Item 1. Business
This
section should be read in conjunction with Part II, Item 7, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations”, Part
II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” and
Part II, Item 8, “Financial
Statements and Supplementary Data”.
The Company
HF Financial Corp. (the “Company”), a unitary thrift
holding company, was formed in November 1991, for the purpose of owning all of
the outstanding stock of Home Federal Savings Bank, now known as Home Federal
Bank, (“Home Federal” or the “Bank”) issued in the mutual to stock conversion
of Home Federal (the “Conversion”). The
Company acquired all of the outstanding stock of the Bank on April 8,
1992. The Company is incorporated under
the laws of the State of Delaware and generally is authorized to engage in any
activity that is permitted by the Delaware General Corporation Law. Unless otherwise indicated, all matters
discussed in this Form 10-K relate to the Company, and its direct and indirect
subsidiaries, including without limitation, the Bank. See “Subsidiary Activities” for further information on the
Company’s and Bank’s subsidiary operations.
The executive offices of the Company and its direct and
indirect subsidiaries are located at 225 South Main Avenue, Sioux Falls, South
Dakota, 57104. The Company’s telephone
number is (605) 333-7556. The Company’s
and Bank’s website is located at www.homefederal.com. Information on this website does not constitute part of this Form
10-K.
The Bank
Home Federal was founded in 1929 and is a federally
chartered stock savings bank headquartered in Sioux Falls, South Dakota. Effective July 1, 2001, the Bank began
operating under the name Home Federal Bank.
The Bank provides full-service consumer and commercial business banking,
including an array of financial products, to meet the needs of its market
place. The Bank attracts deposits from
the general public and uses such deposits, together with borrowings and other
funds, to originate one- to four-family residential, commercial business,
consumer, multi-family, commercial real estate, construction and
agricultural loans. The Bank’s consumer
loan portfolio includes, among other things, automobile loans, home equity
loans, loans secured by deposit accounts and student loans. The Bank also purchases mortgage-backed
securities and invests in U.S. Government and agency obligations and other
permissible investments. Home Federal
does not hold any non-investment grade bonds (i.e., “junk bonds”). The Bank receives loan servicing income on
loans serviced for others and commission income from credit-life insurance on
consumer loans. The Bank, through its
wholly-owned subsidiaries, offers annuities, health, life, hazard and other
insurance products and equipment leasing services. At June 30, 2002, the Company had an investment in the Bank of
$59.0 million. The Bank had income from
continuing operations after taxes of $5.3 million for the 2002 fiscal year.
The Bank’s deposits are insured up to applicable limits
by the Savings Association Insurance Fund (“SAIF”), administered by the Federal
Deposit Insurance Corporation (“FDIC”), and is subject to primary regulation
and examination by the Office of Thrift Supervision (“OTS”).
Segments
Operating segments are defined as components of an
enterprise for which separate financial information is available that is
evaluated regularly by the chief operating decision makers in deciding how to
allocate resources and in assessing performance. The primary reporting segment is the Bank. The Company’s reportable segments do not
meet requirements for separate presentation in the consolidated financial
statements or notes thereto under accounting principals generally accepted in
the United States of America (“GAAP”).
Subsidiary Activities
In addition to the Bank,
the Company had three other wholly-owned subsidiaries as of June 30, 2002: HF Card Services, LLC (“HF Card”), HomeFirst
Mortgage Corp. (the “Mortgage Corp.”) and HF Capital Trust I (“Trust I”).
HF Card, a South Dakota
limited liability company, was established in May 1996 to provide secured,
partially-secured and unsecured credit cards nationwide. The Company announced the discontinuance of
the subprime credit card operation in June 2002. At June 30, 2002, the Company had a negative investment in HF
Card of $10.6 million. HF Card had a
net loss from discontinued operations before taxes of $3.0 million for the 2002
fiscal year, including the write down of the credit card loans to estimated net
realizable value.
HF Card ceased processing subprime credit
card applications in March 1999 and has been managing the portfolio from a
balance of $18.1 million at June 30, 1999, to the remaining balance of $3.8
million at June 30, 2002. The Company is negotiating the sale of the remaining
receivables to a third party. As of
June 30, 2002, the Company had not entered into a definitive agreement for the
sale of the remaining receivables. The Company estimated the net realizable
value of the credit card portfolio based on estimates from a third party. The actual sale of the receivables and
liquidation of HF Card is expected to take place in the first half of fiscal
2003. Results of this discontinuance
have been segregated from continuing operations of the Company. The Company intends to dissolve HF Card upon
liquidation. See Note 2 of “Notes to Consolidated Financial Statements”
and Item 7, “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” for further discussion on discontinued operations.
The Mortgage Corp. is a South Dakota corporation
that, until the fall of 1998, was engaged in the business of originating one-
to four- family residential loans which were sold into the secondary
market. At June 30, 2002, the Company
had a $1,000 investment in the Mortgage Corp.
The Mortgage Corp. is not currently engaged in any business activity. The Mortgage Corp. had income from
continuing operations before tax of $51,000 for the 2002 fiscal year due to
operations of its wholly-owned subsidiary, Mid America Capital Services, Inc.
(“Mid America Leasing”), during the first quarter of fiscal 2002. In September 2001, due to regulations on
funding operations of a subsidiary, the Mortgage Corp. assigned all of the
stock in Mid America Leasing to the Bank.
In November 2001, the Company formed Trust I. Trust I exists for the sole
purpose of issuing trust preferred securities and investing the proceeds in
subordinated debentures of the Company.
These subordinated debentures constitute the sole asset of Trust I. At June
30, 2002, the Company had a $310,000 investment in Trust I. Trust I had no income before tax for the
2002 fiscal year.
In July 2002, the
Company formed HF Capital Trust II (“Trust II”). Trust II exists for the sole purpose of issuing trust preferred
securities and investing the proceeds in subordinated debentures of the
Company. These subordinated debentures
constitute the sole asset of Trust II.
See Note 21 of “Notes to Consolidated Financial Statements” for further
information on this subsequent event.
As a federally chartered
thrift institution, the Bank is permitted by OTS regulations to invest up to
2.00% of its assets in the stock of, or loans to, service corporation subsidiaries. The Bank may invest an additional 1.00% of
its assets in service corporations where such additional funds are used for
inner-city or community development purposes. The Bank currently has less than 1.00% of its assets in
investments in its subsidiary service corporations as defined by the OTS. In addition to investments in service
corporations, the Bank is permitted to invest an unlimited amount in operating
subsidiaries engaged solely in activities in which the Bank may engage in
directly.
The Bank has four
wholly-owned subsidiaries, Hometown Insurors, Inc. (“Hometown”), Mid America
Leasing, Mid-America Service Corporation (“Mid-America”) and PMD,
Inc. (“PMD”).
Hometown, a South Dakota
corporation located in Sioux Falls, South Dakota, provides a full line of
insurance products to customers of the Bank and members of the general public
in the Bank’s market area. Insurance
products offered by Hometown include annuities and life, health, homeowners,
and auto insurance and, to a lesser extent, certain commercial-related
insurance products. The Bank had an
investment in Hometown of $219,000 at June 30, 2002. Hometown had income from continuing
operations before tax of $13,000 for the 2002 fiscal year. Hometown obtains its funding via a
line of credit from the Bank. Banking
regulations do not limit the amount of funding provided to a subsidiary. As of June 30, 2002, the Bank had advanced
$200,000 on an approved line of credit of $200,000. Intercompany interest income and interest expense are eliminated
in the preparation of consolidated financial statements.
Mid America Leasing, a
South Dakota corporation located in Sioux Falls, South Dakota, specializes in
equipment finance leasing. At June 30,
2002, the Bank had a $3.0 million investment in Mid America Leasing. Mid America Leasing had income from
continuing operations before tax of $188,000 for the 2002 fiscal year. Mid America Leasing Co.
obtains its funding via a line of credit from the Bank. Banking regulations do not limit the amount of
funding provided to a subsidiary. As of
June 30, 2002, the Bank had advanced $19.6 million on an approved line of
credit of $20.0 million. Intercompany
interest income and interest expense are eliminated in the preparation of
consolidated financial statements.
Mid-America is a South
Dakota corporation that, until the third quarter of fiscal 2002, provided
residential appraisal services to Home Federal and other lenders in the Bank’s
market area. The cessation of operations
of Mid-America had no material effect on the consolidated financial
statements. At June 30, 2002, the Bank
had a $1,000 investment in Mid-America.
Mid-America is not currently engaged in any business activity. Mid-America had income from continuing
operations before tax of $4,000 for the 2002 fiscal year.
PMD, a South Dakota corporation located in Sioux
Falls, South Dakota, is engaged in the business of buying, selling and managing
repossessed real estate properties. At
June 30, 2002, the Bank had a $1,000 investment in PMD. PMD had no activity during fiscal year 2002.
Market Area
Based on total assets at June 30, 2002, Home Federal is
the largest thrift institution headquartered in South Dakota. The Bank has a total of 33 banking centers
in its market area and 1 internet branch located at www.homefederal.com. The Bank’s primary market area includes
communities located in eastern and central South Dakota, including the cities
of Sioux Falls, Brandon, Pierre, Winner, Freeman, Dell Rapids, Hartford,
Canton, Parker, Lennox, Mitchell, Aberdeen, Mobridge, Brookings, Redfield,
Dakota Dunes, Colman, Crooks, Watertown and Yankton. During August 2000, the Bank expanded its market area to include
a branch in Marshall, Minnesota. The
Bank’s immediate market area features a variety of agri-business, banking,
financial services, health care and light manufacturing firms. The internet branch allows access to
customers nationwide.
Mid America Leasing provides services to customers
nationwide.
Lending Activities
General. The Bank originates fixed-rate
and adjustable-rate (“ARM”) loans secured by one- to four-family
residences. The Bank originates ARM
loans and short-term loans primarily for retention in its portfolio in order to
increase the percentage of loans in its portfolio with more frequent repricing
or shorter maturities than fixed-rate mortgage loans. The Bank has continued to originate fixed-rate mortgage
loans in response to customer demand.
The Bank has generally sold one- to four-family loans with maturities of
15 years or greater into the secondary market with servicing released. On occasion, the Bank has retained 15-year
fixed-rate loans in its loan portfolio to maintain appropriate asset
levels. The Bank’s one- to four-family
loans are primarily secured by homes located in its market area in South Dakota
and Minnesota.
The Bank also originates consumer, multi-family
residential and commercial real estate, construction, agricultural and
commercial business loans in its primary market area. The Bank originates residential and non-owner occupied
construction loans that are presold to borrowers or held for sale by local
builders and, on few occasions, makes land acquisition and development
loans. See the Loan and Lease Portfolio
Composition tables immediately following this section for further detail.
One- to Four-Family Residential Mortgage Lending. Residential loan originations
of this type are generated by the Bank’s marketing efforts, its present
customers, walk-in customers and referrals from real estate brokers and builders. The Bank has focused its lending efforts
primarily on the origination of loans secured by first mortgages on
owner-occupied, one- to four-family residences.
The Bank currently makes
15- and 30-year fixed- and adjustable-rate one- to four-family
residential mortgage loans in amounts up to 95.00% of the appraised value of
the collateral property provided that private mortgage insurance is obtained in
an amount sufficient to reduce the Bank’s exposure at or below the 80.00%
level. The Bank currently offers an ARM
loan which has a fixed rate for the initial 3 to 5 years and converts to a one-year
ARM loan for the remainder of the life of the loan. The Bank also offers a one-year ARM loan with a rate below
the Bank’s then current fixed-rate loan for a comparable 15- or 30-year
term loan. These loans provide for an
annual cap and a lifetime cap at a set percent over the fully-indexed
rate. As a consequence of using caps,
the interest rates on these loans may not be as rate sensitive as is the Bank’s
cost of funds.
In addition, the Bank
offers a 30-year balloon loan which has a fixed-rate for the first
5 or 7 years of the loan term. At the
end of the five- or seven-year period, the loan converts to a 23-
or 25-year fixed-rate loan at the then current market rate provided
that the borrower qualifies at the new rate.
If the borrower fails to qualify at the new rate, the loan becomes
payable in full. These loans are underwritten
to conform to secondary market standards.
The Bank also offers
fixed-rate 15- through 30-year mortgage loans that conform to
secondary market standards. Interest rates charged on these fixed-rate
loans are competitively priced on a daily basis according to market
conditions. Residential loans generally
do not include prepayment penalties.
The Bank also originates fixed-rate one-
to four-family mortgage loans through the South Dakota Housing
Development Authority (“SDHDA”) program.
These loans generally have terms not to exceed 30 years and are either
insured by the Federal Housing Administration (“FHA”), Veteran’s Administration
(“VA”) or private mortgage insuror and must have no more than a 80.00% loan to
value ratio. The Bank receives an
origination fee of 1.00% of the loan amount from the borrower and a servicing
fee generally 0.38% from the SDHDA for these services. The Bank is the largest servicer of loans
for the SDHDA. At June 30, 2002, the
Bank serviced $444.8 million of mortgage loans for the SDHDA. See Note 6 of “Notes to Consolidated
Financial Statements” for information on loan servicing.
In underwriting one-
to four-family residential real estate loans, Home Federal evaluates both
the borrower’s ability to make monthly payments and the value of the property
securing the loan. Property securing
real estate loans made by Home Federal is appraised by an appraiser pursuant to
its appraisal policy. Home Federal
requires borrowers to obtain title, fire and casualty insurance in an amount
not less than the amount of the loan.
Real estate loans originated by the Bank contain a “due-on-sale”
clause allowing the Bank to declare the unpaid principal balance due and
payable upon the sale of the collateral property.
Commercial Business Lending. In order to serve the needs of
the local business community and improve the interest rate sensitivity and
yield of its assets, the Bank originates commercial loans to local
businesses. See “Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Asset/Liability and Risk Management.”
Home Federal’s commercial business lending activities encompass loans
with a variety of purposes and security, including loans to finance accounts
receivable, inventory and equipment and business expansion within the Bank’s
market area. Generally, Home Federal’s
commercial business loans have been to borrowers in its primary lending
areas. The Bank originates commercial
business loans directly and through programs sponsored by the Small Business
Administration (“SBA”) of which a portion of such loans are also guaranteed in
part by the SBA. The Bank generally
originates commercial business loans for its portfolio and retains the
servicing with respect to such loans.
In the future, Home Federal anticipates continued expansion and emphasis
of its commercial business lending, subject to market conditions and the Home
Owners’ Loan Act (“the HOLA”) restrictions.
Interest rates on commercial business loans adjust or float with a
designated national index plus a specified margin. See “Regulation-Business
Activities” for HOLA restrictions.
Commercial business
loans typically are made on the basis of the borrower’s ability to make
repayment from the cash flow of the borrower’s business. As a result, the availability of funds for
the repayment of commercial business loans may be substantially dependent on
the success of the business itself (which, in turn, is likely to be dependent
upon the general economic environment).
The Bank’s commercial business loans are sometimes, but not always,
secured by business assets, such as accounts receivable, equipment and
inventory. However, the collateral
securing the loans may depreciate over time, may be difficult to appraise and
may fluctuate in value based on the success of the business. Whenever possible, all of the Bank’s
commercial business loans include personal guarantees. In addition, on major loans,
the loan officer will perform on site visits, obtain financial statements and
perform a financial review of the loan.
Multi-Family and Commercial Real
Estate Lending. The Bank engages in multi-family and commercial real estate
lending primarily in South Dakota and the adjoining mid-western
states. These lending activities may
include existing property or new construction development or purchased loans.
Loans secured by multi-family
and commercial real estate properties are generally larger and involve a
greater degree of credit risk than one- to four-family residential
mortgage loans. Because payments on loans secured by multi-family and
commercial real estate properties are often dependent on the successful
operation or management of the properties, repayment of such loans may be
subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced
(for example, if leases are not obtained or renewed), the borrower’s ability to
repay the loan may be impaired. In addition, loans secured by property outside
of the Company’s immediate market area may contain a higher degree of risk due
to the fact that the Company may not be as familiar with market conditions
where such property is located. The
Company does not have a material concentration of multi-family or commercial
real estate loans outside of its immediate market area.
The Bank presently originates adjustable-rate,
short-term balloon payment, fixed-rate multi-family and commercial real estate
loans. The Bank’s multi-family
and commercial real estate loan portfolio is secured primarily by apartment
buildings and, to a lesser extent, churches, motels, office buildings, strip
shopping centers and nursing homes. The
terms of such loans are negotiated on a case by case basis. Commercial real estate loans generally have
terms that do not exceed 25 years. The
Bank has a variety of rate adjustment features, call provisions and other terms
in its multi-family and commercial real estate loan portfolio. Generally, the loans are made in amounts up
to 80.00% of the appraised value of the collateral property and with debt
service coverage ratios of 115.00% or higher.
The debt service coverage is the ratio of net cash from operations
before payment of debt service.
However, these percentages may vary depending on the type of security
and the guarantor. Such loans provide
for a negotiated margin over a designated index which is generally the one- to
five-year Treasury Note Rate. The Bank
analyzes the financial condition of the borrower, the borrower’s credit
history, the borrower’s prior record for producing sufficient income from
similar loans, references and the reliability and predictability of the net
income generated by the property securing the loan. The Bank generally requires personal guarantees of
borrowers. Depending on the
circumstances of the security of the loan or the relationship with the
borrower, the Bank may decide to sell participations in the loan. The sale of participation interests in a
loan are necessitated by the amount of the loan or the limitation of Loans to
One Borrower. See “Regulation-Business Activities” for a discussion of
the Loans to One Borrower rule. In return
for servicing these loans for the participants, the Bank generally receives a
fee of 0.25% to 0.38%. Also, income is
received at loan closing from loan fees and discount points. Appraisals on properties securing multi-family
and commercial real estate loans originated by the Bank are performed by
appraisers approved pursuant to the Bank’s appraisal policy.
The Financial
Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”) includes
a provision that limits the Bank’s non-residential real estate lending
(i.e., commercial real estate lending, other than lending on certain multi-family
residences) to no more than four times its total capital. This maximum limitation, which at June 30,
2002 was $236.18 million, has not materially limited the Bank’s lending
practices. See “Regulation-­Regulatory Capital Requirements.”
Under FIRREA, the
maximum amount which Home Federal may lend to any one borrower is 15.00% of
Home Federal’s unimpaired capital and surplus or $8.7 million at June 30, 2002. Loans in an amount equal to an additional
10.00% of unimpaired capital and surplus may be made to the same borrower if
such loans are fully secured by readily marketable collateral. See “Regulation-Business Activities” for a discussion of the Loans to One
Borrower rule.
Construction and Development Lending. The Bank makes construction
loans to individuals for the construction of their residences as well as to
builders and, to a lesser extent, developers for the construction of one-
to four-family residences and condominiums and the development of one-
to four-family lots in the Bank’s primary market area.
Construction loans to
individuals for their residences are structured to be converted to permanent
loans at the end of the construction phase, which typically runs 6 to 12
months. These construction loans have
rates and terms which match the one- to four-family permanent loans
offered by the Bank. Residential
construction loans are generally underwritten pursuant to the same guidelines
used for originating permanent residential loans.
The Bank also makes
loans to developers for the purpose of developing one- to four-family
lots. These loans typically have terms
of one year and carry floating interest rates based on a national designated
index. Loan commitment and partial
release fees are charged. These loans
generally provide for the payment of interest and loan fees from loan
proceeds. The principal balance of
these loans is typically paid down as lots are sold. At June 30, 2002, the Bank had $6.8 million of development loans
included in its construction and development loan portfolio.
Builder construction and
development loans are obtained principally through continued business from
developers and builders who have previously borrowed from the Bank as well as
broker referrals and direct solicitations of developers and builders. The application process includes a
submission to the Bank of plans, specifications and costs of the project to be
constructed or developed. These items
are used as a basis to determine the appraised value of the subject
property. Loans are based on the lesser
of current appraised value and/or the cost of construction (land plus
building).
The Bank makes loans for
the construction of multi-family residential properties. Such loans are generally made at adjustable
rates which adjust periodically based on the appropriate Treasury Note
maturity. At June 30, 2002, all of the
Bank’s construction loans were performing in accordance with their terms.
Construction loans are generally originated
with a maximum loan-to-value ratio of 80.00% and land development loans
are generally originated with a maximum loan-to-value ratio of
60.00%, based upon an independent appraisal.
Because of the uncertainties inherent in estimating development and
construction costs and the market for the project upon completion, it is
relatively difficult to evaluate accurately the total loan funds required to
complete a project, the related loan-to-value ratios and the
likelihood of ultimate success of the project.
Construction and development loans to borrowers other than owner
occupants also involve many of the same risks discussed above regarding multi-family
and commercial real estate loans and tend to be more sensitive to general
economic conditions than many other types of loans.
Prior to making a
commitment to fund a construction loan, the Bank requires an appraisal of the
property, or for larger projects, both an appraisal and a study of the
feasibility of the proposed project.
The Bank’s construction loan policy provides for the inspection of
properties by independent in-house and outside inspectors at the
commencement of construction and prior to disbursement of funds during the term
of the construction loan.
Consumer Lending. Management considers its
consumer loan products to be an important component of its lending
strategy. Specifically, consumer loans
generally have shorter terms to maturity and carry higher rates of interest
than do one-to four-family residential mortgage loans. In addition, management believes that the
offering of consumer loan products helps to expand and create stronger ties to
its existing customer base, by increasing the number of customer relationships
and providing cross-marketing opportunities. For these reasons, Home Federal has continued to focus on the
origination of consumer loans.
Home Federal currently
purchases automobile conditional sales contracts from selected dealers within
its market area as well as originating automobile loans directly.
Loans secured by second
mortgages, together with loans secured by all prior liens, are limited to 100%
or less of the appraised value of the property securing the loan and generally
have maximum terms that do not exceed 10 to 15 years.
The student loans
originated by Home Federal are guaranteed as to principal and interest by the
South Dakota Education Assistance Corporation.
Upon the student nearing graduation, Home Federal sells such student
loans with servicing rights released.
Consumer loan terms vary
according to the type of collateral, length of contract and creditworthiness of
the borrower. Home Federal offers both
open- and closed-end credit.
Overdraft lending is extended through lines of credit that are tied to a
checking account. The credit lines generally
bear interest at 18.00% and are generally limited to no more than $2,000. Loans secured by deposit accounts at the
Bank are currently originated for up to 90.00% of the account balance (although
historically the Bank has loaned up to 100.00% of the account balance), with a
hold placed on the account restricting the withdrawal of the account
balance. The interest rate on such
loans is typically equal to 2.00% above the contract rate.
