicing income totaled $112,000, $264,000 and
$387,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
The Bank earns late charges collected from delinquent customers whose loans are
serviced by the Bank. The Bank is allowed to invest escrow impounds (funds
collected from mortgage customers for the payment of property taxes and
insurance premiums on mortgaged real estate) until they are disbursed on behalf
of mortgage customers, but is not required to pay interest on these funds. At
December 31, 1999, borrowers' escrow funds amounted to $178,000.
Historically, the Bank has not been an active purchaser of loans or
participation interests in loans.
The following table sets forth total loans originated, purchased, sold and
repaid during the periods indicated.
Year Ended December 31,
--------------------------------
1999 1998 1997
---- ---- ----
(In thousands)
Loans originated:
Mortgage loans:
One- to- four family $121,159 $159,259 $ 80,021
Multi-family 2,350 - -
Commercial 21,403 19,118 9,086
Construction 87,956 80,150 74,122
Land 34,964 11,624 3,091
Consumer 46,043 49,253 28,649
Commercial business loans 59,556 65,046 46,436
------- -------- --------
Total loans originated 373,431 384,450 241,405
Loans purchased:
One- to- four family - - -
-------- ------- -------
Total loans originated and purchased 373,431 384,450 241,405
(table continued on following page)
9
Year Ended December 31,
--------------------------------
1999 1998 1997
---- ---- ----
(In thousands)
Loans sold:
Whole loans sold (121,735) (120,761) (70,511)
--------- --------- --------
Total loans sold (121,735) (120,761) (70,511)
Mortgage loan principal repayments (84,602) (115,563) (92,500)
Other loan principal repayments (138,930) (95,080) (70,388)
Increase (decrease) in other items, net 62 (22,410) 3,975
--------- ------- -------
Net increase (decrease) in loans, net $28,226 $30,636 $11,981
======= ======= =======
LOAN COMMITMENTS AND LETTERS OF CREDIT. The Bank issues commitments for
mortgage loans conditioned upon the occurrence of certain events. Such
commitments are made in writing on specified terms and conditions and are
honored for up to 45 days from approval, depending on the type of transaction.
At December 31, 1999, the Bank had no loan commitments (excluding undisbursed
portions of interim construction loans of $51.2 million) and unused lines of
credit of $36.4 million. See Note 18 of Notes to the Consolidated Financial
Statements contained in the Annual Report.
As an accommodation to its commercial business borrowers, the Bank issues
standby letters of credit or performance bonds in favor of entities, usually
municipalities, for whom the Bank's borrowers are performing work or other
services. At December 31, 1999, the Bank had outstanding standby letters of
credit of $7.5 million that were issued primarily to municipalities as
performance bonds. See Note 18 of Notes to the Consolidated Financial
Statements contained in the Annual Report.
LOAN FEES. In addition to interest earned on loans, the Bank receives
income from fees in connection with loan originations, loan modifications, late
payments and for miscellaneous services related to its loan. Income from these
activities varies from period to period depending upon the volume and type of
loans made and competitive conditions.
The Bank charges loan origination fees which are calculated as a percentage
of the amount borrowed. In accordance with applicable accounting procedures,
loan origination fees and discount points in excess of loan origination costs
are deferred and recognized over the contractual remaining lives of the related
loans on a level yield basis. Discounts and premiums on loans purchased are
accreted and amortized in the same manner. The Bank recognized $1.0 million,
$1.2 million and $1.1 million of deferred loan fees during the years ended
December 31, 1999, 1998 and 1997, respectively, in connection with loan
refinancings, payoffs, sales and ongoing amortization of outstanding loans.
The Bank also earns fee income on loans serviced for others. Loan
servicing fees for the year ended December 31, 1999 and 1998 amounted to
$112,000 and $264,000, respectively. At December 31, 1999, the Bank serviced
loans for others totaling $124.1 million. See Note 5 of Notes to the
Consolidated Financial Statements contained in the Annual Report.
NON-PERFORMING ASSETS AND DELINQUENCIES. 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 the payment. Contacts are generally made
ten days after a payment is due. In most cases, deficiencies are cured
promptly. If a delinquency continues, additional contact is made either through
a notice or other means and the Bank will attempt to work out a payment
schedule. While the Bank generally prefers to work with borrowers to resolve
such problems, the Bank will institute foreclosure or other proceedings, as
necessary, to minimize any potential loss.
10
Loans are placed on non-accrual status generally if, in the opinion of
management, principal or interest payments are not likely in accordance with the
terms of the loan agreement, or when principal or interest is past due 90 days
or more. Interest accrued but not collected at the date the loan is placed on
non-accrual status is reversed against income in the current period. Loans may
be reinstated to accrual status when payments are under 90 days past due and, in
the opinion of management, collection of the remaining past due balances can be
reasonably expected.
The Bank's Board of Directors is informed monthly of the status of all
loans delinquent more than 60 days, all loans in foreclosure and all foreclosed
and repossessed property owned by the Bank.
The following table sets forth information with respect to the Bank's
non-performing assets at the dates indicated.
At December 31,
-------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in thousands)
Loans accounted for on a
non-accrual basis:
Mortgage loans:
One- to- four family $328 $74 $ 73 $ 9 $ 37
Construction - - 68 - -
Commercial - - - - -
Consumer loans (automobile) - 32 9 42 70
Other 5 1 - - -
----- ---- ---- ---- ----
Total 333 107 150 51 107
Accruing loans which are
contractually past due 90 days
or more - 66 98 - -
- - - - -
Total of nonaccrual and 90 days
past due loans 333 173 248 51 107
Real estate owned 117 80 - - -
Other repossessed assets 49 - - - -
---- ---- ---- ---- ----
Total nonperforming assets $499 $253 $248 $ 51 $107
==== ==== ==== ===== ====
Restructured loans $ - $ - $ - $ - $ -
==== ==== ==== ===== ====
Nonaccrual and 90 days or more past
due loans as a percentage of loans
receivable, net 0.12% 0.07% 0.11% 0.02% 0.07%
Nonaccrual and 90 days or more past
Due loans as a percentage of total
assets 0.08% 0.05% 0.09% 0.02% 0.05%
Nonperforming assets as a percentage
of total assets 0.13% 0.07% 0.09% 0.02% 0.05%
Interest income that would have been recorded for the year ended December
31, 1999 had non-accruing loans been current in accordance with their original
terms would have amounted to $20,300. No interest was included in interest
income on such loans for the year ended December 31, 1999.
