ITEM 1. BUSINESS
GENERAL
First SecurityFed, is a Delaware corporation that was formed in 1997 by First Security Federal Savings Bank for the purpose of becoming a savings and loan holding company. The Company owns all of the outstanding capital stock of First Security. Unless the context otherwise requires, all references herein to the Company include the Company and the Bank on a consolidated basis.
As a community-oriented financial institution, First Security seeks to serve the financial needs of communities in its ethnically diverse market area. The Bank achieved a significant penetration in its market area by engaging in substantial community service activities and targeting marketing initiatives focused on groups within its market area.
First Security's business involves attracting deposits from the general public and using such deposits, together with other funds, to originate primarily one- to four-family residential mortgage loans and, to a lesser extent, multi-family and commercial real estate, construction, consumer and other loans in its market area. The Bank also invests in mortgage-backed and other securities and other permissible investments.
The Bank offers a variety of accounts having a range of interest rates and terms. The Bank's deposits include passbook and NOW accounts, money market accounts and certificate accounts with terms of three months to five years. The Bank solicits deposits only in its primary market area and does not accept brokered deposits.
MARKET AREA
The Bank's main office is located in Chicago, Illinois and its branch offices are located in Chicago, Illinois, Philadelphia, Pennsylvania and Rolling Meadows, Illinois.
The Bank's Western Avenue office is located on the near northwest side of Chicago in the "Ukrainian Village" community, a middle-income community where the Bank has focused its operations since 1964. This community is located approximately two and one half miles to the northwest of downtown Chicago and approximately three miles west of Lake Michigan. The majority of the community's many businesses are small and local companies. Residences within the community consist primarily of two- to four-family flats and single family homes although there are also mid-size apartment buildings. Real estate values within this community have risen sharply over the last ten years as "gentrification" has begun to occur as a result of the community's proximity to downtown Chicago.
The Bank's Milwaukee Avenue office was opened in 1993 and is located in the "Norwood Park" neighborhood of Chicago. This community is a stable middle income area which also has many residents of Eastern European descent. Residences within the community consist primarily of single family homes as well as two and three flats and small apartment buildings. This area is located approximately eight miles northwest of downtown Chicago.
The Bank's Philadelphia branch was acquired in 1994 through a purchase from the Resolution Trust Corporation. The branch is located in a moderate income neighborhood of Philadelphia known as "Rhawnhurst." The community is home to many persons of Eastern European heritage, including new immigrants. Residences within the community consist primarily of single family row houses and, to a lesser extent, small apartment buildings.
The Bank's suburban Chicago branch was opened in 1977 and is located in Rolling Meadows, Illinois, an upper middle class community located to the northwest of Chicago, near the western border of Palatine, Illinois. Over the last 20 years, Rolling Meadows has experienced significant population and commercial growth. However, as a result of competition, the branch's deposit and loan growth has been modest.
LENDING ACTIVITIES
GENERAL. The principal lending activity of the Bank is originating for its portfolio fixed and, to a much lesser extent, adjustable rate ("ARM") mortgage loans secured by one- to four-family residences located primarily in the Bank's market area. First Security also originates multi-family and commercial real estate, construction, home equity, consumer and other loans in its market area. At December 31, 2000, the Bank's loans receivable, net totaled $275.5 million. See "- Originations of Loans."
The following table sets forth the composition of the Bank's loan portfolio in dollar amounts and in percentages as of the dates indicated.
- ----------- (1) Mixed use refers to real estate on which the borrower both resides and conducts a business.
The following table shows the composition of the Bank's loan portfolio by fixed- and adjustable-rate at the dates indicated.
(1) Mixed use refers to real estate on which the borrower both resides and conducts a business.
The following schedule illustrates the interest rate sensitivity of the Bank's loan portfolio at December 31, 2000. Mortgages which have adjustable or renegotiable interest rates are shown as maturing in the period during which the final payment is due. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
The total amount of loans due after December 31, 2001 which have predetermined interest rates is $247.1 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $20.1 million.
Under federal law, the aggregate amount of loans that the Bank is permitted to make to any one borrower is generally limited to 15% of unimpaired capital and surplus (25% if the security for such loan has a "readily ascertainable" value or 30% for certain residential development loans). At December 31, 2000, based on the above, the Bank's regulatory loans-to-one borrower limit was approximately $10.0 million. On the same date, the Bank had no borrowers with outstanding balances in excess of this amount. As of December 31, 2000, the largest dollar amount outstanding or committed to be lent to one borrower or, group of related borrowers, was a $2.9 million construction loan, secured by a 24 unit condominium building located in Chicago, Illinois. At December 31, 2000, this loan was performing in accordance with its terms. As of the same date, there were 17 other lending relationships with carrying values in excess of $1.0 million.
All of the Bank's lending is subject to its written underwriting standards and to loan origination procedures. Decisions on loan applications are made on the basis of detailed applications and property valuations (consistent with the Bank's appraisal policy). The loan applications are designed primarily to determine the borrower's ability to repay and the more significant items on the application are verified through use of credit reports, financial statements, tax returns or confirmations. All mortgage loans currently originated by First Security are approved by the loan committee, currently comprised of Directors Babyk, Dobrowolsky and Wereszcak and Vice President Korb, and ratified by the full Board of Directors.
The Bank requires title insurance or other evidence of title on its mortgage loans, as well as fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property, depending on the type of loan. The Bank also requires flood insurance to protect the property securing its interest when the property is located in a flood plain.
ONE- TO FOUR-FAMILY RESIDENTIAL REAL ESTATE LENDING. The cornerstone of the Bank's lending program is the origination of loans secured by mortgages on owner-occupied one- to four-family residences. Historically, the Bank focused its residential lending activities on fixed rate loans with terms up to 30 years. In the 1980s, in order to reduce the average term to repricing of its assets, the Bank began to offer 15 year and 10 year fixed rate loans as well as ARMs (although, as a result of customer preference, the Bank's ARM loan volume has been limited). Substantially all of the Bank's one- to four- family residential mortgage originations are secured by properties located in its market area. All mortgage loans currently originated by the Bank are retained and serviced by it.
The Bank currently offers fixed-rate mortgage loans with maturities from 10 to 30 years. The Bank also offers fixed rate balloon products with a 30 year amortization schedule which are due in three or five years and which, under certain circumstances, may be extended for an additional term of up to three or five years, as applicable. As of December 31, 2000, the Bank had $22.7 million of fixed rate loans with original terms of 10 years or less (most of which were three or five year balloon loans), $61.3 million of fixed rate loans with original terms of 10-15 years and $121.0 million of fixed rate loans with original terms of more than 15 years. See "- Originations of Loans."