The underwriting standards employed by the Bank
for consumer loans, including mobile home loans, include an application, a
determination of the applicant’s payment history on other debts, and an
assessment of the ability to meet existing obligations and payments on the
proposed loan. Although
creditworthiness of the applicant is a primary consideration, the underwriting
process also includes a comparison of the value of the security, if any, in
relation to the proposed loan amount.
Consumer loans may
entail greater credit risk than do residential mortgage loans, particularly in
the case of consumer loans which are unsecured or are secured by rapidly
depreciable assets, such as mobile homes, automobiles or boats. 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. In
addition, consumer loan collections are dependent on the borrower’s continuing
financial stability, and thus are more likely to be affected by adverse
personal circumstances. Furthermore, the application of various federal and
state laws, including bankruptcy and insolvency laws, may limit the amount
which can be recovered on such loans.
Agricultural Loans. In order to serve the needs of the local business community and
improve the interest rate sensitivity and yield of its assets, the Bank
originates agricultural loans through its agricultural division. The agricultural division offers loans to its
customers such as: (1) operating loans which are used to fund operating
expenses which typically have a one year term and are indexed to the national
prime rate; (2) term loans on machinery, equipment and breeding stock that may
have a term up to 7 years and require annual payments; (3) agricultural
farmland term loans which are used to fund land purchases or refinances; and
(4) specialized livestock loans to fund facilities and equipment for
confinement enterprises; (5) loans to fund ethanol plant development. Agriculture real estate loans typically will
have personal guarantees, a first lien on the real estate, interest rates
adjustable to the national prime rate or Treasury Note rates, and annual,
quarterly or monthly payments.
Operating and term loans are secured by farm chattels (crops, livestock,
machinery, etc.) the operating assets of the borrower. The Bank also originates agricultural loans
directly and through programs sponsored by the Farmers Service Agency (“FSA”)
of which a portion of such loans are also guaranteed in part by the FSA.
Loan customers are required to supply current
financial statements, tax returns for the past 3 to 5 years, and cash flow
projections which are updated on an annual basis. In addition, on major loans, the loan officer will perform an
annual farm visit, obtain financial statements and perform a financial review
of the loan.
Leasing
Activities
General. Through its wholly-owned
subsidiary, Mid America Leasing, the Bank originates commercial and municipal
leases. These products have a fixed
interest rate for the duration of the lease with terms typically ranging from
24 - 60 months. The leases generally
are 100.00% financed with usually only the first or first and last months’
payments due at lease inception. As a
result of the 100.00% financing and fixed interest rate the yield on leases is
higher than similar type lending products.
Leases are originated generally in an
eight-state area in the upper Midwest but originations can and have expanded
nationwide. All leases are secured by
the equipment leased, with personal guaranties normally obtained on commercial
leases.
Commercial Leases. In order to support the Bank and its customers and to improve
the yield of its assets, Mid America
Leasing originates commercial leases to customers primarily in the upper
Midwest. The Bank offers three types of
commercial leases: capital, tax and Terminal Rental Adjustment Clause leases
(“TRAC”). TRAC is for larger titled
equipment only such as semi-tractors and trailers. Leases may be structured with a contracted residual of as little
as $1.00 up to 20.00% of the equipment cost.
Leases encompass a wide variety of equipment for a variety of commercial
uses. The customer base tends to be
small- to medium-sized businesses that view leasing as another financing option
that augments their overall operation.
Repayment terms tend to be monthly in nature.
As with commercial loans, commercial leases
typically are made on the basis of the borrower’s ability to make repayment
from the cash flow of their business.
As a result, the availability of funds for the repayment of commercial
leases may be substantially dependent on the success of the business
itself. The collateral securing the
leases will generally depreciate over time, may be difficult to appraise and
may fluctuate in value based on the success of the business.
Municipal Leases. The Bank also originates leases to municipal entities such as
cities, counties, and public schools.
The lessee must be a political subdivision of the state in order to qualify
as a municipal lease. Because the
interest income earned on this type of lease is exempt from federal income
taxes, the rate offered to the municipality is usually substantially lower than
a comparable commercial lease.
Repayment terms generally tend to be on an annual or semi-annual basis
coinciding with the municipality’s tax receipts. Residuals are $1.00 for municipal leases.
Repayment is based on the municipality’s
ability to levy and collect taxes.
Assuming the municipality has a bond rating, that, along with audited
financial statements, are the basis for the lease. On larger leases, bond ratings will be reviewed annually as well
as financial statements.
Loan
and Lease Portfolio Composition. The following table sets forth information
concerning the composition of the Company’s loan and lease portfolio from
continuing operations in dollar amounts and in percentages (before deductions
for loans in process, deferred fees and discounts and allowance for losses) as
of the dates indicated. Balances related
to discontinued credit card loan operations have been eliminated for all
periods presented.
(1) Includes one- to four-family loans held for sale.
The following table
shows the composition of the Company’s loan and lease portfolio from continuing
operations by fixed- and adjustable-rate at the dates indicated. Balances related to discontinued credit card
loan operations have been eliminated for all periods presented.
(1) Includes one- to four-family loans held for sale.
The following schedule illustrates the scheduled
principal contractual repayments of the Company’s loan and lease portfolio from
continuing operations at June 30, 2002.
Mortgages which have adjustable or renegotiable interest rates are shown
as maturing at the contractual maturity date.
The schedule does not reflect the effects of possible prepayments or
enforcement of due-on-sale clauses.
(1) Includes one- to four-family loans held for
sale.
(2) Includes
demand loans, loans having no stated maturity and overdraft loans.
(3) Includes equipment finance leases.
The total amount of
loans due after June 30, 2003 which have predetermined interest rates is $233.6
million, while the total amount of loans due after such date which have
floating or adjustable interest rates is $202.9 million.
Scheduled contractual
principal repayments of loans do not reflect the actual life of such
assets. The average life of loans is
substantially less than their average contractual terms because of
prepayments. In addition, due-on-sale
clauses on loans generally give the Bank the right to declare a conventional
loan immediately due and payable in the event, among other things, that the
borrower sells the real property subject to the mortgage and the loan is not
repaid. The average life of mortgage
loans tends to increase, however, when current mortgage loan rates are
substantially higher than rates on existing mortgage loans and, conversely,
decrease when rates on existing mortgages are substantially higher than current
mortgage loan rates. One- to
four-family mortgage loans have prepaid significantly due to the effect of
lower mortgage rates during the last year.
Nonperforming Assets and Classified Loans
Nonperforming Assets. See
“Asset Quality” under Management’s Discussion and Analysis for discussion.
Classified Assets. Federal regulations provide
for the classification of loans and other assets such as debt and equity
securities considered by the OTS to be of lesser quality as “substandard,”
“doubtful” or “loss.” An asset is considered “substandard” if it is
inadequately protected by the current net worth and paying capacity of the
obligor or of the collateral pledged, if any.
“Substandard” assets include those characterized by the “distinct
possibility” that the Bank will sustain “some loss” if the deficiencies are not
corrected. Assets classified as
“doubtful” have all of the weaknesses inherent in those classified
“substandard,” with the added characteristic that the weaknesses present make
“collection or liquidation in full,” on the basis of currently existing facts,
conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those
considered “uncollectible” and of such little value that their continuance as
assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the
Bank to sufficient risk to warrant classification in one of the aforementioned
categories, but possess weaknesses, are required to be designated “special
mention” by management.
When
the Bank classifies problem assets as “loss, “ it is required either to establish
a specific allowance for losses equal to 100% of that portion of the asset so
classified or to charge-off such amount.
The Bank’s determination as to the classification of its assets and the
amount of its valuation allowances is subject to review by the association’s
Regional Director at the regional OTS office, who may order the establishment
of additional general or specific loss allowances.
In
connection with the filing of its periodic reports with the OTS and in
accordance with its classification of assets policy, the Bank regularly reviews
problem loans in its portfolio to determine whether any loans require
classification in accordance with applicable regulations. On the basis of management’s monthly review
of its assets, at June 30, 2002, the Bank had criticized $9.0 million
of its assets as special mention (including certain loans discussed in this
Form 10-K) and the Bank had classified $18.9 million as substandard (including
certain loans discussed in this Form 10-K), and approximately $4.4 million as
doubtful. See “Asset Quality” under
Management’s Discussion and Analysis for further discussion.
Allowance for Loan and Lease
Losses. See “Application of Critical Accounting
Policies” and “Asset Quality” under Management’s Discussion and Analysis for
discussion.
Investment Activities
Home Federal is required
under OTS regulation to maintain a sufficient amount of liquid assets. Liquidity may increase or decrease depending
upon the availability of funds and comparative yields on investments in relation
to the return on loans. Historically,
the Bank has maintained its liquid assets above the minimum requirements
imposed by the OTS regulations and at a level believed by management adequate
to meet requirements of normal daily activities, repayment of maturing debt and
potential deposit outflows. As of
June 30, 2002, the Bank’s liquidity ratio (liquid assets as a
percentage of net withdrawable savings deposits and current borrowings) was
4.78%. See “Regulation-Liquidity.”
Federally chartered
savings institutions have the authority to invest in various types of liquid
assets, including United States Treasury obligations, securities of various
federal agencies, certain certificates of deposit of insured banks and savings
institutions, certain bankers’ acceptances, repurchase agreements and federal
funds. Subject to various restrictions,
federally chartered savings institutions may also invest their assets in
commercial paper, investment grade corporate debt securities and mutual funds
whose assets conform to the investments that a federally chartered savings
institution is otherwise authorized to make directly.
Generally, the
investment policy of the Bank is to invest funds among various categories of
investments and maturities based upon the Bank’s asset/liability management
policies, investment quality and marketability, liquidity needs and performance
objectives.
At June 30, 2002, the
Company’s investments in
mortgage-backed securities totaled $59.7 million, or 8.3% of its total assets.
As of such date, the Bank also had a $6.3 million investment in the stock of
the Federal Home Loan Bank of Des Moines (“FHLB” or “FHLB of Des Moines”) in
order to satisfy the FHLB of Des Moines’ requirement for membership. It is the Bank’s general policy to purchase
investment securities which are U.S. Government securities and federal agency
obligations and other issues rated investment grade.
The composition and maturities of the
investment securities portfolio, excluding equity securities and
mortgage-backed securities, are indicated in the following table.
The
Company’s investment securities portfolio at June 30, 2002 did not contain
securities in excess of 10% of the Company’s stockholders’ equity, excluding
those issued by the United States Government or its agencies. The Company’s investment securities
portfolio also did not contain non-investment grade or other corporate
debt securities (i.e., “junk bonds”).
In addition, the Company does not invest in derivatives as defined by
the Financial Accounting Standards Board.
Home
Federal’s investment security portfolio is managed in accordance with a written
investment policy adopted by the Board of Directors. Investments may be made by the Bank’s officers within specified
limits and approved in advance by the Board of Directors for transactions over
these limits. At the present time, the
Bank does not have any investments that are held for trading purposes. At June 30, 2002, the Company has $29.4
million of securities available for sale, including FHLB stock of $6.3
million. See Note 4 of “Notes to
Consolidated Financial Statements.”
Sources of Funds
General. The Company’s primary sources
of funds are in market deposits, FHLB advances and other borrowings,
amortization and repayments of loan principal, mortgage-backed securities
and callable agency securities and, to a lesser extent, sales of mortgage
loans, sales and/or maturities of
securities, mortgage-backed securities, and short term investments.
Borrowings
of the Bank, presently all from the FHLB of Des Moines, may be used on a short-term
basis to compensate for seasonal reductions in deposits or deposit inflows at
less than projected levels, and may be used on a longer-term basis to
support expanded lending activities.
The Bank in recent years has not relied on outside borrowings other than
FHLB borrowings. The availability of
funds from loan sales is influenced by general interest rates. See Notes 9 and 10 of the “Notes to
Consolidated Financial Statements” for further detail of the Company’s
borrowings.
Deposits. The Bank offers a variety of
deposit accounts having a wide range of interest rates and terms. The Bank’s deposits consist of statement
savings accounts, NOW and checking accounts, money market and certificate
accounts ranging in terms from 30 days to 5 years. The Bank primarily solicits deposits from its market area. The Bank relies primarily on competitive
pricing policies, advertising, and customer service to attract and retain these
deposits.
The
flow of deposits is influenced significantly by general economic conditions,
changes in money market and prevailing interest rates and competition.
The
variety of deposit accounts offered by the Bank has allowed it to be
competitive in obtaining funds and to respond with flexibility to changes in
consumer demand. In recent years, the
Bank has become more susceptible to short-term fluctuations in deposit
flows as customers have become more interest rate conscious. The Bank manages the pricing of its deposits
in keeping with its asset/liability management and profitability
objectives. Based on its experience,
the Bank believes that its statement savings, money market, NOW and checking
accounts are stable sources of deposits.
However, the ability of the Bank to attract and maintain certificates of
deposit, and the rates paid on these deposits, has been and will continue to be
significantly affected by market conditions.
The
following table sets forth the dollar amount of deposits in the various types
of deposit accounts offered by the Company as of the dates indicated.
The following table sets
forth the amount of the Company’s certificates of deposit and other deposits by
time remaining until maturity as of June 30, 2002.
(1) Includes
certificates of deposit of $100,000 or more from governmental and other public
entities.
The Bank solicits
certificates of deposit of $100,000 or greater (“jumbo certificates”) from
various state, county and local government units which carry rates which are negotiated
at the time of deposit. See Note 8
of “Notes to Consolidated Financial Statements.” Deposits at June 30, 2002 and 2001 include $37.4 million and
$37.1 million, respectively of deposits from one local governmental entity, the
majority of which are savings accounts.
Borrowings. Although deposits are the
Bank’s primary source of funds, the Bank’s policy has been to utilize
borrowings when they are a less costly source of funds or can be invested at a
positive rate of return.
The Bank’s borrowings
consist primarily of advances from the FHLB of Des Moines upon the security of
its capital stock of the FHLB of Des Moines and certain pledgable loans,
including but not limited to, its mortgage related loans, mortgage-backed
securities and U.S. Government and other agency securities. Such advances can be made pursuant to
several different credit programs, each of which has its own interest rate and
range of maturities. At June 30, 2002,
the Bank’s FHLB advances totaled $83.4 million, representing 12.37% of total
Company liabilities. See Note 9 of “Notes to Consolidated Financial Statements”
for further detail of the Company’s borrowings.
The following table sets
forth the maximum month-end balances and average balances of FHLB advances and
other borrowings at the dates indicated.
The following table sets
forth certain information as to the Bank’s FHLB advances and other borrowings
of the Company at the dates indicated.
Trust Preferred Securities. The Company issued trust preferred
securities during fiscal 2002 in order to provide funding for investment into
the Bank of Tier I (core) capital and to provide liquidity for repurchasing Company
stock. See Note 10 of “Notes to Consolidated Financial
Statements”.
Competition
Home Federal faces
strong competition, both in originating real estate, commercial and consumer
loans and in attracting deposits. Competition in originating real estate loans
comes primarily from other commercial banks, credit unions and mortgage bankers
making loans secured by real estate located in the Bank’s market areas.
Commercial banks and finance companies provide vigorous competition in consumer
lending. The Bank competes for real
estate and other loans principally on the basis of the quality of services it
provides to borrowers, interest rates and loan fees it charges and the types of
loans it originates.
The Bank attracts the
majority of its deposits through its retail banking offices, primarily from the
communities in which those retail banking offices are located; therefore,
competition for those deposits is principally from other commercial banks and
credit unions located in the same communities.
The Bank competes for these deposits by offering a variety of deposit
accounts at competitive rates, convenient business hours, and convenient branch
locations with interbranch deposit and withdrawal privileges at each. According to information contained in reports
prepared by the FDIC, the Bank is the fifth largest financial institution based
on total deposits with approximately 5.00% of the deposit market share in
Minnehaha County. Minnehaha County
includes the South Dakota cities of Sioux Falls, Brandon, Dell Rapids, Crooks
and Hartford. In addition, on a limited
basis, the Bank also attracts out of market deposits nationally through its
internet branch.
Employees
At June 30, 2002, the
Bank had a total of 328 full-time equivalent employees (“FTEs”) including 18
FTEs of the Bank’s service corporations.
The Bank’s employees are not represented by any collective bargaining
group. Management considers its
relations with its employees to be good.
Regulation
General. The Bank is a federally chartered thrift institution,
the deposits of which are federally insured by the Savings Association
Insurance Fund (the “SAIF”) of the FDIC.
Accordingly, the Bank is subject to broad federal regulation and
oversight extending to all its operations, by its primary federal regulator,
the Office of Thrift Supervision (“OTS”).
The Bank is a member of the FHLB of Des Moines and is subject to certain
limited regulation by the Federal Reserve Board. As the unitary thrift holding company of the Bank, the Company
also is subject to federal regulation and oversight by the OTS. The purpose of the regulation of the Company
and other holding companies is to protect subsidiary savings associations where
deposits are federally insured.
Certain of these
regulatory requirements and restrictions are discussed below or elsewhere in
this document. The following discussion
is intended to be a summary of the material statutes, regulations and policies
applicable to savings associations and their holding companies, and it does not
purport to be a comprehensive discussion of such statutes, regulations and
policies.
Regulation of Federal Savings
Associations. The OTS has extensive authority over the operations of federal
savings associations, such as the Bank.
Pursuant to this authority, the Bank is required to file periodic
reports with the OTS and is subject to periodic examinations primarily by the
OTS and to a lesser extent by the FDIC.
The last examination of the Bank by the OTS concluded on February 28,
2002. Examiners may require a federal savings association to provide for higher
general or specific loan loss-reserves.
In 2002, the OTS realigned its regional supervisory structure and
apportioned supervisory responsibilities to other regions. The Company was previously located in the Central
region and has been reassigned to the Western region. Regulatory differences between regions should not be significant.
Assessments. The OTS has established a
schedule for the assessment of fees upon all savings associations to fund the
operations of the OTS. The general assessment, paid on a semiannual basis,
is computed by totaling three components: the size of the association on which
the basic assessment is based; the association’s supervisory condition, which
would result in an additional assessment based on a percentage of the basic
assessment for any savings institution with a composite rating of 3, 4 or 5 in
its most recent safety and soundness examination; and the complexity of the
association’s operations, which would result in an additional assessment based
on a percentage of the basic assessment for any savings association that
managed over $1.0 billion in trust assets, serviced for others loans
aggregating more than $1.0 billion, or had certain off-balance sheet assets
aggregating more than $1.0 billion. The
Bank’s OTS assessment (standard assessment) for the fiscal year ended June 30,
2002 was approximately $147,000.
Enforcement. Under the Federal Deposit Insurance Act (the “FDI Act”), the OTS
has primary enforcement responsibility over savings associations and has the
authority to bring enforcement action against all “institution-affiliated
parties,” including any controlling stockholder or any stockholder, attorney,
appraiser or accountant who knowingly or recklessly participates in any
violation of applicable law or regulation or breach of fiduciary duty or
certain other wrongful actions that causes or is likely to cause a more than a
minimal loss or other significant adverse effect on an insured savings
association. Civil penalties cover a
wide range of violations and actions and range from $5,000 for each day during
which violations of law, regulations, orders, and certain written agreements
and conditions continue, up to $1.0 million per day for such violations if the
person obtained a substantial pecuniary gain as a result of such violation or
knowingly or recklessly caused a substantial loss to the institution. Criminal penalties for certain financial
institution crimes include fines of up to $1.0 million and imprisonment for up to
30 years. In addition, regulators have
substantial discretion to take enforcement action against an institution that
fails to comply with its regulatory requirements, particularly with respect to
its capital requirements. Possible
enforcement actions range from the imposition of a capital plan and capital
directive to receivership, conservatorship, or the termination of deposit
insurance. Under the FDI Act, the FDIC
has the authority to recommend to the Director of OTS that enforcement action
be taken with respect to a particular savings association. If action is not taken by the Director of
the OTS, the FDIC has authority to take such action under certain
circumstances.
Business Activities. The Bank derives its lending and investment powers from the Home
Owners’ Loan Act, as amended (the “HOLA”), and the regulations of the OTS
thereunder. Under these laws and
regulations, the Bank may invest in mortgage loans secured by residential and
commercial real estate, commercial and consumer loans, certain types of debt
securities and certain other assets.
The Bank may also establish service corporations that may engage in
activities not otherwise permissible for the Bank, including certain real
estate equity investments and securities and insurance brokerage. These investment powers are subject to
various limitations, including (a) a prohibition against the acquisition of any
corporate debt security that is not rated in one of the four highest rating
categories; (b) a limit of 400.00% of an association’s capital on the aggregate
amount of loans secured by non-residential real estate property; (c) a limit of
20.00% of an association’s assets on the aggregate amount of commercial and
agricultural loans and leases with the amount of commercial loans in excess of
10.00% of assets being limited to small business loans; (d) a limit of 35.00%
of an association’s assets on the aggregate amount of consumer loans and
acquisitions of certain debt securities; (e) a limit of 5.00% of assets on
non-conforming loans (loans in excess of the specific limitations of the HOLA);
and (f) a limit of the greater of 5.00% of assets or an association’s capital
on certain construction loans made for the purpose of financing what is or is
expected to become residential property.
Under the HOLA, savings
associations are generally subject to the same limits on Loans to One Borrower
as are imposed on national banks.
Generally, under these limits, a savings association may not make a loan
or extend credit to a single or related group of borrowers in excess of 15.00%
of the association’s unimpaired capital and surplus. Additional amounts may be lent, not in excess of 10.00% of
unimpaired capital and surplus, if such loans or extensions of credit are fully
secured by readily-marketable collateral.
Such collateral is defined to include certain debt and equity securities
and bullion, but generally does not include real estate. At June 30, 2002, the Bank’s lending limit
under this restriction was $8.7 million.
Home Federal is in compliance with the loans-to-one-borrower
limitation and had no borrowers in excess of the Loans to One Borrower
requirements at June 30, 2002.
