Item 1. Business
This section should be read in conjunction with the following parts of this Form 10-K: Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," Part II, Item 7A, "Quantitative and Qualitative Disclosures About Market Risk" and Part II, Item 8, "Financial Statements and Supplementary Data."
The Company
HF Financial Corp. is a unitary thrift holding company that was formed in November 1991 for the purpose of owning all of the outstanding stock of Home Federal Bank (the "Bank"), its principal banking subsidiary. The Company acquired all of the outstanding stock of the Bank on April 8, 1992. Effective as of July 21, 2011, the Company is regulated as a savings and loan holding company by the Board of Governors of the Federal Reserve System ("Federal Reserve"). The Company is incorporated under the laws of the State of Delaware and generally is authorized to engage in any activity that is permitted by the Delaware General Corporation Law. The Company's primary business is to operate the Bank. Unless otherwise indicated, all matters discussed in this Form 10-K relate to the Company and its direct and indirect subsidiaries, including, without limitation, the Bank. See "Subsidiary Activities" below for further information regarding the subsidiary operations of the Company and the Bank.
The executive offices of the Company and its direct and indirect subsidiaries are located at 225 South Main Avenue, Sioux Falls, South Dakota, 57104. The Company's telephone number is (605) 333-7556.
Website and Available Information
The website for the Company and the Bank is located at www.homefederal.com and for the Bloomington, Minnesota branch at www.infiniabank.com. Information on these websites does not constitute part of this Form 10-K.
The Company makes available, free of charge, its Form 10-K, its quarterly reports on Form 10-Q, its current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as soon as reasonably practicable after such forms are filed with or furnished to the U.S. Securities and Exchange Commission ("SEC"). Copies of these documents are available to stockholders upon request addressed to the Secretary of the Company at 225 South Main Avenue, Sioux Falls, South Dakota, 57104.
The Bank
The Bank was founded in 1929 and is a federally chartered stock savings bank headquartered in Sioux Falls, South Dakota. The Bank provides full-service consumer and commercial business banking, including an array of financial products and services, to meet the needs of its marketplace. The Bank attracts deposits from the general public and uses such deposits, together with borrowings and other funds, to originate one- to four-family residential loans, commercial business loans, agriculture loans, consumer loans, multi-family and commercial real estate loans and construction loans. The Bank's consumer
loan portfolio includes, among other types, automobile loans, recreational vehicle loans, boat loans, home equity loans and lines of credit and loans secured by deposit accounts.
Through its trust department, the Bank acts as trustee, personal representative, administrator, guardian, custodian, agent, advisor and manager for various accounts. At June 30, 2013, the trust department of the Bank maintained approximately $108.2 million in assets under management. Wealth management has become a strategic focus of the Bank, and the Bank has added expertise in portfolio management and business development to enhance this business line to drive future growth in assets under management and fee income.
The Bank also purchases agency residential mortgage-backed securities and invests in U.S. Government and agency obligations and other permissible investments. The Bank receives loan servicing income on loans serviced for others and commission income from credit life insurance on consumer loans. The Bank, through its wholly-owned subsidiaries, offers annuities, mutual funds, life insurance and other financial products and services, as well as equipment leasing services.
The Bank's deposits are insured up to applicable limits by the Federal Deposit Insurance Corporation ("FDIC") as administrator of the Deposit Insurance Fund ("DIF"). Effective as of July 21, 2011, the Bank is subject to primary supervision, regulation and examination by the Office of the Comptroller of the Currency ("OCC").
Segments
Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance. The Company's reportable segments are "banking" (including leasing activities) and "other." The "banking" segment is conducted through the Bank and Mid America Capital Services, Inc. ("Mid America Capital") and the "other" segment is composed of smaller non-reportable segments, the Company and inter-segment eliminations. For financial information by segment see Note 1 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Form 10-K.
Subsidiary Activities
In addition to the Bank, the Company had six other wholly-owned subsidiaries at June 30, 2013: HF Financial Group, Inc. ("HF Group"), HF Financial Capital Trust III ("Trust III"), HF Financial Capital Trust IV ("Trust IV"), HF Financial Capital Trust V ("Trust V"), HF Financial Capital Trust VI ("Trust VI") and HomeFirst Mortgage Corp. (the "Mortgage Corp.").
In August 2002, the Company formed HF Group, a South Dakota corporation. HF Group previously marketed software to facilitate employee benefits administration, payroll processing and management and governmental reporting. HF Group no longer actively markets this software and had immaterial operations in 2013. Intercompany interest income is eliminated in the preparation of consolidated financial statements.
In December 2002, the Company formed Trust III, a Delaware corporation, for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust III.
In September 2003, the Company formed Trust IV, a Delaware corporation, for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust IV.
In December 2006, the Company formed Trust V, a Delaware corporation, for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust V.
In July 2007, the Company formed Trust VI, a Delaware corporation, for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole asset of Trust VI.
The Mortgage Corp., a South Dakota corporation formed in September 1994, was previously engaged in the business of originating one- to four-family residential mortgage loans, which were sold into the secondary market. The Mortgage Corp. had no activity during fiscal years 2013 and 2012.
As a federally chartered thrift institution, the Bank is permitted by OCC regulations to invest up to 2% of its assets in the stock of, or loans to, service corporation subsidiaries. The Bank may invest an additional 1% of its assets in service corporations where such additional funds are used for inner-city or community development purposes. The Bank currently has
less than 1% of its assets in investments in its subsidiary service corporations as defined by the OCC. In addition to investments in service corporations, the Bank is permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities in which the Bank may engage directly.
The Bank has four wholly-owned subsidiaries, Hometown Investment Services, Inc. ("Hometown"), Mid America Capital Services, Inc. ("Mid America Capital"), Mid-America Service Corporation ("Mid-America") and PMD, Inc. ("PMD").
Hometown, a South Dakota corporation formed in February 1951, provides financial and insurance products to customers of the Bank and members of the general public in the Bank's market area. Insurance products offered by Hometown primarily include annuities and life insurance products. Hometown obtains its funding via a line of credit from the Bank. Banking regulations do not limit the amount of funding provided to an operating subsidiary. In April 2013, the approved line of credit was increased from $50,000 to $100,000. At June 30, 2013, there were no advances on this line of credit. Intercompany interest income and interest expense are eliminated in the preparation of consolidated financial statements.
Mid America Capital, a South Dakota corporation formed in October 1990, specializes in equipment finance leasing. Mid America Capital obtains its funding through a line of credit from the Bank. Banking regulations do not limit the amount of funding provided to an operating subsidiary. At June 30, 2013, Mid America Capital had advanced $80,000 on an approved line of credit of $2.0 million with the Bank. In July 2013, the approved line of credit was reduced to $250,000 from $2.0 million. Intercompany interest income and interest expense are eliminated in the preparation of consolidated financial statements.
Mid-America, a South Dakota corporation formed in August 1971, in the past provided residential appraisal services to the Bank and other lenders in the Bank's market. Mid-America had no activity during fiscal years 2013 and 2012.
PMD, a South Dakota corporation formed in January 1992, in the past was engaged in the business of buying, selling and managing repossessed real estate properties. PMD had no activity during fiscal years 2013 and 2012.
Market Area
Based on total assets at June 30, 2013, the Bank is the largest savings association headquartered in South Dakota. The Bank has a total of 27 banking centers in its market area and an Internet branch located at www.homefederal.com. The Bank's primary market area includes communities located in eastern and central South Dakota, including the Sioux Falls metropolitan statistical area ("MSA"), and the cities of Pierre, Mitchell, Aberdeen, Brookings, Watertown, and Yankton. The Bank has a banking center in Marshall, Minnesota, which serves customers located in southwestern Minnesota. A banking center in Bloomington, Minnesota, which serves customers in the metropolitan area of the Twin Cities, does business as Infinia Bank, a Division of Home Federal Bank of South Dakota. An Internet branch is located at www.infiniabank.com to serve the Twin Cities market area. The Bank's primary market area features a variety of agribusiness, financial services, health care and light manufacturing firms. The Internet branches and mobile banking allow access to customers beyond traditional geographical areas.
Business Strategy
The Company's business strategy is to remain a community-focused financial institution and to grow and improve its profitability by:
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Continuing to Build Out our Distribution Capabilities in our Existing Markets. The Company strives to fulfill its mission statement every day-"...to be the leading financial services provider to businesses and individuals in the communities we serve." The Company intends to increase its market share in its core market area by providing personalized banking and customized wealth management services. The Company will continue to capitalize on the economics of its market area and strive to maintain a profitable and community-focused financial institution.
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Continuing to Build our Cornerstone Banking Businesses. The Company remains focused on building its cornerstone banking businesses of personal banking, commercial and agriculture banking and wealth management services. In the past several years, the Company has made investments in its infrastructure, technology and human capital, with the specific aim to capitalize on these businesses.
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Expanding Relationships with Existing Customers and Developing Relationships with New Customers. The Company will continue to strive to fund its business through deposits within its market area, with a strategic focus on multiple-service household growth. The Company endeavors to increase existing and new customer relationships by providing individualized personal customer attention with local decision-making authority, which the Company believes positively distinguishes it from its larger, non-locally owned competitors.
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Taking Advantage of Opportunities with Economic Recovery. The Company will continue to position itself to take advantage of appropriate growth opportunities that may arise as the national economy recovers. The Company plans
to grow its lending activities through organic growth and/or, if appropriate opportunities arise, possible acquisitions of banks, thrifts and other financial services companies.
Lending Activities
The Bank originates a variety of loans including one- to four-family residential loans, commercial business loans, agriculture loans, consumer loans, multi-family and commercial real estate loans, and construction loans. Consumer loans include loans for automobile purchases, home equity and home improvement loans and student loans.
Business Banking
Commercial Business Lending. In order to serve the needs of the local business community and improve the interest rate sensitivity and yield of its assets, the Bank originates adjustable- and fixed-rate commercial loans. Interest rates on commercial business loans generally adjust or float with a designated national index plus a specified margin. The Bank's commercial business lending activities encompass loans with a variety of purposes and security, including loans to finance accounts receivable, inventory and equipment and business expansion within the Bank's market area. The Bank originates commercial business loans directly and through programs sponsored by the Small Business Administration ("SBA") of which a portion of such loans are also guaranteed in part by the SBA. The Bank generally originates commercial business loans for its portfolio and retains the servicing with respect to such loans. The Bank anticipates continued expansion and emphasis of its commercial business lending, subject to market conditions and the Home Owners' Loan Act ("HOLA") restrictions. See "Regulation-Loan and Investment Powers" below for HOLA restrictions.
Commercial business loans typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself (which, in turn, may be dependent upon the general economic environment). The Bank's commercial business loans are typically secured by the assets of the business, such as accounts receivable, equipment and inventory. However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. Whenever possible, the Bank's commercial business loans include personal guarantees of the borrowers. In addition, the loan officer may perform on-site visits, obtain financial statements and perform a financial review of the loan.
Multi-Family and Commercial Real Estate Lending. The Bank engages in multi-family and commercial real estate lending primarily in South Dakota and the adjoining Midwestern states. These lending activities may include existing property or new construction development or purchased loans, including loans to builders and developers for the construction of one- to four-family residences and condominiums and the development of one- to four-family lots.
Loans secured by multi-family and commercial real estate properties are generally larger and involve a greater degree of credit risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family and commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower's ability to repay the loan may be impaired. In addition, loans secured by property outside of the Bank's primary market area may contain a higher degree of risk due to the fact that the Bank may not be as familiar with market conditions where such property is located. The Bank does not have a material concentration of multi-family or commercial real estate loans outside of South Dakota and the adjoining Midwestern states.
The Bank presently originates adjustable-rate, short-term balloon payment, fixed-rate multi-family and commercial real estate loans. The Bank's multi-family and commercial real estate loan portfolio is secured primarily by apartment buildings and owner occupied and non-owner occupied commercial real estate. The terms of such loans are negotiated on a case-by-case basis. Commercial real estate loans generally have terms that do not exceed 25 years. The Bank has a variety of rate adjustment features, call provisions and other terms in its multi-family and commercial real estate loan portfolio. Generally, the loans are made in amounts up to 80% of the appraised value of the collateral property and with debt service coverage ratios of 115% or higher. The debt service coverage is the ratio of net cash from operations divided by payments of debt obligations. However, these percentages may vary depending on the type of security and the guarantor. Such loans provide for a negotiated margin over a designated national index. The Bank analyzes the borrower's financial condition, credit history, prior record for producing sufficient income from similar loans, and references as well as the reliability and predictability of the net income generated by the property securing the loan. The Bank generally requires personal guarantees of borrowers.
Depending on the circumstances of the security of the loan or the relationship with the borrower, the Bank may decide to sell participations in the loan. The sale of participation interests in a loan are necessitated by the amount of the loan or the limitation of loans-to-one borrower. See "Regulation-Loans-to-One Borrower" for a discussion of the loans-to-one borrower regulations. In return for servicing these loans for the participants, the Bank generally receives a fee and income is received at
loan closing from loan fees and discount points. Appraisals on properties securing multi-family and commercial real estate loans originated by the Bank are performed by appraisers approved pursuant to the Bank's appraisal policy.
The Bank also makes loans to developers for the purpose of developing one- to four-family lots. These loans typically have terms of one year and carry floating interest rates based on a national designated index. Loan commitment and partial release fees are charged. These loans generally provide for the payment of interest and loan fees from loan proceeds. The principal balance of these loans is typically paid down as lots are sold. Builder construction and development loans are obtained principally through continued business from developers and builders who have previously borrowed from the Bank, as well as broker referrals and direct solicitations of developers and builders. The application process includes a submission to the Bank of plans, specifications and costs of the project to be constructed or developed. These items are used as a basis to determine the appraised value of the subject property. Loans are based on the lesser of current appraised value and/or the cost of construction (land plus building), and land development loans are generally originated with a maximum loan-to-value ratio of 65% based upon an independent appraisal.
The HOLA includes a provision that limits the Bank's non-residential real estate lending to no more than four times its total capital. This maximum limitation, which at June 30, 2013 was $472.7 million, has not materially limited the Bank's lending practices.
Under HOLA, the maximum amount which the Bank may lend to any one borrower is 15% of the Bank's unimpaired capital and surplus, or $18.6 million at June 30, 2013. Loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to the same borrower if such loans are fully secured by readily marketable collateral. The Bank may request a waiver from the OCC to exceed the 15% loans-to-one borrower limitation on a case-by-case basis. See "Regulation-Loans-to-One Borrower" for more information and a discussion of the loans-to-one borrower regulations.
Construction Lending. The Bank makes construction loans to individuals for the construction of their residences, as well as loans to builders and developers for the construction of single family and multi-family residential properties, in the Bank's primary market area.
Construction loans to individuals for their residences are structured to be converted to mortgage loans at the end of the construction phase, which typically runs six to twelve months. Residential construction loans are generally underwritten pursuant to the same guidelines used for originating residential mortgage loans.
The Bank makes loans for the construction of multi-family residential properties. Such loans are generally made at adjustable-rates, which adjust periodically based on the appropriate index.
Construction loans are generally originated with a maximum loan-to-value ratio of 80%, and up to 90% on loans to individuals for construction of their residence, based upon an independent appraisal. Because of the uncertainties inherent in estimating development and construction costs and the market for the project upon completion, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of ultimate success of the project. Construction and development loans to borrowers other than owner occupants also involve many of the same risks discussed above regarding multi-family and commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans.
Prior to making a commitment to fund a construction loan, the Bank requires an appraisal of the property, or, for larger projects, both an appraisal and a study of the feasibility of the proposed project. The Bank's construction loan policy provides for the inspection of properties by independent in-house and outside inspectors at the commencement of construction and prior to disbursement of funds during the term of the construction loan.
Agricultural Loans. In order to serve the needs of the local agricultural community and improve the interest rate sensitivity and yield of its assets, the Bank originates agricultural loans through its agricultural division. The agricultural division offers loans to its customers such as: (i) operating loans that are used to fund the borrower's operating expenses, which typically have a one year term and are indexed to the national prime rate; (ii) term loans on machinery, equipment and breeding stock that may have a term up to seven years and require annual payments; (iii) agricultural farmland term loans that are used to finance (or refinance) land purchases; (iv) specialized loans to fund facilities and equipment for livestock confinement enterprises; and (v) loans to fund ethanol plant development. Agriculture real estate loans typically will have personal guarantees of the borrowers, a first lien on the real estate, interest rates adjustable to the national prime rate or Treasury Note rates, and annual, quarterly or monthly payments. Operating and term loans are secured by farm chattels (crops, livestock, machinery, etc.), which are the operating assets of the borrower. The Bank also originates agricultural loans directly and through programs sponsored by the Farmers Service Agency ("FSA") of which a portion of such loans are also guaranteed in part by the FSA. The Bank also provides financing for part-time farmers and their primary residences. These loans are for customers who derive the majority of their income from non-farming related sources but do derive a portion of their income
from the property they are financing. These loans are typically sold to Farmer Mac with the Bank providing the ongoing servicing. For these services the Bank is paid an annual servicing fee from Farmer Mac.
Loan customers are required to supply current financial statements, tax returns and cash flow projections which are updated on an annual basis. In addition, on major loans, the loan officer will perform an annual farm visit, obtain financial statements and perform a financial review of the loan.
Mortgage Lending
One- to Four-Family Residential Mortgage Lending. One- to four-family residential mortgage loan originations are primarily generated by the Bank's marketing efforts, its present customers, walk-in customers, phone or Internet customers and referrals from real estate agents and builders. The Bank has focused its lending efforts primarily on the origination of loans secured by first mortgages on owner-occupied, one- to four-family residences.
The Bank currently makes 15-, 20- and 30-year fixed- and adjustable-rate one- to four-family residential mortgage ("ARM") loans at loan-to-value ratios consistent with Federal National Mortgage Association ("FNMA")/Federal Home Loan Mortgage Corporation ("FHLMC") guidelines. Loan-to-values exceeding 80% are required to include private mortgage insurance in an amount sufficient to reduce the Bank's or the investor's exposure at or below the 80% level or secure additional financing up to currently 90% of the value of the property. The Bank generally offers an ARM loan with a fixed rate for the initial three, five or seven years, which then converts to a one-year annual rate reset ARM for the remainder of the life of the loan. These loans provide for an annual cap and a lifetime cap at a set percent over the fully-indexed rate.
The Bank also offers a portfolio loan product that is an ARM loan with a fixed rate for the initial seven years, which then converts to a one-year annual rate reset ARM for the remainder of the life of the loan.
The Bank also offers fixed-rate 15- to 30-year mortgage loans that conform to secondary market standards. Interest rates charged on these fixed-rate loans are competitively priced on a daily basis according to market conditions. Residential loans generally do not include prepayment penalties.
The Bank also originates fixed-rate one- to four-family residential mortgage loans through the South Dakota Housing Development Authority ("SDHDA") program. These loans generally have terms not to exceed 30 years and are insured by the Federal Housing Administration ("FHA"), Veterans Administration ("VA"), Rural Development or private mortgage insurance.
During the second quarter of fiscal 2012, the Company was informed by SDHDA that a change in business model was necessary for SDHDA to continue to meet the financing needs of its single family mortgage program in South Dakota. This change in business model effectively ended the new flow of servicing assets from SDHDA to the Company beginning April 1, 2012. Due to this change, the single family mortgage segment of the Company's servicing portfolio has decreased in principal value, but the decrease has partially been offset by new originations of loans sold to Fannie Mae with servicing retained. The Company continues to evaluate potential acquisition of servicing assets dependent upon market conditions and characteristics desirable by the Company, which may include bidding as the master servicer for SDHDA after the initial two year commitment is complete.
The Bank continues to receive a servicing fee, for the loans that continue to be serviced, of generally 0.38% from the SDHDA for these services. The servicing fee rate may subsequently decline to a minimum of 0.25% based on delinquency characteristics. The Bank is currently the largest servicer of loans for the SDHDA. At June 30, 2013, the Bank serviced $635.8 million of mortgage loans for the SDHDA. See Note 4 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8, "Financial Statements and Supplementary Data" in this Form 10-K, for information on loan servicing.
In underwriting one- to four-family residential mortgage loans, the Bank evaluates both the borrower's ability to make monthly payments and the value of the property securing the loan. The property that secures the real estate loans made by the Bank is appraised by an appraiser approved under the Bank's appraisal policy. The Bank requires borrowers to obtain title, fire and casualty insurance in an amount not less than the amount of the loan. Real estate loans originated by the Bank contain a "due-on-sale" clause allowing the Bank to declare the unpaid principal balance due and payable upon the sale of the collateral property.
The Bank offers online mortgage capabilities through QuickClickTM Online Mortgage Solutions, a service that allows customers to check rates, research loan options and complete mortgage applications via the Bank's website. This service is currently available to all branch locations in South Dakota and Minnesota.
Consumer Lending
Other Consumer Lending. The Bank's management considers its consumer loan products to be an important component of its lending strategy. Specifically, consumer loans generally have shorter terms to maturity and carry higher rates of interest than one- to four-family residential mortgage loans. In addition, the Bank's management believes that the offering of consumer loan products helps to expand and create stronger ties to its existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities.
The Bank's consumer loan portfolio includes, among other types, automobile loans, recreational vehicle loans, boat loans, home equity loans and lines of credit and loans secured by deposit accounts. Consumer loan terms vary according to the type of collateral, length of contract and creditworthiness of the borrower. The Bank offers both open- and closed-end credit. Overdraft lending is extended through lines of credit that are tied to a checking account. The credit lines generally bear interest at 18% and are generally limited to no more than $2,000. Loans secured by deposit accounts at the Bank are currently originated for up to 90% of the account balance, with a hold placed on the account restricting the withdrawal of the account balance. The interest rate on such loans is typically equal to 3% above the contract rate.
Home equity loans secured by second mortgages, together with loans secured by all prior liens, are generally limited to a maximum of 90% of the appraised value of the property securing the loan and generally have maximum terms that do not exceed 15 years. Home equity lines of credit have a maximum term of five years.
The underwriting standards employed by the Bank for consumer loans include an application, a determination of the applicant's payment history on other debts, and an assessment of the ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes an analysis of the value of the security, if any, in relation to the proposed loan amount. As of July 1, 2013, the Bank implemented centralized underwriting for all consumer credit requests. This was accomplished through the addition of a Consumer Underwriter and the launch of a credit decisioning engine entitled Decision Pro. This change will ensure that the Bank consistently applies its underwriting standards to all consumer credit requests.
Interest rates on home equity lines of credit are variable based upon a margin over the Wall Street Journal Prime Rate. Home equity lines of credit are stress tested during underwriting to determine the borrower's capacity to repay the debt should economic conditions change. The borrower's debt to income ratio must remain within underwriting guidelines after including the stress tested payment on the home equity line of credit.
Consumer loans may entail greater credit risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or are secured by rapidly depreciable assets, such as automobiles or boats. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.
Leasing Activities
General. Through its wholly owned subsidiary, Mid America Capital, the Bank originates commercial and municipal leases. These products have a fixed interest rate for the duration of the lease with terms typically ranging from 24 to 60 months. The leases generally are 100% financed with either the first or first and last months' payments due at lease inception. As a result of the 100% financing and fixed interest rate, the yield on leases is higher than similar type lending products.
During fiscal 2013, leases were originated in the Bank's trade area in the upper Midwest. All leases are secured by the equipment leased, with personal guarantees of the borrowers normally obtained on commercial leases. In fiscal 2012, Mid America Capital reduced its efforts in originating new leases. It continues to service existing leases, but will continue to see a reduced level of lease balances as payments occur and reach maturity. The decision to reduce marketing efforts will not have a material impact on the Company.
Commercial Leases. In order to support the Bank and its customers and to improve the yield of its assets, Mid America Capital originates commercial leases to customers primarily in the Bank's trade area. Mid America Capital basically has offered two types of commercial leases: capital and tax leases. Leases encompass a wide variety of equipment for a variety of commercial uses. The customer base tends to be small- to medium-sized businesses that view leasing as another financing option that augments their overall operation. Repayment terms tend to be monthly in nature. As with commercial loans, commercial leases typically are made on the basis of the borrower's ability to make repayment from the cash flow of their business. As a result, the availability of funds for the repayment of commercial leases may be substantially dependent on the
success of the business itself. The collateral securing the leases will generally depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
Municipal Leases. The Bank and Mid America Capital also have originated leases to municipal entities such as cities, counties, and public schools. The lessee must be a political subdivision of the state in order to qualify as a municipal lease. Because the interest income earned on this type of lease is exempt from federal income taxes, the rate offered to the municipality is usually substantially lower than a comparable commercial lease. Repayment terms generally are on a monthly, semi-annual or annual basis. Residual values are $1.00 for municipal leases.
Repayment is based on the municipality's ability to levy and collect taxes. Assuming the municipality has a bond rating, that bond rating, together with audited financial statements, are the basis for the lease. On larger leases, bond ratings and financial statements will be reviewed annually.
Loan and Lease Portfolio Composition. Over the past several years, the Company has transformed its loan and lease portfolio from predominantly one-to four-family residential and consumer loans to a more diverse portfolio including commercial and agricultural loans. As part of the Company's business strategy to build the commercial, commercial real estate and agricultural portfolio segments, the Bank has hired several bankers with significant commercial and agricultural lending experience, which has led to successful growth results across these business lines. The Company's commercial, commercial real estate and agricultural portfolio segments represented 79.9% of the Company's total loan and lease portfolio at June 30, 2013, while its residential and consumer portfolio segments accounted for 20.1%. At the same time, the Company continues to prioritize and invest in mortgage lending as it believes this to be a core component of its personal banking strategy.
The following table sets forth information concerning the composition of the Company's loan and lease portfolio from continuing operations in dollar amounts and in percentages (before deductions for allowance for loan and lease losses as of the dates indicated.
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(1)
Includes tax-exempt loans and leases.
(2)
Net of deferred fees and discounts and exclusive of undisbursed portion of loans in process.
The following table sets forth information concerning the balance of the Company's undisbursed portion of loans in process excluded from total gross loans and leases above, and deferred fees and discounts which have been netted against the loans and indicated above as of the dates indicated.
The following table sets forth information concerning the balance of the Company's loans held for sale by loan class, which have been excluded from tables identifying loans and leases receivable as of the dates indicated.
