ITEM 1. BUSINESS - --------------------------------------------------------------------------------
GENERAL
In the following discussion, references to "Bankshares" relate to Community Savings Bankshares, Inc. together with its wholly-owned subsidiary, Community Savings, F. A. (the "Association").
COMMUNITY SAVINGS BANKSHARES, INC.
Bankshares is a Delaware-chartered stock holding company organized in August 1998. Bankshares' primary asset is its investment in its wholly owned subsidiary, the Association. On December 15, 1998, Bankshares completed its reorganization and stock offering (the "Reorganization") in connection with the conversion and reorganization of ComFed, M. H. C. (the "Holding Company"), a mutual holding company, and its mid-tier holding company, Community Savings Bankshares, Inc., a federally chartered mid-tier stock holding company (the "Mid-Tier"). Bankshares sold 5,470,651 shares of common stock at $10.00 per share in a subscription and community offering (the "Offering") resulting in net proceeds of approximately $53.0 million. Bankshares also issued 5,078,233 shares of common stock to existing minority shareholders of the Mid-Tier (the "Exchange") at an exchange ratio of 2.0445 shares (the "Exchange Ratio") for each share of Mid-Tier common stock. The Reorganization was accounted for at historical cost in a manner similar to a pooling of interests. Therefore, all financial information has been presented as if Bankshares had been in existence for all periods presented in this Annual Report on Form 10-K ("Form 10-K") and the Exchange Ratio has been applied to all stock-related data for comparability purposes.
At December 31, 2000, Bankshares had total assets of $962.7 million, total loans of $691.3 million, total deposits of $681.1 million, and total shareholders' equity of $112.5 million. At December 31, 2000, there were 8,542,363 shares of common stock outstanding which trades on The Nasdaq Stock Market under the symbol "CMSV".
Bankshares' executive office is located at 660 U.S. Highway One, North Palm Beach, Florida and its telephone number at that address is (561) 881-2212.
COMMUNITY SAVINGS, F. A.
The Association, founded in 1955, is a federally chartered savings and loan association headquartered in North Palm Beach, Florida and is the wholly owned subsidiary of Bankshares. The Association's deposits are federally insured by the Federal Deposit Insurance Corporation ("FDIC") through the Savings Association Insurance Fund ("SAIF"). The Association has been a member of the Federal Home Loan Bank of Atlanta ("FHLB") since 1955. The Association's primary federal banking regulator is the Office of Thrift Supervision ("OTS").
On December 15, 1998, Bankshares became the holding company for the Association as a result of the completion of the Reorganization. In the course of the Reorganization, the Holding Company and the Mid-Tier were merged with and into the Association. Such mergers were accounted for in a manner similar to a pooling of interests and did not result in any significant accounting adjustments. Net proceeds from the Reorganization approximated $53.0 million which were initially invested in interest-earning deposits, and which have subsequently been disbursed primarily to fund loan originations and securities purchases, and repurchases of Bankshares' common stock in open market repurchase programs. This use of funds reflected the implementation of the Association's business plan to prudently deploy the capital raised in the Reorganization, without an increase in high-risk lending or investment activities.
The Association is a community-oriented financial institution engaged primarily in the business of attracting deposits from the general public residing in the Association's market area (as described below). It uses such funds, together with other borrowings, to invest in various residential and commercial real estate loans, consumer and commercial business loans, and mortgage-backed and related securities ("MBS") and investment securities. See "- Lending Activities" and "- Securities Portfolio". The Association's principal sources of funds are deposits, principal and interest payments on loans and securities, and FHLB advances. The principal source of income is interest received from loans and securities, while principal expenses are interest paid on deposits and borrowings and employee compensation and benefits. See "- Sources of Funds." The Association's strategy is to operate as a well-capitalized, profitable and independent community-oriented savings and loan association. The Association has implemented this strategy by emphasizing retail deposits as its primary
funding source and investing a substantial part of such funds in locally originated residential first mortgage loans, in MBS and in liquid investment securities.
The Association's profitability is highly dependent on its net interest income. The components that determine net interest income are the amount of interest-earning assets and interest-bearing liabilities, together with the yields earned or rates paid on such instruments. The Association is sensitive to managing interest rate risk exposure by better matching asset and liability maturities and rates. This is accomplished while considering the inherent credit risk of assets. The Association maintains asset quality by using comprehensive loan underwriting standards, effective collection efforts as well as by primarily originating or purchasing secured or guaranteed assets. The Association also uses leveraged transactions in which security purchases are funded with lower costing FHLB advances thereby creating an attractive interest rate spread (the difference between the yield earned on the securities and the rate paid on the borrowings).
The Association's executive office is located at 660 U.S. Highway One, North Palm Beach, Florida, and its telephone number at that address is (561) 881-4800.
FORWARD-LOOKING STATEMENTS
Statements contained in this Form 10-K which are not historical facts are forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Amounts herein could vary as a result of market and other factors. Such forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in documents filed by Bankshares with the Securities and Exchange Commission from time to time. Such forward-looking statements may be identified by the use of such words as "believe," "expect," "anticipate," "should," "planned," "estimated," and "potential." Examples of forward looking statements include, but are not limited to, estimates with respect to the financial condition, expected or anticipated revenue, results of operations and business of Bankshares that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to, general economic conditions; changes in interest rates; deposit flows; the level of defaults, losses and prepayments on loans and MBS held by Bankshares in portfolio or sold in the secondary markets; loan demand; real estate values; competition; changes in accounting principles, policies, practices or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting Bankshares' operations, pricing, products and services. The forward-looking statements are made as of the date of this Form 10-K, and Bankshares assumes no obligation to update the forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements.
MARKET AREA AND COMPETITION
Bankshares and the Association are headquartered in North Palm Beach, Florida. Because Bankshares' most significant asset is its ownership of all the issued and outstanding capital stock of the Association, the market area and competition are identical for both entities. The Association operates 21 offices in its market area in southeastern Florida, four of which are located in Martin County, thirteen of which are located in Palm Beach County, three of which are located in St. Lucie County and one of which is located in Indian River County.
The economy in the Association's market area is service-oriented and is significantly dependent upon government, foreign trade, tourism, and its continued attraction as a retirement area. A variety of county-supported programs have been instituted to create new jobs and to encourage relocation or expansion of companies with an emphasis placed on high-technology and service industries. Major employers in Palm Beach County include Pratt and Whitney, Motorola, Inc., Florida Power and Light Co., and Flo Sun, Inc. Martin County major employers include Martin Memorial Medical Center, Northrop Grumman Aircraft Systems, Inc., and Publix Super Markets. St. Lucie County major employers include Columbia Lawnwood Regional Medical, Publix Super Markets, and HCA Medical Center of Pt. St. Lucie. Indian River Memorial Hospital, Publix Super Markets, and New Piper Aircraft Corp are major employers in Indian River County.
Bankshares' market area on the southeast coast of Florida has a large concentration of financial institutions. Many of these institutions are significantly larger and have greater financial resources than the Association. All of these institutions are competitors of the Association to varying degrees. As a result, the Association encounters strong competition both in attracting deposits and in originating real estate and other loans.
The competition for real estate and other loans comes principally from commercial banks, mortgage-banking companies, and other savings associations. The competition for loans has increased substantially in recent years due to the large number of institutions competing in the market area as well as the increased efforts by commercial banks to expand mortgage loan originations. The Association competes for loans primarily through competitive interest rates and the loan fees it charges and the efficiency and quality of services it provides borrowers, real estate brokers, and builders. Factors that affect competition include general and local economic conditions, current interest rate levels, and the volatility of the mortgage markets.
As a result of the sales in 1999 of the majority of the MacArthur Foundation land holdings located in Palm Beach, Martin and St. Lucie Counties, major real estate development began in Northern Palm Beach County during 2000. The Association's lending staff has and will continue to aggressively pursue lending opportunities resulting from this development.
The Association's most direct competition for deposits has come historically from commercial banks, securities broker-dealers, other savings associations, and credit unions in its market area. Continued strong competition from such financial institutions is expected in the foreseeable future. The market area includes branches of several commercial banks that are substantially larger than the Association in terms of state-wide deposits. The Association competes for savings by offering depositors a high level of personal service and expertise together with a wide range of financial services as well as competitive pricing.
LENDING ACTIVITIES
GENERAL. Historically, the principal lending activity of the Association has been the origination of fixed- and adjustable-rate mortgage loans collateralized by one- to four-family residential properties located in its primary market area. It is the Association's intention to offer varied products in the residential mortgage loan area. The Association currently emphasizes the origination of adjustable-rate residential mortgage ("ARM") loans, and fixed-rate residential mortgage loans with terms of 15 years or less. In addition, the Association encourages origination of residential mortgage loans which provide for a fixed-rate of interest during the first five or seven years and which thereafter convert to ARM loans, the interest rate of which adjusts annually. At times, it has been the Association's policy to sell in the secondary market, on a servicing retained basis, all fixed-rate mortgage loan originations with terms to maturity greater than 15 years. However, based on management's assessment of the market at a particular time and Board of Director established limits, the Association may periodically decide to retain such loans in the portfolio. At December 31, 2000, there were no loans held for sale and loans serviced for other institutions totaled $9.2 million.
Although the Association's primary emphasis is on residential real estate lending, the Association's policy is to meet demand for other types of loans by offering a wide variety of loan programs designed to meet customers' needs. In response to customer demand, the Association has expanded its commercial lending programs by adding new commercial loan officers and a credit analyst to its staff. The Association intends to continue to pursue the origination of such loans during 2001 in connection with providing services to its small business customers.
At December 31, 2000, the net loan portfolio totaled $691.3 million. At such date, the weighted average remaining term to maturity of the net loan portfolio was approximately 16.4 years. At December 31, 2000, $353.2 million, or 51% of the total net loan portfolio consisted of loans with adjustable interest rates.
To supplement local loan originations, the Association also invests in MBS that directly or indirectly provide funds principally for residential home buyers in the United States. The Association has also purchased either participations in or whole residential real estate loans serviced by other institutions. Such loans totaled $50.2 million, net of premiums, at December 31, 2000. In addition, the Association participates with other financial institutions in programs to provide residential mortgage loans to low and moderate income borrowers. During 2001, the Association intends to use its loan solicitors to continue the expansion of its lending activities, particularly one- to four-family residential loans and commercial real estate and business loans. However, competition for commercial loans remains high in its marketplace, and the Association may not be able to significantly increase the amount of such loans in its portfolio.
ANALYSIS OF LOAN PORTFOLIO. Set forth below is selected data relating to the composition of the loan portfolio by type of loan at the dates indicated.