Safety and Soundness Standards. Pursuant to the FDI Act, as
amended by FDICIA and the Riegle Community Development and Regulatory
Improvement Act of 1994 (the “Community Development Act”), the OTS and the
federal bank regulatory agencies adopted, a set of guidelines prescribing
safety and soundness standards pursuant to FDICIA, as amended. The guidelines establish general standards
relating to internal controls and information systems, internal audit systems,
loan documentation, credit underwriting, interest rate exposure, asset growth,
asset quality, earnings, and compensation, fees and benefits. In general, the guidelines require, among
other things, appropriate systems and practices to identify and manage the
risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and
unsound practice and describe compensation as excessive when the amounts paid
are unreasonable or disproportionate to the services performed by an executive
officer, employee, director or principal stockholder. In addition, the OTS adopted regulations that authorize, but do
not require, the OTS to order an institution that has been given notice by the
OTS that it is not satisfying any of such safety and soundness standards to
submit a compliance plan. If, after
being so notified, an institution fails to submit an acceptable compliance plan
or fails in any material respect to implement an accepted compliance plan, the
OTS must issue an order directing action to correct the deficiency and may
issue an order directing other actions of the types to which an
undercapitalized association is subject under the “prompt corrective action”
provisions of FDICIA. If an institution
fails to comply with such an order, the OTS may seek to enforce such order in
judicial proceedings and to impose civil money penalties.
Information Sharing. On October 26, 2001, the President signed
into law the Uniting and Strengthening America by Providing Appropriate Tools
Required to Intercept and Obstruct Terrorism Act of 2001 (Public Law 107-56)
(the “USA PATRIOT Act of 2001”). Of the
many goals of the USA PATRIOT Act of 2001, the facilitation of information
sharing among governmental entities and financial institutions for the purpose
of combating terrorism and money laundering is of paramount importance. Section 314 of the USA PATRIOT Act of 2001
furthers this goal by providing for the sharing of information between the
government and financial institutions, and among financial institutions
themselves. As with many other
provisions of the USA PATRIOT Act of 2001, Congress has charged the Department
of the Treasury with developing regulations to implement these
information-sharing provisions. Section
314(a) of the USA PATRIOT Act of 2001 requires regulations encouraging
cooperation between financial institutions and the federal government through
the exchange of information regarding individuals, entities, and organizations
engaged in or reasonably suspected of engaging in terrorist acts or money
laundering activities.
Customer Identification Programs for Banks. The
Department of the Treasury, through the Financial Crimes Enforcement Network
(“FinCEN”), together with the Office of the Comptroller of the Currency
(“OCC”), the Board of Governors of the Federal Reserve System (“Board”), the
FDIC, the OTS and the National Credit Union Administration (“NCUA”)
(collectively, the “Agencies”) are jointly issuing a proposed regulation to
implement section 326 of the USA PATRIOT Act of 2001. Section 326 requires the Secretary of the Treasury (“Secretary”)
to jointly prescribe with each of the Agencies, the Securities and Exchange
Commission (“SEC”), and the Commodity Futures Trading Commission (“CFTC”), a
regulation that, at a minimum requires financial institutions to implement
reasonable procedures to verify the identity of any person seeking to open an
account, to the extent reasonable and practicable; maintain records of the
information used to verify the person’s identity; and determine whether the
person appears on any lists of known or suspected terrorists or terrorist
organizations provided to the financial institution by any governmental
agency. The proposed regulation applies
to banks, savings associations and credit unions.
Insurance of Accounts and Regulation by
the FDIC. The Bank is a member of the SAIF, which is administered by the
FDIC. Savings deposits are insured up to $100,000 per insured member (as
defined by law and regulation) by the FDIC and such insurance is backed by the
full faith and credit of the United States Government. As insurer, the FDIC imposes deposit
insurance premiums and is authorized to conduct examinations of and to require
reporting by FDIC-insured institutions.
It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious risk
to the FDIC. The FDIC also has the
authority to initiate enforcement actions against savings associations, after
giving the OTS an opportunity to take such action, and may terminate the
deposit insurance if it determines that the institution has engaged or is
engaging in unsafe or unsound practices, or is in an unsafe or unsound
condition.
Pursuant to FDICIA, the FDIC established a
risk based assessment system for determining the deposit insurance assessments
to be paid by insured depositary institutions.
Under the assessment system, the FDIC assigns an institution to one of
three capital categories based on the institution’s financial information as of
the quarter ending three months before the beginning of the assessment
period. The three capital categories
consist of (a) well-capitalized, (b) adequately capitalized or (c)
undercapitalized. The FDIC also assigns
an institution to 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.
Under the regulation, there are nine assessment risk classifications
(i.e., combinations of capital groups and supervisory subgroups) to which different
assessment rates are applied. Assessment
rates currently range from 0.00% of deposits for an institution in the highest
category (i.e., well capitalized and financially sound, with no more than a few
minor weaknesses) to 0.27% of deposits for an institution in the lowest
category (i.e., undercapitalized and substantial supervisory concern). The FDIC is authorized to raise the
assessment rates as necessary to maintain the required reserve ratio of
1.25%. As a result of the Deposit
Insurance Funds Act of 1996 (the “1996 Act”), both the BIF and the SAIF
currently satisfy the reserve ratio requirement at June 30, 2002.
The 1996 Act also provides that the FDIC
cannot assess regular insurance assessments for an insurance fund unless
required to maintain or to achieve the designated reserve ratio of 1.25%,
except on those of its member institutions that are not classified as “well
capitalized” or that have been found to have “moderately severe” or
“unsatisfactory” financial, operational or compliance weaknesses. The Bank has not been so classified by the
FDIC or the OTS.
In addition, the 1996 Act expanded the
assessment base for the payments on the bonds (the “FICO bonds”) issued in the
late 1980s by the Financing Corporation to recapitalize the now defunct Federal
Savings and Loan Insurance Corporation to include the deposits of both BIF- and
SAIF-insured institutions beginning January 1, 1997. Both BIF and SAIF-insured deposits are assessed the same FICO
rates.
Under the FDI Act, 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.
The management of the Bank does not know of any practice, condition or
violation that might lead to termination of deposit insurance.
The FDIC has adopted
regulations that generally prohibit payments to directors, officers and
employees contingent upon termination of their affiliation with an FDIC-insured
institution or its holding company (i.e., “golden parachute payments”) if the
payment is received after or in contemplation of, among other things,
insolvency, or a determination that the institution or holding company is in “troubled
condition.” Certain types of employee
benefit plans are not subject to the prohibition. The regulations would also generally prohibit certain
indemnification payments for civil money penalties or other enforcement action.
Regulatory Capital Requirements. Federally insured savings
associations, such as the Bank, are required to maintain a minimum level of
regulatory capital. The OTS has
established capital standards, including a tangible capital requirement, a
leverage ratio (or core capital) requirement and a risk-based capital
requirement applicable to such savings associations. These capital requirements must be generally as stringent as the
comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements in
excess of these standards on individual associations on a case-by-case
basis.
The capital regulations
require tangible capital not less than 1.50% of adjusted total assets (as
defined by regulation). Tangible
capital generally includes common stockholders’ equity and retained earnings,
and certain noncumulative perpetual preferred stock and related earnings on
withdrawable accounts and deposits that qualify as core capital. In addition, all intangible assets, other
than a limited amount of purchased mortgage servicing rights and other
categories must be deducted from tangible capital. At June 30, 2002, Home Federal had $3.5 million of unamortized
loan servicing rights, none of which were required to be deducted from tangible
capital.
The OTS regulations
establish special capitalization requirements for savings associations that own
subsidiaries. Under these regulations
certain subsidiaries are consolidated for capital purposes and others are
excluded from assets and capital. In
determining compliance with the capital requirements, all subsidiaries engaged
solely in activities permissible for national banks or engaged in certain other
activities solely as agent for its customers such as mortgage banking
activities are “includable” subsidiaries that are consolidated for capital
purposes in proportion to the association’s level of ownership, including the
assets of includable subsidiaries in which the association has a minority
interest that is not consolidated for GAAP purposes. All subsidiaries of the Bank are includable subsidiaries.
The capital standards
also require core capital equal to at least 4.00% of adjusted total assets (as
defined by regulation). Core capital
generally consists of tangible capital plus certain intangible assets, and up
to 25% of other intangibles which meet certain separate salability and market
valuation tests. At June 30, 2002, the
Bank had $5.3 million in intangible assets which were subject to these tests. The amount of servicing rights includable as
core capital is limited to 50.00% of such capital. At June 30, 2002, the Bank
had Tier I (core) capital equal to $53.3 million, or 7.44% of adjusted total
assets, which is $24.6 million above the minimum leverage ratio requirement of
4.00% as in effect on that date.
The OTS risk-based
capital requirement requires savings associations to have total capital of at
least 8.00% of risk-weighted assets.
Total capital consists of core capital, as defined above, and
supplementary capital. Supplementary
capital consists of certain permanent and maturing capital instruments that do
not qualify as core capital and general valuation loan and lease loss
allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy
the risk-based requirement only to the extent of core capital up to
100.00% of core capital. At
June 30, 2002, Home Federal had no capital instruments that qualified as
supplementary capital and $4.5 million of general loss reserves, which was not
in excess of 1.25% of risk-weighted assets.
Certain exclusions from
capital and assets are required to be made for the purpose of calculating total
capital, in addition to the adjustments required for calculating core
capital. Such exclusions consist of
equity investments (as defined by regulation) and that portion of land loans
and nonresidential construction loans in excess of an 80% loan-to-value
ratio and reciprocal holdings of qualifying capital instruments. Home Federal had no such exclusions from
capital and assets at June 30, 2002.
In determining the
amount of risk-weighted assets, all assets, including certain off-balance
sheet items, will be multiplied by the appropriate risk weight based on the
risks inherent in the type of assets.
The risk weights assigned by the OTS for principal categories of assets
are (i) 0.00% for cash and securities issued by the U.S. Government or
unconditionally backed by the full faith and credit of the U.S. Government,
(ii) 20.00% for securities (other than equity securities) issued by U.S.
Government sponsored agencies, high quality mortgage-backed securities and mortgage-backed securities issued
by, or fully guaranteed as to principal and interest by, the FNMA or the FHLMC
except for those classes with residual characteristics or stripped mortgaged-related
securities, (iii) 50.00% for prudently underwritten permanent one- to
four-family first lien mortgage loans not more than 90 days delinquent
and having a loan-to-value ratio of not more than 80.00% at
origination unless insured to such ratio by an insurer approved by FNMA or
FHLMC, and (iv) 100.00% for all other loans and investments, including consumer
loans, commercial loans, repossessed and loans more than 90 days past due and
all other assets.
On June 30, 2002, the
Bank had total risk-based capital of $57.7 million (including $53.3 million in
core capital and $4.5 million in qualifying supplementary capital) and risk-weighted
assets of $575.3 million (including $1.3 million in converted off-balance
sheet assets), or total capital of 10.04% of risk-weighted assets. This amount was $11.7 million above the
8.00% requirement in effect on that date.
The
following table sets forth Home Federal’s compliance with its capital
requirements at June 30, 2002.
(1) Tier I (core) capital figures are determined as a percentage of total
adjusted assets; risk-based capital figures are determined as a
percentage of risk-weighted assets.
(2) The Bank’s investment in its subsidiaries is included for purposes of
calculating regulatory capital.
(3) Includes qualifying supplementary capital of $4.5 million.
Under FDICIA all the
Federal banking agencies, including the OTS, must revise their risk-based
capital requirements to ensure that such requirements account for interest rate
risk, concentration of credit risk and the risks of non-traditional
activities, and that they reflect the actual performance of and expected loss
on multi-family loans.
Prompt Corrective Action Standards. The OTS and the FDIC are
authorized and, under certain circumstances, required to take certain actions
against any association that fails to meet its capital requirements. The OTS is
generally required to take action to restrict the activities of an
“undercapitalized association” (generally defined to be one with less than
either a 4.00% core ratio, a Tier 1 risked-based capital ratio or an
8.00% risk-based capital ratio). Any
such association must submit a capital restoration plan and until such plan is
approved by the OTS may not increase its assets, acquire another institution,
establish a branch or engage in any new activities, and generally may not make
capital distributions. The OTS is
authorized to impose the additional restrictions, discussed below that are
applicable to significantly undercapitalized associations.
As a condition to the
approval of the capital restoration plan, any company controlling an
undercapitalized association must agree that it will enter into a limited
capital maintenance guarantee with respect to the institution’s achievement of
its capital requirements.
Any savings association
that fails to comply with its capital plan or is “significantly
undercapitalized” (i.e., Tier 1 risk-based or core capital ratios of less than
3.00% or a risk-based capital ratio of less than 6.00%) must be subject
to one or more of the additional specified actions and operating restrictions
mandated by FDICIA. These actions and
restrictions include requiring the issuance of additional voting securities;
limitations on asset growth; mandated asset reduction; changes in senior
management; divestiture, merger or acquisition of the association; restrictions
on executive compensation; and any other action the OTS deems appropriate.
An association that
becomes “critically undercapitalized” (i.e., a tangible capital ratio of 2.00%
or less) is subject to further restrictions on its activities in addition to
those applicable to significantly undercapitalized associations. The FDIC must restrict the activities of a
critically undercapitalized association and, among other things, prohibit any material
transaction outside the ordinary course of business or engaging in certain
transactions with affiliates, without the approval of the FDIC. The OTS must appoint a receiver (or
conservator with the concurrence of the FDIC) for a savings association, with
certain limited exceptions, within 90 days after it becomes critically
undercapitalized.
Any undercapitalized
association is also subject to other possible enforcement actions by the OTS or
the FDIC. Such actions could include a
capital directive, a cease-and-desist order, civil money penalties,
the establishment of restrictions on all aspects of the association’s
operations or the appointment of a receiver or conservator or a forced merger
into another institution. The grounds
for appointment of a conservator or receiver include substantially insufficient
capital and losses or likely losses that will deplete substantially all capital
with no reasonable prospect for replenishment of capital without federal
assistance.
If the OTS determines
that an association is in an unsafe or unsound condition or is engaged in an
unsafe or unsound practice it is authorized to reclassify a well-capitalized
association as an adequately capitalized association and if the association is
adequately capitalized, to impose the restrictions applicable to an undercapitalized
association.
The imposition by the
OTS or the FDIC of any of these measures on the Bank may have a substantial
adverse effect on the Bank’s and the Company’s operations and profitability and
the value of the Company’s Common Stock.
The Company’s shareholders do not have preemptive rights, and therefore,
if the Company is directed by the OTS or the FDIC to issue additional shares of
Common Stock, such issuance may result in the dilution in the percentage of
ownership of the Company of those persons owning shares of the Company’s Common
Stock.
Limitations on Dividends and Other
Capital Distributions. OTS regulations impose various restrictions
or requirements on associations with respect to their ability to pay dividends
or make other distributions of capital.
OTS regulations prohibit an association from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the regulatory
capital of the association would be reduced below the amount required to be
maintained for the liquidation account established in connection with its
mutual to stock conversion.
The OTS imposes various
restrictions or requirements on the Bank’s ability to make capital
distributions, including cash dividends. A savings institution that is the
subsidiary of a savings and loan holding company must file an application or a
notice with the OTS at least 30 days before making a capital distribution. The
Bank must file an application for prior approval if the total amount of its
capital distributions, including the proposed distribution, for the applicable
calendar year would exceed an amount equal to the Bank’s net income for that
year plus retained net income for the previous two years. However, a savings
association subsidiary of a savings and loan holding company, such as the Bank,
will continue to have to file a notice, unless the specific capital
distribution requires an application.
The OTS may disapprove
of a notice or application if:
• the
Bank would be undercapitalized following the distribution;
• the
proposed capital distribution raises safety and soundness concerns; or
• the
capital distribution would violate a prohibition contained in any statute,
regulation or agreement.
Liquidity. All savings associations,
including Home Federal, are required to maintain a sufficient amount of liquid
assets to ensure its safe and sound operation.
For a discussion of what the Bank includes in liquid assets, see
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources.” At June 30, 2002, the Bank’s overall liquid asset ratio
was 4.78%.
Branching. Subject to certain limitations,
the HOLA and the OTS regulations permit federally chartered savings
associations to establish branches in any state of the United States. The authority to establish such branches is
available (a) in states that expressly authorize branches of savings
associations located in another state or (b) to an association that qualifies
as a “domestic building and loan association” under the Internal Revenue Code
of 1986, which imposes qualification requirements similar to those for a
“qualified thrift lender” under the HOLA.
See “QTL Test.” The authority
for a federal savings association to establish an interstate branch network
would facilitate a geographic diversification of the association’s
activities. This authority under the
HOLA and the OTS regulations preempts any state law purporting to regulate
branching by federal savings associations.
Community Reinvestment. Under the Community
Reinvestment Act (the “CRA”), as implemented by OTS regulations, a savings
association has a continuing and affirmative obligation consistent with its
safe and sound operation to help meet the credit needs of its entire community,
including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or
programs for financial institutions nor does it limit an institution’s
discretion to develop the types of products and services that it believes are best
suited to its particular community, consistent with the CRA. The CRA requires the OTS, in connection with
its examination of a savings association, to assess the association’s record of
meeting the credit needs of its community and to take such record into account
in its evaluation of certain applications by such association. The CRA also requires all institutions to
make public disclosure of their CRA ratings.
The Association received an
“Outstanding” CRA rating in its most recent examination.
The CRA regulations rate
an institution based on its actual performance in meeting community needs. In particular, the rating system focuses on
three tests: (a) a lending test, to
evaluate the institution’s record of making loans in its assessment areas; (b)
an investment test, to evaluate the institution’s record of investing in
community development projects, affordable housing, and programs benefiting low
or moderate income individuals and businesses; and (c) a service test, to
evaluate the institution’s delivery of services through its branches, ATMs and
other offices. The amended CRA
regulations also clarify how an institution’s CRA performance would be
considered in the application process.
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 65.00% of its
portfolio assets (which consists of total assets less the sum of goodwill and
other intangible assets, properties used to conduct the savings association’s
business and specified liquid assets not exceeding 20.00% of total assets) in
qualified thrift investments on a monthly average for 9 out of every 12 months
on a rolling basis. At June 30, 2002,
the Bank maintained 78.09% of its portfolio assets in qualified thrift
investments, and thus met the test. The
Bank has met the QTL test since its inception.
Loans and mortgage-backed
securities secured by domestic residential housing, FHLB stock, credit card
loans, educational loans and certain small business loans as well as certain
obligations of the Federal Savings and Loan Insurance Corporation (“FSLIC”),
the FDIC and certain other related entities may be included in qualifying
thrift investments without limit. FHLMC
and FNMA stock and certain other housing-related and non-residential
real estate loans and investments, including loans to develop churches, nursing
homes, hospitals and schools, and consumer loans and investments in
subsidiaries engaged in housing-related activities may also be included,
in varying amounts, not to exceed 20.00% of portfolio assets.
Any savings association
that fails to meet the QTL test must either convert to a national bank charter
or operate under certain restrictions on its activities, unless it requalifies
as a QTL and thereafter remains a QTL.
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. See “Holding
Company Regulation.”
Transactions with Affiliates. The Bank’s authority to engage
in transactions with its “affiliates” is limited by the OTS regulations and by
Sections 23A and 23B of the Federal Reserve Act (the “FRA”). In general, an affiliate of the Association
is any company that controls the Association or any other company that is controlled
by a company that controls the Association, excluding the Association’s
subsidiaries other than those that are insured depository institutions. The OTS regulations prohibit a savings
association (a) from lending to any of its affiliates that is engaged in
activities that are not permissible for bank holding companies under Section
4(c) of the BHC Act and (b) from purchasing the securities of any affiliate
other than a subsidiary. Section 23A
limits the aggregate amount of transactions with any individual affiliate to
10.00% of the capital and surplus of the savings association and also limits
the aggregate amount of transactions with all affiliates to 20.00% of the
savings association’s capital and surplus.
Extensions of credit to affiliates are required to be secured by
collateral in an amount and of a type described in Section 23A, and the
purchase of low quality assets from affiliates is generally prohibited. Section 23B provides that certain
transactions with affiliates, including loans and asset purchases, must be on
terms and under circumstances, including credit standards, that are
substantially the same or at least as favorable to the association as those
prevailing at the time for comparable transactions with non-affiliated
companies. In the absence of comparable
transactions, such transactions may only occur under terms and circumstances,
including credit standards, that in good faith would be offered to or would
apply to non-affiliated companies.
The Association’s authority to extend credit to
its directors, executive officers, and 10.00% shareholders, as well as to
entities controlled by such persons, is currently governed by the requirements
of Sections 22(g) and 22(h) of the FRA and Regulation O of the FRB
thereunder. Among other things, these
provisions require that extensions of credit to insiders (a) be made on terms
that are substantially the same as, and follow credit underwriting procedures
that are not less stringent than, those prevailing for comparable transactions
with unaffiliated persons and that do not involve more than the normal risk of
repayment or present other unfavorable features and (b) not exceed certain
limitations on the amount of the association’s capital. In addition, extensions of credit in excess
of certain limits must be approved by the association’s board of directors.
Certain transactions
with directors, officers or controlling persons are also subject to conflict of
interest regulations enforced by the OTS.
These conflict of interest regulations and other statutes also impose restrictions
on loans to such persons and their related interests. Among other things, such loans must be made on terms
substantially the same as those for loans to unaffiliated individuals.
Real Estate Lending Standards. The OTS and the other federal
banking agencies adopted regulations to prescribe standards for extensions of
credit that (a) are secured by real estate or (b) are made for the purpose of
financing the construction of improvements on real estate. The OTS regulations require each savings
association to establish and maintain written internal real estate lending
standards that are consistent with safe and sound banking practices and
appropriate to the size of the association and the nature and scope of its real
estate lending activities. The
standards also must be consistent with accompanying OTS guidelines, which
include loan-to-value ratios for the different types of real estate loans. Associations are also permitted to make a
limited amount of loans that do not conform to the proposed loan-to-value limitations
so long as such exceptions are reviewed and justified appropriately. The guidelines also list a number of lending
situations in which exceptions to the loan-to-value standards are justified.
Privacy Regulations. Under OTS regulations adopted pursuant to the Gramm-Leach-Bliley
Act of 1999 (“GLB Act”), the Bank is required to adopt procedures
to protect customers’ “nonpublic personal information.” The new regulations generally require that
the Bank disclose its privacy policy, including identifying with whom it shares
a customer’s “nonpublic personal information,” to customers at the time of
establishing the customer relationship and annually thereafter. In addition, the Bank is required to provide
its customers with the ability to “opt-out” of having it share their personal
information with unaffiliated third parties and not to disclose account numbers
or access codes to nonaffiliated third parties for marketing purposes. The Bank currently has a privacy protection
policy in place, which has been reviewed, for compliance with the regulations.
Holding Company Regulation. The Company is a unitary thrift holding company subject to
regulatory oversight by the OTS. As
such, the Company is registered with and files reports with the OTS and is subject
to regulation and examination by the OTS.