The following table sets forth the composition of the Company's loan and lease portfolio from continuing operations by fixed- and adjustable-rate in dollar amounts and in percentages (before deductions for allowance for loan and lease losses) as of the dates indicated. Adjustable-rate loans are tied to various indices including prime rate and the treasury yield curve and have reset dates ranging from daily to several years.
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(1)
Includes tax-exempt loans and leases.
(2)
Net of deferred fees and discounts and exclusive of undisbursed loans in process.
The following schedule illustrates the scheduled principal contractual repayments of the Company's loan and lease portfolio at June 30, 2013. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
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(1)
Includes equipment finance leases and tax-exempt loans and leases.
Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of loans is substantially less than their average contractual terms because of prepayments. In addition, due-on-sale clauses on loans generally give the Bank the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan rates are substantially higher than rates on existing mortgage loans and decrease when rates on existing mortgages are substantially higher than current mortgage loan rates.
Potential Problem Loans
Nonperforming Assets. See "Asset Quality" under Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K for discussion.
Classified Assets. Federal regulations provide for the classification of loans, leases and other assets, such as debt and equity securities considered by the OCC to be of lesser quality, as "substandard," "doubtful" or "loss." An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the "distinct possibility" that the Company will sustain "some loss" if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses inherent in those classified "substandard," with the added characteristic that the weaknesses present make "collection or liquidation in full," on the basis of currently existing facts, conditions, and values, "highly questionable and improbable." Assets classified as "loss" are those considered "uncollectible" and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the Company to sufficient risk to warrant classification in one of the aforementioned categories, but possess weaknesses, are required to be designated "criticized" or "special mention" by management.
When the Company classifies problem assets as "loss," it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge-off such amount. The Company's determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the Bank's Assistant Deputy Comptroller at the regional OCC office, who may order the establishment of additional general or specific loss allowances.
In connection with the filing of its periodic reports with the OCC and in accordance with its classification of assets policy, the Company regularly reviews problem loans and leases in its portfolio to determine whether any loans or leases require classification, as well as investment securities, in accordance with applicable regulations. On the basis of management's monthly review of its assets, at June 30, 2013, the Company had designated $40.2 million of its assets as classified. Other potential problem loans are included in criticized and classified assets. See "Asset Quality" under Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K for further discussion.
Allowance for Loan and Lease Losses. See "Application of Critical Accounting Policies" and "Asset Quality" under Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K for discussion.
Investment Activities
The Bank is required under OCC regulation to maintain a sufficient amount of liquid assets. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans.
Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers' acceptances, repurchase agreements and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest their assets in commercial paper, investment grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly.
Generally, the Bank invests funds among various categories of investments and maturities based upon the Bank's asset/liability management policies, investment quality and marketability, liquidity needs and performance objectives. At June 30, 2013, approximately 95.9% of its investment portfolio was in AAA-rated, liquid agency residential mortgage-backed securities.
At June 30, 2013, the Bank's investments in agency residential mortgage-backed securities totaled $406.9 million, or 33.4% of its total assets, and did not include any private-label securities. As of such date, the Bank also had an $8.9 million investment in the stock of the Federal Home Loan Bank of Des Moines ("FHLB" or "FHLB of Des Moines") in order to satisfy the FHLB of Des Moines' requirement for membership.
The composition and maturities of the investment securities portfolio, excluding equity securities, are indicated in the following table:
The effective maturities for the Bank's agency residential mortgage-backed securities are much shorter due to the combination of prepayments and the $347.4 million adjustable-rate agency residential mortgage-backed securities. The variable or hybrid (fixed for a period of time and then variable thereafter) structure gives the Bank flexibility in risk management of the balance sheet.
Management has a process to identify securities that could potentially have a credit impairment that is other-than-temporary. This process involves evaluating the length of time and extent to which the fair value has been less than the amortized cost basis, reviewing available information regarding the financial position of the issuer, monitoring the rating of the security, and projecting cash flows. Management also determines if it is more likely than not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity. To the extent the Company determines that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized. In fiscal 2013, there were no other-than-temporary impairment losses. See Note 2, "Investment Securities," of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 of this Form 10-K for additional information.
The Bank's investment securities portfolio is managed in accordance with a written investment policy adopted by the Bank's Board of Directors. Investments may be made by the Bank's officers within specified limits and approved in advance by the Bank's chief executive officer for transactions over these limits. At June 30, 2013, the Bank does not have any investments that are held for trading purposes and had $424.2 million of securities available for sale, including agency residential mortgage-backed securities of $406.9 million. See Note 2 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K for further information on the Company's investment portfolio.
Sources of Funds
General. The Company's primary sources of funds are net income, in-market deposits, FHLB advances and other borrowings, amortization and repayments of loan principal, agency residential mortgage-backed securities and callable agency securities. Secondary sources include sales of mortgage loans, sales and/or maturities of securities, out-of-market deposits and short-term investments.
Borrowings of the Bank are primarily from the FHLB of Des Moines, and may be used on a short-term basis to compensate for seasonal reductions in deposits or deposit inflows at less than projected levels, and may be used on a longer-term basis to support expanded lending activities. The Bank has established collateral at the Federal Reserve Bank of Minneapolis ("FRB") as a contingent source of funding. See Note 8 of the "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K for further detail of the Company's borrowings.
Deposits. The Bank offers a variety of deposit accounts having a wide range of interest rates and terms. The Bank's deposits consist of statement savings accounts, checking accounts, money market and certificate of deposit accounts ranging in terms from 30 days to five years for our non-brokered certificates. The Bank primarily solicits deposits from its market area, with a strategic focus of multiple-service household growth. The Bank relies primarily on customer service, competitive pricing policies and advertising to attract and retain these deposits. Based on liquidity needs, the Bank may, from time to time, acquire out-of-market deposits in those circumstances where wholesale funding offers either a maturity or cost efficiency not available with retail deposits. At June 30, 2013, out-of-market deposits accounted for less than 3% of total deposits.
The flow of deposits is influenced by general economic conditions, changes in money market and prevailing interest rates and competition. The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. In recent years, the Bank has been susceptible to short-term fluctuations in deposit flows due to economic conditions, interest rate sensitivity and safety needs of customers. The Bank manages the pricing of its deposits in keeping with its asset/liability management and profitability objectives. Based on its experience, the Bank believes that its savings, money market, and checking accounts are stable sources of deposits. However, the ability of the Bank to attract and maintain certificates of deposit, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions.
The following table sets forth the dollar amount of deposits in the various types of deposit accounts offered by the Bank as of June 30:
The following table sets forth the amount of the Company's certificates of deposit and other deposits by time remaining until maturity at June 30, 2013:
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(1)
Includes funds from the Certificate of Deposit Account Registry Service ("CDARS") certificate of deposit program of $13.0 million.
(2)
Includes certificates of deposit of $100,000 or greater of $22.4 million.
(3)
Includes certificates of deposit from governmental and other public entities, excluding out-of-market certificates of deposit.
(4)
Includes certificates of deposit of $100,000 or greater of $4.7 million.
The Bank solicits certificates of deposit of $100,000 or greater from various state, county and local government units which carry rates which are negotiated at the time of deposit. See Note 7 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K. Deposits at June 30, 2013, and 2012 included $96.4 million and $113.3 million, respectively, of deposits from one local governmental entity.
Borrowings. Although deposits are the Bank's primary source of funds, the Bank's policy has been to utilize borrowings when they are a less costly source of funds or can be invested at a positive rate of return.
The Bank's borrowings consist primarily of advances from the FHLB of Des Moines upon the security of its capital stock of the FHLB of Des Moines and certain pledgeable loans, including but not limited to, its mortgage related loans, agency residential mortgage-backed securities and U.S. Government and other agency securities. Such advances can be made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. At June 30, 2013, the Bank's FHLB advances totaled $166.9 million, representing 14.9% of total liabilities. See Note 8 of "Notes to Consolidated Financial Statements," which is included in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K for further detail of the Company's borrowings.
The following table sets forth the maximum month-end balances and average balances of FHLB and FRB advances and other borrowings of the Company at the dates indicated:
The following table sets forth certain information as to the Bank's FHLB and FRB advances and other borrowings of the Company at the dates indicated:
Competition
The banking business is highly competitive and the Bank experiences competition in each of its markets from many other financial institutions, many of which are larger and may have significantly greater financial and other resources. Specifically through the Bank, the Company competes with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as super-regional, national and international financial institutions, that operate offices in the Company's primary market areas and elsewhere. Many of these competitors are also well-established financial institutions.
Competitors that are not depository institutions are generally not subject to the extensive regulations that apply to the Bank. The Bank competes with these institutions both in attracting deposits and in making loans. The Bank competes for deposits by offering a variety of deposit accounts at competitive rates, convenient business hours and convenient branch locations with inter-branch deposit and withdrawal privileges at each. The Bank competes for loans on the basis of quality of service, interest rates, loan fees and loan type. In addition, the Bank must attract its customer base from other existing financial institutions and from new residents. In new markets that the Bank may enter, the Bank will also compete against well-established community banks that have developed relationships within the community.
Employees
At June 30, 2013, the Bank had a total of 306 full-time employees and 28 part-time employees. The full-time employees include nine employees of the Bank's subsidiary corporations. The Bank's employees are not represented by any collective bargaining group. Management considers its relations with its employees to be good.
Regulation
General
The Company is regulated as a savings and loan holding company by the Federal Reserve. As a savings and loan holding company, the Company is required to file reports with, and otherwise comply with, the rules and regulations of the Federal Reserve and of the SEC under federal securities laws.
The Bank is a federally chartered thrift institution that is subject to broad federal regulation and oversight extending to all of its operations by its primary federal regulator, the OCC, and by its deposit insurer, the FDIC. Such regulation covers all aspects of the banking business, including lending practices, safeguarding deposits, capital structure, transactions with affiliates and conduct and qualifications of personnel. The Bank is a member of the FHLB of Des Moines.
The Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act")
Major financial reform legislation, known as the Dodd-Frank Act, was signed into law by the President in July 2010. Many of the provisions of the Dodd-Frank Act affecting the Company and Bank have effective dates ranging from immediately upon enactment of the legislation to several years following enactment of the Dodd-Frank Act.
Of particular significance to thrift institutions is that, as a result of regulatory restructuring called for by the Dodd-Frank Act, both the Company and Bank transitioned to the jurisdiction of their current primary federal regulators on July 21, 2011. Prior to that date, the Company and Bank had been subject to consolidated supervision and regulation by the Office of Thrift Supervision ("OTS").
In connection with the transition to new regulators for federal savings associations and their holding companies, the Dodd-Frank Act provides that OTS orders, resolutions, determinations, agreements, regulations, interpretive rules, other
interpretations, guidelines, procedures and other advisory materials that were in effect before the transfer date are now to be enforced by the Federal Reserve and OCC with respect to savings and loan holding companies and federal savings associations, respectively, unless the Federal Reserve or OCC modifies, terminates, or sets aside such guidance or until superseded by the Federal Reserve or OCC, a court, or operation of law.
Among the Dodd-Frank Act's significant regulatory changes, it created a new federal consumer protection agency, the Consumer Financial Protection Bureau (“CFPB”), that is empowered to promulgate new consumer protection regulations and revise existing regulations in many areas of consumer protection, including with respect to mortgage lending. The CFPB has exclusive authority to issue regulations, orders and guidance to administer and implement the objectives of federal consumer protection laws. The Dodd-Frank Act also transferred the enforcement authority over certain large institutions with respect to compliance with the federal consumer protection laws from the existing banking agencies to the CFPB. Given the size of the Bank, primary jurisdiction for enforcement of the federal consumer protection laws remains with the OCC. The Company and Bank are continuing to closely monitor and evaluate developments under the Dodd-Frank Act with respect to our business, financial condition, results of operations and prospects. For further discussion on the potential impact of the Dodd-Frank Act on the Company and Bank, see "Risk Factors" below.
The following discussion is intended to provide a summary of the material statutes and regulations applicable to savings and loan holding companies and federal savings associations with activity and size profiles that are similar to those of the Company and Bank, respectively, and does not purport to be a comprehensive description of all such statutes and regulations.
Regulation of Federal Savings Associations
As the new primary federal regulator for federal savings associations as of July 21, 2011, the OCC has extensive authority over the operations of federal savings associations, including the Bank. This regulation and supervision establishes a comprehensive framework for activities in which a federal savings association can engage and is intended primarily for the protection of the DIF and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes.
Business Activities
The activities of federal savings associations are generally governed by federal laws and regulations. These laws and regulations delineate the nature and extent of the activities in which federal savings associations may engage. In particular, the lending authority for federal savings associations for various asset types is limited to a specified percentage of the association's capital or assets.
Loan and Investment Powers
The Bank derives its lending and investment powers from the HOLA and the OCC's implementing regulations thereunder applicable to federal savings associations. Under these laws and regulations, the Bank may invest in mortgage loans secured by residential and commercial real estate, commercial and consumer loans, certain types of debt securities and certain other assets, subject to any investment limitations that may apply depending on asset type. The Bank may also establish service corporations that may engage in activities not otherwise permissible for the Bank, including certain real estate equity investments and securities and insurance brokerage activities.
Loans-To-One Borrower
Under the HOLA, the Bank is generally subject to the same limits on loans-to-one borrower as are imposed on national banks. With specified exceptions, the Bank may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of the association's unimpaired capital and surplus. Additional amounts may be loaned, not in excess of 10% of unimpaired capital and surplus, if such loans or extensions of credit are fully secured by readily-marketable collateral.
Assessments
The OCC collects supervisory assessments from federal savings associations by calculating such assessments on a semi-annual basis based generally on the amount of an association's total balance sheet assets. The OCC's assessment structure imposes a surcharge for federal savings associations that require increased supervisory resources.
Enforcement
The OCC has primary enforcement responsibility over federal savings associations, including the Bank. In general, these enforcement actions may be initiated in response to violations of laws and regulations and to unsafe or unsound practices and can result in, among other things, assessments of civil money penalties, issuance of cease and desist orders and removal of
directors and officers. Under the Federal Deposit Insurance Act, the FDIC has the authority to recommend to the Comptroller of the Currency that an enforcement action be taken with respect to a particular savings association. If action is not taken by the OCC, the FDIC may take action under certain circumstances.
Safety and Soundness Standards
Under federal law, the OCC has adopted a set of guidelines prescribing safety and soundness standards. The guidelines establish general standards relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal stockholder.
In addition, the OCC is authorized to order a federal savings association that has been notified that it is not satisfying applicable safety and soundness standards to submit a compliance plan. If, after being so ordered, an association fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the OCC must issue an order directing action to correct the deficiency and may issue an order directing corrective actions and other actions of the types to which an undercapitalized association is subject under the "prompt corrective action" provisions of federal law. If a bank fails to comply with such an order, the OCC may seek to enforce such order in judicial proceedings and to impose civil money penalties.
Regulatory Capital Requirements
OCC regulations require the Bank to meet three minimum capital standards:
•
a tangible capital ratio requirement of 1.50%;
•
a leverage (core capital) ratio requirement of 4.00% (3.00% if a savings association has been assigned the highest composite rating); and
•
a risk-based capital ratio requirement of 8.00%.
The OCC is also authorized by statute to establish minimum capital requirements for an individual savings association as the OCC, in its discretion, deems appropriate in light of the particular circumstances at the savings association. In assessing an institution's capital adequacy, the OCC takes into consideration not only these numeric factors but also qualitative factors and has the authority to establish higher capital requirements for individual institutions where necessary. The Bank, as a matter of prudent management, targets as its goal the maintenance of capital ratios which exceed these minimum requirements and that are consistent with the Bank's risk profile.
At June 30, 2013, the Bank exceeded each of its capital requirements as shown in the following table:
_____________________________________
(1)
The Bank's investment in its subsidiaries is included for purposes of calculating regulatory capital.
(2)
Tier I (core) capital figures are determined as a percentage of total adjusted assets; risk based capital figures are determined as a percentage of risk-weighted assets.
In July 2013, the OCC and Federal Reserve issued a final rule revising the regulatory capital rules applicable to all national banks and federal savings associations as well as their holding companies (except for certain savings and loan holding companies that are "substantially engaged" in commercial or insurance underwriting activities) generally beginning on January
1, 2015. The rule implements the Basel Committee's December 2010 framework known as "Basel III" for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. The final rule implements a revised definition of regulatory capital, a new common equity Tier 1 minimum capital requirement of 4.5%, and a higher minimum Tier 1 capital requirement of 6.0% (which is an increase from 4.0%). Under the final rule, the total capital ratio remains at 8.0% and the minimum leverage ratio (Tier 1 capital to total assets) for all banking organizations, regardless of supervisory rating, is 4.0%.
Additionally, under the new rule, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to risk-weighted assets. The final rule also enhances risk sensitivity and addresses weaknesses identified by the regulators over recent years with the measure of risk-weighted assets, including through new measures of creditworthiness to replace references to credit ratings, consistent with the requirements of the Dodd-Frank Act.
Except for the largest internationally active banking organizations (which are subject to the "advanced approaches" provisions of the final rule), the new minimum capital requirements generally become effective for all banking organizations on January 1, 2015, whereas the capital conservation buffer and the deductions from common equity Tier 1 capital phase in over time, beginning on January 1, 2016. Similarly, non-qualifying capital instruments phase out over time.
Prompt Corrective Action Regulations
Under the OCC prompt corrective action regulations, the OCC is required to take certain, and is authorized to take other, supervisory actions against undercapitalized savings associations. For this purpose, a savings association is placed in one of the following five categories based on its capital:
•
well-capitalized;
•
adequately capitalized;
•
undercapitalized;
•
significantly undercapitalized; or
•
critically undercapitalized.
The severity of the action authorized or required to be taken under the prompt corrective action ("PCA") regulations increases as an institution's capital decreases within the three undercapitalized categories. A savings association may not pay a dividend or make any other capital distributions or pay management fees to any controlling person if, following such distribution, the savings association would be undercapitalized. The OCC is required to monitor closely the condition of an undercapitalized savings association and to restrict the growth of its assets.
An undercapitalized savings association is required to file a capital restoration plan within 45 days of the date the association receives notice that it is within any of the three undercapitalized categories, and the plan must be guaranteed by its parent holding company, subject to a cap on the guarantee that is the lesser of:
•
an amount equal to 5% of the association's total assets at the time it became "undercapitalized;" and
•
the amount that is necessary (or would have been necessary) to bring the association into compliance with all capital standards applicable with respect to such association as of the time it fails to comply with the plan.
If a savings association fails to submit an acceptable plan, it is treated as if it were "significantly undercapitalized." Banks that are "significantly" or "critically undercapitalized" are subject to a wider range of regulatory requirements and restrictions. A savings association is generally treated as "well-capitalized" if its total risk-based capital ratio is 10% or greater, its Tier 1 risk-based capital ratio is 6% or greater, its leverage ratio is 5% or greater, and it is not subject to any order or directive by the OCC to meet a specific capital level.
At June 30, 2013, the Bank met the applicable regulatory criteria for being considered "well-capitalized."
The new capital rules issued by the federal banking agencies in July 2013 described above maintain the general structure of the current PCA framework while incorporating the increased minimum capital requirements.
Federal Deposit Insurance of Accounts and Regulation by the FDIC
The Bank is a member of, and pays deposit insurance assessments to, the DIF, which is administered by the FDIC. All deposits of the Bank are insured up to $250,000 per depositor for each account ownership category.
FDIC insurance of deposits is backed by the full faith and credit of the U.S. government. In order to maintain the DIF, the FDIC imposes deposit insurance premiums on member institutions and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines to pose a serious risk to the DIF. The FDIC also has the authority to initiate enforcement actions against savings associations, after giving the OCC an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged or is engaging in unsafe or unsound practices, or is in an unsafe or unsound condition.
In December 2009, along with each institution's risk-based deposit insurance assessment for the third quarter of 2009, all non-exempt insured depository institutions were required to prepay their quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012. The prepaid assessment credit program ended with the final credit application on the quarterly deposit insurance invoice issued in the first quarter of 2013. Accordingly, the FDIC has resumed collecting deposit insurance assessments from insured institutions based on a rate schedule that became effective in April 2011 which defines a bank's assessment base as its average consolidated total assets minus its average tangible equity, and calculates the assessment that is due according to an institution's risk category. The FDIC has suspended dividends indefinitely; however, in lieu of dividends, and pursuant to its authority to set risk-based assessments, the FDIC has adopted progressively lower assessment rate schedules that will take effect when the reserve ratio exceeds 1.15%, 2.00%, and 2.50%. The FDIC has authority to increase insurance assessments. A significant increase in DIF insurance premiums would have an adverse effect on the operating expenses and results of operations of the Bank.
In addition, all FDIC-insured institutions are required to pay assessments to the FDIC at an annual rate that is adjusted quarterly to reflect changes in the assessment base as determined from the quarterly bank Call Report submissions to fund interest payments on bonds issued by the Financing Corporation ("FICO"), an agency of the federal government established in 1987 to recapitalize the predecessor to the DIF. These assessments, which are adjusted quarterly, will continue until the FICO bonds mature in 2017 through 2019.
Under federal law, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OCC. The Bank's management does not know of any practice, condition or violation that might lead to termination of deposit insurance.
Limitations on Dividends and Other Capital Distributions
Federal regulations govern the permissibility of capital distributions by a federal savings association. Pursuant to the Dodd-Frank Act, savings associations that are part of a savings and loan holding company structure must file a notice of a declaration of a dividend with the Federal Reserve. In the case of cash dividends, OCC regulations require that federal savings associations that are subsidiaries of a stock savings and loan holding company must file an informational copy of that notice with the OCC at the same time it is filed with the Federal Reserve. Under certain circumstances set forth in OCC regulations and as described below, a federal savings association is required to submit an application or notice to the OCC before it may make a capital distribution.
A federal savings association proposing to make a capital distribution is required to submit an application to the OCC if: (1) the association does not qualify for expedited treatment pursuant to criteria set forth in OCC regulations; (2) the total amount of all of the association's capital distributions (including the proposed capital distribution) for the applicable calendar year exceeds the association's net income for that year to date plus the association's retained net income for the preceding two years; (3) the association would not be at least adequately capitalized following the distribution; or (4) the proposed capital distribution would violate a prohibition contained in any applicable statute, regulation, or agreement between the association and the OCC or the Company's and Bank's former regulator, the OTS, or violate a condition imposed on the association in an application or notice approved by the OCC or the OTS.
A federal savings association proposing to make a capital distribution that is not otherwise required to submit an application to the OCC is required to submit a prior notice to the OCC if: (1) the association would not be well-capitalized following the distribution; (2) the proposed capital distribution would reduce the amount of or retire any part of the association's common or preferred stock or retire any part of debt instruments such as notes or debentures included in the association's capital (other than regular payments required under a debt instrument); or (3) the association is a subsidiary of a savings and loan holding company and is not required to file a notice regarding the proposed distribution with the Federal Reserve. As noted above, if a notice with the Federal Reserve is required to be filed, then an informational copy of the notice filed with the Federal Reserve needs to be simultaneously provided to the OCC.
Each of the Federal Reserve and OCC have primary reviewing responsibility for the applications or notices required to be submitted to them by savings associations relating to a proposed distribution. The Federal Reserve may disapprove of a notice, and the OCC may disapprove of a notice or deny an application, if:
•
the savings association would be undercapitalized following the distribution;
•
the proposed distribution raises safety and soundness concerns; or
•
the proposed distribution violates a prohibition contained in any statute, regulation, enforcement action or agreement between the savings association (or its holding company, in the case of the Federal Reserve) and the entity's primary federal regulator, or a condition imposed on the savings association (or its holding company, in the case of the Federal Reserve) in an application or notice approved by the entity's primary federal regulator.
The Bank is not permitted to pay dividends on its stock if its regulatory capital would fall below the amount required for the liquidation account established to provide a limited priority claim to the assets of the Bank to qualifying depositors (Eligible Account Holders) who continue to maintain deposits at the Bank after its conversion from a federal mutual savings and loan association to a federal stock savings bank pursuant to its Plan of Conversion adopted on August 21, 1991.
During the fiscal year ended June 30, 2013, the Bank paid cash dividends to the Company totaling $5.7 million.
Liquidity
All savings associations, including the Bank, are required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation. For a discussion of what the Bank includes in liquid assets, see Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Form 10-K.
Branching
Federal savings associations may establish branches in any state to the extent allowed under the HOLA and OCC regulations.
Community Reinvestment
Under the Community Reinvestment Act ("CRA") as implemented by OCC regulations, the Bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA requires the OCC, in connection with its examination of a savings association, to assess the Bank's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain regulatory applications by the Bank.
The CRA regulations rate an institution based on its actual performance in meeting community needs. In particular, the rating system focuses on three tests: (i) a lending test, to evaluate the institution's record of making loans in its assessment areas; (ii) an investment test, to evaluate the institution's record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses; and (iii) a service test, to evaluate the institution's delivery of services through its branches, other offices and automated teller machines.
The CRA requires all institutions to make public disclosure of their CRA ratings. The Bank received an overall CRA rating of “Satisfactory” at its last CRA evaluation, which was completed as of evaluation date June 14, 2012.
Qualified Thrift Lender Test
Under the HOLA, the Bank must comply with the qualified thrift lender ("QTL") test. Under the QTL test, the Bank is required to maintain at least 65% of its "portfolio assets" (which equals total assets less (i) specified liquid assets up to 20% of total assets, (ii) intangibles, including goodwill, and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed securities, credit card loans, student loans and small business loans) in at least nine months of the most recent 12-month period. A savings association may also satisfy the QTL test by qualifying as a "domestic building and loan association" as defined in the Internal Revenue Code of 1986, as amended.
At June 30, 2013, the Bank held 77.0% of its portfolio assets in qualified thrift investments and had more than 65% of its portfolio assets in qualified thrift investments in 12 of the 12 months during the fiscal year ended June 30, 2013, and thus qualified under the QTL test. The Bank has met the QTL test since its inception.
A savings association that fails the QTL test and is unable to demonstrate a reasonable likelihood of meeting it in the future may be required to convert to a commercial bank charter and be subject to limitations as such.
Transactions with Affiliates and Insiders
The Bank's authority to engage in transactions with its "affiliates" is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"), Section 11 of the HOLA and implementing regulations under Regulation W issued by the Federal Reserve. The OCC, with the concurrence and non-objection of the FDIC, is authorized to grant exemptions from the restrictions of Section 23A through the issuance of exemptive orders.