11
REAL ESTATE OWNED. See Note 1 of Notes to the Consolidated Financial
Statements contained in the Annual Report for a discussion of the accounting
treatment of real estate owned. At December 31, 1999, the Bank had 2 properties
in real estate owned which consisted of two single family residences.
RESTRUCTURED LOANS. Under GAAP, the Bank is required to account for
certain loan modifications or restructuring as a "troubled debt restructuring."
In general, the modification or restructuring of a debt constitutes a troubled
debt restructuring if the Bank for economic or legal reasons related to the
borrower's financial difficulties grants a concession to the borrowers that the
Bank would not otherwise consider. Debt restructurings or loan modifications
for a borrower do not necessarily always constitute troubled debt
restructurings, however, and troubled debt restructurings do not necessarily
result in non-accrual loans. The Bank did not have any restructured loans at
December 31, 1999.
ASSET CLASSIFICATION. The OTS has adopted various regulations regarding
problem assets of savings institutions. The regulations require that each
insured institution review and classify its assets on a regular basis. In
addition, in connection with examinations of insured institutions, OTS examiners
have authority to identify problem assets and, if appropriate, require them to
be classified. There are three classifications for problem assets:
substandard, doubtful and loss. Substandard assets have one or more defined
weaknesses and are characterized by the distinct possibility that the insured
institution will sustain some loss if the deficiencies are not corrected.
Doubtful assets have the weaknesses of substandard assets with the additional
characteristic that the weaknesses make collection or liquidation in full on the
basis of currently existing facts, conditions and values questionable, and there
is a high possibility of loss. An asset classified as loss is considered
uncollectible and of such little value that continuance as an asset of the
institution is not warranted. If an asset or portion thereof is classified as
loss, the insured institution establishes specific allowances for loan losses
for the full amount of the portion of the asset classified as loss. All or a
portion of general loan loss allowances established to cover possible losses
related to assets classified substandard or doubtful can be included in
determining an institution's regulatory capital, while specific valuation
allowances for loan losses generally do not qualify as regulatory capital.
Assets that do not currently expose the insured institution to sufficient risk
to warrant classification in one of the aforementioned categories but possess
weaknesses are designated "special mention" and monitored by the Bank.
The aggregate amounts of the Bank's classified and special mention assets
were as follows:
At December 31,
------------------
1999 1998
---- ----
(In thousands)
Loss $ - $ -
Doubtful 74 8
Substandard assets 3,553 1,411
Special mention 162 -
At December 31, 1999, substandard assets consisted of six repossessed
assets totaling $166,000, ten one-to-four family mortgage loans totaling
$670,000, fifty consumer loans totaling $471,000, and eight commercial loans
totaling $2.2 million. Doubtful loans consisted of three consumer loans of
$24,000 and four commercial loans totaling $50,000. See Note 5 to the
Consolidated Financial Statements contained in the Annual Report for further
discussion.
ALLOWANCE FOR LOAN LOSSES. The Bank has established a systematic
methodology for the determination of provisions for loan losses. The
methodology is set forth in a formal policy and takes into consideration the
need for an overall general valuation allowance as well as specific allowances
that are tied to individual loans.
12
In originating loans, the Bank recognizes that losses will be experienced
and that the risk of loss will vary with, among other things, the type of loan
being made, the creditworthiness of the borrower over the term of the loan,
general economic conditions and, in the case of a secured loan, the quality of
the security for the loan. The Bank increases its allowance for loan losses by
charging provisions for loan losses against the Bank's income.
The general valuation allowance is maintained to cover losses inherent in
the loan portfolio. Management's periodic evaluation of the adequacy of the
allowance is based on the Bank's past loan loss experience, known and inherent
risks in the portfolio, adverse situations that may affect the borrower's
ability to repay, the estimated value of any underlying collateral, and current
economic conditions. Specific valuation allowances are established to absorb
losses on loans for which full collectibility cannot be reasonably assured. The
amount of the allowance is based on the estimated value of the collateral
securing the loan and other analyses pertinent to each situation. Generally, a
provision for losses is charged against income quarterly to maintain the
allowances.
At December 31, 1999, the Bank had an allowance for loan losses of $4.1
million. Management believes that the amount maintained in the allowances at
December 31, 1999 will be adequate to absorb losses inherent in the portfolio.
Although management believes that it uses the best information available to make
such determinations, future adjustments to the allowance for loan losses may be
necessary and results of operations could be significantly and adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations. Furthermore, while the Bank believes it has
established its existing allowance for loan losses in accordance with GAAP,
there can be no assurance that regulators, in reviewing the Bank's loan
portfolio, will not request the Bank to increase significantly its allowance for
loan losses. In addition, because future events affecting borrowers and
collateral cannot be predicted with certainty, there can be no assurance that
the existing allowance for loan losses is adequate or that substantial increases
will not be necessary should the quality of any loans deteriorate as a result of
the factors discussed above. Any material increase in the allowance for loan
losses may adversely affect the Bank's financial condition and results of
operations.
13
The following table sets forth an analysis of the Bank's gross allowance
for possible loan losses for the periods indicated.
