Back to GetFilings.com
0
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, 2000 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.
---------------------
(Exact name of registrant as specified in its charter)
Tennessee 62-1721072
---------------- -----------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) I.D. Number)
114 West College Street, Murfreesboro, Tennessee 37130
- ----------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (615) 893-1234
--------------
Securities registered pursuant to Section 12(b) of the Act: None
----
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no
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 26,
2000, was $83,481,412 (7,104,801 shares at $11.75 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, 2000 ("Annual Report") (Parts I and II).
2. Portions of Definitive Proxy Statement for the 2001 Annual Meeting
of Stockholders (Part III).
PART I
ITEM 1. BUSINESS
- ------------------
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, 2000, the Company had total assets
of $384.3 million, total deposits of $336.5 million and shareholders' equity of
$44.0 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 and the Securities and Exchange Commission ("SEC"). 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 13 and 14 of the 2000
Annual Report to Stockholders ("Annual Report") included herein as Exhibit 13.
LENDING ACTIVITIES
GENERAL. At December 31, 2000, the Bank's total loans receivable portfolio
amounted to $283.7 million, or 73.82% 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 $64.8 million, or 20.6% of total loans at December 31, 2000. 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,
--------------------------------------------------------------------------------------------
2000 1999 1998 1997 1996
----------------- ----------------- --------------- --------------- --------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ ------
(Dollars in thousands)
Mortgage Loans:
One-to-four
family(1). . . . $ 64,776 20.6% $ 60,261 18.1% $ 75,554 24.8% $ 82,930 32.9% $ 81,279 33.1%
Multi-family. . . 2,519 0.8 780 0.2 1,125 0.4 1,338 0.5 2,847 1.2
Commercial. . . . 80,029 25.4 71,419 21.4 52,516 17.2 39,690 15.8 30,099 12.3
Construction. . . 56,015 17.8 69,421 20.9 84,900 27.9 54,666 21.7 61,032 24.9
Land acquisition
and development. 21,498 6.8 40,645 12.2 15,367 5.1 17,011 6.8 18,799 7.7
-------- --------- -------- --------- -------- ------ -------- ------ -------- ------
Total mortgage
loans . . . . . 224,837 71.4 242,526 72.8 229,462 75.4 195,635 77.7 194,056 79.2
-------- -------- -------- -------- --------
Consumer Loans:
Home equity
lines of credit 5,322 1.7 4,788 1.4 3,790 1.2 2,783 1.1 1,964 0.8
Automobile. . . . 8,609 2.7 8,632 2.6 6,788 2.2 5,028 2.0 3,716 1.5
Unsecured . . . . 1,884 0.6 1,649 0.5 1,527 0.5 1,684 0.7 1,779 0.7
Other secured . . 36,280 11.5 38,809 11.7 32,792 10.8 23,852 9.5 23,037 9.4
-------- --------- -------- --------- -------- ------ -------- ------ -------- ------
Total consumer
loans . . . . . 52,095 16.5 53,878 16.2 44,897 14.7 33,347 13.3 30,496 12.4
-------- --------- -------- --------- -------- ------ -------- ------ -------- ------
Commercial
business loans. . 38,177 12.1 36,456 11.0 30,213 9.9 22,544 9.0 20,698 8.4
-------- --------- -------- --------- -------- ------ -------- ------ -------- ------
Total loans . . . 315,109 100.0% 332,860 100.0% 304,572 100.0% 251,526 100.0% 245,250 100.0%
========= ========= ====== ====== ======
Less:
Undisbursed
portion of loans
in process. . . 26,471 51,243 52,098 30,178 36,573
Net deferred
loan fees . . . 742 785 773 710 701
Allowance for
loan losses . . 4,235 4,136 3,231 2,804 2,123
-------- --------- -------- --------- --------
Total loans
receivable,
net . . . . . . $283,661 $276,696 $248,470 $217,834 $205,853
======== ========= ======== ======== ========
- ------------
(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, 2000, $64.8 million, or 20.6% of the Bank's total loan
portfolio, consisted of such loans. The Bank originated $103.2 million, $121.2
million and $159.3 million of one-to-four family residential mortgage loans
during the years ended December 31, 2000, 1999, and 1998, 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.