Under Regulation W's restrictions on transactions with affiliates generally applicable to all insured depository institutions, the aggregate amount of covered transactions with any individual affiliate is limited to 10% of the unimpaired capital and surplus of the savings association. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings association's unimpaired capital and surplus. Loans and other specified transactions with affiliates are required to be secured by collateral in an amount and of a type described in federal law. The purchase of low-quality assets from affiliates is permitted only under certain circumstances. Transactions with affiliates must be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliates.
Additional amendments to Regulation W that implement the Dodd-Frank Act address the additional restrictions on savings associations under Section 11 of the HOLA, including provisions prohibiting a savings association from making a loan to an affiliate that is engaged in activities that are not permitted for bank holding companies under the Bank Holding Company Act ("BHCA") and provisions prohibiting a savings association from purchasing or investing in securities issued by an affiliate that is not a subsidiary.
The Bank's authority to extend credit to its directors, executive officers and principal shareholders, as well as to entities controlled by such persons, is governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the Federal Reserve, as made applicable to federal savings associations by the HOLA. Among other things, these provisions require that extensions of credit to insiders:
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be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with third parties and that do not involve more than the normal risk of repayment or present other features that are unfavorable to the Bank; and
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not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank's capital.
In general, a savings association's lending limit with respect to any individual insider may not exceed 15% of the association's unimpaired capital and unimpaired surplus, with an allowance for an additional 10% if secured by readily marketable collateral. A savings association's general aggregate lending limit with respect to all insiders is the association's unimpaired capital and unimpaired surplus. Transactions between a savings association and its executive officers are subject to additional and more stringent restrictions on when such transactions are permissible. In addition, extensions for credit in excess of certain limits must be approved by the Bank's board of directors.
Section 402 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, generally prohibits the extension of personal loans to directors and executive officers of issuers (as defined in the Sarbanes-Oxley Act). The prohibition does not apply, however, to extensions of credit including mortgages advanced by an insured depository institution, such as the Bank, that are subject to the restrictions on transactions with insiders under Section 22(h) of the FRA.
Consumer Protection and Compliance Provisions
The Bank is subject to various laws and regulations dealing generally with consumer protection matters. The Bank may be subject to potential liability under these laws and regulations for material violations. The Bank's loan operations are also subject to federal laws applicable to credit transactions, such as the:
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Federal "Truth-In-Lending Act," governing disclosures of credit terms to consumer borrowers;
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"Home Mortgage Disclosure Act of 1975", requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
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"Equal Credit Opportunity Act," prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
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"Fair Credit Reporting Act of 1978," as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, and requiring certain identity theft protections and certain credit and other disclosures;
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"Fair Debt Collection Act," governing the manner in which consumer debts may be collected by collection agencies;
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"Real Estate Settlement Procedures Act," as amended, governing disclosures of fee estimates that would be incurred by a borrower during the mortgage process;
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"Servicemembers Civil Relief Act"; and
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Rules and regulations of the federal agencies charged with the responsibility of implementing and enforcing these federal laws.
The Bank's deposit operations are also subject to federal laws applicable to deposit transactions, such as the:
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"Truth in Savings Act," which imposes disclosure obligations to enable consumers to make informed decisions about accounts at depository institutions;
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"Right to Financial Privacy Act," which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
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"Electronic Funds Transfer Act" and Regulation E issued by the Federal Reserve Board to implement that Act, which govern automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of automated teller machines and other electronic banking services; and
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Rules and regulations of the federal agencies charged with the responsibility of implementing and enforcing these federal laws.
Federal savings associations are subject to the same preemption standards as those applicable to national banks, with respect to the application of state consumer laws to the inter-state activities of federally chartered depository institutions. Under the preemption standards established under the Dodd-Frank Act for both national banks and federal savings associations, preemption of a state consumer financial law is permissible only if: (1) application of the state law would have a discriminatory effect on national banks or federal savings associations as compared to state banks; (2) the state law is preempted under a judicial standard articulated by the U.S. Supreme Court that requires a state consumer financial law to prevent or significantly interfere with the exercise of the national bank's or federal savings association's powers before it can be preempted; or (3) the state law is preempted by another provision of federal law. Additionally, the Dodd-Frank Act specifies that such preemption standards only apply to national banks and federal savings associations themselves, and not their non-depository institution subsidiaries or affiliates.
Beginning in July 2011, a new governmental entity known as the Consumer Financial Protection Bureau or "CFPB" became responsible for administering and carrying out the purposes and objectives of the "federal consumer financial laws, and to prevent evasions thereof," with respect to all financial institutions that offer financial products and services to consumers. The CFPB is also authorized to prescribe rules applicable to any covered person or service provider identifying and prohibiting acts or practices that are "unfair, deceptive, or abusive" in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service. With its broad rulemaking and enforcement powers, the CFPB has the potential to reshape the consumer financial laws through rulemaking and enforcement of unfair, deceptive or abusive practices, which may directly impact the business operations of financial institutions offering consumer financial products or services including the Bank.
Real Estate Lending Standards
The OCC and the other federal banking agencies adopted regulations to prescribe standards for extensions of credit that (i) are secured by real estate or (ii) are made for the purpose of financing the construction of improvements on real estate. The OCC regulations require the Bank to establish and maintain written internal real estate lending standards that are consistent with safe and sound banking practices and appropriate to the size of the association and the nature and scope of its real estate lending activities. The standards also must be consistent with accompanying OCC guidelines, which include loan-to-value ratios for the different types of real estate loans. The Bank is also permitted to make a limited amount of loans that do not conform to the proposed loan-to-value limitations so long as such exceptions are reviewed and justified appropriately. The guidelines also list a number of lending situations in which exceptions to the loan-to-value standards are justified. The Bank has established and implemented these required policies regarding real estate lending activities.
In early 2013, the CFPB issued eight final rules concerning the regulation of mortgage markets in the U.S. pursuant to the Dodd-Frank Act. The rules amend several existing regulations, including Regulation Z (Truth in Lending), X (Real Estate Settlement Procedures Act), and B (Home Mortgage Disclosure).
With respect to the Regulation Z amendments, the current regulation prohibits a creditor from making a higher-priced mortgage loan without regard to the consumer's ability to repay the loan. The final rule implements provisions of the Dodd-Frank Act which generally require creditors to make a reasonable, good faith determination of a consumer's ability to repay any consumer credit transaction secured by a dwelling (excluding an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan) and establish certain protections from liability under this requirement for “qualified mortgages.” The final rule also implements a provision of the Dodd-Frank Act which limits prepayment penalties. In addition, the final rule requires creditors to retain evidence of compliance with the rule for three years after a covered loan is consummated. This final rule is anticipated to become effective on January 10, 2014.
The CFPB also issued a final rule that amends Regulation Z to implement statutory changes made by the Dodd-Frank Act that lengthen the time for which a mandatory escrow account established for a higher-priced mortgage loan must be maintained. The rule also exempts certain transactions from the statute's escrow requirement. The primary exemption applies to mortgage transactions extended by creditors that operate predominantly in rural or underserved areas, together with their affiliates originate a limited number of first-lien covered transactions, have assets below a certain threshold, and together with their affiliates do not maintain escrow accounts on extensions of consumer credit secured by real property or a dwelling that are currently serviced by the creditors or their affiliates (subject to certain exceptions). This rule became effective on June 1, 2013.
The CFPB also issued a final rule amending Regulation Z by expanding the types of mortgage loans that are subject to the protections of the Home Ownership and Equity Protections Act of 1994 (“HOEPA”), revising and expanding the tests for coverage under HOEPA, and imposing additional restrictions on mortgages that are covered by HOEPA, including a pre-loan counseling requirement. The final rule also amends Regulation Z and Regulation X by imposing certain other requirements related to homeownership counseling, including a requirement that consumers receive information about homeownership counseling providers. This final rule is anticipated to become effective on January 10, 2014.
The CFPB also issued a joint final rule with the federal banking agencies to amend Regulation Z by implementing new appraisal provisions in the Truth in Lending Act that were added by the Dodd-Frank Act. The rule requires creditors to obtain a full interior appraisal by a certified or licensed appraiser for non-exempt “higher-risk mortgage loans” (“HPMLs”). HPMLs are mortgages with an annual percentage rates that exceed the average prime offer rate by a specified percentage. The rule also requires a second such appraisal at the creditor's expense for certain properties held for less than 180 days. Exemptions include qualified mortgages, reverse mortgages, bridge loans, construction loans and certain manufactured homes. In addition, the rule requires creditors to provide the consumer a copy of all written appraisals performed in connection with the HPML at least 3 days prior to closing. This final rule is anticipated to become effective on January 18, 2014.
The CFPB also issued a final rule amending Regulation Z to implement requirements and restrictions imposed by the Dodd-Frank Act concerning loan originator compensation; qualifications of, and registration or licensing of loan originators; compliance procedures for depository institutions; mandatory arbitration; and the financing of single-premium credit insurance. The final rule revises or provides additional commentary on Regulation Z's restrictions on loan originator compensation, including application of these restrictions to prohibitions on dual compensation and compensation based on a term of a transaction or a proxy for a term of a transaction, and to recordkeeping requirements. The final rule also establishes tests for when loan originators can be compensated through certain profits-based compensation arrangements. A provision of the final rule prohibiting mandatory arbitration clauses and waivers of certain consumer rights became effective on June 1, 2013. All other provisions of the rule are anticipated to become effective on January 10, 2014, unless further action by the CFPB changes the effective date.
The CFPB also amended the mortgage servicing rules under both Regulation X and Regulation Z. The Regulation X final rule implements Dodd-Frank Act sections addressing servicers' obligations to correct errors asserted by mortgage loan borrowers; to provide certain information requested by such borrowers; and to provide protections to such borrowers in connection with force-placed insurance. Additionally, the final rule addresses servicers' obligations to establish reasonable policies and procedures to achieve certain delineated objectives; to provide information about mortgage loss mitigation options to delinquent borrowers; to establish policies and procedures for providing delinquent borrowers with continuity of contact with servicer personnel capable of performing certain functions; and to evaluate borrowers' applications for available loss mitigation options. Further, the final rule modifies and streamlines certain existing servicing-related provisions of Regulation X. The Regulation Z final rule implements Dodd-Frank Act sections addressing initial rate adjustment notices for adjustable-rate mortgages, periodic statements for residential mortgage loans, prompt crediting of mortgage payments, and responses to requests for payoff amounts. The final rule also amends current rules governing the scope, timing, content, and format of disclosures to consumers regarding the interest rate adjustments of their variable-rate transactions. These final rules affecting mortgage servicing activities are anticipated to become effective on January 10, 2014.
The CFPB also amended Regulation B to implement an amendment to the Equal Credit Opportunity Act concerning appraisals and other valuations that was enacted as part of the Dodd-Frank Act. In general, the revisions to Regulation B require creditors to provide to applicants free copies of all appraisals and other written valuations developed in connection with an application for a loan to be secured by a first lien on a dwelling, and require creditors to notify applicants in writing that copies of appraisals will be provided to them promptly. This final rule is anticipated to become effective on January 18, 2014.
Privacy Regulations
Pursuant to regulations implementing the Gramm-Leach-Bliley Act of 1999, the Bank is required to adopt procedures to protect customers' "nonpublic personal information." The regulations generally require that the Bank disclose its privacy policy, including identifying with whom it shares a customer's "nonpublic personal information," to customers at the time of establishing the customer relationship and annually thereafter. In addition, the Bank is required to provide its customers with the ability to "opt-out" of having it share their personal information with unaffiliated third parties and not to disclose account numbers or access codes to nonaffiliated third parties for marketing purposes. The Bank currently has a privacy protection policy in place, which has been reviewed, for compliance with the regulations.
Protection of Customer Information
In addition to certain state laws governing protection of customer information, the Bank is subject to federal regulatory guidelines establishing standards for safeguarding customer information. These regulations implement certain provisions of the Gramm-Leach-Bliley Act. The guidelines describe the federal banking agencies' expectations for the creation, implementation and maintenance of an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity of the institution and the nature and scope of its activities. The standards set forth in the guidelines are intended to ensure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer. Federal guidelines also impose certain customer disclosure requirements and other actions that financial institutions are required to take in the event of unauthorized access to customer information.
Identity Theft Prevention
Financial institutions are required to develop and implement a written identity theft prevention program to detect, prevent, and mitigate identity theft in connection with the opening of certain accounts or certain existing accounts.
Among the requirements under the rule, the Bank is required to adopt "reasonable policies and procedures" to:
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identify relevant red flags for covered accounts and incorporate those red flags into the program;
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detect red flags that have been incorporated into the identity theft prevention program;
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respond appropriately to any red flags that are detected to prevent and mitigate identity theft; and
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ensure the identity theft prevention program is updated periodically, to reflect changes in risks to customers or to the safety and soundness of the financial institution or creditor from identity theft.
Prohibitions Against Tying Arrangements
Federal savings associations are subject to statutory prohibitions on certain tying arrangements involving products or services offered by associations and their affiliates. Specifically, a depository institution is prohibited from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution. This prohibition is subject to exceptions for certain product arrangements, including where the tied product is also a traditional banking product (that is, a loan, discount, deposit or trust service).
Trust Activities Regulation
The Bank, through its trust department, acts as trustee, personal representative, administrator, guardian, custodian, record keeper, agent, registrar, advisor and manager for various accounts. The Bank derives its trust powers from Section 5(n) of the HOLA and the regulations and policies of the OCC. Under these laws, regulations and policies, the trust activities of federal savings associations are governed by both federal and state laws. Generally, the scope of trust activities that the Bank can provide will be governed by the laws of the states in which the Bank is "located" (as such term is defined under the regulations of the OCC), while other aspects of the trust operations of the Bank are governed by federal laws and regulations. If the trust activities of a federal savings association are located in more than one state, however, then the scope of fiduciary services that the federal savings association can provide will vary depending on the laws of each state.
Federal Reserve System
Under Federal Reserve regulations, the Bank is required to maintain noninterest-earning reserves against its transaction accounts. Federal Reserve regulations currently exempt the first $12.4 million of otherwise reservable balances from the reserve requirements. A 3% reserve is required for transaction account balances over $12.4 million and up to $79.5 million. Transaction account balances over $79.5 million are subject to a reserve requirement of approximately $2.013 million plus 10% of any amount over $79.5 million. Because required reserves must be maintained in the form of either vault cash, a noninterest bearing account at a Federal Reserve Bank, or a pass-through account as defined by the Federal Reserve, the effect of this reserve requirement is to reduce the Bank's interest-earning assets to the extent that the requirement exceeds vault cash.
The Federal Reserve has, and is likely to continue to have, an important impact on the operating results of financial institutions through its power to implement national monetary policy, among other things, in order to curb inflation or combat a recession. The Federal Reserve affects the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject.
Federal Home Loan Bank System
The Bank is a member of the FHLB of Des Moines, which is one of 12 regional FHLBs that administer the home financing credit function of savings associations. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB system. It makes loans (i.e., advances) to members in accordance with policies and procedures established by the Board of Directors of the FHLB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. The Bank, as a member of the FHLB of Des Moines, is required to acquire and hold shares of capital stock in the FHLB of Des Moines equal to 0.12% of the total assets of the Bank at December 31 annually. The Bank is also required to own activity-based stock, which is based on a percentage of the Bank's outstanding advances. These percentages are subject to change at the discretion of the FHLB Board of Directors.
The Bank receives dividends on its FHLB stock, subject to approval by the FHLB. For the fiscal year ended June 30, 2013, dividends paid by the FHLB of Des Moines to the Bank totaled approximately $223,000, which constitutes a $38,000 decrease compared to the amount of dividends received in fiscal 2012.
Anti-Money Laundering / Combating Terrorist Financing Provisions
The Bank is subject to the regulations of the OCC and Financial Crimes Enforcement Network which implement the Bank Secrecy Act, as amended by the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, commonly known as the USA PATRIOT Act, which gives the federal government expanded powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements.
By way of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among bank regulatory agencies and law enforcement bodies. Moreover, among other requirements, Title III of the USA PATRIOT Act, as implemented by regulatory guidelines, imposes the following requirements with respect to financial institutions:
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Pursuant to Section 352, all financial institutions must establish anti-money laundering programs that include, at a minimum: (i) internal policies, procedures, and controls, (ii) specific designation of an anti-money laundering compliance officer, (iii) ongoing employee training programs, and (iv) an independent audit function to test the anti-money laundering program.
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Pursuant to Section 326, financial institutions are required to implement reasonable procedures to (1) verify the identity of any person opening an account; (2) maintain records of the information used to verify the person's identity; and (3) determine whether the person appears on any list of known or suspected terrorists or terrorist organizations. To carry out these procedures, each financial institution must establish a written customer identification program appropriate for its size, location and type of business.
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Section 312 requires financial institutions that establish, maintain, administer or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) to establish appropriate, specific and, where necessary, enhanced due diligence policies, procedures and controls designed to detect and report money laundering.
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Financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and is subject to certain recordkeeping obligations with respect to correspondent accounts of foreign banks.
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Bank regulators are directed to consider a holding company's effectiveness in combating money laundering when ruling on FRA and Bank Merger Act applications.
Holding Company Regulation
We are a unitary savings and loan holding company within the meaning of the HOLA. As such, we are required to register with and be subject to Federal Reserve examination and supervision as well as comply with certain reporting requirements. In addition, the Federal Reserve has enforcement authority over us and any of our non-savings institution subsidiaries. Among other things, this authority permits the Federal Reserve to restrict or prohibit activities that are determined to be a serious risk to the financial safety, soundness or stability of a subsidiary savings association.
"Grandfathered" Savings and Loan Holding Company Status
Because we acquired the Bank prior to May 4, 1999, we are a "grandfathered" unitary savings and loan holding company under the Gramm-Leach-Bliley Act. As such, we are exempt from the limitations on certain unrelated business activities that apply to other savings and loan holding companies and their subsidiaries that are not savings associations, provided the Bank continues to be a "qualified thrift lender." If, however, we are acquired by a non-financial company, if we acquire another savings association subsidiary (and we become a multiple savings and loan holding company) or, as a result of proposed legislative changes, we will terminate our "grandfathered" unitary savings and loan holding company status, and become subject to certain additional limitations on the types of business activities in which we could engage, which are generally limited to "financially related" activities permissible for bank holding companies, as defined under the Gramm-Leach-Bliley Act.
Restrictions Applicable to All Savings and Loan Holding Companies
Federal law prohibits a savings and loan holding company, including us, directly or indirectly, from acquiring:
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control (as defined under the HOLA) of another savings institution (or a holding company parent) without prior Federal Reserve approval;
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through merger, consolidation, or purchase of assets, another savings institution or a holding company thereof, or acquiring all or substantially all of the assets of such institution (or a holding company) without prior Federal Reserve approval; or
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control of any depository institution not insured by the FDIC (except through a merger with and into the holding company's savings institution subsidiary that is approved by the Federal Reserve).
In addition, if the Bank fails the QTL test (discussed above), we must change our status with the Federal Reserve as a savings and loan holding company and register as a bank holding company under the BHCA within one year of the Bank's failure to so qualify.
The HOLA also prohibits a savings and loan holding company (directly or indirectly, or through one or more subsidiaries) from acquiring or retaining, except with the prior written approval of the Federal Reserve, more than 5% of a non-subsidiary savings association or a non-subsidiary holding company. In evaluating applications by holding companies to acquire savings associations, the Federal Reserve must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the DIF, the convenience and needs of the community and competitive factors.
Activities Restrictions
Prior to the Dodd-Frank Act, savings and loan holding companies were generally permitted to engage in a wider array of activities than those permissible for their bank holding company counterparts and may have concentrations in real estate lending that are not typical for bank holding companies. Section 606 of the Dodd-Frank Act amended the HOLA by inserting a new requirement that conditions the ability of savings and loan holding companies that are not exempt from HOLA's restrictions on activities to engage in certain activities, effective as of July 21, 2011. Pursuant to this new requirement, a covered saving and loan holding company may engage in activities that are permissible only for a financial holding company under section 4(k) of the BHCA if the covered company meets all of the criteria to qualify as a financial holding company, and complies with all of the requirements applicable to a financial holding company as if the covered savings and loan holding company was a bank holding company. Moreover, going forward, savings and loan holding companies engaging in new
activities permissible for bank holding companies will need to comply with notice and filing requirements of the Federal Reserve.
If the Federal Reserve believes that an activity of a savings and loan holding company or a nonbank subsidiary constitutes a serious risk to the financial safety, soundness, or stability of a subsidiary savings association and is inconsistent with the principles of sound banking, the purposes of HOLA or other applicable statutes, the Federal Reserve may require the savings and loan holding company to terminate the activity or divest control of the nonbanking subsidiary.
Source of Strength and Capital Requirements
The Dodd-Frank Act requires all companies that directly or indirectly control an insured depository institution, including savings and loan holding companies, to serve as a source of financial and managerial strength to its subsidiary depository institution(s). Moreover, pursuant to the Dodd-Frank Act, savings and loan holding companies will for the first time, generally beginning on January 1, 2015, become subject to the same capital and activity requirements as those applicable to bank holding companies.
The Dodd-Frank Act requires the federal banking agencies to establish consolidated risk-based and leverage capital requirements for insured depository institutions, depository institution holding companies and systemically important nonbank financial companies. These requirements must be no less than those to which insured depository institutions are currently subject to. As noted above, under “-Bank Capital Requirements,” in July 2013, the Federal Reserve and other federal banking agencies issued a final rule revising regulatory capital rules applicable to all insured depository institutions and their holding companies (except for certain savings and loan holding companies that are "substantially engaged" in commercial or insurance underwriting activities). As a result, no later than January 1, 2015, savings and loan holding companies including the Company will become subject to consolidated capital requirements which we have not been subject to previously, which are: (i) a minimum common equity Tier 1 capital ratio of 4.5%; (ii) a minimum Tier 1 capital ratio of 6.0%; (iii) a minimum total capital ratio of 8.0%; and (iv) a minimum leverage ratio (Tier 1 capital to total assets) of 4.0%.
Moreover, among the other significant aspects of the final rules for smaller depository institution holding companies-those with assets less than $15 billion, which include the Company-is the authority to continue to count as Tier 1 capital most existing trust preferred securities that were issued prior to May 19, 2010, rather than being required to phase such securities out of regulatory capital.
Examination
To help facilitate the transition of savings and loan holding companies to the supervisory jurisdiction of the Federal Reserve, the Federal Reserve instructed its examiners to use the first supervisory cycle beginning in July 2011 to inform savings and loan holding companies about how their operations compare to the Federal Reserve's supervisory expectations, which was expected to allow for savings and loan holding company management to make operational changes in response to the Federal Reserve's supervisory expectations, if necessary.
Since the completion of the first supervisory cycle, the Federal Reserve has generally, to the greatest extent possible taking into account any unique characteristics of savings and loan holding companies and the requirements of the HOLA, performed its supervisory functions and assessed the condition, performance, and activities of savings and loan holding companies on a consolidated basis in a manner that is consistent with the Federal Reserve's established risk-based approach regarding bank holding company supervision. As with bank holding companies, the Federal Reserve's objective is to ensure that a savings and loan holding company and its nondepository subsidiaries are effectively supervised and can serve as a source of strength for, and do not threaten the soundness of, its subsidiary depository institution(s).
Change of Control
The federal banking laws require that appropriate regulatory approvals must be obtained before an individual or company may take actions to "control" a bank or savings association. The definition of control found in the HOLA is similar to that found in the BHCA for bank holding companies. Both statutes apply a similar three-prong test for determining when a company controls a bank or savings association. Specifically, a company has control over either a bank or savings association if the company:
(1)
directly or indirectly or acting in concert with one or more persons, owns, controls, or has the power to vote 25% or more of the voting securities of a company;
(2)
controls in any manner the election of a majority of the directors (or any individual who performs similar functions in respect of any company, including a trustee under a trust) of the board; or
(3)
directly or indirectly exercises a controlling influence over the management or policies of the bank.
The implementing regulation of the Federal Reserve includes a specific definition of "control" similar to the statutory definition, with certain additional provisions.
The Federal Reserve generally reviews investments and relationships with savings and loan holding companies by companies using the current practices and policies applicable to bank holding companies to the extent possible for purposes of implementing the HOLA. Given that Federal Reserve practice is to consider potential control relationships for all investors regardless of investment level in connection with applications submitted under the BHCA, the Federal Reserve will review potential control relationships for all investors in connection with applications submitted to the Federal Reserve under Section 10(e) or 10(o) of HOLA. The Federal Reserve often obtains a series of commitments from investors seeking non-control determinations.
The federal banking laws require minority investors that are unwilling to bear the responsibilities associated with controlling a banking organization to limit their influence over the management and policies of the banking organization. That is, investors seeking the protection of being free from regulation and oversight as a savings and loan holding company under the HOLA are limited in their involvement and influence over the management and policies of the savings and loan holding company and its subsidiaries.
Federal Securities Laws and the Sarbanes-Oxley Act
Our common stock is registered with the SEC under the Exchange Act. We are subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act.
Our stock held by persons who are affiliates (generally officers, directors and principal stockholders) of us may not be resold without registration or unless sold in accordance with certain resale restrictions. If we meet specified current public information requirements, each of our affiliates is able to sell in the public market, without registration, a limited number of shares in any three-month period.
As a public company, we are subject to the Sarbanes-Oxley Act, which implements a broad range of disclosure, corporate governance and accounting measures for public companies designed to promote honesty and transparency and to protect investors from corporate wrongdoing. Furthermore, the NASDAQ Global Market enacted corporate governance rules that implement some of the mandates of the Sarbanes-Oxley Act. The NASDAQ rules include, among other things, requirements ensuring that a majority of the Board of Directors are independent of management, establishing and publishing a code of conduct for directors, officers and employees, and calling for stockholder approval of all new stock option plans and all material modifications to such plans. These rules affect us because our common stock is listed on the NASDAQ Global Market.
Delaware General Corporation Law
We are incorporated under the laws of the State of Delaware. Thus, the rights of our stockholders are governed by the Delaware General Corporation Law.
Federal and State Taxation
The Company and its direct and indirect subsidiaries file a consolidated federal income tax return on a fiscal year basis. In addition, each of Trust III, Trust IV, Trust V and Trust VI are required to file individual trust returns on a calendar year basis.