Under
the GLB Act, any company which becomes a unitary savings and loan holding
company pursuant to a charter application filed with the OTS after May 4, 1999
is prohibited from engaging in non-financial activities or affiliating with
non-financial companies. All unitary
savings and loan holding companies in existence prior to May 4, 1999, such as
the Company, are “grandfathered” under the GLB Act and may continue to operate
as a unitary savings and loan holding company without any limitations in the
types of business activities in which it can engage at the holding company
level, provided the Bank continues to satisfy the QTL Test. In addition, the OTS has
enforcement authority over the Company and its non-savings association
subsidiaries which also permits the OTS to restrict or prohibit activities that
are determined to be a serious risk to the subsidiary savings association.
As a “grandfathered”
unitary thrift holding company, the Company generally is not subject to
activity restrictions. If the Company
acquires control of another savings association as a separate subsidiary, it
would become a multiple savings and loan holding company, and the activities of
the Company and any of its subsidiaries (other than the Bank or any other SAIF-insured
savings association) would become subject to such restrictions unless such
other associations each qualify as a QTL and were acquired in a supervisory
acquisition.
If the Bank fails the
QTL test, the Company must obtain the approval of the OTS prior to continuing
after such failure, directly or through its other subsidiaries, any business
activity other than those approved for multiple savings and loan holding
companies or their subsidiaries. In
addition, within one year of such failure the Company must register as, and
will become subject to, the restrictions applicable to bank holding
companies. The activities authorized
for a bank holding company are more limited than are the activities authorized
for a unitary or multiple savings and loan holding company. See “Qualified Thrift Lender Test.”
In addition, for grandfathered savings and loan
holding companies, such as the Company, the GLB Act also prohibits the sale of
such entities to nonfinancial companies.
This prohibition is intended to restrict the transfer of grandfathered
rights to other entities and, thereby, prevent evasion of the limitation on the
creation of new unitary savings and loan holding companies.
Federal Securities Law. The stock of the Company is
registered with the Securities and Exchange Commission (“SEC”) under the
Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Company is subject to the information,
proxy solicitation, insider trading restrictions and other requirements of the
SEC under the Exchange Act.
Company stock held by
persons who are affiliates (generally officers, directors and principal
stockholders) of the Company may not be resold without registration or unless
sold in accordance with certain resale restrictions. If the Company meets specified current public information
requirements, each affiliate of the Company is able to sell in the public
market, without registration, a limited number of shares in any three-month
period.
Federal Reserve System. . Under the Federal Reserve
Board’s (FRB) regulations, the Bank is required to maintain
non-interest-earning reserves against its transaction accounts. FRB regulations
generally require that (a) reserves of 3.00% must be maintained against
aggregate transaction accounts of $41.3 million or less, subject to adjustment
by the FRB, and (b) a reserve of $1.2 million plus 10.00% (subject to
adjustment by the Federal Reserve Board between 8.00% and 14.00%) must be
maintained against that portion of total transaction accounts in excess of
$41.3 million. The first $5.7 million of otherwise reservable balances are
exempted from the reserve requirements. The Bank is in compliance with these
reserve requirements. Because required reserves must be maintained in the form
of either vault cash, a noninterest bearing account at a Federal Reserve Bank,
or a passthrough account as defined by the Federal Reserve Board, the effect of
this reserve requirement is to reduce the Bank’s interest-earning assets to the
extent that the requirement exceeds vault
Savings associations are
authorized to borrow from the FRB”discount window,” but FRB regulations require
associations to exhaust other reasonable alternative sources of funds,
including FHLB borrowings, before borrowing from the FRB.
Federal Home Loan Bank System. The Bank is a member of the
FHLB of Des Moines, which is one of 12 regional FHLBs, that administers the
home financing credit function of savings associations. Each FHLB serves as a reserve or central
bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of
consolidated obligations of the FHLB System.
It makes loans to members (i.e., advances) in accordance with policies
and procedures established by the board of directors of the FHLB. These policies and procedures are subject to
the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLB are required to
be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances
are required to provide funds for residential home financing.
As a member, Home
Federal is required to purchase and maintain stock in the FHLB of Des
Moines. At June 30, 2002, Home Federal
had $6.3 million in FHLB stock, which was in compliance with this
requirement. In past years, the Bank
has received substantial dividends on its FHLB stock. Over the past five fiscal years such dividend yields have averaged
5.88% and were 3.52% for fiscal year 2002.
For the fiscal year ended June 30, 2002, dividends paid by the FHLB of
Des Moines to Home Federal totaled approximately $223,000, which constitutes a
$128,000 decrease in the amount of dividends received in fiscal 2001. This reduction is primarily due to a
decrease in interest rates from the prior year.
Under federal law, the
FHLBs are required to provide funds for the resolution of troubled savings
associations and to contribute to low and moderately-priced housing
programs through direct loans or interest subsidies on advances targeted for
community investment and low- and moderate-income housing
projects. These contributions have
affected adversely the level of FHLB dividends paid and could continue to do so
in the future. These contributions
could also have an adverse effect on the value of FHLB stock in the future. A
reduction in value of the Bank’s FHLB stock may result in a corresponding
reduction in Home Federal’s capital.
Under the GLB Act,
membership in the FHLB system is now voluntary for all federally-chartered
savings associations such as the Bank. Gramm-Leach also replaces the existing
redeemable stock structure of the FHLB system with a capital structure that
requires each FHLB to meet a leverage limit and a risk-based permanent capital
requirement. Pursuant to the GLB Act,
the new capital plan for the FHLB of Des Moines was approved on July 10, 2002
by the Federal Housing Finance Board, which may be implemented as early as July
1, 2003, with a deadline to implement the plan by January 10, 2004.
Sarbanes-Oxley Act. On July 31, 2002, President George W. Bush signed into law the
Sarbanes-Oxley Act of 2002. The
Sarbanes-Oxley Act implements a broad range of corporate governance and
accounting measures for public companies designed to promote honesty and
transparency in corporate America and better protect investors from corporate
wrongdoing. The Sarbanes-Oxley Act’s
principal legislation includes:
• the creation of
an independent accounting oversight board;
• auditor
independence provisions which restrict non-audit services that accountants may
provide to their audit clients;
• additional
corporate governance and responsibility measures, including the requirement
that the chief executive officer and chief financial officer certify financial
statements and the expansion of powers of audit committees;
• expanded
disclosure requirements, including accelerated reporting of stock transactions
by insiders;
• mandatory
disclosure by analysts of potential conflicts of interest; and
• a range of
enhanced penalties for fraud and other violations.
We do not believe that the Sarbanes-Oxley Act
will have a material adverse affect upon the Company’s operations in the near
term.
Federal and
State Taxation
The
Company and its direct and indirect subsidiaries file a consolidated federal
income tax return on a fiscal year basis.
In addition, Trust I and Trust II are required to file a trust return on
a calendar year basis.
In addition to the
regular income tax, corporations, including savings associations such as the
Bank, generally are subject to a minimum tax.
An alternative minimum tax is imposed at a minimum tax rate of 20.00% on
alternative minimum taxable income, which is the sum of a corporation’s regular
taxable income (with certain adjustments) and tax preference items, less any
available exemption. The alternative
minimum tax is imposed to the extent it exceeds the corporation’s regular
income tax and net operating losses can offset no more than 90.00% of
alternative minimum taxable income.
To the extent earnings
appropriated to a savings association’s bad debt reserves for “qualifying real
property loans” and deducted for federal income tax purposes exceed the
allowable amount of such reserves computed under the experience method and to
the extent of the association’s supplemental reserves for losses on loans
(“Excess”), such Excess may not, without adverse tax consequences, be utilized
for the payment of cash dividends or other distributions to a shareholder
(including distributions on redemption, dissolution or liquidation) or for any
other purpose (except to absorb bad debt losses). As of June 30, 2002, the Bank’s Excess for tax purposes totaled
approximately $4.8 million.
The Bank and its
consolidated subsidiaries have been audited by the IRS with respect to
consolidated federal income tax returns through 1985. With respect to years
examined by the IRS, all deficiencies have been satisfied.
South Dakota Taxation. The Bank is subject to the
South Dakota franchise tax to the extent that such corporations are engaged in
business in the state of South Dakota. South Dakota does not have a corporate
income tax. The franchise tax will be
imposed at a rate of 6.00% on franchise taxable income which is computed in the
same manner as federal taxable income with some minor variations to comply with
South Dakota law, other than the carryover of net operating losses which is not
permitted under South Dakota law. A
South Dakota return of franchise tax must be filed annually.
Minnesota Taxation. The Bank is subject to the Minnesota Corporate
Income tax to the extent that such corporations are engaged in business in the
state of Minnesota. The Corporate
Income tax is imposed at a rate of 9.8% on
corporate taxable income which is computed in the same manner as federal
taxable income with some minor variations to comply with Minnesota law. A Minnesota return of Corporate Income tax
must be filed annually.
Delaware Taxation. As a Delaware holding company,
the Company is exempted from Delaware corporate income tax but is required to file
an annual report with and pay an annual fee to the State of Delaware. The Company is also subject to an annual
franchise tax imposed by the State of Delaware.
Executive Officers of the Company
The following information as to the business experience during
the past five years is supplied with respect to executive officers of the
Company and the Bank.
Curtis L. Hage - Mr. Hage,
age 56, is Chairman, President and Chief Executive Officer of the Company. He was elected Chairman of the Board of
Directors of the Company in September 1996 and has held the position of
President and Chief Executive Officer since February 1991. Prior to such time, Mr. Hage served as
Executive Vice President of the Bank since 1986. Since joining the Bank in 1968, he served in various capacities
prior to being elected Executive Vice President. Mr. Hage received his M.B.A. from the University of South Dakota
and attended the Graduate School of Savings Institution Management at the
University of Texas.
Jack P.
Hearst - Mr. Hearst, age 50, is Executive Vice
President/Chief Operations Officer of the Company. He joined the Bank in 1999 as Vice President/Credit Cards and was
promoted to Senior Vice President/Subsidiary Operations in October 2000. Prior to joining the Bank, he was employed
by Citicorp-Corporate Control and Risk Assessment as the Audit Director for
Citicorp Bankcards, a credit card company.
Mr. Hearst received a B.S. from the University of Missouri.
Darrel L.
Posegate - Mr. Posegate, age 44, is Senior Vice President/Chief
Financial Officer and Treasurer of the Company, a position he has held since
January 2002. He was employed as Chief
Financial Officer for West Des Moines State Bank, Des Moines, IA, a state
banking institution, from 1998 until joining Home Federal. Prior to that time he was employed as
President of Liberty Services, Inc., a bank services company, from 1994 to
1998. Mr. Posegate received his B.A.
degree from Luther College, Decorah, IA, and is a Certified Public Accountant.
David A. Brown - Mr. Brown, age 40, is
Senior Vice President/Commercial Banking, a position he has held since November
1999. Prior to joining Home Federal,
Mr. Brown served as Vice President/Manager Commercial Banking at Firstar Bank,
Sioux City, Iowa, a national banking institution, a position he held since
December 1998. Mr. Brown received his
Masters of Business Administration and a B.S. in Business Administration from
University of South Dakota.
Mary F. Hitzemann - Ms. Hitzemann, age 49, is
Senior Vice President/Human Resources, a position she has held since October
1993. Ms. Hitzemann joined Home Federal
in January 1993. Prior to that time,
she was employed as Vice President of Human Resources for Rapid City Regional
Hospital from May 1989 to May 1992. Ms.
Hitzemann received her B.A. degree from Augustana College.
Terry L. Kappes - Mr. Kappes, age 48, is
Senior Vice President/Retail Banking, a position he has held since
June 1998. Prior to that time, he
was employed with Bank One - Colorado, Grand Junction, Colorado, a national
banking institution, from 1993 until joining Home Federal with his most recent
position being Senior Vice President/Retail Market Manager. Mr. Kappes served as Senior Vice President
for First Bank System, Billings, Montana from 1988 to 1991 and First Bank of
South Dakota, Sioux Falls, South Dakota from 1977 to 1988. Mr. Kappes received his B.A. degree
from Oral Roberts University, Tulsa, Oklahoma.
Sharon A.
Manuel - Ms. Manuel, age 52, is Senior Vice
President/Corporate Services, a position she has held since November 2001. Since joining the Bank in April 1994, she
served as Vice President/Regional Coordinator in the Retail Banking area as
well as being responsible for the telephone banking department. She then assumed the responsibility for managing
technology-orientated projects, such as internet banking, bill payment, debit
card and Home Federal’s internet website.
Prior to joining Home Federal, she was employed by Citibank for thirteen
years. She received a two-year business
degree from Mankato Business College.
John E.
Roers - Mr. Roers, age 55, is Senior Vice
President/Agricultural Lending, a position he has held since joining Home
Federal on October 31, 1995. Prior to
that time, he was employed as Agricultural Loan Officer and Department Manager
for Western Bank, Sioux Falls (then First Bank) from June 1981 to October 1996
and for Western Bank, Marshall, Minnesota from February 1974 to May 1981. Mr. Roers received his Bachelor of
Science and Masters of Science from North Dakota State University.
Mark S. Sivertson - Mr. Sivertson, age 44, is Senior Vice
President/Trust Officer, a position he has held since July 1996. He joined Home Federal in February 1995 as
Vice President/Trust Officer. Prior to
joining Home Federal, Mr. Sivertson was Vice President and Trust Officer in
charge of the Investment Management and Trust Department at Western Bank. He holds a law degree from the University of
North Dakota and the Certified Trust Financial Advisor designation from the
American Bankers Association.
Gary L. Smith - Mr. Smith, age 48, is Senior Vice
President/Information Systems, a position he has held since July 1998. Mr. Smith joined Home Federal in 1979 and
was promoted to Vice President in 1988.
He received his B.S. from the University of South Dakota.
Natalie A.
Solberg - Ms. Solberg, age 39, is
Senior Vice President/Retail Support.
Since joining the Bank in February 1994, she has been responsible for
managing automated telephone banking, deposit operations and retail support
functions. She was promoted to Vice
President/In-Touch Banking in October 1995, and subsequently, held the position
of Vice President/Retail Support. Prior
to joining Home Federal, she was employed by the Bank of New York from October
1989 to October 1993. Ms. Solberg
received her B.S. from Northern State University.
Michael H. Zimmerman - Mr. Zimmerman, age 49, is
Senior Vice President/Senior Retail Lending Officer, a position he has held
since joining Home Federal in August 1996.
Prior to that time, he was employed as Vice President/Mortgage Loan
Manager for First Trust and Savings Bank, Cedar Rapids, Iowa from October 1995
to August 1996 and as Vice President/Eastern Regional Manager for Homeland
Savings Bank FSB, Waterloo, Iowa from May 1995 to October 1995; and as Vice
President/ Manager Real Estate Lending for Homeland Bank, N.A., Waterloo, Iowa
from August 1992 to April 1995. Mr.
Zimmerman received his B.A. from Dana College, Blair, Nebraska.
Cristie M. Lawson - Ms. Lawson, age 33, is Vice President/Controller
for the Bank. Ms. Lawson joined the
Bank in March 1995 as Staff Accountant.
She has held various positions of increasing responsibility within the
Accounting Department and was promoted to her current position in July
2000. Ms. Lawson received her B.A. from
Augustana College.
Item 2.
Item 2.
Properties
The Company and its
direct and indirect subsidiaries conduct their business at the main office
located at 225 South Main Avenue, Sioux Falls, South Dakota, 57104. Currently, the Bank also conducts business
from 32 other offices located in its primary market area. Of such 32 business offices, the Company
owns 19 and leases 13 others.
The total net book value
of the Company’s premises and equipment (including land, building, leasehold
improvements and furniture, fixtures and equipment) at June 30, 2002 was $13.7
million. See Note 7 of “Notes to
Consolidated Financial Statements.”
Item 3.
Item 3.
Legal Proceedings
The Company, Home
Federal and its subsidiaries are involved as plaintiff or defendant in various
legal actions arising in the normal course of their businesses. While the ultimate outcome of these
proceedings cannot be predicted with certainty, it is the opinion of
management, after consultation with counsel representing Home Federal and the
Company in the proceedings, that the resolution of these proceedings should not
have a material effect on the Company’s consolidated financial position or
results of operations. The Company and
its direct and indirect subsidiaries are not aware of any legal actions or
proceedings outside of the normal course of business.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
No matter was submitted
to a vote of security holders, through the solicitation of proxies or
otherwise, during the quarter ended June 30, 2002.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity and Related Stockholder Matters
Stock Listing
The
Company’s Common Stock is traded under the symbol “HFFC” on the NASDAQ National
Market System.
The
following table sets forth the range of high and low sale prices for the
Company’s Common Stock for each of the fiscal quarters of the two years ended
June 30, 2002 and 2001. Quotations for
such periods are as reported by NASDAQ.
As of September 16,
2002, the Company had 542 holders of record of its Common Stock.
The transfer agent for
the Company’s Common Stock is Mellon Investor Services, PO Box 3315, South
Hackensack, New Jersey, 07606-1915.
Dividends
On a quarterly basis,
the Company paid cash dividends of $0.11 per share throughout fiscal 2002 as
compared to $0.105 per share throughout fiscal 2001. The Board of Directors intends to continue the payment of
quarterly cash dividends, dependent on the results of operations and financial
condition of the Company, tax considerations, industry standards, economic
conditions, general business practices and other factors the Board of Directors
deems relevant. On July 24, 2002, the
Board of Directors approved an increase in cash dividends to $0.115 per share
and the Company paid the respective cash dividends on August 21, 2002 to
shareholders of record on August 7, 2002.
The Company’s ability to pay dividends is dependent on the dividend
payments it receives from its subsidiary, the Bank, which are subject to
federal and state regulations.
Sales of Unregistered Stock
The Company has had no
sales of unregistered stock within the last fiscal year.
Item 6.
Item 6.
Selected Financial Data
The following table sets
forth selected financial data with respect to the Company for the periods
indicated. This information should be
read in conjunction with the Financial Statements and related notes appearing
elsewhere in this Form 10-K and “Management’s Discussion and Analysis of
Financial Condition and Results of Operations.” The Company’s selected financial statement and operations data
for each of the years set forth below have been derived from financial
statements which have been audited by McGladrey & Pullen, LLP, independent
public accountants.
(1) All periods presented have
been restated to eliminate effect of discontinued operations.
(2) Net interest income divided
by average interest-earning assets.
(3) Nonperforming loans and
leases include nonaccruing loans and leases and accruing loans delinquent more
than 90 days.
(4) Total noninterest expense
divided by the sum of net interest income plus total noninterest income.
Item 7.
Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations
This section should be read in conjunction
with Item 8, “Financial Statements and Supplementary Data”, as well as Item 7A,
“Quantitative and Qualitative Disclosures About Market Risk” and Part I, Item
1, “Business”.
General
The Company is a financial services provider
and, as such, has inherent risks that must be managed in order to achieve net
income. Primary risks that affect net
income include credit risk, liquidity risk, operational risk, regulatory
compliance risk and reputation risk.
The Company’s net income is derived by management of the net interest
margin, the ability to collect fees from services provided, by controlling the
costs of delivering services and the management of loan and lease losses. The primary source of revenues comes from
the net interest margin, which represents the difference between income on
interest-earning assets (i.e. loans and investment securities) and expense on
interest-bearing liabilities (i.e. deposits and borrowed funding). The net interest margin is affected by
regulatory, economic and competitive factors that influence interest rates,
loan demand and deposit flows. Fees
earned include charges for deposit services, trust services and loan services. Personnel costs are the primary expenses
required to deliver the services to customers.
Other costs include occupancy and equipment and general and
administrative expenses.
During the fourth quarter of fiscal 2002, the
Company committed to a plan to discontinue its subprime credit card operation
through its subsidiary, HF Card. HF
Card ceased processing subprime credit card applications in March 1999 and
managed the portfolio from a balance of $18.1 million at June 30, 1999 to $3.8
million at June 30, 2002. As of June
30, 2002, the Company had not entered into a definitive agreement for the sale
of the remaining receivables. The
Company estimated the net realizable value of the credit card portfolio based
on estimates from a third party. The actual
sale of the receivables and liquidation of HF Card is expected to take place in
the first half of fiscal 2003. Results
of this discontinuance have been segregated from continuing operations of the
Company. See Note 2 of “Notes to Consolidated Financial Statements”
for further discussion on discontinued operations.
Financial Condition Data
At June 30, 2002,
the Company had total assets of $722.9 million, a decrease of $61.1 million
from the level at June 30, 2001. The
decrease was primarily due to a reduction in certificates of deposit (“CDs”)
balances of $72.3 million compared to the prior year. Approximately $37.7 million CDs were withdrawn due to repricing
in the marketplace at rates higher than the Bank viewed prudent given the early
prepayments and sales of residential real estate loans. In addition, stockholders’ equity decreased
from $52.5 million at June 30, 2001 to $48.5 million at June 30, 2002,
primarily due to Company stock repurchases of $5.6 million and payment of cash
dividends of $1.6 million offset by net income of $3.2 million.
The Company
continued to reduce the funding mix of CDs to total deposits by emphasizing the
money market accounts. By decreasing
the CD to total deposit ratios, the Company expects its cost of funds will be
lower over time.
The decrease in securities available for sale
of $20.6 million was primarily the result of sales, maturities and calls
of $59.1 million exceeding purchases
of $38.5 million.
The increase in mortgage-backed securities
available for sale of $16.0 million was primarily the result of purchases of
$46.1 million exceeding sales, amortization and repayments of principal of
$30.4 million. The Bank’s purchases of
mortgage-backed securities available for sale were comprised primarily of thirty
year, original maturity, variable-rate mortgage-backed securities.
The $38.6 million decrease in deposits was
primarily due to a decrease in certificates of deposit of $72.3 million offset
by increases in checking accounts of $14.9 million, money market accounts of
$18.3 million and savings accounts of $535,000.
Advances from the FHLB and other borrowings
decreased $24.1 million for the year ended June 30, 2002 primarily due to
scheduled maturities, payments and amortization on FHLB advances of $106.3 million
which were partially offset by the Company obtaining new advances of $89.0
million during the fiscal year.
Analysis of Net Interest Income
Net interest income
represents the difference between income on interest-earning assets and expense
on interest-bearing liabilities. Net
interest income depends upon the volume of interest-earning assets and
interest-bearing liabilities and the interest rates earned or paid on them.