LOAN AND MORTGAGE-BACKED AND RELATED SECURITIES MATURITY AND REPRICING SCHEDULE. The following table sets forth certain information as of December 31, 2000 regarding the dollar amount of loans, net of loans in process ("LIP"), and MBS maturing in the Association's portfolio based on their contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Adjustable- -rate loans are included in the period in which interest rates are next scheduled to adjust rather than in which they contractually mature. Fixed-rate loans are included in the period in which the final contractual repayment is due. Fixed-rate MBS are assumed to mature in the period in which the final contractual payment is due on the underlying mortgage.
The following table sets forth at December 31, 2000, the dollar amount of all fixed-rate and adjustable-rate loans due after December 31, 2001 based on either the repricing date or the contractual maturity as described above.
Fixed Adjustable Total ----- ---------- ----- (Dollars in thousands)
Real estate loans: One- to four-family residential $259,901 $122,782 $382,683 Commercial, multi-family and land 21,353 9,007 30,360 Consumer and commercial business 4,506 - 4,506 -------- -------- -------- Total (net of LIP) $285,760 $131,789 $417,549 ======== ======== ========
Percentage of total loans (net of LIP) 41.22% 19.01% 60.23% ======== ======== ========
Mortgage-backed and related securities $ 53,340 $ - $ 53,340 ======== ======== ========
ONE- TO FOUR-FAMILY RESIDENTIAL REAL ESTATE LOANS. The Association's primary lending activity consists of the origination of one- to four-family, owner-occupied, residential mortgage loans secured by properties located in its market area. Such loans are generally underwritten in conformity with the criteria established by Fannie Mae ("FNMA"), with the exception of loans exceeding applicable FNMA dollar limits and loans purchased through the Association's affiliation with a consortium of financial institutions which provides loans to low and moderate income borrowers, as discussed below. The Association generally does not originate one- to four-family residential loans secured by properties outside of its market area although in recent periods it has purchased a modest amount of single-family residential loans secured by properties in the southeast United States and California. At December 31, 2000, $511.3 million, or 67.8%, of the gross loan portfolio consisted of one- to four-family residential mortgage loans. The weighted average contractual maturity of one- to four-family residential mortgage loans at the time they are originated is approximately 27 years. However, it has been the Association's experience that the average length of time such loans remain outstanding is approximately 5 years.
The Association currently offers one- to four-family residential mortgage loans with terms typically ranging from 15 to 30 years, and with adjustable or fixed interest rates. In addition, the Association offers hybrid residential mortgage loans. These loans have a fixed-rate of interest during the first five or seven years of the term of the loans. After this fixed-
rate period expires, the loans convert to ARM loans with an annual interest rate adjustment. This loan product allows the Association to offer a loan with a relatively short period during which the interest rate is fixed but which typically provides for an initial interest rate which is greater than could be obtained on ARM loans originated in the local market. This loan product is generally offered with a term of between l5 and 30 years. Originations of fixed-rate mortgage loans, hybrid loans, and ARM loans are monitored on an ongoing basis and are affected significantly by the level of market interest rates, customer preference, the Association's asset/liability strategy, and loan products offered by its competitors. In a rising interest rate environment, which existed throughout 2000, borrowers typically prefer fixed-rate loans to ARM loans. Nonetheless, the Association has continued to emphasize the origination of ARM loan products. ARM loan originations totaled $144.4 million, or 83.9%, of all one- to four-family loan originations during the year ended December 31, 2000.
The Association currently offers ARM loans with an annual adjustment based on changes in the weekly average yield on U.S. Treasury securities adjusted to a constant maturity of one year ("Treasury Index") plus a margin, usually 287.5 basis points. Each ARM loan has an annual interest rate adjustment limitation of 200 basis points and a maximum lifetime adjustment of 600 basis points above the initial rate. ARM loans are originated with initial rates below the fully indexed rate, the amount of such discount varying depending upon market conditions. Management determines whether a borrower qualifies for an ARM loan based on the fully indexed rate of the ARM loan at the time the loan is originated. Negative amortization of the ARM loans is not allowed. One- to four-family residential ARM loans totaled $273.6 million at December 31, 2000.
The primary purpose of offering ARM loans is to make the loan portfolio more interest rate sensitive. However, because the interest income earned on ARM loans varies with prevailing interest rates, such loans do not offer as consistently a predictable stream of interest income as compared to long-term, fixed-rate loans. In addition, ARM loans have the potential for increased credit risk associated with potentially higher monthly payments due from borrowers as general market interest rates increase and the loan interest rate is adjusted upward. It is possible, therefore, that during periods of rising interest rates, the risk of default on ARM loans may increase due to the upward adjustment of interest costs to the borrower. To offset this risk, loans are underwritten as if the highest market rate the borrower would be capable of paying under the terms of the loan was in effect.
Fixed-rate loans generally are originated and underwritten according to standards that permit sale in the secondary mortgage market. Whether management can or will sell fixed-rate loans in the secondary market, however, depends on a number of factors including the yields and the terms of the loans, market conditions, the Association's current interest rate sensitivity gap position and Board of Director established limits. The Association has followed varying policies with respect to retention in the portfolio of fixed-rate loans with contractual terms in excess of 15 years. Its current policy is to limit fixed-rate loans, including loans with 30 year terms, to a specified percentage of total assets. The Association's fixed-rate mortgage loans are amortized on a monthly basis with principal and interest due each month. One- to four-family residential real estate loans often remain outstanding for significantly shorter periods than their contractual terms because borrowers may refinance or prepay loans at their option without prepayment penalties.
As an integral part of its community reinvestment activities, the Association participates with other financial institutions in local consortiums. These consortiums are committed to provide financing of one- to four-family mortgage loans for low- and moderate-income borrowers. The consortiums underwrite and package the loans. The loans are then either sold to the member institutions on a whole loan basis or closed and funded directly by the member institution. These loans are originated to borrowers within the Association's market area and provide for either fixed or adjustable rates of interest. The Association determines which loans it will purchase or fund directly after conducting its own due diligence review of the loan package offered. The Association closed approximately $675,000 in consortium loans during fiscal 2000. Management intends, subject to market conditions, to continue to participate in consortiums of this nature in the future.
The Association also purchases single-family residential loans from other sources, such as mortgage origination companies, or brokers, under the same guidelines as described above. In addition, such loan purchases include a contract between the mortgage origination company and the Association, which contains an indemnification clause protecting the Association from loss resulting from misrepresentations in the loan applications or other information provided to the Association. During fiscal 2000, $57.1 million of such loans were closed. Management intends, subject to market conditions, to continue purchasing and/or closing such loans.
The Association may purchase participation interests or whole loans secured by one- to four-family residences when funds available for lending exceed the demand for residential loans in its local market or to facilitate funding of large
projects. At December 31, 2000, the loan portfolio included $49.8 million of loan participations and whole loans secured by one- to four-family residences. Purchases of such loans totaled $29.4 million during fiscal 2000.
The Association's fixed-rate one- to four-family residential first mortgage loans customarily include due-on-sale clauses, which are provisions giving the Association the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells or otherwise disposes of the underlying real property serving as security for the loan. Due-on-sale clauses are an important means of adjusting the rates on the fixed-rate mortgage loan portfolio (and to a lesser extent ARM loans), and the Association has generally exercised its rights under these clauses.
Regulations limit the amount that a savings association may lend relative to the appraised value of the real estate securing the loan, as determined by an appraisal at the time of loan origination. Appraisals are generally performed by an independent outside appraiser. Such regulations permit a maximum loan-to-value ratio of 95% for loans secured by residential property and 85% or less for all other real estate loans. The Association's lending policies generally limit the maximum loan-to-value ratio on both fixed-rate and ARM loans without private mortgage insurance to 80% of the lesser of the appraised value or the purchase price of the property which serves as collateral for the loan. For one- to four-family real estate loans with loan-to-value ratios of between 80% and 95%, the borrower is generally required to obtain private mortgage insurance. An origination fee of between 1% and 2% of the total loan amount on all one- to four-family loans may be charged depending on the market conditions. Fire and casualty insurance (and flood insurance if the property is within a designated flood plain), as well as title insurance regarding good title, are required on all properties securing real estate loans made by the Association.
CONSTRUCTION AND LAND LOANS. At December 31, 2000, $113.2 million, or 15.0%, of the gross loan portfolio consisted of one- to four-family residential construction loans. Fixed- and adjustable-rate residential construction loans are currently offered primarily for the construction of owner-occupied single-family residences in the Association's market area to builders who have a contract for sale of the property or to owners who have a contract for construction. Advances are made as each phase of construction is completed and verified by the Association. In addition, construction loans are also made to builders for single-family residences held for sale. Such loans totaled $18.8 million at December 31, 2000. Construction loans for owner-occupied single-family residences are generally structured to become permanent loans upon completion of construction, and are originated with terms of up to 30 years with an allowance of up to six months for construction during which period the borrower makes interest-only payments. Construction loans to builders for residences held for sale are generally originated for a term of up to one year and provide for interest-only payments.
At December 31, 2000, the Association's largest real estate construction loan was a $23.8 million line of credit, with disbursed funds of $16.0 million. In order to comply with the Association's regulatory loans-to-one-borrower limit, a $12.5 million participation interest in the line of credit was sold by the Association to Bankshares. This acquisition and construction line of credit is secured by single-family estate homes and condominiums located on the Atlantic Ocean in Indian River County and is performing in accordance with its terms.
Construction loans are also offered on multi-family and commercial real estate property. At December 31, 2000, multi-family and commercial real estate construction loans totaled $34.0 million, or 4.5%, and $8.2 million, or 1.1%, of the gross loan portfolio, respectively.
In addition, loans are originated within the Association's market area which are secured by individual unimproved or improved lots zoned primarily to become single-family residences, as well as commercial and agricultural properties. At December 31, 2000, land loans totaled $20.2 million, or 2.7%, of the gross loan portfolio. Land loans are currently offered as either one-year ARM loans or fixed-rate loans with terms of up to 15 years. The maximum loan-to-value ratio for such land loans is 75%.
Adjustable-rate single-family construction and land loans are currently offered at the Treasury Index plus a margin, usually between 287.5 and 400 basis points. Adjustable-rate construction loans and land loans have an annual interest rate cap of 200 basis points and a lifetime interest rate cap of either 500 or 600 basis points over the initial interest rate. Initial interest rates may be below the fully indexed rate but the loan is underwritten at the fully indexed rate.
Construction lending generally involves a greater degree of credit risk than one- to four-family residential mortgage lending. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction or development and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of value proves to be inaccurate, the Association may be confronted with a completed project which has a value which is insufficient to
assure full repayment. Loans made on lots carry the risk of adverse zoning changes, environmental issues, or other restrictions on future use.