In addition to the regular income tax, corporations, including savings associations such as the Bank, generally are subject to a minimum tax. An alternative minimum tax is imposed at a minimum tax rate of 20% on alternative minimum taxable income, which is the sum of a corporation's regular taxable income (with certain adjustments) and tax preference items, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the corporation's regular income tax and net operating losses can offset no more than 90% of alternative minimum taxable income.
To the extent net income appropriated to a savings association's bad debt reserves for "qualifying real property loans" and deducted for federal income tax purposes exceed the allowable amount of such reserves computed under the experience method and to the extent of the association's supplemental reserves for losses on loans ("Excess"), such Excess may not, without adverse tax consequences, be utilized for the payment of cash dividends or other distributions to a shareholder (including distributions on redemption, dissolution or liquidation) or for any other purpose (except to absorb bad debt losses). At June 30, 2013, the Bank's Excess for tax purposes totaled approximately $4.8 million. The Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves.
South Dakota Taxation. The Bank is subject to the South Dakota franchise tax to the extent that such corporations are engaged in business in the state of South Dakota. South Dakota does not have a corporate income tax. The franchise tax will be imposed at a rate of 6% on franchise taxable income which is computed in the same manner as federal taxable income with
some minor variations to comply with South Dakota law, other than the carryover of net operating losses which is not permitted under South Dakota law. A South Dakota return of franchise tax must be filed annually.
Minnesota Taxation. The Bank is subject to the Minnesota corporate income tax to the extent that such corporations are engaged in business in the state of Minnesota. The corporate income tax is imposed at a rate of 9.8% on corporate taxable income, which is computed in the same manner as federal taxable income with some minor variations to comply with Minnesota law. A Minnesota return of corporate income tax must be filed annually.
Delaware Taxation. As a Delaware holding company, the Company is exempted from Delaware corporate income tax but is required to file an annual report with and pay an annual fee to the State of Delaware. The Company is also subject to an annual franchise tax imposed by the State of Delaware, which is made in quarterly payments.
Taxation in Other States. Mid America Capital is required to file state income tax returns in those states which lessees have operations. The total taxes paid in the year ended June 30, 2013 were not material to the operation of the Company.
Executive Officers
The following table lists the executive officers of the Company and the Bank at September 9, 2013:
Business Experience of each Executive Officer
STEPHEN M. BIANCHI, age 49, has served as the Chief Executive Officer of the Company and the Bank since November 2011, and as President of the Twin Cities market for the Bank since April 2010. Prior to joining the Bank, he worked at Associated Bank from 2006 to 2010, where he held positions including Senior Vice President, Minnesota Regional President and Minnesota Regional Commercial Banking Manager. Before that, he was Twin Cities Business Banking Manager for Wells Fargo Bank, where he held several other banking and management positions nearly 14 years. Mr. Bianchi received his B.S. degree in Finance and M.B.A. from Providence College.
BRENT R. OLTHOFF, age 42, has served as Senior Vice President, Chief Financial Officer and Treasurer of the Company since November 2010. Prior to such time, he served as Senior Vice President, Chief Financial Officer and Treasurer of the Bank since April 2007. Mr. Olthoff first joined the Bank in July 2001, and was promoted to Vice President/Finance in July 2004. From February 2006 to April 2007, Mr. Olthoff was employed by FTN Financial, a capital markets firm in Memphis, Tennessee, where he was Vice President/Asset Strategies. Mr. Olthoff received his B.B.A degree in Finance from Iowa State University.
JON M. GADBERRY, age 51, has served as Senior Vice President/Wealth Management of the Bank since December 2007. Prior to joining the Bank, Mr. Gadberry was employed by Bank of the West as Vice President/Trust Manager from April 2003 to December 2007. Mr. Gadberry received his B.S. in Business Administration from Concordia College in Moorhead, Minnesota.
KEVIN G. SANCHEZ, age 49, has served as Senior Vice President/Human Resources of the Bank since January 2013. Prior to that time, he served as a Vice President/Human Resource Manager from January 2008 and Vice President/Market Manager of the Bank since November 2000. Prior to joining the Bank, he was employed with First Citizens Bank, Billings, MT as a Vice President Retail Manager from 1996-2000 and also had an extensive career with First Bank System from 1980-1996 in Montana, Nebraska, and Iowa. Mr. Sanchez attended Eastern Montana College with a focus in Business Administration.
MICHAEL WESTBERG, age 46, has served as the Senior Vice President/Chief Credit Officer of the Bank since January 2011. Prior to that time, he served as Senior Vice President/Corporate Strategy of the Bank from May 2008 and Senior Vice President/Personal Banking of the Bank between July 2006 and May 2008. Mr. Westberg joined the Bank in February 1996 as a branch manager. Mr. Westberg received his B.A in Management from The University of Sioux Falls, Sioux Falls,
SD. Mr. Westberg also graduated with High Honors from ABA's National Graduate School of Banking, Fairfield University, Fairfield, CT.
WENDY A. WILLS, age 41, has served as Senior Vice President/Corporate Strategy of the Bank since January 2013. Prior to that time, she served as Vice President/Corporate Strategy of the Bank since January 2011 and Vice President/Marketing since May 2010. Ms. Wills first joined the Bank in 1997 holding various positions in marketing and was promoted to Vice President/Marketing in 2007. From 2007 to 2010, she worked for HenkinSchultz Communication Arts as a Senior Account Executive. Ms. Wills received her B.A. degree in Studio Art and Communications from Concordia College in Moorhead, Minnesota.
BRUCE E. HANSON, CPA, age 50, has served as Vice President, Controller of the Bank since October 2008. Prior to joining the Bank, he was employed as Vice President, Controller at South Dakota State Medical Holding Co., dba Dakotacare, from 1996 to September 2008. Mr. Hanson received his B.A. degree in Accounting from the University of South Dakota.
There are no family relationships involving any of the Company's executive officers, directors and director nominees.
Item 1A.
Item 1A. Risk Factors
The following are certain risk factors that could affect our business, financial condition, operating results and cash flows. These risk factors should be considered in connection with evaluating the forward-looking statements contained in this Annual Report on Form 10-K because these risk factors could cause our actual results to differ materially from those expressed in any forward-looking statement. The risks we have highlighted below are not the only ones we face. If any of these events actually occur, our business, financial condition, operating results or cash flow could be negatively affected. We caution you to keep in mind these risk factors and to refrain from attributing undue certainty to any forward-looking statements, which speak only as of the date of this report.
Risks Related to Our Industry and Business
Difficult economic and market conditions have adversely affected our industry.
From December 2007 to June 2009, the United States experienced the worst economic downturn since the Great Depression. This period was marked by reduced business activity across a wide range of industries and regions, significant increases in unemployment, volatility and disruption in the capital and credit markets, and dramatic declines in the housing market, with decreasing home prices and increasing delinquencies and foreclosures, which negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions across the United States. The recession was also marked by tightening of the credit markets and steep declines in the stock markets, which resulted in a difficult loan environment and decreased the value of our portfolio of investment securities.
Although the domestic economy continued its modest recovery during our 2013 fiscal year, the recovery is weak and there can be no assurance that the economy will not enter into another recession, whether in the near or long term. Furthermore, real estate values and the demand for commercial real estate loans have not fully recovered, and reduced availability of commercial credit and continuing unemployment have negatively impacted the credit performance of commercial and consumer credit. Additional market developments such as a worsening of economic conditions in Europe would likely exacerbate the lingering effects of the difficult market conditions experienced by us and others in the financial services industry and could further slow, stall or reverse the slow recovery in the U.S.
Increased regulation of our industry continues to increase our regulatory compliance costs, impact our sources of revenue, and create regulatory uncertainty.
Implementation of the 2010 Dodd-Frank Act and other legislative and regulatory initiatives taken by Congress and the federal banking regulators has changed and will significantly change the current bank regulatory structure and affect the lending, investment, trading and operating activities of banking institutions and their holding companies, which is expected to continue to significantly increase our regulatory compliance costs.
Our regulators continue to propose rules and implement provisions of the Dodd-Frank Act. For example, the Dodd-Frank Act required the federal banking agencies to establish consolidated risk-based and leverage capital requirements for insured depository institutions, depository institution holding companies and systemically important nonbank financial companies. In July 2013, the Federal Reserve and other federal banking agencies issued a final rule revising regulatory capital rules applicable to all insured depository institutions and their holding companies (except for certain savings and loan holding companies engaged in commercial activities). The new rule implements higher minimum capital requirements, includes a new common equity Tier 1 capital requirement, and establishes criteria that instruments must meet in order to be considered common equity Tier 1 capital, additional Tier 1 capital, or Tier 2 capital. The new minimum capital to risk-weighted assets
requirements are a common equity Tier 1 capital ratio of 4.5% and a Tier 1 capital ratio of 6.0%, which is an increase from 4.0%, and a total capital ratio that remains at 8.0%. The minimum leverage ratio (Tier 1 capital to total assets) is 4.0%. The new minimum capital requirements are anticipated to become effective on January 1, 2015. As a result, no later than July 2015, the Company will become subject to consolidated capital requirements which we have not been subject to previously.
The Dodd-Frank Act also created a new government agency, the Consumer Financial Protection Bureau ("CFPB") with broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions like the Bank, including the authority to prohibit "unfair, deceptive or abusive" acts and practices. In early 2013, the CFPB issued eight final rules concerning the regulation of mortgage markets in the U.S. pursuant to the Dodd-Frank Act. These rules amend several existing regulations, including Regulation Z (Truth in Lending), X (Real Estate Settlement Procedures Act), and B (Home Mortgage Disclosure).
Many other provisions of the Dodd-Frank Act still require extensive rulemaking, guidance and interpretation by regulatory agencies. Accordingly, in many respects, the ultimate impact of the legislation and its effects on the U.S. financial system and the Company remain uncertain. We are continuing to closely monitor and evaluate regulatory developments. Such developments could adversely affect our financial condition and results of operations through significant increases in our regulatory compliance costs.
Determination of the appropriate level of the allowance for loan losses involves a high degree of subjectivity and requires significant estimates, and actual losses may vary from current estimates.
The Bank maintains an allowance for loan losses to provide for loans in its portfolio that may not be repaid in their entirety. The determination of the appropriate level of the allowance for loan losses involves a high degree of subjectivity and requires us and the Bank to make significant estimates of current credit risks and future trends, all of which may undergo material changes.
In evaluating the adequacy of the Bank's allowance for loan losses, we consider numerous quantitative factors, including our historical charge-off experience, growth of our loan portfolio, changes in the composition of our loan portfolio and the volume of delinquent and classified loans. In addition, we use information about specific borrower situations, including their financial position and estimated collateral values, to estimate the risk and amount of loss for those borrowers. Finally, we consider many qualitative factors, including general and economic business conditions, duration of the current business cycle, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters, which are by nature subjective and fluid. Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding the Bank's borrowers' abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors. In considering information about specific borrower situations, our analysis is subject to the risk that we are provided inaccurate or incomplete information. Because of the degree of uncertainty and susceptibility of these factors to change, the Bank's actual losses may vary from our current estimates.
Additionally, bank regulators periodically review the Bank's allowance for loan losses and may require an increase in the provision for loan losses or recognize loan charge-offs based upon their judgments, which may be different from ours. Any increase in the Bank's allowance for loan losses or loan charge-offs required by these regulatory authorities may adversely affect our operating results.
We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to do so may materially adversely affect our performance.
We are a community bank, and our reputation is one of the most valuable components of our business. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected, by the actions of our employees or otherwise, our business and, therefore, our operating results may be materially adversely affected.
Our financial success is dependent on the prevailing economic, political and business conditions as well as the population growth in South Dakota and Minnesota.
Our success and growth is dependent on the income levels, deposits and population growth in our primary market area, which are communities located in eastern and central South Dakota, including the Sioux Falls metropolitan statistical area ("MSA") and the cities of Pierre, Mitchell, Aberdeen, Brookings, Watertown and Yankton, and Minneapolis, Minnesota. If the communities in which we operate do not grow or if prevailing economic conditions locally are unfavorable, our business will be negatively affected.
Additionally, there are inherent risks associated with our lending activities, including credit risk, which is the risk that borrowers may not repay outstanding loans or the value of the collateral securing loans decreases. Our business operations and activities are predominantly concentrated in the state of South Dakota and most of our credit exposure is in that state, so we are specifically at risk from adverse economic, political and business conditions that affect South Dakota. Accordingly, economic and business conditions in South Dakota, such as increases in unemployment, commercial and consumer delinquencies and real estate foreclosures, as well as decreases in real gross domestic product, home and land prices or home sales, will each adversely impact our credit risk.
For example, credit card issuers are a significant employer in the Sioux Falls MSA. New regulation or other changes that negatively impact the credit card industry and cause these companies to scale back their operations and reduce personnel could negatively affect the economic conditions in South Dakota, which in return could negatively impact our credit risk and business.
Our financial success is dependent on our ability to compete effectively in highly competitive markets.
We operate in the highly competitive markets of South Dakota and Minnesota. Our future growth and success will depend on our ability to compete effectively in these markets. Through the Bank, we compete for loans, deposits and other financial services in geographic markets with other local, regional and national commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as super-regional, national and international financial institutions. Many of our competitors offer products and services different from us, and have substantially greater resources, name recognition and market presence than we do, which benefits them in attracting business. Larger competitors may be able to price loans and deposits more aggressively than we can and have broader customer and geographic bases to draw upon.
Competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us. Through the Bank, we compete with these institutions both in attracting deposits and in making loans. In addition, we must attract our customer base from other existing financial institutions and from new residents. There is a risk that we will not be able to compete successfully with these other financial institutions in our markets, and that we may have to pay higher interest rates to attract deposits or charge lower interest rates to obtain loan volume, resulting in reduced profitability. In new markets that we may enter, we will also compete against well-established community banks that have developed relationships within the community.
We are subject to extensive regulations that may limit or restrict our activities, and the cost of compliance is high.
We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various regulatory agencies, currently including the OCC, Federal Reserve and the FDIC. Banking regulations are primarily intended to protect the DIF and depositors, not stockholders. Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to regulatory capital requirements, which require us to maintain adequate capital to support our growth. If we fail to meet these capital and other regulatory requirements, our ability to grow, our cost of funds and FDIC insurance, our ability to pay dividends on our common stock, and our ability to make acquisitions could be materially and adversely affected.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, Real Estate Settlement Procedures Act, Truth-in-Lending Act or other laws and regulations could result in fines or sanctions, and curtail expansion opportunities.
Financial institutions are required under the USA PATRIOT and Bank Secrecy Acts to develop programs to prevent financial institutions from being used for money-laundering and terrorist activities. Financial institutions are also obligated to file suspicious activity reports with the U.S. Treasury Department's Office of Financial Crimes Enforcement Network if such activities are detected. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure or the inability to comply with these regulations could result in fines or penalties, curtailment of expansion opportunities, intervention or sanctions by regulators and costly litigation or expensive additional controls and systems. During the last few years, several banking institutions have received large fines for non-compliance with these laws and regulations. In addition, the federal government has imposed and is expected to expand laws and regulations relating to residential and consumer lending activities that create significant new compliance burdens and financial risks. We have developed policies and continue to augment procedures and systems designed to assist in compliance with these laws and regulations.
Liquidity risks could affect operations and jeopardize our financial condition.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources to accommodate our existing and future lending and investment activities could have a substantial negative effect on
our liquidity and severely constrain our financial flexibility. Our primary source of funding is retail deposits gathered through our network of branch offices. Our alternative funding sources include, without limitation, brokered certificates of deposit, federal funds purchased, Federal Reserve Discount Window borrowings, FHLB of Des Moines advances and short- and long-term debt.
The Bank has historically obtained funds principally through local deposits and it has a base of lower cost transaction deposits. Generally, we believe local deposits are a cheaper and more stable source of funds than other borrowings, because interest rates paid for local deposits are typically lower than interest rates charged for borrowings from other institutional lenders and reflect a mix of transaction and time deposits, whereas brokered deposits typically are higher cost time deposits.
Our costs of funds, profitability and liquidity will be adversely affected to the extent we have to rely upon higher cost borrowings from other institutional lenders or brokers to fund loan demand or liquidity needs, and changes in our deposit mix and growth could adversely affect our profitability and the ability to expand our loan portfolio.
The Bank currently has a $15.0 million unsecured line of federal funds with First Tennessee Bank, NA, which did not have an outstanding balance at June 30, 2013 and 2012. The line was advanced upon during the past 12 months for contingent funding testing purposes.
The Bank currently has a $20.0 million unsecured line of federal funds with Zions Bank, which did not have an outstanding balance at June 30, 2013 and 2012. The line was advanced upon during the past 12 months for contingent funding testing purposes.
We may look to sell production assets, such as mortgage loans, into the secondary market as a means to manage the size of our balance sheet and manage the use of our capital. The demand for these products in the capital markets is not driven by us and may not benefit us at the time we look to sell the loans.
Our liquidity, on a parent only basis, may be adversely affected by certain restrictions on receiving dividends from the Bank without prior regulatory approval.
Our profitability may be affected by changes in market interest rates.
Through our banking subsidiary, the Bank, our profitability depends in large part on our net interest income, which is the difference between interest earned from interest-earning assets, such as loans and mortgage-backed securities, and interest paid on interest-bearing liabilities, such as deposits and borrowings. Our net interest income will be adversely affected if market interest rates change such that the interest we pay on deposits and borrowings increase faster than the interest earned on loans and investments.
Our results of operations will be affected by domestic economic conditions and the monetary and fiscal policies of the U.S. government and its agencies. The Federal Reserve has, and is likely to continue to have, an important impact on the operating results of lending institutions through its power to implement national monetary policy, among other things, in order to curb inflation or combat a recession. The Federal Reserve affects the levels of bank loans, investments and deposits through its control over the issuance of U.S. government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. If short-term interest rates rise, and if rates on our deposits and borrowings re-price upwards faster than the rates on our long-term loans and investments, we may experience compression of our net interest margin, which will have a negative effect on our results of operations. We cannot predict the nature or impact of future changes in monetary and fiscal policies. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition, results of operations, and cash flows.
While we intend to manage the effects of changes in interest rates by adjusting the terms, maturities and pricing of our assets and liabilities, our efforts may not be effective in a changing rate environment and our financial condition and results of operations may suffer.
Changes in market interest rates or other conditions may have an adverse impact on the fair value of the Company’s available-for-sale securities, stockholders’ equity and profits.
GAAP requires the Company to carry its available-for-sale securities at fair value on its balance sheet. Unrealized gains or losses on these securities, reflecting the difference between the fair market value and the amortized cost, net of its tax effect, are included as a component of stockholders’ equity. When market rates of interest increase, the fair value of the Company’s securities available-for-sale generally decreases and equity correspondingly decreases. When rates decrease, fair value generally increases and stockholders’ equity correspondingly increases. However, due to significant disruptions in global financial markets, such as those which occurred in 2008, this usual relationship can be disrupted.
Prices and volumes of transactions in the nation’s securities markets can be affected suddenly by economic crises, such as that experienced in the United States and internationally in 2008, or by other national or international crises, such as national disasters, acts of war or terrorism, changes in commodities markets, or instability in foreign governments. Disruptions in securities markets may detrimentally affect the value of securities that we hold in our investment portfolio, such as through reduced valuations due to the perception of heightened credit and liquidity risks. There can be no assurance that declines in market value associated with these disruptions will not result in other than temporary impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.
A significant portion of our loan portfolio is secured by real estate; therefore, we have a high degree of risk from a downturn in our real estate markets and the local economy and face risks that are unique to holding foreclosed real estate.
A downturn in the real estate market and local economy in South Dakota could hurt our business because a significant portion of our loans are secured by real estate located in South Dakota. Real estate values and real estate markets are generally affected by, among other things, changes in regional or local economic conditions, fluctuations in interest rates, and the availability of loans to potential purchasers. If real estate values decline in South Dakota, including farmland values, the value of real estate collateral securing our loans could be significantly reduced. Our ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished and we would be more likely to suffer losses on defaulted loans.
Additionally, the Bank faces certain risks that are unique to holding foreclosed real estate, such as the risk that hazardous or toxic substances are found on the foreclosed property, which may require the Bank to incur substantial expenses to remediate or materially reduce the property's value. Although the Bank has policies and procedures in place to ensure that an environmental review is performed before initiating any foreclosure action on real property, these reviews may turn out to be insufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard in connection with foreclosed real estate could have a material adverse effect on our financial condition and results of operations.
We have significant exposure to risks associated with the agriculture industry due to our loan concentration.
Agricultural loans comprised 25.5% of our total loan and lease portfolio at June 30, 2013. A number of these loans have relatively large balances. Payments on agricultural loans are dependent on the profitable operation or management of the farm property securing the loans. The deterioration of one or a few of these loans may cause a significant increase in nonperforming loans. Our agricultural loans may involve a greater degree of risk than other loans, and the ability of the borrower to repay may be affected by many factors outside of the borrower's control, including adverse weather conditions that prevent the planting of a crop or limit crop yields (such as hail, drought and floods), loss of livestock due to disease or other factors, declines in market prices for agricultural products and the impact of government regulations (including changes in price supports, subsidies and environmental regulations). In addition, many farms are dependent on a limited number of key individuals whose injury or death may significantly affect the successful operation of the farm. If the cash flow from a farming operation is diminished, the borrower's ability to repay the loan may be impaired. The primary crops in our market areas are corn and soybeans. Accordingly, adverse circumstances affecting these crops could have an adverse effect on our agricultural loan portfolio. While virtually all of our agricultural operating loan crop borrowers utilize federal crop insurance programs to insure against weather-related losses, we cannot be certain that insurance coverages will be adequate to fully satisfy cash flow and associated operating requirements. Furthermore, any extended period of low commodity prices, significantly reduced yields on crops, reduced levels of government assistance to the agricultural industry and/or reduced farmland values could result in a significant increase in our nonperforming loans. An increase in nonperforming loans could result in a loss of net income from these loans, an increase in the provision for loan losses, and/or an increase in loan charge-offs, which would have an adverse impact on our results of operations and financial condition.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure. There is no assurance that any such losses would not materially and adversely affect our results of operations.
Future acquisitions and expansion activities may disrupt our business, dilute existing stockholders and adversely affect our operating results.
We intend to continue to evaluate potential acquisitions and expansion opportunities in the normal course of our business. To the extent that we grow through acquisitions, we may not be able to adequately or profitably manage this growth. Acquiring other banks, thrifts, or financial service companies, as well as other geographic and product expansion activities, involve various risks including:
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risks of unknown or contingent liabilities;
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unanticipated costs and delays;
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risks that acquired new businesses do not perform consistent with our growth and profitability expectations;
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risks of entering new markets or product areas where we have limited experience;
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risks that growth will strain our infrastructure, staff, internal controls and management, which may require additional personnel, time and expenditures;
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exposure to potential asset quality issues with acquired institutions;
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difficulties, expenses and delays of integrating the operations and personnel of acquired institutions, and start-up delays and costs of other expansion activities;
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potential disruptions to our business;
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possible loss of key employees and customers of acquired institutions;
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potential short-term decreases in profitability; and
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diversion of our management's time and attention from our existing operations and business.
We may participate in FDIC-assisted acquisitions, which could present additional risks to our financial condition.
We may make opportunistic whole or partial acquisitions of troubled financial institutions in transactions facilitated by the FDIC. In addition to the risks frequently associated with acquisitions, an acquisition of a troubled financial institution may involve a greater risk that the acquired assets under perform compared to our expectations. Because these acquisitions are structured in a manner that would not allow us the time normally associated with preparing for and evaluating an acquisition, including preparing for integration of an acquired institution, we may face additional risks including, among other things, the loss of customers, strain on management resources related to collection and management of problem loans and problems related to integration of personnel and operating systems. Additionally, while the FDIC may agree to assume certain losses in transactions that it facilitates, there can be no assurances that we would not be required to raise additional capital as a condition to, or as a result of, participation in an FDIC-assisted transaction. Any such transactions and related issuances of stock may have dilutive effect on earnings per share and share ownership.
Attractive acquisition opportunities may not be available to us in the future.
We expect that other banking and financial service companies, many of which have significantly greater resources than us, will compete with us in acquiring other banks, thrifts, and financial service companies. This competition could increase prices for potential acquisitions that we believe are attractive. Also, acquisitions are subject to various regulatory approvals. If we fail to receive the appropriate regulatory approvals, we will not be able to consummate an acquisition that we believe is in our best interests. Among other things, our regulators consider our capital, liquidity, profitability, regulatory compliance and levels of goodwill and intangibles when considering acquisition and expansion proposals. Any acquisition could be dilutive to our earnings and stockholders' equity per share of our common stock.
We may need to raise additional capital in the future, and such capital may not be available when needed or at all.
We are required by regulatory agencies to maintain adequate levels of capital to support our operations and such levels may be increased by legislative and regulatory developments. To complete any future acquisitions and expansion activities, we may need to raise additional capital. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control. Accordingly, we may not be able to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through organic or external growth could be materially impaired.
In the event that we are able to raise capital through the issuance of additional shares of common stock or other securities, the ownership interests of current investors would be diluted and the per share book value of our common stock may be diluted. New investors may also have rights, preferences and privileges senior to the holders of our common stock, which may adversely affect the holders of our common stock.
We are subject to security and operational risks, especially relating to our use of technology that could damage our reputation and our business.
We rely heavily on communications and information systems to conduct our business. Furthermore, we have access to large amounts of confidential financial information and control substantial financial assets, including those belonging to our customers, to whom we offer remote access, and we regularly transfer substantial financial assets by electronic means. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers. Any failure, interruption or breach in security of our systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations. Although we, with the help of third-party service providers, intend to continue to implement security technology and establish operational procedures to prevent such damage, our security measures may not be successful.
In addition, advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms we and our third-party service providers use to encrypt and protect customer transaction data. A failure of such security measures could have a material adverse effect on our financial condition and results of operations. We also face the risk of operational disruption, failure, termination or capacity constraints caused by third parties that facilitate our business activities by providing technology such as software applications, as well as financial intermediaries. Such parties could also be the source of an attack on, or breach of, our operational systems, data or infrastructure.