Average Balances, Interest Rates and Yields. The following table presents for the periods
indicated, the total dollar amount of interest income from average
interest-earning assets and the resulting yields, as well as the interest
expense on average interest-bearing liabilities, expressed both in dollars and
rates, and the net interest margin. The
table does not reflect any effect of income taxes. All average balances are monthly average balances and include the
balances of nonaccruing loans. The
yields and costs for the years ended June 30, 2002, 2001 and 2000 include fees
which are considered adjustments to yield.
Balances related to discontinued credit card loan operations have been
reclassified to non-interest earning assets for all periods presented.
(1) Includes interest on
accruing loans and leases past due 90 days or more.
(2) Includes primarily U.S.
Government and agency securities and FHLB daily time.
(3) Yields do not reflect the
tax exempt nature of municipal securities.
(4) Previously reported in
interest-bearing liabilities under checking and money market. Rates have been restated for all periods
presented to reflect change in classification.
(5) Net interest margin is net
interest income divided by average interest-earning assets.
Rate/Volume Analysis of Net Interest Income
The following schedule presents the dollar
amount of changes in interest income and interest expense for major components
of interest-earning assets and interest-bearing liabilities. It distinguishes between the increases and
decreases due to fluctuating outstanding balances that are due to the levels
and volatility of interest rates. For
each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume (i.e.,
changes in volume multiplied by old rate) and (ii) changes in rate (i.e.,
changes in rate multiplied by old volume).
For purposes of this table, changes attributable to both rate and
volume, which cannot be segregated, have been allocated proportionately to the
change due to volume and the change due to rate.
(1) Includes interest on accruing loans and
leases past due 90 days or more.
(2) Includes primarily U.S. Government and agency
securities and FHLB daily time.
Application of Critical
Accounting Policies
GAAP requires management
to utilize estimates when reporting financial results. The Company has identified the policy
discussed below as a Critical Accounting Policy because the accounting estimate
requires management to make certain assumptions about matters that may be
uncertain at the time the estimate was made and a different method of
estimating could have been reasonably made that could have a material impact on
the presentation of our financial condition, changes in financial condition or
results of operations.
Allowance for Loan and
Lease Losses - GAAP requires the Company to set aside reserves or maintain an
allowance against inherent loan and lease losses in the loan and lease
portfolio. Management must develop a
consistent and systematic approach to estimating the appropriate balances that
will cover the inherent losses. Due to
the uncertainty of future events, the approach includes a process that may
differ significantly from other methodologies and still produce an estimate
that is in accordance with GAAP.
The allowance is compiled by utilizing the
Company’s loan risk rating system which is structured to identify the weakness
of the loan portfolio. The risk rating
system has evolved to a process whereby management believes the system will
properly identify the credit risk associated with the loan portfolio. Due to the segmenting of loans for the
allowance calculation, the estimate of the allowance for loan and lease losses
could change materially if the loan risk rating system would not properly identify
the strength of a large or a few large loan customers. Although management believes that it uses
the best information available to determine the allowance, unforeseen market or
borrower conditions could result in adjustments and net earnings being significantly
affected if circumstances differ substantially from the assumptions used in
making the final determinations.
Asset Quality
When a
borrower fails to make a required payment on real estate secured loans within
10 to 15 days after the payment is due, the Bank generally institutes
collection procedures by issuing a late notice. The customer is contacted again when the payment is 30 days past
due. In the case of consumer loans, the
borrower is sent a notice when a loan is 10 days past due and is contacted by
telephone when a loan is 30 days past due.
In most cases, delinquencies are cured promptly; however, if a loan has
been delinquent for more than 30 days, the Bank attempts additional written as
well as verbal contacts and, if necessary, personal contact with the borrower
in order to determine the reason for the delinquency and to effect a cure, and,
where appropriate, reviews the condition of the property and the financial
circumstances of the borrower. Based
upon the results of any such investigation, the Bank may: (i) accept a
repayment program which under appropriate circumstances could involve an
extension in the case of consumer loans for the arrearage from the borrower,
(ii) seek evidence, in the form of a listing contract, of efforts by the
borrower to sell the property if the borrower has stated that he is attempting
to sell, or (iii) initiate foreclosure proceedings. When a loan payment is
delinquent for 90 days, the Bank generally will initiate foreclosure
proceedings unless management is satisfied the credit problem is correctable.
Loans are generally classified as nonaccrual
when there are reasonable doubts as to the collectibility of principal and/or
interest and/or when payment becomes 90 days past due, except loans which are
well secured and in the process of collection.
Interest collections on nonaccrual loans, for which the ultimate
collectibility of principal is uncertain, are applied as principal reductions.
Nonperforming assets increased to $11.5
million at June 30, 2002 from $5.9 million at June 30, 2001, an increase of
$5.6 million. In addition, the ratio of
nonperforming assets to total assets, which is one indicator of credit risk
exposure, increased to 1.59% at June 30, 2002 as compared to 0.76% at June 30,
2001.
Nonaccruing loans and leases increased to
$10.2 million at June 30, 2002 from $5.3 million at June 30, 2001, an increase
of $4.9 million. Included in nonaccruing loans and leases at June 30, 2002 were
thirteen loans totaling $886,000 secured by one- to four-family real estate,
six loans in the amount of $3.7 million secured by commercial real estate,
three mobile home loans totaling $25,000, eighteen commercial business loans
totaling $1.9 million, seven agriculture loans totaling $2.8 million, one
multi-family loan totaling $290,000 and forty-one consumer loans totaling
$690,000. See Note 5 of “Notes to
Consolidated Financial Statements” for information concerning interest income
foregone on impaired loans.
The Company’s nonperforming loans and leases,
which represent nonaccrual and past due 90 days and still accruing, have
increased $5.5 million from the levels in the prior year. Management believes the general economic
conditions, including the affects of terrorist attacks in September 2001, is a
primary reason for this increase in nonperforming loans and leases. The risk rating system in place is designed
to identify and manage the nonperforming loans and leases. Commercial and agricultural loans and
equipment finance leases will have specific reserve allocations based on
collateral values or based on the present value of expected cash flows. Loans and leases that are not performing do
not necessarily result in a loss. The increase
is also related to a few large commercial and agricultural loans that have been
analyzed for collateral value and appropriate loss reserves have been
allocated.
As of June 30, 2002, the Company had $374,000
of foreclosed assets. The balance of
foreclosed assets at June 30, 2002 consisted of $132,000 in consumer collateral
(excluding mobile home loans), $3,000 in mobile homes and $239,000 in
single-family residences.
At June 30, 2002, the Bank had criticized $9.0 million of its assets as special mention
(including certain loans discussed in this Form 10-K) and the Bank had classified
$18.9 million as substandard (including certain loans discussed in this Form
10-K), and approximately $4.4 million as doubtful that management has
determined need to be closely monitored because of possible credit problems of
the borrowers or the cash flows of the secured properties. These loans were considered in determining
the adequacy of the allowance for possible loan losses. The allowance for possible loan losses is
established based on management’s evaluation of the risks inherent in the loan
portfolio and changes in the nature and volume of loan activity. Such evaluation, which includes a review of
all loans for which full collectability may not be reasonably assured,
considers the estimated fair market value of the underlying collateral, present
value of expected principal and interest payments, economic conditions,
historical loss experience and other factors that warrant recognition in
providing for an adequate loan and lease loss allowance.
The Company plans to implement a formal risk-rating system for
classifying leases in the first half of fiscal 2003.
Although the Company’s management believes that the June 30, 2002
recorded allowance for loan and lease losses was adequate to provide for
probable losses on the related loans and leases, there can be no assurance that
the allowance existing at June 30, 2002 will be adequate in the future.
In accordance with the Company’s internal
classification of assets policy, management evaluates the loan and lease
portfolio on a monthly basis to identify loss potential and determines the
adequacy of the allowance for loan and lease losses quarterly. Loans are placed on nonaccrual status when
the collection of principal and/or interest become doubtful. Foreclosed assets include assets acquired in
settlement of loans. The Company did
not have any material troubled debt restructurings at any of the dates
presented. The following table sets
forth the amounts and categories of the Company’s nonperforming assets from
continuing operations for the periods indicated. Balances related to discontinued credit card loan operations have
been eliminated for all periods presented.
(1) Consists of nonperforming consumer loans exclusive of mobile home loans
and credit card loans.
(2) Total foreclosed assets do not include land held for sale.
(3) Nonperforming assets include
nonaccruing loans and leases, accruing loans and leases delinquent more than 90
days and foreclosed assets.
(4) Percentage is calculated based upon total assets of the Company and its
direct and indirect subsidiaries on a consolidated basis.
(5) Nonperforming loans and leases includes nonaccruing loans and leases and
accruing loans and leases delinquent more than 90 days.
The following table sets forth information
with respect to activity in the Company’s allowance for loan and lease losses
from continuing operations during the periods indicated. Balances related to discontinued credit card
loan operations have been eliminated for all periods presented.
(1) Nonperforming loans and leases
include nonaccruing loans and leases and accruing loans and leases delinquent
more than 90 days.
The
distribution of the Company’s allowance for loan and lease losses at the dates
indicated is summarized in the following table. Balances related to discontinued credit card loan operations have
been eliminated for all periods presented.
(1) Includes
construction loans.
(2) Includes
equipment finance leases.
(3) Excludes
allowance for loan losses relating to mobile home loans.
(4) The Company migrated its allocation
methodology of reserves by type in 2002 to reflect a more systematic method
based in part on the Company’s historical chargeoffs by each loan type as compared
to primarily a pro rata allocation based on loan balances in prior years.
The allowance for loan and lease losses was
$4.5 million at June 30, 2002 as compared to $5.5 million at June 30,
2001. The ratio of the allowance for
loan and lease losses to total loans and leases decreased from 0.96% at June
30, 2001 to 0.78% at June 30, 2002. The
Bank’s management has considered nonperforming assets and other assets of
concern in establishing the allowance for loan and lease losses. The Bank continues to monitor its allowance
for possible loan and lease losses and make future additions or reductions in
light of the level of loans in its portfolio and as economic conditions
dictate. The
current level of the allowance for loan and lease losses is a result of
management’s assessment of the risks within the portfolio based on the
information revealed in credit reporting processes. The Bank utilizes a
risk-rating system on all commercial business, agricultural, construction and
multi-family and commercial real estate loans, including purchased loans. A periodic credit review is performed on all
types of loans to establish the necessary reserve based on the estimated risk
within the portfolio. This assessment of risk takes into account the
composition of the loan portfolio, historical loss experience for each loan
category, previous loan experience, concentrations of credit, current economic
conditions and other factors that in management’s judgment deserve recognition.
Regulators have reviewed the Bank’s methodology for determining allowance
requirements on the Bank’s loan portfolio and have made no required
recommendations for increases in the allowances during the three year period
ended June 30, 2002.
Real
estate properties acquired through
foreclosure are recorded at the lower of cost or fair value (less a deduction
for disposition costs). Valuations are
periodically updated by management and a specific provision for losses on such
properties is established by a charge to operations if the carrying values of
the properties exceed their estimated net realizable values.
Although
management believes that it uses the best information available to determine
the allowances, unforeseen market conditions could result in adjustments and
net earnings being significantly affected if circumstances differ substantially
from the assumptions used in making the final determinations. Future additions to the Bank’s allowances
result from periodic loan, property and collateral reviews and thus cannot be
predicted in advance. See Note 1 of
“Notes to Consolidated Financial Statements” for a description of the Bank’s
policy regarding the provision for losses on loans and leases.
Comparison
of the Years Ended June 30, 2002 and June 30, 2001
Continuing
Operations
General. The Company’s net income from continuing operations increased
$276,000 to $4.9 million for the year ended June 30, 2002 as compared to $4.6
million for the year ended June 30, 2001.
As discussed in more detail below, the increase was due to a variety of
key factors, including an increase in net interest income of $1.3 million and
an increase in noninterest income of $1.7 million offset by a decrease in
operating expenses of $2.4 million.
Interest Income. Interest income decreased $10.1 million from $58.2 million for
the year ended June 30, 2001 to $48.0 million for the year ended June 30,
2002. The decrease in interest income
was primarily due to repricing of loans and investments that generally
reflected the decline in national interest rates. From June 30, 2001 to June 30, 2002 the prime rate dropped from
6.75% to 4.75%. The total change of
$10.1 million consisted of $8.3 million due to rate changes and $1.8 million
due to volume changes. Average loan
balances decreased $14.2 million due to amortizations, prepayments and proceeds
from sales of loans and leases exceeding originations and purchases. The Company continues to manage yields by
changing the types of loans that comprise the portfolio to loans that have a
higher yield than single-family real estate loans. Commercial business loans,
agricultural business loans and equipment finance leases comprise 25.26% of the
total loan and lease portfolio at June 30, 2002 as compared to 22.28% at June
30, 2001. The percentages of business
type loans should remain stable at these levels due to restrictions imposed by
HOLA at 20.00% of total Bank assets. In
addition, one-to four-family loans comprise 13.78% of the total loan portfolio
at June 30, 2002 as compared to 21.71% at June 30, 2001. The yield on average earning assets
decreased to 7.13% as compared to 8.36% one year ago.
Interest Expense. Interest expense decreased $11.5 million from $35.1 million for
the year ended June 30, 2001 to $23.6 million for the year ended June 30,
2002. The $25.8 million decrease of
average interest-bearing liabilities resulted in a $2.0 million decrease in
interest expense. The average balance
of deposits decreased $7.6 million at June 30, 2002 as compared to the prior
fiscal year. The average rate paid on
deposits decreased to 3.63% as compared to 5.51% one year ago. The average balance of FHLB advances and
other borrowings decreased $24.9 million during fiscal year 2002. The average rate paid on FHLB advances and
other borrowings decreased to 5.45% at June 30, 2002 from 5.90% at June 30,
2001. See “Financial Condition Data”
for further discussion.
Net Interest Income. The Company’s net interest
income from continuing operations for the year ended June 30, 2002 increased
$1.3 million, or 5.77%, to $24.4 million compared to $23.1 million for the same
period ended June 30, 2001. The
increase in net interest income was due primarily to an increasing net interest
margin as earning asset balances and national interest rates were declining. The Company’s earning asset balances
declined primarily because higher yielding mortgage loans were refinancing at
lower rates while certificate of deposits funding were refinancing as
well. The Company experienced
considerable runoff in its one- to four-family loan portfolio due primarily to
lower national mortgage loan rates.
Provision for Losses on Loans and Leases. The allowance
for loan and lease losses is maintained at a level which is considered by
management to be adequate to absorb probable losses on existing loans and
leases that may become uncollectible, based on an evaluation of the
collectability of loans and prior loan loss experience. The evaluation takes into consideration such
factors as changes in the nature and volume of the loan portfolio, overall
portfolio quality, review of specific problem loans, and current economic
conditions that may affect the borrower’s ability to pay. The allowance for loan and lease losses is
established through a provision for losses on loans and leases charged to
expense.
During the year ended June 30, 2002, the
Company recorded a provision for losses on loans and leases of $1.9
million compared to $1.5 million for
the year ended June 30, 2001, an increase of $423,000. See “Asset Quality” for further discussion.
The allowance for loan and lease losses at
June 30, 2002 was $4.5 million. The
allowance decreased from the June 30, 2001 balance primarily as a result
charge-offs exceeding recoveries by $3.0 million offset by the provision for
losses on loans of $1.9 million. The
ratio of allowance for loan and lease losses to nonperforming loans and leases
at June 30, 2002 was 40.02% compared to 97.73% at June 30, 2001. The allowance for loan and lease losses to
total loans and leases at June 30, 2002 was 0.78% compared to 0.96% at June 30,
2001. The Bank’s management believes
that the June 30, 2002 recorded allowance for loan losses was adequate to
provide for probable losses on the related loans and leases, based on its
evaluation of the collectability of loans and leases and prior loss experience.
Noninterest Income. Noninterest income was $11.1 million for the year ended June 30,
2002 as compared to $9.4 million for the year ended June 30, 2001.
Fees on deposits increased $300,000 due
primarily to an increase in volume from deposits acquired in new branch
acquisitions/openings during the last half of fiscal 2001 and an increase in
monthly fees charged on savings accounts.
Loan servicing income increased $291,000 for
the year ended June 30, 2002 as compared to the same period in the prior fiscal
year primarily due to the package sale of $23.1 million of one- to four-
family, 15- and 30-year fixed-rate loans during the first quarter of fiscal
2002.
Gain on sale of loans increased $676,000 for
the year ended June 30, 2002 as compared to the same period in the prior fiscal
year. This increase was due to
increased sales into the secondary market, which included $116,000 net gain on
the package sale of $23.1 million one- to four-family, 15- and 30-year fixed
rate loans during the first quarter of fiscal 2002. In addition, the volume of loans originated for resale into the
secondary market increased to $158.3 million as compared to $76.4 million in
the prior fiscal year.
Loan fees and service charges increased
$284,000 for the year ended June 30, 2002.
This increase was primarily due to an increase in loans originated and
held in portfolio of $43.4 million over the prior year.
Gain on sale of securities increased $135,000
for the year ended June 30, 2001 as compared to the same period in the prior
fiscal year. This increase was due to
no sales occurring in the prior fiscal year.
Long-term fixed-rate mortgage-backed securities were sold to reduce the
potential market value loss of rising interest rates.
Noninterest Expense. Noninterest expense increased $2.4 million from $23.5 million for
the year ended June 30, 2001 to $26.0 million for the year ended June 30,
2002. This increase was primarily due
to an increase in compensation and employee benefits of $2.0 million, an
increase in other general and administrative expenses of $311,000 and an
increase in advertising expense of $293,000 offset by a decrease in federal
insurance premiums of $165,000.
The increase in compensation and employee
benefits was primarily related to seven new bank branches opened and one branch
acquisition since the first half of fiscal 2001. In addition, pension costs increased $381,000 for the year ended
June 30, 2002 as compared to the same period in the prior fiscal year due to a
combination of higher payroll covered and the investment performance of the
pension trust account.
The increase in advertising was primarily due
to a new marketing campaign and logo change undertaken in fiscal 2002.
The
Company expects the cost for property and casualty coverage will be increasing
at its next renewal date due to the terrorists attacks of September 11,
2001. The Company has been informed by
its property and casualty insurance carrier that due to terrorist attacks of September 11, 2001, and the resulting
unavailability of reinsurance in the market,
insurance contracts will be amended with exclusionary language that will
clearly define what is considered war and terrorist activity and excludes
coverage for certain war and terrorist actions. Management believes that these exclusions could have an impact on
the Company’s financial performance should an event such as the events of
September 11, 2001 take place in the Company’s trade territory.
Income tax expense. The Company’s income tax expense for both of the years ended June
30, 2002 and June 30, 2001 was $2.9 million, a decrease of $73,000. This decrease was primarily due to the
decrease in the Company’s effective tax rate from 38.93% at June 30, 2001 to
36.96% at June 30, 2002 due to changes in permanent tax differences.
Discontinued Operations
Income
(loss) from discontinued operations. The $1.7
million loss from discontinued operations for the year ended June 30, 2002 as
compared to income of $12,000 for the prior fiscal year was primarily due to
the write down of the credit card portfolio to net realizable value of $1.1
million and one-time closing costs of $108,000. See Note 2 of “Notes to Consolidated Financial Statements” for
further discussion on discontinued operations.
Comparison of the Years Ended June
30, 2001 and June 30, 2000
Continuing
Operations
General. The Company’s net income from continuing operations decreased
$934,000 to $4.6 million for the year ended June 30, 2001 as compared to $5.5
million for the year ended June 30, 2000.
As discussed in more detail below, this decrease was due primarily to an
increase in interest expense of $5.9 million and an increase in noninterest
expense of $3.0 million. These
decreases to income were partially offset by an increase in interest income of
$6.5 million, a decrease in provision for losses on loans and leases of
$200,000 and an increase in noninterest income of $1.1 million.
Interest Income. Interest income increased $6.5 million from $51.7 million for the
year ended June 30, 2000 to $58.2 million for the year ended June 30,
2001. The $64.4 million increase of
average earning assets resulted in a $4.9 million increase in interest
income. Average loan balances increased
$42.4 million due to originations and purchases exceeding amortizations, prepayments
and sales and from leases and loans acquired in new branch and company
acquisitions and openings during the last half of fiscal 2000 and fiscal
2001. The Company continues to manage
yields by changing the types of loans that comprise the portfolio to loans that
have a higher yield than single-family real estate loans. Commercial business loans, agricultural
business loans and equipment finance leases comprise 22.28% of the total loan
portfolio at June 30, 2001 as compared to 19.17% at June 30, 2000. In addition, one-to four-family loans
comprise 21.71% of the total loan portfolio at June 30, 2001 as compared to
23.62% at June 30, 2000. The yield on
average earning assets increased to 8.36% as compared to 8.19% one year ago.
Interest Expense. Interest expense increased $5.9 million from $29.1 million for
the year ended June 30, 2000 to $35.1 million for the year ended June 30,
2001. The $52.8 million increase of
average interest-bearing liabilities resulted in a $2.6 million increase in
interest expense. The average balance
of deposits increased $49.7 million primarily due to deposits acquired in new
branch acquisitions and openings during the last half of fiscal 2000 and fiscal
2001. The average rate paid on deposits
increased to 5.51% as compared to 5.03% one year ago. The average balance of FHLB advances and other borrowings
increased $3.1 million during fiscal year 2001. The average rate paid on FHLB advances and other borrowings
increased to 5.90% at June 30, 2001 from 5.19% at June 30, 2000. See “Financial Condition Data” for further
discussion.
Net Interest Income. The Company’s net interest
income for the year ended June 30, 2001 increased $599,000, or 2.66%, to $23.1
million compared to $22.5 million for the same period ended June 30, 2000. The increase in net interest income reflects
an overall increase in net earning assets offset by a reduction in the net
interest spread on average earning assets to 2.78% for the period ended June
30, 2001 from 3.13% for the same period in 2000. The decrease in the net interest spread is due primarily to a
declining rate environment.
Provision for Losses on Loans and Leases. The allowance
for loan and lease losses is maintained at a level which is considered by
management to be adequate to absorb probable losses on existing loans and
leases that may become uncollectible, based on an evaluation of the
collectability of loans and prior loan loss experience. The evaluation takes into consideration such
factors as changes in the nature and volume of the loan portfolio, overall
portfolio quality, review of specific problem loans, and current economic
conditions that may affect the borrower’s ability to pay. The allowance for loan and lease losses is
established through a provision for losses on loans and leases charged to
expense.
During the year ended June 30, 2001, the
Company recorded a provision for losses on loans and leases of $1.5
million compared to $1.7 million for
the year ended June 30, 2000, a decrease of $200,000. See “Asset Quality” for further discussion.