MULTI-FAMILY RESIDENTIAL REAL ESTATE LOANS. Loans secured by multi-family real estate constituted approximately $10.5 million, or 1.4%, of the gross loan portfolio at December 31, 2000. At December 31, 2000, a total of 51 loans were secured by multi-family residential properties. Multi-family residential loans are primarily secured by rental properties with between five and thirty-six units. At December 31, 2000, substantially all multi-family residential loans were secured by properties located within the Association's market area. At December 31, 2000, multi-family residential loans had an average principal balance of approximately $206,000. At such date, the largest multi-family residential loan consisted of a commitment to disburse $8.5 million of which $4.2 million had been extended. Such loan was performing in accordance with its terms. Multi-family residential loans are currently only offered with adjustable interest rates, although in the past, fixed-rate multi-family residential loans also were originated. Multi-family residential loans typically have adjustable interest rates tied to a market index and amortize over 20 to 25 years. An origination fee of between 1% to 2% is usually charged on multi-family residential loans. Multi-family residential loans are generally originated for amounts up to 75% of the appraised value of the property securing the loan. The initial interest rate on multi-family residential loans is currently priced using the Treasury Index plus a margin, usually between 325 and 375 basis points depending on the nature and size of the project. Originations of multi-family loans have been limited in recent years due to the limited demand for such projects in the Association's market area.
In its underwriting process, the Association reviews the ability of expected net operating income generated by the real estate to support the debt service, the age and condition of the collateral, the financial resources and income level of the borrower, the borrower's experience in owning or managing similar properties, and any financial reserves the borrower may have.
Loans secured by multi-family real estate generally involve a greater degree of credit risk than one- to four-family residential mortgage loans and may carry larger loan balances. This increased credit risk is a result of 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. Furthermore, the repayment of loans secured by multi-family property is typically dependent upon the successful operation of the related real estate property.
COMMERCIAL REAL ESTATE LOANS. Loans secured by commercial real estate constituted approximately $37.3 million, or 4.9%, of the gross loan portfolio at December 31, 2000. Commercial real estate loans are secured by improved property such as offices, hotels, small business facilities, strip shopping centers, warehouses, commercial land, and other non-residential buildings. At December 31, 2000, substantially all of the commercial real estate loans were secured by properties located within the Association's market area. At December 31, 2000, 179 loans were secured by commercial real estate with an average principal balance of approximately $208,000. Commercial real estate loans are currently only offered with adjustable interest rates, although in the past the Association originated fixed-rate commercial real estate loans. The terms of each commercial real estate loan are negotiated on a case-by-case basis, although such loans typically have adjustable interest rates tied to a market index such as the prime rate plus a margin. An origination fee of up to 1% of the principal balance of the loan is typically charged on commercial real estate loans. Commercial real estate loans originated by the Association generally amortize over 15 to 20 years and have a maximum loan-to-value ratio of 75%.
An experienced commercial lending manager, two commercial loan officers, and a credit analyst are part of the Lending Division staff. During the year ended December 31, 2000, $6.0 million of commercial real estate loans were originated resulting in an aggregate total of such loans of $37.3 million. The Association intends to continue to emphasize the origination of commercial real estate and business loans to its commercial customers in the future due to the favorable return earned by the Association on such loans. The Association's ability to originate such loans is limited by intense competition for commercial loans in its market area.
At December 31, 2000, the largest commercial real estate loan relationship had an outstanding principal balance of $2.2 million, which is within the Association's regulatory loans-to-one-borrower limit. The collateral for the loan is two business parcels containing multiple retail stores, lumberyards, and office buildings located in the Association's market area. The loan is currently performing in accordance with its terms.
In underwriting commercial real estate loans, the same underwriting standards and procedures are employed as are used in underwriting multi-family real estate loans. Loans secured by commercial real estate generally involve a higher degree of risk than one- to four-family residential mortgage loans and carry larger loan balances. This increased credit risk
is a result of 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 difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced, the borrower's ability to repay the loan may be impaired.
CONSUMER LOANS. As of December 31, 2000, consumer loans totaled $14.0 million, or 1.9%, of the gross loan portfolio. The principal types of consumer loans offered are home equity lines of credit, fixed-rate second mortgage loans, automobile loans, mobile home loans, boat loans, recreational vehicle loans, unsecured personal loans, and loans secured by deposit accounts. Home equity lines of credit are offered on a variable-rate basis, predominately tied to the Wall Street Journal prime rate. The collateral for these loans is the borrower's principal residence. Other consumer loans are offered primarily on a fixed-rate basis with maturities generally of five years or less. Consumer loans are underwritten using the Association's customary lending standards. The Association anticipates that its involvement in consumer lending will continue but recognizes that local competition for consumer loans may limit the Association's ability to significantly increase the total of its consumer loan portfolio.
Consumer loans generally have shorter terms and higher interest rates than traditional mortgage loans, but generally entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as automobiles, mobile homes, boats, and recreational vehicles. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In particular, amounts realizable on the sale of repossessed automobiles may be significantly reduced based upon the condition of the automobiles and the fluctuating demand for used automobiles.
COMMERCIAL BUSINESS LOANS. The Association currently offers commercial business loans to finance small businesses in its market area. Commercial business loans are primarily offered as a customer service to business account holders. Such loans may include commercial lines of credit, loans on inventory, equipment, receivables, or other collateral and unsecured loans. The Association emphasizes its activities in the commercial business lending market as part of its goal to increase commercial lending. Currently, competition in the Association's market area makes it difficult to increase originations of such loans. At December 31, 2000, the 110 commercial business loans outstanding had an aggregate balance of $5.5 million and an average loan balance of approximately $50,000. Commercial business loans originated during the year ended December 31, 2000 totaled $6.7 million. Commercial business loans are offered with both fixed- and adjustable-interest rates. Adjustable-rates on commercial business loans are priced against the Wall Street Journal prime rate, plus a margin. The loans are offered with terms of up to five years and are underwritten using the Association's customary underwriting standards.
At December 31, 2000, the largest commercial business loan was a $2.5 million line of credit secured by accounts receivable, contract rights, inventory, equipment, furniture and personal property. The line of credit did not have an outstanding principal balance at December 31, 2000 and it is currently performing in accordance with its terms.
Commercial business loans generally bear higher interest rates than residential loans, but they also may involve a higher risk of default since their repayment is generally dependent on the successful operation of the borrower's business or are collateralized by property that may not provide an adequate source of repayment. Personal guarantees from the borrower or a third party are generally obtained as a condition to originating its commercial business loans.
LOAN ORIGINATIONS, SOLICITATION, PROCESSING, COMMITMENTS, AND PURCHASES. Loan originations are derived from a number of sources such as real estate broker referrals, existing customers, developers, and walk-in customers. In the case of a real estate loan, an independent appraiser approved by the Association appraises the real estate intended to secure the proposed loan. Outside members of the Board of Directors, the Chairman of the Board of Directors, the President, certain other officers, and branch managers have been granted the authority to approve loans in various amounts depending on the types of loans involved. In addition, the Association has a Loan Committee, consisting of at least one outside director and the President, the Division Director of Lending and the New Loan Operations Manager. Larger loans must be approved by one or more of such members of the Loan Committee depending on the size of the loan. Loans in excess of $2.5 million may only be approved by any three members of the Large Loan Committee. The members of the Large Loan Committee include five of the outside directors, the President, the Division Director of Lending, and the New Loan Operations Manager. At December 31, 2000, commitments to originate loans, excluding the undisbursed portion of loans in process, totaled $6.9 million.
If the loan is approved, the commitment letter specifies the terms and conditions of the proposed loan including the amount of the loan, interest rate, amortization term, a brief description of the required collateral, and required insurance coverage. Fire and casualty insurance is required at the time the loan is made and throughout the term of the loan, and upon request of the Association, flood insurance may be required. Title insurance is required on all loans secured by real property.
In addition to originations, the Association also purchases loans secured by one- to four-family residences from consortiums, mortgage origination companies, or brokers, as previously discussed in "One- to Four-Family Residential Real Estate Loans." The Association may also purchase participation loans when funds available for lending exceed the demand for loans in its local market or to facilitate funding of larger projects. All of such purchased loans, which totaled $49.8 million at December 31, 2000, are secured by residential real estate loans. Substantially all of such loans are whole loans; however, participation interests account for approximately $4.9 million of the $49.8 million.
ORIGINATION, PURCHASE AND SALE OF LOANS. The table below shows the loan origination, purchase and sales activity for the periods indicated.
LOAN ORIGINATION FEES AND OTHER INCOME. In addition to interest earned on loans, the Association may receive loan origination fees. To the extent that loans are originated or acquired for its portfolio, Statement of Financial Accounting Standards No. 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases" ("SFAS No. 91") requires that loan origination fees and costs be deferred and amortized as an adjustment of yield over the life of the loan by using the level yield method. ARM loans originated below the fully-indexed interest rate will have a substantial portion of the deferred amount recognized as income in the initial adjustment period. Fees and costs deferred under SFAS No. 91 are recognized into income immediately upon the prepayment or the
sale of the related loan. At December 31, 2000, unearned discounts and premiums, and deferred loan origination fees and costs totaled $2.0 million. Loan origination fees vary with the volume and type of loans and commitments made and purchased, principal repayments, and competitive conditions in the mortgage markets which, in turn, respond to the demand and availability of funds.
In addition to loan origination fees, the Association also receives servicing income and other fees that consist primarily of servicing fees, late charges, and other miscellaneous fees. Such fees totaled $237,000, $387,000, and $198,000 for the years ended December 31, 2000, 1999, and 1998, respectively.
LOAN SERVICING. Although the Association primarily originates loans for its own portfolio, it also has sold fixed-rate loans to Freddie Mac ("FHLMC") and to FNMA. At December 31, 2000, the unpaid principal balances of loans sold totaled approximately $9.2 million. The Association services such loans, receiving a fee of between 0.25% and 0.375% per loan. The Association does not purchase loan servicing from other sources.
LOANS-TO-ONE BORROWER. Savings and loan associations are subject to the same loans-to-one borrower limits as those applicable to national banks. Under current regulations, loans to one borrower are restricted to an amount equal to 15% of the Association's unimpaired capital and unimpaired surplus on an unsecured basis, and an additional amount equal to 10% of unimpaired capital and unimpaired surplus if the loan is secured by readily marketable collateral (generally, financial instruments and bullion, but not real estate). This 15% limitation resulted in a dollar limitation of approximately $12.8 million at December 31, 2000. The Association was in compliance with the regulation at December 31, 2000.
The following table presents the five largest lending relationships at December 31, 2000:
At December 31, 2000, all of the aforementioned loans were performing in accordance with their terms.