Year Ended December 31,
-----------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in thousands)
Allowance at beginning of period $3,231 $2,804 $2,123 $1,997 $1,776
Provision for loan losses 991 452 700 120 80
Recoveries:
Mortgage loans:
One- to- four family - - - 14 8
Multi-family - - - - 68
Commercial - - - 1 101
Construction - - - - 3
Consumer loans:
Automobiles 13 8 23 - -
Unsecured - - 5 191 -
Other - 21 1 12 12
Commercial business loans 3 - 1 - -
----- ----- ---- ---- ----
Total recoveries 16 29 30 218 192
Charge-offs:
Mortgage loans:
One- to- four family 5 - - 10 -
Construction - - - - 6
Consumer loans:
Home equity lines of credit - - - - -
Automobile 35 16 40 - 4
Credit card 3 5 1 - -
Unsecured 9 - - 196 -
Other 47 33 5 6 34
Commercial business loans 3 - 3 - 7
---- ---- ---- ---- ----
Total charge-offs 102 54 49 212 51
---- ---- ---- ---- ----
Net recoveries (charge-offs) (86) (25) (19) 6 141
---- ---- ---- ---- ----
Allowance at end of period $4,136 $3,231 $2,804 $2,123 $1,997
====== ====== ====== ====== =====
Allowance for loan losses as a
percentage of total loans outstanding
at the end of the period 1.24% 1.06% 1.11% 0.87% 1.00%
Net (charge-offs)recoveries as a
percentage of average loans
outstanding during the period (0.03)% (0.01)% (0.01)% -% 0.09%
Allowance for loan losses as a
percentage of nonperforming loans
at end of period 1,242.04% 3,019.63% 1,130.65% 4,162.75% 1,866.36%
14
The following table sets forth the breakdown of the allowance for loan
losses by loan category at the dates indicated. Management believes that the
allowance can be allocated by category only on an approximate basis. The
allocation of the allowance to each category is not necessarily indicative of
future losses and does not restrict the use of the allowance to absorb losses in
any other category.
At December 31,
--------------------------------------------------------------------
1999 1998 1997 1996 1995
------------ ------------- ------------- ------------ ----------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Category in Category in Category in Category in Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Mortgage loans:
One-to-four family $ 301 18.1% $ 378 24.8% $415 32.9% $122 33.1% $108 36.4%
Multi-family 4 0.2 6 0.4 20 0.5 4 1.2 3 0.9
Commercial 1,101 21.4 788 17.2 595 15.8 301 12.3 221 11.1
Construction 740 20.9 492 27.9 367 21.7 245 24.9 148 23.9
Land. 346 12.2 231 5.1 255 6.8 188 7.7 138 6.8
Consumer loans:
Home equity
lines of credit 72 1.4 57 1.2 42 1.1 25 0.8 9 0.5
Automobile 129 2.6 102 2.2 75 2.0 46 1.5 27 1.4
Credit cards 74 0.1 6 0.1 3 0.1 - - - -
Loans secured by
deposit accounts - 0.6 - - - - - - 1 -
Unsecured 17 0.4 17 0.4 22 0.6 22 0.7 20 1.0
Other secured 582 11.1 453 10.8 358 9.5 288 9.4 209 10.6
Commercial business
loans 547 11.0 338 9.9 338 9.0 259 8.4 148 7.4
Unallocated 223 N/A 363 N/A 314 N/A 623 N/A 965 N/A
---- ---- --- --- --- --- --- --- --- ---
Total allowance
for loan losses $4,136 100.0% $3,231 100.0% $2,804 100.0% $2,123 100.0% $1,997 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
15
INVESTMENT ACTIVITIES
The Bank is permitted under federal law to invest in various types of
liquid assets, including U.S. Treasury obligations, securities of various
federal agencies and of state and municipal governments, deposits at the
FHLB-Cincinnati, certificates of deposit of federally insured institutions,
certain bankers' acceptances and federal funds. Subject to various
restrictions, the Bank may also invest a portion of its assets in commercial
paper and corporate debt securities. Savings institutions like the Bank are
also required to maintain an investment in FHLB stock. The Bank is required
under federal regulations to maintain a minimum amount of liquid assets. See
"Regulation" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources," contained in the
Annual Report.
The Bank purchases investment securities with excess liquidity arising when
investable funds exceed loan demand. The Bank's investment securities purchases
generally have been limited to U.S. Government and agency securities with
contractual maturities of between one and five years.
The Bank's investment policies generally limit investments to U.S.
Government and agency securities, municipal bonds, certificates of deposits,
marketable corporate debt obligations, and mortgage-backed securities. The
Bank's investment policy does not permit hedging activities or the purchase of
high risk mortgage derivative products or non-investment grade corporate bonds.
Investments are made based on certain considerations, which include the interest
rate, yield, settlement date and maturity of the investment, the Bank's
liquidity position, and anticipated cash needs and sources (which in turn
include outstanding commitments, upcoming maturities, estimated deposits and
anticipated loan amortization and repayments). The effect that the proposed
investment would have on the Bank's credit and interest rate risk and risk-based
capital is also considered.
The following table sets forth the amortized cost and fair value of the
Bank's debt and mortgage-backed and related securities, by accounting
classification and by type of security, at the dates indicated.
At December 31,
----------------------------------------------------------
1999 1998 1997
----------------- ------------------ -------------------
Percent Percent Percent
Amortized of Amortized of Amortized of
Cost(1) Total Cost(1) Total Cost(1) Total
------- ------- ------- ------- ------- -------
(In thousands)
Held to Maturity:
Debt Securities:
U.S. Treasury
obligations $ - -% $ - -% $1,000 6.80%
U.S. Government agency
obligation - - - - 700 4.76
Mortgage-backed
securities 651 6.86 959 1.95 1,301 8.84
FHLB stock 1,878 19.78 1,751 3.56 1,631 11.09
----- ----- ----- ---- ------ ------
Total held to
maturity securities 2,529 26.64 2,710 5.51 4,632 31.49
----- ----- ----- ---- ------ ------
Available for Sale:
Debt Securities:
U.S. Treasury
obligations - - - - 3,039 20.66
U.S. Government
agency obligations 6,964 73.36 46,505 94.49 7,038 47.85
----- ----- ------ ----- ------ ------
Total available for
sale securities 6,964 73.36 46,505 94.49 10,077 68.51
----- ----- ------ ----- ------ -----
Total portfolio $9,493 100.00% $49,215 100.00% $14,709 100.00%
====== ====== ======= ====== ======= ======
(footnotes on following page)
16
(1) The market value of the investment portfolio amounted to $9.5 million,
$49.3 million and $14.7 million at December 31, 1999, 1998 and 1997,
respectively. At December 31, 1999, the market value of the principal
components of the Bank's investment securities portfolio was as follows: U.S.
Government securities, $6.9 million; mortgage-backed securities, $645,000; and
FHLB, $1.9 million.
The following table sets forth the maturities and weighted average yields
of the debt and mortgage-backed securities in the Bank's investment securities
portfolio at December 31, 1999.