The allowance for loan and lease losses was
$5.5 million at June 30, 2001 and June 30, 2000. The ratio of allowance for loan and lease losses to nonperforming
loans and leases at June 30, 2001 was 97.73% compared to 264.63% at June 30,
2000. The allowance for loan and lease
losses to total loans and leases at June 30, 2001 was 0.96% compared to 1.00%
at June 30, 2000. The Bank’s management
believes that the June 30, 2001 recorded allowance for loan losses was adequate
to provide for probable losses on the related loans, based on its evaluation of
the collectability of loans and prior loss experience.
Noninterest Income. Noninterest income was $9.4 million for the year ended June 30,
2001 as compared to $8.3 million for the year ended June 30, 2000.
Fees on deposits increased $842,000 due to an
increase in volume from deposits acquired in new branch acquisitions/openings
during the last half of fiscal 2000 and fiscal 2001.
Commission and insurance income from the sale
of financial and insurance products increased $182,000 primarily due to a
greater emphasis on the production of non-interest income revenue.
Gain on sale of loans increased $207,000 for
the year ended June 30, 2001 as compared to the same period in the prior fiscal
year. This increase was due to
increased sales into the secondary market.
Gain on sale of securities decreased $185,000
for the year ended June 30, 2001 as compared to the same period in the prior
fiscal year. This decrease was due to
no sales occurring in the current fiscal year.
Noninterest Expense. Noninterest expense increased $3.0 million from $20.5 million for
the year ended June 30, 2000 to $23.5 million for the year ended June 30,
2001. This increase was primarily from
an increase in compensation and employee benefits of $2.2 million, occupancy
and equipment of $521,000, advertising expense of $206,000 and amortization of
intangible assets of $113,000.
The increase in compensation and employee
benefits, occupancy and equipment and amortization of intangible assets was
primarily related to seven new bank branches opened and two nonbank operations
acquired since September 1999.
Income tax expense. The Company’s income tax expense for the year ended June 30, 2001
was $2.9 million compared to $3.1 million for the year ended June 30, 2000, a
decrease of $148,000. This decrease was
primarily due to the decrease in the Company’s income from continuing
operations before income tax from $8.6 million to $7.5 million offset by an
increase in the Company’s effective tax rate from 35.75% at June 30, 2000 to
38.93% at June 30, 2001 due to changes in permanent tax differences.
Discontinued Operations
Income
(loss) from discontinued operations. The $12,000
income from discontinued operations for the year ended June 30, 2001 as
compared to a loss of $262,000 for the prior fiscal year was primarily due to
the credit card loan portfolio decreasing from $9.6 million at June 30, 2000 to
$6.1 million at June 30, 2001. See Note
2 of “Notes to Consolidated Financial Statements” for further discussion on
discontinued operations.
Liquidity and Capital Resources
The Bank’s primary sources of funds are in
market deposits, FHLB advances and other borrowings, amortization and
repayments of loan principal, mortgage-backed securities and callable
agency securities and, to a lesser extent, sales of mortgage loans, sales
and/or maturities of securities, mortgage-backed securities, and short-term
investments. While scheduled loan
payments and maturing securities are relatively predictable, deposit flows and
loan prepayments are more influenced by interest rates, general economic
conditions, and competition. The Bank attempts to price its deposits to meet
its asset/liability objectives consistent with local market conditions. Excess balances are invested in overnight
funds.
Federal regulations have historically
required the Bank to maintain minimum levels of liquid assets. The required percentage has varied from time
to time based upon economic conditions and savings flows and is currently 0.00%
of net withdrawable savings deposits and current borrowings. Liquid assets for purposes of this ratio
include cash, certain time deposits, U.S. Government and corporate securities
and other obligations generally having remaining maturities of less than five
years. The Bank has historically
maintained its liquidity ratio at a level in excess of that required by these
regulations. At June 30, 2002, the
Bank’s regulatory liquidity ratio was 4.78%.
Liquidity management is both a daily and long-term
responsibility of management. The Bank
adjusts its investments in liquid assets based upon management’s assessment of
(i) expected loan demand, (ii) projected loan sales, (iii) expected deposit
flows, (iv) yields available on interest-bearing deposits, and (v) the
objectives of its asset/liability management program. Excess liquidity is
invested generally in interest-bearing overnight deposits and other short-term
government and agency obligations.
During fiscal 2002, the Bank decreased its borrowings with the FHLB by
$17.3 million.
The Bank anticipates that it will have
sufficient funds available to meet current loan commitments. At June 30, 2002, the Bank had outstanding
commitments to originate loans of $45.0 million and to sell loans of $14.7
million. The Bank had no commitments to
purchase or sell securities.
Although deposits are the Bank’s primary
source of funds, the Bank’s policy has been to utilize borrowings where the
funds can be invested in either loans or securities at a positive rate of
return or to use the funds for short-term liquidity purposes. During fiscal 2002, the Bank increased the
amount of pledgeable loans at the FHLB in order to increase its contingent
liquidity sources. Also, the Bank is
implementing arrangements to acquire out of market certificate of deposits as
an additional source of funding. The
Bank may also seek other sources of contingent liquidity including federal
funds purchased lines with correspondent banks and lines of credit with the
FRB. See “Financial Condition Data” for
further analysis.
The Company currently has
in effect a stock buy back program in which up to 10.00% of the common stock of
the Company outstanding on May 1, 2002 may be acquired through April 30,
2003. A total of 113,800 shares of
common stock have been purchased pursuant to this current program and the
previous program in effect during fiscal year 2002. Pursuant to a series of stock buy back programs initiated by the
Company since 1996, the Company has purchased an aggregate of 1,559,030 shares
of common stock through June 30, 2002. Included in the aggregate is a block of 340,421 shares of common
stock repurchased in a private transaction on February 13, 2002.
Savings institutions
insured by the Federal Deposit Insurance Corporation are required by the
Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”)
to meet three regulatory capital requirements.
If a requirement is not met, regulatory authorities may take legal or
administrative actions, including restrictions on growth or operations or, in
extreme cases, seizure. Institutions
not in compliance may apply for an exemption from the requirements and submit a
recapitalization plan. Under these
capital requirements, at June 30, 2002, the Bank met all current capital
requirements.
The OTS has adopted a core capital
requirement for savings institutions comparable to the requirement for national
banks. The OTS core capital requirement
is 4.00% of total adjusted assets for thrifts that receive the highest
supervisory rating for safety and soundness.
The Bank had core capital of 7.44% at June 30, 2002.
At June 30, 2002 and 2001, securities with a
fair value of $74.2 million and $84.4 million, respectively, were pledged as
collateral for public deposits and other purposes. Deposits at June 30, 2002 and 2001 include $37.4 million and
$37.1 million, respectively, of deposits from one local governmental entity,
the majority of which are savings accounts.
Impact of Inflation and Changing
Prices
The Consolidated Financial Statements and
Notes thereto presented in this Form 10-K have been prepared in accordance with
accounting principles generally accepted in the United States of America, which
require the measurement of financial position and operating results in terms of
historical dollars without considering the change in the relative purchasing
power of money over time due to inflation.
The impact of inflation is reflected in the increased cost of the Bank’s
operations. Unlike most industrial companies, nearly all the assets and
liabilities of the Bank are monetary in nature. As a result, interest rates have a greater impact on the Bank’s
performance than do the effects of general levels of inflation. Interest rates do not necessarily move in
the same direction or to the same extent as the prices of goods and services.
Effect of
New Accounting Standards
Recent accounting pronouncements: In July, 2001, the Financial Accounting Standards Board (“FASB”)
issued two statements - Statement 141, Business
Combinations, and Statement 142, Goodwill
and Other Intangible Assets, which will impact the Company’s
accounting for its reported goodwill.
Statement 141:
• Eliminates the pooling
method for accounting for business combinations.
• Requires that intangible assets
that meet certain criteria be reported separately from goodwill.
• Requires negative goodwill
arising from a business combination to be recorded as an extraordinary gain.
Statement 142:
• Eliminates the amortization
of goodwill and other intangibles that are determined to have an indefinite
life.
• Requires, at a minimum,
annual impairment tests for goodwill and other intangible assets that are
determined to have an indefinite life.
• Requires the carrying value
of goodwill which exceeds its implied fair value to be recognized as an
impairment loss.
Upon adoption of these Statements, the Company is required to:
• Evaluate its existing
intangible assets and goodwill that were acquired in prior business
combinations and to make any necessary reclassifications in order to conform to
the new criteria.
• Reassess the useful lives of
intangible assets and adjust the remaining amortization periods accordingly.
• Recognize any remaining
negative goodwill as income.
The provisions of FASB Statement 141 apply to all business combinations
initiated after June 30, 2001 and all business combinations accounted for by
the purchase method for which the date of acquisition is July 1, 2001, or
later. The provisions of FASB Statement
142 were implemented by the Company in the first quarter of its 2003 fiscal
year. Upon initial adoption of FASB
Statement 142, the Company will stop amortizing goodwill which will reduce
amortization expense on current goodwill by approximately $391,000 in fiscal
year 2003.
In
August 2001, the FASB issued Statement 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. This Statement addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. This Statement supersedes FASB Statement No.
121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and
the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions, for the disposal of
a segment of a business (as previously defined in that Opinion). The provisions of this Statement are
effective for financial statements issued for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years, with early
application encouraged. The provisions
of this Statement generally are to be applied prospectively. During fiscal year 2002, the Company adopted
the provisions of Statement 144 to record discontinued operations of the credit
card portfolio.
In
June 2002, the FASB issued Statement 146, Accounting
for Costs Associated with Exit or Disposal Activities. This Statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3,
“Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring).” The provisions of this
Statement are effective for exit or disposal activities that are initiated
after December 31, 2002. The adoption
of Statement No. 146 is not expected to have a material effect on the financial
position or results of operations of the Company.
Asset/Liability and Risk Management
Interest rate risk is the most significant market
risk affecting the Company. Other types
of market risk, such as foreign currency exchange rate risk and commodity price
risk, do not arise in the normal course of the Company’s business
activities. The Bank, like other
financial institutions, is subject to interest rate risk to the extent that its
interest-bearing liabilities with short- and medium-term maturities
mature or reprice more rapidly than its interest-earning assets. The Company
does not currently engage in trading activities or use derivative instruments
to control interest rate risk although it may in the future, if necessary, to
manage interest rate risk.
As a continuing part of its financial
strategy, the Bank considers methods of managing this asset/liability mismatch
consistent with maintaining acceptable levels of net interest income. In order to properly monitor interest rate
risk, the Board of Directors has created an Asset/Liability Committee whose
principal responsibilities are to assess the Bank’s asset/liability mix and
recommend strategies to the Board that will enhance income while managing the
Bank’s vulnerability to changes in interest rates.
In managing market risk and the
asset/liability mix, the Bank has placed its emphasis on developing a portfolio
in which, to the extent practicable, assets and liabilities reprice within
similar periods. The goal of this policy is to provide a relatively consistent
level of net interest income in varying interest rate cycles and to minimize
the potential for significant fluctuations from period to period.
One approach used to quantify interest rate
risk is the net portfolio value (“NPV”) analysis. In essence, this analysis calculates the difference between the
present value of the liabilities and the present value of expected cash flows
from assets and off-balance sheet contracts.
The following table sets forth, at June 30, 2002, an analysis of the
Company’s interest rate risk as measured by the estimated changes in NPV
resulting from instantaneous and sustained parallel shifts in the yield curve
(+ 300 or -100 basis points, measured in 100 basis point increments). Due to the abnormally low prevailing interest
rate environment, -200 and -300 NPV were not estimated by the OTS.
The data in the following tables is based on
assumptions utilized by the OTS in assessing interest rate risk of thrift
institutions and published in “Selected Asset and Liability Price Tables as of
June 30, 2002”. Even if interest rates
change in the designated amounts, there can be no assurance that the Company’s
assets and liabilities would perform as set forth below. In addition, a change in U.S. Treasury rates
in the designated amounts accompanied by a change in the shape of the Treasury
yield curve would cause significantly different changes to the NPV than
indicated below.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk Management
The Company ‘s net income is largely
dependent on its net interest income. Net interest income is susceptible to
interest rate risk to the degree that interest-bearing liabilities mature or
reprice on a different basis than interest-earning assets. When
interest-bearing liabilities mature or reprice more quickly than
interest-earning assets in a given period, a significant increase in market
rates of interest could adversely affect net interest income. Similarly, when
interest-earning assets mature or reprice more quickly than interest-bearing
liabilities, falling interest rates could result in a decrease in net income.
In an attempt to manage its exposure to
change in interest rates, management monitors the Company’s interest rate risk.
Management’s Asset-Liability Committee meets periodically to review the
Company’s interest rate risk position and profitability, and to recommend
adjustments for consideration by executive management. Management also reviews
the Bank’s securities portfolio, formulates investment strategies, and oversees
the timing and implementation of transactions to assure attainment of the Board
‘s objectives in the most effective manner. Notwithstanding the Company’s
interest rate risk management activities, the potential for changing interest
rates is an uncertainty that can have an adverse effect on net income.
In adjusting the Company’s asset/liability
position, management attempts to manage the Company’s interest rate risk while
enhancing net interest margins. At times, depending on the level of general
interest rates, the relationship between long and short-term interest rates,
market conditions and competitive factors, management may determine to increase
the Company’s interest rate risk position somewhat in order to increase its net
interest margin. The Company’s results of operations and net portfolio values
remain vulnerable to increases in interest rates and to fluctuations in the
difference between long- and short-term interest rates.
Consistent with the asset/liability
management philosophy described above, the Company has taken several steps to
manage its interest rate risk. First, the Company has structured the security
portfolio to shorten the repricing of its interest-earning assets. The
Company’s recent purchases of mortgage-backed securities and securities
available for sale have had either short or medium terms to maturity or
adjustable interest rates. At June 30, 2002, the Company had securities
available for sale of $16.6 million with contractual maturities of five years
or less and adjustable rate mortgage-backed securities of $45.7 million.
Mortgage-backed securities amortize and experience prepayments of
principal. The Company has received
average cash flows from principal paydowns, maturities, sales and calls of all
securities available for sale of $54.3 million annually over the past three
fiscal years. The Company also controls interest rate risk reduction by
emphasizing non-certificate depositor accounts. The Board and management
believe that such accounts carry a lower cost than certificate accounts, and
that a material portion of such accounts may be more resistant to changes in
interest rates than are certificate accounts. At June 30, 2002, the Company had
$50.4 million of savings accounts, $157.8 million of money market accounts and
$103.0 million of checking accounts, representing 55.31% of total depositor
accounts.
One approach used to quantify interest rate
risk is the net portfolio value (“NPV”) analysis. In essence, this analysis
calculates the difference between the present value of liabilities and the
present value of expected cash flows from assets and off-balance sheet
contracts. See Item 7, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Asset/Liability and Risk Management” for further discussion.
The Company does not currently engage in
trading activities or use derivative instruments to control interest rate risk.
Even though such activities may be permitted with the approval of the Board of
Directors, the Company does not intend to engage in such activities in the
immediate future.
Interest rate risk is the most significant
market risk affecting the Company. Other types of market risk, such as foreign
currency exchange rate risk and commodity price risk, do not arise in the
normal course of the Company’s business activities.
Item 8.
Item 8.
Financial Statements and Supplementary Data
CONTENTS
INDEPENDENT AUDITOR’S
REPORT
ON THE FINANCIAL STATEMENTS
CONSOLIDATED FINANCIAL
STATEMENTS
Statements
of financial condition
Statements of income
Statements
of stockholders’ equity
Statements of cash
flows
Notes to
consolidated financial statements
INDEPENDENT AUDITOR’S REPORT
To the Board of Directors
and Stockholders
HF Financial Corp.
Sioux Falls, South Dakota
We have audited the
accompanying consolidated statements of financial condition of HF Financial
Corp. and subsidiaries as of June 30, 2002 and 2001, and the related
consolidated statements of income, stockholders’ equity and cash flows for each
of the three years in the period ended June 30, 2002. These financial statements are the responsibility of the
Company’s management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits
in accordance with auditing standards generally accepted in the United States
of America. Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of HF Financial Corp. and
subsidiaries as of June 30, 2002 and 2001, and the results of their operations
and their cash flows for each of the three years in the period ended June 30,
2002, in conformity with accounting principles generally accepted in the United
States of America.
Sioux Falls, South Dakota
August 15, 2002
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF FINANCIAL CONDITION
June 30, 2002 and 2001
(Dollars in Thousands)
See Notes to Consolidated Financial
Statements.
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF INCOME
Years Ended June 30, 2002, 2001 and 2000
(Dollars in Thousands, Except Per Share Data)
See Notes to Consolidated Financial Statements.
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
Years Ended June 30, 2002, 2001 and 2000
(Dollars in Thousands, Except Per Share Data)
See Notes to Consolidated Financial Statements.
HF FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
Years Ended June 30, 2002, 2001 and 2000
(Dollars in Thousands)
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
HF FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands)
Note 1. Summary of Significant Accounting Policies
The accounting and
reporting policies of HF Financial Corp. (the Company) and subsidiaries conform
to accounting principles generally accepted in the United States of America and
to general practice within the industry.
The following is a description of the more significant of those policies
that the Company follows in preparing and presenting its consolidated financial
statements.
Principles of
consolidation: The accompanying consolidated financial
statements include the accounts of the Company, the Company’s wholly-owned
subsidiaries, HomeFirst Mortgage Corp., HF Card Services, LLC (HF Card), and
Home Federal Bank (formerly known as Home Federal Savings Bank) (the Bank), and
the Bank’s wholly-owned subsidiaries, Hometown Insurors, Inc., Mid-America
Service Corporation and PMD, Inc. The
financial statements also include the accounts of Mid America Capital Services,
Inc. (Mid America Capital), which at June 30, 2001 was a wholly owned
subsidiary of HomeFirst Mortgage Corp.
During fiscal year 2002, Mid America Capital was transferred from a
wholly owned subsidiary of HomeFirst Mortgage to a wholly owned subsidiary of
the Bank with no affect on the consolidated financial statements. Additionally, during fiscal year 2002, the
Company formed a wholly owned subsidiary named HF Financial Capital Trust I
(the Trust). All intercompany balances
and transactions have been eliminated in consolidation.
Basis of financial
statement presentation: In preparing the financial
statements, management is required to make estimates and assumptions that
affect the reported amounts of assets and liabilities as of the date of the
statement of financial condition and revenues and expenses for the year. Actual results could differ significantly
from those estimates. A material
estimate that is particularly susceptible to significant change in the
near-term relates to the determination of the allowance for loan and lease
losses.
Management believes that
the allowance for loan and lease losses is adequate. While management uses available information to recognize possible
losses on loans and leases, future additions to the allowance may be necessary
based on changes in economic conditions.
In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Bank’s allowance for loan and lease losses. Such agencies may require the Bank to
recognize additions to the allowance based on their judgments about information
available to them at the time of their examination.
Cash and cash equivalents:
For purposes of reporting the statements of cash flows, the Company
includes as cash equivalents all cash accounts which are not subject to
withdrawal restrictions or penalties and time deposits with original maturities
of 90 days or less. The Company had no
cash equivalents at June 30, 2002 and $60,000 at June 30, 2001.
Trust assets:
Assets of the trust department, other than trust cash on deposit at the
Bank, are not included in these financial statements because they are not
assets of the Bank.
Securities:
Management determines the appropriate classification of securities at
the date individual securities are acquired and evaluates the appropriateness
of such classifications at each statement of financial condition date.
Securities available for
sale are those debt securities that the Company intends to hold for an
indefinite period of time, but not necessarily to maturity, and all equity
securities. Any decision to sell a
security classified as available for sale would be based on various factors,
including significant movements in interest rates, changes in the maturity mix
of the Company’s assets and liabilities, liquidity needs, regulatory capital
considerations, and other similar factors.
Securities available for sale are carried at fair value and unrealized
gains or losses are reported as increases or decreases in other comprehensive
income, net of the related deferred tax effect.
Premiums and discounts on
securities are amortized over the contractual lives of those securities, except
for mortgage-backed securities, for which prepayments are probable and
predictable, which are amortized over the estimated expected repayment terms of
the underlying mortgages. The method of
amortization results in a constant effective yield on those securities (the
interest method). Interest on debt
securities is recognized in income as accrued.
Realized gains and losses on the sale of securities are determined using
the specific identification method.
Loans held for sale:
Loans receivable which the Bank may sell or intends to sell prior to
maturity are carried at the lower of net book value or fair value on an
aggregate basis. Such loans held for
sale include loans receivable that management intends to use as part of its
asset/liability strategy, or that may be sold in response to changes in
interest rates, changes in prepayment risk or other similar factors.
Loans and leases
receivable: Loans receivable are stated at unpaid
principal balances, less the allowance for loan losses, and net of deferred
loan origination fees, costs and discounts.
Discounts and premiums on
loans are amortized to income using the interest method over the remaining
period to contractual maturity, adjusted for prepayments.
Loans are generally
classified as nonaccrual when there are reasonable doubts as to the
collectibility of principal and/or interest and/or when payment becomes 90 days
past due, except loans which are well secured and in the process of
collection. Uncollectible interest on
loans that are impaired or contractually past due is charged off based on
management’s periodic evaluation. The
charge to interest income is equal to all interest previously accrued, and
income is subsequently recognized only to the extent cash payments are received
until, in management’s judgment, the borrower’s ability to make periodic
interest and principal payments is no longer in doubt, in which case the loan
is returned to accrual status.
Loans and leases
receivable (continued): The Company’s leases
receivable are classified as direct finance leases. Under the direct financing
method of accounting for leases, the total net payments receivable under the lease
contracts and the residual value of the leased equipment, net of unearned
income, are recorded as a net investment in direct financing leases and the
unearned income is recognized each month on a basis which approximates the
interest method. Accrual of interest income is suspended when collection is
doubtful.
The allowance for loan
and lease losses is established as losses are estimated to have occurred
through a provision for loan losses charged to earnings. Loan losses are charged against the allowance
when management believes the uncollectibility of a loan balance is
confirmed. Subsequent recoveries, if
any, are credited to the allowance.
The allowance for loan
losses is evaluated on a regular basis by management and is based upon
management’s periodic review of the collectibility of the loans in light of
historical experience, the nature and volume of the loan portfolio, adverse
situations that may affect the borrower’s ability to repay, estimated value of
any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as
it requires estimates that are susceptible to significant revision as more
information becomes available.