ASSET QUALITY
DELINQUENCIES. The Association's collection procedures provide that when a loan is 15 days past due, a computer-generated late charge notice is sent to the borrower requesting payment. If the delinquency continues at 30 days, a delinquent notice is sent and personal contact efforts are attempted, either in person or by telephone. Also, plans to arrange a repayment plan are made at this point. If a loan becomes 60 days past due and no progress has been made in resolving the delinquency, a 10-day demand letter is sent and personal contact again is attempted. The loan also becomes subject to possible legal action if suitable arrangements to repay have not been made. In addition, the borrower is advised that he or she may obtain access to consumer counseling services, to the extent required by regulations of the Department of Housing and Urban Development ("HUD"). When a loan continues in a delinquent status for 90 days or more, and a repayment schedule has not been made or kept by the borrower, generally a notice of intent to foreclose is sent to the borrower, giving the borrower 10 days to repay all outstanding interest and principal. If the delinquency is not cured, foreclosure proceedings are initiated.
DELINQUENT LOANS. Loans are reviewed on a regular basis and are placed on a non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. In addition, loans are placed on non-accrual status when either principal or interest is 90 days or more past due, or if less than 90 days, in the event that the loan has been referred to the Association's legal counsel for foreclosure. Interest accrued and unpaid at the time a loan is placed on a non-accrual status is charged against interest income.
The following table sets forth information with respect to loans past due 60 to 89 days in the loan portfolio at the dates indicated.
At December 31, ---------------------- 2000 1999 1998 ---- ---- ---- (In thousands)
Loans past due 60-89 days: One- to four-family residential $701 $426 $695 Commercial and multi-family real estate - - - Consumer and commercial business 17 - 100 Land 3 - - ---- ---- ---- Total loans past due 60-89 days $721 $426 $795 ==== ==== ====
NON-PERFORMING ASSETS. At December 31, 2000, non-performing assets (non-performing loans and real estate owned ("REO")) totaled $3.5 million, and the ratio of non-performing assets to total assets was 0.36%. Real estate acquired by the Association through foreclosure or by deed in lieu of foreclosure is classified as substandard until such time as it is sold. REO is recorded at cost which is the estimated fair value of the property at the time the loan is foreclosed. Prior to foreclosure, these properties are carried at fair value less estimated costs to sell.
The following table sets forth information regarding non-accrual loans delinquent 90 days or more, and real estate acquired or deemed acquired by foreclosure at the dates indicated. When a loan is delinquent 90 days or more, all accrued interest thereon is fully reserved and the loan ceases to accrue interest thereafter. For all the dates indicated, there were no material restructured loans within the meaning of SFAS No. 15 (as amended by SFAS No. 121).
The largest non-performing asset at December 31, 2000 consisted of two loans totaling $2.3 million to a local builder for the construction of 78 golf course villas. Scheduled interest became delinquent when slower than expected sales reduced the project's cash flows. At the present time, management does not anticipate incurring any loss of principal on these loans.
During the year ended December 31, 2000, gross interest income of $249,000 would have been recorded on non-performing loans accounted for on a non-accrual basis if the loans had been current throughout the period. No interest income on non-accrual loans was included in income during such period.
The following table sets forth information regarding delinquent loans, REO, and loans to facilitate the sale of REO at December 31, 2000.
At December 31, 2000 -------------------- Balance Number ------- ------ (Dollars in thousands)
Residential real estate: Loans 60 to 89 days delinquent $ 701 15 Loans more than 89 days delinquent 2,888 13 Commercial and multi-family real estate: Loans 60 to 89 days delinquent - - Loans more than 89 days delinquent - - Consumer and commercial business: Loans 60 to 89 days delinquent 17 3 Loans more than 89 days delinquent 8 3 Land: Loans 60 to 89 days delinquent 3 1 Loans more than 89 days delinquent 420 2 REO 170 3 Other repossessed assets - - Loans to facilitate sale of REO 229 4 ------ ------ Total $4,436 44 ====== ======
CLASSIFICATION OF ASSETS. Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered by OTS to be of lesser quality as substandard, doubtful, or loss assets. 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 savings institution 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 that do not expose the savings institution to risk sufficient to warrant classification in one of the aforementioned categories, but which possess some weaknesses, are required to be designated special mention by management.
When a savings institution classifies problem assets as either substandard or doubtful, it is required to establish general allowances for loan losses in an amount deemed prudent by management. General allowances represent loss allowances that have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When a savings institution classifies problem assets as loss, it is required either to establish a specific allowance for losses equal to 100% of the amount of the assets so classified, or to charge off such amount. A savings institution's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS, which can order the establishment of additional general or specific loss allowances. Problem loans in the portfolio are regularly reviewed to determine whether any of such loans require classification in accordance with applicable regulations.
The following table sets forth the aggregate amount of the Association's classified assets at the dates indicated.
- -------------------------------------------------------------------------------- At December 31, 2000 1999 1998 ---- ---- ---- (In thousands)
Substandard assets (1) $3,808 $3,052 $3,056 Doubtful assets - - - Loss assets 2 6 291 ------ ------ ------ Total classified assets $3,810 $3,058 $3,347 ====== ====== ======
- -------------------------------------------------------------------------------- (1) Includes three loans aggregating $1.1 million which were performing according to their terms at December 31, 1999, but which management classified as substandard due to doubts about the future collectibility of such loans. Subsequent to December 31, 1999, two of these loans were paid off by the borrower. During 2000, the Association foreclosed on the property securing the third loan. The fair market value of $61,000 is included in REO at December 31, 2000. The property was sold for a loss by the Association during February 2000.
ALLOWANCE FOR LOAN LOSSES. Management's policy is to provide for estimated losses on the loan portfolio based on management's evaluation of losses inherent in the loan portfolio that may be incurred. Provisions for losses, which increase the allowances for loan losses, are established by charges to income. Such allowances represent the amounts which, in management's judgment, are adequate to absorb charge-offs of existing loans which may become uncollectible. The adequacy of the allowance is determined by management's monthly evaluation of the loan portfolio and related collateral, in light of past loss experience, the volume and type of lending engaged in by the Association, present economic conditions and other factors considered relevant by management.
Management continues to review the entire loan portfolio to determine the extent, if any, to which further additional loan loss provisions may be deemed necessary. Management believes that the current allowance for loan losses is adequate, however, there can be no assurance that the allowance for loan losses will be adequate to cover losses that may in fact be realized in the future or that additional provisions for loan losses will not be required.
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES. The following table sets forth the analysis of the allowance for loan losses for the periods indicated.
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES. The following table sets forth the allocation of allowance for loan losses by loan category for the periods indicated. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance by category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses incurred in any category.
SECURITIES PORTFOLIO
The Association's primary focus is the origination of loans. However, during past periods when mortgage loan demand was moderate and the Association had de-emphasized the origination of fixed-rate loans, management invested excess liquidity in investment securities, including mutual funds, and in MBS rather than purchasing whole loans or loan participations. At December 31, 2000, the Association's securities portfolio including interest-earning deposits at the FHLB totaled $191.4 million or 19.9% of total assets. Such securities are subject to classification based on the intentions of management. Securities purchased for the portfolio are classified as either held to maturity or as available for sale. The Association has no securities classified as trading.
The Association maintains an Investment Committee which meets on a monthly basis to review the securities portfolio and make recommendations to be carried out by management. Members of the Investment Committee consist of the Association's Chief Executive Officer, Chief Financial Officer, and Senior Vice President of Lending. All investments owned by the Association must be rated BBB or higher by a recognized rating service. In the event that a security rating falls below BBB, that security is considered for adverse classification by the investment committee. The December 31, 2000 held to maturity securities included a mortgage-backed security with a book value of $1.8 million whose rating had fallen to B and was included on the Association's watch list.
Investments purchased are comprised primarily of United States Government and agency obligations, mutual funds that invest in mortgage-backed securities and government and agency obligations, MBS, corporate debt securities, interest-earning deposits at the FHLB, and FHLB stock. Some of such investments allow the issuer to call the securities at predetermined times during the life of the security. There were no calls during the year ended December 31, 2000. Principal repayments on amortizing securities totaled $11.2 million during 2000 as compared to $29.5 million during 1999. The repayments are a general reflection of higher market rates of interest which cause certain securities to pay off more slowly.
The Association was previously required under federal regulations to maintain a minimum amount of liquid assets invested in specified short-term securities and certain other investments. The Association generally maintained a portfolio of liquid assets that exceeded regulatory requirements. Liquidity levels were increased or decreased depending upon the yields on investment alternatives and upon management's judgment as to the attractiveness of the yields then available in relation to other opportunities and its expectation of the level of yield that would be available in the future, as well as management's projections as to the short term demand for funds to be used in loan origination and other activities. While the liquidity regulation has been discontinued by the OTS for 2001, liquidity levels will continue to be monitored by Association management on a regular schedule. For further information regarding the securities portfolio see Notes 1, 2 and 3 to the Notes to Consolidated Financial Statements contained in Bankshares' Annual Report to Shareholders for the Year Ended December 31, 2000 (the "Annual Report") attached hereto as Exhibit 13.
SECURITIES PORTFOLIO MATURITIES. The following table sets forth the scheduled maturities, carrying values, market values and average yields for the securities portfolio at December 31, 2000.
MORTGAGE-BACKED AND RELATED SECURITIES. The Association invests in MBS which are included in the securities portfolio and are classified as either available for sale or held to maturity. At December 31, 2000, net MBS totaled $67.4 million, or 7.0%, of total assets. Of this amount, $12.4 million and $55.0 million were classified as held to maturity and available for sale, respectively. At December 31, 2000, the market value of the net MBS portfolio totaled approximately $67.3 million. Management primarily invests in fixed-rate MBS with weighted average lives of five to seven years. Management believes that investing in short-term MBS allows for better management of the Association's exposure to fluctuations in interest rates. During fiscal year 2000, $635,000 of MBS were purchased, using funds provided by public funds deposits, odd-term certificates of deposit and FHLB advances.
Collateralized mortgage obligations ("CMOs") are typically issued by a special-purpose entity (in the Association's case, private issuers or government agencies), which may be organized in a variety of legal forms, such as a trust, a corporation, or a partnership. The entity aggregates pools of pass-through securities, which are used to collateralize the CMO. Once combined, the cash flows are divided into "tranches" or "classes" of individual bonds, thereby creating more predictable average durations for each bond than the underlying pass-through pools. Accordingly, under the CMO structure, all principal paydowns from the various mortgage pools are allocated to a CMO's first class until it has been paid off, then to a second class until such class has been paid off, and then to the following classes in order of priority. Substantially all of the CMOs held in the securities portfolio consist of senior sequential tranches, primarily investments in one of the first three tranches of the CMO. By purchasing senior sequential tranches, management is attempting to ensure the cash flow associated with such an investment. Generally, such tranches have stated maturities ranging from 6.5 years to 30 years; however, because of prepayments, the expected weighted average life of these securities is less than the stated maturities. While non-agency private issues are somewhat less liquid than CMOs issued or guaranteed by Government National Mortgage Association ("GNMA"), FNMA or FHLMC, they generally have a higher yield than agency insured or guaranteed CMOs, such higher yield reflecting in part the lack of such guarantee or protection.