The Bank also originates fixed rate home equity loans with terms of up to ten years. These loans are written so that the total balance does not exceed the lesser of $35,000 or 75% of the appraised value of the security property when combined with the balance of the first mortgage lien. At December 31, 2000, the Bank had $2.9 million of home equity loans, all of which are classified in the tabular data as one- to four-family residential loans.
The Bank also offers ARMs which carry interest rates which adjust at a margin (generally 250 basis points) over the yield on the One Year and the Three Year Average Monthly U.S. Treasury Constant Maturity Indexes ("CMT"). Such loans may carry terms to maturity of up to 30 years. The ARM loans currently offered by the Bank provide for a cap on annual interest rate changes of 200 basis points and a lifetime cap generally of 600 basis points over the initial rate. Initial interest rates offered on the Bank's ARMs may be approximately 100-150 basis points below the fully indexed rate, although borrowers are qualified at the fully indexed rate. As a result, the risk of default on these loans may increase as interest rates increase. At December 31, 2000, one- to four-family ARMs totaled $7.9 million or 2.79% of the Bank's total loan portfolio.
First Security will generally lend up to 90% of the lesser of the sales price or appraised value of the security property on owner occupied one- to four-family loans; provided, however, that private mortgage insurance is obtained in an amount sufficient to reduce the Bank's exposure to not more than 80% of the sales price or appraised value, as applicable. The loan-to-value ratio on non-owner occupied, one- to four-family loans is generally 80% of the lesser of the sales price or appraised value of the security property. Non-owner occupied one- to four-family loans may pose a greater risk to the Bank than traditional owner occupied one- to four-family loans. In underwriting one- to four-family residential real estate loans, the Bank currently evaluates the borrower's ability to make principal, interest and escrow payments, the borrower's credit history, the value of the property that will secure the loan and debt to income ratios.
Residential loans do not currently include prepayment penalties, are non-assumable and do not produce negative amortization. The Bank's underwriting practices do not comply in every way with those required by most purchasers in the secondary market. For instance, the Bank, on occasion, will lend to borrowers that have income/debt service ratios below that required by many secondary market purchasers. In that event, the Bank will require that the borrower have other attributes which justify approving a loan, such as a favorable repayment record with the Bank on previous lending relationships, favorable cash flow, a low loan to value ratio or other assets which can be used as additional collateral. The Bank has found that non-compliance with secondary market standards at the time of origination does not in and of itself cause credit problems since the Bank has engaged in this type of lending for many years and its overall delinquency experience on these loans has been satisfactory to date. In addition, these loans, once seasoned, generally are saleable on the secondary market. Furthermore, the Bank has found that these policies and procedures help the Bank maintain and improve its customer relations, which is critical in the communities the Bank serves.
While the Bank seeks to originate most of its one- to four-family residential loans in amounts which are less than or equal to the applicable Federal Home Loan Mortgage Corporation maximum, the Bank does make one- to four-family residential loans in amounts in excess of such maximum. The Bank's delinquency experience on such loans has been similar to its experience on its other residential loans.
The Bank's residential mortgage loans customarily include due-on-sale clauses giving the Bank the right to declare the loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the property subject to the mortgage and the loan is not repaid.
MULTI-FAMILY AND COMMERCIAL REAL ESTATE LENDING. In order to increase the yield of its loan portfolio and to complement residential lending opportunities, the Bank originates permanent multi-family and commercial real estate loans secured by properties in its primary market area. As a result of the strong economy in the Bank's Chicago market area as well as increased customer demand, the Bank has been able to increase its originations of these types of loans over the last several years. At
December 31, 2000, the Bank had multi-family loans totaling $19.3 million, or 6.82% of the Bank's total loan portfolio, and $20.8 million in commercial real estate loans, representing 7.38% of the total loan portfolio.
The Bank's multi-family loan portfolio consists primarily of loans secured by 24 or fewer units. The Bank's commercial real estate loans are primarily secured by retail stores, small office buildings, store/apartment complexes, taverns and store front offices.
The Bank's multi-family real estate loans generally carry a maximum term of five years and have fixed rates, although most of these loans are five year balloons with a 25 year or more amortization schedule. These loans are generally made in amounts of up to 75% of the lesser of the appraised value or the purchase price of the property. Most of the Bank's commercial real estate loans are five year balloon loans with fixed rates of interest. Also included in the Bank's commercial real estate loans are $5.1 million of lines of credit secured by commercial real estate with floating interest rates tied to the prime rate of interest. Commercial real estate loans are generally made in amounts up to 75% of the lesser of the appraised value or the purchase price of the property.
Appraisals on properties securing multi-family and commercial real estate loans in excess of $200,000 are performed by an independent appraiser designated by the Bank at the time the loan is made. All appraisals on multi-family and commercial real estate loans are reviewed by the Bank's loan committee. In addition, the Bank's underwriting procedures require verification of the borrower's credit history, income and financial statements, banking relationships, references and income projections for the property. The Bank obtains personal guarantees on these loans.
At December 31, 2000, the Bank's largest commercial real estate or multi-family loan outstanding totaled $2.9 million and was secured by a 24 unit condominium building located in Chicago, Illinois. The loan was performing in accordance with its terms as of that date.
Multi-family and commercial real estate loans may present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans.
CONSTRUCTION LENDING. The Bank originates construction loans to builders, developers and individuals to finance development of one to four family, multi-family and, to a lesser extent, small commercial properties. Most of the loans do not have prearranged takeout financing at the time of commitment and most of the underlying projects do not have tenants or buyers at the time of commitment.
The Bank has significantly increased its construction lending activities over the last several years primarily as a result of a favorable economic climate, particularly within the Bank's Chicago market area. These loans generally carry interest rates that float with the prime rate of interest and have maturities of one year or less.
The Bank requires independent appraisals with a loan to value ratio not in excess of 80%. Disbursements are made in increments as construction progresses, and inspections warrant. Land loans do not exceed 60% of the appraised value or actual cost.
As of December 31, 2000 the Bank has committed $11.7 million to borrowers for construction loans. As of this same date, $9.0 million of the committed funds have been disbursed.
CONSUMER LENDING. Management believes that offering consumer loan products helps to expand the Bank's customer base and to create stronger ties to its existing customer base. In addition, because consumer loans generally have shorter terms to maturity and carry higher rates of interest than do residential mortgage loans, they can be valuable asset/liability management tools. The Bank originates a variety of different types of consumer loans, including home equity lines of credit, and deposit account loans for household and personal purposes. Due to the tax advantages to the borrower of home equity lines of credit, the Bank has focused its recent consumer lending activities primarily on home equity lending. At December 31, 2000 consumer loans totaled $8.9 million or 3.15% of total loans outstanding.
Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. Other than the home equity lines of credit, the Bank's consumer loans are made at fixed interest rates, with terms of up to five years.