We also face the potential risk of losses due to fraud, including commercial checking account fraud, automated teller machine ("ATM") skimming and trapping, write-offs necessitated by debit card fraud, and other forms of online banking fraud, which are being more sophisticated and present new challenges as mobile banking increases, as well as employee fraud. Employee errors could also subject us to financial claims for negligence. We maintain a system of internal controls and insurance coverage to mitigate against operational risks, including data processing system failures and errors and customer or employee fraud. Should our internal controls fail to prevent or detect an occurrence, and if any resulting loss is not insured or exceeds applicable insurance limits, such failure could have a material adverse effect on our business, financial condition and results of operations.
We continually encounter technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology driven by products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
The loss of one or more of our key personnel, or our inability to attract, assimilate and retain highly qualified personnel in the future, could harm our business.
As a community bank, we expect our future growth to be driven in large part by the relationships that our personnel maintain with our customers. We depend on the talents and leadership of our executive team, including Stephen M. Bianchi, our President and Chief Executive Officer, and Brent R. Olthoff, our Senior Vice President, Chief Financial Officer and Treasurer. There is an increasing risk in our industry around the lack of human capital with experience, training and skills in financial services. Therefore, the competition for qualified personnel in the financial services industry can be intense. The inability to continue to attract, retain and motivate key personnel could adversely affect our business.
Adverse weather affecting the markets we serve could hurt our business and prospects for growth.
The South Dakota economy, in general, is heavily dependent on agriculture and therefore the overall South Dakota economy, and particularly the economies of the rural communities that we serve, can be greatly affected by severe weather conditions, including droughts, storms, tornadoes and flooding. Unfavorable weather conditions may decrease agricultural
productivity or could result in damage to our branch locations or the property of our customers, all of which could adversely affect the local economy. An adverse affect on the economy of South Dakota would negatively affect our profitability.
Changes in or interpretations of accounting standards may materially impact our financial statements.
Accounting principles generally accepted in the United States and accompanying accounting pronouncements, implementation guidelines, interpretations and practices for many aspects of our business are complex and involve subjective judgments, including, but not limited to, accounting for the allowance for loan and lease losses and pending and incurred but not reported health claims. Changes in these estimates or changes in other accounting rules and principles, or their interpretation, could significantly change our reported net income and operating results, and could add significant volatility to those measures, without a comparable underlying change in cash flow from operations.
The holders of our junior subordinated debentures have rights that are senior to those of our stockholders.
We have supported our continued growth through the issuance of trust preferred securities from special purpose trusts and accompanying sales of junior subordinated debentures to these trusts. The accompanying junior subordinated debentures have an aggregate liquidation amount totaling $24.8 million at June 30, 2013. Payments of the principal and interest on the trust preferred securities of these trusts are conditionally guaranteed by us. Further, the accompanying junior subordinated debentures that we issued to the trusts are senior to our shares of common stock. As a result, we must make payments on the junior subordinated debentures before any dividends can be paid on our common stock and, in the event of our bankruptcy, dissolution or liquidation, the holders of the junior subordinated debentures must be satisfied before any distributions can be made on our common stock.
Risks Relating to Our Common Stock
The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell shares of our common stock at times or at prices you find attractive.
The stock market and, in particular, the market for financial institution stocks, experienced significant volatility during the recent economic downturn. In some cases, the markets produced downward pressure on stock prices for certain issuers without regard to those issuers' underlying financial strength. Furthermore, the trading price of the shares of our common stock depends on many other factors that may change from time to time and may be beyond our control. This may make it difficult for you to resell shares of our common stock at times or at prices you find attractive.
Among the factors that could affect our stock price are those identified in the section entitled "Special Cautionary Note Regarding Forward-Looking Statements" and as follows:
•
actual or anticipated quarterly fluctuations in our operating results and financial condition;
•
changes in financial estimates or publication of research reports and recommendations by financial analysts or actions taken by rating agencies with respect to our common stock or those of other financial institutions;
•
failure to meet analysts' revenue or earnings estimates;
•
speculation in the press or investment community generally or relating to our reputation, our market area, our competitors or the financial services industry in general;
•
strategic actions by us or our competitors, such as acquisitions, restructurings, dispositions or financings;
•
actions by our current stockholders, including sales of common stock by existing stockholders and/or directors and executive officers;
•
fluctuations in the stock price and operating results of our competitors;
•
future sales of our equity, equity-related or debt securities;
•
changes in the frequency or amount of dividends or share repurchases;
•
proposed or adopted regulatory changes or developments;
•
anticipated or pending investigations, proceedings or litigation that involve or affect us;
•
trading activities in our common stock, including short-selling;
•
domestic and local economic factors unrelated to our performance; and
•
general market conditions and, in particular, developments related to market conditions for the financial services industry.
A significant decline in our stock price could result in substantial losses for individual stockholders and could lead to costly and disruptive securities litigation.
Our ability to pay dividends depends primarily on dividends from our banking subsidiary, the Bank, which is subject to regulatory limits.
We are a unitary thrift holding company and our operations are conducted primarily by our banking subsidiary, the Bank. Since we receive substantially all of our revenue from dividends from the Bank, our ability to pay dividends on our common stock depends on our receipt of dividends from the Bank.
Dividend payments from the Bank are subject to legal and regulatory limitations, generally based on net income and retained earnings. The ability of the Bank to pay dividends to us is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. The Bank may not be able to generate adequate cash flow to pay us dividends in the future. The inability to receive dividends from the Bank could have an adverse effect on our business and financial condition.
Furthermore, holders of our common stock are only entitled to receive the dividends as our Board of Directors may declare out of funds legally available for such payments. Although we have historically paid cash dividends on our common stock, we are not required to do so and our Board of Directors could reduce or eliminate our common stock dividend in the future. This could adversely affect the market price of our common stock.
Additionally, we may elect in the future to defer interest payments on our junior subordinated debentures discussed above. The debenture agreements prohibit dividend payments on our common stock following the deferral of interest payments on the subordinated debentures underlying the trust preferred securities.
The trading volume in our common stock has been low, and the sale of a substantial number of shares of our common stock in the public market could depress the price of our common stock and make it difficult for you to sell your shares.
Our common stock is listed to trade on The Nasdaq Global Market but is thinly traded. As a result, you may not be able to sell your shares of common stock on short notice. Additionally, thinly traded stock can be more volatile than stock trading in an active public market. The sale of a substantial number of shares of our common stock at one time could depress the market price of our common stock, making it difficult for you to sell your shares and impairing our ability to raise capital.
We may raise additional capital, which could have a dilutive effect on the existing holders of our common stock and adversely affect the market price of our common stock.
We are not restricted from issuing additional shares of common stock or securities that are convertible into or exchangeable for, or that represent the right to receive, common stock. We may evaluate opportunities to access the capital markets taking into account our regulatory capital ratios, financial condition and other relevant considerations, and subject to market conditions, we may take further capital actions. Such actions could include, among other things, the issuance of shares of common stock in public or private transactions in order to further increase our capital levels above the requirements for a well-capitalized institution established by the federal bank regulatory agencies as well as other regulatory targets.
We face significant regulatory and other governmental risks as a financial institution, and it is possible that capital requirements and directives could in the future require us to change the amount or composition of our current capital, including common equity.
The issuance of any additional shares of common stock or securities convertible into or exchangeable for common stock or that represent the right to receive common stock, or the exercise of such securities, could be substantially dilutive to holders of our common stock. Holders of our shares of common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series and, therefore, such sales or offerings could result in increased dilution to our stockholders. The market price of our common stock could decline as a result of sales of shares of our common stock or the perception that such sales could occur.
Certain provisions of our Certificate of Incorporation and Bylaws, as well as Delaware and federal law, may discourage, delay or prevent an acquisition of control of us.
Certain provisions included in our Certificate of Incorporation and Bylaws, as well as certain provisions of the Delaware General Corporation Law and federal law, may discourage, delay or prevent potential acquisitions of control of us, particularly
when attempted in a transaction that is not negotiated directly with, and approved by, our Board of Directors, despite possible benefits to our stockholders.
Specifically, our Certificate of Incorporation and Bylaws, as the case may be, include certain provisions that:
•
limit the voting power of shares held by a stockholder beneficially owning in excess of 10% of the then-outstanding shares of our common stock;
•
require that certain business combinations between us and a stockholder beneficially owning in excess of 10% of the then-outstanding shares of our capital stock entitled to vote in the election of directors be approved by the affirmative vote of the holders of at least 66 2/3% of the then-outstanding shares of stock entitled to vote in the election of directors, voting together as a single class, or be approved by the affirmative vote of the majority of the outstanding shares of our capital stock entitled to vote if the business combination (i) is approved by a majority of the Board of Directors serving prior to the 10% stockholder becoming such, and/or (ii) involves consideration per share generally equal to that paid by such 10% stockholder when such stockholder acquired his, her or its stock;
•
divide our Board of Directors into three classes serving staggered three-year terms and provide that a director may only be removed prior to the expiration of a term for cause by the affirmative vote of the holders of at least 80% of the voting power of all of the then-outstanding shares of capital stock entitled to vote in an election of directors;
•
require that a special meeting of stockholders be called pursuant to a resolution adopted by a majority of our Board of Directors;
•
authorize the issuance of preferred stock with such designations, rights and preferences as may be determined from time to time by our Board of Directors; and
•
require that an amendment to our Certificate of Incorporation be approved by a vote of at least two-thirds of our directors then in office and thereafter by our stockholders by a majority of the total votes eligible to be cast at a stockholders meeting called for that purpose; provided, however, with respect to the amendment of certain provisions regarding, among other things, provisions relating to the voting limits of holders of more than 10% of our common stock, the number, classification, election and removal of directors, amendment of the Bylaws, call of special stockholder meetings, acquisitions of control, director liability, and certain business combinations, in addition to any vote of the holders of any class or series of our capital stock required by applicable law or by our Certificate of Incorporation, such amendments must be approved by the affirmative vote of the holders of at least 80% of the voting power of all of our then-outstanding capital stock entitled to vote generally in the election of directors, voting together as a single class.
Furthermore, federal law requires Federal Reserve approval prior to any direct or indirect acquisition of "control" (as defined in Federal Reserve regulations) of the Bank, including any acquisition of control of us. By statute, a company would be found to "control" the Bank if the Company: (1) directly or indirectly or acting in concert with one or more persons, owns, controls, or has the power to vote 25% or more of the voting securities of the Company or Bank; (2) controls in any manner the election of a majority of the directors of the Company's or Bank's board; or (3) directly or indirectly exercises a controlling influence over the management or policies of the Company and Bank. The Federal Reserve's implementing regulations include a specific definition of "control" similar to the statutory definition, with certain additional provisions. In addition to the rebuttable presumptions of control set forth in the implementing regulations, the Federal Reserve's supervision manual for supervised institutions provides that there are a number of other circumstances that are indicative of control and may call for further investigation to uncover facts that support a determination of control.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
The Company and its direct and indirect subsidiaries conduct their business at the main office located at 225 South Main Avenue, Sioux Falls, South Dakota, 57104. At June 30, 2013, the Bank has a total of 27 banking centers in its market area and Internet access located at www.homefederal.com and www.infiniabank.com. Of such 27 total banking centers, the Bank owns 14, including the main office, and leases 13 others. For a description of the Bank's market area, see Item 1, "Business-Market Area" of this Form 10-K.
The total net book value of the Company's premises and equipment (including land, building, leasehold improvements and furniture, fixtures and equipment) at June 30, 2013 was $13.9 million. Management believes there is a continuing need to keep facilities and equipment up-to-date and continued investment will be necessary in the future.
Item 3.
Item 3. Legal Proceedings
The Company, the Bank and each of their subsidiaries are, from time to time, involved as plaintiff or defendant in various legal actions arising in the normal course of their businesses. While the ultimate outcome of any such proceedings cannot be predicted with certainty, it is generally the opinion of management, after consultation with counsel representing the Bank and the Company in any such proceedings, that the resolution of any such proceedings should not have a material effect on the Company's consolidated financial position or results of operations. The Company, the Bank and each of their subsidiaries are not aware of any material legal actions or other proceedings contemplated by governmental authorities outside of the normal course of business.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Stock Listing
The Company's common stock is traded under the symbol "HFFC" on the NASDAQ Global Market.
The following table sets forth the range of high and low sale prices for the Company's common stock for each quarter of the two most recent fiscal years ended June 30, 2013 and 2012. Quotations for such periods are as reported by the NASDAQ Global Market.
At September 9, 2013, the Company had 416 holders of record of its common stock.
The transfer agent for the Company's common stock is Computershare, P.O. Box 358015, Pittsburgh, PA 15252.
Dividends
The Company paid cash dividends on a quarterly basis of $0.1125, $0.1125, $0.1125 and $0.1125 per share throughout fiscal 2013. The Company paid cash dividends on a quarterly basis of $0.1125, $0.1125, $0.1125 and $0.1125 per share in fiscal 2012. On July 29, 2013, the Board of Directors announced the approval of a cash dividend of $0.1125 per share and the Company paid the respective cash dividends on August 16, 2013 to stockholders of record on August 9, 2013.
The Company's ability to pay dividends on its common stock is dependent on the dividend payments it receives from the Bank, since the Company receives substantially all of its revenue in the form of dividends from the Bank. Future dividends are not guaranteed and will depend on the Company's ability to pay them.
Federal regulations govern the permissibility of capital distributions by a federal savings association. Pursuant to the Dodd-Frank Act, savings associations that are part of a savings and loan holding company structure must now file a notice of a declaration of a dividend with the Federal Reserve. In the case of cash dividends, OCC regulations require that federal savings associations that are subsidiaries of a stock savings and loan holding company must file an informational copy of that notice with the OCC at the same time it is filed with the Federal Reserve. OCC regulations further set forth the circumstances under which a federal savings association is required to submit an application or notice before it may make a capital distribution.
A federal savings association proposing to make a capital distribution is required to submit an application to the OCC if: (1) the association does not qualify for expedited treatment pursuant to criteria set forth in OCC regulations; (2) the total amount of all of the association's capital distributions (including the proposed capital distribution) for the applicable calendar year exceeds the association's net income for that year to date plus the association's retained net income for the preceding two years; (3) the association would not be at least adequately capitalized following the distribution; or (4) the proposed capital distribution would violate a prohibition contained in any applicable statute, regulation, or agreement between the association and the OCC or violate a condition imposed on the association in an application or notice approved by the OCC.
A federal savings association proposing to make a capital distribution is required to submit a prior notice to the OCC if: (1) the association would not be well capitalized following the distribution; (2) the proposed capital distribution would reduce the amount of or retire any part of the association's common or preferred stock or retire any part of debt instruments such as notes or debentures included in the association's capital (other than regular payments required under a debt instrument); or (3) the association is a subsidiary of a savings and loan holding company and is not required to file a notice regarding the proposed distribution with the Federal Reserve, in which case only an informational copy of the notice filed with the Federal Reserve needs to be simultaneously provided to the OCC.
Each of the Federal Reserve and OCC have primary reviewing responsibility for the applications or notices required to be submitted to them by savings associations relating to a proposed distribution. The Federal Reserve may disapprove of a notice, and the OCC may disapprove of a notice or deny an application, if:
•
the savings association would be undercapitalized following the distribution;
•
the proposed distribution raises safety and soundness concerns; or
•
the proposed distribution violates a prohibition contained in any statute, regulation, enforcement action or agreement between the savings association (or its holding company, in the case of the Federal Reserve) and the entity's primary federal regulator, or a condition imposed on the savings association (or its holding company, in the case of the Federal Reserve) in an application or notice approved by the entity's primary federal regulator.
The Company's ability to pay dividends is also subject to the terms of its outstanding trust preferred securities and the accompanying junior subordinated debentures. Under the terms of these debentures, the Company may defer interest payments on the debentures for up to five years. If the Company defers such interest payments, the Company may not declare or pay any cash dividends on any shares of its common stock during the deferral period.
In addition, the Company has a line of credit for $4.0 million with United Bankers' Bank with no outstanding balance at June 30, 2013. The line of credit matures on October 1, 2013. In case of default on the line of credit, the Company's ability to pay cash dividends may be restricted.
Stockholder Return Performance
The following line graph compares the cumulative total stockholder return on the Company's common stock to the comparable cumulative total return of the NASDAQ Market Index and the NASDAQ Bank Index for the last five years.
The performance graph assumes that on July 1, 2008, $100 was invested in the Company's common stock (at the closing price of the previous trading day) and in each of the indexes. The comparison assumes the reinvestment of all dividends. Cumulative total stockholder returns for the Company's common stock, the NASDAQ Market Index and the NASDAQ Bank Index are based on the Company's fiscal year ending June 30, 2013. The performance graph represents past performance and should not be considered to be an indication of future performance.
COMPARISON OF 5-YEAR CUMULATIVE TOTAL STOCKHOLDER RETURN
AMONG HF FINANCIAL CORP., NASDAQ MARKET INDEX AND NASDAQ BANK INDEX
ASSUMES $100 INVESTED ON JULY 01, 2008 AND DIVIDENDS REINVESTED
Equity Compensation Plan Information
The following table sets forth certain information about the common stock that may be issued upon exercise of options, warrants and rights under all of the Company's existing equity compensation plans at June 30, 2013, including the 2002 Stock Option and Incentive Plan, the 1996 Director Restricted Stock Plan, and the 1991 Stock Option and Incentive Plan (collectively, the "Incentive Plans"). The 1996 Director Restricted Stock Plan expired on January 1, 2007, the 1991 Stock Option and Incentive Plan expired on October 27, 2002, and the 2002 Stock Option and Incentive Plan expired on September 20, 2012. Although the column below entitled "Number of Shares to be Issued Upon Exercise of Outstanding Options, Warrants and Rights" includes common stock to be issued upon unexpired options issued under the Incentive Plans, no common stock remains available for future awards under the Incentive Plans.
Plan Category
Number of Shares to be
Issued Upon Exercise of
Outstanding Options,
Warrants and Rights
Weighted-Average
Exercise Price of
Outstanding Options,
Warrants and Rights
Number of Shares
Remaining Available for
Future Issuance Under
Equity Compensation Plans
(Excluding Shares Reflected
in the First Column)
Equity plan compensation plans approved by stockholders
137,481
$
13.98
-
Equity plan compensation plans not approved by stockholders
N/A
N/A
N/A
Total
137,481
$
13.98
-
Sales of Unregistered Stock
None.
Issuer Purchases of Equity Securities
None.
Item 6.
Item 6. Selected Financial Data
The following table sets forth selected consolidated financial statement and operations data with respect to the Company for the periods indicated. This information should be read in conjunction with the Financial Statements and related notes appearing in Part II, Item 8 "Financial Statements and Supplementary Data" of this Form 10-K and with Part II, Item 7
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
This section should be read in conjunction with the following parts of this Form 10-K: Forward-Looking Statements, Part II, Item 8 "Financial Statements and Supplementary Data," Part II, Item 7A
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk Management
The Company's net income is largely dependent on its net interest income. Net interest income is susceptible to interest rate risk to the extent that interest-bearing liabilities with short- and medium-term maturities mature or reprice more rapidly than its interest-earning assets. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net income.
In an attempt to manage its exposure to changes in interest rates, management monitors the Company's interest rate risk. The Asset/Liability Committee meets periodically to review the Bank's interest rate risk position and profitability, and to recommend adjustments for consideration by executive management. Management also reviews the Bank's securities portfolio, formulates investment strategies, and oversees the timing and implementation of transactions to assure attainment of objectives in the most prudent, effective manner. In managing market risk and the asset/liability mix, the Bank has placed its emphasis on developing a portfolio in which, to the extent practicable, assets and liabilities reprice within similar periods. Notwithstanding the Company's interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income. The Company does not currently engage in trading activities to control interest rate risk although it may in the future, if necessary, to manage interest rate risk. The Company has entered into interest rate swap contracts to convert variable-rate trust preferred debt into a fixed rate instrument to modify interest rate risk. In addition, the Bank has entered into back-to-back and one-way interest rate swap contracts to provide a fixed rate facility to borrowers on respective loans. See Note 10 of "Notes to Consolidated Financial Statements" of this Form 10-K for additional information.
In adjusting the Company's asset/liability position, management attempts to manage the Company's interest rate risk while enhancing net interest margins. At times, depending on the level of general interest rates, the relationship between long and short-term interest rates, market conditions and competitive factors, management may determine to increase the Company's interest rate risk position somewhat in order to increase its net interest margin. The Company's results of operations and net portfolio values remain vulnerable to increases in interest rates and to fluctuations in the difference between long- and short-term interest rates.
Consistent with the asset/liability management philosophy described above, the Company has taken several steps to manage its interest rate risk. The Company has structured its security portfolio to shorten the repricing of its interest-earning assets. The Company's agency residential mortgage-backed securities and securities available for sale typically have either short or medium terms to maturity or adjustable interest rates. At June 30, 2013, the Company had investment securities available for sale of $11.6 million with contractual maturities of five years or less. Adjustable-rate agency residential mortgage-backed securities totaled $347.4 million at June 30, 2013. Agency residential mortgage-backed securities amortize and experience prepayments of principal. The Company has received average cash flows from principal paydowns, maturities, sales and calls of all securities available for sale of $168.7 million annually over the past three fiscal years. The Company also manages interest rate risk reduction by utilizing non-certificate depositor accounts for certain liquidity purposes. Management believes that such accounts carry a lower cost than certificate accounts, and that a material portion of such accounts may be more resistant to changes in interest rates than are certificate accounts. At June 30, 2013, the Company had $115.6 million of savings accounts, $212.8 million of money market accounts and $308.3 million of checking accounts, representing 70.9% of the Bank's total depositor account balances.
One approach used to quantify interest rate risk is the Bank's NPV analysis. In essence, this analysis calculates the difference between the present value of liabilities and the present value of expected cash flows from assets and off-balance sheet contracts. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations-Asset/Liability and Risk Management" of this Form 10-K for further discussion regarding the NPV analysis and an analysis of the Company's interest rate risk as measured by the estimated changes in NPV resulting from instantaneous and sustained parallel shifts in the yield curve.
Item 8.
Item 8. Financial Statements and Supplementary Data
Management's Report on Internal Control over Financial Reporting
The management of HF Financial Corp. and its subsidiaries (the "Company") is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended) for the Company. The Company's internal control over financial reporting was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Under the supervision and with the participation of the Company's management, including its President and Chief Executive Officer and its Senior Vice President, Chief Financial Officer and Treasurer, the Company conducted an evaluation of the effectiveness of its internal control over financial reporting at June 30, 2013 based on the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in 1992. Based on this evaluation, management concluded that the Company's internal control over financial reporting was effective at June 30, 2013.
The effectiveness of the Company’s internal control over financial reporting as of June 30, 2013, has been audited by Eide Bailly LLP, the independent registered public accounting firm who also has audited the Company’s consolidated financial statements included in this Annual Report on Form 10-K. Eide Bailly LLP’s report on the Company’s internal control over financial reporting appears on the following page.
/s/ STEPHEN M. BIANCHI
/s/ BRENT R. OLTHOFF
Stephen M. Bianchi
President and
Chief Executive Officer
Brent R. Olthoff
Senior Vice President,
Chief Financial Officer and Treasurer
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM'S REPORT ON THE FINANCIAL STATEMENTS
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM'S REPORT ON THE INTERNAL CONTROLS OVER FINANCIAL REPORTING
CONSOLIDATED FINANCIAL STATEMENTS
Statements of Financial Condition
Statements of Income
Statements of Comprehensive Income
Statements of Stockholders' Equity
Statements of Cash Flows
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
HF Financial Corp.
Sioux Falls, South Dakota
We have audited the accompanying consolidated statements of financial condition of HF Financial Corp. as of June 30, 2013 and 2012, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the years in the three year period ended June 30, 2013. HF Financial Corp.'s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HF Financial Corp. as of June 30, 2013 and 2012, and the results of its operations and its cash flows for each of the years in the three year period ended June 30, 2013, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), HF Financial Corp.'s internal control over financial reporting as of June 30, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 1992, and our report dated September 13, 2013 expressed an unqualified opinion.
Sioux Falls, South Dakota
September 13, 2013
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
HF Financial Corp.
Sioux Falls, South Dakota
We have audited HF Financial Corp's internal control over financial reporting as of June 30, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 1992. HF Financial Corp's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on HF Financial Corp's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, HF Financial Corp maintained, in all material respects, effective internal control over financial reporting as of June 30, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 1992.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of HF Financial Corp, and our report dated September 13, 2013 expressed an unqualified opinion.
Sioux Falls, South Dakota
September 13, 2013
HF FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
HF FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED JUNE 30, 2013, 2012 AND 2011
(DOLLARS IN THOUSANDS, except share data)
HF FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED JUNE 30, 2013, 2012 AND 2011
(DOLLARS IN THOUSANDS, except share data)
HF FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED JUNE 30, 2013, 2012 AND 2011
(DOLLARS IN THOUSANDS, except share data)
HF FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 2013, 2012 AND 2011
(DOLLARS IN THOUSANDS, except share data)
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
NOTE 1-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of HF Financial Corp. and subsidiaries ("the Company") conform to accounting principles generally accepted in the United States of America and to general practice within the industry. The following is a description of the more significant of those policies that the Company follows in preparing and presenting its consolidated financial statements.
Nature of Operations
The Company, a unitary thrift holding company, was formed in November 1991, for the purpose of owning all of the outstanding stock of Home Federal Bank ("the Bank"). The Company is incorporated under the laws of the State of Delaware and generally is authorized to engage in any activity that is permitted by the Delaware General Corporation Law. The executive offices of the Company and its direct and indirect subsidiaries are located in Sioux Falls, South Dakota.