SECURITIES HELD TO MATURITY. At December 31, 2000, investment securities held to maturity totaled $34.0 million and included United States Government and agency obligations totaling $16.2 million, MBS totaling $12.4 million and corporate debt issues totaling $5.4 million.
The following tables set forth the carrying value of, and activity in the securities held to maturity at the dates indicated. At December 31, 2000, the aggregate market value of the securities was approximately $36.7 million.
Year Ended December 31, ------------------------------------ 2000 1999 1998 ---- ---- ---- (In thousands) Securities held to maturity Balance, beginning of period $ 38,802 $ 52,619 $ 67,801 Purchases 2 - - Calls - - (1,427) Sales - - - Maturities - - (3,386) Repayments (6,469) (14,723) (12,067) Discount and premium amortization 1,690 1,457 1,523 Transfer to available for sale - (413) - Write down of impaired security - (138) - Gain on calls - - 175 -------- -------- -------- Balance, end of period $ 34,025 $ 38,802 $ 52,619 ======== ======== ========
SECURITIES AVAILABLE FOR SALE. Securities available for sale are carried on the books at fair value as required by FASB No. 115 and totaled $131.4 million at December 31, 2000. Included in securities available for sale are equity securities totaling $60,000, mutual funds totaling $35.2 million, United States Government and agency obligations totaling $34.2 million, corporate debt issues totaling $6.9 million and MBS totaling $55.0 million.
Mutual fund investments include mutual funds that invest primarily in mortgage-backed securities and government and agency securities, and are classified as available for sale for accounting purposes. The mutual funds which invest in mortgage-backed securities have characteristics similar to the MBS in which they invest. Mutual fund investments include approximately $34.9 million in funds which invest in adjustable-rate mortgage-backed securities issued by FNMA, FHLMC and GNMA, as well as CMOs and real estate mortgage investment conduits and other securities collateralized by or representing interests in real estate mortgages.
The following tables set forth the carrying value of, and activity in, the securities available for sale at the dates indicated.
Year Ended December 31, ------------------------------------- 2000 1999 1998 ---- ---- ---- (In thousands) Securities available for sale: Balance, beginning of period $ 140,840 $ 95,151 $ 142,269 Purchases 2,632 73,314 25,086 Transfer from held to maturity - 413 - Calls - (5,000) (40,323) Sales (15,000) - - Maturities - - - Repayments (4,768) (14,802) (31,955) Write-down of impaired security (138) - - Discount and premium amortization 92 116 323 (Gain) loss on sales and calls (75) - - Increase (decrease) in market value 3,835 (4,352) (249) --------- --------- --------- Balance, end of period $ 131,418 $ 144,840 $ 95,151 ========= ========= =========
Included in corporate debt issues at December 31, 2000 and 1999 are two asset-backed securities issued by the Auto Bonds Receivable Corporation (the "Auto Bonds"), which were purchased during fiscal year 1994, and are secured by automobile loan receivables. At December 31, 1999, the Auto Bonds were in default with materially reduced payments occurring. Consequently, management determined that the decline in fair value on the Association's investment in the Auto Bonds was other than temporary, resulting in a write down of $138,000 and a reclassification from held to maturity to available for sale, resulting in a balance of $413,000. During fiscal year 2000, management recorded an additional write down of $138,000, resulting in a balance of $254,000 at December 31, 2000. The trustee for the Auto Bonds brought suit against the risk default insurance carrier to require payment of the principal balance and accrued interest on these bonds. Management cannot be certain as to the outcome of such litigation.
INTEREST-EARNING DEPOSITS AND FHLB OF ATLANTA STOCK. On a daily basis, management primarily invests excess funds in an interest-earning overnight account at the FHLB of Atlanta. The balance of this account was $26.0 million at December 31, 2000. In addition, interest-earning deposits totaling $1.3 million were held in other financial institutions at December 31, 2000. Such funds are available to provide liquidity to meet lending requirements and daily operations.
The Association is required to purchase and maintain FHLB of Atlanta stock based on the Association's asset size and its outstanding total of FHLB advances. FHLB of Atlanta stock is not readily marketable as it is not traded on a registered security exchange.
The following table sets forth the carrying value of interest-earning deposits and FHLB of Atlanta stock at the dates indicated.
SOURCES OF FUNDS
GENERAL. Deposits are the major source of funds for lending and other investment purposes. In addition to deposits, funds are derived from the amortization and prepayment of loans and mortgage-backed and related securities, the maturity of investment securities, operations and, if needed, advances from the FHLB. Scheduled loan principal repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources or on a longer term basis for general business purposes. Although the Association periodically reviews the features and terms of its deposit products, the Association does not intend to materially change any of the deposit products or services it currently offers.
DEPOSITS. Consumer and commercial deposits are attracted principally from within the Association's market area through the offering of a broad selection of deposit instruments including non-interest-bearing demand accounts, NOW accounts, passbook savings, money market deposit accounts, term certificate accounts and individual retirement accounts. While deposits of $100,000 or more are accepted, premium rates for such deposits are not currently offered. Deposit account terms vary according to the minimum balance required, the period of time during which the funds must remain on deposit, and the interest rate, among other factors. A committee consisting of the Association's President and management representing the operations, accounting, lending and marketing functions meets weekly to evaluate the internal cost of funds, survey rates offered by competing institutions, review the Association's cash flow requirements for lending and liquidity and the amount of certificates of deposit maturing in the upcoming weeks. This committee executes rate changes when deemed appropriate. Funds are not obtained through brokers, nor are funds solicited outside the Association's market area.
The following table sets forth information regarding interest rates, terms, minimum amounts, and balances of deposits as of December 31, 2000.
The following table sets forth the change in dollar amount in the various types of savings accounts offered between the dates indicated:
The following table sets forth the certificates of deposit classified by rates as of the dates indicated.
At December 31, ----------------------------------- 2000 1999 1998 ---- ---- ---- Rate (In thousands) - ----
3.00% or less $ 272 $ 286 $ 940 3.01 - 3.99% - 12 11 4.00 - 4.99% 5,899 135,880 74,835 5.00 - 5.99% 134,354 151,899 238,564 6.00 - 6.99% 226,301 67,028 33,983 7.00 - 7.99% 64,751 8,571 8,856 -------- -------- -------- Total certificates of deposit $431,577 $363,676 $357,189 ======== ======== ========
The following table sets forth the amount and maturities of certificates of deposit at December 31, 2000.
Amount Due ----------------------------------------------------------- Less Than 1-2 2-3 3-4 4-5 Rate One Year Years Years Years Years Total - ---- -------- ----- ----- ----- ----- ----- (In thousands)
3.00% or less $ 272 $ - $ - $ - $ - $ 272 3.01 - 3.99% - - - - - - 4.00 - 4.99% 3,352 850 545 1,152 - 5,899 5.00 - 5.99% 120,089 6,812 7,063 390 - 134,354 6.00 - 6.99% 148,757 47,855 1,771 4,693 23,225 226,301 7.00 - 7.99% 1,520 62,693 62 - 476 64,751 -------- -------- -------- -------- -------- -------- Total certificates of deposit $273,990 $118,210 $ 9,441 $ 6,235 $ 23,701 $431,577 ======== ======== ======== ======== ======== ========
The following table indicates the amount of negotiable certificates of deposit of $100,000 or more by time remaining until maturity as of December 31, 2000.
Certificates of Deposit of $100,000 Remaining Maturity or More - ------------------ -------------- (In thousands)
Three months or less $19,721 Three through six months 8,946 Six through twelve months 19,529 Over twelve months 32,790 ------- Total $80,986 =======
Deposits are used to fund loan originations, the purchase of securities and for general business purposes. The deposit growth in fiscal year 2000 of $67.1 million reflected the use of odd-term and promotional certificate of deposit products, as well as increased retail deposits generated by aggressive, competitive pricing of such products in the market area. The Association also continues to emphasize commercial checking accounts for small local businesses.
The following table sets forth the net changes in the deposit activities for the periods indicated.
Year Ended December 31, ---------------------------------------- 2000 1999 1998 ---- ---- ---- (In thousands)
Deposits $3,250,479 $2,875,680 $2,737,244 Withdrawals 3,208,622 2,875,669 2,715,239 ---------- ---------- ---------- Net increase before interest 41,857 11 22,005 credited Interest credited 25,269 19,532 21,687 ---------- ---------- ---------- Net increase in deposits $ 67,126 $ 19,543 $ 43,692 ========== ========== ==========
BORROWINGS. Savings deposits are the primary source of funds for lending and investment activities and for general business purposes. If the need arises, advances from the FHLB may be used to supplement the supply of lendable funds and to meet deposit withdrawal requirements as well as in leveraged transactions used to purchase securities. Advances from the FHLB typically are collateralized by the Association's stock in the FHLB and a blanket floating lien on the Association's one- to four-family first mortgage loans. At December 31, 2000, $146.7 million of FHLB advances were outstanding with a weighted average interest rate of 5.87%.
The FHLB functions as a central reserve bank providing credit for the Association and other member savings institutions and financial institutions. As a member, the Association is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and certain of its home mortgages and other assets (principally, securities that are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of a member institution's net worth or on the FHLB's assessment of the institution's creditworthiness. Although advances may be used on a short-term basis for cash management needs, FHLB advances have not been, nor are they expected to be, a significant long-term funding source for the Association, although the Association periodically utilizes its ability to access advances in order to take advantage of investment opportunities which may arise, or to fund loan originations if liquidity is low.
On September 30, 1983, the Association sold two of its branches to another financial institution. Under terms of the sale, the Association issued a 10.94%, 30-year term mortgage-backed bond (the "Bond") for approximately $41.6 million. A discount was recorded on the Bond which is being accreted using the interest method of accounting over the life of the Bond. The Bond bears an interest rate that is adjustable semi-annually on each April 1 and October 1 to reflect changes in the average of the United States 10-year and 30-year long-term bond rates. At December 31, 2000, the net outstanding balance of the Bond was $13.6 million with an effective rate of 9.97%. For further information on the Bond, see Note 10 to the Notes to the Consolidated Financial Statements in the Annual Report attached hereto as Exhibit 13.