A loan is considered
impaired when, based on current information and events, it is probable that the
Company will be unable to collect the scheduled payments of principal or
interest when due according to the contractual terms of the loan
agreement. Factors considered by
management in determining impairment include payment status, collateral value,
and the probability of collecting scheduled principal and interest payments
when due. Loans that experience
insignificant payment delays and payment shortfalls generally are not
classified as impaired. Management
determines the significance of payment delays and payment shortfalls on a
case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower’s prior payment record, and the amount of
the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan
basis for commercial and construction loans by either the present value of
expected future cash flows discounted at the loan’s effective interest rate,
the loan’s obtainable market price, or the fair value of the collateral if the
loan is collateral dependent.
Large groups of smaller
balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately
identify individual consumer and residential loans for impairment disclosures.
Loan origination fees and
related discounts: Loan fees and certain direct loan
origination costs are deferred, and the net fee or cost is recognized as an
adjustment to interest income using the interest method over the contractual
life of the loans, adjusted for prepayments.
Commitment fees and costs
relating to commitments, the likelihood of exercise of which is remote, are
recognized over the commitment period on a straight-line basis. If the commitment is subsequently exercised
during the commitment period, the remaining unamortized commitment fee at the
time of exercise is recognized over the life of the loan as an adjustment of
yield.
Loan servicing:
The cost allocated to mortgage servicing rights purchased or retained
has been recognized as a separate asset and is being amortized in proportion to
and over the period of estimated net servicing income. Mortgage servicing rights are periodically
evaluated for impairment based on the fair value of those rights. Fair values are estimated using discounted
cash flows based on current market rates of interest. For purposes of measuring impairment, the rights are stratified
by one or more predominant risk characteristics of the underlying loans. The Bank stratifies its capitalized mortgage
servicing rights based on the interest rate of the underlying loans. The amount of impairment recognized is the
amount, if any, by which the amortized cost of the rights for each stratum
exceed their fair value.
Cost in excess of net assets
acquired (intangibles):
Intangibles are the difference between purchase prices and the amounts
assigned to the net assets acquired and accounted for under the purchase method
of accounting. Management reassesses the carrying value and remaining life of
intangible assets on an ongoing basis. Whenever events indicate that the
carrying values are impaired, the excess cost over fair value of those assets
is adjusted appropriately. As of June 30, 2002, management believes there is no
impairment with respect to these assets.
Foreclosed real estate
and other properties: Real estate and other properties acquired
through, or in lieu of, loan foreclosure are initially recorded at lower of
cost or fair value less estimated costs to sell at the date of
foreclosure. Costs relating to
improvement of property are capitalized, whereas costs relating to the holding
of property are expensed. Valuations
are periodically performed by management, and charge-offs to operations are
made if the carrying value of a property exceeds its estimated fair value less
estimated costs to sell.
Land held for development
is carried at the lower of cost, including
cost of improvements and amenities incurred subsequent to acquisition,
or fair value less cost to sell. Costs
relating to the development and improvement of property are capitalized,
whereas costs relating to holding property are expensed. During fiscal year 2002, management’s intent
was changed from developing the property to selling the property, and
accordingly, at June 30, 2002, the property was reclassified as held for sale
with no effect on the consolidated financial statements. The carrying amount of land held for sale
was $1,298 at June 30, 2002 and 2001.
Office properties and
equipment: Land is carried at cost. All other office properties and equipment
are carried at cost, less accumulated depreciation and amortization. Buildings and improvements and leasehold
improvements are depreciated primarily on the straight-line method over the
estimated useful lives of the assets which is five to fifty years. Furniture, fixtures, equipment and
automobile are depreciated using both the straight-line and declining balance
methods over the estimated useful lives of the assets which is three to twelve
years.
Income taxes:
Deferred taxes are provided on an asset and liability method whereby
deferred tax assets are recognized for deductible temporary differences and
operating loss and tax credit carryforwards and deferred tax liabilities are
recognized for taxable temporary differences.
Temporary differences are the differences between the reported amounts
of assets and liabilities and their tax bases.
Deferred tax assets are reduced by a valuation allowance when, in the
opinion of management, it is more likely than not that some portion or all of
the deferred tax assets will not be realized.
Deferred tax assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of enactment.
Earnings per share (EPS):
Basic EPS represents income available to common stockholders divided by
the weighted-average number of common shares outstanding during the
period. Diluted EPS reflects additional
common shares that would have been outstanding if dilutive potential common
shares had been issued.
Segment reporting: Operating segments are defined as
components of an enterprise for which separate financial information is
available that is evaluated regularly by the chief operating decision makers in
deciding how to allocate resources and in assessing performance. The primary reporting segment is the Bank.
Fair value of financial
instruments: The following methods and assumptions were
used by the Company in estimating the fair value of its financial instruments:
Cash and cash equivalents:
The carrying amounts reported in the statements of financial condition
for cash and cash equivalents approximate their fair values.
Securities:
Fair values for investment securities are based on quoted market prices,
except for stock in the Federal Home Loan Bank for which fair value is assumed
to equal cost.
Loans and leases:
Approximately 50% of loans at both June 30, 2002 and 2001 are
variable-rate loans that reprice frequently and have no significant change in
credit risk. Fair values on these loans
are based on carrying values. The fair
values for fixed-rate loans and leases are estimated using discounted cash flow
analyses, using interest rates currently being offered for loans and leases
with similar terms to borrowers with similar credit quality or from quoted
market prices of similar loans and leases sold, adjusted for differences in
loan and lease characteristics.
Accrued interest
receivable: The carrying value of accrued interest
receivable approximates its fair value.
Mortgage servicing rights:
Fair values are estimated using discounted cash flows based on current
market rates of interest.
Off-statement-of-financial-condition
instruments: Fair
values for the Company’s off-statement-of-financial-condition instruments
(unused lines of credit and letters of credit), which are based upon fees
currently charged to enter into similar agreements taking into account the
remaining terms of the agreements and counterparties’ credit standing, are not significant.
Deposits:
The fair values for deposits with no defined maturities equal their
carrying amounts which represent the amount payable on demand. Fair values for fixed-rate certificates of
deposit are estimated using a discounted cash flow calculation that applies
interest rates currently being offered on certificates to a schedule of
aggregated expected monthly maturities on certificates of deposit.
Borrowed funds:
The carrying amounts reported for variable rate advances approximate
their fair values. Fair values for
fixed-rate advances and other borrowings are estimated using a discounted cash
flow calculation that applies interest rates currently being offered on
advances and borrowings with corresponding maturity dates.
Preferred securities of
subsidiary trust: The carrying amount for Company obligated
manditorily redeemable preferred securities of subsidiary trust that solely
holds subordinated debentures approximates fair value.
Accrued interest payable
and advances by borrowers for taxes and insurance:
The carrying values of accrued interest payable and advances by
borrowers for taxes and insurance approximate their fair values.
Stock-based compensation:
The Company accounts for stock-based compensation in accordance with
Accounting Principles Board (APB) Opinion No. 25.
Recent accounting
pronouncements: In July 2001, the Financial Accounting
Standards Board (FASB) issued two statements - Statement 141, Business Combinations, and Statement 142, Goodwill and Other Intangible Assets, which
will impact the Company’s accounting for its reported goodwill.
Statement 141:
• Eliminates the pooling
method for accounting for business combinations.
• Requires that intangible
assets that meet certain criteria be reported separately from goodwill.
• Requires negative goodwill
arising from a business combination to be recorded as an extraordinary gain.
Statement 142:
• Eliminates the
amortization of goodwill and other intangibles that are determined to have an
indefinite life.
• Requires, at a minimum,
annual impairment tests for goodwill and other intangible assets that are
determined to have an indefinite life.
• Requires the carrying
value of goodwill which exceeds its implied fair value to be recognized as an
impairment loss.
Upon adoption of these Statements, the
Company is required to:
• Evaluate its existing
intangible assets and goodwill that were acquired in prior business
combinations and to make any necessary reclassifications in order to conform to
the new criteria.
• Reassess the useful lives
of intangible assets and adjust the remaining amortization periods accordingly.
• Recognize any remaining
negative goodwill as income.
The provisions of FASB Statement 141 apply to
all business combinations initiated after June 30, 2001 and all business
combinations accounted for by the purchase method for which the date of
acquisition is July 1, 2001, or later.
The provisions of FASB Statement 142 were implemented by the Company in
the first quarter of its 2003 fiscal year.
Upon initial adoption of FASB Statement 142, the Company will stop
amortizing goodwill which will reduce amortization expense on current goodwill
by approximately $391 in fiscal year 2003.
In August 2001, the FASB issued Statement
144, Accounting for the Impairment or
Disposal of Long-Lived Assets.
This Statement addresses financial accounting and reporting for the
impairment or disposal of long-lived assets.
This Statement supersedes FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of, and the accounting and
reporting provisions of APB Opinion No. 30, Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, for the disposal of a segment of a business (as
previously defined in that Opinion).
The provisions of this Statement are effective for financial statements
issued for fiscal years beginning after December 15, 2001, and interim periods
within those fiscal years, with early application encouraged. The provisions of this Statement generally
are to be applied prospectively. During
fiscal year 2002, the Company adopted the provisions of Statement 144 to record
discontinued operations of the credit card portfolio.
In June 2002, the FASB issued Statement 146, Accounting for Costs Associated with Exit or Disposal
Activities. This Statement
addresses financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No.
94-3, “Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring).” The provisions of this
Statement are effective for exit or disposal activities that are initiated
after December 31, 2002. The adoption
of Statement No. 146 is not expected to have a material effect on the financial
position or results of operations of the Company.
Note 2. Discontinued Operations
In June 2002, management
committed to a plan to sell the subprime credit card operations through its
subsidiary, HF Card, which was previously reported in the credit card segment
of the Company. HF Card ceased processing
subprime credit card applications in March 1999 and has been managing the
portfolio from a balance of $18,062 at June 30, 1999, to the remaining balance
of $3,765 at June 30, 2002. The Company
is negotiating the sale of the remaining receivables to a third party. As of June 30, 2002, the Company had not
entered into a definitive agreement for the sale of the remaining
receivables. The Company estimated the
net realizable value based on estimates from a third party and reclassified the
net realizable value of $1,115 from loans receivable to loans held for
sale. The actual sale of the
receivables and liquidation of HF Card is expected to take place in the first
half of fiscal 2003. Including the
write down of the credit card portfolio to net realizable value of $1,115 and
one-time closing costs of $108, the Company recorded a net loss from
discontinued operations of $1,686, net of tax benefit of $868, for the year
ended June 30, 2002. Amounts of revenue
(including interest income on loans and noninterest income) and pretax profit
(loss) reported in discontinued operations for the years ended June 30, 2002,
2001, and 2000 were $2,413 and $(2,554); $3,848 and $18; and $8,457 and $(397),
respectively.
Note 3. Acquisitions
During the year ended
June 30, 2001, HomeFirst Mortgage Corp. purchased 100% of the outstanding
capital stock of Mid America Capital Services, Inc., a finance leasing company,
for net cash consideration of $2,857.
Intangibles of $723 were recorded and are being amortized into expense
by the straight-line method over 10 years.
This acquisition was accounted for under the purchase method of
accounting.
Results of operations of
the acquired entity since the date of acquisition are included in the
consolidated financial statements. Unaudited pro forma consolidated results of
continuing operations for the year ended June 30, 2001 as though the entity had
been acquired as of the beginning of the fiscal year prior to the acquisition
follows (in thousands, except per share data):
The unaudited pro forma
combined summary of operations does not purport to be indicative of the results
which actually would have been obtained if the acquisition had been made at the
beginning of the fiscal year prior to the respective acquisition, or of those
results which may be obtained in the future. The unaudited pro forma combined
summary of operations includes the effects of additional interest expense on
debt incurred in connection with the acquisition as if the debt had been
outstanding since the beginning of the period presented. In addition, the summary of operations
includes amortization of the cost in excess of net assets of company acquired
in connection with the acquisition as if it had been acquired as of the
beginning of the periods presented.
During the years ended
June 30, 2001 and 2000, several smaller acquisitions were also made. During the
year ended June 30, 2001, the Bank acquired the assets and liabilities of a
branch of a local commercial bank and received cash consideration of $2,218, as
the liabilities assumed exceeded the assets acquired. Intangibles of $330 were
recorded and are being amortized to expense by the straight-line method. This acquisition was treated as a purchase
for accounting purposes, and the results of operations of the acquired branch
since the date of acquisition are included in the consolidated financial
statements. In 2000, the Bank acquired
the assets and liabilities of a branch of another local commercial bank, and
received cash consideration of $775.
Also in 2000, Hometown Insurors, Inc. paid $300 to acquire the customer
base of a local insurance agency, and an additional $150 was paid during 2001
under contingency provisions of the purchase agreement. These acquisitions were treated as purchases
for accounting purposes, and the results of operations of the acquired entities
since the dates of acquisition are included in the consolidated financial
statements.
Note 4. Investments in Securities
The amortized cost and
fair values of investments in securities at June 30, 2002, all of which are
classified as available for sale according to management’s intent, are as
follows:
The amortized cost and fair values of debt
securities as of June 30, 2002, by contractual maturity, are shown below. Expected maturities will differ from
contractual maturities because the borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
Equity securities have
also been excluded from the maturity table above because they do not have
contractual maturities associated with debt securities. The Bank, as a member of the Federal Home
Loan Bank system, is required to maintain an investment in capital stock of the
Federal Home Loan Bank. No ready market
exists for the stock, and it has no quoted market value. For disclosure purposes, such stock is
assumed to have a fair value which is equal to cost.
The components of other
comprehensive income (loss) - net change in unrealized gain (loss) on
securities available for sale are as follows:
Proceeds from the sale of
securities available for sale in 2002 were $14,831 and resulted in gross gains
of $170 and gross losses of $(35).
There were no sales of securities in 2001, and accordingly, no realized
gains or losses. Proceeds from the sale
of securities during 2000 were $5,386 and resulted in gross gains of $201 and
gross losses of $(16).
At June 30, 2002 and
2001, securities with a fair value of $74,200 and $84,397, respectively, were
pledged as collateral for public deposits and other purposes.
The amortized cost
and fair values of investments in securities at June 30, 2001, all of which are
classified as available for sale according to management’s intent, are as
follows:
Note
5. Loans and Leases Receivable
Loans and leases receivable at June 30, 2002
and 2001 consist of the following:
Loans held for
sale totaling $6,559 at June 30, 2002 consist of one-to-four family fixed-rate
loans and credit card loans (Note 2).
At June 30, 2001, loans held for sale totaling $7,270 consisted of
one-to-four family fixed-rate loans.
Activity in the allowance
for loan and lease losses included in continuing operations is summarized as
follows for the years ended June 30:
The following is a
summary of information pertaining to impaired loans:
No additional
funds are committed to be advanced in connection with impaired loans.
Note 6. Loan Servicing
Mortgage loans
serviced for others (primarily the South Dakota Housing Development Authority)
are not included in the accompanying consolidated statements of financial
condition. The unpaid principal
balances of mortgage loans serviced for others was $520,250 and $493,657 at
June 30, 2002 and 2001, respectively.
Custodial balances
maintained in connection with the foregoing loan servicing, and included in
deposits and advances by borrowers for taxes and insurance, were approximately
$2,017 and $1,946 at June 30, 2002 and 2001, respectively.
The carrying
values of mortgage servicing rights were $3,467 and $2,775 at June 30, 2002 and
2001, respectively. The fair values of
these rights were $5,275 and $5,346 at June 30, 2002 and 2001, respectively. The fair values of the mortgage servicing
rights were estimated as the present value of the expected future cash flows
using a discount rate of 10% and 15% as of June 30, 2002 and 2001,
respectively. The Company recognized
expense for amortization of the cost of mortgage servicing rights in the amount
of $347, $272 and $297 for the years ended June 30, 2002, 2001 and 2000,
respectively.
No valuation
allowances were provided for mortgage servicing rights capitalized during the
years ended June 30, 2002 and 2001.
Note 7. Office Properties and Equipment
Office properties
and equipment at June 30, 2002 and 2001 consist of the following:
In addition, the
Bank leases several branch facilities under operating lease agreements which
require minimum rentals totaling $1,246 through the year ending June 30, 2006.
Note
8. Deposits
Deposits at June
30, 2002 and 2001 consist of the following:
Scheduled
maturities of certificates of deposit are as follows:
Deposit accounts are insured up to $100 by
the Savings Association Insurance Fund (SAIF) under management of the Federal
Deposit Insurance Corporation (FDIC).
The aggregate amount of jumbo certificates of deposit with a minimum
denomination of $100 was approximately $46,905 and $64,391 at June 30, 2002 and
2001, respectively. Deposits at June
30, 2002 and 2001 include $37,390 and $37,079, respectively, of deposits from
one local governmental entity, the majority of which are savings accounts.
Note
9. Advances From Federal Home Loan Bank
and Other Borrowings
Advances from the
Federal Home Loan Bank of Des Moines at June 30, 2002 and 2001 are summarized
as follows:
Aggregate
maturities of advances, computed based on call date, are as follows: 2003 $47,936; 2004 $13,462; 2005 $11,090;
2006 $1,070; 2007 $1,048; and thereafter $8,828. Prepayment of the callable advances results in a prepayment fee
as negotiated between the Bank and the Federal Home Loan Bank.
Advances are
secured by stock in the Federal Home Loan Bank of Des Moines, one-to-four
family first mortgage loans with balances exceeding 120% of the amount of the
related advances and multi-family first mortgage loans with balances exceeding
140% of the amount of the related advances.
In order to provide additional borrowing collateral, commercial real
estate first mortgage loans with balances exceeding 175% of the amount of the
related advances have also been pledged at the Federal Home Loan Bank. In addition, home equity line of credit
loans and home equity second mortgages (with balances exceeding 200% and 175%
of the amount of related advances, respectively) have been pledged to provide
borrowing collateral.
The Bank had a
$20,000 letter of credit from the Federal Home Loan Bank of Des Moines, on
which nothing was drawn at June 30, 2002 and expired on July 5, 2002.
Other borrowings
consist of the following at June 30,
2002 and 2001:
The Company has a
contract for deed which requires monthly payments of $9, plus interest at 7.0%,
to October 2013. The contract for deed,
which is secured by land held for sale with a carrying value of $1,298, had a
balance of $874 and $922 at June 30, 2002 and 2001, respectively. Aggregate maturities of the contract for deed
are as follows: 2003 $53; 2004 $56; 2005 $60; 2006 $65; 2007 $69 and
thereafter $571.
In August 2000, the
Company entered into a $3,000 revolving note agreement with an unrelated bank,
which had a balance of $0 and $3,000 outstanding at June 30, 2002 and 2001,
respectively, and matured in August 2001.
Mid America
Capital Services, Inc. had a $4,000 line of credit with an unrelated bank,
which had a balance of $0 and $3,000 at June 30, 2002 and 2001, respectively,
and matured in September 2001. Mid America
Capital Services, Inc. also had notes outstanding to its former stockholders
totaling $0 and $740 at June 30, 2002 and 2001, respectively.
Note 10. Company Obligated Manditorily Redeemable
Preferred Securities of Subsidiary Trust That Solely Holds Subordinated
Debentures
On November 28,
2001, the Company issued 10,000 shares totaling $10.0 million of Company
Obligated Mandatorily Redeemable Preferred Securities of HF Financial Capital
Trust I. The Trust exists for the sole
purpose of issuing trust preferred securities and investing the proceeds in
subordinated debentures of the Company.
These subordinated debentures constitute the sole asset of the
Trust. The securities provide for
cumulative cash distributions calculated at a rate based on six-month LIBOR
plus 3.75% adjusted semi-annually. The
Company may, at one or more times, defer interest payments on the capital
securities for up to 10 consecutive semi-annual periods, but not beyond
December 8, 2031. At the end of the
deferral period, all accumulated and unpaid distributions will be paid. The capital securities will be redeemed on
December 8, 2031; however, the Company has the option to shorten the maturity
date to a date not earlier than December 8, 2006. The capital securities have no voting rights, are unsecured, and
rank junior in priority of the payment to all of the Company’s indebtedness and
senior to the Company’s capital stock.
Proceeds from trust preferred securities can be injected into the Bank
and qualify as Tier I capital for regulatory capital purposes.
Note 11. Income Tax Matters
The Company and
subsidiaries file a consolidated federal income tax return on a fiscal year
basis. The Bank is allowed bad debt
deductions based on actual charge-offs.
In addition, the Trust files a trust return on a calendar year basis.
The consolidated
provision for income taxes from continuing operations consists of the following
for the years ended June 30:
Income tax expense is
different from that calculated at the statutory federal income tax rate to
pretax income from continuing operations.
The reasons for this difference in the tax expense are as follows:
The components of
the net deferred tax asset as of June 30, 2002 and 2001 are as follows:
Retained earnings at June
30, 2002 and 2001, include approximately $4,805 related to the pre-1987
allowance for loan losses for which no deferred federal income tax liability
has been recognized. These amounts
represent an allocation of income to bad debt deductions for tax purposes
only. If the Bank no longer qualifies
as a bank, or in the event of a liquidation of the Bank, income would be
created for tax purposes only, which would be subject to the then current
corporate income tax rate. The
unrecorded deferred income tax liability on the above amount for financial
statement purposes was approximately $1,634 at June 30, 2002 and 2001.
Note 12. Regulatory Capital
The Bank is
subject to various regulatory capital requirements administered by federal
banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if
undertaken, could have a direct material effect on the Bank’s financial
statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of the
Bank’s assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices.
The Bank’s capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.
Quantitative
measures established by regulation to ensure capital adequacy require the Bank
to maintain minimum amounts and ratios (set forth in the following table) of
total and Tier I capital (as defined in the regulations) to risk-weighted
assets (as defined), and of Tier I capital (as defined) to adjusted total
assets (as defined). Management
believes, as of June 30, 2002 and 2001, that the Bank meets all capital
adequacy requirements to which it is subject.
As of June 30,
2002, the most recent notification from the Office of Thrift Supervision (OTS)
categorized the Bank as “adequately capitalized” under the regulatory framework
for prompt corrective action. To be
categorized as adequately capitalized, the Bank must maintain minimum total
risk-based, Tier I risk-based, and Tier I (core) capital ratios as set forth in
the table. There are no conditions or
events since that notification that management believes have unfavorably
changed the Bank’s category.