The Bank was founded in 1929 and is a federally chartered stock savings bank headquartered in Sioux Falls, South Dakota. The Bank provides full-service consumer and commercial business banking, including an array of financial products, to meet the needs of its market place. The Bank attracts deposits from the general public and uses such deposits, together with borrowings and other funds, to originate one-to-four family residential, commercial business, consumer, multi-family, commercial real estate, construction and agricultural loans. The Bank's consumer loan portfolio includes, among other things, automobile loans, home equity loans, loans secured by deposit accounts and student loans. The Bank also purchases agency residential mortgage-backed securities and invests in U.S. Government and agency obligations and other permissible investments. The Bank receives loan servicing income on loans serviced for others and commission income from credit-life insurance on consumer loans. Through its trust department, the Bank acts as trustee, personal representative, administrator, guardian, custodian, agent, advisor and manager for various accounts. The Bank, through its wholly-owned subsidiaries, offers annuities, mutual funds, life insurance and other financial products, and equipment leasing services.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company, the Company's wholly-owned subsidiaries, HomeFirst Mortgage Corp. (the "Mortgage Corp."), HF Financial Group, Inc. ("HF Group"), and Home Federal Bank (the "Bank") and the Bank's wholly-owned subsidiaries, Hometown Investment Services, Inc. ("Hometown"), Mid America Capital Services, Inc. ("Mid America Capital"), Mid-America Service Corporation ("Mid-America") and PMD, Inc ("PMD"). All intercompany balances and transactions have been eliminated in consolidation.
Basis of Financial Statement Presentation and Use of Estimates
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of financial condition and revenues and expenses for the fiscal year. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near-term related to the determination of the allowance for loan and lease losses, self-insurance, security impairment and servicing rights. Management has evaluated subsequent events for potential disclosure or recognition through September 13, 2013, the date of the filing of the consolidated financial statements with the Securities and Exchange Commission.
Cash and Cash Equivalents
For purposes of reporting the statements of cash flows, the Company includes as cash equivalents all cash accounts which are not subject to withdrawal restrictions or penalties, due from banks, federal funds sold and time deposits with original maturities of 90 days or less.
Trust Assets
Assets of the trust department, other than trust cash on deposit at the Bank, are not included in these consolidated financial statements because they are not assets of the Bank.
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Securities
Management determines the appropriate classification of securities at the date individual securities are acquired and evaluates the appropriateness of such classifications at each statement of financial condition date.
Securities available for sale are those debt securities that the Company intends to hold for an indefinite period of time, but may not hold necessarily to maturity, and all equity securities. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities available for sale are carried at fair value and unrealized gains or losses are reported as increases or decreases in other comprehensive income net of the related deferred tax effect. Sales of securities available for sale are recorded on a trade date basis.
Premiums and discounts on securities are amortized over the contractual lives of those securities, except for agency residential mortgage-backed securities, for which prepayments are probable and predictable, which are amortized over the estimated expected repayment terms of the underlying mortgages. The method of amortization results in a constant effective yield on those securities (the interest method). Interest on debt securities is recognized in income as accrued. Realized gains and losses on the sale of securities are determined using the specific identification method.
Securities Impairment
Management continually monitors the investment security portfolio for impairment on a security by security basis and has a process in place to identify securities that could potentially have a credit impairment that is other-than-temporary. This process involves the length of time and extent to which the fair value has been less than the amortized cost basis, review of available information regarding the financial position of the issuer, monitoring the rating of the security, cash flow projections, and the Company's intent to sell a security or whether it is more likely than not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity. To the extent we determine that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized. If the Company intends to sell a security or it is more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, the Company recognizes an other-than-temporary impairment in net income for the difference between amortized cost and fair value. If we do not expect to recover the amortized cost basis, we do not plan to sell the security and if it is not more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, the recognition of the other-than-temporary impairment is bifurcated. For those securities, the Company separates the total impairment into a credit loss component recognized in net income, and the amount of the loss related to other factors is recognized in other comprehensive income net of taxes.
The amount of the credit loss component of a debt security impairment is estimated as the difference between amortized cost and the present value of the expected cash flows of the security. The present value is determined using the best estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset- backed or floating rate security. Currently, the Company does not have other-than-temporarily impaired debt securities for which credit losses exist.
Level 3 Fair Value Measurement
Generally Accepted Accounting Principles ("GAAP") requires the Company to measure the fair value of financial instruments under a standard which describes three levels of inputs that are used to measure fair value. Level 3 measurement includes significant unobservable inputs that reflect the Company's own assumptions about the assumptions that market participants would use in valuing an asset or liability. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. Although management believes that it uses a best estimate of information available to determine fair value, due to the uncertainty of future events, the approach includes a process that may differ significantly from other methodologies and still produce an estimate that is in accordance with GAAP.
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Loans Held for Sale
Loans receivable, which the Bank may sell or intend to sell prior to maturity, are carried at the lower of net book value or fair value on an aggregate basis. Such loans held for sale include loans receivable that management intends to use as part of its asset/liability strategy, or that may be sold in response to changes in interest rates, changes in prepayment risk or other similar factors.
Loans and Leases Receivable, Net
Loans receivable are stated at unpaid principal balances, less the allowance for loan and lease losses, and net of deferred loan origination fees, costs and discounts.
The Company's leases receivable are classified as direct finance leases. Under the direct financing method of accounting for leases, the total net payments receivable under the lease contracts and the residual value of the leased equipment, net of unearned income, are recorded as a net investment in direct financing leases and the unearned income is recognized each month on a basis which approximates the interest method.
For purposes of the disclosures required pursuant to the adoption of amendments to ASC 310, the loan portfolio was disaggregated into segments and then further disaggregated into classes for certain disclosures. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for credit losses. A class is generally determined based on the initial measurement attribute, risk characteristics of the loan, and an entity's method for monitoring and assessing credit risk. Residential and Consumer loan portfolio segments include classes of one-to- four family, construction, consumer direct, consumer home equity, consumer overdraft and reserves, and consumer indirect. Commercial, Commercial Real Estate and Agriculture loan portfolio segments include the classes of commercial business, equipment finance leases, commercial real estate, multi-family real estate, construction, agricultural business, and agricultural real estate.
Interest on loans is recognized on an accrual basis at the applicable interest rate on the principal amount outstanding. Loan origination fees and direct costs as well as premiums and discounts are amortized as level yield adjustments over the respective loan terms. Unamortized net fees or costs are recognized upon early repayment of the loans. Loan commitment fees are generally deferred and amortized on a straight-line basis over the commitment period.
Impaired loans are generally carried on a nonaccrual status when there are reasonable doubts as to the collectability of principal and/or interest and/or when payment becomes 90 days past due, except loans which are well secured and in the process of collection. For all portfolio segments and classes accrued but uncollected, interest is reversed and charged against interest income when the loan is placed on nonaccrual status. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral is sufficient to recover the principal balance and accrued interest. Interest payments received on nonaccrual and impaired loans are normally applied to principal. Once all principal has been received, additional interest payments are recognized on a cash basis as interest income.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and insignificant payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial, commercial real estate and agricultural loans by either the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent.
As part of the Company's ongoing risk management practices, management attempts to work with borrowers when necessary to extend or modify loan terms to better align with their current ability to repay. Extensions and modifications to loans are made in accordance with internal policies and guidelines which conform to regulatory guidance. Each occurrence is unique to the borrower and is evaluated separately. In a situation where an economic concession has been granted to a borrower that is experiencing financial difficulty, the Company identifies and reports that loan as a troubled debt restructuring ("TDR").
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Management considers regulatory guidelines when restructuring loans to ensure that prudent lending practices are followed. As such, qualification criteria and payment terms consider the borrower's current and prospective ability to comply with the modified terms of the loan. Additionally, the Company structures loan modifications with the intent of strengthening repayment prospects.
The Company considers whether a borrower is experiencing financial difficulties, as well as whether a concession has been granted to a borrower determined to be troubled, when determining whether a modification meets the criteria of being a TDR under ASC 310-40. For such purposes, evidence which may indicate that a borrower is troubled includes, among other factors, the borrower's default on debt, the borrower's declaration of bankruptcy or preparation for the declaration of bankruptcy, the borrower's forecast that entity-specific cash flows will be insufficient to service the related debt, or the borrower's inability to obtain funds from sources other than existing creditors at an effective interest rate equal to the current market interest rate for similar debt for a non-troubled debtor. If a borrower is determined to be troubled based on such factors or similar evidence, a concession will be deemed to have been granted if a modification of the terms of the debt occurred that management would not otherwise consider. Such concessions may include, among other modifications, a reduction of the stated interest for the remaining original life of the debt, an extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk, a reduction of accrued interest, or a reduction of the face amount or maturity amount of the debt.
A modification of loan terms that management would generally not consider to be a TDR could be a temporary extension of maturity to allow a borrower to complete an asset sale whereby the proceeds of such transaction are to be paid to satisfy the outstanding debt. Additionally, a modification that extends the term of a loan, but does not involve reduction of principal or accrued interest, in which the interest rate is adjusted to reflect current market rates for similarly situated borrowers is not considered a TDR. Nevertheless, each assessment will take into account any modified terms and will be comprehensive to ensure appropriate impairment assessment.
Loans that are reported as TDRs apply the identical criteria in the determination of whether the loan should be accruing or nonaccruing. Typically, the event of classifying the loan as a TDR due to a modification of terms is independent from the determination of accruing interest on a loan in accordance with accounting standards.
For all non-homogeneous loans (including TDRs) that have been placed on nonaccrual status, our policy for returning nonaccruing loans to accrual status requires the following criteria: six months of continued performance, timely payments, positive cash flow and an acceptable loan to value ratio. For homogeneous loans (including TDRs), typical in our residential and consumer portfolio, the policy requires six months of consecutive timely loan payments for returning nonaccrual loans to accruing status.
The allowance for loan and lease losses is maintained at a level that management determines is sufficient to absorb estimated probable incurred losses in the loan portfolio through a provision for loan losses charged to net income. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Management charges off loans, or portions of loans, in the period that such loans, or portions thereof, are deemed uncollectible. The collectability of individual loans is determined through an estimate of the fair value of the underlying collateral and/or an assessment of the financial condition and repayment capacity of the borrower. The allowances for loan and lease losses are comprised of both specific valuation allowances and general valuation allowances that are determined in accordance with authoritative accounting guidance. Additions are made to the allowance through periodic provisions charged to current operations and recovery of principal on loans previously charged off.
The allowance for loan and lease losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
Specific valuation allowances are established based on the Company's analysis of individual loans that are considered impaired. If a loan is deemed to be impaired, management measures the extent of the impairment and as required establishes a specific valuation allowance for that amount. The Company applies this classification as necessary to loans individually evaluated for impairment in the loan portfolio segments of commercial, commercial real estate and agricultural loans. Smaller
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balance homogeneous loans are evaluated for impairment on a collective rather than an individual basis. The Company generally measures impairment on an individual loan and the extent to which a specific valuation allowance is necessary by comparing the loan's outstanding balance to either the fair value of the collateral, less the estimated cost to sell or the present value of expected cash flows, discounted at the loan's effective interest rate. A specific valuation allowance is established when the fair value of the collateral, net of estimated costs, or the present value of the expected cash flows is less than the recorded investment in the loan.
The Company also follows a process to assign general valuation allowances to loan portfolio segment categories. General valuation allowances are established by applying the Company's loan loss provisioning methodology, and reflect the estimated probable incurred losses in loans outstanding. The loan loss provisioning methodology considers various factors in determining the appropriate quantified risk factors to use in order to determine the general valuation allowances. The factors assessed begin with the historical loan loss experience for each of the loan portfolio segments. The Company's historical loan loss experience is then adjusted by considering qualitative or environmental factors that are likely to cause estimated credit losses associated with the existing portfolio to differ from historical loss experience, including, but not limited to, the following:
•
Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices;
•
Changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;
•
Changes in the nature and volume of the portfolio and in the terms of loans;
•
Changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans;
•
Changes in the quality of the Company's loan review system;
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Changes in the value of the underlying collateral for collateral-dependent loans;
•
The existence and effect of any concentrations of credit, and changes in the level of such concentrations;
•
Changes in the experience, ability, and depth of lending management and other relevant staff; and
•
The effect of other external factors, such as competition and legal and regulatory requirements, on the level of estimated credit losses in the existing portfolio.
By considering the factors discussed above, the Company determines quantified risk factors that are applied to each non-impaired loan or loan type in the loan portfolio to determine the general valuation allowances.
The time periods considered for historical loss experience are the most recent five years, three years and twelve month periods. The Company also evaluates the sufficiency of the overall allocations used for the loan and lease loss allowances by considering the loss experience in the most recent twelve month period.
The process of establishing the loan and lease loss allowances may also involve:
•
Periodic inspections of the loan collateral;
•
Regular meetings of executive management with the pertinent Board committee, during which observable trends in the local economy, commodity prices and/or the real estate market are discussed;
•
Analysis of the portfolio in the aggregate, as well as on an individual loan basis, taking into consideration payment history, underwriting analyses, and internal risk ratings.
In order to determine their overall adequacy, each loan portfolio segment respective loan and lease loss allowance is reviewed quarterly by management and by the Audit Committee of the Company's Board of Directors, as applicable.
Future adjustments to the allowance for loan and lease losses and methodology may be necessary if economic or other conditions differ substantially from the assumptions used in making the estimates or, if required by regulators, based upon
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information at the time of their examinations. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels vary from previous estimates.
Revenue Recognition
The Company derives a portion of its revenues from fee-based services. Noninterest income from transaction-based fees is generally recognized when the transactions are completed. Noninterest income from service-based fees is generally recognized over the period in which the service was provided.
Loan Origination Fees and Related Discounts
Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the interest method over the contractual life of the loans, adjusted for prepayments.
Commitment fees and costs relating to commitments, the likelihood of exercise of which is remote, are recognized during the commitment period. If the commitment is subsequently exercised during the commitment period, the remaining unamortized commitment fee at the time of exercise is recognized over the life of the loan as an adjustment of yield.
Loan Servicing
The cost allocated to servicing rights purchased or retained has been recognized as a separate asset, is initially measured at fair value, and is being amortized in proportion to and over the period of estimated net servicing income. Servicing rights are periodically evaluated for impairment based on the fair value of those rights. Fair values are estimated using discounted cash flows based on current market rates of interest. For purposes of measuring impairment, the rights are stratified by one or more predominant risk characteristics of the underlying loans. The Bank stratifies its capitalized servicing rights based on loan type. The Company performs quarterly testing to determine if loan servicing rights purchased and retained servicing rights are impaired.
Servicing rights acquired for cash from other financial institutions are classified as an investing activity within the cash flow statement. Originated mortgage loans for sale where servicing rights are retained is included within the operating activity section of the cash flow statement as a non-cash activity adjustment.
Trust Services and Investment Management
Trust services and investment management fees include investment management, personal trust, employee benefits, and custodial trust services.
Commission and Insurance Income
Commission and insurance revenues are derived from the sales of financial and insurance products, including acting as an independent agent to provide life, long-term care, and disability insurance for individuals and hail and multi-peril crop insurance for agricultural customers.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company-put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Goodwill and Intangible Assets
Goodwill is the difference between the purchase price and the amounts assigned to the identifiable net assets acquired and accounted for under the purchase method of accounting.
On an annual basis and at interim periods when circumstances require, the Company tests the recoverability of its goodwill. The Company has the option, when each test of recoverability is performed, to first assess qualitative factors to
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determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company determines that it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, then additional analysis is unnecessary. If the Company concludes otherwise, then a two-step impairment analysis, whereby the Company compares the carrying value of each identified reporting unit to its fair value, is required. The first step is to quantitatively determine if the carrying value of the reporting unit is greater than its fair value. If the Company determines that this is true, the second step is required, where the implied fair value of goodwill is compared to its carrying value.
Intangible assets are recorded at cost and amortized using the straight line method over their estimated useful lives.
Foreclosed Real Estate and Other Properties
Real estate and other properties acquired through, or in lieu of, loan foreclosure are initially recorded at lower of cost or fair value less estimated costs to sell at the date of foreclosure. Costs relating to property improvements are capitalized whereas costs relating to the holding of property are expensed. Valuations are periodically performed by management and charge-offs to operations are made if the carrying value of a property exceeds its estimated fair value less estimated costs to sell.
Office Properties and Equipment
Land is carried at cost. All other properties and equipment are carried at cost, less accumulated depreciation. Buildings and improvements and leasehold improvements are depreciated primarily on the straight-line method over the estimated useful lives of the assets, which are five to fifty years. Furniture, fixtures, equipment and automobiles are depreciated using both the straight-line and declining balance methods over the estimated useful lives of the assets, which are three to twelve years.
Income Taxes
Income taxes are accounted for using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax-basis carrying amounts. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
In the preparation of income tax returns, tax positions are taken based on interpretation of federal and state income tax laws. Management periodically reviews and evaluated the status of uncertain tax positions and makes estimates of amounts ultimately due or owed. The benefits of tax positions is recorded in income tax expense in the consolidated financial statements, net of the estimates of ultimate amounts due or owed including any applicable interest and penalties. The Company's policy is to report interest and penalties, if any, related to unrecognized tax benefits in income tax expense in the Consolidated Statements of Income. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period in which the enactment date occurs.
The determination of current and deferred income taxes is an accounting estimate which is based on the analyses of many factors including interpretation of federal and state income tax laws, the evaluation of uncertain tax positions, differences between the tax and financial reporting bases of assets and liabilities (temporary differences), estimates of amounts due or owed such as the timing of reversal of temporary differences and current financial accounting standards. Actual results could differ from the estimates and tax law interpretations used in determining the current and deferred income tax liabilities.
Marketing and Community Development
Marketing and community development costs are generally expensed as incurred and are included as noninterest expenses on the consolidated statements of income. Advertising costs, which are included within this total, were $866, $926, and $1,008 for the fiscal 2013, 2012 and 2011, respectively. Prepaid advertising costs at June 30, 2013 and 2012 totaled $55 and $41, respectively.
Earnings Per Share ("EPS")
Basic EPS represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period, inclusive of non-vested share-based payment awards. Diluted EPS reflects additional
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common shares that would have been outstanding if dilutive potential common shares had been issued. The non-vested shares of common stock issued to employees and directors are included in the outstanding shares of common stock in calculating basic and diluted EPS.
Segment Reporting
Operating segments are defined as components of an enterprise for which discrete financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance. The Company's reportable segments are "banking" (including leasing activities) and "other." The "banking" segment is conducted through the Bank and Mid America Capital and the "other" segment is composed of smaller non-reportable segments, the Company and intersegment eliminations.
The management approach is used as the conceptual basis for identifying reportable segments and is based on the way that management organizes the segments within the enterprise for making operating decisions, allocating resources, and monitoring performance, which is primarily based on products.
_____________________________________
(1)
Included in total assets were goodwill and intangible assets, net totaling $4,366 and $572 for the Banking segment and Other segment, respectively, at June 30, 2013.
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(2)
Included in total assets were goodwill and intangible assets, net totaling $4,366 for the Banking segment at June 30, 2012 and 2011.
Stock-based Compensation
The Company uses the Black-Scholes option-pricing model and the modified prospective method in which compensation cost is recognized for all awards granted as well as for the unvested portion of awards outstanding. See Note 17 for more information on the Company's stock option and incentive plans.
Self-insurance
The Company has a self-insured health and dental plans for its employees, subject to certain limits. The Bank is named the plan administrator for these plans and has retained the services of independent third party administrators to process claims and handle other duties for these plans. The third party administrators do not assume liability for benefits payable under these plans. To mitigate a portion of the risks involved with the self-insured health plan, the Company has a stop-loss insurance policy through a commercial insurance carrier for coverage in excess of $75 per individual occurrence.
The Company assumes the responsibility for funding the plan benefits out of general assets; however, employees cover some of the costs of covered benefits through contributions, deductibles, co-pays and participation amounts. An employee is eligible for coverage upon completion of 30 calendar days of regular employment. The plans, which are on a calendar year basis, are intended to comply with, and be governed by, the Employee Retirement Income Security Act of 1974, as amended.
The accrual estimate for pending and incurred but not reported health claims is based upon a pending claims lag report provided by a third party provider. Although management believes that it uses the best information available to determine the accrual, unforeseen health claims could result in adjustments and net income being significantly affected if circumstances differ substantially from the assumptions used in estimating the accrual. Net healthcare costs are inclusive of health and dental claims expenses and administration fees offset by stop loss and employee reimbursement. The following table is a summary of net healthcare costs by quarter during the fiscal years ended June 30:
Interest Rate Contracts and Hedging Activities
The Company uses derivative financial instruments to modify exposures to changes in interest rates and market prices for other financial instruments. To qualify for and maintain hedge accounting, the Company must meet formal documentation and effectiveness evaluation requirements both at the hedge's inception and on an ongoing basis. The application of the hedge accounting policy requires strict adherence to documentation and effectiveness testing requirements, judgment in the assessment of hedge effectiveness, identification of similar hedged item groupings, and measurement of changes in the fair value of hedged items. If in the future derivative financial instruments used by the Company no longer qualify for hedge accounting, the impact on the consolidated results of operations and reported net income could be significant, as discussed below.
Derivative instruments are recorded on the Consolidated Statements of Financial Condition as Other assets or Accrued expenses or Other liabilities measured at fair value through adjustments to either accumulated other comprehensive income within stockholders' equity or within net income. Fair value is defined as the price that would be received to sell a derivative asset or paid to transfer a derivative liability in an orderly transaction between market participants on the transaction date. Fair value is determined using available market information and appropriate valuation methodologies.
The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer effective in offsetting changes in the cash flows of a hedged item (including forecasted transactions); (2) the derivative expires
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or is sold, terminated, or exercised; (3) the derivative is de-designated as a hedge instrument, because it is unlikely that a forecasted transaction will occur; or (4) management determines that designation of the derivative as a hedge instrument is no longer appropriate.
When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the balance sheet at its fair value, and gains and losses that were accumulated in other comprehensive income will be recognized immediately in net income. In all other situations in which hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet, with subsequent changes in its fair value recognized in current period net income.
Interest rate swaps utilized by the Company are typically accounted for as cash flow hedges, including hedging the interest rate risk in the cash flows of long-term, variable-rate instruments, including subordinated debentures. The Company also has utilized interest rate swaps to hedge the interest rate risk in the cash flows of variable-rate deposits, accounted for as a cash flow hedge. The cumulative change in fair value of the hedging derivatives, to the extent that it is expected to be offset by the cumulative change in anticipated interest cash flows from the hedged exposures, are deferred and reported as a component of other comprehensive income ("OCI"). The differential to be paid or received on cash flow swap agreements is accrued as interest rates change and is recognized in interest expense.
The Company also enters into interest rate swaps with loan customers to provide a facility to mitigate the interest rate risk associated with offering a fixed rate to the borrower on the respective loans. These swaps are matched in exact offsetting terms to interest rate swaps that the Company enters into with an outside third party. The interest rate swaps are reported at fair value in other assets or accrued expenses and other liabilities. The Company's interest rate swaps qualify as derivatives, but are not designated as hedging instruments.
Further discussion of the Company's financial derivatives is set forth in Note 10 of the Consolidated Financial Statements.
Recent Accounting Pronouncements
In June 2011, FASB issued ASU 2011-05 "Comprehensive Income" (ASC Topic 220) and in December 2011 issued ASU 2011-12 as an update for the effective date for reclassification of adjustments out of accumulated other comprehensive income. These updates require the presentation of comprehensive income in financial statements. An entity has the option to present the total comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and early adoption is permitted. The Company adopted these updates in the first quarter of fiscal 2013 and the adoption did not have a material effect on the Company's consolidated financial condition, results of operations or cash flows.
In December 2011, FASB issued ASU 2011-11 “Balance Sheet” (ASC Topic 210), disclosures about offsetting assets and liabilities. This update affects all entities that have financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement. The requirements amend the disclosure requirements on offsetting in Section 210-20-50. The guidance is effective for annual periods beginning January 1, 2013 and the interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Company plans to adopt this update in the first quarter of fiscal 2014 and does not expect the adoption to have a material effect on the Company's consolidated financial condition, results of operations or cash flows.
In October 2012, FASB issued ASU 2012-06 “Business Combinations” (ASC Topic 805), subsequent accounting for an indemnification asset recognized at the acquisition date as a result of a government-assisted acquisition of a financial institution. This guidance requires that in a business combination, an acquirer should measure at each subsequent reporting date an indemnification asset on the same basis as the indemnified liability or asset, subject to any contractual limitations on its amount, and, for an indemnification asset that is not subsequently measured at its fair value, management's assessment of the collectability of the indemnification asset. The guidance is effective for annual periods beginning December 15, 2012 and the interim periods within those annual periods. The Company plans to adopt this update in the first quarter of fiscal 2014 and does not expect the adoption to have a material effect on the Company's consolidated financial condition, results of operations or cash flows.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
In February 2013, FASB issued ASU 2013-02 “Comprehensive Income” (ASC Topic 220), reporting of amounts reclassified out of accumulated other comprehensive income. This updates objective is to improve the reporting of reclassifications out of accumulated other comprehensive income by requiring an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its entirety to net income. The guidance is effective prospectively for reporting periods beginning after December 15, 2012. The Company adopted this update in the third quarter of fiscal 2013 and the adoption did not have a material effect on the Company's consolidated financial condition, results of operations or cash flows.
In February 2013, FASB issued ASU 2013-04 “Liabilities” (ASC Topic 405), obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date. This update requires measuring the obligation resulting from joint and several liability arrangements to include (1) the amount the reporting entity agreed to pay on the basis of its arrangement amount its co-obligors and, (2) any additional amount the reporting entity expects to pay on behalf of its co-obligors. The guidance is effective for fiscal years beginning after December 15, 2013 and the interim periods within those fiscal years. The amendments in this update should be applied retrospectively to all prior periods presented for those obligations resulting from joint and several liability arrangements within the update's scope that exist at the beginning of an entity's fiscal year of adoption. Early adoption is permitted. The Company plans to adopt this update in the first quarter of fiscal 2015 and does not expect the adoption to have a material effect on the Company's consolidated financial condition, results of operations or cash flows.
In April 2013, FASB issued ASU 2013-07 “Presentation of Financial Statements” (ASC Topic 205), liquidation basis of accounting. The amendments require an entity to prepare its financial statements using the liquidation basis of accounting when liquidation is imminent. Liquidation is imminent when the likelihood is remote that the entity will return from liquidation and either (a) a plan for liquidation is approved by the person or persons with the authority to make such a plan effective and the likelihood is remote that the execution of the plan will be blocked by other parties or (b) a plan for liquidation is being imposed by other forces (for example, involuntary bankruptcy). The guidance is effective for entities that determine liquidation is imminent for fiscal years beginning after December 15, 2013 and the interim periods within those fiscal years. The Company plans to adopt this update in the first quarter of fiscal 2015 and does not expect the adoption to have a material effect on the Company's consolidated financial condition, results of operations or cash flows.