On October 24, 1994, in connection with the Association's Plan of Reorganization into a mutual holding company, the Association established an Employee Stock Ownership Plan ("ESOP") for all eligible employees. The ESOP is funded by two loans from Bankshares. ESOP Loan I was used to purchase 389,248 shares of common stock (as adjusted by the Exchange Ratio of 2.0445) in the open market. The loan is being repaid from the Association's contributions to the ESOP over a period of up to seven years and had an outstanding balance of $244,000 at December 31, 2000. The loan has a fixed interest rate of 8.50%. ESOP Loan II was used to permit the ESOP to purchase an additional 437,652 shares in connection with the Reorganization. The loan is being repaid over 15 years and the loan had an outstanding balance of $3.8 million at December 31, 2000 and has a fixed interest rate of 7.75%. For further information, see Note 13 to the Notes to the Consolidated Financial Statements in the Annual Report attached hereto as Exhibit 13.
The following table sets forth the source, balance, and rate of borrowings for the years ended December 31, 2000, 1999, and 1998.
SUBSIDIARY ACTIVITIES
The Association currently has two active subsidiaries.
ComFed, Inc. ("ComFed") was formed in February 1971 to operate an insurance agency, Community Insurance Agency, which sells mortgage life insurance. ComFed also receives income and incurs related expenses from the sale of third party mutual funds and annuities. Such third party mutual funds and annuities include products widely marketed to the investing public and have investment advisors that are not affiliated with ComFed. For the year ended December 31, 2000, ComFed reported net income of $131,000. At December 31, 2000, the Association had an equity investment in ComFed of $88,000.
Palm River Development Co., Inc. ("Palm River"), incorporated in 1999, is involved in a real estate development venture commenced in mid-1999 to construct and sell single-family lots, condominiums, villa homes and carriage homes on 117 acres of land located in Indian River County, Florida. Under the terms of the development agreement, Palm River will fund all construction and development costs, including the cost of acquiring the land, and receives interest on any outstanding funding. Profits from home and lot sales, after interest, are divided equally between Palm River and its development partner. Palm River's investment in and advances to the real estate venture totaled $14.0 million at December 31, 2000. Palm River recognized a net loss of $939,000 during the year ended December 31, 2000. This net loss represents the expected recognition of start-up costs during the preliminary stages of this construction project. Developed lot closings are expected to commence during the first half of 2001. Construction of the models is expected to begin in the first half of 2001. Currently, the sale of all the units is anticipated to be completed during 2004.
Number Of units Reservations Type of units planned on units (1) - -------------------------------------------------------------------------------
Riverfront single-family lots 17 11 Condominiums 48 8 Villa single-family homes 112 3 Carriage duplex homes 22 3 --- -- Total 199 25 === ==
- ----------- (1) Reservations require a deposit of 10% of the purchase price from the buyer to reserve a particular lot or home but allow the purchaser to cancel the reservation without penalty. Reservations are being converted to contracts as a result of the receipt of certain approvals were received from city and county authorities in February 2001. Cancellation of contracts results in the purchasers forfeiting their deposits.
A $12.5 million line of credit from the Association is used by the project to fund operations as needed. An additional $6.0 million loan from Bankshares for the project was made during 2000. At December 31, 2000, the Association had an equity loss in Palm River of $1.1 million. The balances of the loans from the Association and Bankshares were $10.3 million and $6.0 million, respectively, at December 31, 2000.
PERSONNEL
As of December 31, 2000, Bankshares had no separately compensated employees. Officers of Bankshares are employees of the Association and receive all compensation from the Association. Because Bankshares' primary activity is holding the stock of the Association, employees of the Association only perform limited duties for Bankshares.
As of December 31, 2000, the Association had 254 full-time and 36 part-time employees. None of the Association's employees is represented by a collective bargaining group. The Association believes it has a good relationship with its employees.
REGULATION
Set forth below is a brief description of certain laws and regulations applicable to Bankshares and the Association. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.
GENERAL
The Association, as a federally chartered savings institution, is subject to federal regulation and oversight by the OTS extending to all aspects of its operations. The Association also is subject to regulation and examination by the FDIC, which insures the deposits of the Association to the maximum extent permitted by law, and requirements established by the Federal Reserve Board. Federally chartered savings institutions are required to file periodic reports with the OTS and are subject to periodic examinations by the OTS and FDIC. The investment and lending authority of savings institutions are prescribed by federal laws and regulations, and such institutions are prohibited from engaging in any activities not permitted by such laws and regulations. Such regulation and supervision primarily is intended for the protection of depositors and not for the purpose of protecting shareholders.
BANKSHARES
HOLDING COMPANY ACQUISITIONS. In December 1998, Bankshares became a unitary savings and loan holding company within the meaning of the Home Owners' Loan Act, as amended ("HOLA"), and has registered with the OTS. The HOLA and OTS regulations generally prohibit a savings and loan holding company, without prior OTS approval, from acquiring, directly or indirectly, the ownership or control of any other savings institution or savings and loan holding company, or all, or substantially all, of the assets or more than 5% of the voting shares thereof. These provisions also prohibit, among other things, any director or officer of a savings and loan holding company, or any individual who owns or
controls more than 25% of the voting shares of such holding company, from acquiring control of any savings institution not a subsidiary of such savings and loan holding company, unless the acquisition is approved by the OTS.
HOLDING COMPANY ACTIVITIES. Bankshares operates as a unitary savings and loan holding company. Generally, there are only limited restrictions on the activities of a unitary savings and loan holding company which applied to become or were a unitary savings and loan holding company prior to May 4, 1999 and its non-savings institution subsidiaries. Under the enacted Gramm-Leach-Bliley Act of 1999 (the "GLBA"), companies which applied to the OTS after May 9, 1999 to become unitary savings and loan holding companies are restricted to engaging in those activities traditionally permitted to multiple savings and loan holding companies. If the Director of the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings institution, the Director may impose such restrictions as deemed necessary to address such risk, including limiting (i) payment of dividends by the savings institution; (ii) transactions between the savings institution and its affiliates; and (iii) any activities of the savings institution that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings institution. Notwithstanding the above rules as to permissible business activities of grandfathered unitary savings and loan holding companies under the GLBA, if the savings institution subsidiary of such a holding company fails to meet the QTL test, as discussed under "-The Association - Qualified Thrift Lender Test," then such unitary holding company also shall become subject to the activities restrictions applicable to multiple savings and loan holding companies and, unless the savings institution requalifies as a QTL within one year thereafter, shall register as, and become subject to the restrictions applicable to, a bank holding company. See "-The Association - Qualified Thrift Lender Test."
The GLBA also imposed new financial privacy obligations and reporting requirements on all financial institutions. The privacy regulations require, among other things, that financial institutions establish privacy policies and disclose such policies to its customers at the commencement of a customer relationship and annually thereafter. In addition, financial institutions are required to permit customers to opt out of the financial institution's disclosure of the customer's financial information to non-affiliated third parties. Such regulations become mandatory as of July 1, 2001.
The HOLA requires every savings institution subsidiary of a savings and loan holding company to give the OTS at least 30 days' advance notice of any proposed dividends to be made on its guarantee, permanent or other nonwithdrawable stock, or else such dividend will be invalid. See "- The Association - Capital Distributions."
AFFILIATE RESTRICTIONS. Transactions between a savings institution and its "affiliates" are subject to quantitative and qualitative restrictions under Sections 23A and 23B of the Federal Reserve Act and OTS regulations. Affiliates of a savings institution include, among other entities, the savings institution's holding company and companies that are controlled by or under common control with the savings institution.
In general, Sections 23A and 23B and OTS regulations issued in connection therewith limit the extent to which a savings institution or its subsidiaries may engage in certain "covered transactions" with affiliates to an amount equal to 10% of the institution's capital and surplus, in the case of covered transactions with any one affiliate, and to an amount equal to 20% of such capital and surplus, in the case of covered transactions with all affiliates. In addition, a savings institution and its subsidiaries may engage in covered transactions and certain other transactions only on terms and under circumstances that are substantially the same, or at least as favorable to the savings institution or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies. A "covered transaction" is defined to include a loan or extension of credit to an affiliate; a purchase of investment securities issued by an affiliate; a purchase of assets from an affiliate, with certain exceptions; the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any party; or the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.
In addition, under OTS regulations, a savings institution may not make a loan or extension of credit to an affiliate unless the affiliate is engaged only in activities permissible for bank holding companies; a savings institution may not purchase or invest in securities of an affiliate other than shares of a subsidiary; a savings institution and its subsidiaries may not purchase a low-quality asset from an affiliate; and covered transactions and certain other transactions between a savings institution or its subsidiaries and an affiliate must be on terms and conditions that are consistent with safe and sound banking practices. With certain exceptions, each loan or extension of credit by a savings institution to an affiliate must be secured by collateral with a market value ranging from 100% to 130% (depending on the type of collateral) of the amount of the loan or extension of credit.
OTS regulations generally exclude all non-bank and non-savings institution subsidiaries of savings institutions from treatment as affiliates, except to the extent that the OTS or the Federal Reserve Board decides to treat such subsidiaries as affiliates. The regulations also require savings institutions to make and retain records that reflect affiliate transactions in reasonable detail, and provides that certain classes of savings institutions may be required to give the OTS prior notice of affiliate transactions.
THE ASSOCIATION
INSURANCE OF ACCOUNTS. The deposits of the Association are insured to the maximum extent permitted by the SAIF, which is administered by the FDIC, and are backed by the full faith and credit of the U.S. Government. As insurer, the FDIC 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 threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OTS an opportunity to take such action.
The FDIC may terminate the deposit insurance of any insured depository institution, including the Association, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances which would result in termination of the Association's deposit insurance.
REGULATORY CAPITAL REQUIREMENTS. The OTS capital requirements consist of a "tangible capital requirement," a "leverage capital requirement" and a "risk-based capital requirement." The OTS is also authorized to impose capital requirements in excess of those standards on individual institutions on a case-by-case basis.
Under the tangible capital requirement, a savings association must maintain tangible capital in an amount equal to at least 1.5% of adjusted total assets. Tangible capital is defined as core capital less all intangible assets (including supervisory goodwill), plus a specified amount of purchased mortgage servicing rights.
Under the leverage capital requirement adopted by the OTS, savings associations maintain "core capital" in an amount equal to at least 4% (3% if the savings association receives the OTS's highest rating) of adjusted total assets. Core capital is generally defined as common stockholders' equity, including retained earnings. At December 31, 2000, the Association's ratio of core capital to total adjusted assets was 7.73%.
Under the risk-based capital requirement, a savings association must maintain total capital (which is defined as core capital plus supplementary capital) equal to at least 8.0% of risk-weighted assets. A savings association must calculate its risk-weighted assets by multiplying each asset and off-balance sheet item by various risk factors, which range from 0% for cash and securities issued by the United States Government or its agencies to 100% for repossessed assets or loans more than 90 days past due. Qualifying one- to four-family residential real estate loans and qualifying multi-family residential real estate loans (not more than 90 days delinquent and having an 80% or lower loan-to-value ratio), are weighted at a 50% risk factor. Supplementary capital may include, among other items, general allowances for loan losses. The allowance for loan losses includable in supplementary capital is limited to 1.25% of risk-weighted assets. Supplementary capital is limited to 100% of core capital.