The Bank's home equity lines of credit are written so that the total commitment amount, when combined with the balance of the first mortgage lien, may not exceed 75% of the appraised value of the property. These loans are written with fixed terms of up to five years and carry interest rates that float with the prime rate of interest. At December 31, 2000, the Bank's home equity lines of credit totaled $7.1 million outstanding, or 2.53% of the Bank's total loan portfolio.
The underwriting standards employed by the Bank for consumer loans include a determination of the applicant's payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is of 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. 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.
ORIGINATIONS OF LOANS
Real estate loans are originated by First Security's staff through walk-ins and referrals from existing customers or real estate agents.
The Bank's ability to originate loans is dependent upon customer demand for loans in its market and to a lesser extent, customer service and marketing efforts. Demand is affected by both the local economy and the interest rate environment. As a result of the strong real estate market in the Bank's primary market areas and its emphasis on customer service and community outreach, the Bank has experienced significant loan growth in recent years. See "-- Market Area." However, as a result of consumer demand, most recent originations have carried fixed rather than adjustable rates. Under current policy, all loans originated by First Security are retained in the Bank's portfolio. See "-- One- to Four- Family Residential Lending" and "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset/Liability Management" in the Annual Report attached as Exhibit 13 hereto.
As a reflection of the Bank's emphasis on customer service, the Bank has not sold loans in the past but may do so in the future to manage interest rate risk. Servicing of such loans would be retained by the Bank.
The following table shows the loan origination, purchase and repayment activities of the Bank for the periods indicated.
DELINQUENCIES AND NON-PERFORMING ASSETS
DELINQUENCY PROCEDURES. When a borrower fails to make a required payment on a loan, the Bank attempts to cure the delinquency by contacting the borrower. Generally, Bank personnel work with the delinquent borrower on a case by case basis to solve the delinquency. Generally, a late notice is sent on all delinquent loans followed by a phone call after the thirtieth day of delinquency. Additional written and verbal contacts may be made with the borrower between 30 and 60 days after the due date. If the loan is contractually delinquent for 90 days, the Bank may institute appropriate action to foreclose on the property. Generally, after 120 days, foreclosure procedures are initiated. If foreclosed, the property is sold at public sale and may be purchased by the Bank.
Real estate acquired by First Security as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until it is sold. When property is acquired by foreclosure or deed in lieu of foreclosure, it is recorded at the lower of cost or fair value less estimated selling costs. After acquisition, all costs incurred in maintaining the property are expensed. Costs relating to the development and improvement of the property, however, are capitalized.
The following table sets forth the Bank's loan delinquencies by type, by amount and by percentage of type at December 31, 2000.
CLASSIFICATION OF ASSETS. Federal regulations require that each savings institution classify its own assets on a regular basis. In addition, in connection with examinations of savings institutions, OTS and FDIC examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: Substandard, Doubtful and Loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of Substandard assets, with the additional characteristics that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified Loss is considered uncollectible and of such little value that continuance as an asset on the balance sheet of the institution is not warranted. Assets classified as Substandard or Doubtful require the institution to establish prudent general allowances for loan losses. If an asset or portion thereof is classified as a loss, the institution charges off such amount against the loan loss allowance. If an institution does not agree with an examiner's classification of an asset, it may appeal this determination to the District Director of the OTS.
On the basis of management's review of its assets, at December 31, 2000, the Bank had classified a total of $1.6 million of its loan and other assets as follows:
First Security's classified assets consist of the non-performing loans referred to below.
NON-PERFORMING ASSETS. The table below sets forth the amounts and categories of non- performing assets in the Bank's loan portfolio. Accrued interest on loans delinquent 90 days or more is credited to an interest reserve account which offsets the amount of capitalized interest in loans receivable. See Note 3 of the Notes to Consolidated Financial Statements in the Annual Report attached as Exhibit 13 hereto. Foreclosed assets include assets acquired in settlement of loans.
For the years ended December 31, 1999 and December 31, 2000, gross interest income (less additions to the interest reserve) which would have been recorded had the non-accruing loans (and accruing loans delinquent 90 days or more) been current in accordance with their original terms amounted to $99,000 and $123,000, respectively. No interest income was recognized on non-accruing loans for the years ended December 31, 2000 and December 31, 1999, respectively.
OTHER LOANS OF CONCERN. In addition to the non-performing assets set forth in the table above, as of December 31, 2000, there were no other loans with respect to which known information about the possible credit problems of the borrowers or the cash flows of the security properties have caused management to have concerns as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the non-performing asset categories.
Management considers the Bank's non-performing and "of concern" assets in establishing its allowance for loan losses.
The following table sets forth an analysis of the Bank's allowance for loan losses.
The distribution of the Bank's allowance for losses on loans at the dates indicated is summarized as follows:
The allowance for loan losses is established through a provision for loan losses charged to earnings based on management's evaluation of the risk inherent in its entire loan portfolio. Such evaluation, which includes a review of all loans of which full collectibility may not be reasonably assured, considers the market value of the underlying collateral, growth and composition of the loan portfolio, delinquency trends, adverse situations that may affect the borrower's ability to repay, prevailing economic conditions and other factors that warrant recognition in providing for an adequate allowance for loan losses. In determining the general reserves under these policies, historical charge-offs and recoveries, changes in the mix and levels of the various types of loans, collateral values the current loan portfolio and current economic conditions are considered.
While management believes that it uses the best information available to determine the allowance for loan losses, unforeseen economic and market conditions could result in adjustments to the allowance for loan losses, and net earnings could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination.
SECURITIES ACTIVITIES
GENERAL. Generally, the investment policy of the Company is to invest funds among categories of investments based upon its asset/liability management policies, investment quality, loan and deposit volume, liquidity needs and performance objectives. In accordance with the Company's asset/liability management policy, the Company has recently focused a significant part of its investment activities on instruments with terms to repricing or maturity of five years or less and municipal securities which are exempt from federal taxes.
The Bank must maintain minimum levels of investments and other assets that qualify as liquid assets under OTS regulations. 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 liquid assets at levels above the minimum requirements imposed by the OTS regulations and above levels believed adequate to meet the requirements of normal operations, including potential deposit outflows. At December 31, 2000, the Bank's liquidity ratio for regulatory purposes was 10.28%. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset/Liability Management" and "- Liquidity and Capital Resources" in the Annual Report attached as Exhibit 13 hereto.
The Company's securities are classified into two categories: held-to-maturity and available-for-sale. Securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. All other securities not classified as held-to-maturity are classified as available-for-sale. At December 31, 2000, the Company had $31.9 million of securities classified as available-for-sale. Available-for-sale securities are reported at fair value with unrealized gains and losses included, on an after-tax basis, in a separate component of shareholders' equity.