Less Than One to Over Five to Over Ten
One Year Five Years Ten years Years
------------ ------------- ------------ ------------
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
(Dollars in thousands)
Held to Maturity:
Debt Securities:
U.S. Government
agency
obligations $ - -% $ - -% $ - -% $ - -%
Mortgage-backed
securities - - - - - - 651 6.37
FHLB stock 1,878 7.00 - - - - - -
----- ---- --- ---- ---- -- --- ----
Total held
to maturity
securities 1,878 7.00 - - - - 651 6.37
----- ---- ---- ---- ---- ---- --- ----
Available for Sale:
Debt Securities:
U.S. Government
agency obligations 6,964 5.71 - - - - - -
----- ---- --- --- --- --- --- ---
Total available-
for-sale
securities 6,964 5.71 - - - - - -
----- ---- ---- ---- ---- ---- ---- ---
Total portfolio $8,842 5.98% $ - -% $ - -% $651 6.37%
====== ==== ==== ==== ===== ==== === ====
DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS
GENERAL. Deposits are the major external source of funds for the Bank's
lending and other investment activities. In addition, the Bank also generates
funds internally from loan principal repayments and prepayments and maturing
investment securities. Scheduled loan repayments are a relatively stable source
of funds, while deposit inflows and outflows and loan prepayments are influenced
significantly by general interest rates and money market conditions. Borrowings
from the FHLB-Cincinnati may be used on a short-term basis to compensate for
reductions in the availability of funds from other sources. At December 31,
1999, the Bank had no other borrowing arrangements.
DEPOSIT ACCOUNTS. Most of the Bank's depositors reside in Tennessee. The
Bank's deposit products include a broad selection of deposit instruments,
including NOW accounts, demand deposit accounts, money market accounts, regular
passbook savings, statement savings accounts and term certificate accounts.
Deposit account terms vary with the principal difference being the minimum
balance deposit, early withdrawal penalties and the interest rate. The Bank
reviews its deposit mix and pricing weekly. The Bank does not utilize brokered
deposits, nor has it aggressively sought jumbo certificates of deposit.
17
The Bank believes it is competitive in the type of accounts and interest
rates it offers on its deposit products. The Bank does not seek to pay the
highest deposit rates but a competitive rate. The Bank determines the rates
paid based on a number of conditions, including rates paid by competitors, rates
on U.S. Treasury securities, rates offered on various FHLB-Cincinnati lending
programs, and the deposit growth rate the Bank is seeking to achieve.
The following table sets forth information concerning the Bank's time
deposits and other interest-bearing deposits at December 31, 1999.
Weighted
Average Percentage
Interest Original Minimum of Total
Rate Term Category Amount Balance Deposits
---- ------- -------- ------ ------ -------
(In thousands)
1.23% - NOW Accounts $1,000 $46,472 15.04%
1.24 - Savings Accounts 100 13,017 4.21
4.04 - Money Market Accounts 5,000 63,796 20.65
Certificates of Deposit
-------------------------
3.01 32 to 89 Days Fixed-term, Fixed Rate 1,000 153 0.05
4.25 90 to 181 Days Fixed-term, Fixed Rate 1,000 682 0.22
5.41 182 to 364 Days Fixed-term, Fixed Rate 1,000 28,452 9.21
5.99 12 Months Fixed-term, Adjustable Rate 1,000 1,701 0.55
4.79 18 Months Floating Rate IRA 250 479 0.16
5.37 12 to 18 Months Fixed-term, Fixed Rate 1,000 44,797 14.50
5.31 18 to 23 Months Fixed-term, Fixed Rate 1,000 742 0.24
4.77 18 Months Fixed Rate IRA 250 7,817 2.53
5.58 24 to 35 Months Fixed-term, Fixed Rate 1,000 12,069 3.91
5.27 36 to 47 Months Fixed-term, Fixed Rate 1,000 1,261 0.41
5.21 48 to 59 Months Fixed-term, Fixed Rate 1,000 54 0.02
5.67 60+ Months Fixed-term, Fixed Rate 1,000 10,468 3.39
5.55 2 Years Fixed-term, Adjustable Rate 1,000 2,858 0.93
5.69 3 to 60 Months Fixed-term, Fixed Rate 100,000 39,419 12.76
The following table indicates the amount of the Bank's jumbo certificates
of deposit by time remaining until maturity as of December 31, 1999. Jumbo
certificates of deposit have principal balances of $100,000 or more and the
rates paid on such accounts are generally negotiable.
Maturity Period Amount
- ---------------- ---------
(In thousands)
Three months or less $ 8,128
Over three through six months 10,723
Over six through twelve months 16,206
Over twelve months 4,362
--------
Total $39,419
=======
18
DEPOSIT FLOW
The following table sets forth the balances of savings deposits in the
various types of savings accounts offered by the Bank at the dates indicated.
At December 31,
-----------------------------------------------------------------
1999 1998 1997
--------------------- ----------------------- ---------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
------- ----- ------- ------ ----- -------- ------ -----
(Dollars in thousands)
Non-interest-bearing. . . $34,692 11.23% ($4,396) $39,088 14.69% $13,237 $ 25,851 10.41%
NOW checking. . . . . . . 46,472 15.04 10,844 35,628 13.39 4,075 31,553 12.71
Passbook savings accounts 13,017 4.21 (574) 13,591 5.11 (1,648) 15,239 6.14
Money market deposit. . . 63,796 20.65 11,330 52,466 19.72 9,723 42,743 17.22
Fixed-rate certificates
which mature in the
year ending:
Within 1 year . . . . . 125,691 40.69 26,126 99,565 37.43 (9,916) 109,481 44.10
After 1 year, but
within 2 years . . . . 14,352 4.65 (1,123) 15,475 5.82 (1,063) 16,538 6.66
After 2 years, but
within 5 years . . . . 10,732 3.47 513 10,219 3.84 3,357 6,862 2.76
Thereafter. . . . . . . 177 0.06 177 - - - - -
------- ----- ------ ------ ----- ----- ----- ----
Total. . . . . . . $308,929 100.0% $42,897 $266,032 100.00% $17,765 $248,267 100.00%
======= ===== ======= ======= ====== ======= ======== ======
TIME DEPOSITS BY RATES. The following table sets forth the amount of time
deposits in the Bank categorized by rates at the dates indicated.