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 non-residential construction loans in excess of an 80% loan-to-value ratio and reciprocal holdings of qualifying capital instruments. However, in calculating regulatory capital, institutions can add back unrealized losses and deduct unrealized gains net of taxes, on debt securities reported as a separate component of GAAP capital.
OTS regulations establish special capitalization requirements for savings associations that own service corporations and other subsidiaries, including subsidiary savings associations. According to 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, engaged solely in mortgage-banking activities, 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, including the assets of includable subsidiaries in which the association has a minority interest that is not consolidated for GAAP purposes. For excludable subsidiaries, the debt and equity investments in such subsidiaries are deducted from assets and capital. At December 31, 2000, the $9.2 million investment in Palm River was subject to a deduction from tangible capital.
The OTS amended its risk-based capital requirements to require institutions with an "above normal" level of interest rate risk to maintain additional capital. A savings association is considered to have a "normal" level of interest rate risk if the decline in the market value of its portfolio equity after an immediate 200 basis point increase or decrease in market interest rates (whichever leads to the greater decline) is less than two percent of the current estimated market value of its assets. The market value of portfolio equity is defined as the net present value of expected cash inflows and outflows from an association's assets, liabilities, and off-balance sheet items. The amount of additional capital that an institution with an above normal interest rate risk is required to maintain (the "interest rate risk component") equals one-half of the dollar amount by which its measured interest rate risk exceeds the normal level of interest rate risk. The interest rate risk component is in addition to the capital otherwise required to satisfy the risk-based capital requirement. Implementation of this component has been postponed by the OTS. The final rule was to be effective as of January 1, 1994, subject however to a three quarter lag time in implementation. However, because of continuing delays by the OTS, the interest rate risk component has never been operative.
At December 31, 2000, the Association exceeded all of its regulatory capital requirements, with tangible, core and risk-based capital ratios of 7.73%, 7.73%, and 14.29%, respectively. See Note 14 to the Notes to Consolidated Financial Statements included in the Annual Report, attached hereto as Exhibit 13.
The OTS and the FDIC generally are authorized to take enforcement action against a savings association that fails to meet its capital requirements, which action may include restrictions on operations and banking activities, the imposition of a capital directive, a cease-and-desist order, civil money penalties or harsher measures such as the appointment of a receiver or conservator or a forced merger into another institution. In addition, under current regulatory policy, an association that fails to meet its capital requirements is prohibited from paying any dividends.
PROMPT CORRECTIVE ACTION. Under the prompt corrective action regulations of the OTS, an institution is deemed to be (i) "well-capitalized" if it has total risk-based capital of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or more, has a Tier 1 leverage capital ratio of 5.0% or more and is not subject to any order or final capital directive to meet and maintain a specific capital level for any capital measure, (ii) "adequately capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more and a Tier 1 leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized," (iii) "undercapitalized" if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less that 4.0% or a Tier 1 leverage capital ratio that is less than 4.0% (3.0% under certain circumstances),(iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a Tier 1 leverage capital ratio that is less than 3.0%, and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Under specified circumstances, a federal banking agency may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized institution as critically undercapitalized).
An institution generally must file a written capital restoration plan which meets specified requirements with its appropriate federal banking agency within 45 days of the date that the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. A federal banking agency must provide the institution with written notice of approval or disapproval within 60 days after receiving a capital restoration plan, subject to extensions by the agency. An institution which is required to submit a capital restoration plan must concurrently submit a performance guaranty by each company that controls the institution. In addition, undercapitalized institutions are subject to various regulatory restrictions, and the appropriate federal banking agency also may take any number of discretionary supervisory actions.
At December 31, 2000, the Association was in the "well capitalized" category for purposes of the above regulations and as such is not subject to any of the above mentioned restrictions.
SAFETY AND SOUNDNESS GUIDELINES. The OTS and the other federal bank regulatory agencies have established guidelines for safety and soundness, addressing operational and managerial standards, as well as compensation matters for insured financial institutions. Institutions failing to meet these standards are required to submit compliance plans to their appropriate federal regulators. The OTS and the other agencies have also established guidelines regarding asset quality and earnings standards for insured institutions. The Association believes that it is in compliance with these guidelines and standards.
LIQUIDITY REQUIREMENTS. All savings institutions were previously required to maintain an average daily balance of liquid assets equal to a certain percentage of the sum of its average daily balance of net withdrawable deposit accounts and borrowings payable in one year or less. The liquidity requirement varied from time to time (between 4% and 10%) depending upon economic conditions and savings flows of all savings institutions. During 2000, the required minimum liquid asset ratio was 4%. For the month ended December 31, 2000, the Association's average liquidity ratio was 8.7%. This regulation was discontinued by the OTS effective in 2001.
CAPITAL DISTRIBUTIONS. OTS regulations govern capital distributions by savings institutions, which include cash dividends, stock redemptions or repurchases, cash-out mergers, interest payments on certain convertible debt and other transactions charged to the capital account of a savings institution to make capital distributions.
A savings institution must file an application for OTS approval of the capital distribution if either (1) the total capital distributions for the applicable calendar year exceed the sum of the institution's net income for that year to date plus the institution's retained net income (which takes into account capital distributions made) for the preceding two years, (2) the institution would not be at least adequately capitalized following the distribution, (3) the distribution would violate any applicable statute, regulation, agreement or OTS-imposed condition, or (4) the institution is not eligible for expedited treatment of its filings. If an application is not required to be filed, savings institutions which are a subsidiary of a holding company (as well as certain other institutions) must still file a notice with the OTS at least 30 days before the Board of Directors declares a dividend or approves a capital distribution.
BRANCHING BY FEDERAL SAVINGS INSTITUTIONS. OTS policy permits interstate branching to the full extent permitted by statute (which is essentially unlimited). Generally, federal law prohibits federal savings institutions from establishing, retaining or operating a branch outside that state in which the federal institution has its home office unless the institution meets the Internal Revenue Service's (the "IRS") domestic building and loan test (generally, 60% of a thrift's assets must be housing-related) ("IRS Test"). The IRS Test requirement does not apply if: (i) the branch(es) result(s) from an emergency acquisition of a troubled savings institution (however, if the troubled savings institution is acquired by a bank holding company, does not have its home office in the state of the bank holding company bank subsidiary and does not qualify under the IRS Test, its branching is limited to the branching laws for state-chartered banks in the state where the savings institution is located); (ii) the law of the state where the branch would be located would permit the branch to be established if the federal savings institution was chartered by the state in which its home office is located; or (iii) the branch was operated lawfully as a branch under the state law prior to the savings institution's conversion to a federal charter.
Furthermore, the OTS will evaluate a branching applicant's record of compliance with the Community Reinvestment Act of 1977 ("CRA"). An unsatisfactory CRA record may be the basis for denial of a branching application.
COMMUNITY REINVESTMENT ACT AND THE FAIR LENDING LAWS. Savings institutions have a responsibility under the CRA and related regulations of the OTS to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act (together, the "Fair Lending Laws") prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An institution's failure to comply with the provisions of CRA could, at a minimum, result in regulatory restrictions on its activities, and failure to comply with the Fair Lending Laws could result in enforcement actions by the OTS, as well as other federal regulatory agencies and the Department of Justice.
QUALIFIED THRIFT LENDER TEST. All savings institutions are required to meet a QTL test to avoid certain restrictions on their operations. A savings institution can comply with the QTL test by meeting the IRS Test or by meeting the second prong of the QTL test set forth in the HOLA. A savings institution that does not meet the QTL test must either convert to a bank charter or comply with the following restrictions on its operation. Upon the expiration of three years from the date the savings institution ceases to be a QTL, it must cease any activity and not retain any investment not permissible
for a national bank and immediately repay any outstanding FHLB advances (subject to safety and soundness considerations).
Currently, the portion of the QTL test that is based on the HOLA rather than the Code requires that 65% of an institution's "portfolio assets" (as defined) consist of certain housing and consumer-related assets on a monthly average basis in nine out of every 12 months. Assets that qualify without limit for inclusion as part of the 65% requirement are loans made to purchase, refinance, construct, improve or repair domestic residential housing and manufactured housing; home equity loans; mortgage-backed securities (where the mortgages are secured by domestic residential housing or manufactured housing); stock issued by the FHLB; and direct or indirect obligations of the FDIC. In addition, small business loans, credit card loans, student loans and loans for personal, family, and household purposes are allowed to be included without limitation as qualified investments. The following assets, among others, also may be included in meeting the test subject to an overall limit of 20% of the savings institution's portfolio assets: 50% of residential mortgage loans originated and sold within 90 days of origination; 100% of consumer and educational loans (limited to 10% of total portfolio assets); and stock issued by the FHLMC or the FNMA. Portfolio assets consist of total assets minus the sum of (i) goodwill and other intangible assets, (ii) property used by the savings institution to conduct its business, and (iii) liquid assets up to 20% of the institution's total assets. At December 31, 2000, the qualified thrift investments of the Association were approximately 78.5% of its portfolio assets.
FEDERAL HOME LOAN BANK SYSTEM. The Association is a member of the FHLB of Atlanta, which is one of 12 regional FHLBs that administer the home financing credit function or savings institutions. 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. At December 31, 2000, the Association had $146.7 million of FHLB advances. See Note 9 to Notes to Consolidated Financial Statements in the Annual Report.
As a member, the Association is required to purchase and maintain stock in the FHLB of Atlanta in an amount equal to at least 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year. At December 31, 2000, the Association had $8.1 million in FHLB stock, which was in compliance with this requirement.
The FHLBs are required to provide funds for the resolution of troubled savings institutions and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have adversely affected the level of FHLB dividends paid and could continue to do so in the future. These contributions also could have an adverse effect on the value of FHLB stock in the future. The dividend yield on the Association's FHLB stock was 7.75%, 7.57% and 7.25% for the fiscal years ended December 31, 2000, 1999, and 1998, respectively.
FEDERAL RESERVE SYSTEM. Federal Reserve Board regulations require all depository institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and Super NOW checking accounts) and non-personal time deposits. At December 31, 2000, the Association was in compliance with the 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.
TAXATION FEDERAL TAXATION
For federal income tax purposes, Bankshares files a consolidated federal income tax return with the Association on a fiscal year basis.
On May 13, 1997, permission was received from the IRS to change the accounting period, for federal income tax purposes, from September 30th to December 31st, effective December 31, 1996.