MORTGAGE-BACKED AND RELATED SECURITIES. In order to supplement its lending activities and achieve its asset/liability management goals, the Company invests in mortgage-backed and related securities. As of December 31, 2000, all of the mortgage-backed and related securities owned by the Company are issued, insured or guaranteed either directly or indirectly by a federal agency or are rated "AAA" by a nationally recognized credit rating agency. However, it should be noted that, while a (direct or indirect) federal guarantee or a high credit rating may indicate a high degree of protection against default, they do not indicate that the securities will be protected from declines in value based on changes in interest rates or prepayment speeds.
Consistent with its asset/liability management strategy, at December 31, 2000, $7.6 million, or 58.4% of the Company's mortgage-backed and related securities were available-for-sale. In addition, on the same date, $7.2 million or 55.5% of the Company's mortgage-backed and related securities carried adjustable rates. Finally, as discussed further below, at December 31, 2000, the Company had $620,000 million of collateralized mortgage obligations ("CMOs") with anticipated average lives of five years or less. For additional information regarding the Company's mortgage-backed securities portfolio, see Note 2 of the Notes to Consolidated Financial Statements in the Annual Report attached as Exhibit 13 hereto.
The Company's CMOs are securities derived by reallocating the cash flows from mortgage- backed securities or pools of mortgage loans in order to create multiple classes, or tranches, of securities with coupon rates and average lives that differ from the underlying collateral as a whole. The terms to maturity of any particular tranche is dependent upon the prepayment speed of the underlying collateral as well as the structure of the particular CMO. Although a significant proportion of the Company's CMOs are interests in tranches which have been structured (through the use of cash flow priority and "support" tranches) to give somewhat more predictable cash flows, the cash flow and hence the value of CMOs is subject to change.
The Company has invested in CMOs as an alternative to mortgage loans and conventional mortgage-backed securities as part of its asset/liability management strategy. Management believes that, depending on market conditions, CMOs may represent attractive investment alternatives relative to other investments due to the wide variety of maturity and repayment options available. In particular, the Company has from time to time concluded that short and intermediate duration CMOs (five year or less average life) often represent a better combination of rate and duration than adjustable rate mortgage- backed securities.
To assess price volatility, the Federal Financial Institutions Examination Council ("FFIEC") adopted a policy in 1992 which requires an annual "stress" test of mortgage derivative securities. This policy, which has been adopted by the OTS, requires the Company to annually test its CMOs, and other mortgage-related securities to determine whether they are high-risk or nonhigh-risk securities. Mortgage derivative products with an average life or price volatility in excess of a benchmark 30-year, mortgage- backed, pass-through security are considered high-risk mortgage securities. Under the policy, savings institutions may generally only invest in low-risk mortgage securities in order to reduce interest rate risk. In addition, all high-risk mortgage securities acquired after February 9, 1992 which are classified as high risk at the time of purchase must be carried in the institution's trading account or as assets available-for- sale. At December 31, 2000, the most recent quarterly test date, none of the Company's mortgage-backed securities were classified as "high-risk."
The following table sets forth the composition of the Company's mortgage-backed securities at the dates indicated.
The following table sets forth the contractual maturities of the Company's mortgage-backed securities at December 31, 2000.
As of December 31, 2000, the Company did not have any mortgage-backed securities in excess of 10% of retained earnings except for FHLMC issues, amounting to $5.0 million.
The market values of a portion of the Company's mortgage-backed securities held-to-maturity have been from time to time lower than their carrying values. However, for financial reporting purposes, such declines in value are considered to be temporary in nature since they have been due to changes in interest rates rather than credit concerns. See Note 2 of the Notes to Consolidated Financial Statements in the Annual Report attached as Exhibit 13 hereto.
The following table shows mortgage-backed securities purchase, sale and repayment activities of the Company for the periods indicated.
The Company's holdings of mortgage-backed securities are approximately 3.0% of the Company's total assets. Since pass-through mortgage-backed securities generally carry a yield approximately 50 to 100 basis points below that of the corresponding type of residential loan (due to the implied federal agency guarantee fee and the retention of a servicing spread by the loan servicer), and the Company's CMOs also carry lower yields (due to the implied federal agency guarantee and because such securities tend to have shorter actual durations than 30 year loans), in the event that the proportion of the Company's assets consisting of mortgage-backed and related securities increases, the Company's asset yields could be somewhat adversely affected. The Company will evaluate mortgage-backed and related securities purchases in the future based on its asset/liability objectives, market conditions and alternative investment opportunities.
OTHER SECURITIES. In order to complement its lending and mortgage-backed securities activities, and to increase its holdings of short and intermediate term assets, the Company invests in liquid investments and in high-quality investments, such as U.S. Treasury and agency obligations. At December 31, 2000 and December 31, 1999, the Company's securities portfolio totaled $97.2 million and $96.5 million, respectively. At December 31, 2000, the Company did not own any other securities of a single issuer which exceeded 10% of the Company's retained earnings, other than federal agency obligations. See Note 2 of the Notes to Consolidated Financial Statements in the Annual Report attached as Exhibit 13 hereto for additional information regarding the Company's other securities portfolio.
The following table sets forth the composition of the Company's other securities and other earning assets at the dates indicated.
The composition and maturities of the other securities portfolio, excluding FHLB stock, are indicated in the following table.
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(1) Includes 89.4 million of callable securities.
See Note 2 of Notes to the Consolidated Financial Statements in the Annual Report attached as Exhibit 13 hereto for a discussion of the Company's securities portfolio.
SOURCES OF FUNDS
GENERAL. The Bank's primary sources of funds are deposits, payments (including prepayments) of loan principal, interest earned on loans and securities, repayments of securities, borrowings and funds provided from operations.
DEPOSITS. First Security offers deposit accounts having a wide range of interest rates and terms. The Bank's deposits consist of passbook, NOW, money market and various certificate accounts. The Bank relies primarily on competitive pricing, customer service and community outreach to attract and retain these deposits. The Bank's customers may access their accounts through any of the Bank's five offices and five automated teller machines ("ATMs"). In addition, the Bank's customers may access their accounts through several nationwide ATM networks. The Bank only solicits deposits in its market area and does not currently use brokers to obtain deposits.
The Bank manages the pricing of its deposits in keeping with its asset/liability management, profitability and growth objectives. 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. However, as some customers have become more interest rate conscious, the Bank has become more susceptible to short-term fluctuations in its certificate of deposit flows.
Management believes that the "core" portion of the Bank's regular savings, NOW and money market accounts, which amounted to $101.9 million or 40.3% of total deposits at December 31, 2000, can have a lower cost and be more resistant to interest rate changes (and competing non-depository financial products) than certificate accounts. The Bank utilizes customer service, community outreach and marketing initiatives in an effort to build and maintain the volume of such deposits. However, there can be no assurance as to whether the Bank will be able to maintain or increase its core deposits in the future.