2
The Bank also originates ARM loans at rates and terms competitive with market
conditions. At December 31, 2000, $54.9 million, or 17.4% 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, VA and THDA loans are generally sold to private investors with
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). 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.
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.
3
At December 31, 2000, the composition of the Bank's construction loan portfolio
was as follows:
Outstanding Percent of
Balance(1) Total
---------- -----
(In thousands)
Residential:
Speculative construction $30,270 54.04%
Pre-sold construction 13,168 23.51
Construction/permanent 7,209 12.87
Commercial and multi-family 5,368 9.58
--------- -------
Total $56,015 100.00%
======= ======
____________________
(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 115 local builders, many of whom may have only one or two
speculative loans outstanding from the Bank. The Bank considers approximately 30
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, 2000, the Bank had 8
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 $1.4 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, 2000, the largest outstanding pre-sold construction loan
had an outstanding balance of $270,000 and was performing according to its
terms.
4
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 8.50%,
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, 2000, the largest
outstanding construction/permanent loan had an outstanding balance of $348,000
and was performing according to its terms.
The Bank also provides construction financing for non-residential properties
(i.e., multi-family and commercial properties). At December 31, 2000, such
construction loans amounted to $5.4 million.
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.
5
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, 2000, the Bank had land A&D loans with aggregate
approved commitments of $21.5million, of which an aggregate of $19.5 million was
outstanding. At December 31, 2000, the largest land A&D loan had an outstanding
balance of $1.2 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, 2000, the Bank did not have any nonaccruing land A&D loans.
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, 2000, $80.0 million, or 25.4% 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.
Narrative appraisals are required for all properties securing commercial real
estate loans in excess of $250,000. On loans of $250,000 or less, a short form
or drive-by appraisals is acceptable. Narrative appraisals over $250,000 must
be completed by a state certified appraiser with a "general" certification.
Appraisals or drive-by on loans of $250,000 or under may be performed by any
state certified or in-house appraiser. All appraisals go through final review
by bank 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.
6
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, 2000, the largest
commercial real estate loan had an outstanding balance of $3.8 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
focus 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, 2000, commercial business loans amounted to $38.2 million, or 12.1% of total
loans.
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, 2000, the largest commercial business loan was a $2.0 million
line of credit secured by commercial real estate taken as an abundance of
caution. Such loan was performing according to its terms at December 31, 2000.
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.
7
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, 2000, the Bank's consumer loans
totaled $52.1 million, or 16.5%, 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
11.9%, 12.3% and 12.8% of the Bank's total loan originations in the fiscal years
ended December 31, 2000, 1999 and 1998, 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, 2000 were less than $75,000. At
December 31, 2000, approved lines of credit totaled $7.0 million, of which $5.3
million was outstanding.
At December 31, 2000, the Bank's automobile loan portfolio amounted to $8.6
million, or 2.7%, 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.
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 $36.3 million, or 11.5% of total loans, at
December 31, 2000.
At December 31, 2000, unsecured consumer loans amounted to $1.9 million, or 0.6%
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 $560,000 at December 31, 2000. Approved credit
card lines totaled $2.1 million at December 31, 2000. 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.
8
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, 2000, the Bank had $42,000
of consumer loans accounted for on a nonaccrual basis.
MATURITY OF LOAN PORTFOLIO. The following table sets forth certain information
at December 31, 2000 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 $ 4,995 $ 5,726 $ 7,170 $11,619 $37,785 $ 67,295
Construction 45,090 5,656 217 - 79 51,042
Commercial 19,714 22,653 26,934 3,958 6,770 80,029
Consumer and other loans 14,072 20,982 15,475 1,522 44 52,095
Commercial business loans 23,045 7,849 5,959 674 650 38,177
-------- ------- ------- ------- ------- --------
Total $106,916 $62,866 $55,755 $17,773 $45,328 $288,638
======== ======= ======= ======= ======= ========
9
The following table sets forth the dollar amount of all loans due after December
31, 2001, which have fixed interest rates and have floating or adjustable
interest rates.