At December 31,
-----------------------------------
1999 1998 1997
---- ---- ----
(Dollars in thousands)
0.00 - 1.99% $ 400 $ 202 $ -
2.00 - 3.99% 182 862 65
4.00 - 4.99% 24,087 31,101 3,097
5.00 - 5.99% 77,515 71,039 86,058
6.00 - 6.99% 48,657 21,724 43,305
7.00% and over 111 331 356
----------- -------- --------
Total $150,952 $125,259 $132,881
======== ======== ========
19
TIME DEPOSITS BY MATURITIES. The following table sets forth the amount of
time deposits in the Bank categorized by maturities at December 31, 1999.
Amount Due
---------------------------------------------------
After After
One to Two to Three
Less Than Two Three to Four After
One Year Years Years Years 4 Years Total
-------- ----- ----- ----- ------ -----
(Dollars in thousands)
0.00 - 1.99% $ 400 $ - $ - $ - $ - $ 400
2.00 - 3.99% 182 - - - - 182
4.00 - 4.99% 20,774 2,350 235 242 486 24,087
5.00 - 5.99% 66,762 6,974 1,146 1,732 901 77,515
6.00 - 6.99% 37,462 5,028 2,064 3,086 1,017 48,657
7.00% and over 111 - - - - 111
------- ------ ----- ----- ----- ------
Total $125,691 $14,352 $3,445 $5,060 $2,404 $150,952
======== ======= ====== ====== ====== ========
DEPOSIT ACTIVITY. The following table set forth the savings activity of
the Bank for the periods indicated.
Year Ended December 31,
-------------------------------------
1999 1998 1997
---- ---- ----
(In thousands)
Beginning balance $266,032 $248,267 $214,533
-------- -------- --------
Net deposits (withdrawals)
before interest credited 39,070 14,075 30,832
Interest credited 3,827 3,690 2,902
-------- -------- --------
Net increase (decrease)
in deposits 42,897 17,765 33,734
-------- -------- --------
Ending balance $308,929 $266,032 $248,267
======== ======== ========
BORROWINGS. Savings deposits are the primary source of funds for the
Bank's lending and investment activities and for its general business purposes.
The Bank has the ability to use advances from the FHLB-Cincinnati to supplement
its supply of lendable funds and to meet deposit withdrawal requirements. The
FHLB-Cincinnati functions as a central reserve bank providing credit for savings
associations and certain other member financial institutions. As a member of
the FHLB-Cincinnati, the Bank is required to own capital stock in the
FHLB-Cincinnati and is authorized to apply for advances on the security of such
stock and certain of its mortgage loans and other assets (principally securities
that are obligations of, or guaranteed by, the U.S. Government) provided certain
creditworthiness standards have been met. Advances are made pursuant to several
different credit programs. Each credit program has its own interest rate and
range of maturities. Depending on the program, limitations on the amount of
advances are based on the financial condition of the member institution and the
adequacy of collateral pledged to secure the credit. At December 31, 1999, the
Bank did not have any advances outstanding from the FHLB-Cincinnati.
At December 31, 1999, the Company had borrowings in the amount of $45.0
million payable to a commercial bank. The note dated December 16, 1999, bearing
an interest at prime rate minus 1.125%, was due on June 16, 2000. All of the
outstanding stock of the Bank was pledged as collateral on the loan. On January
19, 2000, the Company retired the outstanding debt.
20
The following table sets forth certain information regarding short-term
borrowings by the Bank at the end of and during the periods indicated:
At or For the
Year Ended December 31,
---------------------------------------
1999 1998 1997
---- ---- ----
(Dollars in thousands)
Maximum amount of borrowings
outstanding at any month end $45,000 $ - $ -
Approximate average borrowings
outstanding 2,005 - -
Approximate weighted average rate paid
on borrowings 7.38% -% -%
TRUST DEPARTMENT
The OTS granted trust powers to the Bank on December 13, 1991. The Bank is
one of the few banks in the Bank's primary market area providing a broad range
of trust services. These services include acting as trustee under a living
trust, a Standby Trust or Testamentary Trust; acting as personal representative;
agency services, including custody accounts, agent for the trustee, and agent
for the personal representative; and trustee and agent services for accounts
subject to the provisions of the Employee Retirement Income Security Act of
1974, as amended ("ERISA"). In addition to providing fiduciary and investment
advisory services, the Bank provides employee benefit services, such as
Self-Directed Individual Retirement Accounts ("IRAs"). At December 31, 1999,
trust assets under management totaled approximately $286.0 million.
REGULATION
GENERAL
The Bank is subject to extensive regulation, examination and supervision by
the OTS as its chartering agency, and the FDIC, as the insurer of its deposits.
The activities of federal savings institutions are governed by the Home Owners'
Loan Act, as amended ("HOLA") and, in certain respects, the Federal Deposit
Insurance Act ("FDIA") and the regulations issued by the OTS and the FDIC to
implement these statutes. These laws and regulations delineate the nature and
extent of the activities in which federal savings associations may engage.
Lending activities and other investments must comply with various statutory and
regulatory capital requirements. In addition, the Bank's relationship with its
depositors and borrowers is also regulated to a great extent, especially in such
matters as the ownership of deposit accounts and the form and content of the
Bank's mortgage documents. The Bank must file reports with the OTS and the FDIC
concerning its activities and financial condition in addition to obtaining
regulatory approvals prior to entering into certain transactions such as mergers
with, or acquisitions of, other financial institutions. There are periodic
examinations by the OTS and the FDIC to review the Bank's compliance with
various regulatory requirements. The regulatory structure also gives the
regulatory authorities extensive discretion in connection with their supervisory
and enforcement activities and examination policies, including policies with
respect to the classification of assets and the establishment of adequate loan
loss reserves for regulatory purposes. Any change in such policies, whether by
the OTS, the FDIC or Congress, could have a material adverse impact on the
Company, the Bank and their operations. The Company, as a savings and loan
holding company, is also required to file certain reports with, and otherwise
comply with the rules and regulations of, the OTS and the SEC.
21
FEDERAL REGULATION OF SAVINGS ASSOCIATIONS
OFFICE OF THRIFT SUPERVISION. The OTS is an office in the Department of
the Treasury subject to the general oversight of the Secretary of the Treasury.