The table below sets forth the Bank's deposit flows for the periods indicated.
The following table sets forth the dollar amount of savings deposits in the various types of deposit programs offered by the Bank as of the dates indicated.
The following table shows rate and maturity information for the Bank's certificates of deposit as of December 31, 2000
The following table indicates the amount of the Bank's certificates of deposit and other deposits by time remaining until maturity as of December 31, 2000.
For additional information regarding the composition of the Bank's deposits, see Note 7 of the Notes to the Consolidated Financial Statements in the Annual Report attached as Exhibit 13 hereto.
BORROWINGS. First Security's other available sources of funds include advances from the FHLB of Chicago and other borrowings. The Bank's FHLB advances to date have primarily consisted of subsidized borrowings to fund special housing programs. As a member of the FHLB of Chicago, the Bank is required to own capital stock in the FHLB of Chicago and is authorized to apply for advances from the FHLB of Chicago. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB of Chicago may prescribe the acceptable uses for these advances, as well as limitations on the size of the advances and repayment provisions. At December 31, 2000, the weighted average term to maturity of the Bank's FHLB advances was 44 months. See Note 8 of the Notes to Consolidated Financial Statements in the Annual Report attached as Exhibit 13 hereto.
The following table sets forth the maximum month-end balance and average balance of FHLB advances for the periods indicated.
SUBSIDIARY ACTIVITIES
As a federally chartered savings bank, First Security is permitted by OTS regulations to invest up to 2% of its assets in the stock of, or loans to, service corporation subsidiaries, and may invest an additional 1% of its assets in service corporations where such additional funds are used for inner-city or community development purposes. In addition to investments in service corporations, federal institutions are permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities which a federal savings association may engage in directly.
At December 31, 2000, First Security had one wholly owned service corporation, Western Security Service Corporation ("Western" or the "Subsidiary"). Western, an Illinois corporation, was incorporated November 1977 for the purpose of offering customers and members of the general public credit, life, mortgage and disability insurance. First Security's investment in Western was $28,597 as of December 31, 2000. Western recognized net income loss of $1,655 during the year ended December 31, 2000 and $1,869 during the year ended December 31, 1999.
COMPETITION
First Security faces strong competition both in originating real estate loans and in attracting deposits. Competition in originating loans comes primarily from credit unions, mortgage bankers, commercial banks and other savings institutions, which also make loans secured by real estate located in the Bank's market area. First Security competes for loans principally on the basis of the interest rates and loan fees it charges, the types of loans it originates, community outreach and the quality of services it provides to borrowers.
Competition for those deposits is principally from credit unions, commercial banks, mutual funds, securities firms and other savings institutions located in the same communities. The ability of the Bank to attract and retain deposits depends on its ability to provide an investment opportunity that satisfies the requirements of investors as to rate of return, liquidity, risk, convenient locations and other factors. The Bank competes for these deposits by offering competitive rates, convenient business hours, community outreach and a customer oriented staff.
REGULATION
GENERAL
First Security is a federally chartered savings bank, the deposits of which are federally insured and backed by the full faith and credit of the United States Government. Accordingly, First Security is subject to broad federal regulation and oversight extending to all its operations. First Security is a member of the Federal Home Loan Bank ("FHLB") of Chicago and is subject to certain limited regulation by the Board of Governors of the Federal Reserve System ("Federal Reserve Board"). As the savings and loan holding company of First Security, the Company also is subject to federal regulation and oversight. The purpose of the regulation of the Company and other holding companies is to protect subsidiary savings associations. First Security is a member of the Savings Association Insurance Fund ("SAIF") and the deposits of First Security are insured by the Federal Deposit Insurance Corporation ("FDIC"). As a result, the FDIC has certain regulatory and examination authority over First Security.
Certain of these regulatory requirements and restrictions are discussed below or elsewhere in this document.
FEDERAL REGULATION OF SAVINGS ASSOCIATIONS
The Office of Thrift Supervision ("OTS") has extensive authority over the operations of savings associations. As part of this authority, First Security is required to file periodic reports with the OTS and is subject to periodic examinations by the OTS and the FDIC. The last regular OTS and FDIC examinations of First Security were as of December 31, 2000 and April 23 1990, respectively. Under agency scheduling guidelines, it is likely that another examination will be initiated in the near future. When these examinations are conducted by the OTS and the FDIC, the examiners may require First Security to provide for higher general or specific loan loss reserves. All savings associations are subject to a semi-annual assessment, based upon the savings association's total assets, to fund the operations of the OTS.
The OTS also has extensive enforcement authority over all savings institutions and their holding companies, including First Security and the Company. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OTS. Except under certain circumstances, public disclosure of final enforcement actions by the OTS is required.
In addition, the investment, lending and branching authority of First Security is prescribed by federal laws and it is prohibited from engaging in any activities not permitted by such laws. For instance, no savings institution may invest in non-investment grade corporate debt securities. In addition, the permissible level of investment by federal associations in loans secured by non-residential real property may not exceed 400% of total capital, except with approval of the OTS. Federal savings associations are also generally authorized to branch nationwide. First Security is in compliance with the noted restrictions.
First Security's general permissible lending limit for loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At December 31, 2000, First Security's lending limit under this restriction was $1.0 million. First Security is in compliance with the loans-to-one-borrower limitation.
The OTS, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution which fails to comply with these standards must submit a compliance plan.
INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC
First Security is a member of the Savings Association Insurance Fund ("SAIF"), which is administered by the FDIC. Deposits are insured up to applicable limits 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 in unsafe or unsound practices or is in an unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their level of capital and supervisory evaluation. Under the system, institutions classified as well capitalized (I.E., a core capital ratio of at least 5%, a ratio of Tier 1 or core capital to risk-weighted assets ("Tier 1 risk-based capital") of at least 6% and a risk-based capital ratio of at least 10%) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (I.E., core or Tier 1 risk-based capital ratios of less than 4% or a risk-based capital ratio of less than 8%) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions will be made by the FDIC for each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semiannual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF-insured deposits. In setting these increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. The FDIC may also impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC.
Effective January 1, 1997, the premium schedule for BIF and SAIF insured institutions ranged from 0 to 27 basis points. The assessment was reduced to 2.12 basis points as of January 1, 2000, when BIF insured institutions began to fully participate in the assessment. As of January 1, 2001, the assessment stood at 1.96 basis points. These assessments, which may be revised based upon the level of BIF and SAIF deposits will continue until the bonds mature in the year 2017.