Fixed Floating or
Rates Adjustable Rates
------ ----------------
(In thousands)
Mortgage loans:
Residential $ 14,687 $47,613
Construction - 5,952
Commercial 53,547 6,768
Consumer and other loans 32,869 5,154
Commercial business loans 14,412 720
-------- -------
Total $115,515 $66,207
======== =======
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 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 $500,000 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 $500,000, 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.
10
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 most 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 may retain 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 $111.4 million at December 31, 2000. The Bank is
generally paid a fee equal to 0.25% of the outstanding principal balance for
servicing sold loans. Loan servicing income totaled $129,000, $112,000 and
$264,000 for the years ended December 31, 2000, 1999 and 1998, 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, 2000, borrowers' escrow funds amounted to $174,000.
Historically, the Bank has not been an active purchaser of loans or
participation interests in loans.
11
The following table sets forth total loans originated, purchased, sold and
repaid during the periods indicated.
Year Ended December 31,
---------------------------------
2000 1999 1998
---- ---- ----
(In thousands)
Loans originated:
Mortgage loans:
One-to-four family $ 103,150 $ 121,159 $ 159,259
Multi-family 2,179 2,350 -
Commercial 16,404 21,403 19,118
Construction 63,066 87,956 80,150
Land 4,814 34,964 11,624
Consumer 31,131 46,043 49,253
Commercial business loans 40,238 59,556 65,046
---------- ---------- ----------
Total loans originated 260,982 373,431 384,450
Loans purchased:
One-to-four family - - -
---------- ---------- ----------
Total loans originated and purchased 260,982 373,431 384,450
Loans sold:
Whole loans sold (104,074) (121,735) (120,761)
---------- ---------- ----------
Total loans sold (104,074) (121,735) (120,761)
Mortgage loan principal repayments (82,909) (84,602) (115,563)
Other loan principal repayments (70,315) (138,930) (95,080)
Increase (decrease) in other items, net 3,281 62 (22,410)
---------- ---------- ----------
Net increase (decrease) in
loans, net $ 6,965 $ 28,226 $ 30,636
========== ========== ==========
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, 2000, the Bank had no loan commitments (excluding undisbursed
portions of interim construction loans of $26.5 million) and unused lines of
credit of $35.3 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, 2000, the Bank had outstanding standby letters of
credit of $7.4 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 $837,000, $1.0
million and $1.2 million of deferred loan fees during the years ended December
31, 2000, 1999 and 1998, respectively, in connection with loan refinancings,
payoffs, sales and ongoing amortization of outstanding loans.
12
The Bank also earns fee income on loans serviced for others. Loan servicing
fees for the year ended December 31, 2000 and 1999 amounted to $129,000 and
$112,000, respectively. At December 31, 2000, the Bank serviced loans for
others totaling $111.4 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.
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.
13
The following table sets forth information with respect to the Bank's
non-performing assets at the dates indicated.