Bankshares and the Association are subject to the rules of federal income taxation generally applicable to corporations under the Code. Most corporations are not permitted to make deductible additions to bad debt reserves under the Code. However, prior to the effective date of legislation passed in 1996, savings and loan associations and savings associations such as the Association, which met certain tests prescribed by the IRS may have benefited from favorable
provisions provided for in Section 593 of the code regarding deductions for taxable income for annual additions to the bad debt reserve.
During 1996, effective for years beginning after December 31, 1995, legislation was passed that repealed section 593 of the Code. Section 593 allowed thrift institutions, including the Association, to use the percentage-of-taxable income bad debt accounting method, if more favorable than the specific charge-off method, for federal income tax purposes. The excess reserves (deduction based on the percentage-of-taxable income less the deduction based on the specific charge-off method) accumulated post-1987 are required to be recaptured ratably over a six year period beginning in 1996. The excess reserve as of December 31, 1996 was approximately $435,000. The same legislation forgave the tax liability on pre-1987 accumulated bad debt reserves which would have penalized any thrift choosing to adopt a bank charter because the tax would have become due and payable. The unrecorded potential liability that was forgiven approximated $4.3 million. See Note 11 to the Notes to the Consolidated Financial Statements in the Annual Report, attached hereto as Exhibit 13.
Deferred income taxes arise from the recognition of certain items of income and expense for tax purposes in years different from those in which they are recognized in the financial statements. In February 1992, the FASB issued Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). SFAS No. 109 was implemented by Bankshares retroactively, effective October 1, 1993. The liability method accounts for deferred income taxes by applying the enacted statutory rates in effect at the balance sheet date to differences between the book cost and the tax cost of assets and liabilities. The resulting deferred tax liabilities and assets are adjusted to reflect changes in tax laws.
Bankshares is subject to the corporate alternative minimum tax which is imposed to the extent it exceeds Bankshares' regular income tax for the year. The alternative minimum tax will be imposed at the rate of 20% of a specially computed tax base. Included in this base will be a number of preference items, including the interest on certain tax-exempt bonds issued after August 7, 1986. In addition, for purposes of the alternative minimum tax, the amount of alternative minimum taxable income that may be offset by net operating losses is limited to 90% of alternative minimum taxable income.
The Association was audited by the IRS for the tax year 1990 during fiscal year 1994. Based upon the audit, the Association received a "no-change" letter from the IRS. Bankshares has not been audited by the IRS. The fiscal years ended December 21, 2000, 1999, and 1998 for Bankshares and the Association are open for audit by the IRS. In addition, the fiscal year ended September 30, 1998 for the Association is open for audit. See Notes 1 and 11 to the Notes to the Consolidated Financial Statements in the Annual Report.
STATE TAXATION
Under the laws of the State of Florida, Bankshares and its subsidiary are generally subject to 5.5% tax on net income. The tax may be reduced by a credit of up to 65% of the tax due as a result of certain intangible taxes. The tax is deductible by Bankshares in determining its federal income tax liability. Bankshares has not been audited by the State of Florida.
ITEM 2.
ITEM 2. PROPERTIES - --------------------------------------------------------------------------------
Bankshares owns no property independently from the Association. The Association conducts its business through its home office located in North Palm Beach, Florida, and 21 full-service branch offices located in Palm Beach, Martin, St. Lucie, and Indian River Counties. The following table sets forth certain information concerning the home office and each branch office of the Association at December 31, 2000. The aggregate net book value of the Association's premises and equipment and real estate held for investment was $25.3 million and $2.2 million at December 31, 2000, respectively. Real estate held for investment represents a pro-rata portion of the Association's office building located on Port St. Lucie Blvd. which is leased to tenants and a parcel of land held for future sale located adjacent to the Association's Maplewood office. For additional information regarding the Association's properties, see Note 6 to the Notes to the Consolidated Financial Statements in the Annual Report, attached hereto as Exhibit 13. In addition, the Association owns or has placed earnest funds on four parcels of real estate for use as possible future branch sites. The Association's total investment in such other properties totaled $1.9 million at December 31, 2000 which is included in the aggregate net book value of the Association's premises and equipment set forth above.
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(1) A branch office is also located at the same site.
(2) This lease expires on August 8, 2001 and provides for a renewal option which runs through August 8, 2003. Construction has begun on a new office to replace the existing leased facility on land owned by the Association. The new office is expected to be completed and the leased office closed in July 2001
(3) The current lease expires on October 31, 2001 and provides for a renewal option which runs through October 31, 2016. However, the Association has entered into a contract to purchase the land and building. The closing is currently expected to be completed before June 2001.
(4) This lease expires on June 25, 2004 and provides for a renewal option which runs through June 25, 2014.
(5) This lease expires on September 1, 2002.
(6) Construction of an addition which will provide drive-in services is expected to begin in March 2001 and to be completed by June 2001
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS - --------------------------------------------------------------------------------
There are various claims and lawsuits in which Bankshares is periodically involved incident to its business. In the opinion of management, no material loss is expected from any of such pending claims or lawsuits.
ITEM 4
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - --------------------------------------------------------------------------------
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS - --------------------------------------------------------------------------------
For information concerning the market for Bankshares' common stock, see "The Association - Capital Distributions" in Part 1, Item 1 and the section captioned "Corporate Information" in Bankshares' Annual Report attached as Exhibit 13 hereto and which is incorporated herein by reference.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA - --------------------------------------------------------------------------------
The "Financial Highlights" section of Bankshares' Annual Report is incorporated herein by reference.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - --------------------------------------------------------------------------------
The "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of Bankshares' Annual Report is incorporated herein by reference.
ITEM 7 - A QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK - --------------------------------------------------------------------------------
Information with respect to quantitative and qualitative disclosures about market risk is incorporated by reference to the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk Analysis, and - Market Value of Portfolio Equity" in the Annual Report.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA - --------------------------------------------------------------------------------
The financial statements identified in Item 14(a)(1) hereof are incorporated by reference to Bankshares' Annual Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - --------------------------------------------------------------------------------
Information required by this section is incorporated herein by reference from Bankshares' definitive Proxy Statement for the Annual Meeting of Shareholders filed March 26, 2001 (the "Proxy Statement"), specifically the section captioned "Ratification of Appointment of Independent Auditors".
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - --------------------------------------------------------------------------------
Information concerning Directors and Executive Officers of Bankshares is incorporated herein by reference from the Proxy Statement, specifically the sections captioned "Information with Respect to Nominees for Director, Directors Whose Terms Continue and Executive Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION - --------------------------------------------------------------------------------
Information concerning executive compensation is incorporated herein by reference from the Proxy Statement, specifically the section captioned "Executive Compensation".
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 Proxy Statement, specifically the section captioned "Beneficial Ownership of Common Stock by Certain Beneficial Owners and Management".
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - --------------------------------------------------------------------------------
Information concerning relationships and transactions is incorporated herein by reference from the Proxy Statement, specifically the section captioned "Executive Compensation - Indebtedness of Management and Affiliated Transactions."
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - --------------------------------------------------------------------------------
The exhibits and financial statement schedules filed as a part of this Form 10-K are as follows:
(a)(1) Financial Statements Independent Auditors' Report Consolidated Statements of Financial Condition, December 31, 2000, and 1999 Consolidated Statements of Operations, Years Ended December 31, 2000, 1999 and 1998 Consolidated Statements of Shareholders' Equity, Years Ended December 31, 2000, 1999 and 1998 Consolidated Statements of Cash Flows, Years Ended December 31, 2000, 1999 and 1998 Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules
No financial statement schedules are filed because the required information is not applicable or is included in the consolidated financial statements or related notes.
(a)(3) Exhibits
3.1 Certificate of Incorporation of Community Savings Bankshares, Inc.*
3.2 Bylaws of Community Savings Bankshares, Inc.*
4.0 Form of Stock Certificate of Community Savings Bankshares, Inc.*
10.1 Amended and Restated 1995 Stock Option Plan**
10.3 Amended and Restated 1995 Recognition and Retention Plan for Employees and Outside Directors**
10.3 Amended and Restated 1999 Stock Option Plan**
10.4 Amended and Restated 1999 Recognition and Retention Plan and Trust Agreement**
10.5 Employment Agreement between Community Savings Bankshares, Inc., Community Savings, F. A. and James B. Pittard, Jr. ***
10.6 Change in Control Agreement between Community Savings Bankshares, Inc., Community Savings, F. A. and James B. Pittard, Jr. ***
10.7 Form of change in Control Agreement with Larry J. Baker, CPA, Cecil F. Howard, Jr., Michael E. Reinhardt and certain non-executive officers, and Community Savings Bankshares, Inc. and Community Savings, F. A. ***
10.8 Amended and Restated Supplemental Retirement Income Plan
13 2000 Annual Report to Shareholders
21 Subsidiaries of the Registrant - Reference is made to Item 1 "Business" for the required information.
23 Consent of Crowe Chizek and Company LLP
* Incorporated by reference from the Registration statement on Form S-1 (333-62069) first filed with the Securities and Exchange Commission ("SEC") on August 21, 1998.
** Incorporated by reference from Bankshares' definitive proxy statement dated November 10, 1999 filed with the SEC on said date.
*** Incorporated by reference from Bankshares' Annual Report on Form 10-K for the fiscal year ended December 31, 1999 filed with the SEC on March 24, 2000.
(b) Reports on Form 8-K:
None.
(c) The exhibits listed under (a)(3) above are filed herewith.
(d) Not applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 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.
COMMUNITY SAVINGS BANKSHARES, INC.
Date: March 26, 2001 By: /s/ JAMES B. PITTARD, JR. ------------------------------------- James B. Pittard, Jr. President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By: /s/ JAMES B. PITTARD, JR. By: /s/ LARRY J. BAKER, CPA ------------------------------- ------------------------------- James B. Pittard, Jr., Larry J. Baker, CPA, President and Chief Senior Vice President, Executive Officer Chief Financial Officer (Principal Executive Officer) and Treasurer (Principal Financial and Accounting Officer)
Date: March 26, 2001 Date: March 26, 2001
By: /s/ FREDERICK A. TEED By: /s/ JOHN SHELDON CLARK ------------------------------- ------------------------------- Frederick A. Teed, Chairman John Sheldon Clark, Director of the Board
Date: March 26, 2001 Date: March 26, 2001
By: /s/ ROBERT F. CROMWELL By: /s/ RONALD P. JAWORSKI ------------------------------- ------------------------------- Robert F. Cromwell, Director Ronald P. Jaworski, Director
Date: March 26, 2001 Date: March 26, 2001
By: /s/ HAROLD I. STEVENSON ------------------------------- Harold I. Stevenson, Director
Date: March 26, 2001