The OTS generally possesses the supervisory and regulatory duties and
responsibilities formerly vested in the Federal Home Loan Bank Board. Among
other functions, the OTS issues and enforces regulations affecting federally
insured savings associations and regularly examines these institutions.
FEDERAL HOME LOAN BANK SYSTEM. The FHLB System, consisting of 12 FHLBs, is
under the jurisdiction of the Federal Housing Finance Board ("FHFB"). The
designated duties of the FHFB are to supervise the FHLBs, to ensure that the
FHLBs carry out their housing finance mission, to ensure that the FHLBs remain
adequately capitalized and able to raise funds in the capital markets, and to
ensure that the FHLBs operate in a safe and sound manner. The Bank, as a member
of the FHLB-Cincinnati, is required to acquire and hold shares of capital stock
in the FHLB-Cincinnati in an amount equal to the greater of (i) 1.0% of the
aggregate outstanding principal amount of residential mortgage loans, home
purchase contracts and similar obligations at the beginning of each year, or
(ii) 1/20 of its advances (i.e., borrowings) from the FHLB-Cincinnati. The Bank
is in compliance with this requirement with an investment in FHLB-Cincinnati
stock of 1.9 million at December 31, 1999. Among other benefits, the
FHLB-Cincinnati provides a central credit facility primarily for member
institutions. It is funded primarily from proceeds derived from the sale of
consolidated obligations of the FHLB System. It makes advances to members in
accordance with policies and procedures established by the FHFB and the Board of
Directors of the FHLB-Cincinnati.
FEDERAL DEPOSIT INSURANCE CORPORATION. The FDIC is an independent federal
agency established originally to insure the deposits, up to prescribed statutory
limits, of federally insured banks and to preserve the safety and soundness of
the banking industry. The FDIC maintains two separate insurance funds: the Bank
Insurance Fund ("BIF") and the SAIF. The Bank's deposit accounts are insured by
the FDIC under the SAIF to the maximum extent permitted by law. As insurer of
the Bank's deposits, the FDIC has examination, supervisory and enforcement
authority over all savings associations.
Under applicable regulations, the FDIC assigns an institution to one of
three capital categories based on the institution's financial information, as of
the reporting period ending seven months before the assessment period. The
capital categories are: (i) well-capitalized, (ii) adequately capitalized, or
(iii) undercapitalized. An institution is also placed in one of three
supervisory subcategories within each capital group. The supervisory subgroup
to which an institution is assigned is based on a supervisory evaluation
provided to the FDIC by the institution's primary federal regulator and
information that the FDIC determines to be relevant to the institution's
financial condition and the risk posed to the deposit insurance funds. An
institution's assessment rate depends on the capital category and supervisory
category to which it is assigned with the most well-capitalized, healthy
institutions receiving the lowest rates.
On September 20, 1996, the Deposit Insurance Funds Act ("DIF Act") was
enacted, which, among other things, imposed a special one-time assessment on
SAIF member institutions, including the Bank, to recapitalize the SAIF. As a
result of the DIF Act and the special one-time assessment, the FDIC reduced the
assessment schedule for SAIF members, effective January 1, 1997, to a range of
0% to 0.27%, with most institutions, including the Bank, paying 0%. This
assessment schedule is the same as that for the BIF, which reached its
designated reserve ratio in 1995. In addition, since January 1, 1997, SAIF
members are charged an assessment of 0.065% of SAIF-assessable deposits for the
purpose of paying interests on the obligations issued by the Financing
Corporation ("FICO") in the 1980s to help fund the thrift industry cleanup.
BIF-assessable deposits are charged an assessment to help pay interest on the
FICO bonds at a rate of approximately .013%. Since December 31, 1999 FICO
payments have been shared pro rata between BIF and SAIF members.
The FDIC is authorized to raise the assessment rates in certain
circumstances. The FDIC has exercised this authority several times in the past
and may raise insurance premiums in the future. If such action is taken by the
FDIC, it could have an adverse effect on the earnings of the Bank.
22
Under the Federal Deposit Insurance Act ("FDIA"), insurance of deposits may
be terminated by the FDIC upon a finding that the institution has engaged in
unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations or has violated any applicable law, regulation, rule, order or
condition imposed by the FDIC or the OTS. Management of the Bank does not know
of any practice, condition or violation that might lead to termination of
deposit insurance.
LIQUIDITY REQUIREMENTS. Under OTS regulations, each savings institution is
required to maintain an average daily balance of liquid assets (cash, certain
time deposits and savings accounts, bankers' acceptances, and specified U.S.
Government, state or federal agency obligations, mortgage-backed securities and
certain other investments) equal to a monthly average of not less than a
specified percentage (currently 4.0%) of its net withdrawable accounts plus
short-term borrowings. Monetary penalties may be imposed for failure to meet
liquidity requirements.
PROMPT CORRECTIVE ACTION. The FDIA requires each federal banking agency to
implement a system of prompt corrective action for institutions that it
regulates. The federal banking agencies have promulgated substantially similar
regulations to implement this system of prompt corrective action. Under the
regulations, an institution shall be deemed to be (i) "well capitalized" if it
has a total risk-based capital ratio of 10.0% or more, has a Tier I risk-based
capital ratio of 6.0% or more, has a leverage ratio of 5.0% or more and is not
subject to specified requirements to meet and maintain a specific capital level
for any capital measure; (ii) "adequately capitalized" if it has a total
risk-based capital ratio of 8.0% or more, a Tier I risk-based capital ratio of
4.0% or more and a leverage ratio of 4.0% or more (3.0% under certain
circumstances) and does not meet the definition of "well capitalized;" (iii)
"undercapitalized" if it has a total risk-based capital ratio that is less than
8.0%, a Tier I risk-based capital ratio that is less than 4.0% or a leverage
ratio that is less than 4.0% (3.0% under certain circumstances); (iv)
"significantly undercapitalized" if it has a total risk-based capital ratio that
is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a
leverage ratio that is less than 3.0%; and (v) "critically undercapitalized" if
it has a ratio of tangible equity to total assets that is equal to or less than
2.0%.
The FDIA also provides that a federal banking agency may, after notice and
an opportunity for a hearing, reclassify a well capitalized institution as
adequately capitalized and may require an adequately capitalized institution or
an undercapitalized institution to comply with supervisory actions as if it were
in the next lower category if the institution is in an unsafe or unsound
condition or is engaging in an unsafe or unsound practice. The OTS may not,
however, reclassify a significantly undercapitalized institution as critically
undercapitalized.