At December 31,
-----------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
(Dollars in thousands)
Loans accounted for on a
non-accrual basis:
Mortgage loans:
One- to- four family. . . . . . . . . $ 71 $ 328 $ 74 $ 73 $ 9
Construction. . . . . . . . . . . . . 10 - - 68 -
Commercial. . . . . . . . . . . . . . - - - - -
Consumer loans (automobile). . . . . . . 38 - 32 9 42
Other . . . . . . . . . . . . . . . . 4 5 1 - -
------ ------ ------ ------ ------
Total . . . . . . . . . . . . . . . 123 333 107 150 51
Accruing loans which are contractually
past due 90 days or more. . . . . . . . - - 66 98 -
------ ------ ------ ------ ------
Total of nonaccrual and 90 days past
due loans . . . . . . . . . . . . . . . 123 333 173 248 51
Real estate owned . . . . . . . . . . . . 64 117 80 - -
Other repossessed assets. . . . . . . . . 22 49 - - -
------ ------ ------ ------ ------
Total nonperforming assets . . . . . $ 209 $ 499 $ 253 $ 248 $ 51
====== ====== ====== ====== ======
Restructured loans. . . . . . . . . . . . $ - $ - $ - $ - $ -
====== ====== ====== ====== ======
Nonaccrual and 90 days or more past
due loans as a percentage of loans
receivable, net . . . . . . . . . . . . 0.04% 0.12% 0.07% 0.11% 0.02%
Non-accrual and 90 days or more past due
loans as a percentage of total assets . 0.03% 0.08% 0.05% 0.09% 0.02%
Non-performing assets as a percentage of
total assets. . . . . . . . . . . . . . 0.05% 0.13% 0.03% 0.09% 0.02%
Interest income that would have been recorded for the year ended December 31,
2000 had non-accruing loans been current in accordance with their original terms
would have amounted to $15,000. No interest was included in interest income on
such loans for the year ended December 31, 2000.
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, 2000, the Bank had 2 properties in real
estate owned which consisted of one single family residence and one commercial
property.
14
RESTRUCTURED LOANS. Under U.S. 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, 2000.
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,
---------------
2000 1999
---- ----
(In thousands)
Loss $ - $ -
Doubtful 142 74
Substandard assets 3,641 3,553
Special mention 202 162
15
At December 31, 2000, substandard assets consisted of five repossessed assets
totaling $86,000, one construction loan totaling $512,000, nine one-to-four
family mortgage loans totaling $698,000, forty five consumer loans totaling
$703,000 and eighteen commercial loans totaling $1.6 million. Doubtful loans
consisted of two consumer loans totaling $16,000 and eight commercial loans
totaling $126,000. 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.
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, 2000, the Bank had an allowance for loan losses of $4.2 million.
Management believes that the amount maintained in the allowance at December 31,
2000 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 U.S. 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.
16
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,
-------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
(Dollars in thousands)
Allowance at beginning of period. $4,136 $3,231 $2,804 $2,123 $1,997
Provision for loan losses . . . . 306 991 452 700 120
Recoveries:
Mortgage loans:
One- to- four family. . . . . . - - - - 14
Multi-family. . . . . . . . . . - - - - -
Commercial. . . . . . . . . . . - - - - 1
Construction. . . . . . . . . . - - - - -
Consumer loans:
Automobiles . . . . . . . . . . 23 13 8 23 -
Unsecured . . . . . . . . . . . - - - 5 191
Other . . . . . . . . . . . . . - - 21 1 12
Commercial business loans. . . . 6 3 - 1 -
------- ------- ------- ------- ------
Total recoveries . . . . . . . 29 16 29 30 218
Charge-offs:
Mortgage loans:
One- to- four family. . . . . . 48 5 - - 10
Construction. . . . . . . . . . - - - - -
Consumer loans:
Home equity lines of credit . . - - - - -
Automobile. . . . . . . . . . . 52 35 16 40 -
Credit card . . . . . . . . . . 6 3 5 1 -
Unsecured . . . . . . . . . . . 25 9 - - 196
Other . . . . . . . . . . . . . 37 47 33 5 6
Commercial business loans. . . . 68 3 - 3 -
------- ------- ------- ------- ------
Total charge-offs. . . . . . . 236 102 54 49 212
------- ------- ------- ------- ------
Net recoveries (charge-offs) . (207) (86) (25) (19) 6
------- ------- ------- ------- ------
Allowance at end of period. . $4,235 $4,136 $3,231 $2,804 $2,123