The following table
summarizes the Bank’s compliance with its regulatory capital requirements at
June 30, 2002 and 2001:
Note
13. Stockholders’ Equity
The Company
currently has in effect a stock buy back program in which up to 10% of the
common stock of the Company outstanding on May 1, 2002 may be acquired through
April 30, 2003. A total of 113,800
shares of common stock have been purchased pursuant to this current program and
the previous program in effect during fiscal year 2002. Pursuant to a series of stock buy back
programs initiated by the Company since 1996, the Company has purchased an
aggregate of 1,559,030 shares of common stock through June 30, 2002. Included in the aggregate is a block of
340,021 shares of common stock repurchased in a private transaction on February
13, 2002.
The Company has
authorized 50,000 shares of Preferred Stock, designated as “Series A Junior
Participating Preferred Stock” with a stated value of $1.00 per share. Outstanding shares of the Junior Preferred
Stock are entitled to cumulative dividends.
Such shares have voting rights of 100 votes per share and a preference
in liquidation. The shares are not
redeemable after issuance.
The Company also
has preferred share purchase rights (Rights). Each Right entitles the
registered holder to purchase from the Company one one-hundredth of a share of
Series A Junior Participating Preferred Stock at a price of $65 per
one-hundredth of a preferred share, subject to the complete terms as stated in
the Rights Agreement. The Rights become
exercisable immediately after the earlier of (i) ten business days following a
public announcement that a person or group has acquired beneficial ownership of
20% or more of the outstanding common shares of the Company (subject to certain
exclusions), (ii) ten business days following the commencement or announcement
of an intention to make a tender offer or exchange offer, the consummation of
which would result in the beneficial ownership by a person or group of 20% or
more of such outstanding common shares.
The Rights expire on October 22, 2006, which date may be extended
subject to certain additional conditions.
Under current
regulations, the Bank is not permitted to pay dividends on its stock if its
regulatory capital would reduce below (i) the amount required for the liquidation
account established to provide a limited priority claim to the assets of the
Bank to qualifying depositors (Eligible Account Holders) at March 31, 1992 who
continue to maintain deposits at the Bank after its conversion from a federal
mutual savings and loan association to a federal stock savings bank pursuant to
its Plan of Conversion adopted August 21, 1991, or (ii) the Bank’s regulatory
capital requirements. Capital
distributions are limited to the greater of 100% of net income for the year to date
plus 50% of the amount by which the lesser of the institution’s tangible, core
or risk-based capital exceeds its capital requirement for such capital
commitment, as measured at the beginning of the calendar year or up to 75% of
net income over the most recent four quarter period. On August 14, 2002, the Bank sent written notification to the OTS
of its intention to pay up to 50% of the Bank’s net income for each quarter in
the year ending June 30, 2003, to the Company.
Note
14. Earnings Per Share
A reconciliation
of the income and common stock share amounts used in the calculation of basic
and diluted earnings per share (EPS) for the fiscal years ended June 30, 2002,
2001 and 2000 follow.
Options outstanding of approximately 180,000
and 142,000 shares of common stock at weighted average share prices of $14.44
and $14.46 during the years ended June 30, 2002 and 2001, respectively, were
not included in the computation of diluted earnings per share because the
exercise prices of those instruments exceeded the average market prices of the
common shares during the years.
Note
15. Defined Benefit Plan
The Company has a
noncontributory (cash balance) defined benefit pension plan covering all
employees of the Company and its wholly-owned subsidiaries who have attained
the age of twenty-one and have completed one year of service. The benefits are based on 6% of each
eligible participant’s annual compensation, plus income earned in the accounts
at a rate determined annually based on 30-year treasury note rates. The Company’s funding policy is to make the
minimum annual required contribution plus such amounts as the Company may
determine to be appropriate from time to time.
One hundred percent vesting occurs after five years, and retirement at
age 65.
Information
relative to the Company’s defined benefit plan is presented below:
The components of pension
cost for the years ended June 30 consist of the following:
The components in
the balance sheet consist of:
The
weighted-average post-retirement and pre-retirement discount rates used in
determining the actuarial present value of the benefit obligations were 5.45%
and 7.50% for fiscal year 2002 and 6.23% and 7.50% for fiscal year 2001,
respectively. The rate of increase in
future compensation levels used to determine the actuarial present value of the
benefit obligations was 5.5% for both fiscal years 2002 and 2001. The expected long-term rate of return on
plan assets was 8.0% for both fiscal years 2002 and 2001.
Note
16. Retirement Plan
The Company had an
employee stock ownership plan (ESOP) covering all full-time employees of the
Company who have attained age 21 and completed one year of service during which
they worked at least 1,000 hours. The
ESOP included an employee savings plan feature which provided for voluntary
contributions by eligible employees on a tax-deferred basis with no matching
contribution by the Company. All shares
owned by the ESOP are included in earnings per share computations, with shares
being allocated to eligible employees as the corresponding ESOP debt was
repaid. At June 30, 2002, the ESOP
holds 246,084 shares, all of which have been allocated to eligible employees.
For financial
statement purposes, expense for the ESOP is determined on the percentage of
shares allocated to participants each period (allocations are based on
principal and interest payments) times the original amount of the debt plus the
interest incurred.
During fiscal year
2001, the final payment for the ESOP was made. Effective July 1, 2001, the ESOP
was amended and restated, and renamed the HF Financial Corp. Retirement Savings
Plan. The amended plan is intended to be a qualified profit sharing plan with a
cash or deferred arrangement pursuant to Code Section 401(k) and regulations
issued thereunder. Participation and eligibility requirements are similar to
the previous plan. The amended plan continues to allow voluntary contributions
by eligible employees, and also allows discretionary contributions by the
Company, as determined annually by the Board of Directors. The total compensation cost charged to
expense related to the retirement plans mentioned above was $216, $113 and $113
for 2002, 2001 and 2000, respectively.
Note
17. Stock-Based Compensation Plans
The Company has
stock-based compensation plans which are described below. The Company applies APB Opinion No. 25 and
related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for grants
under the fixed stock option plans. Had
compensation cost for the Company’s stock-based compensation plans been
determined based on the grant date fair values of awards (the method described
in FASB Statement No. 123), reported income from continuing operations and
earnings per common share would have been reduced to the pro forma amounts
shown below:
The fair value of each
incentive stock option grant is estimated at the grant date using the
Black-Scholes option-pricing model. No options were granted during fiscal year
2000. The following weighted average
assumptions were used for grants in fiscal years 2002 and 2001,
respectively: a dividend rate as a
percentage of stock price of 3.52% and 3.02%; price volatility of 25.00% and
26.00%; risk-free interest rates of 4.58% and 5.10% and expected lives of seven
years for both years.
Under the
Company’s stock option and incentive plan (Option Plan), stock options of
828,000 common shares, of which 10,000 shares are restricted under a stock pool
(see below), may be granted to directors and employees of the Bank. Options granted under the Option Plan may be
either options that qualify as Incentive Stock Options, as defined in Section
422 of the Internal Revenue Code of 1986, as amended (the Code), or options
that do not qualify. The Option Plan
also provides for the award of stock appreciation rights, limited stock
appreciation rights and restricted stock.
During fiscal year 2002, 10,342 shares of the restricted stock were
awarded under the Plan. These shares
vest 33 1/3% after 3 years, 66 2/3% after 4 years, and 100% after 5 years of
continued employment. The vesting
period for these shares may accelerate based on the Company meeting certain
performance criteria, in which the shares would vest 25% after year 1, 0% in
year 2, and 25% in each of the next 3 years.
The issuance cost of these shares was $129 and is being amortized over
the vesting period of five years, with the unamortized balance included in
deferred compensation in the consolidated statements of financial
condition. During fiscal year 2002, $21
was recorded as amortization expense.
At June 30, 2002, 531,076
shares of common stock were reserved for issuance under the Option Plan. The options granted under the Option Plan
expire ten years from the date of grant.
During fiscal year
2001, the Company created a pool of 10,000 restricted shares (Pool). Awards
from the Pool are at the discretion of the Chairman of the Board of Directors
on a spot basis to employees. The restricted shares vest 33 1/3% after 3 years,
66 2/3% after 4 years, and 100% after 5 years of continued employment. Key provisions of the Pool include: outright
grant of shares with restrictions as to sale, transfer, and pledging; during
the restriction period, the grantee receives dividends and has voting rights
related to the shares awarded; all nonvested shares are forfeited upon
termination. During 2001, no
shares were issued from the Pool. During fiscal year 2002, 3,475 shares were
awarded under the Plan. The issuance
cost of these shares was $40 and is being amortized over the vesting period of
five years, with the unamortized balance included in deferred compensation in
the consolidated balance sheet. During
fiscal year 2002, $7 was recorded as amortization expense.
A summary of the status
of the plan and changes during the years ended June 30 are as follows:
Options for
183,374, 232,005 and 193,780 shares were exercisable at June 30, 2002, 2001 and
2000, respectively. The weighted
average fair value of options granted was $2.78 and $2.88 for the fiscal years
ended June 30, 2002 and 2001, respectively.
Fixed options outstanding
at June 30, 2002 are summarized as follows:
The Company has a
Director Restricted Stock Plan (Plan) which provides that awards of restricted
shares of the Company’s common stock be made to outside directors of the
Company. The Plan is designed to allow
for payment of the annual retainer fee in shares of the Company’s common stock,
with the inclusion of an annual cost of living adjustment based on the Consumer
Price Index. Each outside director is
entitled to all voting, dividend and distribution rights during the restriction
period. The effective date of the Plan
was July 1, 1997. The Plan has 75,000
shares allocated to it and is in effect for a period of ten years. During fiscal years 2002, 2001 and 2000,
7,560, 11,249 and 7,252 shares were awarded and $103, $100 and $98 of expense
was incurred under the Plan as the annual retainer for the Company’s Board of
Directors for the years ending June 30, 2002, 2001 and 2000, respectively.
Note
18. Financial Instruments
The Bank is a
party to financial instruments with off-balance-sheet risk in the normal course
of business to meet the financing needs of its customers. These financial instruments include
commitments to extend credit, standby letters of credit and financial guarantees. Those instruments involve, to varying
degrees, elements of credit and interest-rate risk in excess of amounts
recognized in the consolidated statements of financial condition. The contract or notional amounts of those
instruments reflect the extent of the Bank’s involvement in particular classes
of financial instruments.
The Bank’s
exposure to credit loss in the event of nonperformance by the other party to
the financial instrument for commitments to extend credit, standby letters of
credit, and financial guarantees written is represented by the contractual
notional amount of those instruments.
The Bank uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments.
Unless noted otherwise,
the Bank does not require collateral or other security to support financial
instruments with credit risk.
Estimated fair
values of the Company’s financial instruments are as follows:
Note
19. Commitments, Contingencies and
Credit Risk
The Bank
originates first mortgage, consumer and other loans primarily in eastern South
Dakota and holds residential and commercial real estate loans which were
purchased from other originators of loans located throughout the United States. The Bank has primarily unsecured credit card
loans which were issued through third parties nationwide to a target customer
market consisting of sub-prime credit customers who have either an insufficient
credit history or a negative credit history.
The Bank issued no new credit cards in fiscal years 2002 and 2001 and
announced discontinuation of this operation in fiscal year 2002. Collateral for substantially all noncredit
card consumer loans are security agreements and/or Uniform Commercial Code
(UCC) filings on the purchased asset.
At June 30, 2002 and 2001, the Bank has approximately $74 and $99 of
loans sold with recourse to the Federal National Mortgage Association
(FNMA). The collateral securing these
loans are one-to-four family mortgage loans, which are seasoned. Unused lines of credit amounted to $68,369
and $58,880 at June 30, 2002 and 2001, respectively. Unused letters of credit amounted to $1,221 and $1,213 at June
30, 2002 and 2001, respectively. The
lines of credit and letters of credit are collateralized in substantially the
same manner as loans receivable.
The Bank had
outstanding commitments to originate loans of $44,980 and to sell loans of
approximately $14,705 at June 30, 2002.
The portion of commitments to originate or purchase fixed rate loans
totaled $34,269 with a range in interest rates of 5.7% to 7.6%. No losses are expected to be sustained in
the fulfillment of any of these commitments.
The Company is
involved in various claims and legal actions arising in the ordinary course of
business. In the opinion of management,
based upon consultation with legal counsel, the ultimate disposition of these
matters will not have a material adverse effect on the Company’s consolidated
financial position.
Note 20. Cash Flow Information
Changes in other
assets and liabilities for the years ended June 30, 2002, 2001 and 2000 consist
of:
Note
21. Subsequent Event
On July 11, 2002, the
Company issued 5,000 shares totaling $5.0 million of Company Obligated
Mandatorily Redeemable Preferred Securities of HF Financial Capital Trust
II. The Trust was established and
exists for the sole purpose of issuing trust preferred securities and investing
the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the
sole asset of the Trust. The securities
provide for cumulative cash distributions calculated at a rate based on
three-month LIBOR plus 3.65%. The
Company may, at one or more times, defer interest payments on the capital
securities for up to 20 consecutive quarterly periods, but not beyond October
7, 2032. The capital securities will be
redeemed on October 7, 2032; however, the Company has the option to shorten the
maturity date to a date not earlier than July 7, 2007. Holders of the capital securities have no
voting rights, are unsecured, and rank junior in priority of the payment to all
of the Company’s indebtedness and senior to the Company’s capital stock.
Note 22. Financial Information of HF Financial Corp.
(Parent Only)
The Company’s
condensed balance sheets as of June 30, 2002 and 2001 and related condensed
statements of income and cash flows for each of the years in the three year period
ended June 30, 2002 are as follows:
CONDENSED BALANCE
SHEETS
CONDENSED
STATEMENTS OF INCOME
CONDENSED
STATEMENTS OF CASH FLOWS
Note
23. Quarterly Financial Information
(Unaudited)
(Dollars in
thousands except per share data)
(1) Certain amounts for
all periods presented have been reclassified to discontinued operations (Note
2).
(2) During the fourth quarter of
fiscal year 2002, the Company recorded a provision of $2,073 and reclassified
$577 from the allowance for loan and lease losses directly against credit card
loans receivable and transferred the loans from loans receivable to loans held
for sale at their estimated net realizable value (Note 2).
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
During the Company’s two
most recent fiscal years there have been no disagreements with our accountant
on any matter of accounting principle or financial statement disclosure.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information regarding
untimely filings pursuant to Section 16 of the Securities Exchange Act of 1934,
as amended, is incorporated in this Form 10-K by reference from the Company’s
definitive Proxy Statement for the Annual Meeting of Stockholders to be held in
2002, a copy of which will be filed not later than 120 days after the close of
the fiscal year.
Directors
Information concerning
Directors of the Company is incorporated in this Form 10-K by reference from
the definitive Proxy Statement for the Annual Meeting of Stockholders to be
held in 2002, a copy of which will be filed not later than 120 days after the
close of the fiscal year.
Executive officers
Information regarding
the business experience of the executive officers of the Company and the Bank
contained in Part I of this Form 10-K is incorporated herein by
reference.
Item 11.
Item 11. Executive Compensation
Information concerning
executive compensation is incorporated in this Form 10-K by reference from the
definitive Proxy Statement for the Annual Meeting of Stockholders to be held in
2002, a copy of which will be filed not later than 120 days after the close of
the fiscal year. Information contained
under the headings “Board Compensation Committee Report on Executive
Compensation” and “Stockholder Return Performance Presentation” is not
incorporated in this Form 10-K.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information concerning
security ownership of certain beneficial owners and management is incorporated
in this Form 10-K by reference from the definitive Proxy Statement for the
Annual Meeting of Stockholders to be held in 2002, a copy of which will be
filed not later than 120 days after the close of the fiscal year.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information concerning
certain relationships and related transactions is incorporated in this Form
10-K by reference from the definitive Proxy Statement for the Annual Meeting of
Stockholders to be held in 2002, a copy of which will be filed not later than
120 days after the close of the fiscal year.
Information contained under the headings “Board Compensation Committee
Report on Executive Compensation” and “Stockholder Return Performance
Presentation” is not incorporated in this Form 10-K.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Documents
filed with this report.
(1) See “HF
Financial Corp. Index to Consolidated Financial Statements” under Item 8,
“Financial Statements and Supplementary Data” of this report.
(2) All
supplemental schedules are omitted because of the absence of conditions under
which they are required or because the information is shown in the Consolidated
Financial Statements or notes thereto.
(a) (3) Exhibits
Regulation
S-K Exhibit
Number
Document
Reference to
Prior Filing
or Exhibit
Number
Attached
Hereto
Sequential Page
Number Where
Attached Exhibits
Are Located in This
Form 10-K Report
3.1
Articles
of Incorporation
(1)
Not Applicable
3.2
By-Laws
(1)
Not Applicable
4.1
Rights Agreement
(4)
Not Applicable
10.1
Employment Contracts between the Bank and
Curtis L. Hage
(1) #
Not Applicable
10.2
Amendment to Employment Contract between the Bank and
Curtis L. Hage
(3) #
Not Applicable
10.3
1991 Stock Option and Incentive Plan
(2) #
Not Applicable
10.4
Articles of Incorporation of HF Card Services LLC
(3)
Not Applicable
10.5
Amendment to 1991 Stock Option and Incentive Plan
(5) #
Not Applicable
10.6
1996 Director Restricted Stock Plan
(5) #
Not Applicable
10.7
Employment Contract between the Bank and
Gene F. Uher
(5) #
Not Applicable
10.8
Employment Contract between the Bank and Mark S.
Sivertson
(6) #
Not Applicable
10.9
Employment Contract between the Bank and Michael H.
Zimmerman
(6) #
Not Applicable
10.10
Change in Control Contract between the Bank and
Gene F. Uher
(6) #
Not Applicable
10.11
Change in Control Contract between the Bank and Mark S.
Sivertson
(6) #
Not Applicable
10.12
Change in Control Contract between the Bank and Michael
H. Zimmerman
(6) #
Not Applicable
10.13
Amendment to Employment Contract between the Bank and
Gene F. Uher
(7) #
Not Applicable
10.14
Employment Contract between the Bank and David A. Brown
(8) #
Not Applicable
10.15
Change in Control Contract between the Bank and David
A. Brown
(8) #
Not Applicable
10.16
Guarantee Agreement dated November 28, 2001 by and
between HF Financial Corp. and Wilmington Trust Company
(9)
Not Applicable
10.17
Indenture Agreement dated November 28, 2001 by and
between HF Financial Corp. and Wilmington Trust Company
(9)
Not Applicable
10.18
Confidential Separation Agreement between the Bank and
Gene F. Uher*
10.18 #
21.1
Subsidiaries of Registrant
21.1
23.1
Consents
of Experts and Counsel
23.1
(1) Filed as
exhibits to the Company’s Form S-1 registration statement filed on
December 6, 1991 (File No. 33-44383) pursuant to Section 5 of the
Securities Act of 1933.
(2) Filed
as exhibits to the Company’s Annual Report on Form 10K for the fiscal year
ended June 30, 1993.
(3) Filed
as exhibits to the Company’s Annual Report on Form 10K for the fiscal year
ended June 30, 1996.
(4) Filed
as Exhibit I to the Company’s filing on Form 8-A, filed on October 28, 1996.
(5) Filed
as exhibits to the Company’s Annual Report on Form 10K for the fiscal year
ended June 30, 1997.
(6) Filed
as exhibits to the Company’s Annual Report on Form 10K for the fiscal year
ended June 30, 1998.
(7) Filed
as exhibits to the Company’s Annual Report on Form 10K for the fiscal year
ended June 30, 1999.
(8) Filed
as exhibits to the Company’s Annual Report on Form 10K for the fiscal year
ended June 30, 2001.
(9) Filed
as exhibits to the Company’s Form 10Q for the quarter ended December 31, 2001.
# Management
or compensatory plan or arrangements required to be filed.
* Certain
portions of this exhibit have been omitted based upon a request for order
granting confidential treatment. The
omitted portions have been filed separately with the Securities and Exchange
Commission.
All of such previously
filed documents are hereby incorporated in this Form 10-K by reference in
accordance with Item 601 of Regulation S-K.
(b) Reports on Form 8-K
The Company filed Form
8-K, Item 5, “Other Events” with the Securities and Exchange Commission on May
24, 2002 announcing approval by the Company’s Board of Directors to repurchase
up to 10% of its outstanding common stock through April 30, 2003.
SIGNATURES
Pursuant to the
requirements of Section 15(d) of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HF FINANCIAL CORP.
By
/s/ Curtis L. Hage
Curtis L. Hage, Chairman,
President and
Chief Executive Officer
(Duly Authorized
Representative)
Pursuant to the
requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons in the capacities and on the dates
indicated.
CERTIFICATIONS
I, Curtis L. Hage, certify that:
1. I have reviewed this Annual Report on Form 10-K of H.F.
Financial Corp.;
2. Based on my knowledge, this Annual Report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report; and
3. Based on my knowledge, the financial statements, and other
financial information included in this Annual Report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this annual report.
I, Darrel L. Posegate, certify that:
1. I have reviewed this Annual Report on Form 10-K of H.F.
Financial Corp.;
2. Based on my knowledge, this Annual Report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report; and
3. Based on my knowledge, the financial statements, and other
financial information included in this Annual Report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this annual report.
CERTIFICATION
PURSUANT TO
18 U.S.C.
§1350,
AS ADOPTED
PURSUANT TO
SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of H.F. Financial Corp. (the
“Company”) on Form 10-K for the year ended June 30, 2002, as filed with the
Securities and Exchange Commission on the date hereof (the “Report”), I, Curtis
L. Hage, Chairman, President and Chief Executive Officer of the Company,
certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
(1) The Report fully complies with the
requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934;
and
(2) The information contained in the Report
fairly presents, in all material respects, the financial condition and results
of operations of the Company.
CERTIFICATION PURSUANT TO
18 U.S.C.
§1350,
AS ADOPTED
PURSUANT TO
SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of H.F. Financial Corp. (the “Company”)
on Form 10-K for the year ended June 30, 2002, as filed with the Securities and
Exchange Commission on the date hereof (the “Report”), I, Darrel L. Posegate,
Senior Vice President and Chief Financial Officer of the Company, certify,
pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that to the best of my knowledge:
(1) The Report fully complies with the
requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934;
and
(2) The information contained in the Report
fairly presents, in all material respects, the financial condition and results
of operations of the Company.
Index to Exhibits
Exhibit
Number
10.18
Confidential
Separation Agreement between the Bank and Gene F. Uher*
21.1
Subsidiaries
of Registrant
23.1
Consents of Experts and
Counsel
* Certain portions of this
exhibit have been omitted based upon a request for order granting confidential
treatment. The omitted portions have
been filed separately with the Securities and Exchange Commission.