REGULATORY CAPITAL REQUIREMENTS
Federally insured savings associations, such as First Security are required to maintain a minimum level of regulatory capital. The OTS has established capital standards which require the Bank to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets and of Tier I capital to qualifying total assets (leverage ratio). 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 a leverage ratio of 4% of adjusted total assets (as defined by regulation). Tier I capital, used to calculate the leverage ratio, generally includes common stockholders' equity and retained income and certain noncumulative perpetual First Security stock and related income. In addition, all intangible assets, other than a limited amount of purchased mortgage servicing rights, must be deducted from Tier I capital for calculating compliance with the requirement. At December 31, 2000, First Security had $154,000 of intangible assets recorded as assets on its financial statements, as a result of its acquisition of assets and assumption of liabilities from the Resolution Trust Corporation in 1994.
The OTS regulations establish special capitalization requirements for savings associations that own subsidiaries. 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 are "includable" subsidiaries that are consolidated for capital purposes in proportion to the association's level of ownership. For excludable subsidiaries the debt and equity investments in such subsidiaries are deducted from assets and capital.
At December 31, 2000, First Security had Tier I capital of $65.3 million or 16.6% of adjusted total assets, which is approximately $49.6 million above the minimum requirement of 4% of adjusted total assets in effect on the date.
The capital standards also require Tier I capital equal to at least 4% of risk-weighted assets.
At December 31, 2000, First Security had Tier I capital equal to $65.3 million or 32.4% of risk- weighted assets, which is $57.2 million above the minimum Tier I risk-based capital ratio of 4% in effect on that date.
The OTS risk-based requirement requires savings associations to have total capital of at least 8% 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. The OTS is also authorized to require a savings association to maintain an additional amount of total capital to account for concentration of credit risk and the risk of non-traditional activities. At December 31, 2000, First Security had $2.6 million of general loss reserves of which $2.5 million qualifies as supplementary capital, which was less than 1.25% of risk-weighted assets.
Certain exclusions from capital and assets are required to be made for the purpose of calculating total 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. First Security had no such exclusions from capital and assets at December 31, 2000.
In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the OTS has assigned a risk weight of 50% 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% at origination unless insured to such ratio by an insurer approved by the FNMA or FHLMC.
OTS regulations also require that a savings association with more than normal interest rate risk exposure deduct from its total capital, for purposes of determining compliance with such requirements, an amount equal to 50% of its interest-rate risk exposure multiplied by the present value of its assets. This exposure is a measure of the potential decline in the net portfolio value of a savings association, greater than 2% of the present value of its assets, based upon a hypothetical 200 basis point increase or decrease in interest rates (whichever results in a greater decline). Net portfolio value is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. The rule will not become effective until the OTS evaluates the process by which savings associations may appeal an interest rate risk deduction determination. It is uncertain as to when this evaluation may be completed. Any savings association with less than $300 million in assets and a total risk-based capital ratio in excess of 12% is exempt from this requirement unless the OTS determines otherwise. At the present time, the proposal is not expected to have a material impact on the Bank.
On December 31, 2000, First Security had total risk-based capital of approximately $67.8 million (including $65.3 million in core capital and $2.5 million in qualifying supplementary capital) and risk-weighted assets of $201.9 million; or total capital of 33.6% of risk-weighted assets. This amount was $51.7 million above the 8% requirement in effect on that date.
The OTS and the FDIC are authorized and, under certain circumstances required, to take certain actions against savings associations that fail to meet their 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% core capital ratio, a 4% Tier 1 risked-based capital ratio or an 8% 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 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% or a risk-based capital ratio of less than 6%) must be made subject to one or more of additional specified actions and operating restrictions which may cover all aspects of its operations and include a forced merger or acquisition of the association. An association that becomes "critically undercapitalized" (I.E., a tangible capital ratio of 2% or less) is subject to further mandatory restrictions on its activities in addition to those applicable to significantly undercapitalized associations. In addition, 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 the general enforcement authority of the OTS and the FDIC, including the appointment of a conservator or a receiver.
The OTS is also generally authorized to reclassify an association into a lower capital category and impose the restrictions applicable to such category if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition.
The imposition by the OTS or the FDIC of any of these measures on the Association may have substantial adverse effects on its operations and profitability.
LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS
OTS regulations impose various restrictions on savings associations with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. OTS regulations also prohibit a savings 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.
Generally, savings associations, such as First Security, that before and after the proposed distribution meet their capital requirements, may make capital distributions during any calendar year equal to the greater of 100% of net income for the year-to-date plus 50% of the amount by which the lesser of the association's tangible, core or risk-based capital exceeds its capital requirement for such capital component, as measured at the beginning of the calendar year, or 75% of its net income for the most recent four quarter period. However, an association deemed to be in need of more than normal supervision by the OTS may have its dividend authority restricted by the OTS. First Security may pay dividends in accordance with this general authority.
Savings associations proposing to make any capital distribution need only submit written notice to the OTS 30 days prior to such distribution. Savings associations that do not, or would not meet their current minimum capital requirements following a proposed capital distribution, however, must obtain OTS approval prior to making such distribution. The OTS may object to the distribution during that 30- day period based on safety and soundness concerns. See "- Regulatory Capital Requirements."
The OTS has proposed regulations that would revise the current capital distribution restrictions. Under the proposal a savings association that is a subsidiary of a holding company may make a capital distribution with notice to the OTS provided that it has a CAMEL 1 or 2 rating, is not of supervisory concern, and would remain adequately capitalized (as defined in the OTS prompt corrective action regulations) following the proposed distribution. Savings associations that would remain adequately capitalized following the proposed distribution but do not meet the other noted requirements must notify the OTS 30 days prior to declaring a capital distribution. The OTS stated it will generally regard as permissible that amount of capital distributions that do not exceed 50% of the institution's excess regulatory capital plus net income to date during the calendar year. A savings association may not make a capital distribution without prior approval of the OTS and the FDIC if it is undercapitalized before, or as a result of, such a distribution. As under the current rule, the OTS may object to a capital distribution if it would constitute an unsafe or unsound practice. No assurance may be given as to whether or in what form the regulations may be adopted.
LIQUIDITY
All savings associations, including First Security, are required to maintain an average daily balance of liquid assets equal to a certain percentage of the average daily balance of its liquidity base during the preceding calendar quarter or a percentage of the amount of its liquidity base at the end of the preceding quarter. For a discussion of what First Security includes in liquid assets, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" in the Annual Report attached as Exhibit 13 hereto. This liquid asset ratio requirement may vary from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings associations. At the present time, the minimum liquid asset ratio is 4%.
Penalties may be imposed upon associations for violations of the liquid asset ratio requirement. At December 31, 2000, First Security was in compliance with the requirement, with an overall liquid asset ratio of 10.28%.
This regulation may be withdrawn as a result of recent Federal legislation.