======= ======= ======= ======= ======
Allowance for loan losses as a
percentage of total loans out-
standing at the end of the period 1.34% 1.24% 1.06% 1.11% 0.87%
Net (charge-offs) recoveries as a
percentage of average loans
outstanding during the period (0.07)% (0.03)% (0.01)% (0.01)% -%
Allowance for loan losses as
a percentage of nonperforming
loans at end of period 3,443.09% 1,242.04% 3,019.63% 1,130.65% 4,162.75%
17
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,
------------------------------------------------------------------------------
2000 1999 1998 1997 1996
-------------- -------------- -------------- -------------- --------------
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
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
(Dollars in thousands)
Mortgage loans:
One-to-four family $ 395 20.6% $ 301 18.1% $ 378 24.8% $ 415 32.9% $ 122 33.1%
Multi-family . . . 11 0.8 4 0.2 6 0.4 20 0.5 4 1.2
Commercial . . . . 1,075 25.4 1,101 21.4 788 17.2 595 15.8 301 12.3
Construction . . . 840 17.8 740 20.9 492 27.9 367 21.7 245 24.9
Land . . . . . . . 142 6.8 346 12.2 231 5.1 255 6.8 188 7.7
Consumer loans:
Home equity
lines of credit. 72 1.7 72 1.4 57 1.2 42 1.1 25 0.8
Automobile . . . . 144 2.7 129 2.6 102 2.2 75 2.0 46 1.5
Credit cards . . . 3 0.1 74 0.1 6 0.1 3 0.1 - -
Loans secured by
deposit accounts - - - 0.6 - - - - - -
Unsecured. . . . . 26 0.5 17 0.4 17 0.4 22 0.6 22 0.7
Other secured. . . 532 11.5 582 11.1 453 10.8 358 9.5 288 9.4
Commercial business
loans. . . . . . 807 12.1 547 11.0 338 9.9 338 9.0 259 8.4
Unallocated . . . . 188 N/A 223 N/A 363 N/A 314 N/A 623 N/A
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Total allowance
for loan losses $4,235 100.0% $4,136 100.0% $3,231 100.0% $2,804 100.0% $2,123 100.0%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
18
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 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 deposit, 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,
------------------------------------------------------
2000 1999 1998
------------------ --------------- ---------------
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. . . . . . $ - -% $ - -% $ - - %
U.S. Government agency obligation. . - - - - - -
Mortgage-backed securities. . . . . . 594 1.70 651 6.86 959 1.95
FHLB stock. . . . . . . . . . . . . . 2,020 5.80 1,878 19.78 1,751 3.56
------- ------- ------ ------- ------- -------
Total held to maturity securities . . 2,614 7.50 2,529 26.64 2,710 5.51
------- ------- ------ ------- ------- -------
Available for Sale:
Debt Securities:
U.S. Treasury obligations. . . . . . 9,009 25.84 - - - -
U.S. Government agency obligations . 23,238 66.66 6,964 73.36 46,505 94.49
------- ------- ------ ------- ------- -------
Total available for sale securities 32,247 92.50 6,964 73.36 46,505 94.49
------- ------- ------ ------- ------- -------
Total portfolio . . . . . . . . . . . $34,861 100.00% $9,493 100.00% $49,215 100.00%
======= ======= ====== ======= ======= =======
- ------------
(1) The market value of the investment portfolio amounted to $34.9 million, $9.5
million and $49.3 million at December 31, 2000, 1999 and 1998, respectively. At December
31, 2000, the market value of the principal components of the Bank's investment securities
portfolio was as follows: U.S. Government securities, $32.2 million; mortgage-backed
securities, $589,000, and FHLB, $2.0 million.
19
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, 2000.
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 . . . . . . - - - - - - 594 7.52
FHLB stock. . . . . . . . 2,020 7.50 - - - - - -
------ ---- ------ ---- --- -- ---- ----
Total held to
maturity securities . 2,020 7.50 - - - - 594 7.52
------ ---- ------ ---- --- -- ---- ----
Available for Sale:
Debt Securities:
U.S. Treasury obligations 8,000 6.24 1,009 6.55 - - - -
U.S. Government agency
obligations . . . . . . 13,142 6.36 10,096 6.50 - - - -
------ ---- ------ ---- --- -- ---- ----
Total available-for-sale
securities. . . . . . . 21,142 6.31 11,105 6.50 - - - -
------ ---- ------ ---- --- -- ---- ----
Total portfolio. . . . . .$23,162 6.41% $11,105 6.50% $ - -% $594 7.52%
======= ==== ======= ===== === === ==== =====
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,
2000, the Bank had no other borrowing arrangements.