An institution generally must file a written capital restoration plan that
meets specified requirements, as well as a performance guaranty by each company
that controls the institution, with the appropriate federal banking agency
within 45 days of the date that the institution receives notice or is deemed to
have notice that it is undercapitalized, significantly undercapitalized or
critically undercapitalized. Immediately upon becoming undercapitalized, an
institution shall become subject to various mandatory and discretionary
restrictions on its operations.
At December 31, 1999, the Bank was categorized as "well capitalized" under
the prompt corrective action regulations of the OTS.
STANDARDS FOR SAFETY AND SOUNDNESS. The federal banking regulatory agencies
have prescribed, by regulation, standards for all insured depository
institutions relating to: (i) internal controls, information systems and
internal audit systems; (ii) loan documentation (iii) credit underwriting; (iv)
interest rate risk exposure; (v) asset growth; (vi) asset quality; (vii)
earnings; and (viii) compensation, fees and benefits ("Guidelines"). The
Guidelines set forth the safety and soundness standards that the federal banking
agencies use to identify and address problems at insured depository institutions
before capital becomes impaired. If the OTS determines that the Bank fails to
meet any standard prescribed by the Guidelines, the agency may require the Bank
to submit to the agency an acceptable plan to achieve compliance with the
standard. Management is aware of no conditions relating to these safety and
soundness standards which would require submission of a plan of compliance.
23
QUALIFIED THRIFT LENDER TEST. All savings associations, including the
Bank, are required to meet a qualified thrift lender ("QTL") test to avoid
certain restrictions on their operations. This test requires a savings
association to have at least 65% of its portfolio asset (as defined by
regulation) in qualified thrift investments on a monthly average for nine out of
every 12 months on a rolling basis. As an alternative, the savings association
may maintain 60% of its assets in those assets specified in Section 7701(a)(19)
of the Internal Revenue Code. Under either test, such assets primarily consist
of residential housing related loans and investments. At December 31, 1999, the
Bank met the test and its QTL percentage was 65.56%.
Any savings association that fails to meet the QTL test must convert to a
national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the BIF. If such an association has not yet requalified or converted to a
national bank, its new investments and activities are limited to those
permissible for both a savings association and a national bank, and it is
limited to national bank branching rights in its home state. In addition, the
Bank is immediately ineligible to receive any new FHLB borrowings and is subject
to national bank limits for payment of dividends. If such association has not
requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national bank. In addition, it must repay promptly any
outstanding FHLB borrowings, which may result in prepayment penalties. If any
association that fails the QTL test is controlled by a holding company, then
within one year after the failure, the holding company must register as a bank
holding company and become subject to all restrictions on bank holding companies
including permissible activity restrictions.
CAPITAL REQUIREMENTS. Under OTS regulations a savings association must
satisfy three minimum capital requirements: core capital, tangible capital and
risk-based capital. Savings associations must meet all of the standards in
order to comply with the capital requirements. The Company is not subject to
any minimum capital requirements.
OTS capital regulations establish a 3% core capital or leverage ratio
(defined as the ratio of core capital to adjusted total assets). Core capital
is defined to include common stockholders' equity, noncumulative perpetual
preferred stock and any related surplus, and minority interests in equity
accounts of consolidated subsidiaries, less (i) any intangible assets, except
for certain qualifying intangible assets; (ii) certain mortgage servicing
rights; and (iii) equity and debt investments in subsidiaries that are not
"includable subsidiaries," which is defined as subsidiaries engaged solely in
activities not impermissible for a national bank, engaged in activities
impermissible for a national bank but only as an agent for its customers, or
engaged solely in mortgage-banking activities. In calculating adjusted total
assets, adjustments are made to total assets to give effect to the exclusion of
certain assets from capital and to account appropriately for the investments in
and assets of both includable and nonincludable subsidiaries. An institution
that fails to meet the core capital requirement would be required to file with
the OTS a capital plan that details the steps they will take to reach
compliance. In addition, the OTS's prompt corrective action regulation provides
that a savings institution that has a leverage ratio of less than 4% (3% for
institutions receiving the highest CAMEL examination rating) will be deemed to
be "undercapitalized" and may be subject to certain restrictions. See "--
Federal Regulation of Savings Associations -- Prompt Corrective Action."
As required by federal law, the OTS has proposed a rule revising its
minimum core capital requirement to be no less stringent than that imposed on
national banks. Only those savings associations rated a composite one (the
highest rating) under the CAMEL rating system for savings associations are
permitted to operate at or near the regulatory minimum leverage ratio of 3%.
All other savings associations will be required to maintain a minimum leverage
ratio of 4%. OTS may require higher leverage ratios if warranted by the
particular circumstances or risk profile of an association.
Savings associations also must maintain "tangible capital" not less than
1.5% of the Bank's adjusted total assets. "Tangible capital" is defined,
generally, as core capital minus any "intangible assets" other than purchased
mortgage servicing rights.
24
Each savings institution must maintain total risk-based capital equal to at
least 8% of risk-weighted assets. Total risk-based capital consists of the sum
of core and supplementary capital, provided that supplementary capital cannot
exceed core capital, as previously defined. Supplementary capital includes (i)
permanent capital instruments such as cumulative perpetual preferred stock,
perpetual subordinated debt and mandatory convertible subordinated debt, (ii)
maturing capital instruments such as subordinated debt, intermediate-term
preferred stock and mandatory convertible subordinated debt, subject to an
amortization schedule, and (iii) general valuation loan and lease loss
allowances up to 1.25% of risk-weighted assets.
The risk-based capital regulation assigns each balance sheet asset held by
a savings institution to one of four risk categories based on the amount of
credit risk associated with that particular class of assets. Assets not
included for purposes of calculating capital are not included in calculating
risk-weighted assets. The categories range from 0% for cash and securities that
are backed by the full faith and credit of the U.S. Government to 100% for
repossessed assets or assets more than 90 days past due. Qualifying residential
mortgage loans (including multi-family mortgage loans) are assigned a 50% risk
weight. Consumer, commercial, home equity and residential construction loans
are assigned a 100% risk weight, as are nonqualifying residential mortgage loans
and that portion of land loans and nonresidential construction loans that do not
exceed an 80% loan-to-value ratio. The book value of assets in each category is
multiplied by the weighing factor (from 0% to 100%) assigned to that category.