QUALIFIED THRIFT LENDER TEST
All savings associations, including First Security, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings association to have at least 65% of its portfolio assets (as defined by regulation) in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings association may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code. Under either test, such assets primarily consist of residential housing related loans and investments. At December 31, 2000, First Security met the test and has always met the test since its effectiveness.
Any savings association that fails to meet the QTL test must convert to a national bank charter, unless it requalifies as a QTL and thereafter remains a QTL. If an association does not requalify and converts to a national bank charter, it must remain SAIF-insured until the FDIC permits it to transfer to the BIF. If such an association has not yet requalified or converted to a national bank, its new investments and activities are limited to those permissible for both a savings association and a national bank, and it is limited to national bank branching rights in its home state. In addition, the association is immediately ineligible to receive any new FHLB borrowings and is subject to national bank limits for payment of dividends. If such association has not requalified or converted to a national bank within three years after the failure, it must divest of all investments and cease all activities not permissible for a national bank. In addition, it must repay promptly any outstanding FHLB borrowings, which may result in prepayment penalties. If any association that fails the QTL test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. See "- Holding Company Regulation."
COMMUNITY REINVESTMENT ACT
Under the Community Reinvestment Act ("CRA"), every FDIC insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices 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 the examination of First Security, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by First Security. An unsatisfactory rating may be used as the basis for the denial of an application by the OTS.
The federal banking agencies, including the OTS, have recently revised the CRA regulations and the methodology for determining an institution's compliance with the CRA. Due to the heightened attention being given to the CRA in the past few years, First Security may be required to devote additional funds for investment and lending in its local community. First Security was examined for CRA compliance in March 1999 and received a rating of satisfactory.
TRANSACTIONS WITH AFFILIATES
Generally, transactions between a savings association or its subsidiaries and its affiliates are required to be on terms as favorable to the association as transactions with non-affiliates. In addition, certain of these transactions, such as loans to an affiliate, are restricted to a percentage of the association's capital. Affiliates of First Security include the Company and any company which is under common control with First Security. In addition, a savings association may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of most affiliates. The OTS has the discretion to treat subsidiaries of savings associations as affiliates on a case by case basis.
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 for loans to unaffiliated individuals.
HOLDING COMPANY REGULATION
The Company is a unitary savings and loan holding company subject to regulatory oversight by the OTS. As such, the Company is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. 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 unitary savings and loan 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 First Security 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 First Security 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."
The Company must obtain approval from the OTS before acquiring control of any other SAIF-insured association. Such acquisitions are generally prohibited if they result in a multiple savings and loan holding company controlling savings associations in more than one state. However, such interstate acquisitions are permitted based on specific state authorization or in a supervisory acquisition of a failing savings association.
FEDERAL SECURITIES LAW
The stock of the Company is registered with the 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.
First SecurityFed Financial, Inc. 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
The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts). At December 31, 2000, First Security was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements that may be imposed by the OTS. See "-Liquidity."
Savings associations are authorized to borrow from the Federal Reserve Bank "discount window," but Federal Reserve Board regulations require associations to exhaust other reasonable alternative sources of funds, including FHLB borrowings, before borrowing from the Federal Reserve Bank.
FEDERAL HOME LOAN BANK SYSTEM
First Security is a member of the FHLB of Chicago, 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, which are subject to the 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, First Security is required to purchase and maintain stock in the FHLB of Chicago. At December 31, 2000, First Security had $3.3 million in FHLB stock, which was in compliance with this requirement. In past years, First Security has received substantial dividends on its FHLB stock. Over the past five calendar years such dividends have averaged 6.88% and were 7.59% for calendar year 2000. As a result of its holdings, the Bank could borrow up to $66 million from the FHLB.
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 First Security's FHLB stock may result in a corresponding reduction in First Security's capital.
For the year ended December 31, 2000, dividends paid by the FHLB of Chicago to First Security totaled $217,800, which constitutes a $72,300 increase from the amount of dividends received in calendar year 1999.
FEDERAL AND STATE TAXATION
Savings associations such as First Security that meet certain conditions prescribed by the Internal Revenue Code of 1986, as amended (the "Code"), were previously permitted to establish reserves for bad debts and to make annual additions thereto which may, within specified formula limits, be taken as a deduction in computing taxable income for federal income tax purposes. The amount of the bad debt reserve deduction is computed under the experience method. Under the experience method, the bad debt reserve deduction is an amount determined under a formula based generally upon the bad debts actually sustained by the savings association over a period of years.
In addition to the regular income tax, corporations, including savings associations such as First Security, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% 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% of alternative minimum taxable income.
A portion of the Bank's reserves for losses on loans 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 December 31, 2000, First Security's excess for tax purposes totaled approximately $20 million.
First Security files its federal, state and local income tax returns on a calendar year basis using the accrual method of accounting.
First Security has not been audited by the IRS with respect to consolidated federal income tax returns in the past five years. With respect to years examined by the IRS, either all deficiencies have been satisfied or sufficient reserves have been established to satisfy asserted deficiencies. In the opinion of management, any examination of still open returns (including returns of subsidiary and predecessors of, or entities merged into, First Security) would not result in a deficiency which could have a material adverse effect on the financial condition of First Security and its consolidated subsidiary.
ILLINOIS TAXATION. For Illinois income tax purposes, the Bank is taxed at an effective rate equal to 7.18% of Illinois taxable income. For these purposes, "Illinois Taxable Income" generally means federal taxable income, subject to certain adjustments (including the addition of interest income on state and municipal obligations and the exclusion of interest income on United States Treasury obligations).
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.
EMPLOYEES
At December 31, 2000, the Company, including its subsidiaries, had a total of 94 employees, including 24 part-time employees. The Bank's employees are not represented by any collective bargaining group. Management considers its employee relations to be good.
EXECUTIVE OFFICERS OF THE CORPORATION WHO ARE NOT DIRECTORS
The business experience of each executive officer who is not also a director is set forth below.
Harry Kucewicz. Mr. Kucewicz, age 44, is currently serving as the Treasurer and Chief Operating and Financial Officer of both the Corporation and Bank. He began working at the Bank in 1978 as the Controller. He was elected Treasurer and Chief Financial Officer in 1990 and Chief Operating Officer in August 1994. Mr. Kucewicz is responsible for all of the Corporation's and Bank's financial and accounting functions.
Mary H. Korb. Ms. Korb, age 53, is currently Vice President of the Corporation and Vice President - Lending of the Bank. Ms. Korb supervises all aspects of the Bank's lending operations, including lending compliance. Ms. Korb has been with the Bank since 1970, and has served in her present capacity since March 1991.
Irene S. Subota. Ms. Subota, age 54, currently serves as Vice President of the Corporation and as Vice President - Savings of the Bank. Ms. Subota is in charge of all aspects of the Bank's savings function, including compliance. Ms. Subota has been employed by the Bank since 1973, and has served in her current position since 1992.