During fiscal 2013, FASB issued several ASUs: ASU No. 2012-01 through ASU No. 2013-08. Except for those ASUs mentioned above, the remaining ASUs issued entail technical corrections or clarifications to existing guidance or affect guidance related to specialized industries or entities and therefore have minimal, if any, impact on the Company.
Reclassification
Certain balances from June 30, 2012 and 2011 have been reclassified in the Notes to Consolidated Financial Statements to conform to the fiscal 2013 presentation.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
NOTE 2-INVESTMENTS IN SECURITIES
The amortized cost and fair value of investments in securities, all of which are classified as available for sale according to management's intent, are as follows:
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
Management has a process to identify securities that could potentially have a credit impairment that is other-than-temporary. This process involves evaluating the length of time and extent to which the fair value has been less than the amortized cost basis, reviewing available information regarding the financial position of the issuer, monitoring the rating of the security, and projecting cash flows. Management also determines if it is more likely than not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity. To the extent the Company determines that a security is deemed to be other-than-temporarily impaired, an impairment loss is recognized.
For all securities that are considered temporarily impaired, the Company does not intend to sell these securities (has not made a decision to sell) and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost, which may occur at maturity. The Company believes that it will collect all principal and interest due on all investments that have amortized cost in excess of fair value that are considered only temporarily impaired.
The following tables present the fair value and age of gross unrealized losses by investment category:
The unrealized losses reported for U.S. government agencies relate to three securities issued by the Federal National Mortgage Association (“FNMA”) and one security issued by the Federal Home Loan Bank ("FHLB"). The unrealized losses are primarily attributable to changes in interest rates and the contractual cash flows of these investments which are guaranteed by an agency of the U.S. government. Management does not believe the unrealized losses at June 30, 2013 represents an other-than-temporary impairment for these investments. The Company does not have the intent to sell these securities (has not made a decision to sell) and has assessed that it is not more likely than not that the Company will be required to sell these securities before anticipated recovery of fair value.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
The unrealized losses reported for municipal bonds relate to 32 municipal general obligation or revenue bonds. The unrealized losses are primarily attributed to changes in credit spreads or market interest rate increases since the securities were originally acquired, rather than due to credit or other causes. Management does not believe any individual unrealized losses at June 30, 2013, represent an other-than-temporary impairment for these investments. The Company does not have the intent to sell these securities (has not made a decision to sell) and has assessed that it is not more likely than not that the Company will be required to sell these securities before anticipated recovery of fair value.
The unrealized losses reported for agency residential mortgage-backed securities relate to 113 securities issued by Federal National Mortgage Association ("FNMA"), the Government National Mortgage Association ("GNMA"), or the Federal Home Loan Mortgage Corporation ("FHLMC"). These unrealized losses are primarily attributable to changes in interest rates and the contractual cash flows of those investments which are guaranteed by an agency of the U.S. government. Management does not believe any of these unrealized losses at June 30, 2013, represent an other-than-temporary impairment for those investments. The Company does not have the intent to sell these securities (has not made a decision to sell) and has assessed that it is not more likely than not that the Company will be required to sell these securities before anticipated recovery of fair value.
The following table presents the amounts recognized in the Consolidated Statements of Income for other-than-temporary impairments charged to net income:
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(1)
Includes $8 of other-than-temporary impairment related to Fannie Mae common stock.
The amortized cost and fair value of debt securities at June 30, 2013, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Equity securities have been excluded from the maturity table above because they do not have contractual maturities associated with debt securities.
Proceeds from the sale of securities available for sale in fiscal 2013 were $116,552 and resulted in gross gains and gross losses of $2,174 and $64, respectively. Proceeds from the sale of securities available for sale in fiscal 2012 were $78,188 and
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
resulted in gross gains and gross losses of $1,491 and $1, respectively. Proceeds from the sale of securities available for sale in fiscal 2011 were $84,276 and resulted in gross gains and gross losses of $2,698 and $6,300, respectively.
At June 30, 2013, and 2012, securities with a fair value of $416,889 and $369,694, respectively, were pledged as collateral for public deposits, borrowing and other purposes.
NOTE 3-LOANS AND LEASES RECEIVABLE
Loans and leases receivable by classes within portfolio segments, consist of the following:
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(1)
Includes $2,024 and $2,262 tax exempt leases at June 30, 2013 and 2012, respectively.
(2)
Exclusive of undisbursed portion of loans in process of $49,868 and $21,700, at June 30, 2013 and 2012, respectively.
(3)
Net of deferred loan fees of $664 and $553, at June 30, 2013 and 2012, respectively.
Loans held for sale totaling $9,169 and $16,207 at June 30, 2013 and 2012, respectively, consist of one-to-four family fixed-rate loans.
Portfolio Segments:
Residential real estate and single-family interim construction loans are underwritten primarily based on borrowers' credit scores, documented income and minimum collateral values. Relatively small loan amounts are spread across many individual borrowers which minimizes credit risk in the residential portfolio. In addition, management evaluates trends in past due loans and current economic factors on a regular basis.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
Commercial loans are underwritten after evaluating and understanding the borrower's ability to operate profitably and prudently expand its business. The Company's management examines current and projected cash flows to determine the ability of the borrower to repay its obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. These cash flows, however, may not be as expected and the value of collateral securing the loans may fluctuate. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee.
Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company's commercial real estate portfolio are diverse by type and management monitors the diversification of the portfolio on a quarterly basis. Management also tracks the level of owner-occupied property versus non-owner-occupied property. Land development loans are underwritten using feasibility studies, independent appraisal reviews and financial analysis of the developers or property owners. Generally, borrowers must have a proven track record of success. Commercial construction loans are generally based upon estimates of cost and value of the completed project. These estimates may not be accurate. Commercial construction loans often involve the disbursement of substantial funds with the repayment dependent on the success of the ultimate project. Sources of repayment for these loans may be pre-committed permanent financing or sale of the developed property.
Agricultural loans are collateralized by real estate and/or non-real estate assets. Agricultural real estate loans are primarily comprised of loans for the purchase of farmland. Loan-to-value ratios on loans secured by farmland generally do not exceed 75%. Agricultural non-real estate loans are generally comprised of term loans to fund the purchase of equipment, livestock and seasonal operating lines to cash grain farmers to plant and harvest corn and soybeans. Specific underwriting standards have been established for agricultural-related loans including the establishment of projections for each operating year based on industry-developed estimates of farm input costs and expected commodity yields and prices. Operating lines are typically written for one year and secured by the crop and other farm assets as considered necessary. Agricultural loans carry significant credit risks as they involve larger balances concentrated with single borrowers or groups of related borrowers. In addition, repayment of such loans depends on the successful operation or management of the farm property securing the loan or for which an operating loan is utilized. Farming operations may be affected by adverse weather conditions such as drought, hail or floods that can severely limit crop yields.
Consumer loans are collateralized by primary and secondary positions on real estate, as well as automobiles and other personal assets. Under consumer home equity loan guidelines, the borrower will be approved for a loan based on a percentage of their home's appraised value less the balance owed on the existing first mortgage. Major risks in home equity lending include the borrower's ability to service the existing first mortgage plus second mortgage, the Company's ability to pursue collection in a second lien position upon default, and overall risks in fluctuation in the value of the underlying collateral property. Under consumer loans collateralized by automobiles and other personal assets, the payment often depends on the borrower's creditworthiness and ability to generate sufficient cash flow to service the debt. Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.
On June 30, 2013, $77,324 of commercial and agricultural operating loans were pledged to secure potential discount window borrowings from the Federal Reserve Bank. Additionally, $403,046 of one-to-four family, commercial and agricultural real estate loans were pledged to secure potential borrowings from the Federal Home Loan Bank. See Note 8,“Advances from Federal Home Loan Bank and Other Borrowings,” for information on the advance equivalents related to the loans pledged.
The Company has granted loans to directors, executive officers or related interests in the normal course of business. These loans were made on substantially the same terms, including rates and collateral, as those prevailing at the time for comparable transactions with other unrelated customers, and do not involve more than a normal risk of collection. The aggregate amount of loans to such related parties was approximately $1,646 and $1,666 at June 30, 2013 and 2012, respectively.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
Activity in the allowance for loan losses included in continuing operations is summarized as follows for the fiscal years ended June 30:
The following tables summarize the activity in the allowance for loan and lease losses by portfolio segment for the fiscal years ended June 30:
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
The following tables summarize the related statement balances by portfolio segment:
Credit Quality Indicators
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. For loans other than residential and consumer, the Company analyzes loans individually, by classifying the loans as to credit risk. This analysis includes non-term loans, regardless of balance and term loans with an outstanding balance greater than $100. Each loan is reviewed annually, at a minimum. Specific events applicable to the loan may trigger an additional review prior to its scheduled review, if such event is determined to possibly modify the risk classification. The summary of the analysis for the portfolio is calculated on a monthly basis. The Company uses the following definitions for risk ratings:
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
Pass-Loans classified as pass represent loans that are evaluated and are performing under the stated terms. Pass rated assets are analyzed by the pay capacity, the current net worth, and the value of the loan collateral of the obligor.
Special Mention-Loans classified as special mention possess potential weaknesses that require management attention, but do not yet warrant adverse classification. While the status of a loan put on this list may not technically trigger their classification as Substandard or Doubtful, it is considered a proactive way to identify potential issues and address them before the situation deteriorates further and does result in a loss for the Company.
Substandard-Loans classified as substandard are inadequately protected by the current net worth, paying capacity of the obligor, or by the collateral pledged. Substandard loans must have a well-defined weakness or weaknesses that jeopardize the repayment of the debt as originally contracted. They are characterized by the distinct possibility that the Company will sustain a loss if the deficiencies are not corrected.
Doubtful-Loans classified as doubtful have the weaknesses of those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans that fall into this class are deemed collateral dependent and an individual impairment analysis is performed on all relationships. Loans in this category are allocated a specific reserve if the estimated discounted cash flows from the loan (or collateral value less cost to sell for collateral dependent loans) does not support the outstanding loan balance or charged off if deemed uncollectible.
The following tables summarize the credit quality indicators used to determine the credit quality by class within the portfolio segments:
Credit risk profile by internally assigned grade-Commercial, Commercial real estate and Agricultural portfolio segments
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
Credit risk profile based on payment activity-Residential and Consumer portfolio segments
The following table summarizes the aging of the past due financing receivables by classes within the portfolio segments and related accruing and nonaccruing balances:
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(1)
Loans accruing and delinquent greater than 90 days have either government guarantees or acceptable loan-to-value ratios.
(2)
Net of deferred loan fees and discounts and exclusive of undisbursed portion of loans in process.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
_____________________________________
(1)
Loans accruing and delinquent greater than 90 days have either government guarantees or acceptable loan-to-value ratios.
(2)
Net of deferred loan fees and discounts and exclusive of undisbursed portion of loans in process.
At June 30, 2013, the Bank had identified $24,381 of loans as impaired which includes performing troubled debt restructurings. A loan is identified as impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Interest income on impaired loans is generally recognized on a cash basis. The average recorded investment of impaired loans is calculated using the daily average balance.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
The following table summarizes impaired loans by class of loans and the specific valuation allowance:
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(1)
Represents the borrower's loan obligation, gross of any previously charged-off amounts.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
The following table summarizes the Company's average recorded investment in impaired loans by class of loans and the related interest income recognized:
No additional funds are committed to be advanced in connection with impaired loans.
Modifications of terms for the Company's loans and their inclusion as troubled debt restructurings are based on individual facts and circumstances. Loan modifications that are included as troubled debt restructurings may involve reduction of the interest rate or renewing at an interest rate below current market rates, extension of the term of the loan and/or forgiveness of principal, regardless of the period of the modification.
Loans and leases that are considered troubled debt restructurings are factored into the determination of the allowance for loan and lease losses through impaired loan analysis and any subsequent allocation of specific valuation allowance, if applicable. The Company measures impairment on an individual loan and the extent to which a specific valuation allowance is necessary by comparing the loan's outstanding balance to either the fair value of the collateral, less the estimated cost to sell or the present value of expected cash flows, discounted at the loan's effective interest rate. During fiscal 2013, new TDRs consisted of two commercial real estate, four commercial business, two agricultural, two residential, and 10 consumer loans. In total, 10 were evaluated for impairment based on collateral adequacy and 10 were evaluated for impairment based upon the present value of discounted cash flows.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
The following is a summary of the Company's performing troubled debt restructurings which are in-compliance with their modified terms:
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(1)
Includes 14 customers, which are in compliance with their restructured terms, that are not accruing interest and have a recorded investment balance of $18,616.
(2)
Includes eight customers, which are in compliance with their restructured terms, that are not accruing interest and have a recorded investment balance of $11,213.
Excluded from above, at June 30, 2013, the Company had one agricultural relationship with a recorded balance of $9 that was originally restructured in fiscal 2012, two consumer relationships with a recorded balance of $44 that were originally restructured in fiscal 2013, and one residential relationship with a recorded balance of $84 that was originally restructured in fiscal 2013. These loans are not in compliance with their restructured terms and are in nonaccrual status. At June 30, 2012, the Company had one agricultural relationship with a recorded balance of $117, which was not in compliance with its restructured terms. It was in nonaccrual status at the time of the original restructuring in fiscal 2011. Loans can retain their accrual status at the time of their modification if the restructuring is not a result of terminated loan payments. For nonaccruing loans, a minimum of six months of performance related to the restructured terms are required before a loan is returned to accruing status.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
New restructured contracts during the previous 12 months ended June 30 are as indicated:
Of the restructured contracts during the previous 12 months ended June 30, 2013, 18 were customers who had loan maturity extensions granted which did not reduce the interest rate below the market rate and two were customers who declared bankruptcy. Two of these restructured contracts defaulted in fiscal 2013 and are in foreclosure. Of the restructured contracts during the previous 12 months ended June 30, 2012, six were customers who had loan maturity extensions granted which did not reduce the interest rate below the market rate. None of these restructured contracts defaulted in fiscal 2012.
NOTE 4-LOAN SERVICING
Mortgage loans serviced for others (primarily the South Dakota Housing Development Authority) are not included in the accompanying consolidated statements of financial condition.
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(1)
Changes to carrying amounts are reported net of loan servicing income on the statements of income for the periods presented.
Custodial balances maintained in connection with mortgage loan servicing, and included in advances by borrowers for taxes and insurance, were approximately $11,467 and $11,619, at June 30, 2013 and 2012, respectively.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
The fair values of mortgage servicing rights were $10,987 and $11,932, at June 30, 2013 and 2012, respectively. The fair values of the servicing rights were estimated as the present value of the expected future cash flows using a discount rate of 10.0% and 9.0% for valuation purposes at June 30, 2013 and 2012, respectively. Prepayment speeds utilized at June 30, 2013 and 2012 were 13.5% and 16.1%, respectively, which are used in the calculation of the amortization expense for the subsequent quarter. Prepayment speeds are analyzed and adjusted each quarter.
NOTE 5-OFFICE PROPERTIES AND EQUIPMENT
The Company leases office equipment, which requires minimum rentals totaling $14 through April 2016. The Company incurred rent expense of $933, $1,702 and $1,140 for fiscal 2013, 2012 and 2011, respectively. Fiscal 2013 and 2012 rent expense included accelerated lease termination obligations of $3 and $550, respectively, due to branch closures. In addition, the Company has leased property under various operating lease agreements, which expire at various times.
The total rental commitments at June 30, 2013, under the leases are as follows:
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
NOTE 6-GOODWILL AND INTANGIBLE ASSETS, NET
The following table presents the components at June 30:
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(1) Banking segment related goodwill.
(2) Other segment related intangible assets.
(3) Amortization life of 10.0 years.
(4) Amortization life of 2.0 years.
Amortization expense of intangible assets for fiscal years ended June 30, 2013, 2012 and 2011, were $26, $0 and $0.
Scheduled amortization expense of intangible assets at June 30, 2013, are as follows:
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
NOTE 7-DEPOSITS
Deposits consist of the following:
Scheduled maturities of certificates of deposit at June 30, 2013, are as follows:
All deposit accounts are permanently insured up to $250 by the Deposit Insurance Fund ("DIF") under management of the Federal Deposit Insurance Corporation ("FDIC"). The aggregate amount of jumbo certificates of deposit with a minimum denomination of $100 was approximately $131,423 and $131,584 at June 30, 2013 and 2012, respectively. Deposits at June 30, 2013 and 2012, include $96,384 and $113,333, respectively, of deposits from one local governmental entity, the majority of which are savings account balances.
The Company has deposits from directors, executive officers or related interests in the normal course of business. These deposits are substantially at the same terms and rates for comparable transactions with other unrelated customers. The aggregate amount of deposits from such related parties was approximately $630 and $523 at June 30, 2013 and 2012.
NOTE 8-ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER BORROWINGS
Advances from the Federal Home Loan Bank of Des Moines ("FHLB") and other borrowings are summarized as follows:
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(1)
The Company has an available line of credit with United Bankers' Bank for liquidity needs of $4,000 with no funds advanced at June 30, 2013. The Company has pledged 100% of bank stock as collateral for this line of credit.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
(2)
The Bank is a participating lender in the South Dakota Housing Development Authority program for flood victims in the north-eastern part of the state of South Dakota, at May 2007. The money is provided to the Bank at a zero percent interest rate to be used in making loans to such flood victims. This is a revolving line of credit, in which the participating lender may borrow, prepay and re-borrow for a term of 10 years. The outstanding balances at June 30, 2013 and 2012 were $288 and $294, respectively.
Aggregate maturities of advances from FHLB and other borrowings at June 30, 2013, computed based upon contractual maturity date, are as follows:
Prepayment of convertible, or callable, advances results in a prepayment fee as negotiated between the Bank and the FHLB. Convertible advances without a strike rate are subject to be called at the FHLB's discretion. Convertible advances tied to LIBOR strike rates may only be called if the three-month LIBOR rate is equal to or greater than the indicated strike rate.
Advances with the FHLB are secured by stock in the FHLB, which is comprised of membership stock and activity-based stock. The membership stock requirement is based on a percentage of total assets as of the preceding December 31. At June 30, 2013 and 2012, the Bank held $1,459 and $1,469, respectively, in membership stock. The activity-based stock requirement is based on 4.45% of advances outstanding; however, effective August 1, 2013, the requirement reduced to 4.00%. At June 30, 2013 and 2012, the Bank held $7,426 and $6,323, respectively, in activity-based stock.
In addition, advances with the FHLB are secured by one-to four-family first mortgage loans, multi-family first mortgage loans and investment securities. In order to provide additional borrowing collateral, commercial real estate first mortgage loans, agricultural real estate first mortgage loans, home equity line of credit loans and home equity second mortgage loans have also been pledged with the FHLB. At June 30, 2013, the Bank had total collateral with the FHLB of $453,287, of which $248,087 was available for additional borrowing. At June 30, 2012, the Bank had total collateral with the FHLB of $407,416, of which $262,038 was available for additional borrowing.
Advances with the Federal Reserve Bank are secured by commercial and agricultural business loans. At June 30, 2013, the Bank had total collateral with the Federal Reserve Bank of $64,945, of which $64,945 was available for borrowing.
The Bank currently has a $15,000 unsecured line of federal funds with First Tennessee Bank, NA, which had no outstanding balance at June 30, 2013 and 2012. The line was advanced upon during the past 12 months for contingent funding testing purposes.
The Bank currently has a $20,000 unsecured line of federal funds with Zions Bank, which had no outstanding balance at June 30, 2013 and 2012. The line was advanced upon during the past 12 months for contingent funding testing purposes.
The Company has a line of credit for $4,000 with United Bankers' Bank for liquidity needs, which was renewed on October 1, 2012. At June 30, 2013, there were no outstanding advances under this Loan Agreement and the note has a maturity of October 1, 2013. In connection with entering into the Loan Agreement, the Company also entered into a Commercial Pledge Agreement with the Lender, granting the Lender a first security interest in 100% of the stock of the Bank. The Loan Agreement contains customary events of default and affirmative covenants with which the Company and Bank were in compliance at June 30, 2013.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
NOTE 9-SUBORDINATED DEBENTURES PAYABLE TO TRUSTS
The Company has issued and outstanding 24,000 shares totaling $24,000 of Company Obligated Mandatorily Redeemable Preferred Securities. These four Trusts were established and exist for the sole purpose of issuing trust preferred securities and investing the proceeds in subordinated debentures of the Company. These subordinated debentures constitute the sole assets of the four Trusts. The securities provide for cumulative cash distributions calculated at a rate based on three-month LIBOR plus a range from 1.65% to 3.35% adjusted quarterly. The Company may, at one or more times, defer interest payments on the capital securities for up to 20 consecutive quarterly periods, but not beyond the respective maturity date. At the end of the deferral period, all accumulated and unpaid distributions must be paid. The capital securities have redemption dates ranging from January 7, 2033 to October 1, 2037; however, the Company has the option to shorten the respective maturity date for all four securities as the call option date has passed. Holders of the capital securities have no voting rights, are unsecured, and rank junior in priority of the payment to all of the Company's indebtedness and senior to the Company's capital stock.
During the fourth quarter of fiscal 2013, the Company repurchased 3,000 shares totaling $3,000 of trust preferred securities that were originally issued in July 2007. This transaction reduced the outstanding shares totaling $27,000 at June 30, 2012 to $24,000 and resulted in a gain of $870. Simultaneously, the Company unwound the associated interest rate swap and recognized a charge of $718. The overall impact of the two related transactions was a net gain of $152, which is included in the other noninterest income in the financial statements. See Note 10 "Interest Rate Contracts" for information on the interest rate swap agreement.
NOTE 10-INTEREST RATE CONTRACTS
Interest rate swap contracts are entered into primarily as an asset/liability management strategy of the Company to modify interest rate risk. The primary risk associated with all swaps is the exposure to movements in interest rates and the ability of the counterparties to meet the terms of the contract. The Company is exposed to losses if the counterparty fails to make its payments under a contract in which the Company is in a receiving status. The Company minimizes its risk by monitoring the credit standing of the counterparties. The Company anticipates the counterparties will be able to fully satisfy their obligations under the remaining agreements. These contracts are typically designated as cash flow hedges.
The Company has outstanding interest rate swap agreements with notional amounts totaling $22,000 to convert four variable-rate trust preferred securities into fixed-rate instruments. The agreements have a weighted average maturity of 2.2 years and have fixed rates ranging from 5.68% to 6.58% with a weighted average rate of 5.96%. The fair value of the derivatives was an unrealized loss of $1,446 at June 30, 2013 and an unrealized loss of $2,986 at June 30, 2012. The unrealized loss at June 30, 2012 includes the effective swaps and the forward-starting swap agreements which became effective in fiscal 2013. The Company pledged $1,524 in cash under collateral arrangements at June 30, 2013, to satisfy collateral requirements associated with these interest rate swap contracts.
During the fourth quarter of fiscal 2013, the Company terminated the interest rate swap agreement with notional amount of $5,000 that was related to the extinguished variable-rate trust preferred security. The Company recognized a charge of $718 which is included in other noninterest income in the financial statements. See Note 9 "Subordinated Debentures Payable to Trusts" for amounts reported from the transaction.
The Company has borrower interest rate swap agreements with notional amounts totaling $32,021 to facilitate customer transactions and meet the borrower's financing needs. These swaps qualify as derivatives, but consist of two different types of instruments. The back-to-back loan swaps are not designated as hedging instruments, while the one-way loan swaps are classified as fair value hedging instruments. The loan interest rate swap derivatives had no impact on the consolidated statements of income for fiscal years ended June 30, 2013 and 2012. Any amounts due to the Company are expected to be collected from the borrowers. Credit risk exists if the borrower's collateral or financial condition indicates that the underlying collateral or financial condition of the borrower makes it probable that amounts due will be uncollectible. Management monitors this credit exposure on a quarterly basis.
During the first quarter of fiscal 2013, the Company terminated its five interest rate swap agreements with notional amounts totaling $35,000 which converted the variable-rate attributes of a pool of deposits into fixed-rate instruments. The
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
Company recognized a charge of $1,456, which is included in other noninterest income in the financial statements. Comparatively, no gain or loss was recognized in net income for fiscal 2012 related to interest rate swaps.
No deferred net losses on interest rate swaps in other comprehensive loss at June 30, 2013, are expected to be reclassified into net income during the next fiscal year. See Note 18 "Accumulated Other Comprehensive Loss" for amounts reported as other comprehensive loss.
The following table summarizes the derivative financial instruments utilized at June 30, 2013:
The following table summarizes the derivative financial instruments utilized at June 30, 2012:
The following table details the derivative financial instruments, the average remaining maturities and the weighted-average interest rates being paid and received at June 30, 2013:
The following table summarizes the amount of gains (losses) included in the income statements:
NOTE 11-INCOME TAX MATTERS
The Company and subsidiaries file a consolidated federal income tax return on a fiscal year basis in the U.S. federal jurisdiction and various states. The Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2009. The Bank is allowed bad debt deductions based on actual charge-offs.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
The consolidated provision for income taxes from continuing operations consists of the following for the fiscal years ended June 30:
Income tax expense is different from that calculated at the statutory federal income tax rate. The reasons for this difference in tax expense for the fiscal years ended June 30 are as follows:
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
The components of the net deferred tax asset are as follows:
Retained earnings at June 30, 2013 and 2012, include approximately $4,805 related to the pre-1987 allowance for loan losses for which no deferred federal income tax liability has been recognized. These amounts represent an allocation of income to bad debt deductions for tax purposes only. If the Bank no longer qualifies as a bank, or in the event of a liquidation of the Bank, income would be created for tax purposes only, which would be subject to the then current corporate income tax rate. The unrecorded deferred income tax liability on the above amount for financial statement purposes was approximately $1,634.
The Company had no unrecognized tax benefits at June 30, 2013 and 2012. The Company recognized no interest and penalties on the underpayment of income taxes during fiscal 2013 and 2012, and had no accrued interest and penalties on the balance sheet at June 30, 2013 and 2012. The Company has no tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase with the next twelve months.
NOTE 12-REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital (as defined) to adjusted total assets (as defined). Management believes, at June 30, 2013 and 2012, that the Bank meets all capital adequacy requirements to which it is subject.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
At June 30, 2013, the Bank met the regulatory criteria for being considered a "well-capitalized" institution. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I (core) capital ratios as set forth in the following table. There are no conditions or events since that notification that management believes have unfavorably changed the Bank's category.