20
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.
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, 2000.
Weighted
Average Percentage
Interest Original Minimum of Total
Rate Term Category Amount Balance Deposits
- --------- ---------------- --------------------------- --------- -------- ---------
(In thousands)
1.47% - NOW Accounts $ 1,000 $ 52,343 17.57%
1.24 - Savings Accounts 100 13,248 4.45
4.79 - Money Market Accounts 5,000 69,797 23.43
Certificates of Deposit
---------------------------
4.54 32 to 89 Days Fixed-term, Fixed Rate 1,000 300 0.10
4.85 90 to 181 Days Fixed-term, Fixed Rate 1,000 657 0.22
6.25 182 to 364 Days Fixed-term, Fixed Rate 1,000 25,788 8.66
6.83 12 Months Fixed-term, Adjustable Rate 1,000 1,772 0.59
6.00 18 Months Floating Rate IRA 250 338 0.11
6.46 12 to 18 Months Fixed-term, Fixed Rate 1,000 53,312 17.90
6.70 18 to 23 Months Fixed-term, Fixed Rate 1,000 3,219 1.08
5.59 18 Months Fixed Rate IRA 250 7,116 2.39
6.12 24 to 35 Months Fixed-term, Fixed Rate 1,000 13,588 4.56
5.75 36 to 47 Months Fixed-term, Fixed Rate 1,000 1,426 0.48
5.39 48 to 59 Months Fixed-term, Fixed Rate 1,000 43 0.01
5.73 60+ Months Fixed-term, Fixed Rate 1,000 9,472 3.18
5.93 2 Years Fixed-term, Adjustable Rate 1,000 516 0.17
6.76 3 to 60 Months Fixed-term, Fixed Rate 100,000 44,969 15.10
21
The following table indicates the amount of the Bank's jumbo certificates of
deposit by time remaining until maturity as of December 31, 2000. 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 $ 7,571
Over three through six months 8,532
Over six through twelve months 22,169
Over twelve months 6,697
--------
Total $44,969
=======
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,
--------------------------------------------------------------------------
2000 1999 1998
------------------------- -------------------------- ---------------
Percent Percent Percent
of Increase of Increase of
Amount Total (Decrease) Amount Total (Decrease) Amount Total
------ ----- ------ ------ ----- -------- ------ -----
(Dollars in thousands)
Non-interest-bearing. . . . . $ 38,630 11.48% $ 3,938 $ 34,692 11.23% ($4,396) $ 39,088 14.69%
NOW checking. . . . . . . . . 52,343 15.55 5,871 46,472 15.04 10,844 35,628 13.39
Passbook savings accounts . . 13,248 3.94 231 13,017 4.21 (574) 13,591 5.11
Money market deposit. . . . . 69,797 20.74 6,001 63,796 20.65 11,330 52,466 19.72
Fixed-rate certificates which
mature in the year ending:
Within 1 year . . . . . . . 133,195 39.58 7,504 125,691 40.69 26,126 99,565 37.43
After 1 year, but within
2 years . . . . . . . 20,097 5.97 5,745 14,352 4.65 (1,123) 15,475 5.82
After 2 years, but within
5 years. . . . . . . . 9,175 2.73 (1,557) 10,732 3.47 513 10,219 3.84
Thereafter. . . . . . . . . 49 0.01 (128) 177 0.06 177 - -
-------- ------- -------- -------- ------- --------- -------- -------
Total. . . . . . . . . . $336,534 100.00% $27,605 $308,929 100.00% $ 42,897 $266,032 100.00%
======== ======= ======== ======== ======= ========= ======== =======
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,
------------------------
2000 1999 1998
---- ---- ----
(Dollars in thousands)
0.00 - 1.99% $ 101 $ 400 $ 202
2.00 - 3.99% 190 182 862
4.00 - 4.99% 3,062 24,087 31,101
5.00 - 5.99% 17,893 77,515 71,039
6.00 - 6.99% 107,738 48,657 21,724
7.00% and over 33,532 111 331
-------- -------- --------
Total $162,516 $150,952 $125,259
======== ======== ========
22
TIME DEPOSITS BY MATURITIES. The following table sets forth the amount of time
deposits in the Bank categorized by maturities at December 31, 2000.