Adrian Hawryliw. Mr. Hawryliw, age 64, has served as Philadelphia Branch Manager of the Bank since 1994 when the Philadelphia, Pennsylvania branch was acquired from the Resolution Trust Corporation, and is currently a Vice President of the Bank and of the Corporation. Mr. Hawryliw is responsible for supervising operations of the Philadelphia, Pennsylvania branch, including business development, retail deposits, real estate lending, accounting and marketing. He has over 34 years of banking experience in the Philadelphia area, holding various positions including Chief Financial Officer and Vice President/Investments for other area institutions.
Paul T. Brandriwsky. Mr. Brandriwsky, age 45, is currently Vice President and Chief Operating Officer of both the Corporation and the Bank. He began working at the Bank in 2000 and was appointed to his present capacity at that time. Mr. Brandriwsky has over 20 years of experience in banking management, lending and real estate. His is responsible for the day-to-day operations of the Bank's retail banking branches, human resources and marketing/advertising.
ITEM 2.
ITEM 2. PROPERTIES
The following table sets forth information concerning the main office and each branch office of the Bank at December 31, 2000. At December 31, 2000, the Bank's premises had an aggregate net book value of approximately $2.6 million.
- ---------------------------- (1) The lease expires in July 2003.
The Bank believes that its current facilities are adequate to meet the present and foreseeable future needs of the Bank and the Company. However, in the future, the Bank may consider the addition of one or more new branches within the Chicago or Philadelphia areas.
The Bank's depositor and borrower customer files are maintained by an independent data processing company. The net book value of the data processing and computer equipment utilized by the Bank at December 31, 2000 was approximately $359,000.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
From time to time, First Security is involved as plaintiff or defendant in various legal proceedings arising in the normal course of its business. While the ultimate outcome of these various legal proceedings cannot be predicted with certainty, it is the opinion of management that the resolution of these legal actions should not have a material effect on the Company's and the Bank's financial position or results of operations.
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 December 31, 2000.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Page 44 of the attached 2000 Annual Report to Stockholders is herein incorporated by reference.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Pages 2 and 3 of the attached 2000 Annual Report to Stockholders is herein incorporated by reference.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Pages 4 through 15 of the attached 2000 Annual Report to Stockholders is herein incorporated by reference.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Pages 16 through 43 of the attached 2000 Annual Report to Stockholders is herein incorporated by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There has been no Current Report on Form 8-K filed within 24 months prior to the date of the most recent financial statements reporting a change of accountants and/or reporting disagreements on any matter of accounting principle or financial statement disclosure.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
Information concerning Directors of the Corporation is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held in April 2001 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 Corporation and the Bank who are not also directors contained in Part I of this Form 10-K is incorporated herein by reference.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's directors and executive officers, and persons who own more than 10% of the Company's Common Stock (or any other equity securities, of which there is none), to file with the SEC initial reports of ownership and reports of changes in ownership of the Company's Common Stock. Officers, directors and greater than 10% shareholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file.
To the Company's knowledge, based solely on a review of the copies of such reports furnished to the Company and written representations that no other reports were required during the fiscal year ended December 31, 2000, all Section 16(a) filing requirements applicable to its officers, directors and greater than 10% beneficial owners were complied with.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held in April, 2001, a copy of which will be filed not later than 120 days after the close of the fiscal year.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held in April, 2001, 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 herein by reference from the definitive Proxy Statement for the Annual Meeting of Stockholders to be held in April, 2001 a copy of which will be filed not later than 120 days after the close of the fiscal year.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) FINANCIAL STATEMENTS:
The following financial statements are included in this Form 10-K:
1. Five-Year Summary of Selected Consolidated Financial Data. 2. Report of Independent Auditors 3. Consolidated Balance Sheets at December 31, 2000 and 1999. 4. Consolidated Statements of Income for the fiscal years ended December 31, 2000, 1999 and 1998. 5. Consolidated Statements of Shareholders' Equity for the fiscal years ended December 31, 2000, 1999 and 1998. 6. Consolidated Statements of Cash Flows for the fiscal years ended December 31, 2000, 1999 and 1998. 7. Notes to Consolidated Financial Statements.
(a)(2) FINANCIAL STATEMENT SCHEDULES:
All financial statement schedules have been omitted as the required information is inapplicable or has been included in the Notes to Consolidated Financial Statements.
(a)(3) EXHIBITS:
See Exhibit Index.
(b) REPORTS ON FORM 8-K:
There were no current reports on Form 8-K filed by the Corporation during the quarter ended December 31, 2000.
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.
/s/ Julian E. Kulas /s/ Steve Babyk - ------------------------------------- ------------------------------------- Julian E. Kulas Steve Babyk President, Chief Executive Officer Director and Director (PRINCIPAL EXECUTIVE OFFICER)
Date: 3/31/01 Date: 3/31/01 ------------------------------- -------------------------------
/s/ Lila Maria Bodnar /s/ Myron Dobrowolsky - ------------------------------------- ------------------------------------- Lila Maria Bodnar Myron Dobrowolsky Recording Secretary and Director Director
Date: 3/31/01 Date: 3/31/01 ------------------------------- -------------------------------
/s/ Terry Gawryk /s/ George Kawka - ------------------------------------- ------------------------------------- Terry Gawryk George Kawka Secretary and Director Director
Date: 3/31/01 Date: 3/31/01 ------------------------------- -------------------------------
/s/ Paul Nadzikewycz /s/ Jaroslav H. Sydorenko - ------------------------------------- ------------------------------------- Paul Nadzikewycz Jaroslav H. Sydorenko Chairman of the Board Director
Date: 3/31/01 Date: 3/31/01 ------------------------------- -------------------------------
/s/ Chrysta Wereszczak /s/ Harry Kucewicz - ------------------------------------- ------------------------------------- Chrysta Wereszczak Harry Kucewicz Director Principal Financial and Accounting Officer
Date: 3/31/01 Date: 3/31/01 ------------------------------- -------------------------------
EXHIBIT INDEX
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* Filed as an Exhibit to the Company's Form S-1 Registration Statement filed on July 21, 1997 (File No. 333-31739) pursuant to Section 5 of the Securities Act of 1933. All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-K.
** Filed as an Exhibit to the Company's Form 10-Q Quarterly report filed on November 15,1999 (File No. 000-23063) pursuant to Section 12 of the Securities Exchange Act of 1934. All of such previously filed documents are hereby incorporated by reference in accordance with Item 601 of Regulation S-K.
*** Filed as an Exhibit to the Company's Definitive Proxy Statement on Schedule 14A on March 24, 1998 (File No. 0-23063). All of such previously filed documents are hereby incorporated herein by reference in accordance with Item 601 of Regulation S-K.