These products are then totaled to arrive at total risk-weighted assets.
Off-balance sheet items are included in risk-weighted assets by converting them
to an approximate balance sheet "credit equivalent amount" based on a conversion
schedule. These credit equivalent amounts are then assigned to risk categories
in the same manner as balance sheet assets and included risk-weighted assets.
The OTS has incorporated an interest rate risk component into its
regulatory capital rule. Under the rule, savings associations with "above
normal" interest rate risk exposure would be subject to a deduction from total
capital for purposes of calculating their risk-based capital requirements. A
savings association's interest rate risk is measured by the decline in the net
portfolio value of its assets (i.e., the difference between incoming and
outgoing discounted cash flows from assets, liabilities and off-balance sheet
contracts) that would result from a hypothetical 200 basis point increase or
decrease in market interest rates divided by the estimated economic value of the
association's assets, as calculated in accordance with guidelines set forth by
the OTS. A savings association whose measured interest rate risk exposure
exceeds 2% must deduct an interest rate risk component in calculating its total
capital under the risk-based capital rule. The interest rate risk component is
an amount equal to one-half of the difference between the institution's measured
interest rate risk and 2%, multiplied by the estimated economic value of the
association's assets. That dollar amount is deducted from an association's
total capital in calculating compliance with its risk-based capital requirement.
Under the rule, there is a two quarter lag between the reporting date of an
institution's financial data and the effective date for the new capital
requirement based on that data. A savings association with assets of less than
$300 million and risk-based capital ratios in excess of 12% is not subject to
the interest rate risk component, unless the OTS determines otherwise. The rule
also provides that the Director of the OTS may waive or defer an association's
interest rate risk component on a case-by-case basis. Under certain
circumstances, a savings association may request an adjustment to its interest
rate risk component if it believes that the OTS-calculated interest rate risk
component overstates its interest rate risk exposure.
25
The following table presents the Bank's regulatory capital compliance as of
December 31, 1999.
Percent of
Adjusted Total
Amount Assets(1)
------ ---------
(Dollars in thousands)
Tangible capital $79,212 20.29%
Minimum required tangible capital 5,855 1.50
------- -----
Excess $73,357 18.79%
======= =====
Core capital $79,212 20.29%
Minimum required core capital(2) 11,712 3.00
------ -----
Excess $67,500 17.29%
======= =====
Risk-based capital(3) $83,348 23.48%
Minimum risk-based capital requirement 28,402 8.00
------ -----
Excess $54,946 15.48%
======= =====
(1) Based on adjusted total assets of $390.4 million for purposes of the
tangible and core capital requirements, and risk-weighted assets of $355.0
million for purposes of the risk-based capital requirement.
(2) The current OTS core capital requirement for savings associations is 3%
of total adjusted assets. The OTS has proposed core capital requirements that
would require a core capital ratio of 3% of total adjusted assets for thrifts
that receive the highest supervisory rating for safety and soundness and a core
capital ratio of 4% to 5% for all other thrifts.
(3) Percentage represents total core and supplementary capital divided by
total risk-weighted assets.
LIMITATIONS ON CAPITAL DISTRIBUTIONS. OTS regulations impose uniform
limitations on the ability of all savings associations to engage in various
distributions of capital such as dividends, stock repurchases and cash-out
mergers. Under currently effective regulations, an application to and the
prior approval of the OTS will be required to any capital distribution if the
institution does not meet the criteria for "expedited treatment" of applications
under OTS regulations (i. e., generally safety and soundness, compliance and
Community Reinvestment Act examination ratings in the two top categories), if
the total capital distributions for the calendar year exceed net income for that
year plus the amount of retained net income for the preceding two years, if the
institution would be undercapitalized following the distribution or the
distribution would otherwise be contrary to statute, regulation or agreement
with OTS. If an application is not required, the institution must still provide
prior notice to OTS of the capital distribution. In the event the Bank's
capital fell below its regulatory requirements or the OTS notified it that it
was in need of more than normal supervision, the Bank's ability to make capital
distributions could be restricted. In addition, the OTS could prohibit a
proposed capital distribution by any institution, which would otherwise be
permitted by the regulation, if the OTS determines that such distribution would
constitute an unsafe or unsound practice.
LOANS TO ONE BORROWER. Under the HOLA, savings institutions are generally
subject to the national bank limit on loans to one borrower. Generally, this
limit is 15% of the Bank's unimpaired capital and surplus, plus an additional
10% of unimpaired capital and surplus, if such loan is secured by
readily-marketable collateral, which is defined to include certain financial
instruments and bullion. The OTS by regulation has amended the loans to one
borrower rule to permit savings associations meeting certain requirements,
including capital requirements, to extend loans to one borrower in additional
amounts under circumstances limited essentially to loans to develop or complete
residential housing units. At December 31, 1999, the Bank's limit on loans to
one borrower was $25.0 million. At December 31, 1999, the Bank's largest
aggregate amount of loans to one borrower was $12.8 million, all of which were
performing according to their terms.
ACTIVITIES OF ASSOCIATIONS AND THEIR SUBSIDIARIES. When a savings
association establishes or acquires a subsidiary or elects to conduct any new
activity through a subsidiary that the association controls, the savings
association must notify the FDIC and the OTS 30 days in advance and provide the
information each agency may, by regulation, require. Savings associations also
must conduct the activities of subsidiaries in accordance with existing
regulations and orders.
The OTS may determine that the continuation by a savings association of its
ownership control of, or its relationship to, the subsidiary constitutes a
serious risk to the safety, soundness or stability of the association or is
inconsistent with sound banking practices or with the purposes of the FDIA.
Based upon that determination, the FDIC or the OTS has the authority to order
the savings association to divest itself of control of the subsidiary. The FDIC
also may determine by regulation or order that any specific activity poses a
serious threat to the SAIF. If so, it may require that no SAIF member engage in
that activity directly.
TRANSACTIONS WITH AFFILIATES. Savings associations must comply with
Sections 23A and 23B of the Federal Reserve Act ("Sections 23A and 23B")
relative to transactions