Amount Due
----------------------------------------------------
After After
One to Two to Three After
Less Than Two Three to Four Four
One Year Years Years Years Years Total
--------- ----- ----- ----- ----- -----
(Dollars in thousands)
0.00 - 1.99%. . $ 101 $ - $ - $ - $ - $ 101
2.00 - 3.99%. . 190 - - - - 190
4.00 - 4.99%. . 2,288 222 229 323 - 3,062
5.00 - 5.99%. . 13,600 1,801 1,548 665 279 17,893
6.00 - 6.99%. . 92,150 10,610 3,049 975 954 107,738
7.00% and over. 24,866 7,464 784 100 318 33,532
-------- ------- ------ ------ ------ --------
Total . . . . . $133,195 $20,097 $5,610 $2,063 $1,551 $162,516
======== ======= ====== ====== ====== ========
DEPOSIT ACTIVITY. The following table set forth the savings activity of the
Bank for the periods indicated.
Year Ended December 31,
----------------------------
2000 1999 1998
---- ---- ----
(In thousands)
Beginning balance $308,929 $266,032 $248,267
-------- -------- --------
Net deposits
before interest credited 23,075 39,070 14,075
Interest credited 4,530 3,827 3,690
-------- -------- --------
Net increase
in deposits 27,605 42,897 17,765
-------- -------- --------
Ending balance $336,534 $308,929 $266,032
======== ======== ========
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, 2000, the
Bank had two advances outstanding from the FHLB-Cincinnati in the amount of
$1.6 million with a weighted average rate of 3.68%.
At December 31, 2000, the Company did not have any borrowings outstanding.
The following table sets forth certain information regarding short-term
borrowings by the Bank at the end of and during the periods indicated:
23
At or For the
Year Ended December 31,
-----------------------
2000 1999 1998
---- ---- ----
(Dollars in thousands)
Maximum amount of borrowings
outstanding at any month end $1,614 $45,000 $ -
Approximate average borrowings
outstanding 3,414 2,005 -
Approximate weighted average rate paid
on borrowings 5.10% 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, 2000, trust assets
under management totaled approximately $280.0 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.
24
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 $2.0 million at December 31, 2000. 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.
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.
25
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, 2000, 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.
26
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, 2000, the Bank met the
test and its QTL percentage was 69.13%.
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."
27
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.
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 in 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.
28
The following table presents the Bank's regulatory capital compliance as of
December 31, 2000.
Percent of
Adjusted Total
Amount Assets(1)
-------- ---------
(Dollars in thousands)
Tangible capital. . . . . . . . . . . . $41,918 10.98%
Minimum required tangible capital . . . 5,725 1.50
------- ------
Excess. . . . . . . . . . . . . . . . . $36,193 9.48%
======= ======
Core capital. . . . . . . . . . . . . . $41,918 10.98%
Minimum required core capital(2). . . . 11,449 3.00
------- ------
Excess. . . . . . . . . . . . . . . . . $30,469 7.98%
======= ======
Risk-based capital(3) . . . . . . . . . $46,153 13.96%
Minimum risk-based capital requirement. 26,442 8.00
------- ------
Excess. . . . . . . . . . . . . . . . . $19,711 5.96%
======= ======
- ----------
(1) Based on adjusted total assets of $381.6 million for purposes of the
tangible and core capital requirements, and risk-weighted assets of $330.5
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 for 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.
29
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, 2000, the Bank's limit on loans to
one borrower was $13.9 million. At December 31, 2000, the Bank's largest
aggregate amount of loans to one borrower was $9.0 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 t