The following table summarizes the Bank's compliance with its regulatory capital requirements:
NOTE 13-STOCKHOLDERS' EQUITY
The Company has authorized 50,000 shares of Preferred Stock, designated as "Series A Junior Participating Preferred Stock" with a stated value of $1.00 per share. Outstanding shares of the Junior Preferred Stock are entitled to cumulative dividends. Such shares have voting rights of 100 votes per share and a preference in liquidation. The shares are not redeemable after issuance. No shares of Preferred Stock were outstanding at June 30, 2013.
Federal regulations govern the permissibility of capital distributions by a federal savings association. Pursuant to the Dodd-Frank Act, savings associations that are part of a savings and loan holding company structure must now file a notice of a declaration of a dividend with the Federal Reserve. In the case of cash dividends, OCC regulations require that federal savings associations that are subsidiaries of a stock savings and loan holding company must file an informational copy of that notice with the OCC at the same time it is filed with the Federal Reserve. OCC regulations further set forth the circumstances under which a federal savings association is required to submit an application or notice before it may make a capital distribution.
A federal savings association proposing to make a capital distribution is required to submit an application to the OCC if: (1) the association does not qualify for expedited treatment pursuant to criteria set forth in OCC regulations; (2) the total amount of all of the association's capital distributions (including the proposed capital distribution) for the applicable calendar year exceeds the association's net income for that year to date plus the association's retained net income for the preceding two years; (3) the association would not be at least adequately capitalized following the distribution; or (4) the proposed capital distribution would violate a prohibition contained in any applicable statute, regulation, or agreement between the association and the OCC or violate a condition imposed on the association in an application or notice approved by the OCC.
A federal savings association proposing to make a capital distribution is required to submit a prior notice to the OCC if: (1) the association would not be well-capitalized following the distribution; (2) the proposed capital distribution would reduce the amount of or retire any part of the association's common or preferred stock or retire any part of debt instruments such as notes or debentures included in the association's capital (other than regular payments required under a debt instrument); or (3) the association is a subsidiary of a savings and loan holding company and is not required to file a notice regarding the proposed distribution with the Federal Reserve, in which case only an informational copy of the notice filed with the Federal Reserve needs to be simultaneously provided to the OCC.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
Each of the Federal Reserve and OCC have primary reviewing responsibility for the applications or notices required to be submitted to them by savings associations relating to a proposed distribution. The Federal Reserve may disapprove of a notice, and the OCC may disapprove of a notice or deny an application, if:
•
the savings association would be under-capitalized following the distribution;
•
the proposed distribution raises safety and soundness concerns; or
•
the proposed distribution violates a prohibition contained in any statute, regulation, enforcement action or agreement between the savings association (or its holding company, in the case of the Federal Reserve) and the entity's primary federal regulator, or a condition imposed on the savings association (or its holding company, in the case of the Federal Reserve) in an application or notice approved by the entity's primary federal regulator.
On July 29, 2013, the Board of Directors declared a $0.1125 per share dividend payable on August 16, 2013, to shareholders of record as of August 9, 2013. This cash dividend has not been reflected in the consolidated financial statements.
NOTE 14-EARNINGS PER SHARE
Following is a reconciliation of the net income and common stock share amounts used in the calculation of basic and diluted EPS.
Options and SARs outstanding of approximately 74,200 shares of common stock at a weighted average share price of $15.26 during the fiscal year ended June 30, 2013, were not included in the computation of diluted earnings per share because the exercise price of those instruments exceeded the average market price of the common shares during the year. Options and SARs outstanding of approximately 154,100 shares of common stock at a weighted average share price of $14.07 during the fiscal year ended June 30, 2012, were not included in the computation of diluted earnings per share because the exercise price of those instruments exceeded the average market price of the common shares during the year. Options outstanding of approximately 258,000 shares of common stock at a weighted average share price of $14.12 during the fiscal year ended June 30, 2011, were not included in the computation of diluted earnings per share because the exercise price of those instruments exceeded the average market price of the common shares during the year.
NOTE 15-DEFINED BENEFIT PLAN
The Company has a noncontributory (cash balance) defined benefit pension plan covering all employees of the Company and its wholly-owned subsidiaries who have attained the age of 21 and have completed 1,000 hours in a plan year. The benefits are based on 6% of each eligible participant's annual compensation, plus income earned in the accounts at a rate determined
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
annually based on 30-year Treasury note rates. The Company's funding policy is to make the minimum annual required contribution plus such amounts as the Company may determine to be appropriate from time to time. 100% vesting occurs after three years with a retirement age of the later of age 65 or three years of participation.
Information relative to the components of net periodic benefit cost measured at/or for the fiscal years ended for the Company's defined benefit plan is presented below.
_____________________________________
(1)
Amounts included in other liabilities and other assets on the Consolidated Statements of Financial Condition for June 30, 2013 and 2012, respectively.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
The information relative to the components of net periodic benefit cost for the Company’s defined benefit plan is presented below:
The estimated net loss that will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year is $211.
The weighted-average assumptions used to determine benefit obligations are as follows:
The weighted-average assumptions used to determine net periodic benefit cost are as follows:
The overall expected long-term rate of return on assets is based on economic forecasts and projected asset allocation.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
The Company's pension plan weighted-average asset allocations by asset category are as follows:
_____________________________________
(1)
Includes a plus/minus range of 10.0%
(2)
Includes a plus/minus range of 5.0% and includes cash and cash equivalents
(3)
Maximum allowed of 10.0%
_____________________________________
(1)
Includes a plus/minus range of 10.0%
(2)
Includes a plus/minus range of 5.0% and includes cash and cash equivalents
(3)
Maximum allowed of 10.0%
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
The fair value of the Company's pension plan assets at June 30 by asset category are as follows:
The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
Cash-The carrying amounts reported in the plan assets for cash approximate their fair values.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
Securities-Fair values for investment securities are based on quoted market prices
The objective of the pension plan investment policy for equities is to pursue a growth strategy that results in capital appreciation. The objective of the pension plan investment policy for fixed rate instruments and cash equivalents is to ensure safety of principal and interest.
The Company expects to contribute $455 to its pension plan in fiscal 2014. The minimum required contribution is $0.
Estimated Future Benefit Payments: The following benefit payments which reflect expected future service, as appropriate, are expected to be paid during the fiscal years ended June 30:
NOTE 16-RETIREMENT SAVINGS PLAN
The Company has a retirement savings plan covering all employees of the Company who have attained age 21 and completed one expected year of service during which they worked at least 1,000 hours. The plan is intended to be a qualified profit sharing plan with a cash or deferred arrangement pursuant to IRS Code Section 401(k) and regulations issued there under. The plan allows voluntary contributions by eligible employees, and also allows discretionary contributions by the Company as determined annually by the Board of Directors. The total compensation cost charged to expense related to the plan was $356, $319 and $371 for fiscal 2013, 2012 and 2011, respectively.
NOTE 17-STOCK-BASED COMPENSATION PLANS
During fiscal 2003, the Company established the 2002 Stock Option and Incentive Plan ("2002 Option Plan"). Under the 2002 Option Plan, awards for an aggregate amount of 907,500 common shares could be granted to directors and employees of the Bank. Options granted under the Option Plan could have been either options that qualify as Incentive Stock Options, as defined in the Code, or options that do not qualify. Options granted had a maximum term of 10 years. The 2002 Option Plan also provided for the award of stock appreciation rights, limited stock appreciation rights and nonvested stock. The 2002 Option Plan expired by its terms on September 20, 2012, and no new awards may be made thereunder after such date. No plan has been implemented since the expiration of the 2002 Option Plan.
The Company had a long-term incentive plan, which provided for the grant of nonvested stock awards and for stock appreciation rights ("SARs") settled in stock under the 2002 Option Plan if the Company achieved certain performance levels. No nonvested stock awards were issued in fiscal 2013, 2012 and 2011. During fiscal 2013, 2012 and 2011, $36, $61 and $153, respectively, were recorded as amortization expense. No SARs were issued in fiscal 2013, 2012 and 2011. During fiscal 2013, 2012 and 2011, $41, $65 and $104, respectively, were recorded as amortization expense.
Due to the expiration of the plan, no shares of nonvested stock or SARs will be issued in fiscal 2014 as compensation for service during fiscal 2013 under the plan.
During fiscal 2004, the Company created a pool of 12,100 nonvested shares for grants under the 2002 Option Plan ("2002 Pool"). In January 2012, the Board of Directors authorized an additional 50,000 nonvested shares to be added to the pool under this plan. The key provisions of the 2002 Pool include: outright grant of shares with restrictions as to sale, transfer, and pledging; during the restriction period, the grantee receives dividends and has voting rights related to the shares awarded; and all nonvested shares are forfeited upon termination. During fiscal 2013, 2012 and 2011, 9,000, 33,150 and 6,847 nonvested shares, respectively, were awarded under the Pool. The issuance value of these nonvested shares was $115, $405 and $68, respectively, and is being amortized over their vesting periods with the unamortized balance included in additional paid in capital in the consolidated balance sheet. During fiscal 2013, 2012 and 2011, $172, $62 and $39, respectively, were recorded as
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
amortization expense. The nonvested shares of common stock issued to employees are included in the outstanding shares of common stock which is used in calculating earnings per share.
In association with the 2002 Option Plan, awards of nonvested shares of the Company's common stock were made to outside directors of the Company. Each outside director is entitled to all voting, dividend and distribution rights during the vesting period. No shares were awarded in fiscal 2013, but during fiscal 2012 and 2011, shares of nonvested stock awarded were 20,409 and 18,777, respectively. The nonvested shares vest on the first anniversary of the date of grant. During fiscal 2013, 2012 and 2011, amortization expenses recorded were $131, $195 and $186, respectively. The nonvested shares of common stock issued to outside directors are included in the outstanding shares of common stock which is used in calculating earnings per share.
The fair value of each incentive stock option and each stock appreciation right grant was estimated at the grant date using the Black-Scholes option-pricing model. There were no issuances in fiscal 2013, 2012 and 2011.
Stock option activity for the fiscal year ended June 30, 2013, was as follows:
Stock appreciation rights activity for the fiscal year ended June 30, 2013, was as follows:
The Company applied a forfeiture rate of 17.0% when calculating the amount of options and stock appreciation rights expected to vest at June 30, 2013. This rate is based upon historical activity and will be revised if necessary in subsequent periods if actual forfeitures differ from these estimates. The total intrinsic value of options exercised was $22, $35 and $5, respectively, during fiscal 2013, 2012 and 2011, while amortization expense was recorded of $41, $65 and $104, respectively. At June 30, 2013, there was $7 of total unrecognized compensation cost related to nonvested SARs awards. The cost is expected to be recognized over a weighted-average period of two months for SARs awards. Cash received from the exercise of options and SARs for fiscal 2013, 2012 and 2011, was $43, $175 and $139, respectively. There were no cashless option exercises or related tax benefit realized for fiscal 2013, 2012 and 2011. The company generally uses treasury shares to satisfy stock option exercises.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
Nonvested share activity for the fiscal years ended June 30, follows:
Pretax compensation expense recognized for nonvested shares for fiscal 2013, 2012 and 2011 was $209, $123 and $192, respectively, which produced related tax benefits of $71, $47 and $73, respectively. At June 30, 2013, there was $292 of total unrecognized compensation cost related to nonvested shares granted under the 2002 Option Plan. That cost is expected to be recognized over a weighted-average period of 17 months. The total fair value of shares vested during fiscal years fiscal 2013, 2012 and 2011, was $255, $94 and $529, respectively.
In association with the 2002 Option Plan, awards of nonvested shares of the Company's common stock were made to outside directors of the Company. Each outside director was entitled to all voting, dividend and distribution rights during the vesting period. Pretax compensation expense recognized for nonvested shares for fiscal 2013, 2012 and 2011, was $131, $195 and $186, respectively, which produced related tax benefits of $45, $74 and $71, respectively. At June 30, 2013, there was no unrecognized compensation cost related to nonvested shares. The total fair value of shares vested during fiscal 2013, 2012 and 2011, was $259, $207 and $160, respectively.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
NOTE 18-ACCUMULATED OTHER COMPREHENSIVE LOSS
The components of accumulated other comprehensive loss during fiscal years ended June 30, are as follows:
Cumulative other comprehensive gain (loss) balances were:
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
NOTE 19-FINANCIAL INSTRUMENTS
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of amounts recognized in the consolidated statements of financial condition. The contract or notional amounts of those instruments reflect the extent of the Company's involvement in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and financial guarantees written is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Unless noted otherwise, the Company does not require collateral or other security to support financial instruments with credit risk.
The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
Cash and cash equivalents-The carrying amounts reported in the statements of financial condition for cash and cash equivalents approximate their fair values.
Securities-Fair values for investment securities are based on quoted market prices or whose value is determined using discounted cash flow methodologies, except for correspondent bank stock for which fair value is assumed to equal cost.
Loans and leases, net-The fair values for loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms and credit quality. Leases are stated at cost which equals fair value.
Accrued interest receivable-The carrying value of accrued interest receivable approximates its fair value.
Servicing rights-Fair values are estimated using discounted cash flows based on current market rates of interest.
Interest rate swap contracts-Valuations of interest rate swap contracts are based on inputs observed in active markets for similar instruments. Typical inputs include the LIBOR curve, option volatility and option skew.
Off-statement-of-financial-condition instruments-Fair values for the Company's off-statement-of-financial-condition instruments (unused lines of credit and letters of credit), which are based upon fees currently charged to enter into similar agreements taking into account the remaining terms of the agreements and counterparties' credit standing, are not significant. Many of the Company's off-statement-of-financial-condition instruments, primarily loan commitments and standby letters of credit, are expected to expire without being drawn upon; therefore, the commitment amounts do not necessarily represent future cash requirements.
Deposits-The fair values for deposits with no defined maturities equal their carrying amounts, which represent the amount payable on demand. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on a comparably termed wholesale funding alternative (i.e., FHLB borrowings).
Borrowed funds-The carrying amounts reported for variable rate advances approximate their fair values. Fair values for fixed-rate advances and other borrowings are estimated using a discounted cash flow calculation that applies interest rates currently being offered on advances and borrowings with corresponding maturity dates.
Subordinated debentures payable to trusts-Fair values for subordinated debentures are estimated using a discounted cash flow calculation that applies interest rates on comparable borrowing instruments with corresponding maturity dates.
Accrued interest payable and advances by borrowers for taxes and insurance-The carrying values of accrued interest payable and advances by borrowers for taxes and insurance approximate their fair values.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
Estimated fair values of the Company's financial instruments are as follows:
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
Fair Value Measurement
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
Fair value accounting guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
The Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company's own assumptions about the assumptions that market participants would use in pricing an asset or liability. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
The table below presents the Company's balances of financial instruments measured at fair value on a recurring basis by level within the hierarchy at June 30, 2013:
The Company used the following methods and significant assumptions to estimate the fair value of items:
Securities available for sale: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs), or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs). The Company outsources this valuation primarily to a third party provider which utilizes several sources for valuing fixed-income securities. Sources utilized by the third party provider include pricing models that vary based by asset class and include available trade, bid, and other market information. This methodology includes broker quotes, proprietary models, descriptive terms and conditions databases, as well as extensive quality control programs. As further valuation sources, the third party provider uses a proprietary valuation model and capital markets trading staff. This proprietary valuation model is used for valuing municipal securities. This model includes a separate yield curve structure for Bank-Qualified municipal securities. The grouping of municipal securities is further broken down according to insurer, credit support, state of issuance, and rating to incorporate additional spreads and municipal curves. Management reviews this third party analysis and has approved the values estimated for the fair values.
Interest rate swap contracts: The fair values of interest rate swap contracts relate to cash flow hedges of trust preferred debt securities issued by the Company and for specific borrower interest rate swap contracts classified as fair value hedges in net loans and leases receivable and non-designated derivatives. The fair value is estimated by a third party using inputs that are observable or that can be corroborated by observable market data and, therefore, are classified within Level 2 of the valuation hierarchy. These fair value estimations include primarily market observable inputs, such as yield curves, and include the value associated with counterparty credit risk. Management reviews this third party analysis and has approved the values estimated for the fair values.
The Company had no assets or liabilities that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during fiscal years 2013 and 2012 and thus, no reconciliation is presented.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
The table below presents the Company's balances of financial instruments measured at fair value on a nonrecurring basis by level within the hierarchy at June 30, 2013:
The table below presents the Company's balances of financial instruments measured at fair value on a nonrecurring basis by level within the hierarchy at June 30, 2012:
The significant unobservable inputs used in the fair value measurement of impaired loans not dependent on collateral primarily relate to present value of cash flows. Cash flows are derived from scenarios which estimate the probability of default and factor in the amount of estimated principal loss. The resulting fair value is then compared to the carrying value of each credit and a specific valuation allowance is recorded when the carrying value exceeds the fair value.
The significant unobservable inputs used in the fair value measurement of collateral for collateral-dependent impaired loans primarily relate to customized discounting criteria applied to the customer's reported amount of collateral. The amount of the collateral discount depends upon the marketability of the underlying collateral. The Company's primary objective in the event of default would be to monetize the collateral to settle the outstanding balance of the loan, in which collateral with lesser marketability characteristics would receive a larger discount.
The Credit Administration department evaluates the valuations on impaired loans and other real estate owned monthly. The results of these valuations are reviewed at least quarterly by the internal Asset Classification Committee and are considered in the overall calculation of the allowance for loan and lease losses. Unobservable inputs are monitored and adjusted if market conditions change.
Servicing rights, net do not trade in an active, open market with readily observable prices. While sales of mortgage servicing rights do occur, the precise terms and conditions typically are not readily available to allow for a “quoted price for similar assets” comparison. Accordingly, the Company relies on an internal discounted cash flow model to estimate the fair value of its mortgage servicing rights. The Company uses a valuation model to project mortgage servicing rights cash flows based on the current interest rate scenario, which is then discounted to estimate an expected fair value of the mortgage servicing rights. The valuation model considers portfolio characteristics of the underlying mortgages, contractually specified servicing fees, prepayment assumptions, discount rate assumptions, other ancillary revenue, costs to service, and other economic factors. Certain tranches of the portfolio may exhibit distinct liquidity traits compared to other tranches. The Company reassesses and periodically adjusts the underlying inputs and assumptions used in the model to reflect market conditions, and assumptions that a market participant would consider in valuing the mortgage servicing rights asset. In addition, the Company compares its fair value estimates and assumptions to observable market data for mortgage servicing rights, where available, and to recent market activity and actual portfolio experience. Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the fair value hierarchy. The Company uses the amortization method (i.e., lower of amortized cost or
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
estimated fair value), not fair value measurement accounting, for its servicing rights assets. During the year, the estimated fair value was less than the amortized cost and a valuation allowance was recorded, which classifies servicing rights, net as a nonrecurring valuation.
Foreclosed real estate and other properties include those assets which have subsequent market adjustments after the original possession as a foreclosed asset. The estimated fair value is based on what the local markets are currently offering for assets with similar characteristics, less costs to sell, which the Company classifies as a Level 3 fair value measurement. Foreclosed assets which have market adjustments due to the modifications in values that are not reflected in the most recent appraisal or valuation, or have updated appraisals with valuation changes since its inclusion as a foreclosed asset are included as a nonrecurring valuation.
For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis at June 30, 2013, the significant unobservable inputs used in the fair value measurements were as follows:
NOTE 20-COMMITMENTS, CONTINGENCIES AND CREDIT RISK
The Bank originates first mortgage, consumer and other loans in our coverage area and holds residential and commercial real estate loans which were purchased from other originators of loans located throughout the United States. Collateral for substantially all consumer loans are security agreements and/or Uniform Commercial Code ("UCC") filings on the purchased asset. Unused lines of credit amounted to $195,868 and $158,588 at June 30, 2013 and 2012, respectively. Unused letters of credit amounted to $3,656 and $4,185 at June 30, 2013 and 2012, respectively. The lines of credit and letters of credit are collateralized in substantially the same manner as loans receivable.
The Bank had outstanding commitments to originate or purchase loans of $40,815 and to sell loans of approximately $9,169 at June 30, 2013. The portion of commitments to originate or purchase fixed rate loans totaled $20,510 with a range in interest rates of 2.0% to 7.0%. At June 30, 2013, the Bank had eleven outstanding commitments to purchase $9,246 investment securities available for sale and no commitments to sell investment securities available for sale. No losses are expected to be sustained in the fulfillment of any of these commitments.
At June 30, 2013, the Bank had an allowance for credit losses on off-balance sheet credit exposures of $90, as compared to $79 at June 30, 2012. This amount is maintained as a separate liability account to cover estimated potential credit losses associated with off-balance sheet credit instruments such as off-balance sheet loan commitments, standby letters of credit, and guarantees.The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, based upon consultation with legal counsel, the ultimate disposition of these matters will not have a materially adverse effect on the Company's consolidated financial position.
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
NOTE 21-CASH FLOW INFORMATION
Changes in other assets and liabilities for the fiscal years ended June 30, consist of:
NOTE 22-FINANCIAL INFORMATION OF HF FINANCIAL CORP. (PARENT ONLY)
The Company's condensed balance sheets at June 30 and related condensed statements of income and cash flows for the fiscal years ended June 30, are as follows:
Condensed Statements of Financial Condition
Condensed Statements of Income
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
Condensed Cash Flows
HF FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2013 AND 2012
(DOLLARS IN THOUSANDS, except share data)
NOTE 23-QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
NOTE 24-SUBSEQUENT EVENTS
Management has evaluated subsequent events for potential disclosure or recognition through the date that the financial statements were available to be issued. There are no subsequent events that occurred that require additional disclosure.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
Not applicable.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of June 30, 2013, an evaluation was performed by the Company's management, including the Company's President and Chief Executive Officer and the Company's Senior Vice President, Chief Financial Officer and Treasurer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) to provide reasonable assurance that information required to be disclosed in the reports the Company files and submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Based upon that evaluation, the Company's President and Chief Executive Officer and the Company's Senior Vice President, Chief Financial Officer and Treasurer concluded that the Company's disclosure controls and procedures were effective as of June 30, 2013.
Management's Report on Internal Control over Financial Reporting
Management's report on internal control over financial reporting is included in Part II, Item 8 "Financial Statements and Supplementary Data," and is furnished herein.
Changes in Internal Control Over Financial Reporting
There were no changes in the Company's internal control over financial reporting that occurred during the fourth quarter ended June 30, 2013, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Directors
Information regarding Directors of the Company is incorporated by reference from the discussion under the heading "Information with Respect to Nominees and Continuing Directors" in the Company's Proxy Statement for the 2013 Annual Meeting of Stockholders, a copy of which will be filed not later than 120 days after June 30, 2013 (the "2013 Proxy Statement").
Executive Officers
Information regarding Executive Officers of the Company is contained in Part I, Item 1 "Business" of this Form 10-K pursuant to Instruction 3 to Item 401(b) of Regulation S-K, and is incorporated by reference herein.
Compliance with Section 16(a) of the Exchange Act
Information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, is incorporated by reference from the discussion under the heading "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's 2013 Proxy Statement.
Code of Ethics
Information regarding the Company's Code of Conduct and Ethics is incorporated by reference from the discussion under the heading "Code of Conduct and Ethics" in the Company's 2013 Proxy Statement.
Director Nominations
Information regarding material changes, if any, to the procedures by which the Company's stockholders may recommend nominees to the Company's Board of Directors is incorporated by reference from the discussion under the heading "Director Nominations" in the Company's 2013 Proxy Statement.
Audit Committee and Audit Committee Financial Expert
Information regarding the Company's Audit Committee and Audit Committee Financial Expert is incorporated by reference from the discussion under the heading "Meetings of the Board of Directors, Committees of the Board of Directors and Independent Directors" in the Company's 2013 Proxy Statement.
Item 11.
Item 11. Executive Compensation
Information regarding executive compensation and other related disclosures required by this Item are incorporated by reference from the discussion under the headings "Compensation Discussion and Analysis," "Personnel, Compensation and Benefits Committee Report," "Executive Compensation," "Director Compensation" and "Personnel, Compensation and Benefits Committee Interlocks and Insider Participation" in the Company's 2013 Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information on the securities authorized for issuance under the Company's compensation plans (including any individual compensation arrangements) is contained in Part II, Item 5 "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities" of this Form 10-K, and is incorporated by reference herein.
Information concerning security ownership of certain beneficial owners and management is incorporated by reference from the discussion under the heading "Security Ownership of Certain Beneficial Owners and Management" in the Company's 2013 Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Certain Transactions
Information concerning transactions with related persons and the review, approval or ratification thereof is incorporated by reference from the discussion under the headings "Transactions with Related Persons" and "Policy on Review, Approval or Ratification of Transactions with Related Persons" in the Company's 2013 Proxy Statement.
Information concerning director independence is incorporated by reference from the discussion under the headings "Meetings of the Board of Directors, Committees of the Board of Directors and Independent Directors" in the Company's 2013 Proxy Statement.
Item 14.
Item 14. Principal Accountant Fees and Services
Information concerning the fees for professional services rendered by the Company's registered public accounting firm and the pre-approval policies and procedures of the Company's Audit Committee is incorporated by reference from the discussion under the heading "Proposal No. IV-Ratification of Independent Registered Public Accounting Firm" in the Company's 2013 Proxy Statement.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)
The following documents are filed as part of this Form 10-K:
(1)
Consolidated Financial Statements:
(2)
All financial statement schedules are omitted because of the absence of conditions under which they are required or because the information is shown in the Consolidated Financial Statements or notes thereto in Item 8 above.
(3)
See "Exhibit Index".
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.
HF FINANCIAL CORP.
Date:
September 13, 2013
By:
/s/ STEPHEN M. BIANCHI
Stephen M. Bianchi,
President and Chief Executive Officer
(Principal Executive Officer)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Stephen M. Bianchi and Brent R. Olthoff, or any of them, his or her attorneys-in-fact, for such person in any and all capacities, to sign any amendments to this report and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that either of said attorneys-in-fact, or substitute or substitutes, may do or cause to be done by virtue hereof
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.
Exhibit Index
_____________________________________
* Filed herewith.
** Furnished herewith.
+ Indicates a management contract or compensation plan.
Index of Attached Exhibits